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Sudden Spending Cuts Likely to Bleed Slowly

February 22, 2013
The Wall Street Journal
Sudeep Reddy

The political jousting over the federal spending cuts set to start March 1 largely comes down to how much of an economic blow they could deal. But it may take a while to assess whether it feels more like a punch or a pinch, because the reductions will take effect over many months.

Democrats say trimming the federal budget by about $109 billion a year, including $85 billion in the fiscal year that ends in September, would needlessly cut government services and harm a fragile recovery. "It's a step in the wrong direction for where the economy is now," White House economist Alan Krueger said in a recent interview.

Many GOP lawmakers are trying to blame the Obama administration for what they also see as damaging cuts. But some Republicans emphasize that the federal reductions—to lower the budget deficit—can be absorbed by the overall economy as the private sector gains traction. The planned cuts are "a bad idea whose time has come," said economist Douglas Holtz-Eakin, a Republican. "You can't spend at the rate we're spending. Somewhere it's going to have to come down."

The economic proof for either side will be muddied by the slow effects of the cuts on the overall U.S. recovery.

The cuts officially begin March 1, reducing what is known as "budget authority"—such as the ability to sign a federal contract—by $85 billion in the fiscal year that ends in September. But actual outlays of federal dollars can trail the budget for months or years. The Congressional Budget Office estimates that government spending would be reduced by about $44 billion over the next seven months—equivalent to 0.5% of the country's total economic output over that time.

For the 2014 fiscal year, which begins in October, federal spending would drop by $89 billion, or about 2.5% of total federal spending, according to the CBO.

For the nation's overall economic growth, the immediate effects of the cuts will be hard to discern. Many federal workers wouldn't be furloughed until April. As a result, they will continue being paid through late March. Some temporary workers and contractors already have been affected, but many agencies and firms have held off instituting the cuts while lawmakers debate their next moves.

Forecasters at Macroeconomic Advisers estimate the cuts—based on actual outlays of federal money—would reduce U.S. economic growth this year by 0.6 percentage point, to 2% from 2.6%, if they continued without any changes. But the spending cuts also would lead the Federal Reserve to delay raising interest rates, boosting growth by 0.1 percentage point in 2014, the firm forecasts.

By the end of 2014, the cuts would cost about 700,000 jobs, pushing the jobless rate up 0.25 percentage point higher than it would be otherwise, to 7.4% by the end of that year, according to the firm. The jobless rate was 7.9% last month.

For the overall economy, the impact of the cuts "is not catastrophic," Macroeconomic Advisers said this week. But it warned that the "indiscriminate" nature of the cuts—hitting spending across the board—would hurt, coming on top of almost $200 billion in tax increases that started January 1. The firm said that "by far the preferable policy is a credible long-term plan to shrink the deficit more slowly" through some tax increases, tailored spending cuts and an overhaul of entitlement programs.

The cuts would disproportionately affect parts of the nation with a concentration of federal workers or defense-related companies, such as communities around Washington and the southeastern U.S.

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