Well, Colorado College, as I am sure all of you reading this article know, Barack Hussein Obama has been re-elected. Feel free to celebrate and enjoy the victory, but as you celebrate, keep in mind that very little has changed regarding the state of American politics. The same problems that existed before the election went into full swing are still present and in some cases much more pressing than six months ago. Specifically, I want to remind everyone about sequestration and its inevitably looming activation date on Jan 2 when $1.2 trillion worth of cuts to discretionary spending will occur.
There are currently three possible outcomes to the sequestration problem. First, Congress compromises and finds a viable combination of revenue increases and spending cuts. Second, sequestration happens and it triggers a second recession. Third, and somewhat more likely, Congress (or the President) likely causes a downgrade in American credit ratings by delaying the start of sequestration. The first option, while the best solution, is also the least likely, and the other two options both have serious negative consequences for the American economy.
To begin we need to understand what the sequester is and why such an irresponsible policy is part of America’s political landscape. The Budget Control Act of 2011 (BCA) passed through Congress as part of the negotiation process to raise our debt ceiling. In order to get Republican support for raising the debt ceiling and avoiding a default, Congress agreed, through the BCA, to create a bipartisan committee to change the country’s budget and eliminate our $1.2 trillion deficit through increases in revenue, or taxes, and cuts to discretionary spending over a 10-year period. However, if the committee failed a set of automatic cuts to military and other discretionary spending would occur. Not surprisingly, the committee failed to make the report deadline and sequestration came into effect.
Congress compromising and finding $1.2 trillion of cuts and revenue boosts is the way out of sequestration. But because Democrats kept the Senate and did not get a supermajority and the Republicans kept the House, it is unlikely that either side will be able to ram a piece of partisan legislation through Congress. Given this state of Congress, one must assume that compromises would need to happen to find a solution. However, if we look at the current sequestration avoidance proposals it is readily evident that both sides are far apart.
According to the Congressional Research Service there are two significant proposals. First is President Obama’s FY2013 Budget. The budget proposes repealing the 2001, 2003, and 2010 tax cuts for singles making over $200,000 annually and couples making $250,000 or more. In addition, it places caps on Overseas Contingency Operations, curbs military spending, and generates savings from reforming Medicare, Medicaid and agriculture programs. However, Obama’s budget is essentially political posturing in a divided Congress. Republicans love the Bush Tax cuts and have pledged not to raise taxes. They also swear by the necessity of increasing not cutting defense military spending. Therefore two of the major components of Obama’s budget are highly partisan and unlikely to gain traction in the House. Furthermore, the agro-business lobby is one of the most powerful forces in Washington and will rally major support against this budget.
The next option is the Sequester Replacement and Reconciliation Act of 2012 (H.R. 5652). This bill passed the House on May 10, 2012, and would cancel $98 billion in discretionary defense and non-defense spending. But, the main focus of this bill is to cut non-defense spending and while it would reduce the deficit by $262 billion by FY2022, it will not pass the Senate because it targets social welfare programs that Democrats passionately care about. In fact, despite this bill passing through the House six months ago the fact that it has never reached the floor of the Senate is both not surprising and indicative of how unlikely it is that this bill would pass. Finally, President Obama has publicly stated on multiple occasions that he will veto the bill if it were to pass out of Congress.
If we look at the tenor of discourse in the legislative branch it becomes clear that neither side is interested in engaging on the sequestration. Speaker John Boehner (R-Ohio) stated recently to Politico, “Lame-duck Congresses aren’t known for doing big things and probably shouldn’t do big things, so I think the best you can hope for is a bridge… I would think that would be the best you can hope for and even that is going to be difficult to do.” The bridge idea that Speaker Boehner describes would be some compromise to delay sequestration while providing some revenue increases and budgetary cuts. But given that Congress would have to come up with these cuts I, like Boehner, am skeptical about the viability of this plan.
Furthermore, two high-ranking Democratic senators and the logical leaders of the Senate’s anti-sequestration movement, Majority Leader Mitch McConnell and Chair of the Finance Committee Max Baucus, are both up for reelection in 2014 and are likely facing contentious races. They are both therefore likely to tread lightly on this issue. Statements from Senators Lamar Alexander (R-TN) and Michael Bennet (D-CO), who are talking about a bipartisan deal, both have acknowledged that any deal will be unpopular at home. With major leadership positions up for grabs it is likely that senators will avoid controversial decisions rather than risk their job security. The incentive to compromise and work before Jan 2 is therefore minimal at best.
We have seen that it is unlikely that there will be compromise between the Republicans and Democrats given the legislative climate and the looming threat of high stakes midterm elections so we can now begin to consider the effects of sequestration coming into effect. According to The Denver Post and a study by George Mason University, Colorado could lose 42,000 jobs due to sequestration. Granted, Colorado is one of the states facing the harshest loses because of the military establishment and high numbers of defense contractors. But while Colorado would be particularly devastated, the Congressional Budget Office thinks that the sequester, combined with the expiration of various tax breaks at the end of the year, add up to between 3.6 to 5 percent of GDP. In all likelihood constricting the budget and cutting spending in this way would result in the start of a new recession. The major parallel in U.S. economic history is 1968 when the United States increased individual, corporate, excise and payroll taxes by 3.1 percent of GDP to pay for the Vietnam War and slow inflation and the next year the economy fell into a recession.
Finally, if Congress and the President are unable to reach a deal but choose to bump back the sequester start date it could potentially lead to a downgrade of America’s credit rating. Moody’s Investor Service stated back in September that they would downgrade America’s credit rating from AAA to Aa1 if a sequestration avoidance deal did not occur during the lame duck session. Moody’s is considering downgrading American credit because of the uncertainty surrounding sequestration, and simply kicking this can down the road does not mitigate uncertainty. A credit downgrade could potentially harm the American bond market by driving up interest rates, decreasing the amount of borrowing and spending, and triggering a new recession. Despite currently negative real interest rates, borrowing has been slow, and if capital becomes more expensive we are again likely to see the start of a second recession. The counterargument to this line of thinking is that when Standard and Poor’s downgraded America’s credit rating after the debt ceiling debacle, the bond market actually saw an increase in investment, driving down interest rates. But, markets are unpredictable and generally uncertainty and risk driving away rather than attract investment. Ignoring the threat of a credit downgrade, while it worked in the past, is a dangerous game that could come back to harm America’s economy.
There are three potential outcomes to sequestration: Congress compromises, the sequestration happens triggering a recession, or we delay sequestration and potentially also cause a recession due to a credit downgrade. Therefore, avoiding a recession and passing through this problem unwounded is unlikely. Current American fiscal policy is unsustainable, but the way out is dependent on an intractable Congress choosing to compromise on an issue that has been haunting American politics since the summer of 2011. So Colorado College, celebrate Obama winning the presidency but remember that a year and a half ago our legislators loaded a gun and aimed it directly at our economy, and in two months that gun will go off.