At the beginning of fiscal year 2018, nearly half of the 50 US states are facing budget shortfalls as they cope with a sluggish economy, uncertain revenues and soaring costs—especially for pensions and health care. As fractious state legislatures convene to tax and spend, policymakers should recall lessons learned during the Great Recession, when states had no other choice but to take decisive action to remain solvent.

Executive summaryEver since the Great Recession, state governments have faced fiscal stresses that have significantly changed the scope of revenues and expenditures. Demographic changes, inaccurate revenue forecasts and rapidly expanding financial obligations are forcing the states to find new, perhaps creative, ways to manage their budgets.

Our analysis finds that state budget authorities learned many lessons from their efforts during the Great Recession. This will help soften the impact of looming budget distress and could point the way forward to greater solvency. Still, several states such as Illinois have already experienced multiple down-grades of their credit rating. While widespread credit defaults do not appear likely, the combination of an economic downturn, soaring health care costs, more pensioners and shifting federal budget priorities could make state fiscal situations more perilous.

Key takeaways ◽ Fiscal 2018 for the states follows two consecutive years of widespread weakness in tax revenues and limited

budget flexibility. Despite spiraling costs, state budgets are projected to increase just 1.0% in FY 2018.

◽ State governments face both present and looming problems in paying promised benefits and other financial obligations. The collective budget shortfall for all 50 states is estimated to be as high as $4 trillion.

◽ Public pension plans are a critical concern as growth in liabilities vastly outstrips growth in assets. Large public pension plans are funded at just 70% of what they’re obligated to pay in benefits to retirees.

◽ The Great Recession exposed the cyclical vulnerabilities of state tax revenues and the pitfalls of dependence on federal funding. States responded with tax increases, spending cuts and other budget stabilizing actions.

◽ The current budget predicament is forcing states to pay more attention than ever to the long-term costs of any new fiscal obligations.

Allianz Global Investors White Paper Series

Under the MacroscopeState Budgets and Fiscal Obligations: Collisions Ahead

Steven R. Malin, Ph.D. Director Senior Investment Strategist Global Investment Strategy

September 2017

“It was also observed that the budgets of some state and local governments were under strain, limiting growth in the their expenditures.”

— FOMC meeting minutes, July 25-26, 2017

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

2

Revenue shortfalls weaken the states’ fiscal situationDuring the past five decades, the 50 US states have experienced a full range of fiscal uncertainty tied to national economic hardships— stagflation in the 1970s, a weak national economy in the early 1980s and again in the early 1990s, the bursting of the technology bubble in 2000, post-9/11 fallout and the Great Recession. Each period of fiscal stress forced the states to adjust spending and taxes to meet the challenges imposed by the economic cycle.

The goal of budgeting through economic cycles is to minimize service disruptions while also avoiding over-commitment to future spending obligations. State fiscal policies typically adjust pro-cyclically over economic cycles, meaning that during periods of economic strength states tend to increase spending and lower tax rates; states typically reduce expenditures and raise taxes as the economy stalls. Unlike the federal government, though, states cannot run persistent budget deficits due to their respective constitutional, or statutory, limitations.

Presently, some eight years after the end of the Great Recession, slow revenue growth, in particular, is creating fiscal stress in most states, forcing governors and legislatures to make difficult budgeting

decisions. Most states still describe their fiscal situation as “stable in the near term,” but revenue growth likely will decelerate further if there is a downturn in the national economy in 2018 or 2019. Meanwhile, caseloads and the need for government services continue to increase even if revenues are not keeping pace with demand.

As a consequence, for the first time since the end of the Great Recession, a significant number of states find themselves facing budget shortfalls. For the fiscal year (FY) 2017 or the current biennium (for states that enact a two-year budget), 22 states report that they had addressed, or would address, a budget shortfall before the end of the fiscal year. No overarching characteristic identifies the states facing budget shortfalls, except that revenue collections are not in line with spending plans. (See Exhibit 1.)

States experiencing FY 2017 shortfalls include energy producing states, such as Alaska, Montana, West Virginia and North Dakota, where lower oil and natural gas prices weakened employment, personal income, consumer spending and tax revenues. Agriculture-dependent states, such as South Dakota, also face revenue shortfalls, reflecting weak commodity prices. Other states, such as Vermont, point to changing

Why states face budget shortfalls

The primary reason for state budget shortfalls varies across the states. Some examples of the challenges facing states are below:

◽ Alaska. At current oil prices, Alaska would have a $2.9 billion shortfall in FY 2017 and a $2.7 billion shortfall in FY 2018 unless the state uses earnings from Alaska’s $50 billion Permanent Fund to support government operations.

◽ Arizona. Stable revenue collections, but still facing challenge of maintaining structurally balanced budget.

◽ Colorado. The Colorado economy has been strong, as has population in-migration, which has supported demand for government services. Additionally, state law requires certain state expenditures on K-12 education, Medicaid, transportation, and capital construction, among other programs. Constitutional constraints on revenue (namely, the Taxpayer Bill of Rights Amendment and Gallagher Amend-ment) are limiting the amount of revenue the state can collect and spend or save. Combined, these factors have resulted in a budget shortfall.

◽ Connecticut. Rapid growth in fixed costs (primarily debt and retirement related expenses) coupled with historically slow revenue growth.

◽ Florida. Revenues are stable, but demand for spending always exceeds available revenues.

◽ Illinois. Without a budget for over 22 months, the state’s financial picture remains bleak. With over $12.5 billion in unpaid bills, and no agreed to path toward budget resolution yet found, the outlook is far past concerning.

◽ Iowa. There is no indication that Iowa is headed into a recession in the near term, but it is facing a difficult time. State revenues are

still experiencing very slow growth in income taxes, but sales and use tax growth has turned flat. Iowa’s economy is showing signs of weakness in some areas.

◽ Massachusetts. Generally, the Massachusetts economy is performing well when looking at markers like the unemployment rate and business confidence. Despite these indicators, revenue collections have underperformed. The last four months of the fiscal year have historically accounted for 40 percent of total revenue, so the state is monitoring any changes in collections.

◽ Mississippi. Overall, the revenue for the state has seen little to no growth and in some categories is experiencing a decline.

◽ Nevada. The shortfall over the 2015-2017 biennium is primarily due to increased K-12 enrollment, a shortfall in the Local School Support Tax dedicated for K-12 education and greater than projected Medicaid caseloads.

◽ North Carolina. Revenues are outpacing a cautious forecast as economic conditions stabilize. Expenditures are currently within budget.

