In 2015 U.S. states should expect growing but variable revenues, financial position stabilization, and ongoing exposure to federal action, according to a Fitch Ratings report.
Local governments should expect moderate revenue growth, controlled spending, and mixed long-term liabilities, according to a second Fitch report.
"State credit has substantially stabilized in the recovery, as indicated by the 10:1 ratio of Stable to Negative Rating Outlooks and limited rating actions taken in 2014. However, risks remain weighted to the downside," said Laura Porter, managing director.
After experiencing 17 consecutive quarters of tax revenue growth, state revenues were essentially flat in the first half of 2014, reflecting the reversal of the 2012 income acceleration effect.
For the current fiscal year, most states are assuming growth in line with baseline trends.
Revenue forecasting is increasingly challenging due to increased volatility in state revenue results, including from capital gains. One-time events make it difficult to identify baseline revenue growth levels, a problem exacerbated by unpredictability in stock market and commodity price performance.
As revenues recover, state budget managers, who face demands for additional spending and tax relief, have remained cautious. With the majority of gubernatorial incumbents re-elected, this approach will likely continue despite persistent pressures.
Medicaid has been the area of state budgets most challenging to control. Fitch expects Medicaid to continue to be the biggest area of focus for state budget managers in 2015. Given the dominance of Medicaid in federal funding flows to the states, any material reduction in federal support for the program could be negative for state credit, particularly in the absence of related mandate relief.
"Fitch believes that few local governments it rates are still struggling to reduce spending to compensate for a combination of weak revenue performance and pension payment increases. Now the challenge is long-been-postponed spending, including wage increases, service restoration, and infrastructure and facility maintenance needs. Fitch believes this will continue in 2015, but is a much more manageable challenge than the heavy cuts required during the downturn," said Amy Laskey, managing director. "There will likely be instances of spending growth overtaking revenue increases but Fitch expects structural balance to prevail. Most local governments have been able to preserve or restore reserves to prudent levels that would provide a cushion if an unexpected downturn occurred."
