Big Bird Whacking, Cuts And Inflation

December 3, 2012       Thomas McLaughlin      

Now that the election is over it’s time to look at the realities of federal decision-making and how those choices are likely to affect nonprofits. The federal government’s budget process is enormous, complicated, and intensely political. But there are a few central trends that even now can be discerned in the fog. Others are not yet clear, but seem inescapable.

Debt vs. Deficit

First, here’s a quick clarification. The federal budget deficit refers to the year-by-year difference between total inflows and total outflows. It is roughly equivalent to the line in your audit’s Statement of Activities that is labeled “change in net assets.” The federal deficit for the year just ended on September 30 was reported to be $1.09 trillion (total spending at $3.8 trillion), down from $1.297 trillion last year.

The federal debt refers to the accumulated results of these year-by-year deficits (or surpluses). It is roughly equivalent to the line on your balance sheet (or “statement of position”) labeled “total net assets.” At the moment, the federal debt is reported to be more than $16 trillion. In your financial statements, if you spend $1 million per year, this debt level would be equivalent to almost $6 million.

The Changes

There are four potentially major financial threats to nonprofits’ revenues in the near and intermediate future:

  • Federal funding cuts;
  • State and municipal funding cuts;
  • Big Bird whacking; and,
  • Inflation.

Federal funding cuts. It seems all but certain that categorical federal funding reductions are on the way. A public budgeting memo from federal authorities warned executive branch agencies to expect fund reductions of 5 percent in FY 2013. Another memo for FY 2014 pointed to 8 percent across-the-board reductions in domestic spending, and 9 percent reductions in defense.

None of these amounts include the reductions called for by the looming sequestration cuts. These are the terms cobbled together two years ago during the federal debt ceiling debates that established automatic across-the-board spending reductions should Congress fail to agree on a new budget.

To get a sense of what this could mean for your organization, try to follow the money trail from any government contracts backward. Should you have a contract with a federal agency, build these reductions (at a minimum) into your contingency planning from now on.

State and Municipal Cuts. Many state and municipal budgets are in disarray, often because of the pressures on federal funding, but also because state and municipal governments have had to wrestle with their own fiscal challenges such as deficit spending, massive pension debts, and cash flow shortages. The factor here is much more variable because the unique elements of each state’s funding streams determine the degree of impact on nonprofits.

The wild card in state and municipal budgets is that whatever these reductions may be, they could be on top of the federal reductions, thereby creating a double whammy. For instance, Medicaid payments are shared equally by the federal and state governments, so a 10 percent federal cut reduces the state’s expected share of federal Medicaid payments to 45 cents on the dollar, and a state cut of the same amount means that former Medicaid dollar you used to receive is now worth only about 90 cents. Cuts compound cuts in this scenario.

Big Bird Whackings

National Public Radio, Public Broadcasting Service, Amtrak and the National Endowment for the Arts have long been targets for funding elimination. While not of material significance in an environment of trillion dollar budget adjustments, these symbolic cuts are always politically compelling and there is an especially increased likelihood of at least some of them occurring during the upcoming political maneuverings.

Already community action funding and the perennial target of Head Start have seen threats during recent budget debates.

These potential reductions are game-changers for a certain segment of nonprofits. Next to these wholesale attacks, double-digit revenue reductions look good.

Inflation

When countries’ debt limits grow to the extent of the U.S. debt, options for fixing the problem are limited. One can grow out of it by adjusting spending to be at or below revenue for enough years to pay off the debt. A government can also debase the currency, making it worth less to own. And, of course, a government can also default — miss payment — on one or more of its long-term debt instruments.

But there is another avenue for dealing with high government debt loads — inflation. This works for those who owe debts because one is forever paying off yesterday’s debts with increasingly inflated dollars. The parties that lose out in this whole process are the debt-holders who are getting repaid for their investment in dollars that are worth less and less.

Except for debt-holders and those whose incomes don’t keep up with inflation — which can be a considerable percentage of the population — inflation is a relatively slow and less disruptive means of working down debt than the others noted above. The Federal Reserve has already begun this process with its Quantitative Easing program in which it pumps more money into the economy. Bill Gross, one the country’s most respected bond traders, recently noted that bond traders interested in making 30-year investments were effectively accepting the equivalent of about 2.6 percent average inflation per year. This is as good a signal as any that inflationary pressures are already baked into the economy.

Inflation has a positive side for nonprofits in that foundation grants are likely to keep up with inflation since professionally managed portfolios should be able to return enough to cover both the inflation rate and whatever growth is prevalent in the larger economy. But government funding will likely be less able to cope, making for a mixed picture.

Conclusion

Eventually the U.S. economy will grow out of its current predicament. Everything it will do to get there can be found on a small list of choices. Decisions about the details of those choices and how they will be put together are be made at the federal and state/municipal levels and started November 7. Pay careful attention.

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Thomas A. McLaughlin is the founder of the consulting firm McLaughlin & Associates and a faculty member at the Heller School for Social Policy at Brandeis University. He is the author of ‘Nonprofit Strategic Positioning’, published by Wiley & Sons. His email address is tamclaughlin@comcast.net