2/20/13 – Here Comes the Sequester

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Feb 20, 2013 10:48:20 AM

and tagged Fiscal Cliff, Politics and the Economy

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In the last round of the Washington budget debates—the fiscal cliff—a compromise was finally reached, whereby the Bush administration tax cuts were extended for the vast majority of the population, while taxes went up on people with incomes over $400,000 (or $450,000 for joint filers). In addition, the expiration of the payroll tax waiver raised taxes on everyone with wage income.

You probably remember this. It was only a couple of weeks ago.

At the time, I said that, while the deal avoided the immediate hit to demand that resumption of Clinton-era tax rates would have created, it didn’t actually solve any of the real problems. Moreover, the tax deal was the easy part; Congress punted on the spending cuts, with the presumption that a deal could be cut before the “sequester,” as the mandated spending cuts are called, kicked in.

You may remember that as well—the spending cuts that were designed to be so onerous that no sane Congress or administration would actually let them take effect. The spending cuts that were designed to be a gun to the head of both parties, forcing responsible compromise.

Guess what? They didn’t, and we’re now approaching another round of brinksmanship. The good thing is that, this time, while the cuts will certainly have negative effects on the economy, the impact won’t be nearly as large as the one the tax hikes would have created. Moreover, the general economy has continued its slow healing process, and we are somewhat better prepared to sustain demand even if the sequester hits. Finally, state and local governments, as I have noted before, are now in a position to pick up the slack as federal government spending declines.

Because of this, bargaining power seems to have shifted somewhat. In the last round of negotiations, Speaker Boehner said that the Republicans would accept the sequester spending cuts rather than allow additional taxes, and they appear to be holding to this stance. Democrats, who apparently expected Republicans to blink rather than accept the sequester’s cuts in defense spending, are now starting to push harder, fearing that the domestic spending cuts will do them more damage than the defense cuts would do to Republicans.

This storm is only just starting to spin up, but expect to see a great deal more about it in the media. Effectively, both sides agree that the spending cuts as proposed are stupid, but both sides are also locked into their own takes on how to resolve the problem.

In an encouraging sign, Alan Simpson and Erskine Bowles, who developed the previous bipartisan deal that bears their names (and which I thought was the best available solution at the time), have resurfaced with a new plan. I haven’t yet reviewed it in detail, but by attempting to move the debate away from partisanship and toward a solution, they are providing a real service.

We will be talking about the sequester debate a lot more, but for now, consider this the warm-up. The show’s about to start.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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