Pennsylvania's fiscal 2017 budget makes progress on, but does not fully resolve the commonwealth's sizable structural budget gap, according to Fitch Ratings.

The budget increases funding for policy areas including K-12 education while meeting Pennsylvania's statutory commitment toward full actuarial pension funding. However, it relies on a mix of recurring and non-recurring measures to achieve balance, Fitch said.

Last December, the commonwealth's Independent Fiscal Office (IFO) estimated a nearly $2 billion fiscal 2017 structural gap for the general fund (6% of then projected revenues). Fitch said its AA-minus long-term issuer default rating (IDR) anticipates gradual progress towards structural balance, which this budget achieves.

Revenue measures to support the fiscal 2017 budget include a range of tax increases and one-time measures to generate approximately $1.3 billion in new money. The tax increases are recurring measures, but generally narrow in scope with some uncertainty in projected collections.

The largest component is a $1 increase in the cigarette tax projected to generate $430 million annually.

Other narrow measures include extending the commonwealth's sales tax to digital downloads such as music and apps, levying new taxes on e-cigarettes, smokeless and roll-your-own tobacco, and a new tax on casinos' gross table games revenues.

One-time measures make up approximately half of the $1.3 billion in new money, and some of these items also present some uncertainty, Fitch said. A $200 million loan (to be repaid over five years) from a state medical malpractice fund is the most significant non-recurring source.

Other less certain non-recurring items include $100 million from gaming expansion legislation that will not be finalized until September at the earliest; $75 million in licensing fees for a Philadelphia casino originally authorized in 2014 but still not fully approved; and $100 million from a new tax amnesty program.

On the spending side, the budget increases general fund expenditures approximately 5% over fiscal 2016 spending to $31.5 billion. This excludes $95 million for the Commonwealth Financing Authority now recorded outside of the general fund, but still paid from commonwealth appropriations. K-12 funding will see a $200 million increase in basic aid funding (3.5%), allocated based on the commonwealth's new funding formula that takes into account various socioeconomic factors for each school district.

Importantly, the budget also includes approximately $500 million in additional funding for Pennsylvania to fully fund its pension contributions, Fitch said.

The commonwealth's AA-minsu IDR, below average for a U.S. state, reflects Pennsylvania's still structurally unbalanced budget, as well as Fitch's expectation that the commonwealth will utilize its significant budgetary flexibility to make gradual progress toward structural budgetary balance, the agency said.

Pennsylvania benefits from a large, diversified and expanding, albeit slowly, economic base, according to Fitch. The fiscal 2017 budget is an important step in addressing the commonwealth's fiscal challenges. But Pennsylvania still faces obstacles and difficult decisions before it can fully align recurring revenues and expenditures, Fitch said.

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