GOLDMAN: Hide Your Kids, The Sequester Is Coming

Goldman's Alec Phillips writes in a note that the automatic spending cuts required by the so-called "Sequester" (the spending caps imposed by the 2011 debt ceiling deal) are now a matter of "when" and not "if."

He examines the sequester as part of the broader fiscal triple threat that we're seeing right now: Debt ceiling + ongoing budget resolution + sequester.

While the debt ceiling has the potential to do the most damage, from a probabilistic standpoint (because the debt ceiling is unlikely to be breached) the sequester has the most potential to do real harm.

He writes:

Allowing the sequester to hit would, in our view, have greater implications for growth than a short-lived government shutdown, but would not be as severe as a failure to raise the debt limit. Although Republicans in Congress generally support replacing the defense portion of the sequester with cuts in other areas, there is much less Republican support for delaying them without offsetting the increased spending that would result.

Phillips goes on:

If the sequester were fully implemented, it would have very disruptive effects in some areas of the budget, particularly defense. In order to fulfill the requirements of the sequester, the Department of Defense (DoD) would need to reduce spending authority by around 9% for FY2013. The administration would have little flexibility in how to implement this cut, so every program, project, and account would need to be cut by the same amount. This would mean, for example, furloughing most civilian DoD employees for a full month before the end of the fiscal year, and cutting basic activities like healthcare for active-duty military and aircraft maintenance.On the non-defense side, the cuts would be similarly disruptive though the political effects might not be as salient.

Sequestration would be much more disruptive in 2013 than it would be in 2014 and beyond. The budget agreement that Congress reached in the summer of 2011 cut spending through two mechanisms: (1) annual caps on congressional appropriations and (2) the sequester, which cuts the level of spending authority by $109bn below the cap just mentioned. Since the 2011 law called for sequestration to take effect January 1, 2013--three months into the fiscal year--it was structured as an across the board cut to the spending level already in place. For 2014 and beyond, the sequester simply lowers the cap mentioned earlier by an additional $109 billion. That means that instead of across the board cuts, for FY 2014 and beyond Congress can appropriate funds as it sees fit as long as it stays below the caps. Delaying the sequester to the start of the coming fiscal year would not simply "kick the can" on fiscal restraint but it would also allow a less disruptive and more efficient cut to be implemented.

This chart shows the various fiscal drags the economy is experiencing, including the spending cuts.

Goldman Sachs

For a further look at the economic impact of the sequester, see here >