Is the ‘Sequester’ Smart for Deficit Reduction?

Almost everyone agrees that the so-called “sequester” in its current form, which cuts about $1.2 trillion in federal spending between defense and non-defense programs indiscriminately, is a bad idea. The oft-used Washington metaphor is between taking a hatchet to the federal budget versus using a scalpel. Cutting the funding of most discretionary programs, such as the National Institute of Health or the Naval Forces, by a specific percent means key services will be eliminated, though they might have been salvaged through more specific spending cuts.

Of course, the irrationality of the sequester was designed to force Congress to come up with better deficit reduction. Those ideas for smarter deficit reduction are now in jeopardy, given the posturing and lack of progress between President Obama and Congressional Republicans. The sequester, though, does raise questions over which areas of the federal budget need trimming in order to maintain a sustainable long term deficit.

I’ve written before about how deficit reduction is overblown in today’s environment. Classical economics argues that by running a deficit, the government must borrow money to pay its debts and crowds out investment spending by increasing interest rates. However, this is not a serious concern today given that 10 year interest rates are at historic lows. In fact, given that real interest rates are negative in the short to medium term, now would actually be a good time for the government to borrow money and increase our deficit spending. Free money is, after all, a good thing.

Although deficits have gone up more rapidly since the start of the recession, running deficits is a typical characteristic of recessions, considering the decreased tax revenue and the cost of increased unemployment benefit payments. Paul Krugman has worked to show that federal spending as a percentage of potential GDP, or GDP if we were at a full employment economy, went up about 4% during the Bush years and has gone down more than 2% since the end of the recession in 2009. So for right now, we’re doing okay with the deficit.

But that doesn’t mean there isn’t a long term concern with respect to the deficit. If the ratio of public debt to GDP surpasses 90% or so in the future, that could represent real economic danger. Not only does the retirement of the Baby Boomers threaten to hike up Medicare and Social Security expenditures in the decades to come, American health care costs per citizen are the highest in the developed word. And health care spending is only scheduled to grow in the years to come. This graph from the Bipartisan Policy Center demonstrates this growth well:

Of course, one of the primary goals of the Affordable Care Act was to reduce health care costs. It remains to be seen whether the bill will accomplish that, but growth in health care spending relative to growth in GDP has slowed down over the past few years—a hopeful sign for health care spending. But if the Affordable Care Act can’t contain the long term growth of health care costs, it may need significant revision or adaptations.  Under Obamacare, the federal government will generously assist states in providing eligibility for Medicaid to those making 133% of the poverty line, meaning health care expenditures should increase significantly in the next few years.

What does all of this mean for the sequester and our recent efforts to implement deficit reduction? The sequester focuses on defense and non-defense discretionary spending, though the driver of deficit growth is clearly health care spending. Granted, some believe we should decrease defense spending because our military is too big or that we spend too much money on wasteful transportation projects. But for the purposes of deficit reduction, neither is a sensible policy.

The smarter, more sensible approach would be a restructuring of Medicare and Medicaid spending to make the programs more sustainable in the long term. This might mean a switch from fee-for-service health care payments, as Obamacare intends to do, or it might require another policy restructuring altogether.  

Yet Medicare and Medicaid escape the spotlight because of politics. It’s easier to cut funding for the NIH than it is to cut Medicare spending.  No politician wants to look like he’s pushing seniors off the cliff

A lot of discretionary programs, including the National Weather Service and the Federal Aviation Administration, do some very important things that we take for granted, and the sequester threatens the effectiveness of these programs. The sequester will have a lot of immediately bad impacts on postal delivery, flight schedules, law enforcement and other important things that the government does. 

But rather than solve the real issue of deficit reduction, Republicans will probably take the non-defense cuts, while Democrats accept the defense reductions. Both sides achieve part of their respective ideological agendas, while making the country worse off.  


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