The $1.2 trillion in across-the-board federal budget cuts known as sequestration will not directly impact states’ finances, but will dampen their economic outlook and slow the recovery of their revenues, which are still struggling to return to pre-recession levels, Moody’s Investors Service said Tuesday.
That conclusion comes from a seven-page report, the first in a series of in-depth analyses on the impact of the sequester on each public finance sector rated by Moody’s.
The $1.2 trillion of spending cuts are to be phased in over 10 years, but the first $85 billion are to be implemented from March 1 through the next six months.
Sequestration’s direct impact on state budgets is limited because most state spending of federal funds — 51% — is for Medicaid and transportation, which are not included in the cuts.
Federal grants to state and local governments totaled $607 billion in 2011, according to the Congressional Budget Office. Of the federal grant program funding that states receive, about 82% is exempt from sequestration, the report said.
“Most of those funds flow through and are administered by state governments but the funding cuts do actually affect state budgets,” Moody’s said. This would include federal grants for community development or education made to states, but ultimately passed through to local governments or school districts.
Another major finding in the report is that most of the sequestration cuts are to be made to discretionary defense programs and will be felt most heavily in states whose economies have concentrations of defense procurement contracting such as triple A-rated Maryland, Virginia and Missouri.
In total, 7.8% or $43 billion of cuts will hit discretionary defense programs, according to the Office of Management and Budget.
Federal defense procurement spending is 9.6% of Virginia’s gross domestic product, making it the number one state in the U.S. most exposed to the cuts. Moody’s assigned the state a negative outlook reflecting its indirect linkages to federal downsizing.
The District of Columbia and Maryland were also in the top ten list of states most exposed to sequestration cuts.
North Carolina was the least exposed state with only 0.9% of defense procurement contracts as a part of its GDP. Moody’s assigned a stable outlook to that state.
Finally, the report said that sequestration has diminished hope of a robust economic recovery for states with forecasts declining anywhere from 0.1% to 0.4% in calendar 2013 as a result of federal downsizing.
“This economic risk is a key driver in the negative outlook we maintain for the state sector,” Moody’s said.
The report said that the potential for federal furloughs would negatively affect state revenues and soften the withholding portion of their personal income tax collections. Additionally, consumer confidence would drop in states with the most federal employment, such as the District of Columbia with 29.2% federal employees out of the total employment, and sales tax collections would similarly slow.
