What the Fiscal Cliff Means for State and Local Budgets

See which programs get the biggest cuts, and when they'll really happen.
by , | December 3, 2012

For full coverage of the fiscal cliff's impact on states and localities, click here.

The White House and Congress appear to be making little progress in their negotiations to avert the so-called "fiscal cliff" the country is set to face in January as a result of scheduled, automatic spending cuts coupled with the expiration of lower tax rates.

For state and local governments, already facing their own budgetary challenges, the $1.2 trillion in cuts threatens to exacerbate their own struggles with revenue in the wake of the recession.

Non-defense programs -- depending on their category -- will face face cuts of 7.6 percent or 8.2 percent percent. Grants that fund education programs, workforce development, public safety and education are all at risk.

This week, state legislators from across the country are convening in Washington, where many will meet with federal lawmakers and try to make their case against the cuts. On Tuesday, the governors of Arkansas, Delaware, Minnesota, Oklahoma, Utah and Wisconsin are scheduled to discuss the issue with the president.

Those meetings come on the heels of last month's visit to Washington by many of the country's top mayors, who met with congressional leaders and Vice President Joe Biden to stress the importance of avoiding the fiscal cliff.

But many state and local leaders -- like the rest of the country -- are wondering what, exactly, will happen if their efforts lead to naught. Here are some of the answers.

Will sequestration be a huge blow to local government budgets?

No – at least not those cuts themselves.

Direct federal aid is a very small portion of city budgets, representing only about 4.2 percent of municipal government revenue, according to the latest data from the Census. Sequestration would force automatic cuts of 8.2 percent in non-defense discretionary programs – the kind of programs like Community Development Block Grants, community policing grants, and workforce training grants that cities care about.

Mayors have warned of the dire impact that losses to those programs might have. But the reality is that we're talking an 8.2. percent cut to 4.2 percent of a city's budget. In total, the loss would represent, on average, about one third of one percent of city revenue.

That’s not to say cities are out of the woods completely. While mayors have emphasized the importance of federally-funded grants, the greater risk of the “fiscal cliff” would be broader damage to the economy. Cities are funded by property taxes, sales taxes and income taxes, all of which would suffer in the event of a double-dip recession triggered by the fiscal cliff. Cities are still reeling from the effects of the economic downturn, suffering their sixth consecutive year of revenue declines, and a double-dip recession would only exacerbate that challenge.

Additionally, cities may need to worry more about how states will react to the cuts than the federal cuts themselves. Cities get about 29 percent of their revenue from states, which in turn, get about 27 percent of their revenue from the feds. As the Manhattan Institute’s Stephen Eide writes, "instead of lobbying Congress, cities should lobby their states to offset local-aid cuts by granting them additional authority to address their ongoing budget problems."

So there’s no need for local governments to worry?

That’s not entirely true either. City officials say that because of two factors – their own declining revenue and ongoing cuts to federal programs – they’re at the breaking point. In many cases, cities are so strained that if sequestration happen, some officials say they won’t be able to plug the budget holes left by the feds.

Baltimore city officials, for example, recently prepared a report outlining which programs would suffer under sequestration. They highlighted CDBG, a flexible program the city uses to fund literacy programs, foreclosure counseling, and low-interest financing of of home renovations.

Baltimore officials say that the CDBG budget been cut by 30 percent over the last two years, and sequestration could drain their funding by $1.5 million to $16.5 million. "A cut of this size on top of those sustained over the past two years will force the discontinuation of some programs and limit others that annually provide housing and social services to many thousand low- and moderate-income Baltimore households," city officials wrote.

If the cuts happen, city officials warn that Baltimore may be forced to reduce the number of people getting job training and the number of low-income youths in educational programs. On the other hand, it’s worth noting the context of the cut: the loss to CDBG represents less than .05 percent of Baltimore’s $3.1 billion budget.

So will sequestration obliterate state budgets?

