Massachusetts budget taps rainy day fund, federal aid

Paul M. Drury, CFA, Portfolio Manager, and Garrett L. Hamilton, CFA, Portfolio Manager, 03/24/21

  • Massachusetts Governor Charlie Baker proposed a $45.6 billion budget for FY 2022.
  • The budget proposes a withdrawal from the state’s rainy day fund.
  • The plan does not include tax increases for state residents.

Massachusetts Governor Charlie Baker released a $45.6 billion budget proposal for FY 2022 in January. The proposal relies on federal aid and a withdrawal from the state’s rainy day fund to balance the budget and avoid raising taxes.

The budget estimates $30.12 billion in tax revenue and 3.5% higher total tax collection compared with FY 2021.

The proposal reflects a 0.7% reduction in spending from FY 2021. The budget includes decreases in tax projections from MassHeath, the state’s Medicaid and children’s health insurance program which experienced costs increases last year due to the pandemic. The state anticipates that costs and caseloads will decline as the pandemic recedes.

The budget has many goals, including pandemic response and economic development. The plan includes funds for cities and towns, and programs addressing substance abuse and racial equality. The plan also funds the state’s new Student Opportunity Act, which provides support for school districts with students from low-income households.

More federal aid approved

To balance the budget, the proposal relies on federal aid and a withdrawal from the state’s budget stabilization fund.

Massachusetts expects to tap the fund for about $1.35 billion to cover the current fiscal year. For FY 2022, the budget proposal calls for a $1.6 billion withdrawal, which would leave about $1.11 billion in the fund.

Still, that amount could change now that Congress has approved The American Rescue Plan (ARP). The ARP provides billions in federal aid for states. Massachusetts expects to receive $8.1 billion in direct government aid, including $4.44 billion for the state and $3.78 for local governments. (Tax Foundation)

Receipts higher than anticipated

Massachusetts was one of a handful of states that saw higher-than-expected tax receipts in FY 2021. About seven months into FY 2021, tax revenue was up 4.5% over the same period in the prior year.

The state’s financial status has also benefited from higher cost reimbursement for Medicaid. The federal government increased its percentage reimbursement of Medicaid costs by 6.2 percentage points through at least the end of fiscal 2021. This could mean an extra $880 million in fiscal 2021, according to state projections (S&P Global).

Credit outlook stable

In a February 22 report, S&P Global Ratings noted the governor’s budget proposal presents “a relatively stable credit picture in the near term.”

The proposed rainy day fund withdrawal did not change the outlook. The S&P report stated that the proposal is a “moderate drawdown, from levels we believe are currently good, to a level we would still consider adequate.”

The report noted that the withdrawal was “not necessarily a cause for credit concern unless indicative of a large ongoing structural deficit, or the state lacks willingness to rebuild reserves during strong economic times.”

S&P rates the state’s general obligation bonds AA.

Challenges include potential higher health-care costs, education spending, and pension obligations. The state will also have to rebuild its reserve fund.

Massachusetts is also monitoring a pending Supreme Court case — New Hampshire versus Massachusetts — that could change the rules for cross-border taxation. If the court rules that non-residents who are no longer commuting and working remote should not be subject to Massachusetts income tax, the state could lose a significant amount of revenue.

Prior to the pandemic, more than 97,000 New Hampshire residents — or 15% of the state’s workforce — commuted to work in Massachusetts (Census 2017, most recent data available). New Hampshire has one of the highest rates of interstate commuting in the nation, second only to Rhode Island.

Putnam’s municipal bond experts are looking closely at the budget burdens on states caused by the Covid-19 pandemic, and how these factors, among others, could affect the relative value and credit risk of bond issues, including Massachusetts municipal bonds. Putnam continues to view the State of Massachusetts as well positioned from a financial and governance standpoint, and we believe the state has the tools available to weather the pandemic.

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