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State, Local Governments Anxious as 'Fiscal Cliff' Nears
December 10, 2012

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Democrats and Republicans remain optimistic that a deal can be reached so that the U.S. economy doesn't go off the year-end "fiscal cliff." State and local lawmakers remain nervous, however.

Leaders of both parties say that the lines of communication remain open and that the top negotiators are confident of reaching agreement on the key issues. President Barack Obama and House Speaker John Boehner met during the weekend, but neither revealed details of the meeting. A common target for both parties os cutting budget deficits by more than $4 trillion during the next 10 years. The details of those massive cuts remain to be worked out.

The "cliff" is a massive combination of spending cuts and tax increases that will go into effect on January 1, 2013 unless Congress acts to change them and the President signs the bill. Democrats and Republicans were unable to reach a long-term during the debt ceiling crisis of 2011, but one thing that they did agree on was to postpone dealing with any larger issues until after the November elections. Those elections returned President Obama to office and kept Boehner and the Republican Party in charge of the House and the Democratic Party in charge of the Senate. Now that the elections have happened, however, members of both parties are looking to make a deal.

Both parties want to extend the 2001 and 2003 "Bush tax cuts," which reduced the tax rates for all Americans. The point of difference on taxes, however, is that the Democrats want to let the tax cuts for the wealthiest 2 percent of Americans expire. In effect, taxes on those earning more than a certain amount would go up, since the tax cut passed a decade ago would disappear. The position of the Republican Party continues to be that the tax cuts should remain in place for all Americans, regardless of their income level. However, in recent days, more and more Republicans have hinted that they would be willing to approve a bill rescinding tax cuts on the nation's top earners in exchange for more clarity around spending cuts, of which the "cliff" mandates an automatic $600 billion across a wide range of government departments.

The non-partisan Congressional Budget Office has estimated that, if the country went over the "cliff" and the $600 billion in spending cuts and tax increases mandated by a 2011 deal went into effect, the U.S. economy would be back in recession. The mandated spending cuts would be far-reaching and deep, affecting most parts of the U.S. budget, including defense spending. The details of those cuts are known; what is not known thus far are details of what either political party would propose as an alternative.

It's not just at the federal level that going over the "cliff" would hurt. State and local governments are increasingly sounding alarms about projected shortfalls resulting from spending cuts approved by federal lawmakers.

Many states have federal subsidies at the heart of their education and defense budgets; any reduction in federal money would result in a hole in a state budget that would need to be filled with additional revenue or remain essentially a spending cut. One federal estimate lists $7.5 billion in federal funding for grant programs like early childhood programs and food subsidies that would disappear if the economy goes over the "cliff." Also included in the prescribed cuts are a total of $33.6 billion in defense spending cuts.

State lawmakers as well are having negotiations for their 2013 budgets. The longer the federal government waits to signal its intentions, the less time state lawmakers will have time to react to the federal government's decisions.

Changes in federal tax rates would affect state tax rates as well. An increase in federal income tax would bring about an increase in state income tax. So, too, with a tax cut, or, in this case, an extension of a tax cut. If the "Bush tax cuts" are extended for 100 percent or 98 percent of Americans, then state budgets will continue to get correspondingly less income, as they have done in the decade or so that those federal tax cuts have been in existence.

Another possible revenue increase could come if the federal governments eliminates a series of tax deductions, as has been discussed both in 2011 and more recently. Fewer options for taxpayers to claim deductions against their income means an overall increase in taxes paid, at both the federal level and the state level.

Lowest of all are the local governments, which are affected by state budgets and, by extension, by the federal budget. Local lawmakers will have the least time of all to enact new budgets.

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