Federal Spending Cuts to Curb State Flexibility, BlackRock Says

Federal spending cuts this year will mean job losses and lower tax revenue while reduced aid will put pressure on budgets in many states that may lead to tax increases or service rollbacks, according to BlackRock Inc.

“Federal fiscal austerity will constrain state governments, but financial flexibility remains,” analysts led by Peter Hayes, head of municipal bonds at the world’s biggest asset manager, said today in a report. New York-based BlackRock manages $109 billion of the securities.

On top of $85 billion in spending cuts under the budget sequestration that began March 1, future steps to curb the federal deficit may put fiscal pressures on states, the analysts said. While the jointly funded Medicaid program for the poor was exempt this year, it may become a target, forcing states to raise taxes and fees, divert money from other services, delay funding for pensions and use reserves, they said.

Virginia, Maryland and Hawaii are the three states with the greatest reliance on federal spending, and cuts to jobs, defense contracts and direct aid could have “adverse effects” on their economies, according to the report. While it remains a threat to the $3.7 trillion municipal-securities market, the analysts said the elimination of tax-exemptions for state and local general-obligation debt is “highly unlikely.”

State debt is lagging behind the broader market, with a total return of 0.27 percent this year compared with 0.41 percent for all munis, according to Bank of America Merrill Lynch indexes.

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