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Updated Jul 29, 2011, 4:18 pm
WASHINGTON – Arizona’s economy gets $14 billion in federal funds each year, which has officials in Phoenix keeping a nervous eye on negotiations in Washington over the federal debt limit.
If Congress does not reach a debt-limit deal by Tuesday’s deadline, state governments could face budget shortfalls or more difficulty issuing bonds to pay for roads, hospitals and water systems.
“The point is we won’t know until Congress and the president give some direction on how they will allocate dollars,” said Matthew Benson, a spokesman for Gov. Jan Brewer.
Benson noted that more than half of the federal funds to the state go to the Arizona Health Care Cost Containment System — the state’s Medicaid program. He added that federal money also goes to schools and transportation, and to social services like food stamps through the Department of Economic Security.
He said some Arizona agencies might be able to cover for lost federal funds for a short time, but no one is really sure what will happen.
No one knows what the federal treasury will or will not pay after the debt-limit is passed Tuesday: The federal government will still bring in enough in taxes to pay about 60 percent of its bills for the month.
But no reduction is good for the states. Unlike the federal government, states are constitutionally required to pass balanced budgets and cannot borrow money to close budget shortfalls, according to the Pew Center on the States, a public policy research group. A loss of federal funding could overwhelm many state budgets.
Jeff Hurley, a policy analyst for the National Conference of State Legislatures, said states would only be able to last a few days without federal funding. After that, the lack of federal aid could do budget damage to cities and states, which are already in a delicate position from the recession.
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“States have been in fiscally perilous situations the last five years,” Hurley said.
Budget experts worry that the effect of a federal default could ripple through state economies, damaging the national recovery if an agreement is not reached.
Brian Sigritz, director of fiscal studies for states at the National Association of State Budget Officers, said that the longer states are cut off, the larger the impact would be on the overall economy.
“On an economic standpoint, the economy could flatten back into a recession,” Sigritz said.
A federal government default could also do more than take money out of state coffers — it could add to states’ bills at the same time, by making it more expensive for governments to issue the bonds they need to pay for projects.
Moody’s Investors Service is one of the credit agencies that has hinted at a possible downgrade of the United State’s Aaa credit score. It is also looking at states’ bond ratings.
Arizona has an Aa3 score, not Moody’s highest score but still ranked as investment-worthy. But Moody’s said in a first-quarter report that Arizona’s credit status was changed from stable to negative because of the state’s “financial weakness” and “revenue underperformance.”
Authors of the Pew report pointed out that an increase in interest rates could threaten funding for government capital projects.
“State and local governments issue debt to pay for capital projects that provide services and create jobs,” said Sarah Emmans, a Pew research manager and author of the report.
She said that a national default could result in a gridlock of capital markets and municipal debt. With higher interest rates, states would have to find alternatives to fund public works projects or just forgo them all together, Emmans said.
The one bright note in the Pew report for local governments is the suggestion that investors wary of buying federal instruments because of the possible credit downgrade could see municipal bonds as a more sound investment.
Moody’s spokesman David Jacobson said it would be unusual, but not impossible for a state to have a higher rating than a sovereign nation. But he said a threat to the sovereign — like the debt limit the U.S. faces — would be sure to impact the sub-sovereign, which can include both corporations and states.
“No matter what rating you have, you’re going to be affected by any sort of risk to a sovereign,” Jacobson said.