May 2, marks the 8-month mark in the countdown to possible federal budget “sequestration” that could reduce federal spending in 2013 by roughly $109 billion, across defense and nondefense discretionary spending programs. Unless Congress enacts legislation on the subject by January 2, 2013, defense accounts could be reduced next year by 10 percent and many nondefense discretionary accounts by 8 percent. These across-the-board spending reductions are the result of the failure of the Joint Select Committee on Deficit Reduction, aka the “Super Committee,” to agree last Fall on legislation to generate $1.5 trillion in budgetary savings over 10 years that Congress could consider pursuant to the Budget Control Act of 2011.

We believe that it is important for our clients to recognize the potential for the imposition of sequestration and substantial federal budget cuts in the new year, or the possibility that Congress will legislate alternative spending reductions during the balance of this Congressional session.

Every sector of the U.S. economy has a stake in the handling of the sequestration issue, which could lead to reduced and delayed federal contracting, elimination of grant programs, public employee furloughs, lower Medicare payments to health care providers, law enforcement cutbacks, and slower processing of federal regulations, applications, and other paperwork due to cutbacks in agency resources.

Some examples of the potential impact of January, 2013 budget cuts can help one understand the enormity of the situation.

For example, reflecting ongoing concern among federal officials regarding the impact of sequestration on education programs (other than Pell Grants, which are exempt from such reductions), Education Secretary Arne Duncan testified on March 28, 2012 before the House Committee on Education and the Workforce that:

“A 7.8 percent reduction in funding for large State formula grant programs that serve over 21 million students in high poverty schools and 6.6 million students with special needs could force States, school districts, and schools to slash teacher salaries, lay off teachers, or reduce services to these needy children. More specifically, the resulting cut of more than $1.1 billion to Title I could mean denying funding to nearly 4,000 schools serving more than 1.6 million disadvantaged students, and more than 16,000 teachers and aides could lose their jobs.”i

Meanwhile, anyone with an interest in biomedical research (pharmaceutical companies, scientists, patient advocates, investors, etc.) should note the recent testimony of National Institutes of Health Director Francis Collins before the Senate Labor, HHS, Education and Related Agencies Subcommittee, when he told that panel that:

“(I)f the sequesters were to kick in on January 2, 2013...NIH would expect to lose 7.8 percent of the budget, about $2.4 billion. That would of course happen with the fiscal year already three months along. The estimate that has been put forward by an analysis would result in roughly 2,300 grants that we would not be able to award in fiscal year '13 that we otherwise would've expected to. And that represents almost a quarter of our new and competing grants that would result in success rates for applicants who come in with new applications or competing ones falling to historically low levels, and would be devastating for many investigators who are seeking to continue programs that they have had funded in the past and are back for their competing renewal or who are starting things that are entirely new.”ii

The health care sector offers another example of how sequestration can affect institutions, employees, and patients. Health care providers under the Medicare system face the prospect of reductions of up to 2 percent of the program’s costs per year and the BCA mandated that such reductions could only come from payments made to providers. The Congressional Budget Office estimated that these savings will amount to $123 billion over 10 years and the American Hospital Association (AHA) has estimated that hospitals will bear roughly 1/3 of that burden, or $41 billion over 10 years. As part of its advocacy effort on the issue of sequestration, the AHA has cited a study which concluded that 194,000 jobs could be lost at hospitals throughout the nation as a result of such payment reductions to providers. At this point, it is not clear how the Medicare program sequestration reductions would affect beneficiaries, but it is realistic to consider whether the quality of care will suffer or if health care providers would have yet another reason to be reluctant to continue accepting Medicare patients.

Elsewhere in the health care sector, there are estimates that the required budget cuts would mean that roughly 800,000 – 1.1 million fewer patients would be served by Community Health Centers and would lose access to primary care and other basic health care services. The broader population would have to contend with a possible $400 million reduction in Centers for Disease Control resources, which are used for infectious disease outbreaks, disease prevention and screening and immunization for children.

The impact of sequestration on the Department of Energy would reduce the Office of Science budget by roughly $400 million and the Office of Energy Efficiency and Renewable Energy by as much as $150 million, eliminating scientific research and programs aimed at helping our nation diversify its energy sources across all sectors, including residential and industrial uses.

How Did We Get Here? The Road to Sequestration

Last year’s debt ceiling compromise ("Budget Control Act” or BCA) included a legislative mandate for the bipartisan and bicameral “Super Committee,” which Congress directed to develop a bill that would reduce federal spending by $1.5 trillion over a 10 year period. This group met over a three-month period and exchanged proposals dealing with entitlement programs, discretionary spending, and taxes, but they did not achieve consensus. After the collapse of Super Committee negotiations on spending reductions, Washington policymakers have been increasingly preoccupied with sequestration.  

