States sounding warning bells about debt ceiling debate

As Congress and the White House engage in political brinkmanship over the debt ceiling, state governments are already bracing for a stoppage of federal funding and warning of the consequences of a failure to reach an agreement soon.

"Without the borrowing authority to sell bonds, the federal government simply wouldn't have any funds to provide," said Brian Wanko, legislative director, State-Federal Affairs Program, National Conference of State Legislators. "Federal funds to states would immediately stop, including reimbursements and matching funds for joint interests. This is a big problem for states and presents uncertainty in not knowing how long a U.S. default will last." 

NCSL released a statement last week citing the possibility of dire financial consequences and noting that federal debt has more than tripled in the past 15 years to over $31 trillion. 

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The National Governor's Association is also trying to get Congress' attention about the debt ceiling and affected appropriations via a letter addressed to both houses last week. Their big concern is protecting the state's safety net programs including Medicaid as they wrestle with legislators over state budgets. 

"In fiscal year 2022, federal funds accounted for 38% of state budgets according to the National Association of State Budget Officers, up from 31% percent in fiscal year 2019, prior to the COVID pandemic," NGA wrote. "States' ability to make funding decisions and administer essential programs are inextricably tied to the federal budget."  

Rating agencies are adding their voices to the chorus. In early March Moody's Investors Service was predicting Aug. 18 as the "X date" for a full blown crisis. The date is tied to federal tax collection numbers which the U.S. Treasury says are off. "Compared to the federal revenue of $2.12 trillion for the same period last year federal revenue has decreased by $74 billion," the agency noted.

The 3% drop in revenue combined with a drop in Treasury bond yields keyed to the debt deadline are rattling Wall Street. 

The country has faced financial calamity in the past via four government shutdowns that vexed the Clinton, Obama, and Trump administrations. A credit default could push the country past a shutdown and into untested waters. "It is hard to say what the full impact would be on states since a default related to not raising the debt limit would be unprecedented," said Brian Sigritz, Director of State Fiscal Studies, National Association of State Budget Officers. "State governments have dealt with the disruptive impact of a federal government shutdown in the past, but this type of situation would be more unpredictable." 

To avoid sliding into the unpredictable, House Speaker Kevin McCarthy has floated a plan that would hold spending flat to 2022 levels while clawing back unspent COVID funds. 

The House Ways and Means Committee also advanced a default prevention act in March that would prioritize paying U.S. sovereign bond holders first to avoid a credit default.  A tiered system received a painful analysis by the Center on Budget and Policy Priorities in February.

Per the CBPP, "Once the federal government reaches the debt limit, it can no longer borrow to meet its obligations and can only make payments from cash deposits it receives. When the deposits don't provide sufficient cash, then the federal government would not be able to make payments to cover all of what is owed until sufficient cash becomes available."