Federal regulatory agencies are facing the threat of extensive budget cuts in their rule writing and enforcement functions under the “sequestration” process under the Deficit Reduction law.

The appropriations process produces budget deficits because program advocates can make strong arguments for increased spending without being required to identify other programs that should be cut to offset those outlays. In 1985, the Gramm-Rudman law “sequestration” mechanism that sought to turn the process into a zero sum game.

“Sequestration” has two meanings. Technically, it means automatic, indiscriminate, pro rata budget cuts to reduce overall spending to a predetermined level. In practice, “sequestration” is a gun that Congress holds to its own head to force program advocates to accept compensating cuts elsewhere for fear that resources for their favorite program otherwise will be cut.

The Deficit Reduction law modified Gramm-Rudman to provide that sequestration will occur in January 2013 unless Congress adopts—by Dec. 23, 2011—a law reducing spending by $1.2 trillion in 2012-2021. If Congress fails to act or adopts a law that reduces spending by less that $1.2 trillion, spending will automatically be reduced in equal amounts over these years to produce $1.2 trillion in cuts.

If sequestration occurs, indiscriminate but uniform pro rata cuts will be divided equally between defense and non-defense programs that have not been exempted. Core national security functions and the major domestic entitlement programs (Social Security and Medicaid) will not be reduced, and cuts in Medicare are limited to 2 percent. The major departure from the original Gramm-Rudman process is that many more national security programs are now subject to sequestration in an effort to force proponents of defense spending to demand cuts in domestic programs in order to prevent reductions in military spending.

The conventional wisdom is that disputes over spending and taxes are so intractable that the Joint Select Committee (JSC) established to draft a deficit reduction law cannot possibly succeed in devising a proposal to save $1.2 trillion that will pass both Houses and that the President will sign. If that prediction is correct and a full sequestration occurs, the Congressional Budget Office estimates that eligible defense programs will be cut by 10 percent, eligible non-defense programs by 7.8 percent and Medicare by 2 percent.

Few regulatory agencies are exempt from sequestration. Budget cuts of this magnitude, extending for nine years, would have substantial adverse effects on regulatory agencies in all their functions, including promulgating rules, supervision of regulated entities, inspections and enforcement. Regulators would be forced to scale back their operations and concentrate of fewer, priority targets. The uniform pro rata cuts would produce similar effects in all other covered programs.

The calculus underlying the sequestration mechanism is that the adverse consequences of extensive, indiscriminate cuts will break the policy deadlock. It is designed to force Congress to end the zero sum game, prioritize among programs and agree to targeted reductions in less-essential programs to avoid extensive cuts in vital programs. The Gramm-Rudman process had this effect in 1985. Although a sequestration was imposed in early 1986, the pro rata amount was small and readily absorbed by the agencies. Congress thereafter took steps to assure that the sequestration experiment was not repeated.

Based on that experience, I believe the most likely outcome of the JSC process is passage of a law that will make substantial progress toward the $1.2 trillion level, with the shortfall covered by a threatened sequestration in January 2013. Whatever the result, this exercise will frame the principal issue for the 2012 elections.