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Automatic Spending Cuts Start With Few Initial Effects

March 04, 2013

Automatic U.S. Spending Cuts Start With Few Initial Effects

The dome of the U.S. Capitol is lit up in the evening in Washington, D.C.. Photographer: Pete Marovich/Bloomberg

Across-the-board spending cuts to U.S. defense and domestic programs, known as sequestration, took effect on March 1. It will be a few weeks before the full effects are felt by federal agencies, defense contractors and the public. This gives negotiators more time to strike a deal.

Here are questions and answers about the cuts and the status of budget talks in Washington:

What happened March 1?

Automatic cuts, half affecting defense spending and the remainder spread over other federal agencies, went into effect. The federal government is reducing spending by $1.2 trillion over the next nine years, including $85 billion over the final seven months of this fiscal year.

What are the potential economic implications of the cuts?

The nonpartisan Congressional Budget Office estimates that the automatic budget reductions, if they are not stopped, will cause a 0.6 percentage-point reduction in U.S. economic growth this year. Federal Reserve Chairman Ben S. Bernanke told the Senate Banking Committee on Feb. 26 that “this additional near- term burden on the recovery is significant.”

The median forecast of economists surveyed by Bloomberg last week calls for a loss of 0.5 percentage points from the gross domestic product and 350,000 U.S. jobs.

How will federal agencies be affected?

The law requires that each program, project or activity at every federal agency be cut an equal percentage, though the definitions of these terms may vary across agencies.

The effective cuts would be about 13 percent for defense programs and 9 percent for non-defense programs, according to the Office of Management and Budget. Payments to Medicare providers would be cut less than other spending, with a maximum of 2 percent. Agency leaders may have some discretion in applying the cuts.

What are some specific cuts that could occur?

The Federal Aviation Administration would probably close more than 100 air-traffic control towers about April 1, Transportation Secretary Ray LaHood has said. The Coast Guard would reduce its presence in the Arctic by one third, Homeland Security Secretary Janet Napolitano has said.

Does anyone have a plan to stop the reductions?

Democrats and Republicans are locked in a standoff over how to replace the cuts, especially whether to include new revenue in such a deal. Republicans reject Democrats’ call for additional higher taxes for top earners. The Democrats’ plan would have replaced this year’s part of the spending reduction with a smaller cut to defense programs, a halt in direct payments to farmers and a tax increase imposing a minimum 30 percent rate on top earners.

What was the Republican plan to replace the cuts?

The Senate Republicans’ proposal would have kept the $85 billion in cuts this year while requiring Obama to submit a proposal by March 15 on how to allocate them. Both plans failed to advance in the Democrat-controlled Senate last week.

How have the markets reacted?

Investors haven’t been deterred much. The Standard & Poor’s 500 Index (SPX) rose 0.5 percent to 1,525.25 at 4 p.m. in New York, after falling as much as 0.3 percent earlier. The Dow Jones Industrial Average gained 37.86 points, or 0.3 percent, to 14,127.52.

Yields on 10-year Treasuries rose three basis points, or 0.03 percentage point, to 1.87 percent at 2:01 p.m. New York time, according to Bloomberg Bond Trader data.

What’s next in the House and Senate?

Republicans and Democrats are focused on finding a way to keep the government operating for the rest of the fiscal year after a stopgap measure funding federal programs expires March 27. Both parties say they are eager to avoid a government shutdown.

House Republicans introduced a measure that would finance the U.S. government at an annual rate of about $982 billion through Sept. 30, keeping the automatic spending cuts that began March 1. The House is set to vote on the measure by March 7.

The bill would include new spending bills for the Pentagon and the Department of Veterans Affairs, subject to the spending cuts. It also would cancel a 0.5 percent pay raise for federal civilian employees that is scheduled to take effect in April.

Senate Democrats plan to offer a $1.043 trillion spending plan.

Would Obama agree to a lower spending level?

Obama indicated on March 1 that he would sign a stopgap measure if it reflects previous agreements on funding. He has urged replacing the automatic cuts with a combination of spending cuts, including in entitlement programs, and higher revenue from eliminating tax breaks for the wealthiest earners.

Will the effects of the cuts be immediate?

Probably not. About $42 billion of the sequestered funds would have been spent in fiscal 2013, according to the CBO. Funds appropriated in one year often are spent in future years, so the effects of some cuts won’t be seen until fiscal 2014 and beyond.

What about federal workers?

Federal employees must be given 30 days’ notice before they are furloughed, or required to take unpaid time off. So notices would go out even if no furloughs end up occurring. The Pentagon said it would furlough up to 800,000 civilian employees.

How are the cuts distributed?

An estimated $43 billion in defense cuts would be targeted at national security and military operations. Another $26 billion will come from domestic programs including health, education, drug enforcement, national parks and other agencies. An estimated $11 billion involves reduced payments to Medicare providers, cuts in agriculture programs and reduced unemployment benefits.

Is any federal spending exempt from the reductions?

Yes. There will be no cuts to military pay, veterans benefits and Social Security checks. These exemptions create a disproportionate effect in other parts of the budget, such as defense contractors, meat inspection and national parks.

Which cuts are most likely to be replaced or stopped?

Republicans and Democrats from states that are home to defense contractors or military bases are motivated to replace the Pentagon cuts. Democrats have emphasized the harm that could result from cuts to programs serving low-income individuals like the Women, Infants and Children nutrition program and cuts to the Education Department.

How much deficit reduction has been accomplished with tax increases and how much has come from spending cuts?

Even without a bipartisan consensus, the U.S. has reduced the budget 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.

To contact the reporter on this story: Heidi Przybyla in Washington at hprzybyla@bloomberg.net

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


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