THE STATE'S FINANCIAL REPORT CARD

Overview
As Comptroller, an important part of my job is to report directly to the people of Connecticut on state government finances. The information that I present must be both accurate and accessible. This report would be of limited value if I used accounting standards that failed to disclose the state's true financial position or if a degree in accounting were required to understand the numbers.

To guarantee accuracy, I am using Generally Accepted Accounting Principles (GAAP) for reporting, which is the recognized standard for business and government. I have selected a report card presentation because most people have received them and are familiar with the grading system. This serves as Connecticut state government's financial mastery test.

The grades are given in five areas relating to short-term fiscal results and the long-term financial outlook for state government. A grade and a summary explanation of how the grade was determined is provided below for each category. The grades are based on careful analysis of state financial data and Connecticut's position relative to other states. The detailed data and comparative statistics supporting the grades are contained in the body of this report. I hope this information will help Connecticut's citizens to understand where our state has been and where it is headed.

The National Economy: A
The expanding national economy with its associated strong financial market gains has generated unexpected increases in revenues for states. Connecticut, like a majority of other states, has seen its tax receipts swell, producing consecutive General Fund surpluses. The national economy is experiencing its longest period of sustained growth in three decades. More than fourteen million jobs have been added since the recovery began, with job growth averaging over 2 percent per year. As of this writing, the national unemployment rate has dropped to a historically low 4.7 percent level. After a long period of wage stagnation, 1997 produced real growth in wages and salaries. The importance of the impact of a strong national economy on Connecticut's fiscal position should not be underestimated.

The State Economy and 1997 Fiscal Performance: B
A strong economy results in reduced state spending for social support programs and higher state tax revenues. During 1997, Connecticut's economic growth improved the state's overall fiscal position. The state experienced its strongest level of job growth in more than a decade, adding almost 30,000 new jobs during Fiscal Year 1997. The state's current 2 percent rate of employment growth approximates the national rate. In October 1997, (the latest data available) the unemployment rate in the state was 4.7 percent, down a full percent from the previous year. Connecticut remains number one in the nation in per capita income ($33,875 in 1996) with final figures for 1997 expected to show growth of over 5 percent. Wages and salaries in the state have also shown steady growth over the past year. Most indicators of future state economic activity are pointing up. Between the third quarter of 1996 and 1997, new business starts were up 25.4 percent and housing permits expanded by 10.9 percent.

Against this positive backdrop, some notable problems persist. The unemployment rates in our cities are well above the state-wide average. State median household income adjusted for inflation has actually declined by 7.8 percent from five years ago. Furthermore, Connecticut ranks fifth in the nation in income inequality, with the top fifth of families earning 14.2 times more than the bottom fifth. Such employment and income disparities threaten the prospects for long-term growth.

Although spending exceeded budgeted appropriations by $150 million, the strong economy generated sufficient revenues to close Fiscal Year 1997 with a General Fund surplus of $252 million. The Transportation Fund also produced a surplus of $47 million. Despite the positive performance of these two closely watched funds, when all governmental funds are considered, the state actually finished the year in a deficit position. The overall governmental operating deficit for FiscalYear 1997 was $95 million. The deficit results from the failure of the state's grant, loan and housing programs to bring in sufficient revenues to keep these funds in balance. In other words, the deficits in these special revenue funds for Fiscal Year 1997 were large enough to more than offset surpluses in the General and Transportation Funds. The resulting overall operating deficit must be funded through borrowing (i.e., issuing bonds). While the state continued to operate in a deficit position in Fiscal Year 1997, the $95 million deficit was lowest in 10 years, which must be factored into this grade.

There was an additional positive development in Fiscal Year 1997. Because the General Fund produced a surplus, money was available for transfer into the state's Budget Reserve (or rainy day) Fund. The fund is intended to cushion the fiscal impact of any future economic downturn and provide a degree of fiscal stability. At the end of Fiscal Year 1997, $96 million of the General Fund surplus was transferred to the state's rainy day fund bringing the fund balance to $336.9 million. It is unfortunate, however, that in these good economic times, the fund remains $130.2 million short of its statutory target of 5 percent of net General Fund appropriations.

