[House Hearing, 107 Congress]
[From the U.S. Government Printing Office]
CBO ROLE AND PERFORMANCE: ENHANCING
ACCURACY, RELIABILITY, AND RESPONSIVENESS
IN BUDGET AND ECONOMIC ESTIMATES
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
HEARING HELD IN WASHINGTON, DC, MAY 2, 2002
Serial No. 107-29
Printed for the use of the Committee on the Budget
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COMMITTEE ON THE BUDGET
JIM NUSSLE, Iowa, Chairman
JOHN E. SUNUNU, New Hampshire JOHN M. SPRATT, Jr., South
Vice Chairman Carolina,
PETER HOEKSTRA, Michigan Ranking Minority Member
Vice Chairman JIM McDERMOTT, Washington
CHARLES F. BASS, New Hampshire BENNIE G. THOMPSON, Mississippi
GIL GUTKNECHT, Minnesota KEN BENTSEN, Texas
VAN HILLEARY, Tennessee JIM DAVIS, Florida
MAC THORNBERRY, Texas EVA M. CLAYTON, North Carolina
JIM RYUN, Kansas DAVID E. PRICE, North Carolina
MAC COLLINS, Georgia GERALD D. KLECZKA, Wisconsin
GARY G. MILLER, California BOB CLEMENT, Tennessee
PAT TOOMEY, Pennsylvania JAMES P. MORAN, Virginia
WES WATKINS, Oklahoma DARLENE HOOLEY, Oregon
DOC HASTINGS, Washington TAMMY BALDWIN, Wisconsin
JOHN T. DOOLITTLE, California CAROLYN McCARTHY, New York
ROB PORTMAN, Ohio DENNIS MOORE, Kansas
RAY LaHOOD, Illinois MICHAEL E. CAPUANO, Massachusetts
KAY GRANGER, Texas MICHAEL M. HONDA, California
EDWARD SCHROCK, Virginia JOSEPH M. HOEFFEL III,
JOHN CULBERSON, Texas Pennsylvania
HENRY E. BROWN, Jr., South Carolina RUSH D. HOLT, New Jersey
ANDER CRENSHAW, Florida JIM MATHESON, Utah
ADAM PUTNAM, Florida
MARK KIRK, Illinois
Rich Meade, Chief of Staff
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
Hearing held in Washington, DC, May 2, 2002...................... 1
Dan L. Crippen, Director, Congressional Budget Office........ 4
Rudolph G. Penner, Senior Fellow, the Urban Institute........ 44
Kevin A. Hassett, Resident Scholar, American Enterprise
William G. Gale, Senior Fellow, the Brookings Institution.... 57
Prepared statement and additional submission of:
Prepared statement....................................... 12
Response to Chairman's question concerning resource
Mr. Penner................................................... 48
Dr. Hassett.................................................. 53
Dr. Gale..................................................... 60
CBO ROLE AND PERFORMANCE: ENHANCING ACCURACY, RELIABILITY, AND
RESPONSIVENESS IN BUDGET AND ECONOMIC ESTIMATES
THURSDAY, MAY 2, 2002
House of Representatives,
Committee on the Budget,
The committee met, pursuant to call, at 10:13 a.m. in room
210, Cannon House Office Building, Hon. Jim Nussle (chairman of
the committee) presiding.
Members present: Representatives Nussle, Sununu, Gutknecht,
Watkins, Brown, Spratt, Price, Moran, and Matheson.
Chairman Nussle. Good morning. Today we are holding a
hearing to examine the role and the performance of the
Congressional Budget Office. In recent years there has been a
trend in government to develop ways to measure how departments
and agencies are performing their duties and fulfilling their
responsibilities and then to directly tie budgeting to that
process. The idea is to inject some measure of accountability
into government and to reward departments and agencies based on
CBO, however, has really never been subject to that kind of
scrutiny from the Budget Committee since its creation as part
of the 1974 Budget Act. To my understanding, and based on our
research, there is no real significant oversight of the
Congressional Budget Office by this committee, and I am not
sure that even one hearing could accomplish the kind of
oversight that should be required for one hearing today. We
really haven't found any record of any genuine CBO oversight by
the Budget Committee, and we are sure that it has never been
the regular part of this committee's routine. It is something
that I was hoping to inject into the schedule of the Budget
Committee as part of my taking over the committee chairmanship
last year. In fact, we were going to hold a hearing last fall
during the calm time of the budget process, after all the work
was done and the appropriation bills were completed. And, of
course, everybody's fall changed quite significantly.
We hope to begin today to exercise that oversight of the
Congressional Budget Office, and I can promise you that this is
the first step, not just a last step. In fact, as a follow-up
to this hearing, I will be sending a survey to House Members
and in particular committees, committee chairmen, soliciting
their opinion about the Congressional Budget Office. There is a
lot of interaction that Congress has with Members and
committees, leadership, both sides of the aisle, and I think it
would be good to gain some opinion based on that direct
committee service, if you will, to give some idea about the
Today's hearing really has several purposes. No. 1, we are
going to review both the intended role of the Congressional
Budget Office, and its performance in meeting the emerging
needs of Congress; No. 2, we will review CBO's plans to improve
the accuracy of the economic and budgetary projections; and
finally, we will examine the difference between dynamic scoring
and CBO's current method that has been referred to by some as
We will also look at how the agency maintains, I think, a
successful record of nonpartisan service to the Congress.
Today's hearing will help this committee and we hope other
congressional committees gain a better understanding of exactly
what the Congressional Budget Office does and how well it does
it. This is important not only from the performance standpoint,
but may also help to serve Congress to be more appreciative of
the difficult job that the Congressional Budget Office has the
kind of job that they have to do for us. CBO is sometimes
unfairly used as a lightning rod for criticism because
committees are often frustrated by their own budgetary and time
constraints, and this hearing hopefully will get some of that
out on the table. And certainly this committee is probably not
immune from that either.
At any large organization, there are professionals that we
believe distinguish themselves above and beyond the call of
duty, and I would like to take a moment to just publicly thank
the various employees at the Congressional Budget Office. I am
going to do something unique; I am going to read some names of
some people that we have observed to go above and beyond the
call of duty. By doing this, it may suggest to some that some
aren't doing a good job, and I don't want that to be the case.
What I have tried to do is put together a list of people that
we have observed, it is our observation, have really provided
exemplary service and gone above and beyond the call of duty.
You do a great job at CBO, even though from time to time you
are a whipping post. But these are some of the people that I
have had a chance to work with or my staff has, and I would
just like to highlight them:
Peter Fontaine, who works as the Deputy Assistant Director;
Jennifer Smith, general counsel; Janet--I am going to hopefully
get this right--Airis, who is in the scorekeeping unit; Edward
Blau, scorekeeping unit; Sandy Davis, projections unit; Paul
Cullinan, who is human resources; Sheila Dacey, I believe is
the name, human resources; Kathy Ruffing, human resources;
Christi Sadoti, who is also with human resources; Kent
Christensen, who is Defense/International Relations/Veterans;
Joseph Whitehill, Defense/International Relations; David
Weiner, who is a tax analyst; as well as Mark Booth, who is
also a tax analyst.
These are folks who we have had an opportunity to work with
and have really gone above and beyond the call of duty. They
deserve our appreciation for the work that they do.
Conversely, there are areas in a large organization that we
believe could use some improvement, and one example that comes
immediately to mind that we have heard criticism about not only
from the Budget Committee, but also from other committees, is
when we go after health cost estimates. We have observed that
the unit involving health has had a history of--and again, I am
just giving you direct from customer surveys--have been accused
of being discourteous, perennially late with estimates, and
have to some extent--again from customer service reports--have
had a poor grasp of how the House operates and how we use some
of those economic estimates from time to time.
Again, I don't want to name names. This is an opportunity
to talk about improvement, and this is one area that has been
frustrating. This may also be one of the most complicated
areas, too, which may in part be the answer, but we believe it
could stand some improvement.
So we have a full plate today, and I am happy, as always,
to have the opportunity to hear from our distinguished Director
of the Congressional Budget Office, Dan Crippen, who is hear to
testify, and I look forward to your testimony today. We are
also glad to have Rudolph Penner, who is a senior fellow from
the Urban Institute; Kevin Hassett, who is from the American
Enterprise Institute; and William Gale, who is from Brookings.
These are our panelists for today. We look forward to their
testimony. I know Members have expressed some interest from
time to time on many of these topics, and so I hope we will
begin today by starting to answer some of those questions, get
some of those issues out on the table. And, as I say, this is
the first step in what we hope is really a never-ending process
of providing better communication, oversight and understanding
between our two entities.
With that, I turn to John Spratt for any comments.
Mr. Spratt. Thank you, Mr. Chairman. And quickly so as not
to delay the hearing, let me simply say that I am glad we are
having the hearing. I think it is pertinent, because we are
witnessing right now the slow and, I think, sad demise of the
budget process. One key element in that process clearly is the
Congressional Budget Office, and has been here since its
creation in 1974. There is no doubt now, 28 years after your
creation, about the relevancy and need for your role. We have
got to have a budget shop of our own. It has to be honest,
straightforward, rigorous and politically disinterested.
And I will say to Dr. Crippen, when he was first appointed,
I was concerned because he had clear partisan identifications,
and he has, I think, bent over backwards to work with our side
and to be fair and is responsive to us as he is to the other
side, and I very much appreciate that.
Let me say, Mr. Chairman, that when I first came to
Washington as a young officer in the Army working for the
comptroller of the Department of Defense--and that was in
1969--when I came back to Congress in 1983, the biggest
difference between Congress then and Congress in 1969-71 was
the extent to which this Congress has established sort of an
independence--more dependence, because we had improved our
staff, committee staff, personal staff and agencies like the
Congressional Budget Office.
There was no Congressional Budget Office in 1969-71.
Consequently, a lot of the work that Congress needed done on
the budget we had to do for Congress. Repeatedly I can recall
putting together schedules and documents that I thought, ``why
don't the appropriators themselves have this information? They
appropriate all of this money. Why can't they go back and do a
cost history of the C-5A?'' Nevertheless, I stayed up late
nights and got that information ready to meet deadlines, but I
knew all along we had an inside advantage, because we were
presenting it and could slant it and did in our favor, and the
Congress was much too dependent on outside sources.
We need agencies like CBO if we are to be an independent
branch, and so for that reason, I think this is an important
I will also say, in those days I think it was just after
the creation of OMB, and it was still the old Bureau of the
Budget, and one of the things we had there were a lot of people
who had been there for a long time, from administration to
administration. It was not quite as politicized as it is today,
or at least it didn't appear to be to me. One of the advantages
you got was that you had people in the old Bureau of the Budget
who had a long-term perspective. They remembered the cycles in
the defense budget. They remembered procurement history. They
learned the lessons of the budget, learned them well, and they
were the wise men and women of the government at that
particular point in time.
And we had CBO with the same kind of expertise that you are
here on the up cycles, here on the down cycles. You make
optimistic projections and find out you were wrong and learn
from experience that you need to temper some of the enthusiasm
that you may have or feelings you may have now about whatever
it is, productivity or the state of the economy. You learn from
experience to do these things, and it is important that we have
that kind of continuity and long-term perspective in the
Congressional Budget Office.
So we are all striving for that. We will never attain what
we want. We keep striving for it, and I think that is what this
hearing should be about, how do we do better with what we need
to do in order to improve the budget process. And I thank you
both for coming.
Chairman Nussle. Thank you, Mr. Spratt.
Director Crippen, welcome again to the Budget Committee,
and we are pleased to receive your testimony at this time.
STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET
Mr. Crippen. Thank you, Mr. Chairman. As you said, this
hearing is not a surprise in the sense that you have long
stated an interest in doing this. It was tentatively scheduled
for last fall, so it is long overdue and we are glad to be here
today to be able to do it.
I want to apologize a little in advance. Because of the
breadth of the hearing, I am going to speak a bit longer than I
normally would. Obviously I will not cover everything that is
of interest to you and your members, but there are a couple of
topics that I think are not only timely, but also important to
the overall process, and I want to address those topics in my
oral remarks before we begin.
The two issues that I think are of particular interest
today to the committee are the accuracy of CBO's forecasts,
including how we develop our baseline, and the related issue,
as you mentioned, Mr. Chairman, of dynamic scoring. The written
testimony that we have submitted is devoted much more to
dynamic scoring than to the accuracy of our forecasts, because
much of the material I will reference today on accuracy is
already in the public domain through various CBO reports.
Before I begin talking about those two issues, though, I
would like to put some of the many numbers we will likely
discuss today in perspective. Over the next 10 years, the U.S.
economy will produce something in the neighborhood of $140
trillion of goods and services. The Federal Government will
collect and spend about $25 trillion during that time, roughly
20 percent of GDP. So when we discuss a change of say, $1
trillion in a 10-year estimate, we are discussing less than 1
percent of what the economy will generate over the next 10
years, or about 4 percent of the entirety of the Federal Budget
over those 10 years.
Put another way, small changes in those very large numbers,
especially when multiplied over the 10 years, can produce
seemingly large changes. For example, a change of one-tenth of
1 percentage point the growth rate of real GDP will alter
surpluses or deficits by nearly $250 billion over 10 years.
One-tenth of 1 percentage point can be $250 billion of
surpluses or deficits over a 10-year span.
Spending changes of similarly small magnitudes today also
can have profound effects over 10 years. For example, $10
billion more in discretionary spending this year will result in
over $100 billion in additional baseline expenditures over the
next decade. The supplemental spending bill that you are about
to consider, nearly $30 billion at last check, will add almost
$500 billion, a half a trillion dollars, to baseline spending.
If Medicare spending grew 1 percent faster than we anticipate
in the baseline, that faster growth would add over $200 billion
to outlays over 10 years.
With those parameters in mind, Mr. Chairman, let me first
address in general terms your primary concern, namely the
accuracy of our forecasts. To make budget projections, we must
first forecast how we expect the economy to perform. To do so,
we use a wide range of resources: private forecasts; analysis
by the Federal Reserve; our advisory panel, consisting of 20
economists, many of whom you are familiar with; analysis of the
Blue Chip reports; comments from you and your staff; as well as
a forecast of the administration. All of those resources are
used to produce our forecast, which we got together something
like 2 months before we publish our budget outlooks. And
sometimes that 2 months can be very important.
I would submit, Mr. Chairman, that our economic forecasts
are as good or better than most others. We recently published
an analysis of exactly that point, comparing our forecasts with
those of other forecasters, both in government and out. As the
dean of my graduate school was fond of telling me, that might
be seen as damning by faint praise. None of us are very good at
making those kinds of forecasts, particularly when they are
very far in the future. In fact, we generally, as you know,
straight-line our economic forecasts after 5 years, because we
don't know anything about years 6 through 10 that would inform
Economists are even worse, Mr. Chairman, at predicting
turning points in the economy, one of the places we find
ourselves at the moment. As you have said, Mr. Chairman, you
can change the channel looking for a different forecast, but I
am afraid that from what we know today, it will likely be as
correct as the channel you currently have on.
The second task we must perform to arrive at a budget
outlook is to translate our economic forecast into budget
forecasts and projections. On the expenditure side of the
ledger, the translation is somewhat easier. For example, higher
inflation leads straightforwardly to higher cost-of-living
adjustments. Lower economic growth means higher expenditures
for unemployment, Medicaid, and Temporary Assistance for Needy
Families, as well as higher interest rates and higher debt-
In addition, we must forecast the number of people who will
participate in Federal programs, their level of need of
services, the behavior of doctors in prescribing treatments,
the creativity of State governments in qualifying for Federal
dollars, the prices of crops and commodities around the world,
and the response of hospitals to investigations by the Justice
Projecting discretionary spending is virtually impossible
because the policies change every year, but that is still easy
when compared with projecting income tax revenues and other
receipts. While there are hundreds of sources of revenue, the
principal contributors are individual and corporate income
taxes and payroll taxes. Unfortunately, the principal
components of the tax base--wages and salaries plus corporate
profits--are not perfectly correlated with the overall
performance of the economy; also, varying amounts of those are
not taxed at all, while some other non-income components--such
as capital gains--are taxed.
Taxpayers and corporations currently hold trillions of
dollars worth of unrealized capital gains. When they choose to
recognize those gains and incur taxes on them is not well
understood. Clearly, reduced tax rates on capital gains have
produced more realizations and revenues in the short run, but
it is not clear what the effect will eventually be on the pool
of unrealized gains and, therefore, future tax revenues.
Obviously, the level and volatility of the equity markets
cause changes in investing and, therefore, realizations of
gains or losses. But again, that relationship is not clear.
Equities are responsible for only a part of the revenue from
gains; slightly over half, as I recall. A significant amount
also results from realizing gains on real estate and other
assets about which even less is known.
The changing composition and distribution of the tax base
also create problems for projecting. Firms may shift
compensation from wages to nontaxable fringe benefits, such as
cafeteria plans for health care. Corporations may change their
status to ``subchapter S,'' or limited liability companies to
have their profits taxed only at the individual level. The
changing importance of bonuses and stock options may imply
changes in the level of revenue that income will yield in taxes
as more or less income accrues to those taxed at the highest
In addition, Mr. Chairman, to the difficulties in
forecasting the economy's levels of spending and revenues, CBO
is constrained by law to estimating a very particular baseline,
which is a projection of spending and revenues based on current
law, without anticipating any changes in policy over the next
10 years. It is important to recognize and remember that this
baseline is not a prediction of outcomes, but rather a starting
place from which to measure the effects of policy changes.
Clearly the Congress and the President will have to change
policies in many ways over the next decade, some of them
reasonably predictable. The so-called extenders package of tax
credits, for example, has been renewed on occasion, but we
assume for the baseline that it expires as currently scheduled.
Why is that the case? Well, those tax credits haven't always
been extended on time. There have been lapses of 8 or 9 months,
and once in a while a tax credit is actually eliminated. But
most important, the Budget Act tells us to assume the
expiration of all tax provisions as scheduled, except excise
taxes dedicated to trust funds.
Obviously, this committee could move to change the Budget
Act to include expiring tax provisions in the baseline. I would
guess, without further analysis, however, there are many
provisions that would be affected in unanticipated ways, such
as expiring provisions that raise taxes.
Mr. Chairman, I know that you have commented on the
inclusion in the baseline of discretionary spending that occurs
one time but is assumed to go on forever. That is a fact, and
it has been so since the beginning, because the Budget Act
requires us to do so. The spending for the cleanup of New York,
the purchase of a space shuttle, the funding of the decennial
census, all gets built into the baseline, inflated, just like
paying the light bill at the Capitol.
I certainly wouldn't disagree with you that including some
of those expenditures may overstate what is defined as current
policy on discretionary appropriations and, therefore, inflate
the baseline. But I suspect, Mr. Chairman, that ultimately the
committee wouldn't want CBO to determine what constitutes one-
time spending and what does not. While some examples are
obvious, there are many that are not so obvious.
Again, you would need to change the Budget Act to instruct
us to make those reductions, and, I would hope, include some
criteria for making the determination, or frankly you could put
language in appropriation bills as they are developed to
indicate that certain spending was intended to be one time
Most of those changes, however, would not dramatically
affect the baseline or the measurement of actual outcomes. The
obvious one-time expenditures are not large when compared with
the totals. More important, the rules for constructing the
baseline that simply inflate the prior year's level of
discretionary spending have consistently resulted in an
underestimation of the actual level of domestic discretionary
But the question remains, after taking all of the
constraints and complexities into account: How have we done?
What is our bottom line, as you said, Mr. Chairman? How do you
assess it? For the last several years, we have published a
chapter in our January baseline report titled ``The Uncertainty
of Budget Projections.'' That chapter--chapter 5--makes it
plain for all to see where we have missed in the past, by how
much, and some of the analysis we have undertaken to mitigate
some of the errors. Ultimately, we then produce a series that
shows how uncertain our projections are based on those past
This first chart, Mr. Chairman, which has been dubbed the
``fan chart,'' you have seen before; it has been part of our
ongoing effort to examine the uncertainty in looking out even 5
years let alone 10. The change in the budget outlook from
January 2001 to January 2002, as dramatic as it was, was within
last year's fan chart. I will say, however, that it was closer
to the edge than to the middle.
What has played into those uncertainties? What has led
outcomes to differ from our forecast? A look back at our
forecast in 1997, for example, comparing it to the actual
outcome, starts to explain some of the uncertainty. From this
chart, Mr. Chairman, which was on the cover of our mid-year
report in 2000, we see that the legislation enacted after we
made our projections in 1997 did not play a big role in the
change in actual fiscal policy. What happened was that a
dramatic and unanticipated increase in revenues occurred over
What happened that was represented? Well, first the economy
grew stronger than anyone had expected, and for a longer
period, mostly due to productivity increases few analysts had
anticipated. Second, more of the growth of the economy occurred
in taxable income, both for individuals and corporations, than
is typical. Third, the tax rates increased as taxpayers were
pushed into higher brackets. Finally, the robust stock market
provided more capital gains.
We did not, Mr. Chairman, immediately or completely
incorporate all of those changes into our forecast, since we
could not assess their permanence. Over time, as some of the
factors continued, we began to incorporate many of the changes,
such as higher productivity and higher revenues for a given
level of GDP. But that was then, Mr. Chairman, and this is now.
As the cover of our most recent baseline report shows, the
dramatic reversal of fortune over the next year or two was
caused primarily by the onset of a recession and the unusual
decline in the largest tax bases.
One might say that what the economy gives, the economy can
take away. Obviously, in future years, legislation affecting
both spending and revenues has a large effect on the change in
this outlook. But then why did the big swing due to the economy
First, there was a slowdown and recession we did not
predict. Nor, frankly, did anyone else--again, as I said,
damning by faint praise--as this chart indicates.
Second, this recession is decidedly different from the
last, and I will speak more about that in a moment.
Third, the Bureau of Economic Analysis revised its
historical data last July between our two January estimates to
reduce estimates of investment in growth in 1999 and 2000. BEA
reduced by almost one full percentage point the growth rate for
2000. I will repeat that. BEA reduced in July of 2001 its
estimate of growth for calendar year 2000 by almost one full
percentage point. We had relied on BEA's earlier 2001 higher
estimate to make our forecast of January 2001.
In addition, the revisions reduced estimates of capital
investments and, hence, the outlook for productivity in the
Finally, revenues have collapsed faster than the economy, a
complete reversal of the trends of the late 1990s.
Mr. Chairman, some of those points can be made by looking
at what appears to be happening this year, this month. There
have been press reports that revenue collections for April are
dramatically lower than was expected by either the Treasury or
by us. How can that be, given that we have seen 5-plus percent
growth in GDP reported by the BEA?
First, of course, April's collections are based largely on
last year's income, not the current quarter's. More important
though, it appears that the tax base is not rebounding at the
same pace as is the economy.
If you look at this next chart, you will see what has
happened and is happening to the tax base. The recession, while
mild if measured by GDP, was much more severe when measured by
the tax base. Further, it appears to us that BEA's July
revision, coming 2 months from now, will include a substantial
reduction in historical data for wages and salaries.
What does this portend? Well, the relatively good economic
news of late on GDP growth and productivity should produce
economic growth greater than we forecast for this year, but
starting from a much lower level. Total revenues will be lower
this year, and probably next, than our current projections. So
even though we currently have good economic news, we have the
anomaly of lower revenues than projected. This chart, this
result, I suggest, clearly illustrate the limitations of our
projections and those of everyone else.
In this case, we have the apparently anomalous result of
the economy recovering quicker and stronger than we expected
but revenues falling well below what we estimated despite that.
If our first quarter estimates of GDP had been closer to the
mark, we would have forecast even more revenue than we
collected in April. In short, the economy changes in
substantial ways no one foresees; and taxpayers change their
behavior in work and savings and investment, and in realization
of capital gains, in characterization of income in ways we
Mr. Chairman, I am certain you will still have many
questions about our accuracy, but before I turn to them, I want
to discuss a related issue, that of dynamic scoring of
legislation. Much of the body of Federal law and regulation and
any legislative changes to it have effects on the performance
of the economy and often particular sectors within it. In fact,
changing how the economy works is often the objective of such
laws and such policy changes. So information about the
macroeconomic effects of proposed legislation and the budgetary
implications of those effects could often be useful in the
That is what I mean by ``dynamic scoring,'' for the purpose
of today's hearing, the effects of legislation on the
macroeconomy and how those feed back into the Federal Budget.
