Sequestration May Do Little to Reduce the Deficit

The billions of dollars in savings promised by the sequester could turn out to be no more than a pipe dream.

Planes line up for takeoff at Dallas Fort Worth International Airport in Grapevine, Texas. Most of the Federal Aviation Administration budget will be subject to the sequester cuts. Fully included in those cuts is the FAA’s “operations” account, which goes largely toward paying the salaries of our nation's 15,000 air traffic controllers who prevent our aircraft from running into one another in the skies. (AP/LM Otero)
Planes line up for takeoff at Dallas Fort Worth International Airport in Grapevine, Texas. Most of the Federal Aviation Administration budget will be subject to the sequester cuts. Fully included in those cuts is the FAA’s “operations” account, which goes largely toward paying the salaries of our nation's 15,000 air traffic controllers who prevent our aircraft from running into one another in the skies. (AP/LM Otero)

There is a right way and a wrong way to cut federal spending, but the sequestration plan about to go into effect is perhaps the most boneheaded approach that could possibly be concocted. There is finally a good deal of discussion about some of the major downsides of this deficit-cutting approach and its impact on public safety, military readiness, and the economy, but there is one fact about it that is not widely known and is not being widely discussed. The sequester won’t reduce the deficit by anything close to the $85 billion that’s being advertised. What’s more, it may not reduce the deficit at all. There are a number of reasons why this is the case.

First, user fees fund many of the functions of the government that are subject to the sequestration. To the extent that sequestration reduces the ability of government to perform these functions, these fees will not be collected.

Take, for instance, air traffic control. We spend a little more than $15 billion a year maintaining and operating our air-transportation system. Most of that money comes from user fees charged to airline passengers for air cargo and aviation fuel. If you buy a ticket to fly to Orlando, for example, you pay $3.90 to the Airport and Airway Trust Fund as part of the tax included in the price of your ticket. Last year the trust fund generated a little more than $11 billion—covering nearly 70 percent of the total expenses of the Federal Aviation Administration, or FAA.

Based on the Budget Control Act of 2011—which first introduced the sequester—most of the FAA budget will be subject to the across-the-board sequestration cuts even though the agency is largely funded by user fees. Fully included in those cuts is the FAA’s “operations” account, which totals about $9.7 billion a year and goes largely toward paying the salaries of the 15,000 air traffic controllers who prevent our commercial airliners and all other aircraft from running into one another in the skies.

As a consequence of the sequester, on March 1, 2013, the FAA—as well as most other domestic agencies—will have its annual budget cut by 5.3 percent. FAA operations will be cut by a little more than $500 million. Moreover, that reduction in funding will have to be taken from FAA operations for the remainder of the current fiscal year. Since we will be five months into the fiscal year on March 1, about 40 percent of that budget will have already been spent, leaving the agency with only 60 percent—or about $5.8 billion—from which to absorb a $500 million cut. That means a reduction of more than 9 percent in monthly spending for the rest of this fiscal year. A spending reduction of that size can only be accomplished by cutting work schedules, which means at least a 9 percent decline in the number of hours worked by air traffic controllers.

As the National Air Traffic Control Association pointed out in December, “Reduction in air traffic control services will ultimately result in fewer flights, creating a ripple effect that will hurt the airlines, pilots, flight attendants, private aviation, airport employees, passengers, and all of the businesses that depend on a vibrant aviation sector.” Moreover, fewer flights will also mean a reduction in payments into the Airport and Airway Trust Fund—from which most of the funds to operate the system are appropriated. The decline in air traffic will by itself offset much of the theoretical budget savings. If the 9 percent reduction in time worked by controllers results in only a 5 percent reduction in takeoffs and landings, the government will lose roughly $320 million of the $6.4 billion it would otherwise collect in user fees for the rest of the year. Even if one chooses to ignore the tax loss from the array of economic activities that most certainly will be impacted by a reduction in both flights and work hours for air traffic controllers, most of the assumed savings from the sequester will be lost through the reduced collection of user fees.

And the FAA is not an isolated case.

User fees are collected to offset at least a portion of the spending of dozens of government agencies, such as the Patent and Trademark Office, the Securities and Exchange Commission, the Food Safety Inspection Service, the U.S. Judiciary, the Food and Drug Administration, the State Department, and the National Park Service. Some agencies—such as the Patent and Trademark Office—generate more revenue than they spend. If agencies keep part of their workforce at home each day, the deficit will not be reduced. In fact, it will increase.

