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Fiscal Cliff 2013 Will Bury Debt-Ridden U.S. Cities

By , Money Morning •

With fiscal cliff 2013 approaching on January 2, it is struggling U.S. cities that stand to suffer the most if Congress fails to help.

These U.S. municipalities are already in terrible fiscal shape due to the effects of The Great Recession. Now they're facing the effects of automatic tax increases and deep spending cuts of 9%, about $560 billion in total.

Like Gramm-Rudman-Hollings from 1985 that imposed automatic spending cuts, these powerful one-two combinations will floor cities that have unwisely come to rely on federal aid.

"Cities are going to be facing very rough waters for the next couple of years," predicted Michael Pagano, dean of the College and Urban Planning and Public Affairs at the University of Illinois-Chicago.

Cities Struggling Ahead of Fiscal Cliff 2013

At present, well over $630 billion in annual aid is given to state and local governments. In addition, much of the $819 billion stimulus package The American Recovery and Reinvestment Act of 2009 went to assist the states' recovery from the effects of The Great Recession.

Rather than using the stimulus funds to stabilize precarious financial positions, the majority of the funds went to employee costs, such as salaries and benefits, particularly pension programs.

The money wasn't even enough.

In 2010, the Nelson A. Rockefeller Institute of Local Government reported that local governments made approximately $50 billion in pension contributions. Remaining to be paid is $3 trillion in unfunded pension benefits and about $1 trillion in healthcare costs.

This is a direct result of the local leadership.

Pensions paid to state and local employees have destroyed the budgets. Over the last decade, the annual required pension contributions as a part of payroll soared from around 5% in 2001 to over 15% in 2001. Elected officials sought the favor of unions by rubber-stamping compensation demands.

That lack of fiscal prudence and political leadership is now shredding the tax base of municipalities across the country.

As an example of this largess that could not be afforded, in San Bernardino, CA, the average salary for a fireman was over $130,000. Compounding this was a pension system that allowed for retirement at age 50 with full pay and benefits.

San Bernardino just filed for bankruptcy on August 1, 2012.

While municipalities are filing bankruptcy to obviate these pension obligations and voters are sending them to defeat at the polls, it is too little, too late with fiscal cliff 2013 looming. The number of employee reductions for local governments last year was 66,000, most in the education department.

That number will continue to grow.

Going over the fiscal cliff will make it even worse. Municipalities cannot turn to soaring property taxes or transfer payments for the needed revenue. Home sales are still sluggish and housing values are down.

Higher federal taxes will result in less discretionary income to be spent at the local level, depriving jurisdictions of needed sales taxes.

State and local governments had always counted on Congress to bail them out when hard times arrived. But with an automatic 9% reduction in federal spending, there will not be that latitude anymore for members of Congress.

There is virtually no chance anything will be done by Congress and the Obama administration before the elections in November. This lack of a meaningful solution to the budget impasse could reduce economic growth by 2-3% in 2013, according to Tom Binnings, an economist with Summit Economics.

That falling economic growth will compound the impact of the fiscal cliff tax increases and spending decreases at the federal level.

In addition, due to the huge federal budget deficit and the soaring national debt, interest payments take up an increasingly larger share of overall spending.

If the fiscal cliff is run over on Jan. 2, 2013, municipalities across the country will be the "Thelma and Louise" in the front seat heading downward, joined together for a very unpleasant landing.

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