- The sequester should make a big dent in US debt. The bad news is that political squabbles will undo that.
- The much-decried March 1 sequester achieved an accidental, modest 2.5% reduction in the growth of federal spending.
- Starting in the 2014 fiscal year, the sequester reduces outlays by $120bn per yr, provided the cuts are not rescinded.
- Despite Congress’s work, the economy may slow enough to prevent more agreements, such as on tax and entitlement reform.
- Weaker employment growth coupled with slowing factory activity have contributed to a sharp rise in negative "surprises.”
The good news is that the sequester should make a big dent in US debt. The bad news is that political squabbles will undo that.
The much-decried March 1 sequester achieved an accidental, modest 2.5% reduction in the growth of federal spending over the next decade, although neither party wanted it to take effect at all. Part of an agreement reached by the White House and Congress after the mid-2011 "debt ceiling" fiasco, the cuts were designed to be unattractive enough to force agreement on more rational deficit control. But Congress and the White House failed to agree, and the sequester was triggered.
Just over a month later, the president's new budget already proposed canceling the sequester - a bad idea.
Starting in the 2014 fiscal year, the sequester reduces outlays by $120bn per year, provided the cuts are not rescinded. Under the current plan, there are $3 of annual tax increases of $180bn (enacted in January) for every $2 of annual sequester spending cuts of $120bn. To avoid the full force of the fiscal cliff, some deficit reduction measures will take full effect in 2014 and beyond, amounting to $300bn. This total deficit reduction is about 1.8% of 2014 GDP, which is enough to reduce the deficit from $1,089bn in 2012 to $845bn in 2013, and on down to $615bn in 2014. In terms of the deficit-to-GDP ratio, that's 7% in 2012, down to 5.3% in 2013, and 3.7% in 2014. That is substantial progress.
The years 2015-2017 look even better, with the Congressional Budget Office projecting deficits at an average of just 2.5% of GDP. The debt-to-GDP ratio stabilizes at about 75% on a slight negative trajectory, from 77% in 2014 down to 73.1% in 2018. The CBO projects a modest post-2018 rise in the debt-to-GDP ratio, due largely to a rather unlikely assumed rise in the interest costs on federal debt.
This is good news. Despite much partisan discord and continued bluster about "unsustainable" deficits, Congress and the president actually have managed to put US fiscal policy on a sustainable path, with a stable to falling debt-to-GDP ratio. The bad news is that the economy may slow sharply enough to prevent any more agreements, such as on tax and entitlement reform, that would put America on a path to long-term fiscal health.
Despite entailing substantial progress on deficit reduction, raising taxes and/or cutting spending in 2013 have been neither satisfying nor fun. In the sense that the long-promised bond market collapse has not ensued from inaction, US deficits have been sustainable. Consequently, however, there's no sense of urgency to reform or rescue the economy.
And little has changed after four years of comforting boosts from government spending and tax cuts, which resulted in trillion-dollar deficits approaching 8-9% of GDP — levels never seen in peacetime America. Interest rates remain close to all-time lows. The share of federal revenue going to pay interest on federal debt is close to a record low, at about 1.4%. Why, many in Congress must ask themselves in private, endure the real pain of higher taxes or bigger cuts?
The first six weeks of the post-sequester period have been instructive. None of the president's promised sequestration horrors has emerged, and some of the prophesized tragedies, such as "pink slips" for teachers, have been shown to be absolutely false. White House loyalists still have not given up. After a weak report on March employment, former White House economist Austan Goolsbee opined that the sequester was to blame, amid skeptical chuckles from other analysts.
If sequester-driven cuts cost 100,000 jobs per month before any measures were even been enacted, we are surely in trouble when the real spending cuts come along.
The White House's desire to attribute all bad economic outcomes to the sequester is prelude to another year of fractious, unproductive debate in Washington about how to reduce deficits. As already noted, the president's budget proposal would rescind the spending cuts while adding $563bn more in taxes on the wealthy, even though the $1.8tn of tax increases over 10 years already enacted in January produced 50% more fiscal drag than the sequester's $1.2tn in cuts.
For 2013 alone, the $180bn tax increase enacted in January was four times the $45bn sequester spending cuts. Coupled with a "tax" of about $90bn from higher oil prices, the total of 2013 fiscal/oil tax drag, prior to cuts, is about $270bn. The $45bn in cuts raises that total to $315bn, or nearly 2% of GDP. That drag is contrasted with average fiscal thrust of nearly 3% of GDP over the 2009-2012 period.
The "fiscal swing" of 5% - from an average 2009-2012 fiscal thrust of 3% of GDP, to 2013's 2% of GDP drag - means that a sharp US slowdown is likely in mid-2013, notwithstanding the heartening signs of growth in the housing sector and a strong push from rising stock prices, all while interest rates remain remarkably low. The sequester will be blamed for any slowdown, but the real cause will be a swing from a previously steady stimulus to about $225bn of fiscal drag (and the bad luck of about $90bn in higher energy costs).
The signs of a mid-year 2013 slowdown have already begun to appear. Weaker employment growth coupled with slowing factory activity have contributed to a sharp rise in negative "surprises" - much like the ones appearing during the mid-2010-2012 period that spawned a mid-year "swoon".
The "swoon" is bad for deficit reduction for three reasons. First, it reduces GDP growth - the tax base. Second, it raises the burden of already overburdened monetary policy of sustaining growth during contractions. And third, the slowdown will produce nasty recriminations about the deficit reduction achieved in 2013, which will, in turn, further enflame the parties and passions that prevent deficit reductions.
Republicans will decry the tax increases as crippling, and vow to allow no more. Democrats will decry the spending cuts and vow to allow no more without tax increases. The president has proposed rescinding the sequester. The reality, being demonstrated by the already weak US economy, is that the further tax increases and spending cuts being proposed by the president would worsen the situation.
We shall reach September, the eve of the next fiscal year, having made no progress on deficit reduction largely because no one feels a powerful need to do so. A debt ceiling crisis, merely postponed by "continuing resolution", will loom yet again, and cries of "disaster" will return. Eventually, fiscal year 2014 will begin without a budget, and only with a series of contentious, delaying resolutions.
Is this state of affairs sustainable? You bet. Just as sustainable as the ongoing deficits that we continue to decry while incongruously complaining about a deficit-reducing sequester.