The Center's work on 'Process' Issues


The Risks of Dynamic Scoring

February 26, 2015 at 11:06 am

In a guest TaxVox blog post for the Tax Policy Center’s series on “dynamic scoring,” I discuss some of the risks of a new House rule requiring dynamic scoring for official cost estimates of tax reform and other major legislation.  Under dynamic scoring, those estimates would incorporate estimates of how legislation would affect the size of the U. S. economy and, in turn, federal revenues and spending.

Dynamic estimates vary widely depending on the models and assumptions used.  I conclude that to make sense of those scores, policymakers will need more information about the models and assumptions than the House rule requires:

The House rule allows the House to use any increase in revenue from highly uncertain estimates of macroeconomic growth to pay for other policies. Policymakers will also be tempted to use a favorable dynamic estimate as proof that a policy is good for the economy and therefore should be enacted.  But the uncertainty and gaps in the models may mean that such a simple conclusion isn’t appropriate. Lawmakers will need more information than the House rule requires to assess the reliability of the estimate and to understand a bill’s possible economic effects.

“Generational Accounting” Is Misleading and Uninformative

February 24, 2015 at 9:55 am

The topic of “generational accounting” will likely surface when economist Lawrence Kotlikoff, who helped develop the approach over 20 years ago, testifies at tomorrow’s Senate Budget Committee hearing.  Generational accounting purports to compare the effects of federal budget policies on people born in different years.  But it’s far more likely to obscure than illuminate the budget picture, as we have explained.

Generational accounting calculates “lifetime net tax rates” for each one-year cohort of the population through at least age 90 and a separate lifetime net tax rate for all future generations combined.  Those measures are supposed to reflect each generation’s tax burden, minus the benefits it receives through programs such as Social Security and Medicare, under existing budget policies.

But generational accounting rests on several highly unrealistic assumptions.  Its calculations of lifetime net tax rates assume that there would be no changes whatsoever in current law for taxes or benefit policies for anyone now alive.  It doesn’t account for the benefits that government spending can have for future generations (for example, education and infrastructure spending that raises living standards).  And it ignores the fact that our children and grandchildren will be richer than we are and have more disposable income, even if they pay somewhat higher taxes.

Generational accounting’s most serious flaw may be that it requires projecting such key variables as population growth, labor force participation, earnings, health care costs, and interest rates through infinity.  Budget experts recognize that projections grow very iffy beyond a few decades — and spinning them out to infinity makes them much more so.  The American Academy of Actuaries describes projections into the infinite future as “of limited value to policymakers.”

The Congressional Budget Office, CBPP, and other leading budget analysts focus instead on the next 25 years or so, which amply documents future fiscal pressures and presents a reasonable horizon for policymakers.  These organizations produce simple, straightforward long-run projections that show the path of federal revenues, spending, and debt under current budget policies.  In that way, they show clearly what’s driving fiscal pressures, and when (see chart).

Policymakers should certainly look beyond the standard ten-year horizon of most budget estimates, but they already have the tools to do that. Generational accounting is hard to interpret and easily misunderstood, and including it in the federal government’s regular budget reports and cost estimates would be a mistake.

Setting the Record Straight on Student Loan Costs

February 18, 2015 at 11:05 am

President Obama’s 2016 budget estimates that the outstanding portfolio of federal student loans will be $21.8 billion less profitable than previously thought over the loans’ lifetime.  This reestimate doesn’t mean that the program “had a $21.8 billion shortfall last year,” as a Politico story stated.  Nor does it justify adopting an alternative accounting method (so-called “fair-value accounting”) that would artificially inflate the program’s cost.  The reestimate is, indeed, completely unrelated to the accounting method.

Here, briefly, is what the reestimate does and doesn’t mean.

Lending programs appear in the budget with up-front estimates of the net costs or profits to the government over the loans’ lifetime.  In the case of student loans, the government makes a profit, even after accounting for defaults, which is why student loans are a good deal for both students and the government.  If the government later concludes that its earlier estimates of lifetime costs were too high or low, it reestimates all outstanding loans.  The reestimate is recorded in the year it’s made (in this case, 2015), not in the many past years in which the loans were issued.

The recent $22 billion upward reestimate is the net result of three factors:

  • The President’s decision to permit students who borrowed before 2008 to switch to the Pay-As-You-Earn (PAYE) repayment plan will raise future costs by an estimated $9 billion.  PAYE caps monthly loan payments at 10 percent of borrowers’ incomes and forgives the remaining debt after 20 years of payments.
  • More student borrowers than originally expected are switching to other repayment plans that tie payments to borrowers’ incomes, raising future costs by an estimated $15 billion.
  • Expected defaults are down (that is, more borrowers are expected to repay their loans than previously estimated), lowering future costs by an estimated $2 billion.

This isn’t a “shortfall.”  No cash is missing, nor are the 2015 inflows and outflows of student loans $22 billion lower than initially thought.  Rather, the $22 billion reestimate is a new, and slightly less sanguine, view of the net profits that the government will make over the next few decades on the student loans that are now outstanding.

