Budget Cuts Seen as Risk to Growth of US Economy

Rep. Lynn Jenkins., House Speaker John Boehner and Rep. Cathy McMorris Rodgers after the House Republican Conference meeting on Feb. 13.
Bill Clark | CQ Roll-Call | Getty Images
Rep. Lynn Jenkins., House Speaker John Boehner and Rep. Cathy McMorris Rodgers after the House Republican Conference meeting on Feb. 13.

The fresh round of federal spending cuts scheduled to begin next week would slow economic growth in the next year, though not nearly as much as going over the so-called fiscal cliff might have, economists said.

The cuts — a result of a policy known as sequestration — most likely would reduce growth by about one-half of a percentage point in 2013, according to a range of government and private forecasters.

That could be enough to again slow the arrival of a recovery, producing instead another year of sluggish growth and high unemployment.

Such economic forecasts are even cloudier than normal because of uncertainty about the cumulative impact of the rounds of federal spending cuts and tax increases in the last few years. Whether the government's repeated flirtation with fiscal turmoil is causing businesses to postpone or reduce planned investment is also unclear.

Some evidence suggests that companies, particularly in the military industry, cut investment last year in anticipation of sequestration, which was originally scheduled to begin Jan. 1.

The Commerce Department estimated that the economy shrank slightly in the fourth quarter.

Consumer spending remained relatively strong last year, but may have weakened early this year after an increase in payroll taxes, part of a deal to avoid the worst of the fiscal cliff tax increases and to delay its spending cuts.

"Where are all the customers? And where's their money?" a Wal-Mart executive wrote in a February e-mail obtained by Bloomberg News, bemoaning a sharp decline in sales. Wal-Mart sales accounted for more than 2 percent of domestic economic activity in recent years.

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Many economists are particularly critical of the arbitrary nature of the cuts, arguing that Congress could reduce annual deficits by the same amount with far less economic damage by spreading the cuts across a broader range of programs, directing them at lesser priorities or giving government agencies more discretion in how they make them.

"There's a better way to do this," said Joel Prakken, chairman of Macroeconomic Advisers, a forecasting company based in St. Louis. Still, he and others emphasized that the impact would most likely not be nearly as bad as the cost of the tax increases and spending cuts that had been scheduled to take effect Jan. 1.

"Even though it's bad policy, the macro effects are small compared with going over the fiscal cliff," he said. "That was a recession. This is a deceleration."

The cumulative effect of the sequester and the tax deal struck in January might slash economic growth by as much as 1.25 percentage points — from a growth rate that otherwise might have been more than 3 percent — in 2013, economists estimate. Mr. Prakken predicts that the economy still would grow at about the same 2 percent annual pace it has managed in the years since the recession.

Sequestration would slash agencies' "budget authority" by about $85 billion, but the Congressional Budget Office this month estimated that actual outlays would fall by only about $44 billion in the 2013 fiscal year, with the rest accruing over time. That is still about 1 percent of total federal spending to be squeezed out in a matter of months.

Many economists argue that the same cuts could be made with less pain by postponing some of them until later in the decade, when the economy is likely to be stronger. Many argue that growing spending on health care programs like Medicaid and Medicare is the real threat to the federal budget, not domestic spending on areas like education and support for poor families.

They also argue that macroeconomic estimates of the impact on growth probably understate the damage that will be caused by cutting spending indiscriminately.

"It's the nature of the cuts that is most pernicious — across-the-board, without thought, cutting everything and anything including programs everyone thinks are good and effective," said Mark Zandi, chief economist at Moody's Analytics. "It's impossible to calculate in terms of dollars and cents what you're doing when you have these mindless cuts."

The cuts would begin to take effect by March 1, and Congressional leaders appear increasingly resigned to let the deadline pass without action.

A broader deal is possible before a second deadline at the end of the month, when a budget deal is necessary to avoid a government shutdown. Any such deal could significantly reduce the economic impact of sequestration, which forecasters project will mostly fall in the second and third quarters.

In normal times the Federal Reserve could offset the impact of spending cuts by reducing interest rates. But these are not normal times. The Fed already is engaged in a vast effort to stimulate the economy, using monetary policy to suppress interest rates. The Fed's chairman, Ben S. Bernanke, has warned repeatedly that such policy has limited power to offset additional cuts.

Some politicians are warning that agencies will need to take steps like furloughing air traffic controllers or shrinking early childhood programs.

"We are doing everything possible to limit the worst effects on D.O.D. personnel, but I regret that our flexibility within the law is extremely limited," said Leon E. Panetta, the defense secretary, in a letter to his staff on Wednesday. "We have no legal authority to exempt civilian personnel funding from reductions. As a result, should sequestration occur and continue for a substantial period, D.O.D. will be forced to place the vast majority of its civilian work force on administrative furlough."

While the cuts would take a modest toll on the overall economy, the pain would be concentrated in some areas, like the Washington suburbs that are home to many federal workers and government contractors.

"Sequestration would feel like a cold to most of the nation, but to Prince George's County and the rest of the Washington metropolitan area, it would feel like a bad case of pneumonia," Rushern L. Baker III, the executive of Prince George's County in Maryland, said on Tuesday in a statement issued with the leaders of neighboring counties.