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[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

 
                  CBO ROLE AND PERFORMANCE: ENHANCING
               ACCURACY, RELIABILITY, AND RESPONSIVENESS
                    IN BUDGET AND ECONOMIC ESTIMATES
=======================================================================

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION
                               __________

              HEARING HELD IN WASHINGTON, DC, MAY 2, 2002
                               __________

                           Serial No. 107-29
                               __________

           Printed for the use of the Committee on the Budget

  Available on the Internet: http://www.access.gpo.gov/congress/house/
                              house04.html

                     U.S. GOVERNMENT PRINTING OFFICE
79-481                       WASHINGTON : 2002
________________________________________________________________________
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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
JOHN E. SUNUNU, New Hampshire        JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
PETER HOEKSTRA, Michigan               Ranking Minority Member
  Vice Chairman                      JIM McDERMOTT, Washington
CHARLES F. BASS, New Hampshire       BENNIE G. THOMPSON, Mississippi
GIL GUTKNECHT, Minnesota             KEN BENTSEN, Texas
VAN HILLEARY, Tennessee              JIM DAVIS, Florida
MAC THORNBERRY, Texas                EVA M. CLAYTON, North Carolina
JIM RYUN, Kansas                     DAVID E. PRICE, North Carolina
MAC COLLINS, Georgia                 GERALD D. KLECZKA, Wisconsin
GARY G. MILLER, California           BOB CLEMENT, Tennessee
PAT TOOMEY, Pennsylvania             JAMES P. MORAN, Virginia
WES WATKINS, Oklahoma                DARLENE HOOLEY, Oregon
DOC HASTINGS, Washington             TAMMY BALDWIN, Wisconsin
JOHN T. DOOLITTLE, California        CAROLYN McCARTHY, New York
ROB PORTMAN, Ohio                    DENNIS MOORE, Kansas
RAY LaHOOD, Illinois                 MICHAEL E. CAPUANO, Massachusetts
KAY GRANGER, Texas                   MICHAEL M. HONDA, California
EDWARD SCHROCK, Virginia             JOSEPH M. HOEFFEL III, 
JOHN CULBERSON, Texas                    Pennsylvania
HENRY E. BROWN, Jr., South Carolina  RUSH D. HOLT, New Jersey
ANDER CRENSHAW, Florida              JIM MATHESON, Utah
ADAM PUTNAM, Florida
MARK KIRK, Illinois
[Vacancy]

                           Professional Staff

                       Rich Meade, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel

                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, May 2, 2002......................     1
Statement of:
    Dan L. Crippen, Director, Congressional Budget Office........     4
    Rudolph G. Penner, Senior Fellow, the Urban Institute........    44
    Kevin A. Hassett, Resident Scholar, American Enterprise 
      Institute..................................................    51
    William G. Gale, Senior Fellow, the Brookings Institution....    57
Prepared statement and additional submission of:
    Mr. Crippen:
        Prepared statement.......................................    12
        Response to Chairman's question concerning resource 
          allocation.............................................    28
    Mr. Penner...................................................    48
    Dr. Hassett..................................................    53
    Dr. Gale.....................................................    60

    CBO ROLE AND PERFORMANCE: ENHANCING ACCURACY, RELIABILITY, AND 
            RESPONSIVENESS IN BUDGET AND ECONOMIC ESTIMATES

