[UPDATED 3:30 pm on 1/8/2013 with revised CSBA estimates] WASHINGTON: The battle of the fiscal cliff is over, but the war to stop sequestration rages on – and President Obama’s decision that his new Secretary of Defense should be former Sen. Chuck Hagel, the Republican other Republicans love to hate, makes it even harder to get a deal.

The all-too-plausible nightmare scenario: This March, the US government defaults on its debt for the first time in history, loses its AAA credit rating, and then shuts down for the first time in 17 years. Meanwhile the Pentagon faces at least $45 billion in automatically allocated across-the-board cuts with a Secretary weakened by a bitter confirmation battle.

Even the best-case scenario that has a reasonable chance to happen still cuts Defense, albeit perhaps as little as $10 billion, applied not blindly but according to some kind of rational prioritization.

“You will probably see…legislation that takes part of the sting out of sequestration by giving the Department of Defense a little more flexibility in how they spend the dollars,” guessed Rep. Randy Forbes, chairman of the seapower panel on the House Armed Services Committee, in an interview with Breaking Defense. “You’ll see some of the dollars put back from sequestration, but I’m afraid not all of them.”

“It’s certainly not what I want to occur,” sighed Forbes. “That’s what I think is most likely.” (Forbes voted against the Jan. 1 deal).

“I imagine defense cuts of some kind will be included but probably not on the same scale or mechanisms as sequester,” agreed one Democratic Congressional staffer. “They’ve already voted to cut it, so if they back the cuts up in size and just told DoD to determine on its own, that seems like a pretty plausible outcome.”

“We’ll resolve sequestration but, oh, by the way, you’re going to get cuts that probably aren’t that different from what sequestration would have entailed,” agreed Byron Callan director of market forecasting firm Capital Alpha Partners His best guess is $20-$30 billion in cuts in 2013, but, “an optimistic case,” Callan added, would be $10-15 billion.

No matter what happens, however, the exhausting, exhaustive budget planning process will be in shambles, not just for 2013 but for the year to come as well.

“It’s almost inevitable that there’ll be some delay” in rolling out the 2014 budget request, traditionally due in February, Pentagon comptroller Robert Hale said at the Brookings Institution this morning. “Normally, we’d be transmitting data to OMB by now and we’re not.” The federal budget is so huge and complicated that the military starts building it two years in advance. Today, we don’t know what spending levels will be for the fiscal year already underway, let alone the next.

“In nearly four decades,” said Hale, a hardened veteran of the budget wars, “I’ve never seen a period of greater budgetary uncertainty….It gives new meaning to the phrase ‘March Madness.'”

“We need,” Hale began, then corrected himself: “We DESPERATELY need more stability both in terms of budget size and particularly budget process.”

“It’s madness,” echoed budget expert Todd Harrison, of the Center for Strategic and Budgetary Assessments in an earlier conversation with Breaking Defense. “The fact that we set all of these up to occur within March is just madness – [and] completely self-inflicted. Something’s got to give here to break the cycle of behavior that we’re seeing.”

The Mathematics of Dysfunction
[This section has been revised with updated figures from CSBA’s Todd Harrison]

How did we get here? The New Year’s Day compromise avoided tax hikes on the middle class but punted on the other two parts of the so-called fiscal cliff: (1) the federal debt ceiling that limits what the government can borrow – which it technically has already hit – and (2) the automatic budget cuts known as sequestration. The Treasury will probably run out of room and gimmicks on the debt by March. The sequester, meanwhile, will begin to take effect March 1^st, with a second phase of the automatic cuts following on the 27^th – the same day the six-month continuing resolution now funding federal operations expires.

One slender silver lining is that the sequester will be somewhat smaller: $45 billion instead of $62, by Hale’s estimates; $48 billion, by Harrison’s [a revision of his estimate on the 7th — ed.]. That’s because the New Year’s deal – formally called the American Taxpayer Relief Act of 2012 despite being passed on 1/1/2013 – not only pushed back the date of the sequester but cut its amount as well.

