The pandemic-induced economic and fiscal shock wave which rippled across U.S. states and local communities beginning in March 2020 has now, more than a year later, given way to more stability. In S&P Global Ratings' view, the fiscal 2022 budget cycle showcases the various fiscal policy paths states are taking to shape their respective recoveries and address the social and public health toll created by COVID-19. As of June 29, 2021, 37 states have adopted their fiscal year 2022 budgets, and the balance have state legislatures finalizing budget negotiations or are awaiting governors' signatures.

Now down to the wire, most legislative budget negotiations faced fewer physical barriers to convening and have had the added wrinkle of determining how to deploy an unprecedented level of federal aid to states signed into law over the past 15 months, with the American Rescue Plan Act (ARPA) being the most recent example. This extraordinary level of federal stimulus, coupled with many states reporting improving economic and fiscal outlooks as pandemic restrictions continue to lift, supports our view that for the majority of these states, late budget adoption will primarily be rooted in legislative and executive fiscal policy differences, rather than indicating pandemic-related structural budget imbalance. While we continue to monitor the ongoing effects of fiscal stress on states and late budget adoption on operations and debt service risks, the absence of a budget does not necessarily signify immediate credit deterioration, in our view. As we've observed in the past, some states indeed have a pattern of last-minute negotiations and routinely adopt certain measures which provide additional time to finalize their budgets.

Chart 1

Brighter Prospects Ease Budget Development Pressures For States' Fiscal Year 2022

While the level of preparedness--at least fiscally--was comparatively mixed across states, the injection of significant federal aid has allowed them to navigate a period of elevated uncertainty with limited exceptions. Having been forced to prioritize liquidity in an uncertain environment, we have observed states focusing on preserving reserves with an eye toward structural balance longer term as they enter fiscal 2022. The added boost in federal aid continues to work its way through state and local governments, and we anticipate the short- to medium-term budget outlook for the former will continue to improve.

The broader U.S. economic outlook looks brighter, although an uneven recovery may persist and cloud the budget trajectory for some states through fiscal 2022. While the strengthening manufacturing and oil and gas sectors have rebounded quicker than our expectations at the onset of the pandemic, the leisure and hospitality sector's recovery has been comparatively mixed and slower off the gate. However, we anticipate the latter will accelerate later in the year and into the next as broader openings and levels of comfort emerge. This trend will be crucial for certain states like Hawaii (AA+/Negative) and Nevada (AA+/Negative) and, to a lesser extent, Florida (AAA/Stable), which have outsized leisure and hospitality sectors. Beyond the short term, we anticipate the permanence of remote work or any of its derivatives will become clearer and could lend support to a restructuring of state revenue mixes, even if just on the margins.

Although some states continue to develop their budgets or iron out the finer details, many have considerable discretion over their budgets and cash flows to temporarily fund operations and debt service if a budget is not enacted by the start of the fiscal year. Crucially, the structure of most state bonds, as well as--in many cases--the states' authority for funding debt service, tends to insulate them from credit deterioration in the event of late budget enactment. Similar to the rest of the municipal bond market, most state debt is structured with serially amortizing principal. It is rare in the state sector that the obligor's ability to fund its impending debt payments depends on liquidity from a new round of financing obtained in the credit markets.

In a late budget situation, risks to a state's ability to fund its debt service payments often stem from administrative, structural, or timing constraints for obligations contingent on annual budget appropriations, rather than from an underlying lack of fiscal capacity.

In an apparent recognition of the potential for late budget enactment, many states have procedures in place that protect debt service, including:

• Continuing appropriation provisions or pre-funding debt service payments early in the fiscal year;
• Avoiding structuring bonds with debt service payments early in the fiscal year;
• Continuing resolutions (measures that temporarily fund government operations, including debt service, when the budget has not been enacted by the start of the fiscal year);
• Authorizing provisions in law allowing the treasurer to make debt service payments in the absence of a budget; and
• Piecemeal budgeting (approving appropriations for debt service or other priority payments while negotiations over other aspects of the budget continue).

For a state that has not developed countermeasures to mitigate these latent risks, however, a late budget heightens its exposure to a missed or nonpayment event if the debt administration functions of agencies and departments responsible for debt payments are impaired.

State Budget Roundup

States Without June 30 Fiscal Year End

New York (AA+/Stable; April); Texas (AAA/Stable; August); and Alabama (AA/Stable; October); and Michigan (AA/Negative; October).

