FROM: Kenny Hodge, Associate Director
DATE: April 17, 2013
RE: Sequestration Update: The Process and its Impact on Federal Health Programs
On August 2, 2011, President Obama signed into law the Budget Control Act (BCA) of 2011 (P.L. 112-25). This bill allowed the President to raise the debt limit by $2.1 trillion in three steps and cut federal spending by $917 billion over ten years. The bill also established the Joint Select Committee on Deficit Reduction (the “Super Committee”), tasked with approving at least another $1.2 trillion in deficit reduction by November 23, 2011. As a failsafe in case the Super Committee did not produce a plan, the BCA included a sequestration trigger to ensure at least $1.2 trillion of deficit reduction, split evenly among defense and non-defense programs. When the Super Committee announced they failed to reach an agreement on November 21, 2011, the sequestration process commenced. This memorandum explains the sequestration process and its impact on federal healthcare programs.
The Sequestration Mechanism
The sequester mechanism was originally created in 1985 in the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985 for the same purpose for which it is being used today: to provide automatic spending cuts if federal spending exceeds a set of fixed targets, or caps.
Upon passage of the BCA, a set of spending caps were automatically put into place on discretionary programs, reducing the deficit by $917 billion from fiscal year (FY) 2012 through FY 2021. These caps were based off of 2011 Congressional Budget Office (CBO) spending projections for those years. Thus, while discretionary spending will be reduced as compared to spending projections, federal spending will still be allowed to grow moving forward. No future automatic sequester cuts to discretionary spending will occur because the caps will be implemented at the beginning of each fiscal year. Funds in the accounts of federal agencies will never be reduced at one time; instead these agency accounts will be replenished with fewer funds than they had received the previous fiscal year.
When the Super Committee failed to produce a deficit reduction plan, the BCA’s $1.2 trillion deficit-reducing failsafe was triggered. This failsafe includes two parts: 1) a new set of lower mandatory and discretionary spending caps; and 2) an automatic budget-cutting enforcement tool (i.e., the sequester itself). This new regime of lower BCA federal spending caps and the enforcement tool to preserve them are today referred to as “sequestration.”
In the context of sequestration, 2013 is a special case. The BCA provided that sequestration would begin on January 2, 2013. Although this date was later postponed to March 1, 2013 by the fiscal cliff deal reached in January, the new spending caps were set to be implemented in the middle of a fiscal year , which begins on October 1. This mid-fiscal year timing is why, unlike the initial BCA cuts, sequestration was required to reduce the deficit in 2013. This tool cut funding from federal agencies across the board, at a set percentage dependent on the type of program (discretionary or non-discretionary) and category (defense or non-defense).
The Office of Management and Budget (OMB) is tasked with utilizing the sequester mechanism to enact these cuts. Each year until 2021, OMB will create a sequestration report estimating if the BCA spending caps will be breached during that fiscal year and recommend any sequestration cuts needed to bring federal spending in line with the BCA caps. OMB action generally would only occur when Congress appropriates funding at a level that breaches these caps.
2013 Discretionary Spending Reductions
After the failure of the Super Committee and more than one year of discussions thereafter about ways to avoid the sequester, it finally took effect on March 1, 2013, reducing funds in federal accounts by $85 billion for FY 2013.
Most of the public health agencies within the Department of Health and Human Services (HHS), namely the Food and Drug Administration (FDA), the Health Resources and Services Administration (HRSA), the Centers for Disease Control and Prevention (CDC), and the National Institutes of Health (NIH), are funded as non-defense discretionary programs. When OMB released its FY 2013 sequestration report, it determined that non-defense discretionary accounts will be cut at a rate of 5.0% in order to implement the sequester cuts in FY 2013. OMB also determined that user fees, such as the FDA user fees paid by the pharmaceutical drug and medical device industries, are part of the sequestrable base for non-defense discretionary program funding.
The Centers for Medicare and Medicaid Services (CMS) are impacted much differently because of special sequestration exemptions in the BCA for Medicare and Medicaid. Medicaid is entirely exempt, while Medicare provider payment cuts are capped at 2%. Thus, while these cuts are not insignificant, sequestration affects a smaller percentage of the program’s overall budget.
The chart below outlines the sequester’s impact on federal health programs in FY 2013.
Projected Sequester Amount
Percentage of Budget *
|Centers for Medicare and Medicaid Services (CMS)||
$11,851 of $1,124,532
|Food and Drug Administration (FDA)||
$209 of $4,176
|National Institutes of Health (NIH)||
$1,553 of $31,049
|Health Resources and Services Administration (HRSA)||
$365 of $8,512
|Centers for Disease Control and Prevention (CDC)||
$303 of $6,019
* Note: While most of the funding for these agencies comes from non-defense discretionary accounts, some funds are categorized as either mandatory or defense related. Hence, these numbers are not all equal to the 5.0% non-defense discretionary sequester rate.
