Trickle-Down Debtonomics: How a Failure to Raise the Debt Ceiling will Impact State Budgets

Posted by Jeffrey Brown on Jul 31, 2011

Filed Under (U.S. Fiscal Policy)

As I write this blog, President Obama and Congressional leaders have still failed to agree on a deficit reduction package that would provide sufficient political cover to allow a majority of Representatives and Senators to vote to raise the debt ceiling.  (If they manage to pull a rabbit out of a hat this weekend before this post goes public, you can view this as a “what could have been” post.)

 Last week, I pondered the impact of a failure to raise the debt ceiling on broader economic activity.  A few days later, my colleague George Pennacchi, in an interview, provided further detail about the economic impact (read it here).  If politicians decide that they do not want to skip interest payments, and if they do not want to shortchange senior citizens or the military, then we are going to have to pretty much make everyone else wait for their payments.  One group that has been largely overlooked in the discussion – state and local governments.

 An exception to the overlook is a report issued by Pew Center for the States.  They point out the direct and indirect ways that the failure to raise the debt ceiling could negatively and substantially impact state and local budgets.  A few examples they cite include delayed payments to states for the many programs for which there is shared budgetary responsibility, such as Medicaid.  Or delays in grants to state, such as for education.  More indirectly, if financial market concerns extend beyond U.S. treasuries, this could increase borrowing costs to state and local governments as well.

 In short, while most of the focus has been on the impact of the debt impasse on federal spending, it is important to recognize that this will also likely “trickle down” on states in the form of cash-flow / liquidity constraints. 

Here’s hoping that by the time this blog is posted, it is already out-of-date.