No Cheers for Sequestration

Josh Barro is the lead writer for the Ticker, Bloomberg View's blog on economics, finance and politics. His primary areas of interest include tax and fiscal policy, state and local government, and planning and land use.
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Over at Slate (naturally), Matt Yglesias writes that, as ways of cutting the deficit go, the sequester actually isn't so bad. He says: "if you're a 'defense' dove like me and have a non-utopian view of the domestic discretionary budget then this looks like we're mostly talking about harmless spending cuts." Therefore, he says, it's better to let it hit than to repeal it.

This is wrongheaded for three reasons.

1. Yglesias underestimates the magnitude of the negative economic impacts of the sequester, which hurts in two ways. One is that deficit reduction is destimulative, a fact that would be similarly true of any sequester replacement with the same deficit impact. The other, unique to the sequester, is that it is haphazard and unpredictable. An alternative deficit-reduction plan could provide clarity about who would lose their jobs and whose contracts would be axed. The sequester will force households and businesses to operate in an environment where they don't know what government spending is coming; some will cut back on consumption and then get the payments they expected all along.

So even if you like the sectoral arrangement of the sequester (no tax increases and very limited hits to entitlements), you have to think about whether you are OK with the mess and uncertainty it creates. Like Yglesias, I'd like to see significant cuts in the defense budget. But I'm not inclined to take them in the haphazard and unpredictable form the sequester offers.

2. The sectoral arrangement of the sequester isn't that awesome. Nondefense discretionary spending is headed toward historically low levels; the president's budget will have this category at 2.8 percent of gross domestic product by 2017, the first time it has been below 3 percent in more than 50 years. Yglesias is right that there is lots of waste in this category, but there are also lots of good projects that aren't being funded now, even before the sequester. A further aggregate cut of 8 percent is not desirable, especially because the existence of wasteful spending the budget now demonstrates that cuts do not necessarily fall where they should.

On the defense side, we are also headed to unusually low spending levels (2.9 percent of GDP by 2017, also a record postwar low), though in this area I think record reductions are desirable. But is the sequester really a rare opportunity to achieve defense spending cuts that we must seize despite its flawed structure? Mitt Romney talked about keeping defense spending at 4 percent of GDP, but both President Barack Obama's budget and that of the House Republicans contemplate much lower levels. Republicans' apparent willingness to let the sequester hit is a reflection of how defense hawks' influence in the party has declined, and I expect future opportunities to cut military budgets even if the sequester is unwound.

3. What would be so terrible about "straightforwardly undoing" the sequester? Interest rates are extremely low, and it doesn't appear that government borrowing is crowding out private-sector activity. Austerity is much more likely to harm the economy by suppressing demand than to help it by freeing up capital for private investment. Yglesias allows that there are better deficit-cutting alternatives than the sequester, but he doesn't explain why any of them are better than the option he claims to be taking down: replacing the sequester with nothing.

If we must have a deficit-reduction package, the president's proposed terms are much better: further cuts to Medicare and some nonrate tax-revenue increases. These types of deficit-reduction measures would have limited negative impacts on the economy if designed right, though the specific tax-increase mechanisms Democrats have been floating, designed to entirely avoid taxpayers earning less than $250,000, are gimmicky and inefficient. My most preferred option is to wait a year or two before doing any sort of deficit-reduction package.

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