State budgets to aid U.S. growth amid federal cuts

Bloomberg News
Posted1/12/2014 6:47 AM

WASHINGTON -- State and local governments are poised to increase spending this year, adding to the U.S. economic expansion, even as their federal counterpart cuts back.

Outlays by state and local authorities will add about 0.2 percentage point to gross domestic product in 2014, according to a forecast by economists at Morgan Stanley in New York. The federal government will probably contribute nothing to a projected increase of at least 2.6 percent in this year's GDP.

The boost to growth represents a shift from 2010 through 2012, when cuts by states and municipalities reduced U.S. output by 0.3 percentage point each year on average, according to Commerce Department data. The reductions to GDP from local governments were the longest and deepest in the post-World War II era.

"The bulk of the fiscal imbalance at the state and local level is in the rearview mirror," said Ellen Zentner, a New York-based senior economist for Morgan Stanley. "It's just another example of a headwind for the U.S. economy that's shifting to a tail wind."

Unlike the federal government, most states and localities must balance their budgets, which prevents them from running deficits for an extended period and prompts immediate cuts to outlays when the fiscal situation deteriorates.

With the economic expansion in its fifth year, localities are collecting more income and property taxes as the labor market recovers and home prices rise. That has enabled them to start hiring again.

"State and local governments went through the pain, and now they're in a position to start rebuilding again," Ward McCarthy, chief financial economist at Jefferies LLC in New York, said in an interview.

Federal Reserve Chairman Ben Bernanke made the same point in a speech Friday in Philadelphia.

"Throughout much of the recovery, state and local government budgets have been highly contractionary, reflecting their adjustment to sharply declining tax revenues," he said in remarks to the American Economic Association. Now, "the budgetary situations of state and local governments have improved, reducing the need for further sharp cuts."

McCarthy contrasted that with the federal government's budgetary woes.

"The lesson learned here, however, is that if you try to delay the inevitable, things don't get better, and that's what's happening in Washington," he said.

A $1.01 trillion budget deal crafted by Sen. Patty Murray, a Washington Democrat, and Rep. Paul Ryan, a Wisconsin Republican, at the end of last year eases the federal spending cuts, known as sequestration, in part by raising user fees.

What the deal didn't do is address long-term deficit reduction, in which lawmakers would need to make changes to programs such as Social Security, Medicare and Medicaid that make up almost half of federal spending.

"Congress will still have to continue to reach for the ever-elusive grand bargain," said Zentner. "Short-term, we've been set firmly on the path for improvement at the federal level."

Federal budget cuts have been a drag on GDP for 10 of the 12 quarters through September, at the peak subtracting 1.19 percentage points from growth in the last three months of 2012. That was the biggest quarterly detraction from GDP attributed to federal spending cuts in 29 years.

Gains in the labor market are one reason behind the improvement at the state and local level as fatter payrolls boost income-tax revenue. Employers are projected to add 195,000 workers in December, according to the median forecast of economists surveyed by Bloomberg ahead of the Labor Department's report next week. That would put last year's cumulative employment increase at 2.27 million, making it the best year since 2005.

Part of that gain is among state and local governments. Since reaching a more than seven-year low in January, their payrolls have climbed by 87,000 workers to 19.2 million.

"Their payrolls are growing, and these are good-paying jobs," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. LaVorgna projects gains among state and local governments will add 0.3 percentage point to GDP this year.

More hiring may be on the way. Nonfederal agencies had 339,000 job openings in October before adjusting for seasonal variations, the most for that month since 2007, according to Labor Department figures. By comparison, federal agencies had 38,000 positions waiting to be filled, the least for any October since 2003.

Rising property values will also augment revenue. The S&P/Case-Shiller index of home prices in 20 cities increased 13.6 percent in October from a year earlier, the biggest jump since February 2006, a report showed this week. The gauge is up 23.7 percent since reaching a nine-year low in March 2012.

More tax revenue is collected from property taxes than from any other source at the local level, making them critical for fiscal health, according to a Nov. 18 paper from the Tax Policy Center.

After cutting jobs and budgets to compensate for declining revenue from the 18-month recession that ended in 2009, 43 U.S. states enacted higher spending levels in fiscal 2014 from 2013, according to a report released Dec. 10 by the National Association of State Budget Officers in Washington.

Aggregate general-fund expenditures this year are set to climb by $26.3 billion, or 3.8 percent, to $721.8 billion, with increases heavily targeted for education and Medicaid, the report said.

"Signs of fiscal distress continue to subside, and most states expect revenue and spending growth in fiscal 2014," the report said.

While spending growth will be limited by 2014 revenue increasing at a projected 0.8 percent, which compares with a 5.7 percent gain last year, many states ended fiscal 2013 with a budget surplus that could provide some cushion, according to the report.

California, the most-populous state, has projected that it will end the fiscal year in June with a $2.2 billion surplus. Democrats controlling the legislature said the state can afford to spend more on welfare and other social programs and still add to reserves.

Minnesota Management and Budget has projected a $1.1 billion surplus for the fiscal 2014-15 budget. If that holds, Gov. Mark Dayton, D, said in a Dec. 5 statement that his priorities would be to end three Minnesota business-to- business taxes and enact a middle-class tax cut.

Increased spending at the municipal level also can provide a boost to local economies. The 2014 budget proposed by Mayor Michael Coleman of Columbus, the Ohio capital, calls for increasing the total general operating fund to $796.7 million from $757.2 million in 2013.

Coleman wants targeted spending increases such as $7.5 million for education, $709,000 for tourism and $300,000 for arts groups as a way to improve quality of life in the 15th- largest U.S. city, spokesman Dan Williamson said.

"A high quality of life attracts jobs like nothing else," Williamson said in a telephone interview.

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