Shelley B. Leibowitz Director | Morgan Stanley
Morgan Stanley Investment Management (MSIM) has published its 12th annual State of the States Report, which shows a slowdown in state revenue growth following two years of rapid expansion due to pandemic-related government stimulus. The report indicates a stable credit outlook for most states, with many planning budget cuts of about 6% for the next fiscal year.
Craig Brandon, co-head of Municipal Investing for MSIM, commented on the findings: “While we believe most states are on solid footing, there are several critical factors looming that will have long-term implications for states’ creditworthiness and ability to respond to shifting market dynamics. Unfunded pension liabilities and increasing Medicaid costs continue to challenge state budgets, while natural disasters continue to have an outsized impact not only on budgets but also future planning. Additionally, out-migration and demographic shifts are two issues that warrant close examination.”
The report notes that state debt levels remain generally low as many states reduced borrowing after the Great Recession and experienced GDP growth. Rainy day fund balances are at record highs, with projections indicating further increases in 2025. However, five states currently have less in reserves than they did in 2007.
Brandon added: “Understanding how states rank from a credit standpoint influences portfolio decisions. With a new Presidential Administration and uncertainty related to the potential extension of the Tax Cuts and Jobs Act, this analysis pinpoints areas of strength and deficiencies, and helps us identify which states are positioned to address policy changes, demographic shifts and unforeseen events that tap into state agencies and budgets and leverage infrastructure resources.”
Key findings include a decline in debt and unfunded pension burdens due to GDP growth, investment returns, and pension reforms. Nonetheless, overall pension liabilities remain substantial despite over-contributions by many states in recent years. Puerto Rico is highlighted as an outlier with a 59% liabilities-to-GDP ratio. Medicaid costs significantly impact state budgets, especially in Colorado, Missouri, Arizona, Pennsylvania, Connecticut, and Kentucky.
The comprehensive report developed by MSIM's municipal research team ranks the 50 states plus Puerto Rico based on creditworthiness using both quantitative factors like financial performance and qualitative analysis such as projected budget shortfalls or surpluses.