No one can pinpoint if and when a recession might occur, but there are signs that state and local governments are reacting prudently to the rumblings.

As the primary issuers of municipal bonds, it is important their fiscal house is in order. So far, we see positive signs.

For example, in January, California’s governor projected a $22.5 billion shortfall for the state’s 2023-2024 state budget. In its “May Revision,” the state projects a $31.5 billion shortfall and has plans to address it.

“The administration,” according to the governor, “proposes to resolve the shortfall through a series of spending reductions, trigger cuts, and delays or deferrals of spending authorized in earlier years as well as through internal borrowing and fund shifts.”

Planning ahead

Other states also anticipate lower revenue.

Illinois said its tax revenue in April was $1.84 billion less than it was in 2022. In New Jersey, April income tax payments came in lower than expected and the state decreased its forecasted revenue by $2.3 billion.

While it is never good news when revenue doesn’t meet expectations, it bodes well that officials foresee what’s coming and prepare for it.

It is also helpful that state and local governments are in relatively good shape to withstand turbulence, as we have noted (“Strong States Behind the Municipal Bond Market”).

Public coffers weathered the pandemic relatively well and, in its aftermath, many states and cities have thrived. Federal aid provided a boost and tax revenue grew. Many states added to their reserves. Several states are stronger fiscally today than before the pandemic.

Earlier this month Illinois passed its $50.4 billion budget. It includes a $200 million supplemental pension payment, adds to the state’s rainy-day fund and pays off the state’s $450 million of tobacco bonds.

In March, Fitch Ratings moved Illinois’ outlook to positive from stable, while the state’s credit rating has been upgraded several times over the past two years.

“The approved fiscal 2024 budget continues some of the positive momentum in recent years,” Eric Kim, Fitch’s lead Illinois analyst, told The Bond Buyer.

In New Jersey, officials were caught off guard by the drop in revenue but said it was manageable.

“We are well prepared to handle this April surprise,” Treasurer Liz Muoio said last month.

While New Jersey state lawmakers are currently meeting to discuss a raft of bills for the 2024 fiscal year, which starts July 1, the governor’s proposed budget from earlier this year called for fully funding the public-worker pension fund obligations.

Governments, as Franklin Templeton noted, have many tools to address upcoming fiscal challenges.

“While the forecast looks cloudy, state and local governments have largely planned well for a rainy day, and we believe they should be able to address these challenges without ratings downgrades or serious changes in credit quality,” the investment firm said.

Advance refunding bonds support states

Congress can further support the fiscal health of state and local governments by passing legislation restoring the tax-exempt status of advance refunding bonds.

Refinancing municipal bonds, also referred to as advance refunding, enables issuers to replace older, higher-interest rate bonds with new, lower-interest rate bonds and therefore save money.

The tax-free feature of advance refunding bonds was removed as part of the 2017 tax overhaul. It was a bad idea and should be reversed.

A new bipartisan bill was introduced last month in the Senate that would restore the tax-free status of advance refunding bonds. We strongly support its passage.

State and local government finances fluctuate in unexpected ways, so it is impossible to predict precisely how they will fare.

But municipal bonds are the engine that finances critical community needs and they depend on healthy issuers.

Like all municipal bond investors, we cheer when governments prudently manage their finances and have the tools to do so.