                              ----------                              

                         THURSDAY, MAY 2, 2002

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:13 a.m. in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Sununu, Gutknecht, 
Watkins, Brown, Spratt, Price, Moran, and Matheson.
    Chairman Nussle. Good morning. Today we are holding a 
hearing to examine the role and the performance of the 
Congressional Budget Office. In recent years there has been a 
trend in government to develop ways to measure how departments 
and agencies are performing their duties and fulfilling their 
responsibilities and then to directly tie budgeting to that 
process. The idea is to inject some measure of accountability 
into government and to reward departments and agencies based on 
performance.
    CBO, however, has really never been subject to that kind of 
scrutiny from the Budget Committee since its creation as part 
of the 1974 Budget Act. To my understanding, and based on our 
research, there is no real significant oversight of the 
Congressional Budget Office by this committee, and I am not 
sure that even one hearing could accomplish the kind of 
oversight that should be required for one hearing today. We 
really haven't found any record of any genuine CBO oversight by 
the Budget Committee, and we are sure that it has never been 
the regular part of this committee's routine. It is something 
that I was hoping to inject into the schedule of the Budget 
Committee as part of my taking over the committee chairmanship 
last year. In fact, we were going to hold a hearing last fall 
during the calm time of the budget process, after all the work 
was done and the appropriation bills were completed. And, of 
course, everybody's fall changed quite significantly.
    We hope to begin today to exercise that oversight of the 
Congressional Budget Office, and I can promise you that this is 
the first step, not just a last step. In fact, as a follow-up 
to this hearing, I will be sending a survey to House Members 
and in particular committees, committee chairmen, soliciting 
their opinion about the Congressional Budget Office. There is a 
lot of interaction that Congress has with Members and 
committees, leadership, both sides of the aisle, and I think it 
would be good to gain some opinion based on that direct 
committee service, if you will, to give some idea about the 
performance.
    Today's hearing really has several purposes. No. 1, we are 
going to review both the intended role of the Congressional 
Budget Office, and its performance in meeting the emerging 
needs of Congress; No. 2, we will review CBO's plans to improve 
the accuracy of the economic and budgetary projections; and 
finally, we will examine the difference between dynamic scoring 
and CBO's current method that has been referred to by some as 
static scoring.
    We will also look at how the agency maintains, I think, a 
successful record of nonpartisan service to the Congress.
    Today's hearing will help this committee and we hope other 
congressional committees gain a better understanding of exactly 
what the Congressional Budget Office does and how well it does 
it. This is important not only from the performance standpoint, 
but may also help to serve Congress to be more appreciative of 
the difficult job that the Congressional Budget Office has the 
kind of job that they have to do for us. CBO is sometimes 
unfairly used as a lightning rod for criticism because 
committees are often frustrated by their own budgetary and time 
constraints, and this hearing hopefully will get some of that 
out on the table. And certainly this committee is probably not 
immune from that either.
    At any large organization, there are professionals that we 
believe distinguish themselves above and beyond the call of 
duty, and I would like to take a moment to just publicly thank 
the various employees at the Congressional Budget Office. I am 
going to do something unique; I am going to read some names of 
some people that we have observed to go above and beyond the 
call of duty. By doing this, it may suggest to some that some 
aren't doing a good job, and I don't want that to be the case. 
What I have tried to do is put together a list of people that 
we have observed, it is our observation, have really provided 
exemplary service and gone above and beyond the call of duty. 
You do a great job at CBO, even though from time to time you 
are a whipping post. But these are some of the people that I 
have had a chance to work with or my staff has, and I would 
just like to highlight them:
    Peter Fontaine, who works as the Deputy Assistant Director; 
Jennifer Smith, general counsel; Janet--I am going to hopefully 
get this right--Airis, who is in the scorekeeping unit; Edward 
Blau, scorekeeping unit; Sandy Davis, projections unit; Paul 
Cullinan, who is human resources; Sheila Dacey, I believe is 
the name, human resources; Kathy Ruffing, human resources; 
Christi Sadoti, who is also with human resources; Kent 
Christensen, who is Defense/International Relations/Veterans; 
Joseph Whitehill, Defense/International Relations; David 
Weiner, who is a tax analyst; as well as Mark Booth, who is 
also a tax analyst.
    These are folks who we have had an opportunity to work with 
and have really gone above and beyond the call of duty. They 
deserve our appreciation for the work that they do.
    Conversely, there are areas in a large organization that we 
believe could use some improvement, and one example that comes 
immediately to mind that we have heard criticism about not only 
