State of the States & Local Governments

The fiscal condition of state governments continues to improve nearly five years after the onset of the financial crisis. While challenges remain in the current environment of slow economic growth, states have taken the necessary actions to balance budgets and to ensure full and timely payment on debt obligations. In fact, the vast majority of states were successful in balancing their fiscal year (FY) 2013 budgets on or ahead of the July 1, 2012, start.

This report reviews the progress states have made in balancing budgets in this post-Great Recession environment. Since our last report in November of 2011, states have continued to benefit from modest revenue growth and more manageable (i.e., more easily closed) budget gaps. Public sector job reductions continue, but the rate of cuts has diminished. The onset of federal austerity mentioned in our last report is arguably the biggest threat to state financial health, although, as then, we believe most states will make the necessary fiscal adjustments. While this report focuses primarily on state governments, federal and state policy decisions influence financial outcomes at the local level as well. While federal and state spending cuts often result in similar retrenchment by local governments, legal and regulatory frameworks within states, as well as intergovernmental transfer payments, have rendered municipal bankruptcies and defaults very rare. Indeed, the lack of bankruptcies and debt defaults among local governments more than four years after the greatest economic crisis since the Great Depression is reassuring and, in fact, consistent with our expectations. The few financially stressed local governments and US territories are unique situations and do not reflect the relative fiscal strengths of US states. The main points of this report are summarized below.

Key Points

• State fiscal prospects have improved modestly, evidenced in slight revenue growth, spending constraint and reduced budget gaps.
• Federal fiscal austerity will constrain state governments, but financial flexibility remains.
• Local government defaults and bankruptcies have been and should continue to be rare, due in large part to state intervention. Rising property taxes spurred by an emerging rebound in housing prices also bodes well for local governments. US territories, which have inherently weaker credit profiles than state governments, remain under stress but will likely continue to pay full and timely general obligation (GO) debt service.
• States will continue to balance their budgets by cutting spending and offloading costs to local governments. Federal spending cuts, particularly in the defense sector, may have larger negative employment and tax consequences for local governments.
• Pension and Other Post-Employment Benefits (OPEB) liabilities are major concerns for state and local governments given declining asset values and funding pressures. Significant reforms are under way and should eventually reduce liabilities, although new accounting rules will result in lower funded ratios.

Read Report.