Truesee's Daily Wonder

The debt-and-deficit bill signed into law on Tuesday forestalled a dangerous federal government default. But it will also slash aid to states already reeling from the recession, almost certainly forcing them to curtail services and raise revenues to pay for programs once bankrolled by Congress.

The bill, which the Senate approved and President Obama signed into law Tuesday, will eventually raise the government’s debt limit by more than $2 trillion in exchange for equivalent savings. Congress will achieve nearly $1 trillion of those savings by cutting domestic discretionary spending – including funds for education, health care, job training – to its lowest level in over half a century, as a share of the GDP.

“State budgets are already devastated,” says Ethan Pollack, a senior policy analyst at the Economic Policy Institute. “This deal just makes it far worse and shifts a lot of the pain onto state and local governments.”

When state lawmakers hashed out budgets for the fiscal year that began in July, 42 states and the District of Columbia faced a collective budget gap of $103 billion, according to the Center on Budget and Policy Priorities (CBPP), which tracks state spending. Because every state except Vermont requires a balanced budget, almost all were compelled to slash services, raise taxes, or both.

The law passed Tuesday will shrink the government’s non-security, domestic, discretionary spending by about $500 billion over the next 10 years, according to the CBPP. Nearly a third of those funds typically flow to states.

States rely on federal aid to pay for many popular programs, including Head Start, work study, energy and housing subsidies, highway repair, and emergency response. With fewer federal dollars available, states will need to restrict their own resources to vital institutions, while cutting or charging fees for less-crucial services.

Taxpayers can expect larger class sizes, fewer police officers, and more potholes, says Jo Comerford, executive director of the National Priorities Project, a left-leaning non-profit that monitors government spending.

“We’re way past cutting the fat or program efficiencies,” says Ms. Comerford. “Now we’re into cuts that are really affecting quality of life and forcing really hard choices.”

States’ painful budget decisions are likely to extend beyond fees and service cuts.

Since August 2008, state and local governments have trimmed workforces at a rate of about 10,000 to 20,000 positions per month, according to the CBPP. Reduced federal aid will likely mean more state-level job and benefits cuts, which in turn could slow states’ recoveries.

When workers receive lower pay or lose their jobs, they consume less, and the ripple effect continues throughout the state’s economy, costing even more jobs,” says a June report by the CBPP

Still, most states are relieved to see a deal that averts government default – particularly the handful of states that faced credit rating downgrades if the federal government failed to pay its bills. In addition, the ballooning federal deficit was unsustainable, says Robert Ward, deputy director of the Rockefeller Institute of Government in Albany, N.Y.

“If Congress had done nothing, what would the impact have been for states then?” asks Mr. Ward. “It’s hard to argue that the status quo could simply continue forever.”

The deficit reduction law includes a second phase of cuts worth up to $1.5 trillion. The plan calls for a joint committee in Congress to recommend savings, which could take the form of tax increases, entitlement reforms, or more spending cuts. If the recommendations aren’t acted upon by the end of the year, automatic reductions of $1.2 trillion will be applied to defense and domestic programs, including Medicare.

More than two-thirds of the federal funds flowing to states go to mandatory programs, including cash assistance and Medicaid. Medicaid alone accounts for nearly half – about $248 billion – of the $586 billion states will receive from the federal government this year.

For this reason, many analysts are convinced the joint committee will recommend changes to Medicaid, possibly restricting the number of recipients and shifting more costs to the states.

“Medicaid will almost certainly be on the table,” says Ward. “The looming deficits are just too big to ignore, and too big to close with tax increases or military reductions alone.”

Though Congress has yet to target specific programs for reductions – the most severe of which won’t take effect until after the 2012 elections – advocacy groups are already bracing for a new era of austerity.

In New York City, a group called New Yorkers Against Budget Cuts planned to meet on Wall Street Tuesday afternoon to protest the debt law.

“We’re calling people out to vent their frustration with the cutbacks at the federal level,” said Larry Hales, one of the group’s co-founders, before the event.

Mr. Hales, who lives in Jersey City, N.J., has been unemployed since 2009, when he was laid off from a job as a community organizer. Earlier this year, Hales’ unemployment benefits expired, and the state stopped sending him a monthly cash assistance check. He says he doesn’t expect either to be restored.