Under the BCA, $1.2 trillion in spending reductions must take place over 10 years. Recent estimates suggest that about $109 billion a year would be reduced from anticipated federal spending, from both defense and non-defense accounts and from discretionary appropriations and entitlement (mandatory) programs on a proportional basis. In the first year (Fiscal Year 2013, which begins October 1, 2012), the reductions in discretionary spending would occur through across-the-board cuts and in Fiscal Years 2014-2021, the reductions would take place by lowering the statutory annual ceilings on discretionary spending for both defense and non-defense programs – limits that are set forth within the BCA. The House and Senate Appropriations Committees would then work within those lower ceilings in developing their annual spending bills.

There would be some exceptions to the sequestration process and uniform reductions across all other non-exempt programs. Unless modified by a subsequent law, these automatic “sequestration” cuts would be split equally between defense and non-defense programs, and mandatory programs including Medicare (on the provider side, not the beneficiary side, and subject to a 2 percent cap on reductions for the entire program). Other programs, such as Social Security, Medicaid, Veterans benefits and medical care, Pell Grants, and military pay would be exempt from the sequestration cuts.

The exact nature of “exempt” programs is based on the Balanced Budget and Emergency Deficit Control Act of 1985 (BBEDCA) sections 255 and 256. Click here to download a very recent Congressional Research Service report, which contains the lists of exempt programs. Reflecting the potential “gray” areas in this analysis, House Budget Committee Chairman Paul Ryan, R-Wis., sent a letter to the Office of Management and Budget last week seeking clarification of what the Administration specifically believes will be exempt from sequestration. Also last week, the Administration confirmed for the first time that it views all Veterans programs to be exempt.

Possible Next Steps

The sheer magnitude of the potential sequestration cuts, particularly the concern about reducing defense and security spending by $50 billion next year, has led some policymakers to offer a variety of suggested next steps. Both the President’s Fiscal Year 2013 Budget and the recently passed House Budget Resolution authored by Chairman Ryan sought to substitute a mix of other spending reductions and budgetary savings for the savings that would occur from annual sequestrations over the next 10 years.

The Administration’s Fiscal Year 2013 Budget in February sought to render automatic sequestration unnecessary by identifying what it termed $3.6 trillion in federal budget savings over 10 years, including $600 billion in specific budget cuts, savings of $848 billion from reduced military operations in Iraq and Afghanistan, nearly $2 trillion in additional federal revenue, and $800 billion in reduced interest payments on the debt.

Meanwhile, the House Republican majority has set in motion a Budget Reconciliation process that is attempting to generate approximately $18 billion in Fiscal Year 2013 mandatory spending savings and $261 billion over 10 years as part of a downpayment toward the $109 billion that must be saved in Fiscal Year 2013 to avoid automatic sequestration. Coupled with the House GOP decision to reduce Fiscal Year 2013 appropriations by $19 billion more than required under the BCA statutory discretionary spending levels, this would be a significant step toward avoiding the across-the-board cuts set to occur in eight months. Under the Budget Reconciliation process, House Committees must propose specific legislation to achieve such savings and then the full House will consider them after the Budget Committee approves the proposals. Ordinarily, this process would also occur in the Senate and the two versions would be reconciled, but there is no current comparable effort taking place on the Senate side in terms of a Budget Resolution or Budget Reconciliation. It is expected that if the House takes these steps, it will permit the GOP leadership to claim that it did “all that we could” to forestall automatic sequestration in the event that a compromise is not achieved before January 2, 2013.

Some in Congress would like to re-energize ad hoc bipartisan efforts to develop a legislative package along the lines suggested by the Simpson-Bowles Commission last year (which would have saved $4 trillion over 10 years) or that envisioned by the “Gang of Six” Republican and Democratic Senators (projected similar budget savings). Along with lower discretionary spending, those proposals would include substantial savings from the Medicare program and other entitlements and increased revenue from tax reform. There is no established legislative process for consideration of these or other proposals; what made the Super Committee’s work quite unique was that the Budget Control Act created specific parliamentary procedural protections for any legislative output of the panel, freeing it from amendment and filibusters. Accordingly, for any bipartisan budget plan to receive consideration in the House and Senate, it will take an unprecedented collaboration by the Republican and Democratic leadership.

It is also worth noting that many in Congress have echoed comments made by Defense Secretary Leon Panetta, who has criticized the Budget Control Act for requiring as much as $600 billion in reductions from the defense budget over the next 10 years if sequestration takes place. This could be the impetus for Congress to revisit the sequestration provisions in some way during the next few months. Please note that if the overall spending caps are left intact, but defense is exempted to some extent, that simply means that all other federal programs will have to take a harder hit in projected reductions.

Conclusion

Over the next few months we expect to see repeated attempts by Members of Congress to find a pathway forward that substitutes other budgetary savings for the across-the-board reductions of $109 billion that would occur on January 2, 2013. Given the current highly politicized atmosphere leading up to the 2012 Presidential and Congressional elections, it is highly unlikely that before America votes in November Congress will enact legislation to prevent sequestration. A growing number of Members of Congress would like to revisit sequestration during the “lame duck” session after the elections, when there might be a different dynamic and when the prospect of the cuts may be sufficiently daunting to trigger legislative activity (as we’ve seen in the case of possible government shutdowns and the debt ceiling crisis last Summer).