JULY 3, 2012

US PUBLIC FINANCE

SPECIAL COMMENT

Trend of On Time State Budgets Continues as Revenues Improve

Every state adopted a budget on time for fiscal 2013. The adoption of timely budgets in the last two cycles (most state fiscal years begin July 1) reflects moderate improvement in state fiscal conditions, and the fact that states have largely avoided the political showdowns that marked the peak of the recession. The trend of on-time budget passage underscores the willingness of state officials to make difficult fiscal decisions. While the economic recovery remains tepid and fiscal challenges remain, revenues are growing and budget gaps are markedly lower. According to the Center for Budget and Policy Priorities (CBPP), state budget gaps totaled $191 billion in fiscal 2010 and $130 billion in fiscal 2011. A separate study by the National Association of State Budget Officers estimated total budget gaps of $110 billion for fiscal 2012. This special comment discusses the current budgetary environment for all states, the trend in measures used to balance state budgets and the institutional mechanisms in place for states to address late budgets, particularly with respect to debt service payments. Our findings reflect:

Table of Contents:
LATE BUDGETS REFLECT POLITICAL DISCORD AND/OR SUPERMAJORITY VOTING REQUIREMENTS NO GOVERNMENT SHUTDOWNS FOR FISCAL 2013 ESTABLISHED PROCEDURES ENSURE TIMELY DEBT SERVICE PAYMENTS IN LATE BUDGET SITUATIONS ECONOMIC AND REVENUE GROWTH HELP STATES TO OVERCOME THE POLITICAL STALEMATE THAT MARKED MUCH OF THE DOWNTURN MOODYS RELATED RESEARCH

2 3 3

4 6

Analyst Contacts:
NEW YORK +1.212.553.1653

Kimberly Lyons +1.212.553.4673 Assistant Vice President Analyst kimberly.lyons@moodys.com Nicholas Samuels +1.212.553.7121 Vice President Senior Analyst nicholas.samuels@moodys.com Emily Raimes +1.212.553.7203 Vice President Senior Analyst emily.raimes@moodys.com Timothy Blake +1.212.553.0849 Managing Director Public Finance timothy.blake@moodys.com Robert A. Kurtter +1.212.553.4453 Managing Director Public Finance robert.kurtter@moodys.com

Every state enacted a budget on time for fiscal 2013. By comparison, four states enacted their budgets late in fiscal 2009, five in fiscal 2010, three in fiscal 2011 and one last yearMinnesota; Improving revenues have helped states overcome much of the political intractability that led to late budgets during the downturn. Through the spring, more than half the states report that fiscal 2012 revenues exceeded budgeted forecasts and most others were on target.

U.S. PUBLIC FINANCE

Late Budgets Reflect Political Discord and/or Supermajority Voting Requirements

The strength of financial governance and the efficiency of state budget procedures is an important credit consideration. Late budgets primarily reflect political disagreements, and in extreme cases lead to government shutdowns. In some states the requirement that a legislative supermajority approve the budget can exacerbate existing political disagreement. However, even when budget enactment is delayed, most states resolve their issues in a relatively short period, with no long-term impact on their fiscal health or credit. Eight states have experienced at least one late budget in the last five years, and four of those eight states have experienced more than one late budget in the same time period (Exhibit 1). The states that tend to be late typically have established practices in place to ensure that disbursements for debt service and other expenses continue, even in the absence of full year spending plans. These practices are established by state constitution, statute, or by policy. Most states begin their fiscal year on July 1 (four states have different fiscal years: Alabama and Michigan begin October 1; New York on April 1; and Texas on September 1). For fiscal 2013, the legislatures in Massachusetts and South Carolina passed budgets late in the legislative session, but before the beginning of the new fiscal year. In both states, budget laws grant the governor a period to review the measures, 10 days for Massachusetts and five for South Carolina. Because the spending measures were passed so late, neither governor signed the budget by July 1. We do not consider these budgets late, however, since the full-year spending measures were passed and in both cases, the states enacted interim spending measures that cover operations and debt service.
EXHIBIT 1

Improving Trend for Budget Adoption

States that missed the start of the fiscal year
State G.O. Debt Rating FY2012 FY2011 FY2010 FY2009

