budget cuts

Can states save us from sequester doom?

March 5, 2013: 9:45 AM ET

Just as $85 billion worth of sequester cuts kick in, some states are seeing budget surpluses for the first time in years.

Welcome home, budget surplus.

Welcome home, budget surplus.

FORTUNE -- This week, Congress began focusing on a March 27 deadline to adopt a new spending bill or else face a government shutdown. As lawmakers painstakingly negotiate a deal, they may try to scale back the sequester cuts that kicked in on Friday.

The $85 billion worth of cuts are certainly deep, potentially costing the U.S. economy 750,000 jobs (or roughly four months' worth of employment growth). But an unlikely cushion could mitigate  such a blow: state governments, says Milton Ezrati, senior economist at Lord Abbettt, a New Jersey-based investment management firm.

Recall when the housing market went bust in 2007. Several states suffered tremendous budget problems as tax revenues plummeted. State and local budgets are still fragile, but an improving economy has modestly raised tax revenues at an annual rate of more than 2% during the past year through September (the most recent month for which complete data exists), according to a report by Ezrati.

For the first time in years, states hardest hit by the Great Recession are seeing budget surpluses just as funding from Washington shrinks.

MORE: Why the Fed is failing to boost lending

Following major spending cuts and big tax increases approved by voters, California expects to take in $2.4 billion more in revenue than it will spend this fiscal year. Wisconsin could see a budget surplus of up to $484 million. Texas' financial picture is not nearly as dire as it was two years ago; as of January, it had an estimated $8.8 billion budget surplus, helped by increased revenues from sales taxes, as well as oil and natural gas production.

And for the first time in six years, Florida lawmakers aren't calling for spending cuts. Working with a modest budget surplus, Gov. Rick Scott has proposed a $74.2 billion budget that includes an across-the-board pay raise for teachers as well as bonuses for state workers.

To be sure, it will be difficult for some states to escape the sequester's wrath. The New York Times has compiled a list quantifying its impacts. Virginia, heavily made up of Defense Department workers, will be among the hardest hit with nearly 90,000 workers facing furloughs.

During the budget talks, lawmakers from such states will almost certainly try to slim down the sequester cuts. But even if they're unsuccessful, the cuts aren't expected to cause much of an economic shock, experts have said.

MORE: Why the stock market will yawn at the sequester

In his report, Ezrati put it this way: "It will be the same old drag."

This isn't necessarily a good thing. Without the sequester, there would be far fewer layoffs and furloughs. And the economy would probably grow faster. The budget cuts will likely prolong the steady decline in government spending we've seen for the past few years.

Between early 2009 and mid-2010, federal government spending shot up to an annual growth rate of 6.3% thanks largely to President Obama's multi-billion dollar stimulus package. As funds dried out, spending fell 4.5% in 2011 and almost 3% in 2012. A similar story played out across state and local governments, where the trickling down of federal funds helped raise spending on public salaries, services and the like by an annual rate of 4.6% through mid-2009. By 2010, however, spending fell by 3.5%. It dropped 2.5% in 2011 and nearly 1% in 2012.

Nationwide, the sequester could cut funding to state programs by $5.8 billion, according to the National Conference of State Legislators. That's not something to yawn at, but it could be far worse if states like Florida and California weren't seeing a brighter financial picture today.

Maybe it's time for Congress look to their home states for some financial advice.

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