Fitch says California must contain spending to continue rebound

Fri Nov 22, 2013 2:40pm EST

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Nov 22 () - (The following statement was released by the rating agency)

Nov 22 - California is benefiting from an economic and revenue rebound, combined
with three consecutive balanced budgets. However, continuing this progress will
require the state to resist restoring spending levels and prioritize the payoff
of past borrowing for operations, Fitch Ratings 
says. Although California's fiscal situation has improved significantly, we also
believe it remains a long way from fully recovering from the effects of the two
fiscal crises experienced in the past decade.

California's Legislative Analyst's Office (LAO) published its state fiscal 
outlook this week, projecting continued budgetary surpluses through fiscal 2019,
a forecast that we consider reasonable. LAO's favorable outlook is the product 
of ongoing economic growth, recent temporary tax increases and consistent state 
actions to maintain spending austerity at a time of rising revenues. 
Notwithstanding recent budgetary discipline, the state historically has had 
difficulty restraining spending growth during periods of strong fiscal 
performance, setting the stage for more severe fiscal weakness in the inevitable
recession that follows. 

The governor has long emphasized the importance of eliminating the budgetary 
borrowing, mainly owed to schools, remaining from these fiscal crises. The state
has made material strides to date, lowering the balance to $26.9 billion in 
fiscal 2013 from $34.7 billion in fiscal 2011. The state's forecast assumes 
budgetary borrowing will fall to $4.7 billion by fiscal 2017.

In our view, California has other budgetary challenges beyond repaying 
borrowing. The state has yet to correct the deep underfunding of teacher pension
contributions, which CalSTRS estimated at $4.5 billion as of July 1, 2014. And 
annual interest payments to the federal government on the state's unemployment 
trust fund deficit, estimated to be $9.7 billion as of Dec. 31, 2013, are 
ongoing. The state's October 2013 unemployment insurance fund forecast assumes 
benefit payments exceeding employer receipts through 2015, with only slow 
progress lowering the deficit in the near term.

The LAO report also notes the risk of another recession during the forecast 
period. The volatility of California's tax revenues, particularly capital gains 
taxes, has been a key factor in the state's recent fiscal crises. In our view, 
temporary tax rates approved by voters last year are likely to increase this 
volatility. Institutional changes made since the 2008-2009 recession would make 
timelier, more effective responses to future cash and budgetary weakness more 
likely, although the state has not yet begun rebuilding its rainy day fund as a 
cushion against revenue underperformance. Recent revenue momentum is solid; 
year-to-date through October, the Department of Finance reports revenue 
collections 1.9% over forecast, with solid personal income tax receipt levels 
offsetting weakness in sales and corporation tax receipts.
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