When Congress Cuts Spending: Consequences for New Jersey

By Sven Larson, PhD.

Governor Christie is relentless in his fight for spending restraint. An early example of his fiscal fortitude was his famous response to threats from the legislature to shut down state government over a budget fight. The governor promised he would go back to the governor’s mansion, order a pizza, have a beer and watch a ballgame until they decided to open government again.

He has shown similar determination on the revenue side, especially in the fight over putting a leash on property taxes. But there is one part of the state budget that neither the governor nor the legislature has paid much attention to: federal funds.

Federal Aid to States, which is the formal name of federal money going in to state budgets, is a very big operation. In 2011 Uncle Sam sent $630 billion to the states for spending programs that cover everything under the sun. The largest posts are Medicaid, transportation, education and programs for children and families. But there is also money in there for things like milk in our school lunch cafeterias, bullet-proof vests for police officers and recreational trails for terrain vehicles.

Even though states sometimes treat these funds as free money, obviously it has to come from somewhere. Furthermore, most programs come with a requirement that states produce matching funds.

New Jersey is no exception. In 2009 we received $13.5 billion, half of which went to Medicaid. In order to keep the federal Medicaid dollars coming we had to match the federal grant dollar-for-dollar. That balance is now about 58 percent federal, 42 percent state: the federal government has increased its Federal Aid to States spending in recent years. This is partly due to the so called “Stimulus Bill”, but the underlying annual growth is about seven percent.

The real danger with depending on these funds is that Uncle Sam borrows a good part of what he gives us. And this is where our very dependency on federal funds becomes a problem. What do we do when Congress starts cutting spending to balance its budget?

A $630-billion package of spending programs is far too big to escape the chopping board.

At that point New Jersey will have no control over what cuts Congress decides to make. All we know is that once they get around to cutting spending, it will probably be in the form of drastic, almost panic-driven, indiscriminate cuts.

This will have two problems. The first is purely political but nevertheless important. Federal Aid to States may be funded by the federal government, but it is run by the states. Therefore, Governor Christie and the legislature will be held accountable for cuts initiated by the federal government, while Congress gets to look unashamedly fiscally responsible.

Hardly a scenario that the governor and the state lawmakers should be very happy about.

Just to put in perspective what this means, consider that in 2009 New Jersey received $13.5 billion in federal funds (according to the Census Bureau). Of that, about half, $6.3 billion, was for Medicaid, $1.6 billion was transportation funds, $1.3 billion went to programs for children and families and Jersey schools got $612 million.

Suppose the federal government decided to make a small, five-percent cut in these funds. That would be equivalent to $675 million. To make up for that with tax increases, the state would have to (again considering 2009 numbers) more than double the gasoline tax, or more than double the vehicle registration tax.

If we tried another tax increase on higher incomes, we would have to double the taxes on earnings above $100,000.

But all hope is not lost. We can shield New Jersey from panic-style cuts to federal funds. One radical idea would actually involve income taxes, but not the ones that go into the state coffers. Each year New Jersey taxpayers pay personal federal income taxes; in 2009 the total personal tax liability to Uncle Sam was $44 billion. That same year we got, again, $13.5 billion from the federal government.

Common sense says that it is wasteful to have New Jersey families send a lot of money down to the federal government and then have the federal government send some of it back. What if we could find a way to re-route some of those personal federal income tax payments directly in to the state treasury? Congress would no longer need to send us $13.5 billion and therefore would not need $13.5 billion from New Jersey families.

There are, of course, several practical problems associated with this idea. But our state’s dependency on federal funds, while helpful in some ways, is also a potentially big threat to our fiscal stability. All we know is that Congress will deal with its budget deficit at some point, and when they do there is a real risk that they pull out a fiscal chainsaw. At that point, we will have no time to thoughtfully manage cuts to federal funds.

If on the other hand we start considering “big” solutions now, we may be able to shield our state from the fiscal fallout when Congress finally starts doing something about its deficit.

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Sven R. Larson, Ph.D., is Senior Fellow in Economics at the Wyoming Liberty Group and a guest contributor for Common Sense Institute of New Jersey. He holds a Ph.D. in social sciences with major in economics and has taught economics at colleges in three countries. His research on health policy, taxes, and government budgeting and entitlement reform has been published by free market think tanks across the country.