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Spending Cuts Signal Austere Future for Domestic Programs

March 01, 2013

Spending Cuts Signal Austere Future for U.S. Domestic Programs

Flight deck crewmen watch as an F/A-18C Hornet aircraft prepares to land aboard the aircraft carrier USS Carl Vinson (CVN 70) as the ship conducts flight operations in the Pacific Ocean on Feb. 13, 2013. Photographer: Petty Officer 3rd Class George M. Bell/Navy Media Content Services via Bloomberg

Automatic cuts set to take effect today will pinch U.S. government functions as the country enters a more austere era that could push discretionary spending as a share of the economy to its lowest level in at least 50 years.

U.S. lawmakers locked in partisan feuds are turning to across-the-board cuts in national security, education and anti- poverty programs rather than structural changes to retirees’ benefits and the tax code.

Discretionary spending -- which excludes Medicare and Social Security -- will fall to 5.3 percent of the gross domestic product by 2023, the lowest level since at least 1962, according to a Brookings Institution report released yesterday. That’s down from 8.3 percent in 2012.

“We keep putting more pressure on a shrinking part of the pie,” South Dakota Senator John Thune, a member of the Republican leadership, said in an interview.

In part because of political deadlock, the U.S. hasn’t resorted to austerity measures like those in Greece, Spain and the U.K. Still, the lack of political consensus has led to more than $3 trillion in deficit reduction over the past two years, including the automatic cuts known as sequestration and higher taxes for top earners.

Even if Congress agrees to replace some of the cuts, lawmakers will be under pressure to adhere to the lower spending level that kicks in today. House Republicans are uniting behind a proposal to keep the government operating after March 27 that takes sequestration into account, reducing the spending cap to about $974 billion from the current level of $1.043 trillion.

‘Extremely Serious’

Senator Ben Cardin, a Maryland Democrat whose state is home to tens of thousands of federal employees, said the increasing toll of cuts on discretionary programs is “extremely serious.”

“It’s going to have a major impact on our economy,” Cardin said in an interview. “It’s going to hurt people who rely upon governmental services. It’s going to hurt the federal workforce. It’s going to hurt contractors. People are going to get laid off, they’re going to get furloughed. It’s going to affect people’s lives.”

Lawmakers have resisted further tax increases and largely spared entitlement programs such as Social Security and Medicare that are projected to generate unsustainable future deficits.

“We’re doing it in the worst possible way,” said Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics in Washington. “It’s the total inverse of smart budget consolidation.”

Investment Blocked

The paralysis embodied by sequestration will prevent the U.S. from investing in research, infrastructure and worker retraining as other countries are doing, Kirkegaard said.

In areas of the budget that are being hit hardest, the cuts will be seen over the next decade.

“They’re focusing on the wrong deficit issues,” said William Gale, a senior fellow at Brookings, who says more needs to be done to address structural, long-term deficits. “They’re reducing the deficits that happen to be good deficits and they’re not doing anything about the deficits in the future that happen to be bad deficits.”

Since 2010, deficit reduction has dominated political discourse in Washington, contributing to a near-constant atmosphere of crisis and yielding an uneven approach.

“We’ve just have failed to do the work, and that leads us from one needless crisis to another,” Senator Roy Blunt, a Missouri Republican, said yesterday on the Senate floor.

Recurring Deadlines

Republicans and Democrats disagree over how fast the deficit should shrink and how to accomplish that goal. Few U.S. lawmakers challenge the idea that the budget gap is an urgent problem, and even those who do are confronted with recurring deadlines that drive Congress back to deficit cutting.

As a result, governing in the U.S. today is a competition for dwindling future resources, and congressional proposals are measured against the yardstick of how much they cut the deficit.

In the three years since deficit reduction became a top priority in Congress, the winners have been Medicare recipients and the losers are agencies that fund national defense, education and anti-poverty efforts.

The deficit as a share of the economy jumped during the financial crisis, rising to 10.1 percent of gross domestic product in 2009 from 1.2 percent in 2007, according to the Office of Management and Budget. The crisis and resulting recession caused tax revenue to drop and spending to increase on unemployment benefits, food stamps and stimulus programs.

Deficit Drop

For fiscal 2013, which ends Sept. 30, the deficit will be $845 billion, or 5.3 percent of GDP, according to the Congressional Budget Office. That’s the first time the deficit will drop below $1 trillion since 2008.