◽ South Dakota. Lower than expected sales tax revenues due to slow farm economy and E-commerce sales.

◽ Virginia. Virginia’s economic outlook is stable, and is seeing a rebound from a weak FY 2016. However, Virginia’s economy is facing headwinds from potential cuts in federal spending.

◽ Wyoming. Principal reasons for the shortfall include lower than anticipated natural gas and oil prices, lower coal volumes, and lower sales and use tax collections compared to the forecasts in place at the time the 2017-2018 budget was initially developed.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

3

demographics as a challenge to state budgets. Some states, Virginia for one, with close economic ties to the federal government, wait to see which federal policy changes could affect state budgets.

According to a survey by the National Conference of State Legislatures (NCSL), 20 states anticipate addressing a shortfall again in FY 2018, or the upcoming biennium. Of those states, 13 also are addressing an FY 2017 shortfall, some states of which may be facing more prolonged financial challenges, or are addressing structural deficit.

Federal government actions ease impacts of the Great Recession on statesBudget authorities learned important lessons about how to best address expected budget shortfalls this year and next by analyzing fiscal responses to the Great Recession less than a decade ago. During that episode, policy-makers attempted to ease fiscal stress by implementing broad-based actions at all levels of government.

In recognition of state fiscal troubles, Congress passed the American Recovery and Reinvestment Act (the “Recovery Act” or “ARRA”) in February 2009. This legislation was designed to stimulate the economy, create jobs and stabilize state and local budgets. It contained a combination of tax cuts, grants for infrastructure projects and additional fiscal stabilization support for state services and programs.

ARRA resulted in complex and fragmented disbursement of federal dollars to state and local governments, with mixed programmatic success, depending on the strength of pre-existing funding mechanisms and fiscal management capacity. Most of the federal support used to stabilize state budgets came in the form of enhanced Federal Medical Assistance Percentage rates (FMAP), which are used to determine matching federal funds for certain medical and social service programs, and a newly created State Fiscal Stabilization Fund (SFSF) that targeted K-12 and higher

education. However, the scope of ARRA was much greater than Medicaid and education, providing additional funds for an estimated 200 categorical federal grant programs. (See Exhibit 2.)

As intended, ARRA prevented total state expenditures from declining during the recession. By doing so, the additional federal dollars also changed the composition of revenue sources for state expenditures. At the same time that spending from general funds and other state funds declined, state spending of federal funds experienced sizable increases. Infusion of federal funds enabled states to raise total expenditures in both fiscal 2009 and 2010, even though spending from state funds declined in both years. This resulted in overall growth in state expenditures in FY 2009 and 2010, albeit more slowly than the historical average of approximately 6.0%. Total state expenditures climbed to $1.56 trillion in fiscal 2009, a 5.4% nominal increase from fiscal 2008, and reached $1.62 trillion in fiscal 2010, a 3.8% increase.

States responded individually to recession-related fiscal stressesEven with ARRA’s passage, additional funds from the federal government were not enough for states to avoid budget cuts and meet the added demand for state services caused by the faltering economy.

As demand for state services picked up and state tax revenues declined, additional federal funds provided through ARRA were most heavily targeted towards K-12 education and Medicaid, by far the two largest components of state expenditures. The targeting of funds to K-12 education and Medicaid also shaped the allocation of state budget cuts, which on a dollar basis, were greatest in these areas. In fiscal 2009, state decisions to cut state funding for Medicaid and K-12 education by 1.2% and 1.3%, respectively, were in large part driven by the knowledge that ARRA funds could help replenish the state cuts. (See Exhibit 3.)

Collectively, the states responded to the Great Recession with tax increases, budget cuts and other budget stabilizing actions.

Source: NASBO Foiscal Survey of the States, Spring 2017; Allianz Global Investors.

12

32 34 37

25

39

2013

2

9 66

5

4

5

4

36

9 10 7

20

7

2533

0

10

20

30

40

50

2010 2011 2012 2013 2014 2015 2016 2017

Number of States Above Target Number of States On TargetNumber of States Below Target

Fiscal Year

Exhibit1: General fund revenue collections vs. budget projections

Source: NASBO Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

31.6

61.1

50.1

5.80.9

0

10

20

30

40

50

60

70

2009 2010 2011 2012 2013

Fiscal Year

Billio

ns o

f dol

lars

Exhibit 2: ARRA spending for Medicaid and State Fiscal Stabilization Fund

Source: NASBO Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

4

However, the states had to cope with greater sensitivity of their tax collections, over time, to changes in the national economy than during previous economic cycles. Heightened sensitivity mainly reflected the magnitude and composition of the personal income being taxed. Revenue forecasts that frequently proved inaccurate due to the rapid deterioration of the economy also complicated the budgeting process and increased the vulnerability of states to unanticipated revenue shortfalls.

To increase revenues during the recession, states commonly eliminated exemptions, broadened tax bases, raised fees, limited deductions and increased tax rates. However, tax increases as a share of general fund collections were less in the Great Recession than in prior periods of economic decline.

The majority of tax increases were targeted towards personal income and consumption, with more states increasing personal income taxes than sales taxes. A number of states that enacted tax increases did so temporarily. In some instances, this practice resulted in continued fiscal stress as the temporary tax increases expired.

Current state fiscal conditions: Partly a legacy of recession-era decisionsCurrent state fiscal conditions remain partly a legacy of the Great Recession, when state fiscal authorities had little control over the underlying economic factors that increased demand for state spending on Medicaid, higher education, human and social services, and unemployment compensation, among others. Due to additional federal aid and political decisions shaped by the poor health of the economy, budget cuts were larger and more commonplace than enacted revenue increases. Discretionary spending reductions were influenced partially by the expectation that ARRA funds could help replenish the reduced state funding of outlays.

However, due to legal mandates, entitlements and political pressures, states did not have full flexibility to make discretionary spending cuts.

Entitlement program spending, for example, often is set by formulae enacted in law and falls outside the discretion of budget planners. Political considerations aside, constraints on spending cuts also came from dedicated, or earmarked, revenues that had to be spent. As a result, budget cuts were uneven across spending categories during the recession, with areas like public assistance, higher education and aid to local governments receiving the largest reductions.

From FY 1979 through FY 2008, state general fund expenditures commonly experienced healthy growth that averaged 5.6% per year (1.6% in constant dollars), with little variation from year to year. This stability enabled state budget planners to develop spending plans based on the prior year’s funding, plus some additional amount at the margin determined via legislative processes to account for inflation or changes in spending priorities.

