Debt Deal May Not Be as Rough on States as Initially Feared

For states, the federal agreement to raise the debt ceiling has inspired confusion and consternation in equal parts. State officials knew that cuts in federal aid were coming their way, but when the deal was struck August 1, they had little sense of how deep the reductions would be and which programs they’d cover. Now the details are becoming clearer, and some experts are reaching an unexpected conclusion: The damage to state budgets may not be so bad after all.

Prominent among those experts is Marcia Howard, a veteran state budget-watcher and editor of Federal Funds Information for States. Her view, after studying the details of the bargain, is that given the inevitability of some sort of federal deficit reduction, there’s a strong case that states will escape with less pain than they feared.

Crucial exemptions

The most immediate portion of the spending cuts included in the debt deal are only for “discretionary” programs, not “mandatory” entitlement programs such as Medicare, Social Security and, most relevant for states, Medicaid. These reductions take the form of annual caps to discretionary federal spending. The law says nothing about how Congress must meet those caps, other than a requirement that the cuts be balanced for the first two years between security and non-security spending.

The debt deal limits discretionary spending over the next ten years to a level $917 billion under the Congressional Budget Office’s “current law baseline” — the federal government’s expectations for what expenditures would have been without the deal. But in actual dollar terms, the impact will be reduced because the baseline assumes inflation-based spending growth.

For federal fiscal year 2012, which begins October 1, the caps reduce spending on discretionary programs by $7 billion compared to the current year, with $2 billion of the cuts coming from non-security programs. The caps allow for $24 billion more in spending than the budget resolution the U.S. House of Representatives previously approved — a plan that would have cut some state grant programs by as much as 20 percent. “The deal recognizes that states are still trying to work themselves out of the fiscal morass they’ve been in since 2009,” says Michael Bird, federal affairs counsel for the National Conference of State Legislatures. “This gives us essentially another 12 months of level funding or close to level funding.”

Then, for fiscal 2013 and the years that follow, the caps actually allow discretionary spending to increase slightly year-to-year, although not enough to compensate for any significant inflation. This would cause real reductions in services, since the cost of providing the same level of services typically increases over time. Still, Howard argues, it wouldn’t necessarily be a major break from the past. “Many of these grant programs,” she says, “have been level-funded for a very long time.”

When it actually writes its budget for the next fiscal year or future fiscal years, Congress is under no obligation to spend all the way up to the cap. It could cut more deeply. But, of course, it could have done that even if the caps in the debt deal had never been put in place.

Waiting for the trigger

Designing the second portion of the spending reductions is supposed to be the job of the congressional “Super Committee,” which is charged with finding a way to cut at least another $1.2 trillion. Under the law, the Super Committee can propose whatever it wants, cutting from anywhere in the budget. “I think our members are most wary about Medicaid reductions,” Bird says, “and they should be.” There’s a good chance, though, that the committee won’t take any action at all.

The Super Committee will consist of six congressional Democrats and six congressional Republicans. The Democrats are probably going to insist that any proposal include new revenue — either tax increases or other tax changes that would bring in more money — especially if the committee is going to cut the entitlements for Medicare, Medicaid or Social Security. The Republicans are expected to favor major reductions in spending on those entitlement programs and insist that no new revenue be included. That will make it difficult for the Super Committee to find the seven votes necessary to refer a plan to Congress, or for a plan to be agreed on in the committee that could actually win the necessary approval from the full House and Senate.

If the Super Committee fails to reach agreement, $1.2 trillion in spending cuts will be made automatically starting in 2013, through what’s known as the “trigger.” That would actually be good news for quite a few state programs that rely on federal funding.

Many expensive programs are exempt from the trigger cuts, including most that are considered “mandatory,”  which means that some of the largest joint state-federal programs aren’t vulnerable. Those include Medicaid, the Children’s Health Insurance Program, Temporary Assistance for Needy Families (welfare) and the Supplemental Nutritional Assistance Program (food stamps). Transportation grants are mostly exempt, too. While federal agencies — most notably the military — would have to cut back, reductions such as those would not prove particularly painful for most states. Those states that depend heavily on military spending would incur the most significant economic losses. But all told, according to Howard’s analysis, roughly three-quarters of the money that the federal government currently sends to states would be excluded from the trigger’s cuts.

What isn’t exempt under the trigger is discretionary funding (other than for transportation) that the federal government now makes available to states. This funding would face large cuts, especially on top of those Congress will make to meet the caps in discretionary spending in the first half of the deal. Everything from education funding to money for affordable housing to early childhood programs such as Head Start would be subject to the cuts at the trigger stage. “We’re hoping against hope that we can just hold the line,” says Yasmina Vinci, executive director of the National Head Start Association, “and that the number of children who are funded can be maintained.”

Some of these cuts would significantly alter state budgets and would hurt beneficiaries of federally funded services, but would not necessarily throw a state’s budget out of balance. The real problem for states would be the programs that they are legally required to preserve, even in the absence of federal funding. States would still have to fund special education, for example, even if Washington offered less help to do so. That could strain some state budgets.

The strongest case that the debt deal will hurt states badly doesn’t come from the cuts in the deal itself.  It’s the context in which they occur, one in which states have been cutting their own budgets for years. “We’re looking at years until states have recovered from the recession even before the federal government cuts back on state aid,” says Michael Leachman, of the Center on Budget and Policy Priorities. “This is going to lead to more pressure on state budgets at a time when they’re already having a hard time caring for the needs of their state.” The other big concern is that this will not be the last round of federal deficit reduction. Entitlement programs could be cut later.

While states can operate with more clarity than they did immediately after Congress passed the debt ceiling deal, they still can’t be sure what will happen next. No one is. The next Congress could change the law in any way it pleases. The Super Committee could still surprise everyone and come up with a new bargain that both Republicans and Democrats would support. “I don’t think we really know how this is going to work,” Howard says. “We’re just taking it one step at a time.”