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Sequester storm gathers over D.C. economy

Let the sequester begin.

President Barack Obama on Friday signed an order that starts putting into place federal spending cuts that could begin forcing layoffs of federal workers. Obama signed his directive, entitled "Sequestration Order for Fiscal Year 2013," after he and congressional leaders failed to come up with an alternative budget plan.

The nation's capitol and nearby Virginia and Maryland will likely feel the worst of the impact. States heavily-reliant on federal spending - as far away as New Mexico - are also in for some rough weather.

With half of the roughly $85 billion in cuts targeting the Pentagon, the impact will be heavily concentrated in D.C., Virginia and Maryland, where defense spending accounted for about 10 percent of the three states’ combined economies in 2010, according to a report last month from Wells Fargo economists Mark Vitner and Michael Brown.

“Cuts in nondefense outlays would likely trigger significant furloughs, layoffs at civilian contractors and generally less business for supporting services, including law firms, caterers, airlines and hotels,” the report said.

Related story: As meeting yields no breakthrough, Obama blames 'dumb' cuts on GOP

The law mandating spending cuts gives federal agencies until the end of the fiscal year to complete them, but the Defense Department has already notified its 800,000 civilian employees of possible furloughs, and private defense contractors have already begun cutting back.

Virginia, where many defense contractors have set up shop near the federal money spigot, is squarely in the cross-hairs of the impending budget cuts. The state is home to 174,000 federal workers, 19 military facilities (including both the Pentagon and the country’s largest naval base in Norfolk), 90 federal offices, 550 federal government-leased or -owned properties, and 25,000 federal government contractors.

Last month, Republican Gov. Robert McDonnell wrote a letter to President Barack Obama warning that his state stands to lose $4.2 billion in economic output over five years - or 0.6 percent of total state gross domestic product - if the cuts take full effect.

“In the event that you and the Congress take no action and allow sequestration to proceed, we are estimated to lose approximately 82,000 direct jobs at federal agencies and contractors, and an additional 82,000 indirect jobs supported by business and personal spending that will be impacted by the cuts,” McDonnell wrote.

The federal cuts, in turn, have forced the Old Dominion to tighten its own belt; McDonnell’s proposed budget for next year includes $2.3 billion spending cuts, including deep cuts to K-12 education and health and human services

Maryland is also bracing for the coming storm. Democratic Gov. Martin O’Malley unveiled a budget in January that boosts the state’s Rainy Day Fund from 5 percent to 6 percent of the state’s $16 billion general fund. Though Maryland's economy relies about as heavily as Virginia's on federal spending, the state has done a better job battening down the budget hatches with more than $1 billion in reserves to blunt the impact of further federal cutbacks.

The budget pain for the region began two years ago, after the flow of federal dollars to the greater DC economy began drying up. Federal spending in the area - including the northern Virginia and Maryland suburbs - fell by 8.4 percent in the two fiscal years ending last October, according to the George Mason University Center for Regional Analysis.

Since peaking in July 2010, federal employment has declined by 2.3 percent. Despite the cuts, the unemployment rate in D.C. stood at 8.4 percent in December, down from a peak of 10.4 percent at the end of the recession. Virginia's jobless rate was 5.6 percent, down from a post-recession peak of 7.4 percent; Maryland’s was 6.7 percent in December, down from 8.0 percent. The national rate was 7.8 percent in December.

While the regional Washington economy is ground zero for the sequester budget shock, the pain of spending cuts will be felt as far away as Alaska.

The biggest losers of defense dollars, for example, would be California, Texas and Virginia, which each took in more than $30 billion last year, according to the Pew Center on the States.

Some smaller states are also big spending targets. While defense accounted for more than 8 percent of Virginia’s economy in 2011, Pentagon spending made up 6 percent of Mississippi’s economy and 5.5 percent of Connecticut’s, according to the Pew Center.

Hawaii, home to the U.S. Navy’s Pacific Fleet, also could see layoffs and reduced income growth, according to the Wells Fargo economists.

“In addition, Alaska with its Air Force, Army and Naval operations would also be disproportionately impacted from defense cuts,” they said.

The effect would also be concentrated in cities that benefit from heavy defense spending, including Huntsville, Ala., San Diego and St. Louis

The pain could be blunted if Congress eventually breaks the stalemate that produced the painful package with the explicit purpose of forcing compromise on a more rational alternative. Analysts say that – at about half percent of U.S. GDP - the depth of the cuts need not be so painful. But because Congress mandated that agencies wield the budget axe blindly across all spending, they have no discretion in deciding where to make the cuts.

Once the furloughs begin, Congress can expect the phones to start ringing. Some of the loudest complaints will likely come from large defense companies and other large contractors with operations spread across many states. Those calls from voters are often more effective than conventional lobbying efforts, Neal Dihora, a defense industry analyst at Morningstar, said.

“The whole job loss angle is a whole lot stronger from a company’s perspective,” he said. “It’s a lot better to rally the employee base than to throw a lot of money in a handful of Congressmen’s pockets.”

State governors have haven’t had much luck lately lobbying for more aid from Washington, which currently provides about one-quarter of state and local revenues, according to the Center on Budget and Policy Priorities. Since the 2009 federal stimulus package dried up two years ago, states have scrambled to stabilize their budgets which – unlike the federal government – have to be balanced every year. The sequester will inflict even more pain.

The 2011 Budget Control Act – which created the sequester time bomb when enacted in August 2011 - has cut federal funding for a wide range of state and local services, including education, water treatment, law enforcement, and others, to the lowest level in four decades as a share of the economy. If the full impact of the sequester cuts take effect, states will lose another $6 billion in federal funding, according to the CBPP.

Information from Reuters was included in this report.