Why Sequestration May Not Actually Reduce America’s Deficit

The United States is on the brink of sequestration, the $1.2 trillion in automatic budget cuts included in the summer 2011 deficit deal that will begin taking effect March 1 if Congress does not act to avert them. The goal of the cuts is to reduce America’s budget deficit, which remains Washington’s focus even as unemployment is high and the overall economic recovery is modest at best.

Despite the $85 billion in cuts that will take place this year, it is entirely possible that sequestration won’t actually lead to substantial shrinking of America’s deficit. There are a number of reasons for that, as Scott Lilly from the Center for American Progress explained in a column today. The primary reason, though, is that fiscal contraction caused by sequestration is likely to slow economic growth, reducing tax revenue and preventing meaningful deficit reduction, as CAP’s Adam Hersh notes:

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.

Lilly estimates that the cuts could result in $17 billion in lost revenue this year, but because reducing government investment will also inhibit private sector growth, the effects may be even bigger than the Congressional Budget Office projects:

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.

It may seem counter-intuitive to say that cutting spending won’t reduce the deficit, but Europe provides evidence that that could be the case. The result of fiscal contraction in Europe has been slower economic growth, second (and possibly third) recessions, and high unemployment, all of which has hampered deficit reduction efforts. Spain and France have both missed deficit reduction targets because of slow growth. When the United Kingdom’s austerity efforts began in 2010, finance leaders projected its deficits would fall from 4.8 percent of the total economy to just 1.9 percent by now. Instead, three years and a second recession later, it stands at 4.3 percent.

If America’s goal is to reduce long-term deficits and debt, the fastest way to do so would be to invest more money now into programs that will foster job creation and economic growth. Previous economic downturns were bolstered by government spending, and the current recovery was aided by initial efforts to stimulate the economy. Focusing on spending cuts and other austerity measures now, however, will only hamper growth, meaning, as Lilly wrote, “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.”