Standard & Poor’s examines why the credit quality of US states has fared better than that of Euro member states during the “Great Recession.”
For some individual U.S. states, the economic contraction was even more pronounced than it was for some of the 17-member eurozone nations. As with the eurozone nations, U.S. states participate in a single currency area, largely depriving them of any monetary based policy responses to economic contractions (such as pursuing an export-led recovery through currency devaluation).
So, how can it be that, whereas seven (41%) of eurozone sovereign ratings are ‘BBB+’ or lower, no U.S. state fell to below ‘A-’ during or after the Great Recession?
We attribute much of the state sector’s above-average creditworthiness to countercyclical federal fiscal policies that involve reduced federal tax liabilities and large scale outlays during economic downturns. Some federal tax and spending changes occur automatically and some as a matter of discretionary fiscal policy. These changes mitigate the budget impact of recessions for states. From a global perspective, such federal fiscal actions are unique because they serve as a source of broad economic support without encroaching too much on states’ fundamental sovereignty.
In fact, U.S.-style federalism involves a high degree of fiscal independence for states — latitude that could theoretically allow for widespread mismanagement. And there is variation in credit quality among the states. But the range of ratings for U.S. states is both tighter and higher (spanning from ‘AAA’ to ‘A-’) than that found in most other sectors. In addition, the gradual upward migration of state ratings through the years reflects the trend among the states toward stronger financial management policies and practices. And while federalism in the U.S. context tends to encourage fiscal discipline, it does little to compel it. The variation in credit quality among states reflects this fact.
Recent developments, such as implementation of the sequestration cuts in March, signal the possibility that policymakers could scale back somewhat the federal government’s role in the economy.
In our view, unless Congress changes the structure of the federal spending cuts under the Budget Control Act of 2011 (BCA), it could slow the rate of GDP growth through the next decade.
But we do not believe that incrementally less federal support for the economy poses a major threat to state credit quality. More important is the underlying institutional framework that makes up the federal-state fiscal relationship, in particular, countercyclical federal tax and spending policies. Even with the BCA in effect, this distinguishing feature of U.S. fiscal federalism remains intact.