The details are mind-numbing – the mathematically faint of heart should feel free to skip this paragraph – but in essence the 2011 Budget Control Act set up a two-phase sequestration. I rely here heavily on Todd Harrison’s patient explanation (as Breaking Defense contributor Loren Thompson told me, “nobody is able to keep up with this but Todd”) [and even Harrison had to call me back with updated figures a day later]:
1) The first, larger tranche is what Harrison calls the “penalty sequester.” Originally, this first phase would have taken effect Jan. 2nd – though actual implementation would have taken months – and whopped almost $110 billion out of the federal budget; half of that, $55 billion, would have come from budget function 050, which funds the Defense Department plus a few other odds and ends, so DoD would have taken a $52 billion cut.
2) But the BCA also reduced the budget caps that set maximum spending in various areas, a parliamentary device to prevent Congress from simply turning around and re-appropriating the sequestered funds. The initial “penalty” sequester would still leave budget function 050 above the cap, so a second “after-session” sequester would kick in to cut another $11 billion. The total cut from function 050: $66 billion. From DoD specifically: $63 billion.
To make everything as maddening as possible, the Jan. 1 deal made the penalty sequester to budget function 050 some $12 billion smaller, but it made the after-session sequester $2 billion larger [updated: and, as Harrison discovered the day after Hale’s remarks, radically increased the number of agencies affected, spreading out a cut originally concentrated on the Pentagon to affect the Departments of Homeland Security, Veterans’ Affairs, and Energy]. The bottom line is that sequestration will now cut an estimated $48 billion specifically from DoD.

$48 billion is Harrison’s estimate: Hale’s is only $45. [updated: “He may have been rounding, and I may have underestimated the amount of the sequester impact on Homeland Security and VA,” sighed Harrison. “The upside to the way they write this legislation and make it so complicated is it keeps people like you and me employed,” he told me on Tuesday afternoon. “If it were simple and straightforward, none of us would be needed.”]

“I hope you’ll take those numbers as rough,” Hale himself said apologetically to a questioner this morning at Brookings, after going through just some of those figures with the caveat that his staff is still figuring out all the wrinkles of the law. “Is that clear, sort of?”

The Limits To Compromise

All this painful math is moot if Congress wants it to be, of course. The 1/1 deal, the Budget Control Act, and for that matter the willfully mindless nature of the sequestration mechanism as established by the Gramm-Rudman-Hollings Act of 1985 are all mere laws, not commandments carved in stone. With the President’s signature, Congress can pass new laws to overturn them. The country’s long-term fiscal problems are real, but this particular crisis is entirely self-imposed.

At the very least, the Office of Management and Budget could use an existing loophole in the sequestration law to propose an alternative set of cuts to reach the required total, cuts that protect priority programs instead of slicing everything equally. But the Administration has been reluctant to take this out, and if they did, Congress would have to approve it.

Harrison’s not optimistic. “Because sequestration is mindless,” he said, “it allows people in Congress to let the budget be cut without their fingerprints being on it…. No one has to vote for specific cuts this way.”

In other words, as disastrous as the country’s current path may be, changing direction requires taking responsibility, which legislators understandably hate to do because voters, especially highly motivated primary voters, tend to punish them for cutting their pet interests.

As comptroller Hale said this morning, the Congress “votes for lower defense budgets and then says we can’t do the things that are needed to achieve them. They prohibited, for example, the retirement of Navy ships [and] turned down many of the requests we made to slow the growth in military compensation.” At least, Hale noted, the final version of the 2012 National Defense Authorization Act did allow some of the requested cuts to the Air National Guard.

Those controversial cuts may have brought the budget realities home to many legislators in the way no top-line number could. “For a lot of members not on the committees [that cover defense], concern over those Guard units made those defense cuts real for the first time,” one Republican staffer told Breaking Defense. Dovish Democrats and Republican budget hawks alike find it much easier to advocate cutting the Defense budget in general than to accept a home-state unit shutting down. “A lot of delegations – many of whom have members that have been advocating for more and deeper cuts – realized what those cuts would do.”

