Minnesota received good fiscal and economic news recently, as the Fitch rating agency improved the state’s bond rating from AA+ to AAA—the highest rating possible. The improved rating will translate into reduced borrowing costs for Minnesota state and local governments and is further indication that Minnesota’s economy is doing well, contrary to conservative claims.
Fitch is one of three independent rating agencies, along with Standard & Poor’s (S&P) and Moody’s, that periodically evaluates the credit worthiness of governments based on financial and economic conditions, financial and debt management practices, pension liabilities, and demographic factors. According to Minnesota Management & Budget:
Bond ratings are important as they measure the credit risk to the investors and affect the interest rates of the bonds. When Minnesota has a higher bond rating, it indicates to investors that we are a safe investment risk and they will accept a lower rate of return. This translates into lower interest rates for the state and reduces our cost of borrowing.
The last time the State of Minnesota enjoyed a AAA rating from all three rating agencies was in 2002. Moody’s downgraded the state bond rating from AAA to Aa1 in 2003, while Fitch and S&P downgraded Minnesota’s bond rating to AA+ in 2011.* The 2003 and 2011 downgrades corresponded with the use of “accounting gimmicks” in order to balance the state budget. In 2003, the state delayed aid payments to school districts† in order to produce a one-time reduction in state expenditures, while in 2011 the state obtained a one-time cash infusion through the sale of future state tobacco settlement revenue.‡ Rating agencies typically look askance at these sorts of accounting gimmicks, insofar as they are merely quick fixes that do not address the root causes of state budget problems.
The recent upgrade from Fitch follows an improved rating outlook from S&P in 2015, from “stable” to “positive.”
According to the press release from Fitch, Minnesota’s restored AAA rating “reflects a combination of positive credit developments.” Specifically,
The ‘AAA’ rating reflects Minnesota’s solid and broad-based economy, a revenue structure well designed to capture economic growth, a low liability burden, and strong control over revenues and spending that, in conjunction with a sophisticated approach to reserve funding, leaves the state exceptionally well positioned to manage throughout the economic cycle while maintaining a high level of financial flexibility.
Several other observations from Fitch merit additional scrutiny and comment.
Minnesota’s restored AAA rating from the impartial financial experts at Fitch is good news for state residents and businesses. Much of the credit for the AAA rating goes to progressive policies, which were in large part responsible for ending the cycle of recurring budget deficits and accounting gimmicks that had plagued the state during the preceding decade and that contributed to the loss of the AAA rating in the first place.
*Moody’s uses a different rating scale than Fitch and S&P. For Moody’s, Aa1 is the rating immediately below AAA. For Fitch and S&P, AA+ is the rating immediately below AAA.
†During periods of budget deficits, state policymakers frequently respond by delaying a percentage of state aid payments to public schools until the following fiscal year through (1) an aid payment shift (in which the state delays an increased portion of the school aid appropriation) and/or (2) a levy recognition shift (in which school districts are required to “recognize” property tax receipts before they actually materialize, hence allowing the state to delay aid payments to schools by an equivalent amount). While this shift does not reduce the amount that public schools are “entitled” to spend, it may require them to spend down budget reserves or engage in short-term borrowing. The primary effect of the K-12 funding shift is to reduce state spending on a one-time basis in the fiscal year in which the shift initially occurs. However, school funding shifts by themselves do nothing to resolve long-term imbalances between state revenues and expenditures, and thus rating agencies tend to view them unfavorably.
‡As part of the deal to end the 2011 state government shutdown, state policymakers agreed to sell a future stream of state revenue resulting from the 1998 tobacco settlement for the sake of a one-time upfront cash infusion through the issuance of “tobacco settlement revenue bonds.” This revenue was used to reduce state general fund debt service spending in the FY 2012-13 biennium. The apparent spending reduction resulting from this accounting maneuver was illusory insofar as the debt service spending was still occurring, but was funded with non-general fund dollars on a temporary basis. As with school funding shifts, the sale of future state revenue streams do nothing to resolve long-term imbalances between state revenues and expenditures (and may make future revenue shortfalls more likely), and hence rating agencies tend to view them unfavorably.