U.S. Budget Update

Lost in the intense investor attention being devoted to the sovereign debt issues of the Eurozone, have been the on-going federal budget debates in the U.S. While it is likely that President Obama and Congress are happy to have attention devoted elsewhere, there are some critical dates rapidly approaching which are likely to refocus attention back on Washington. By way of review, it should be recalled that under the law passed last July (called the Budget Control Act or BCA),which raised the debt ceiling, a sequester mechanism was created which will cut federal spending across the board starting January 1, 2013 unless Congress can agree to $1.2 trillion in budget savings, spread over 10 years, the end of this year. To assist in this process, the BCA created a commission of Congress, called the Joint Dei cit Reduction Committee, composed of 3 democrats and 3 republicans from the House of Representatives and 3 democrats and 3 republicans from the Senate. This Committee (popularly called the budget super committee) is required to make its ecommendations back to Congress by November 23, and Congress must then approve or reject the recommendations by December 23 with no opportunity for amendment. Those ecommendations that are approved then go to President Obama for signature and become law. In the meantime, the BCA gave the President the authority to raise the dei cit ceiling further starting in January 2012 (within limits) to keep the government operational in 2012 and beyond. So, what if the budget super committee makes no recommendation? After all, it takes a majority of 7 members to recommend and the committee is equally divided by political party. It is also possible that Congress will approve only some or even none of the recommendations. What then? That is when the sequester mechanism kicks in. The BCA charges the budget super committee to deliver $1.5 trillion of budgetary savings. However, if they deliver less than $1.2 trillion and/or Congress approves less than $1.2 trillion, the automatic, across the board sequester mechanism starts to cover any shortfall. A simple example will illustrate how the sequester mechanism might operate. There is some consensus that the budgetary super committee might agree on a small mix of $500 billion or so of spending cuts and modest revenue increases (mostly involving higher user fees or highly specii c taxes). Assuming a $500 billion savings number, the following is an example (in billion $)

$ 1,200.0 (Total Sequester)
- 500.0 agreed to dei cit reduction
= 700.0
÷ 9 years (no sequester in FY 2012)
= $77 * total annual sequester

*ignores any interest expenses which are exempt from sequester.