State Savings Overflowing Amidst Pause On Spending, Tax Relief

State tax collections have surged in recent years to the point that nearly $3 billion in excess revenue could be returned to taxpayers, but so too has the amount of money that Massachusetts keeps stashed away and the state now has more than five times as much in its rainy day fund as it did five years ago.

Massachusetts pumped $2.3 billion into its Stabilization Fund, during fiscal year 2022, which ended June 30, bringing the reserve account’s balance to a historic high of $6.9 billion. And the fiscal year 2023 budget that Gov. Charlie Baker signed last month would put the Stabilization Fund on track to reach yet another record high of roughly $8.4 billion by next summer, his administration has said.

Combined with “remarkably strong revenue performance in fiscal 2022,” the amount of money socked away in reserves has Massachusetts and other states “in a much better position entering fiscal 2023 compared to the prior year,” Fitch Ratings said in a report issued this week on state budget trends.

“The majority of states continue to take a prudent approach of enhancing their budget resilience through adding to reserves, paying down liabilities, and applying what may be temporary revenues to one-time, rather than ongoing, spending. States are making sizable deposits to rainy day funds, many of which are now considered fully funded,” Fitch said.

The credit rating agency said that Massachusetts’ rainy day fund ended fiscal year 2022 with a balance “equal to nearly 17% of tax revenue” and pointed out that the fund’s bottom line has “more than quintupled since ending fiscal 2017 with a $1.3 billion balance.”

While there is no one-size-fits-all rule for how much a state should hold in reserve, 10 percent of budgeted spending has long been considered an ideal target. Before the pandemic, Massachusetts was short of that target. At the end of fiscal 2020, the stabilization fund balance of $3.5 billion was only 8 percent of that year’s $43.321 billion budget. By comparison, the $6.9 billion balance at the end of fiscal 2022 represented more than 14.3 percent of the $48.1 billion state budget lawmakers approved last year and the projected balance of $8.4 billion at the end of fiscal year 2023 would represent about 16 percent of budgeted spending.

Instead of stashing so much money away, alternatives include spending it to address unmet needs, or adopting tax relief or incentives to help Massachusetts residents or make the state more competitive with other states. Some of those approaches were included in economic development bills that cleared the branches with unanimous votes but were put on hold Aug. 1 because legislative leaders wanted to reassess the state’s fiscal picture.

The reserves are also meant to gird the state against an economic downturn. After “historically strong” U.S. gross domestic product growth of 5.7 percent in 2021, Fitch said it expects that growth will slow sharply in 2022 to 2.9 percent, and then even further to 1.5 percent in 2023 due to rising inflation and tightening monetary policy.

Eric Kim, Fitch’s senior director for state governments, said Wednesday that most states are “well positioned for slower growth” but that the most salient risk to state government credit ratings over the next year and a half is “definitely the potential for an economic downturn.”

“State revenues are very closely linked to economic performance, income and sales taxes are driven by economic activity, so if we do hit a recession and there are sustained declines in things like wages, jobs and consumer spending, then that will bring down state revenues and tighten budgets, for sure,” Kim said Wednesday. “We do think that states are generally well-positioned to manage through a downturn, having rebuilt some fiscal resilience in recent years. But a recession can be unpredictable and how deep it is, or even what sectors of the economy get hit hardest — so there’s still clearly some risk there.”

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