from the Budget Committee, but also from other committees, is 
when we go after health cost estimates. We have observed that 
the unit involving health has had a history of--and again, I am 
just giving you direct from customer surveys--have been accused 
of being discourteous, perennially late with estimates, and 
have to some extent--again from customer service reports--have 
had a poor grasp of how the House operates and how we use some 
of those economic estimates from time to time.
    Again, I don't want to name names. This is an opportunity 
to talk about improvement, and this is one area that has been 
frustrating. This may also be one of the most complicated 
areas, too, which may in part be the answer, but we believe it 
could stand some improvement.
    So we have a full plate today, and I am happy, as always, 
to have the opportunity to hear from our distinguished Director 
of the Congressional Budget Office, Dan Crippen, who is hear to 
testify, and I look forward to your testimony today. We are 
also glad to have Rudolph Penner, who is a senior fellow from 
the Urban Institute; Kevin Hassett, who is from the American 
Enterprise Institute; and William Gale, who is from Brookings. 
These are our panelists for today. We look forward to their 
testimony. I know Members have expressed some interest from 
time to time on many of these topics, and so I hope we will 
begin today by starting to answer some of those questions, get 
some of those issues out on the table. And, as I say, this is 
the first step in what we hope is really a never-ending process 
of providing better communication, oversight and understanding 
between our two entities.
    With that, I turn to John Spratt for any comments.
    Mr. Spratt. Thank you, Mr. Chairman. And quickly so as not 
to delay the hearing, let me simply say that I am glad we are 
having the hearing. I think it is pertinent, because we are 
witnessing right now the slow and, I think, sad demise of the 
budget process. One key element in that process clearly is the 
Congressional Budget Office, and has been here since its 
creation in 1974. There is no doubt now, 28 years after your 
creation, about the relevancy and need for your role. We have 
got to have a budget shop of our own. It has to be honest, 
straightforward, rigorous and politically disinterested.
    And I will say to Dr. Crippen, when he was first appointed, 
I was concerned because he had clear partisan identifications, 
and he has, I think, bent over backwards to work with our side 
and to be fair and is responsive to us as he is to the other 
side, and I very much appreciate that.
    Let me say, Mr. Chairman, that when I first came to 
Washington as a young officer in the Army working for the 
comptroller of the Department of Defense--and that was in 
1969--when I came back to Congress in 1983, the biggest 
difference between Congress then and Congress in 1969-71 was 
the extent to which this Congress has established sort of an 
independence--more dependence, because we had improved our 
staff, committee staff, personal staff and agencies like the 
Congressional Budget Office.
    There was no Congressional Budget Office in 1969-71. 
Consequently, a lot of the work that Congress needed done on 
the budget we had to do for Congress. Repeatedly I can recall 
putting together schedules and documents that I thought, ``why 
don't the appropriators themselves have this information? They 
appropriate all of this money. Why can't they go back and do a 
cost history of the C-5A?'' Nevertheless, I stayed up late 
nights and got that information ready to meet deadlines, but I 
knew all along we had an inside advantage, because we were 
presenting it and could slant it and did in our favor, and the 
Congress was much too dependent on outside sources.
    We need agencies like CBO if we are to be an independent 
branch, and so for that reason, I think this is an important 
hearing.
    I will also say, in those days I think it was just after 
the creation of OMB, and it was still the old Bureau of the 
Budget, and one of the things we had there were a lot of people 
who had been there for a long time, from administration to 
administration. It was not quite as politicized as it is today, 
or at least it didn't appear to be to me. One of the advantages 
you got was that you had people in the old Bureau of the Budget 
who had a long-term perspective. They remembered the cycles in 
the defense budget. They remembered procurement history. They 
learned the lessons of the budget, learned them well, and they 
were the wise men and women of the government at that 
particular point in time.
    And we had CBO with the same kind of expertise that you are 
here on the up cycles, here on the down cycles. You make 
optimistic projections and find out you were wrong and learn 
from experience that you need to temper some of the enthusiasm 
that you may have or feelings you may have now about whatever 
it is, productivity or the state of the economy. You learn from 
experience to do these things, and it is important that we have 
that kind of continuity and long-term perspective in the 
Congressional Budget Office.
    So we are all striving for that. We will never attain what 
we want. We keep striving for it, and I think that is what this 
hearing should be about, how do we do better with what we need 
to do in order to improve the budget process. And I thank you 
both for coming.
    Chairman Nussle. Thank you, Mr. Spratt.
    Director Crippen, welcome again to the Budget Committee, 
and we are pleased to receive your testimony at this time.

