The contours of the deal that would re-open the U.S. government and lift the debt-ceiling keep changing by the hour. It’s becoming clear, though, that whatever compromise emerges from Congress, it will be a short-term fix, nothing more than a bit of breathing room for lawmakers to hatch out a better agreement on spending and tax reforms. But remember how this ended the last time? Without a better deal and with $80 billion of sequester cuts.
The real danger in the current negotiations, isn’t so much that they might not be finalized until shortly after Oct. 17—the Treasury would be able to pay creditors and all its bills until Oct. 22—but that they will lead to more abrupt spending reductions.
The second tranche of the sequester is set to kick in on Jan. 15 unless House and Senate can reach a compromise on new spending reductions or, better still, agree to repeal the law that imposes the sequester in the first place. The Budget Control Act of 2011, which ended the last fiscal crisis, imposes a series of funding caps, worth $1.2 trillion overall, on federal budgets from 2013 to 2021. If Democrats and Republicans can’t find a way to spend within those limits, the sequester kicks in, which brings federal spending under the statutory caps via automatic, across-the-board cuts. The cap for 2014 is $967 billion, so lawmakers can either agree on spending reductions that would bring the federal budget under limit, or they can decide they need to spend more and take down the BCA. If they do neither, the slashing will, once again, happen indiscriminately and have the heaviest impact on the economy. Considering how things are going, that might be exactly the outcome we’re headed for.
It’s tempting to brush off the potential consequences of another sequester. After all, the first round of meat-cleaver style spending reductions doesn’t seem to have had much of an effect on U.S. growth so far. A number of sensible voices in Washington, though, are warning that American hasn’t yet felt the brunt of the 2013 sequester because many of those cuts haven’t even begun to affect federal agencies’ actual outlays in many cases. For example, here’s how the Bipartisan Policy Center (BPC) says the Department of Defense (DoD) will spend the $3.2 billion Congress gave it for new submarines in 2013:
If that $3.2 billion was significantly lower than what DoD normally gets for submarines, it would take seven years for the full effect of those budget reductions to show in the real economy. Besides, notes the BPC, large defense contractors have backlogs of work awarded in pre-sequester contracts that is helping sustain the industry through 2013. Budget cuts, in other words, take a long time to work their way through the federal bureaucracy and into the real economy. But they do eventually hit. The Congressional Budget Office estimates that eliminating automatic spending reductions would boost U.S. real GDP by between 0.2% and 1%, and employment by between 300,000 and 1.2 million full-time jobs in 2014. More cuts would only slow the recovery even further.
In terms of risks to the Canadian economy, then, a U.S. debt default is potentially extremely dangerous but also very unlikely. A sequester 2.0, which would hurt U.S. growth, is a less dire but much more likely outcome.
Erica Alini is a reporter based in Cambridge, Mass., and a regular contributor to CanadianBusiness.com, where she covers the U.S. economy.