US Budget Season Implications for the Muni Market

Key takeaways:

  1. We knew that California would announce a budget deficit.
  2. California’s credit ratings incorporate the tax volatility it faces, so as long as the state employs a diverse approach to addressing any deficits, we don’t expect any ratings actions at this time.
  3. A slowdown in US economic activity is likely to impact most states and some could see budget deficits as costs rise at the same time.
  4. States and many muni credits go into this period of slower or negative growth with very strong balance sheets and reserve funds.

For those who watch state budgets closely, January marks the official beginning of “budget season” with California Governor Gavin Newsom’s release of his preliminary budget for fiscal year 2024 (FY24). With the sheer size of California’s budget and its highly volatile tax revenue structure, among other things, the California budget release gives us a peek into some of the challenges or opportunities that the larger US states will have as we move closer to June 2023 budget adoptions.

It was no surprise that Newsom announced a budget deficit. First, the state has been reporting monthly underperformance of revenues since the summer. Second, the state is highly dependent on capital gains and personal income tax revenue, which are weakening due to stock market weakness and wage growth slowing. And finally, the state had been seeing unprecedented revenue growth post-pandemic and we know that this would not continue indefinitely, especially given the Federal Reserve’s increases in interest rates and inflationary pressures.