States benefited mightily from federal pandemic aid and better-than-expected revenue, but how will they fare as relief funds wind down and revenue slows?
Early reports are encouraging.
Officials from New York and California, which together account for about one-third of the municipal bond market, for example, see budget shortfalls in the fiscal year ahead. Other states are also experiencing declining tax revenue while their spending exceeds forecasts.
Analysts are buoyed, however, because when coffers were flush, officials planned for a slowdown.
“Most states have built up their reserve levels to record-level highs and have many credit strengths, which lends itself to credit stability in the near term,” according to a recent report by Schwab, citing Standard and Poor’s.
Record rainy day funds
As many recall, in the wake of the pandemic, headline-grabbing predictions called for an economic calamity. Fortunately, they were wrong.
The federal government passed a series of measures and provided about $1 trillion of aid to state and local governments.
This unprecedented assistance, along with strong growth and healthy revenues, helped put many states on solid footing. As of the end of the first quarter of 2023, when all revenues since January 2020 were combined, tax revenue exceeded its pre-Covid growth trend in about three-quarters of the states, according to Pew.
Importantly, states’ total fund balances and rainy-day funds both reached record highs. As one analyst said last year: “States’ financial health is its strongest in decades.”
Those reserve funds will come in handy.
The aggregate state rainy-day fund is almost 14% of general fund spending – the highest level since the late 1980s, according to Schwab. The reserves, and other funds, “should provide a liquidity credit cushion for the coming year and beyond.”
For the first time since 2016, all states are at least rated A by Standard and Poor’s.
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Healthy issuers
As a result of healthy balance sheets, many states lowered taxes, some more than once.
With most pandemic-era federal programs winding down this year and states’ revenue growth easing, some analysts see a more typical fiscal picture ahead.
“Tax receipts are still significantly above levels experienced prior to the pandemic, and rainy-day balances relative to spending remain multiple times higher than during much of the last 15 years,” according to a recent report by Lord Abbett. “With the decline in growth of tax receipts, we also anticipate spending by state and local governments will lessen, as many states move beyond the one-off expenditures of last year.”
States play an important role in the municipal bond market. They issue bonds, and their finances also have downstream effects, as fiscally healthy states are less likely to decrease aid to local governments, which are issuers, too.
We welcome the measures states took to shore up their reserves (“States, Locals Showing Prudence Amid Economic Rumblings”).
This planning, along with the fact that states have unique abilities to cope with potential shortfalls, is why no state has defaulted in almost 100 years.
It also helps explain investors’ outlook and their robust demand for tax-free municipal bonds.