However, over the two-year period of fiscal 2009 and 2010, states reduced general fund expenditures by $64 billion principally via employee layoffs, furloughs, agency consolidation, reduced local aid, and scaling back of health and retirement plans for state workers, to name a few. Some states also enacted widespread reforms to the hiring, pay and benefit packages of the public sector workforce.

The recession exposed the cyclical vulnerabilities of state tax revenues, forcing governors and state legislatures to search for more stable sources of revenue. Revenue stability efforts included broadening the tax base to include a greater portion of economic activity, reducing reliance on business income and capital gains, and developing ways to deal with the volatility of those revenue sources.

Actual and anticipated revenue shortfalls prompted state fiscal authorities to enact $39.7 billion in revenue increases during FY 2009 and 2010 alone. Taxes were increased by some states for major tax structures (sales, personal and corporate income) by raising rates, reducing credits and deductions, and expanding tax bases. States also addressed faltering collections by increasing user fees and instituting additional revenue measures.

Exhibit X: Nominal Annual Percentage Change in General Fund Spending

-10

-5

0

5

10

15

20

1979 1984 1989 1994 1999 2004 2009 2014

Annu

al p

erce

ntag

e cha

nge

Fiscal Year

Exhibit 3: Nominal annual percentage change in general fund spending (all states)

FY 2014 figure is based on governors’ recommended budgets.Source: NASBO Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

5

Lessons learned from government responses to the Great Recession The lessons learned from the economic downturn have resulted already in many states making adjustments to their long-standing fiscal practices. Here are a few examples:

◽ Review of the impacts of ARRA reveals that the legislation diminished state fiscal autonomy and brought unexpected administrative challenges. As a result, the states now acknowledge unanimously the need for more robust rainy day funds in order to become less-reliant on federal largesse and recapture fiscal independence. Insert rainy day funds box close to here

◽ The recession reminded states that spending growth in good economic times should be coupled with fiscal reforms that guard against spending disruptions when the economy falters and revenue declines. Fiscal authorities now commonly deposit a portion of collections from volatile taxes, such as capital gains or dividends, into their states’ rainy day fund during periods of economic strength.

◽ Revenue declines experienced in the recession also reveal that state tax systems have not kept pace with changes in the economy. State tax systems are failing to fully capture revenue from a large swath of total economic activity. Fiscal authorities now recognize that the exclusion from taxation of many services, online sales and digital outputs leaves untapped some large potential revenue streams.

◽ States need to improve their forecasts of economic and financial conditions or else risk sizeable budget shortfalls again when cyclical conditions ultimately deteriorate. To promote better fiscal preparedness, fiscal authorities must adjust their forecasting models more frequently, improve their understanding of the assumptions built into revenue estimations, and compare actual revenue collections to mandate estimations.

◽ States can achieve better revenue certainty by tying temporary tax increases to economic conditions or revenue collections rather than the fiscal or calendar year.

States may now be at a fiscal inflection pointThe combination of slow economic growth, demographic changes, eroding tax bases and rising long-term public sector liabilities, such as employee retirement and benefit packages, suggests that state and local government finance may be approaching an inflection point. Immediate budgetary challenges are being considered in relation to the financial cost of promised benefits and other long-term financial obligations more so than at any other period in recent memory. Greater emphasis on reforming states’ long-term spending obligations is reducing structural imbalance risk for future state budgets even though states are still faced with current spending pressures.

The Great Recession confirmed that while every state is unique, their budgetary challenges and linkages to the national demographic and economic trends are increasingly similar. States are adapting long-term financial plans to account for a maturing economic cycle and population base. Budget-officer commentaries now suggest

a deepening awareness of the need to reduce the risk of structural imbalances in state budgets now in order to avoid draconian spending cuts later.

ARRA served to extend the available timeline for tough budgetary decision-making by sustaining state and local government budgets into the economic recovery. In the absence of a rapid economic expansion, there also is an opportunity for structural reform of state revenue systems to capture more of the economic activity in the service sector and online that, presently, passes as an untapped source of revenue.

Fiscal 2018 budgets: Caution after consecutive years of sluggish revenue growth

In that context, the states are approaching fiscal 2018 cautiously following two consecutive years of widespread weakness in tax collections and limited budget flexibility. State budgets are projected to increase just 1.0% in fiscal 2018 according to governors’ recommended budgets, the smallest nominal growth rate for general fund spending since fiscal 2010, when general fund spending declined due to the economic downturn and significant federal stimulus funds were provided to mitigate the full impact of that decline. (See Exhibit 4.)

By comparison, general fund spending increased by roughly 4.8% in fiscal 2017, the highest rate of growth since before the Great Recession, helping total general fund spending surpass its pre-recession peak level in fiscal 2008 for the first time in real terms.1 In total, 24 states report estimated expenditures for fiscal 2017 below their inflation-adjusted fiscal 2008 levels.

General fund revenue collections in fiscal 2017, at levels below budget projections, resulted in 23 states enacting net mid-year budget cuts totaling about $5 billion, a historically large number of states in a non-

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

Billio

ns o

f dol

lars

FY 2017 RecommendedFY 2018 Recommended

All Other

TransportationHigherEducation

Medicaid

CorrectionsPublicAssistance

PK-12Education

Exhibit 4: Recommended general fund spending changes by category

Source: NASBO Fiscal Surey of the States, Spring 2017; AllianzGlobal Investors.

1. These figures mostly predate April 2017 when most income tax returns were filed. Since the time of tax

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

6

recession period. Revenues from all sources, including sales, personal income, corporate income and all other taxes and fees, are coming in below original forecasts at the time of budget enactment in 33 states, on target in four states, and above forecasts in 13 states.

Broken down by tax types, aggregate sales, personal income and corporate income tax collections are each coming in below what was budgeted. Aggregate general fund revenues are projected to increase only modestly in fiscal 2018. Governors recommended budgets, including proposed tax and fee changes, expect collections to grow 3.1% in fiscal 2018 – an improvement over the 2.4% growth estimated for fiscal 2017 and the 1.8% growth the states experienced in fiscal 2016.

Governors’ budget proposals for fiscal 2018 are based on forecasted growth of 2.7% for sales taxes, 4.1% for personal income taxes, and 3.9% for corporate income taxes. These proposals forecast total general fund tax revenues of $824.1 billion in fiscal 2018, compared to the estimated $799.5 billion collected in fiscal 2017 and actual collections of $780.7 billion in fiscal 2016.