  STATEMENT OF DAN L. CRIPPEN, DIRECTOR, CONGRESSIONAL BUDGET 
                             OFFICE

    Mr. Crippen. Thank you, Mr. Chairman. As you said, this 
hearing is not a surprise in the sense that you have long 
stated an interest in doing this. It was tentatively scheduled 
for last fall, so it is long overdue and we are glad to be here 
today to be able to do it.
    I want to apologize a little in advance. Because of the 
breadth of the hearing, I am going to speak a bit longer than I 
normally would. Obviously I will not cover everything that is 
of interest to you and your members, but there are a couple of 
topics that I think are not only timely, but also important to 
the overall process, and I want to address those topics in my 
oral remarks before we begin.
    The two issues that I think are of particular interest 
today to the committee are the accuracy of CBO's forecasts, 
including how we develop our baseline, and the related issue, 
as you mentioned, Mr. Chairman, of dynamic scoring. The written 
testimony that we have submitted is devoted much more to 
dynamic scoring than to the accuracy of our forecasts, because 
much of the material I will reference today on accuracy is 
already in the public domain through various CBO reports.
    Before I begin talking about those two issues, though, I 
would like to put some of the many numbers we will likely 
discuss today in perspective. Over the next 10 years, the U.S. 
economy will produce something in the neighborhood of $140 
trillion of goods and services. The Federal Government will 
collect and spend about $25 trillion during that time, roughly 
20 percent of GDP. So when we discuss a change of say, $1 
trillion in a 10-year estimate, we are discussing less than 1 
percent of what the economy will generate over the next 10 
years, or about 4 percent of the entirety of the Federal Budget 
over those 10 years.
    Put another way, small changes in those very large numbers, 
especially when multiplied over the 10 years, can produce 
seemingly large changes. For example, a change of one-tenth of 
1 percentage point the growth rate of real GDP will alter 
surpluses or deficits by nearly $250 billion over 10 years. 
One-tenth of 1 percentage point can be $250 billion of 
surpluses or deficits over a 10-year span.
    Spending changes of similarly small magnitudes today also 
can have profound effects over 10 years. For example, $10 
billion more in discretionary spending this year will result in 
over $100 billion in additional baseline expenditures over the 
next decade. The supplemental spending bill that you are about 
to consider, nearly $30 billion at last check, will add almost 
$500 billion, a half a trillion dollars, to baseline spending. 
If Medicare spending grew 1 percent faster than we anticipate 
in the baseline, that faster growth would add over $200 billion 
to outlays over 10 years.
    With those parameters in mind, Mr. Chairman, let me first 
address in general terms your primary concern, namely the 
accuracy of our forecasts. To make budget projections, we must 
first forecast how we expect the economy to perform. To do so, 
we use a wide range of resources: private forecasts; analysis 
by the Federal Reserve; our advisory panel, consisting of 20 
economists, many of whom you are familiar with; analysis of the 
Blue Chip reports; comments from you and your staff; as well as 
a forecast of the administration. All of those resources are 
used to produce our forecast, which we got together something 
like 2 months before we publish our budget outlooks. And 
sometimes that 2 months can be very important.
    I would submit, Mr. Chairman, that our economic forecasts 
are as good or better than most others. We recently published 
an analysis of exactly that point, comparing our forecasts with 
those of other forecasters, both in government and out. As the 
dean of my graduate school was fond of telling me, that might 
be seen as damning by faint praise. None of us are very good at 
making those kinds of forecasts, particularly when they are 
very far in the future. In fact, we generally, as you know, 
straight-line our economic forecasts after 5 years, because we 
don't know anything about years 6 through 10 that would inform 
our forecasts.
    Economists are even worse, Mr. Chairman, at predicting 
turning points in the economy, one of the places we find 
ourselves at the moment. As you have said, Mr. Chairman, you 
