Not to worry! Another budget crisis is almost upon us! This time it’s not the dread fiscal cliff or the debt ceiling, but rather the “sequester”—the extremely crude cutting mechanism that essentially nobody favors but that seems likely to happen anyway. It’ll drag down the economy, impair the functioning of the government across the board, and do nothing to improve America’s fiscal sustainability over the long run.
Here’s what you need to know.
What is it? Sequestration is broad, automatic, across-the-board cuts to most categories of government spending. These are scheduled to take effect on March 1. Social Security, Medicaid, targeted anti-poverty programs, military pay, and the operational cost of ongoing wars are exempted. Benefits for Medicare patients won’t be touched, but payment rates to providers will. Everything else is getting the ax. And it’s not a small ax. The military’s 2013 budget will be cut by just over 7.3 percent, and domestic discretionary programs will be cut by over 5 percent.*
So the sequester is a bipartisan deal that everyone supports? Quite the opposite! The debt ceiling was a hard deadline, but neither side wanted to give up on the grand bargain. So they raised the debt ceiling limit and appointed a “supercommittee” to continue the bargaining. The sequester was meant to be a stick—something everyone agreed was a terrible idea—that provided members of the supercommittee with an incentive to agree to an alternative means of deficit reduction. The cuts were evenly divided between defense and non-defense segments to give Democrats and Republicans equal pressure to seek an alternative.
What’s so bad about spending cuts? Two things. One is that a time of high unemployment and ultra-low interest rates is a strange time to be cutting spending. Putting a credible deal in place to cut spending over the long term might be helpful, but actually reducing expenditures in 2013 will hurt the recovery. The cuts are also poorly structured. Common sense says that some of the government’s discretionary programs are more important than others, and that you want to cut the less useful programs rather than the more useful ones. The sequester makes no judgment about the merits and no effort at cost-benefit analysis. Things are just cut willy-nilly.
How much spending is being cut exactly? A total of $85.3 billion in 2013 with the number rising steadily each subsequent year to a total of approximately $1.2 trillion over 10 years.* A bit less than 10 percent of that total is estimated to be lower interest rate costs since the government will be borrowing less. The rest is program cuts.
What’s the economic impact going to be? In the short term, it will be pretty severe. Goldman Sachs’ Alec Phillips thinks we could see almost a full percentage point cut off growth in the second and third quarters of GDP. The most visible initial impact will be civilian layoffs at the Pentagon and furloughs at defense contractors. Other impacts will be a bit harder to see. A nearly 10 percent cut in Section 8 housing assistance vouchers, for example, won’t directly lead to layoffs. But the hardship inflicted on low-income families will mean reduced sales for the businesses they patronize with downstream consequences. All told, the Bipartisan Policy Center thinks full implementation could lead to a million fewer jobs next year.
How about the impact on programs? It’s difficult to predict. The essence of the sequester is that agencies have very little authority to prioritize in the cuts. The statutory language says cuts must happen at the “program-project-activity” level—i.e., you can’t do double cuts in one program to spare another from the ax—but the technical meaning of this is unclear for some agencies. This is going to create implementation problems for large procurement initiatives or construction projects. You can’t really buy 89 percent of an aircraft carrier or build 92 percent of a dam. Consequently, the aggregate level of disruption will probably be bigger than the percentage cuts suggest. On the military side, since troop pay and the ongoing war in Afghanistan are spared, the cuts in future weapons programs and other procurement will be very big.
But at least this fixes the deficit, right? Not really. Certainly the deficit is made lower by these cuts. But the deficit right now isn’t a problem. The thing people worry about is the long-term budget implications of the aging population and rising health care costs. Yet the sequester doesn’t touch programs related to those issues.
So why doesn’t Congress just call the whole thing off? Republicans want to cancel the defense sequester and replace it with cuts in programs for low-income people. Democrats still favor a grand bargain that raises taxes and trims entitlements. Republicans are still against raising taxes. Congress tried to bluff itself and now it’s prepared to call its own bluff.