Why Sequestration Savings Are Largely An Illusion

In the three years since it was signed into law, the Budget Control Act of 2011 has become a focus of continuous partisan controversy.  That’s especially true of the provision in the law called “sequestration” that imposes caps on spending by the defense department and domestic agencies.  Republicans don’t like the law, but say it is a useful mechanism for reining in federal borrowing; Democrats say the cure is worse than the disease.  What tends to get lost in the partisan debate is precisely how much money sequestration is actually saving.  The law mandates savings of $110 billion annually through 2021, divided equally between military and domestic discretionary spending.  However, when you scrutinize the size and composition of the cuts that sequestration has imposed on the government, it isn’t clear the law really improves the nation’s fiscal health.  Here are four reasons why.

First of all, the scale of the savings mandated by the law are modest relative to overall federal spending.  With the fiscal 2015 federal budget likely to come in just a tad shy of $4 trillion, $110 billion represents savings of less than 3%.  Many members of Congress seem to think sequestration has been a major factor in reducing the government’s yearly deficits, but that simply isn’t so.  The size of annual deficits is likely to decline by roughly a trillion dollars between the year the budget law was passed and 2015, but sequestration accounts for only about 10% of that decline.  The improvement is being caused mainly by rising tax receipts as the economy recovers and the expiration of tax cuts inherited from the Bush years.

Second, sequestration has not had an appreciable impact on federal borrowing because the main drivers of new borrowing are beyond the scope of the budget law.  Those drivers are formula-driven entitlement programs, particularly healthcare programs like Medicare and Medicaid.  That kind of “mandatory” spending was largely excluded from sequestration by the authors of the law, and so the government must still incur additional debt each year to keep up with rising entitlement costs.  It appears that cumulative federal debt will reach $20 trillion in fiscal 2018, meaning that a 1% increase in interest rates would raise the cost of servicing the debt about $200 billion annually.

Third, because of the way congressionally-mandated savings are being derived in the budget process, the composition of federal spending is gradually shifting from investment to consumption.  This isn’t just a consequence of excluding entitlement programs from sequestration, it also results from the fact that technology programs are easier to cut than personnel costs for a variety of practical and political reasons. But cutting technology investments typically makes the underlying programs less efficient, and so the government gets less benefit from each dollar it spends.  For instance, budget caps have forced the Pentagon to reduce the number of F-35 fighters it will buy in 2015 from a planned number of 42 to 34.  The slower ramp-up of production means each plane will cost more because economies of scale are lost; per-plane costs would fall faster if production rates were higher.

Fourth, the law fails to consider how limiting federal investment in new technology will increase costs and diminish competitiveness across the economy.  The Obama Administration has indicated that due to sequestration it will have to slow work on the NextGen system for modernizing management of national airspace, scale back transition to a more resilient and efficient electrical grid, cut the level of spending on healthcare research, and pare investment in clean-energy technologies.  Collectively, these changes have the potential to impose sizable costs on taxpayers and consumers that rival the scale of savings generated by sequestration.  Government spending may shrink, but only at the cost of making the nation’s economy less productive and safe than it might have been.