Staying the Course with Sequestration

This is no time to backtrack on the path to fiscal sustainability

Against all odds, the federal government was forced to enact $1.2 trillion in spending cuts over nine fiscal years as part of the Budget Control Act of 2011. As debt-ceiling negotiations loom this fall, it is essential that hard-won spending restraints not be abandoned.

Despite the heated rhetoric emerging from Washington at the time, the initial cuts from sequestration proved to be modest. At most, the sequester reduced spending by a mere $44 billion in the current fiscal year out of the $3.5 trillion in total government outlays, according to the nonpartisan Congressional Budget Office. The majority of the dire predictions made at the time have since been proven wrong. The gains in the nation’s fiscal situation from these modest spending cuts should not be squandered. Reversing sequestration would, in the words of CBO director Douglas Elmendorf, “lead to greater federal debt reduce the nation’s income and increase the risk of a fiscal crisis” in the future.

Sequestration was a blunt instrument requiring cuts across all discretionary spending programs. This so-called “meat cleaver” approach was inevitable precisely because it was a last resort. Facing the need to rein in a deficit of more than $1 trillion, lawmakers still failed to reach an agreement on spending cuts to replace sequestration. A broad-based spending-cut solution was the one least likely to be derailed by special interests. The Budget Control Act, which gave us sequestration, did exactly that.

It should come as no surprise that agencies were, by and large, able to accommodate the modest cuts implemented this fiscal year with minor reductions in services and short furloughs. Many federal agencies did not even need to furlough employees, and the hardest hit, such as the Department of Defense, furloughed far fewer employees than originally estimated for only six days, down from the early warning of 22 days. The next stage is going to be harder, but the importance of retaining these gains in fiscal responsibility is correspondingly greater. The newest figures from the Office of Management and Budget show even higher projected spending over the next decade — up $154 billion, even from April’s estimates — after a slight improvement in the fiscal outlook for this year.

The decrease in this year’s deficit resulted not so much from the modest spending cuts from sequestration, but from increases in taxes — including the return to old levels in payroll taxes and higher income taxes. According to a 2010 study co-authored by former Obama adviser Christina Romer and husband David Romer, the economy feels the negative impact of tax increases with a one-year lag, and then gross domestic product falls by $1.10 for every dollar increase in taxes. Reversing sequestration and returning spending to the higher trajectory would mean even higher debt, and, consequently, higher taxes in the future. As was the case with the stimulus, it is uncertain whether increasing spending would produce much of a benefit, but there would be a guaranteed cost of lower growth in the future and far fewer policy options in the event of another crisis.

In a study co-authored with Harvard economist Robert Barro, my Mercatus Center colleague Veronique de Rugy found that, for a given level of taxes, defense-spending cuts reduce the need for future public borrowing. They estimated that, over five years, each dollar of defense-spending reduction would generate $1.30 of extra private spending as GDP grows. A similar “multiplier” effect would appear with spending cuts in other government programs; it is not unique to defense.

Despite sequestration, federal spending totals are still set to grow, from $3.5 trillion in 2013 and 22 percent of GDP to $5.7 trillion and 22.2 percent of GDP in 2023, according to the Office of Management and Budget’s latest figures. This growth is largely driven by mandatory spending programs, such as Social Security, Medicaid and Medicare, and interest payments, which currently consume more than 66 percent of the federal budget. By 2023, 76 cents of every dollar of federal spending will be consumed by mandatory spending and interest payments, even if the spending cuts from sequestration are maintained.

Sequestration is, therefore, no more than a very small first step in addressing our fiscal problems because it is limited to cuts in discretionary spending. The federal fiscal situation cannot improve as long as mandatory spending is excluded from reform.

Modest sequestration achieved at least two things: It put a brake on the spending-growth rate, and it demonstrated that spending cuts were possible. The next round of cuts might be a little harder, but if they are broad-based, they could set the nation on the path to fiscal sustainability.