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State budgets in jeopardy as nation nears 'fiscal cliff'

Betsey Daley is worried.

As the Virginia Senate Finance Committee’s staff director, she’s preparing for the impact of what’s known as the “fiscal cliff,” a $607 billion bundle of federal tax increases and automatic spending cuts that could savage state budgets – and return the nation to recession – beginning in first days of 2013.

Unlike most states, Virginia has a $30 million emergency fund set aside to soften the blow of this massive budget contraction, but Daley and her colleagues in state government are still anxious.

They know a third of Virginia’s economy depends on federal spending. They know hundreds of thousands of Virginians’ jobs are in jeopardy in the next year alone. What they don’t know — and what no one knows — is whether Congress will act to avert this crisis.

“Are they going to kick the can down the road? Are these cuts going into place? It’s just fraught with uncertainly,” Daley said.

That uncertainty is being felt in state capitals nationwide, according to Jeff Hurley, a senior policy specialist at the National Conference of State Legislatures.

“States are closely linked to what the federal government does,” he said. “There’s a severe correlation between the two that gets left unnoticed.”

Related: More stories from the Investigative Reporting Workshop, American University

The twisted trail to the edge of the fiscal cliff began with the bitter fight over raising the nation’s debt limit in August 2011. After weeks of contentious debate, congressional Republicans and the White House finally signed off on a deal allowing the U.S. to borrow more money. Part of the agreement was the creation of a “super committee” in Congress that would find ways to trim expected deficits by roughly $1.5 trillion over a decade. If the committee failed to reach an agreement, tax increases and automatic spending reductions — including deep defense cuts — would take effect on Jan. 1, 2013. Paralyzed by gridlock, the committee announced its failure later that year, and lawmakers have not brought forward a comprehensive solution to the problem since.

The debt ceiling compromise postponed the next round of the budget debate until after the November election. But it also effectively pulled the pin on a live grenade that might explode, taking the economy with it. Congress can still put the pin back when it convenes a lame-duck session next month, but here is what will happen if lawmakers fail to reach a deal by New Year’s:

•    The so-called “Bush tax cuts” will expire, raising income taxes on all Americans. Republicans bitterly oppose this and forced President Obama to accept an extension of the lower rates two years ago. The White House recently reiterated that Obama would veto any bill to avoid the fiscal cliff unless it includes tax increases on incomes of more than $250,000. The president continues to support the lower rates for other taxpayers.

•    Payroll taxes, which pay for Social Security, will return to their normal rate of 6.2 percent of income. They have been at 4.2 percent, a measure President Obama and Democrats favored to help lower-income workers weather the recession. The AARP and some Democrats have said they oppose continuing this reduction because it excaberates funding issues for Social Security.

•    Federal spending will be cut $106 billion in 2013, with reductions evenly divided between defense and non-defense funds. According to the non-partisan Center on Budget and Policy Priorities (PDF), this means approximately a 7.5 percent cut in affected defense programs and approximately an 8.4 percent cut in most affected non-defense discretionary programs. Republican presidential candidate Mitt Romney and many others in the GOP have said they oppose the planned reductions in military spending, but they have yet to identify specific ways they would cut the budget.

George Mason University economist Stephen Fuller said there’s consensus on what all this would mean.

“I think there is near unanimity on the impact of the fiscal cliff driving the economy into recession,” he said, adding that the consequences for Virginia would be particularly devastating.

“When a third of the state’s economy depends on federal spending, and about 20 percent on Department of Defense spending, and you nibble at that, it’s a big bite,” he said.

In a report (PDF) published in July, Fuller estimates that the spending cuts alone would cost Virginia 207,571 jobs by next September. His research suggests that California, the world’s ninth largest economy, would be the only state taking a bigger hit. Meanwhile, he already sees signs that economic growth has slowed in the sector of Virginia’s economy that includes federal contractors, historically the state’s primary source of growth.

This is especially worrisome for Northern Virginia, home to 75 percent of the state’s federal contracting jobs. Fuller notes that Fairfax County has the most federal contracting positions of any county in the naton. The Tidewater area of eastern Virginia is home to several large naval bases and other defense installations, making it particularly vulnerable to reductions in military spending.

Perhaps as a result of these realities, Virginia has made itself a national leader in preparing for the fiscal cliff. The state's $30 million Federal Action Contingency Trust (FACT) fund was created to replenish some of the money the state might lose as a result of federal budget cuts. Still, Betsey Daley and her colleague Clyde Cristman, a Virginia Senate fiscal analyst, worry the emergency funds won’t be sufficient.

“Is this enough money to mitigate the impact that we’ll feel? I doubt it,” Cristman said.

The Virginia legislature plans to convene for a short session in January to address the fiscal cliff in whatever form it ultimately takes, but Cristman said policymakers are taking a wait-and-see approach.

“Until there are hard and fast plans as to how this is going to be implemented, it’s hard to do anything other than just speculate,” he said.

Not everyone in Virginia politics is keeping quite as quiet about the issue.

The topic of federal budget cuts surfaced just recently during the final debate in the U.S. Senate campaign between Republican George Allen, the former U.S. senator, and Democrat Tim Kaine, the former governor.

Allen criticized Kaine for supporting the deal to raise the debt limit, arguing Kaine’s actions hurt hundreds of thousands of Virginians by threatening their jobs.

“They should never be used as a political bargaining chip to raise taxes on job-creating small businesses,” Allen said.

Kaine spokeswoman Lily Adams said the former governor backed the imperfect plan along with a bipartisan group of prominent elected officials, including Virginia’s current chief executive, Bob McDonnell, a Republican.

She said Kaine believed the emergency compromise was necessary, because the alternative would have been disastrous for the nation.

 “The consequences of default were too great,” Adams said.

The outcome of congressional campaigns like the Allen-Kaine race remains to be seen. In the meantime, several lawmakers on Capitol Hill have quietly begun the process of trying to avoid the fiscal cliff altogether. A Senate “Gang of Eight," which includes Virginia Democrat Mark Warner, has committed to crafting a more palatable deficit reduction deal, even though few observers expect much progress before the election.

“What we lack is a bipartisan consensus on what the solution has got to be,” said Daniel Stohr, the communications director for Aerospace Industries Association, which represents several aerospace and defense manufacturing companies headquartered in Virginia.

Stohr hopes Congress uses the two months after Election Day to rise above partisan polarization, come together in good faith and negotiate a solution. But he also believes lame-duck sessions are typically unproductive. He's pessimistic that this year’s will be any different.

“Quite often, these guys are just making a rude gesture on the way out the door,” he said.

This story originally appeared on the Investigative Reporting Workshop, American University website.