In other ways, however, members may be less motivated than ever to stop sequestration. The direct threat to the average voter was tax increases, which the Jan. 1 bargain largely averted. Staving off budget cuts and a federal default, however disastrous, simply doesn’t have the same political impact.

Indeed, sequestration was almost overlooked altogether in the New Year’s scramble to avoid tax increases. “The fact that the sequester was dealt with at all has to be viewed as some sort of a victory,” said Dan Stohr, communications director for the Aerospace Industries Association, which has campaigned against sequestration all year. “They did manage to get a mini-deal on the sequester to push it two months back.”

“That said, they’re kicking the can down the road,” Stohr acknowledged. Worse yet, he went on, “they’re now juxtaposing the debt ceiling deadline with trying to get rid of the sequester. So that complicates things dramatically.”

As they did in 2011, Republicans want to offset any increase in the amount the government can borrow by a decrease in what it spends, and implementing sequestration is the easiest way to do that. Democrats would prefer to offset a debt ceiling increase by further raising taxes on the rich, if only by eliminating deductions rather than raising rates again, and by cutting the Defense budget, both ideas the GOP abhors. Republicans would rather protect Defense and cut entitlements, which were exempted from sequestration. Neither side has shown much interest in the others’ solution.

“There’s this sharp political divide,” said Callan, “with the Administration saying revenues are absolutely going to be on the table and the GOP saying we’ve done that, this is all about spending…. The idea of a grand bargain, it just doesn’t seem feasible.”

The Hagel Factor

Further poisoning the waters is Pres. Obama’s choice of retired Nebraska Senator Chuck Hagel for Secretary of Defense. At first glance, replacing a long-time Democratic activist like Leon Panetta with a Republican war veteran like Hagel would seem to be a conciliatory gesture. It’s not.

Hagel has repeatedly criticized fellow Republicans. Most prominently, Hagel came out against his Senate colleague John McCain in the 2008 election campaign and all but endorsed Obama for President. Even before the invasion of Iraq, Hagel warned, prophetically, that the Bush Administration had not thought through what to do after Saddam fell. He opposed Bush’s troop surge in Iraq and Obama’s in Afghanistan. He even repeatedly hit the one bipartisan hot button in the foreign policy and national security domain when he voted against some sanctions on Iran, urged Israel to negotiate with Hamas, and decried the excessive influence of what he called the “Jewish lobby.” As for the Defense Department itself, he’s called its budget “bloated.”

Hagel is an “in-your-face” challenge to Republicans, said South Carolina Sen. Lindsey Graham on CNN yesterday.

Other Republicans have been less vituperative, so far, and Hagel may well win them over. “Once Republicans reacquaint themselves with Hagel’s credentials, they will realize his nomination to the Pentagon’s top job is a gift from the White House,” said Loren Thompson, a member of the Breaking Defense Board of Contributors. “Chuck may sound like an ecumenical internationalist when he’s talking about foreign policy, but his views on domestic policy were decidedly conservative during his two terms as Senator.”

Ultimately, it’s almost certain Hagel will be confirmed. Senate Minority Leader Mitch McConnell promised him a “fair hearing,” which presumably means the Senate will get to vote on the nomination rather than have it subject to a hold, and the Democrats have the votes. And after being forced to give up on Susan Rice’s nomination to be Secretary of State, Obama is unlikely to back down from a fight on Hagel.

Even a minority of the minority can make the confirmation fight a bitter one. The more bitter that fight becomes, the greater the damage not only to Hagel’s ability to lead the Department of Defense but to the two parties’ ability to compromise on anything else. And they’re running out of time.

Even a modest bargain to avert the sequester, one that includes some cuts to defense, will require hard negotiations over myriad details. “That’s not likely to be part of a last minute bargain,” said Harrison. “Better start working now. [By] the last week of February, if we haven’t seen the outlines of a plan like that, it’s not likely to happen.”