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By Steve Levy

Sequestration--Small but Stupid

Uploaded: Feb 26, 2013

Federal budget spending will be reduced by $85 billion from current levels starting on March 1 if no action is taken to modify or postpone the sequester.

These reductions are small in relation to the overall economy, poorly targeted in terms of promoting economic growth or attacking the major causes of spending growth and stupid, as they were planned to be in the hope the both political parties would come together to develop a smarter approach to deficit reduction.

The reductions are small in the sense that the $85 billion would reduce growth in the economy by perhaps 0.5% from say 2.2% to 1.7% in 2013. Job growth might be reduced from 2.2 million jobs to 1.5 million. But even this is an exaggeration of the immediate impact because half of the budget reductions would be for spending authorized this year but to take place later.

In characterizing the job cuts, many media reports mention the number of jobs that will or could be affected by furloughs. So the number 64,000 is mentioned as potential civilian defense job cuts, when in fact that is the total number of civilian defense jobs in California for which some workers will be asked to take one day off every two weeks without pay. I don't mean to minimize the impact of these cuts on individuals and specific services but a furlough is different from a job loss.

Because the cuts are targeted some areas of the economy and public services would be hit harder while others including Social Security, Medicaid, most of Medicare, food stamps, the active military force and most veterans programs would see no reductions.

There could well be service reductions at airports as air controllers and TSA personnel take furlough days—one unpaid day off every two weeks. The same is true for national parks and the federal programs for education—special education, school lunches, and Head Start—will see budget reductions. And under the sequester plan, half of the budget reductions would come in defense spending on non-military personnel and contracts.

I characterize the planned sequester as stupid for several reasons. One is that the sequester only addresses one of the major spending areas in the budget—defense—and leaves unaddressed major benefit programs in health care and elsewhere. These benefit programs should be included in any successful long-term deficit reduction plan.

Two, the sequester does include areas of investing for our future where I think preparing for future prosperity requires more, not less funding. This includes areas of investing in people, research and infrastructure—all foundations for economic growth. So the sequester includes reductions in grants to universities and other organizations for research in health, energy and technology—all of which take us in the wrong directions in terms of preparing for the future.

The big money is in defense and benefit programs including the largest cause of long-term budget fears, rising health care costs combined with an aging population.

So one debate over deficit reduction is what is the smartest way to allocate the reductions, which are often reductions in the growth of spending. Citizens or political parties saying "not here" are not helpful to reaching agreement on "if not here, then where".

The planned sequester also does not include two elements of smart long-term deficit reduction where the political parties have strong to moderate disagreement.

There is strong disagreement about whether reducing tax credits and deductions for individuals and corporations should be part of deficit reduction. We have settled the issue of tax rates but, for example, Martin Feldstein, a conservative economist, wrote recently in the Wall Street Journal that a 2% cap on tax deductions and exclusions would reduce the federal deficit by $2 trillion over a decade.

Obviously the more that deficit reduction occurs from raising revenues through reducing deductions and tax credits, the less that will have to come from service cuts or reductions in payments to individuals.

The second principle, on which there should be some agreement, is that deficit reduction should start small but build over time. Starting small is to avoid restraining growth at a time when we are still digging out of the recession.

Building deficit reduction over time is because the problem just gets worse in the second ten years so solving the problem only until 2022 does not solve the problem.

There are some obvious deficit reduction ideas that embody both starting small and building to a larger level over time.

Changing the price index used to calculate Social Security and other benefits that go up with inflation is one such approach. If there is $1 trillion in payments per year tied to price increases and we lower the inflation adjustment by 0.5% per year, the savings are $5 billion in the first year, $50 billion in the 10th year and $100 billion in the 20th year.

Similarly if we ask all but the poorest residents to pay a slightly higher share of Medicare costs, the amount of savings would increase each year as health care and Medicare costs go up.

And Feldstein suggests that we can phase in the 2% cap on deductions, in line with the idea of starting small and building to a larger deficit reduction as the economy improves,

If we can come together and address the major areas of budget spending—defense and benefit programs—and allow a portion of deficit reduction to come from reducing tax deductions and credits (we can argue whether this should be limited to people making more than $400,000 or $200,000 or $100,000), then we will reduce the deficit successfully and for the long-term.

That will leave us space to invest more, not less, in our children, in our infrastructure and in federal support for science and R&D funding—all especially important to California and Silicon Valley.