Budget Adoption Pending Governor's Signature

Arizona (AA/Stable)

Arizona's legislature has approved a budget that incorporates large tax cuts requested by the governor, and which he is expected to sign before the July 1 start of the state's fiscal year.

California (AA-/Stable)

California's legislature is currently in the process of passing a budget, which the governor is expected to sign shortly. Due to continuing appropriation legislation, even if the budget is signed a few days after the July 1 start of the state's fiscal year, we do not expect any disruption to state services. While the budget may be signed into law near the July 1 beginning of California's fiscal year, some items were left for further negotiations between the governor and the legislature in the coming months to be enacted in "trailer bills."

Delaware (AAA/Stable)

The General Assembly has passed a $4.77 billion fiscal 2022 general fund operating budget, and the governor has expressed an expectation to sign it into law. As of close of business on June 28, the budget has yet to be enacted. Revenues continue to rebound from forecasted lows and a revenue forecast update by the Delaware Economic and Financial Advisory Council (DEFAC) as of June 18, 2020, increased expected general fund revenues by $71.5 million (1.2%) for fiscal 2022 over the council's May projections. DEFAC is now projecting an unencumbered cash balance of $975.2 million for fiscal 2021, which helps inform the state's appropriation limits for fiscal 2022. Even in the event of a late budget, Delaware code directs the treasurer to make debt service payments if the General Assembly has not authorized the appropriation.

Hawaii (AA+/Negative)

The state's budget framework is in place and we understand will be signed by the governor before the start of the fiscal year. On June 21, the governor released a list of measures he intends to veto, including measures related to the appropriation of federal resources received under the CARES Act of 2020 and ARPA. Citing an improved economic outlook, the governor indicated certain measures adopted by the legislator either are no longer viewed as necessary or else conflict with guidance of permissible uses of federal funds. While the legislature can override the governor's vetoes by July 6, we anticipate the state's core operating fiscal measures will become effective before the start of its next fiscal year.

Ohio (AA+/Stable)

On June 28, 2021, Ohio's legislature passed its budget plan for the fiscal 2022-2023 biennium. State and federal general revenue fund (GRF) appropriations total $34.8 billion for fiscal 2022 and $39.2 billion for fiscal 2023, annual increases of 2.1% and 12.6%, respectively. Ohio's state-only GRF appropriations total approximately $24.2 billion in fiscal 2022 and $26.1 billion in fiscal 2023, increases of 7.1% and 7.9%, respectively. The legislative budget will go before the governor for his signature, line-item veto of certain portions of the bill if he chooses, or a full veto. In the event of a late budget, however, Ohio has authority to approve a provisional spending plan that funds state agencies at prior fiscal year levels, which we believe would have minimal effect on the state's day-to-day operations. In addition, a provisional budget mandates the inclusion of allocations for debt service and authority to make lease rental payment appropriations for the entire biennium.

Budget Development In Progress

Massachusetts (AA/Stable)

The governor has filed a one-month interim budget to keep state government running through July, if the state should not enact a budget by July 1, the start of the state's fiscal year. If necessary, Massachusetts can extend the interim budget month by month, as it did multiple times in fiscal 2021.The legislature has traditionally enacted such an interim budget before enacting a final fiscal budget in late July or August, although the fiscal 2021 budget during the pandemic year was not finally adopted until December 2020.

Minnesota (AAA/Negative)

As of June 28, the Minnesota legislature passed more than half of its 14 omnibus budget bills for the 2022-2023 biennium, including its agriculture, commerce and energy, environment, health and human services, higher education, housing, legacy, and transportation bills. However, several budget bills remain. If the remaining ones are not signed into law by June 30, funding may lapse for those areas, resulting in a potential partial shutdown for them. Minnesota last failed to pass a budget by its June 30 deadline in 2011, when a significant budget shortfall resulted in a 20-day government shutdown. During that time, a court order authorized funding for core functions of state government, including debt service and aid to schools and local governments. Since that time, the Minnesota Supreme Court has ruled that the courts cannot order funding for other branches. The state has identified specific critical services that would continue in the event of a shutdown, and payment of debt service is included in that list.

