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Financial Planning > Tax Planning > Tax Reform

Sequestration Cuts Imminent; Government Shutdown Looms

By Melanie Waddell

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As the nation braced for the $85 billion in sequestration cuts to kick in on March 1, Joe Lieber of Washington Analysis laid out the “numerous tools available” to blunt sequestration’s impact. He said that, based on the Congressional Budget Office’s (CBO) estimates release in early February, sequestration’s impact “may be less than many fear.”

While the sequestration cuts will “clearly still be economically material in terms of the drag on GDP,” Lieber said, he doubts the policy will remain in effect through the end of the fiscal year if, as he suspects, “the unprecedented move leads to chaos within the federal government and a continued outcry from both Democrats and Republicans, who worry about indiscriminate cuts to non-defense and defense accounts.”

Furthermore, President Obama’s comments urging Congress in early February to replace the sequester with a mix of “unspecified spending cuts and tax increases did little to change our opinion that the policy will go into effect.”

Lieber said that regarding defense cuts, Pentagon planning guidance “stresses that near-term cuts would be absorbed primarily by civilian personnel furloughs, hiring freezes, and various administrative support and maintenance activities.”

Reductions to key weapons hardware programs, he said, “would be ‘back-loaded,’ thereby lessening the immediate threat that contractors might otherwise face.” Moreover, “in order to further mitigate sequestration’s impact on acquisition priorities, this guidance directs the services to ‘identify and prioritize any essential reprogramming actions’ that might be required to permit budget officers greater flexibility in shifting funds between accounts to protect certain programs.”

Lieber also noted that the continuing resolution (CR) that funds the federal government through March 27 provides another potential vehicle to mitigate the sequester, though he doesn’t believe Republicans would force a government shutdown. “Congress could give the various agencies authority to reprogram, or transfer, funds from one budget function to another,” Lieber said.

For example, Lieber said that Sen. Jim Inhofe, R-Okla., has proposed such an option for the Defense Department. “Lawmakers could also provide some additional funding in the CR for defense or non-defense discretionary spending, or they could decide to do away with the sequester altogether, with offsets or without (though the latter is very unlikely). How destructive the sequestration is will in part determine what Congress does.”

Obama urged Congress in early February to delay the looming sequestration cuts by passing a package of both spending cuts and tax hikes, but Obama’s plan was said to be DOA in the House.

While both the House and the Senate are “working toward budget proposals that I hope reflect this balanced approach,” Obama said, “I know that a full budget may not be finished before March 1, and, unfortunately, that’s the date when a series of harmful automatic cuts to job-creating investments and defense spending—also known as the sequester—are scheduled to take effect.”

Obama told lawmakers that if they can’t act “immediately on a bigger package” by the time the $1.2 trillion in sequester cuts are scheduled to go into effect, they should at least “pass a smaller package of spending cuts and tax reforms that would delay the economically damaging effects of the sequester for a few more months.”

A “balanced mix” of spending cuts and tax reform, Obama continued, “is the best way to finish the job of deficit reduction. The overwhelming majority of the American people—Democrats and Republicans, as well as Independents—have the same view.”

But House Speaker John Boehner, R-Ohio, countered the same day in February that Obama “first proposed the sequester and insisted it become law. Republicans have twice voted to replace these arbitrary cuts with common-sense cuts and reforms that protect our national defense.” Republicans, he continued, “believe there is a better way to reduce the deficit, but Americans do not support sacrificing real spending cuts for more tax hikes. The president’s sequester should be replaced with spending cuts and reforms that will start us on the path to balancing the budget in 10 years.”

Lieber predicted there was a more than 60% chance that sequestration will go into effect on March 1. But how long it continues, he said, is unclear. “The odds of it lasting through the entire fiscal year are no worse than one in three. One of the many factors that will determine the policy’s duration is how much political and economic upheaval it creates.” Lieber said that “credible estimates” put job losses from a seven-month sequester at up to 1 million, with GDP drag up to 0.7%. “A sequester of this magnitude has never occurred, so the execution and impact of it is unknown,” he said.

Republicans, Lieber said, “have clearly decided that sequestration provides them with their best leverage to try to extract a large 10-year deficit reduction bill.” Consequently, “the GOP leadership and many, many of their rank-and-file are more than willing to allow the $85 billion in cuts to go into effect if they are not fully offset with alternative, targeted reductions.” Politically, Lieber continued, “we do not believe that the House GOP leadership can afford to allow a mix of revenue and spending offsets before March 1, which the Democrats will insist upon.”

Despite the looming sequestration deadline, Obama noted that economists and business leaders have stated the economy is “poised for progress in 2013.”

However, Obama also said that the nation has “seen the effects that political dysfunction can have on our economic progress,” citing how the “drawn-out process for resolving the fiscal cliff hurt consumer confidence.”

Political dysfunction, he said, “will cost us jobs and hurt our economy.”

Indeed, the Congressional Budget Office released in early February its budget and economic outlook for the next 10 years, which stated that if the current laws that govern federal taxes and spending do not change, the budget deficit will shrink this year to $845 billion, or 5.3% of gross domestic product (GDP), its smallest size since 2008. Deficits will continue to shrink over the next few years, CBO said, falling to 2.4% of GDP by 2015.

However, CBO said that deficits are projected to increase later in the coming decade “because of the pressures of an aging population, rising health care costs, an expansion of federal subsidies for health insurance and growing interest payments on federal debt.” As a result, “federal debt held by the public is projected to remain historically high relative to the size of the economy for the next decade.”

By 2023, “if current laws remain in place, debt will equal 77% of GDP and be on an upward path,” CBO projected.

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