A bipartisan commission in 2010, a congressional supercommittee in 2011 and recurring talks between President Barack Obama and House Speaker John Boehner, an Ohio Republican, haven’t produced an accord on how to address fiscal policy.

Still, even without a bipartisan consensus, the U.S. has reduced the deficit by about $2.4 trillion since Republicans took control of the House in January 2011. Most of that came from spending cuts Republicans secured later that year. Another $630 billion, plus interest, was shaved in January, when Congress agreed to let income tax rates rise for top earners.

Another $1.2 trillion in spending reductions over nine years is set to start today. The cuts will curb economic growth by 0.5 percentage point this year and wipe out 350,000 jobs if they stay in place through December, according to the median forecast of 26 economists surveyed by Bloomberg last week.

Cutting Spending

The prospect of the cuts hasn’t deterred investors. The Standard & Poor’s 500 Index (SPX) is up 6.2 percent since the start of the year, closing yesterday at 1,514.68 in New York. The Dow Jones Industrial Average fell 0.2 percent to 14,054.49, and is less than 1 percent away from its October 2007 record.

Yields on 10-year Treasuries have been little changed over the past month, falling three basis points, or 0.03 percentage point to 1.88 percent at 5 p.m. in New York. The dollar led gains in world markets last month, climbing 3.5 percent, according to Intercontinental Exchange Inc.’s Dollar Index, which tracks the currency against those of six major U.S. trading partners.

If Congress does nothing, the cuts set to start today will stay in place and the deficit would reach 2.4 percent of GDP by 2015, according to the CBO. The deficit then would start rising, reaching 3.8 percent of GDP by 2022.

Discretionary Programs

Discretionary programs are easier to cut because their budgets are set annually rather than locked into law by benefit formulas. Lawmakers are also reluctant to impose entitlement changes immediately, preferring to protect current retirees -- who vote -- and phasing in changes over time.

“There is no question that for a long time, the long-term budget outlook has been driven by the mandatory spending, health spending in particular,” Douglas Holtz-Eakin, a former CBO director and adviser to 2008 Republican presidential candidate John McCain, told the Senate Finance Committee Feb. 26. “You’re not going to grow your way out of it. It’s been clear for a long time you can’t patch your way out of it.”

The result means less money for infrastructure, education, and defense. Deficit reduction has kept the economy below its capacity for several years, said Andrew Fieldhouse, federal budget policy analyst at the Economic Policy Institute in Washington, which favors helping low- and middle-income workers.

“Timing is everything,” Fieldhouse said. “And if you cut back now, you’re actually going to make it harder to address your long-term challenges because austerity in a depressed economy is particularly damaging.”

Diverging Approaches

Democrats say higher revenue must be part of the solution. An aging population and rising health-care costs, they say, mean that the long-run average of revenues at about 18 percent of GDP can’t be sustained.

“We want a balanced approach: we want revenues, we want spending cuts, a nice, even balance on both,” Senator Tom Harkin, an Iowa Democrat and Appropriations Committee member, said in an interview. “I think the Republicans are going to be held accountable, dearly accountable, for this.”

Republicans say a spending-only approach to deficit reduction is essential.

“Taxes are off the table,” Senator Richard Burr, a North Carolina Republican, said in an interview. “We have to do more cuts. There’s no way we can financially sustain where we are as a country.”

To make a significant dent in federal spending, “you’ve got to reform entitlements,” Burr said.

Entitlement Changes

Regardless of whether entitlement changes are paired with revenue, they’re hard to design. Policy makers aren’t sure which changes would most effectively slow growth in health-care costs.

Because of the desire to protect current retirees, significant changes don’t generate much savings in the 10-year congressional budget scoring time frame. They are also easy to turn into political weapons, as Republicans did with the Medicare cuts that helped finance Obama’s 2010 health-care law.

Senator Rob Portman, an Ohio Republican, said he still sees room for an agreement that would address entitlement programs and revamp the tax code.

“The mark of leadership over the next four years is whether the president provides cover for the Democrats to reform entitlements and do the things that need to be done,” he told reporters yesterday.

To contact the reporters on this story: Richard Rubin in Washington at rrubin12@bloomberg.net; Kathleen Hunter in Washington at khunter9@bloomberg.net

To contact the editor responsible for this story: Jodi Schneider at jschneider50@bloomberg.net


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