How will the federal budget sequester affect state and local government budgets?

The federal budget sequestration will strain some visible federal programs — Head Start, air traffic control.  But what will the federal budget sequestration do to state and local government budgets?

There are enough moving parts that the answer is not clear, but it appears that, overall, most state and local governments will feel relatively limited budget effects in the present fiscal year and over the coming years.  For most of us, it may take some time to recognize the damage that the cuts will do.

To put the various financial threats in perspective, it’s helpful to nail down some basics (using numbers from the non-partisan Congressional Budget Office‘s February 2013 publication The Budget and Economic Outlook: Fiscal Years 2013 to 2023).

At the end of last year, to avert the so-called “fiscal cliff”, Congress and the President agreed to extend the Bush era income tax cuts for all except those earning more than $400,000.  That deal allowed the stimulus-related payroll tax cut to expire, but protected middle class earners from a more significant potential rate rise from the scheduled expiration of the Bush era tax cuts.

By keeping most of the Bush era tax cuts in place, the deal added $0.4 trillion per year to the federal deficit.  Nonetheless, as a result of the legislated rate increases, bracket creep and economic growth, individual income tax revenue is projected to rise from 7.3% of the economy in 2012 to 9.8% in 2023.  All federal tax revenues taken together will rise from 16% of the economy in 2012 to roughly 19% of the economy and remain at that level through the decade.  19% is a level consistent with the average level over the past 40 years.

Even with the budget sequestration, under current policies, annual federal spending will rise from $3.5 trillion in 2012 to $5.9 trillion in 2023, so remaining at a historically high level as a share of the overall economy — roughly 22%.

Much of federal spending is mandatory and substantially exempt from the sequestration.  The biggest mandatory programs are Social Security, Medicare and Medicaid.  Annual spending on social security is projected to rise from $0.8 trillion in 2012 to $1.4 trillion in 2023.  Annual health spending  (mostly Medicare and Medicaid) is expected to more than double from $0.8 trillion in 2012 to $1.8 trillion in 2023.  Social security and health together will grow from 45% of annual federal spending in 2012 to 55% in 2023.  Growth in these programs is driven by the aging of the population and the continued rapid rise in health care costs.

Although economic growth and the sequester-forced cuts in discretionary areas will bring the federal deficit from 7.0% of the gross national product in 2012 to 2.4% in 2015, the deficit will drift back up to 3.8% later in the decade as a result of the spending growth in the mandatory programs.   Rising interest rates on the national debt will also expand the deficit and the deficit will, in turn, continue to drive the national debt upwards as compared to the economy (rising from 72.5% in 2012 to 77.0% in 2023).  These debt projections all build-in the impact of the budget cuts forced by the “sequestration” that took effect last week.  (See the Center on Budget and Policy Priorities for the impact of war spending on the deficit.)

The CBO expresses these concerns about the rising federal debt level:

If the amount of debt held by the public remains so large, federal spending on interest payments will increase substantially when interest rates rise to more normal levels. Because federal borrowing generally reduces national saving, the stock of capital assets, such as equipment and structures, will be smaller and aggregate wages will be less than if the debt were lower. In addition, lawmakers will have less flexibility than they ordinarily might to use tax and spending policies to respond to unanticipated challenges. Moreover, such a large debt poses an increased risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.

Yet, from a state budget perspective, the federal commitment to Medicaid, so far undiminished, has been central good news.  Additionally, Congress protected from the sequestration, TANF, the main welfare program for needy families.  Of $8.5 billion expected by Massachusetts in Fiscal 2014 (roughly 1/4 of the state budget), $8.2 billion of it is in health and human services and much of this funding is protected from currently proposed cuts.

The National Conference of State Legislatures estimates the total direct loss to Massachusetts governmental units in federal fiscal 2013 at $108 million, including both state and local government. The NCSL grants database covers 216 federal programs that contribute to state and local governments — it does not cover grants to private sector entities.

The NCSL database does not explicitly classify grant programs as state or local, but, based on the major programs, it appears that a little less than half of the funding loss will be at the local level and a little more than half at the state level. So, with a total state budget of approximately $33 billion and total local spending of approximately $12 billion the losses work out very roughly to 0.2% at the state level and 0.4% at the local government level.

The federal sequester will force real cuts in a host of other federal programs, roughly evenly divided between defense and non-defense together.  Discretionary programs will be forced to actually drop roughly 10% from $1.185 trillion in 2012 actual to $1.170 trillion in 2014, according to the CBO.  For the following 7 years, discretionary spending will be allowed to rise gradually at 1.7%, a little below the rate of inflation.  So, the tightness will continue, but less dramatically. Click here for a Whitehouse inventory of Massachusetts cuts, going beyond cuts that directly affect state and local governmental budgets.

I’ve previously expressed  a concern about how we tend to balance our budget at the state level:  Protecting the programs that are most visible to our constituents and our local government partners — program like education and transportation — while hollowing out less visible but equally critical programs like public health.  With the recent drug lab and meningitis tragedies, we saw the consequences of under-spending on public health.

I see a parallel at the federal level.  Most of us aren’t going to feel direct impacts from the sequestration in the near term.  Knowing that, Congress has let it happen. But in the long run, I fear that, through some unpleasant surprises, we are going to find out more about what the less visible federal programs taking the deep cuts have actually been doing for us.

Published by Will Brownsberger

Will Brownsberger is State Senator from the Second Suffolk and Middlesex District.