The Sequester, and How Not to Solve a Budget Problem

Federal spending is going to be cut by $1.1 trillion over the next decade, starting this weekend. Neither party is happy about it, and almost everyone thinks it's a bad idea.

Want to learn more? Good, let's go.

The "sequestration," as it's called, was originally agreed upon in the summer of 2011 as part of the deal to raise the debt ceiling. Both parties agreed on the spending cuts, but neither actually wanted them to happen. The idea was to threaten indiscriminate spending cuts both sides would hate, hoping it would entice legislatures to work together to find a more amicable solution to lowering the budget deficit. They didn't, and so now here we are. It's as if you and your spouse made a commitment that if you couldn't agree on who cleans the kitchen tonight, you'd both vow to smash your own fingernails with a hammer, hoping it would push you toward an agreement. Now the kitchen is still a mess, the clock is ticking, and the hammer awaits. Only politicians can think of this stuff.

Narrowing the deficit may be an admirable goal, though be careful what you wish for, as Europe is now realizing. What's crazy about the sequester is the composition of the cuts. Nearly all of the cuts hit "discretionary spending," which basically means everything except entitlements like Social Security, Medicare, and Medicaid. Education, justice, science, road repairs, and air traffic control all get cut. Social Security gets a pass.

Roger Altman of Evercore Partners explained how mindless that logic is in the Financial Times this week:

Cutting discretionary spending is like invading Iraq when the attack came from Afghanistan. Everyone knows that the federal spending problem involves the soaring cost of health care entitlements, which are not covered by the sequestration. The share of US gross domestic product consumed by Medicare alone is projected to rise from 3.7 per cent today to 6.7 per cent in 25 years. Meanwhile, discretionary spending is declining as a share of economic output, and it is already being subjected to a $1.1tn 10-year cut that was initiated in 2011.

Basically, the sequestration leaves everything that is growing alone, while cutting everything that is already declining.

Here's one way to look at it:

Source: Congressional Budget Office.

Social Security spending is set to jump over the next two decades. The sequester leaves it alone. Medicare is set to balloon. The sequester pokes at it, but not enough to make a difference. Medicaid spending is set to explode. The sequester won't touch it. "Other" spending is already set to decline substantially -- and that's where the sequester's biggest cuts will hit.

And the discretionary spending cuts are indiscriminate. Here's Altman again:

Each area of the discretionary budget will be forced to share the cuts equally. How bad is this? Imagine a hospital deciding to cut every department by an equal amount. Oncology and cardiology would be reduced as much as cosmetic surgery. No medical institution would ever do this. Life-or-death areas would be cut last.

Museums and national parks will receive the same percentage cut as education and the FBI. Nuclear regulation is cut by the same percentage as the Library of Congress. It makes no logical sense. And again, that was by design.

Non-defense discretionary spending is already on track to hit its lowest share of GDP in more than half a century. Defense spending, while monstrous compared to the rest of the world, is actually below its historical share of the economy, and already set to decline further as the war in Afghanistan draws down. The only major budget categories growing above historic norms are entitlements like Social Security and Medicare. Yet they are the only areas we seem unwilling to cut.

Worse, they are indeed the hardest government service to cut, as virtually everyone benefits from them directly. Whenever the topic of entitlements and deficits arises, someone points out that entitlements don't add to the deficit because they are paid for separately. This is nonsense. Yes, you paid into the entitlement system. But you are likely set to receive multiple times back what you put in, adjusted for inflation and discounted to present value. Pretending that entitlements don't add to the deficit doesn't help the fact that they do, accounting for virtually all of the long-term deficit projection. It is entirely misinformed to want to stem the long-term budget deficit while asking for entitlements to be left alone.

There is no budget crisis today. Someday, there will be. If the sequester is any indication of how we plan to address it, we're in trouble. 


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  • Report this Comment On February 27, 2013, at 3:23 PM, slpmn wrote:

    Ugliest example of partisan government inaction I have ever witnessed. Since, as you explain, it doesn't make any rational sense to cut the budget this way, even if you want to see it cut, it obviously has nothing to do with economics and everthing to do with politcs. So which side should be blamed?

