Congress Deal Averting Tax Increase Curbs Risk to States

Congress Deal Averting Tax Increase Curbs Risk to State Recovery
Senate Majority Leader Harry Reid, a Democrat from Nevada, left, walks into the U.S. Capitol in Washington, D.C., U.S. Photographer: Andrew Harrer/Bloomberg

The agreement passed by Congress to keep taxes from increasing on most U.S. workers in 2013 eases a threat to states and cities only now emerging from the fiscal crisis brought on by the eighteen-month recession.

A day after the income-tax rate increases kicked in, the House of Representatives approved a Senate bill to block higher levies on everyone earning less than $400,000 and delay automatic budget cuts. State and local government officials had said inaction would deal a setback to the economy, hammering revenue and undermining a newfound financial stability.

The agreement followed weeks of fitful negotiations over how to prevent more than $600 billion of tax increases and mandatory spending cuts from beginning in 2013. As talks stopped and started, governors and mayors lobbied Washington, urging them against shifting more costs onto their budgets.

“If we truly went over the fiscal cliff and we had a recession, that would be just devastating,” Donald Boyd, a fellow at the Nelson A. Rockefeller Institute of Government in Albany, New York who studies state finances, said ahead of the agreement. “Taking that off the table, it removes a massive worry.”

State and local governments are only now recovering from the housing market crash and the longest recession since the Great Depression, which diminished tax revenue and forced them to fire workers, cut spending and raise taxes.

Stability at Risk

States have closed about $593 billion in deficits over the past five years, according to the Center on Budget and Policy Priorities in Washington. That created a drag on the economy from late 2009 until the third quarter of this year, when state and local government spending rose as revenue improved.

That stability was placed at risk by the struggle in Washington over a deficit that has exceeded $1 trillion in each of the four years President Barack Obama has been in office.

The nonpartisan Congressional Budget Office estimated that a failure to stop the automatic federal spending cuts and tax increases, known as the “fiscal cliff,” would push the economy into a recession during the first half of 2013. Illinois estimated that would cut $1 billion from its tax revenue over the next two years. California projected receipts would be as much as $11 billion lower through mid-2014.

While the agreement that passed Congress may avoid pushing the economy into a new downturn, it also may exert a drag on growth. By allowing a 2 percent payroll tax cut to lapse and raising income taxes on the wealthy, it will help reduce growth in the first quarter to 1 percent, from 3.1 percent in 2012’s third quarter, the latest data available, according to economists at JPMorgan Chase & Co. and Bank of America Corp.

Cuts Delayed

The agreement also delays until March mandatory spending cuts that would have cut some state and local government aid. While the largest state programs, including Medicaid and funding for roads, were exempt from the cuts, others weren’t.

The reductions would have cost states $7.5 billion for education, health care and community development programs, according to Federal Funds Information for States, a budget-tracking service created by the National Conference of State Legislatures, based in Denver, and the National Governors Association in Washington. That’s a small share of the approximately $519 billion that states received in aid last year.

Philadelphia Mayor Michael Nutter, president of the U.S. Conference of Mayors, urged Congress to follow up to prevent the across-the-board cuts.

“I implore Congress to stop kicking the can down the road and to do what is right for hard-working citizens who rely on domestic programs that are now slated for deep, automatic cuts,” he said in a statement.

The continuing pressure in Washington has raised concerns among states that aid for programs such as Medicaid -- which is being expanded under Obama’s health-care program -- may face deeper cutbacks.

“This problem isn’t going away,” said Boyd, from the Rockefeller Institute. “They’re going to continue to be a target.”