The Fiscal Cliff Sequel

"Our revels now are ended. These our actors, as I foretold you, were all spirits, and are melted into air, into thin air." Prospero, The Tempest, Act IV, Scene 1

The curtain has closed on the shadow play "The Fiscal Cliff." The actors have left and the journalists are sweeping the stage. As foretold in August 2011 it was theater, not a reality show, and certainly not reality itself. But gird your loins for the next round; the fight is far from over.

The endgame drama was a tax bill, not a spending bill, and certainly not a Grand Bargain. It did not affect spending very much at all, as nearly two-thirds of the Republican members of the House pointed out yesterday in voting against the deal.

Because it deferred virtually all of the spending issues, it opened up the opportunity for a new theatrical performance to come to town, one everybody will recognize: "The Debt Ceiling: The Sequel."

We will get to fight the sequester fight all over again in the next two months, without the tax issues to balance it out. Senator Lindsey Graham, already on the record for saying (wrongly) that the Pentagon might have to send out 800,000 layoff notices if the Pentagon budget were hit by sequester, has already advertised that his party should "save your powder for the debt ceiling fight."

But this is not going to be the same kind of fight. The markets are not going to bounce up and down about the spending issue, not in the ecstatic way they bounded up today.  The economic consequences of billions of dollars in added taxes are not the same as the consequences of spending cuts this year ($109 billion) that are less than 1 percent of overall federal spending.

Budgets and spending are familiar year-by-year struggles for Congress. Because negotiators could not get even close to a spending agreement last month, they pushed this fight to March — about the same time that Secretary Geithner has said that the United States will hit the debt ceiling after his ability to shuffle funds around to avoid going over the top will run out of steam. So the same two trains — spending and the debt ceiling — are heading toward each other as they were in the summer of 2011.

What does this mean for federal spending and, my beat, for defense? Not much. Defense is still a side show, a "residual" in a larger agreement.

This week’s deal postponed the Budget Control Act’s spending sequester for two months, which meant some of the savings that were supposed to happen between January 2 and March 1 — about $24 billion — needed to be covered in some way. The deal agreed to apply some of the revenues from the tax changes to cover some of that spending gap.

Then, to make sure the FY 2013 budget does not go over the cap for this fiscal year, there will be about $12 billion in spending cuts, $4 billion of which will take place this fiscal year and $8 billion in FY 2014. These cuts would be split 50/50 between "security" (meaning defense, nuclear weapons, foreign policy, homeland security, and veterans’ affairs) and "non-security" spending.

This little piece doesn’t mean much for defense. If the FY 2013 defense budget went down another $2 billion from what the appropriations committees’ bills look like today (they are slightly over the cap), it would affect a tiny fraction of the defense budget — a rounding error for DOD. And if these cuts were spread out to the other security agencies, it would be even less of a hit. Appropriators find this kind of chump change in their pocket lint, every year.

The long-term sequester is a bigger budgetary deal and it comes March 1, ahead of the cap limitation I just discussed. This is the ten-year defense hit Secretary Panetta (and Senators McCain, Graham, and Ayotte, Chairman McKeon of the House Armed Services Committee, and the Aerospace Industries Association) have been hyperventilating about for more than a year. In the absence of a spending deal that postpones this ten-year sequester, the defense budget would decline by something like $490 billion from the current budget projection.

Now, I gotta tell ya, this is not the big deal these "defenders of defense" make it out to be. Losing $500 billion from the flat defense budgets projected over the next ten years would still be the smallest post-conflict drawdown the defense budget has experienced since the end of World War II — maybe 15 percent of the ten-year budgets DOD projects today. For FY 2013, this sequester would now mean $43.5 billion out of the FY 2013 defense budget, less than before, but still significant.

But DOD would still have to manage it. Once again, for the record, military personnel are unaffected — the president has already waived them from sequester, as the law allows. The industry would survive, because they are working on existing contracts, but business would get smaller than they hoped over the next decade. (We are already in a drawdown now, so most of the major defense contractors have already been cutting back in anticipation.) The Office of Management and Budget has made it clear that DOD’s operating accounts (Operations and Maintenance) would have substantial flexibility, not what Secretary Panetta has called a "meat axe" approach.

And DOD would retain the capacity to reprogram funds, much of which can be done internally, without prior congressional approval. In fact, over the past 12 years, DOD has carried out more than 1,100 such reprogrammings, ranging from roughly $12 billion in FY 2000 to as much as $49 billion in FY 2008.

A spending deal would be necessary in any case; we need a budget every year. But this year, like the last two, will be something special, courtesy of the debt ceiling’s return. Republicans are going to want a pound of flesh for having violated the Norquist pledge and raised taxes on the rich. Defeat is not a pretty thing. And the Democrats are going to want to avoid domestic spending cuts and, especially, changes in Medicare and Social Security benefits. We will be watching this new drama intensely as the new Congress comes in, the media discover the debt ceiling, and March 1 approaches. So get some more popcorn, settle down, and enjoy the show.