    I tend to think the Democrats should be taking more heat, since they clearly do not want to touch the social entitlements, which are their domain, historically. The Republicans seem to have made peace with hacking away at the big non-entitlement entitlement - Defense, which is their historical domain, and I give them credit for that. Not too much, however, since they are doing their best to turn this into political points via things like the group portrait holding the "#Obamasequester" sign at the capitol. Really catchy, guys.

    If I were really cynical, I would say they know this is going to hurt the economy, and want to pin it on the Democrats now, so they have an advantage next election. Because that's really what the national budget should be about, right - which party has an advantage in the next election? Pathetic!

    Sadly, the fallout is going to be lots of cuts to small programs do good and a hit to the economy that no investor should want to see right now. Oh, and it might make bonds look good for another few years, too....

  • Report this Comment On February 27, 2013, at 3:25 PM, StopPrintinMoney wrote:

    the sky is falling! the sky is falling!!

  • Report this Comment On February 27, 2013, at 3:37 PM, TMFGortok wrote:

    The 'cuts' are cuts in spending increases. Next year we will still spend more than we did this year, and the next year, and the next year, well, you get the idea.

    The cuts that are enacted in this fiscal year don't even take us back to 2011's budget. Does anyone honestly believe that we were not spending enough in 2011?

    As long as Austerity means every day people being taxed to bail out bankers, then yes, it's not going to work: http://bastiat.mises.org/2013/02/mark-thornton-explains-the-...

  • Report this Comment On February 27, 2013, at 3:43 PM, TMFMorgan wrote:

    ^ In real terms we'll be spending less in 2013 than we did in 2011. And don't tell me real terms doesn't count: You can't hyperventilate about inflation in one breath and ignore it the next. If you believe ShadowStats' inflation figures, real federal spending will decline by about 4% a year over the next five years.

  • Report this Comment On February 27, 2013, at 8:10 PM, SuntanIronMan wrote:

    We voted for these people. These are the people we choose to lead the country. So when slpmn asks who is to blame: It is we the people! White House proposed it, Congress passed it, White House signed it and now everybody is running away from it. And we voted for all of these jokers. We deserve all of this. Remember that next time you are in the voting booth.

  • Report this Comment On February 27, 2013, at 10:03 PM, NickD wrote:

    Raise the voting age to 40 and cap it at 60. that would solve all kinds of problems.

  • Report this Comment On February 27, 2013, at 10:08 PM, smartmuffin wrote:

    "and almost everyone thinks it's a bad idea"

    This is a blatant lie. Almost every POLITICIAN thinks it's a bad idea. The American people, as a whole, are split roughly 50/50 on this.

  • Report this Comment On February 28, 2013, at 9:42 AM, anasianjew wrote:

    "^ In real terms we'll be spending less in 2013 than we did in 2011. And don't tell me real terms doesn't count: You can't hyperventilate about inflation in one breath and ignore it the next. If you believe ShadowStats' inflation figures, real federal spending will decline by about 4% a year over the next five years."

    Yes, our spending is, as you claim, is decreasing in "real terms".......... which makes perfect sense since Debt to GDP ratio continues to rise.

    Roflz..Give me a break..

  • Report this Comment On February 28, 2013, at 10:24 AM, TMFMorgan wrote:

    ^ Nominal spending from 2011 to 2013 will increase 3.19% (including sequester). Inflation totaled 5% during the period, or about 10% if you follow ShadowStats. No "roflz's" or breaks are needed.

  • Report this Comment On February 28, 2013, at 11:15 AM, anasianjew wrote:

    Morgan,

    My roflz stands: you are a financial analyst, you should know better. I am tempted to add a “ROLFLZ “+ “!” to your reply.

    Nominal, inflation adjusted spending figures tells me nothing in the context of government spending in relation to the size/scope of government. In any credible analysis, relevant ratios are used in relation to the posed problem: none were used in your piece above.

    Bottom line, the real Debt to GDP ratio (inflation adjusted) is going up: all the other stuff/charts you cited are irrelevant. Government spending is outpacing the growth in the economy: if nothing is done, the rate of rise in debt/GDP is projected to speed up. If this “government investment” is intended to speed up the pace of growth, it is failing miserably.

    So yes, government spending in relation to the economy is increasing with no signs of abatement. If; however, that Debt/GDP number flat lined and started decreasing, I might take your analysis more seriously.

