With debt deal, states brace for cuts in federal aid

The domestic spending cuts contemplated in the debt-ceiling deal are sure to compound the dire fiscal situation confronting the states, which already are reducing jobs and slashing once-untouchable programs to balance their budgets.

The measure that President Obama signed into law on Tuesday does not lay out specific reductions, but with federal dollars accounting for a third of state revenue, analysts said steep cuts will be unavoidable.

“The debt-limit deal inevitably will lead to large federal cuts in programs for state and local governments,” said Nicholas Johnson, vice president for state fiscal policy at the Center on Budget and Policy Priorities. “This is going to begin in the middle of the worst year for state budgets.”

Cutbacks at the state and local levels are a primary reason that the nation’s economic growth has slowed to a crawl.

The debt-ceiling deal calls for a $900 billion reduction in projected domestic spending over the next decade. The savings will be achieved by imposing spending caps, with the exact allocations to be determined by Congress.


Adding to the uncertainty, a special congressional committee created by the debt measure is charged with coming up with an additional $1.2 trillion in cuts by the end of the year. And many analysts are concerned that some of those cuts could come from federal funding for Medicaid, which is among the largest expenses in many states. Medicaid, the joint federal-state health-care program for the poor and disabled, also represents by far the largest source of federal aid to states.

“They might be looking at Medicaid in the second round of cuts,” said Brian Sigritz, director of state fiscal studies at the National Association of State Budget Officers. “Transportation and infrastructure programs also could be cut back.”

Locally, officials are bracing for the worst.

District Mayor Vincent C. Gray is working to prioritize services in anticipation of federal cuts, according to a spokesman. The city expects to receive $2 billion in federal money this year. About 70 percent of that is for Medicaid, according to Natwar M. Gandhi, the District’s chief financial officer.

A memo circulating in the administration of Maryland Gov. Martin O’Malley (D) listed “good news” and “bad news” about the debt-ceiling deal.

The memo noted that averting a federal default reduces the likelihood of a downgrade in U.S. credit and improves the chances that Maryland will maintain its AAA bond rating, keeping the state’s borrowing costs low.

Cited among the “bad news” were caps on domestic spending.

Warren Deschenaux, the chief budget adviser to the Maryland General Assembly, said that while welfare and Medicaid are protected in the first phase of the deal, transportation, education and environmental programs are not.

“That will hurt gradually as cuts are phased in,” Deschenaux said. “The bigger problem is more long-term and related to constraints on defense spending, employment and wages. The potential is there for slower growth than we are used to, similar to the mid-90s.”

He added that to the extent that the commission “decides to open up” entitlements for cuts, “the direct budget pressure could become much more acute.”

O’Malley issued a statement Monday supporting the deal, saying that “recklessly driving our country into default would kill our fragile economic recovery.” But, he added, “so too would massive, irresponsible public sector cuts.”

Virginia officials said they would not speculate on the deal’s potential impact. “We really don’t know yet,” said Jeff Caldwell, a spokesman for Gov. Robert F. McDonnell (R).

Whatever the size of the eventual cuts in federal funding to states, they will come at an inopportune time. This year, the states had to close more than $100 billion in budget gaps, mostly through spending reductions that often affected programs previously considered sacrosanct.

That came on top of about $400 billion in budget shortfalls in the previous three fiscal years, caused by diminished revenue coupled with a surge in the demand for social service programs during the recession.

The Center on Budget and Policy Priorities says that in the wake of the recession, 34 states have cut K-12 education funding, 43 have reduced college funding, and 31 have slashed money for health care.

In all, state and local governments have cut 577,000 jobs since 2008, accelerating the unemployment rate.

For states, “the uncertainty remains,” said Kil Huh, a director of research at the Pew Center on the States. “This is going to translate into some reduction for states. Where they are and how deep they are, we don’t know yet. But they don’t come at a good time.”

Staff writers Nikita Stewart and John Wagner contributed to this report.

Michael A. Fletcher is a national economics correspondent, writing about unemployment, state and municipal debt, the evolving job market and the auto industry.
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