Virginia's Bond Rating in Danger of Downgrade

July 20, 2011

As Virginia finished a lean year with a revenue surplus, Gov. Bob McDonnell voiced outrage Tuesday that the state’s bond rating could be downgraded for the first time ever because of Washington’s inability to balance its budget and manage the federal debt.

On the day the Republican governor trumpeted Virginia collecting $311 million more revenue than was budgeted, Moody's Investor Service warned Virginia and four other states their AAA credit scores could be lowered if the federal government’s superlative bond rating also is lowered.

“I’m very unhappy. In fact, we’re furious,” Mr. McDonnell said, lashing out at both Congress and the White House over their inability to agree on a package to reduce spending and raise the nation’s $14.3 trillion limit on borrowing by the Aug. 2 deadline. Without a deal, the United States would default on debt for the first time in its history.

“It’s a national embarrassment to the United States of America to get two weeks from defaulting,” he said. He noted that Virginia has a Republican House and Democratic Senate, just as Congress does, yet a state budget passed in February unanimously and just one day late.

Last week, Moody's put the federal government under review for a possible downgrade as debt-reduction talks between the Democratic president and the House’s GOP leadership appeared to falter.

Moody's also examined 15 state governments with AAA bond ratings to determine those most at risk from a federal fiscal calamity. On Tuesday, the influential global debt-rating agency sent letters to officials in Virginia, Maryland, Tennessee, New Mexico and South Carolina noting that they were under review because of their important ties to the federal government.

Any action on the states’ ratings would come within 10 days of a federal downgrade, the firm said.

“So, through no fault of our own, we have a AAA bond rating that’s been in place since 1938 that we’ve been informed, just hours ago, may be in jeopardy … because of the inability and the ineptitude of the president and the Congress to reach a deal on how to fund the obligations of the United States of America,” the usually reserved Mr. McDonnell said at a news conference.

On Washington’s doorstep, Virginia is rich with military bases, defense and government contractors and federal employees. That’s particularly true in the two most populous regions which are the state’s economic engine the Northern Virginia suburbs of Washington, including the Pentagon, and Hampton Roads, home to the world’s largest U.S. Navy base.

Virginia, with a long legacy of debt aversion and tight budgeting, has never had less than a perfect bond rating, a guarantee to investors and institutional borrowers that the state presents the lowest possible risk. A rating downgrade means the state would pay higher interest rates to borrow money for capital projects.

In 2004, the prospect of a Moody's downgrade helped persuade 17 Republicans in the House of Delegates to break with their anti-tax GOP leadership and support a Democratic package of reforms and tax increases to address a persistent structural imbalance in the state budget.

During the worst national economy in decades, McDonnell and his predecessor, Democrat Tim Kaine, imposed deep retrenchments by state government to reconcile revenue shortfalls totaling nearly $7 billion since 2007.

Virginia has used spending cuts, savings, federal stimulus aid and cash from the state’s “rainy day” reserves to show modest year-end balances.

Democrats said Mr. McDonnell’s surplus announcement is disingenuous given the number of obligations the state has ignored.

State Sen. A. Donald McEachin compared it to a working person declaring a personal surplus on payday before any of the bills are paid. Local governments have seen state aid for programs administered locally slashed, forcing cities and counties to either cut services or levy more taxes to pay for them, said Mr. McEachin, Henrico Democrat.

“Virginia has $600 million in unfunded VRS liabilities and over $3 billion issued in road bonds,” said Mr. McEachin, referring to the state retirement system. “Those are outstanding bills that will need to be paid.”

The bulk of the surplus comes from individual income tax collections that exceeded forecasts by nearly $200 million.

The year’s general fund collections totaled $15.45 billion. The official estimate of state revenues, which is used for budgeting, was only $15.14 billion.

Taxes withheld from individual paychecks totaled $9.63 billion, topping the $9.57 billion forecast. Income tax withholding accounts for nearly two-thirds of Virginia’s general fund, which covers such core services as health care services, law enforcement and public safety and public education.

Taxes paid by the self-employed and on investments exceeded the state’s official target of slightly more than $2 billion by $110 million. Income tax refunds were nearly $28 million less than expected.

Corporate income taxes grew by 3 percent rather than the projected decline of almost 5 percent from fiscal year 2010 collections.

Retail sales taxes fell by 2.3 percent from the previous year, but that still beat the state’s own forecast for a 3.7 percent drop-off.

Much of the excess is already obligated.

Nearly half, $147 million, goes to replenish the rainy day reserves left nearly depleted by years of fiscal distress. State law allocates $32.2 million to the Water Quality Improvement Fund. McDonnell said he intends to use $4.3 million of the unencumbered surplus to provide relief to southwestern Virginia localities devastated by powerful deadly tornadoes and to make an unspecified additional contribution to Virginia’s public employee pension fund.


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