can change the channel looking for a different forecast, but I 
am afraid that from what we know today, it will likely be as 
correct as the channel you currently have on.
    The second task we must perform to arrive at a budget 
outlook is to translate our economic forecast into budget 
forecasts and projections. On the expenditure side of the 
ledger, the translation is somewhat easier. For example, higher 
inflation leads straightforwardly to higher cost-of-living 
adjustments. Lower economic growth means higher expenditures 
for unemployment, Medicaid, and Temporary Assistance for Needy 
Families, as well as higher interest rates and higher debt-
service costs.
    In addition, we must forecast the number of people who will 
participate in Federal programs, their level of need of 
services, the behavior of doctors in prescribing treatments, 
the creativity of State governments in qualifying for Federal 
dollars, the prices of crops and commodities around the world, 
and the response of hospitals to investigations by the Justice 
Department.
    Projecting discretionary spending is virtually impossible 
because the policies change every year, but that is still easy 
when compared with projecting income tax revenues and other 
receipts. While there are hundreds of sources of revenue, the 
principal contributors are individual and corporate income 
taxes and payroll taxes. Unfortunately, the principal 
components of the tax base--wages and salaries plus corporate 
profits--are not perfectly correlated with the overall 
performance of the economy; also, varying amounts of those are 
not taxed at all, while some other non-income components--such 
as capital gains--are taxed.
    Taxpayers and corporations currently hold trillions of 
dollars worth of unrealized capital gains. When they choose to 
recognize those gains and incur taxes on them is not well 
understood. Clearly, reduced tax rates on capital gains have 
produced more realizations and revenues in the short run, but 
it is not clear what the effect will eventually be on the pool 
of unrealized gains and, therefore, future tax revenues.
    Obviously, the level and volatility of the equity markets 
cause changes in investing and, therefore, realizations of 
gains or losses. But again, that relationship is not clear. 
Equities are responsible for only a part of the revenue from 
gains; slightly over half, as I recall. A significant amount 
also results from realizing gains on real estate and other 
assets about which even less is known.
    The changing composition and distribution of the tax base 
also create problems for projecting. Firms may shift 
compensation from wages to nontaxable fringe benefits, such as 
cafeteria plans for health care. Corporations may change their 
status to ``subchapter S,'' or limited liability companies to 
have their profits taxed only at the individual level. The 
changing importance of bonuses and stock options may imply 
changes in the level of revenue that income will yield in taxes 
as more or less income accrues to those taxed at the highest 
rates.
    In addition, Mr. Chairman, to the difficulties in 
forecasting the economy's levels of spending and revenues, CBO 
is constrained by law to estimating a very particular baseline, 
which is a projection of spending and revenues based on current 
law, without anticipating any changes in policy over the next 
10 years. It is important to recognize and remember that this 
baseline is not a prediction of outcomes, but rather a starting 
place from which to measure the effects of policy changes.
    Clearly the Congress and the President will have to change 
policies in many ways over the next decade, some of them 
reasonably predictable. The so-called extenders package of tax 
credits, for example, has been renewed on occasion, but we 
assume for the baseline that it expires as currently scheduled. 
Why is that the case? Well, those tax credits haven't always 
been extended on time. There have been lapses of 8 or 9 months, 
and once in a while a tax credit is actually eliminated. But 
most important, the Budget Act tells us to assume the 
expiration of all tax provisions as scheduled, except excise 
taxes dedicated to trust funds.
    Obviously, this committee could move to change the Budget 
Act to include expiring tax provisions in the baseline. I would 
guess, without further analysis, however, there are many 
