The Subcommittee on Legislative & Budget Process

Hearing
on
"Assessing the Accuracy of Federal Budget Estimating"

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TESTIMONY | TRANSCRIPT PART I | TRANSCRIPT PART II

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PART I

 

WITNESSES

 

• David Malpass, Chief Global Economist, Bear, Stearns & Co., Inc.
• Stephen Entin, President, Institute for Research on the Economics of Taxation
• Peter Orszag, Senior Fellow, Brookings Institution

 

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PART II

 

WITNESSES

Panel 1:

 

Panel 2:

 

 

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PURPOSE OF THE HEARING

The purpose of the hearing is to consider the current federal estimating conventions that are used to determine the budgetary impacts of proposed policy changes. The hearing will provide a description of these conventions as currently applied by the Congressional Budget Office (CBO) and the Office of Management and Budget (OMB). Because of the great influence that estimates of revenue and spending changes have over whether a proposal is adopted,¹ these estimating conventions are under great scrutiny. One commonly debated method for improving the accuracy of estimates is to incorporate more macroeconomic (behavioral) effects. While current estimating models take into account a number of behavioral reactions to tax and spending changes, these models are limited in their inclusion of feedback effects. The hearing will provide points for consideration regarding why and what additional feedback effects might be considered for inclusion in estimating conventions, and what policy changes would need to occur in order to include those effects.

This Subcommittee hearing will lay the groundwork for policymakers to further examine whether current estimating methodologies adequately meet their needs, and if not, what changes might be pursued in order to better meet those needs.

 

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BACKGROUND

Under the Congressional Budget Act of 1974, the Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) are to provide estimates of the budgetary effects of all legislative proposals reported by Congressional committees. The Act assigns JCT the responsibility of preparing the estimates of most revenue legislation, and CBO does the estimates of spending proposals. CBO also develops the baseline, which serves as the benchmark for measuring the effects of proposed policy changes – this 10-year baseline is a projection of macroeconomic performance, reflecting anticipated changes in the economy, demographics, and other relevant factors.

The Balanced Budget Act of 1985, as amended by the Budget Enforcement Act (BEA), also assigns important estimating responsibilities to the Office of Management and Budget (OMB) in the executive branch. OMB, in turn, depends on the Department of the Treasury for its revenue estimates and the President’s Council of Economic Advisors (CEA) for the baseline estimate. The BEA also placed dollar limits on discretionary budget authority and outlays and established a pay-as-you-go (PAYGO) requirement, under which changes in legislation affecting revenues and mandatory spending, in total, may not increase the deficit in any year.

Congressional and Executive branch estimators employ the same basic estimating conventions. Those conventions are simple and practical, but not without their limitations. They have served best when changes in policy are small and when concern has been focused on budget totals. Their limitations are most apparent when policymakers are considering substantial changes or when they are interested in identifying the full effects of individual proposals.

Current budget enforcement procedures reflect these basic estimating assumptions. As specified by the budget committees, CBO’s estimates of spending proposals and JCT’s revenue estimates have been consistent with the economic assumptions used in preparing the annual budget resolution. OMB’s PAYGO estimates must use the economic assumptions underlying the President’s budget submission. If the proposals are adopted, that approach produces estimates of total revenues and outlays that correctly reflect the new fiscal policies. But the procedure does not attempt to measure the full incremental cost or savings of an individual proposal that would affect the economic aggregates, such as gross domestic product (GDP) or price level.

The budget estimates are also based on numerous assumptions about the effects of the proposed policies – that is, how those policies might change individual behavior in response to new economic incentives. Although enactment of some proposals might affect the overall economy, the estimates traditionally exclude macroeconomic responses. Some tax or spending bills might affect aggregate demand (total spending in the economy) and, if not offset by changes in monetary policy, restrain or stimulate the economy in the short run. Other proposed legislation could alter the supplies of labor, capital, or technology that determine the potential growth of the economy in the long run. In both cases, use of the economic assumptions underlying the budget resolution or the President’s budget could lead to an over- or underestimate of the budgetary effects of the proposal.

In theory, estimators could incorporate macroeconomic effects into budget estimates, thereby providing more information to the Congress and more comprehensive pay-as-you-go scoring. In practice however, such a change would raise several difficult issues, including the following: (1) results could depend greatly on assumptions about the behavior of the Federal Reserve Board; (2) in situations where little consensus exists on the magnitude of the macroeconomic effects, the estimates would be subject to considerable controversy and uncertainty; (3) macroeconomic effects occurring within the usual 5-year estimating period may not accurately represent the long-term economic gains or losses; and (4) Congress would need to change the Congressional Budget Act and the Balanced Budget Act to make the budget process consistent with the new estimating approach.

Given the PAYGO requirement under the BEA, by not explicitly recognizing certain macroeconomic effects in estimates of the budgetary impact of legislative proposals, some legislation believed to be beneficial to the economy is put at a procedural disadvantage, and some legislation that could hurt the economy has a procedural advantage. The limitation of current estimating practices could be overcome if the macroeconomic consequences of legislative proposals were reflected in the estimate of each bill rather than in the budget resolution’s economic assumptions. However, the Congress would need to consider a number of important questions before changing practices: (1) what types of macroeconomic consequences might be included; (2) how large are these effects likely to be; (3) what degree of consensus exists within the economics profession concerning the macroeconomic effects of various proposals; (4) how many resources would be needed to incorporate these effects; and (5) how would the budget process need to be changed to accommodate this change?²

On January 10, 1995, the House and Senate Committees on the Budget held a Joint Hearing to review Congressional Budget Cost Estimating. That hearing was the last time this issue was seriously addressed. This hearing will continue to explore forecasting issues and the changes, if any, that need to be made to ensure more accurate revenue and expenditure forecasting.

 

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1. Under the budget rules, which were designed to deal with large deficits, revenue-losing legislation (tax cuts) must be offset with spending cuts or other revenue increases.
2. "Budget Estimates: Current Practices and Alternative Approaches," January 1995, Congressional Budget Office.

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