What the Federal Shutdown Means for State and Local Governments

States and localities aren't too concerned about the immediate impacts of the federal shutdown that began at midnight, but a prolonged one is another matter.
by | October 1, 2013

State and local government budget experts say the first federal government shutdown in 17 years shouldn't be too disruptive to their operations in the short-term, but if it lasts more than a week, they could start to encounter serious challenges.

READ: Full coverage of the federal shutdown's impact on states and localities.

"A couple of days is a pain in the neck ... but doable; nobody likes it, but it happens," says Scott Pattison, executive director of the National Association of State Budget Officers. "The longer a shutdown goes, the longer the impact it starts to have."

The feds' first shutdown since one in 1995 that lasted until 1996 began at midnight after the Democratic-led Senate rejected the Republican-controlled House measure that would have kept the government running but delayed enforcement of Obamacare's individual mandate and stripped lawmakers of their government health benefits.

It was the third time the House attached provisions that undermined the president's health care law to legislation that was necessary to keep the federal government afloat.

Pattison says state budget officials are less concerned with the immediate, administrative impacts of a federal shutdown, and more worried about the broader effects that the federal shutdown could have on the economy. He warned that an economic slowdown brought on by a shutdown could mean less tax revenue for all levels of government to spend on infrastructure and and services.

A prolonged shutdown could also negatively affect economic activity in states and localities with a particularly heavy federal presence, like Maryland, Virginia and Washington, D.C., and communities where federal contractors are major employers.

Cornelia Chebinou, Washington director of the National Association of State Auditors, Comptrollers and Treasurers, says state officials are closely reading a Sept. 17 memo released by the federal Office of Management Budget that directs federal agencies on how to respond to a shutdown.

States are using that guidance to try to figure out how their own programs will be impacted. But Chebinou says the impact isn't exactly clear so far, and federal officials aren't doing a good job helping states find answers. "We're trying to get more information," she says. "We don't have a lot."

Back and forth on Obamacare

The current impasse stems from Congressional Republicans' efforts to defund the Affordable Care Act. Last week, the House passed a continuing budget resolution to keep the government running when the 2014 fiscal year started on Oct 1. (A continuing resolution is needed because none of the appropriations bills that Congress uses to fund various portions of the government have been passed so far.) But the House Republicans' stopgap measure included an extra provision that would have stripped away funding for the president's signature health reform law as a condition of keeping the government open.

The Senate, in turn, took that language out, so the House came back and tried again, this time adding a provision that would delay implementation of health reform. The Senate said no to that too. Just before the midnight Monday was the House's third unsuccessful attempt to change the health care law as a condition of keeping the government open.

Want more politics news? Click here.

Democrats say they're unwilling to accept those provisions and insist that the House should pass a "clean" spending bill without changes to a law that's more than three years old. President Obama called the Republicans' maneuvers "extraneous and controversial" to the budget process. Republicans, on the other hand, say the Senate could have kept the government running if they'd simply agree to delay implementation of Obamacare.

It's unclear just how long Senate Democrats and House Republicans may be willing to drag on with their fight. In 1995 and 1996, the shutdowns totaled 28 days. But in 2011, the threat of a shutdown was resolved with an 11th hour deal.

What's impacted and what's not

Marcia Howard, executive director of Federal Funds Information for States (FFIS), speculated that there are workarounds for disbursing money to states -- even in scenarios where states are expecting difficulty.

"I have never seen a statute that Congress and the administration haven't figured out a way to get around," says Howard, whose organization tracks the impact of federal budgets and spending on states. "Even if there's a 'shutdown,' it's not like the vault doors get closed, and no money comes out of the doors. It doesn't work that way."

What matters the most in determining the shutdown's impact on a particular governmental program is whether its funding is mandatory or discretionary. Generally, mandatory programs won't be affected, and discretionary programs will be.

Of the federal grant funding that FFIS tracks -- which include the grants most important to state governments -- about two-thirds are considered mandatory.

Howard says Medicaid is funded one quarter in advance, so that program will not face huge challenges during the shutdown. Moreover, under federal law, states would eventually get paid back for any lapses in Medicaid payments -- even if the shutdown lasts for an extended period of time. Funding for the Children's Health Insurance Program will also continue during the shutdown.

Some other programs are "forward funded," meaning Congress has already appropriated the funding they need for the first quarter of FY 2014. Those include some foster care programs, as well as some education programs like Title I and Special Education grants, which won't be impacted. Some but not all Head Start grants will be affected by a shutdown. The federal COPS program, which helps state and local governments hire police, is also safe.

Highway programs are largely funded by a special account called the Highway Trust Fund -- not the general fund -- so they will largely be spared too. That means it's unlikely that construction on transportation infrastructure would come to a halt. However, projects that receive funding through some discretionary grants like TIGER could be affected by the shutdown.

While there's been much speculation about the impact the shutdown may have on the food stamps program, known as SNAP, the Department of Agriculture's guidance indicates that it's using language from the 2009 stimulus that should allow it to keep spending money on that program through the end of October.

