August 20, 2015

Fiscal Health Tax Climate and Best Practices for Budgeting

Testimony before the Pennsylvania Senate Finance Committee and Senate State Government Committee
Key materials

Thank you Chairman Folmer and Chairman Eichelberger for inviting me to testify today on the subject of Pennsylvania’s budget and fiscal outlook. The Commonwealth of Pennsylvania has weathered several years of budgetary stress and continues to face near-term difficulty balancing the yearly budget. 

Pressures in the form of lower-than-projected revenues, increasing programmatic costs, and demographic changes have been building for many years. Pennsylvania’s financials are weak on a short-term and on a long-term basis, partially owing to policy and fiscal choices over the years, and partially because of the wider economy. Three credit ratings agencies—Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s—downgraded the commonwealth’s bond rating in 2014 in response to these trends.

In my recent research, “Ranking the States by Fiscal Condition,” Pennsylvania is ranked 41st out of the 50 states. In my testimony I will highlight several areas of fiscal weakness:

  1. Poor and deteriorating cash liquidity. Pennsylvania is ranked 45th in the nation for cash solvency.
  2. Ongoing difficulty matching revenues and expenses during the fiscal year. Pennsylvania is ranked 39th for budget solvency.
  3. Long-run obligations are significant. Pennsylvania is ranked 36th for long-run solvency.
  4. Unfunded pension and other postemployment benefits (OPEB) liabilities are a fiscal risk. Pennsylvania is ranked 26th for trust fund solvency.

I will also offer some suggestions for improving the fiscal position of the commonwealth.

Background

Recently I authored a study that ranks the 50 states according to their fiscal condition. The motivation for this study was to devise a tool for policymakers and the public to assess their state’s fiscal condition, relative to the other states, based on the audited reports of the state government. 

Fiscal condition is made up of five “dimensions” of solvency: cash, budget, long-run, service-level, and trust fund. Each of these dimensions consists of two to three indicators that measure the extent to which a state has sufficient resources to meet short-term and long-term commitments. The data to assess solvency is taken from each state’s Comprehensive Annual Financial Report (CAFR) for fiscal year (FY) 2013, the most recent year available when the analysis was performed. This study measures the financial position of the total primary government and includes both governmental activities and business-type activities.

Based on FY 2013 and compared to the other 49 states, Pennsylvania’s overall fiscal ranking is 41 with a score of −1.14, which means Pennsylvania’s fiscal performance is 1.14 standard deviations below the average performance of the states. This score only provides a measure of relative position. For a better understanding of Pennsylvania’s fiscal condition, it is necessary to look at the individual indicators that make up each dimension of solvency. 

In the following sections I go through the individual metrics for each dimension of fiscal solvency. In addition to providing the metrics from the FY 2013 study, I updated Pennsylvania’s metrics using recently released FY 2014 data to see how things have changed.

1. Cash Solvency

In FY 2013 Pennsylvania ranks 45th for cash solvency. Cash solvency measures the degree to which the state has enough cash on hand to cover short-term bills, which include accounts payable, vouchers, warrants, and short-term debt. The three metrics that make up cash solvency include the cash ratio, quick ratio, and current ratio. The cash ratio only includes the most liquid forms of cash. The quick and current ratios include less liquid forms of cash. A ratio of 2 or greater for any of these metrics is generally considered healthy.

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