Another Way of Looking at the CBO Forecast

You wind up reading a lot of these days about budget cuts.  Indeed, in yesterday's New York Times, you had Steven Rattner making the claim that the President and Congress had already introduced trillions of dollars in spending cuts.  Using a chart from the CFRB, Mr. Rattner argues that, including the sequester, we have already had $2.8 trillion of spending cuts.  And yet, as I have noted in the past, the rate of growth forecast in the budget is 5.3% over the next 10 years.

As the same time, the President likes to talk about the need for "a balanced approach" by which he means more spending and more taxes than are already projected.  So let's look at the projection.  What's below is the CBO forecast expressed in real per capita terms using the census forecast of population and the CBO forecast for inflation.

In real, per capita terms, spending growth over the forecast average 2.5% and that's after the spending reductions in the BCA and the sequester.  Over the same period, revenues grow by 3.4% per year.  So Mr. Rattner's claim of spending cuts to the tune of multiple trillions of dollars flies in the face of spending growing faster already than inflation plus population.

And the President's request for "a balanced approach" is actually a request for spending to grow faster than 2.5% per year in real, per capita terms and a request for taxes to grow faster in real per capita terms than 3.4% per year.

Such are the perils of baseline budgeting and the language around budgeting that is used in Washington.

Sometimes It's Even Worse

Well, I'll admit I was wrong.  A week or so ago, before the CBO score was out, I estimated that the Senate sequester replacement plan would defer most of the deficit reduction until later and do very little of it in 2013.

So in summary, the best case is that the bill reduces the deficit by about $8 billion this year.  The worse case is that it adds about $3 billion to the deficit this year.  Neither is anywhere close to $85 billion in deficit reduction this year.

Well now the CBO score is out and it is in fact worse than I thought.  Let's start with spending.  The Senate bill increases spending relative to the baseline with the sequester included by $63 billion.  In other words, it eliminates $85 billion in spending reductions in 2013 and replaces them with $22 billion in net spending reductions over the next 10 years.  And of this $22 billion, only $5 billion (net) comes in the next 5 years.

On the tax side, it adds $55 billion of tax increases, almost all of which come from the application of a new alternative minimum tax, beginning at incomes of $1 million.

So to review, the bill as scored by the CBO, replaces $85 billion in deficit reduction in 2013 achieved by spending reductions with $400 million of deficit increase in 2013 (a small spending increase almost offset by a small tax increase) and $77 billion of deficit reduction over the next 10 years, 72 percent of which ($55 billion over $77 billion) is tax increases.

So the "balanced proposal" of the Senate achieves no deficit reduction in 2013, less deficit reduction over 10 years than the sequester would achieve in 1 year, and has more than 70 percent of the deficit reduction coming from tax increases.

A replacement it is not.

A Balanced Plan?

The White House is fond of arguing that our changes in fiscal policy should be "balanced" between tax increases and spending cuts.  As a recent example, see this from Dan Pfeiffer.  In it, Mr. Pfeiffer refers as an example of the President's notion of balance to his proposal to the supercommittee.  So I decided to take a look at it in a little bit more detail.

The conclusion was surprising even to me.  The way I would suggest the math is "fair" would score the President's proposal at $70 in tax increases for every $1 in real spending cuts.  I wasn't expecting balance but I was expecting more balance than this.  Let me tell you how I got there.

The President and his team present this as a "balanced" proposal over and above the savings from the Budget Control Act.  The administration provides a convenient summary of its proposal in Table S-6.

American Jobs Act - $447 billion
Mandatory Savings - $(257) billion
Health Savings - $(320) billion
Cap OCOs - $(1084) billion
Tax reform - $(1573) billion
Interest savings - $(715) billion

When I first looked at the table, I didn't think much of it but then I started reflecting on the word choice.

The first thing that occurred to me was the use of the word "savings" in relationship to what others might call spending cuts.  I started by assuming it was just a word choice thing but then I decided to go look at table S-4 where the specific programmatic recommendations are made.

Here are some of the components of "Mandatory Savings" and their sizes:

Increase government fees charged by Fannie Mae and Freddie Mac - $27.5 billion
Increase the passenger aviation fee - $15.0 billion
Raising Unemployment Insurance taxes - $33.0 billion
Recoup financial sector assistance (a tax one presumes) - $30 billion

So of the $257 billion in mandatory savings, at least $100 billion are tax or fee increases.  This ignores increased copays for Tricare and other things that are individual costs.  So roughly 40% of the "savings" are actually tax increases.

