Staring down the barrel

Virginia prepares for the effects of federal budget cuts

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Print this page by Tim Loughran

Washington is in a budget-cutting mode — currently on course, for example, to scale back defense spending by a total of more than $1 trillion in the next decade.

Virginia is particularly vulnerable to dramatic budget shifts because federal spending makes up nearly a third of the commonwealth’s economy.  It is anyone’s guess at this point whether Congress will fully implement its plans and what effect they will have on the Virginia economy, particularly in Northern Virginia and Hampton Roads, the two most populous regions of the state.

In fact, George Mason University’s Center for Regional Analysis (CRA) and Old Dominion University’s Economic Forecasting Project agree that, if Congress and the White House follow through on promises to cut the federal deficit to a more manageable level, tens of thousands of jobs in both regions could be at risk.

This political and economic uncertainty has Virginia companies and the state government preparing for much leaner times.

In Roanoke County, ITT Exelis has laid off 375 of 1,400 workers at its military equipment plant, citing the end of U.S. military action in Iraq, the planned exit of ground troops from Afghanistan in 2014 and the proposed downsizing of the U.S. Army and Marine Corps during the next several years.

In McLean, consulting powerhouse Booz Allen Hamilton reduced its headcount by 516 employees, including about 10 percent of its senior and midlevel managers, a move designed to make the company more cost competitive in government contracting and other target markets.   

In Portsmouth, modeling and simulation company SimIS Inc. has begun to shift its focus away from Pentagon work to target the health-care industry. The 32-employee firm predicts 90 percent of this year’s revenue will come from new health-care customers and says it will need a total of 200 employees by 2015 to meet their needs.

Meanwhile in Richmond, Gov. Bob McDonnell plans to mitigate the impact of about $2 billion in possible cuts in annual federal grants for schools, courts, hospitals, roads and law enforcement in the 2013-14 budget cycle by doubling the state’s revenue stabilization, or “rainy day,” fund to $609 million and boosting the Federal Action Contingency Trust (FACT) fund by $20 million to $50 million. (McDonnell recently created FACT to lessen the effects of lower federal spending across the commonwealth.)

Further cuts in annual federal payments to the state treasury and to local governments could not come at a worse time for Virginia’s cities and counties. Many have found it increasingly difficult to attract new businesses since the Great Recession began at the end of 2007, says Neal Menkes, director of fiscal policy at the Virginia Municipal League. With local property values, real estate tax collections and the level of state assistance in almost-constant decline during these last four years, many localities have been unable to deliver the road systems, sewer lines and work-force development programs that companies require to make meaningful, long-term investments. 

“Economic development is so much more than giving companies tax incentives,” says Menkes. “One thing almost every locality has done is cut their capital budget, which hurts their [economic] infrastructure in so many ways … It’s going to take quite awhile, several years, to make an even modest recovery to where we used to be.”

Fewer, small contracts
For the McDonnell administration, the expected decline in the size and number of government contracts won by Virginia companies is much more worrisome than federal payments to the state, says Secretary of Finance Richard D. (Ric)Brown. “Those [losses] will affect our economy and potentially our [income and sales] tax receipts and our employment base.”

In the biennial 2010-12 budget two-thirds of Virginia’s $30 billion general fund came from individual income taxes and 20 percent came from sales taxes. At the same time the state got about $20 billion in direct federal grants and contracts.

While preparing for a possible shock from federal budget cuts starting in January 2013, the McDonnell administration still projects a slow, steady economic expansion during the next two years. It based its most recent budget proposal on forecasts of 3.3 percent growth in the state’s economy in fiscal year 2013 (which begins on July 1) and 4.5 percent growth in FY 2014.

More specifically, the Department of Taxation predicts that Virginians’ personal income will rise by 3.5 percent in FY 2013 and by 4 percent in 2014.  (Personal income includes wages and a variety of other income sources, like interest on savings accounts, rental properties, pensions and government transfers.)

Federal spending of $136.1 billion in 2010 across Virginia on salaries, wages, leases, supplies and procurement contracts accounted for 32 percent of the state’s $423.5 billion economy, with $58.1 billion coming directly from the Department of Defense, according to the CRA at George Mason University.

