Putnam Tax Exempt Fixed Income Team

Sequester to affect state and local finances

Putnam Tax Exempt Fixed Income Team, 5/8/2013

Since January, much of the talk from the political class has revolved around sequestration, the other half of the fiscal cliff that mandated 2% across-the-board spending cuts. While the political rhetoric associated with those cuts often has painted them as catastrophic, we believe the fallout for most states is likely to be fairly benign. The cuts certainly won't be beneficial for states and local communities, but we believe the effects will not be extremely widespread and the impact will be staggered over time. Sectors and localities that benefit most from federal support and areas that are heavily reliant on military and defense spending are the most likely to be negatively affected, we believe. But at this point, it is difficult to quantify exactly how sequestration will impact states' finances. The ultimate effect will depend on how well these states have prepared and budgeted for the sequestration cuts.

In terms of overall state finances, we have generally seen improvements across the board. For fiscal year 2013, 48 states are projecting increased tax revenues versus those of 2012, according to the National Conference of State Legislatures. While this is an encouraging trend, challenges continue to exist at the local level. Many states have lowered expenses by reducing their financial support to cities and counties, and should the economy begin to decelerate in the first half of 2013, we believe that would almost certainly negatively affect municipal finances.