WASHINGTON — Some of the deficit reduction proposals adopted by Congress in legislation earlier this month could thwart the nation’s sluggish economic recovery and hurt state and local governments, Standard and Poor’s warned in a report Thursday.
“In our opinion, the longer deficit-reduction framework adopted as part of the Budget Control Act of 2011 could undermine the already fragile economic recovery and complicate aspects of state and local fiscal management ... potentially weaken[ing] our view of certain individual credit profiles of obligors across the sector,” the rating agency said.
However, critical cuts in federal funding to state and local governments are unlikely to occur before 2013. Therefore, state and local governments would likely have plenty of advance notice so that they have time to make budget adjustments, the report said.
Under the first phase of the new law, $917 billion of deficit reduction — $756 billion of decreases in discretionary outlays plus interest savings on the debt — would occur over 10 years.
“But much of the reduced spending for this phase is back-loaded,” the report said. Only $25 billion and $46 billion of spending cuts would occur in fiscal years 2012 and 2013, respectively.
“Although the loss of any amount of federal funds may impede states’ efforts to maintain fiscal balance, particularly in light of the slow economic recovery, states have experienced much larger revenue losses than this in recent years,” the rating agency said.
Under phase two, a new 12-member congressional super committee is to recommend how to reduce the federal deficit by at least $1.2 trillion over the next 10 years. The recommendations are to be made public by Nov. 23, 2011 and voted on by Congress no later than Dec. 23, 2011. The the committee cannot come up with a plan that can be enacted by Jan. 15, 2012, automatic, mostly across-the-board cuts of $1.2 trillion are triggered.
“From the standpoint of state and local governments’ fiscal positions, the structure of the automatic trigger cuts have the potential to be more favorable than cuts that could derive from the joint special committee recommendations,” the report said.
According to Standard and Poor’s, federal sources of revenue comprise about 32% of total state revenues.
“In a scenario where the across-the-board cuts were triggered, state grants and pass-through funds could experience large reductions,” the rating agency said. However, states’ would have a year’s advance notice and could take action to accommodate the cuts, it said.
In addition, Standard and Poor’s said, “We believe that the reduced aid to states might not have a commensurately negative effect on states’ fiscal positions” because they could make programmatic cuts.
Alternatively, the super committee could make its own deficit reduction recommendations, including calls for reduced federal funding for entitlement programs such as Medicaid.
According to the Centers for Medicare and Medicaid Services, total governmental spending on Medicaid was $374 billion in 2009, $247 billion of which was funded by the federal government.
If federal funding for Medicaid was converted to block grants or there were changes to the formula upon which federal matching amounts are determined, states could incur greater funding responsibility unless they are also granted increased flexibility regarding service requirements, the rating agency said.
On tax reform, Standard & Poor’s said, if President Bush’s income tax cuts are allowed to expire, tax-exempt munis would increase in value to investors and their interest rates would decrease for issuers, it said. But Congress could instead decide to reduce the tax code’s current tax exemptions and deductions or even eliminate the tax-exempt status of interest earnings on muni bonds, “which in our view would likely increase the interest costs to municipal issuers,” the rating agency said.
Elimination of the mortgage interest tax deduction could have far-reaching negative effects on the real estate market, which is already suffering, it said.
