Jan. 8 (Bloomberg) -- State and local governments are in their best financial shape since the recession, giving them leeway to cushion the U.S. economy from federal budget cuts with spending and hiring of their own.
After slashing their workforces by about half a million in the past five years, state and local authorities will add employees in 2013, said Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. Their payrolls in the fourth quarter will be 220,000 larger than in the same period for 2012, he projects.
Their expenditures and investment also will be higher, rising by 1.8 percent, triple the increase last year, according to projections by St. Louis-based Macroeconomic Advisers.
“The bloodletting on the state- and local-government level has finally passed through,” said Jim Diffley, chief U.S. regional economist for IHS Global Insight in Philadelphia. “They’re no longer subtracting from growth.”
The shift will help the U.S. weather the blow from federal tax increases and spending cuts, keeping the expansion on course, Zandi said. He forecasts that gross domestic product will climb 2.1 percent this year after rising 2.3 percent in 2012, with the expansion getting stronger as the year progresses.
States and municipalities, which accounted for 12 percent of GDP in 2011, won’t be a drag on growth this year for the first time since 2009, said Ben Herzon, a senior economist at Macroeconomic Advisers. The economic rebound means they’re collecting more taxes, reducing the need for more spending cuts.
State revenue will increase 3.9 percent during the 2012-2013 budget year to surpass the peak reached before the full effect of the 18-month recession took hold, according to a Dec. 14 report by the National Governors Association and the National Association of State Budget Officers.
Fifty-seven percent of cities said they were “better able to meet financial needs” in 2012 than in 2011, the first time a majority reported an improvement since the economic contraction that began in December 2007, a separate National League of Cities survey released Sept. 13 found.
The improvement in finances has helped allay concerns among investors about defaults in the tax-exempt municipal-bond market, where the securities have rallied in anticipation of higher taxes on the wealthy. The $3.7 trillion muni market returned 7.3 percent in 2012, compared with 2.2 percent for U.S. Treasury debt, according to Bank of America Merrill Lynch data. Last year was the fourth in a row for gains in total municipal-bond returns, the longest such stretch since 2007.
Last week’s federal budget deal, which included a rise in the top income-tax rate to 39.6 percent from 35 percent, was “positive for municipals,” said Alan Schankel, head of fixed-income research at Janney Montgomery Scott LLC in Philadelphia.
Bill Gross, manager of the world’s largest bond fund at Pacific Investment Management Co. in Newport Beach, California, has directed 5 percent of the fund’s $285 billion to munis for three straight months -- the longest since at least 2006 that local borrowings have represented that large a share of holdings.
Gross said he’s taking a “cautious” approach to state and local debt because Congress may change the tax-exempt status of the securities.
“We’re holding on to our positions, but muni rates are in this cloud of ‘will they or won’t they’ be taxed in terms of withholdings,” he told Bloomberg Television’s “Market Makers” on Jan. 4.
Faced with the need to balance their budgets, state and local governments were forced into austerity mode after the recession hit, Diffley said. That continued into last year. Payrolls in December alone fell 10,000 on a seasonally-adjusted basis, as reductions by counties and cities overwhelmed an increase by the states, according to data from the Labor Department in Washington.
Now they may be poised to expand, said Donald Boyd, a senior fellow at the Rockefeller Institute of Government in Albany, New York. “We’re likely to see some growth in payrolls” this year, he said.
California, the most-populous U.S. state, will end unpaid furlough days for its workers in June, a policy it first put in place in 2009 at the height of the financial crisis.
Building also is picking up. After falling in March to its lowest level in more than five years, construction by state and local governments rose 2.3 percent to a seasonally-adjusted annual rate of $252 billion in November, figures from the Commerce Department in Washington show.
The country’s third most-populous state, New York, may break ground this year on a $3.14 billion new bridge to replace the 57-year-old Tappan Zee crossing over the Hudson River. The city government in Oxford, Mississippi, is building a new firehouse, expanding tennis courts and giving its employees a 3 percent raise, Mayor George Patterson said.
“We kept our heads down for a few years, but this year we feel like we’re turning the corner,” he said.
That’s not to say states and municipalities are trouble-free. While they’ve come through the worst of the crisis, they still face longer-term financial challenges, including rising costs for the Medicaid health-care program and underfunded pension plans, Boyd said.
He cited another big danger: the likelihood that the federal government will reduce its aid to the states as it seeks to rein in a budget deficit that has topped $1 trillion in each of the past four years. States get about one-third of their revenues from Washington.
The agreement Congress hammered out to avoid more than $600 billion in automatic spending reductions and tax increases --the so-called fiscal cliff -- spared states from cutbacks, at least for now. Under the pact, the decrease in expenditures was put off until March.
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.
While that’s a small share of the approximately $519 billion that states received in aid last year, Boyd said further cuts are likely.
That means local governments may get less help from the states, Diffley said.
Cities and counties also are lagging behind because they depend on property taxes for much of their revenue, and home prices are just now starting to recover, he added. Prices rose 4.3 percent in October from a year earlier, the biggest 12-month advance since May 2010, according to the most recent data from the S&P/Case-Shiller Composite 20-City Home Price Index.
Columbus, Ohio, fired more than 100 workers when the worst of the recession hit the city and successfully sought approval for higher income taxes from voters, said Dan Williamson, a spokesman for Mayor Michael Coleman. Now it is holding employment steady, he said.
It has been working on a $342 million sewer project and is planning another program to create more parkland along its riverfront.
“We faced our own fiscal cliff in 2009,” Williamson said. “Now, we’re in very good shape. There’s always stresses, there’s always worries, but we feel whatever comes our way in the near term, we can handle it.”