  • Report this Comment On February 28, 2013, at 11:28 AM, TMFMorgan wrote:

    <<Bottom line, the real Debt to GDP ratio (inflation adjusted) is going up:>>

    Total debt to GDP has declined every year since 2008. The decline in financial sector/private market debt is outpacing the rise in federal debt.

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&am...

    <If nothing is done, the rate of rise in debt/GDP is projected to speed up.>>

    If nothing else is done, federal debt/GDP is projected to decline for the next five years and be lower a decade from now than it is today (orange line in this chart):

    http://g.foolcdn.com/editorial/images/13972/deficit2_large.P...

  • Report this Comment On February 28, 2013, at 11:41 AM, TMFMorgan wrote:

    <<So yes, government spending in relation to the economy is increasing with no signs of abatement.>>

    Government spending as a share of GDP is set to decline in each of the next six years.

    http://www.whitehouse.gov/sites/default/files/omb/budget/fy2...

  • Report this Comment On February 28, 2013, at 11:43 AM, TMFMorgan wrote:

    ^ (Should add: those figures don't include the sequester, so the 2 basis point bump in 2016 becomes a decline.)

  • Report this Comment On February 28, 2013, at 12:02 PM, TMFMorgan wrote:

    <<In any credible analysis, relevant ratios are used in relation to the posed problem: none were used in your piece above.>>

    The chart does indeed include projected spending as a share of GDP.

  • Report this Comment On February 28, 2013, at 1:35 PM, anasianjew wrote:

    Morgan,

    I have no clue why you cited this graph:

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&am...

    Pardon my ignorance and lack of sophistication, but what does TCMDO mean? As it stands right now, that graph makes no sense to me.

    I would cite debtclock.org where I get brief updates during my grape juice breaks I take at work; however, the site looks like it was designed by a 5 year old using Microsoft FrontPage 96. Also, I don’t know how he/she wrote the algorithms and what data is cited to model the rate of increase: it looks like it provides a good ballpark figure, but I can’t confirm. As such, I will refrain from citing an unconfirmed source.

    Thank you for the Fed website! I will add that to a list of other sources I use for datamining. Using your own source and playing around with the graphing feature, this is what I came up with when I queried and plotted straight forward, easily understood datasets:

    “Real GDP” and “Gross Federal Debt”

    http://research.stlouisfed.org/fred2/graph/?g=g1O

    “Federal Debt as percentage of Gross Domestic Product”

    http://research.stlouisfed.org/fred2/graph/?g=g1M

    Perhaps I lack the necessary sophistication, education and technical expertise to derive higher meaning from these graphs, but it looks like both are trending toward a undesirable direction. In the 1 graph, the gap between GDP and Debt is shrinking rapidly. This is confirmed with the 2 graph (unacceptably high debt to GDP ratio).

    Any data coming from the Executive branch is questionable. When we have a president citing 2 trillion dollars in savings partly because there will no longer be a surge in Iraq, I find any number coming from the Whitehouse laughable. That is like saying the US Govt is saving 300 billion because we are not engaging in amphibious landing operations in Normandy and Iwo Jima to stop Japanese/German expansion……in 2013.

    I don’t know what your motives are for posting a seemingly irrelevant graph in response to my reply. Either you are:

    1) Trying to analyze yourself out of reality.

    2) In hoping I will just take your word and not investigate your source, you post some abscure graph (with a mysterious acronym) showing a downward trend to hide the fact that I pointed out a hole the size of the Holland Tunnel, which challenges the entire premise this article.

    There is a spending problem in Washington D.C. What IS scary is how much resistance there is to cut 2 cents for every dollar spent.

  • Report this Comment On February 28, 2013, at 1:49 PM, TMFMorgan wrote:

    TCMDO = Total credit market debt outstanding. It's the most complete measure of debt that exists.

    << looks like both are trending toward a undesirable direction.>>

    Federal debt grew faster than GDP from 07-13, yes. What's important now is where they're heading. You need a forecast for that based on current law, particularly the effects of the 2011 Budget Control Act, the recent tax hikes and the spending sequester. That's what the chart I included (orange line) shows.

    <<I don’t know what your motives are for posting a seemingly irrelevant graph >>

    Which was irrelevant?

    <<Any data coming from the Executive branch is questionable.>>

    Whose figures are you using when you say federal spending is forecast to grow faster than GDP?

