My crystal ball on how the sequester will play out

Lots of pundits are puzzling through the politics of the federal sequester that began March 1, trying to figure out how long it will last and what the end game will be. If it were simply a matter of exercising common sense, it would have never occurred in the first place. Neither party claims it wanted the sequester, so a one line law passed by both the House and the Senate repealing the sequester would have done the trick. But of course what parties say they want and what they actually do are two different things. The reality is that neither party nor the White House saw advantage in capitulation and Republicans simply refuse to compromise.

The sequester could be moot by March 26, which is when the current continuing resolution funding the government runs out. If no new resolution is passed, sequester will be the least of the government’s problems. It will simply shut down, except for whatever is considered to be emergency services. So federal employees worried about whether they will be furloughed one day a week will have bigger problems to worry about: total unemployment, at least until something is passed into law. The experience in 1996 didn’t go well for Republicans, so it is probably something they will not want to repeat. Time will tell.

The earliest impact of the sequester is going to be on constituencies that Republicans care the most about: defense and the massive military industrial complex that depends on defense spending. Federal employees may have thirty days to avoid furloughs, but defense contractors won’t be so lucky. This means that Republicans will endure most of the initial heat for blocking a resolution to the sequester. And the impact will fall most heavily in red states. Here in Virginia, our governor Bob McDonnell is already squealing, due to the huge defense contractor community both in the Washington suburbs and in the Hampton Roads area. The bright red state of Texas is also likely to be one of the first to get squeezed as well, as they also have their thumbs deep into the federal defense pie. They also host huge bases where much of the surrounding community has their livelihood dependent upon spending at these bases, such as Fort Hood.

Doubtless the military industrial complex is already frantically dialing their senators and legislators asking them to strike a deal. The only question is how long Republicans will choose to hold out against this squealing. And that depends on Republicans not affiliated with the Tea Party and whether they will bolt. If they find common ground with House Democrats, they would have a majority to end the sequester. This has been the tactic that Speaker Boehner has repeatedly used so far when he cannot convince his own party to take necessary action. What is unclear is whether enough pressure can be exerted to affect this change.

It’s more likely all parties will find a reason to drag it out through March 26. The question then becomes not the sequester, but what can pass a divided congress in the way of a continuing resolution to fund the government. What would normally happen is a split the difference bill between the House and the Senate. The Senate would probably not pass a continuing resolution that funds the government at the sequester rate through the end of the fiscal year without it being softened through tax increases. The House will probably not approve any resolution that increases taxes.

My bet is that in the end it will be the defense cuts that force the bargain and affect political compromise. The rationale from Republicans will go something like this: “We can no longer afford to jeopardize our nation’s security by these unilateral cuts to defense.” The compromise: ditch the defense cuts, but keep the non-discretionary cuts in place, but spread this pain over all discretionary spending. The deal will be in essence to cut the sequester in half, at least through the end of the fiscal year, and leave it in fiscal year 2014 to be figured out through the appropriation process. This way everyone sort of wins. Defense takes a smaller hit, but it will still be considered “manageable” by Republicans. Non-defense discretionary spending will be trimmed as well, but to the 2%-3% level vs. the 5%-6% for the year that has to be spread out through the end of fiscal year 2013 now.

Anyhow, that’s my crystal ball. We’ll see how this all works out, but one thing is certain: it won’t be easy or pretty.

But we actually NEED those government services

It’s hard to believe, but there are senators and congressional representatives who actually want to be in the Supercongress.

The Supercongress (otherwise known as the Joint Select Committee on Deficit Reduction) was a creation of recent legislation signed into law to raise the federal debt ceiling. It will consist of twelve members, six from the House and six from the Senate, with each house contributing three Republicans and Democrats each, appointed by their majority and minority leaders. The Supercongress gets to write a bill that will realize at least $1.5 trillion in deficit reduction over ten years. The law will be voted on by each house and only a simple majority is required for passage. No amendments or filibusters are allowed. If their recommendations are not voted into law and signed by the president, the “one size fits all” meat cleaver comes out, chopping most programs including defense by large amounts, exempting only some of the biggest entitlements.

It’s clear that the legislation authorizing an extension of the federal debt ceiling did not solve our deficit problem. That’s the job of the Supercongress: twelve of 535 people in Congress, required to seek compromise that so far has proven elusive. By law, the committee must have its recommendations by November 23, 2011 and both houses must vote on it by December 23, 2011.

In the field of project management, we have use a term called the triple constraint. Every project is constrained by three forces: cost, scope and schedule. If you want to manage a project properly, you must adjust these factors intelligently or the project will fail to meet its objectives of delivering a project on time and within cost. The federal government has its own triple constraints: taxes, deficits and programs. In the past, no one wanted to raise taxes and no one wanted services cut, so deficits expanded. Now deficits cannot expand, at least beyond the current debt ceiling, without new legislation. This means that either taxes have to rise, programs must be cut, or some combination of the above.

