NEW YORK, Sept 17 (Reuters) - While U.S. states' financial health has strengthened in 2018 compared with last year, fewer than half have enough financial reserves to weather the first year of a moderate recession, according to an S&P Global Ratings report on Monday.
Only 20 states have the reserves needed to operate for the first year of an economic downturn without having to slash budgets or raise taxes, S&P said.
"In their fight against recessions, budget reserves are what states send to the frontline," the report said. "They are an internal source of immediate liquidity and can provide transitional funding to agencies before budget cuts take effect."
States face worse revenue shortfalls in the next recession compared with the Great Recession, S&P said. That is because states rely more heavily on personal income taxes as a percentage of general fund revenues now than a decade ago, with the taxes currently contributing a combined 55 percent to the funds compared with 49 percent in 2008, S&P said.
In addition to lacking reserves, states at risk of severe financial stress in the first year of the next recession also have higher revenue volatility and elevated fixed costs, including debt payments and pension contributions, S&P said.
Increased social costs like Medicaid could also contribute to the steepening of budget shortfalls, it said.
There are 15 states at risk of large revenue shortfalls in the first year of a recession, 21 states with moderate shortfall risks and 14 states expected to have low shortfalls.
In the case of a moderate recession, states could see general fund shortfalls between 9.9 percent and 11.8 percent year over year, compared with 8.1 percent from 2008 to 2009, S&P said.
Still, state financial health has strengthened in the current year compared with last year, and the likelihood of an economic downturn starting in the next 12 months is a mere 10 percent to 15 percent, S&P said.
A Moody's Analytics report, also released on Monday, said the number of states with sufficient reserves to withstand a recession increased to 23 from 16 last year.
There is also a greater number of states that are significantly unprepared for even a small downturn, with 17 states holding far less funds than they need, compared with 15 in 2017, Moody's said.
Those states, in order of least-prepared, are Louisiana, Oklahoma, North Dakota, New Jersey, Montana, Kentucky, Virginia, Missouri, Arizona, Illinois, Pennsylvania, Wisconsin, Kansas, New Hampshire, Mississippi, Michigan and Arkansas.
(Additional reporting by Karen Pierog in Chicago; Editing by Dan Grebler)