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Wednesday, December 7, 2011

The Budget Control Act of 2011: Effects on Spending Levels and the Budget Deficit

Marc Labonte
Specialist in Macroeconomic Policy

Mindy R. Levit
Analyst in Public Finance

The Budget Control Act of 2011 (BCA) was signed into law by President Obama on August 2, 2011 (P.L. 112-25). In addition to increasing the debt limit, the BCA contained a variety of measures intended to reduce the deficit by at least $2.1 trillion over the FY2012-FY2021 period. These included $917 billion in savings from statutory caps on discretionary spending and the establishment of a Joint Select Committee on Deficit Reduction.

The BCA discretionary spending caps are projected to result in $917 billion in deficit reduction over the FY2012-FY2021 period. Some types of spending are not subject to the caps, including for spending on Overseas Contingency Operations and emergencies. The precise programmatic impact of these reductions in discretionary spending will be determined in the annual appropriations process. Under the Congressional Budget Office’s (CBO’s) August 2011 baseline, which incorporates the effects of the BCA, the discretionary spending caps result in a decline in spending in nominal dollar terms in FY2012 and FY2013. Discretionary spending under the caps is projected to decline from 9.0% of GDP in FY2011 to 6.2% of gross domestic product (GDP) in FY2021. Since FY1962, the first year for which data are available, discretionary spending as a percentage of GDP has only been that low in one other year (FY1999).

Beyond the BCA’s deficit reduction achieved via the discretionary spending caps, the Joint Committee was created to find additional deficit reduction. On November 21, 2011, the co-chairs of the Joint Committee announced that they were unable to reach an agreement before the committee’s deadline. As a result, a $1.2 trillion automatic spending reduction process has been triggered to begin in January 2013 unless Congress and the President act to eliminate or change the process before then. The automatic reduction would be divided evenly between defense and non-defense spending. Many large mandatory programs are exempt from this process. The automatic reduction in spending for non-exempt accounts in FY2013 is projected to be 10% for defense, 2% for Medicare, and 7.8% for other mandatory and non-defense discretionary, resulting in further deficit reduction of $1.1 trillion between FY2013 and FY2021. Overall, 85% of the automatic spending cuts in FY2014 are projected to fall on discretionary programs. Cuts to discretionary spending through the automatic reduction would be in addition to those cuts resulting from the discretionary spending caps. After taking those two provisions into account, total discretionary spending would not regain its 2011 level until 2021 in nominal terms.

While the BCA is projected to reduce the deficit, it does not eliminate budget deficits or growth in the federal debt over the 10-year budget window. Using a current law baseline (where a series of tax cuts are assumed to expire and controls on Medicare payments to doctors are allowed to take effect), budget deficits are estimated to total $3.6 trillion and the federal debt is projected to increase by $4.4 trillion over the next 10 years. Under a current policy baseline (where a series of tax cuts are extended and controls on Medicare payments to doctors are not allowed to take effect), deficits over the next 10 years total $8.6 trillion and the debt would continue to rise faster than GDP. Since the debt cannot perpetually rise faster than GDP, additional spending cuts or revenue increases would eventually be needed.

Since deficit reduction under the BCA is relatively small in FY2012, the short-term effects on the economy should be limited. In the long run, economic theory suggests that large deficits would have negative effects on interest rates, investment spending, trade deficits, and GDP.

Date of Report: November 29, 2011
Number of Pages: 32
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