In using the term ``dynamic scoring,'' that is what most folks
are referring to; that is, a tax bill in which you would try to
assess its effects on the economy and somehow incorporate those
effects into the scoring of the bill.
Such information would include the effects of tax changes
on saving or labor supply and, therefore, on long-term growth.
It might also include effects from additional income generated
by entrepreneurship, which is promoted by lower tax rates; or
increases or decreases in aggregate output caused by the
effects of subsidies or taxes in changing the allocation of
resources. Some analysts also suggest that it should include
demand-side effects, such as when tax cuts or spending
increases boost employment and economic activity during periods
of recession and recovery.
For the purposes of scoring legislation for recording the
annual effects of a bill as it passes through the Congress, CBO
and the Joint Committee on Taxation's formal estimates of the
cost of legislative proposals do not--and I would suggest
today, Mr. Chairman, cannot--include those macroeconomic
effects in a useful and credible way. Why is that the case?
Principally because the macroeconomic consequences of today's
actions will be determined largely by future policy, by
altering the budget resources that will be available.
When policy decisions have budgetary implications, they
affect future resources. For example, a spending increase or a
tax cut now must be financed by either lower spending or higher
taxes in the future. Those future decisions about that
financing frequently determine the macroeconomic effect of
today's policy changes. There is a fundamental difference
between a tax cut financed by roughly contemporaneous cuts in
spending and a tax cut financed by additional borrowing for
some years and higher taxes in the future. The first may well
increase GDP; the second is very likely to reduce it.
Let me reiterate, Mr. Chairman, because this is a critical
point for us. If you believe, as many of you do, that reducing
taxes today will help hold down Federal spending in the future,
then in general it is more likely that a tax cut will help the
economy grow. If, however, you believe, as others of you do,
that a tax cut today will need to be reversed in the near
future, then future economic growth may well be diminished.
By the way, the empirical evidence for either of those
outcomes suggests that the effects, in any event, will be very
small given the size of fiscal policy changes relative to the
size of the economy.
Any estimate of the macroeconomic impact of a policy
proposal included in a cost estimate would have to make a
specific and, I would argue, predictable assumption about those
future policy actions. The ordinary conventions of the
baseline, for example, would constrain the estimate to assuming
that tax cuts would be financed by borrowing. Under that
assumption, any positive effect of lower marginal tax rates
could be partially or totally offset by the drag of debt on
capital formation and growth. As a practical matter, under that
assumption few tax cuts would have a positive effect on the
There is no objective way to make the choice, and differing
assumptions produce opposite results. So CBO could make an
assumption about what the next five Congresses and at least two
Presidents will do, but doing so would subject us and, I would
suggest, the results to a chorus of controversy. Although the
lines are not bright, those possible assumptions, as is obvious
to all, do tend to break down along partisan lines, which makes
any choice arbitrary at best.
In addition to the need to specify alternative political
futures, the assessment of legislative effects on the economy
is often complicated by offsetting effects and, often in the
same bill, offsetting provisions. In general, reducing taxes
results in increased after-tax income and, therefore, reduces
the incentive to work. However, cuts in marginal rates, as most
economists believe, will also increase the marginal payoff from
work and, therefore, increase labor force participation.
More specifically, in last year's tax legislation, the
reduction in marginal rates should increase labor supply--an
analysis we did for the July report last year suggested as
much--but by small amounts, for two reasons. First, because of
the small size of the tax reductions; and second because the
alternative minimum tax will counteract the positive effects in
later years. On the other hand, the increase in the child tax
credit in the same bill will likely diminish labor force
participation, predictably by second earners. So on balance
some provisions will help, and some will hurt.
Further, to attribute any short-run stimulative effects to
legislation, monetary policy must be assumed to be constant;
that is, it must be assumed that the Fed will not react to a
change in fiscal policy, an assumption not likely to hold in
Finally, and potentially most important, the reaction of
taxpayers to specific policy changes may be based as much on
their perceptions as the reality. For example, do all taxpayers
assume the expiration, or sunset of last year's changes will
take place as scheduled? Or, will some provisions sunset, but
not others? The perception of taxpayers and, therefore, their
reaction to those reductions will be what drives our revenue.
Although I believe it is impractical to incorporate
information about macroeconomic impacts in formal cost
estimate, that information can usefully be presented in other
ways. CBO has frequently described the macroeconomic effects of
both past and proposed legislation either in separate reports
or in its description of the economic assumptions underlying a
baseline. In such reports we are not constrained by the
conventions of baseline estimating but can explore the
implications of alternative assumptions. CBO can describe how
the macroeconomic effects of a policy change depend on its
Returning, Mr. Chairman, to today's primary topic, that of
accuracy, many analysts believe that including more dynamic
effects in CBO's and joint committee's cost estimates would
improve the accuracy of budget projections. Frankly, however,
that does not seem to be the case. It is difficult to estimate
precisely the fully dynamic effects of legislation, even after
enactment. The underlying determinants of revenue program costs
change for a variety of reasons, many of them hard to
determine, and not just because of changes in legislation or
policy. Even years later, there is rarely an actual figure that
you could hang your hat on--that is a clear measure of what the
legislation actually did--with which to compare our original
Nevertheless, the history of CBO's projections certainly
does not suggest that they would have been improved had the
macroeconomic effects of policy changes been included in cost
estimates. That was not surprising, frankly, because when CBO
prepares its budget projections, it estimates the effects of
current policy, including recently enacted law, on the economic
outlook, including the effects of recent policy changes that
may seem likely to be significant. So CBO's baselines are
already a fully dynamic representation of the effects of
A comprehensive review of CBO's revenue baseline following
changes in tax law shows no pattern of underestimating revenue
following tax cuts or overestimating it following tax
In practice, inaccuracies in forecasting receipts appear
largely to reflect difficulties in predicting turning points in
the business cycle, shortcomings in the most recently available
income measures that we use in our models, and inherently
unpredictable events, such as shifts in the income distribution
and rapid changes in stock prices.
On the outlay side, estimating errors result from a variety
of economic and technical factors. Interest rates, the
unemployment rate, inflation, and economic growth may differ
from CBO's forecast and, therefore, affect outlays for
interest, Federal credit, unemployment compensation, and a
whole host of programs. In general, those sources of errors do
not seem to be related to any failure to predict the
macroeconomic effects of legislative changes.
In summary, Mr. Chairman, I do not believe that dynamic
scoring by CBO and JCT in the formal sense of bill scoring--
incorporating the macroeconomic effects into the bill-costing
process--would improve the analysis provided to Congress. There
is no objective way that congressional staff can make
assumptions about the current session, let alone future
congressional actions, public expectations of those actions, or
future monetary policy. Such assumptions in this case would
drive results and undermine their credibility. Favorable scores
would be sought for spending programs as well as for tax
The current process may be far from perfect, and indeed
that is why we are here today, but it is also better, I think,
than one that would require dynamic scoring of legislation.
With that, Mr. Chairman, I will conclude. Thank you.
Chairman Nussle. Thank you. Thank you, Dan, for your
testimony and your responsiveness to this committee.
[The prepared statement of Mr. Crippen follows:]
Prepared Statement of Dan L. Crippen, Director, Congressional Budget
Mr. Chairman and members of the committee, I am happy to appear
before you this morning to discuss how the Congressional Budget Office
(CBO) can best inform the Congress about its economic and budget
projections and about the dynamic economic consequences of tax and
Summary and Introduction
The Congressional Budget and Impoundment Control Act of 1974 set up
a process that allows the Congress to take the primary role in
formulating the budget a role that in previous years had been performed
by the administration. That law assigns to CBO the tasks of making
baseline projections of revenues and outlays and estimating the
budgetary effects of the spending proposals reported by committees. It
gives to the Joint Committee on Taxation (JCT) the job of preparing
estimates for most revenue legislation. The two organizations
coordinate their efforts on estimates for complex pieces of legislation
that affect both revenues and outlays.
CBO's and JCT's estimates play an important role in the legislative
process, providing the Congress with the information it needs to
evaluate budgetary proposals independently. Since the inception of the
Congressional budget process in 1975, those estimates have been used to
assess whether a bill will breach the limits in the budget resolution
or be subject to a point of order on the floor of the House or Senate.
Since the passage of the Budget Enforcement Act in 1990, the Congress
has used those estimates to monitor compliance with discretionary
spending caps and with the pay-as-you-go requirements for legislation
that affects revenues or mandatory spending.
Much of the body of Federal law and regulation affects the
performance of the economy. In fact, changing how the economy works is
the objective of many legislative proposals. Thus, information about
the macroeconomic effects of proposed legislation and the implications
of those effects for the budget may often be useful in the legislative
process. (The term ``dynamic'' refers to those macroeconomic effects as
well as to the microeconomic effects that are reflected in CBO's and
JCT's cost estimates).
In terms of projecting the cost of legislation as it passes through
the Congress, CBO's and JCT's formal estimates do not and, I suggest,
could not include those macroeconomic effects in a useful and credible
way. There are four reasons:
First, the macroeconomic consequences of today's actions will be
determined by policy decisions that have not yet been made. When policy
decisions have budgetary implications, they can affect future policy by
altering the budgetary resources that will be available. For example, a
current spending increase or tax cut must be financed with either lower
spending or higher taxes in the future. Such future decisions about
financing frequently determine the macroeconomic effects of today's
policies. There is a fundamental difference between a tax cut financed
by a roughly contemporaneous cut in spending and a tax cut financed by
additional borrowing for several years and higher taxes after that. The
first may well increase gross domestic product (GDP); the second is
very likely to reduce it.
Put another way, if you believe that cutting taxes today will help
hold down Federal spending in the future, then in general, a tax cut is
more likely to help the economy grow. If, however, you believe that a
tax cut today will need to be reversed in a few years, then future
economic growth may be diminished. In either case, the empirical
evidence for those outcomes suggests that the effects would be small,
given the size of fiscal policy changes relative to the size of the
Any estimate of the macroeconomic impact of a policy proposal that
was included in a cost estimate would have to make a specific,
conventional assumption about those future policy actions. The ordinary
conventions of the baseline, for example, would constrain the estimate
to assuming that tax cuts would be financed by borrowing. Under that
assumption, any positive effect of lower marginal tax rates could be
partially or totally offset by the drag of debt on capital formation
(investment) and growth. As a practical matter, under that assumption,
few tax cuts would be estimated to have a positive impact on the
There is no objective way to choose which assumption to use, and
differing assumptions can produce opposite results. CBO could make an
assumption about what the next five Congresses and at least two
Presidents will do, but doing so would subject us and the results to a
chorus of controversy. Although the lines between choices are not
bright, those possible assumptions tend to break along partisan lines,
making any choice arbitrary at best.
Second, in addition to the need to specify alternative political
futures, the assessment of legislative effects on the economy is often
confounded by offsetting effects. In general, tax cuts result in
increased after-tax income and therefore reduce the incentive to work.
However, cuts in marginal rates also increase the marginal payoff from
work and boost labor force participation.
More specifically, the reduction in marginal rates enacted in last
year's tax legislation should increase the labor supply, but by small
amounts because of the small size of the reduction and because the
alternative minimum tax will counteract the positive effects in later
years. Conversely, the increase in the child tax credit will probably
diminish labor participation by second earners.
Third, to attribute any short-run stimulative effects to
legislation, estimators must assume that monetary policy will remain
constant (that the Federal Reserve will not react to a change in fiscal
policy) an assumption not likely to prove true.
Fourth, and potentially most important, the reaction of taxpayers
to specific policy changes may be based as much on their perceptions of
a change as on the objective reality of the provision. For example, do
taxpayers assume that the sunset (expiration) of last year's tax cuts
will take place as scheduled, or that some provisions will expire and
In short, integrating dynamic scoring into cost estimates would
pose intractable problems. Before I go into detail about those
problems, I want to describe how CBO prepares its economic and budget
forecasts and what kind of dynamic effects are built into its cost
CBO'S Economic and Budget Projections
In many cases, the accuracy of cost estimates is not very sensitive
to the accuracy of the baseline economic and budget projections that
underlie them. However, those baseline projections are important
because they determine CBO's estimate of future budgetary trends under
the baseline concept
Each year, CBO prepares a set of spending and revenue projections
that assume the continuation of current laws and policies. Those
projections are known as the baseline. Such a current-law baseline is
not intended to be a prediction of Federal spending and receipts. After
all, any such prediction would undoubtedly include some assumptions
about potential changes in current laws. Instead, the baseline serves
as a neutral benchmark against which lawmakers can gauge the effects of
proposed changes in spending and revenue policies. It is constructed
according to rules set forth in law, mainly in the Balanced Budget and
Emergency Deficit Control Act of 1985 and the Congressional Budget Act
For revenues and mandatory spending, section 257(b) of the Deficit
Control Act requires that the baseline be projected as though current
laws will continue without change. In most cases, the laws that govern
revenues and mandatory spending are permanent. The baseline projections
therefore reflect only anticipated changes in the economy,
demographics, and other relevant factors that affect the implementation
of those laws.
The rules differ for discretionary spending, which is governed by
annual appropriation acts. Section 257(c) of the Deficit Control Act
states that projections of discretionary budget authority after the
current year should be adjusted to reflect inflation using specified
indexes as well as a few other factors (such as the costs of renewing
certain expiring housing contracts and of annualizing adjustments to
Federal pay). Accordingly, CBO's baseline extrapolates discretionary
spending from the current level, adjusting for projected rates of
inflation and other specified factors over the next 10 years.
That formulaic approach to developing baseline projections can be
problematic. For example, all discretionary budget authority
appropriated for the current year is inflated and extended through the
entire projection period even if it was enacted for an emergency or
other one-time event. Some emergency appropriations may not be
repeated, but various types of emergencies that necessitate additional
appropriations arise every year. Similarly, some appropriations will
naturally vary from year to year, such as funding for the decennial
The Deficit Control Act does not allow for any adjustments to that
mechanical approach, but the Budget Committees have the flexibility of
choosing different assumptions for a ``budget resolution baseline,''
and CBO has frequently provided the committees with alternative
estimates to allow for such adjustments. In any case, the baseline is a
reasonable starting point for the annual consideration of budgetary
plans and specific policy options. Annual baseline projections
represent CBO's best judgment about how the economy and other factors
will affect Federal revenues and spending under existing laws and
economic and budget projections
CBO's baseline budget projections rely on the agency's economic
forecasts. Those forecasts have been about as accurate, on average, as
those of private forecasters and the administration. All forecasters
have missed forecasts of recessions but the evidence shows that there
is no reliable way to predict recessions. CBO has often been cautious
in its projections, but that caution has sometimes served it well.
Before the most recent recession, CBO anticipated a slowdown in the
economy. Although CBO was not at all sure when that slowdown would
occur, it was sure that the growth rates of more than 4 percent that
had prevailed for 4 years could not continue without causing
inflationary pressures in the labor market. CBO shared that view with
many other forecasters, including those at the Federal Reserve. The
first intimation that the slowdown could be serious came in January
2001, when the Federal Reserve's Board of Governors began to lower
interest rates. CBO instituted a ``recession watch'' at that point to
ensure that it did not overlook any signs, either in official data or
in anecdotal evidence, that might indicate that the slowdown was
turning into a recession. At no time through the summer of 2001 did the
recession-watch team think that the evidence supported much more than a
50 percent probability of recession. Consequently, CBO's summer 2001
economic update continued to forecast a slowdown without recession,
although it did discuss the economy's unusually high vulnerability to
After the attacks of September 11, the economy turned down sharply
enough to cause the slowdown already under way to be considered a
recession. Like most forecasters, CBO anticipated that the recession,
although mild by historical standards, would nevertheless be deep
enough to slow revenue growth and to last for a couple of quarters.
Whether CBO was right or wrong on that score remains unclear. The
headline estimates of GDP growth and unemployment suggest that the
recession was much milder than CBO had anticipated. However, taxable
income seems to have taken a much more significant hit than the GDP
figures suggest. And CBO received confirmation last week that the
Bureau of Economic Analysis (BEA) significantly overestimated wage and
salary income in 2001. As a result, even while BEA is releasing
estimates of GDP growth of more than 5 percent for the first quarter of
2002, revenues are coming in even weaker than CBO's January or March
2002 forecasts anticipated.
That episode illustrates several points. First, CBO's economic
forecasts generally do not differ greatly from those of private
forecasters. CBO regularly studies its own record and those of other
forecasters to see what can be learned, and it publishes those
analyses. Second, both CBO and private forecasters have to contend with
changing and inconsistent data, which makes describing past events and
forecasting future events difficult. Third, despite those difficulties,
CBO's prediction last summer that the economy would barely avoid a
recession would most likely have proved true had the attacks of
September 11 not occurred.
CBO has also attempted to evaluate the accuracy of its budget
projections. That task is much more difficult than evaluating economic
projections because, as noted above, CBO's baseline budget projections
reflect the economic and budgetary consequences of current law at the
time they are made and assume that current policies will not change.
Policy changes are inevitable, however, which is why CBO removes the
effects of those changes when it measures the accuracy of its budget
projections. The result is the ``fan chart'' that CBO first published
in January 2001 and updated and improved in January 2002 (see Figure
1). That chart shows the range of uncertainty around CBO's baseline
projections of the surplus or deficit based on the accuracy of its past
projections. (The chart extends out only 5 years, because CBO has too
short a record of 10-year forecasts to allow useful analysis).
As expected, CBO's analysis shows that the accuracy of its budget
projections is closely linked to the accuracy of its economic
projections; that accuracy falls off quickly as the projection horizon
extends. CBO has also learned from its analysis that cyclical movements
in the economy have larger budgetary effects than can be attributed
simply to the cyclical movement of major income categories. CBO is
working to incorporate those additional cyclical movements such as
changes in the proportion of total income going to highly taxed
households into its projection models.
Aside from CBO's own analyses, a number of outside economists have
studied CBO's projections. In separate analyses, Rudolph Penner (a
former CBO director) and Alan Auerbach found no evidence that CBO's
budget projections have been biased that is, have been overly
optimistic or overly pessimistic throughout the agency's history. Some
strings of optimistic and pessimistic forecasts might suggest the
possibility that certain information could have been better used.
However, Penner suggested other reasons for such strings to occur, such
as caution in identifying changes in trends. Stephen McNees, an analyst
at the Federal Reserve Bank of Boston, tracked the accuracy of private
and official economic forecasts for many years; his latest study,
published in 1995, found that CBO's forecasts were as good as private
forecasts and better than some alternative models.
Notes.--This figure shows the estimated likelihood of alternative
projections of the surplus or deficit under current policies. The
calculations are based on CBO's past track record. CBO's January 2002
baseline projections fall in the middle of the darkest area. Under the
assumption that policies do not change, the probability is 10 percent
that actual surpluses or deficits will fall in the darkest area and 90
percent that they will fall within the whole shaded area.
Actual surpluses or deficits will of course be affected by
legislation enacted during the next 10 years, including decisions about
discretionary spending. The effects of future legislation are not
included in this figure.
An explanation of how this probability distribution was calculated
is available at www.cbo.gov.
Source: Congressional Budget Office.
How Dynamic Are Current Cost Estimates?
Estimating the revenue effects of a tax proposal requires two
pieces of information: the proposed change in the tax rate and the
resulting change in the tax base. A static estimate assumes that the
tax base does not change in response to a change in the tax rate. For
example, a static revenue estimate of a proposed tax on luxury cars
would simply multiply the tax rate by a baseline number of luxury cars
sold. Such a static estimate would neglect the fact that the tax would
discourage people from purchasing luxury cars, so it would probably
overestimate the revenue increase from imposing the tax.
Neither JCT, CBO, nor the administration actually produces static
budget estimates. All revenue estimates used in the policy process
include estimates of the effect on the tax base of changes in tax
rates. JCT's and CBO's estimates of the budgetary impact of spending
and tax proposals incorporate a wide variety of behavioral changes in
response to economic incentives; those changes are often called dynamic
Revenue estimates typically include effects related to the timing
of economic activity, effects related to shifting income between
taxable and nontaxable categories, effects on supply and demand, and
interactions with other taxes. For example, timing effects in a cost
estimate of an increase in the capital gains tax account for the fact
that taxpayers will accelerate their realizations of gains to avoid the
higher tax rate. Similarly, the scheduled expiration of tax breaks that
are not expected to be extended is usually accompanied by a temporary
shift in economic activity. Cost estimates of a change in marginal
income tax rates include the effect on the tax base that comes from
recharacterizing compensation from taxable wages and salaries to
nontaxable fringe benefits. Supply and demand effects show up in cost
estimates for a gasoline tax; those estimates reflect the fact that
higher tax rates induce consumers to buy less gasoline. Likewise,
estimates of changes in the capital gains tax take account of the fact
that taxpayers will (even apart from timing effects) realize more gains
at lower tax rates.
Policy changes can also have repercussions for taxes other than
those they affect directly. For example, cost estimates of changes in
depreciation schedules take into account the changes in payroll tax
liabilities of self-employed people that result from their changed
proprietorship income. Likewise, all estimates of changes in indirect
taxes, such as excise taxes, reflect reductions in income taxes that
result from the fact that excise taxes reduce other types of income.
Those same principles apply to spending programs. If a proposal
would alter a benefit program, CBO's cost estimate would reflect any
change in participation that was likely to result. For example, CBO's
estimate of the cost of a proposal to change Medicare payments to
health care providers incorporates its estimate of resulting changes in
the volume of services provided. Similarly, CBO's estimates for pending
agriculture legislation include anticipated effects on crop prices and
Assessing the Macroeconomic Impacts of Legislation
Information about the macroeconomic effects of proposed legislation
and the budgetary implications of those effects could often be useful
in the legislative process. Such information would include the effects
of tax changes on saving or labor supply (and therefore on growth). It
also might include effects from additional income generated when lower
tax rates promote entrepreneurship, or increases or decreases in output
caused by the impact of subsidies or taxes on the allocation of
resources among various activities. Some analysts also suggest
including demand-side effects, such as the increased employment and
economic activity during periods of recession and recovery that stems
from tax cuts or spending hikes.
Although those macroeconomic effects are important, it may be
impossible to incorporate them in budget scoring in a way that is
credible. Any forecast of the economy involves judgments about many
complex issues, and CBO routinely has to make assumptions on the basis
of incomplete information and its best judgment. Nevertheless, dynamic
scoring involves more-fundamental problems than do most of the other
types of analyses for which CBO is responsible. One of the most serious
conceptual problems is that the predicted macroeconomic effects of a
particular piece of legislation will depend critically on the analyst's
assumptions about how the change will influence future policy
Any estimate of the macroeconomic impact of a policy proposal
included in a cost estimate would have to make a specific, conventional
assumption about future policy actions. For example, the ordinary
conventions of the baseline would constrain the estimate to assuming
that tax cuts would be financed by borrowing. Thus, any positive effect
from lower marginal tax rates could be partially or totally offset by
the drag of debt on investment and growth. In practice, because most
tax bills include provisions other than cuts in marginal rates, few of
those bills would have a positive estimated effect on the economy under
Information about macroeconomic impacts can be more usefully
presented in other ways than in a cost estimate. CBO has frequently
described the macroeconomic effects of both past and proposed
legislation either in separate reports or in its description of the
economic assumptions underlying a baseline (for various examples, see
the appendix). In those reports, CBO is not constrained by the
conventions of baseline estimating and can explore the implications of
alternative assumptions. Thus, CBO can describe how the macroeconomic
effects of a policy change depend on its financing.
CBO faces some of the same problems in constructing its baseline,
which also has to reflect estimates of the macroeconomic effects of
policy in this case, of the taxes and spending programs currently in
place. Those estimates are difficult to make, in large part because of
uncertainties about the future policy implications of current policy.
