- Most U.S. states entered 2020 on a comparatively stable footing, benefiting from a decade-long national economic expansion.
- Ratings on issuers with narrower payment streams are more susceptible to immediate pressures than a state or local government's general credit quality.
- State and local governments with concentrated economic activities are more likely to see revenue declines.
The COVID-19 pandemic and the consequential global economic recession will affect U.S. state and local governments to varying degrees. During this period of pronounced economic volatility, S&P Global Ratings recognizes the public health crisis across the country and the strain on state governments coordinating a response across all levels of government. As economic forecasts change, implementation of federal relief efforts emerge, and other information becomes available, we will continually evaluate our U.S. state portfolio for potential credit implications. On April 1, S&P Global Ratings revised its sector outlook to negative for all U.S. public finance sectors, reflecting in part the precipitous decline in economic conditions to end the quarter, which is anticipated to continue at least through the second quarter. (See "All U.S. Public Finance Sector Outlooks Are Now Negative," published on April 1, 2020 on Ratings Direct).
As the pace of the COVID-19 outbreak accelerates across the country, governments continue to work to help contain its effects on the public's health and mitigate the social and economic toll that continues to rise, in some instances, at alarming rates. A distinguishing characteristic of the COVID-19-induced recession is that efforts to contain its spread have resulted in a sharp decline in economic activity. S&P Global Economics economists now forecast that the resulting economic toll will be extensive, but will occur in a shorter time relative to the Great Recession. Their most recent year-on-year U.S. second-quarter GDP estimates suggest a contraction of at least 12.7% (See "Economic Research: It’s Game Over For The Record U.S. Run; The Timing of A Restart Remains Uncertain," published on March 27, 2020 on RatingsDirect). The current policy responses have an immediate effect on U.S. state and local governments' operating environment.
While economic and budgetary trends since the Great Recession have been uneven among different states, most generally entered 2020 on a relative stable footing, benefiting from a national economic expansion spanning over a decade. Their broad authority to set and modify tax rates provides additional flexibility in realigning service demands during periods of slow revenue growth. Even as states receive similar revenue streams as some local governments, they generally exhibit significantly greater resilience during economic contractionary periods in part due to their individually broad economic and taxing base.
During periods of stress, a state's government framework and budgetary management become increasingly important. Areas of fiscal flexibility generally include discretion in establishing funding levels for assistance, change program disbursements, and shifting responsibilities--through mandates--to local governments. (See "When The Cycle Turns: Government Framework Is A Significant Factor In States’ Ability To Navigate Downturns," published May 23, 2019). However, fiscal responses during the pandemic and recession will vary for both state and local governments. Only time will tell whether the COVID-19 pandemic will result in permanent structural changes to economic and fiscal structures in state and local governments. Nevertheless, states remain in the front seat as the country works to adapt to this new normal.
Against a backdrop of relentless market volatility, deteriorating economic conditions, and an escalating social and public health crisis throughout the country, we are actively assessing the credit implications for our state and local government portfolio. Our assessments will reflect our applicable criteria and guidance. S&P Global Ratings will take rating actions if merited.
Risk Factors For U.S. State And Local Governments
Given the abruptness and scale of the economic decline in the U.S., we anticipate broad budgetary pressure as expenditures escalate and revenues streams contract. We generally will consider the following characteristics more likely for a rating transition in the near term:
- Limited liquidity and availability of alternative sources to address short-term cash needs (debt service reserves, lines of credit, and other liquidity facilities);
- Narrower payment streams (leisure and hospitality taxes, lottery and gaming revenue, motor fuels taxes and fees, and sales and use taxes) are more susceptible to immediate pressures than a state's general credit quality; and
- Concentrated economic activities, particularly in leisure, energy, and trade, are more likely to see revenue declines.
More than a decade removed from the Great Recession, states are relatively well positioned to absorb the initial COVID-19 outbreak shock to their economies, which began in earnest--albeit unevenly--in the middle of March. Beyond the initial shock, the rippling effects have escalated quickly and now all state and local governments are actively deploying resources to curb the human toll on their communities.
