Rising fixed costs and declining revenue will make balancing Connecticut Gov. Dannel Malloy's proposed $40.6 billion biennial budget a heavy lift, said S&P Global Ratings.
"Bringing the [budget] into balance will involve painful adjustments," credit analyst David Hitchcock wrote in a commentary.
According to Hitchcock, the spending plan by the Democrat is consistent with S&P's negative outlook on its AA-minus rating for Connecticut's general obligation bonds. S&P lowered its outlook from stable on Nov. 30.
Malloy is looking to close a $1.7 billion annual deficit.
S&P calculated that general fund debt service, pension, and other post-employment payments will amount to roughly 29% of revised forecast revenue plus proposed revenue enhancements in fiscal 2018, assuming state lawmakers pass Malloy's plan to push about $408 million of annual employer teacher pension contributions -- one-third the total cost -- onto cities and towns. The state now pays all of them.
Budget imbalance prompted bond rating agencies to downgrade Connecticut three times in 2016. Fitch Ratings and Kroll Bond Rating Agency also assign AA-minus ratings to Connecticut GOs while Moody's Investors Service assigns an equivalent Aa3 rating. Moody's has a negative outlook while Fitch and Kroll have stable outlooks.
"Rising state pension and other post-employment benefit payments are colliding with weak revenue growth because of poor economic performance in the state's financial sector," said Hitchcock. "Although other states are also reporting weak revenue growth and rising pension costs, Connecticut remains especially vulnerable to an unexpected economic downturn due to its particularly volatile revenue structure."
Turmoil over the budget looms in the legislature, where the Senate is split 18-18 between Democrats and Republicans. A bill last month to restructure pension payments required Lt. Gov. Nancy Wyman, also a Democrat, to break a tie with her vote in favor.
Democrats have a slim lead in the House of Representatives, 78-72 with one vacancy.
Deputy Senate Republican Majority Leader Scott Frantz of Greenwich said Connecticut's financial struggles have been predictable for more than a decade, "with a completely unsustainable rate of growth in spending on structural costs and far too much borrowing that further adds to the state's fixed costs, especially as interest rates rise."
Frantz added: "The proposed budget is an admission that the state can no longer afford to pay for many of its obligations and will rely on the municipalities to pick up the slack, which means that local property tax rates will rise."
The shift in teacher pension costs is tantamount to a second pension overhaul, said Municipal Market Analytics, which called it "a more positive credit development for the state."
Implementation challenges, however, are "quite high," according to MMA, which expects bond rating agencies and investors to scrutinize the final budget before reacting.
Malloy's proposed tweaks to the school-aid formula could also be a backdoor way of complying with state Superior Court Judge Thomas Moukawsher's order for Connecticut to rework the formula to better assist its poorest cities: Hartford, Bridgeport, New Haven and Waterbury.
"It could benefit poor cities at the expense of the rich and lower overall local aid," said Hitchcock. Connecticut's cities and towns are responsible for kindergarten through 12th grade education and the state spends about 81% of its $5 billion of local aid on education.
"Combined with other local aid cuts, municipalities' credit quality could be subject to greater uncertainty," Hitchcock added.
According to MMA, Hartford and Waterbury would receive about $40 million apiece in incremental aid, while 145 municipalities would lose aid after the netting of pension costs. Several middle-class towns, said MMA, could see aid cuts of more than $10 million.
In an offsetting move, Malloy will allow towns to begin assessing property taxes on hospitals, which in turn would be eligible for some state reimbursement. He would also create a five-tier system to gauge municipal financial health and provide state assistance where necessary. Capital city Hartford is teetering on insolvency.
"But pushback in the legislature has, predictably, been fast, strong, and negative," said MMA.