States are OK despite weakening revenues: ratings agencies

State government finances will likely remain in decent shape this year despite signs revenues are weakening, according to rating agencies.

Total state tax revenues declined 8% in nominal terms in December and 13.5% when -adjusted for inflation from a year earlier, the Urban Institute reported. In the July to December period, total state tax revenues were up 2.7% in nominal terms but down 4.3% in inflation-adjusted terms compared to a year earlier.

The head of the states groups at Moody’s Investors Service and Fitch Ratings, Emily Raimes and Eric Kim respectively, acknowledged revenues appear to be slowing, but said states are in a good position to deal with this as a result of generally strong reserve levels.

S&P Global Ratings said in a January report state reserves are expected to be 130% higher this year than in 2019.

Most states were cautious when projecting revenues for this fiscal year, Kim said, and this put them in reasonably good shape as revenues soften.

Apart from California, state revenues are doing “pretty well,” Raimes said. California’s big revenue drop is consistent with its history of volatility and is also partly connected to its recently enacted millionaire’s tax, she said. Much of its revenue come from millionaires’ capital gains taxes and the markets’ poor performance last year caused a big fall off, she said.

While state revenues will be difficult to predict over the next few months, Raimes said, April, when most individual income taxes are filed, will be a key month.

Geoff Buswick, head of S&P’s states group, said, “we are watching what states are assuming in their budgets for the next fiscal year, which is where the [revenues’] lower purchasing power may come into play.”

None of the three ratings agencies have negative outlooks on any of the states they rate.

For all three, the economy’s path is the biggest concern this year. Moody’s is projecting a slowdown. S&P says states would be able to weather a mild recession.

Raimes said, while state pension funding ratios were probably hit last year by the stock markets’ declines, rising interest rates somewhat offset that. Moody’s takes unfunded liabilities into account for ratings, particular for states with large ones, like New Jersey and Illinois.

Unfunded pensions were not a major problem for most states, Kim said.

S&P expects pension funded ratios to “decline meaningfully” due to market deterioration.