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 Keynesian Stimulus the Best Approach?

Greg Mankiw tackles Keynes, and the Obama administration's fiscal policy:

When devising its fiscal package, the Obama administration relied on conventional economic models based in part on ideas of John Maynard Keynes. Keynesian theory says that government spending is more potent than tax policy for jump-starting a stalled economy.

The report in January put numbers to this conclusion. It says that an extra dollar of government spending raises G.D.P. by $1.57, while a dollar of tax cuts raises G.D.P. by only 99 cents. The implication is that if we are going to increase the budget deficit to promote growth and jobs, it is better to spend more than tax less.

But various recent studies suggest that conventional wisdom is backward.

. . .

Like [a] doctor facing a mysterious illness, economists should remain humble and
open-minded when considering how best to fix an ailing economy. A growing body of evidence suggests that traditional Keynesian nostrums might not
be the best medicine.

I await Paul Krugman's response.

How Do We Gauge the Stimulus?

Greg Mankiw responds to Paul Krugman's self-righteous assault on "conservative economists" who question the veracity of the administration's stimulus numbers.

Mankiw writes:

I do not object to claims such as,

A: "Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus."

But it is absurd to suggest that you can say,

B: "We have measured how many jobs the stimulus has saved or created, and the number is X."

Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is, of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials. A good example is here, where can you "learn" that 110,185.36 jobs have been created or saved in California alone.

Marginal Tax Rates and Health Care Reform

In his latest NYT op-ed, Greg Mankiw argues that the current health care proposals will substantially raise marginal tax rates on middle-income earners. This has a lot to do with how economists (and policy analysts) view taxes, which isn't necessarily the way everyone else views taxes.

For example, Mankiw explains:

A family of four with an income, say, of $54,000 would pay $9,900 for health care. That covers only about half the actual cost. Uncle Sam would pick up the rest.

Now suppose that the same family earns an additional $12,000 by, for example, having the primary earner work overtime or sending a secondary worker into the labor force. In that case, the federal subsidy shrinks, so the family’s cost of health care rises to $12,700.

In other words, $2,800 of the $12,000 of extra income, or 23 percent, would be effectively taxed away by the government’s new health care system.

Will this dramatically damaged economic productivity? I'm not sure, but Mankiw's point should be taken seriously.

Ouch.

Greg Mankiw tears into President Obama for his health care hypocrisy.

I suppose that while the president is apologizing to John McCain for attacking McCain's proposal to tax employer-provided health insurance, he should also apologize to Hillary Clinton for criticizing Clinton's proposal to mandate health coverage . . . .

Health Care Cost Savings and the Baucus Plan

Today, the CBO released its preliminary cost estimate [pdf] of the Senate Finance Committee's health care proposal.

The new bill -- which would mandate coverage, but drop the public option -- is expected to reduce the federal deficit by about $49 billion over the next 10 years. This seems like great news. However, CBO Director Doug Elmendorf notes:

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. (If those changes arose from future legislation, CBO would estimate their costs when that legislation was being considered by the Congress.)

This is, of course, the same objection that Megan McArdle has made. Greg Mankiw tries to put it into layman's terms:

[T]he plan would reduce the deficit if it were carried out as written, but there is good reason based on historical experience to be skeptical that it would be.

Let me try to put CBO's point in a more familiar setting: Your friend Joe, who says he want to lose weight, asks you for an extra slice of pie after dinner. Naturally, you are doubtful about the wisdom of the request. "Ahem, Joe," you whisper, "Aren't there a lot of calories in that?"

"Yes," he says, "but the pie is part of a larger plan. I am committed not only to eating that slice of pie but also to going to the gym every day for the next week and spending at least half a hour on the treadmill. That exercise will more than work off those extra calories."

"But that's what you said last week, when you asked for piece of cake. And you didn't end up going to the gym."

"Yes, I know" he replies ruefully, "but this time I really mean it . . . . Can you please pass the pie?"

I think this is pretty on-target. Heart-wrenching stories like this not only prevent lawmakers from following through with proposed cost-cutting plans, but often force them to expand benefits and increase funding to health care entitlement programs.

Update: Time Magazine offers this primer on the Baucus health bill.