November Municipal Market Update: Looking Past the Negative Municipal Credit Headlines

State revenue trends in focus: While headlines may turn negative, municipal credit conditions remain strong

In recent months, state and local government tax collections have fallen from the exceptionally high and unsustainable levels in fiscal years 2021 and 2022. Total state and local revenue declined 7% in the third quarter from the same quarter last year; however, the overall backdrop remains healthy when put in context.Footnote1 State governments’ fiscal year 2024 budgeted personal income tax collections remain approximately 25% above pre-pandemic levels,Footnote2 sales tax revenues remain relatively stable, property tax trends remain positive, and state and local governments remain flush with accumulated reserves.Footnote3 We expect to see an increase in negative headlines over the coming months as state governments report softer collections relative to prior years – potentially with some falling short of 2024 budget assumptions – but this is likely indicative of a return to a more healthy and sustainable trajectory as opposed to a harbinger of growing credit weakness.

Recent data from California highlights the headline-grabbing revenue declines: California’s October general fund tax receipts missed budget expectations by -31%, with personal income tax (PIT) receipts down -$20 billion relative to budget estimates.Footnote4 This shortfall likely reflects both the shifting revenue environment and the last-minute, one-month extension of the income tax filing deadline. If the October cash report is an early indicator of economic headwinds and a sizeable upcoming budget deficit, we feel California is well-positioned to manage the downturn. Unlike during the global financial crisis, the state is not dealing with a liquidity crisis or governance constraints. Rather, this is a budgetary challenge for which the state has been preparing: California maintains solid reserves and liquidity, and is already operating under a scaled back fiscal year 2024 budget. We would expect the state to respond to an upcoming deficit with austerity measures and use of reserves.

While California was early to make fairly sweeping spending cuts in its 2024 budget, we would note that most large states have dialed back revenue growth estimates considerably for fiscal years 2023 and 2024. Figure 1 illustrates this, specifically showing how a number of states (e.g., Connecticut, New York, and New Jersey) passed budgets that assumed revenue declines and expectations of relatively flat growth in 2024. This is a major positive, as states did not create spending plans for the current fiscal year under the expectation of ongoing robust revenue growth; rather, they were already approaching coming budget cycles with caution. We expect this will make any coming adjustments due to revenue underperformance far easier than if budgets had assumed ongoing revenue growth.