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Sequestration: Which States Are Most Vulnerable?

 February 26, 2013 03:02 PM

(By Mani) Over the course of the past few weeks, it has become more and more likely that the sweeping set of automatic federal spending cuts, also known sequestration, will take place as scheduled beginning on March 1.

The amount of budget sequestration is determined by the difference between the cap set by Congress in the annual Budget Resolution and the excess amount appropriated by Congress beyond the annual cap.

"The process of budget sequestration will harm certain states disproportionally," Wells Fargo economist Mark Vitner said in a client note.

The annual sequestration process was brought into the public spotlight back in 2011 when the Budget Control Act of 2011 established automatic budget cuts, a sequestration of spending authority if a designated deficit reduction committee failed to arrive at a long-term deficit reduction plan.

[Related -Northrop Grumman Corporation: How Defense Budget Will Fare In 2014?]

In December of last year, the nation climbed over the "fiscal cliff," and Congress delayed the implementation of the sequestration process until March 1 and reduced the amount of budget cuts to be implemented this fiscal year to around $85 billion.

"Even with the reduction in cuts for this fiscal year ending in September, there is still an estimated $1 trillion in total cuts expected over the next 10 years, which will affect state economies on two fronts, defense cuts and non-defense cuts," Vitner noted.

The adverse economic effects from defense cutbacks will potentially cut wages and employment in areas with a defense presence and regions with large defense contractors. Cuts in non-defense programs will affect a large number of hospitals, government contractors and research institutions.

[Related -Lockheed Martin Corporation (NYSE:LMT): How A Small Budget Deal Impacts Defense Contractors?]

The impending defense cuts will likely have a greater immediate impact effect on state economies due to the fact that these cuts are concentrated in a specific industry, which itself is concentrated in a handful of areas as opposed to the non-defense cuts that are spread across a wider number of industries and geographic areas.

The potential effects on these states include military layoffs, cuts in defense contracts, reductions in military personnel and may result in another round of base closures. Moreover, these states would also face spill-over effects stemming from slower income growth and higher unemployment, which will cut into state and local tax receipts and increase demand for social services.

Let's see which states that have the greatest exposure to federal funding cuts. In general, the greater Washington, D.C. area and southern states will be the hardest hit while states in the Midwest and along the West Coast will likely be impacted to a lesser extent.

The regional impact of defense cuts is primarily concentrated in the Pacific West and the areas in and around Washington, D.C. Among the states most likely to be impacted is Hawaii, home to the U.S. Navy's Pacific Fleet, which could see layoffs and reduced income growth, which in turn would weigh on economic growth.

"In addition, Alaska with its Air Force, Army and Naval operations would also be disproportionally impacted from defense cuts," Vitner said.

The District of Columbia along with its neighboring suburbs in Northern Virginia and suburban Maryland are particularly vulnerable due to the multitude of defense agencies and contractors located in the region. Large defense contractors such as Lockheed Martin Corporation (NYSE: LMT), Northrop Grumman Corporation (NYS: NOC), General Dynamics Corporation (NYSE: GD) are based out of these regions.

Moreover, defense outlays are estimated to have accounted for 9.8 percent of the combined D.C., Virginia and Maryland economies in 2010.

Other areas vulnerable to defense cuts include Huntsville, Alabama and St. Louis, Missouri. Both have outsized exposure to the aerospace industry and will see growth slow if the military purchases fewer fighter jets, missiles and helicopters. Huntsville is likely more vulnerable due to its smaller size.

"Smaller towns that host large military bases are probably the most vulnerable areas in the sequestration battle because so much of their economic wellbeing is tied to the continued flow of defense dollars," Vitner noted.

Georgia is home to three such areas: Columbus, Warner Robbins and Hinesville. In Texas, El Paso and Waco, home to Fort Bliss, and Fort Hood, may also be vulnerable.

Among larger metro areas, the greatest potential impact is in large Navy towns such as San Diego and Norfolk-Virginia Beach.

Here are the states that are most susceptible to non-defense spending cuts, which would be spread across the country. Cuts in non-defense outlays likely would trigger significant furloughs, layoffs at civilian contractors and generally less business for supporting services, including law firms, caterers, airlines and hotels.

The Washington, D.C., Maryland and Virginia regions will again face sizable impacts from budget sequestration. Other states that rely on federal grant and procurement programs such as New Mexico and Idaho will also likely face headwinds to economic growth over the next 10 years if the full set of budget cuts is allowed to go into effect.

New Mexico, which is home to the Los Alamos National Laboratory, is another area where cuts in federal spending will be hard to offset. In addition, smaller Medicare reimbursements and a reduction in research grants to major universities are likely to be prime targets for budget cuts.

"The effect from these cuts would likely fall heaviest on smaller states that have relatively few alternative funding sources to make up for any shortfalls in federal funding," Vitner said.

Given the partisan gridlock over the past year, it is unlikely that a prompt solution to avoiding the impending sequestration process will transpire quickly.



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