Republicans think they are being principled by saying they will not allow taxes or the deficit to rise, meaning all deficit reduction will come from program cuts. Members of the new Supercongress are already nervous. Some of them are carefully qualifying their conditions. For example, some Republicans are saying they might allow revenues to increase by “closing loopholes”, as if these were not tax increases. This scenario is unlikely in any event because Republicans will be pressured by their party not to permit any tax increases. Even if some new taxes become part of the bargain, it won’t begin to be enough to close the deficit gap. As much as Republicans would like to get rid of the EPA and Education Departments, Democrats will ensure these agencies would survive. In any event, these programs are tiny compared to entitlements. Which means the only way to realize savings will be to cut entitlements like Medicare, Medicaid and Social Security. In short, the committee and Congress would have to vote in favor of a package guaranteed to cheese off the voting public come November 2012.

A few outcomes can be predicted with reasonable certainty:

  • Those Republicans and Tea Partiers dead set against raising both taxes and the debt ceiling will pine for the good old days when they would just charge the difference, and wonder why they were so brainless to press the issue when they will take the political fallout. Most of them will be thrown out of office if they follow through on their convictions. Their hands have not yet been pressed to the hot stove yet. When it is, they will realize that America has an important message for them: Don’t you dare mess with my Social Security and Medicare! They will learn something amazing: a vocal minority called The Tea Party does not represent Americans at large.
  • You don’t mess with American business either. American business depends as much on the federal dole as do Social Security and Medicare recipients. Take, for example, our bloated defense industry. Do you think they are going to go on a diet without expending massive amounts of capital to ensure they are exempted? Granted, a lot of defense spending is wasted, purchasing armaments, equipment and services that our own defense secretary says we don’t need. But that money still goes somewhere. It feeds a huge array of middle class defense and technology workers, and keeps afloat companies like Northrup Grumman, Boeing and Unisys. It pays for lavish salaries for their CEOs, provides for their corporate jets and their personal staffs. Take away their defense business and for all practical purposes they go bankrupt. Since defense spending still be severely curtailed with automatic cuts, they would be dramatically impacted. Expect a whole lot of hullaballoo if the tail does not continue to wag the dog.
  • But all that wailing will be nothing compared to heat Congress will get from the soldiers if their retirement benefits are scaled back and their health care costs go through the roof. They already work at substandard wages, often 24/7 in battle zones, and put their lives on the line for our freedom. They do so for patriotic reasons but also because the military offers a fair deal: low pay now for retiring at age 40 on half pay and virtually no health care costs. This is some compensation for the hassle they endure while in the military. They are going to go ballistic. Weren’t these same politicians spouting platitudes about supporting the troops?
  • When push comes to shove, which will happen sometime after whatever laws gets passed or not, future congresses are going to do the only sensible thing they can do in this mess to minimize the political impact: raise taxes, mostly on those who will inflict the lowest political pain. Eventually Congress will figure out this will be the rich people. In addition, poor people will continue to take it on the chin. If any entitlement really becomes a shadow of itself, it will be Medicaid. In the eyes of Congress, the poor always have been and will be second class citizens.

Republicans operate under the illusion that government is a massively wasteful institution. It is certainly bloated, but mostly out of necessity. Major problems like income security and health care in old age do not happen due to the genius of the private sector. Had such solutions existed, none of these programs would have come into existence in the first place.

The reality is the world we live in is incredibly complex, and we need a government to ensure it all works in the first place. Abolishing the EPA does not solve the pollution problem. Getting rid of the Education Department will not make American children better educated. What we need is greater value from the services we already have. We need to control the costs of entitlements like Medicare so people get more benefit. Congress is supposed to look at programs like Medicare and say, “This fee for service thing is too costly. We need to do it more intelligently and pay for outcomes instead.” That’s the real job Congress was elected to do, they just don’t realize it yet. They will after the wreckage of the 2012 election.

Congress can start with a few of my suggestions.

Bet on more debt

Revolution is breaking out not only in Egypt but also on Capitol Hill. While protestors demanding freedom are taking over Tahrir Square in Cairo, Republican senators and legislators complaining that oppressive “socialism” is diminishing our freedom.

On Capitol Hill, we have the expected noise principally from Republicans about how dreadfully awful our $1.5 trillion dollar deficit this year will be (I agree) and how it must be stopped now! The chess pieces are moving. Earlier in the week, Senate Republicans forced a vote on the repeal of the Affordable Care Act, which predictably lost. Certain federal district courts apparently don’t like the ACA either. One Florida judge declared the whole act unconstitutional.

Glimmers of Republican sanity are emerging. House Republicans, or at least its leadership, seem to be backing away from an earlier threat not to extend the federal debt ceiling later this year, realizing that the resulting economic meltdown may not be good for their reelection prospects. Meanwhile, President Obama is playing a clever game of defense, setting boundaries on what is acceptable and not acceptable to cut and vowing to veto bills with earmarks. Overall, the momentum certainly seems to be on the side of those trying to cut deficits and reduce the size of the federal government. This time will the cut federal spending and deficits crowd actually succeed?

