How Eliminating the Automatic Spending Reductions Specified by the Budget Control Act Would Affect the U.S. Economy in 2014

Report
July 25, 2013

Letter to the Honorable Chris Van Hollen

This letter provides an analysis of how a cancellation of the automatic spending reductions specified by the Budget Control Act of 2011 (Public Law 112-25) would affect the U.S. economy. Pursuant to that act, federal spending in 2013 has been subject to across-the-board cuts, also referred to as sequestration. (Certain programs—including Social Security, for example—are exempt from those reductions.) For the 2014–2021 period, the act requires automatic reductions, through sequestration, of nonexempt mandatory spending and reductions in the caps on discretionary budget authority.

As requested, CBO analyzed a proposal under which the automatic spending reductions in effect for 2013 would be canceled at the beginning of August and none of the reductions scheduled for 2014 would be implemented; for 2013, mandatory payments made after early August would be at the rates in effect prior to sequestration, and agencies would have an additional year to obligate the restored discretionary funding. In total, by CBO’s estimates, canceling the automatic spending reductions effective August 1 would increase outlays relative to those under current law by $14 billion in fiscal year 2013 and by $90 billion in fiscal year 2014.

Those changes would increase the level of real (inflation-adjusted) gross domestic product (GDP) by 0.7 percent and increase the level of employment by 0.9 million in the third quarter of calendar year 2014 (the end of fiscal year 2014) relative to the levels projected under current law, CBO estimates. (The estimated effects are given for the third quarter of calendar year 2014, rather than the fourth quarter, because the policy being analyzed addresses only fiscal years 2013 and 2014.) The effects on output and employment in calendar year 2013 would be smaller than those in 2014.

Those figures represent CBO’s central estimates, which correspond to the assumption that key parameters of economic behavior (in particular, the extent to which higher federal spending boosts aggregate demand in the short term) equal the midpoints of the ranges used by CBO. The full ranges CBO uses for those parameters suggest that, in the third quarter of calendar year 2014, real GDP could be between 0.2 percent and 1.2 percent higher, and employment 0.3 million to 1.6 million higher, under the proposal than under current law. Because those estimates indicate the effects of a prospective change in law, they do not encompass the full impact of the sequestration that has already occurred.

Although output would be greater and employment higher in the next few years if the spending reductions under current law were reversed, that policy would lead to greater federal debt, which would eventually reduce the nation’s output and income below what would occur under current law. Moreover, boosting debt above the amounts projected under current law would diminish policymakers’ ability to use tax and spending policies to respond to unexpected future challenges and would increase the risk of a fiscal crisis (in which the government would lose the ability to borrow money at affordable interest rates).