U.S. state tax-supported debt, in the aggregate, continued to moderate during fiscal 2020, with marginal declines across some debt metrics compared to the previous year. Compared to the years following the Great Recession, this was rather restrained. The most common security types of total tax-supported debt type issued remains general obligation- and appropriation-backed debt, representing about three-fourths of states' total share. Aggregate tax-supported state debt outstanding declined by 0.7% compared to fiscal 2019.

Three states--Hawaii, Illinois, and New Jersey--saw their debt burden increase during the pandemic as they tapped capital markets for budgetary relief or deficit financing purposes in fiscal 2020. These states already rank in the top 10 of states with high debt burdens. Illinois took out a $1.2 billion one-year loan through the Federal Reserve's newly created Municipal Liquidity Fund (MLF) and an additional $2 billion three-year loan from the program. Given improving state tax revenue projections in the current year, however, it could repay the MLF borrowing in fiscal 2022 to generate interest cost savings.

Most states, though, were adequately positioned to cover fiscal 2020 budgetary gaps through structural budget adjustments, reserve funds, or a combination of recurring and non-recurring financial measures.

Chart 1

Table 1

State Debt Borrowing Trends Are Stable Following The Initial Pandemic Shock

The sudden and sharp plunge into the pandemic-induced recession diverted most states' from delivering on adopted budget programs and caused them to address public health and safety risk management, including maintaining continuity of essential operations and covering pandemic-related expenditures, while safeguarding liquidity and preserving reserve flexibility. As a result, many postponed or reduced new money debt issuance for capital or maintenance purposes until the path out of the pandemic became clearer.

However, slowing state capital borrowing in fiscal 2020 may not reflect an anomaly due to the pandemic, but a continuation of a longer-term trend of deleveraging. Between 2009 and 2020, state debt service as a share of the overall budget held relatively constant, reflecting not only debt management strategies to limit fixed-cost growth, but also a general push to fund capital projects on a pay-as-you-go basis. The National Association of State Budget Officers (NASBO) reported capital spending increased by 10.3% (reaching $126.6 billion) in fiscal 2020 from the year prior, the highest level in 20 years. However, of that share, pay-as-you-go has grown to 74% of state spending on capital expenditures in fiscal 2020, with federal resources (25.8%) and dedicated (earmarked) state funds (42.6%) accounting for the greatest shares. General funds accounted for the lowest share at 5.6%. Bond proceeds comprised just 26.0% of total capital spending, which NASBO reports was the lowest share since 2001.

Chart 2

This trend is consistent with our view of aggregate state debt levels, as reflected in table 2. Median debt per capita averaged approximately $947 over the last five years, declining 8.5% from the peak level of $1,036 per capita in 2012. Since 2009, median aggregate debt of states fell by nearly 7.5% with approximately one-third of states reducing their total outstanding net tax-supported debt. As a share of governmental spending, debt service from 2009 to 2020 averaged 3.7%.

Table 2

Lost Decade: $1.5 Trillion In State And Local Infrastructure Investment

Deleveraging among many U.S. states could be, in part, a lingering symptom of the overall shallow economic recovery from the Great Recession, which constrained states' discretionary spending, coupled with efforts to contain spending on Medicaid, pensions, and retiree health care benefits that outpaced revenue growth (see "When The Credit Cycle Turns, U.S. States May Be Tested In Unprecedented Ways", published Sept. 17, 2018, on RatingsDirect). States also weighed the fiscal implications of issuing new debt that committed them to not only layer on large amounts of spending for debt service, but also costs of design and construction--and the ongoing operations and maintenance--of new infrastructure and capital assets, which could impair expenditure flexibility in (see "U.S. State Debt Levels May Be More Sustainable Than The Condition Of The Nation's Infrastructure," Oct. 19, 2015). Consequently, we believe pay-as-you-go capital spending could continue to supplant the need for additional capital borrowing for some states over the near term, likely keeping state debt trends stable overall.

However, states' collective effort to fund infrastructure has fallen short of what is needed, in our opinion. As chart 2 illustrates, the decade-long downshift in infrastructure investment across state and local governments since the Great Recession was likely substantial. As we noted in "Infrastructure After COVID-19: Risk Of Another Lost Decade Of U.S. State Government Capital Investment," published Oct. 29, 2020, if state and local government investment continued at the rate prior to the Great Recession, $1.5 trillion more in infrastructure spending would have occurred from 2009 to 2019. This missed opportunity contributed to a decade of shallow economic growth, missed productivity gains, and deferred maintenance that would inevitably increase the costs of deferred capital projects.