As we previously noted--under hypothetical scenarios--the level of preparedness for a recession is mixed, with certain states possibly lacking sufficient reserves to absorb the fiscal stress beyond the immediate short term. (See "When The Credit Cycle Turns, U.S. States May Be Tested In Unprecedented Ways," published Sept. 17, 2018). Lower rated states are most exposed to credit pressure derived from exogenous shocks given their comparatively weaker credit metrics, including lower reserve levels, cyclical revenue streams, and elevated fixed costs (e,g., pensions, debt service, other postemployment benefits).
Despite their differing operating frameworks, local governments share the same credit pressure characteristics. Additionally, certain states and local communities whose employment composition is concentrated in sectors including manufacturing, mineral extraction and refining, and tourism are doubly exposed to the current credit stress. However, regardless of rating, all governmental entities are exposed to a further acceleration of economic deterioration possibly stressing budgets, with revenues contracting and expenditures escalating above trend. While we anticipate the current situation will remain fluid, active management and access to liquidity will remain key credit considerations to address developments on the ground and the subsequent secondary effects as they materialize. As communities across the country endure a period of near complete economic shutdown, their successful resuscitation will depend largely on the present policy responses both at national and state levels to help minimize the damage to the governmental entities' longer term economic stability. In our view, together with federal supplemental appropriations to support small businesses, public health agencies, the enhancement of Medicaid funding and unemployment insurance, and most recently the enactment of the Coronavirus Aid, Relief, and Economic Security Act, could provide meaningful support to minimize the direct effects of the outbreak within the short term.
Personal income tax (PIT) receipts are one of two major sources for many state governments. In the near term, we expect states to see a significant erosion in PIT receipts. At the time of publication, all states that levy income taxes have modified their filing and payment dates with the majority following the federal government deadline of July 15. The shift in revenue collections from one fiscal year to another will force these states to readjust their cash forecasts. Such a timing delay will result in states leaning more heavily on internal and external sources of liquidity. States with an increased reliance on PIT revenues have a propensity for greater volatility primarily due to its linkages to financial markets via taxes on nonwage capital gains income. (see "Market Volatility Has Varying Impact On U.S. States’ Capital Gains Tax Exposure," published March 10, 2020). Rapidly increasing unemployment claims at a magnitude that greatly exceeds the last recession will further exacerbate the shock decline to PIT receipts.
Sales and use taxes are typically one of two major revenue sources for many state and local governments. The growing size of the demand shock from social distancing, the closure of private businesses, and travel restrictions on large areas of the country are expected to result in an immediate decline in projected sales and use tax revenue. Further shocks to the labor market and declining payrolls will continue to pressure demand in the near term. The speed to which the economy--labor markets and supply chains based on small and medium-sized businesses, in particular--can get back to normal once the pandemic passes will indicate how sales and use taxes perform for the remainder of the year.
While we consider gas tax revenues to be relatively stable from a macro perspective, given the critical nature of gasoline for various modes of transportation, we believe state motor fuel taxes face high risk in the near term given their dependence on consumption levels. Typically, nationwide gasoline sales have fluctuated less than total consumption of goods and services, even during severe economic downturns and price fluctuations. However, in our view, the COVID-19 outbreak is a unique stressor for motor fuel tax collections as many non-commercial drivers remain in their homes and off the roads. Many states also collect miscellaneous transportation revenues such as motor vehicle related taxes, fees, and fines; we view these revenue streams as having elevated risk in the near term as well.
In our view, the credit risk for leisure and hospitality tax revenue is very high and the trend is likely to worsen over the near term. Based on our recent U.S. economic forecast, state-level interventions to prevent the community spread of COVID-19, including halting non-essential business and domestic and international travel, are likely to weigh down consumer spending on tourism, leisure, and hospitality services within at least the short term. These containment measures have required tourism and convention center destinations to cancel or postpone large conferences and events indefinitely, which has had a direct negative effect on hotels, entertainment venues (including stadiums and arenas), and rental agencies.
