Upcoming Federal Budget Deadline: What It Might Mean for Cities

Cities using federally funded economic development programs will stand to lose funding if the federal government fails to pass a deficit reduction plan by Jan. 2.
(Published Oct 3, 2012)

Congress and President Obama fought in 2011 over whether to increase the nation’s debt ceiling, an action that has become increasingly controversial as the nation’s debt has grown. With negotiations stalled, Congress passed and the president signed the Budget Control Act of 2011 (BCA), which increased the debt ceiling and created a joint committee of Congress tasked with developing a bipartisan plan to reduce the federal deficit by $1.2 trillion.

In order to hold their own feet to the fire, the sides agreed to a provision that imposes across-the-board spending cuts to nearly all federal programs if Congress and the President failed to enact the required deficit reduction. These cuts, referred to as “sequestration,” are set to take effect on Jan. 2, 2013, unless a deficit reduction agreement is reached.

Sequestration, as well as the end of the Bush-era tax cuts and the federal payroll tax holiday, leave the nation facing what is commonly referred to as a “fiscal cliff.” The Congressional Budget Office has predicted that these events would likely send the economy back into recession, a view also held by Minnesota State Economist Thomas Stinson, who has publicly described the negative impact on the economy as akin to tripling the cost of gasoline overnight.

In addition to the financial impact of a second recession, which would likely increase future state deficits, sequestration itself would directly impact cities. Among other things, sequestration would require an 8.2 percent cut to non-defense discretionary spending, cutting funds to programs that cities rely upon for economic development and other needs.

Cuts to the Community Development Block Grant program (CDBG)
Sequestration would result in a $3.4 billion cut to the CDBG program, which funds community development projects. Cities with populations under 50,000 apply for grants through the Minnesota Department of Employment and Economic Development (DEED), and larger cities and urban counties receive grants directly from the federal government.

In 2012, DEED awarded 31 cities and counties approximately $16.7 million in Small Cities Development Program grants (see a list of past grant recipients).

The sizes of the grants ranged from $175,400 to $1 million, with the majority of grants falling between $400,000 and $750,000. Because the majority of these funds have already been granted to the recipients, it is unlikely that sequestration will impact the 2012 awards.

Preliminary proposals for the 2013 application cycle are due on Nov. 15. The 8.2 percent funding cut would eliminate nearly $1.4 million in available funds. This could mean that three or four qualified projects will not receive funding. (This excludes funding cuts to larger cities and urban counties.)

Cuts to Build America Bond (BAB) subsidies
BABs are taxable municipal bonds for which the federal government pays the issuer a direct subsidy of 35 percent of borrowing costs. BABs were created in 2009 as part of an economic stimulus package to help fund public works and infrastructure projects.

Minnesota municipalities issued BAB bonds for 86 projects totaling $852 million (pdf) prior to the end of the program in 2010. Sequestration would reduce the federal interest subsidy to 32.3 percent, and municipal issuers would need to make up the difference from their own coffers.

While it is highly unlikely that the interest subsidy reduction will cause municipal default on the bond, municipalities will have higher interest costs for as long as the cuts remain in place.

Many BABs have “extraordinary call provisions” that allow bond issuers to redeem bonds if the federal government reduces the interest subsidy. Because interest rates have continued to decline since 2009, it might be financially advantageous for a city with BABs to redeem the bonds and refinance them at lower interest rates. Cities should contact their financial advisors to discuss redemption options.

The League will continue to monitor developments at the federal level and the potential impacts that sequestration or other budget agreements will have on Minnesota cities.

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