- Massachusetts' fiscal picture has been relatively robust, with mid-fiscal 2021 tax revenues ahead of the same period in 2020, and well ahead of the 2021 budget.
- Growth is projected to continue into fiscal 2022.
- Should tax revenues decline as projected in fiscal 2021, overall operating revenue would still remain stable thanks to increased federal aid.
- The governor's proposed draw from the budget stabilization fund would still leave it at what we would consider adequate levels.
- Due in part to lower Medicaid caseloads, on the expectation that the COVID-19 pandemic will recede, the budget proposal anticipates overall spending will decline in fiscal 2022.
Massachusetts' fiscal 2022 executive budget proposal presents a relatively stable credit picture in the near term, in S&P Global Ratings' view. While budget challenges remain, contributing to a likely second consecutive year of decline in the commonwealth's budget stabilization fund (BSF), revenues are projected to come in much stronger than anticipated shortly after the pandemic began. Although the governor's budget proposal likely will see significant modifications before legislative enactment--Massachusetts' fiscal 2021 budget was adopted 11 months after the original proposal was submitted--the state's revenue projections indicate some fiscal 2022 budget flexibility will exist when the time comes to enact a final budget.
The governor has proposed what we view as a moderate drawdown of the state's BSF, from levels we believe are currently good, to a level we would still consider adequate. The executive budget projects an estimated $1.0 billion BSF drawdown in fiscal 2021 (less than the original "not to exceed $1.7 billion" provision contained in the enacted 2021 budget), after which the BSF would hold $2.5 billion at fiscal end June 30, 2021, or a good 5.3% of estimated budgetary operating funds expenditures (see table). The governor proposes a further $1.4 billion BSF drawdown in fiscal 2022, leaving a balance equal to an adequate 2.4% of proposed 2022 expenditures. We believe BSF drawdowns of this magnitude are to be expected during economic downturns and not necessarily a cause for credit concern unless indicative of a large ongoing structural deficit, or the state lacks willingness to rebuild reserves during strong economic times. The BSF has a long history of cyclical drawdowns in recessions and rebuilding during good times (see chart 1). Current law, which has occasionally been overridden during the annual budget process, diverts a portion of excess capital gains tax above a formula threshold into the BSF. At the same time, if revenues exceed the executive budget projection in fiscal 2021, as they did for the month of January, the drawdown in the BSF in fiscal 2021 could be even lower.
Massachusetts Has Enjoyed Robust Fiscal 2021 Revenues
Extraordinary federal revenues during the pandemic have assisted Massachusetts' finances, especially higher cost reimbursement for Medicaid. We consider the commonwealth to have relatively large health care costs, so the extra reimbursement has been very timely. Estimated fiscal 2021 safety net appropriations, primarily health care, equal about 54% of projected total operating funds expenditures and other uses (see table), partially reflecting an increase in Medicaid caseloads (see chart 2). The federal government has increased its percentage reimbursement of Medicaid costs by 6.2 percentage points through at least the end of fiscal 2021, which the state estimates will amount to an extra $880 million in fiscal 2021. This has contributed to an increase in overall federal revenue (table), and resulting overall in essentially stable fiscal 2021 combined tax and other nontax budget revenue compared with 2020. Without the extra federal reimbursement, this might have caused budget distress, since the executive budget projects total operating tax revenue, after deduction of dedicated tax revenue to other uses and not including tax settlements and judgements, will fall 1.8% in fiscal 2021 from actual 2020 revenue, after a decline of 0.3% in 2020. However, this projection might be conservative. There is reason to believe revenue might not fall 1.8% in 2021--actual January monthly tax collections have come in higher than the executive budget projection that was just released. Federal revenue has also been bolstered by additional Coronavirus Aid Relief and Economic Security Act funding, and the executive budget proposal does not include potential future federal aid to states that is not in current law.
In fact, Massachusetts' fiscal 2021 tax revenue has held up relatively well, considering the pandemic. At of the end of January 2021, actual operating tax revenue was up 4.5% fiscal year to date over the same seven-month prior-year period, notwithstanding the executive budget's projection of a decline, particularly due to strong income tax revenue. The seven-month rise in tax revenue was led by an 8.8% increase in nonwithheld income tax related to future estimated income tax payments.
We believe the rise in estimated income tax payments could be related to capital gains tax volatility as we ranked Massachusetts the fourth most sensitive state to potential swings in capital gains tax in our article "Market Volatility Has Varying Impact on U.S. States’ Capital Gains Tax Exposure," published March 10, 2020, on RatingsDirect. There are times--such as now--when this works to the commonwealth's advantage, although it can also create above-average revenue risk when capital markets do poorly. Strong state income tax collections during the first seven months of fiscal 2021 helped outweigh a slow 1.1% increase in sales taxes, which were weakened by a 32.6% decline in state meals sales tax as a result of pandemic restrictions.
S&P Global Ratings is also following a potential U.S. Supreme Court case between Massachusetts and New Hampshire that could put significant amounts of state income tax from remote workers at risk (see "Massachusetts and New York State Could Lose Billions of Income Tax Dollars if Lawsuit Challenging Remote Work Succeeds," published Jan. 22, 2021), with an unknown potential impact on Massachusetts' fiscal 2022 budget.
In comparison with the current January 2021 consensus forecast of a decline in fiscal 2021 tax revenue, the state's January 2020 (pre-pandemic) forecast projected that overall tax revenues would rise 2.8% in fiscal 2021. After the start of the 2021 fiscal year, Massachusetts passed a series of short-term interim budgets before enacting a final fiscal 2021 budget in December 2020, based on an interim updated October 2020 tax revenue forecast, which projected a 6.8% decline in tax revenue in the fiscal year ending June 30, 2021.