Several governors are proposing a net tax and fee increase for fiscal 2018, with tax hikes more commonly recommended on general sales, cigarettes and tobacco products, motor fuels and alcoholic beverages; proposed tax reductions mostly aim at personal and corporate income taxes. Fifteen states are proposing net tax increases of $4.9 billion, while 12 states are proposing net decreases totaling $1.2 billion, resulting in a net tax increase of $3.7 billion. This net change is driven primarily by tax increases recommended by the governors of Oklahoma, Pennsylvania and Washington State, totaling $3.2 billion combined. (See Exhibit 5.)

To put these figures into historical context, total general fund revenues first surpassed their pre-recession high of $680 billion in nominal terms in fiscal 2013. After adjusting for inflation, estimated total general fund revenues for fiscal 2017 rose to just above its pre-recession peak, nearly a decade ago. Looking at individual states, exactly half (25 states) have exceeded their fiscal 2008 general fund revenue levels after adjusting for inflation.

The improved revenue situation projected for fiscal 2018 reflects continued job growth, as well as some tentative signs of modest

economic recovery in energy-producing. States heavily reliant upon energy production for their revenues now forecast positive revenue growth in fiscal 2018, after some experienced multiple years of general fund revenue declines. (See Exhibit 6.)

General fund spending is projected to be $828 billion in fiscal 2018 according to governors’ recommended budgets, compared to an estimated $819 billion in fiscal 2017. Overall, 15 governors called for nominal general fund spending decreases in fiscal 2018, signifying the fiscal difficulties a number of states face, particularly after two years of weak revenue growth.

The governors’ extremely modest general fund spending increases in fiscal 2018 across all programs are far smaller than the $23.9 billion recommended by governors in their fiscal 2017 budgets. Proposed FY 2018 spending increases mainly target K-12 education, the largest category of state general fund spending, which would receive a $6.1 billion funding boost on net under governors’ budget proposals. Medicaid, the second largest component of state general fund spending, would see only a $1.6 billion increase in general fund spending.2

Governors’ recommended FY 2018 budgets also call for a moderate net spending increase for corrections, as well as slight net increases for higher education and public assistance. Additionally, transportation

Exhibit 5: Summary of recommended fiscal year 2018 state revenue changes

Taxes

Proposed Revenue Changes Sales Personal

Income Corporate

IncomeTobacco/

Cigarettes Motor Fuel Alcohol Other Fees

Number of States Proposing Increase 8 5 3 9 4 4 9 7

Number of States Proposing Decrease 7 12 9 0 0 0 6 2

Net Change (Millions of Dollars) $1,685 ($1,205) ($153) $791 $726 $104 $1,36 $134

Source: NASBO Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

Exhibit 6: State general fund expenditure growthFiscal Years 2016-2018

Number of States

Spending Growth FY 2016 ActualFY 2017

EstimatedFY 2018

Recommended

0% or less 9 6 15

>0% up to 5% 23 25 29

>5% up to 10% 17 16 6

>10% 1 3 0

Source: NASBO Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

2. This figure is lowered mainly due to a fund accounting change in Ohio.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

7

would see a small bump in general fund spending.3 For all other program areas, Governors recommended a net decline in general fund spending totaling $1.1 billion.

Public pension plan funding sputters in FY 2016Budget stresses in many states and cities mean governments face both present and looming problems meeting obligations to pensioners. Many states and localities either cannot afford to make aggressive payments or opt to stretch them out over decades so big outlays are delayed. Even the large run-up in stock prices that helped deliver solid earnings for pension plans in the fiscal year ended June 30 will not be nearly enough to ensure all state and local retirees receive their promised future benefits. Estimates of their collective shortfall vary from $1.6 trillion to $4.0 trillion.

Currently, large public plans have just 70% of what they need to pay future benefits to their retirees – and funding levels will not improve significantly unless cities and states ramp up their yearly pension contributions. The ratio of assets to liabilities for the 170 plans in the Public Plans Database was as high as 103% at its peak in 2001.4

The pension predicament is a result of decades of low government contributions, overly optimistic investment assumptions, over-promises on benefits and two recessions that left many retirement systems with deep funding holes. Demographics also played a role: Liabilities are rising as waves of baby boomers retire, leaving fewer active workers to contribute to pension plans.

For many pensions, funding problems worsened in the years following the 2008 financial crisis as falling interest rates hit, and largely remained at, record low levels. Some states pushed through benefit cuts that moved new employees onto less-generous 401(k)-style plans, but those changes often failed to alleviate funding woes because they did not affect existing retirees.

Many pension funds tried to address the issue by ramping up their ownership of equities in the hope of benefiting from an eight-year bull market. Public pension funds had a median 56.6% of their holdings in equities as of June 30, 2017, compared with 54.9% a year earlier, according to Wilshire TUCS. But that level of exposure to stocks means that public pensions will experience even more funding stress if a bear market returns.

Many pension plans are preparing for lower returns by scaling back predictions of what they will earn in the future, an actuarial adjustment that pushes liabilities higher. Public pensions use a combination of investment income and contributions from employees, states and municipalities to fund benefits. Even if returns remain elevated, large public pensions likely will not be able to reverse their shortfall in coming years.

Few states are having more trouble with these issues than Illinois, which has struggled for years to agree on budget priorities and pay for mounting pension liabilities. One result is that the fund that oversees

retirement money for state employees, judges and lawmakers now has just 35% of what it needs to pay for all future retirement obligations. Even with investment earnings of 12% in the fiscal year ended June 30, Illinois’s funding deficit widened further. With liabilities now three times investment assets, Illinois would need investment returns of 20% and more every year for decades in order to fully fund its pension obligations. (See Exhibit 7.)

Most other states also experienced pension funding shortfalls, though their magnitude varies widely. The fund that oversees retirement for Connecticut state employees has just 35.5% of what it needs to pay for future obligations and a separate fund for teachers has 56%. Connecticut pension plan managers admit that they erred by not contributing more to the fund in past years. Though Connecticut retirement funds earned a collective return of 14.3% in the most recent fiscal year, plan managers have reduced expectations of future gains from 8.0% to 6.9%. (See Exhibit 8.)

There is always a temptation when budgets are strained to look for a way to reduce pension funding. Yet most states have enacted some type of reform over the past decade to shore up their pension funds for the future. California and New Jersey, among others, are moving forward with plans that would boost respective pension assets, dramatically decrease unfunded liabilities and reduce payouts for the immediate future.