  • Report this Comment On February 28, 2013, at 4:15 PM, anasianjew wrote:

    Morgan,

    Ahh. Reading your reply in relation to your previous post, it makes sense.

    The data I reference to observe what is preceived to be concensus is the CBO

    http://www.cbo.gov/publication/43907

    Reading the CBO, it is good theorycraft; however, many times these projections are way off mark. Case in point:

    http://www.aei-ideas.org/2012/12/in-2002-cbo-predicted-2012-...

    Surprise surprise, that projection failed to predict 2 wars and a massive recession. The CBO was off by 67%

    I believe and still believe many of these projections are largely useless and have to do more with academic exercise then actually providing useful information. I can go down the list of even more “projections” that were made that were off the mark by a mile (i.e. unemployment wouldn’t go above 8%; summer of recovery etc.)

    As with investing in individual stocks, future performance has a lot to do with confidence and good leadership that can adapt and navigate rough waters: it is hard to do that when your debt/GDP ratio is hitting the 100% mark, anemic economic growth and absolutely nothing to show for it. The president has no intention of curbing spending nor exhibited any real leadership in anything. Additionally, there is an entire entitlement scheduled to go online here in a few years (Obamacare), which was sold as something that would “save money” and “reduce the deficit”. I have yet to know any public project that has met budget targets: once it is online, Murphy’s law will take hold and balloon the deficit. It is laughable to think that this 10,000 page monstrosity will NOT accelerate government spending.

    If anything, these projections are extremely conservative.

    The fact that he is claiming doom/gloom because we are cutting a whopping 2% percent of federal spending indicates to me that any attempts to control spending are out the window for the next 3 years.

  • Report this Comment On February 28, 2013, at 5:18 PM, TMFMorgan wrote:

    <<I believe and still believe many of these projections are largely useless and have to do more with academic exercise then actually providing useful information>>

    But again, what projections are you referring to when you say "if nothing is done, the rate of rise in debt/GDP is projected to speed up"?

    Of course, budget projections are just an estimate and usually wrong because we can't predict events like wars (or positive events like the dot-com boom in the 1990s, which brought surplus). But we're talking about current law. "We don't know the future" is a lot different from "debt to GDP is projected to speed up."

  • Report this Comment On February 28, 2013, at 5:22 PM, TMFMorgan wrote:

    To elaborate, when you say "The data I reference to observe what is preceived to be concensus is the CBO," the CBO's link you provided shows debt/GPD declining. One the first page.

  • Report this Comment On February 28, 2013, at 5:28 PM, whereaminow wrote:

    ---> Yes, you paid into the entitlement system. But you are likely set to receive multiple times back what you put in, adjusted for inflation and discounted to present value. <---

    You keep citing that report from the Urban Institute. They are a government back-rolled welfare policy group. They are a marketing group for welfare. I would believe that Red Bull actually gives me wings before I would buy that unscientific Urban Institute garbage.

    David in Liberty

  • Report this Comment On February 28, 2013, at 10:45 PM, skypilot2005 wrote:

    Morgan wrote:

    “The idea was to threaten indiscriminate spending cuts both sides would hate, hoping it would entice legislatures to work together to find a more amicable solution to lowering the budget deficit. They didn't, and so now here we are.”

    THEY didn’t?

    The House has proposed a budget. The Senate has not.

    The President has not shown any leadership regarding the budget.

    “They” must mean the Democrats?

    Sky

  • Report this Comment On March 02, 2013, at 7:15 AM, skypilot2005 wrote:

    Morgan wrote:

    "Federal spending is going to be cut by $1.1 trillion over the next decade, starting this weekend. Neither party is happy about it, and almost everyone thinks it's a bad idea."

    I looked back. The President didn't seem to think so last October in his Des Moines Register interview.

    He needs to stop "campaigning" and start leading.

    Morgan, please put the Kool-Aide down and stop believing everything the White House and Senate Democrats say about this.

    Sky

  • Report this Comment On March 05, 2013, at 1:46 PM, toastedseeds wrote:

    From what I have read Obama has made many offers on cutting entitlements, but republicans don't hear or believe it. I think the problem lies on the right not the left, but note the left isn't much better.

    Here's an article outlining some of the concessions Obama has offered.

    http://www.washingtonpost.com/blogs/wonkblog/wp/2013/03/02/t...

    ts

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