provisions that would be affected in unanticipated ways, such 
as expiring provisions that raise taxes.
    Mr. Chairman, I know that you have commented on the 
inclusion in the baseline of discretionary spending that occurs 
one time but is assumed to go on forever. That is a fact, and 
it has been so since the beginning, because the Budget Act 
requires us to do so. The spending for the cleanup of New York, 
the purchase of a space shuttle, the funding of the decennial 
census, all gets built into the baseline, inflated, just like 
paying the light bill at the Capitol.
    I certainly wouldn't disagree with you that including some 
of those expenditures may overstate what is defined as current 
policy on discretionary appropriations and, therefore, inflate 
the baseline. But I suspect, Mr. Chairman, that ultimately the 
committee wouldn't want CBO to determine what constitutes one-
time spending and what does not. While some examples are 
obvious, there are many that are not so obvious.
    Again, you would need to change the Budget Act to instruct 
us to make those reductions, and, I would hope, include some 
criteria for making the determination, or frankly you could put 
language in appropriation bills as they are developed to 
indicate that certain spending was intended to be one time 
only.
    Most of those changes, however, would not dramatically 
affect the baseline or the measurement of actual outcomes. The 
obvious one-time expenditures are not large when compared with 
the totals. More important, the rules for constructing the 
baseline that simply inflate the prior year's level of 
discretionary spending have consistently resulted in an 
underestimation of the actual level of domestic discretionary 
spending.
    But the question remains, after taking all of the 
constraints and complexities into account: How have we done? 
What is our bottom line, as you said, Mr. Chairman? How do you 
assess it? For the last several years, we have published a 
chapter in our January baseline report titled ``The Uncertainty 
of Budget Projections.'' That chapter--chapter 5--makes it 
plain for all to see where we have missed in the past, by how 
much, and some of the analysis we have undertaken to mitigate 
some of the errors. Ultimately, we then produce a series that 
shows how uncertain our projections are based on those past 
errors.
    This first chart, Mr. Chairman, which has been dubbed the 
``fan chart,'' you have seen before; it has been part of our 
ongoing effort to examine the uncertainty in looking out even 5 
years let alone 10. The change in the budget outlook from 
January 2001 to January 2002, as dramatic as it was, was within 
last year's fan chart. I will say, however, that it was closer 
to the edge than to the middle.
    What has played into those uncertainties? What has led 
outcomes to differ from our forecast? A look back at our 
forecast in 1997, for example, comparing it to the actual 
outcome, starts to explain some of the uncertainty. From this 
chart, Mr. Chairman, which was on the cover of our mid-year 
report in 2000, we see that the legislation enacted after we 
made our projections in 1997 did not play a big role in the 
change in actual fiscal policy. What happened was that a 
dramatic and unanticipated increase in revenues occurred over 
that period.
    What happened that was represented? Well, first the economy 
grew stronger than anyone had expected, and for a longer 
period, mostly due to productivity increases few analysts had 
anticipated. Second, more of the growth of the economy occurred 
in taxable income, both for individuals and corporations, than 
is typical. Third, the tax rates increased as taxpayers were 
pushed into higher brackets. Finally, the robust stock market 
provided more capital gains.
    We did not, Mr. Chairman, immediately or completely 
incorporate all of those changes into our forecast, since we 
could not assess their permanence. Over time, as some of the 
factors continued, we began to incorporate many of the changes, 
such as higher productivity and higher revenues for a given 
level of GDP. But that was then, Mr. Chairman, and this is now. 
As the cover of our most recent baseline report shows, the 
dramatic reversal of fortune over the next year or two was 
caused primarily by the onset of a recession and the unusual 
decline in the largest tax bases.
    One might say that what the economy gives, the economy can 
