Moody’s says Arkansas budget reserves not recession-proof, Gov. Hutchinson cites legislative fix

A new study issued Wednesday (Oct. 18) by Moody Analytics says Arkansas and 14 other states don’t have enough reserves from the state’s general collections to pay for basic government services if the U.S. economy enters another recession.

But Gov. Asa Hutchinson, in a response to a Talk Business & Politics query, said the latest Moody’s report doesn’t reflect the $100 million-plus long-term reserve fund that was created during the special legislative session that ended on May 3.

“The purpose of this fund is to have a reserve in the event of a recession or other economic downturn. This is the first time in history that such a reserve fund exists,” Hutchinson said. “Arkansas has endured recessions before and the result is generally a reduction in services and budget reductions.”

The Moody’s report, which puts Arkansas’ tax revenue shortfall at only 6.2% if a severe recession were to happen, follows an earlier advisory by the Wall Street credit ratings giant in 2016 that compelled Gov. Hutchinson, his advisors and several legislative budget hawks to push the General Assembly to create a $103 million recession-ready contingency fund to help the state improve its current bond rating.

“Since 1945, we have weathered recessions without deficit spending because that is required by our Revenue Stabilization Act. While we do have various reserve accounts that serve as a budget cushion, it is important that we continue to build our reserve fund for the future,” Hutchinson explained in a statement to Talk Business & Politics.

According to language in the newly passed Act 7, approved by a vote of 70-24 in the House and 27-7 in the Senate during the First Extraordinary Session of 2017, transfers from the fund can only be made after the state’s chief financial officer certifies that a “revenue shortfall” exists when collections are forecasted to increase less than 3% “over and above” gross revenue collections from the previous year.

Moody’s latest analysis says to weather the next recession without having to resort to potentially disruptive fiscal measures, an average state would need to have more than 10% of its budget put away in reserve. To weather an even larger downturn, akin to the Great Recession, an average state would need more than 16%.

“An inescapable economic reality is that there will be another a recession, regardless of how high-flying the economy may appear,” said Dan White, head of fiscal policy research at Moody’s Analytics. “As such, it is only prudent for states to prepare themselves for that recession.”

The Moody’s study also examines the preparedness of states’ finances to endure economic downturns. Economists at the New York-based credit ratings firm ran a stress test of all 50 states to arrive at an estimate of each state’s recessionary needs if a moderate or severe recession were to occur. The study considers the impact of the business cycle on state revenues and spending over two fiscal years.

The results of the stress test show that a majority of states are relatively prepared for a recession similar in severity to the typical recession in recent decades, 16 states have the reserves they need, while 19 states have most of the funds. On the other hand, 15 states, including Arkansas, have significantly fewer funds than they need for the next recession, while only nine states have the funds they need to withstand a more severe economic slump like the Great Recession.

“A lesson of the Great Recession is that states must formulate targeted reserve levels with intentionally crafted policy goals in mind,” said White. “Planning for the next recession involves the difficult balancing act of putting away enough money today to prepare for a future downturn, without stunting the current economic expansion.”

The report also noted that each state’s tax and industrial structure makes it unique in its reaction to a recession, underlining the necessity for all states to stress-test their own needs for recession preparedness as opposed to a one-size-fits-all approach for the whole country. The report said there is a tremendous amount of variance among the recessionary needs of different states.

“Alaska, for example, highly dependent on volatile commodity markets for tax revenue, has the largest potential fiscal shock during a moderate recession, at more than 40% of its budget. Meanwhile, Arkansas has a much less volatile tax or economic structure, limiting its liabilities to around 7% of its general fund budget. As a result, when asked, ‘How much should a state put away for a rainy day?’ the answer, as to so many other good economic questions, is that ‘it depends,’” the report states.

The 50-state analysis also noted that the share of the total recessionary fiscal stress from Medicaid was lower than expected. The simulated Medicaid shock to states was less than expected, largely because of the number of states that have opted into the expansion provisions of the Affordable Care Act.

“By taking on these additional enrollees, states have increased their long-term liabilities, and as a result Medicaid will continue to make up an even larger share of their general fund budgets. However, an interesting side effect of these increased liabilities is less volatility as it relates to the business cycle,” the report concludes.

The Moody’s report, however, does not consider President Donald Trump’s executive order last week halting cost-sharing subsidies in the individual marketplace under the Affordable Care Act (ACA). On Tuesday, Gov. Hutchinson held a news conference to quell fears that Trump’s decision to end federal subsidies to insurance carriers would hurt the more than 300,000 individuals who receive health care under the state’s popular Arkansas Works program.

Under the legislation passed during the special session, the legislature transferred $105 million from the voter-approved Arkansas Healthy Century Trust Fund to the newly created Long Term Reserve Fund. Monies from the tobacco settlement provided core funding for the Arkansas Healthy Century Trust Fund, which has been gaining in interest for nearly 17 years.