The loss of user fees, however, is not the only negative impact of the sequester. Many of the federal employees who will be furloughed are tasked on a day-to-day basis with collecting revenues, identifying overcharges by government contractors or service providers, and preventing fraudulent or inappropriate claims for government benefits.

The most notable example of this is the Internal Revenue Service, better known as the IRS. We will spend about $12 billion this year collecting the $2.7 trillion that will flow into the federal treasury. For every $100 we collect in taxes, we spend just 44 cents on the agency that operates the system. For years numerous observers such as the Government Accountability Office have argued that the money spent to operate the IRS is not nearly enough and that as a result large sums owed by tax cheats remain uncollected. In 2011 IRS Commissioner Douglas Shulman argued to the House Ways and Means Committee that cutting his agency’s budget would result in revenue losses approximately seven times the amount cut. Based on that arithmetic, sequestration will cut the agency’s budget by a little more than $600 million and result in a $4.5 billion loss in tax revenue.

The Centers for Medicare & Medicaid Services processes 1.2 billion Medicare claims each year, distributes and monitors $270 billion in Medicaid funds to the states, and certifies and monitors well more than half a million Medicare providers. They do this on a budget of $3.8 billion per year—about $320 million a month. That monthly budget will be cut by 9 percent on March 1 if sequestration goes into effect, but the agency’s workload will not be cut at all. Even if the percentage increase in the number of erroneous or excessive claims that make it through the system as a result of this cut is relatively small, the dollar impact will be large considering that the agency will make more than $300 billion in payments to providers over the coming seven months.

Nowhere is the issue of money management under sequestration more problematic than at the U.S. Department of Defense. Largely because the pay of uniformed service personnel has been exempted from sequestration, the percentage cut to the rest of the department will be larger than in nondefense programs. The size of the cut against the department’s annual budget of activities subject to sequestration will be about 9 percent. For those programs that spend money at a fairly uniform monthly rate during the year, however, the entire 9 percent cut will have to be taken out of the program’s budget during the remaining seven months of the year, resulting in what will actually be more than a 15 percent cut during that period. For most office at the Department of Defense, the magnitude of that cut will translate into about 22 days of furlough for every employee.

The American taxpayer will pay a price for these furloughs in a number of ways. Most of the talented and best-performing people on the Department of Defense workforce, for example, are certain to have second thoughts about a career in government service if their paychecks shrink by more than 15 percent between now and October. Another effect will be the cost of buying the equipment that our military needs to maintain its capability to fight.

Making this situation even more complicated—and fiscally destructive—is the fact that many of the agreements that the Department of Defense has with its vast network of contractors are based on a certain volume of demand. Whether the military is buying truck tires, ammunition rounds, or steel pots, contractors make their bids based on being able to distribute their fixed costs among a certain number of units. Sequestration will force the Pentagon to fall below that level of purchasing for many of items in the defense supply chain. As a result, many contractors will be entitled to renegotiate the price of their goods. That will be an expensive proposition for the government in terms of the cost of the renegotiation and the fact that the Pentagon will end up paying more per unit of items required for the defense inventory. But even worse, these renegotiations will come at precisely the same time that a significant portion of the Department’s procurement workforce is being sent home on furlough. This is a scenario that could very well be a bonanza for some contractors—but it will certainly not produce good results for the taxpayer.

Another example of the true cost of sequestration is its impact on the Defense Contract Audit Agency. This agency has about 5,000 employees and an annual budget of roughly $500 million. The agency examines not only contractor performance on contracts that have been completed, but also pricing proposals on contracts that are about to go into effect. In their budget submission to Congress for fiscal year 2013, the agency pointed out that they recover more than five times as much in savings as they spend on operations:

The DCAA continues to return savings to the Government that exceed the cost of its operations. In FY 2011, the Agency audited $19 billion of costs incurred on contracts and reviewed 2,681 forward pricing proposals amounting to $103 billion. Approximately $3.5 billion in net savings were reported because of the audit findings. The return on taxpayers’ investment is approximately $5.80 for each dollar invested ($600 million in FY 2011, including reimbursable).

Sequestration will force a $45 million cut to the Defense Contract Audit Agency’s budget, compelling its 5,000 audit personnel to give up a collective 110,000 work days over the next seven months. Not only will the backlog of unaudited contracts grow exponentially, but the $45 million so-called savings is also likely to translate into $315 million in government overpayments to contractors.

