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Moody’s Expects New Jersey To Use ‘One-Shots’ To Fill Shortfall

Christie
Credit: Governor's Office/Tim Larsen

While Gov. Chris Christie is proclaiming that there is “nothing off the table” to close this year’s $800 million budget gap, Moody’s Investors Service said yesterday it will be keeping a close watch not only on how heavily the state relies on “one-time solutions” to close the current gap, but also on whether those short-term fixes cause further problems in next year’s budget.

Treasurer Andrew Sidamon-Eristoff’s announcement that New Jersey is facing a major budget crisis with just two months to go in the fiscal year was such a serious shock that Democratic legislative leaders passed up the opportunity for partisan sniping and pledged to work cooperatively with the embattled governor -- even though the most likely solution could be a cut or deferral of part of this year’s $1.558 billion pension payment.

One of the biggest concerns among state officials is the reaction of the bond-rating agencies to the types of measures the state will need to take to fill a significant current-year revenue shortfall for the fifth time in just three fiscal years. Three weeks ago today, Standard and Poor’s downgraded the state’s bond rating to single-A status -- above only Illinois and California—which will increase the state’s borrowing costs. S&P, Moody’s and Fitch Ratings, Inc., all list New Jersey’s credit outlook as “negative” and criticized the fiscal gimmicks Sidamon-Eristoff had to use to plug a $697 million budget hole just two months ago.

State leaders are right to be worried.

“When we look at how at how the budget is balanced, we will pay close attention to the mix between recurring cuts and one-time solutions, and what type of one-time solutions get utilized,” Moody’s Vice President Baye Larsen said in an interview yesterday. “Whatever portion of the gap is resolved with one-time measures, the problem will cascade into Fiscal Year 2015, and additional balancing will need to be done then.

“Given the fact that the state has utilized nontraditional approaches to balance the budget gaps they dealt with earlier in the fiscal year, it is very likely they will have to consider similar nontraditional balancing tactics for this budget gap as well,” Larsen said.

Those “nontraditional balancing tactics” included the Christie administration’s decision to retroactively cut pension payments by $93.7 million this year and to trade $400 million in future tobacco bond revenue for a one-time $92 million upfront payment to help plug a $694 million budget gap identified by Christie in his February 25 budget speech.

Larsen’s March 28 report in Moody’s U.S. Public Finance Weekly Credit Update, entitled “New Jersey’s Reduced Pension Contribution Reflects Persistent Budget Pressure,” concluded that those maneuvers were a sign of the state’s budgetary weakness.

With the latest $800 million gap, New Jersey’s budgetary weakness is worse now than it was then.

“These revenue numbers are troubling,” said Assembly Majority Leader Lou Greenwald (D-Camden), a former budget committee chairman. “Bumper sticker slogans and town hall theatrics won't solve this pressing problem.”

That didn’t stop Christie from using his Statehouse news conference yesterday to claim that the new $800 million shortfall “just puts a greater spotlight on the point I have been making at town hall meetings” -- that the New Jersey state budget cannot “grow out of” the soaring pension, retiree health benefit, and debt-service costs that are going to eat up 94 percent of the increase in state revenues for FY15.

Christie said he was surprised when he learned about the deficit Monday at noon, and immediately called Senate President Stephen Sweeney (D-Gloucester) and Assembly Speaker Vincent Prieto (D-Hudson) to notify them of the problem.

“I’m going to use every tool at my disposal to get a balanced budget,” Christie said. When asked if that included a partial cut or delay in the state’s pension payment, he said there is “nothing off the table,” and that it would be “irresponsible” to rule out any solution when the state has to fill such a large budget gap with just 60 days left before the FY14 ends on June 30.

He said he would ask his Treasury Department and his governor’s office to come up with solutions. In addition to Sidamon-Eristoff and his top aides, sources said they expect Lou Goetting, the governor’s deputy chief of staff who served as a deputy treasurer under Republican Gov. Christine Todd Whitman, to play a key role in crafting the budget plan. Christie said he hoped to work in a “collaborative process” with Democratic legislative leaders, but if not, he said he would “do what I did in 2010,” when he unilaterally imposed $2 billion in midyear budget cuts.

Christie said the steep drop in income tax collections -- which Sidamon-Eristoff attributed to high-income taxpayers shifting more income than expected from 2013 into 2012 to avoid a hike in the top federal income tax rate from 35 percent to 39.6 percent -- proved his point that “when you raise tax rates on higher-income people, people will change their behavior to avoid” paying the higher taxes.