Tough decisions for states

What's less clear is whether states would be reimbursed for keeping programs that aren't "forward funded" running, if they opt to plug the gap with their own state funds.

That could be a difficult proposition in states that are still just barely starting to recover from the recession. "We feel Michigan's got a budget that's in balance now," says Kurt Weiss, a spokesman for the Michigan Department of Technology, Management and Budget. "Getting into the practice of replacing lost federal fund with state money... it's not what we want to get into."

Among those programs that could be affected are those that serve some of states' most vulnerable residents.

The Low Income Home Energy Assistance Program, for example, provides poor people with money to pay heating and cooling bills. That's a discretionary program that would be impacted by the shutdown.

Also in trouble would be TANF, which provides cash to the indigent, and the Social Services Block Grant, which provides state funding for things like elder abuse protection, senior services, and child care. TANF is a mandatory program, but because its reauthorization expired Tuesday, it would need to be extended in a continuing resolution or another vehicle to continue along.

The school breakfast and lunch programs, as well as WIC, which provides food and healthcare for women and children, could be affected too. Still, both may have a degree of flexibility. In the case of the nutrition programs, because states draw on a line of credit they might be in the clear into October. States are allowed to carry 1 percent of their WIC authority into the following year, which could help keep that program in good shape during a short-term shutdown.

One of the thornier issues, Pattison says, could be what to do with state employees funded with federal grants. States might pick up the difference, at least for a time, but they might have to make tough decisions in the event of a longer shutdown.

For example, unemployment insurance benefits are mandatory, and they don't require appropriations, so they wouldn't be impacted by the shutdown. But the federal funds that help pay states' costs of administering the UI program are subject to appropriations, so those payments would be interrupted. States may be able to carry funds over from the previous year to help defray the impact.

Marcia Hale, who led the White House office that served as liaison to state and local governments during the last shutdown, says today's shutdown seems different from the one in 1996. Back then, Hale says, "we were in uncharted territory." At that time, state and local officials had less of an understanding of what a potential shutdown meant. They also didn't believe Congress would really let it happen.

Today, states have more experience with the issue, since Congress has faced a slew of threats over shutdown and default in recent years. In fact, the shutdown threat in 2011 may have helped state and local governments prepare for what's happening today, Pattison says.

Local governments largely spared

Meanwhile, local governments are likely to face fewer challenges than states. Officials with the National League of Cities and the National Association of Counties say that's largely because local governments get relatively little direct federal funding.

"In reality, a week or two weeks or even three weeks -- you'll have little effect," says Lars Etzkorn, program director for federal relations at the National League of Cities. "It's not the end of the world," he added.

Nonetheless, local governments -- still reeling from the impacts of the recession -- are frustrated that they're spending constrained resources they have on addressing the issue. "It creates unnecessary delays for our folks and wastes a lot of time with planning," says Deborah Cox, director of legislative affairs at the National Association of Counties.

Philip Joyce, a professor of management, finance and leadership at the University of Maryland, says state and local officials would likely notice the absence of furloughed federal officials who manage and process grants. "It will slow down the process, little by little eating away at the infrastructure of government," Joyce says.

Joyce also says that if citizens start noticing a lack of services they depended on from the feds, they may expect their state and local governments to pick up the slack. Citizens, he says, likely don't notice or care much about the distinction between different levels of government.

What it means for bonds

There could also be an impact on local governments who are preparing to issue bonds, especially if they're for projects that have significant federal funding components. In those cases, localities might delay going to market if they're worried the uncertainty will cause higher borrowing costs.

In the municipal market, some types of bonds that rely on payments from the federal government as their primary source of revenue to pay debt service are more exposed to the risk of a shutdown. Those bonds include highway and mass transit debt and Section 8 affordable housing.

But the bigger threat to state and localities could come in a few weeks. Government issuers are more vulnerable to a potential federal default on debt than they are a government shutdown. The U.S. Treasury estimates that if an agreement on the $16.7 trillion debt ceiling is not reached by Oct. 17, it will have only $30 billion per day to fund commitments, which would not be enough to meet its net daily expenditures that reach as high as $60 billion. (Any actual missed payments, however, would not likely happen until Nov. 1.)

If the U.S. debt ceiling is not raised, all spending -- including non-discretionary spending that is protected in a government shutdown -- would be eligible for cuts.

States that receive federal transfers to pay for services, or in some cases to pay for debt service, could see at least a reduction (if not a total wipeout) of that funding. Additionally, public finance issuers would also "likely face higher borrowing costs, and market access would be challenging," Moody’s Investor Services said Monday.

Most state and local issuers, however, have protected themselves against that possibility by already allocating funds or scheduling payments ahead of time.

Governing staff writers Liz Farmer and J.B. Wogan contributed to this report.

Join the Discussion

After you comment, click Post. You can enter an anonymous Display Name or connect to a social profile.

More from FedWatch