From Fiscal Cliff to Fiscal Roller Coaster

Published: January 03, 2013

CONGRESSPolicy and LegislationPublic FinanceSequestration

After a protracted pre- and post-election battle, President Obama and Congress have reached an agreement to avoid what is probably the most telegraphed punch in history: the “fiscal cliff.” But before we get too excited (whether it be because they were able to accomplish much of anything in this session of Congress or because we could possibly be retiring the annoyingly overused phrase “fiscal cliff), let’s take stock of what’s actually happened and what it means for federal contractors.

The most significant outcome of this legislation (aka the American Taxpayer Relief Act of 2012), for citizens is that there will be tax increases for households with taxable income over $450,000, tax stability through extended tax relief programs for everyone else, and an extension of unemployment benefits. The most significant outcome for government contractors: you have to wait another 2 months to know if and how sequestration will occur. While most are glad to see the players reach any kind of agreement, the general consensus is that this bill avoids the cliff but puts the government on a roller coaster. February and March will see agencies heading up yet another steep hill as Congress and the Administration work through yet another debt ceiling debate, sequestration rears its head again on March 1, and the current FY 2013 Continuing Resolution expires on March 27. March 27 is also the date that the spending reductions must be evaluated and implemented unless other legislation is enacted.
The American Taxpayer Relief Act of 2012 includes two sections under the sequestration provision:
1.     Postpones the sequester until March 1 and adjusts the discretionary caps down about $4B for FY 2013 at the time that the President triggers sequestration. The original post-sequestration discretionary caps were $546B for security agencies, and $501 for non-security.  This new bill adjusts those to $544B and $499B respectively. For FY 2014, caps are reduced from $556B and $510B to $552B and $506B, a total of $8B.

Note that “security” and “non-security” agency categories were defined differently for the original caps; security agencies included DoD, DHS, VA, State and Other International Programs and the National Nuclear Security Administration (NNSA). After the failure to identify deficit reductions, the definition of “security” agencies was revised to budget function 50- National Defense. 

2.     Allows the transfer of retirement funds to Roth IRAs without distribution. 
Considering the $109B in cuts that would happen each year for the 9 months of FY 2013 that would be impacted, that equates to approximately $12B per month. By reducing discretionary caps and increasing tax revenue generated from retirement transfers, the government delay effectively pays for the two-month delay by this combination of cuts and revenue increases. 
Impact on Contract Spending
Table 1. below provides a quick perspective on the potential impact of this sequestration delay on the contracting community.
Table 1
It’s clear that this bill is not aimed at addressing sequestration, but as we’ve been speculating for awhile now, “sequestration-like” cuts will happen whether it’s through formal sequestration or more targeted cuts through the appropriations process. By kicking the can down the road a bit, sequestration coincides with the expiration of the current CR, which is an opportune time to make adjustments. 
As agencies wait an additional two months for the ax to fall, they will continue to procure, albeit not at the same level as needed or previously planned in some cases. Sequestration does not impact dollars that are already obligated, so agencies continue day-to-day operations and obligate dollars to effectively “lock in” what they can while they can.  A December 20 memo from Defense Secretary Leon Panetta asserted that while they are planning for sequestration, the immediate impact would be minimal. For contractors, this could mean that effects of budget cuts wouldn’t necessarily be deeply felt until summer (though most contractors have already started to see the impact of the uncertainty surrounding sequestration). 
In the meantime, contractors should be hustling to determine the worst case scenario for their affected programs and talking to agency POCs to learn:
  • Which budget accounts fund their contracts.
  • Potential percentage cuts to the relevant budget accounts.
  • The priority placed on the contract and/or contract options and modifications to learn if they will likely be funded even under sequestration.
  • The possibility of moving options, modifications, task orders, etc. to be funded in the second quarter of FY 2013 to avoid the sequestration ax.
While it is a relief that some of the larger issues have been addressed with this legislation, it does not change the height of the cliff for contractors; it simply buys them more time to find a better fitting parachute.