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It’s Not Just Defense Cuts: Sequester Would Cripple Our Economy

Posted by Mackenzie Eaglen on

If the election results are pretty clear next week, expect to hear two things: the sounds of snoring from an exhausted Washington political class and the first tentative mentions of the shape of a solution to the dire fiscal cliff our country may fall off of in January. Given the enormity of the repercussions facing the country, I asked Mackenzie Eaglen at the American Enterprise Institute to spell out the larger national security implications at stake. Tea Party devotees should read this dedicated Republican’s analysis closely. The Editor.

The session of Congress after next week’s elections has been dubbed “the mother of all lame ducks.” Given how lame Congress has been so far this year, what will be different after the election?

Congress must tackle a complex array of major issues — what Beltway wallahs are calling the “fiscal cliff” — all at the same time. The cliff is the net effect of sequestration spending cuts when combined with massive tax increases scheduled to go into effect at the start of 2013. Together, they would reduce the federal budget deficit by close to $500 billion in 2013 alone and threaten to push the economy into a recession. Can Congress cope with such fundamental issues in a speedy and effective manner?

One senior Pentagon official, in discussing sequestration, recently said that “in the absence of certainty, people will tend to gravitate to the most negative behaviors.” This seems to reflect market behavior across the economy right now.

While President Obama said during the third debate that sequestration would not happen, there’s not much evidence to back up his claim. And some effects are already being felt, even though the Budget Control Act goes into effect on Jan. 2.

The aerospace, shipbuilding and defense industries have largely stopped hiring new employees as sequestration’s shadow looms larger. Industry investment in infrastructure is frozen. Research and development is slowing. Mergers and acquisitions are being sidelined as investors wait for a signal.

The overhang of uncertainty is growing and overtaking concerns of a possible worsening Eurozone crisis across many sectors of America’s economy, not just aerospace and defense. A recent Bank of America Merrill Lynch survey found that nearly one in five U.S. fund managers see the “fiscal cliff” as a greater concern than the Eurozone crisis. Morgan Stanley issued a report last month that stated, “While our analysts are somewhat less worried about the impact of European bank strains, the negative impact of fiscal cliff uncertainty is becoming more widespread.”

Small businesses are greatly concerned by the situation. A recent survey by the National Federation of Independent Businesses found that uncertainty over economic conditions and government action (or inaction) was the second and fourth most pressing concerns for small business owners across the country, respectively. Over one-third of respondents reported that the looming economic and political uncertainty was a “critical” problem for their business. This figure will only rise in the coming months as markets react more to budget contraction and businesses start to see their profits fall in advance of January.

The nation’s leading financial officials agree. Chairman of the Federal Reserve Ben Bernanke has argued that the economic recovering is being “held back” by the ongoing fiscal uncertainty, and that the country faces a “shallow recession” that could cost over one million jobs in 2013 if “unsustainable” fiscal policies are not reversed. Treasury Secretary Timothy Geithner agreed, stating that the fiscal cliff would lead “at least” to a recession next year.

Wider Impact of the Fiscal Cliff

Yet sequestration is only part of the problem. The fiscal cliff as a whole is clearly about a larger and more fundamental debate in Washington. It is no coincidence all of these events are set to happen at once after the presidential elections. In its most recent report, CBO lays out three alternatives for Congress to deal with the fiscal cliff. Each carries risks and advantages, but one path forward seems most reasonable: resolve the fiscal cliff now while coming to a broader agreement about long-term debt reduction.

The first option, according to CBO, is to — gulp — go over the fiscal cliff. Some have called this option a deliberate cliff dive. For some, the idea behind the jump is that while the country would suffer short-term economic pain, it would achieve some medium-term deficit reduction. It would reduce federal debt held by the public from 73 percent in 2012 to 58 percent in 2022. Sen. Patty Murray of Washington has indicated some willingness to go this route: “[I]f we can’t get a good deal…that calls on the wealthy to pay their fair share…then I will absolutely continue this debate into 2013.”

A quick look at the numbers, however, reveals that a cliff dive would be damaging and irresponsible. The effects of sequestration on the military and our national security are well documented by this point. The other domestic and economic effects of sequestration have gotten less attention.

A recent study by Regional Economic Models, Inc., demonstrates some of the harmful effects of non-defense sequestration on our economy. If sequestration goes into effect then professional and technical services would lose $600 billion in sales, the manufacturing sector would lose $400 billion, and finance and insurance services would lose close to $400 billion over the next 10 years. In 2013 alone, every American worker would lose up to $750 in income and a family of four would see its income reduced as much as $1,800. This would translate to roughly three million jobs lost during that period, on top of a reduction in GDP of some $300 billion a year. The unemployment rate could go up by about 2 percentage points.

