Understanding Sequestration

SequestrationIf you like political drama, you’re in luck. It seems like just yesterday the news was filled with references to the fiscal cliff. Now, sequestration dominates the headlines. Look for more political confrontation to unfold as sequestration gets under way.

What Exactly is Sequestration?

Sequestration refers to a series of automatic, across-the-board spending cuts to federal government agencies that are scheduled to take place in fiscal years 2013 through 2021. The cuts, totaling $1.2 trillion, will be split evenly between defense and domestic discretionary spending. The cuts are effective March 1. (The cuts were originally scheduled to take effect January 1 but were postponed to March 1 as part of the last-minute fiscal cliff deal reached on New Year’s Day.)

How Did Sequestration Come Into Being?

Sequestration was created from the August 2011 standoff over the U.S. debt ceiling. In conjunction with agreeing to raise the debt ceiling (which allowed the U.S. Treasury to pay its monetary obligations and avoid a default), Congress imposed approximately $2 trillion worth of spending cuts–$1 trillion that was spelled out in the debt ceiling bill (the Budget Control Act of 2011) and another approximately $1 trillion that would be implemented through sequestration–a broad, across-the-board series of default spending cuts that would take effect beginning in 2013.

The idea was that sequestration would be a measure of last resort, and that Congress could act to replace the sequestration cuts with an equal amount of alternate spending reductions. Indeed, the Budget Control Act of 2011 created a deficit reduction “supercommittee” that was charged with reaching consensus on additional budget cuts that would avoid sequestration. The supercommittee failed, paving the way for sequestration to take effect.

What’s Going To Be Cut?

The automatic cuts are going to effect government agencies, split evenly between defense and domestic programs. More than $500 billion is scheduled to be cut from the Defense Department and other national security agencies. The remaining cuts will affect a variety of domestic programs, including education, public safety, energy, national parks, food inspections, housing aid, transportation, and law enforcement.

Social Security, Medicaid, and Medicare benefits are exempt from sequestration. Although cuts to Medicare provider payments are on the table, they can’t exceed 2% of current payments.

In 2013, the cuts will total $85 billion (sequestration originally called for approximately $109 billion in cuts this year, but the American Taxpayer Relief Act of 2012 reduced the required cuts by $24 billion). The Congressional Budget Office estimates that in 2013, funds for defense spending (other than spending for military personnel) will be cut by about 8%, and non-defense spending subject to automatic reductions will be cut by between 5% and 6%. (Source: Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2013 to 2023, February 2013)

You may have heard a great deal about what’s going to happen as a result of the sequester, and much of it has likely been alarming. It’s important to understand, though, that the government will not be shutting down. In fact, while it’s hard to know exactly how things will play out as the cuts are implemented, most individuals are probably not going to notice a significant, immediate effect.  Whether Congress addresses some or all of these issues over the coming weeks or months is anyone’s guess. So stay tuned.

What Should I Do?

Be patient. Government agencies and departments touch many aspects of our lives and the employees in these agencies and departments will likely experience downsizing and furloughs resulting in diminished service and longer wait times for all of us. Patience will serve you and the resource constrained service workers well.

When it comes to your portfolio, patience and discipline are the hallmarks of every successful investor. It is possible that the markets will look negatively upon the sequester, or it could respond positively to the decreased spending. the fact is, none of us can predict these events. Diversification is the one proven strategy for managing risk and uncertainty.

 

IMPORTANT DISCLOSURES:  Independence Advisors, LLC, does not provide tax or legal advice. The information presented here is not specific to any individual’s personal circumstances. To the extent that this material concerns tax matters, it is not intended or written to be used, and cannot be used, by a taxpayer for the purpose of avoiding penalties that may be imposed by law.  Each taxpayer should seek independent advice from a tax professional based on his or her individual circumstances. These materials are provided for general information and educational purposes based upon publicly available information from sources believed to be reliable—we cannot assure the accuracy or completeness of these materials.  The information in these materials may change at any time and without notice.

About Mark Rioboli

Mark A. Rioboli, CFP®, CFS is Director of Wealth Management for Independence Advisors, bringing over 25 years of experience in the wealth management industry. Have a question for Mark? CLICK HERE TO ASK MARK

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