(Corrects Conning's description in paragraph 15 to "investment management company")
* New formula to be based on population growth, inflation
* Governor would like to see new cap in constitution
* Texas rated AAA by Moody's, AA+ by Standard and Poor's
By Karen Brooks
AUSTIN, Dec 17 (Reuters) - Governor Rick Perry and other Republican lawmakers in Texas want to amend the state constitution to cap spending at the combined rate of inflation and population growth to maintain the state's fiscal health.
The state constitution currently limits spending to the estimated increase in state personal income, which would tend to be higher than the proposed cap.
"By taking this step, we can make constitutionally sure that Texas never spends as freely as Washington, D.C.," reads Perry's Texas Budget Compact, published on the governor's website.
A similar cap is already used in Colorado.
However any constitutional amendment must be approved by two-thirds of the members in the state legislature. Republicans lack a supermajority, which means some Democrats would have to support the measure.
Once approved by the legislature, the amendment must be ratified by voters.
Critics argue that proposing new spending limits amounts to ignoring the needs of Texans, especially students and the elderly.
The new budget should ensure that "Texas moves forward in a responsible way that provides for the growth of its citizens and the needs of its children, the elderly, colleges, universities, financial aid for college students and middle income Texans," said Democratic Representative Sylvester Turner, vice chairman of the House Appropriations Committee.
During the last session in 2011, lawmakers passed a $173.4 billion budget for fiscal 2012 and 2013 that included about $70.4 billion in non-dedicated spending.
Last month, the state's budget advisory board, composed of the house speaker, lieutenant governor and other lawmakers, agreed to limit spending to a 10.71 percent increase or a total of $77.4 billion in nondedicated funds.
POPULATION GROWTH AN ISSUE
Texas has been criticized by some bond rating agencies that say relying on spending cuts to balance its budget or make up for funding gaps is not a viable solution for a state that could continue to see rising costs. Texas has no personal income taxes, but imposes some franchise taxes on corporations.
Texas is rated AAA by Moody's investor service and AA+ by Standard and Poor's.
The budget challenges of the state, the second most populous after California, are mainly due to its population growth and linked to infrastructure, transportation and rising costs of Medicaid.
Texas is the fastest growing state in terms of population, adding 529,000 people since the 2010 Census.
"It's challenging to keep up with the growth, but they do start from a very strong position," said Paul Mansour, head of municipal credit research for Conning, an investment management company based in Hartford, Connecticut.
"In an nutshell, Texas does have some budgetary challenges going forward, but they enter this upcoming budget season in a position of strength and - with the exception of Alaska - probably the highest (rainy day fund) budget balance of any state in America."
In its recent "State of the States" report, which evaluates and ranks state credit quality, Conning ranked Texas third in the nation in financial soundness - up two spots from its ranking six months before - behind North Dakota and Wyoming.
The firm ranked Connecticut last, California at 44 and Illinois at 46.
Texas enjoys one the lowest borrowings costs in the $3.7 trillion municipal bonds market. Texas 10-year bonds this week were trading about 17 points above the Municipal Market Data top rated bonds. That compares with a spread of 129 basis point for Illinois bonds, 55 basis points for Nevada and 49 for California.
Texas, which requires that lawmakers pass a balanced budget, is one of four states that crafts a budget every two years.
Lawmakers will begin writing the state's budget after the comptroller releases revenue estimates for the 2014-15 biennium, expected a day or two before the Legislature convenes on Jan. 8. (Reporting by Karen Brooks; Editing by Lisa Shumaker)