Among all 50 states, according to CRA data, Virginia ranks first in federal procurement (government contracts) and sixth behind California, Texas, New York, Florida and Pennsylvania in total federal spending. Defense spending accounts for more than 900,000 jobs in the commonwealth.
$490 billion plus $600 billion

Currently, the Obama administration is trimming defense spending requests to abide by Congress’ mandate last year that about $490 billion of scheduled increases be cut from the next 10 years of Pentagon budgets. Defense spending has risen almost 6 percent annually since the 9/11 terrorist attacks.

An extra $600 billion in defense cuts could occur through 2021 because of the Budget Control Act of 2011, which ended last summer’s debt ceiling crisis in Washington. That total represents half of the $1.2 trillion in cuts scheduled to take effect automatically starting next year because a bipartisan congressional “super committee” failed to agree on a plan of its own. The additional cuts could have a significant effect on Virginia, says GMU economist Stephen Fuller, director of the CRA. According to his calculations, the commonwealth could lose 123,000 military and civilian jobs, $7 billion in wages and more than $10 billion in overall economic activity.

In this scenario Northern Virginia, home of many of the state’s top defense contractors, could lose a combined 93,000 jobs and almost $8 billion in economic activity during the next decade. At the same time Hampton Roads, a region whose massive U.S. Navy facilities have helped it weather numerous recessions since World War II, could see its economy shrink by almost $2 billion and lose about 21,000 jobs. John McClain, senior fellow at the CRA, points out the projections represent what would happen if no actions are taken to change the debt ceiling package passed last August. The starting points for measuring these declines are not necessarily today’s levels of employment and economic activity but “what might have been” if the Budget Control Act had not occurred. 

Vinod Agarwal, director of the Old Dominion University’s Economic Forecasting Project, reached similar conclusions in his forecast for Hampton Roads, released in late January. In the report, he analyzed the local economic impact of two different spending models the Pentagon may adopt:.
Using Congressional Budget Office estimates of a possible 7 percent (or $1.45 billion) cut in Pentagon spending in Southeast Virginia, Agarwal and his fellow ODU economists suggest that the region’s economy might shrink by 3.2 percent and lose 26,900 jobs, or 2.7 percent of the region’s total employment, through 2014.

If the Pentagon’s cuts go even deeper, to as much as 11 percent (or $2.28 billion in reduced spending across Hampton Roads), as suggested by the Center for Strategic and Budgetary Assessments think tank in Washington, companies in the area could shed as many as 42,450 jobs (4.24 percent of the work force) as its economy contracts by more than 5 percent. (See chart on page 29.)

Yet, Agarwal is quick to point out, “I view these as worst-case scenarios. We don’t believe [deep military spending cuts are] going to happen … the purpose of putting out this analysis is to alert people to what could happen.”

The reason for Agarwal’s optimism is simple: “I don’t think the Republicans in the House [of Representatives] will ever permit cuts of $600 billion ... Even Secretary [of Defense Leon] Panetta says the Pentagon can’t take those kinds of cuts … And it’s already clear the Navy’s budget will not be cut by even 7 percent … I’m not a politician, but as a rational economist, I don’t think it will happen.”

Indeed, House Majority Leader Eric Cantor, who represents Virginia’s 7th District, has backtracked on his August vote in favor of the Budget Control Act, saying he opposes any deep cuts to military spending.

Signaling what might be a powerful Republican theme in this November’s congressional and presidential elections, Cantor told reporters on Capitol Hill in late January that he prefers a plan in which all federal agencies roll back their budgets by a combined $60 billion a year during the next decade. That move would relieve the Defense Department of eliminating $600 billion from its spending plans. “I just think the defense of this country is a priority,” he said.

That sentiment is echoed by Republican Rep. Randy Forbes, whose 4th District includes a large chunk of Hampton Roads. He has roundly criticized the White House’s plan to trim spending on ground troops in meeting the $490 billion reduction mandate.  “This administration ... is dismantling our nation’s greatest strategic asset and accepting grave risk in the process,” he said. “Virginians will undoubtedly suffer as a result of this administration’s budget proposal — so, too, will our allies — but it is our men and women in uniform who will suffer the most….America is a superpower on a dangerous and rapid course towards mediocrity.”

A BRAC winner again?
Northern Virginia and Hampton Roads, however, could benefit from some proposed defense strategies. 

