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Trying to Strike Delicate Balance on Size of State’s Budget Reserves

Murphy’s plan to bump up the budget reserves should make credit-rating agencies happy, but if lawmakers want the money to go to more pressing needs, it could mean another downgrade

tightrope walker

Wall Street credit-rating agencies and other fiscal watchdogs routinely knock New Jersey for maintaining razor-thin budget reserves, and one thing that’s been largely overlooked in Gov. Phil Murphy’s proposed budget for the upcoming fiscal year is a plan to give the surplus account a major boost.

But if the governor’s plan to pad the reserves by nearly $350 million is derailed by Democratic lawmakers, it could risk another credit-rating downgrade for the state.

And Murphy’s plan for the surplus could already be in jeopardy as legislative leaders continue to resist the major tax hikes that are key elements of the governor’s overall spending plan, including a higher income tax for millionaires and a return to a 7 percent sales tax. The increased revenue from these initiatives will make it easier for Murphy to add to the surplus.

The drafting of a fiscal year 2019 appropriations bill is still pending in the Legislature, but there have been suggestions that some of the money earmarked for the surplus should instead be used to pay for other parts of the governor’s budget that are higher priorities for lawmakers. They include increased spending on K-12 education, mass transit, property-tax relief, and public-worker pensions.

Weakening the surplus account would be politically convenient for majority Democrats who are balking at Murphy’s tax hikes, and it could even be tempting for the governor, a first-term Democrat, as he looks to avoid an ugly government shutdown that would unfold if a budget deal cannot be reached before the June 30 deadline. But it could also lead to another downgrade from the credit-rating agencies, since they already consider the state to be running on a very tight margin.

“We’ve all read their letters of opinion on what they are looking for,” state Treasurer Elizabeth Maher Muoio told lawmakers during a recent budget hearing in Trenton.

“They’re looking for a strong surplus,” she added.

A history of credit-rating downgrades

New Jersey was hit with a string of credit-rating downgrades during the eight-year tenure of former Republican Gov. Chris Christie, and at this point only Illinois has a worse debt grade among U.S. states. The downgrades are a major source of embarrassment for the state, and Democrats repeatedly heaped criticism on Christie for them. But downgrades also typically mean New Jersey taxpayers get hit with higher interest costs when the state government has to borrow money for long-term initiatives that can’t be funded in a single budget.

In their warnings to investors, credit-rating agencies have highlighted a number of things they don’t like about New Jersey’s current finances, including a huge unfunded pension liability and significant debt. They’ve also routinely criticized the state for using too many one-shot budget gimmicks, and for maintaining only the slimmest of reserves.

In fact, several weeks ago S&P Global Ratings, which rates New Jersey’s credit at A-, commented on the surplus issue as it weighed in on Murphy’s overall budget proposal for fiscal 2019. While the governor is calling for the surplus account to be increased significantly compared with the budget he inherited from Christie — from $409 million to $751 million — S&P still labeled that level of reserves a “small 2 percent of proposed appropriations.”

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By contrast, the latest research compiled earlier this year by The Pew Charitable Trusts indicates the median amount of budget reserves for all 50 U.S. states during fiscal 2017 totaled about 8 percent of their overall spending. Pew’s research also ranked New Jersey among the states that maintain the slimmest of reserves, having enough money socked away to cover just 4.6 days of operating expenses. Only Connecticut, at 4.4 days, fared worse than New Jersey in Pew’s analysis, which also explained why states should maintain healthy reserves.

“States use reserves and balances to manage budgetary uncertainty, deal with revenue forecasting errors, prevent severe spending cuts or tax increases when there are unexpected revenue shortfalls, and cope with unforeseen emergencies,” Pew said.

OLS sees a smaller surplus

When the issue of the surplus account came up during the latest budget committee hearings in Trenton, lawmakers focused on a different accounting of the surplus for fiscal 2019 that came from the nonpartisan Office of Legislative Services. The OLS projects a $517 million surplus, officials said, largely because its tax-collection forecast is less optimistic than Murphy’s.

Asked by Senate Budget and Appropriations Committee Chair Paul Sarlo (D-Bergen) how rating agencies might respond to a surplus totaling $517 million instead of over $700 million, OLS Budget and Finance Officer Frank Haines suggested it could be a concern since it would not be “as healthy as it should be for a budget our size.”

“I think a surplus that small will put us on the outside of the boundaries of what other states (maintain), and outside the boundaries of some common math on what an adequate surplus should be,” he went on to say.

Sarlo had a similar question for Muoio, the state treasurer, and she noted the smaller surplus forecast by OLS would equal less than 2 percent of total spending, which is set to increase to over $37 billion in fiscal 2019 unless lawmakers come up with significant cuts.

“What rating agencies want to see is that we get closer to 6 to 8 percent, working our way to 10 percent,” Muoio said.

“I’m comfortable in saying they will definitely like a $700 million surplus better than a $500 million surplus,” she went on to say.

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