Depending on the magnitude and duration of shelter-in-place orders and social distancing efforts, state and local governments that rely more on volatile revenue tied to leisure and hospitality (e.g., hotel room taxes, rental car fees, entertainment surcharges, and other tourism-related revenue) are likely at higher risk of backstopping revenue shortfalls with available liquidity the longer these activities are at a standstill. In our view, securities backed by leisure and hospitality revenue could also bear the brunt of economic and financial headwinds for longer as businesses may be slow to recover or permanently close, and consumers could take a "wait-and-see" approach to discretionary spending on travel, leisure, and hospitality services as social distancing restrictions wind down.
Given the abruptness of the shutdown of economic activities, we view the risk level of these revenue streams to be high as state residents' access to outlets for sale becomes increasingly limited. We expect the risk level to worsen over time as COVID-19 containment measures become more protracted. We also expect the risk level to vary across states based on the severity of COVID-19 containment measures implemented and concentration of revenues. States with significant gaming activities which are more likely to be associated with businesses most affected by restricted movements (e.g., casinos and hotels) will feel the most acute softening of revenues, in our view. While we note that online access to gaming and lottery access has increased over the years, most state still rely significantly on retail outlets for sales.
Lottery and gaming revenues are typically a less significant source of state revenues to the general fund (generally less than 5% of general fund revenue), although often used to support education spending. To the extent declines require other resources to supplement education funding, this could add a degree of budgetary pressure longer term. However, where this revenue stream is pledged solely to debt obligations, extended closures could lead to credit pressures.
Although generally not as large a source of state revenue as income or sales tax, state corporate income tax is nevertheless a significant contributor to state revenue. This source of revenue has always been volatile, and as a result, many states budget conservatively for corporate income tax receipts. However, the scale of the decline in this volatile revenue source is likely to be far greater than most states had budgeted. We anticipate that this source of revenue will decline dramatically, likely affecting fiscal 2021 revenues due to the lag between the calendar tax year and most states' fiscal year. The National Association of State Budget Officers noted for fiscal year 2020 that corporate income taxes were already forecasted to decline a modest 2.4% across states, prior to the COVID-19 pandemic.
While property taxes are typically viewed as a lower volatility revenue stream, there are various proposals under consideration to delay property tax payments to alleviate the immediate burden on taxpayers. Given that many municipalities, school districts, and special districts rely on property taxes as a chief operating revenue source, potential delays that extend through a new fiscal year could pressure budgets and stress liquidity. Even if property tax collection dates remain unchanged, delinquencies could rise, adding for pressure to local entities that depend and budget with high collection rate expectations. Although very few states levy a direct property tax at the state level, local property taxes can have a large effect on some states' finances nonetheless, because they often have to back-fill a decline in local school district property tax revenue to bring per-pupil funding up to a specified funding formula level to ensure an adequate education. Thus, a decline in assessed values can directly affect many states' general fund finances.
- All U.S. Public Finance Sector Outlooks Are Now Negative, April 1, 2010
- It's Game Over For The Record U.S. Run; The Timing Of A Restart Remains Uncertain, March 27, 2020
- U.S. State Unemployment Insurance Claims Are Not An Immediate Challenge To State Liquidity, March 23, 2020
- Pension Brief: Liquidity Is A Rising Concern For U.S. Public Pensions In Down Markets, March 24, 2020
- U.S. Oil-Producing States' Fiscal Preparedness Varies As Prices Collapse, March 11, 2020
- S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure, March 19, 2020
- Market Volatility Has Varying Impact On U.S. States’ Capital Gains Tax Exposure, March 10, 2020
- When The Credit Cycle Turns, U.S. States May Be Tested In Unprecedented Ways, Sept. 17, 2018
- When The Cycle Turns: Government Framework Is A Significant Factor In States’ Ability To Navigate Downturns, May 23, 2019
This report does not constitute a rating action.
|Primary Credit Analysts:||Oscar Padilla, Farmers Branch (1) 214-871-1405;|
|Timothy W Little, New York + 1 (212) 438 7999;|
|Secondary Contacts:||Ladunni M Okolo, New York (1) 212-438-1208;|
|Jillian Legnos, Hartford (1) 617-530-8243;|
|David G Hitchcock, New York (1) 212-438-2022;|
|Thomas J Zemetis, New York + 1 (212) 438 1172;|
|Sussan S Corson, New York (1) 212-438-2014;|
|Geoffrey E Buswick, Boston (1) 617-530-8311;|
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