The Sequester A-Cometh

The next big political battle will be whether or not to delay the “sequester”—automatic cuts to both mandatory and discretionary government spending.

The “delay it” gang argues the sequester will be an additional economic headwind. Perhaps as egregious, it could result in up to 1 million job losses. The “play it out” gang, mostly Republicans, argues the nation is in need of some serious fiscal responsibility, and the sequester is but one small step in that direction.

Some history: The sequester is upon us because the “Super Committee” (set up by the optimistically named “Budget Control Act of 2011”) failed to, well, control the budget. Hence, a series of automatic tax hikes and budget cuts were slated to kick in January 1, i.e., the fiscal cliff. Which, turns out, was more of a fungible cliff—a huge chunk of the automatic cuts was legislated away, and the spending cuts were booted to March 1.

Which tells you the sequester could be pushed back again. Or legislated away. Or changed in some other way—this is a political machination and an arbitrary deadline.

Or Republicans might drag their heels and let the sequester play out. Doing so could provide them political cover to raise the debt ceiling again (another purely political machination which could be upon us again as soon as mid-May)—e.g., “We don’t like raising the debt ceiling, but we had to compromise on that to get our way on the sequester.” Something along those lines.

So what happens if the sequester plays out exactly as is? Billed as precipitous spending cuts, the cuts are actually to prior spending growth projections. Which means mandatory spending doesn’t fall at all—it will grow $52 billion in 2013 (2.5% over 2012). Discretionary spending does fall overall—down -$58 billion, a decrease of -4.5% over 2012. (Note the decrease in discretionary is about perfectly offset by the increase in mandatory.) Thanks to lower interest rates, net interest costs fall -$2 billion (which is good, not bad). In all, total government spending is projected to fall -$9 billion in 2013.

Yes, it’s a headwind. But a tiny one—detracting -0.06% from GDP. Total 2012 government spending fell -$40 billion, or -0.26% of GDP (i.e., more than 2013). The initial Q4 GDP estimate showed a -0.1% contraction, but full-year 2012 GDP grew 2.2%—and total payrolls grew 1.835 million. Government payrolls shrank -68,000 but were clearly overwhelmed by private employment gains.

Exhibit 1: Payroll Growth Since the Recession

Source: Thomson Reuters, Bureau of Labor Statistics from 12/31/2008 to 12/31/2012.

So how does a much smaller contraction in government spending in 2013 amount to 1 million jobs lost? Shrinking government spending has weighed on headline GDP for nearly the entirety of the expansion, while the much bigger private economy has largely grown robustly (Q4 included). But during the entire expansion, government job losses have totaled just -636,000. Those losses have been more than offset by private sector payroll gains—totaling over 4.1 million. (See Exhibit 1.)

We’ve no doubt the will-they/won’t-they sequester debate will be massive, but we caution against conflating that with the actual economic fallout.