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Sequestration Takes a Big Bite out of Economic Growth

President Obama

SOURCE: AP/ Charles Dharapak

President Barack Obama speaks about the sequester in Washington, D.C.

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The U.S. economy shrank by 0.1 percent in the fourth quarter of 2012—a bad omen for the economic recovery achieved since the end of the Great Recession in 2009.

After growing 3.1 percent in the preceding quarter and 2 percent on average in the previous four quarters, the U.S. economy is on the edge of recession once again. Thanks in no small part to the concerted campaign for budgetary austerity from conservatives in Congress, this abrupt slowdown of the economy is taking a national economic toll—largely resulting from the repeated fiscal cliffs and crises that have thrown a wrench in the path of sound management of the government’s fiscal policy.

The next episode in this saga is due on March 1, when automatic across-the-board spending cuts mandated by the Budget Control Act of 2011 are set to take effect, and $85 billion must be cut from the federal budget from March through the end of 2013.

Figure 1 illustrates the economic effects of recent and pending fiscal contractions—and the uncertainty created by politics—on the growth of the U.S. economy in our near future.[1] The economic costs of fiscal contraction can far outstrip what could be gained from slashing federal spending, as contraction translates into lost jobs and more limited investments, and as the ramifications eventually ripple throughout the entire economy.

The U.S. gross domestic product stood at $15.8 trillion in the fourth quarter of 2012. In the fall of 2012, the Congressional Budget Office estimated that if Congress were to reverse the series of tax changes and spending cuts due at the start of 2013—known collectively as the fiscal cliff—it would boost real GDP by 3 percent, or $16.3 trillion, by the fourth quarter of 2013.

The 11th-hour deal negotiated by the White House, House Speaker John Boehner (R-OH), and Senate Minority Leader Mitch McConnell (R-KY), and passed on New Year’s Day, delayed the sequester spending cuts until March 1 and managed to forestall only a portion of the fiscal contraction by altering part of the tax code. As a result of this contraction and the grinding of policy uncertainty on the economy, on February 5 the Congressional Budget Office projected a new, lower baseline for economic growth of 1.8 percent through the fourth quarter of this year—a loss of potential U.S. economic output of $190 billion.

The sequester is set to do more damage to the U.S. economy if politicians fail to stop it. Figure 1 also shows that the projected effect of the sequester will be to lower U.S. economic output by $287 billion from where we would be without any fiscal contraction—barely ahead of where the U.S. economy was at the end of 2012. To be certain—with sequestration on top of other fiscal contraction draining so much momentum—the U.S. economy would need to steer clear of all other risks to growth: potential oil- and commodity-price shocks, slowing global demand for U.S. exports, and the faltering confidence in the governability of U.S. economic policy. It is possible none of those risks will rear their ugly heads in the next year, but it would be foolish to bet America’s economic future on it.

That the push for fiscal austerity is stalling the U.S. economy and threatening another recession is only the tip of the iceberg. It is also standing in the way of reviving growth and the foundations for sustaining broadly shared economic prosperity: investments in education, infrastructure, energy, and scientific research. What’s more, sound economic growth policies lie well within our means. As John Makin and Daniel Hanson, economists at the American Enterprise Institute, write: “[D]eficits have been, and will continue to be for some time, eminently sustainable.” But the sequester, according to Makin and Hanson, “could cause a US recession.”

With the economy needing $900 billion more demand to operate at full employment levels—the GDP needed to get unemployment down to 5 percent—conservatives in Congress need to stop standing in the way of efforts to fill this hole, let alone digging it one-third deeper.

Adam Hersh is an Economist with the Economic Policy team at the Center for American Progress.

[1] The economic growth effects of various fiscal policy choices over the course of 2013 is based on: Congressional Budget Office, “Economic Effects of Policies Contributing to Fiscal Tightening in 2013” (2012), available at http://www.cbo.gov/sites/default/files/cbofiles/attachments/11-08-12-FiscalTightening.pdf; and analysis of CBO and BEA data in: Adam Hersh, “Fiscal Austerity Threatens U.S. Economy” (Washington: Center for American Progress, 2013), available at http://www.americanprogress.org/issues/economy/report/2013/01/30/51146/fiscal-austerity-threatens-the-u-s-economy/.

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