State and Local Fiscal Health Indicators

State and local governments manage $4.1 trillion in combined annual budgets (Census Bureau, FY 2023). Their fiscal health directly affects municipal bond creditworthiness, property values, and public service quality. For investors holding $4.0 trillion in municipal securities (SIFMA, 2024), understanding fiscal health indicators separates informed analysis from guesswork. The practical skill: learning to read the ratios that rating agencies and institutional investors use to assess credit risk.

Core Fiscal Health Indicators Defined

Fiscal health measures a government's ability to meet current obligations, fund long-term liabilities, and maintain service levels without unsustainable tax increases or debt growth. Five categories of indicators capture the complete picture.

Liquidity Ratios: Measure short-term ability to pay bills.

• Current Ratio = Current Assets / Current Liabilities. A ratio above 1.0 indicates sufficient short-term resources. Below 0.8 signals potential cash flow stress.
• Quick Ratio = (Cash + Investments + Receivables) / Current Liabilities. Excludes less liquid assets like inventory or prepaid items.
• Days Cash on Hand = Unrestricted Cash / (Operating Expenses / 365). Measures how long the government can operate without new revenue.

Budgetary Solvency: Measures whether revenues cover expenditures.

• Operating Ratio = Operating Revenue / Operating Expenses. Above 1.0 means the government runs a surplus; below 1.0 indicates a deficit.
• Fund Balance Ratio = Unrestricted Fund Balance / Total Expenditures. Healthy governments maintain 10-25% as a reserve buffer (GFOA recommends minimum 16.7% or two months of expenditures).

Long-Term Solvency: Measures ability to meet future obligations.

• Debt-to-Revenue Ratio = Total Debt / Annual Revenue. Above 100% indicates debt exceeds annual revenue capacity.
• Debt Per Capita = Total Debt / Population. Allows comparison across differently-sized jurisdictions.
• Pension Funded Ratio = Pension Assets / Pension Liabilities. Below 60% is considered stressed; below 40% is severely underfunded.

Service-Level Solvency: Measures ability to maintain public services.

• Per Capita Spending on core services (police, fire, infrastructure). Declining per capita spending may indicate service degradation.
• Capital Outlay Ratio = Capital Spending / Depreciation. Below 1.0 suggests infrastructure is deteriorating faster than it's being replaced.

Socioeconomic Base: Measures underlying economic capacity.

• Median Household Income relative to state and national averages.
• Unemployment Rate compared to state and national benchmarks.
• Property Tax Base Growth (assessed valuation trends).

State-Level Fiscal Health Comparison

States vary widely in fiscal position. The table below shows key metrics for selected states (FY 2023 data from Pew Charitable Trusts and state CAFRs):

Key observations:

• Wyoming maintains reserves exceeding two years of operating expenses, providing substantial fiscal flexibility.
• Illinois and New Jersey carry the lowest pension funded ratios among major states, contributing to lower credit ratings and higher borrowing costs.
• Debt per capita varies by a factor of 3x across states, reflecting different infrastructure financing strategies and accumulated obligations.

Worked Example: Analyzing a Municipal Issuer

Consider evaluating a mid-sized city (population 150,000) for a potential municipal bond investment.

Step 1: Gather Financial Data from CAFR

From the city's Comprehensive Annual Financial Report:

• General Fund Revenue: $180 million
• General Fund Expenditures: $172 million
• Unrestricted Fund Balance: $31 million
• Total Outstanding Debt: $245 million
• Pension Assets: $890 million
• Pension Liabilities: $1,120 million
• Cash and Investments: $48 million
• Current Liabilities: $22 million

Step 2: Calculate Key Ratios

Step 3: Form an Assessment

This city shows:

• Positive operating margin (surplus of $8 million)
• Adequate reserves (above GFOA minimum)
• Strong short-term liquidity
• Moderate long-term debt burden
• Pension funding above the 60% stress threshold

Credit assessment: Investment-grade quality, likely A category or better.

