For 2013, Fitch Ratings has more negative than positive outlooks on state and tax-supported local governments.

While Fitch does not assign a rating outlook for the entire tax-supported local government sector, it currently has 8% on a negative rating outlook or watch and just 1% on a positive rating outlook or watch. The outlooks are usually for a 12- to 24-month period.

According to “U.S. Local Government Tax-Supported Rating Outlook,” Fitch expects most of its local rating actions to be affirmations in 2013. However, it expects “a continued above-average ratio of downgrades compared to historical norms.”

“After four to five years of cuts for many local governments, the ability to further reduce discretionary spending is limited,” six Fitch analysts wrote in the report. “However, continuing increases in pension and other inflexible costs make such reductions even more important.”

Fitch expects that in 2013 property and non-property tax revenues will slowly improve for localities. Some areas will benefit from stronger revenue growth.

However, sharp cuts in government aid or a federal fiscal cliff-induced recession could curb local revenues, the Fitch analysts wrote.

Local governments typically allot at least two-thirds of their general budgets to labor spending, Fitch estimates. Thus it is key to keep these costs under control, the analysts wrote. “Fitch looks for evidence of a positive relationship among the parties, whether organized labor is present or not. Nevertheless, Fitch has greater concern the more legally constrained management’s role is in the relationship.”

Through the first 11 months of this year, Fitch downgraded 8% of tax-supported localities and upgraded 2% of them.

In a separate report, “2013 Outlook: U.S. States,” five Fitch analysts explain Fitch’s stable outlook for states in 2013. “This outlook reflects the expectation of manageable budget challenges in an environment of continued slow economic and revenue growth. There is an unusually high degree of uncertainty in the outlook, largely due to significant decisions that will be made at the federal government level.”

After severe declines in the recession, states have had 10 consecutive quarters of revenue growth, the analysts report. This has allowed the rebuilding of financial cushions.

However, “spending growth in some areas, particularly health care and pensions, continues to outpace slow revenue growth and pressure budgets in many states.” Federal Medicaid rules and legal challenges to pension changes will challenge attempts to curb state spending.

The federal government going over the fiscal cliff would primarily be a credit negative for states, Fitch warns. If not addressed, the fiscal cliff will likely push the United States into a recession with a greater than 10% unemployment rate, the analysts wrote. Such a recession would have a major negative impact on state government tax revenue. Further, federal deficit reduction measures would “likely” lower funding to the states.

In 2012, Fitch downgraded just one state, Kentucky, and upgraded none.

As of early December Fitch has negative rating outlooks on four states: Florida, Maine, Pennsylvania and Washington. Florida is rated AAA and the other three are rated AA-plus. Fitch has positive rating outlooks on Michigan and New York. Fitch has given Michigan an AA-minus rating and New York an AA rating.

Fitch’s lowest rated state is California, with an A-minus rating.

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