Can we live with the budget 'sequester'? Yes, but it’s better if we don’t.
Congress has many incentives to prevent the $100 billion 'sequester', the feared 'fiscal cliff' among them. But it’s main drawback is that it’s a blunt tool for a delicate budgetary task.
How bad would it be if the federal government had to suddenly lop $100 billion off its budget next year, with cuts of 8 or 9 percent in just about every discretionary program?
The question isn't just hypothetical.
This is what is scheduled to occur come January, as a result of the 2011 Budget Control Act – a law designed to nudge Congress toward fiscal responsibility by creating a situation that neither Democrats nor Republicans like.
Sure enough, both sides disparage the idea of "sequestration," as the automatic spending cuts are called. But they haven't yet found a compromise to avoid the event. So either a full-court press by policymakers after Election Day will yield an alternative fiscal plan, or the cuts may happen.
"If you'd asked me three or four months ago, I'd say no chance" that the cuts would take effect, says Rudolph Penner, a former director of the Congressional Budget Office now with the Urban Institute. "I don't say that any more."
The threat has grown more real, even as both sides have sounded dire warnings.
The Obama administration has predicted a "reduction in readiness" for the military, and on the budget's nondefense side, it says "sequestration would undermine investments vital to economic growth, threaten the safety and security of the American people, and cause severe harm to programs that benefit the middle-class, seniors, and children."
Conservatives, for their part, have been sounding equally vivid alarms, focused squarely on the defense side of the budget.
"These cuts would leave the U.S. with its smallest Army since World War II, its smallest Navy since World War I, and its smallest Air Force ever – and this at a time when the world is not growing safer but more dangerous every day," policy analysts Emily Goff and Steven Bucci wrote this month in a Heritage Foundation report.
A more nuanced reality
Yes, the threatened cuts are serious, but the reality may be more nuanced than the partisan sound bites suggest.
Before diving into details, it's important to keep some context in mind.
The potential spending cuts are important for two reasons. The first is simple pragmatism: Decision time is coming quickly, and this is an issue that could affect everything from stock market prices to whether government contractors eliminate thousands of jobs.
The second has to do with politics: The debate over the automatic cuts parallels the presidential election duel over fiscal visions between President Obama and Mitt Romney.
Mr. Romney isn't stumping for the sequester, but his approach to federal spending has important parallels to it. Mr. Obama's approach does not.
Romney calls for an immediate 5 percent cut in discretionary nondefense spending – a budget move that could be called sequester lite. And within four years, he wants to bring federal spending down to 20 percent of the nation's gross domestic product – and then to keep it capped at that level.
Obama, by contrast, would leave federal spending above 22 percent of GDP, and doesn't call for any cap.
With the Senate likely to remain a battleground that is firmly in the control of neither party, the presidential election appears unlikely to give either party a firm mandate on fiscal policy. But the election could serve as a referendum about which candidate's vision voters prefer to give greater influence to, when the bargaining gets going in earnest.
Cuts would be 'across the board'
Back to the cuts: The 2011 law calls for cuts equaling about $100 billion a year, centered mostly in the discretionary portion of the federal budget. This means that some of the programs most important to Americans from day to day – Social Security, Medicaid, food stamps, and more – would not be affected. Medicare, another broad-reaching program, could see spending cuts of 2 percent under the law.
Beyond that, the cuts would essentially be "across the board," which would translate into a roughly 8 percent cut in each nondefense discretionary program next year, including air-traffic control and food-safety inspections. Military programs would face 9 percent cuts.
So there would be $100 billion in cuts each year, but compared with what benchmark of future spending? That money would be subtracted from a "baseline" that assumes federal spending grows at the rate of inflation each year.
These cuts, by themselves, aren't the kind of thing that would normally throw the economy into recession. The economy is growing at a current pace of about 2 percent a year, and $100 billion represents 0.6 percent of a year's GDP.
Still, the problem at this particular time is that the sequester is just part of a larger "fiscal cliff," which includes scheduled tax hikes next year as well. Taken together, the impact would be enough to cause a new recession unless Congress acts to reduce the cliff, forecasters say.
That's why economists generally expect Congress to take action – whether it comes late this year or as a retroactive maneuver, reducing the spending cuts and tax hikes early in the new year, after they have already started to take effect. The longer policymakers wait, however, the more the cliff's feared or real impacts could pinch economic growth.
An impact on lives
Beyond the impact on the wider economy, the spending cuts have other significant implications. One is on Americans' daily lives.
Mr. Penner, the former CBO chief, says he doesn't think the effects on domestic life would be severe. "There might be some inconvenience," he says, such as waiting longer for a passport. "It's not like closing the government, as we have done sometimes." (But stay tuned. "Government shutdown" is a whole separate problem that could recur some time next year, if political gridlock prevails.)
Penner isn't saying 8 percent cuts would be easy for the government to manage. The law doesn't give an agency like the Federal Aviation Administration flexibility to, say, shift funds from technology investments to give more money to cover the day-to-day air-traffic controllers. That lack of flexibility, though, is something Congress could potentially change by modifying the law.
Scott Lilly at the liberal Center for American Progress has done his own analysis of the problem, noting that the cuts of about 8 percent would go into effect after the fiscal year is already three months old. That means agencies might really find themselves scrambling to reduce outlays by about 12 percent in the remaining nine months of the fiscal year. One strategy many agencies could take, he suggested in a June report, might be to furlough workers for as much as 4.7 weeks each, spread over those months.
Many experts say some of the harshest impacts would come on the defense side of the discretionary ledger. That's because the law provides that military pay won't be reduced, so the savings need to come out of procurement, training activities, and the like. And, as on the domestic side, the law appears to leave little flexibility.
"If the Navy were budgeted to issue contracts on 10 ships in fiscal year 2013, then it would not be permitted to cancel one of the ships but would have to apply the cuts equally across each of the 10 ships," Lilly predicted in his report.
In the presidential race, Romney is the champion of spending cuts, but he makes a big exception when it comes to defense. He calls for expanding military spending, rather than cutting it alongside his reductions in discretionary spending.
Critics of Romney say the Republican's spending-cut zeal is too extreme, and would erode important nondefense programs. Critics of Obama, by contrast, worry that he won't do enough to tame spending, which, if unchecked, might grow to become a hindrance to economic growth.
Entitlements and tax revenues untouched
Almost all budget experts agree that sequestration is a very bad way to tackle federal deficits. Far better is for politicians to do the difficult work of devising a long-term strategy for deficit reduction. That would mean making judgment calls among programs, rather than impose equal cuts for all.
Many finance experts say the larger lesson that emerges from the sequester law is this: America's giant fiscal problem appears impossible to solve if two big tools – entitlement reform and tax-revenue changes – are left on the sidelines. So far, Republicans in Congress have insisted that fiscal progress be sought only through spending cuts, while Democrats have shied away from entitlement changes that might result in leaner benefits.
The Budget Control Act was a stopgap measure that emerged from that lack of consensus. But the act can't come near to closing America's fiscal gap.
Cutting $100 billion a year is a relatively significant percentage of discretionary spending, in part because the discretionary portion of the budget keeps shrinking (as the entitlement portion grows). Yet $100 billion is a relatively small part of a federal spending that totals some $3.8 trillion for 2013.
"The things that are really causing us budget problems are protected" by the sequester law, Penner says.