Prolonged federal shutdown could damage Connecticut’s fragile economic recovery

As the federal government stood at the brink of a shutdown, state and business leaders were most wary Monday of a prolonged stoppage.

Though many of the 9,000 federal employees residing in Connecticut could be furloughed shortly after the new fiscal year begins Tuesday, a potential lag in billions in federal dollars earmarked for the Nutmeg State poses the biggest threat to state government.

And should a shutdown linger for several weeks, or more than a month, both furloughs and a bottleneck in federal aid could undo much of Connecticut’s already sluggish recovery from the last recession.

‘This recovery is very much in jeopardy’

“The spectre of uncertainty would be key” if a shutdown of a month or more were to develop, said Don Klepper-Smith, a senior economist with DataCore Partners in New Haven. “It would mean less hiring, less job creation, less economic growth. Then this recovery is very much in jeopardy.”

Despite its reputation as a wealthy state that therefore receives little federal funding, Connecticut actually does relatively well in this regard.

A report last year from the state legislature’s Program Review and Investigations Committee showed Connecticut received $56 billion of the $3.3 trillion in federal funding distributed on a statewide basis in 2010, placing the Nutmeg State fourth-highest on a per capita basis. This involves not only the roughly $8 billion sent to state government, public colleges and universities and to cities and towns, but also funds distributed to non-profits and to private institutions.

Besides furloughed federal workers, some military personnel remaining on active duty also won’t receive a paycheck until a budget agreement is reached. Military and civilian contractors also could see funding stalled — a consistent theme tied to the shutdown.

Connecticut’s businesses already are wary of a state economy that has regained just half of the 121,000 jobs it lost in the last recession, Klepper-Smith said.

If consumer confidence, weakened by furloughs and delayed federal payments, remains shaky for several weeks or a month, Connecticut could lose roughly half of the economic growth projected for the fourth quarter of 2013, he added.

“A lot of companies won’t see any effects [of the shutdown] at all, so I think that type of scenario takes time,” said Peter Gioia, chief economist for the Connecticut Business and Industry Association. “Eventually it gets ugly, but it doesn’t get ugly immediately.”

Investor confidence is crucial

Things get particularly ugly, Klepper-Smith said, if investors — and not just consumers and businesses — catch the faltering confidence bug.

“Then a shutdown would have a huge impact,” he said. “Confidence is the key to continued economic expansion.”

News of Congress’s inability to resolve its differences Monday was already credited with causing a significant dip in  the U.S. stock market. 

Given Connecticut’s proximity to Wall Street, the financial services sector represents a crucial part of the state’s economy, particularly in lower Fairfield County. And Klepper-Smith noted that the last recession began with a pronounced loss of jobs in the financial services sector in 2008 and 2009.

“When that happens,” Klepper-Smith added, “it’s hard to predict … when you can stop the bleeding and turn the economy to the upside again.”

Steven P. Lanza, the executive editor of the Connecticut Economy, the quarterly review published by UConn, said the potential government shutdown is just one factor contributing to uncertainty that could set back the state’s economic recovery. 

“These protracted debates and squabbles over the budget and debt limits and fiscal cliffs and the like has raised the level of political uncertainty, and that has had real economic consequences,” Lanza said.

Even a federal shutdown of a just a few days would mean two-tenths of a percentage point off the gross domestic product, a contraction that would mean the loss of 300 jobs in Connecticut, Lanza said.

A shutdown of three to four weeks would cause a 1.4 percent loss in GDP, enough to cost 2,000 jobs in Connecticut with an income of $100 million, he said.

An even larger danger, he said, is that economists like Mark Zandi of Moody’s Analystics see a shutdown followed by a debt-ceiling debate as potentially triggering a severe recession.

“Even a mild recession would have severe effects on Connecticut’s economy,” he said. In 2000, the U.S. economy fell into recession for just two quarters, costing the state 23,000 jobs.

The state has recovered about 60,000 of the 120,000 jobs lost in the 2008 recession.

“We’d be back where we were two years ago,” Lanza said.

Lanza spoke a press conference with Sen. Richard Blumenthal at HABCO, a small engineering and aerospace company in Glastonbuary that has been growing, but now is ready to delay further hiring. 

Connecticut’s budget, and not just its economy, is tied closely to the health of Wall Street, and the biggest threat from a federal shutdown — again — comes from a prolonged standoff.

Roughly one-third of the $8.8 billion in state income tax receipts Connecticut expects to collect this year are tied to capital gains, dividends and other investment-related earnings. This is one of the most volatile components of the state’s revenue system, routinely growing — or shrinking— in double-digit percentages when the economy shifts.

If a shutdown lasts long enough to wound the economy, this could be where the state budget feels the most pain.

Gov. Dannel P. Malloy’s budget chief, Office of Policy and Management Secretary Benjamin Barnes, sent a warning letter to state agency heads last week.

“You should also be aware that my office is considering various contingencies to ensure that the state’s budget remains in balance if tax revenues falter in the face of a shutdown,” Barnes wrote.

Malloy sent a letter to state workers on Monday acknowledging that Connecticut’s partnership with the federal government on health care, social service and unemployment benefit programs would be affected by a shutdown. The question is simply: By how much?

“A prolonged federal shutdown will disrupt our partnership in many ways, and we should all be deeply concerned about it,” the governor wrote. “Let us assure you:  Connecticut will do what we can to ensure that the services we provide will continue.  We will honor our commitments to employees, and our obligations to our residents to the utmost of our ability.”

State’s cash flow troubles could return

Barnes directed department leaders last week to develop contingency plans for programs that rely heavily on federal assistance.

Technically, this fiscal year’s $18.7 billion state operating budget is supported by about $1.3 billion in federal aid. But a more accurate number is about $4 billion.

That’s because Malloy and the legislature effectively removed about $2.7 billion in federal funding for Medicaid programs off the books. But the aid still exists and will be spent this year.

Several billions of dollars more support state capital programs, particularly transportation, or assist public universities and municipalities.

Both state and municipal leaders have said over the past week they still are studying how severely governments here will be affected. But the main concern is that federal dollars, while eventually due to arrive in the Nutmeg State, could be delayed substantially.

Unfortunately, state government has been struggling with cash flow problems for much of the past two years even before the threat of billions of dollars in stalled federal assistance.

According to the monthly cash flow reports from state Treasurer Denise L. Nappier, her office transferred funds from capital programs to the common cash pool used to pay operating bills for eight straight months, from November 2011 through June 2012.

After receiving approval from the governor, Nappier established an emergency line of credit of $300 million last December as state government entered another six-month stretch of transferring from capital projects to cover bills and other disbursements.

Only recently has state government appeared to be emerging from this cash flow problem. The state has avoided transfers from capital programs for three consecutive months, and Nappier said that if the positive trend continues she would cancel the line of emergency credit in December.

“I think the larger cities, with their social service and housing programs, are going to be in the same situation as the state,” James Finley, executive director of the Connecticut Conference of Municipalities, said Monday.

In federal court in Connecticut, the shutdown would curtail or postpone civil cases, but would not affect criminal cases for at least 10 days. If the shutdown continues beyond that, judiciary would reassess the situation for criminal cases around Oct. 15.

Meanwhile, the state’s only federal prison, the Federal Correctional Institution for women in Danbury would not be affected by the shutdown. The federal Bureau of Prisons has multi-year authority and adequate funding to continue operating during the lapse, according to the Department of Justice.

Staff Writer Grace Merritt contributed to this article.