The Anti-Economist — March 12, 2013, 5:02 pm

We Need a Shadow CBO

The trouble with the Congressional Budget Office???s long-term budget projections

I have written before on this blog and in my Harper’s Magazine column about the distorted long-term budget projections produced by the Congressional Budget Office. The CBO’s figures are a primary source of the current alarm about the need to cut government spending even with the economy weak.

To earn its “non-partisan” label, the CBO makes unrealistic assumptions that for the most part merely project past trends into the future, and sometimes don’t even do that — underscoring the need, in my view, for a “shadow CBO” that exposes the office’s outlandish assumptions and offers us a set of alternative projections based on realistic ones. The office forecasts, for instance, that U.S. debt as a proportion of GDP will be 150 percent by the early 2030s and nearly 200 percent by 2037. Michael Linden, a highly competent economist at the Center for American Progress, has made a good start at exposing the assumptions that underlie such predictions by taking a close look at the office’s June 2012 long-term forecast:

Since CBO released its long-term outlook in June 2012, we’ve already made significant progress toward bringing down our deficits. First, contrary to CBO’s assumption, we did not extend all of the Bush tax cuts at the end of 2012. Instead, the American Taxpayer Relief Act allowed approximately $600 billion of the Bush tax cuts to expire as scheduled, thereby raising future revenue projections. Second, the most recent CBO budget outlook, published in early February 2013, shows substantially less spending over the next 10 years than was projected in June’s long-term outlook. Finally, given the scheduled drawdown in Afghanistan, it seems unlikely that we will continue spending more than $100 billion a year—as is currently projected—on foreign wars. Incorporating these changes brings the 2037 debt projection down from 199 percent of GDP to 169 percent.

Linden goes on to point out that the CBO is projecting no rise in tax revenues as a proportion of GDP, even though these revenues usually go up with the rise in personal and corporate income that accompanies economic expansion. The office is also expecting a sudden increase in non-entitlement spending in 2022 — the very spending that Congress is now working to cut. Thus, the CBO is building into its projections deficit increases that likely won’t occur. Moreover, if these programs receive additional funding in the future — and let’s hope they do — they may be accompanied by tax increases to finance them.

The CBO’s projections are further skewed quite seriously by the office’s assumption that health care costs — which drive Medicare and Medicaid spending — will increase at the same rapid rate as they have in the past couple of decades, despite the fact that these costs have risen far more slowly in the past four years.

Linden concludes that adjusting for all of these factors would cut the CBO’s 2037 debt prediction from nearly 200 percent to under 100 percent. He leaves out one additional CBO assumption, though: the “crowding out” argument, which states that government budget deficits reduce savings, in turn limiting capital investment and therefore growth. The following example underscores the problems with this assumption:

Last year, the CBO projected that without a fiscal-cliff compromise — in other words, if the economy contracted alongside in the face of reduced government spending and higher taxes — the nation would have gone into a pretty serious recession in 2013. But, it added, by 2016 or so, the economy would be better off, because it would have resumed its normal growth track with a lower deficit. And people believed that. Oh my. To repeat, the office was saying that a recession would have been beneficial to the long-term economic health of the United States. Their analysis was straight from the playbook of the Austrian economists of the 1930s and 1940s: recessions are good cleansing agents, in a nutshell.

As I said, we badly need a shadow Congressional Budget Office to challenge the authority of the current one. The alarmism of the CBO is influencing U.S. budget discussions for the worse, damaging the economy and placing the country’s long-term welfare at risk. 

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writes the Anti-Economist column and blog for Harper’s Magazine.

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How Germany Reconquered Europe

The euro and its discontents

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  • peter_principle

    According to James Galbraith, there is an even more basic flaw in the CBO’s projections, which is that it assumes the real short-term interest rate will remain higher than real GDP growth — by about a percentage point, as I recall — pretty much forever.

    If you think about it, debt service that grows faster than income, year in and year out, is an automatic recipe for penury for any borrower, public or private. It’s also a completely crazy assumption — that is, assuming the Fed isn’t taken over by Rand Paul or other assorted crazies.

    In the CBO’s projections, the rising net interest burden is what really wrecks the federal budget, and most of that is due to the compounding effect of its real interest rate assumption. Remove that, and things instantly look a lot less scary.

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