My vote: bet on more debt. It seems likely that non-defense discretionary spending will be frozen for a few years. Of course, there will be lots of threats and wailing about how bad things are and how the dynamics must change now. However, that’s all they are: threats and wailing. To effect real change, new external drivers are needed. Specifically, our creditors need to stop lending us money (or slow the amount of money they are lending us) or bond rating firms (some of whom were bailed out by federal tax money just a couple of years ago) need to downgrade the U.S. Treasury’s AAA bond rating.

There is little evidence now that either of these things will happen. Why? There are many reasons but principally there is an enormous surplus of capital in the world, including trillions held by U.S. companies. Many of those holding the capital are already heavily invested in U.S. treasuries and do not want to see their investment’s value diminished. A lot of their extra money can certainly be invested in other stocks and bonds, but even blue chip companies are not as safe a refuge for money as U.S. treasury bills. Seeking safety, it seems unlikely that capital will flee U.S. securities.

The improving economy will eventually increase tax revenues. It will be hard to see over the next few years, particularly since Congress and the president have already agreed to borrow money to fund a cut in social security withholdings. Nevertheless, eventually the economy will pick up a head of steam, bringing in more in the way of revenues and thus lessening the deficit. As the deficit shrinks, however marginally, the animus to cut federal spending eases as well. Getting out of wars in Iraq and Afghanistan will help eventually as well.

Another reason to bet on debt is to consider what really matters. For Republicans, the deficit is a talking point toward their real utopian goal of cutting the size of the federal government. To seriously do this they need sixty plus votes in the Senate, a majority of the House and a Republican president. Two out of three are possible in 2012, but three out of three are very unlikely. As for right now, we will all have to muddle through somehow. What this will amount to in the end is probably a freeze on non-defense discretionary spending. President Obama noted in his State of the Union speech that this is only fifteen percent of federal spending, so a freeze does not solve any underlying problems. Medicare costs in particular will keep rising.

Republicans talk about cutting Medicare and Medicaid, but it is mostly talk. What they really want to do is cut non-defense discretionary spending. They want symbolic victories, like getting rid of the Department of Education and the Corporation for Public Broadcasting because these agencies offend them. Even if they succeed, which is unlikely, they don’t address the real problem. Discretionary spending outside of Defense has not been the principle cause of deficits since the Great Depression.

The real problems driving up the debt, aside from the bad economy and tax cuts are: Medicare, Medicaid and defense spending. Of the three, only one is a realistic target for major cuts. Can you pick the right target? If you said Medicaid, come up and claim your prize. Why Medicaid? Because when push comes to shove, the disenfranchised are always the first to go. You can see it in being played out right now in state and local governments. Here in Virginia, for example, services for the mentally ill were one of the first cut. A few people speak for the mentally ill, but not many and they are not well organized. Nor do they contribute to politicians’ war chests. Even with Medicaid, it is not going to go away, but if forced to choose between the three, it will be the first to be sizably cut. That is because those who buy influence ultimately win. The poor, being poor, cannot buy influence, and survive only on largess. So Medicaid stands a decent chance of being a loser, while farm subsidies will doubtless continue. (After all, they go principally to red states, and principally to large agricultural companies.)

The Defense Department may get symbolic cuts, but that’s all they will be. Secretary of Defense Robert Gates is proposing “cuts”, but this does not mean he expects DoD’s budget to go down. No, he is proposing slowing its rate of growth. While there are some Tea Partiers who would favor real and painful cuts to the Department of Defense, there are too many teats feeding off the military industrial complex. Cuts will be mostly symbolic and weapons systems built in large numbers of congressional districts, as usual, will be mostly immune to cuts.

Social Security is largely untouchable. Social Security will neither be abolished nor will it be replaced with some sort of voucher system. Any honest Republican knows this. At worst, the retirement age will be increased but that will prove unpopular with voters, who can hardly keep a job now. Moreover, social security is not insolvent. It will always have a steady revenue stream through withholdings. The only concern is that over the next twenty years it will be slowly drawing from its trust of already accumulated savings, i.e. Treasury bills, unless the law changes.

Medicare spending is the most chronic and largest problem. Cutting it and raising taxes are the only two things that will seriously reduce the deficit. Unfortunately, it remains popular with the public and retirees depend on it. Republicans live in a fantasy world that it can be converted into a voucher system. To fix Medicare will require making painful choices among many vested interests including doctors, drug companies, retirees, hospitals, ancillary insurance providers and clinics. For it to become solvent will require that hardest of work: everyone must share in the misery. Of course, everyone will want someone else to endure the misery, not them.

The last reason to bet on debt is that tax increases have become anathema. When push comes to shove, Republicans will put deficit spending ahead of tax increases. This is as sure as the sun will rise. The only way to seriously raise tax rates is to have a Democratic congress, sixty plus Democratic votes in the Senate and a Democratic president. That too is very unlikely.

So for the short term, unless our creditors and rating firms force our hand, expect barbarians at the gate, but wielding only noise as weapons. More debt will win because it is the least painful choice. Future generations, after all, aren’t yet of voting age.