What's the Deal with CBO's Scoring?

There's been a lot of wonky discussion about the CBO's scoring methods lately. The other day, Ezra Klein defended the CBO against conservative critics, insisting that the agency's costs estimates represent the "best guess of the town's most rigorous guesser."

Ezra writes:

[B]e very careful with any criticism of CBO that seems to be merited by a particular score rather than a particular methodological difficulty. To put that slightly differently, does anyone think that conservatives would be squawking if CBO had disappointed Democrats by saying the bill would save less money than either the House or Senate incarnations? If not, then keep in mind that this is a political, not technical, dispute. To establish my own credentials on this, here's the post I wrote defending the CBO when liberals were arguing that it was underestimating health-care reform's savings.

I think Ezra is a bit disingenuous when he pretends that he's never engaged in partisan attacks of specific CBO cost estimates. (See here, for example.) But there is a much bigger criticism of Ezra's point, which Greg Mankiw articulates very well here.

By convention, the CBO uses something called "static" budget scoring to determine a bill's impact on the federal budget. This kind of scoring essentially disregards the macroeconomic implications of federal actions.

Here is how former CBO director Douglas Holtz-Eakin explained it:

For every piece of legislation . . . the budgetary impacts are estimated using the same, unchanging baseline projections of overall gross domestic product (GDP) and its aggregate income components. Specifically, the estimates do not include the effects of legislation on the supply of labor or on saving (and hence on overall economic growth); they do not include effects on income that might result from the influence outlays and taxes, say, may have on technological progress; they do not include the increases or decreases in output that are caused by the way subsidies or taxes reallocate resources among various activities; they do not include the effects on national saving and other incentive effects that result from the government’s financing of the budget change; and they do not include the income and employment effects that arise from the impact of fiscal policy on aggregate spending in the economy in a recession.

To steal a premise from Paul Ryan, this means that the CBO's current scoring methods would assume no macroeconomic impact if the federal government increased spending by, say, 50 trillion dollars . . . just as long as that new spending was offset by 50 trillion dollars in tax increases.

The alternative to static scoring is some kind of "dynamic" budget analysis, which would account for macroeconomic feedback effects rather than simply holding baselines GDP estimates constant. This would give us a much more accurate cost estimate for large policy changes.

Under the current assumptions, we're virtually guaranteed to get an faulty score.

Is Ezra Missing the Point?

Ezra Klein is continuing to hurl ad hominem attacks at Joe Lieberman, some of which are reasonable and fair and some of which are absurd and speculative. Regardless of how you feel about Lieberman, I think it's clear that there is something missing from this critique:

[T]ake the public option. Lieberman has cycled through a variety of explanations, none of which made the slightest lick of sense. First, he said the public option would increase the deficit. That's flatly untrue. Not only did CBO say the exact opposite, projecting savings of $25 to more than $100 billion, depending on the construction, but the idea didn't even make conceptual sense -- the cost of health-care reform comes from the subsidies, which apply to private and public insurance equally.

Well, sort of.

Regardless of its construction, the public plan would have probably attracted more people who received federally subsidized care. So, while the subsidies would technically "apply to private and public insurance equally," it's unlikely that they would be allocated equally. The public plan would get an unequal share of the subsidies, but this probably wouldn't be enough to make up for the adverse selection problem.

As Ezra himself explained:

[B]ecause the public option is, well, public, it won't want to do the unpopular things that insurers do to save money, like manage care or aggressively review treatments. It also, presumably, won't try to drive out the sick or the unhealthy. That means the public option will spend more, and could, over time, develop a reputation as a good home for bad health risks, which would mean its average premium will increase because its average member will cost more.

The nightmare scenario, then, is that private insurers cotton onto this and accelerate the process, implicitly or explicitly guiding bad risks to the public option. In theory, the exchanges are risk-adjusted, and the public option will be given more money if it ends up with bad risks, but it's hard to say how that will function in practice.

If this is true, can the "level-playing field" public plan really survive in a competitive exchange without a government backstop? If it can't, will the government attempt bail it out? This would undoubtedly increase the federal deficit.

Moreover, despite what the CBO says, some of the cost-saving provisions in the Senate health care bill are unlikely to actually reduce the deficit because they're not going to be implemented.

Here is what David Brooks wrote in today's NYT:

The bill is not really deficit-neutral. It’s politically inconceivable that Congress will really make all the spending cuts that are there on paper. But the bill won’t explode the deficit, and that’s an accomplishment.

Back in September, CBO director Doug Elmendorf acknowledged this point:

These projections assume that the proposals are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation. For example, the sustainable growth rate (SGR) mechanism governing Medicare’s payments to physicians has frequently been modified (either through legislation or administrative action) to avoid reductions in those payments. The projected savings for the Chairman’s proposal reflect the cumulative impact of a number of specifications that would constrain payment rates for providers of Medicare services. The long-term budgetary impact could be quite different if those provisions were ultimately changed or not fully implemented.

There is fundamental disconnect between the CBO projections and political reality.

Will the Public Plan Cost More?

The CBO projects that the public option will likely have higher premiums than private insurance options.

