State view of federal debt debate: There will be no happy ending

With the August 2 deadline less than a week away before the federal government reaches its debt limit, state budget officials across the country are preparing for the potential impact on state budgets depending on what Congress and the President agree (or don’t agree) to.

According to at least one state budget director, there will be “no happy endings” for states regardless of what occurs.

Washington’s budget director, Marty Brown, however, is a little more optimistic.

I had a chance to talk with Brown today about the state’s contingency plans depending on what scenario unfolds in D.C. on the debt debate. He said for at least 6-8 weeks after August 2, Washington would be in position to ride out the storm due to the state Treasurer’s cash management strategy of moving away from investing in short term treasuries and into cash holdings. Here are details on a letter Washington’s Treasurer sent the state’s congressional delegation earlier this week about the need for quick resolution of this problem.

The biggest unknown for state officials is how the federal government would prioritize payments if the debt ceiling is reached. While the state could weather reductions in most federal matching funds for the short term, it could not withstand prolonged absence of Medicaid matching funds.

In an ideal world according to Brown, a deal would be reached that raises the debt limit and makes reductions in federal spending except for Medicaid funds.

Brown’s biggest concern about a short-term failure to resolve the debt debate is the impact on the state economy and future revenue forecasts (Washington currently has an ending fund balance of only $163 million or less than 0.5% of spending).

With little traction to date on solving this problem, some in Congress have floated the possibility of providing a framework for the federal government to prioritize which bills it pays if the debt limit is reached.

This has drawn another warning, however, from Standard and Poor’s. According to Reuters:

“Prioritizing debt payments to avoid a default would be ‘deeply disruptive’ to the economy, Standard & Poor’s global head of sovereign ratings said in an interview with CNBC on Tuesday.

David Beers’ warning comes as Republican and Democratic leaders scramble to agree on a plan to raise the U.S. debt ceiling before the Treasury runs out of cash to service its obligations on August 2.

Beers said the Treasury could ‘theoretically’ prioritize debt payments over other government obligations for some time while negotiations continue in Washington.

‘But it’s worth remembering what that would mean — it would mean a very sudden fiscal shock that the longer it lasted would filter powerfully through the system,’ Beers said.

‘Potentially that would be deeply disruptive to the economy.’”

If there is one positive that can come from all this it is perhaps the recognition in D.C. that the way to avoid this problem in the future is to stop approving budgets that require credit card payments. Since the discipline to do so voluntarily has proven to be elusive, one option is to follow the lead of the states that structurally require themselves to balance their budgets.

We may know later his week if Congress agrees. A vote is being discussed in the House to consider a proposed constitutional balanced budget amendment.

Jason Mercier is the director of the Center for Government Reform at the Washington Policy Center. He serves on the Executive Committee of the American Legislative Exchange Council’s Tax and Fiscal Policy Task Force and is the private sector chairman of ALEC’s Fiscal Federalism Working Group. He is a contributing editor of the Heartland Institute’s Budget & Tax News, serves on the board of the Washington Coalition for Open Government, and was an advisor to the 2002 Washington State Tax Structure Committee. In June 2010, Governor Gregoire appointed Jason as WPC’s representative on her Fiscal Responsibility and Reform Panel. Jason holds a Bachelor’s degree in Political Science from Washington State University.

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