If there’s one thing that pundits of all ideological stripes agree upon, it’s that the federal government cannot continue running $1 trillion-a-year deficits without inducing a Boomergeddon-style fiscal and economic melt-down. The only question worth asking is how we avoid the worst-case scenario: through spending cuts, tax increases or a combination of the two. (It would be wonderful if the economy would simply grow its way out of its fiscal malaise, with booming growth generating booming tax revenues, but the causality is likely to run the other way, with an ever-growing federal debt crowding out private investment and growth.)
Whatever path Congress and a newly elected (or re-elected) president pursue, the results are not likely to make life easier for the country’s 50 governors. Any pruning of federal spending will (a) reduce state aid to states and localities , (b) reduce federal procurement spending that props up local economies, and assuming a restructuring in the federal tax code, (c) cut federal income-tax deductibility for state and local taxes, thus increasing Virginians’ federal tax payments.
As the “Report of the State Budget Crisis Task Force” makes clear, a return to fiscal responsibility by the federal government will come at the expense of Virginia and the other states.
Direct federal spending. Of the six states examined in the report, Virginia will be the most severely impacted by a reduction in federal spending on employment and procurement. Write the authors:
Virginia, with its dependence on defense procurement and its cadre of federal workers and retirees, is at particular risk. … Total direct federal spending per capita in Virginia – including procurement, wages, retirement, and other spending – is 60 percent above the national average and accounts for about 32 percent of Virginia’s gross state product. Among the study states, Virginia ranks first in federal procurement, which makes up more than 13 percent of its state GDP; federal salaries and wages constitute approximately five percent of state GDP.
Federal aid to states and localities. Fortunately, Virginia is less vulnerable to cutbacks in federal aid to states and localities. Of the federal government’s $3.8 billion in FY 2012 outlays, $612 consists of grants to state and local governments. The dominant program is Medicaid, but the spending also covers the Child Health Insurance Program Expenditure program, highway and transit funding, community development grants, housing assistance, pollution controls and more. If these grants were cut only 10% across the board — probably a conservative assumption because so much of this spending is discretionary and not locked into entitlements — the states would collectively lose $60 billion a year.
Under that scenario, Virginia would lose nearly $1.1 billion. That’s painful but not as bad as for others. Among the six states studied, the cuts would amount only to $1,327 per capita in Virginia, a fraction of the $3,163 per capita cuts in New York and considerably less than the national average, based on FY 2010 numbers.
The outlook for the years ahead is made considerably more complicated by the Affordable Care Act’s massive expansion of the Medicaid program, 90% of which will be paid for by the federal government after the phase-in period. The Task Force authors question whether that commitment is sustainable over the long term.
Federal income tax deductions. Finally, on the grounds that Congress will be forced to reign in tax expenditures (tax deductions, credits and exemptions) as a way to increase revenue, the study examines the impact of a rollback in tax deductions for state and local government taxes. As a moderate-tax state, Virginia has less to lose than some — but more than commonly realized.
Among those Virginians who claim deductions on their federal income taxes, the average deduction is $9,229 — 36% higher than the national average. Thus, any scaling back of state and local tax deductions will hit Virginia than many other states. Of course, high-tax states like New York, New Jersey and California would be hammered.
In previous commentary, I have emphasized Virginia’s dependence upon federal employment and procurement. But the study makes clear that direct federal spending is only one one factor that needs to be considered. The Old Dominion also would lose federal aid to states and localities, while a sweeping tax restructuring could penalize households that deduct state-and-local taxes from their federal income. Add it all up and we may not be the single-most vulnerable state in the country, but every indicator suggests that fiscal stress in Washington, D.C., eventually will be felt as fiscal stress in Richmond.
Special thanks to criminal defense lawyer Nicole Naum for her support of Bacon’s Rebellion.