Chart 3

Minding The Gap: Mass Transit Providers' Capital Improvement Plans Stall in 2020

Ridership levels across mass transit providers within the U.S. remain materially depressed (chart 4), but demand is generally improving along with the easing of COVID-19 restrictions, ongoing vaccination progress, and improving economic conditions. We believe the infusion of federal stimulus aid totaling $69.5 billion from three separate relief acts will bolster liquidity positions in the mass transit sector, and provide important financial flexibility for the next 24 to 36 months as ridership levels recover and stabilize, allowing those transit operators that rely heavily on fare revenues time to implement measures to right-size their operations to achieve a structural balance.

Chart 4

Transit systems are capital intensive and rely on significant federal, state, and local funding for their capital improvement plans (CIP), as they typically have insufficient operating revenues from fares to cover ongoing capital needs. Given material declines in ridership, some mass transit providers have slowed down capital spending commensurately with the reduction in demand, resulting in backloading their capital needs as these projects have been delayed, but not canceled. Alternatively, some issuers eliminated components of their CIPs altogether for system expansion given the reduction in demand.

CIPs are typically funded by local, state, and federal sources. Federal and state support, in the form of grants, have historically funded a significant portion of mass transit issuers capital improvement plans, around 31% and 23%, respectively in fiscal 2019 according to the FTA (chart 5). In fiscal 2019, 2,046 federal grants were awarded totaling $15.4 billion (chart 6).

Chart 5

Some mass transit issuers have recently pursued local tax support through ballot initiatives for their CIPs, including Capital Metro Transportation Authority (Proposition A, property tax) and Los Angeles County Metropolitan Transportation Authority (Measure M, sales tax). While new measures require voter approval, they can be a reliable funding source for major projects to supplement federal and state grants. We expect overall state and federal support to be sustained given the essentiality of mass transit service and the benefits of reduced congestion within their service areas.

Chart 6

Infrastructure Investment And Economic Recovery: Stay The Course Or Boldly Go?

The federal government's authorization of nearly $5.2 trillion of demand-driven stimulus enacted across several separate relief acts provided states and transportation agencies with direct aid to bolster their fiscal conditions and reduce further economic harm to sectors hardest hit by the pandemic. However, stimulus funds are likely to have only a temporary effect on the economic recovery and are unlikely to have a sustained effect on the pace of U.S. GDP growth beyond the near- to-medium term. S&P Global Economics believes that a longer-lasting economic accelerator could come from federal government investment in infrastructure. With over three-fourths of government fixed assets (approximately $12.1 trillion, or 77%) being held by state and local governments, we believe that a meaningful investment in infrastructure--including roads and bridges, public and freight transportation networks, education, utilities, housing, water management, conservation, and internet access--would produce tangible benefits and be supportive of longer-term credit quality.

On the other hand, we believe the economic and fiscal costs of inaction or underinvestment could continue to compound for states and transportation agencies the longer missed infrastructure investments go unfunded. In its 2021 infrastructure report card, the American Society of Civil Engineers (ASCE) estimated that the total investment gap will increase to $2.59 trillion over the next 10 years compared to the $2.1 trillion estimated in 2017. Over the next 20 years, ASCE estimates the economic opportunity costs of failing to act to close the infrastructure investment gap would include the loss of $10 trillion in potential U.S. GDP growth, more than three million jobs, and $2.4 trillion in export value by 2039.

In our opinion, the investment in high quality and more efficient infrastructure has the potential to fuel growth in state economies, now and into the future. S&P Global Economics estimates that a $2.1 trillion infrastructure program, similar in size to the $2.3 trillion in the original American Jobs Plan proposal, if done wisely, would have multiplier effects on U.S. economic activity and boost private-sector investment and productivity over the next 10 years than without an infrastructure plan (see, "Economic Research: Infrastructure: What Once Was Lost Can Now Be Found--The Productivity Boost," May 6, 2020). S&P Economics also believes that this would have a positive effect for individuals and consumers by supporting project-related and permanent job creation, wage and personal income growth, and more household spending. In our view, the effects of these investments would ultimately fall to the bottom line for states and transportation agencies, in terms of future efficiency gains, cost mitigation, and capturing additional revenue from economic growth.

If one of the proposed federal infrastructure packages or a combination thereof is approved, we believe this is likely to be transformational and incentivize some states to increase in their share of general capital expenditures to help address the remaining infrastructure gap. In addition, the proposed infrastructure plan is likely to benefit transportation agencies by funding a greater share of their CIPs. These funds could also indirectly alleviate some pressure on local and state governments that provide capital subsidies to transportation agencies.

