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Fitch: Pennsylvania revenue shortfall adds pressure, but options remain

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Pennsylvania's recent announcement of a $425 million estimated general fund revenue shortfall for the current fiscal year through April adds to fiscal pressure the state is facing, according to Fitch Ratings.

The state, whose general obligation bonds are rated AA with a negative outlook by Fitch, faced significant challenges in balancing the budget for the coming fiscal year 2015 even before the revenue forecast was reduced, Fitch said in a news release.

Given the state's lack of substantive reserves, the new revenue shortfall will require significant expenditure reductions with just two months remaining this fiscal year, the release said. However, unlike New Jersey, which also recently announced significant revenue declines that triggered a rating downgrade by Fitch, Pennsylvania's shortfall appears more manageable and the commonwealth's current budget does not include significant one-time measures beyond partial use of last year's ending general fund balance.

According to the Pennsylvania Department of Revenue, the shortfall is primarily attributable to weakness in personal income tax collections, as is the case in the nearby states of New Jersey and Connecticut. Previously, Fitch noted that sharp revenue gains in fiscal 2013 in several income tax-reliant states were at least partially due to income acceleration into calendar year 2012 in advance of federal tax changes.

The fiscal 2014 shortfalls appear related to an underestimate of the lingering effects of that acceleration in some states. Pennsylvania has already implemented multiple rounds of expenditure reductions over the past several years, making further reductions more difficult, the release said.

Rising pension-funding demands present another obstacle. Pension reform measures proposed last year by the governor did not receive legislative support, and no specific measures to reduce costs have been enacted yet this year. Fitch believes the state has some revenue flexibility because of its moderate tax burden, as well as economic and revenue upside attributable to its growing natural-gas industry.

"The current administration and legislative leadership have generally been resistant to broad-based tax increases in recent years, choosing instead to balance budgets primarily with expense cuts," the Fitch report concluded.

The negative outlook on Pennsylvania's bond debt primarily reflects Fitch's view that growth in fixed costs could outpace revenue growth, pressuring Pennsylvania's financial profile. Continued inability to address these concerns, or worsening of any of these conditions over the near term, could trigger further negative rating action, the release said.

The Fitch report echoes a recent Independent Fiscal Office study, which projects a long-term structural deficit starting with the 2014-15 budget deliberations. The IFO considers demographic, economic, revenue and expenditure trends that might affect fiscal position.

That’s because surplus funds carried over from 2010-11 have been steadily consumed and will be nearly exhausted by the end of the current fiscal year, according to the IFO. Mandated employer contributions for pensions and health care inflation will continue to drive much of the expenditure growth in the five-year projections.

The unfunded liabilities of the Public School Employees’ Retirement System and the State Employees’ Retirement Systemare more than $47 billion.

Budget talk is expected to dominate the agenda when state lawmakers, who go on break after today, return June 2.

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