Congress lashes out at states; states hit back

WASHINGTON Wed Jan 26, 2011 3:27pm EST

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WASHINGTON (Reuters) - Republicans in the Congress have lambasted states for their economic problems and now states are hitting back, telling the federal government to rein in its own deficit.

U.S. Republicans, riding a wave of opposition to government bailouts, have refused to give extra stimulus to states and are pushing them to cut spending to balance budgets. States say Washington must control its own federal budget gap, but not by making states' financial problems deeper.

"Despite states' difficult fiscal situation, governors are not calling for new one-time help from the federal Treasury," the bipartisan National Governors Association said in a letter to Congressional leaders sent on Monday.

"We encourage the federal government to follow the lead of states and make the tough decisions necessary to get its fiscal house in order," the letter said.

The financial dilemma of U.S. states has added risk to the traditionally safe municipal bond market. It has made a target out of public sector union contracts and pension benefits, pitting local governments against their workforces. Cuts in federal support could aggravate the situation.

U.S. Republicans are unified in the belief states must dig themselves out of their fiscal hole. After all, they swept November's mid-term elections and gained control of the House of Representatives on promises to cut spending and criticism of federal support to states.

Republicans may introduce a bill to allow states to declare bankruptcy, effectively forcing them to sort out finances in court and renegotiate contracts.

House Republicans will introduce a bill next month to ban the U.S. government from helping with states' pension liabilities. That follows a bill last week from Representative Randy Neugebauer, a Republican, to ban the U.S. Federal Reserve from giving states temporary cash loans.

Faced with this legislative challenge, states have gone on the offensive. In their letter this week, the governors said the U.S. government should not reduce its deficit by shifting its costs to states. They said states should share "savings when reductions or reforms are made at the federal level."

'NO BAILOUTS'

States face a collective budget gap of $175 billion through 2013 even after closing gaps totaling $230 billion over the past two years, the governors association says.

The most conservative estimate says states are short $700 billion in total for covering pensions funding.

In contrast, the federal debt is $14 trillion and the deficit $1.48 trillion. During his annual address to Congress on Tuesday, President Barack Obama laid out plans to freeze spending and save $400 billion over a decade.

Part of the "tough love" approach to states by U.S. Republicans stems from party tension. The states in the worst shape -- California, Illinois, New York -- historically lean Democratic. Senate Republican Leader Mitch McConnell has put his party's message about states bluntly, saying: "No bailouts". Still, some Senate Democrats are also concerned that states will soon ask for federal help.

After the recession that began in 2007 devastated state revenue and drove up demand for social services, states hiked taxes and slashed spending to wipe out deficits.

They also turned to the federal government, which responded with an $814 billion economic stimulus plan that included the largest transfer of federal funds to states in U.S. history.

After nearly three years of budget woes, states have few places left to cut and their residents have no interest in tax increases, making it hard for them to return to fiscal health.

"The recession forced many states to take difficult short-term actions to balance budgets and to find innovative ways to make government a more efficient and productive instrument that can do more with less," the governors said in their letter. "The federal government must now do the same."

(Additional reporting by Andy Sullivan; Editing by Andrew Hay)

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