The governor's new fiscal 2022 budget proposal--using a revised Jan. 15, 2021, consensus revenue forecast for both fiscals 2021 and 2022--projects 3.8% tax revenue growth in fiscal 2022, excluding tax settlements and judgements, after a small 1.8% decline in 2021, and a slight 0.3% decline in 2020(table). The executive budget tax forecast for fiscal 2022 amounts to a 2.9% tax decline over the original pre-pandemic January 2020 forecast for fiscal 2021. However, the updated 2021 forecast might already be too low. Actual Jan. 31, 2021, seven-month tax revenues were 2.5% above the revised 2022 executive budget consensus forecast for 2021. Tax collections for just the one-month period in January 2021 were even more robust: Total one-month tax collections were 13.3% above the prior one-month period, including a 15.6% one-month increase in income tax and a 2.9% increase in sales tax.
Based on the improved revenue forecast, we believe state liquidity will remain strong, despite the legal inability of the general fund to borrow internally from other funds and even if conservative budget assumptions come true. For more information on state liquidity, see our summary on the commonwealth's outstanding cash flow notes (published Nov. 25, 2020).
|Massachusetts -- Combined Operating Funds|
|Fiscal 2018||Fiscal 2019||Fiscal 2020||Executive budget 2021 projection||Proposed 2022 budget|
|Income tax (late filings in 2020 accrued to fiscal 2020)||16,240||17,109||17,361||16,680||17,418|
|Total tax revenue||27,776||29,693||29,609||29,090||30,241|
|Transfers of dedicated taxes out||4,275||4,580||4,862||5,081||5,793|
|Federal reimbursements and grants||11,377||11,772||12,795||13,971||12,564|
|Total nontax revenue||19,130||20,607||20,717||21,723||20,694|
|Total revenues and other sources||42,642||45,767||45,488||45,533||45,308|
|Executive Office of Education appropriations||7,454||7,934||8,330||8,392||8,370|
|Safety net appropriations||22,038||23,136||24,135||25,609||25,091|
|Total expenditures and other uses||42,074||44,716||45,929||47,382||46,928|
|Operating surplus as % of expenditures and other uses||1.4||2.4||(1.0)||(3.9)||(3.5)|
|Budget stabilization fund (BSF) balance||2,001||3,424||3,501||2,523||1,105|
|BSF as % of appropriations||4.8||7.7||7.6||5.3||2.4|
|Sources: Fiscal 2022 executive budget documents; Massachusetts Comptroller reports.|
The Consensus Revenue Forecast Indicates Expenditure Restraint
The legislature has historically had its own spending priorities, and is likely to revise the governor's spending proposal, but the ability to raise spending will be significantly constrained by the consensus revenue forecast. The governor's 2022 budget proposal anticipates a 0.7% decrease in overall budgeted spending in fiscal 2022, primarily due to declining Medicaid caseloads (chart 2) in fiscal 2022, leaving other spending relatively untouched. The executive budget calculates that overall gross spending would decline 1.0% if Medicaid spending transfers were excluded. One of the provisions of increased federal Medicaid reimbursement was that existing eligibility for state residents cannot be reduced, which has affected Massachusetts' ability to perform redeterminations related to Medicaid eligibility, as it had previously been doing. Presumably, if the increased federal reimbursement rates returned to pre-pandemic levels, the state would regain such ability. Nevertheless, we believe there could be some risk to the state budget if increased federal reimbursements--likely to continue through at least March 2022 based on the Biden administration's recent announcements--ended, and caseloads did not recede to pre-pandemic levels.
Due to ongoing programmatic spending growth pressures, the governor has recommended drawing down the BSF by $1.4 billion as noted, with the draw equal to about 3% of budget, and which we view as a temporary structural budget gap. We also believe Massachusetts' consistent underfunding of the commonwealth's actuarial annual pension contributions creates an additional small structural budget gap, which we earlier calculated at about 2% of budget in fiscal 2020 (see our full analysis on Massachusetts' general obligation debt, Nov. 10, 2020.
The executive budget proposal primarily retains funding stability for existing programs, with relatively small amounts available for new initiatives. Overall, office of education appropriations, the second-biggest area of spending after safety net spending, would remain essentially flat (table 1).
Massachusetts' Credit Challenges Remain Manageable
While a pandemic and the accompanying economic restrictions and tax losses are not good for credit quality, Massachusetts has managed well through the recent recession, and we expect it to retain adequate reserves even if the proposed BSF drawdown were to occur. Certain challenges remain, such as health care and education programmatic spending growth, and a small but growing structural budget gap related to pension underfunding. Also, the commonwealth will need to rebuild the BSF after fiscal 2022, when future stock market and capital gains tax returns might not be as robust as they are now. Nevertheless, we currently view these credit challenges as manageable at the current rating level.
- Massachusetts and New York State Could Lose Billions of Income Tax Dollars if Lawsuit Challenging Remote Work Succeeds, Jan. 22, 2021
- Market Volatility Has Varying Impact on U.S. States’ Capital Gains Tax Exposure, March 10, 2020
- Massachusetts full analysis, Nov. 10, 2020
- Massachusetts summary, Nov. 25, 2020
This report does not constitute a rating action.
|Primary Credit Analyst:||David G Hitchcock, New York + 1 (212) 438 2022;|
|Secondary Contact:||Jillian Legnos, Hartford + 1 (617) 530 8243;|
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