In New Jersey, the state is pledging its lottery—which an outside analysis determined was valued at $13.5 billion—as an asset to state pension funds. The action would reduce the pension system’s $49 billion unfunded liability and improve its funded ratio from 45 % to about 60 %, according to State Treasurer Ford Scudder. The roughly $1 billion in annual lottery proceeds, which currently go to education and human services, among other programs, will now be divvied up among state pension funds. The largest share—nearly 78 % —will go to the teachers’ pension fund.

3. Since most states rely primarily on other fund sources to finance transportation spending, general fund spending adjustments are not necessarily reflective of overall recommended state spending changes for transportation.

4. These data are based on the GASB 67 standard

Perc

ent

Exhibit X: Annual Return for State and Local Pensions

-25

-20

-15

-10

-5

0

5

10

15

20

1992 1995 1998 2001 2004 2007 2010 2013 2016

Fiscal Year

Exhibit 7: Annual return for state and local pensions

Source: Census of Governments; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

8

The uncommon, but not rare, Illinois fiscal stresses

On June 1, 2017, S&P Global Ratings and Moody’s Investors Service downgraded the credit rating of the State of Illinois to BBB-, just one notch above a non-investment grade rating. S&P also placed the state rating on a negative watch, meaning that the rating agency could again downgrade Illinois ‘s credit. S&P warned that Illinois is in danger of entering a “negative credit spiral” in which the lower credit rating makes it more expensive for the state to borrow and even harder for the state to pay its bills, resulting in an even lower credit rating.

Since 2009, the state’s credit rating has been downgraded a total of 21 times by the three major rating agencies. The downgrades began when Illinois started borrowing to conceal the drastic under-funding of the state’s pension obligations. In 2010, Moody’s downgraded Illinois credit to the lowest of any state. The next five downgrades occurred despite tax increases of $32 billion, a sizeable total deemed by the rating agencies to be insufficient to meet payment obligations. Since then, eight additional downgrades beset the state’s credit rating, reflecting rating agency concerns about the absence of major economic reforms.

Adverse demographics and structural economic forces have undoubtedly played a role in Illinois’s problems and those forces will, over the longer term, threaten the long-term sustainability of public finances in many states and municipalities.

Over the past several years, a relatively small number of governments faced severe budget and debt crises. Most notable among these were the California budget crisis in 2008 and 2009, the Chapter 9 bankruptcies of Stockton, CA and Detroit, MI in 2013 and, most recently, the ongoing Puerto Rico debt crisis triggered by a partial debt default in mid-2015.

Illinois’s current problems are a direct result of the political gridlock between a Republican governor and a Democrat-controlled legislature, with the two sides unable to agree on a budget for the past two fiscal years. True to form, the Governor wanted to balance the budget via spending cuts, while the Democrats wanted to raise taxes. As a result, the state now owes around $15 billion in unpaid bills to vendors.

The bigger problem facing Illinois in the long term, though, is its unfunded pension liabilities, which could be as high as $250 billion (if we include unfunded local government liabilities that the state might have to pay ultimately) and the adverse demographic and economic trends that will make it very hard for the state to correct that shortfall. In that respect, the problems in Illinois and other rust belt states resemble the current crisis in Puerto Rico.

The root of Puerto Rico’s problem is that its real economy has been contracting almost continually since 2006, when the phasing out of federal tax breaks for manufacturing firms located in Puerto Rico was completed. Since Puerto Ricans are U.S. citizens, the decline in the real economy triggered a wave of emigration to the mainland, with the population shrinking by 8% over the past decade. A declining population and manufacturing base mean

that it becomes increasingly harder to service existing as tax revenues dry up. Default becomes all but inevitable.

Illinois is suffering from many of the same pressures of an aging and declining population and shrinking tax base. Since 2010, Illinois is one of only four states (together with Connecticut, West Virginia and Vermont) that have experienced an outright population decline. Over the same period, the national population increased by more than 4%.

In addition, changing demographics within the Rust Belt mean that fewer working-age people are supporting more retirees. According to the Illinois Department of Public Health, the total state population is projected to increase by 2.2% from 2015 to 2025, while the population of those over 65 years of age is expected to increase by a remarkable 34%.

As far as the overall size of the Illinois economy is concerned, it hasn’t done too badly in recent years. Between 2010 and 2016, State nominal GDP increased 21.1%, only slightly below the 24.2% increase in the national economy. But the real damage was done well before that. Over the past 20 years, the Illinois economy has expanded by only 80%, well below the 105% increase in the national economy.

Illinois’s state debt currently stands at around $60 billion, which is well above the $20 billion Detroit bankruptcy, but a little less than the $70 billion debt of Puerto Rico. Those numbers are a bit misleading, though, since they do not take into account the variations in population size and economy. Nevertheless, looking at the ability to service debt using the size of overall revenues, Illinois is still in the top 10 of states seemingly at risk, alongside Massachusetts, Connecticut, Rhode Island, New Hampshire and New Jersey. But as of early summer 2017, Connecticut, Rhode Island and Wisconsin were still negotiating budget documents and all three states failed to pass budgets by July 1 deadlines.

Connecticut’s legislature recently granted final approval to a $1.5 billion labor-concessions agreement that will put a dent in the state’s projected $5 billion budget deficit, and the Rhode Island Senate is set to vote Thursday on a $9.2 billion budget deal that has already cleared the state’s House of Representatives.

In Wisconsin, lawmakers are debating revenue-raising measures to help solve a roughly $1 billion transportation-funding shortfall. Republican Governor Scott Walker has pledged to veto a gas tax increase while championing a $3 billion incentive package to encourage Foxconn Technology Group to build a major industrial facility in the state.

Meanwhile, Minnesota Democratic Governor Mark Dayton defunded the state’s Republican legislature after lawmakers passed a $46 billion budget in a May special session that included a $650 million tax-cut bill the governor opposed. Lawmakers took Mr. Dayton to court, where a county judge on July 19 ruled the governor’s veto of the legislature’s operating budget unconstitutional.

The governor appealed that ruling last week, though the budget remains in place.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

9

The move hasn’t impressed credit rating agencies, though.

