One of the abiding strengths of America has been its focus on the future and what tomorrow will bring. It has brought us an optimism and outlook on life that few in foreign lands can fathom.
Optimism about what’s ahead strengthens our wish to know more about the future and drives our interest in predictions of it, despite the uncertainties of that process.
Some forecasting is absolutely necessary. A business has to predict next month’s or next year’s sales in order to estimate costs, labor hours and cash needs. A government needs a forecast of population growth in order to provide the public schools, fire protection and law enforcement that will be required.
A budget is inherently a forecast. It is a financial portrait of some future time and it is shaped by three major elements: accounting, finance and economics. In business, for example, the budget process usually begins with a sales and revenue forecast placed in the context of an economic forecast and vetted by the ability to finance its implied capital and cash flow requirements.
All forecasts, no matter how simple, rely on an assumed model of the past and future.
In one of the basic, first-cut budget processes, for example, a business owner might want to see what the financial statement would look like if sales increased, say, 5 percent next year. In its simplest form, this assumes that next year will be just like this one; that the increased sales volume increase won’t change any of the internal relationships in the company, and that the firm’s competitors will not respond in any way. These might be perfectly reasonable assumptions, depending on the circumstances, but they are assumptions nonetheless, and taken together they form an economic model.
The federal government spent just over $3.5 trillion in 2014 and will probably spend between 7 and 8 percent more in 2015. This is a huge budget, and its massive size means that its assumptions cannot be as simple as a small company’s. Government spending won’t just hire people and buy things; it will affect overall economic output. We cannot spend that amount of money without affecting our economy and that, in turn, will affect government revenue. Until recently, though, there was no economic model used to calculate those effects.
It was the budget’s economic impact and its feedback effects on the budget itself that got the Congress interested in a new type of “best estimate” of the future budget impact of its spending bills. Consequently, it has directed the Congressional Budget Office (CBO) to begin including the economic impact as part of its analysis of proposed legislation. And for reasons not known to ordinary mortals dwelling outside the Washington, D.C. beltway, the process is called, “dynamic scoring.”
Adding economic impact to the budgetary process is not really a new concept. Many large companies in the private sector have been including economic effects in their forecasts. In urban environments sometimes this involves evaluating their economic “footprint.” Even small companies, if they are located in non-urban areas sometimes grow enough to find themselves the largest employer in the community and the company’s direct, indirect and feedback effects of its budget have to be taken into account in order to get an accurate forecast.
For the federal government, however, the process is different because estimating the economic impact of a spending bill requires an assumption about what macroeconomic model is chosen for the calculations.
There is no single macroeconomic model enjoying universal acceptance by economists. And, as importantly, validating a macroeconomic model’s accuracy and applicability to a specific proposed spending bill will be difficult in many cases, and perhaps impossible in some.
Despite the disagreements and the uncertainty about models, the basic idea behind adding an estimate of the full economic impact of proposed spending programs is smart, wise, and overdue. It will not be an easy task for the CBO, though. Besides the known problems with macroeconomic model selection, there will undoubtedly be other problems that we don’t yet know about. Congress should plan on an extended parallel testing procedure – several years’ worth —to get the best out of the new system.
During that period the CBO should provide Congress with parallel calculations for proposed spending bills, showing the traditional budget forecast side-by-side with the dynamic scoring forecast. That would give Congress, analysts, and the public, an opportunity to see which method consistently produced the most accurate and most useful picture for decision-makers.
Parallel testing and user evaluations will silence most of the current critics and could deliver a better budget process. And while it is difficult to be enthused about federal government spending in general, we can be optimistic about improving the budget process.
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