Fiscal Year-End Letter to the Governor dated September 17, 2020

September 17, 2020

The Honorable Ned Lamont
Governor of the State of Connecticut
State Capitol
Hartford, Connecticut

Dear Governor Lamont:

I write to provide you with the legal financial statements for Fiscal Year 2020. These statements have been prepared in accordance with statutory provisions designed to incorporate designated expenditure accruals of Generally Accepted Accounting Principles (GAAP) into the budget process. It is important to recognize that these statements have not been fully audited at this writing. The figures are subject to final audit adjustment and should be viewed as preliminary results. Final audited statements will be released on or before December 31, 2020.

The General Fund ended Fiscal Year 2020 with a surplus of $38,709,505. In a typical year, once the audit is completed, the surplus would be transferred to the Budget Reserve Fund (BRF). However, the balance in the BRF has reached the statutory limit of 15 percent of current year net General Fund appropriations. Therefore, a separate provision of the Connecticut General Statutes (CGS) will apply as described below. The Transportation Fund had an operating deficit of $151,685,947, which left a positive fund balance of $168,430,363 at the close of Fiscal Year 2020.

In FY 2020, as in the two previous fiscal years, significant progress was made toward building the balance of the BRF. This was primarily due to the revenue volatility cap, first implemented in FY 2018. This statutory provision requires revenues above a certain threshold to be transferred to the BRF. For FY 2020, the cap was $3,294.2 million for estimated and final income tax payments and revenue from the Pass-through Entity tax. At year-end, a volatility transfer of $530,316,290 was made to the BRF.

Prior to the close of FY 2020, the balance of the BRF was just over $2.5 billion. Adding the $530.3 million volatility transfer brought the BRF total to $3.036 billion, or 15.11 percent of net General Fund appropriations for FY 2021. As a result, the BRF is currently $22.9 million above the statutory 15 percent cap. According to CGS Section 4-30a (c)(1)(A), no further transfers will be made to BRF. Instead, the State Treasurer will decide what is in the best interest of the state, whether to transfer the balance above the 15 percent threshold as an additional contribution to the State Employee Retirement Fund (SERF) or to the Teachers' Retirement System (TRS).

In addition, once the audit of FY 2020 operations is complete and the General Fund surplus is confirmed, it will be the State Treasurer�s decision whether to transfer the $38.7 million surplus to SERF or TRS to reduce unfunded service liability. Achieving and surpassing the 15 percent threshold represents an important benchmark for Connecticut. Due to fiscal discipline and hard work, our state is in a much stronger position to provide critical services to those in need and to weather the public health and fiscal crisis brought on by the COVID-19 pandemic.

In contrast with FY 2019, which was characterized by relative stability throughout the year, the General Fund budget experienced extreme volatility in FY 2020 as the result of the COVID-19 pandemic and its impact on the state�s economy. The FY 2020 budget plan included a built-in General Fund surplus of $141.1 million at the start of the fiscal year. The projected surplus was gradually reduced during the first quarter due to higher than anticipated spending in several accounts, including Medicaid and Adjudicated Claims. The November 15, 2020 consensus revenue forecast between Office of Policy and Management (OPM) and the Office of Fiscal Analysis (OFA) reduced projected revenues, which resulted in the first deficit estimate of the year. However, the General Fund deficit remained relatively small and manageable until the extent of the coronavirus pandemic became known.

In March, due the public health emergency declaration, social distancing measures and the closure of non-essential business began taking their toll on the state�s economy. Large-scale layoffs resulted in historic levels of unemployment not seen since the Great Depression. In addition to these economic disruptions, stock market losses and extensions of various tax filing deadlines led to a high level of uncertainty that was reflected in the April 30th consensus forecast, which reduced revenue estimates significantly. By May, both OPM and OSC were projecting a deficit of $934 million, which represented about 4.8 percent of General Fund expenditures.

As the year progressed, smaller General Fund deficit projections resulted from improvements on several fronts. One major factor was a change in timing for anticipated Federal Medicaid reimbursements for hospital inpatient and outpatient supplement payments. In the end, these reimbursements were received in FY 2020, instead of being delayed until FY 2021, which improved the revenue picture by approximately $379 million. As the year progressed, a combination of spending restraint and continued improvement in revenues, especially during the statutory tax accrual period, helped eliminate the deficit before year-end.

