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Dreams and reality: The forces shaping government spending in 2017

December 22, 2016 Ben Vaught

Bloomberg Government regularly publishes insights, opinion and best practices from our community of senior leaders and decision-makers. This column is written by Ben Vaught, Director of Onvia Exchange.

Although Merriam-Webster recently unveiled “surreal” as its Word of the Year for 2016, it’s looking increasingly likely that 2017 will become the true year of surrealism – the movement described nearly one hundred years ago by poet Andre Breton as existing to resolve the previously contradictory conditions of dream and reality. In the coming months, the election-year dreams of 2016 will clash with financial realities of 2017 and beyond, with few indicators whether they can be resolved, or which priorities will prevail.

At the federal level, policymakers and budget writers are preparing to fit into one budget multiple contradictory items such as massive tax cuts, nearly a trillion dollars in infrastructure investments, and unknown amounts of adjustments to defense, entitlement and other spending categories.

Within state and local governments, policy and budget writers have been dealing with their own form of surrealism for much of the past decade: the ever-increasing gap between demand for services and supply of new revenue, especially at the state level.

In this surreal environment, punctuated by heightened economic uncertainty and political unrest, business and government leaders alike are taking a deeper look at the underlying forces that will shape 2017.

2017 Economic Outlook: Modest Growth and Long-Term Uncertainty for Government Spending

Economists and investors appear to have arrived at a dual consensus regarding the economic outlook in 2017 and beyond. For 2017, modest but steady growth is expected, but beyond that timeframe the waters become significantly murkier.

In the short term, the market seems excited about the promise of a Trump presidency. With a more conservative, potentially “business friendly” commander-in-chief, and one who has voiced a desire to cut taxes and invest in infrastructure significantly, market observers are generally expecting a return to a more normal level of growth. A survey of 60 economists conducted by the Wall Street Journal has concluded that GDP growth should continue at approximately a 2% rate heading into 2017.

However, it may take some time for any of the new administration’s major policy shifts to make a noticeable impact. “Growth can be affected in 2017, but that effect will come more from the anticipation of policy changes than any direct policy changes themselves,” said Dan White, Senior Economist at Moody’s Analytics. “For example, financial markets are already beginning to price in some fiscal stimulus from the incoming administration, and that has dramatically pushed up long-term interest rates. Higher long-term rates will weigh on the pace of growth as early as the first half of 2017.”

Beyond 2017 lies a large amount of economic uncertainty. In the Wall Street Journal survey, 87% of panelists interviewed indicated that the recent election had brought more uncertainty to markets and the overall economy. With so many details about the new administration to be determined, including how and when the potential infrastructure stimulus goes into effect, the adjustment or re-negotiation of trade deals like NAFTA, and the effects of new health care and immigration laws, economists have adopted a “wait and see” mentality.

The worst-case scenario of a recession happening remains unlikely, though according to the survey, the odds have increased slightly – from around 14% last year to 19% currently. More likely is a mild cyclical rebound. Jobs are increasing at a moderately good rate and unemployment is relatively low, both of which make it likely that the economy will make up some of the ground lost in a somewhat weak 2016.

State and Local Government Spending

2015 marked a return to form for many state and local governments, with an increase in total purchasing of 5.1% year-over-year – the first year-over-year increase since the recession. 2016 brought this recovery down to a more sustainable pace, more in-line with the slow, steady 2% national rate of economic growth (real GDP).

In 2017 this modest growth from 2016 is expected to continue. But like the nation’s economic outlook, this growth is the product of a dual consensus.

Bullish observers note the stability provided to governments by steady, if slow, economic growth. The less volatility, the more governments can shift focus from cost-cutting to planning for modest investments. Government employees provide at least some support for this assessment. In a survey of over 550 government agency procurement professionals by Onvia, 33% expected an increase in spending levels while only 9% expected a decrease.

The bears point to the ever-widening gap between revenue generated and the services citizens expect state and local governments to provide. The national rate of recovery may not be enough to keep pace with this gap. According to a recent survey by the National Association of State Budget Officers (NASBO), half of all states reported lower-than-expected revenues for their 2016 fiscal years. 19 states made mid-year budget cuts totaling $2.8 billion, the report continued. The reasons for these slowdowns in the states are varied – dependent on tax structure, regional economic climate and choices by state policymakers. However, the broader point is clear: states will need a stronger economic recovery headwinds to realize more than modest spending growth.

The Wild Card: Infrastructure Investment

A casualty of the recession has been a near-unilateral pulling back from infrastructure spending across federal, state and local governments. In 2016 there were hopeful signs that this pullback is about to come to an end.

Most visibly has been President-elect Trump’s promise to inject approximately $1 trillion into infrastructure investments. Much is still unknown about the nature of these investments, but there is a clear need and a growing consensus that now is the time to act on infrastructure.

Lost in the national coverage, however, was a nationwide trend towards funding large infrastructure projects at the state and local level. Over $200 billion in funding initiatives were approved on the November ballot. Several states increased gas taxes to fun road construction. Statewide water propositions passed in California and Texas. Local governments passed “mega project” transportation packages. Two states, Illinois and New Jersey, even passed “lockbox” initiatives to ensure that transportation funds are used solely for transportation.

When the promise of job creation and economic growth is added to the political mix, the likelihood of large-scale infrastructure investments in 2017 move even closer from dream to reality.

Uncertainty abounds over the next year – starting at the top with the President-elect and flowing down through federal, state and local governments. After the recession governments were asked to do more with less, leverage innovation, and find efficiencies. Now, they will be asked to do the surreal.

The opinions presented in this column are those of the author and do not necessarily reflect the opinions of Bloomberg Government or Bloomberg LP.

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