The reestimate isn’t particularly large in percentage terms, either.  It’s about 2.9 percent of the outstanding portfolio of student loans, which is three-quarters of a trillion dollars.

Also, while Senator Deb Fischer (R-NE) cited the reestimate in introducing a bill requiring the use of “fair-value accounting” for student loans and other credit programs, “fair-value accounting” would make student loan accounting less accurate, not more, and it wouldn’t have avoided these reestimates.

Here’s why.  By law, the government estimates the costs or profits of its loans based on the difference between what the government will pay out in loans (including the cost to the Treasury of financing the loans) and the interest, principal, and associated fees that borrowers will repay over time, accounting for expected defaults.  “Fair-value” proponents say that the budget should reflect the higher financing and other costs that a private lender would incur if it, not the federal government, made the loans.  This approach would record loans as less profitable (or more expensive) to the government than they really are by including costs in the budget that the federal government never has to pay.  For these reasons, we strongly oppose “fair-value accounting,” as we’ve explained here, here, and here.

Importantly, even if the government had been using phantom “fair-value” costs in its initial estimates of student loans, it still would have needed to make the same upward revision in 2015 due to the three factors described above.  “Fair-value accounting” would not have affected that reality in any way.

FAQs on Budget “Reconciliation”

January 22, 2015 at 2:59 pm

Republican leaders plan to use a legislative process called “reconciliation,” which allows for special and speedy congressional consideration of certain tax and spending bills, to advance their fiscal policy agenda in 2015.  In the Senate, members can’t filibuster reconciliation bills, and the scope of amendments they can offer to them is limited, giving this process real advantages for enacting controversial budget and tax measures.  Our new report addresses some frequently asked questions about reconciliation:

  • How Often Have Policymakers Used Reconciliation?
  • What Kinds of Changes Can a Reconciliation Bill Include?
  • How Does Congress Start the Reconciliation Process?
  • What Role Do Committees Play?
  • What Special Role Do the Budget Committees Play?
  • How Many Reconciliation Bills May Congress Consider Each Year?
  • Can the Full House or Senate Amend a Reconciliation Bill?
  • What Happens After Each Chamber Adopts a Reconciliation Bill?
  • What Procedural Advantages Does Reconciliation Have in the Senate?
  • What Procedural Advantages Does Reconciliation Have in the House?
  • Can Reconciliation Be Used to Increase Deficits?
  • What Is the Byrd Rule?
  • What Provisions are “Extraneous” Under the Byrd Rule?
  • How Is the Byrd Rule Enforced?

Click here for the report.

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New House Rule Could Ease Passage of Deficit-Increasing Tax Cuts

January 5, 2015 at 11:02 am

Our new paper analyzes a House Republican plan to amend House rules this week to require the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) to use “dynamic scoring” for official cost estimates of tax reform and other major legislation.   Under dynamic scoring, the official cost estimates would incorporate estimates of how legislation would affect the size of the U. S. economy and, in turn, federal revenues and spending.

Incoming Ways and Means Committee Chairman Paul Ryan has said this change is designed simply to generate more information on the impact of proposed policies.  In reality, however, the House would be asking CBO and JCT for less information, not more, and the new rule could facilitate congressional passage of tax cuts that are revenue-neutral only on paper.

As our paper explains:

CBO and JCT already provide macroeconomic analyses of some proposed bills as a supplement to the official cost estimates they produce.  These analyses typically present a range of estimates of the legislation’s impact on the economy.

The new House rule, in contrast, asks for an official cost estimate that only reflects a single estimate of the bill’s supposed impact on the economy and the resulting revenue impact.  By incorporating additional revenue in the official cost estimate (as a result of an estimate of economic growth), this would enable lawmakers to write bills with deeper tax-rate cuts, or smaller offsetting curbs on tax breaks, than they otherwise could do.

The economic impact of even a well-designed tax reform plan is likely to be modest relative to the size of the U.S. economy.  But the estimates of revenue gains from the plan’s estimated dynamic effects could be large in the context of current fiscal debates.  Those estimates could also be highly dubious, depending on the models and assumptions used.

For example, JCT estimated that the tax reform plan that former Ways and Means Chairman Dave Camp produced last year could generate between $50 billion and $700 billion of additional revenue over the decade through faster economic growth (see chart), with the $700 billion estimate reflecting a series of very rosy assumptions — including the assumption that a future Congress will stabilize the debt as a share of gross domestic product (GDP) by approving large spending cuts that aren’t part of the Camp bill.  If highly optimistic economic and fiscal assumptions like these are included in official cost estimates but then fail to materialize, the result will be higher deficits and debt.  And as CBO, JCT, and other analysts have warned, tax cuts that ultimately expand deficits can slow economic growth, rather than increase it, because the higher deficits can create a drag on saving and investment.

Click here for the full paper.