It was a political argument aimed squarely at any Democratic legislators who might be considering trying to plug the budget gap by passing a “millionaire’s tax” increase on New Jersey’s estimated 16,000 millionaires or a “half-millionaire’s tax” hike on the 1 percent of New Jerseyans who pay 40 percent of the state’s income tax.

Christie also dismissed a question about whether his Treasury Department, which has overestimated tax revenues three years in a row, should have been aware of the magnitude of the shift in income by wealthy taxpayers prior to the January 1, 2013, “fiscal cliff.” Christie noted that the nonpartisan Office of Legislative Services and treasury departments in other states made the same mistake. “A number of states across the country are dealing with the exact same problem,” he said.

Larsen, the Moody's vice president, agreed that it is more difficult for a state like New Jersey that relies more heavily on high-income taxpayers to estimate “the impact of the federal tax increases on high-income taxpayers.” However, she noted that “there has been a lot of research and industry discussion in the past year on the risk of lower-than-expected 2014 income taxes, so we have been anticipating this as a potential budget risk for all states.”

The State University of New York’s Nelson A. Rockefeller Institute of Government warned seven weeks ago that the “disappearing temporary effects of the fiscal cliff” were the cause of anemic income tax collections in the fourth quarter of 2013 that were the weakest since 2010, and analysts cautioned that state governments might be facing a bitter April surprise.

With regard to New Jersey’s revenue estimates, Larsen said “we have commented on the three consecutive years of optimistic revenue assumptions that have resulted in midyear budget gaps, and those optimistic estimates are key components of the persistent budget challenges.” However, she added that “the reason behind the (current) revenue shortfall is less important than the actuality of it and how they respond to it.”

“We’re focused first on the impact on the FY14 budget, and given that there are only two months left in the fiscal year, there is very little time and very little of the budget left to adjust to this shortfall,” Larsen said. “This new shortfall is only 2.5 percent of the budget, but only 17 percent of the budget is left, so the shortfall is equivalent to almost 15 percent of the remaining appropriations.”

Larsen said it is Moody’s Investors Service’s “perspective is that it will be a significant challenge to balance the budget this late in the year, and that the specific actions they take will be very important in understanding how this reverberates in FY15.”

Any one-time revenues or nonrecurring budget savings used to make up this year’s $800 million shortfall would have to be matched by equivalent cuts in the FY15 budget. And that does not include the reductions that will have to be made in FY15 spending when Sidamon-Eristoff adjusts his $34.4 billion revenue projection for FY15 downward to reflect the fact that revenue collections for FY14 are now expected to total just $31.8 billion -- not the $32.6 billion he projected in February.

Moody’s and the other bond-rating agencies criticized the state’s decision to cut its surplus to less than 1 percent of state revenues in both its FY14 and FY15 budgets -- a problem that was underscored by the most recent budget shortfall.

“Given the state’s narrow liquidity and fund balance, there is very little to rely on to balance the shortfall,” Larsen said. “The state treasurer stated that he would not use any of the fund balance. Even if he did, it would cover less than half of the shortfall.”

Moody’s dropped New Jersey’s credit outlook from “stable” to “negative” in December, and those credit outlooks traditionally remain in place for 12 to 18 months, although Moody’s pays close attention to ongoing fiscal developments, Larsen said.

In its most recent report on the state, Moody’s listed four factors that could lead the bond-rating agency to lower New Jersey’s actual credit rating, as Standard and Poor’s did earlier this month. First would be the state’s “failure to restore liquidity position” by increasing the surplus, which was not contemplated in Christie’s original budget proposal and is less likely now that the state is facing such a large shortfall.

The second was “slower-than-projected revenue growth that increases budgetary pressure, particularly in light of rapidly growing pension” and retiree healthcare costs. The $800 million shortfall is due to slower-than-projected revenue growth -- even if other states made the same forecasting mistake -- and any reduction or deferral of scheduled pension payments would exacerbate future pension cost growth.

The third factor was “growing dependence on nonrecurring budget solutions,” a reliance that is likely to grow substantially as a result of the $800 million budget fix.

Finally, Moody’s cited “a return to economic stagnation or a significant increase in the state’s debt position.” New Jersey has yet to make up the jobs lost during the Great Recession, and the most recent unemployment statistics showed a spike in discouraged workers no longer looking for work. The state has overborrowed so heavily for the Transportation Trust Fund that the transportation capital fund will be a billion dollars short in FY16, Transportation Commissioner Jim Simpson confirmed at an Assembly Budget Committee hearing Monday.

“Everybody’s worried that the bond agencies are going to lower the credit rating again,” one Republican source acknowledged yesterday

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