If you like polit­i­cal dra­ma, you’re in luck. It seems like just yes­ter­day the news was filled with ref­er­ences to the fis­cal cliff. Now, com­ing to the­aters every­where, is “seques­tra­tion.” 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 effec­tive March 1, 2013. From 2013 through 2021, seques­tra­tion is sched­uled to cut $1.2 tril­lion from 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 non­de­fense 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. Fed­er­al agen­cies will noti­fy employ­ees of pos­si­ble fur­loughs, and the Defense Depart­ment will do the same with civil­ian employ­ees, but those fur­loughs like­ly won’t take effect for at least a month. In addi­tion to poten­tial lay­offs and fur­loughs, indi­vid­ual agen­cies will begin announc­ing and imple­ment­ing oth­er cost-sav­ing mea­sures.

Wait, there’s more …

While it has­n’t received the same lev­el of atten­tion as seques­tra­tion, there’s anoth­er prob­lem rapid­ly approaching–the gov­ern­ment is run­ning out of mon­ey again. Fed­er­al fund­ing for the cur­rent fis­cal year expires on March 27, 2013. Unless Con­gress autho­rizes addi­tion­al fund­ing, a par­tial gov­ern­ment shut­down would result.

In addi­tion, a few months lat­er, expect anoth­er debt ceil­ing debate. The fed­er­al gov­ern­ment reached its $16.394 tril­lion debt ceil­ing lim­it at the end of 2012. Con­gress sub­se­quent­ly sus­pend­ed the debt ceil­ing lim­it until May 19, 2013, and although the U.S. Trea­sury has some abil­i­ty to con­tin­ue oper­a­tions beyond that date, at some point the debt ceil­ing debate will need to be addressed. Thus, it’s con­ceiv­able that any short-term agree­ment on seques­tra­tion would include pro­vi­sions that address these dead­lines as well.

Whether Con­gress address­es some or all of these issues over the com­ing weeks or months is any­one’s guess. So stay tuned. And pass the pop­corn.

Relat­ed Posts:

Annu­al Tax Update Let­ter to Our Clients & Friends

What is the Fis­cal Cliff?