However, uncertainties about the macroeconomic effects of fiscal
policy, although important, probably do not loom large in the broad
context of an economic forecast. CBO's analysis of its past forecasting
inaccuracies does not suggest that better estimates of the effects of
policy on the economy would have significantly improved its record of
The rest of this section of my statement examines the problems of
policy analysis in greater detail, first reviewing the ways in which
policy can affect the economy and then discussing the interactions with
future policy that make assessing macroeconomic impacts difficult.
CBO's analysis of the Economic Growth and Tax Relief Reconciliation Act
of 2001 (EGTRRA) illustrates the types of problems that arise and shows
why a meaningful assessment of the macroeconomic consequences cannot be
captured in a single number used as an input in a cost estimate.
effects on saving and labor supply
The main macroeconomic effects that current procedures leave out of
cost estimates are those that affect the level of production through
saving and labor supply. Tracing the effects of changes in taxes or
spending on labor supply and saving, and consequently on GDP and
receipts, is complicated by several factors.
First, the effects could go in either direction depending on the
particulars of the policy change. For example, an increase in the child
tax credit would tend to reduce the labor supply because it would raise
families' after-tax income. In turn, that boost in income might lessen
some people's incentive to work, especially second earners in families
with one person already working full time. In contrast, the effect on
labor supply of cutting marginal tax rates is theoretically ambiguous.
Although such a cut would increase after-tax pay from work, thus giving
people an incentive to work more, it would also increase families'
after-tax income, which could decrease work. Empirical studies suggest
that, in total, cutting marginal tax rates probably increases labor
Second, the economic effects of a tax cut or a spending increase
also depend on how the policy would redistribute resources among
generations and income groups. For example, a Social Security reform
that reduced current workers' expectations of the benefits that will be
paid to them when they retire would be likely to reduce current
consumption and increase saving.
Third, tracking effects on national saving is complex because there
are offsetting influences to consider. For instance, a tax cut would
normally reduce revenues and government saving (unless spending cuts
followed). Depending on the details of the proposal, however, it might
increase or decrease private saving.
effects on entrepreneurship
Tax policy can also affect the economy more subtly, by changing the
environment for entrepreneurship and innovation. By that route, higher
tax rates could slow economic growth and reduce tax receipts below what
would be estimated under current procedures.
Quantifying effects on entrepreneurship is difficult, however. A
few recent studies measuring the willingness of people to leave
salaried jobs and start small businesses have found some evidence
suggesting that the progressivity of the tax system (that is, the
extent to which taxes increase as incomes rise) diminishes
entrepreneurship. How that effect translates into innovation and
improvements in productivity remains to be established. Moreover,
because tax evasion appears to be greater among noncorporate firms than
among corporate ones, it is even more difficult to determine whether
revenues would be increased or decreased as a result.
effects on economic efficiency
Many legislative proposals take the form of tax preferences or
subsidies, so they alter the allocation of labor and capital in the
economy, sometimes adversely and sometimes favorably. Consequently,
even if a given tax preference or subsidy increases investment (capital
formation), it can also have the effect of reducing how productive that
capital is by shifting resources from more-productive to less-
Those impacts affect GDP and the tax base, but they can be
difficult to quantify. Their effects can also be counterintuitive. A
subsidy designed to offset a problem that exists in a market can
introduce other inefficiencies; similarly, a tax preference can have
unintended effects that result in diverting capital and labor to less-
Other types of legislation besides those that mainly alter taxes or
government spending can significantly affect efficiency and output. For
example, changes in laws that affect regulation of the economy such as
environmental or worker safety laws, airline or telecommunications
deregulation, changes in the minimum wage, or bankruptcy reform could
also alter business decisions. Such legislation would be very hard to
analyze perhaps impossible, because in many cases its effect would
depend on the details of implementing regulations but it could
certainly alter the performance of the economy.
effects on demand
The previously mentioned effects are ways in which budget policy
can influence the supply side of the economy. However, when people talk
about using a tax cut to avoid or climb out of a recession, they are
describing another way in which fiscal policy affects the economy
through its short-term impact on overall spending, or demand-side
effects. (Those are often called Keynesian effects, after the economist
who first pointed out their significance).
Demand-side effects tend to have a temporary impact on real income
and employment, but only to the extent that the economy is below its
normal capacity to produce. Once output and employment reach their
long-term sustainable levels, additional stimulus tends to translate
into higher inflation. So the effect of budget legislation on
macroeconomic demand depends critically on where the economy is in the
business cycle and where it will be throughout the 10-year budget
window. CBO makes no attempt to forecast the business cycle more than
18 months to 2 years ahead.
Including demand-side effects in cost estimates would present
severe problems. To begin with, several different pieces of legislation
might each have the potential by itself to boost demand and therefore
output. But if the House or Senate passed one of those pieces of
legislation, the others would have less of a problem to remedy. That
situation creates the possibility of substantial double-counting of the
same output gains.
In addition, figuring out the likely effect of fiscal policy on
short-run spending is complicated by the possible responses of the
Federal Reserve, which is also implementing policy to achieve its own
targets for output and unemployment. Chairman Alan Greenspan and the
Federal Open Market Committee navigate between recession and inflation
by controlling economy-wide spending, but they use monetary rather than
fiscal policy to do so. The Federal Reserve takes fiscal policy into
account, along with other factors, in determining the need for
additional monetary actions. Thus, instead of assuming that fiscal
policy affects spending independent of monetary policy, one might
reasonably assume that changes in fiscal policy are changes in policy
that the Federal Reserve no longer has to undertake. The fiscal policy
change might therefore be credited with little or no incremental effect
on demand. Depending on which of those views one takes, the demand-side
effects of fiscal policy will appear very different.
The appropriate assumption about how monetary policy will respond
to changes in fiscal policy is something that could evolve over time,
even with respect to a particular piece of legislation. Business-cycle
conditions change, as does the aggressiveness with which the Federal
Reserve uses monetary policy to counter business cycles. Any assumption
about the way in which monetary policy would respond is highly
speculative, requiring guesses about not only the Federal Reserve's
behavior but also the challenges it will face.
what does a legislative proposal displace?
The difficulty of assessing interactions of fiscal and monetary
policy is just one example of a pervasive problem with dynamic scoring:
how to determine a proposal's broader policy consequences. Even when
CBO knows all of the details of a proposed policy change, such as a tax
cut, it still does not know what would happen to fiscal policy without
the tax cut. Would spending be higher now or in the future, or would
there be a tax cut later? Would a tax cut now be reversed in a decade?
Would only government borrowing change within the budget window? The
answers to those questions are often crucial to evaluating the
macroeconomic impact of proposed legislation.
Finding agreement on the most likely course of future policy is
unlikely. Some people argue that cutting taxes now is good for the
economy because otherwise the size of the surplus will encourage
additional government spending. Others argue that too large a tax cut
is bad for the economy because it uses up surpluses that could be
available to pay retirement and health costs and other needed
government expenses. Those arguments turn on different assumptions
about what other policy changes would follow from a tax cut, and they
reflect fundamentally different views of the political process.
Macroeconomic models suggest that those different assumptions would
produce very different macroeconomic outcomes.
To forecast the effect of such policy changes on the economy, CBO
would not only have to forecast the implications for future government
policy decisions but also need to guess what individuals and business
leaders believe those implications will be. Economists agree that
expectations have a significant effect on economic responses. A tax cut
that is believed to be permanent, for instance, is likely to have very
different implications for spending and labor-supply decisions than one
that is believed to be transitory.
the example of egtrra
CBO's and JCT's analyses of the Economic Growth and Tax Relief
Reconciliation Act of 2001 illustrate the extent to which estimates are
already dynamic. They also demonstrate the difficulties of estimating
the dynamic macroeconomic effects of legislation. JCT's estimators were
responsible for including many of the microdynamic effects. CBO's
analysis, completed after passage of the legislation, added its
assessment of the macrodynamic effects to JCT's analysis. The two
analyses together suggest that even such a large package of measures as
EGTRRA probably has only relatively small implications for incentives
to work and to save, in part because the package contains provisions
with opposite implications. CBO's analysis also underscored the
sensitivity of those conclusions to assumptions about how other
policies would be affected by the law's changes.
JCT's cost estimate included that agency's best estimate of several
behavioral responses to the law. Those responses included the shift of
a portion of compensation into taxable wages and salaries and away from
nontaxable fringe benefits in response to EGTRRA's reduction in
marginal tax rates. (Nontaxable fringe benefits include items such as
employers' contributions to retirement plans and employer-paid health
insurance). That shift offset a portion of the budgetary cost of
EGTRRA. JCT also included estimates for a number of changes in the way
people plan their estates, such as choosing to give different amounts
of taxable gifts.
CBO's estimate of the macroeconomic effects of EGTRRA appeared not
in a cost estimate but in its update of the economic outlook published
in the summer of 2001. Consistent with the rules for producing the
baseline, the base-case analysis assumed no change in future tax or
spending policies as a result of the legislation the tax reductions
were assumed to be offset by a decrease in budget surpluses. However,
the economic analysis deviated from normal budget rules in that it did
not consider the effects of the law's scheduled sunset in 2010.
Effects on Work and Private Saving. CBO found that EGTRRA contained
a number of provisions with different, and sometimes opposing,
macroeconomic effects that were not part of JCT's cost estimate. Some
of those provisions created incentives for people to work more or to
By CBO's estimate, EGTRRA will reduce the average effective
marginal tax rate on income from labor in 2006 by about 1.8 percentage
points (or one-twentieth of the current tax rate) and the average
effective marginal rate on capital income by 0.5 percentage points (or
one-fortieth of the current tax rate). Other provisions will have the
opposite effect. For example, boosting the child tax credit will
probably reduce the supply of labor by raising families' after-tax
income, thereby lessening the incentive for possible second earners in
those families to work. CBO estimated that if the law did not expire,
the net effect of all those factors would be to increase labor supply
after a decade by between 0.1 percent and 0.4 percent.
CBO also concluded that under base-case assumptions, EGTRRA will
probably increase private saving because it reduces marginal tax rates
on capital income and thus enhances the incentives for people to save.
The legislation may also increase saving among some low-income people
through its nonrefundable credit for contributions to individual
retirement accounts or 401(k) plans. However, increases in private
saving are likely to be quite small, given the small reduction in the
effective tax rate on capital income.
Effects on Demand. CBO's analysis of EGTRRA focused on the law's
long-term macroeconomic effects, even though the perceived need for a
short-term economic stimulus to lessen an impending recession may have
played an important part in its passage. As it turned out, the
components of the law aimed at promoting short-term stimulus were
perhaps uniquely well timed (in comparison with other efforts to use
fiscal policy to combat recession). Most important, the law provided an
initial rebate of taxes payable on income earned in 2001. Although
initial surveys could not find any evidence that the rebates increased
consumption when they were issued in the third quarter of 2001, they
were in place to help consumers weather the difficult period after
September 11 and may have contributed to the continued strength of
As noted above, assessing the amount of macroeconomic stimulus
provided by any fiscal policy package is complicated by the need to
guess what the Federal Reserve's response might be. Indeed, views of
what actions the Federal Reserve might take have changed in the period
since EGTRRA was enacted. Last summer, CBO and most other forecasters
anticipated a relatively mild slowdown in the economy, which might not
have dipped into recession. However, that projection reflected both the
stimulus in EGTRRA and monetary policy actions. The Federal Reserve had
already acted vigorously early in 2001 to lower interest rates, and in
the absence of fiscal stimulus, it might have lowered rates even
After September 11, most forecasters switched to believing that the
economy was entering at least a moderate and possibly a severe
recession. In those circumstances, the fact that fiscal policy was
fortuitously providing a stimulus at exactly the right moment was
presumably very helpful to the Federal Reserve, which faces constraints
on the effectiveness of monetary policy when economic conditions
The recession, however, has proved to be the mildest on record, and
many forecasters now anticipate the moment when monetary policy may
begin to tighten. It is once again plausible to imagine that had EGTRRA
provided no fiscal stimulus, the Federal Reserve would have lowered
rates more and kept them down longer.
Some analysts have suggested that EGTRRA may have actually
contracted demand in the short run by raising long-term interest rates
(in response to smaller expected future surpluses). But it is not clear
that EGTRRA reduced expected future surpluses. Well before the tax
legislation was under consideration, many market participants assumed
that such large surpluses would not materialize. Consequently, they did
not expect EGTRRA to increase future borrowing requirements
significantly, and accordingly they did not alter their expectations of
future interest rates.
Implications for Future Policy. In its analysis of EGTRRA, CBO
emphasized that the quantitative conclusions about the law's
macroeconomic effects are very sensitive to assumptions about policy
responses as well as to the public's expectations about those
responses. Ordinary baseline assumptions are inadequate for such an
analysis. One example was noted in the preceding paragraph: EGTRRA's
actual effect on interest rates reflected not how the law deviated from
a constant-policy baseline but how it changed people's expectations
about future policy. More generally, analyzing EGTRRA as if, without a
tax cut, no other policies would ever change implies the unlikely
outcome that the tax cut will permanently reduce revenues relative to
CBO concluded that the law might either increase or decrease GDP
depending, among other things, on assumptions about its implications
for future policy. If the tax cuts in EGTRRA are accompanied by a
comparable reduction in government spending, GDP is likely to be higher
than it would have been without EGTRRA, and revenue increases from that
additional growth will offset a portion of the law's budgetary cost. By
contrast, if EGTRRA turns out to reduce the government's surplus,
national saving and GDP are likely to fall, and the budgetary cost of
the law will most likely be larger than JCT estimated.
Because the tax cuts are scheduled to expire, people's beliefs
about whether they will indeed end will determine much of the course of
the economy in the later years of the estimate. That problem has
implications for both the dynamic effects normally included in cost
estimates and the macroeconomic feedback effects that are not. Because
of the sunset, EGTRRA provides for one of the largest tax increases
ever in 2011. If the public believes that the increase is likely to
occur, that belief can change substantially the extent to which people
try to take advantage of the lower tax rates in the interim. Similarly,
the chance that scheduled cuts in tax rates may not take place can
alter behavior now.
Other Types of Legislation
Much of the discussion of dynamic scoring has been limited to
revenues. But all the concepts that apply to receipts apply to outlays
as well. Indeed, many of the same principles apply to nonbudgetary
legislation. So as not to distort policy choices, CBO and JCT should
inform the Congress about the likely macroeconomic effects of both tax
and spending proposals and how those effects reflect on the budget.
A large number of spending proposals are rooted in claims that they
will increase output. Education, research, and infrastructure spending
are all examples of outlays that, because they are by their nature
investment, can potentially boost output and generate more receipts.
Advocates of other outlays, such as health care, could make similar
claims. In addition to the potential supply-side effects on output, all
outlays can lay claim to demand effects. Those effects are generally
regarded as even stronger for spending than for taxes.
Incorporating a full range of dynamic effects in cost estimates for
outlays is especially problematic with regard to appropriations. Unlike
the laws that affect entitlement programs, appropriation legislation
does not extend across the entire budget horizon. Decisions about
discretionary spending are made 1 year at a time. It would make little
sense to try to analyze the macroeconomic effect of each additional
year of spending rather, any useful analysis would have to make broad
assumptions about what spending would be in the future. But the
difficulty of analyzing discretionary spending does not mean that it
has no effect on the economy: it is still one-third of the budget and a
crucial determinant of that budget's balance and thus of government
saving. Although including discretionary spending in a prospective
analysis of the macroeconomic effects of fiscal policy would pose
severe problems, leaving it out would tend to bias the information
provided to the Congress about the effects of policy.
Further complicating cost estimates of spending is the fact that
the effects are not confined to outlays. By their very nature, economic
changes that stem from policy decisions on the spending side of the
budget play out on the revenue side. As a result, a fully dynamic
estimate for a reform of Social Security could, if the reform was
likely to alter national saving and growth, affect estimates of the
Federal tax base and Federal revenues in the long run.
The effect could also go in the other direction, influencing
distant parts of the spending side of the budget. Almost any large
policy change that affected the economy significantly would affect
interest rates. Besides debt-service costs, changes in interest rates
would alter spending for a number of programs that involve lending or
Because the macrodynamic effects of revenues affect spending and
vice versa, including them creates jurisdictional problems for the
Congressional budget process itself. Once macroeconomic effects are
taken into account, a spending bill has revenue implications,
potentially causing a piece of spending legislation to be of concern to
the tax-writing committees. Committee allocations under the Budget Act
would probably need to reflect the effects of spending legislation on
revenues and the effects of tax legislation on outlays, which would add
a great deal of complexity to the budget process. And to incorporate
such interactions into the estimate of a bill's cost, it might be
necessary to make changes to the laws governing the budget process.
Can CBO Improve Its Baseline Projections By Accounting for
Macroeconomic Feedbacks in Its Cost Estimates?
Some people believe that including more dynamic effects in CBO's
and JCT's cost estimates would improve the accuracy of CBO's baseline
budget projections, but that does not seem to be the case.
When CBO prepares its baseline budget projections, its economic
forecast incorporates the effects of current policy. So CBO's baselines
are already a fully dynamic representation of the effects of current
policy. Moreover, there is no evidence that CBO is making any
systematic mistakes in its assessment of the effects of policy in the
baseline. A comprehensive review of CBO's revenue baselines after
changes in tax law shows no pattern of underestimating revenue
following tax cuts or overestimating it following tax increases.
It is difficult to estimate precisely the full dynamic effects of
legislation on program costs or on revenues, even after enactment. The
underlying determinants of revenues and program costs change for a
variety of reasons, many of which are hard to identify. Even years
later, there is rarely an ``actual'' figure an indisputable measure of
what the legislation actually did with which to compare an estimate.
In practice, inaccuracies in forecasting receipts appear largely to
reflect difficulties in predicting turning points in the business
cycle, shortcomings in the most recently available income measures used
in CBO's models, and inherently unpredictable events such as shifts in
the distribution of income and rapid changes in stock prices. On the
outlay side, errors in estimating result from various economic and
technical factors. Interest rates, the unemployment rate, inflation,
and economic growth may differ from CBO's forecast and thereby affect
outlays for interest, Federal credit programs, unemployment
compensation, benefit programs that are indexed to inflation, and
means-tested entitlement programs. In general, those sources of error
do not seem to be related to any failure to predict the macroeconomic
effects of legislative changes.
CBO regularly reviews the accuracy of its budget projections to
improve its forecasting methods. When actual data differ significantly
from projections, CBO analyzes the reasons underlying the differences
and makes changes on the basis of those findings. For example,
forecasts of capital gains receipts have contributed in both directions
to inaccuracies in revenue forecasts. Capital gains realizations were
below what CBO had expected in 1989 and the early 1990s but above
expectations in 1996, 1998, and 1999. On those occasions, CBO reviewed
and revised its methods for forecasting capital gains receipts. In no
instance did the analysis of errors or the revision in methodology
suggest that the errors had resulted from a failure to account for the
macroeconomic feedbacks of capital gains legislation.
CBO does not believe that ``dynamic scoring'' by it and JCT,
incorporating the macroeconomic effects of legislative changes into the
process of estimating a bill's cost, would improve the analysis
provided to the Congress. There is no objective way that Congressional
staff can make assumptions about the actions of current and future
Congresses, about public expectations of those actions, or about future
monetary policy. Such assumptions would drive results and undermine
their credibility. Favorable estimates would be sought for spending
programs as well as for tax provisions. The current process may be far
from perfect, but it is also far better than one that would require
The Congress needs complete information about the budgetary effects
of any tax or spending legislation. Given the nature of the budget
process and the fundamental limitations of macroeconomic analysis,
however, that information is most appropriately provided not in cost
estimates but in separate reports and analyses that are not required to
fit into the straitjacket of assumptions necessary for cost estimates.
Appendix: Past Estimates of the Macroeconomic Impacts of Legislation
The Congressional Budget Office has consistently published
assessments of the macroeconomic effects of major policy actions or
proposals, although it has not incorporated those assessments into cost
estimates of proposed legislation for scoring purposes. For example:
CBO has regularly included in its annual budget and
economic outlook a discussion of the effects of major budgetary changes
on its macroeconomic forecast. Last summer, for example, CBO published
its analysis of how the Economic Growth and Tax Relief Reconciliation
Act of 2001 would affect the long-term economic outlook. In previous
years, CBO published estimates of the macroeconomic effects of welfare
reform and of the reconciliation package of 1997.
CBO provided a detailed analysis of the likely
macroeconomic effects of a proposed cut in capital gains taxes in a
paper requested by the chairman of the House Ways and Means Committee.
CBO published its analysis of the potential macroeconomic
effects of major tax reform (flattening rates and broadening the base
of the income tax as well as substituting a consumption tax for the
income tax). In addition, CBO contributed papers to a conference on tax
reform that JCT held in 1997.
CBO's analyses of the many health proposals made in 1994
included discussions of probable macroeconomic effects.
In 1995, 1996 and 1997, CBO indicated in broad terms in
its economic and budget outlooks how a smaller deficit might contribute
to growth by increasing national saving (the so-called fiscal
CBO recently published a report analyzing approaches to
providing short-term economic stimulus through tax-related options. It
concluded that most of the tax cuts that the report analyzed were
unlikely to generate large first-year increases in gross domestic
Charts Presented at the Hearing
Chairman Nussle. Because this is the first opportunity to
do this, I would like to fly at about 30,000 feet. I am not
sure I would like to--flying at 100 feet is probably not wise
at this moment. Let us take it from a little bit higher vantage
point to start with.
First, with regard to accuracy and static versus dynamic,
as I have told you before, I don't pray at one particular altar
or the other, in part because I don't care what we call it. We
can call it static, dynamic. You can call it whatever you want.
I just want it to be the most accurate way of accomplishing the
goals here, and that is to give us good information not only
from which to make decisions, but also good information to give
us information about the results of those decisions, period.
And if that happens to be called dynamic or static or something
in between, that is fine with me. I just want it to be
So I don't see a real separation between the two, I guess,
to start with, and I have a list of questions, and I think
these are 30,000-feet kind of questions, and what I would like
to do, because there is probably never going to be enough time
to cover them all, is I would like to submit them to you and
give you some time to look at them, because as we are looking
down the road not only at CBO, but at the potential in the
future for changes in some of the key positions, I think this
would be good just for us to consider, for all of the committee
to consider. So I am going to submit a list of questions to you
for that purpose.
But let me just start with some basics. What should be the
core role of a Congressional Budget Office? When this was
accomplished, we thought we knew, and maybe that has changed.
Based on your vantage point, what should be the core role of
CBO, and should it be simply to provide budgetary information
in support of the legislative process, or should it include
more than that, stretching maybe the bounds of current
jurisdiction or even for that matter current technical or
professional ability within the Congressional Budget Office? So
just generally from 30,000 feet, what should your role be, and
is that something that you are currently able to accomplish?
Mr. Crippen. Mr. Chairman, after I got to CBO, I spent at
least a year or so--I mean, I went in with a bias toward maybe
making some changes, because the agency hadn't changed
dramatically in any sense certainly since 1975. The original
design, however, I think was very strong, and still very
useful. That is, half of our professionals, if you will, are
involved in the day-to-day crunching of numbers, putting price
tags on legislation reported from committees, helping
committees think about the costs of various alternatives. The
other half of the professionals contribute greatly to those
considerations. The idea was that budget analysts would not
have much time to respond to congressional needs for numbers
and that the so-called program divisions could take a longer
view of the world and take a little time to assess the critical
assumptions that our budget analysts must make about how the
world works. That was the division of responsibility initially,
and it remains roughly that way today.
We count as program divisions our tax analysis division and
our macroeconomic division, both of which contribute most of
the work on the initial baseline forecast. So for doing just
the baseline as required by law, those divisions are meeting
budgetary requirements, things that we are charged to do by you
and by the statute. In fact, up to 90 percent of what we do is
But the point, I think, that your question tries to raise
is: Should we have the ability to take a longer view of some of
these issues, analyze very specific things, often taking months
to do so, and publish for committees--or others at the request
of committees--the results? And I think the answer has to be
yes, because most of those issues--in fact, I would suggest all
of them--are very pointedly aimed at our ability to answer
questions about the budgetary implications of Federal policy
Now, we also do things on State and local mandates and
private sector mandates, but in the main our day-to-day task is
to put price tags on legislation. The program divisions, those
folks who spend a little longer on specific issues, enlighten
and inform that process. If we want to test critical
assumptions, those are the folks who can do it for us, and as a
result, you see the published results. Now, those published
results may look rather arcane in some cases or very narrow in
others, but they also give everyone involved in the process the
ability to very clearly see what our assumptions are, how we
arrived at them, and what the analysis is. Thus, if there was
any bias or, in fact, ignorance in that process, in those
assumptions, they are publicly available for all interested
parties to comment on and help us improve.
