Beginning in January, approximately $109 billion in across-the-board spending cuts are scheduled to automatically take effect. Known in budget policy circles as a “sequester,” these cuts are unusual in that the executive branch directs how the spending cuts occur, as opposed to the traditional locus for such cuts -- the congressional Appropriations Committees.
Because this sequester could have such a dramatic impact on many federal programs and the economy in general, Congress is eagerly awaiting specifics about how the administration plans to implement the cuts. On Tuesday President Obama signed the Sequestration Transparency Act, which requires him and the Office of Management and Budget to put forth a report in 30 days on how a sequester would be implemented. An overwhelming House majority passed the legislation last month, and the Senate approved it unanimously.
Sequesters have been part of the budget process for decades. Were this sequester to go into effect, however, it would be among the few that have ever actually taken place in this country’s history, and would certainly have the greatest budgetary effect.
The sequester was initially intended as a “Sword of Damocles” over the “super committee” created by the August 2011 deal to raise the debt limit. It was not actually designed to take effect; it was designed to be so unpalatable that the Democrats and Republicans on the committee would feel forced to agree on 10-year that would reduce projected deficits by $1.2 trillion.
Since the committee failed to reach an agreement, the required deficit reduction is supposed to take place annually via the sequester cuts. The first year’s sequester is scheduled to start in January, with reductions evenly divided between defense spending and non-defense spending.
Few in either party think such indiscriminate cuts make sense from a policy standpoint. Democrats and the President are also concerned about the impact of immediate spending cuts on a fragile economy, while Republicans prefer to replace defense cuts with deeper cuts to domestic programs.
Companies that do business with the government worry that they might not have enough time to prepare for whatever income loss they might face from the sequester -- especially since the new fiscal year will have already begun by the time the cuts take effect.
Another concern about the sequester comes from the impact of the uncertainty during the drawn-out political debate over whether the cuts will take place. The debate is occurring at the same time there are other policy uncertainties due to the scheduled expiration of the 2001 and 2003 tax cuts, the payroll tax holiday and the latest “doc fix” for physician payments under Medicare. The combination of all of these policy changes taking place at the same time has been dubbed a “fiscal cliff” that would harm the economy if no changes are made.
Going over the fiscal cliff in January with no other policies in place to soften the blow would be bad economic policy. On the other hand, policymakers need to be mindful of another fiscal cliff: the long-term accumulation of debt, which carries its own threat to our economic future. So simply extending all current policies with no plan to replace the sequester and scheduled tax increases with a more rational approach would also be irresponsible
Ideally, Congress and the President would avoid both fiscal cliffs by getting together on a bipartisan, long-term package to increase some revenues and cut spending along the lines of the Bowles-Simpson proposal. The sooner such a package passed, the better off the economy would be -- although the chances of passage prior to the election are quite slim. Getting a package done after the election or early in the new year, though, would still reduce uncertainty, reassure financial markets and boost public confidence.
This post was written with assistance from Mark Luciano, intern from the Dream Careers internship program