The most significant negative impact of the sequester on the budget will be the loss of revenue due to slower economic growth. The Congressional Budget Office, or CBO, recently estimated that sequestration would cost as many as 750,000 jobs by the end of this year and slow economic growth by about 0.6 percent. According to the Congressional Budget Office:

If all of the fiscal tightening still embodied in current law for 2013 was removed, growth in real GDP [gross domestic product] would be about 1½ percentage points higher this year than CBO currently projects. About 1¼ percentage points of that effect comes from the automatic reductions in federal spending … the expiration of the cut in payroll tax rates, and the increase in marginal tax rates on higher income; the spending changes and the combined tax changes account for about equal portions.

If sequestration represents half of the 1.25 percent reduction in growth projected by the Congressional Budget Office, that amount would equal the loss of about $100 billion in GDP. Because we are expected to collect about 17 percent of GDP in revenues in 2013, the loss to the Treasury would be on the order of $17 billion.

Such estimates, however, are based on macroeconomic modeling, which simply takes the $85 billion cut required by the sequester and extrapolates its impact based on the percentage of total GDP that it represents. But as an economic event, sequestration is likely to have a grossly disproportionate impact. There are hundreds of little bombshells in this package of cuts, and each could seriously impact various segments of the economy in a very disproportionate manner.

The half a billion dollars saved by furloughing air traffic controllers, for example, will do far more than simply leave these men and women with less money in their pocket and less money to give their barber or dry cleaner or local restaurant or clothing store. These workers serve as a linchpin for several large and vital industries. If a 9 percent reduction in air traffic controllers led to a 5 percent reduction in flights, there would be major repercussions on the airline industry—on the employees who make reservations, the baggage handlers, the pilots, and the flight attendants. Those who work in airport concessions, drive taxis, or work in car rental kiosks would also be impacted. There would be lower occupancy rates at airport hotels and probably a significant hit to the nation’s tourism industry in general.

The same is true for Food Safety Inspection Service workers, who must by law be present when meat and poultry packing and processing plants are in operation. There is a significant risk that too few inspectors would be available to allow such facilities to operate at their current levels, which in turn would cost jobs throughout the beef, pork, and poultry industries.

U.S. State Department Consular offices around the world are already operating with serious backlogs of unprocessed visa applications. Sequestration would force a significant increase in wait times for these documents, and cities dependent on foreign tourism—such as New York, Las Vegas, Miami, and Los Angeles—would suffer. Ports of entry would also be affected, both in terms of the waiting time for passengers to clear immigration and customs, and in terms of the parts and goods imported into American markets.

The list goes on. The point is this: Government is intertwined with private-sector activity throughout much of the economy, and in many instances, a reduction in government activity will cause commensurate reduction in private-sector activity. That will damage not only the nation’s economy but also the revenue that the government collects based on the strength of the economy. It is difficult to project with any accuracy how much overall economic activity might be affected by the sequester, but it is very likely that it will be by an amount much larger than is projected by standard econometric modeling.

There are alternatives to this half-witted approach to fiscal austerity. There is no excuse for the Medicare Trust Fund to pay top dollar for prescription drugs used by its beneficiaries. The farm program no longer serves to protect family farmers and thus should have been ended years ago. There are numerous loopholes that should be closed in the tax code, and improving—rather than diminishing—our capacity to collect taxes would make a significant down payment on the level of deficit reduction that is needed. Likewise, there are private interests that get government services for free or at a steep discount; these private interests ought to be paying a fair price for those services. In addition there is significant waste throughout government in both military and nonmilitary programs. That waste will not be addressed unless Congress takes the time to do the oversight that is required. Unfortunately, doing so takes work, and that is something this Congress seems committed to avoiding.

In the seven weeks since the new Congress has convened, the House has scheduled legislative session on only 14 days. Most of those days have been partial work days, where members were not required to be present before 6:30 in the evening—and even then, they only cast a few quick votes before going to dinner in the evening or heading to the airport by early afternoon. In terms of full legislative work days, there have been only four—and those have occurred during the middle of the policy crisis that is certain to inflict lasting damage on the nation’s economy if it is not resolved. Looking forward, the House will have six full legislative work days in March before going home for a full week at the end of March—a vacation that continues for another full week at the beginning of April. By the end of April, the House is out for another week. Nice work if you can get it.

Making wise choices about where to spend taxpayer dollar takes hard work. It takes an understanding of what government programs are supposed to accomplish, what they are actually accomplishing, and what would happen if they were severely curtailed or cut altogether. That is the job the Constitution assigned to the Congress and—most especially—to the House of Representatives. That job is not being done, and the sequester is Exhibit A.

When all of these impacts are added together the savings that can reasonably be expected from sequestration is far less than $85 billion promised, and the fact is there could be no savings at all.

Scott Lilly is a Senior Fellow at the Center for American Progress.

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Scott Lilly

Senior Fellow