So it is a very valuable piece of what we do, and it
doesn't so much expand the boundaries in the sense I think that
you might mean as take very specific issues, like revenue
forecasting, tear them apart and spend time looking at them. We
have had some guest fellows and scholars join us over the past
few years who have done exactly that for us; taken a piece of
the revenue model say, capital gains realizations, tear it
completely apart, try other means of estimating in hopes of
improving our processes. So it is very critical, I think, that
the program divisions feed into our assumptions as well as all
of our daily work.
Chairman Nussle. My understanding is that the ratio is--at
least I have been told the ratio is close to \2/3\:\1/3\.
Mr. Crippen. It is probably the other way around, \1/3\:\2/
3\. The reason for that is if you look at just what we call the
budget analysis division, you can come up with a number that
looks like one-third. But there is also, for example, the
division that does mandates on State and local governments. All
of the private sector mandates are done in the program
divisions, because they have the knowledge about how the
private sector works much more than the budget analysts who
know how Federal programs work. The tax analysis division, as I
said, does much of their work in support of our baseline
development and helps other areas of the budget analysis
division as well.
So the division that one would make by looking just at
budget analysis, I think, is a bit misleading. It is more like
two-thirds involved in the day-to-day crunching of numbers. For
example, the health division, which I hope we talk more about,
is counted as a program division, but they do the lion's share
of work on new benefits, such as the pharmaceutical benefit,
because it is largely a private sector impact. That is, people
are currently getting pharmaceuticals, paid largely for by
either insurance companies or other sources, and so it is the
private sector response that is going to drive the Federal
costs here, and it is a whole new benefit. None of our budget
analysts have ever dealt with a pharmaceutical benefit. So the
health and human resources program division is the one
responsible largely for developing the models, building the
databases, and thinking hard about how those things might work
where we have no experience with them in the past. That is the
only reason it takes a long time. But in the main, I would say
that two-thirds of the activity in the organization is driven
by the day-to-day need to produce estimates for Congress.
[Mr. Crippen's letter following up on Chairman Nussle's
question regarding resource allocation:]
Congressional Budget Office,
Washington, DC, May 16, 2002.
Hon. Jim Nussle,
Chairman, House Committee on the Budget, Washington, DC.
Dear Mr. Chairman: In the hearing before the House Budget
Committee on May 2, 2002, you cited a figure for the proportion
of our resources (one-third) which we expend on budget analysis
work directly related to our statutory mandates. Although I
provided an answer during the hearing, the question of how we
use our resources in support of the budget process is so
important, that I felt it warranted a more detailed response.
Overall, roughly three-quarters of our resources go to directly
supporting the day-to-day cost estimating, scorekeeping, budget
projections and other mandated functions that form the core of
The figure you cited at the hearing no doubt comes from our
appropriation request which shows that roughly one-third of our
staff work in the Budget Analysis Division. What is not clear
from our budget justification, however, is that two other
divisions (Tax Analysis and Macroeconomic Analysis, comprising
roughly one-sixth of our resources) devote nearly all of their
time to planning for, developing models for, and participating
in the construction of our budget and economic projections. In
addition, each of our program divisions devotes considerable
effort to the day-to-day cost estimating and analysis of state,
local, and private sector mandates. For example, much of the
cost estimating for complex bills proposing pharmaceutical
benefits under Medicare is carried out in our Health and Human
Resources Division. Likewise, our private sector mandate
estimates are prepared by staff in our Microeconomic and
Financial Studies Division.
When overhead and administrative support are added, we
conclude that at least three-quarters of our resources go
directly to our core budget related functions, while much of
the remaining one-quarter goes to addressing significant budget
issues in response to the Budget, Appropriations, Senate
Finance, and House Ways and Means Committees.
I would ask that this additional information be inserted in
the hearing record.
Dan L. Crippen,
Chairman Nussle. Well, let us talk about the health
division for a second. I think you are aware of some of the
criticism that is--and we can be specific, but----
Mr. Crippen [continuing]. I am.
Chairman Nussle. We would be happy to, but I think probably
just to speak generally for a moment, why is that such a
challenge? It is just a huge complaint that we continue to
Mr. Crippen. It is, and it is understandable, and we need
to do better. For one thing, it is hard to find good health
care analysts, frankly, especially Ph.D.'s. There is a huge
demand for folks who know anything about how the Federal health
care system works, so it is not uncommon to have very large
salaries be offered to fairly junior members.
There is a difficulty in finding people, but I think that
we have in the past year or so filled most of what we thought
we wanted or needed for resources, and we are dedicating more
resources to health care than we did 3 or 4 years ago.
But in the main, it comes down to the complexity of the
proposals. Because the proposals are new, they tend to have
lots of variations on themes that interact with each other, and
the problem, frankly, Mr. Chairman, often is that the staff and
the members of other committees don't know what they want to
do. They have a monetary or budgetary goal in mind. They have a
policy objective, say--providing pharmaceuticals to elderly
But having said those two things, the filling in-between
takes a very long time for committee and staffs to develop.
They leave holes in the legislation until toward the end of the
process. So it is an iterative process, in which we give them a
gross first impression, and then later do something a little
more refined. For example, a good recent example is when you
all had the stimulus bill on the floor, we didn't get
legislation on some of the provisions until 10 o'clock the
night before. Now, that is not a comment about anybody's
capabilities. It is simply a fact of the way Congress works. So
our response is necessarily dictated in part by when we get
legislative language. Often in these very complex pieces of
legislation, we can't do anything until we actually see the
bill. We can't do much, because the details change the outcome
But a drug estimate takes at least a week and sometimes
longer. If you gave me a fully formed proposal today that
looked at least somewhat like some that we have seen in the
past, we could probably tell you in a week or so with about 10
or 15 people working on it what we think the impact would be.
There are just so many pieces. We have here a benefit that
will cost hundreds of billions of dollars in a market currently
of, or a baseline for spending of, well over a trillion
dollars. So to try and put fine points on it in a way that
makes sense to you and us takes time. That is not an excuse. It
is not a good answer. Obviously, if you put 30 people to work
on an estimate, you might be able to get it in three or four
days, but for some of those provisions, as you have
experienced, and the complaints we have heard, the final
determination is not made until right before you are ready to
go to the floor, and it is part of the process.
For example--in another area, the farm bill--last Friday we
read widely that everyone was waiting for CBO's estimates on
the farm bill. We got the farm bill language yesterday at noon,
we got the conference report. Now, we have seen much of it
before. It is not going to take days, perhaps more than a day
or two or maybe less when we get down to it, but very often, of
course, committees, Members and staff haven't quite finished
what they have in mind, and we get cited as the holdup. I
understand that, it is fine, but we can't and won't put numbers
on things we haven't seen, and that becomes a real impediment
in part of this process when you are moving very quickly from
your conference to a committee, to the floor, and especially
with big pieces of legislation. We can't keep up, and I don't
know that anybody could. It is not just a matter of resources.
Chairman Nussle. Let me ask one more, and it is just
something you mentioned in your testimony that goes right back
to what I was frustrated about earlier this year. You mentioned
that the supplemental, which costs somewhere roughly--you said
$30 billion--has a 10-year effect of $500 billion in the
budget. Who said that? I mean, 30 times 10 is 300 to start
with, No. 1. And No. 2, this is to fight a war, and, I mean, so
you used an example that is the most--probably one of my
biggest frustrations in your testimony, and that is how can
anybody say that a one-time emergency spending bill for
emergency items 10 years from now is going to cost us $500
billion when this is, in fact, one-time expenses?
Mr. Crippen. What I was trying to say, and I obviously
didn't do a good job of it, is that by the rules, by the Budget
Act, that $30 billion will, in our next baseline, get
translated into roughly $500 billion more over the 10 years. It
is not only 30 times 10, it is 30-plus inflation times 10, plus
whatever debt-service costs will be associated with additional
borrowing or less deficit--or less surplus. And so the net
result is going to be a $500 billion hit on the 10-year total
for surpluses or deficits.
As I said in my testimony, I agree with you that one-time
spending probably shouldn't be built into a baseline. But I
don't know how much of that supplemental spending--and Mr.
Spratt may have a better idea than either of us--for defense or
for homeland defense is going to be one time and how much of it
will go on. I don't know that, but we can obviously work
together and develop criteria and change the Budget Act so that
it wouldn't be included.
I am not predicting, Mr. Chairman, that we will need to
spend or indeed will necessarily spend an additional $500
billion or $300-plus billion over the 10 years, but that is how
the baseline will reflect the supplemental spending bill you
are about to pass.
Chairman Nussle. But that information is used in different
ways by different committees, and you ask why I am interested
in looking for a different channel or why anybody from time to
time is interested in looking at a different channel. If we
have got to change the Budget Act, I suppose good luck right
now doing anything with budget enforcement.
Mr. Spratt mentioned he is watching the demise of the
budget process in part because we do have to make some of those
enforcement changes, but we need to get some recommendations
from you on how to do a better job of this, because it is
just--we can't have that situation where we have $30 billion of
emergency ``invade Afghanistan'' kind of money assumed to be
invading Afghanistan, you know, 8 years from now, 10 years from
now. That doesn't make any sense. Or rebuilding New York 10
years from now. I mean, heaven help us if that is what we are
doing 10 years from now.
So at any rate, I know you are frustrated about that, too.
We have got to work together to change the rules.
Mr. Crippen. Part of the answer, and it is not specific to
your example here, but part of the answer is, we would just as
soon not do 10-year forecasts or baselines. If we take a $500
billion number, two-thirds of that increase occurs in the last
5 years, years 6 through 10. You don't get that kind of
multiplier effect over the first few years, the way you do when
you look at a very long-time horizon. We would be perfectly
content doing 4- or 5-year forecasts and baselines, and I
suspect you might be as well. But we don't have that luxury at
the moment. If we can get the Senate to change its rules and
requirements, we could.
So a suggestion for when you are thinking about changing
things this year would be to reel that time frame back in.
There were reasons for initially extending it. I understand
them. But, frankly, people have been able to blow through the
10-year horizon just as easily as they blew through a 5-year
horizon to stage execution of legislation beyond the window. So
I don't know that it has been that much more informative, and
it certainly makes our job a lot harder, and we are subject to
more criticism because of the uncertainty over 10 years.
Chairman Nussle. There are other members who have
questions. I apologize to them for going so far over. These are
obviously some areas that we want to talk about.
Mr. Spratt. I thought you had a good line of questioning
going. Let me follow up on your discussion of the risk inherent
in the whole exercise of forecasting and projecting.
You have got the chapter in your book, I think you have
done that at least 3 years in a row now, but that chapter tends
not to be read. The chart we have all seen, but nevertheless we
get in mind a fixed number, 5.6 percent.
I can't tell you what the percentage likelihood of that is.
I guess it is somewhere around a median percentage of your
chart, but that is what gets fixed in everybody's mind. The
bottom-line black number that you project and all of these
contingencies get forgotten.
One of your predecessors, Bob Reischauer, recommended that
we have some way to wait or discount the outyear projections of
the surplus, or really a surplus is what he was talking about.
Do the same thing for a deficit, but namely, if it was a year
out, you would maybe have a 20 percent discount; 2 years out,
20 percent; 3 years out, 30 percent; and 10 years out, the
discount might be as deep as 70 or 80 percent.
You simply wouldn't for budget purposes, either taxing or
spending, book that projection until you got much closer to it.
Is that: No. 1, is that a worthy idea? No. 2, is it a
Mr. Crippen. I think it is a worthy idea.
I think it is not feasible, although you could do that as
an addendum to the other things we do as another piece of
information. I think it is not feasible because you need a
baseline against which to measure policy changes. And unless
you apply the same kind of uncertainty rules, if you will, to
those policies, you wouldn't want to say that a tax cut in year
5 or 10 was this amount of revenue lost times 0.2 because we
The range is plus or minus, and the nice thing about
looking at just a budget total is that it is the sum of all of
the budget; when you have a surplus or deficit, that is the
final bottom line if you are looking at unified totals. So it
is a little easier to think about how you might take
uncertainty into account there.
But I think it is harder when you are developing a baseline
against which you want to measure legislative changes, so I
don't know that it would help to show uncertainty more than we
do now, but it may; and it may be another number that would get
added into the debate. But I don't think it is feasible to use
it as a baseline.
Mr. Spratt. At least it would postpone, if it worked. If it
were accompanied by some kind of effective or strength or
limitation curve, it would keep us from betting on the come, on
future year projections, and keep us confined to what we saw in
the near term; and as we approached the outyear surpluses, if
we were realizing projections, fine, then next year we could
have a deeper tax cut or a bigger spending increase, one or the
Our biggest concern is what happened in 2001 when both OMB
and CBO converged on an estimate of $5.6 billion. That was
about a billion dollar increase in the 10-year total, different
10 years, between July and January, and it was about a $600-
million increase over and above OMB's estimate just weeks
before. By August, you were acknowledging that it was off by 35
to 40 percent due to economic and technical miscalculations.
How did that happen? How do you prevent it from happening
Mr. Crippen. In general, it happened, I think, because the
budget and the economy beat all of us over the head for 3 or 4
years and produced a lot more revenues than anybody projected,
because productivity was higher. And it is clearly a judgment
call that we make and others make as to when we start
incorporating some of those apparently changed circumstances.
Do we assume that changes in productivity go on forever?
And we have been more cautious than most forcasters--
certainly than some private forecasters--in taking our time and
incorporating some of those apparent changes into projections.
It is one thing to report that we have more productivity; it is
quite another to say that we understand fully why we do and
that we expect that growth to go on forever.
So, frankly, come January 2001, we had seen all these
productivity increases and, therefore, revenue increases, and
there was no reason to believe that productivity was going to
decline substantially; therefore, economic growth was probably
going to be higher, on average, than we had been forecasting.
That alone didn't capture all of the change that was
happening with revenues, because again we were getting more
revenues than any model we had or history would have suggested
for that level of growth in the economy. There was more revenue
from real bracket creep, that pushed more income into higher
tax brackets. But there was also higher capital gains
realizations, and other things that we didn't fully understand.
So we didn't include all of that either in our forecast. We
held back some, and it turns out we maybe should have held back
Not only did we get the economic forecast wrong, itself
wrong, and we had a recession we didn't foresee, but also the
advent of more revenues per dollar of GDP now, at least
certainly today, looks to be reversed--perhaps not completely,
but again we don't know enough today to say that this decline
in revenue relative to GDP is permanent. My suspicion is that
it is not, but I don't have any evidence for that.
So the question becomes: How soon do we start factoring the
recent past into our projections of the future?
We had hesitated for a long time before including, as an
institution, a lot of those productivity changes in our
forecast. But come that January or before that was when we had
the meeting--and I think you were in it for a while--at which
our outside advisers, although they suggested we don't go quite
as far with an increase as we initially thought, were
comfortable in saying those productivity increases are probably
sustainable and therefore we are going to have more growth. No
one knew all of the reasons why we were getting more revenue,
so continuing that part of the growth seemed to be reasonable
There was a confluence of events then, just as there may be
hitting us now, with a reversal of some of those same things.
We have seen productivity be very strong during this recession,
which is unusual. Again, there is no reason to think that
productivity is going to decline over the near term, and I
wouldn't change our outyear forecast of productivity at this
point for any reason I can think of. But again the revenue per
dollar of GDP, at least this month, looks to be well below what
history would suggest.
I don't think that will continue, but we have had the
confluence of events that produced the January estimate. We
then had the passage of legislation that cost a couple of
trillion dollars. We then had a recession, and we are seeing
some things with this recession and revenues that are unusual,
So the combination of losing, if you will, $4 trillion,
half of that was the result of legislation and therefore not a
surprise; the other half was a surprise in the economic
performance and the amount of revenue. So what we saw happening
for several years, some of which we ignored for a while, we
eventually incorporated; and that appears to have been a
mistake today, but I am not sure that come next January we will
say the same thing.
Again, this is only the second year of this 10-year
forecast of $5.6 trillion, minus $2 trillion for legislation
and the economy; and the revenues may fool us again, and come
next January, we may have recovered part of that missing $2
trillion due to economic and technical changes, and so make our
This is the first year after, and it looks much different
today than it did a year ago. About a year from now--I am not
predicting for you--we are going to recover that $2 trillion.
In fact, given current revenue trends, we may be worse off--a
little. But this is only the first year after a 10-year
forecast too, and things are going to happen between now and
year 10 that we certainly didn't foresee, and it may put us
back on the other side of our forecast.
Mr. Spratt. Last year, there were some early warning signs.
One was that for an unprecedented period of time, tax revenues
had grown at a faster rate than taxable income. You weren't
completely sure in your report why. There were some obvious
reasons; whether or not they were the complete reason was
another matter. One was that we had more income gains in the
upper bracket because they pay higher rates. That explained
part of it.
Part of what we did in 1993 was rebuild the revenue base in
the Federal Government, make it more progressive, and then when
the economy produced higher gains in upper brackets, we were
rebounded from that benefit. But I remember reading your
report. You were saying, ``obviously this can't go on forever;
we just don't know when it comes to an end.'' So you tempered a
bit the income growth rate, but you also continued to expect
growth of revenues above the rate of growth in incomes, as I
Mr. Crippen. We certainly can and do anticipate in the
forecast real bracket creep. It is one of the phenomena we know
about; we know that more people get pushed into higher brackets
as real income increases, and that should be, to the extent it
occurred, permanent, and we can anticipate it relative to a
forecast. So, yes, some of that was built in permanently.
Mr. Spratt. The other thing was that you showed--the same
chapter--that from 1995 to 2000 capital revenues had grown from
$40 billion to about $120 billion, a threefold increase over a
5-year period of time; and the market by January was already
headed downward and looking ominous. You didn't really take the
capital gain revenue down by a significant amount. You simply
assumed it would not keep growing at the rate it had grown, and
it would hover at a range of 105 to 110 and gradually climb
back up to about $118 billion, as I recall.
Mr. Crippen. Right.
Mr. Spratt. But that, itself, was a risky assumption, given
the storm clouds that were gathering over the economy,
particularly the stock market then.
Looking back on it, were those assumptions erroneous?
Mr. Crippen. Probably, measured relative to what we know
today; but we don't know a lot yet because, as you know, the
tax data lagged for a year. We don't know exactly what revenue
has disappeared on us for the moment. But what we did in the
kind of steady state you are seeing in the numbers belies the
One, we said we thought capital gains realizations in taxes
were higher than could be sustained relative to the size of the
economy; and we actually, over several years, took that back
down to what the historical average of capital gains were to
the size of the economy. But at the same time, of course, the
economy is growing, so that the nominal number starts to come
down but then stabilizes and then ultimately goes back up. We
took capital gains receipts down, I think in our assumption, by
about 20 percent this year, and we assumed it would continue
down relative to a given size of the economy until it was back
to historical averages.
Now, we may not have taken it down fast enough, and that
may account for some of the effects we are seeing right now.
Frankly, one of the big determinants to a realization of equity
gains is not the market going up inexorably, but volatility;
and the trading volume may be as important in the booking of
losses and gains as the actual change at any market indexes.
Again, what causes taxpayers and corporations to realize what
are trillions of dollars in unrealized gains out there and,
therefore, subject them to tax is something we don't know very
Mr. Spratt. That is another thing that--I guess the first
year I occupied this position as ranking member was 1997, and
we had a big dispute between OMB and CBO as to what revenue
projections were for the next 5 years. CBO finally conceded to
OMB. It turned out OMB was correct, and that increment that you
added across the bottom line to your revenue projection really
made possible the Balanced Budget Agreement of 1995. I think it
was a $57 billion----
Mr. Crippen. It was $45 billion a year.
Mr. Spratt [continuing]. A $45 billion annual increase each
But it was revolutionary to me then to find out how
primitive our methods of projecting and analyzing tax revenues
were. Even after the money comes into Treasury in April, it
takes us a good period of time to know what is capital gains
and what is actual income, which brackets it is coming from,
and what is corporate and individual. It takes at least a year
before, apparently, you get a definitive statement on that.
Is there some way to make our analyses of tax flows better
and more timely than we have got right now?
Mr. Crippen. I think there is. It may by itself get better
in the sense that the more technology the IRS has in service,
the more people submit on-line returns. Those kinds of things
should improve our data processing.
But reporting, too, is a bit archaic. Corporations pay
revenues, but there is no distinction initially between payroll
taxes and income taxes.
It happens with other taxes as well. When we see an amount
of revenue coming into the Treasury, we don't know whether that
is payroll taxes or income taxes. We certainly don't know the
composition of the income taxes until we see the returns.
I think calendar year 1999 is the most recent data
available from the statistics of income----
Mr. Spratt. Three years, 1999.
Mr. Crippen. Calendar year 1999, I think. Right?
Mr. Spratt. Are you watching the flows coming in on the
daily Treasury reports now?
Mr. Crippen. Yes, sir. Unfortunately, yes.
Mr. Spratt. What is happening?
Mr. Crippen. That is what I was trying to address a little
earlier. Clearly we are well below what we expected and what
Apparently what is happening is that the tax base, both
taxable income and corporate profits, is not growing. In fact,
it is at the moment probably declining a bit, certainly not
growing anywhere near what the GDP numbers look like.
We had, as you know, a 5-plus percent growth in what GDP
reported for the first quarter, some of which was inventory
balance, but still some positive, real GDP growth. That is not
being reflected certainly in the tax revenues and, therefore,
not in the tax base. We expect that there is a significant
change in the so-called ``statistical discrepancy'' between GDP
and income. There will be a downward revision, we think a
substantial one, in July in both of the historical tax base
Assuming that revenue collection is roughly contemporaneous
with the development of the tax base, what we are seeing is a
much weaker recovery than the GDP numbers so far have
indicated. Again, we are not sure--I don't know if anybody is--
that that is a one-time temporary phenomenon that happened to
be this month, when we expected more revenues, or whether it is
going to persist through the year.
My expectation is that this will, of course, change. We
aren't going to lower the tax base throughout the course of the
year, but it will mean we are going to start again growing
revenues from a lower base than we expected, which will give us
fewer revenues over the next year or two, at least as we look
So the historical numbers are going to be adjusted down;
the tax bases are not growing as fast as the GDP numbers.
Mr. Spratt. But you can't tell now whether or not we have
lost that lucky phenomenon of taxable revenues growing faster
than taxable incomes?
Mr. Crippen. We cannot.
Mr. Spratt. Capital gains flows, one last question. Bill
Gale will testify in a little while, and he will say that one
of the problems we built into law, the Budget Enforcement Act
and elsewhere, namely, we have defined how you baseline and
project such that we artificially misstate the budget.
For example, we assume that expiring tax provisions that
are popular and almost always renewed will not be renewed; and
when you have something like the tax termination in EGTRA, that
has major implications, particularly for the outyears.
We ignore the trust funds. We treat the trust funds--we
amalgamate them, consolidate them with everything else, and
treat them as though they were ordinary revenues; and then
finally we have got a cash budget. And yet we have programs
that are like defined benefit programs, refused, unfunded
liabilities, and we don't have any kind of institutional means
of sort of backdropping the budget against those long-term
liabilities and informing the process every year of what looms
in the near future in the way of future liabilities.
Would you agree that those are deficiencies in the budget,
and if so, is there a way we can fix them?
Mr. Crippen. I would agree there are different deficiencies
in an ideal world. You are tempting me to put up my usual chart
of how much Medicare and Social Security are going to cost us
in the long run, but I won't do that right now.
There certainly can be changes. You and the chairman agree
that things like one-time expenditures misstate what the
baseline is, or expiration of tax provisions that everyone
knows, in some sense, are going to be renewed.
