Sequestration 101 — Do you actually know how it would work?

Be honest. You have heard us all talking/worrying/complaining about the potential for sequestration since August of 2011, but do you actually know how it would work? I, for one, only had a loose understanding of the process.

Todd Harrison is a senior fellow at the Center for Strategic and Budgetary Assessments. He gave Chris Dorobek on the DorobekINSIDER a detailed breakdown of sequestration and its impact governmentwide.

Harrison’s Take

First Off: A History Lesson

Back in July/August of 2011 when we were approaching the debt ceiling, Congress came together for some last minute negotiations to raise the debt ceiling. That agreement was called the Budget Control Act of 2011. The Act formed the Super Committee tasked with finding $1.2 trillion in deficit reductions. But, the Act also created a binding way to force the cuts in the case the Super Committee failed — that binding resolution was sequestration.

Sequestration was created from an old 1985 law that Congress amended to make sequestration legal.

Not surprisingly the Super Committee failed. So that leaves us with the January 2nd deadline for all agencies to cut their accounts across the government not just at the Defense Department.

How Sequestration Actually Works

Agencies must calculate the amount of cuts required overall. That’s roughly $109 billon that they have to find in savings by fiscal 2013. Half of that (roughly $55 billon) will be taken from DoD.

The cuts have to be applied as a uniform percentage cut across all accounts down at the project level. That amounts to a roughly 10% cut on all projects.

There is one exception, the President has the option to exempt military personnel accounts. President Obama has indicated that he will do that.

White House Sequestration Plan

Congress started to get nervous with what the cuts would actually look like, so they passed a new law to force the White House outline in a transparent way what sequestration will look like.

In a 300 page document the White House went line by line through the budget to show what would by cut and by how much.

Across the Board Cuts

Across the board cuts are a cop out. But the real problem, is cuts can have some unintended consequences. Imagine your family budget. You budget so much money every month for rent, food, car and insurance. Imagine if you had to cut each of those areas by 10%. Some things like your grocery bill you can cut fairly easily. But your rent for example you just can’t cut by 10%. That would mean moving and breaking your lease.

This is the same problem for the DoD.

Take the 200 tomahawk cruise missiles the DoD buys each year from the contractor Raytheon. The contractor is set up to build at that production rate. So if the DoD comes to Raytheon and says I’ve got to cut 10%, I can only buy 180 units. The government is going to have to break the current contract and negotiate a new deal. Raytheon is going to need to adjust it’s production so maybe they have to lay off some people or change the price per unit. So really with that 10% cut you are paying more for each missile. So in the end you don’t end up with 180 missiles you end up with fewer for the the 10% cut.

Some Program Just Can’t Be Cut

For example the Defense Health Program is the military help system. It is not covered under the military personnel exemption so by law it will have to cut its services by 10%. That means about $3 billon will have to come out of the budget. But they system provides health benefits to 10 million active and retired military personnel. It’s not possible for them to make the cuts. So they will have to go to Congress and submit a re-programming request and hope for Congressional approval.

Will Sequestration Happen?

It may depend on the election outcome.

If Congress/White House maintain the status quo: Its reasonable that there would be an incentive for lawmakers to work out a compromise in the lame duck session.

If there is a significant change in control in either branch: there may be incentive for the party that is going to gain power to delay things and not work out a compromise until they take power. But sequestration goes into effect on the 2nd of January, the President gets sworn in on the 4, and Congress not until the 20th, so in that case sequestration could go into effect.

A last minute compromise is also possible where they delay starting sequestration until April. Pass the ball down the field a little bit to take the pressure off.

Either way, we won’t know until the last minute.

How Should You Prepare?

Plan for uncertainty. But that’s hard because a 10% cut is a big uncertainty.

Agencies should be looking at funding sources and how they would be affected, they should start to develop contingency plans. This is especially important for civilan employees because they will be the first to be affected. So if sequestration happens, furloughs will also happen to reduce funding in all accounts.

Contractors have a little more time to deal with sequestration. The impact will be delayed because they depend on the outlays for funding. Sequestration acts on budget authority (how much money an agency actually has). Contractors probably won’t feel a huge delay for 3 years. But uncertainty makes it almost impossible for contractors to hire new employees or build new factories.

Cuts No Matter What

No matter if sequestration happens are not the government needs to understand that cuts are coming. It’s two fold. First we are facing a record federal deficit. Second, we have very low revenues.

The President has proposed reducing the war budget and reducing the DoD’s base budget slightly, and then keeping it stagnant for a few years.

But if you really want to see major deficit reduction you need to look at Medicare and Social Security. Currently the DoD accounts for 15% of the budget, Medicare 14% and Social Security 22%. But the Social Security and Medicare percentages will continue to grow with the babyboomers expected to retire over the next 10 years. We are facing a big deficit no matter what unless we reform those two elements.