The ratings agencies have a more positive view of California’s proposed pension funding plan. Developed by Gov. Jerry Brown and State Treasurer John Chiang’s offices, California will borrow $6 billion from its Surplus Money Investment Fund (rainy day fund) to pay down a portion of its $59 billion unfunded pension liability. The surplus fund account typically earns less than 1% interest, because it is invested for very short periods so that it can be quickly accessed for payment. Brown and Chiang say the money in the surplus fund could be put to better use in the state’s pension fund, where it can be invested for the long-term and earn a higher rate of return. The state is making its full pension payment this year in addition to depositing the loaned money. That will result in a nearly $12 billion boost to the fund this year. The cash infusion would immediately help lower the state’s annual pension bills. California would pay back its surplus fund—plus interest—over the course of a decade. Moody’s Investors Service has called the idea a credit positive one because it “suggests the state will aggressively counter a projected rise in its unfunded pension liabilities.”

With both of these approaches, much of their success depends on how well the pension investments perform. But no matter how that plays out, more governments are likely to follow with their own creative funding solutions.

Infrastructure spending: Desired but usually neglectedIn order to meet current budgetary requirements, the states, generally, neglected the delivery, maintenance, funding and regulation of their public infrastructure for many years, if not decades. This was not always the case. In the 1990s, when the economy was particularly strong, states and localities increased their investments. However, this trend ended after 2000, except for a temporary boost fueled by ARRA funding to states and localities. (See Exhibits 9 and 10.)

State and local governments are the stewards of most of the country’s public capital, owning over 90% of non-defense public infrastructure assets. Although the federal government assists in the building and maintenance of these assets, state and local governments pay 75%

Source: Fitch Ratings; National Association of State Retirement Administrators; Allianz Global Investors.

Top 5 States Bottom 5 States

Exhibit X: Percent of Pension Obligations Funded

Perc

ent f

unde

d

0.0

20.0

40.0

60.0

80.0

100.0

South Dakota Wisconsin Washington NorthCarolina

Oregon Kansas Alaska Connecticut Kentucky Illinois

100% 99.9% 98.7% 96.0% 95.9%

59.9%52.2% 51.9% 48.9% 47.1%

Exhibit 8: Percent of pension obligations funded(Fiscal year 2017)

Source: Fitch Ratings; National Association of State Retirement Administrators; Allianz Global Investors.

Exhibit X: State and local capital spending as a share of gross domestic product 1945-2015

0.0

0.5

1.0

1.5

2.0

2.5

3.0

1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020

Exhibit 9: State and local capital spending as a share of gross domestic product

Source: US Bureau of the Census; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

10

of the cost of maintaining and improving them. States and localities spend about 90% of their capital dollars on key building blocks of a state’s economy: schools, transportation, and drinking water treatment and distribution.

Spending by state and local governments on all types of capital dropped from a high of 3% of the nation’s GDP in the late 1960s and 2.4% in the early 2000s to less than 2% in 2015. Total capital spending as a share of state GDP fell in all but three states and the District of Columbia between 2002 and 2014, with the largest drops in Nevada, Utah, Florida and Arizona. Falling federal spending on infrastructure is

exacerbating the problem. These states’ revenues were hit particularly hard by the Great Recession, resulting in cuts in all parts of the budget, especially after ARRA funds were depleted.

The share of a state’s budget devoted to capital spending can vary based on factors like the size and population density of a state or the age of existing infrastructure. Not surprisingly, then, current investment varies significantly by state. Several large states with small populations — Alaska, North Dakota and South Dakota — spent over 15% of their budget over the past decade on capital expenses. At the other end of the spectrum, three states — Michigan, Rhode Island and Vermont — spent less than 7%. (See Exhibit 11.)

At the federal level, too, infrastructure spending has failed to keep up with growing needs. Federal spending on transportation and water infrastructure decreased annually beginning in 2003. Even the new investments enabled by the Transportation Act of 2015 will be at risk in future years if funding other than increases in the gas tax cannot be found.

States pay for public buildings, facilities, roads, and other infrastructure somewhat differently than the way they fund other types of spending, using debt more frequently and often relying on user fees, such as tolls. Borrowing makes infrastructure projects more affordable by reducing the pressure on a state’s budget in any given year. On average, states finance 32% of their capital spending with bond proceeds. Bond proceeds make up less than 10% of funding for capital projects in 17 states. Grants from the federal government for roads, transit, and other infrastructure also contribute importantly to infrastructure funding. Often, however, federal grants require matching funds.

Some states, either by law or by tradition, do not issue general obligation bonds for infrastructure or other spending. Twenty-two states report that they maintain a formal or informal policy of funding infrastructure on a pay-as-you-go basis, according to a recent National Association of State Budget Officers (NASBO) survey.

Source: US Bureau of the Census; Bureau of Economic Analysis; Allianz Global Investors.

Exhibit X: Capital spending has fallen in most states as a share of gross domestic product

0

2

4

6

8

10

12

14

16

18

<-1.0 -.99 to -.76 -.75 to -.51 -.50 to -.26 -.25 to 0 >0

Num

ber o

f sta

tes

Percentage point change (2002–2013)

Exhibit 10: Capital spending has fallen in most states as a share of gross domestic product

Source: US Bureau of the Census; Bureau of Economic Analysis; Allianz Global Investors.

Exhibit 11: Net migration per 1,000 residents

Fiscal Years

Select States 2011-2012 2012-2013 2013-2014 2014-2015 2015-2016

Colorado 7.6 8.7 9.3 12.5 11.1

Florida 10.7 10.3 13 16.4 16

Illinois -3.7 -3.3 -5.1 -5.7 -6.5

Nevada 7.2 7.1 11 12.6 14.4

New York 0.4 -0.3 -2.2 -2.1 -3.7

North Carolina 5.6 5.8 5.5 6.4 7.9

North Dakota 18 25.2 14.6 15.3 -6.2

Oklahoma 4.9 3.8 7.7 10.8 14

Pennsylvania 0.9 -0.1 -0.1 -0.8 -0.9

Texas 8.3 7.4 9.5 9.8 7.9

Source: Governing.com, State Migration Rates; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

11

On average, states finance only less than 6% of infrastructure spending with general fund taxes (typically sales or income taxes). States that shy away from borrowing for infrastructure projects depend much more heavily on general fund taxes to pay for building and maintaining infrastructure. General fund spending makes up more than 20% of funding for capital projects in eight states — Alaska, Colorado, Indiana, Missouri, New Jersey, North Dakota, Utah, and Wyoming. More typically, the general fund share is small and other state funds make up over a third of funding for capital projects. This includes taxes designated for infrastructure such as gas taxes or user fees like tolls, water and sewer fees, or facility entry fees. (See Exhibit 12.)

