Goldman Sachs on Sequestration Cuts

I think these excerpts from a research piece by Goldman Sachs economist Alec Phillips are helpful in understanding the issues:

In 2011, Congress passed and the President signed the Budget Control Act, which raised the debt limit by $2.1 trillion and cut $2.1 trillion from projected spending over the following ten years. Caps on discretionary spending levels were estimated to reduce spending by $900bn compared with baseline projections that assumed spending would growth with inflation. The remainder of the savings was to be achieved by the congressional “super committee.” To motivate the super committee, and to ensure deficit reduction even if it failed, the legislation established $1.2 trillion in automatic cuts through 2021 by means of sequestration if the super committee could not agree on at least that much in deficit reduction. The super committee failed to agree on a deficit reduction package, leaving sequestration to take effect.
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The cuts are not that large in the context of the $3.5 trillion federal budget, but sequestration will nevertheless cause real disruptions because the law to implement the cuts is very prescriptive and because they must be phased in relatively quickly once triggered ...

We estimate that sequestration will reduce annualized growth in 2013 by 0.6 percentage point (on a Q4/Q4 basis), with the greatest effects in Q2 and Q3. We expect the effect on growth to wane somewhat starting in Q42013, as the rate of reduction in federal spending becomes more gradual. Although sequestration will reduce the level of spending further in 2014, the rate of change will be much more gradual by that point so the effect on growth should be much smaller. ...

We expect slightly less of an effect on employment compared to the effect on GDP growth. The Congressional Budget Office estimates that the cuts will reduce employment at the end of 2013 by 750,000, or roughly a 0.5% reduction in employment, similar to the 0.6pp reduction in growth it assumes will result from sequestration in 2013.

But it is possible that the direct effect on federal employment may be somewhat smaller than the proportional GDP effect would imply. ... several federal agencies have announced that, at least for FY2013, compensation expenses are likely to be reduced by furloughing federal employees. This means that rather than reducing the number of employees proportionally to the cut, the number of days worked would be reduced instead.

Sequestration has happened before, but not quite on this scale. Meaningful cuts under sequestration were scheduled to take effect in 1986, 1988, and 1990. ... Cuts took effect in each of those years but after allowing the first cut to take effect as planned in FY1986, Congress intervened to reduce the subsequent cuts in FY1988 and FY1990. ...

The key timeframe for action will be late March and April. By late March, Congress will need to pass a new “continuing resolution” (CR) to temporarily extend spending authority, which was last extended before the 2012 election and expires March 27.

Of course the sequestration cuts could be changed at any time by an agreement between the President and Congress. It seems unlikely that the House will shut down the government in late March (but you never know), and maybe we will see an agreement to reduce or change the sequestration as part of a "continuing resolution".  This isn't as obvious as the debt ceiling debate ...