In the administration's defense, most of the health savings are actual spending reductions, the largest of which is negotiating drug prices for Medicare.

But now on to the big items, the capping of OCOs and interest.  Capping OCOs is nothing more than not spending money we never intended to spend.  For example, we save $135 billion in 2021 according to this logic but not continuing the wars in Iraq and AfPak until that time.  Is there anyone who seriously expects those wars to be going at the current pace in 2021?  This is an accounting gimmick and nothing more.

Which brings us to interest.  First, it's worth noting that the interest number includes reduced interest from the BCA as well as these new items rather than breaking out the interest as would be more honest.  But more substantively, including the interest savings as a spending cut in the notion of balanced is ridiculous since it would allow a package that was all tax increases to have 15 percent or so of the savings come from "spending cuts."  As I've argued before, interest should be reported separately as it is not a policy change but the outcome of various policy changes.

All of which brings us back to the President's past balanced proposal.  Here's a quick restatement.

Phantom spending cuts (aka cuts that are reductions in money we never intended to spend) work out to $1.1 trillion.  Real spending cuts work out to about $25 billion over 10 years (remembering the President proposed $450 billion in incremental spending).  Tax increases are about $1.7 trillion.  So if we leave the phantom stuff and interest savings out, it's about 70 dollars in tax increases for every dollar of programmatic spending cuts.  An interesting definition of "balance" for sure.

How much growth does it take not to "cut" spending?

Here's a nice quote from Speaker Pelosi today.

"The fact is we've had plenty of spending cuts, $1.6 trillion in the Budget Control Act. What we need is growth," Pelosi said in an interview on "Fox News Sunday." 

But of course, we know that spending in the latest CBO forecast is planned to grow 5.3% per year between now and 2023.  So we are to simultaneously believe that we are cutting spending by $1.6 trillion and growing it by 5.3%.  Of course, that 5.3% assumes the BCA caps hold through 2023, those same caps that the Congress is trying to get rid of for 2013 as we speak.

One is left to wonder how fast spending in Washington would have to grow before we would stop claiming credit for large spending "cuts."

Real Budgeting is Still Better

As promised, I've updated my "real" budget projections on the basis of the CBO forecast that was just released (more observations from the CBO report coming up soon).  A quick summary of the assumptions and findings follows below.

Critical Assumptions

• Spending for each budget category grows at the relevant rate of growth of inflation and population.  Thus, Medicare spending grows at the rate of medical inflation (3.2% over the last 5 years) and the over 65 population (each year as projected by the Census)
• Tax receipts are as assumed in the CBO forecast
• Interest expense is calculated based on public debt and effective interest rate calculated from the CBO projections
• OCO spending assumed to decline to $50 billion and remain there
• Disaster spending rebased to $20 billion in 2013 and beyond
• Discretionary spending, Medicare, and Medicaid assumed to become 10% more efficient over the decade
• UI spending rebased to full employment economy per the numbers in the CBO forecast

The net effect of this is that all major class of spending grow, albeit most grow more slowly than in the CBO baseline forecast.  Medicare for example, grows at 5.3% per annum on average (including efficiency effect).  Defense (including OCO spending) grows at 0.4% per annum but continues to grow in nominal terms.

Meanwhile, revenue is projected to grow at 6.2% per annum.  The combination of these results in a rapid and continued reduction in deficit spending versus the CBO baseline.  I summarize the results in the two charts below.  First, we'll look at deficit to GDP ratios.

The basic change here comes in the medium and long term.  In the CBO forecast, the deficit picture deteriorates dramatically in the latter half of the forecast.  In the "real" baselines, the deficit picture continues to improve to 2023 ending the period nearly 300 basis points better as a percentage of GDP.

Not surprisingly, the debt picture is similar.  Instead of improving and then getting worse as in the CBO forecasts, the "real" budget picture continues to improve over the entire course of the forecast.  So the learning here remains.  A more restrained view of the growth of federal spending can dramatically improve the budget picture without making any major changes to the revenue side of the equation.

The Fallacy of Causation and Solution

This post from Kevin Drum is a good example of one of the fallacies that seems to be making the rounds these days.  In the body of a typical argument about why Republicans are unserious on the deficit (true for most in my view), Kevin makes the following argument.

It's all healthcare, baby. If all of the pressure on the deficit were being applied to serious proposals for reining in healthcare spending, in an effort to get U.S. spending levels down to those prevailing in socialist Europe, I'd probably applaud. 