California Connecticut Illinois Minnesota New York North Carolina Ohio Pennsylvania
Source: Moodys Investor Service

A1/Stable Aa3/Stable A2/Stable Aa1/Negative Aa2/Stable Aaa/Stable Aa1/Stable Aa1/Negative X

X X X X X X X X

X X X

JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE

U.S. PUBLIC FINANCE

No Government Shutdowns for Fiscal 2013

Underscoring how the resolution of significant budget shortfalls can heighten ideological differences and lead to political stalemate, the Minnesota government shutdown for 20 days at the start of fiscal 2012, the longest state shutdown in recent history (Exhibit 2). During the 2011 legislative session, Governor Mark Dayton's original executive budget recommendation included new taxes forecasted to generate approximately $3 billion of recurring revenues. Disagreement over the proposed new taxes for the fiscal 2012-2013 biennium resulted in a budget impasse, with the state legislature staunchly against any additional taxes. The state failed to enact a new biennium budget in time for fiscal 2012, prompting an immediate shutdown of government operations pursuant to statute, which prohibited the state from spending without a legislatively approved budget. Debt service was not affected: mechanisms were put in place to ensure that all of the states bonds continued to be paid on time.
EXHIBIT 2

Only a handful of State Shutdowns Last Ten Years

State G.O. Debt Rating Length of Shutdown Year of Shutdown

Michigan Michigan Pennsylvania New Jersey Minnesota Minnesota

Source: Moodys Investor Service

Aa2/Stable Aa2/Stable Aa1/Negative Aa3/Stable Aa1/Negative Aa1/Negative

2 hours 4 hours 1 day 7 days 8 days 20 days

2007 2009 2007 2006 2005 2011

Established Procedures Ensure Timely Debt Service Payments in Late Budget Situations
While many states have mechanisms to ensure timely debt service and maintenance of operations in the event of late budget adoption, some states have no established contingency plans for late budgets. In states that have no formal statutory or constitutional contingency plans but have a history of late budget adoption, procedures have historically been put in place to address government payments and manage cash flow during periods of budget delays. Some states have contingency plans that allow them to operate under an executive order, a continuing resolution, or an emergency spending bill. These measures ensure that the state can continue government operations, including the payment of debt service obligations. For bonds that require legislative appropriation, such as lease-backed debt, most states set debt service payment dates well beyond the start of the a states fiscal year to avoid possible delays in the event of a late budget adoption. Even with contingency plans or established mechanisms, late budget adoption at the state level can disrupt the flow of state payments to vendors and employees, as well as school districts, cities, public universities and other political subdivisions such as transit systems that rely in part of state funds. A delayed state budget could also result in late debt service payments but states have historically made special accommodations to allow debt service payments to be made on time.

JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE

U.S. PUBLIC FINANCE

Economic and Revenue Growth Help States to Overcome the Political Stalemate that Marked Much of the Downturn
The prevalence of timely budgets reflects the improvement in state revenue trends. While the tradeoffs are still difficult, the magnitude of necessary budget cuts is smaller than in the depths of the recession and attaining budget consensus has been easier and faster. Based on our analysis, through the spring, revenues in more than half the states exceeded forecasts and most others were in line with estimates (Exhibit 3). Revenues in some states, however, continue to miss budgeted targets and others have revised their forecasts downward, opening gaps that states will need to close. New data from the CBPP show that the shortfalls closed in fiscal 2013 budgets totaled $54 billion, still large but about half the size of the gaps they closed going into fiscal 2012. Two states with historically late budgets, New York and California, have both reversed trend in recent years, passing timely budgets for fiscal 2012 and now 2013. New York passed its budget on time for fiscal year 2013 with seemingly little of the infighting of the past. Californias governor signed a budget just days before the end of the fiscal year, assisted in part by a constitutional amendment approved by voters last year that eliminates the legislatures pay for each day it is late passing a budget. Californias budget relies on a temporary tax increase which must be approved by voters in November. If the ballot measure fails, spending cuts to K-12 education will be triggered. Continuing the recent trend of anti-tax governance environments, some states enacted tax reductions for Fiscal 2013. The state of Kansas passed sweeping tax reductions in its 2012 legislative session. The states personal income tax rates will be consolidated at 3% and 4.9%, replacing the current top rates of 6.45% and 6.25% and the low rate of 3.5%. In addition, the states sales tax rate will decline to 5.7% from 6.3% in fiscal 2013 as previously planned. Georgia also enacted tax reductions, most notably a two year sales tax holiday and eliminated the state property tax fee associated with car registrations. In North Dakota, which continues to have the highest economic growth of all states, a measure to repeal property taxes within the state was placed on the June ballot. Proponents of the measure cited the states trend of revenue over-performance as a driver for property tax relief, but voters ultimately voted against the measure.

JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE

U.S. PUBLIC FINANCE

EXHIBIT 3

Year to Date Revenue Performance versus Forecast

State G.O. Rating

FY 2012 Rev YOY (%)

Rev vs Estimates

Alabama Alaska Arizona Arkansas California Colorado Connecticut Delaware Florida Georgia Hawaii Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maine Maryland Massachusetts Michigan Minnesota Mississippi Missouri Montana Nebraska Nevada New Hampshire New Jersey New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania Puerto Rico Rhode Island South Carolina South Dakota Tennessee Texas Utah Vermont Virginia Washington West Virginia Wisconsin Wyoming *** Average Revs YOY Data Summary Revs Vs Estimates:

Aa1/Stable Aaa/Stable Aa3/Stable* Aa1/Stable A1/Stable Aa1/Stable* Aa3/Stable Aaa/Stable Aa1/Stable Aaa/Stable Aa2/Stable Aa1/Stable* A2/Stable Aaa/Stable* Aaa/Stable* Aa1/Negative* Aa2/Negative* Aa2/Stable Aa2/Negative* Aaa/Negative Aa1/Stable Aa2/Stable Aa1/Negative Aa2/Stable Aaa/Stable Aa1/Stable NGO** Aa2/Stable Aa1/Stable Aa3/Stable Aaa/Negative Aa2/Stable Aaa/Stable Aa1/Stable* Aa1/Stable Aa2/Stable Aa1/Stable Aa1/Negative Baa1/Negative Aa2/Negative Aaa/Stable NGO** Aaa/Stable Aaa/Stable Aaa/Stable Aaa/Stable Aaa/Negative Aa1/Negative Aa1/Stable Aa2/Stable NGO**

2.6% 29% 5.3% 2.9% -10% 7.8% 4.7% -5.5% 3.1% 5.1% 12% 6.3% 11.3% 9.0% 6.2% 8.4% 3.7% 1.2% 2.5% 6.7% 2.0% 1.7% 4.1% 4.3% 3.4% 8.2% 5.6% 4.8% -1.8% 3.7% 2.4% -3.3% 1.2% 62% 7.8% 9.2% 0.8% 2.5% 0.9% 3.8% 5.5% 7.4% 3.4% 12% 2.7% 0.9% 5.9% 1.3% 1.0% 2.0% 8.4% 5.6% 29 7 15

Exceeding Exceeding Exceeding In Line With Lagging Exceeding Lagging Lagging Exceeding Exceeding In Line With Exceeding In Line With In Line With Exceeding In Line With In Line With Lagging Exceeding Exceeding Exceeding Exceeding Exceeding Exceeding In Line With Exceeding Exceeding Exceeding Lagging Lagging Exceeding Exceeding In Line With Exceeding Exceeding Exceeding In Line With Lagging In Line With Exceeding Exceeding In Line With Exceeding Exceeding Exceeding In Line With In Line With In Line With In Line With Exceeding Exceeding Exceeding Lagging In Line

* Issuer Rating ** No General Obligation Debt *** Moody's does not currently maintain a public rating on debt supported by the state

JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE

U.S. PUBLIC FINANCE

Moodys Related Research

Special Comment:

Rating Changes for the 50 States from 1973, July 2012 (143616) Outlook for U.S. State Governments Remains Negative in 2012, February 2012 (139230)

Outlook:
To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE

U.S. PUBLIC FINANCE

Report Number: 143551

Author Kimberly Lyons

Senior Production Associate Diana Brimson

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JULY 3, 2012

SPECIAL COMMENT: TREND OF ON TIME STATE BUDGETS CONTINUES AS REVENUES IMPROVE