Garbage In, Garbage Out: Why Real Revenue Will Lag CBO Forecasts

For decades, three fundamental certainties of Uncle Sam’s finances have been that:

1. Tax collections resulting from tax increases are always less than what the Congressional Budget Office (CBO) predicts.
2. Tax collections resulting from across-the-board and investment-related tax cuts always exceed CBO predictions.
3. The annual growth rate of federal spending always exceeds inflation.

Perhaps the excesses of the Obama administration and the rise of the tea party movement will finally do something about Item 3. But for the moment, let’s look at Items 1 and 2. To do that requires a closer look at the CBO.

First, let me be clear that what follows isn’t necessarily a knock on the people who work there. From all appearances, the folks at the agency, which has been particularly beleaguered since Barack Obama took office, do their jobs professionally and effectively. Despite apparent attempts by the administration to put pressure on the CBO and CBO Director Doug Elmendorf — including inappropriately summoning Elmendorf to the White House last summer (he reports to Congress, not the executive branch) — I haven’t seen any indication that CBO has twisted its data, projections, or reports to favor any predetermined conclusion on its own (the key words are “on its own,” which I’ll explain shortly).

But the CBO has three problems. The first is common to any financial forecasting, which is that it’s about as predictable as the weather. There are simply too many variables that are beyond anyone’s control. Assumptions that appear reasonable now often look downright silly in retrospect, but that’s the nature of the beast. Despite this obvious shortcoming, establishment media reporters all too often treat CBO projections — especially the ones containing conclusions that they like — as if they have a special kind of clairvoyance. Katie Couric at CBS News described the CBO’s ObamaCare report released a few days before the legislation’s passage as having a “certified price tag.” That statement by Couric is certifiable.

A second and more serious problem is that politicians are more frequently and brazenly telling CBO what to assume. From what I can tell, as long as these dictated assumptions aren’t completely ridiculous, CBO has to use them. This problem reared its ugly head during the run-up to ObamaCare’s passage in the House, and the extent to which it forced a preordained conclusion is probably unprecedented. Elmendorf & Co. were ordered to use a set of assumptions that led it to “conclude” that Medicare spending growth will trail its historical average by a couple of percentage points. That conclusion runs counter to over four decades of history, and in a 10-year projection probably understated total future costs by hundreds of billions of dollars. CBO qualified its report as much as it could, but it could not change the, ahem, “certified” numbers.

The third problem is that the agency uses what is known as static analysis. This means that it is not allowed to factor in any kind of behavior change by individuals or businesses resulting from new federal legislation. For example, it absurdly assumes that individuals and businesses won’t take any actions that might reduce their reported taxable income next year when federal income tax rates on the highest-earning 5% of the population are slated to go up dramatically.

Many pundits, think-tankers, and others would like to see CBO incorporate dynamic analysis that would factor an estimate of the impact of changed behavior into its work. It’s one thing to predict lower receipts than static analysis would predict; it’s quite another to forecast and defend how much the change would be.

I don’t think it’s possible with any degree of precision, and it would therefore be a mistake to allow CBO to try. While static analysis is far less than perfect, it can at least be calculated, defended, and understood. Any attempt to apply dynamic analysis would very quickly erode CBO’s hard currency of credibility even more quickly than the mandated assumptions problem previously noted.

That said, sensible politicians have every right — in fact, a duty — to explain why CBO’s static numbers won’t work out as predicted, and why. That’s especially true when it comes to federal tax collections. In the current economic environment, which the Wall Street Journal has called “the uncertainty economy,” and what yours truly has been calling the POR (Pelosi-Obama-Reid) economy, tax collections continue to lag, and Obama administration policies and posturing are the reasons why.

In August of last year, CBO predicted that fiscal collections for the year that will end on September 30, 2010, would be $2.264 trillion, an increase of almost $160 billion over fiscal 2009’s total of $2.105 trillion. Reality stubbornly continues to differ. Barring a last-second surprise, the government’s Monthly Treasury Statement for March will show that receipts through six months are actually down from last year by at least $40 billion. Though collections in February and March 2010 came in a bit ahead of 2009, the turnaround is not yet significant enough to be a trend, especially since collections from individuals who pay quarterly estimated taxes continue to trail last year on a monthly basis.

For the same reasons that receipts are staying in the tank, as well as the history lessons in Items 1 and 3 above, ObamaCare’s tax increases will also not produce the amounts the static-analyzing CBO predicts, while higher spending will cause annual deficits to spiral further out of control. You can take it to the bank.

It is an understatement to say that we’re in a world of hurt if ObamaCare isn’t repealed. We’re not heading into a financial ditch; we’re on the edge of a cliff.