Sequestration and the Dire Effects to State Budgets

With Congress set to convene to tackle sequestration and the fiscal cliff, the talk has once again centered around federal budget cuts and their potential effects. Tax hikes are back on the table, according to a few prominent Republicans this weekend. A large number of difficult military cuts looms. But few are thinking about the other layers of public spending that will be affected. State budgets will see massive effects from a potent mix of direct spending cuts and revenue reductions based, ironically, on the expiration of the Bush Tax Cuts.

Using my home state of Oregon as an example, the all funds budget faces a total cut of $6 Billion from a combination of direct funding cuts, loss of matching funds in federal programs and reduced revenue from federal tax INCREASES that are deductible on state returns. That’s a pretty big slice out of a total all funds budget of about $58 billion.

Our all funds budget is funded by 3 main components: 1. General funds, including state tax revenues, approximately $13.71 Billion; 2. Federal funds, approximately $14.9 Billion; and 3. Other funds, approximately $29.1 Billion. The Other Funds portion is the user fees, licensing, etc. – essentially a de facto consumption tax disguised as permitting fees. So really, that $6 Billion cut is being taken out of a budget of around $29 Billion, or a little more than 20%.

And where are those cuts coming from? According to State Senator Brian Boquist, there are several sources:

1. Direct federal fund cuts

2. Tax revenue on the Bush Tax Cuts

Ironically, because federal taxes are deductible on state returns, as federal taxes go up, state revenues are cut. When the Bush Tax Cuts are repealed, not only will it hurt the pocketbook of each individual, but state revenues will also decrease.

3. Tax revenue on federal programs

For example, federal unemployment benefits are taxed at 9%. As that program is curtailed, state tax revenue is reduced.

4. Backfilling on federal matching fund programs

Programs such as TANF (food stamps) provide matching funds. States like Oregon agree to fund a certain amount of the program in exchange for the federal matching funds. So if Oregon does not want to cut a program like TANF then it must use State funds to backfill.

Word around Salem, in talking to several legislators, is that the Democrats really don’t have much of a conception of how much impact these budget cuts will have. It’s apparent that they haven’t wrapped their heads around how much funding they’re going to have to backfill if they want to keep current spending levels unchanged.

Of course, this realization is not likely to make them change their profligate spending ways – after all, Oregon’s general funds spending increased almost 50% between 2005 and 2009.

Which begs the question – is sequestration actually a good thing? Our state legislators have become accustomed to this increased spending. Is this the only way we’ll ever get them to stop spending money or will they just raise taxes to try to fill the gap?

If past performance is any indication of future behavior, prepare for the latter.