Financially, there are three possible outcomes for states in the increasingly dire showdown over the federal debt ceiling, Maryland’s chief budget analyst told lawmakers on Tuesday.
None of them, he said, end well for states:
Ending 1: Congress and President Obama fail to reach agreement to raise the debt ceiling by Aug. 2, and there’s no immediate solution on the horizon to fix the problem. The nation defaults on its debts and the federal credit rating is downgraded. The trouble spreads quickly to states, with Maryland, Virginia and probably three others most closely tied to federal spending facing credit downgrades of their own, possibly within hours or days.
In other words, “all heck breaks loose,” said Warren Deschenaux, director of the Maryland Department of Legislative Services. “It’s the worst possible scenario … and I believe if that happens, one of our smaller considerations will be [Maryland’s] bond rating,” he told the state Senate’s Budget and Taxation Committee, which returned to Annapolis on Tuesday to begin considering contingency plans.
Ending 2: Congress and the President reach a deal that prevents a default, but it’s not good enough to keep one or more of the ratings agencies from downgrading the federal credit rating. Moderate market and economic disruption ensues and states’ credit remains challenged.
“There is a possibility, and I think it’s not at all unlikely, that there is some solution to the debt limit, but that because the federal government failed to make significant inroads to the long-term budgetary problem, there would be a downgrade,” Deschenaux said. “I think that would lead to a more moderate disruption on credit ratings and it’s not clear what effect it would have on states.”
Ending 3: The two sides in Washington reach agreement on a broad deal to raise the debt ceiling and reduce the deficit.
“This may be perceived as a happy ending for the federal government – no downgrade, no defaults, and agreement reached on a big deficit-reduction plan,” Deschenaux said. “That should keep the market happy, but it’s very likely to be at the cost of putting additional costs to state governments.”
“Remember, most of what the states receive is in discretionary [funds] – Medicaid, entitlements, etc.,” Deschenaux testified. “Anything [budget] ‘reform,’ in theory, will be touching both discretionary spending and entitlements.”
For example: In Maryland, lawmakers have built $9.1 billion in federal matching and grant funds into the state budget that began July 1. More than $4 billion comes through Medicaid. The state is banking on another $700 million in food stamps, and hundreds of millions of dollars more each in highway construction, assistance for the poor and education grants.
“The real question is ‘what about me,’ how does it affect us and the answer to that is not very clear,” Deschenaux said, recounting for lawmakers how Moody’s Investors Services put Maryland, Virginia and three other AAA bond-rated states on a credit watch last week because of their financial exposure to a federal default.
Maryland’s year-end financials show it ahead of forecast in tax collections by nearly $300 million, a fraction of its $14.6 billion general fund.
Deschenaux warned lawmakers not to spend the money.
“We have to wait to see what the federal government is going to do.
“It has considerable flexibility in how it treats situations in which it has less revenue coming in than what it is expected to pay. It could pay the first bills due. It could pay everyone proportionally; it could pay some and not others. We hope we don’t get to find out.”
Regardless, Deschenaux said, “I see no happy ending for states.”