But I don't know that, again, you want us trying to make
those determinations. I think you may want to change the rules
to give us some criteria for making determinations about what
you consider to be one-time expenditures or what you consider
in the tax code to be more or less permanent no matter what the
Let me give you an example, though, of the kind of
uncertainty for many real world things we would face. The
alternative minimum tax, affects something like 2 million
taxpayers now--there was a slight fix in last year's bill that
expires, I think, in 2004. But if I recall our projections, we
are going to end up, without a change in law, with something
like 30 million taxpayers--the number rises from 2 million to
32 million--covered by the alternative minimum tax. That is, I
assume, an outcome that is not politically palatable.
Something will happen to the AMT to mitigate that increase,
but what? A complete repeal? A modification? When will it take
place? To whom will it apply? Those are all questions in the
political process that you will answer, but I am not sure we
are in a very good position to predict what, where, and when.
So certainly, in that sense, the criticism of our baseline
about its being unrealistic, which is often the term used, is
true. It doesn't include what may be apparent political
predictions that others can and do make, but I don't know that
you want us making them.
Mr. Spratt. Thank you very much.
Chairman Nussle. Thank you, Mr. Spratt.
I hope your testimony particularly on the receipts coming
in is communicated over to the ongoing process with the
supplemental appropriation, because if this isn't the mother of
all warning signals to the spenders around here about keeping
that bill within the fences, I don't know what is.
Mr. Gutknecht. Mr. Chairman, I apologize. I have been in--
we have a debate going on on the floor, and I have another
meeting I have to go to.
But I want to thank you, Dr. Crippen, for coming up here.
It is sort of like that ad we used to have for the after shave
where they got slapped in the face and the fellow says,
``Thanks, I needed that.'' I want to echo what the chairman
just said, because it is almost like one of those monster
movies, as we watch the development of this, quote, ``emergency
It certainly is a supplemental bill. I am not sure what is
an emergency, but it seems to be growing by the hour; and what
I have learned in my time on the Budget Committee is, we do
seem to have some control over how much we spend. It really is
debatable how much control we have in terms of the revenue that
We can pass tax relief. Clearly, I think--in view of what
has happened and what is happening in the economy--it would be
stupid for us to even consider the idea of raising taxes. I
think that would make a bad situation worse. But I do think we
have a lot of control over spending, and I suspect that, or my
view is that we ought to revisit even our own budget resolution
and make some adjustments in terms of how much we are going to
appropriate over the next several years.
Because I do agree that my view--and since most of what I
have heard so far today is more opinion than fact--opinions are
like belly buttons, everybody has one--so I will share mine.
I think we have lived in somewhat of a false economy for
several years, especially as it related to revenues, and I
think it was generated in part by what we might call the ``dot
com'' phenomenon. I am familiar, for example, with one example
in my home State where if you guys invested probably less than
a million dollars, within 12 months they essentially sold the
idea for $450 million.
Now, that story actually got repeated more often than you
might think in the last several years, and I think that was
artificial. I don't know if that idea was worth $450 million.
Maybe it was; it certainly isn't today. And we saw an awful lot
of that, and as a result, a number of those people who cashed
in on those deals paid a lot of money in taxes. I think those
days are behind us.
But I think the other story that we need to bear in mind,
and I think it is a bigger story than anybody has talked about,
is the amazing resiliency of the American people and the
American economy. If you think about where we were back on
September 15, let us say, with what was happening in the world,
what was happening here in Washington, and what had happened in
New York City and the fact that we were already probably well
into at least an economic slowdown, whether we used the term
``recession'' or not--but clearly, when you look at the
situation we were in then, it is amazing to see where we are
I don't know if the economy really grew at 5.8 percent in
the last quarter, but it is clear that it did grow much faster
than people imagined.
You mentioned productivity. I think that, in fact,
productivity, there is almost an inverse relationship with
unemployment. I look at, for example, the airlines. Virtually
every plane that I get on right now is absolutely full,
virtually every seat is full; and I think the reason is, the
airlines have cut down the number of flights to some degree,
and the number of passengers is going up. So you are going to
see the efficiency of the American economy probably look
But as we go forward--and I agree with the chairman--we
have got to get this message over to the congressional
leadership on both the House and Senate side, to the
appropriators on both the House and Senate side, because the
idea that we can afford to just pass 31, 32--it is almost like
an auction--tomorrow it will be a $33 billion emergency
supplemental. I think we have got to have some long discussions
I appreciate your testimony. Again, I would remind you that
it might be helpful for you to visit with one of our former
colleagues, a Congressman from the State of Wisconsin, who
historically actually did a better job than almost anybody of
predicting where the economy was going. He actually turned
relatively bearish about mid-year last year. I don't know if
investors followed his advice, but if they did, they came out
very well. But Congressman Neumann did a very effective job of
charting where revenues were going and where they will go in
We hope, as you go forward you, will update your models,
using some kind of regression analysis.
The most disturbing thing I have learned today is how far
behind we are in terms of getting accurate data of where we
think we are today; and without accurate data--I mean, we make
bad enough decisions with good data. When we are 3 months, 6
months, 12 months behind, it makes it really difficult.
So I think, mostly, the questions I was going to ask have
been asked, particularly by the ranking member, so I thank you
for coming up, and we look forward to working with you.
Chairman Nussle. Just in case I didn't do it earlier,
members by unanimous consent will have 7 legislative days to
submit questions for the record.
Mr. Price. Thank you, Mr. Chairman.
Welcome back to the committee, Dr. Crippen.
Mr. Crippen. Always good to be here.
Mr. Price. Glad to have you here.
Let me take up this dynamic scoring issue in one of its
aspects, and that is the degree of uncertainty that accompanies
these techniques and the implications they have for your work.
I think almost anybody would agree that dynamic scoring would
be a good thing if we could do it precisely.
If we could know the economy's actual response to policy
changes with certainty, that would be useful. However,
economics is often not that precise, and macroeconomics is one
of its least precise branches.
Budget scoring rules, unfortunately, don't allow for much
certainty. The budget process is premised on point estimates
for budgetary costs rather than the ranges within which costs
might fall--triggers, caps, targets, et cetera, they are either
met or not. The rules don't allow one merely to come close to
meeting these various standards, or at least they should not.
Of course, budget decisions are made in a highly charged
political environment, and the combination of the imprecision,
often, of economics and the budget rules requiring precision
creates a volatile situation.
There is a great temptation to claim dynamic benefits for
any and all policy proposals. Advocates of a particular policy
could use adulterated economic analysis, competing experts or
sheer obfuscation to pressure CBO to score their proposals
favorably. Stakes in the game are especially high, because
relatively small changes in projected growth have huge
consequences for outyear deficits. And the politics are
especially dangerous because the largest budgetary consequences
do not occur until long after the policy changes are made.
So, with those comments, those observations, let me ask you
some questions about how much consensus exists within the
economic profession about the economic effects of tax changes,
for example, on productivity growth; or is there a range of
opinions? For example, do economists have a fairly precise
estimate of the effect of the so-called ``supply side'' tax
cuts of the early 1980s, the effect they had on productivity
growth, or is there a wide range of opinion?
Mr. Crippen. There is certainly a range of opinion and
estimates. I think, if I might add to your question just
slightly, the ability to make those assessments even after the
fact is limited because you have a confluence of a lot of
events; and to know what caused what is very difficult because
of, as you said, the imprecision of our forecasting or
estimating capabilities. And there are anecdotal relationships,
but we don't know that they are correlated.
I mean, the tax cut of 1981 was followed by a tax increase
in 1982, which was followed by the second longest peacetime
expansion in history. Now, what caused what? Certainly most
economists wouldn't say that tax increases help economic growth
in the long run, but there is at least that juxtaposition of
But in addition to the imprecision of our ability to
estimate the relationships, which is what you were getting to,
it is true that that is theory. The models all require that you
make assumptions about future fiscal policy, and I think that
is probably the hardest thing.
We could, perhaps, with enough regressions and enough
computer capacity, ferret out some of the effects of marginal
rate cuts on productivity and other things and be confident, or
somewhat confident, about the numbers we attach to them. But
that won't do us any good unless we know what future fiscal
policy is going to be in the counter-factual scenario one must
So it is not just the imprecision that you allude to that
is there--we could overcome some of that, perhaps--but it is
the inability or probably the inappropriateness of our making
political predictions about what the next 10 years will look
like in terms of fiscal policy.
Mr. Price. What about the investment side or spending side?
Do we know the effects of public investment with any greater
precision than we know the effects of various kinds of tax
policy? Is the situation here the same as with taxes where some
say the effects are large and others say they are small or
Mr. Crippen. We found, I think, a 1995 analysis by CBO that
looked at productivity or the economic effects, macroeffects,
of public investment. A lot of it focused on infrastructure
because, you may recall, the debate at the time was that we
needed more infrastructure, spending on highways and those
kinds of things. We found very little relationship between
public Federal spending on infrastructure and any effects on
There are certainly things that you would think as a matter
of common sense and theory helped, whether it is investment in
education, maybe human capital and other things, but that is
even harder to measure than anything we try to measure now. So,
at the moment, there is probably, if I had to make a guess,
less evidence on the spending side for macroeconomic
stimulation or improvement than there is on the tax side.
Mr. Price. Mr. Chairman, if I may wrap up with one comment
and a final question.
In the face of this kind of imprecision both on the tax
side and the spending side, I think the temptation is all the
greater on the part of legislators to justify their proposals
on the basis of wondrous but unproven projected benefits.
Is it your view that it is more prudent to stick with the
current procedures, which are conservative in the truest sense
of the word? Perhaps there we are risking the possibility that
we will be pleasantly surprised that the budget isn't better
than expected if these supply side benefits actually
Mr. Crippen. I do, Mr. Price. That is not to say that we
can't improve what we do now in the scoring of bills, but I
also think it is important that we continue to provide and do a
better job, if we can, of reporting to Congress what the likely
macroeconomic effects of different legislative proposals might
be. That is different from making a firm, precise prediction of
how much the economy is going to grow because you are going to
do something today, and how much effect that will have on the
What I am suggesting is, we can give you analysis of what
kinds of tax cuts are likely to help the economy grow, what
effects big pieces of legislation might have, but not put
precise numbers down for every year for the next 10 years as
some kind of feedback or offset for any revenue loss or
spending increase. I think what we do now is better than trying
to include dynamic effects in the scoring process itself, but
we can do a better job of informing Congress of what some of
those dynamic effects might be.
Mr. Price. Thank you.
Thank you, Mr. Chairman.
Chairman Nussle. Thank you, Mr. Price.
A couple of things that have come up in some of the
questions. One is going back to the issue of CBO requiring a
change in the law in order to consider, for instance, one-time
expenditures. Let us assume for a moment that that is difficult
to achieve, in other words, some type of a one-size-fits-all
provision that defines how----
Mr. Crippen. Yes.
Chairman Nussle [continuing]. I think that is what you were
saying, that is hard to do. What would be a fall back position?
Would it be appropriate, for instance, to insert in an
emergency supplemental--let us take the one we are talking
about now--that the following items are one-time expenses and
the other items are proved--or whatever the right technical,
legal-beagle language you have got to put in, are proved for
the purposes of computing the baseline? What does CBO need to
see in order for you to make a change?
Mr. Crippen. Like you, I am not sure what the exact words
are, but something that said these are to be considered as one-
time expenditures in CBO's development of a baseline, I think,
would probably cover us.
Is that right? Because it would be signed by the President.
Chairman Nussle. We won't hold to you that head nod, but I
am sure there are other people we----
Mr. Crippen. That would go a very long way because you will
have said we expect this, we, the Congress, are voting for and
enacting this expenditure on the basis that it is one time.
Chairman Nussle. Why isn't the emergency designation itself
enough because of the definition of being one-time,
unanticipated, et cetera, et cetera, kinds of expenditures?
Mr. Crippen. Currently, we are not given the leeway, if you
will, to say an emergency appropriation will not be repeated.
It gets by the rules, by the law, and gets built into the
Chairman Nussle. The one rule was written before the
current rule on emergencies.
Mr. Crippen. Yes.
Chairman Nussle. So why wouldn't the fact that we now have
a new procedure called ``emergencies,'' that is defined as a
one-time expenditure, not be enough?
Mr. Crippen. It didn't change the manner by which we build
the baseline. Essentially, you take this year's expenditures in
total, whether they are emergency or nonemergency doesn't
matter, and inflate that total because it is taken as current
Chairman Nussle. The other question I have is--and I
appreciate that. I just am searching for----
Mr. Crippen. I understand. And that would tell us what you
consider to be one time and that would certainly meet our
Chairman Nussle. Going to what Mr. Price was saying, and
maybe this is not what he was on to, but it did ring with me in
a particular way. There are some States in the country that
budget based on a percentage of the overall, whatever it is,
last year's revenue take or some dynamic of some sort that
measures that, some formula; and you have talked about the fact
that while inaccurate, we are talking about very small
percentages here. Obviously, those percentages add up to a huge
amount of money, but in the context of the overall dynamic of
$20 trillion you were talking about, we have a fairly small
Would there be any industry at all, in considering using
some formulation of a budget that only provided for the use of
a certain percentage of the revenue, where that was determined
by actuals rather than projections?
Mr. Crippen. Sure. Unfortunately, I suspect you are more
correct than not that the current budget process has had its
25- or 27-year run, and it is going to be replaced with
something or mutated into something different. Some of the
things you may well want to consider are those kinds of things.
The Budget Committee currently has the authority, of
course, to tell CBO to develop an alternative baseline. What
you use is up to you, in effect. So you could say for your
purposes, for the budget resolution purposes, you want a
revenue number based on last year's revenues, plus or minus.
That wouldn't preclude us from doing something different as a
baseline, but the baseline is really less to forecast this
year's revenue than it is to measure changes against it. So it
wouldn't, I think, impede the process.
I don't know if my colleagues are shaking their heads or
not behind me, but----
Chairman Nussle. Actually they all left. They are outside
the door now.
Mr. Crippen. I expect there are several of those kinds of
things you could do now that may be very useful as an
alternative to the kind of budget process we have had, if we
can't pass budget resolutions in their current form. We need
something to replace it, and maybe something that you are
suggesting here would be a useful place to start those changes.
Chairman Nussle. One other thing that came to mind, I
think, during Mr. Gutknecht's questions, when you and others
reported last year prior to September 11 and prior to a clearer
understanding of the direction of the economy vis-a-vis the
recession that many now are pinpointed to March, April or May
of 2001, when you reported to us the baseline and projections,
we were told within the fan chart, as I recall, that there was
built into those projections about a $100 billion revenue loss
based on a perceived or potential recession.
So I guess part of what I am--and maybe this isn't a
question, but a concern--is that you might be off, plus or
minus, based on actuals. But it was also a projection that
built in a certain amount of fudge factor, so that it was
further away to some extent than even we are talking about here
today, because built into that was a mild--at that point,
determined a mild or moderate recession.
I don't want to put words into anybody's mouth, but it is a
concern that the recession last year--Mr. Spratt was on this
line of questioning, that the projection was even arguably
further away, based on the fact that there was some give in the
numbers on this $100 billion revenue hit based on this
Do you have any comment on that?
Mr. Crippen. As a matter of process, we can't and don't try
to predict turns of the economy, a recession or recovery, the
points of that; but over a 10-year span we expect there is
going to be one recession as a rule of thumb. And what we did
for the baseline that you are referring to is we took the 1991-
92 recession roughly and said, ``What if that happens sometime
during this 10 years?'' And I suspect we did a mid-year, 5-, 6-
, 7-year, somewhere in there----
Chairman Nussle. Actually, my understanding, it was years 1
Mr. Crippen. More important--was it one or two?
Chairman Nussle. That is what concerns me and others.
Mr. Crippen. In fact, if we hadn't done that, our
projections would have been even further off.
Chairman Nussle. That is what I mean.
Mr. Crippen. Yes. So the question is whether that modeled
recession, as typical, is a good one, and we don't know.
One of the things we changed here, that we modeled, was the
change in the tax base--how much taxable income, wages and
salaries and corporate profits, would go down during a
recession. But what is happening to us now, with revenue
dropping even faster than the tax base, means we are changing
effective tax rates. We didn't model, nor do I know we could,
the changes in effective tax rates we have seen here.
Every recession is unique. This one is particularly so
because it wasn't initiated--the catalyst wasn't the tightening
of monetary policy that we typically see that kicks the
economy. It was caused by a fall-off of capital investment,
mostly by corporations. Consumer demand was actually relatively
robust and, as we have seen, productivity is relatively robust.
But something is happening that we don't yet know in terms
of the effective tax rate or the average tax rate of these
revenue sources, and in this recession they changed much more
dramatically than in 1991-92. So we modeled or included that
past recession, but it was obviously not emblematic of what we
are experiencing now.
Chairman Nussle. Even before--and this is maybe more candid
than I ought to be, but I was using your argument trying to do
battle with John Spratt, saying, ``wait a minute, you don't
have to be quite that pessimistic even though he was warning
us, because we built into this a $100 billion recession,''
which was--1990-92, I don't think anybody would have said that
was a mild recession. That was a pretty significant recession,
or at least moderate, recession; let us call it that, middle of
So in making those projections, if you build that into it,
that is pretty good wiggle room, so to speak. At least we
thought so in January. So that is why, I guess, when we talk
about projections and accuracy, using those arguments, building
in a certain amount of fudge factor for the economy, knowing
that it could in fact be a problematic recession, we are using
those as we are making arguments and making decisions. And when
we are wrong--in this instance, it was really wrong, and that
was even prior to September 11. Certainly, September 11, nobody
is predicting--you don't have any analysts who can predict
Mr. Crippen. I hope not.
Chairman Nussle. But at least from a recession standpoint
those were arguments and those were issues that were used and
relied upon, and it has made it, obviously, very difficult.
So do other members wish to inquire? If not, this is a
start, as we said.
Mr. Crippen. Sure.
Chairman Nussle. As I said before to you, and to your top
staff in particular, we appreciate the responsiveness that you
always give to us on these big questions. We want to get into
the weeds a little bit further as we go, and I will have some
questions that I would like to submit for the record so that we
can talk about some more of these topics. But we appreciate the
time you have given us today and the chance to review some of
these topics and we will continue to do this on an ongoing
Mr. Crippen. As your schedule permits, I would like to take
you up on your offer to come over and have lunch with all of
us, and put some faces on names and things like that, and see
what the Ford House Office Building looks like. You might bring
your colleague, Mr. Spratt, along.
Chairman Nussle. I think that would be a useful exercise.
Thank you very much, and again thank you to the many CBO
employees that are here today to listen and participate in
this. So thank you.
For the next panel we have invited three very distinguished
folks to come, and I think all three have testified before this
committee. First will be Rudolph Penner from the Urban
Institute; Kevin Hassett and William Gale will be here as well.
As is unfortunate at this time in Congress, because of the work
week, we have a number of markups and hearings and other
meetings that are occurring, so we have, actually, quite a bit
of demands on some of these witnesses to testify; and so they
will be along at some point in the very near future.
But in the meantime, we have Dr. Penner, who is a Senior
Fellow from the Urban Institute here to visit with us.
We welcome you. Your entire testimony will be made part of
the record and you may summarize as you would like. Thank you
STATEMENT OF RUDOLPH G. PENNER, SENIOR FELLOW, THE URBAN
Mr. Penner. Mr. Chairman and Mr. Spratt.
Chairman Nussle. There is a button on your microphone you
need to push, I believe.
Mr. Penner. Mr. Chairman, Mr. Spratt, Mr. Price, thank you
for the opportunity to testify.
Few countries give their legislatures as much budgeting
power as that enjoyed by the Congress of the United States, but
it is my experience that any legislature will have more
influence over budget decisions if it can draw on the analysis
of expert staff. And I think there are major advantages in
keeping that staff nonpartisan. It lends more stability as
political power shifts, and that allows the development of
specialized skills in different areas of public policy.
A nonpartisan staff often has more credibility with
outsiders, and although there are exceptions, those analysts
who try to combine rigorous policy analysis with political
judgments typically don't do very well with either.
I am, of course, biased, but I have little doubt that the
existence of the CBO has greatly increased the Congress'
capacity to budget and enhance its influence vis-a-vis the
executive branch. CBO's forecasts give Congress an alternative
view of the economic and budgetary future. Its cost estimates
guard against the Congress unwittingly adopting programs whose
costs are very different in the long run and in the immediate
future, and its policy analysis helps the Congress decide what
works and what doesn't work.
It is inevitable that some of CBO's output will be wrong
and some of it will be annoying to one political party or
another, either because mistakes were made or good analysis was
badly timed. But if one adds up the impressive volume of CBO
cost estimates, analysis and forecasts, a remarkably high
portion is noncontroversial and a remarkably low portion
actually makes people angry.
I will concentrate the rest of my testimony on a very few
areas of the CBO responsibility where I have strong views, but
I would be happy to answer questions about other areas as well.
I shall focus on CBO's projections of budget aggregates that
are used to formulate budget resolutions and on the issue of
dynamic scoring of tax and expenditure policy changes.
No one forecasts anything very well. That is true whether
one looks at pundits forecasting the course of the war in
Afghanistan, demographers forecasting worldwide birth rates or
pollsters forecasting the French presidential election.
I recently studied the history of budget forecasting
errors, and they are pretty discouraging. The average error
made in the forecast of the budget balances used to formulate
the budget resolution is over $100 billion for the first year
covered by the resolution and over $400 billion 5 years out.
These are errors made because of flaws in economic and
technical assumptions and don't include the effect of policy
Ten-year projections were initiated only in 1997, so we
can't test them against reality. But the projection for the
budget balance in 2007 changed over $800 billion between early
1997 and the summer of 2000, and if we make the same kind of
error in our current view of the 2012 budget balance--or I
should say, change it by as much--it will be altered by a cool
$1 trillion for that single year.
Now, the importance of errors of this type depends on how a
forecast is used. Flaws in economic forecasts are unlikely to
obscure the qualitative nature of the budget effects of a tax
cut or entitlement increase; that is to say, if an entitlement
increase is shown to cost very much more in year 7 than in year
4 by a good forecast, the same pattern of cost is likely to be
revealed by a bad forecast as well.
However, 10-year projections of the budget balance are not,
in my view, accurate enough for the purpose of formulating a
budget resolution; and I would very much agree with Dan
Crippen's sentiment that we should shorten the horizon again to
5 years. Even that is somewhat tenuous. If you did that, there
is nothing to prevent the Congress from requesting that CBO do
an economic forecast for years 6 through 10 that could be
buried in an appendix somewhere and used to estimate the
effects of a particular tax or entitlement measure that would
allow the nature of phase-ins to be observed.
Because forecasting is inherently difficult, there is not
much that CBO, the Congress or anyone else can do to greatly
increase the accuracy of budget forecasts. However, there are
actions that you can take that might result in minor
A major frustration facing revenue forecasters that we have
heard several times today is that it takes a very long time to
get detailed information on recent tax receipts. CBO and OMB
will have little information on the causes of the recent
surprising shortfall in revenues by the time they have to do
their summer updates of the budget aggregates; and different
causes for that shortfall will have very different implications
for long-run revenues.
Detailed information on 2001 tax returns will not be
available until October or November, and even that data is not
accurate. As we heard before, it will take 3 years to have
really reliable data from those tax returns. Changes in
reporting could help a lot, and I make some specific
suggestions in my complete testimony.
And, in addition, I don't believe that our statistical
agencies have the budgets necessary to produce high-quality
statistics. It is very difficult to make a decent forecast of
the future if you can't even forecast the past; and we see huge
revisions in the official data from time to time.
Many of the deficiencies in official estimates that are
related to budget forecasting could be ameliorated with minor
infusions of money. The administration has requested a healthy
increase in the Department of Commerce budget this year for
statistical purposes, and I hope that this committee can use
its influence with appropriations to see that go through.
