Although state revenue growth has improved, the inability to meet growth in state expenditures places state reserves under large pressure, the Q4 edition of Conning’s State of the States municipal credit research report reveals.
The report, which ranks each of the 50 states by credit quality, found many states unable to pass budgets on time due to hesitation from legislators to pay taxes, a necessity in states where revenues were less than expected.
Conning found that Utah, Idaho, Florida, Nevada, and Colorado had the highest credit quality while Illinois, New Mexico, Mississippi, Connecticut, and West Virginia were ranked lowest.
The report also noted that the while Pacific Northwest, Mountain, and Southeastern regions are experiencing GDP growth at roughly 5%, there is slower growth (if any) in Northeastern and Midwestern states. Pacific Northwest and Southeastern states experienced “strong growth” in employment, personal income, and home prices, despite an overall declining credit outlook. Some oil and gas states also saw economic improvement due to natural gas prices increasing last quarter.
“The most common thread for all higher-ranking states is a favorable business climate as measured by regulations, state tax policies, and state leadership,” Paul Mansour, a managing director, head of municipal research at Conning and lead author of the report, said in a statement. “We expect that the above-average economic activity in these states will prompt credit upgrades and better price performance going forward.” Mansour added that Conning is looking to add state and local credit exposure in regions and states growing more quickly, while being “more selective” in the slower-growing and lower-ranked states.
In addition, the report also sees no improvement in state pension plan funding since its Q2 State of the States report, noting that funding ratios have declined from 74.5% in 2015 to 71.1% in 2016, attributing one of the issues to states unable to agree on raising their taxes.
Another issue addressed for states already in rough shape are awaiting federal tax changes, specifically states with high personal income tax rates. Conning says that proposed tax reform which limits itemized deductions could mean little to no tax relief., In addition, possible changes in state Medicaid reimbursement plans means a risk-transfer from federal to state governments.
Conning also adds that economic debt’s continued accrual has impacted state credits as well, despite no notable growth in state debt over the past four years, mentioning that annual expenses to service fixed costs of obligations in high economic debt states can account for more than 20% of General Fund expenditures. While pension reforms help, Mansour said the best way states can reduce their economic debt is to “drive tax revenue with growth.” The report notes how California reduced its debt through strong economic growth in the technology sector, reflected by the incentives states and cities are offering “to attract” Amazon’s second headquarters.