Senate Budget Hearing Preview; Politicization of CBO Means Projections Will Favor Deregulation, Tax Cuts and Entitlement Cuts and Will Disfavor Government Spending on Infrastructure and Education

Politicization of CBO; Implications on Policy, Accuracy of CBO Projections and Analyses

CBO oversight hearing. Today at 10:30 AM the Senate Budget Committee is set to hold a hearing on oversight of the Congressional Budget Office (CBO).  Dr. Keith Hall, Director of the CBO, is the lone scheduled witness.  The hearing represents one of the first opportunities for stakeholders to learn the extent to which Mr. Hall is pushing to alter the economic assumptions that are critical to CBO budget projections and analyses of individual legislative items.

Keith Hall bio suggests politicization of CBO. The appointment of Keith Hall to be Director of the Congressional Budget Office is the most dramatic effort by a Congress to overtly politicize the CBO, an organization that has long been relied upon as being objective and nonpartisan.  The CBO’s work is so important and each economic assumption so critical to the ability to pass any given piece of legislation that one could argue the CBO, given the disagreement over economic assumptions in the economic community, has always made political decisions.

Mr. Hall, however, has a much more politically charged background than previous CBO Directors; he previously worked at the Mercatus Center, a conservative think tank funded in part by the Koch Family foundation, and has made statements (detailed in a recent WSJ article) that support tax cuts, entitlement cuts, and deregulation and that disfavor government spending and an increase in the minimum wage.  The Wall Street Journal, in a 2004 article, described Mercatus: “When it comes to business regulation in Washington, Mercatus… has become the most important think tank you’ve never heard of.”

Further, WSJ explained, “Mercatus’s rise owes much to the oil-and-gas company Koch Industries Inc… a privately owned company in Wichita, Kan., that contributes heavily to Republican causes and candidates.”  The CBO’s willingness to implement “dynamic scoring” in its analyses is also in line with a partisan view that favors tax cuts and deregulation and disfavors government spending.

Key CBO departure further hints at politicization.  Edward Davis, special assistant to the Director at CBO, has announced his intention to leave the CBO following the arrival of the Mr. Hall.  One of the ways in which CBO retains its credibility and its reputation for objectivity is its ability to retain key employees during transitions.   While it is yet unclear why Mr. Hall is leaving, the key departure may add to the mounting criticism of politicization at the CBO.

The importance of the economic projections of the CBO in policymaking and the risks of politicization.  Congressional budget projections by the CBO are critical to the legislating process because of their importance to both Congressional procedure and to the news media, which views the CBO as credible, independent, and objective.  A working paper by Philip Joyce at the Brookings institute explained the influence and importance of the CBO: “The perceived importance of CBO… results in large part from the influential role that CBO plays through its cost estimating (“scoring”) process.

While the most high-profile recent example of this was CBO’s role in the debate over passage of the Affordable Care Act, there are scores of lesser bills in each Congress where CBO analyses have a demonstrable effect on the final structure of legislation.”  The paper also notes “CBO has built its influence and credibility by hiring technically skilled staff” and hypothesized, “CBO will be of limited use to Congress and the nation if it becomes viewed as one more source of partisan noise.”

Mounting Scrutiny of CBO Projections and Initiatives Headed into Politically Charged Transition

Healthcare projections under fire: recent CBO revisions, 2012 Fed study.  In March, the CBO significantly revised its long-term budget projections.  According to the CBO, “For the 2016-2025 period, CBO’s new baseline projections show cumulative deficits that are $431 billion less than the $7.6 trillion that the agency projected in January.  The largest factor underlying that reduction is a downward revision in projected growth in premiums for private health insurance, reflecting the fact that spending by private health insurers on health care and administration rose less in 2013…than in preceding years and by much less than the agencies had expected for 2013.  That change boosts projections of revenues from income and payroll taxes and reduces the estimated net costs of the ACA’s health insurance provisions…”

The recent revisions have been predicted for some time by policymakers at the Fed and by others following the CBO.  In a paper posted February 2, 2012, two Federal Research Board analysts, Glenn Follette and Louise Sheiner, wrote “An Examination of Health-Spending Growth in the United States: Past Trends and Future Prospects,” that made several points that were critical of the CBO’s long-term outlook for healthcare spending.  Yves Smith of the economic blog naked capitalism pointed out four major criticisms of CBO highlighted by the Fed paper in a 2012 blog post.

The first criticism was that CBO projections did not account for a consumer response to rising health costs.  The second criticism was that the CBO model showed faster growth for Medicare and Medicaid than private plans.  The third criticism was that the CBO projections violated their own rule of producing a forecast that assumes no future policy changes—by relying on historical trends for growth, the CBO included an assumption of the continued expansion of government-funded health coverage.  The fourth criticism was that, according to the Fed study, more government coverage to low-income citizens would have “only minor consequences to government finances.”

Scrutiny of fair-value accounting.  Republicans in Congress also continue to push for a shift to fair value accounting.  CBO has shown significant interest in fair value accounting in its decision to use FVA when it comes to its analysis of Fannie Mae and Freddie Mac and its decision to produce fair value estimates for federal credit programs. The effort to switch to FVA is already coming under scrutiny for being an accounting system that doesn’t balance and that, as a result, is not an accurate or reliable lens to be used for policy analysis.

According to a Congressional aide: “Fair value accounting as applied to the government fails the basic test of any accounting system. It doesn’t balance. Accounting to FVA, when the government accounts for a credit program, it must assume that it borrows money at a higher rate than it actually costs. This is to account for a ‘market premium cost’, or what FVA proponents argue is what private investors would be required to pay for that same hypothetical investment. But no one actually pays a market premium cost; rather, the market premium cost is just a fantasy cash flow that don’t exist. But under FVA, the government must discount cash flows not against its actual cost of capital, but against a higher, made-up cost. This means that government credit costs will look much higher than they actually are. What this also means is that when the actual accounting for the loans happens as the loans are paid off, there will be a predictable error rate of that market premium amount. In other words, the government pretends it borrows for more than it does, so in order to balance, loans will somehow come in as more profitable than expected by the exact amount of the cost the government pretended to pay in the first place. FVA when applied to government is just accounting fraud. It’s an accounting system that doesn’t balance.”

Criticism of CBO reliance on loanable funds model.  Perhaps most importantly, CBO’s reliance on an assumption that increasing government debt crowds out investment has increasingly come under fire.  The CBO, in its 2014 long-term budget outlook, includes this section on “Less National Saving and Future Income:”

“Large federal budget deficits over the long term would reduce investment, resulting in lower national income and higher interest rates than would otherwise occur.  Increased government borrowing would cause a larger share of the savings potentially available for investment to be used for purchasing government securities, such as Treasury bonds.  Those purchases would crowd out investment in capital goods—factories and computers, for example—which makes workers more productive.”

This statement by CBO is, effectively, an endorsement of “loanable funds theory,” which, at a minimum, is subject to significant disagreement amongst economist and which some economists claim has been proven to be illogical.  The Mercatus Center has written extensively on the crowding out caused by government deficits and, rather than move to a more cautious approach to discussing the importance of “loanable funds theory,” CBO, under the leadership of Mr. Hall, is likely to push ahead with the view that the theory as one of the most important underlying assumptions in CBO projections.