Step 4: Compare to Benchmarks

Compare these ratios to:

• State medians (available from state comptroller reports)
• Similar-sized cities in the region
• Historical trends for this issuer (5-year trend analysis)

Risks, Limitations, and Tradeoffs

Data Lag: CAFRs are published 6-12 months after fiscal year-end. Current conditions may differ from reported figures.

Accounting Variations: States use different accounting standards for pension liabilities (GASB 67/68 vs. prior standards). Some liabilities may be reported differently across jurisdictions.

One-Time Items: Federal pandemic aid (ARPA funds) temporarily inflated reserve balances for many governments through 2024. These non-recurring revenues distort trend analysis.

Economic Sensitivity: States reliant on volatile revenue sources (capital gains taxes in California, oil revenues in Alaska) show wider fiscal swings than states with diversified revenue bases.

Political Risk: Fiscal indicators measure current position but not future policy decisions. A government can deteriorate rapidly from a strong position if revenue is cut or spending expands.

Pension Discount Rate Assumptions: Many pension funded ratios assume 7-7.5% long-term returns. Lower actual returns would worsen funded status. A 1% reduction in assumed returns typically increases liabilities by 10-15%.

Common Pitfalls and How to Avoid Them

Pitfall 1: Focusing only on ratings. Rating agencies provide useful summaries, but ratings lag reality. Detroit's bonds were investment-grade shortly before its 2013 bankruptcy filing.

Avoidance: Read the CAFR directly. Calculate ratios yourself rather than relying solely on agency opinions.

Pitfall 2: Ignoring pension and OPEB liabilities. General obligation bonds may appear well-covered, but unfunded pension obligations represent senior claims that reduce resources available for bondholders.

Avoidance: Always check pension funded ratio and calculate total debt including pension and OPEB (Other Post-Employment Benefits) obligations.

Pitfall 3: Comparing incomparable entities. A wealthy suburb with $100,000 median income cannot be compared directly to an industrial city with $45,000 median income.

Avoidance: Normalize metrics by income level, population, and economic base. Compare like to like.

Pitfall 4: Extrapolating temporary improvements. Pandemic aid boosted reserves in 2021-2023. These funds are non-recurring.

Avoidance: Adjust for one-time revenues when calculating sustainable operating position.

Data Sources for Fiscal Analysis

Checklist: Evaluating State and Local Fiscal Health

Essential (Start Here)

• Obtain most recent CAFR (within 18 months)
• Calculate operating ratio (revenue/expenses)
• Calculate fund balance ratio (target: 16.7%+ per GFOA)
• Calculate current ratio (target: above 1.5)
• Check pension funded ratio (target: above 70%)
• Calculate debt per capita and compare to state median

High-Impact Refinements

• Review 5-year trend for key ratios (improving or deteriorating)
• Identify one-time revenues and adjust for recurring operations
• Check OPEB funded status (often worse than pension)
• Review economic base indicators (income, employment, property values)
• Compare to peer jurisdictions of similar size and type

Before Making Investment Decisions

• Read rating agency reports for methodology and concerns
• Check for recent credit outlook changes (positive, negative, stable)
• Review continuing disclosures on EMMA for material events
• Assess legal structure (GO vs. revenue bond security)
• Consider concentration risk in your municipal portfolio

Your Next Step

Download the CAFR for your state or a municipality where you hold bonds. Calculate the five core ratios (operating ratio, fund balance ratio, current ratio, debt-to-revenue, pension funded ratio) and compare to the benchmarks above. This 30-minute exercise reveals more about credit quality than any rating agency summary.

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Sources:

• U.S. Census Bureau, Annual Survey of State and Local Government Finances (FY 2023)
• SIFMA, Municipal Securities Issuance and Outstanding Data (2024)
• Government Finance Officers Association, Fund Balance Guidelines (2023)
• Pew Charitable Trusts, Fiscal 50: State Trends and Analysis (2024)
• Moody's Investors Service, U.S. State and Local Government Rating Methodology (2024)