The Obama administration plans to keep all 11 of the Navy’s aircraft carrier groups (five of which are based in Norfolk) and increase spending on intelligence, surveillance and reconnaissance, a specialty at Langley Field in Hampton. Additionally, the Pentagon plans to spend an undisclosed amount to increase its use of cyber warfare and cyber security, two areas gaining more attention from information technology companies in Northern Virginia.

Without providing details, Panetta also announced the Pentagon will look to trim the size and number of military installations around the nation in another round of Base Realignment and Closure (BRAC) consolidations, the last version of which began in 2005 and ended last September. Instead of BRAC hurting the commonwealth’s employment totals, as feared early in the process, the Pentagon added new jobs in places like Fort Lee near Hopewell, the new Rivanna Station intelligence facility near Charlottesville, and Marine Base Quantico in Prince William County and Fort Belvoir in Fairfax County.

While many state and local officials hope that Virginia will survive any cuts in the next BRAC round, Panetta warns that future military cuts “will impact on all 50 states and many congressional districts across America.” 

Economic development officials in Northern Virginia and Hampton Roads say companies in each region have the experience, the skills and the determination necessary to survive any expected drop in federal spending.

GMU’s Fuller thinks Northern Virginia companies who benefit from federal spending will enjoy a strong 2012 but should be prepared for some serious belt tightening beginning next January, after the November elections determine who sits in the Oval Office the next four years and which party controls the Congress. 

Gerald L. Gordon, the president and CEO of the Fairfax County Economic Development Authority says that local technology and business services contractors in his region grew even after deep defense cuts during the Carter administration and after the fall of the Soviet Union in the early 1990s. “The places that got hurt were the places where they made things.” However, “this time it will be a little bit different,” he says. “The government is talking about defense cuts, but there could be areas that get more funding such as health IT or alternative energy, and companies know that new opportunities could pop up, kind of like that game Whac-A-Mole. ”

Many of Fairfax County’s defense contractors, Gordon says, began diversifying their business lines in recent years as the White House and Congress began to focus more on alternative energy, health IT and cyber crime. As a result, he says, more information technology companies in the Virginia suburbs of Washington are turning to new opportunities in bioinformatics, clean-energy research and cyber security.

“We’ve always believed that you cannot have a sustainable economy based on one industry or one company, like steel in Pittsburgh, or Boeing in Seattle,” Gordon says. “We’ve been working to diversify this economy for the last three decades. We won’t be as devastated by these cuts as we would have been 30 years ago.”

Sharing Gordon’s optimism is E. Dana Dickens III, the president and CEO of the Hampton Roads Partnership. He says businesses in Southeast Virginia have what it takes to thrive despite federal spending cuts. “When you have 40 to 45 percent of your entire economy wrapped up in federal spending, that’s too many eggs in one basket. We recognize that,” he says. “Don’t get me wrong: Federal spending has benefitted Hampton Roads enormously, but it puts us in a very vulnerable position.”

Dickens says his organization is about two years into an effort to develop “clusters” of businesses that can mentor each other in industries unrelated to the military, such as health care, aerospace, bioscience, commercial robotics and modeling/simulation. The process is expected to give local companies options when the expected slowdown in the Pentagon spending finally begins to bite. “We’re expecting that the [military spending] cuts will not have a significant impact in the next couple of years … This economy will not drop off the table ... We’ve got time and a plan,” Dickens says.

ODU economist Agarwal agrees. His 2012 forecast for Hampton Roads predicts the local economy will expand by almost 2 percent this year. An improving national economy will generate about 2.6 percent more in tourism spending, a 3 percent rise in port activity and a nearly 4 percent increase in retail sales. 

Local companies should add about 6,600 jobs, raising the region’s total to about 738,000, the same level as 2003, says Agarwal, and the local unemployment rate will dip to about 6 percent from 7 percent last year. “Compared to past economic downturns, the region’s recovery process will be unusual in the sense that, despite rising income and expenditures, employment growth in Hampton Roads is expected to proceed at a relatively slow pace. As far as jobs are concerned, local firms, like their counterparts in other areas of the country, appear to have learned to do more with less,” he wrote.

As for the economic future of Virginia and Hampton Roads for the next 10 years, Agarwal concludes: “Something is going to happen, but no one knows what that’s going to be.” 

Federal spending in Virginia
Virginia’s share of federal funding
Two possibilities in Hampton Roads

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