The federal government is an active partner with states in building and maintaining infrastructure. States use federal grants to pay for some 30 % of their infrastructure spending. The federal government provides grants for road and public transit projects, for utilities and a host of other capital expenditures.

The Trump Administration’s target of $1 trillion in infrastructure investment will be funded through a combination of new federal appropriations, incentivized non-federal funding, and newly prioritized and expedited projects. Additional funding for infrastructure will likely be structured to incentivize additional non-federal funding, reduce the cost associated with accepting federal dollars, and ensure federal funds are leveraged such that the end result is at least $1 trillion in total infrastructure spending.

Yet experience with the ARRA demonstrates that the flexibility to use federal appropriations to finance local infrastructure projects creates an unhealthy dynamic in which state and local governments delay projects in the hope of receiving federal funds. Over-reliance on federal grants and other federal funding creates a strong disincentive for non-federal revenue generation.

Still, federal rules, regulations and mandates continue to apply on virtually all infrastructure investments even though the federal government contributes a very small percentage of total infrastructure spending. Approximately one-fifth of infrastructure spending is federal, while the other four-fifths are roughly equally divided between both state and local governments and the private sector.

Even with infrastructure spending a top federal priority, many states continue to focus on immediate goals to increase employment and household incomes. Rather than investing in infrastructure, these states are cutting taxes and offering corporate subsidies in a misguided approach to boosting economic growth. Tax cuts put at risk funding for education, health care and other public investments essential to producing the talented workforce that businesses need. This pattern of neglect of infrastructure by states has serious consequences for productivity, quality of life, long-term real economic growth potential and the standard of living.

Where do the states’ fiscal stresses leave investors?Certainly, the fiscal stresses confronting state budget authorities should not lead to a cascading of defaults on financial obligations. Individual states already have succumb to credit-rating downgrades, but few, if any, states have sufficient budget shortfalls that make default imminent. Instead, the states will have to deal with changing demographics and persistent economic sluggishness in their ways, consistent with their idiosyncratic politics, culture, history and economics.

In the current fiscal year, the states individually will have to figure out how best to budget around specific developing issues. For example:

◽ Changing federal priorities within the Trump Administration and in Congress will likely test the concept of fiscal federalism once again. It remains unknown the extent to which Congress and the Administration will kick back to the states various obligations that, until now, have been assumed by the federal government.

◽ The Trump Administration favors spending $1 trillion over 10 years on various types of infrastructure projects, with at least 40% of the funds coming from private sources. So far, Congress has not authorized or allocated any additional funding for infrastructure projects. Nonetheless, if (more likely, when) spending on infrastructure advances, selection of projects and funding formulas will matter. Thus, it remains unknown, which states will get the most or least funding, the impacts on employment and income, the spillover and multiplier effects on states’ economies, the revenue implications for tax collectors, impacts on the composition of state spending and many other factors. What is not in doubt is that the states with the largest grants from the federal government have the strongest chance of gaining economically and fiscally.

◽ Similarly, the additional federal spending on national defense and homeland security will have more important implications for some states than for others. Thus, fiscal authorities will pay particular attention to the composition of the defense budget and its implications for the level, composition and location Source: National Association of State Budget Officers; Allianz Global Investors.

Exhibit X: Sources of state funding for infrastructure (2014)

Dedicated fees, surpluses and

other state funds35%

State bond proceeds

29%

State general funds

5%

Federal funds31%

Exhibit 12: Sources of state funding for infrastructure (Fiscal year 2014)

Source: National Association of State Budget Officers; Allianz Global Investors.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

12

of procurement, personnel and operations and maintenance activities.

◽ Congress and the Trump Administration continue to struggle with future funding of Medicaid and Medicare, as well as private health insurance generally. Eventually, these disparate policy-makers will make adjustments in each of these areas. When they do, states with the largest low- and moderate-income and senior-citizen populations will be impacted most heavily.

◽ So far in the current decade, population movement among the states has reflected the availability of relatively high paying jobs. For example, when the price of oil rose and fracking became more prevalent and profitable, the population of states like North Dakota surged. However, when the price of oil came back down and drilling subsided, the same states experienced population losses. In this context, state fiscal conditions become heavily dependent upon both the level and the composition of real economic growth.

◽ Historically, states facing the most severe fiscal stresses were forced to choose between slashing outlays, partially by laying off workers, and funding payments to pensioners. Typically, the fiscal authorities chose to cut spending first, usually across-the-board rather than by targeting individual programs, reducing payrolls next and, only when absolutely necessary, reducing or suspending pension obligations. In each of those cases, municipal bondholders sustained losses.

Source: National Association of State Budget Officers; Allianz Global Investors.

Less than 1 percent

Greater than 1 percent but less than 5 percent

Greater than 5 percent but less than 10 percent

Greater than 10 percent

Data are not available

Exhibit 13: State budget surpluses(Fiscal year 2017)

Source: National Association of State Budget Officers; Allianz Global Investors.

Rainy day fund balances become more important

During the financial crisis and ensuing credit freeze in short-term borrowing markets, rainy day funds and other budget reserves served as a source of liquidity that helped states meet short-term cash flow needs. These reserves, commonly called “rainy day funds,” typically amount to between 3% and 8% of budgeted general outlays. However, these specially-designated state reserves were not sufficient to maintain budget stability during the recession.

State balances in rainy day funds are estimated to remain relatively flat overall for the current fiscal year. Excluding Georgia and Oklahoma, which were unable to provide rainy day fund balance data for all three fiscal years, total rainy day fund balances for fiscal 2017 are estimated at $49.6 billion, compared to $49.7 billion in fiscal 2016. States are projecting a roughly $4.0 billion increase in rainy day fund balance levels in fiscal 2018, with governors’ budgets recommending levels totaling $53.5 billion; California’s projected balance increase of $2.7 billion accounts for about two-thirds of this expected growth. (See Exhibit 13.)

Despite limited revenue growth, governors continue to prioritize rainy day fund savings accounts to prepare their states for a future downturn or other unforeseen circumstances. States have made significant progress in bolstering their reserve funds since the

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

13

Texas and Alaska excluded due to restructuring of the rainy day fund, making the data incomparable.Data for Oklahoma and Georgia excluded in fiscal years 2017 and 2018.Source: NASBO, Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

0

10

20

30

40

50

60

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Billio

ns o

f dol

lars

Fiscal Year

Rainy day fund balances total Rainy day fund balances (excluding Alaska and Texas)

Exhibit 14: Rainy day fund balances

Texas and Alaska excluded due to restructuring of the rainy day fund, making the data incomparable.Data for Oklahoma and Georgia excluded in fiscal years 2017 and 2018.Source: NASBO, Fiscal Survey of the States, Spring 2017; Allianz Global Investors.