Again, I want to emphasize that better and more timely
historical data will not enormously improve the accuracy of
forecasts. It won't help us predict another terrorist attack or
a Mideast oil embargo or things of that nature that have a huge
influence on the future, but it may occasionally save us from
making some very big mistakes; and in my view, that would be
Turning to dynamic projections, for many years the Congress
has been frustrated by the inability of the Joint Committee on
Taxation or the CBO to provide a complete accounting of revenue
and outlay effects of behavior responses to policy changes. It
is commonly believed that no behavioral responses are
considered. That is not true. For example, revenue estimators
would take account of an effect of the change in the gasoline
tax on the demand for gasoline, but they do not go further and
estimate the impact on GDP or the CPI or on other macro-
There is nothing to prevent CBO from doing studies to
inform the Congress of the findings of academics and others as
to the complete dynamic effects of specific policy changes, and
in fact, CBO has done such studies on capital gains tax rate
changes and other things.
But in addition to the problems raised by Dan Crippen, I
would like to emphasize some real practical management problems
involved in doing dynamic scoring for a complex tax or
Such a bill usually contains numerous provisions, some pro-
growth, others anti-growth. Dozens of technicians often work on
different provisions of the bill simultaneously at Joint Tax
and at CBO. If he is doing a dynamic scoring, analyst A may
decide that his provisions increase the GDP growth rate next
year by a tenth of a percent. That should force every other
analyst working on the bill to change their estimates.
Two hours later, analyst B might decide that her provision
reduces growths by two-tenths of a percent. Again everybody,
including analyst A, should be changing their estimate.
Moreover, every change in the assumed GDP or CPI or the
unemployment rate will affect almost every other type of
estimate made throughout the budget, whether or not it is
affected by the legislation under consideration.
The budget baseline would have to be recomputed with every
significant piece of legislation, and as Dan emphasized, the
management problem is made even more difficult by the fact that
the Congress often makes important changes in the language of
bills at the last minute, and much of the CBO scoring effort
takes place very late at night and sometimes lasts through the
Congress would, I think, find it difficult to deal with an
ever-changing baseline. Before Gramm-Rudman, the Congress used
to change its baseline with the summer budget update provided
by CBO, but that would change the estimates attached to all
pieces of legislation then being considered. It was decided
this was too disruptive to bargaining over the details of
bills, so the Congress decided at that point to keep the spring
baseline through the whole year.
Mr. Penner. Apparently there are discussions about adding
statements to the text of cost and revenue estimates where
there might be an important effect on macro-variables. These
would be separate from official numerical estimates. Probably
it will be practically necessary to confine those statements to
qualitative rather than quantitative statements; nevertheless,
that may be helpful to the Congress.
If CBO and Joint Tax start making judgments about
macrovariables that would supplement official cost and revenue
estimates, they will have one more activity that will make
people angry. They will have to make some very unpopular
statements. For example, good analysis will show that there are
some tax cuts that decrease growth and some tax increases that
I am thankful that I won't be answering questions from
members about such judgments. Thank you very much.
Mr. Sununu [presiding]. Thank you very much, Mr. Penner.
[The prepared statement of Rudolph Penner follows:]
Prepared Statement of Rudolph G. Penner, Senior Fellow, the Urban
Mr. Chairman, Mr. Spratt and members of the committee, thank you
for the opportunity to testify.
Since leaving the Congressional Budget Office (CBO), I have had the
opportunity to work on budgeting issues in a number of countries. It is
remarkable how many different constitutional arrangements exist for
dividing budgeting power between the executive and legislative branches
of government. But few countries give their legislatures as much
budgeting power as that enjoyed by the Congress of the United States.
Regardless of a legislature's constitutional power, its actual
influence over budget decisions can be enhanced if it can draw on
analyses done by an expert staff. That is true even in parliamentary
systems where the executive branch has most constitutional power. But
obviously, the analytic input from such a staff is most crucial where
it is the legislature that is most important in making budget
There are major advantages in keeping the expert staff nonpartisan.
It lends more stability as political power shifts and that allows the
development of specialized skills in different areas of public policy.
A nonpartisan staff often has more credibility with outsiders, and
although there are exceptions, those analysts who try to combine
rigorous policy analysis with political judgments typically do not do
well with either. It is better to let analysts be analysts and to let
elected politicians decide which of the analytic results can be sold to
I am, of course, biased, but I have little doubt that the existence
of CBO has greatly increased the Congress's capacity to budget and
enhanced its influence vis-a-vis the executive branch. CBO's forecasts
give the Congress an alternative view of the economic and budgetary
future; its cost estimates guard against the Congress unwittingly
adopting programs whose costs are very different in the long run than
in the immediate future; and its policy analysis helps the Congress
decide what works and what doesn't work.
It is inevitable that some of CBO's output will be wrong and some
of it will be annoying to one political party or the other, either
because mistakes were made or good analysis was badly timed. But if one
adds up the impressive volume of CBO cost estimates, analyses, and
forecasts, a remarkably high portion is non-controversial and a
remarkably low portion really makes someone angry.
I shall concentrate the rest of my testimony on a very few areas of
CBO responsibility where I have strong views, but I would be happy to
answer questions about other areas as well. I shall focus on CBO
projections of budget aggregates that are used to formulate budget
resolutions and on the issue of dynamic scoring of tax and expenditure
No one forecasts anything very well. That is true whether one looks
at pundits forecasting the course of the war in Afghanistan,
demographers forecasting worldwide birth rates, or pollsters
forecasting the French presidential election. It is particularly
difficult to forecast the budget balance, because one does not forecast
it directly. One forecasts two much larger numbers--revenues and
outlays--and takes the difference. Relatively small percentage errors
in forecasting revenues and outlays thus imply very much larger
percentage errors in forecasting surpluses or deficits. For example, in
2001, revenues totaled $2 trillion and the surplus $127 billion. Every
1 percent error in forecasting the former implied a 16 percent error in
forecasting the latter.
I recently studied the history of errors and I would like to submit
my results for the record. They are pretty discouraging. The average
error made in the forecast of the budget balance used to formulate the
budget resolution is over $100 billion for the first year covered by
the resolution and over $400 billion 5 years out. These are errors made
because of flaws in economic and technical assumptions and do not
include the effect of policy changes. (They are also adjusted for the
growth in the economy). Ten-year projections were initiated only in
1997; so we cannot test them against reality. But the projection for
the budget balance in 2007 changed over $800 billion between early 1997
and the summer of 2000--an amount equal to more than five times the
value of the 2001 tax cut in 2007. If our view of the 2012 budget
balance changes by a comparable amount over the next 3\1/2\ years
relative to GDP, it will be altered by a cool $1 trillion for that
The importance of errors of this type depends on how a forecast is
used. The 75-year forecast used by the Social Security trustees is
bound to be off by huge amounts in dollar terms, but it is unlikely to
be wrong about its basic qualitative conclusion that the economic
burden of supporting the Social Security system will rise rapidly
between 2010 and 2030. Similarly, flaws in economic forecasts are
unlikely to obscure the qualitative nature of the budget effects of a
tax cut or an entitlement increase. That is to say, if an entitlement
increase is shown to cost very much more in year 7 than in year 4 by a
good forecast, roughly the same pattern of costs is likely to be
revealed by a bad forecast as well. Put yet another way, forecasts of
changes in a baseline due to policy changes are likely to be more
accurate than forecasts of the baseline itself.
But I believe that the Congress asks for too much when they ask CBO
for a 10-year projection of the budget balance for the purpose of
formulating a budget resolution. The projected budget balance is too
erratic from year to year to be used for that purpose. Five years is
about the outside limit for a budget resolution and even that is
tenuous. (I realize that the House emphasized the first 5 years in this
year's resolution). There is nothing to prevent the Congress from
requesting that CBO do an economic forecast for years 6 through 10 that
would be hidden in an appendix somewhere and pulled out to estimate the
effects of a particular tax or entitlement measure. That would allow
the nature of phase-ins to be observed. But I would not compute a
budget balance 10 years hence and put it in a budget resolution,
because that is essentially a useless exercise.
Although errors in forecasts are likely to be huge, there is one
custom that tends to make forecasts seem even more volatile than they
really are. CBO, the press and the public discuss the cumulative budget
balance over five or 10 years. That is likely to change by hundreds of
billions from forecast to forecast and that seems like a lot of money.
But adding the budget balance for 1 year out to that for 5 years out
makes no sense, because the latter is so much less reliable than the
former. It is truly adding apples and oranges. I wish CBO would expunge
the columns from their tables that indicate cumulative totals, but the
custom of using them has become so entrenched that I know that I am
fighting a losing cause.
improving budget forecasts
Because forecasting is inherently difficult, there is not much that
CBO, the Congress, or anyone else can do to greatly increase the
accuracy of budget forecasts. However, there are actions that might
result in minor improvements.
A major frustration facing revenue forecasters is that it takes a
very long time to get information on recent tax receipts. CBO and OMB
will have little information on the causes of the recent surprising
shortfall in revenues by the time that they have to provide budget
updates next summer. Different causes can have very different long-term
implications, detailed information on 2001 tax returns will not be
available until October or November, and even that data will not be
Changes in reporting could help a lot. For example, corporations do
not immediately divide their tax payments between payroll and profit
taxes. If they were asked to report HI tax collections--a proportional
tax--revenue estimators would immediately have valuable information on
total earnings in the corporate sector. Further valuable information
would come from reporting stock options on W-2's for individuals or in
the aggregate for a corporation. Of course, any increase in reporting
comes with a compliance cost imposed on business, but I believe that
these suggestions would not be very costly. It is also possible that a
small infusion of money into the IRS could expedite the processing of
returns, so that revenue estimators would not have to wait so long for
In my view, our statistical agencies do not have the budgets
necessary to produce high quality statistics. Canada does better.
Fundamentally, the Bureau of Economic Analysis (BEA) and the Bureau of
Labor Statistics (BLS) should have more resources for basic research,
so that their data collection techniques could keep up better with the
rapidly changing structure of our economy. Of more immediate interest,
the income side of our GDP accounts that is vital to revenue estimators
is not given the same attention as the product side that is of more
interest to business economists and other observers of the economy.
Although the two sides should be equal in theory, there have been major
statistical discrepancies in recent years. It is very difficult to make
a decent forecast, if we have bad information on past history.
One could go on and on about deficiencies in official statistics
deficiencies that could be ameliorated with minor infusions of money.
The administration requests a healthy increase in the BEA budget this
year. I hope that the Appropriations Committees find a way to fund the
Again, I want to emphasize that better and more timely historical
data will not enormously improve the accuracy of forecasts. It won't
help us predict another terrorist attack or a Mideast oil embargo. But
it may occasionally save us from a big mistake and that would be
estimating revenue and expenditure feedbacks
For many years, the Congress has been frustrated by the inability
of the Joint Committee on Taxation or the CBO to provide a complete
accounting of the revenue and outlay effects of behavioral responses to
policy changes. It is commonly believed that no behavioral responses
are considered. That is not true. Micro responses play a role in making
estimates. For example, revenue estimators would take account of the
effects of a change in gasoline taxes on the demand for gasoline when
they make the revenue estimate that appears in the report on the
legislation. They would not go further and estimate the impact on GDP
or on the CPI or on other macro variables. Thus they miss the impact on
other revenues because of the effects on GDP growth or tax indexing
changes, and the impact on outlays because of changes in unemployment
compensation or because of changes in COLA effects on indexed programs
like Social Security or food stamps.
There is nothing to prevent CBO from doing studies to inform the
Congress of the findings of academics and others as to the complete
dynamic effects of specific policy changes. In fact, CBO has done such
studies on capital gains tax rate changes and other things. The
Congress will probably be disappointed by the wide range of uncertainty
on such matters, but it is no wider than CBO has to deal with when
forecasting the economy more generally.
The real practical problems come if CBO is asked to do dynamic
scoring for a complex tax or reconciliation bill. Such a bill usually
contains numerous provisions--some pro-growth and others anti-growth.
Dozens of technicians often work on different provisions of the bill
simultaneously at JCT and CBO. If he is doing dynamic scoring, analyst
A may decide that his provision increases the GDP growth rate next year
by 0.1 percent. That should force every other analyst to re-estimate
the effects of their provision whether or not they think their
provision has any effect on growth. Two hours later Analyst B may
decide that her provision reduces growth 0.2 percent. Again, everyone,
including Mr. A should redo their estimates. Moreover, every change in
the assumed GDP or the CPI or the unemployment rate will affect almost
every other type of tax revenue and entitlement outlay, whether or not
it is affected by the legislation. The budget baseline would have to be
recomputed with every significant piece of legislation. The implied
management problem is made even more difficult by the fact that the
Congress often makes important changes in the language of bills at the
last minute and much of the CBO scoring effort takes place very late at
night and can last until dawn. Careful dynamic scoring would only be
possible if Congress allowed several days for scoring instead of
several hours, and even then it would be extremely difficult, if not
Another problem is that Congress would find it difficult to deal
with an ever changing baseline. Before Gramm-Rudman the Congress used
to change its baseline with the summer budget update provided by CBO.
That would change the estimates attached to all pieces of legislation
then being considered. But it was decided that this was too disruptive
to bargaining over the details of bills. The Congress decided to let
the earlier baseline be used throughout the year.
The Congress could do dynamic scoring of individual bills without
changing the baseline, but this would often lead to illogical and
inaccurate results. The effect of one program change on the cost of
other programs can often be substantial. For example, anything that
changes the CPI has a relatively large impact on outlays for indexed
entitlement programs and personal income tax revenues.
Apparently, there are discussions about adding statements to the
text of cost and revenue estimates where there might be an important
effect on macro variables. These would be separate from official
numerical estimates. Probably it will be practically necessary to
confine the discussion most of the time to qualitative rather than
quantitative statements. Nevertheless, such statements may be helpful
to the Congress. Although I bemoan the recent ineffectiveness of the
Budget Enforcement Act, it must be admitted that pay-as-you-go rules
created a tyranny of numbers that did not allow the Congress to apply
much judgment in assessing the value of tax and entitlement measures.
Now the Congress has more room to decide whether a provision is better
or worse than the partially static, numerical estimates imply.
If CBO and JCT start making judgments about macro variables that
would supplement official cost and revenue estimates, they will have
one more activity that will make people angry. They will have to make
some very unpopular statements. For example, good analysis will
counter-intuitively show that there are some tax cuts that decrease
growth, and some tax increases that increase growth. I am happy that I
will not be answering phone calls from Members after such judgments are
Mr. Sununu. Mr. Hassett.
STATEMENT OF KEVIN A. HASSETT, PH.D., RESIDENT SCHOLAR,
AMERICAN ENTERPRISE INSTITUTE
Mr. Hassett. Thank you very much. It is a great privilege
to have the opportunity to appear before you today, and I come
today to provide thoughts on the key considerations associated
with accounting for all of the dynamic effects with scoring,
spending and tax proposals. And I have submitted testimony that
is a good deal longer than what I am about to say, so I
encourage you to go there if you have questions about things I
have left out.
For the majority of proposals, current procedures are quite
sound. Most new policies are small enough that they would not
plausibly have a large impact on the economy as a whole.
However, for some policies, a static procedure clearly provides
an inaccurate picture.
The recent debate over the stimulus package provides an
interesting case in point. The measures adopted were in part
designed to help the economy recover from recession. The cost
of the policies, however, was conditioned on the assumption
that there would be no effect on the economy. If such an
assumption were reasonable, then the stimulus package would be
a bad idea. Static scoring methods may bias policy makers away
from measures that reduce taxes by making the revenue loss
associated with reductions appear too high, and this is an
argument we have heard often in town.
I think, to think about this question, we need to
understand better perhaps the uses of scoring. Scoring of a
proposal has two objectives. The first is to provide policy
makers with a prospective on the likely impact of any proposal.
The second is to provide policy makers with hard budget numbers
that can be used when constructing prudent rules to constrain
irresponsible spending or excessive tax reductions.
It is worth mentioning that these two objections are often
in conflict. There is a small body of evidence, for example,
that positive surprises to government revenue may lead to
higher government spending. If Congress were to rely upon a
dynamic score for a tax bill and that score allowed for GDP
and, therefore, tax revenue to be higher, then one might
predict that government spending in the current year would be
less constrained by a dynamic score than it would be by a
Another conflict between the two objectives strikes at the
core of the responsibility of this committee. A budget rule
requires the choice of some number, but in order to think
rationally about the likely impact of a tax policy, one would
like to be presented with a broad range of estimates, each
accompanied by a careful explanation of the sources of
disagreement between it and the other estimates. One would then
apply one's own judgment when deciding the proper course of
action, perhaps after consultation with a disinterested
professional expert--from the CBO, perhaps.
Such a procedure is commonly relied upon by the Federal
Reserve when evaluating the impact of both monetary and fiscal
policy. I used to do it myself when I was there. Professional
staffers provide board members with careful and neutral
analysis, often even presenting them with more than one
estimate--perhaps almost always presenting them with more than
one estimate. The members ultimately decide for themselves how
You know, this is worth repeating. The Fed's models are
subject to the same uncertainties as the CBO's, but they are
constantly used to influence policy. And why are the Fed's
procedures so reasonable and those that we currently use to
evaluate tax policies so unreasonable? I think it is most
likely because the Fed is more insulated from political
pressures, and they are not trying to make one number do too
Mr. Penner, in his testimony, talked about the problems
with dynamic scoring, how if one person changes something, then
everybody else has to change. But I can tell you that for every
green book forecast that the Fed does, that is exactly the
process that people go through, and they keep going until they
converge and nobody has to change anymore; and so it is not to
complex you can't do it.
So it is easy to see, given these conflicting forces, how
we could arrive at a place where we use a flawed system; but
the flawed system has real consequences, and it must be
Now, some observers will certainly argue that static
scoring leads to a world with too few tax reductions, and
others will argue that static scoring leads to a world with too
little government spending. If the negative long-run growth
effects of government spending we accounted for, it might even
be argued that static scoring leads to too much government
All of these arguments, however, miss the important
distortion caused--or the most important distortion caused by
our current system. Because economic analysis is not used to
demonstrate the benefits of tax and spending proposals, there
is virtually no force present disciplining policy makers to
adopt economically sound proposals; we see the unfortunate
results of this quite often.
Economists are, I believe, unanimous in the view that a
well-designed tax system will have as broad a base and as low a
marginal rate as possible, given a set of revenue and social
welfare objectives. They believe this because such a system has
important, positive economic effects. A tax reform like the
1986 Tax Reform Act, that moves us toward the economic ideal,
will have positive, long-run growth effects. Alternatively, a
proposal that narrows the tax base and raises marginal tax
rates, something that is accomplished by many tax credit
programs like the ones in the current energy bills, might well
have negative dynamic effects.
If decision makers relied upon accurate scores of the two
types of proposals, then it would be much harder than it is
today to make their own choice, and a prudent tax policy would
have a much higher chance of gaining bipartisan support.
So I have a few recommendations, and these considerations
suggest, I believe, a number of positive steps that could be
taken. And my first recommendation is that Congress, as a
whole, take a cue from the Federal Reserve and rely more
heavily on its professional staff. When the literature provides
differing opinions as to the efficacy of a certain policy,
there is no substitute for a disinterested, professional
observer who can serve as a referee. The CBO already serves
this function, updating its forecasts--for example, after the
President's tax proposal became law last year, and providing a
dynamic score of its effects after the debate was over.
Congress could immediately begin a process whereby dynamic
scores of new proposals are requested in a timely fashion so
that they can impact the political debate. While the CBO is
certainly not perfect, the able men and women in the agency
would certainly respond to criticisms of their approaches over
time to the extent that the criticisms contained academic
merit. Any move in this direction, by the way, should include a
request that the CBO's methods be more transparent than they
Congress should also recognize--and this is more relevant
for this committee--that revenue estimates currently serve two
purposes, and that this double duty is not necessary or
advisable. The optimal procedure for information revelation may
be quite different from the optimal procedure for establishing
budget rules. Absent budget rules, however, the imprecise
scoring mechanism may have more influence than it should.
One could think of any number of reasonable rules, for
example, that would constrain the growth of government spending
without relying explicitly on real-time revenue forecasts of
the tax cut of the day. If, for example, spending growth
targets were set on an ex anti basis, then spending would be
far less likely to respond positively to positive revenues.
When setting these limits, this committee would have to
debate the optimal level of government spending and adjust
estimates of this level over time in response to new
circumstances. For example, a reconsideration of the spending
caps might be mandatory if a deficit larger than some agreed
upon size emerged. Such careful monitoring creates the
conditions wherein reliance upon dynamic scoring for decision
making is quite feasible and would likely be an important part
of any optimal budget system.
Thank you very much.
Mr. Sununu. Thank you very much, Mr. Hassett.
[The prepared statement of Kevin Hassett follows:]
Prepared Statement of Kevin A. Hassett, Resident Scholar, the American
Mr. Chairman and members of the committee, it is a great privilege
to have the opportunity to appear before you today. I am an economist
who works at the Washington-based think tank, the American Enterprise
Institute. I have spent a good deal of my research time since I
completed my dissertation studying the effects of taxation on the
economy. I come to you today to provide thoughts on the key
considerations associated with accounting for all of the dynamic
effects when scoring spending and tax proposals.
When the Joint Committee on Taxation (JCT) and the Congressional
Budget Office (CBO) provide estimates to Congress of the revenue impact
of a tax package, behavioral effects are only partially accounted for.
Policy changes are not scored as having an impact on the total level of
aggregate activity, a key cornerstone of the budget projection. Policy
changes are scored, however, as having an effect on the composition of
that activity. For example, if Congress were to consider a bill that
provided a tax credit for a particular type of equipment, then the JCT
might assume that firms would employ more of that type of equipment and
less of a type that does not qualify when calculating the cost of the
proposal. Total investment spending in the economy, however, would be
left unchanged by the policy.
For the majority of proposals, such a procedure is quite sound.
Most new policies are small enough that they would not plausibly have a
large impact on the economy as a whole. However, for some policies,
this procedure clearly provides an inaccurate picture. The recent
debate over the stimulus package provides an interesting case in point.
The measures adopted were, in part, designed to help the economy
recover from recession. The cost of the policies, however, was
conditioned on the assumption that there would be no effect on the
economy. If such an assumption were reasonable, then the stimulus
package would be a bad idea. When designing policy, policymakers must
keep a careful eye on their cost. Presumably, the stimulus package was
the size that it was because of the fear that the budgetary
implications of larger measures might be negative. If a more realistic
scoring approach had been adopted, the stimulus bill might well have
Opponents of dynamic scoring most often argue that there is too
much uncertainty concerning the effects of economic policies for one to
expect revenue estimates to be reliable enough to make there use
advisable. They sometimes also argue that political pressure might be
used to influence the scorers. Others note, however, that this aversion
to seeking the truth is accompanied by a cost. Static scoring methods
may bias policymakers away from measures that reduce taxes, by making
the revenue loss associated with reductions appear too high.\1\ Because
of this, an increasing amount of attention has been paid to the
question of dynamic scoring, and a significant amount of progress has
been made by those investigating these issues.
the uses of scoring
Scoring of a proposal has two objectives. The first is to provide
policymakers with a perspective on the likely impact of any proposal.
The second is to provide policymakers with hard budget numbers that can
be used when constructing prudent rules to constrain irresponsible
spending or excessive tax reductions. As you know, rules that
effectively require special overriding actions have often constrained
Congress's ability to adopt policies that have significant negative
effects on the budget balance.
It is worth mentioning that these two objectives are often in
conflict. There is a small body of evidence, for example, that positive
surprises to government revenue may lead to higher government
spending.\2\ If Congress were to rely upon a dynamic score for a tax
bill, and that score allowed for GDP and therefore tax revenue to be
higher, then one might predict that government spending in the current
year would be less constrained by a dynamic score than it would be by a
Another conflict between the two objectives strikes at the core of
the responsibility of this committee. In order to think rationally
about the likely impact of a tax policy, one would like to be presented
with a broad range of estimates, each accompanied by a careful
explanation of the sources of disagreement between it and the other
estimates. One would then apply one's own judgment when deciding the
proper course of action, perhaps after consultation with a
disinterested professional expert (from the CBO perhaps). Such a
procedure is commonly relied upon by the Federal Reserve when
evaluating the impact of both monetary and fiscal policy. Professional
staffers provide Board members with careful and neutral analysis, often
even presenting them with more than one estimate. The members
ultimately decide for themselves how to vote. This is worth repeating.