Ezra Klein explains:

[T]he public plan will pay prices equivalent to those of private insurers and may save a bit of money on administrative efficiencies. But because the public option is, well, public, it won't want to do the unpopular things that insurers do to save money, like manage care or aggressively review treatments. It also, presumably, won't try to drive out the sick or the unhealthy. That means the public option will spend more, and could, over time, develop a reputation as a good home for bad health risks, which would mean its average premium will increase because its average member will cost more. The public option will be a good deal for these relatively sick people, but the presence of sick people will make it look like a bad deal to everyone else, which could in turn make it a bad deal for everyone else.

The nightmare scenario, then, is that private insurers cotton onto this and accelerate the process, implicitly or explicitly guiding bad risks to the public option. In theory, the exchanges are risk-adjusted, and the public option will be given more money if it ends up with bad risks, but it's hard to say how that will function in practice.

This also illuminates one of the more problematic inconsistencies in the health-care debate. Insurers have been blamed for, among other things, doing too much to discriminate against bad health-care risks and refusing to pay for care far too often. They've been blamed, in other words, for saying "no." But they've also been blamed for doing too little to control costs.

But that is how they control costs. We saw this in the late-'90s, when tightly managed care brought cost growth down to the 4 percent range but also triggered a public backlash (it did not, however, appear to hurt health outcomes).

I agree with every word of that.

The PWC Report and the Tax on High-Cost Health Plans

Ezra Klein rips into Megan McArdle for her long-winded defense of the PWC report (pdf) that was comissioned by AHIP, a political advocacy group for the American health insurance industry.

He writes:

McArdle goes to bat for the most indefensible element of the analysis: the decision to avoid estimating the response to the tax on high-cost insurance plans (which is, in fact, the whole point of the tax), and simply pretend that everything will remain unchanged except that a lot of people will pay a large new tax that they don't have to pay. Moreover, she conscripts the Congressional Budget Office to help with the argument: "You might think that everyone is going to structure their benefits to get around this tax," McArdle writes. "But the CBO expects us to collect quite a bit of money from this tax."

Not quite. The Congressional Budget Office projections (which are, in this case, the Joint Committee on Taxation's projections, as the CBO doesn't estimate tax revenues) actually suggest that the bulk of the tax's revenues will come from the response to the tax, not the payment of the tax. As the New York Times reports, the JCT believes that "about $142 billion of the 10-year total of $201 billion to be raised by the [excise tax] would come from increased income and payroll taxes." In other words, the vast majority of the revenues would come because employers would "structure their benefits to get around this tax." Workers would receive more of their compensation in wages and less in health-care benefits, and because wages are taxable and health benefits aren't, tax revenues would go up.

(Megan did, in fact, acknowledge this error prior to Ezra's post.)

There is at least one broader issue with Ezra's point. Common sense tells you that a tax on "Cadillac" health insurance plans will encourage employers to offer cheaper benefits packages. It's ridiculous to argue otherwise, unless you have strong empirical evidence to back up your claim. Pigovian taxes are, after all, designed to alter behavior in exactly this way. So Ezra is clearly right on the merits here.

But, if Ezra is right, isn't this a huge problem for the administration? If workers with good health benefits will likely be forced into cheaper plans, how can the president continually claim that those who like their health insurance can keep what they have?

FactCheck has already called out the president for this canard, but his argument seems particularly disingenuous now that JCT is actually basing its revenue projections on the idea that some employers will offer cheaper benefits packages if the America's Healthy Future Act (pdf) passes.

Don't get me wrong, I'm a big fan of taxing health insurance -- especially Cadillac plans. I think it's good policy, and it's a step away from the employer-based health insurance system. What frustrates me is the president's insistence that we can have our cake and eat it, too.

If we want to control health care costs, we have to discourage overuse of the system. That means pushing people away from big benefits packages, not telling them that they can always keep their current health insurance.

Update: One more point about Ezra's previous post on the PWC report. Ezra apparently takes exception to the authors' assumption of "full cost-shifting of cuts to public programs." This is another way of saying that doctors and hospitals will try to make up for cuts to their reimbursement rates from public programs by increasing their reimbursement rates form private programs.

He writes:

Have you ever heard of that before, in any industry? If Blockbuster decides to cut costs to consumers by negotiating lower payments to movie studios, does Netflix send out a sorrowful e-mail explaining that it will have to increase its membership fee because it now needs to make higher payments to movie studios?

Well, no. But that analogy makes absolutely no sense. The health care industry is different from the movie rental industry -- and pretty much every other industry -- for a number of reasons. (I would again encourage you to listen to the latest episode of This American Life.)

Ezra must know this. Paul Krugman -- whom Ezra once interviewed -- has repeatedly argued that the health care market is like no other market . . . and, in fact, shouldn't be treated as a market at all.

So why is Ezra suddenly trying to pretend that buying health care is in any way equivalent to renting videos? Maybe he's right that cost-shifting won't be a problem, but this comparison is totally spurious.

Update II: Ezra takes a more nuanced position on cost-shifting:

To be clear on my position here, I think there's probably some level of cost-shifting that's between the zero percent that some advocates would like and the 100 percent that the insurance industry suggests. The Lewin Group estimated (pdf) 40 percent, and that sounds reasonable enough to me, though I'd be open to further evidence.

He also makes another rather obvious point:

It's true that a hospital's costs are relatively inelastic on a year-to-year basis, but they're more elastic over time: if they had to adjust to less revenue than they'd like, they'd make certain changes to the way they do business.

Well, yeah. Isn't that, like, the definition of the long-run?