Great Recession, when rainy day fund balances fell to $21.0 billion in fiscal 2010 (or just $10.7 billion when excluding Alaska). Rainy day fund balance levels vary considerably across states, with a median of 5.4% as a share of general fund expenditures in fiscal 2016 (among those states with a rainy day fund established). Twenty-seven states estimate increases in their rainy day fund balances in fiscal 2017, while 13 states reported decreases. For fiscal 2018, 28 states recommend increasing their rainy day fund balances, while just seven states propose declines. (See Exhibit 14.)

Here’s why states keep a portion of their revenues in rainy day funds: ◽ The primary reason for maintaining adequate rainy day funds is

that the additional reserves can help circumvent service disruption during economic downturns by countering declines in tax revenues.

◽ Rainy day funds have other benefits besides the potential to supplant falling revenues.

◽ Availability of rainy day funds gives decision-makers time to consider the scale and scope of budget adjustments needed to meet legal mandates.

◽ Rainy day funds can extend the operation of agencies and programs until the next budget cycle, when spending concerns can be more addressed by accustomed budget processes.

◽ Budget reserves held in rainy day funds are viewed positively by credit rating agencies, ultimately serving to help lower state borrowing costs.

◽ Rainy day funds can also be used to buy time, reducing the need to make immediate cuts to core operations before more thorough spending plans can be devised, which generally requires lengthier legislative debates.

◽ Since prior spending commitments cannot easily be undone, rainy day funds provide a funding cushion to pay for uncontrollable outlays.

◽ Additionally, rainy day funds can be used to maintain agency operations while states that choose tax increases wait for the revenue gains.

◽ Rainy day funds are often needed during times of natural disaster as well, and can be used to match federal funds.

Several states report that rainy day funds were not relied upon heavily during the Great Recession, because economic indicators suggested that the downturn would result in a permanent reset for their respective budgets.

Under the Macroscope | The end of the Fed as we know it?

Bibliography

Ashworth, Paul, ed. “Is the Illinois Budget Crisis a One-Off?” Capital Economics, US Economics Weekly, June 30, 2017..

Basak, Sonali, Katherine Chiglinsky, Brandon Kochkodin. “How America Dug a $375 Billion Pension Hole,” https://www.bloomberg.com/news/articles/2017-08-04/how-america-dug-a-375-billion-pension-hole.html

Congressional Budget Office. “Public Spending on Transportation and Water Infrastructure, 1956-2014,” Report, March 2, 2015.

Congressional Budget Office. “The Macroeconomic and Budgetary Effects of Federal Investment,” Report, June 16, 2016, https://www.cbo.gov/publication/51628.

Forgey, Quint. “Illinois Officials May Be Near Deal,” The Wall Street Journal, June 24, 2017.

Forgey, Quint. “Budgeting Stymies Several States,” The Wall Street Journal, August 2, 2017.

Gillers, Heather, Zusha Elinson.” Police Pensions Put cities in Bind,” The Wall Street Journal, July 5, 2017.

Kamp, Jon. “State Budget Battles Heat Up as Deadline Draws Closer,” The Wall Street Journal, June 30, 2017.

Kamp, jon. “Recovery Leaves Out Some Cities,” The Wall Street Journal, August 9, 2017.

King, Kate. “Budget Disputes Tie Up States,” The Wall Street Journal, June 24, 2017.

Malin, Steven R. “State Budgets in 1990: The Case of the Missing Surpluses,” The Conference Board, Regional Economies and Markets, Second Quarter 1990.

McNichol, Elizabeth. “It’s Time for States to Invest in Infrastructure,” Center on Budget and Policy Priorities, February 23, 2017.

National Association of State Budget Officers. “State Budgeting and Lessons Learned From the Economic Downturn: Analysis and Commentary From State Budget Officers,” Summer 2013.

National Association of State Budget Officers, “The Fiscal Survey of the States: Spring 2017.”

National Association of State Budget Officers.”Summary: Spring 2017 Fiscal Survey of the States,” June 15, 2017.

National Conference of State Legislatures. “State Budget Update: Spring 2017,” May 2017.

Shirley, Chad. “Spending on Infrastructure and Investment,” Congressional Budget Office Blog, March 1, 2017, https://www.cbo.gov/publication/52463.

The Wall Street Journal. “Blue State Budget Breakdowns,” Opinion: Review & Outlook, July 4, 2017.

The White House, “Fact Sheet – 2018 Budget: Infrastructure Initiative,” https://www.whitehouse.gov.

U.S. Bureau of the Census,” 2015 Annual Survey of State Government Finances,” https://www.census.gov/govs/state.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

15

About the authorSteven R. Malin, Ph.D. Director, Senior Investment Strategist Global Investment Strategy

Mr. Malin is senior investment strategist and a director with Allianz Global Investors, which he joined in 2013. He is responsible for making weekly US and global asset-allocation recommendations. Mr. Malin’s responsibilities also include analyzing global economic, financial, political and regulatory developments; and briefing institutional, retail and retirement clients. He has 25 years of financial-markets, central-bank and investment-industry experience. Before joining the firm, he was the director of research at Wealthstream Advisors, a private wealth management firm; and an advisor to Aronson Johnson & Ortiz, a quant-based institutional equity manager. Earlier, Mr. Malin was a senior portfolio manager at AllianceBernstein, serving institutional, sub-advisory, Taft-Hartley and private clients throughout North America. He also worked at the Federal Reserve Bank of New York for more than 16 years, and during this time he was an officer who held several senior positions, including senior economist, media relations officer, vice president in the communications group and corporate secretary. Before that, Mr. Malin was the senior economist, founder and director of the regional economics center at The Conference Board. He also taught graduate and undergraduate macroeconomics and risk-management courses at Barnard College-Columbia University and the City University of New York. Mr. Malin has a B.A. in economics from Queens College and a Ph.D. in economics from the Graduate Center of the City University of New York.

Under the Macroscope | State Budgets and Fiscal Obligations: Collisions Ahead

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or complete-ness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is used only as supporting material to the offshore investment prod-ucts offered by commercial banks under the Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations.This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business

Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Opera-tor), No. 424, Member of Japan Investment Advisers Association]; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.© 2017 Allianz Global Investors U.S., LLC.WP-35-0917 l 246839 l 02524