In FY 2020, General Fund expenditures totaled $19,188,634,108. This represented a decrease of $60.0 million, a small reduction of 0.31 percent below FY 2019 spending levels. One primary reason spending was constrained in FY 2020 was a 15.9 percent decrease in General Fund debt service payments, which came in $354.4 million below the prior year�s total. FY 2019 debt service was higher than normal due to a one-time $380.9 million payment deposited into the Teachers� Retirement Special Capital Reserve Fund (SCRF). Accounting for this change, FY 2020 debt service is more in line with prior years and total FY 2020 General Fund spending would have increased by 1.70 percent above FY 2019 levels. Related to this issue, the state�s pension contribution for Teacher�s Retirement dropped by $83.5 million or 6.5 percent, largely due to a re-amortization of the system�s unfunded liability over a new 30-year period. Lastly, expenditures for Medicaid, the single largest General Fund account, declined by $43.2 million or 1.6 percent compared with FY 2019.

These reductions were partly offset by spending increases in several large General Fund appropriations. Due to medical inflation and population growth, expenditures for retired employees� medical insurance grew by $61.1 million in FY 2020. Spending for active state employee medical increased by $47.8 million over FY 2019. Hospital supplemental payments, which help generate additional Medicaid reimbursements for the state, rose by $55 million. Education Cost Sharing grants to municipalities increased by $32.1 million. Finally, the General Fund contribution to the State Employee Retirement System (SERS) rose by $28.2 million in FY 2020, primarily due to growth in unfunded pension liability.

Overall, employee salaries grew modestly in FY 2020. General Fund salary and wage costs (from all appropriations) totaled $2.76 billion in FY 2020. This represented an increase of $27.9 million or growth of 1.0 percent compared with FY 2019. The full FY 2020 General Fund statement of appropriations and expenditures by line item is presented in Schedule B-3.

Largely due to the impact of the COVID-19 pandemic on the state�s economy, several General Fund revenue categories under-performed their budget targets in FY 2020. Overall, realized revenues totaled $19,193,540,423 and came in a net $266.7 million or 1.4 percent below the FY 2020 budget plan. Compared with the FY 2019�s realized revenues, the decline was larger, down $456.3 million or 2.3 percent.

For FY 2020, collections in five of the six largest tax categories ended the year below budget target. These included the withholding portion of the income tax (-$95.3 million or 1.4% below budget); income tax estimated and final payments (-$179.9 million or 6.5% below budget); sales and use tax (-$126.4 million or 2.8% below budget); corporations tax (-$165.3 million or 15.0% under budget); and health provider tax (-$45.3 million or 4.3% under budget). The exception, which helped offset nearly two-thirds of these decreases, was the Pass-Through Entity Tax (PET) on Partnerships and S-Corporations. The PET exceeded its budget target by $391.9 million or 46.1 percent.

In the other revenue category, closures of non-essential businesses led to declines in other areas, including gambling related revenues. Lottery proceeds totaled $340.1 million, $27.9 million or 7.6 percent lower than budgeted, and casino gaming payments totaled $164.1 million, $61.9 million or 27.4 percent below target. License, permit and fee revenue also under performed, coming in at $307.5 million, $33.7 million or 9.9 percent lower than the budget plan.

Partly due to an enhanced Medicaid reimbursement percentage included in the Families First Coronavirus Response Act, Federal grant revenues ended the year $270.8 million above budgeted levels, representing an increase of 17.7 percent. The complete statement of estimated and realized revenue for FY 2020 is presented in Schedule B-2.

Transportation Fund spending totaled $1,669,768,018 in FY 2020, growing by $60.7 million or 3.8 percent compared with the prior fiscal year. Two fringe benefit accounts and debt service costs were responsible for almost 60 percent of that growth. Transportation Fund contributions for SERS retirement increased by $20.8 million in FY 2020, again primarily due to higher costs for unfunded pension liability. Employee medical insurance costs rose by $4.2 million and transportation-related debt service grew by $9.0 million. Programmatic spending was responsible for the remaining growth, including Department of Transportation (DOT) rail operations, which increased by $20.9 million. In addition, DOT bus operations spending grew by $5.0 million, while the ADA Para-Transit Program increased by $1.9 million.

One area with lower spending was Transportation Fund employee salaries, which dropped by $2.8 million or 1.4 percent, versus the prior year. The primary factor was dramatically lower overtime costs, in part due to a mild winter and lower snow removal costs.

The Transportation Fund had revenue of $1,516,585,006, which was $232.5 million or 13.3 percent below the budget plan for FY 2020. Virtually all categories of tax and other revenue sources under-performed their targets as shown in Schedule C-2.

Connecticut�s budget results are ultimately dependent upon the performance of the national and state economies. Analysts are describing the recovery from the pandemic as K-shaped: those individuals and households that are able to work from home, typically white collar workers, have fared much better than lower wage service sector employees who lost jobs due to business closures.

