Jan. 31 (Bloomberg) -- As the U.S. gross domestic product takes a hit from lower defense budgets, federal spending cuts viewed as unthinkable a few months ago -- $1.2 trillion falling heavily on the Pentagon -- are seen as likely starting March 1.
What’s known as budget sequestration, designed to be so draconian that it would push Democrats and Republicans to compromise on taxes and spending, has hardened the parties’ positions. If the cuts occur, they would require $600 billion in across-the-board military spending reductions over a decade that Defense Secretary Leon Panetta called “devastating.”
While leaders of both parties and President Barack Obama pledged that the cuts wouldn’t happen, they haven’t been able to reach an agreement to prevent it. That may have economic consequences. A 22.2 percent decline in defense spending contributed to yesterday’s Commerce Department estimate that the gross domestic product shrank at a 0.1 percent annual rate.
House Republican leaders, weakened by Obama’s re-election and Democratic gains in the House and Senate, are resigned to accepting the cuts rather than risking a deal with Obama that would mean higher taxes. Democrats see little political benefit in accepting Republican offers to forestall the reductions in exchange for cuts to entitlement programs such as Medicare.
“I want to make sure we save that money,” said Senator Lamar Alexander, a Tennessee Republican. “I’m not going to vote to change it unless we replace it.”
White House press secretary Jay Carney yesterday accused Republicans in Congress of playing “political brinkmanship” by talking about “letting the sequester kick in as though that were an acceptable thing.”
The uncertainty about government spending is creating “major headwinds” for the economy, Carney said.
Alan Krueger, chairman of Obama’s Council of Economic Advisers, said the GDP report emphasizes the need for legislation that stops the automatic spending cuts “to avoid self-inflicted wounds to the economy.”
Congress must “move toward a sustainable federal budget in a responsible way that balances revenue and spending, and replaces the sequester, while making critical investments in the economy that promote growth and job creation and protect our most vulnerable citizens,” Krueger said in an e-mailed statement.
Yesterday’s economic report may not change the underlying political standoff that has prevented Congress from avoiding sequestration.
“Republicans in general, we desperately want a reduction in spending to get government back into balance,” Representative John Fleming, a Louisiana Republican, said in an interview. “We would rather take some cuts in areas that we are not comfortable with than have no cuts at all.”
Some Republicans view their position as a “negotiating tactic” to force Democrats to bargain, said Keith Hennessey, a former economic adviser to President George W. Bush.
Many programs that Democrats care most about would be reduced. According to a report by Obama’s Office of Management and Budget, sequestration would impose cuts of 2 percent to Medicare providers and 7.6 percent to non-defense programs such as TANF, or temporary assistance for needy families. Special education programs could face cuts of up to 8.2 percent.
Senator Bob Casey, a Pennsylvania Democrat, said “neither party can afford to allow” the sequester. Republican comments predicting no deal to replace it may just be political posturing, he said. “I wouldn’t put too much stock in those right now,” Casey said.
The fourth-quarter decline was expected after a higher-than-usual increase in the previous quarter, said Kevin Hassett, a senior fellow at the American Enterprise Institute in Washington, which favors smaller government.
Defense spending was accelerated into the third quarter of last year, which “artificially boosted” growth ahead of the November election to 3.1 percent, Representative Kevin Brady, a Texas Republican, said in a statement.
“Sequester is not to blame,” he said. Defense spending in the last two quarters averaged about the same as in the first half of the year, said Brady, chairman-designate of the Joint Economic Committee.
Congress should replace the automatic cuts with deeper, long-range cuts in entitlement programs, said Hassett, who was an economic adviser to Mitt Romney, the 2012 Republican presidential candidate.
Still, allowing the automatic cuts to take effect won’t be economically damaging and could help signal to private investors that the government is serious about deficit reduction, Hassett said.
Congress created the automatic cuts in August 2011 as part of an agreement to raise the debt ceiling and create a deficit-reduction supercommittee.
While Panetta once called the automatic cuts a “doomsday mechanism,” Deputy Defense Secretary Ashton Carter said in an interview yesterday that it is now “more likely than unlikely” that sequestration will go ahead.
Senate Armed Services Committee Chairman Carl Levin, a Michigan Democrat, said allowing the spending cuts to take effect would damage the economy and national security.
“Today’s GDP report demonstrates what is at stake economically,” Levin said in a statement yesterday. “Top economists have warned us that sequestration could send us back into recession, and we should heed their warnings.”
California Republican Buck McKeon, the House Armed Services Committee chairman, said the GDP report is “disturbing” while also reflecting testimony before his panel a year ago “predicting just this result.”
“This is just the first indicator of the extraordinary economic damage defense cuts will do, in addition to the national security crisis that will follow,” McKeon said.
The automatic cuts would affect programs Democrats and Republicans care about. Defense programs now face a 7.3 percent, or $42.7 billion, cut during the last seven months of fiscal 2013. Nondefense budgets also would be cut by $42.7 billion. The cuts would affect Medicare and many federal agencies while exempting Social Security benefits.
Republicans have been particularly outspoken in warning of the potential harm of the defense cuts.
Senators John McCain and Lindsey Graham planned to tour states including Virginia, North Carolina and Florida to highlight the effects on jobs. McCain and Graham issued a statement in November 2011 saying the cuts “cannot be allowed to occur,” and Senator John Cornyn of Texas called them “truly draconian.”
“We don’t like the kind of cuts,” said Fleming, citing the military cuts. “Still it puts us on an even playing field with Democrats because it is going to cut some things they don’t like too.”
The cuts were scheduled to take effect Jan. 2, 2013. As part of the deal that let tax rates rise for top earners, Congress delayed the start date for two months by finding $12 billion in other spending cuts and $12 billion in revenue.
The administration and Democrats see that action as a precedent for what Obama calls a “balanced” approach that replaces the cuts with spending cuts and tax increases.
House Speaker John Boehner and Budget Committee Chairman Paul Ryan are among Republicans striking a different tone now that the cuts appear to be their best chance to wring spending reductions from Obama. Ryan was the Republican vice presidential nominee last year.
Last year, Boehner, of Ohio, warned that the cuts would “hollow our military,” and Ryan, of Wisconsin, said they would “undercut” critical government operations. Now, Boehner said he has support in his conference for the sequester, and Ryan said last weekend on NBC that it “is going to happen.”
The Republican Party has been losing ground in showdowns with Obama over the budget deficit. Earlier this month the Republican-led House passed an increase in the nation’s borrowing limit with no offsetting spending cuts, abandoning a litmus test known as “the Boehner rule.”
Also, Republicans on Jan. 1 passed legislation that included income-tax rate increases for top earners.
That contrasts with the deal on the table in 2011 before deficit-reduction talks between Obama and Boehner fell apart. Obama had tentatively agreed only to revenue increases by targeting exemptions and credits instead of tax rates. He was considering $250 billion in cuts to Medicare and changing the formula for Social Security cost-of-living adjustments, for about $125 billion more in savings.
“Republicans should have struck a deal at that point,” said Alan Viard, a former economic adviser to Bush and a scholar at the American Enterprise Institute. “That’s the gamble you always take if you don’t take a deal at a particular time.”
Senate Budget Committee Chairwoman Patty Murray, a Washington Democrat, said in an e-mailed statement, “I certainly hope this retreat continues” and Republicans continue to move “toward the balanced approach the American people expect.”
To contact the editor responsible for this story: Jodi Schneider at firstname.lastname@example.org