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Tax Law

State Net Capitol Journal – October 1, 2012

State Net – A LexisNexis Company

Budget & Taxes

NATION NEARING SEQUESTRATION CLIFF: The automatic federal budget cuts that were part of the 11th-hour debt-ceiling deal Congress reached in August of last year - cuts no one really wants - are set to take effect in a few months. And officials at every level of government are anxious about the looming "fiscal cliff."

Last fall when Democrats and Republicans in Congress failed to agree on a plan to reduce the federal deficit and the United States nearly defaulted on its debts, sparking a global financial crisis, they made a deal, the Budget Control Act of 2011, raising the federal debt ceiling but also creating the Joint Special Committee on Deficit Reduction, the so-called "supercommittee." The thinking was that this bipartisan group of 12 Congressional members would be able to do what the 112th Congress - which has been called the worst ever - as a whole could not. The Budget Control Act also provided a major incentive for the members to reach a deficit-reduction agreement: a fallback plan calling for $1.2 trillion in automatic, virtually across-the-board spending cuts, "sequestrations," over the next decade.

Despite that motivation, however, the supercommittee fared no better on the issue than Congress, and its approval deadline came and went last November without a deal. And last month the 112th Congress adjourned so members could go home and campaign for the upcoming elections, leaving the sequestration cuts set to kick in at midnight on Dec. 31.

That prompted harsh words from some of the nation's mayors gathered at the National Press Club in Washington, D.C. on Sept. 20.

"None of us could get away with what passes for governing in this town back in our own cities," said Philadelphia Mayor Michael Nutter.

"We are not going to just sit by quietly while Congress does nothing and just kicks the can down the road," said Atlanta Mayor Kasim Reed.

A letter issued last month by the U.S. Conference of Mayors and signed by more than 130 mayors called sequestration "perhaps the biggest threat to our metro economies."

"These cuts will cost 2 million jobs nationwide," Sacramento Mayor Kevin Johnson said at the D.C. press conference.

The impact of sequestration would be devastating for state governments too. The Federal Funds Information for States, which monitors federal spending levels on grants to state and local governments, estimates the cuts would be around 7.8 percent in FY 2013.

An area of particular concern to states is education funding. According to analysis by the National Conference of State Legislatures, funding for Title I education programs for the disadvantaged would be cut by over $1 billion, and special education funding would be cut by nearly $1 billion.

"Those are big dollars," said Chris Whatley, director of the Council of State Governments' Washington office. "You can't just make easy shifts in education funding."

States with heavy concentrations of military installations also face a major economic hit from sequestration. Funding for military defense research and development would be reduced by $2 billion and operations and maintenance would be reduced by nearly $4 billion, according to NCSL's analysis.

Those impending cuts were undoubtedly on the minds of U.S Senate Armed Services Committee Chairman Carl Levin (D-Michigan) and the ranking Republican on that committee, U.S. Sen. John McCain (R-Arizona), when they issued a rare bipartisan warning to their colleagues last week. In a letter to U.S. Senate Majority Leader Harry Reid (D-Nevada) and U.S. Senate Republican Leader Mitch McConnell (R-Kentucky), the two senators and four others stated that they wanted to "send a strong signal of our bipartisan determination to avoid or delay sequestration and the resulting major damage to our national security, vital domestic priorities and our economy."

The letter addressed the indiscriminate nature of sequestration, which cuts everything, with the exception of Social Security, Medicaid, Medicare and most spending for low-income Americans, which are exempt, by the same amount. As a recent report from the Office of Management and Budget put it: "Sequestration is a blunt and indiscriminate instrument. It is not the responsible way for our nation to achieve deficit reduction."

The letter also alluded to the so-called "fiscal cliff," the combination of sequestration and tax cuts set to expire at the end of the year, which it said the Congressional Budget Office has already warned "could send our fragile economy back into a recession and raise unemployment above 9 percent."

Fiscal Cliff

The "cliff" could still be avoided if Congress stops the sequester by approving an alternate deficit-reduction plan, although it seems more likely that the "lame duck" Congress that returns after the elections will just find a way to kick the can down the road. Some envision a scenario in which the newly elected Congress retroactively stops many of the cuts and tax hikes next year, in effect turning the cliff into more of a slope. But if control of Congress remains split between the two major parties, which seems likely, the 113th Congress may be no more effective in dealing with sequestration or any other issue than the current one. At any rate, it appears the nation's economy is headed down a slope of some kind early next year. (UNITED STATES CONFERENCE OF MAYORS, NATIONAL CONFERENCE OF STATE LEGISLATURES, GOVERNING, WALL STREET JOURNAL, WASHINGTON POST, CONGRESSIONAL BUDGET OFFICE, USA TODAY, STATE NET)

PENSION CUTS TRIM ONLY A NINTH OF STATES' UNFUNDED LIABILITIES: Nearly every state in the nation has made cuts to its public-employee pensions in the past few years. But the measures have only chipped away a fraction of the enormous gap between what states have put into their retirement plans and what they've promised their workers.

According to researchers at Boston College, the new laws have trimmed just $100 billion from states' $900 billion in unfunded pension liabilities. The researchers say the reason is most states have opted to make pension changes that apply only to new employees, which they project will reduce pension costs by 25 percent - but over the next 35 years.

California Gov. Jerry Brown (D) called the pension reductions he signed earlier this month the "biggest rollback to public pension benefits in the history of California pensions." The changes are expected to save the state as much as $55 billion over the next few decades, but because they apply mostly to new hires, they won't do much to reduce the state's unfunded liability in the short term.

Legal considerations have discouraged states from cutting benefits for current employees and retirees. But recent court rulings in Minnesota and Colorado upholding reductions to cost-of-living increases could spur states to explore the legal boundaries of the issue.

"There is a lot of gray area," said Alicia Munnell, director of the Center for Retirement Research at Boston College.

Ohio lawmakers passed a series of changes this month that apply to current and retired workers, as well as new hires. And many of the state's public employee unions actually supported the cuts - less than a year after fighting a tough battle to retain their collective bargaining rights.

"It is a tough pill to swallow," said Kevin Griffin, president of the local teachers union and an English teacher in Dublin, Ohio. But he said it was ultimately a matter of mathematics.

"It came down to the question of whether there will be a pension there for me when I retire or not," he said (WALL STREET JOURNAL)

BUDGETS IN BRIEF: State and local government debt rose in the second quarter, the Federal Reserve Board reported last month. The 0.8 percent annual increase is the first since 2010 (BLOOMBERG). • MISSISSIPPI state economist Darrin Webb said the state slipped into recession during the 2nd quarter of 2012 and will probably remain there in the 3rd quarter because of weak jobs numbers and other factors. He said the state's economy is struggling because of low education levels, poor health and the high rate of births outside marriage (HATTIESBURG AMERICAN). • NEW JERSEY passed NEVADA in the second quarter of this year in the rate of homeowners with seriously delinquent loans, according to the Mortgage Bankers Association. NEW JERSEY's rate rose 1.3 percentage points, to 12.7 percent, making it second only to FLORIDA's, at 17.5 percent (BLOOMBERG). • The Standard & Poor's Case-Shiller index showed a 1.2 percent annual gain in the price of single family homes in 20 cities across the country in July. All 20 cities also showed price increases for the third month in a row, indicating that the nation's housing market has bottomed out (NEW YORK TIMES). • WEST VIRGINIA finished the 2011-12 budget year on June 30 with a budget surplus of nearly $88 million (CHARLESTON GAZETTE)

- Compiled by KOREY CLARK

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