Jan | Feb 2014


The Bitter Pill of Sequestration

Jolt to Economy, Lack of Details and Flexibility Create Problems for States

By Mary Branham
Stephen Fuller likens the pending budget cuts from sequestration to crash dieting.
“There’s a couple of ways to lose 40 pounds,” he said. “Going on a starvation diet is one of them. That’s sequestration. (Then there’s) working out and cutting out dessert and not eating so much bread and reducing the portion size—you’re actually stronger and healthier when you get done and you’ve accomplished the same thing.”
Fuller, director of the Center for Regional Analysis at George Mason University’s School of Public Policy, has conducted several studies of the economic impact of the federal Budget Control Act of 2011. That act, commonly referred to as sequestration, requires a reduction in federal spending over a 10-year-period from selected federal programs if Congress cannot agree on how to reduce the nation’s debt by $1.2 trillion by Jan. 1.
“Federal spending is going to be deeply and abruptly cut and it will come from discretionary programs,” said Fuller.
Both sides of the cuts—defense spending and nondefense spending—will have an impact on states. The problem, said South Dakota Chief Financial Officer Jason Dilges, 2012 president of the National Association of State Budget Officers, is that states can’t really plan for cuts without more specifics.
“If we knew how big the pill was we had to swallow and what it looked like, we’d do our best to be able to make sure we were able to take it,” he said. “Not knowing how big or small or what color it is or what it’s going to taste like, that’s a real tough thing for us, and, like anybody else, the fear of the unknown is really a very powerful thing.”
Add to that the possibility, which many are predicting, that Congress will reach a deal after the elections and the uncertainty grows.
“Most states seem to be approaching it as if something will change the sequester,” said Scott Pattison, NASBO executive director. “The assumption is that Congress and the president will make some change to the sequester.”
 

Immediate Impacts

Nevertheless, budget officers are making contingency plans for the effects of sequestration as best they can, said Pattison.
In Vermont, for instance, state officials are approaching federal reductions from a broad perspective, looking at it as more than what could happen because of the Budget Control Act, said Matt Riven, director of Budget and Management in the Vermont Department of Finance and Management.
“The issue is more than just one bill or one law,” he said, “and we’re taking the longer view of how do we approach an environment that, it’s likely, over the next decade, the federal funds that we receive are going to be diminished.”
Vermont set up an informal process with regular meetings of the budget team to conduct a thorough review of all the programs for which the state receives federal funds. The team looks at the climate in Washington and the effect any potential federal action would have on those programs.
The fiscal offices of both the executive and legislative branches also conduct a semi-annual review of that initial review to develop a consensus analysis.
“The value of that is that it allows us to focus on how to prepare and react to the federal reductions that might be coming rather than fighting about what the real number is,” Riven said.
Vermont also has set aside a one-time reserve to prepare for federal reductions.
“By no means is it big enough to absorb the entire potential (Budget Control Act) reduction, but it would at least help us to absorb a portion of it,” he said.
But absent information about specifics of cuts, Riven said, the state can’t determine which ones it might backfill.
So, like other states, Vermont is telling agencies they should not assume the state would make up cuts, Riven said.
South Dakota, Dilges said, is assuming the cuts will be real and effective Jan. 2, 2013. The budget office has asked departments to look at the proposed programs covered under sequestration and ascertain whether they are pass-through grants to local governments or dollars that can be used for funding staff salaries, benefits and other operating costs.
“Obviously, I think we would try to look at the areas that are most flexible and would allow for us to retain as much staff as we could,” he said.
Then, the state would decide whether it would replace lost federal funds, leave it to the local governments to decide what to do about the program or just eliminate a federal program due to lack of funding, Dilges said.
Chris Whatley, director of The Council of State Governments’ Washington, D.C., office, said 28 of the 42 streams of federal funding to the states would face cuts. The programs facing cuts are found across a range of departments and services, from special education and low-income heating assistance to veterans’ employment and training.
Whatley said states, for the most part, will be able to pass those cuts along to direct beneficiaries—either the people receiving the benefits or local governments that might administer programs. The exception, he said, is in some education funding.
“Cutting education funding is one of the most difficult things for a state to do,” Whatley said, “in part because of protections in state constitutions and state common law.”
Those education cuts are targeted, and some educators believe they would be
harmful, not just in the short-term but also in the long-term
“We know that if sequestration does occur that it will affect our special education, our students with special needs, career-technical education,” said June Atkinson, North Carolina’s superintendent of public instruction. “It will have an impact on our schools that receive Title 1 funding and that will certainly hurt our work in remodeling education and giving the necessary support for us to move forward to nearly a 100 percent graduation rate.”
In fact, the graduation rate of North Carolina students who were involved in career-technical education was 90 percent last year. Cuts would affect from 53,000 to 56,000 students, based on various projections, Atkinson said. And, she said, with the unemployment rate above 9 percent, more students in North Carolina are living in poverty, making the need for Title 1 funding even greater. Federal Title 1 funds target schools with high numbers of students living in poverty.
She hopes Congress will make changes to sequestration. While cuts to federal education spending may be imminent, Atkinson would like the decisions on spending to be left at the state level.
“We would like, at the state level, to have the flexibility of determining where we would take cuts based on what our data show as far as what programs are yielding positive results for students,” she said.
 

Long-Term Impacts

Education isn’t the only area in which the effects of sequestration will be felt long-term.
The immediate impact of sequestration will eliminate some services and jobs, pushing the stagnant unemployment rate of around 8 percent to 9.5 or 9.6 percent, Fuller said. The 228,000 federal jobs lost in nondefense cuts and 48,000 federal jobs lost in defense cuts are just the beginning. Fuller estimated in a July study that a total of 2.1 million jobs would be lost, with about 1.59 million of them coming from small business. Those losses would be direct, indirect or induced—those jobs that depend on spending in other areas of the economy—according to the study.
His July study didn’t include the collateral effects—what happens when the federal government isn’t doing what it always has, things such as food inspection, border control, regulation of motor vehicles or port control. The FAA wouldn’t have as many inspectors, so airplanes wouldn’t fly as often, he said.
“You would have an enormous disruptive effect … that would cost jobs and cost economic activity,” he said.
The argument, he said, is that the economy can’t absorb those kinds of losses. The jolt of sequestration, bringing with it the end of government borrowing that makes it difficult for private sector borrowing, will make it difficult for the private sector to grow faster, Fuller said.
“It takes a long time to shift an economy from government dependence to private sector growth,” he said. “That’s a 10-year proposition, not a one-day proposition.”
In a growing economy, he said, as government pulls back, the stimulus generated from government spending shifts to the private sector, which grows as people invest.
“In a weak global economy, it’s going to take even longer, so that these cutbacks will actually strengthen the overall economy in the long run,” Fuller said. “In the short run, the medicine is pretty severe.”
 

The Need for Cuts

Few people dispute that federal cuts will eventually be made and states will have to make decisions on those cuts.
“At some point, we just have to be prepared and to make the tough decisions that are necessary and not be afraid of them, because we all know that more of the same is not sustainable,” Dilges said.
“The federal deficit is just so large that at some point, I think they’re going to start to have to do something, so we are going to see cuts over the long term whether they do it through sequester or not,” said Pattison.
How cuts will be made is the big question that remains as Congress is in recess until after the election.
“There’s numerous ways to do this and sequestration is the most severe and (will) have enormous negative impacts on the economy,” said Fuller. “The economy is very fragile and this is enough to put it flat on its back.”