Overall Financial Position: C
In addition to looking at the fiscal results for one year of state government operations, it is important to analyze the state's overall financial position. In short, this means to examine the state's accumulated assets, its cumulative liabilities and the resulting fund balances. These numbers are presented on the state's balance sheet. Unfortunately, Connecticut's current balance sheet position is not good and it is getting worse. The General Fund balance sheet presented on a GAAP basis showed a cumulative deficit of $670 million at the end of Fiscal Year 1997. This is an increase of $30 million from the prior fiscal year. Over the past five years, the cumulative General Fund balance sheet deficit has increased by 33 percent.

The main reason for the balance sheet deficit is the state's use of a flawed budgetary accounting system. For annual budgeting purposes, the state uses an accounting system that allows it to post more revenue than was actually accrued over the year and to count less spending than actually occurred through the year. This misrepresentation of state revenues and expenditures is corrected on the balance sheet, which is prepared in accordance with GAAP. Until the state adopts GAAP for budgeting purposes, a negative balance sheet position will likely continue.

The negative balance sheet is of particular concern for people who invest in the state's bonds. Those who purchase these bonds look at the balance sheet as one indicator of the state's financial health. A poor balance sheet position can indicate a higher level of investment risk, and therefore, may require higher state interest payments on borrowed money.

Debt Level: D
Connecticut is a high debt state and each year that debt burden continues to grow. Net state bonded debt was $9.2 billion in Fiscal Year 1997, a 3 percent increase from the previous year. In Fiscal Year 1997, the state increased its outstanding bonded debt by $248 million. Per capita state bonded debt has now reached $2,774. Moody's Investors Service rates Connecticut first in the nation in per capita debt. A high level of bonded debt means that high principal and interest payments are required to service that debt. In Fiscal Year 1997, state debt service payments totaled $1.1 billion. The interest payment alone amounted to $471 million. About one of every 10 dollars the state spends goes to debt service. These are dollars that are not available either for tax relief or to pay for vital programs that benefit the people of this state.

In addition to bonded debt, other forms of long-term debt continued to grow in Fiscal Year 1997. The state's pension debt reached $6.4 billion, payments owed to employees for compensated absences grew to $260 million, unfunded workers compensation payments stood at $283 million, and the state owed $49 million on capital leases. This brought the state's total long-term debt to a staggering $16.3 billion at the end of Fiscal Year 1997, which represented a $357 million increase over the prior year. The U.S. Census Bureau ranks Connecticut fifth highest in the nation in per capita long-term debt. This high level of debt is a poor legacy to leave our children and an unacceptable position for the wealthiest state in the nation.

Financial Practices: C
Bond rating agencies look closely at a state's financial practices in assigning a risk rating on state borrowing. A high rating is indicative of low investor risk, and therefore, a lower interest rate on borrowing is demanded. None of the agencies (Moody's, Standard & Poor's and Fitch Investor Service) that evaluate Connecticut's general obligation bonds have conferred their highest rating on the state. A state as wealthy as Connecticut should carry a top rating on its debt, which could lower state interest payments.

In order to secure top bond ratings and improve its financial well-being, the state must do three things that have proved elusive over the years. First, the state must fill the Budget Reserve Fund, which is still $130.2 million short of its statutory target of 5 percent of net General Fund appropriations. Second, the state must adopt GAAP for annual budget purposes in order to provide an accurate reporting of revenues and expenditures during the year. GAAP implementation, though approved by the legislature, has been delayed to Fiscal Year 2000. Third, the state must fund a higher proportion of the existing liabilities in the state employees' pension fund. At present, only 55 percent of the pension liability is funded. A greater effort is required to address these problems. If the state cannot solve these serious financial management problems now -- in good economic times -- what will happen when the economy turns down?

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