Rating agencies raise concerns on tax plan
Fear overreliance on income tax, $400m borrowing
STATE HOUSE NEWS SERVICE
GOV. DEVAL PATRICK’S $34.8 billion state budget plan and his proposed tax reforms have raised some alarms at Wall Street credit rating agencies, which are concerned about an overreliance on income tax revenue, additional withdrawals from the state’s rainy day fund, and borrowing $400 million in anticipation of future revenues.
“Despite the significant revenue enhancement and positive baseline revenue growth, the budget is not structurally balanced in our opinion and relies on nearly $1 billion of nonrecurring measures,” Standard & Poor’s wrote in a March 18 report. The same report said the outlook of Massachusetts is stable, which “reflects our expectation that Massachusetts will continue to proactively manage its budget.”
“Those are more the trees than the forest,” said Scott Jordan, deputy secretary for capital finance and intergovernmental affairs.
Patrick’s tax overhaul calls for a one-point increase in the income tax, bringing it up to 6.25 percent, coupled with a sales tax decrease, bringing that rate down from 6.25 percent to 4.5 percent, as well as a doubling of the personal exemption, new business taxes, and the elimination of certain tax deductions.
Requiring the income tax to pull in an even greater portion of the state’s revenue would leave Massachusetts vulnerable, Moody’s, another rating agency, asserted.
“Based on fiscal 2013 estimates, 58 percent of the Commonwealth’s general fund revenues come from personal income taxes. The proposed change would increase that to 72 percent, the second highest of any state and an increasing of Massachusetts’ reliance on an already volatile revenue source,” officials from Moody’s wrote in a March 15 report. Regarding the borrowing, the report said, “The short-term borrowing would be paid across three fiscal years and is essentially a deficit financing, an unusual tool for a highly rated state with as strong a financial position as Massachusetts.”
Jordan said Massachusetts counterbalances the volatility of the income tax, by directing a portion of capital gains taxes in excess of $1 billion to the rainy day fund, and pointed out that the Massachusetts sales tax is more limited in scope than other states where more products are subject to the tax.
“It’s not more volatile than the income tax,” Jordan said, of the sales tax. “But its long-term prospects for growth are less.”
In order to smooth the influx of the planned new revenue, the governor’s budget proposes borrowing $400 million in fiscal year 2014, through revenue anticipation notes, which would be repaid over the next three years. The new tax revenue would start arriving midway through fiscal 2014.
Jordan said the borrowing amounts to cash management, and the proposed revenue would pay for it. The $400 million is less than the $1 billion in short-term debt the state regularly issues within a fiscal year.
A $400 million extraction from the state’s stabilization fund that rating agencies have highlighted would be mitigated by the regular deposits in the stabilization fund from capital gains taxes and tax settlements.
“It’s not a static rainy day fund as some states have,” Jordan said. He said, “There’s a chance that the net could be zero. It could be a net deposit.”
“Although moderate in size, Fitch would consider the proposed bonding to be a deficit financing and would evaluate closely the Commonwealth’s plans for reserve funding going forward given the material drawdown of funds at a time of revenue recovery,” Fitch Ratings wrote in its March 15 rating.
Moody’s said the state rainy day fund would still have more than $1 billion after the proposed withdrawal, but said the fund’s balance would fall to 4.7 percent of forecasted tax revenue. Standard & Poor’s noted the rainy day fund balance was about $2.3 billion before the last recession struck.
“A lower reserve translates to less flexibility in our view, given the historical volatility of the revenue base and the uncertainty surrounding potential federal fiscal condition,” S&P wrote in its assessment.
While Jordan said the credit raters’ faith in the state’s fiscal future is apparent in the high credit rating and “stable” outlook given by the big three agencies, concerns have spread beyond the rating agencies.
“When you use the phrase ‘credit negative’ that is, to me, a warning sign,” Treasurer Steven Grossman told the News Service.
Grossman said that when he recently spoke with credit raters ahead of a $525 million borrowing for capital projects, the agencies raised concerns, which he then raised to Patrick and legislative leaders – House lawmakers are in the final stages of rewriting Patrick’s budget with their draft due out April 10.
House Democrats are working on an alternative plan to raise significant amounts of new revenue, though less than the $1.9 billion the governor is seeking. House Speaker Robert DeLeo has said he senses almost no appetite in the House to raise the income tax rate by a full point.
“The treasurer recently provided us with some information relative to some concerns of the rating agencies dealing with the amount of money that was taken from the stabilization fund, the amount of money that was borrowed, so we’ve got considerations there,” DeLeo told the News Service on Monday. “We didn’t want to see our bond rating go down, when we worked so hard to get it up.”
Grossman noted borrowing and repaying money within a fiscal year is a normal practice of state government, and the state receives favorable rates for that lending. Borrowing in one fiscal year with the plan to pay the money back in a future fiscal year is frowned upon, Grossman said, noting the “tone” of the credit raters in addition to their language made their concern clear.
Grossman said the state received a favorable rate when it recently borrowed $525 million, and would go back to the market in May for $750 million.
While Grossman has supported the need for more revenue, he has also cautioned against the borrowing scheme Patrick proposed.
“I’ve made it clear, and consistently, that I think that’s a bad idea,” said Grossman, of the proposed borrowing. “I think that puts us in a bad place.”
Despite his reservations about the governor’s methods, Grossman supports the overall plan of raising new revenue for transportation and education.
“The governor is absolutely right,” Grossman told the Massachusetts chapter of the National Association of Social Workers on Monday. “If we don’t invest in transportation, infrastructure and education; if we don’t find ways to raise some revenue consistent with the needs of protecting middle-class families – to raising exemptions and dealing with the challenges middle-class families have – we’re never going to get to where we need to be.”
Ahead of a Joint Committee on Revenue hearing on a slate of bills, House Revenue Chairman Jay Kaufman (D-Lexington) said he shares concerns about the drawdown on the rainy day fund.“I absolutely share their concern about overreliance on the rainy day fund, and drawing down on reserves,” Kaufman told the News Service. He said he needed more information on other aspects of the credit raters’ report.
In its assessment, Standard & Poor’s also noted there have been no state budget adjustments in connection with sequestration – the federal spending cuts recently ordered by President Obama amid a chorus of worry about impacts on the public and private sectors – but said the Patrick administration was forming a task force to assess economic and budget implications.