Arizona is well-equipped to deal with budget gap: Moody's

Arizona should be able to tackle a growing shortfall given the state's improved reserves, low debt burden, and budget flexibility, Moody's Investors Service said this week. 

The state's general fund faces projected shortfalls of $835 million in fiscal 2024 and nearly $879 million in fiscal 2025, according to the Joint Legislative Budget Committee's latest projections, which are up from an October forecast that showed gaps of $400 million and $450 million respectively.

"The state's ability to close its budget gap and maintain a sound fiscal position will be crucial for its credit quality," the rating agency said in a report. "Arizona is well positioned to address the challenge, given its history of fiscal prudence, an improved rainy-day fund balance, and low leverage and fixed costs."

Moody's, which rates Arizona Aa1 with a stable outlook, said general fund revenue is about 6% lower than forecast halfway through fiscal 2024 "driven mainly by income tax underperformance following historic tax cuts."

It noted that the state's reserve and liquidity positions have improved with a $1.4 billion budget stabilization fund at the end of fiscal 2023 compared to $740 million before the COVID-19 pandemic.

Arizona Governor's Office

Democratic Gov. Katie Hobbs proposed a $16.2 billion general fund budget for fiscal 2025 that aims to address the shortfall with several steps, including agency fund sweeps, taking back unspent money earmarked for capital projects and restricting eligibility for a costlier-than-expected universal school voucher program, while leaving the rainy-day fund intact.

Republicans who control the legislature have pushed back against aspects of the spending plan, particularly restrictions on empowerment scholarship accounts.

Moody's said the fiscal 2024 budget contains nearly $2.9 billion in one-time spending mostly funded by prior surpluses and balances.

"The presence of substantial nonrecurring expenditures will allow the state to remediate revenue shortfalls without having to adopt more painful ongoing cuts," the report said, noting structural budget gaps are in the $200 million to $300 million range.

In addition, Arizona, which does not issue general obligation bonds, tapped surpluses to pay down debt and pension liabilities amid limited new borrowing in recent years, according to Moody's. The state's total long-term liabilities at the end of fiscal 2022 represented 60.5% of own-source revenue, marking the eighth lowest among states.