As supplemental unemployment benefits expired at the end of July, the situation has become more dire for those who have lost jobs. Research by the Center for Budget and Policy Priorities and other groups continues to show that lower income and minority households, especially those with children, are experiencing a disproportionate level of hardship during the pandemic, including joblessness, hunger, eviction, and homelessness. Numerous economists, including Federal Reserve Chairman Jerome Powell, are urging Congress to provide more relief to prevent further damage to the economy and avoid prolonging the recovery, which is stalling amid high levels of coronavirus cases.

Prior to March, Connecticut was experiencing modest, but steady job growth. According to the state Department of Labor (DOL), Connecticut achieved six straight months of employment growth through February 2020. However, with the advent of the coronavirus pandemic and related non-essential business closures, the state and the nation began to suffer historic levels of job losses not seen since the Great Depression of the 1930s.

In April, U.S. payroll employment fell by 20.5 million jobs with declines in all 50 states. Connecticut lost a total of 266,300 net jobs, a 15.9 percent decline in just one month. By May 2020, DOL reported an average of 326,000 state residents were collecting unemployment benefits, compared to just under 28,000 in May of 2019. According to the Connecticut Economic Digest, 2020 unemployment claimants are more likely to be female and are younger on average compared with the Great Recession of 2009-2010. In addition, they are more likely to have worked in service sector positions (accommodation & food service, retail trade, or health care & social assistance) compared with 2009-2010, which saw the largest number of unemployment claims in manufacturing and construction.

By the end of the fiscal year, Connecticut had begun recovering some of the jobs lost, but employment levels were still down significantly on a year-over-year basis. Over the course of FY 2020, the state lost 168,700 nonfarm seasonally adjusted payroll jobs (-10 percent) and had a total of 1,513,900, employed residents as of June 2020. All major employment sectors suffered losses, but leisure & hospitality was particularly hard hit, losing more than a third of its jobs for the period.

As the fiscal year closed, Connecticut's official unemployment rate stood at 10.1 percent in June, up from 3.7 percent from a year earlier. However, DOL cautioned the June 2020 figure was significantly understated due to ongoing data collection and classification issues with the Current Population Survey. DOL�s Office of Research estimated Connecticut�s unemployment rate was much higher, in the range of 16-17 percent for the mid-May to Mid-June period. By comparison, the official U.S. jobless rate in June 2020 was 11.1 percent, although analysts noted that rate was also understated due to the data collection issues noted above. One estimate by the Peterson Institute of International Economics put the U.S.�s �realistic unemployment rate� at 13.0 percent for June.

Berkshire Hathaway HomeServices reported results for the Connecticut housing market for June 2020 compared with June 2019. Sales of single-family homes dropped by 14.83 percent, with the median sale price increasing by 5.08 percent. Reversing a trend from preceding months, new listings were up 10.18 percent in Connecticut. The median list price rose 6.37 percent to $299,900. Average days on the market increased 14.93 percent in June 2020 compared to the same month in the previous year (77 days on average compared with 67 in June 2019). Since that time, the Connecticut housing market has continued to recover from the pandemic related slowdown, with stronger sales and price growth. Some of this improvement has been driven by New York City residents relocating to the suburbs, including to Fairfield County, Litchfield County and the Connecticut shoreline.

According to an August 27th report from the Bureau of Economic Analysis (BEA), U.S. Real Gross Domestic Product (GDP) decreased at an annual rate of 31.7 percent in the second quarter of 2020, according to BEA�s second estimate. This represents the steepest quarterly decline on record, reflecting the significant economic fallout of the coronavirus pandemic. By comparison, the worst quarter during the Great Recession was an 8.4 percent drop in GDP in the fourth quarter of 2008. In the first quarter of 2020, real GDP decreased 5.0 percent. State level GDP results for the second quarter will be released by BEA on October 2, 2020.

As the fiscal year ended, the Conference Board reported that the Consumer Confidence Index showed dramatic improvement in June and reflected less pessimism among consumers due to the re-opening of the economy and relative improvement in unemployment claims. More recently, however, consumer confidence declined in both July and August. The drop was attributed to a resurgence of COVID-19 infections, which threatens to slow economic activity as states in the South and Midwestern U.S. reassess plans for reopening. Consumers reported feeling both business and employment conditions have deteriorated, leading to a more pessimistic view of their own financial prospects, which could cause consumer spending to cool in the months ahead, potentially slowing the nation�s recovery.

My office also issues a Comprehensive Annual Financial Report (CAFR) as an accounting supplement to the budgetary report. The CAFR includes financial statements for all state funds and component units prepared in accordance with Generally Accepted Accounting Principles (GAAP). From a balance sheet perspective, the GAAP unassigned fund balance in the General Fund was a negative $771.4 million as of June 30, 2019. I will report the new unassigned fund balance figure for Fiscal Year 2020 no later than February of 2021 in accordance with U.S. Securities and Exchange Commission (SEC) requirements.