Now It's Time for Sequester Anxiety

UPDATE: The Sequester: What You Need to Know

Senate passage of H.R. 325, the “No Budget, No Pay Act of 2013,” seems likely to occur sometime in the next two weeks. Some senators will have amendments to the bill, but the consensus is that those amendments will fail on the Senate floor.

If all goes smoothly, then the battle over increasing the debt ceiling recedes until summer. That leaves Congress facing a March 1 automatic sequester that would cut both defense and non-defense domestic accounts far below current appropriated levels. So the “fiscal cliff” now gives way to “sequester anxiety.” These across-the-board cuts in Fiscal Year (FY) 2013 spending loom as the next fiscal hurdle for policymakers.

We believe that at least a partial sequester, and very possibly the full sequester, is likely to go into effect.

Our calculations indicate slight changes in the percentage cuts for both defense and non-defense* (as a result of recent developments) as follows:

• Defense discretionary: across-the-board cuts to funds remaining on March 1 by program, project and activity of roughly 16 percent ($55 billion over the next seven months)**
• Non-defense discretionary: across-the-board cuts to funds remaining on March 1 by program, project and activity of roughly 9 percent ($27 billion over the next seven months)**

Defense accounts endure a larger cut because when Congress passed the Continuing Resolution (CR) for Appropriations for FY 2013, defense spending exceeded the original cap imposed by the 2011 Budget Control Act. In short, defense will take both a “big” sequester – as a result of the super committee’s failure – and a “little” sequester, while domestic spending was not increased above cap levels in the CR and thus will only be impacted by the former sequester, resulting in a smaller cut. (Furthermore, the recently-passed $50.5 billion of Sandy relief aid will be subject to sequestration on the non-defense side, thereby reducing the overall percentage cut. An upcoming technical blog post will have more detail on the revised sequester percentages.)

A variety of media accounts have outlined the impact that the pending sequester has already had on defense contracts, as well as the announcement that the Department of Defense has begun a systematic review of the nature of civilian personnel furloughs that might be required. Because the sequester will now occur over a seven-month period, and not the conventional 12-month fiscal year, agencies are already experiencing serious disruption as officials try to determine how they will implement the sequester cuts.

In addition, both the Bipartisan Policy Center’s (BPC) and the Congressional Budget Office’s (CBO) analyses of the economic impact of sequestration have begun to materialize and seem to be generally accurate. A slowdown of business activity due merely to the possibility of a sequester has already led to reductions in workforce among defense contractors and sub-contractors, and in some cases significant profit declines. CBO estimated a decline of 0.7 percent in 2013 gross domestic product (GDP) growth because of the ripple effect of the sequester cuts on smaller businesses and on government personnel. For an economy that already suffers from chronic unemployment and very slow expansion, the sequester could push the nation into sub-2 percent GDP growth for 2013 and perhaps 2014. This morning’s GDP negative growth for the fourth quarter exemplifies the kind of downward pressure a sequester would create.

Our estimate of approximately one million lost jobs due to sequester remains our base case if a full sequester occurs as scheduled on March 1.

Then, Congress must begin to look at the CR for FY 2013, which expires March 27.

Lurking still in the background is the likely battle once again over the debt ceiling, the suspension of which would expire on May 18. As noted above, if H.R. 325 is passed in short order, our estimates are that Treasury will be able to get to August and perhaps beyond before the X Date, when all of its Extraordinary Measures and cash on hand are exhausted.

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* There are also sequester cuts to mandatory spending programs, including a cut of 2 percent to Medicare provider and plan payments, and a larger percentage cut to other non-exempt programs. BPC’s forthcoming post will spell these cuts out in more detail.

** Assumes that funds are obligated proportionally throughout the fiscal year.