Thursday, August 25, 2011

CBO Report: Beware of Moving Baselines

OK sports fans -- imagine playing baseball with two different sets of baselines determining which hits were fair or foul depending on which umpire was behind the plate. Difficult. Now, if the lines were pretty close together, it would only make a difference in a small number of plays. But what if the lines were very far apart -- it would change everything -- where you would deploy defenders, the types of hitters you recruited, the importance of speedy vs. strong players, etc.

The Congressional Budget Office report on the budget outlook for the next decade shows some of the perils of having competing budget baselines. But the dramatic impacts of these different baselines is masked in this report, because its considers only the next decade. These effects become much more severe in future decades.

The CBO's report shows that if CBO's economic assumptions regarding growth, inflation, and housing prices hold true (a big "if"), then the budget deal cut earlier this month will result in the cumulative debt incurred over the next decade falling from $6.7 to $3.5 trillion, which would leave us with a total debt held by the public at about 61% of GDP, a tick below where it stands now.

But these figures assume that current law stays the same. These laws include huge tax cuts that expire, unrealistic Medicare reimbursement rates for doctors, and that the alternative minimum tax will be applied to an increasing number of middle class taxpayers. Virtually no one believes that these policies will stick over the next decade. So, if you use the more realistic "alternative" baseline, the public debt will reach 82 percent of GDP, the highest it has been since 1948.

Over the long term, the differences are far worse. Consider this table from the Bowles-Simpson Commission: As the chart demonstrates, the costs of continuing these policies, most of which are on the tax side of the equation, explode starting in the next decade. If left unchanged, they will drive the deficit to truly unsustainable levels.

Any discussion about cutting the deficit or cutting the debt has to start with a clear understanding of what baseline is being used.

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