Debt-Ceiling Fallout: States to Take Another Hit

The debt-ceiling drama may be over, but -- for state governments -- the ramifications are just beginning to reverberate.

The new law requires a 12-member, bipartisan "super committee" to recommend at least $1.5 trillion in spending cuts by late November. The law also caps discretionary spending, which includes funding for defense, transportation and basic research.

The budget cuts will deal another blow to state economies still struggling to recover to pre-recession levels. Many have relied on federal stimulus money to close budget gaps during the last few years.

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"Now that [stimulus funds] have dried up and additional cuts are coming, states will have to take measures that will be counter cyclical to recovery," says David Adkins, executive director of the non-partisan Council of State Governments in Lexington, Ky. "Many states have gone through several rounds of right-sizing their workforces, including layoffs and furlough days and early retirement, and that will now be forced to continue."

With so many states running lean and mean, there's not much fat to cut. "In Michigan, we've already made tough cuts to get our budget into structural balance," says Kurt Weiss, public information officer at Michigan's state budget office. "We have cut health and human services, education and employee concessions." But 44% of the state's total $47 billion budget comes from the federal government, he said. "It's clear that there will be fewer federal dollars flowing into our state coffers."

For the 2012 fiscal year, about 1% of the budget will be cut. "Although there will likely be some reduction in state programs, the real pain will be felt later down the road," says Jeff Hurley, policy specialist with the National Council of State Legislatures.

Military Cuts

States with economies that rely on military installations and defense contractors are likely to be among the hardest hit, experts say. The budget agreement includes at least $350 billion in defense cuts in the next 10 years. If the super committee doesn't agree on cuts by Thanksgiving, it will trigger $1.2 trillion in automatic reductions in the coming decade, with roughly half of those cuts coming from the Pentagon.

"It's hard to know exactly what will be the final product of the super committee's work, but if they fail to act, it will have fairly devastating consequences," Adkins says.

Companies such as Boeing (BA) could also suffer pain from the cuts. Boeing has 61,000 U.S. employees working on defense programs, with the largest concentrations in Missouri, Washington State, southern California, Arizona and Pennsylvania, according to spokesman Dan Beck.

"We will do everything we can to meet demand for cost management and greater efficiencies on these programs, something the Pentagon has been pushing hard for a year now," Beck says. "We'll look at our workforce. We have had some layoffs even before this because of contracts being completed and taking the appropriate steps to adjust our workforce and consolidate operations to bring down costs."

Marty Brown, director of the Office of Financial Management in Washington state, says he's concerned about the prospect of additional layoffs. "If cuts are made [in defense], it will be tough on our economy because people will...cut back on spending," he says.

Brown also expects to spending cuts reductions in transportation and education, although he has not received any specific information. "We have asked agencies that have lots of federal grants to think, 'what if' -- what if they lose their grants, what will they do with staff, what services would be affected," he says.

Medicaid and Health Care

In addition, state officials also are concerned about health-care costs. The super committee has the ability to cut programs such as Medicare and Medicaid. States have been using federal stimulus money to cover their health-care budget shortfalls, so any Medicaid cutbacks would be particularly problematic, Adkins says. State- and local-government layoffs could boost Medicaid caseloads just as federal stimulus funds dry up and the government cuts back. "It's almost a perfect storm for a fiscal crisis for states," he says.

States are significantly increasing their own Medicaid spending in order to meet federal requirements, according to the National Association of State Budget Officers. Medicaid general-fund spending is projected to increase by $16 billion in the 2012 fiscal year.

Amid the coming cutbacks, states will be hoping for more flexibility in Medicaid rules. "Whether it's pharmacy, provider reimbursement rates, who is eligible and what kind of coverage has to be provided, states will be looking at options to deal with increasing caseloads," Adkins says. "And there are so many unknowns on how new health-care reform will affect those programs."

Tim Keen, director of the Office of Budget and Management in Ohio agrees: "Now that we'll be getting fewer federal dollars, we're hopeful that Washington will provide states with greater flexibility to manage any changes."

University-Research Cuts

Federal cuts in basic research also could impact states with major universities that rely on federal grants, including Washington, Alabama, Minnesota, Ohio and Michigan, Adkins says.

"Grants to state universities come with funds for indirect expenditures to underwrite the cost of physical plants and all of the infrastructure to allow that research to go on," he says. "Many large state universities rely on those indirect dollars in the grantmaking process to fund basic operations. There won't be state funds to supplant those dollars."

Meanwhile, there's no shortage of anxiety because so much remains unclear. "We know the global targets, but we don't know how much will be cut, over what period of time and how it will be done," says H.D. Palmer, spokesperson for the California Department of Finance. "Will there only be cuts or will there be ways to close loopholes? For most states, it's just too early to know what this all means because key decisions have yet to be made."

Michigan official Weiss says he wants to make sure states have a seat at the discussion table. "There should be a strategy for making sure the states stay connected with what's going on in Washington, for the states to be involved in working with the joint committee as they make their decisions," he says.

For now, states that have spent the last few years tightening their belts will have to pull them even tighter. As Jeff Caldwell, press secretary for Virginia Governor Bob McDonnell, says: "We have continued a conservative financial approach which has resulted in two consecutive fiscal years with budget surpluses. We will use this same conservative, measured approach to addressing any necessary choices we must make going forward to balance our budget based upon any funding changes from Washington."