Sequestration: Looming Cuts Over-exaggerated for Political Gain

February 28, 2013

By now you realize that by March 1st, 2013 a series of automatic spending cuts will kick into effect for the next 10 years unless Democrats and Republicans reach some sort of agreement on exactly how to match those cuts/revenues.  These cuts were agreed to by both parties and signed into law by the President so that he could avoid an ugly debate occurring during his presidential election (last November).  They were set to start January 1st.  But in true Washington, DC fashion no agreement could be reached by then and they were pushed back to March 1st.

So what exactly is going to happen?  Over the next decade around $1.2 Trillion will be cut from the federal budget.  Let’s put things in perspective, that’s around $120 Billion/year (actually less for 2013/2014 as they’re gradual).  In FY2012 the US Government enacted spending of $3.796 Trillion.  But we don’t make that much money, the Government borrowed $1.327 Trillion in loans to cover the difference between revenue and spending.  These cuts are designed to eat into that deficit because borrowing $1 Trillion+ every year is  completely unrealistic.  So for 2013 we’d see around 3% of the Federal Budget cut.  But the Federal Budget would still be higher every year as spending would still increase even with cuts.  Funny, I know.

 

So here we stand with both sides disagreeing over the agreement they put into place.  The whole time arguing that they didn’t think it would actually happen.  NICE.  Yet at the end of the day what’s the best move?  Well if we look at GDP there’s a bit of a concern.

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As we can see by the red trendline on the graph, GDP growth took a severe dip last quarter as military spending subsided late in the year.  Fascinatingly, the majority of the cuts from the $1.2 Trillion over the next decade come from….the military.  So we’re in a situation where we’re now arguing about what to cut or if we can stem cuts with more tax increases.  The concern is that too much of a cut too soon will kill GDP growth further and hurt employment.  On the other side is the problem of borrowing $1 Trillion+ per year, which is not advisable (though many economists would debate that wisdom).

At this point, while Washington bickers about who’s to blame, should something go wrong, I think there’s an interesting situation emerging.  In the absence of any deal making, the cuts may stick, and oddly, that might be a good thing.  By forcing our own hands through an agreement no one wants to claim as their own, we may be pushed towards fiscal responsibility.  That might help.  For the past 5 or so years Washington has claimed cutting anything is toxic, a GDP killer.  So we borrowed over $5 Trillion (let me write that out for you $5,000,000,000,000) in loans to cover the past 4 years or so of spending.  Whacky.  That stimulus has come and gone though.  We can’t have unlimited stimulus, at some point there’s a diminishing return.  So now we’re left with trying to ease our way out of this spending spree, and maybe, just maybe, these unwanted cuts are the method of doing so.

We shall see.


Why the Federal Budget Matters….No Easy Way Out

February 21, 2013

There’s a dilemma in current political thinking that seems to only be resolved by the idea “well if we do it at the right time, it should be okay”.

That problem stems around the automatic cuts that are set to take place if some budgeting cannot be agreed upon by those on The Hill.  The problem stems from the fact that deep across the board cuts to federal spending will inevitably impact people by reducing direct payments to those being employed by the federal government, thus hurting employment and GDP.  So we’re told that we cannot have cuts, instead we need revenue increases to cover the deficit.  But…that means higher taxes (of some sort) and that also hurts GDP and employment.  So the other solution is to keep borrowing and hope everything gets better before that borrowing leads to inflation/deflation/or increased unemployment from excess of either.  Currently the Fed is the individual keeping interest rates low (somewhat artificially) by purchasing Treasuries to help maintain Federal Spending.  That’s a good thing for the time being and most countries would refer to it as “Quantitative Easing”.  We call it that here too, but in Washington there’s this pretend notion that somehow the Fed is non-political despite it having the political goal of maintaining low unemployment through currency.  That aside…

 

The Problem doesn’t appear to be easily resolved as it’s multi-faceted as most things are on this level.

  1. Any cuts to the Federal Budget would help to stem any threats from future inflation or deflation if things collapsed
  2. Any cuts to the Federal Budget would have an impact on unemployment and GDP, thus pushing us towards a recession.
  3. Any increase in revenues to offset cuts, would have an impact on lowering GDP and employment.

As we can see, there is no solution which somehow isn’t attached to negative consequences.  So while your favorite flavor political party is arguing the other side is wrong…they’re all somehow right.  What they continue to ignore is the consequences of their own opinion.  Thus we’ll look at it for them.  

Democrats – It is true that raising revenue could stem some of the cuts and produce a larger federal budget.  And while the mantra recently seems to be “tax the rich, they can handle it” what most people don’t understand is that the rich are often very clever and tied in politically with the people you’re telling to tax them.  So while the original intention is to increase taxes on those making loads of money, those people usually shift around their assets to be taxed the least, including moving things offshore (which if documented isn’t illegal).  So some will be clever and find manners to avoid paying too much (thus defeating the purpose) and others that do pay will then reduce employee monies (highering, growth, benefits…).  This isn’t as extreme as the right likes to pretend but nearly every economist on the planet (save maybe Paul Krugman) will tell you that it has some impact on growth, employment and GDP in a negative fashion.  That’s not good, but is it the best of all solutions?  We shall see.

Republicans – It is true that cutting deficits could stem potential future inflation.  While many at the Fed and around the country remind us that CPI doesn’t show inflation currently, that doesn’t mean that unlimited borrowing of around 1/15 of the GDP every year will have no effect.  Certainly if growth happens to slow from things outside of our control (ask Japan how that Tsunami worked out for their economy), then excess debt will have a major impact on bond rates and in effect the future size of the Federal Government during future problems.  That’s not good.  At the same time, the Fed is right.  We’re not seeing signs of runaway inflation and we’re actually seeing mild to low numbers and predictions from economists currently.  This suggests that the fear isn’t realized currently, meaning that borrowing isn’t hurting us currently.  So balance that out, if it’s not hurting us we can keep doing it, but we add in excess risk by doing so….even then we’d have to reign in future spending and predicting for things like disasters and war is nearly impossible.  So is the worry worth potentially crippling employment and growth?  We shall see.

 

Between those two scenarios lies the problem that gladly was brought on by forcing automatic cuts.  These two ideologies seem to have squabble for so long that they may have forced each other into a position where they’re forced to compromise.  As it turns out smart and efficient use of both cuts, future cuts, and increased revenues probably is the safest method to mitigate risk for the future (the Republican argument) and to not damage the present (the Democrat argument).  It turns out the solution to our problems might be to smartly address inefficient areas rather than pet projects.  This is where the awesomeness falls apart as usual in Washington.  Faced with the ability to realistically approach the situation from a bipartisan stance, backed into a compromise corner…both parties have hunkered down demanding that things not be cut.  That pet projects for districts or spending that helps their constituents not be cut one dime.  That revenues not move an inch on those deducting taxes from a vacation home or from millionaires not paying into SS beyond their cap.

 

My plea is to listen to the smart economists from both sides and to move forward and make a small sacrifice on both.  I don’t now if Washington will listen, as recently they’ve proven quite tone deaf.