According to testimony by Acting OMB Director Jeffrey Zients, sequestration would starve many domestic programs of needed funds. They would leave 16,000 teachers out of jobs, 700,000 women and children out of nutrition assistance, and 100,000 children out of the Head Start program. The National Education Association estimates much steeper job loss for teachers and educators, predicted 80,000 education jobs would be lost due to sequestration. Additionally, the National Institute of Health would be forced halt or curtail vital research, and the FAA would have to curtail operations at America’s airports. One report by the Aerospace Industries Associationand Econsult Corp. predicted the potential closure of 246 airport control towers, 1,500 fewer air traffic controllers and the loss of 9,000 security screeners and 1,600 customs officers.

The Department of Health and Human Services has painted a similarly stark picture of how automatic spending cuts would impact daily operations. Under sequestration, the National Institute of Health might be forced to eliminate 2,300 new and competing research project grants, 80,000 fewer children would receive child care assistance, 12,150 fewer individuals would receive benefits through the AIDS Drug Assistance Program, 169,000 fewer individuals would be admitted to substance abuse treatment program, 14,200 fewer homeless individuals would receive assistance, and the Health Care Fraud and Abuse Control program would be disrupted, which saves $1.50 for every $1.00 spent therein. The National Oceanic and Atmospheric Administration weather satellite program would also see funding reductions, putting at risk life-saving warnings of severe weather.

All of this would cause real economic output in 2013 to contract by half a percent of GDP, and negative growth of 2.9 percent over the first half of 2013 would be officially termed a recession. This is not a realistic path forward, and moreover, it would not address the root problem of runaway spending. Because sequestration does little to curtail growing entitlement spending, letting it take effect keeps intact the major drivers or America’s debt.

The second option available to Congress is to simply cancel sequestration without a long-term framework for debt reduction. However, this ignores our growing debt challenge and increases the likelihood of another sovereign debt downgrade, which could bring additional economic and market complications. Under CBO’s alternative fiscal scenario — which reverses most of the fiscal cliff policies — real GDP growth would be roughly 1.7 percent in 2013, and the unemployment rate would be a full percentage point lower than under the fiscal cliff scenario.

However, this short-term growth would come with a cost. Debt held by the public would rise to 90 percent of GDP by 2022. This kick-the-can “solution” could wind up being as detrimental as careening off the fiscal cliff.

The only realistic option outlined by CBO is to moderate spending cuts in the short-term while crafting a long-term vision for comprehensive debt relief. As Chairman Bernanke has said:

The most effective way that the Congress could help to support the economy right now would be to work to address the nation’s fiscal challenges in a way that takes into account both the need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than later would help reduce uncertainty and boost household and business confidence.

What Will Congress Do?

Of course, just because there is one seemingly obvious answer to the problem does not mean that Congress will arrive at the right conclusion. A number of shorter term solutions are gaining steam on Capitol Hill as the prospects for a long-term deal look increasingly bleak.

Speaker of the House John Boehner gave perhaps the strongest indication yet that a lame duck Grand Bargain is highly unlikely. A grand bargain would be “difficult to do,” and more importantly, Boehner said he’s “not sure it’s the right thing to do” with so many retiring members potentially playing pivotal roles in any long-term deal.

Chris Van Hollen, ranking member of the House Budget Committee, has endorsed a three- to six-month delay that would give the new Congress and whoever is president the ability to start afresh in crafting a comprehensive package. Even Secretary of Defense Leon Panetta, originally skeptical of an outright punt past January, has thrown his hands up in the air, saying, “I’ll take whatever the hell deal they can make right now.”

Support for a compromise appears slightly stronger in the Senate. Sen. Lindsey Graham has alluded to a “mini Simpson-Bowles deal,” that would include a small package of spending cuts and revenues as part of a push to buy down a small segment of sequestration for now in the hopes of coming to a longer-term agreement in the future.

Given signaling from many prominent Republicans that they would be willing to accept increased revenues in exchange for reduced defense cuts, Senator Graham’s options may have some legitimate traction in the Senate. The real question is whether the House could get on board.

Despite this momentum, a mini-deal is still only a mini-deal. And Congress may yet elect to punt entirely. If both chambers do not tackle the larger problems relating to the fiscal cliff before January, it is unclear how small cuts or a few more months will change much in the big picture. Putting off a larger deficit reduction package only leaves a future Congress to deal with the same set of issues-and the looming economic consequences.

Sequestration Should Not Wait For December’s Lame Ducks

Reasonable people can differ as to the best path towards a long-term solution, but it is clear the status quo is unacceptable. While the fiscal cliff is about a larger ideological battle between the two parties, the front lines of our economy are hurting all the same. Politicians threatening to take our nation over the “fiscal cliff” in order to score political points need to understand that main street businesses will be hurt first. This poses a real threat to our national security and economy.

As policymakers focus on strengthening the economy, they would do well to consider how sequestration’s defense and other budget cuts — often portrayed as necessary sacrifices to get federal spending in line — can hurt the very economy they are supposedly designed to bolster. Simultaneously weakening the military and the economy is not the answer.

Mackenzie Eaglen, a member of the Breaking Defense Board of Contributors, is a defense analyst at the conservative American Enterprise Institute.

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