Sequestration and the States

Now that the requiem has been written for the Super Committee the question is what does “sequestration” mean for state budgets.    The bottom line is that the collapse of Washington’s latest effort to set the federal budget on sound fiscal footing is a mixed bag for the states.   Medicaid represents the center of gravity of the state-federal fiscal relationship, and the Super Committee’s failure to reach a compromise has spared the program from near term cuts.  However, the nearly $190 billion in “discretionary” pass through grants received by state and local governments are squarely in the cross hairs of the sequestration process.

Baring an unlikely effort by Congress to defang the automatic cuts contained in the Budget Control Act of 2011, Congress will be required to sequester, or remove from consideration, set amounts of discretionary spending below the $1.05 FY2011 baseline spending level to achieve $1.2 trillion in savings by the end of 2020.   Beginning in 2013, federal discretionary spending will dive nearly $100 billion to a total discretionary level of $967 billion and will then slowly increase each year.  Total federal discretionary spending will not crest above the FY2011 level until 2019.

As has been reportedly widely, sequestration cuts will be shared equally between “security” and “non-security” spending.  The security spending includes not only defense, but the State Department budget, foreign aid, intelligence agencies, and many other aspects of America’s national security posture.  However, as the Department of Defense dwarfs these other budget components the military will inevitably bear the brunt of the security cuts.  Anticipating the impact of these cuts, some observers are already speculating that DOD will need to conduct another round of Base Realignment and Closure (BRAC) as early as 2015.

There is a little discussed element of the Budget Control Act which could help ease the sting of these defense cuts.   Defense Secretary Leon Panetta frequently mentions that his department is already grappling with plans to cut $450 billion over ten years as a result of this summer’s $917 billon debt ceiling compromise.  That $450 billion number assumes that the cuts included in the $917 billion agreement, which are already going into effect, will be shared equally among security and non security accounts.  However, unlike the sequester cuts, the Budget Control Act, only requires that the cuts used to generate $917 billion in savings be shared equally for the first two years.  If sequestration kicks in as expected in 2013, triggering another $500 billion in security cuts, you can expect Congress will use this flexibility to dial back some of the $450 billion in scheduled cuts under the $917 billion compromise by forcing non security accounts to cut even more.  

With domestic discretionary spending set to dive by at least $500 billion over the next ten years, and perhaps by much more if defense advocates use the flexibility at their disposal, the stream of grant funding that states receive for everything from rehabilitating released prisoners to funding special education is set to be severely squeezed.  A preliminary estimated of the impact of sequestration on pass through grants conducted by Federal Funds Information for States (FFIS) predicts that federal grant funding will drop by over $24 billion in FY2013 alone.  However, final cuts could go even deeper as even small cuts to federal agencies of 2-5% often translate into magnified cuts to state grant accounts of 20% or higher. 

States will be able to pass on many of these cuts to local governments or community service providers.  However, some of the education funds set to meet the chopping block, particularly Title I disadvantaged schools funding and IDEA special education money, will need to be back filled with state general fund dollars on a near one-to-one basis or risk court actions that could force states to spend even more money than they would otherwise. 

The age of austerity has clearly arrived.  It is still too early to know how heavy the axe will fall on each account and which cuts will gash the deepest into wobbly state general funds.  However, the axe is coming and it will hurt.