Speaker of the House John Boehner, center, leaves a meeting with House Ways and Means Committee Chairman Dave Camp (R-Mich.) Jan. 1 in Washington D.C. The Senate passed a measure partially averting the so-called fiscal cliff earlier in the day Jan.1, while the House approved the bill around 11 p.m. ET. (Chip Somodevilla / Getty Images)
The House on Jan. 1 approved a measure that partially averts the fiscal cliff and delays pending cuts to planned Pentagon spending until March.
The eleventh-hour deal, forged by Vice President Joe Biden and Senate Minority Leader Mitch McConnell, R-Ky., kicks many of the issues that created the hysteria over the so-called fiscal cliff down the road. Part of that is a proposal that delays by two months identical $500 billion cuts to planned defense and domestic spending.
The measure easily passed the Senate early Jan. 1. After a day of twists and turns behind the scenes in the House, it passed with mostly Democratic support. Around 90 House Republicans voted for it. It now goes to President Obama for his signature.
For the Pentagon, the delay means defense officials won’t be issuing furlough and layoff notices, nor canceling contracts just yet. For the U.S. defense industrial base, it also means additional personnel moves are not required soon, and should keep their stock prices relatively stable.
“A two-month delay isn’t good for the markets,” said Larry Korb of the Center for American Progress. “But no sequester, at least right now, means the Pentagon won’t have to do things like cancel [weapon] contracts, cancel training or put off base maintenance.”
The plan extends tax cuts for couples making less than $450,000 and individuals who earn less than $400,000 annually.
In a Dec. 31 midday address, Obama, echoing lawmakers from both parties, said he “wanted a bigger deal ... that doesn’t just deal with the taxes.”
But that larger deal simply became unreachable due to time restraints and ideological differences. And that means another big fiscal fight awaits the new Congress in January, which immediately will tackle Obama’s desired debt-limit increase and issues like the delayed defense and domestic spending cuts.
Had the Biden-McConnell plan not specifically addressed it — or raised $1.2 trillion in projected revenues, which it does not — twin $500 billion cuts to defense and domestic spending would have kicked in Jan. 2.
For now, the Pentagon’s base and war budgets — which collectively could approach $633 billion in 2013 — have, to the surprise of many liberal- and libertarian-leaning lawmakers and analysts, avoided the guillotine.
Senior defense officials have said they can absorb some new spending cuts without a major impact on the Obama administration’s almost year-old DoD military strategy. Some insiders, including Korb, expect in coming months the Defense Department’s budget will be slapped with a $100 billion reduction — likely spread over several years — to help with further federal deficit-reduction efforts.
If sequestration had been allowed to kick in on Jan. 2, all non-exempt Pentagon spending accounts would have had to shrink by about 10 percent.
Pentagon Comptroller Robert Hale and other officials have said furloughs would have been ordered, meaning DoD civilian workers might have been sent home as a way to pay for other activities, such as operations in Afghanistan.
In a late-December memo to DoD employees, Defense Secretary Leon Panetta said Pentagon officials would have “carefully examine other options to reduce costs” before ordering furloughs.
But, for the Pentagon, lawmakers could still act in January and avert the worst-case scenarios.
“I do not expect our day-to-day operations to change dramatically on or immediately after January 2, 2013, should sequestration occur,” Panetta wrote in the memo.
The armed services have not been tasked with developing sequestration implementation plans, sources say. That’s because the services depend on Congress for guidance, and are reluctant to act until lawmakers’ collective will is known.
Hawkish lawmakers banked that an ample number of lawmakers would be mindful of Panetta’s warnings about the national security implications of sequestration, causing them to put aside worries about how to pay for the delay.
“The secretary of defense and the chairman of the Joint Chiefs of Staff have said they will be unable to defend this nation if sequestration happens,” Senate Armed Services Committee Ranking Member John McCain, R-Ariz., told reporters Dec. 31. “That’s good enough for me, and it should be good enough for anybody that’s negotiating.”
Although the Pentagon has avoided the immediate impact of the sequester, the looming prospect of cuts merely postponed will hang over the defense industry.
“I don’t see any real change, it’s just the same people sitting around a table debating the same things,” said James Hasik of Hasik Analytics.
“The effect is essentially the same unless they are just kicking it down the path to eventually kill the reductions. But in the long term that gets you into a situation like Spain or Greece or some other fiscal disaster area.”
And even with the delay, industry executives are expecting cuts, Hasik said. “None of them are under the illusion that it’s going to keep raining money like this.”
The beginning of 2013 is likely to mirror the end of 2012, with industry continuing to apply pressure on congress to eliminate the cuts and companies trimming payroll and approaching the market cautiously in light of the fiscal uncertainty.
And although the worst cuts won’t happen just yet, the prospect of the sequester will still have a dampening effect, said Steve Grundman, the George Lund Fellow at the Atlantic Council.
“I think there’s only a subtle distinction with what investors and the industry will think, between full implementation and a postponement,” he said. “This is a true inflection point in the character of risk, it almost doesn’t matter what happens after today.”
In the past defense was always deemed a fairly low-risk investment area.
Contractors may see good years and bad years, but catastrophic collapse of the market is far fetched. More importantly, however, is that there has been a contingent of congress that has staunchly defended defense spending at all costs.
That has changed.
“National security and defense has traditionally been part of the identity of the Republican Party,” Grundman said. “That portion has been waning, it has been dissolving over time, but a couple of things mark a sharp departure for that party. One is that they’re willing to trade off the adverse effect on defense in order to avoid raising taxes.”
Several news reports surfaced in the days before the new year that Democrats had offered a plan to eliminate the sequester of defense funds in exchange for offsetting tax revenue increases. Even though defense cuts have been temporarily averted, the fact that the GOP was unwilling to make that compromise indicates a shift in priorities.
Without confidence that at least one party will defend defense spending, investors will likely view the defense industry as carrying far more risk.
In addition, companies have been warning that any delay will harm the development of innovative technology, creating something of a research hiatus.
Hasik said that any short term delay will not greatly impact large contractors.
“The folks who are getting hung out to dry are the guys who do the smaller innovative stuff,” he said. “They tend to spend their own money, and a delay in an investment could really hurt them.”
Christopher P. Cavas contributed