Goodbye Debt Ceiling, Hello Sequester

Posted February 25, 2013 by rvillareal

•   While the worst of the fiscal cliff was avoided in January, the remaining tax increases and coming budget reductions represents the biggest increase in fiscal drag since 1969, when the imposition of the Vietnam War surtax contributed to the onset of a mild recession. [private]
• The period of maximum economic risk may be between now and the next six to nine months, when the $85B sequester (starting March 1) has been fully phased-in.  The overall impact of tax increases and spending reductions will be about 1.5 percentage point of GDP in 2013.
• The degree of fiscal drag diminishes significantly in 2014 to about 0.6 percentage point of GDP, as there are no more major deficit reduction items in the pipeline.
• Still, another $2 trillion in deficit reduction is needed on top of the $2.9 trillion already undertaken to stabilize the debt to GDP ratio.  Additional deficit reduction will most likely consist of entitlement spending reductions and further tax increases, two areas of savings which have been very hard to come by so far.
•  In any event, the situation could get very messy.  The combined impact of higher taxes and reduced spending may lead an already slow motion expansion to stumble.  And the loss of 5% to 10% of spending on normal governmental operations from the sequester could be very disruptive in ways that are hard to figure out.  With the deficit picture improving much more than expected, the sequester may be modified or incorporated into work on the continuing resolution which expires March 27 or the work on next year’s budget (or even the debt limit) and  could stretch the effective deadline to mid-2013.

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