Three Reasons Why $1.2 Trillion Isn’t Really $1.2 Trillion

By Loren Adler

Monday, January 23, 2012

UPDATED August 10, 2012

Kevin McGrath contributed to this post.

The Joint Select Committee on Deficit Reduction (JSC) was tasked with reaching consensus on at least $1.2 trillion in savings over the next decade. If achieved and voted into law, this would have – all else equal – made the total U.S. debt burden at the end of 2021 at least $1.2 trillion less than it otherwise would have been.

While the sequester set up by the Budget Control Act of 2011 (BCA) originally was intended to act as a Sword of Damocles, the JSC’s failure means that the automatic cuts are now slated to go into effect as a “replacement” for the deficit reduction that the committee failed to achieve.

So it may come as a surprise that this “replacement” is only projected to cut $1.01 trillion from the debt over the next ten years – $190 billion less than the super committee’s minimum mandate. There are three reasons why the “$1.2 trillion” sequester falls short of achieving the super committee’s deficit reduction goal:

  1. Most importantly, there is a timing difference between discretionary appropriations (the budgetary resources that are made available) and outlays (actual spending, which lags behind appropriations), which lowers the sequester’s deficit reduction between 2013 and 2021 by roughly $80 billion.
  2. To understand why, consider a $100 million aircraft carrier on which construction is scheduled to begin in 2019. Congress appropriates the full $100 million in 2019, but the carrier actually will be constructed over, say, five years – $40 million will be spent in 2019, and then $15 million will be spent in each of the next four years. While the entire $100 million of budget authority was given inside the ten-year window, the final two years of outlays ($15 million in 2022 and 2023) occur afterward. Therefore, $30 million of the outlay savings from cancelling the procurement would happen outside of the ten-year window. Since deficits are calculated by subtracting revenues from outlays, the scored deficit reduction from cancelling the carrier only would be $70 million dollars.

    Thus, that $80 billion of deficit reduction will occur, just not within the 2013-2021 window.

  3. The BCA dictates that 18 percent of the $1.2 trillion (or $216 billion, to be exact) is assumed to come from debt service – or interest – savings, thereby reducing the cuts required from government programs. Whenever spending is cut or revenue is raised, because total debt is made lower than it otherwise would have been, the government spends less on interest payments, as well. Under CBO’s current interest rate projections, however, the program cuts from the sequester only will generate $142 billion in interest savings – $74 billion less than assumed by the law.
  4. Some of the spending cuts to non-exempt mandatory programs will indirectly produce additional outlays. For example, because the sequester cuts Medicare provider payments, and thereby the overall cost of the program, it will reduce the premiums that beneficiaries pay into the system because those premiums are calculated as a percentage of the total cost of Medicare. Since premiums are scored in the budget as offsetting outlays, less money collected in premiums will result in higher net outlays. In total, $31 billion of additional outlays are produced, reducing the net deficit reduction from the sequester by that amount.

While the BCA is unclear in many areas, one point on which it is very clear is that the Office of Management and Budget (OMB) is charged with the authority to carry out the sequester. The best that outside analysts can do at this point is to posit an educated guess as to OMB‘s interpretation.

So, the next time someone in Washington asks you why $1.2 trillion is really only approximately $1.01 trillion, hand them this, and they will either understand and thank you, or wish that they never asked the question in the first place.

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2012-01-23 00:00:00
Issues of timing, interest payments and additional outlays would complicate the sequester’s impact