So the solution to the deficit is all about healthcare.  You can see similar arguments popping up all over the left blogosphere.  Mostly, as in this case, these are arguments for universal health care but leave that aside.  The point is that they represent a fallacy, the fallacy that if A is the cause of a problem then a change in A must be the solution.  Certainly we can look at changing A (health care) but there's no particular reason that changes in A must be the answer.

To make the point, let's take a look at taxes and spending relative to 2000 (the last time the budget was balanced).  I'm going to look at this in two ways.  First, I'm going to look at effective tax rates across the income distribution (similar to my previous post comparing to 1979).  Using the same TPC and CBO assessments, one gets the following picture.

So, relative to the last time we had a surplus, effective federal tax rates in 2013 are projected to be lower for every income group except for the top 1% where rates are projected to be 3.4 percentage points higher than they were in 2000.

By the Kevin Drum logic, I should therefore cut the tax rates of the top 1% and increase the tax rates of everyone else since that would be the way to correct the problem by addressing the changes that led to the problem in the first place.  I rather doubt that Mr. Drum or his intellectual comrades would be in favor of this approach.

We can of course extend this thinking by looking at the spending side of the equation.  In 2000, spending on domestic discretionary programs was 3.0 percent of GDP.  In 2011 (2012 is not yet available), these same programs consumed 4.3% of GDP.  Should we therefore cut these programs by 30% in nominal dollars?  I rather doubt this is the plan that would be embraced by Mr. Drum.  Indeed we know this is not the case since "It's all healthcare, baby."

The point here is not to argue that addressing healthcare isn't an important part of our long term deficit picture but rather to argue the fact that healthcare spending has increased and will continue to do so does not imply that the only (or primary) solution is to reduce or slow the rate of growth of health care spending.  The prescription may or may not be right, the logic is not.

How to be Irresponsible

It's a bit rare that I cross post here but this post from Christopher Demuth is worth reading in its entirety.

In a nutshell, it exposes the loss of focus of both Keynesianism and supply side economics.  Both have been subverted by the political process into a force for moving consumption to today and costs to the future.  In effect, we have a political process that competes for how to be irresponsible as opposed to whether to be.

Which brings me to the current fiscal cliff debate, the perfect incarnation of the how to be irresponsible discussion.  On one side, we have the Democratic party which is asserting that tax increases on 2% of households and (small) unspecified future spending changes will be sufficient to avert the fiscal crisis we face.

On the other side we have the Republican party which is asserting that future unspecified (but larger) spending reductions are sufficient to address the crisis.  I mean, look at these plans in context.  Over the next decade, we plan to spend about $45 trillion and tax about $35 to $40 trillion.  And our tax and spending plans amount to a change of $2 trillion or so in total, a 2.5% change from the most unbalanced place we've ever been.  And that's DC's version of difficult choices.

And that's the debate...a debate about how to be irresponsible...about which irresponsible ideology will prevail.  Unfortunately, regardless of the outcome of the debate, the future is the same.  We run up debt until we can't anymore.  At that point, some combination of future taxpayers and asset holders get well and thoroughly screwed.

Crossing the Streams

OK.  Bad Ghostbusters reference but with all the talk of “cuts” and revenues in Washington these days, I wanted to return to the theme of “real” baseline budgeting.  One of the things that is often said is that balancing the budget will require “massive cuts.”  We must again remember that Washington defines a cut a bit differently than you or I might.  So I will counter with the following picture

Here we see projected spending are receipts based on three sources.  The spending line assumes 2010 spending as the base and grows spending by the rate of inflation plus population as projected in the President’s FY2012 budget submission.  The receipts line is based on the CBO baseline projection subtracting 2 percentage points for every year from FY2013 on to take an (aggressive) assumption of the reduced revenues from making no change in tax policy.  GDP is drawn also from the President’s FY2012 budget submission.

So what would this “spending only” approach tell us.

1.     Spending as a percentage of GDP declines rapidly over the period from 23.6% in 2011 to 19.4% in 2021.  This is without making any cuts in spending.  This is not to say that no benefit cuts may be required but simply that a COLA like view of government spending produces dramatic results.

2.     The government reaches “primary balance”, the goal the President has set for the budget process by 2016 (3.1% deficit) or 2017 (2.4% deficit).

3.     The deficit by 2021 is a mere 0.6% of GDP, suggesting that another couple of years would bring the budget to absolute balance.

Just something for those that argue that a cuts only solution is impossible to think about.  The budget can be nearly balanced with no cuts whatsoever as long as Washington chooses to live within a budget constraint.