Fitch says California must contain spending to continue rebound
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.