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Obama has few options to aid strapped states

By Zachary A. Goldfarb
Washington Post Staff Writer
Sunday, February 27, 2011; 6:33 PM

The budget crisis facing many states is threatening to undermine key elements of President Obama's agenda, but with Republicans in control of the House and widespread concern over the federal deficit, he has few options to make a significant difference.

Even those who say Obama needs to secure significant new federal spending to help states avoid cutting health care and education programs and laying off workers acknowledge the limits.

"We know there is not a great appetite for major new funding, but there is a real short-term crisis here," said Charles Loveless, the legislative director of a powerful labor union, the American Federation of State, County and Municipal Employees.

Eventually, Obama could also come under pressure from state officials and the financial industry to provide emergency aid to states and municipalities if they can't pay off their debts.

Moody's, the credit rating agency, said last week that the "municipal market faces credit pressure not seen since the Great Depression." Some prominent analysts have warned that states and localities may not be able to pay hundreds of billions of dollars in debts. Meanwhile, politicians in Washington are debating whether states should be allowed to declare bankruptcy.

The Obama administration has tried to help states with the 2009 stimulus bill and a 2010 law extending health care and education funding. But all those funds are now about to run out. An estimate by the Center on Budget and Policy Priorities says that states face a combined budget gap of at least $125 billion in the fiscal year starting July 1.

State and local governments have cut 400,000 workers since 2008. The Center on Budget and Policy Priorities says 850,000 more jobs would be lost if states tried to make ends meet solely by getting rid of employees.

Obama has offered several new proposals that could help states in fiscal straits. His 2012 budget unveiled this month would make it easier for states to delay payments on money they have borrowed from the federal government for unemployment insurance payments. Republicans oppose the $3.6 billion measure.

The budget also includes more money for education, boosting federal funding by 11 percent to $77 billion, and hundreds of billions more for infrastructure, such as a $53 billion proposal for high-speed rail.

Nicholas Johnson, a vice president for state fiscal policy at the Center on Budget and Policy Priorities, says that more stimulus money would help. But with both parties now calling for cuts in federal spending, he said his top concern is that the government "avoid making things worse."

Key elements of the Obama agenda are now at risk. In his State of the Union address and at several recent events, Obama has touted a new competitiveness agenda to create jobs. He has said that would rely on education, innovation and infrastrastructure.

"He made clear he's interested in having this debate about long-term economic competitiveness and he's talked about a good education system, a workforce, sound infrastructure," Johnson said. "These are things that are paid for out of state and local budgets."

Indeed, federal funding accounts for only about 10 percent of education spending and 30 percent of transportation spending.

While Obama's overhaul of the nation's healthcare system may be his signature achievement, it is now also being undercut by fiscal hardship in the state capitals. With fewer people employed, more are seeking Medicaid but its funding has not kept pace.

As a result, states are carrying out a wide array of reductions, limiting which doctors can participate, and cutting back on diabetes treatments, vision and dental care, and a host of other medical services.

In some cases, the Obama administration has actually aggravated the states' money problems, according to analysts. The December tax deal, which in part renewed Bush-era tax cuts, allows companies to deduct all business investments from their taxes. The Center on Budget and Policy Priorities said this change could cost states more than $11 billion in tax revenue over two years.

Some analysts warn that a growing number of local governments may not be able to pay their debts. Financial analyst Meredith Whitney , one of the few who correctly predicted the upheaval in the banking sector in 2007 and 2008, has projected 50 to 100 defaults worth hundreds of billions of dollars. Other analysts say that prediction is too dire.

While speculation has mounted that the Obama administration could be asked to bail out troubled states and localities, federal officials have so far shown no interest.

In 2009, amid the financial crisis, California turned to the Treasury Department for help with a $24 billion budget shortfall, but was rebuffed. Instead, California tapped a federal program that helped states issue bonds. The program, known as Build America Bonds, expired in December.

Martin Weiss, chief executive of Weiss Ratings, said he expects the federal government will provide some support to ailing states but not bail them out entirely.

"They will provide some funding, but they will not go all the way and be the lender of last resort," Weiss said. "That limited funding would probably be enough to avoid defaults."

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