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The Impending Sequestration and Tax Rate Debate: Is it really a cliff?

Nov 19

Written by: Grants Office, LLC
Monday, November 19, 2012  RssIcon

By Chris LaPage

Much has been made about the impending doom associated with the automatic spending cuts (sequestration) and expiration of the tax rates established during the George W. Bush Presidency.  All the pundits point to the likelihood of a second recession if politicians in Washington allow the country to go "off the cliff".  Sequestration alone will initiate $1.2 trillion in automatic cuts across the entire budget, which means every sector from education and healthcare to defense spending will be effected.  The measure was put in place because it is not palatable to any politician, Democrat or Republican, to see such blanket cuts in discretionary spending.  The idea was to give Congress and the President time to come to a long-term agreement on deficit reduction.

Now that we are past the elections, the time to negotiate is quickly approaching.  Many fear that the partisan gridlock in Washington will continue and put economic recovery in jeopardy.  Furthermore, those tuned into grants worry about the likely negative impact on federal funding programs.  Grant programs explicitly funded in the budget would be subject to the automatic spending cut while those at the discretion of federal agencies will likely be curtailed as well since those entities will have less funding overall.  While such a scenario is clearly possible, it does not mean that it is probable. 

The blanket cuts will likely be enough to get both sides to reach an agreement.  For those that don't think it will happen by the January 1, 2013, the truth is it doesn't really matter.  Everyone will point to that date as if it is Armageddon.  First and foremost, the $1.2 trillion in tax cuts that will be initiated are scheduled to take place over nine fiscal years, with the last piece taking effect in 2021.  The impact on 2013 federal spending will likely be in the area of $109 billion.  This is still a substantial spending cut that would affect federal grant programs, but probably does not elicit the same eyebrow raising response that is associated with $1.2 trillion.  This is why it is probably more accurate to describe the impending situation as a "staircase" rather than a "cliff". 

Say we arrive on January 2, 2013 and no deal has been reached, technically all federally funded agencies and programs will realize a spending cut.  However, Congress has the ability to make any legislation it passes retroactive to the start of their session.  In other words, the President and Congress can come to a long-term agreement several weeks or months into the 2013 calendar year and rollback the effective date to the January 1, 2013.  In such a scenario, the $109 billion in spending cuts resulting from sequestration will be taken off the books and replaced by the approved deficit reduction package.  In this scenario, it is as if the spending cuts never took effect in the first place.  While we don't know that that new deficit reduction legislation will include, it is likely to include a much smaller spending cut overall than the sequester.  Finally, the final deal will likely be very targeted and will not result in cuts across every federal program.

No one is advocating that the approaching sequestration should be taken lightly.  It is a big deal. However, when it comes to federal grant programs it is important to understand how the spending cuts will roll out and the associated timeline.  If a deal is not reached by the end of the calendar year, there is no reason to start panicking.  There is plenty of time to negotiate.

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