The Debt, the Deal, and the States

After more than six months of partisan bickering, Washington leaders managed to avert default by stealing a page from the Reagan era.   The 74 page bill approved by Congress revives and amends Gramm-Rudman, the marquis deficit reducing legislation of the 1980’s.  The full impact of the deal won’t be known until Congress translates the loose spending targets in the legislation into specific program cuts through the annual appropriations process, but it is clear that federal funding for states is set to drop precipitously. 

The deal achieves a minimum of $900 billion in initial savings by capping annual expenditures both for defense spending and domestic programs.  This puts state budgets squarely in the cross hairs for cuts as grants in aid to state and local government represent almost 40% of the roughly $500 billion that the federal government spends each year on domestic discretionary programs.  What’s more, the legislation mandates a new committee to find and additional $1.2-$1.5 trillion in savings that will likely require significant cuts to Medicaid. 

Here is what we know:

  • The Budget Control Act, drafted as an amendment to Gramm-Rudman, allows the President to raise the debt ceiling by at least $2.1 trillion and as much as $2.4 trillion through an initial increase of $900 billion followed by a second increase of $1.2-$1.5 trillion pending action on new cuts or revenue measures. 
  • The legislation also creates and opportunity for Congress to vote on a resolution of disapproval which would suspend the ceiling increases.  However, this is merely a political gesture (drawn directly from Senator Mitch McConnell’s proposed compromise) which has no prospect of achieving the veto proof majority necessary to be passed into law.   
  • The initial $900 billion increase is offset by cutting $935 billion over ten years by setting hard budget caps which impose spending cuts of roughly $90 billion per year split between security spending (defense, homeland security, foreign affairs etc.) and non security discretionary spending.  For the first two years (2012-2013) a firewall will separate security and non security spending to ensure equal cuts, after 2014 appropriators can choose to cut disproportionately across the full category of discretionary spending. 
  • It creates and mandates a Joint Select Committee on Deficit Reduction, consisting of six Senators and six Representative drawn equally from the two parties, to recommend at least $1.2 trillion of additional cuts and/or revenue measures including changes to mandatory spending (Medicare, Medicaid,  & Social Security).
  • The legislation also requires both chambers of Congress to vote on a balanced budget amendment by the end of the year.
  • If Congress does not act on the Joint Committee’s recommendations, cuts would be made automatically beginning in 2013 through “sequestration,” (a process born out of Gramm-Rudman) which would automatically cut another $1.2 trillion in security and non security discretionary spending over nine years (equal to annual cuts of $133 billion per year).  
  • Medicare cuts would be limited to 2% (on providers, not beneficiaries) and most programs intended to help the poor (including Medicaid, SNAP & unemployment insurance) would be exempt from sequestration.   
  • These exemptions ensure that virtually all of the cuts made by sequestration will fall on discretionary spending.  In addition, as all nine years of cuts must be made equally between security and non security programs some experts estimate that baseline spending on defense could be cut by as much as $850 billion forcing major changes in the country’s national security posture.  The depth of these cuts creates a powerful incentive for Congress to act on the Joint Committee’s recommendations.
  • It gives the President authority to raise the debt limit by $1.2-$1.5 trillion under any one of three circumstances:  1.) if Congress passes cuts or revenue measures recommended by the Joint Committee which fully offset the debt ceiling increase; 2.) if Congress fails to act and the sequestration process is triggered the President will be able to raise the ceiling by up to $1.2 trillion; 3.) if Congress passes a balanced budget amendment and sends it to the 50 states for ratification, the President can raise the debt ceiling by up to $1.5 trillion even without enacting the Joint Committee’s recommendation or triggering sequestration.

While the ultimate effect on state budgets is too early to handicap there are a few things we do know.  States can expect that the new Joint Committee will propose a minimum of $100 billion in cuts to Medicaid over the next ten years, as both the President and House leadership were counting on a minimum of $100 billion in Medicaid savings in their failed efforts to achieve a grand bargain.  States can also be sure that even modest cuts to federal agencies will have dramatic implications for the state grant programs managed by those agencies.  Perhaps the best indicator of this trend is the fact that the proposed FY2012 budget for the Federal Emergency Management Agency (FEMA), currently working its way through the appropriations process, cuts spending by 2.5%, but shrinks state and local grants by 57%.  When push comes to shove, federal agencies and the appropriators who set their budgets prefer to cut state grants rather than to furlough federal employees or cut other core operations. 

We can all breathe a sigh of relief that an economy killing default appears to have been diverted, but for states, which depend on the federal government on average for 35% of their total spending, the tough work lies ahead.