The Fed's models are subject to the same uncertainties as the CBO's,
but they are constantly used to influence policy. Why are the Fed's
procedures so reasonable and those used to evaluate tax policy so
unreasonable? Most likely because the Fed is more insulated from
political pressures, and these make the issue much more complicated.
In the political process, the opposing sides may decide to agree to
the use of a specific number for the purposes of debate. Often, the
competition for the title of ``best estimate'' is extremely tight, and
the choice of a single number by the professional adviser is an
unpleasant task. Again, any accurate statement about the likely impact
of major policy changes will provide a diversity of opinion. If we are
going to adopt budget rules that rely on one number, which should we
chose? There are significant costs and benefits associated with any
number-picking strategy. In particular, the choice of best strategy for
the purposes of constructing a budget rule appears to have a strong
impact on the perceptions of policymakers concerning the likely impact
of the policy. Opponents of President Bush's tax proposal last year,
for example, often spoke as if the static score of that bill were an
unambiguous fact established by the JCT. That is, the choice of a
specific number for revenue estimating purposes necessarily imbues that
number with too much credibility.
One additional point is worth making. Supporters of tax reforms
have often been the strongest advocates of dynamic scoring, but one
should note that the issue of dynamic scoring is not necessarily
limited to tax reduction scenarios. The economic literature implies
that higher government spending can increase short-run economic growth,
while providing a long-run drag on the economy. If one has a short
enough time horizon, it is easy to envision scenarios where the dynamic
positive feedback from higher spending would be scored to be quite
significant. Again, this suggests that there is a conflict between the
two objectives. An accurate picture of the effect of spending policies
would likely relax constraints on government spending that are
associated with revenue estimates. One could even imagine short-run
spending binges occurring because of dynamic scoring, whereby higher
government spending increases estimated GDP and revenue, thereby
leading to a further increase in government spending.
effects of a flawed system
It is easy to see, given these conflicting forces, how we could
arrive at a place where we use a flawed system, even before
consideration of the role of uncertainty. The estimates are used for
several purposes that are often in conflict. But the flawed system has
real consequences, and it must be improved.
Some observers will certainly argue that static scoring leads to a
world with too few tax reductions. Others will argue that static
scoring leads to a world with too little government spending. If the
negative long run growth effects of government spending were accounted
for, it might even be argued that static scoring leads to too much
government spending. All of these arguments, however, miss the most
important distortion caused by our current system. Because economic
analysis is not used to demonstrate the benefits of tax (and perhaps
spending) proposals, there is virtually no force present disciplining
policy makers to adopt economically sound proposals. We see the
unfortunate results of this quite often.
Economists are, I believe, unanimous in the view that a well-
designed tax system will have as broad a base and as low a marginal
rate as possible, given a set of revenue and social welfare objectives.
They believe this because such a system has important positive economic
effects. A tax reform like the 1986 Tax Reform Act, that moves us
toward the economic ideal will have positive long-run growth effects.
Alternatively, a proposal that narrows the tax base and raises marginal
tax rates--something accomplished by the many tax credit programs--
might well have negative dynamic effects. If decision-makers relied
upon accurate scores of the two types of proposals, then it would be
much harder than it is today to make the wrong choice, and a prudent
tax policy would have a much higher chance of gaining bipartisan
the role of uncertainty
There is a great deal of uncertainty among economists concerning
the likely impact of any specific tax proposal on the economy.
Consider, for example, the 1997 JCT Tax Symposium, where many of the
economics profession's most distinguished modelers calculated the
economic effects of a switch to a consumption tax. Estimates of the
impact of such a change on real GDP in 2010 ranged from a low of 1
percent higher GDP to a high of 16.9 percent higher GDP. The mean
estimate of the impact of such a change was 5 percent, and the mean
excluding the highest estimate was 2.1 percent. Obviously, the work of
these scholars defines a fairly wide range of possibilities. Some argue
that uncertainty concerning these estimates is too large for them to be
useful. However, if Congress were to consider the adoption of a
consumption tax, the current system would require the policy to be
scored using an estimate (zero) that is outside of the range of
estimates of our best models, effectively substituting an answer we are
confident is wrong for our best guess.
When might such caution be sensible? Economists who have studied
the impact of uncertainty on optimal decision making have found that it
is also important to track the effect that errors might have in each
direction. If an error in one direction can lead to an extreme negative
consequence, for example, then it will be optimal to be very cautious
and err in the other direction. Such effects are largest in economic
models that do not allow agents to change their behavior over time. If
policy decisions today were irreversible, then it might be optimal for
us to rely upon extremely conservative revenue projections when setting
future spending, especially if it is believed that negative
consequences result from high deficits. As it is, however, policy
changes every year, and a misstep today can easily be reversed in the
future. In such a circumstance, Congress should optimally consider
policies that maximize our expected welfare, and not be as excessively
risk averse as it is under the current system. This reasoning also
suggests that attempts to commit future Congresses to specific policy
paths fundamentally alter the problem, and create a world where it is
more likely to be optimal to be extremely risk averse and rely on
These considerations suggest a number of positive steps. My first
recommendation is that Congress take a cue from the Federal Reserve and
rely more heavily on its professional staff. When a literature provides
differing opinions as to the efficacy of a certain policy, there is no
substitute for a disinterested professional observer who can serve as a
referee. The CBO already serves this function, updating its forecast,
for example, after the President's tax proposal became law last year,
and providing a dynamic score of its effects. Congress could
immediately begin a process whereby dynamic scores of new proposals are
requested in a timely enough fashion that they could have an impact on
the political debate. While the CBO is certainly not perfect, the able
men and women of the agency would certainly respond to criticisms of
their approaches over time to the extent that the criticisms contained
academic merit. Any move in this direction, by the way, should include
a request that the CBO's methods be more transparent than they
Congress might alternatively consider setting up an independent
body for fiscal policy evaluation, modeled after the Federal Reserve's
staff. Such a measure may significantly reduce the chance that
political influence could have an impact on the analysis of the
economic staff, and might also restrain the tendency for the economic
analysis to be tied to unrealistic projections of future policies, as
is now sometimes the case.
Congress should also recognize that revenue estimates currently
serve two purposes and that such double duty is not necessary or
advisable. The optimal procedure for information revelation may be
quite different from the optimal procedure for establishing budget
rules. Absent budget rules, however, the imprecise scoring mechanism
may have more influence than it should. One could think of any number
of reasonable rules, for example, that would constrain the growth of
government spending without relying explicitly in real time on revenue
forecasts. If, for example, spending growth targets were set on an ex
ante basis, then spending would be far less likely to respond
positively to a positive revenues. When setting these limits, this
committee would have to debate the optimal level of government
spending, and adjust estimates of this level over time in response to
new circumstances. For example, a reconsideration of the spending caps
might be mandatory if a deficit larger than some agreed upon size
emerged. Such careful monitoring creates the conditions wherein
reliance upon dynamic scoring is quite feasible, and would likely be an
important part of any optimal budget system.
1. From this perspective, the partial dynamic scoring methods used
may be more biased than a strict static score. For example, an
Investment Tax Credit for a type of equipment would have a higher cost
after the Joint Tax Committee accounted for substitution into that type
of equipment than would be implied by a static score.
2. Von Furstenberg, Green, and Jeong (Review of Economics and
Statistics, 1986) use U.S. Federal budget data from 1954-82 to explore
the relationship of causality between tax revenues and expenditures.
They find that spending does not respond to changes in taxes but that
higher spending leads to higher taxes in the future. Anderson, Wallace,
and Warner (Southern Economic Journal, 1986) use U.S. Federal budget
data from 1946-83, and also conclude that spending causes taxes. In
contrast, Manage and Marlow (Southern Economic Journal, 1986) use U.S.
data from 1929-82 and find that the evidence supports the taxes lead to
spending hypothesis. Ram (Southern Economic Journal, 1988) uses both
annual data from 1929-83 and quarterly data from 1947-83, and concludes
that causality runs from revenue to expenditure. Calomiris and Hassett
(National Tax Journal, 2002) found that revisions to CBO budget
forecasts had a significant effect on subsequent spending decisions.
Mr. Sununu. Welcome, Mr. Gale. I was caught off guard when
I came in, to see you sitting on my right; but I am pleased to
have you here, and I look forward to your testimony.
STATEMENT OF WILLIAM G. GALE, PH.D., SENIOR FELLOW, THE
Mr. Gale. Thank you very much, Mr. Chairman, Mr. Spratt. It
is a pleasure to be here. I would like to take my comments in
reverse order of my written testimony, having heard Dr. Penner
and Dr. Hassett speak.
Let me start by saying that I agree with everything that
Rudy Penner said about CBO: the professionalism, the quality. I
think they do a tremendous job under sometimes very difficult
circumstances. And I also want to echo Kevin Hassett's comment
that the more authority, the more responsibility that is placed
with CBO or with the independent experts, I think the better
the outcome will be. You may not always like the budget
message, but it would be a mistake to blame the messenger for
I want to talk about three things. One is whether the
budget horizon should be shortened to 5 years. Second is a
variety of issues on scoring. And the third, which I think is
the most important, but I will save for last, is that, to me,
the real budget problem is the way we do the baseline, not the
On the budget horizon issue, I think it would be a huge
mistake to shorten the horizon to 5 years, and think that for
One is that in the past year, it is actually the 1 and 5
year forecasts that have jumped all around, much more than the
10-year forecast has, and the 10-year forecast, to the extent
that it did jump, jumped for legislative reasons, whereas the 1
and 5 year jumped mainly for economic and technical reasons. So
if uncertainty in the forecast is the criteria, that would
militate against using the 1 and 5-year forecasts based on
recent evidence and in favor of the 10-year forecasts. I am not
arguing that; I am just saying that the uncertainty in the 10-
year forecast is not a good reason to move away from the 10-
The second reason not shorten the horizon to 5 years is
that there are events beyond 10 years that we know that we need
to pay attention to. Social Security and Medicare are two of
them. To argue that forecasts are just too uncertain suggests
we could just simply ignore those issues now. I don't think
anyone takes that view seriously with regard to Social Security
and Medicare; and if you go out far enough, Social Security and
Medicare are almost all of government. So if it matters for
Social Security and Medicare, it matters for the government
budget as a whole.
The third problem with shortening the budget horizon to 5
years is exemplified by the administration's budget this year.
The administration wants to shorten the budget horizon to 5
years, but then they propose several hundred billion dollars of
tax cuts that don't take effect until after the 5-year window
is over. If you consider shortening the budget window, there
needs to be some provision that you simply can't propose tax
cuts that occur after the fact or after the window closes. And
so I think keeping it at a 10-year window is a sounder decision
for that reason.
So for all of these reasons, plus the fact that the Social
Security and Medicare problems and the long-term fiscal
problems that they create are long-term, shortening the budget
horizon is not only a bad idea, it is exactly the wrong way to
go right now.
I think the real issue shouldn't be that the budget
forecasts are uncertain. Everything is uncertain. The real
issue is how Congress uses those forecasts.
For example, families have to forecast their financial
situation 20, 30 years into the future, but no family
responsibly decides now that they are going to spend all of
their future income. And so the issue isn't whether you look
forward. More information has to be better. The issue is how
Congress uses that information. And I would suggest recognizing
that the surpluses are uncertain and adopting a proposal that
Robert Reich suggested last year, which was just to say that as
you go farther and farther out into the outyears, Congress is
only allowed to allot a smaller and smaller proportion of the
surpluses, thereby recognizing that the surpluses are
But I don't see any reason why Congress should throw away
information, especially information that is very useful, given
the current taxing fiscal situation.
Alright, let me move to scoring issues. Everyone would like
to see the cost and benefits of tax and spending proposals
marked down better. I think there are three issues here, in
declining order of importance.
The most important one is interest costs. A proposal that
raises spending or cuts taxes forces the government to raise
interest payments because it increases Federal debt. Those
interest costs are big. If you have a $1-a-year tax cut for the
next 10 years, the interest costs over the next 10 years are 30
percent as large as the actual tax cut. And it is very simple
to add those to the cost of the program; instead of scoring
that as a $10 tax cut, you would score it as costing $13. I
think that would be a huge improvement. It would reward
fiscally sound programs, and I think that that is a very easy,
simple change that would make a big difference.
A second issue on scoring is that the budget rules or the
laws that govern scoring let Congress get away with all sorts
of timing and budget gimmicks, including slow phase-ins, early
phase-outs, shifting revenues from 1 year to the next, not
adjusting the AMT. The tax cut that Congress passed last year
set appallingly low standards in each of these areas, and there
is no need for that.
It would be very simple to fix these by scoring all
temporary provisions as if they were permanent, by scoring all
programs as if they were fully phased in within 3 to 5 years,
and by requiring that tax changes create conforming changes to
the alternative minimum tax, so a tax cut doesn't push millions
of taxpayers on the AMT.
The third issue, and I think the least important with
respect to scoring, is dynamic scoring. Current budget
estimates include the impact of taxes on a variety of
behavioral responses, but not on macroeffects. There is no
doubt that the macroeffects of policies are important
considerations. Everyone I know thinks that policy makers
should consider the macroeffects of tax cuts or spending
changes absolutely essential.
The question is whether these macroeffects should be
crammed into the straitjacket of the budget revenue estimating
procedures; and my view is that the answer is no, essentially
because our methods are not ready for prime time. It would take
a remarkable amount of effort to do, and I think there are two
other reasons to mention. One is that moving to dynamic scoring
would exacerbate the tendency to have temporary programs,
because temporary programs have bigger effects than permanent
programs within the time period. So it would exacerbate an
already troubling budget trend. And the other reason is that a
full dynamic score in most cases just wouldn't make much
My testimony includes estimated dynamic scores of last
year's tax cut and of fundamental tax reform, and shows that
the change in tax rates that you get out of dynamic scores is
basically zero. Maybe you get a half a percentage point. But if
you are going to do a full dynamic score, you want to include
the interest costs, as well as the effect on GDP; and for
example, under almost any reasonable estimate of the economic
growth effect of last year's tax cut, the interest cost effect
alone dominates the increased revenues that you get from higher
So I think it is a low priority to put dynamic scoring in
the formal revenue process, but I certainly believe that we
should consider the growth effects of tax and spending policies
as front and center.
Let me close with just a couple of words on the baseline
budget. I think the single most critical budget problem facing
the Federal Government is that the standard Federal budgeting
methods seriously misrepresent the financial status of the
government. I don't want to be melodramatic about it, but we
have seen in the Enron scandal how private accounting practices
can seriously misrepresent private financial statuses; and the
way the government reports its budget is also highly
My testimony mentions three problems: One is that we
measure retirement programs on a cash flow basis over 10 years
and so omit the long-term costs. Second, we have a built-in
assumption that real discretionary spending will decline 1
percent per year on a per person basis, which strikes me as a
shrinking government as a baseline. Third, we assume all the
temporary tax provisions expire as scheduled, and we assume
that obvious problems, such as the AMT, will not be addressed.
Together, these problems lead to vast understatements of the
likely cost of current policies and vast overstatement of the
funds that are truly available for new programs and tax cuts.
I will refer you to a table and a figure in my testimony
which show that adjusting for these three things changes the
budget outcome by $5 trillion over the next 10 years, and the
figure at the back of my testimony shows that in 2012, the
difference from these three provisions alone is over a trillion
dollars. And the most remarkable thing, I think, about Figure 1
in the testimony is that the official baseline is sort of up
and going up farther over time, whereas the adjusted baseline
falls and actually declines over time.
So I think the baseline is not only off, but it is giving a
very misleading view of what the financial status of the
government is. And, to me, that is a first-order budget
problem. The other scoring issues I mentioned are second order,
dynamic scoring is third order.
Mr. Sununu. Thank you very much, Mr. Gale.
[The prepared statement of William Gale follows:]
Prepared Statement of William G. Gale, Ph.D., Senior Fellow, the
Mr. Chairman and members of the committee, thank you for giving me
the opportunity to discuss issues concerning budget reform. As a long-
time advocate of budget reform, whose proposals in this regard are
usually greeted with the response that ``accounting is boring,'' I am
pleased to see the committee focus on these issues.
The importance of budget reform issues is gaining widespread
recognition. Part of this trend is due to the large gyrations in budget
surpluses over the last several years, and the obvious fact that how
the budget is presented has a significant influence on the policies
that are chosen. In addition, the Enron scandal has shown that standard
private accounting practices may not be the most revealing way to
present the financial status of corporations, which naturally leads to
questions about whether standard Federal accounting practices are the
most appropriate way to examine public finances.
The case for budget reform is simple and straightforward. First,
the methods used currently to estimate the baseline budget seriously
distort the government's true financial status. Likewise, the methods
used to score new programs sometimes distort those costs as well.
Second, some relatively simple changes could resolve many of the
biggest problems. Third, these changes would likely lead to better and
more informed public policies.
My testimony covers several topics, including problems in the
formulation of the budget baseline and the scoring of new programs, the
debate over whether the official budget window should be reduced from
10 years to 5 years, and the role of the Congressional Budget Office.
It concludes with a series of recommendations for budget reform.
I. The Budget Baseline
The single, most critical budget problem currently facing the
Federal Government is that standard Federal budgeting methods seriously
misrepresent the financial status of the government. The CBO budget
baseline is intended to serve as a ``neutral benchmark * * *
constructed according to rules [that are] set forth in law and long-
standing practices and are designed to project Federal revenues and
spending under the assumptions that current laws and policies remain
unchanged'' (CBO 2002, p. xiii). These rules and practices, however,
are not necessarily the most useful or appropriate choices if one
wishes to gauge the government's fiscal condition or to estimate the
funds that might reasonably be considered available to finance tax cuts
or new spending initiatives. Indeed, the official baseline seems
particularly biased now, given the sunsets embodied in EGTRRA (which
artificially increase the revenue figures shown in the official
a. fixing the 10-year baseline
At least three major problems exist within the current 10-year
budget forecasts. First, by measuring cash-flow over a 10-year horizon,
the budget significantly misrepresents the financial status of
retirement programs for Social Security, Medicare and government
pensions. Second, by assuming that real discretionary spending will
remain constant, the budget builds in about a 1 percent annual decline
in per capita current services. Third, by assuming that all temporary
tax provisions expire as scheduled, and by assuming that obvious
problems--such as the AMT--will not be addressed, the budget creates
huge incentives for budget gimmicks. Together, these three problems
lead to vast understatements of the likely cost of current policy
trajectories and vast overstatements of the funds that are truly
available for new programs or tax cuts.
Correcting these three problems leads to massive revisions in the
budget outlook. For example, the official January 2002 CBO baseline
shows a surplus of $2.3 trillion over the 2003-12 period. Adjusting for
the three factors noted above--by removing retirement trust balances,
holding real discretionary spending constant on a per capita basis,
extending the expiring tax provisions and holding the share of AMT
taxpayers constant at 2 percent--creates a deficit exceeding $3
trillion over the same period (Table 1). That is, these three problems
overstate Federal resources by more than $5 trillion over the next
decade alone. Moreover, the difference between the official and
adjusted baselines rises dramatically over time, reaching more than $1
trillion in 2012 alone (Figure 1).
b. using longer time horizons
In several respects, the 10-year horizon itself is a problem. For
example, although the adjusted budget measures in Table 1 and Figure 1
are easily comparable to existing official figures and provide a more
accurate picture of the government's underlying financial status, they
ignore the long-term implications of current fiscal choices. As noted
above, Social Security and Medicare face substantial deficits over the
next 75 years (and beyond). In the context of an aging population and
rapidly rising medical care costs, incorporating the future imbalances
is necessary to obtain an accurate picture of the fiscal status of the
government as a whole. One way to recognize these problems but still
maintain cash-flow accounting is to extend the planning horizon to
include the years when the liabilities come due.
Extending the budget horizon to include the years when the baby
boomers retire and start collecting Social Security and Medicare
benefits presents a much bleaker situation. Under current
circumstances, the fiscal gap over the next 75 years is about 3.3
percent of GDP under the CBO baseline and more than 5 percent of GDP if
the revenue and spending adjustments noted above are made.
c. do the adjustments matter?
While each set of adjustments mentioned above--fixing the 10-year
baseline and looking at longer time horizons--can be justified by
various theoretical arguments, the threshold question is whether these
changes would matter. The answer is a resounding ``yes.'' The
differences between the official budget baseline and the various
adjusted baselines above have sweeping implications for current and
future fiscal policy.
The fundamental result is that the adjusted 10-year measures and
the long-term fiscal gaps imply the need for massive increases in
future taxes or reductions in future spending given the current
trajectory of fiscal policy. These results not only do not appear in
the official baseline, but the baseline shows the budget outlook
improving over time (Figure 1).
Most generally, the alternatives presented above show that tax cuts
are not simply a matter of returning unneeded or unused funds to
taxpayers, but rather a choice to require other, future taxpayers to
cover a substantial long-term deficit that last year's tax cut
significantly exacerbates. Likewise, the notion that the surplus is
``the taxpayers' money'' and should be returned to them omits the
observation that the fiscal gap is ``the taxpayers' debt'' and should
be paid by them. Thus, the issue is not whether taxpayers should have
their tax payments returned, but rather which taxpayers--current or
future--will be required to pay for the liabilities and spending
obligations incurred by current and past taxpayers.
More specifically, a common justification for last year's tax cut
was that it was affordable, since official surpluses were projected to
be so high over the next decade. As noted above, however, the official
figures are (and were) misleading. In fact, last March, I testified
before this committee that although the official surplus was $5.6
trillion over the next decade, the adjusted 10-year budget faced a
surplus of just $1 trillion, and the government was running a
significant long-term fiscal gap even before EGTRRA was implemented
The adjusted budget measures also show that some common claims made
by the administration and by prominent tax cut advocates are mutually
inconsistent. One recent claim was that large current surpluses make
tax cuts affordable now (Bush 2001, Feldstein 2001 and Hassett 2001a).
The second claim is that Social Security faces a significant long-term
deficit (Bush 2001, Feldstein and Samwick 1997, Hassett 2001b). The
problem with making both claims simultaneously is that the ``surplus''
that allegedly made tax cuts affordable existed only because budgeting
procedures ignore the long-term deficit in Social Security and
Another set of inconsistent claims is that making the tax cut
permanent would be a moderate change, but fixing Social Security
requires large infusions of funds. For example, when the House recently
voted on making last year's tax cut permanent, the revenue cost was
scored at under $400 billion over the next decade (JCT 2002). However,
over the next 75 years, extending the tax cut would cost over 1.4
percent of GDP. This is twice the size of the Social Security shortfall
over that period, 0.7 percent of GDP.\4\ The funds that would be used
to finance making the tax cut permanent could cover the entire Social
Security imbalance plus 70 percent of the Medicare trust fund imbalance
through 2075. The magnitude of the savings available from curtailing
the tax cut relative to the Social Security and Medicare shortfalls may
seem surprising. But that is just because tax cut figures are often
presented over 10 years, while the trust fund imbalances are reported
over 75 years, and because the administration has often argued that the
tax cut is moderate while the Social Security shortfall is huge. In
fact, making the tax cut permanent would have substantial long-term
fiscal implications that are completely hidden by the existing budget
II. Scoring of New Programs
A second set of problems concerns how the budget and legislative
process records the costs of new programs. These problems are worth
addressing, but they are much less important than getting the baseline
a. interest costs
Programs that reduce taxes or raise spending increase government
borrowing and hence impose added interest payments on the Federal
budget. Under current procedures, the interest cost is not assessed as
part of the revenue score. Yet the costs can be significant. A program
that gives a $1 tax cut in each year for a decade, for a total tax cut
of $10, will generate interest costs of about $3 in interest payments
over the decade, under current interest rate forecasts. Including the
interest payments raise the cost of this hypothetical program by 30
Including the interest costs in the budget score would be a simple
and accurate way of reflecting the cost of the program. It would also
reward fiscally sound programs. The increase in the surplus that they
provide would reduce interest payments and hence reduce the recorded
(and actual) cost of the program. Note that this effect does not depend
on the effect of the policy on interest rates, just the effect of the
policy on government borrowing requirements.
b. timing and budget gimmicks
Another problem is that current procedures can be exploited to
misrepresent the costs of particular proposals. For example, by using
slow phase-ins, politicians can reduce a proposal's official cost even
though the long-term cost might be huge. For example, a proposal to
leave the estate tax alone for 10 years and abolish it in year 11 would
have significant long-term costs but would cost virtually nothing in
the 10-year budget window.\5\ This budget gimmick is probably so
transparent that it could never happen. But in 2001, the House of
Representatives passed a bill to phase out and then abolish the estate
tax, with a 10-year cost of $185 billion. Abolishing the tax
immediately would have cost $662 billion over the next decade. So the
House went 70 percent of the way toward the budget gimmick noted above.