North Carolina (AAA/Stable)

North Carolina's Senate passed a general fund budget for the fiscal 2021-2023 biennium on June 24, 2021. The budget, which totals $25.7 billion in fiscal 2021-2022 and $26.6 billion in fiscal 2022-2023, reduces personal and corporate income tax rates, boosts infrastructure spending, and adds to the rainy day fund. The state's House of Representatives will draft its own plan before agreeing on one with the Senate and we understand it could be several weeks before the governor receives the full legislature's agreed-on budget. Once received, the governor will have 10 days for signature or veto. A late budget is not uncommon for North Carolina. Historically, the legislative session has several times extended past the end of the fiscal year, including 2015, when the fiscal 2016-2018 biennial budget was not enacted until September. In 2016, the legislature amended the State Budget Act to allow the Director of the Budget to continue to allocate funds for expenditures at prior-year recurring levels without further legislative action if the budget does not pass by June 30. The state has relied on the continuing resolution statute since 2019, in addition to numerous smaller appropriations bills. According to the Act, when making allocations, the Director of the Budget will ensure the prompt payment of the principal and interest on bonds and notes of the state according to their terms.

Oregon (AA+/Stable)

Oregon's legislature continues to deliberate the state's fiscal 2021-2023 biennium budget for the general and lottery funds. In May of odd-numbered years, the revenue forecast establishes general fund resources available for the upcoming budget, as well as sizing for Oregon's kicker law. The state's most recent revenue forecast as of May 2021 projected that its strong revenue trends would continue, with net general fund revenues ending the current biennium at nearly $2.2 billion, or 10.4% above the 2019 close of session forecast. We understand that based on these projections, the kicker tax rebate is likely to occur in fiscal 2022. Should the state fail to reach a comprehensive budget agreement before the start of the new fiscal year, we understand state agencies will have the legal authority to continue to make debt service payments on outstanding bonds; officials expect a continuing resolution will be adopted before July 1.

Pennsylvania (A+/Negative)

On Friday June 25, 2021, Pennsylvania's legislature passed a general fund budget that totals approximately $40.8 billion and directs $2.5 billion in better-than-anticipated revenue collections into the state's rainy day fund. We understand this would constitute the largest deposit into the fund in over a decade. The budget also allocates a portion of the commonwealth's $7.3 billion inflow of federal aid from the ARPA. Officials expect the governor will sign the budget bill prior to the start of the upcoming fiscal year. The commonwealth, which must pass a balanced budget, has had late budgets in past cycles given protracted budget negotiations.

Rhode Island (AA/Stable)

Rhode Island's House of Representatives passed a $13 billion total funds budget for fiscal 2022, approximately $1.9 billion above the governor's March executive budget proposal. Of this amount, general revenue fund spending would make up $4.55 billion, or a $178.6 million increase in expenditures compared to the executive proposal. The increase primarily reflects the inclusion of relief funds from the ARPA that were not included in the governor's executive budget proposal in March. While the state's Senate has taken up debate on the fiscal 2022 budget before the June 30 deadline, Rhode Island has extended budget negotiations in each of the previous two fiscal years. Under state law, however, it would enter the new fiscal year with the ability to spend up to one-twelfth of the previous year's budget each month until the enactment of the fiscal 2022 budget. Debt service on general obligation (GO) bonds is not subject to these limitations and is appropriated in full.

South Carolina (AA+/Stable)

The South Carolina legislature passed a nearly $11 billion fiscal 2022 budget earlier this month. We understand the budget will be enacted by July 1, 2021 without further action, although the legislature will have an opportunity to override $150 million of spending vetoed by the governor when it meets on June 30.

Wisconsin (AA/Stable)

Wisconsin's Legislative Joint Committee on Finance completed its work on a substitute amendment to the 2021-2023 executive biennial budget proposal, and the full legislature will consider the two-year $87.5 billion total funds budget during the week beginning June 28, 2021. Although the budget could receive legislative approval before June 30, Wisconsin's governor has made public that a partial or full veto of the biennial budget is possible. This reflects what we view as differing policy priorities between the legislature and governor and is not the result of a structural budgetary risk. Earlier this month, Wisconsin's Legislative Fiscal Bureau projected aggregate general fund tax collections to potentially improve by $4.43 billion over the current year and the next two fiscal years, well above its January 2021 estimates. Of Wisconsin's previous 10 biennial budgets, only three were enacted prior to the start of the fiscal biennium, with delays ranging from two days to four months. If a new biennial budget is not in place by July 1, 2021, Wisconsin law sets continuing authority for state agencies to operate with appropriations based on the prior year's budget until a new one is enacted.