2013 Medicare Spending Reductions
With Medicaid and Social Security exempt from sequestration, Medicare is the largest mandatory spending program impacted by the sequester. The BCA and sequester also work differently for mandatory spending compared to discretionary spending. Placing true caps on mandatory spending is not possible because of the automatic nature of the spending. Instead, sequestration reduces the rate of mandatory spending by a fixed amount. As noted before, however, the BCA capped Medicare provider payment cuts at 2%. CMS has some discretion in how to implement these cuts, and the Agency announced on March 1 that it would need until April 1 to implement the cuts. During March, the Agency specified how it will implement the cuts, both for Medicare Fee-for Service (FFS) in Part A and Part B and Medicare’s contractual payments for Medicare Advantage (MA) and Part D.
For Medicare FFS, claims with dates-of-service or dates-of-discharge on or after April 1, 2013 were reduced by 2%. Claims for durable medical equipment (DME), prosthetics, orthotics, and supplies (including DME Competitive Bidding Program claims) were reduced by 2% based upon whether the date-of-service, or the start date for rental equipment or multi-day supplies, was on or after April 1, 2013. These payment adjustments are applied after determining any applicable coinsurance, deductible, or Medicare Secondary Payments. For example, providers normally are reimbursed at a rate of Average Sales Price (ASP) + 6% for Part B drugs and biologics. Only 80% of this payment is made by Medicare, however, while the other 20% is paid for by the beneficiary. Thus, the 2% sequester cuts only apply to the 80% of the payment made by Medicare, resulting in an effective Part B drug reimbursement rate of approximately ASP + 4.3% under sequestration.
For Medicare Advantage and Part D payments, CMS will cut each of its monthly contractual payments to MA and Part D plans by 2% beginning on April 1. Low-income subsidies and additional subsidies for beneficiaries whose spending exceeds catastrophic levels in Part D are exempt from sequestration.
Patient and provider advocates have raised concerns regarding the impact of the 2% reduction in Medicare, focusing heavily on patient access issues that could occur with Medicare Part B drugs and biologics. We anticipate that Congress and the Administration will be closely monitoring patient access issues that may result and may use the outcomes to bolster arguments for or against the ongoing debt and deficit reduction proposals to reduce ASP reimbursement.
Sequestration from 2014-2021
With the 2013 sequester underway, many stakeholders are examining the potential impact of the sequester in the outyears, from 2014-2021. The purpose of sequestration is to reduce the deficit by $109.4 billion each year ($54.7 billion each from defense and non-defense accounts), summing to $1.2 trillion. Additionally, the BCA spending caps were based off of CBO spending projections for those years and, thus, the federal budget will begin growing again in 2014, but at a reduced rate and based off of the projected spending for that year.
With implementation in the middle of FY 2013, 2013 should be the only year where agencies are operationally affected mid-year by the sequester. Instead, the Appropriations Committees in the House and Senate will delegate funding within the newly reduced spending caps for 2014 and beyond. The automatic sequester will act primarily as an enforcement mechanism where spending caps are breached by the Appropriations Committees. This type of enforcement already occurred with the recent enactment of the FY 2013 Continuing Resolution (CR) passed in late March (P.L. 113-6), which funded some federal agencies above the sequestration caps. President Obama issued a second sequestration order on April 5, which cut the CR funding by $1 billion to bring spending for FY 2013 back in-line with what is prescribed for deficit reduction targets this year.
The Medicare cuts for FY 2014 will largely remain unchanged, with a 2% provider payment cut in effect through 2021. The payment cuts technically could dip below 2%, but because Medicare spending is projected to grow faster than the rest of the federal budget, payment cuts likely will remain fixed at the current 2% cap. As a result, Medicare will take a growing share of the $54.7 billion annual non-defense cuts, so other non-defense programs, such as FDA and NIH, will absorb a declining share of the cuts in the sequester outyears. To illustrate, Medicare will account for $11.4 billion (or 21%) of the non-defense cuts in 2014 but $17.8 billion (or 33%) in 2021.
The March 1 sequester cuts have already begun to impact federal health programs. Although the cuts are largely unpopular with most healthcare stakeholders and the source of highly politicized debates among lawmakers, substantive discussions to replace the sequester cuts have stalled. Thus, all stakeholders impacted by federal health programs must deal with the ramifications for the foreseeable future. FY 2013 is likely to be the harshest year for federal agencies, as the federal budget will begin growing again in FY 2014, and the Appropriators in Congress will have the opportunity to fine tune federal funding and avoid the blunt cuts suffered in 2013.
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We hope this memorandum is helpful in understanding the sequestration process and its impacts on federal health programs. We would be pleased to speak in greater detail regarding any of the issues raised in this memorandum.
 The American Taxpayer Relief Act of 2012(P.L. 112-240).
 OMB, OMB Report to the Congress on the Joint Committee Sequestration for Fiscal Year 2013 (2013), available at: http://www.whitehouse.gov/sites/default/files/omb/assets/legislative_reports/fy13ombjcsequestrationreport.pdf
 Funding levels for these agencies were derived from the FY 2013 Continuing Resolution (P.L. 113-6), while the sequestrable amounts were calculated from the OMB sequester report.
 CMS, “Mandatory Payment Reductions in the Medicare Fee-for-Service (FFS) Program – Sequestration,” Medicare FFS Provider e-News (March 8, 2013), available at: http://www.cms.gov/Outreach-and-Education/Outreach/FFSProvPartProg/Downloads/2013-03-08-standalone.pdf.