The key point is that the only reason to design a tax proposal with
those timing features is to hide the true costs. This very fact should
exclude such proposals from consideration.
Other budget gimmicks include proposing tax programs that expire
after short periods of time, shifting revenues from the current year to
the next year (so that the revenues will be ``inside the budget
window''), and not adjusting the alternative minimum tax. The tax cut
enacted last year set new and appallingly low standards in each of
these areas, including the provision that the entire tax cut expires in
2010, and the provision that AMT relief expires in 2004 (thus leading
to the projection that 35 million taxpayers will be on the AMT by
2010).\6\ To be clear, I am not advocating making the full tax cut
permanent, which would be fiscally irresponsible. Rather, my point is
that enacting policies that contain budget gimmicks is bad budget
policy, bad tax policy and bad economic policy.
It would be simple to fix these problems, by not allowing revenue
shifts from the current year into the budget window, by scoring all
temporary provisions as if they were permanent, by requiring all
programs to be fully phased in within a set period, say 3 or 5 years,
and by requiring that tax changes create conforming changes to the AMT
so that regular income tax cuts do not push people onto the AMT.
c. dynamic scoring
A third scoring issue is so-called ``dynamic'' scoring. Current
budget estimates include a the impact of tax changes on a variety of
microeconomic behavioral responses, but do not macroeconomic changes.
Critics argue that this creates a bias against programs that would
raise economic growth. and argue for inclusion of such effects in the
There is no doubt that the effects of policies on the size and
growth rate of the economy are relevant concerns. Just as policy makers
learn important information from both the distributional analysis and
the revenue estimates of tax bills, information on the impact of
proposed legislation on overall economic activity is central to the
evaluation of policy alternatives. Thus, there is no that such analysis
should be, and is, undertaken all the time, and policy makers are well
aware of the macroeconomic implications of proposed laws.
The real question is whether such estimates should be incorporated
into the formal revenue estimates that guide the budget procedures.
Many previous authors have discussed dynamic scoring.\8\ Rather than
review this literature, I will focus on a few main points. In an ideal
world with unlimited resources and perfect knowledge about the relevant
behavioral parameters and structure of the economy, all proposals would
be officially dynamically scored. But in a world of limited resources
(including time between a proposal and a vote) and limited and
controversial knowledge, formally incorporating dynamic scoring into
budget estimates is the least urgent and most difficult change to make
of the items discussed in this testimony.
Dynamic scoring is difficult to perform well for several reasons.
The underlying behavioral responses are uncertain and may vary across
households. The underlying structure of the economy, and any reactions
by the monetary authority or foreign governments are uncertain, but are
critical components of a macro response. Dynamic scoring would have to
be done for all tax and spending programs to be done correctly.
Omitting spending programs would create biases. Likewise, omitting
small programs would create biases: what matters is the macroeconomic
effect relative to the size of the program, not relative to the size of
the economy. The dynamic feedback effect, relative to current method
cost estimates, can be just as important for small programs, even if
the aggregate impact is tiny.
Dynamic scoring is the least urgent of the scoring changes noted
above for two reasons. First, it would actually exacerbate the tendency
to propose temporary programs, since they have bigger effects, within a
given period of time, than permanent ones. Second, a full dynamic score
should include all of the effects of the proposed legislation on the
budget, not just the effect of higher (or lower) GDP. As a result, it
seems unlikely that dynamic scoring would have very large effects, at
least for substantial tax changes. For example, table 2 provides
several rough dynamic scores of last year's tax cut. These score
include the effects on revenues of the change in GDP, and the effects
on Federal interest payments of the increase in government debt and the
increase in interest rates. Even if the tax cut raised GDP by 1 percent
immediately and permanently, the overall dynamic score would be higher
than the JCT score used last year. CBO (2001) estimated that the tax
cut would change GDP by plus or minus 0.5 percent by 2011. Allowing the
maximum effect posited by CBO to phase in slowly over time raises the
dynamic cost even more. Gale and Potter (2002) estimate that EGTRRA
will reduce the size of the economy in 2011 by 0.3 percent, which
creates even a higher dynamic score.
Some have claimed that in certain situations, analysts are certain
that tax changes will raise economic growth and therefore that not
scoring such effects is extremely conservative and biased. Often times,
fundamental tax reform is offered as such a candidate policy. Table 3
shows that if the pure flat tax were dynamically scored, the net effect
would be to reduce the revenue-neutral tax rate by just 0.7 percentage
points. If the flat tax were coupled with transition relief, the
required tax rate is virtually unchanged under the dynamic or the
static score, because the growth effect is so small.
These small effects are consistent with historical evidence on the
lack of impact of taxes on growth (see Gale and Potter 2002 for a more
complete review of the evidence). Historical data show huge shifts in
taxes with no observable shift in growth rates (table 4). Most
strikingly, from 1870 to 1912 the U. S. had no income tax and tax
revenues were just 3 percent of GDP. From 1947 to 2000, the highest
income tax rate averaged 66 percent and revenues were 18 percent of
GDP. Nevertheless, the growth rate of real GDP per capita was identical
in the two periods. In formal tests, Stokey and Rebelo (1995) find no
evidence of a break in growth patterns around World War II. Obviously,
many factors affect economic growth rates, but if taxes were as crucial
to growth as is sometimes claimed, the large and permanent historical
increases in tax burdens and marginal tax rates should appear in growth
statistics. In addition, studies of the impact of previous tax reforms
suggest small effects. For example, Feldstein (1986) and Feldstein and
Elmendorf (1989) find that the 1981 tax cuts had virtually no net
impact on economic growth.
III. The Budget Horizon and the Use of Projected Surpluses
Recent proposals would eliminate the 10-year budget horizon and
replace it with a 5-year window (Penner 2001, OMB 2002). The motivation
for this change is the claim that 10-year budget horizons are too
uncertain to be useful for budgeting. The Bush administration, for
example, notes that ``the 2003 Budget parts ways with Washington's 6
year experiment with 10 year forecasting. Previous budgets' attempts to
look out a decade in the future have varied wildly from year to year.
But 2001 showed finally how unreliable and ultimately futile such
estimates are'' (OMB 2002).
I believe that reducing the budget window to 5 years (indeed,
shortening the window at all) would be a significant mistake, for
several reasons. First, although 10-year budget forecasts are indeed
uncertain, budget estimates over shorter horizons can be even more
uncertain. Table 5 shows that from January 2001 to January 2002, the
10-year surplus (for 2002-11) fell by 71 percent. In contrast, the 5-
year surplus (for 2002-11) fell by 87 percent and the 1-year surplus
(for 2002) fell by more than 100 percent. Moreover, most of the change
in the 1- and 5-year surplus was due to economic and technical changes;
the very uncertainty that the administration is referring to. In
contrast, a minority of the change in the 10-year surplus was economic
and technical changes. Most, instead, was due to legislative changes,
principally the tax cut enacted last year. On an overall basis,
economic uncertainty caused only a 28 percent shift in the 10-year
surplus, but an 80 percent shift in the 1-year forecast and a 44
percent shift in the 5-year forecast. Thus, it is difficult to see why
the 2001 experience should lead one to place more emphasis on the 1-
year or 5-year budget figures. It is also disingenuous for the
administration to claim that the large change in the 10-year surplus
justifies ignoring the 10-year budget window, when its own policies
were the major cause of the change in the 10-year budget surplus.
A second concern is that suggesting that events taking place over
the next 10 years are too uncertain to be used for policy forecasts
implies that one should ignore the looming financing problems in Social
Security and Medicare. But virtually all responsible observers believe
those problems should be addressed sooner rather than later.
Third, at the same time that it proposes shortening the budget
horizon to 5-years, the administration proposes important new proposals
that do not begin to take place until well beyond the 5-year horizon,
as highlighted by the proposal to eliminate the 2010 sunset in EGTRRA.
The administration budget contains a proposed $1.2 trillion reduction
in surplus in the second 5 years of the decade. If the 10-year budget
outlook is so uncertain as to undermine the benefits of presenting 10-
year numbers, it is unclear why it is certain enough to facilitate
policy proposals. Policy makers should link budgeting choices to the
budget horizon, rather than presenting budget figures for one horizon
and then proposing items that have substantial revenue or outlay
implications that take effect outside that horizon.
For all of these reasons, plus the fact that the long-term budget
gap does not reveal itself fully until an extended period of time, it
is hard to imagine a more inappropriate budget ``reform'' than
shortening the budget window.
The real problem is not that budget forecasts are uncertain, but
that Congress feels compelled to allocate every last dollar of the
reported surplus. Families, for example, make financial forecasts of
their future income and spending, but they do not (responsibly) attempt
to spend all future income in the current period. Likewise, Congress
should welcome the longer-run budget estimates as providing useful
information for budget planning, but also enact rules that set aside a
portion of future projected surpluses as a reserve fund, with the share
that is set aside rising as a function of the distance between the
current date and the date of the projected surplus. This is, in
essence, a proposal put forth last year by Robert Reischauer and
discussed further below.
IV. The Role of the Congressional Budget Office
Whatever problems there might be in the budget process, the
performance of the CBO is not one of them. CBO provides remarkably
competent, honest, and timely output in its budget and economic
forecasts. Despite sometimes being subjected to extreme, blatant, and
politically-motivated pressure to change its forecasts or methods, CBO
has been able to maintain a very high degree of professional standards.
Moreover, its professionally-based forecasts are highly respected
precisely because it has been able to withstand such pressure. In
considering budget reform issues and options, it would be a gigantic
mistake to blame the messenger.
Federal budgeting methods do not accurately reflect the financial
status of the government or the costs and benefits of new proposals.
Getting these issues exactly right would prove very difficult, as it
would require highly detailed and technical calculations, a series of
judgment calls, and considerable uncertainty. Nevertheless, a few
simple and understandable rules could address the major problems noted
above and thus provide most of the benefits of an ideal accounting
system accurate measures of the government's fiscal situation and of
the costs and benefits of new programs with few of the costs.
The first change involves the baseline budget calculation. Congress
should remove accumulations in trust funds for Social Security,
Medicare and government pensions from the baseline budget, and commit
not to spend any of these resources on anything other than previously
legislated benefits. The baseline could also provide more realistic and
plausible projections of future policy by adjusting real discretionary
spending for population growth rather than allowing it to fall on a per
person basis, assuming that temporary provisions will be extended and
stipulating that the percentage of tax filers facing the AMT will be
held fixed over time.
The second change would set some of the baseline surplus ``off
limits'' for allocation to new tax and spending programs in case the
underlying tax and spending projections are not realized. Robert
Reischauer, currently the President of the Urban Institute and formerly
the Director of the Congressional Budget Office, has proposed that
Congress should commit only a given percentage of future surpluses to
tax cuts or new spending, with the percentage lower for surpluses
farther in the future (Reischauer 2001). For example, Congress might
commit 80 percent of surpluses projected for the first 2 years of the
10-year budget projection, 70 percent of surpluses in the next two, and
so on, down to 40 percent in the last 2 years. The Reischauer rule
essentially provides a reserve fund. The rule recognizes that budget
projections and economic forecasts are subject to considerable
uncertainty, that uncertainty rises with the time horizon, that new and
unforeseen contingencies will arise, and that policy reversals may
The third change would improve estimates of the costs or benefits
of new tax and spending initiatives to prevent manipulation of the 10-
year budget estimates. Stipulating that all tax or spending programs
must be scored as fully phased in within, say, 5 years would allow some
time for gradual adjustment but would ensure that 10-year costs remain
valid indicators of the long-term effects. Temporary tax or spending
policies should be scored as permanent, and the costs of tax changes
should include the cost of changes in the AMT to ensure that the tax
cut does not raise the number of AMT filers. Finally, including the
interest costs due to higher Federal debt associated with higher
spending or lower taxes would provide a truer measure of the cost of
the plan. Although dynamic scoring has received substantial attention,
it is, in the grand scheme of budget reform, a relatively minor item
that would not affect many proposals and that would prove expensive and
Fourth, although the current budget rules concerning PAYGO
restrictions and discretionary spending caps have many evident defects,
they likely contributed to the successful fiscal discipline in the
1990s. The rules, however, expire at the end of this fiscal year.
Abandoning them without an adequate replacement would be a mistake.
Fifth, the relevance of longer-term budget outcomes could be raised
by having CBO report its long-term forecast at the same time, and in
the same document, as the 10-year forecasts that are produced every
winter in the Economic and Budget Outlook and every summer in the
Other recently discussed rules are less promising. The balanced
budget amendment has received much attention over the past several
years. But if the underlying baseline budget has little economic
significance (as argued above), it is not at all clear why balancing it
is a good idea. The recent proposal to tie tax cuts to a trigger
mechanism, based on the prior year's surplus, is well intended but not
useful. It would create uncertainty and invite budget gimmickry, it
would attempt to determine whether future tax cuts are affordable by
looking at last year's--rather than projected--surpluses, and it would
correct none of the problems noted above.
In concluding, it is useful to distinguish two broad points: the
need for an improved set of budgetary rules, and the desirability of
the particular set of rules motivated and examined above. The need for
changes in the budget rules seems clear. The current cash flow
surpluses mask a much more troubling long-term financial picture.
Current scoring method omit important considerations. And the spending
and PAYGO rules expire shortly. The particular recommendations proposed
above would address many of the major problems in the budget process
with a few simple, plausible rules and would dramatically improve
understanding of the real fiscal status of the government and the real
costs of new tax proposals.
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Mimeo. Presented at the National Tax Association 88th Annual
Conference on Taxation, San Diego, California, October 10,
Office of Management and Budget. Budget of the United States
Government: Fiscal Year 2003. Washington, DC: Government
Printing Office, February 2002.
Penner, Rudolph G. ``Errors in Budget Forecasting.'' Washington, DC:
The Urban Institute, 2001.
Potter, Samara. ``The Budget Process and Alternatives for Reform.''
Brookings Institution Working Paper, April 15, 2000.
Reischauer, Robert D. ``Stop Them Before They Overspend Again.'' New
York Times (February 8, 2001): A31.
Reischauer, Robert D. 2002. ``Framing the Budget Debate for the
Future.'' Testimony before the U.S. Senate Budget Committee.
Washington, DC: January 29, 2002.
Stokey, Nancy L. and Sergio Rebelo. ``Growth Effects of Flat-Rate
Taxes.'' Journal of Political Economy 103 No. 3 (June 1995):
Tyson, Laura D'Andrea. ``Dynamic Scoring: Not Ready for Prime Time.''
Wall Street Journal January 12, 1995.
1. My previous work on budget reform includes Gale (1990, 2001a),
Auerbach and Gale (1999, 2000, and 2001) and Auerbach, Gale and Orszag
2. This section is based on Auerbach, Gale and Orszag (2002).
3. Reischauer (2002) expresses the view that ``Rarely have the
policies underlying the baseline projections been as disconnected from
the policy makers' agendas as they are today.''
4. See Board of Trustees, Federal Old Age and Survivors Insurance
and Disability Insurance Trust Funds (2001, table VI.E5, p. 150) and
Kogan, Greenstein and Orszag (2001). Over an infinite horizon, the
extended tax cut is about the same size as the Social Security
5. The revenue cost in the 10-year window would presumably not be
exactly zero because JCT would allow for changes in gift giving
behavior as households delayed making potentially taxable inter vivos
gifts in order to maximize their soon-to-be untaxed bequests.
6. Friedman, Kogan, and Greenstein (2001) noted that EGTRRA ``* * *
appears to contain more budget gimmicks than any tax bill, and quite
possibly any major piece of legislation, in recent history.'' Crenshaw
(2001) notes that, because of these gimmicks, ``the new tax law doesn't
make planning unnecessary, it just makes it impossible.''
7. This section is based on Potter (2002).
8. See, for example, Aaron (1995), Auerbach (1996), Boskin (1995),
Feldstein (1995), Gravelle (1994), Lyon (1995), and Tyson (1995).
Mr. Sununu. Mr. Spratt, do you have any questions?
Mr. Spratt. Just a few, and I would like to thank you all
for providing, in every case, some valuable ideas and
observations. Every time we deal with this problem, when we try
to come up with solutions, somebody has this platonic notion of
perhaps having a commission of gray beards, distinguished
I think, Mr. Hassett, you would compare them to the Federal
Reserve staff or something like that, who might sit in judgment
on budget estimates and decide rather disinterestedly which
were the right ways to go--OMB, CBO, whatever.
And every time we even give any thought to that, you
recognize that those boards tend to get as politicized as
everything else. And each party, each branch, tries to get its
people on there, tries to get a point of view represented; and
balancing that all out and really getting professional judgment
is a problem.
But one of the things you mentioned was the quality of
economic data that everybody has got to deal with, coming from
BLS and BEA. I believe it was your testimony. It might have
been Rudy Penner's testimony, but would you amplify on that,
because 5 years ago when we were trying to get the CPI problems
ironed out, we went down to BLS and told them, tell us how much
money you need--we are talking small sums of money--to give you
the resources you need to make major decisions that will have
huge impacts on the budget. What is lacking there? What do they
need that they don't have?
Mr. Penner. I think two things, Mr. Spratt.
One, I don't believe they have the money to do the basic
research necessary to keep up with the changing structure of
the economy, which should of course affect the way they collect
Secondly, with minor inclusions of money, I think you could
increase the accuracy of specific types of data.
For example, in the effort to put together the GDP, I think
most of the resources go to estimating the product side of the
accounts, because that is of most interest to business and most
business economists. But the revenue estimator depends on the
income side of the accounts--the wages and salaries, profits
and so forth.
I think, with little extra money, they could put more
resources into that. We have seen huge discrepancies between
the two sides of the account.
Mr. Spratt. So part of this problem of the lag and long
delay in getting an accurate analysis, a definitive analysis of
our revenues, could be cured if we put some more resources into
Mr. Penner. Absolutely, and resources, I think, into the
IRS as well. And I suggest in my complete testimony some
reporting changes that would help a lot.
For example, if corporations recorded specifically the HI
they withheld, it would give revenue estimators a very quick
estimate of total earnings because it is a proportional tax.
But we have to recognize that things like that create a cost on
business, too, but I think most of the things I suggest would
be fairly cheap.
Mr. Spratt. Any other observations from the rest of you
about the quality of data and ways we can improve it,
particularly revenue forecasting?
Mr. Hassett. And can I also respond to the gray beard
Mr. Spratt. Sure.
Mr. Hassett. Rudy would be my choice, but he doesn't have--
but the gray, I guess, I won't comment on. I think the
interesting question is that--would the--if we ask people to
provide an analysis of any policy if we do this, what happens,
I think that public scrutiny would constrain to a great effect,
a great deal what they could do in a political way. And so if
you had a team of economists whose reputation was on the line,
if they are putting out a document that says, ``here is what we
think the profession believes about what happens,'' then if
they have spelled out why they believed that, then if it is
crazy and partisan, then you had better believe you will be
reading about it in the newspaper, and then folks won't listen
to them anymore.
And so I think it would be very easy, and I, as Bill and
Rudy do, have great regard for the CBO staff's ability to get
stuff right. I mean, sure they make mistakes, but I don't see
them as being influenced politically; and, goodness knows,
there are folks who would like to do that.
Mr. Spratt. Well, in dealing with the CPI, we went down to
see Mr. Greenspan and asked him if they would like to be
intermediaries in trying to help us get the Bureau of Labor
Statistics to finish about four or five different studies that
would have adjusted small components of the CPI. And while he
was willing to lend us his resources so that we could
understand the problem better, he really did not want to get
his economic staff involved in policy mediation within the
Federal Government for reasons I guess you can appreciate.
But at that time there was an idea floated, discussed,
about having a commission of distinguished economists which
would sit in judgment on the CPI. They would gather all the
data. They would take all the information that the BLS
generated. They would put it through their models, and then
they would decide exactly what sort of adjustment needed to be
made to bring it down to the most realistic rate of increase in
Fortunately, I think that never happened. Instead, the BLS
went ahead and completed the work, and by the end of last year,
they had effectively adjusted the CPI by a substantial amount.
Mr. Gale. Thank you. There are two issues floating around.
One is the public versus private, and one is the CPI kind of
fix, which is a one-time thing, versus dynamic revenue scores,
which must be an every week, every month type of thing.
I think if you do something like the CPI, which is, you
organize a panel, you do it once. They issue their report like
the Social Security commission. That works for sort of a one-
But for revenue scores, you would be needing to do it every
day, every week; and a panel like that if the Fed staff does
that, they do it privately to the governors. They don't have to
release information. In fact, the Fed is famous for not saying
what it is doing or why. It is all kept in-house.
I think that model works if you are willing to go with
those public information requirements. But if you want a panel
to do dynamic scores or to pronounce on the growth effects of
policies, and they have to defend publicly every judgment that
they make, that is a recipe for failure. I don't think that
Mr. Spratt. Mr. Penner, you commented--somebody used the
phrase, ``the tyranny of numbers,'' I believe it was your
phrase dealing with the PAYGO rule. You go back yourself to the
1980s when we were struggling, trying to get our hands around
And one of the solutions was Gramm-Rudman-Hollings, and the
target on which GRH was focused was a projected deficit. Each
year we were trying to take it down by $36 billion. And we
monkeyed around with that for about 4 or 5 years and finally
figured out that that projection was an economist's construct
and you could get different constructs for the future easily
enough and you could sort of forecast away the deficit. But it
obviously didn't go away; you keep forecasting and rewriting
the Gramm-Rudman budget. And we came to the conclusion in 1990
that we just need simple, hard numbers, a discrete number for
what discretionary spending is going to be, not a projection of
what you have to hit as a summation of all policies, but this
We also said, if you want an increase in the entitlement,
you have got to pay for it one way or another. If you want to
cut taxes, you have got to offset it one way or the other,
either by entitlement cuts or by the taxable revenue increases.
What is your assessment of the 1990s? Don't you think, for
a while at least through the 1990s, those simple rules worked
better than the more complicated effort of trying to hit an
economist's projection of the deficit?
Mr. Penner. Oh, absolutely, Mr. Spratt. The problem with
Gramm-Rudman is that it made the focus of policy the numerical
value of the deficit, and that from year to year is affected
much more by wiggles in the economy and other things than it is
by policy. So the Congress created a very rapidly moving
target, which it was just politically impossible to hit. It
wouldn't have been a problem, except it was enforced so
rigorously with sequestering mechanisms.
So certainly, what was constructed in 1990 was superior.
The Congress created rules that governed its own actions,
things that it controlled, like appropriations and entitlement
law and so forth, instead of trying to control something it
couldn't control in the very short run. So the new rules were a
big improvement in my view. They helped greatly in eliminating
the deficit over the long run.
I was just trying to suggest in my testimony that they also
had some bad effects. They probably made policy making a little
more mechanical than it should have been, but in my view, that
cost was worth it at the time because of the huge deficits. And
we have got to remember, the 1983 deficit would be $600 billion
now, if adjusted for the size of the economy.
With those huge deficits that extended into the 1990s, the
rules were very worthwhile.
And more generally, though, I think there is a tendency to
try and cure every budget problem by promulgating a rule, and
the budget process has gotten complex as a result of that--
frankly, I don't understand it anymore, and I don't think there
are many single human beings who can keep it all straight. So I
do think that a lot of judgment is necessary to supplement
rules like PAYGO or the spending caps or what have you.
Mr. Spratt. Mr. Sununu.
Mr. Sununu. Thank you Mr. Spratt, and I do want to thank
each of our panelists for their time and their testimony. Thank
you very much. We are adjourned.
[Whereupon, at 12:35 p.m., the committee was adjourned.]