In our view, an effective and longer-lasting strategy to infrastructure modernization would pair the large federal investment in infrastructure with a redesign of the federal funding structure to enable more resources for states and transportation agencies, who would remain the stewards over most of capital assets built or rebuilt under such a plan. A sustainable funding structure – whether through one or a combination of setting inflation-based adjustments to current funding sources, additional incentives to support state-driven capital financing, or identification of new dedicated funding sources -- would empower states and transportation agencies to continue making the investments needed to address infrastructure needs and perform upkeep that avoids a backlog of deferred maintenance.

Balancing Future Value And Values: Sustainable Debt Will Play A Role For States and Transportation

The American Jobs Plan proposal is unique relative to past federal infrastructure proposals in that it broadens the definition of infrastructure investment beyond conventional physical and organizational structures and facilities (e.g., roads, utility systems, public transportation, and other government fixed assets). The proposal includes investments that meet health, social, and environmental goals such as: workforce training initiatives in underserved communities for those who could be hit hard by transition to a green economy; expansion of broadband access; and investments to mitigate physical risks associated with climate change. For transportation agencies, the proposal directs funding to replace thousands of buses (with a focus on transitioning fleets to more electronic vehicles) and rail cars, and expanding transit and rail service to support diversity, equity, and inclusion initiatives for communities historically underserved by transit providers. To the extent these projects are debt-financed, states and transportation infrastructure operators are likely to look to sustainability-labeled debt instruments (e.g. green and social bonds) to expand their investor base and draw in different funding mechanisms.

In our report "2021 Sustainable Finance Outlook: Large Growth In Green, Social, Sustainable Labels As Municipal Market Embraces ESG," published Feb. 16, 2021, following strong growth in green bond issues in 2019 and 2020, along with a growing social bond sector, issuers in 41 states have issued at least one series of sustainable debt. However, issuance remains concentrated on the coasts, particularly in California, which accounts for 30% of total municipal sustainable debt issued, and New York, which accounts for 25%. Massachusetts is third with 9% of the total, followed by Florida (5%), and Washington (4%). Notably, the New York Environment and Climate Change Projects Bond Measure will be on the November 2022 ballot. If approved by voters, it would authorize the state to issue $3 billion in general obligation bonds for projects related to environment, natural resources, water infrastructure, and other climate-related projects.

Chart 7

For states, social bonds seeking to address or mitigate a specific social issue (e.g., education, public health and safety, aging, childcare, access to opportunity, or housing) or aiming to achieve positive social outcomes could grow in the coming years. In 2019, California Health Facilities Financing Authority issued approximately $500 million in social bonds for the state's No Place Like Home (NPLH) program, secured by a first lien on a 1% additional personal income tax (PIT) imposed statewide on taxable income of more than $1 million to provide housing for persons who are experiencing or at risk of homelessness, and who need mental health services. The state is authorized to issue up to an additional $1.5 billion in future years toward the NPLH program.

Chart 8

Furthermore, we see transportation as a leading sector for green bond issuance, given the natural linkage between public transit and green priorities, such as reducing carbon emissions and improving resiliency to extreme weather events. Public transit entities, though facing substantial headwinds, operate in a highly capital-intensive line of business and, in many parts of the country, maintain significant expansion plans (see "Outlook For U.S. Not-For-Profit Transportation Infrastructure: Light At Tunnel's End--But How Long Is The Tunnel?," Jan. 13, 2021). Still, many transportation issuers have embarked on green bond initiatives, signaling to the market their incorporation of project design elements generating positive environmental impacts into their capital maintenance and expansion plans. In 2021, Washington Metropolitan Area Transit Authority issued approximately $784 million in green bonds (climate bond certified) that included positive environmental impacts such as energy efficiency investments as part of its Energy Action Plan to reduce carbon dioxide emissions. However, should federal underfunding for critical infrastructure projects occur, states and transportation agencies may bear a greater share of costs needed to address evolving climatic and physical risks. While there are tradeoffs for any state or transportation agency to improve its debt metrics, we believe focus on hardening infrastructure against environmental risks as is a potential opportunity for rating stability in the face of more frequent and severe events.

For information on how S&P Global Ratings incorporates ESG factors in its criteria frameworks, see "Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors," April 28, 2020, and "ESG Brief: Emerging Themes In U.S. Public Finance," June 3, 2021.

Table 3