Robert Kahn

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Robert Kahn analyzes economic policies for an integrated world.

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The Sequester and the Closing Window for a Fiscal Bargain

by Robert Kahn
January 31, 2013

The Committee for a Responsible Federal Budget valiantly continues to make the case for “going big” in the fiscal negotiations. I fear their argument is falling on deaf ears:  the window for a fiscal bargain–grand, bland or otherwise–that deals with our long-term fiscal challenge is closing.  The upcoming sequester battle provides one last opportunity to make such a deal.  Yet both Republicans and Democrats say that they are prepared to allow the sequester to take effect on March 1, at least for a while, and they seem to mean it.  A deal that addresses longer term debt sustainability and at least partly restores the sequester cuts remains possible, though unlikely, as part of the continuing resolution (CR) to fund the government from March 28.  That’s the real deadline.

Why is the window closing?

  • A diminished sense of urgency.  Budget deals since the fall of 2010 have reduced the deficit by $2.35 billion, and by various estimates another $1.25 to $1.5 billion stabilizes the debt at around 80 percent of GDP through the middle of the decade.  Allowing the sequester to go into effect gets you most of the way there.
  • Fundamental differences.  The January 1 fiscal cliff package widened the divide between the sides on what they want from the upcoming negotiations in terms of revenues and entitlement cuts.  Earlier failed efforts to reach a grand bargain also have left scar tissue of bad feelings and distrust that may make a deal harder to achieve.
  • The low hanging fruit is gone.  Now the cuts on the table–e.g. Medicare–and proposals for new revenue face much more entrenched opposition.  For many, the sequester is the less painful option.
  • Market discipline isn’t working.  Both in the summer of 2011 and again last fall, fears of a market meltdown were not realized.  While I’d argue that there were meaningful costs to these episodes in terms of confidence, spending and investment, fear of the market response looks unlikely to play an important role in the upcoming cliff debates.

The Sequester

In this context, it’s hard to see agreement prior to March 1 on any package of alternative measures that would turn off the sequester for this year.  The sequester that resulted from the failure of the “supercommittee” cuts budget authority by $85 billion in fiscal year 2013, constituting half of a percentage point of GDP.  In addition, a “mini-sequester” of around $7 billion resulting from spending above limits set in August 2011 also will take effect on March 27.  However, on a cash basis, the effect on government spending will be felt only slowly.  One reason is that a significant portion of spending–and in particular military spending–pays out over several years after budget authority is received.  Notice periods for furloughs of government employees, and uncertainty about the magnitude of the cuts needed, also mean that the direct reduction in government spending will be small in March before beginning to ramp up.

With logic that only makes sense in DC, it may be easier to reverse the $85 billion in cuts for fiscal year 2013 (and replace them with other measures) after March 1, in the context of the CR that will fund the government from March 27.  This is a hard deadline, as failure to achieve a deal results in a government shutdown that is unlikely to be politically sustainble for more than a few days.  Restoring the cuts through raising the caps in the CR would seem a hard sell to House Republicans, unless replaced by credible cuts elsewhere.  If entitlements and revenue are off the table, it’s difficult to see where cuts to offset the sequester would come from.  Alternatively, replacing at least a portion of the sequester cuts with savings in the out years through revenue and entitlement reforms not only addresses our longer-term challenge, it would defuse the subsequent debt limit and fiscal year 2014 budget cliffs.  Seems worth a try.

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