Again, not exactly. One source to consider is Federal Funds Information for States,  a well-respected research shop that tracks federal spending on state programs. The bad news for states: more than 75 percent of the 216 programs FFIS tracks are subject to the sequester and will face automatic cuts if Congress fails to act.

But the dollar amount tells a different story. About 82 percent of the actual funding states get is exempt from the sequester, and in fact, FFIS projects that some programs will see an increase in federal funding next year.

Why aren’t states seeing big cuts? When lawmakers created the fiscal cliff mechanism, they exempted Medicaid along the Children’s Health Insurance Program from the sequester. That’s good news for states, since Medicaid represents the biggest transfer of funds from feds to the states each year. A year ago, when a Congressional "super committee" held meetings in hopes of generating a compromise that would avoid sequestration, some state officials privately suggested the committee's failure was a good thing. Under sequestration, Medicaid won't get cut. In a negotiation to avoid a cut, anything -- including Medicaid -- is on the table. Ultimately for states, the bigger concern may come as lawmakers negotiate ways to avoid the fiscal cliff.

Which programs face the biggest threats under sequestration

Among programs likely to be of interest to Governing readers, education grants face a lot of trouble. Overall, Department of Education grants tracked by FFIS would drop from a $37.5 billion to $34.4 billion under sequestration. Local governments are also particularly concerned about drops in various public housing programs. Two Section 8 public housing programs would see their funding drop from $28.4 billion to about $26.1 billion. That funding doesn’t go directly to cities, but ultimately, city officials would have to deal with the consequences of large numbers of people without housing, National League of Cities officials tell Governing.

To dig deeper on specific cuts, the nearly 400-page Office of Management and Budget report on sequestration offers some specifics.

What’s the impact on infrastructure?

The transportation community lucked out. Only about 4 percent of transportation funding in the FFIS is affected by the sequester. That’s because the money for roads mostly comes from the Highway Trust Fund, which has a unique funding mechanism – the gas tax – that gives it a sort of special status in budgetary matters.

But transportation isn’t in the clear entirely. The Federal Highway Administration Emergency Relief Program – a special program that funds repairs that are the result of natural disasters – would see its budget drop $136 million from $1.7 billion. That cut comes at a time when states and localities are still reeling from the aftermath of Hurricane Sandy. The Federal Transit Administration’s largest grant program isn’t exempt either. It would stand to lose $156 million out of its $1.9 billion budget.

To complicate matters, part of highway funding is exempt, but the not all of it is, since some of it doesn't actually come from the gas tax.

What do "across-the-board" cuts really mean?

Exactly that: federal programs subject to the sequester will be subject to a specific percentage cut, and federal departments won’t have the discretion to pick and choose how those cuts will be applied. The cuts will be the same across program, project and activity, according to FFIS.

However, it’s important to note that every federal grant recipient won’t necessarily see its federal funding decline by the same amount. For formula grants, for example, the same formula will still apply. It’s just the total amount distributed by the grant program that would be reduced by the same amount.

Meanwhile, states and localities will be free to respond to the reduced funding as they see fit.

What about the timing? Do states and localities lose their money when the cuts come in January?

Not necessarily. Federal agencies have some discretion in terms of the timing of the cuts, according to FFIS and OMB. The cut will impact FY 2013 budgets. But the law doesn’t explicitly state how that cut will be implemented.

The federal fiscal year ends Sept. 30. Conceivably, agencies could plan on applying the cut toward the end of the year in hopes that Congress will then time to restore their funding, at least partially, within the same fiscal year. That would help mitigate or even eliminate the impact of the cut. As FFIS notes, the Department of Education has announced that some of the reductions will be enacted after July 1 in order to ensure they won’t affect the current school year.

Also, FFIS notes that the sequester will be reflected in grants issued after Jan 2 – since some grants have been awarded and spent. If the cuts do happen, it will be grants issued in the latter half of the year that bear the brunt of the impact.

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