Budget Sequestration Likely To Start Dragging Down Economy Before November Election

Under the terms of the Budget Control Act passed into law last year, federal programs are due for automatic, across-the-board spending cuts beginning on January 2. The law calls for $1.2 trillion in new savings over the nine years between 2013 and 2021, with cuts split equally between defense and domestic programs. Without going into all the intricacies of the law, what this means in practical terms for the Department of Defense is that on January 2 each of its programs, projects and activities will be cut by whatever rate is necessary to generate $55 billion in savings for fiscal 2013. Budget analysts say the rate of reduction will be 10 percent if all defense accounts are cut, or 13 percent if military personnel are exempted — an option the president has pursuant to the law.

Few people in Washington understand the budget law. One of the things they don’t get is that the federal bureaucracy and supplier community will begin reacting to impending cuts long before they are actually triggered. In fact, the defense industry is already doing so, deferring new hiring and capital investments until the budget outlook becomes clearer. Although government managers have not been given guidance to do the same, they will probably start receiving instructions in late summer that result in a gradual slowdown in the federal obligation of funds. By the beginning of the new fiscal year on October 1, billions of dollars that otherwise would have been flowing into the economy will be bottled up as bureaucrats wait to see whether Congress acts to avert the cuts.

Thus, if the Obama Administration wants to avoid damage to the economy from automatic spending cuts, it will have to act soon to find a way out of the trap created by the Budget Control Act. It’s not enough to wait until a congressional lame-duck session after November elections, because by then the whole federal contracting system will have slowed to a snail’s pace in anticipation of cuts with predictable results for the economy’s already anemic recovery. Coming on top of other budget uncertainties and potential slowdowns in China and Europe, the cumulative impact could be enough to stop economic growth in its tracks. So while the White House political team may be telling the president it is premature for him to wade into the budget battle, the reality is that failure to act now could create the kind of economic conditions that preclude a second term.