Sequestration Monster: Reality or Boogeyman?

By Taylor Land

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Source: BKL / flickr

The debt-ceiling crisis of 2011 sparked public panic and the most volatile week for financial markets since the 2008 financial crisis. As the United States inched closer to defaulting on its debt obligations, the pressure intensified until it culminated on August 2, 2011, the effective deadline to avoid default. The Senate passed the Budget Control Act of 2011 (BCA) on August 2, and President Obama signed the bill shortly thereafter. At the time, little public attention was given to the contents of the agreement beyond the fact that it raised the debt ceiling and avoided potential catastrophe. However, the BCA set the groundwork for large, across-the-board spending cuts to the United States Federal Government’s budget in 2013, which particularly targeted defense spending. Many experts projected that the cuts would have disastrous effects on the defense industry, but two years into sequestration the results have been far less devastating than expected.

First Things First: What were they thinking?

For both Republican and Democratic lawmakers, the plan was never to implement the $1.2 trillion spending cuts proposed in the BCA. Rather, the proposed cuts were intended to be so devastatingly painful and so poorly constructed that both sides of the aisle would be sufficiently incentivized to work together and design a plan that all parties could agree was better than the status quo. The group tasked with the responsibility of building the framework for this agreement was the Joint Select Committee on Deficit Reduction, popularly dubbed the “super committee.” The committee featured several Beltway heavyweights, including former Senator John Kerry and Senator Rob Portman.

In what now appears to be the most predictable outcome imaginable, the committee failed to reach an agreement as Democratic members insisted on revenue increases through higher taxes on wealthy Americans and Republican members insisted on entitlement cuts and decreasing the top marginal tax rate from 35% to 28%. After negotiations broke down, deficit reduction and automatic cuts became a topic of the 2012 presidential election, during which President Obama stated he would veto any attempt by Congress to cancel the $1.2 trillion sequester. The plan that was meant to be so horrifically bad that we could all agree to hate it became the de facto plan for our future.

Automatic Spending Cuts (Emphasis on Defense)

Federal government spending authority was reduced by roughly $85 billion for fiscal year 2013, and similar cuts were implemented for all following years up to 2021.

The cuts were evenly split between domestic and defense programs, with half affecting defense discretionary spending (weapons purchases, base operations, construction, etc.) and the rest affecting both mandatory and discretionary domestic spending. Total spending cuts were set at $1.2 trillion by 2021, and defense spending was set to be cut by $454 billion (interest was removed before the spending cuts were split between defense and domestic).

Defense spending outlays fell from $670.3 billion in 2012 to $627.6 billion in 2013. This equates to a $42.7 billion, or 6.4 percent, decrease in year-to-year spending. Additionally, it was a 7.7 percent decrease from expected funding. For 2014, defense spending was set to fall again to $593.4 billion dollars, a 5.5 percent decrease. The defense budget is scheduled to rise gradually from $593 billion to $714 billion between 2014 and 2023 for annual growth rate of 2.1 percent over the time period. This is well below the 7.1 percent annual spending growth rate that was experienced between 2000-2012.

Defense Department Resistance and Overstated Spending Cuts

Prior to the implementation of the sequester budget cuts, the Department of Defense assessed the impact of the cuts as so grim that the Pentagon refused to even plan for them until a month before they were set to take effect. Since then, Pentagon planners have built a strong coalition of defense lawmakers against keeping sequestration spending caps on the military. Defense leaders have warned that any plan that keeps sequestration in place will have devastating effects on military missions and readiness, and have repeatedly implored Congress to find some way to undo the BCA that mandates across-the-board spending cuts.

In a March 2015 House Armed Services Committee hearing, several military officials resorted to strong rhetoric in order to express their concerns. Army Secretary John McHugh referred to sequestration as “an enemy at home” as dangerous as any overseas threat facing the services. Air Force Secretary Deborah Lee James added that sequestration “is going to place American lives at risk, both at home and abroad.”

Despite the military service secretaries and chiefs railing against the dangers of sequestration, Republicans from the House Budget Committee unveiled their fiscal 2016 spending plans – which keep the caps in place. This displayed Congressional willingness to move ahead with the federal budget caps, even in the face of dire warnings coming from defense officials and supporters. This indicated that the United States is accepting a decreased defense presence in the world in the long-term.

News reports continue to emphasize the devastating effects of sequestration on national security, but the numbers indicate otherwise. Through the use of the war budget, the Department of Defense was able to limit actual cuts in 2013 to a modest 5.6 percent, and almost entirely eliminate cuts in 2014. In contrast, sequestration has reduced funding for domestic programs – from Head Start to cancer research – that did not have the flexibility to avoid cuts the way the Pentagon has. Additionally, the Bipartisan Act of 2013 has already reduced the level of cuts planned for 2015. After troops have been removed from Afghanistan, the Pentagon may lose its “war” budget loophole (though it’s likely to continue asking). However, President Obama has asked for an additional $26 billion for military spending in 2015 and $115 billion for military spending for fiscal years 2016 through 2019. Though the sequester has posed real challenges to the Defense Department, these challenges seem to be more manageable than originally anticipated by experts, both inside and outside of the military.

Defense Contractors

The defense contracting industry was expected by most analysts to take a big hit under sequestration. With a shrinking defense budget to draw contracts from, it reasonably followed that defense contractors would suffer under the new conditions. However, this was far from the case. Many leading defense contractors, including Lockheed Martin, Northrop Grumman and General Dynamics, have seen their stock prices roughly double since sequestration was implemented, and are now selling near all-time high prices. The S&P Aerospace & Defense Select Industry Index, which boasts an annualized growth rate of 26.6 percent over the past three years, has greatly outperformed the S&P 500 since the budget cuts were implemented.

contractor vs s&p
Figure 1: Blue= S&P Aerospace an Defense Industry Index; Green= S&P 500

The industry’s impressive growth was achieved, largely, through downsizing in the form of layoffs in order to minimize costs. Lockheed Martin alone has reduced its workforce by more than 20 percent since 2008. Additionally, small firms have struggled in the new environment, forcing some to exit the market. This decreases competition for contracts and makes budget cuts more manageable for the established firms. “The biggest change has been a return to a much more disciplined approach to programs and requirements,” said one executive at BAE. More recently, U.S. intervention in Iraq and Syria has provided a windfall of opportunity for defense contractors, particularly munition makers. The main risk to defense contractors is the possibility that the Defense Department could lose its “war” budget loophole upon withdrawal from Afghanistan, but even this risk is minor as the defense budget is set to gradually increase through 2021 even under BCA conditions.

Conclusion: We Survived!

The budget cuts initiated by the Budget Control Act of 2011 have drawn several commonly held assumptions into question. Many Democrats feared that steep spending cuts would result in a weakened economy due to the loss of direct economic stimulation, as well as the loss of a Keynesian multiplier effect that ripples through the larger economy. Many Republicans feared that such large and indiscriminate cuts to the defense budget would undermine military capabilities and national security. Neither side was completely wrong, but both sides appear to have overestimated the negative effects. Defense contracting companies did face layoffs, but the effects don’t appear to have rippled through the economy and what’s left of the industry has refocused around efficiency. Finally, the military has had to make unpleasant choices due to the budget cuts, which it claims has been detrimental to readiness. But as the United States winds down its major operations in the Middle East and exits the post-9/11 era, this may be a reality that Americans are willing to accept.


TL 3Taylor Land is a Master’s candidate at the Patterson School studying international security and economics. His core interests are geopolitics and macroeconomics, with regional interest in Europe and the Middle East. Taylor can be contacted at taylor.land@uky.edu

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