NEW YORK - New Jersey Gov. Chris Christie released his proposed $32.15 billion budget for fiscal 2013 on Feb. 21. The budget remains structurally unbalanced, is built on what Standard & Poor's Ratings Services regards as optimistic economic projections to close the budget gap, and increases New Jersey's (AA-minus/stable) reliance on nonrecurring revenues.

Tax reduction is the cornerstone of the governor's proposed budget with a total fiscal impact of $530.8 million. The 2013 budget reflects the continued phase in of tax relief measures approved in fiscal 2012, valued at $347.5 million in fiscal 2013, coupled with the first phase of 10% across-the-board income tax reductions. The governor is also proposing an increase of the Earned Income Tax Credit to 25% from 20%; however, this measure would not have a financial impact until fiscal 2014. In his budget message, the governor indicated that he would veto any tax increase.

Although the budget more than doubles the state's contribution to its pension system, it continues to defer full funding of the actuarial required contribution (ARC). Other reform measures discussed as part of the governor's budget message include education reform centered on tenure, expanding charter schools, and raising salaries of high-performing teachers. The governor has also proposed restructuring the University of Medicine and Dentistry as recommended by a task force in December 2011.

"Although the budget does not reflect major funding changes to public higher education institutions, the restructuring could potentially affect the credit quality of some of these higher education institutions, based on how revenues are allocated after the restructuring," said Standard & Poor's credit analyst John Sugden-Castillo.

The $32.15 billion budget proposal increases spending by $1.16 billion, or 3.7%, from fiscal 2012 adjusted appropriations. Education spending, net of pension and health benefit funding, increases by $315 million, or 3.1%, to $10.36 billion, accounting for about one-third of the budget. Education spending increases include $121 million in formula aid and $109 million in school construction debt service, with smaller items making up the balance of the $315 million.

When spending for teachers' pensions is included, total education funding grows to $11.74 billion. Department of human services spending rises by $822 million, but primarily reflects service delivery shifts to this department from the department of health.

In turn, the budget reduces health department funding by $945 million.

Funding for transportation rises by $91 million to reflect New Jersey's growing general support of transportation infrastructure. Slightly more than half of the increase ($587 million) in total spending is tied to pension funding cost increases.

Total funding for defined benefit pensions grows to $1.1 billion in fiscal 2013 from $484 million in fiscal 2012. Defined Benefit Pension funding accounts for 3.33%of spending in the proposed budget.

Despite this significant increase, New Jersey is only funding 28.6%, or 2/7ths, of its statutorily determined actuarial recommended contribution, which is different from ARC as defined by GASB. According to the state, the ARC as calculated by GASB is normally higher than the statutorily determined actuarial recommended contribution. The underfunding of the ARC results in continued pressure on its pension system.

The state revenue estimate reflects 7.3% growth in total revenues to $31.86 billion, after accounting for tax relief measures. Based on the state's revenue projections, revenues would have grown by 9% prior to downward adjustments to reflect reduced tax rates.

The governor's proposed 10% income tax reduction would phase in over three years in equal increments and due to the differences between in fiscal and calendar years, would not have a full-year effect on the 2013 budget, limiting its financial impact to $183.3 million.

New Jersey estimates the full-year impact of this measure in fiscal 2014 at $550 million, growing to $916.5 million and $1.1 billion in fiscal years 2015 and 2016, respectively.

The state is forecasting the income tax revenue to grow by 8.6%, prior to adjusting revenues to account for the proposed changes and the phasing-in of the second stage of the gross income tax relief package legislated last year, and by 6.3% after it factors in tax relief. Year-to-date gross income tax revenues are currently coming in 3.8% above last year and 2.9% below budget as of December 2011.

According to the budget, sales tax revenues will rise by 4.7% in fiscal 2013, compared with 3.6% in fiscal 2012 year-to-date. The budget forecasts corporate taxes to grow 10.9% relative to fiscal 2012, even after accounting for a $127.5 million reduction in revenues due to a tax relief package passed in 2012. The budget assumes 10.2% aggregate growth for other revenues.

"Due to New Jersey's high incomes and the state's progressive income tax structure, we believe revenues could rebound significantly in a strong economy," said Mr. Sugden-Castillo. "However, in our view, the economic assumptions that underpin the state's revenue forecast appear to be optimistic based on current and projected economic conditions at the state and national levels," he added. Through the first half of fiscal 2012, New Jersey revenues grew 3.2% from fiscal 2011, but are still falling 3.2% below budgeted amounts. According to IHS Global Insight Inc., the state will register 1.3% growth in 2012- 16th among all states. Unemployment in the state was 9% as of December 2011. IHS Global Insight projects employment will not return to pre-recession levels until 2015 and projects unemployment to remain above 8% through 2014.

The 2013 budget depends on the use of $288 million of fund balance and increases its reliance on nonrecurring revenues to $1.6 billion. Nonrecurring revenues account for 5% of total revenues, up from 4% in fiscal 2012. About one-third of the nonrecurring revenues reflects tax policy changes with the balance made up of fund balance, revenue-related initiatives, and appropriation-related offsets. The state currently projects ending fiscal 2012 with $588 million in reserves, down from $873 million at the beginning of the fiscal year. Assuming no further reductions to fund balance are needed to cover revenue shortfalls in fiscal 2012, reserves would fall to $300 million or less than 1% of expenditures at fiscal year-end 2013 if the legislature adopts the proposed budget. At this level, New Jersey's fund balance would provide a limited financial cushion with which to offset revenue shortfalls should current revenue growth assumptions turn out to be optimistic.

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