Last week the credit rating agency Moody’s downgraded Nevada’s general obligation bonds – one of the most common type of state-issued bonds – from Aa1 to Aa2. Could the same happen to Washington state?
Nevada’s lower rating certainly doesn’t put them in the “junk bond” category – but the downgrade does represent growing investor uncertainty stemming from structural revenue problems, outlined in an accompanying Moody’s report, that have striking similarities to Washington’s.
The first of the Nevada’s ‘credit challenges’, according to Moody’s, is that state revenue depends heavily on a sales and use tax that is extremely narrow in scope; it applies only to tangible goods and products used to deliver services, and exempts service providers like hairdressers and attorneys.
If that doesn’t sound familiar, it should. Washington also relies heavily on a sales taxes and exempts professional services from taxation.
The second ‘credit challenge’ in Moody’s report is a “lack of revenue diversity” – specifically: “no personal income tax. [Nevada] has missed out on the increase in income tax revenues seen elsewhere.”
Without a personal income tax, a dramatic drop in tourism – such as that following the Great Recession – wreaks havoc on Nevada’s tax revenues. That lack of tax diversity exposes the state to more risk than other states that have more balanced tax structures, because potential investors worry that if sales or gaming revenues falter, the state may not be able to repay its debts.
This should ring a bell here in Washington too. Like Nevada, Washington relies heavily on the sales tax and does not have a personal income tax. Not surprisingly, the Great Recession has contributed to a projected $5 billion+ revenue shortfall in the state’s 2011-13 budget.
Nevada’s third and final ‘credit challenge’ is the legislative super-majority (2/3rds vote) required to raise taxes or fees. Again, from Moody’s: “A large structural imbalance between recurring revenues and expenditures that has been reconciled previously by temporary taxes, the depletion of available reserves and fund sweeps. The renewal of revenue enhancements requires approval of 2/3rds of a divided legislature.”
This is a problem for Nevada because for the past several years, the state has levied temporary taxes and fees to cover debt service and pay for roads, schools and other public services, hoping that a quick end to the recession would restore tax revenues to previous highs. But as the recession drags on, temporary taxes and fees are no longer adequate to cover up Nevada’s structural problems.
In most other states, there’s no real danger of defaulting on bonds. If funds to repay bondholders run short, lawmakers can raise taxes to pay creditors. But in Nevada, as Moody’s analyst Julius Vizner notes, “The supermajority requirement to raise taxes presents a hurdle to achieving balance on an ongoing basis going forward.”
A narrow tax base, the lack of a personal income tax, and a 2/3 requirement for raising revenue clearly makes investors nervous about Nevada’s ability to raise revenue. And of those same three ‘credit challenges’ Moody’s cites as reasons to downgrade Nevada’s credit rating, Washington is three for three.
This doesn’t mean Washington’s credit rating will be downgraded next – there are still major differences between the two states – but it should concern legislators enough to take a serious look at Washington’s tax structure and spending priorities.