take away. Obviously, in future years, legislation affecting 
both spending and revenues has a large effect on the change in 
this outlook. But then why did the big swing due to the economy 
occur?
    First, there was a slowdown and recession we did not 
predict. Nor, frankly, did anyone else--again, as I said, 
damning by faint praise--as this chart indicates.
    Second, this recession is decidedly different from the 
last, and I will speak more about that in a moment.
    Third, the Bureau of Economic Analysis revised its 
historical data last July between our two January estimates to 
reduce estimates of investment in growth in 1999 and 2000. BEA 
reduced by almost one full percentage point the growth rate for 
2000. I will repeat that. BEA reduced in July of 2001 its 
estimate of growth for calendar year 2000 by almost one full 
percentage point. We had relied on BEA's earlier 2001 higher 
estimate to make our forecast of January 2001.
    In addition, the revisions reduced estimates of capital 
investments and, hence, the outlook for productivity in the 
future.
    Finally, revenues have collapsed faster than the economy, a 
complete reversal of the trends of the late 1990s.
    Mr. Chairman, some of those points can be made by looking 
at what appears to be happening this year, this month. There 
have been press reports that revenue collections for April are 
dramatically lower than was expected by either the Treasury or 
by us. How can that be, given that we have seen 5-plus percent 
growth in GDP reported by the BEA?
    First, of course, April's collections are based largely on 
last year's income, not the current quarter's. More important 
though, it appears that the tax base is not rebounding at the 
same pace as is the economy.
    If you look at this next chart, you will see what has 
happened and is happening to the tax base. The recession, while 
mild if measured by GDP, was much more severe when measured by 
the tax base. Further, it appears to us that BEA's July 
revision, coming 2 months from now, will include a substantial 
reduction in historical data for wages and salaries.
    What does this portend? Well, the relatively good economic 
news of late on GDP growth and productivity should produce 
economic growth greater than we forecast for this year, but 
starting from a much lower level. Total revenues will be lower 
this year, and probably next, than our current projections. So 
even though we currently have good economic news, we have the 
anomaly of lower revenues than projected. This chart, this 
result, I suggest, clearly illustrate the limitations of our 
projections and those of everyone else.
    In this case, we have the apparently anomalous result of 
the economy recovering quicker and stronger than we expected 
but revenues falling well below what we estimated despite that. 
If our first quarter estimates of GDP had been closer to the 
mark, we would have forecast even more revenue than we 
collected in April. In short, the economy changes in 
substantial ways no one foresees; and taxpayers change their 
behavior in work and savings and investment, and in realization 
of capital gains, in characterization of income in ways we 
don't predict.
    Mr. Chairman, I am certain you will still have many 
questions about our accuracy, but before I turn to them, I want 
to discuss a related issue, that of dynamic scoring of 
legislation. Much of the body of Federal law and regulation and 
any legislative changes to it have effects on the performance 
of the economy and often particular sectors within it. In fact, 
changing how the economy works is often the objective of such 
laws and such policy changes. So information about the 
macroeconomic effects of proposed legislation and the budgetary 
implications of those effects could often be useful in the 
legislative process.
    That is what I mean by ``dynamic scoring,'' for the purpose 
of today's hearing, the effects of legislation on the 
macroeconomy and how those feed back into the Federal Budget. 
In using the term ``dynamic scoring,'' that is what most folks 
are referring to; that is, a tax bill in which you would try to 
assess its effects on the economy and somehow incorporate those 
effects into the scoring of the bill.
    Such information would include the effects of tax changes 
on saving or labor supply and, therefore, on long-term growth. 
It might also include effects from additional income generated 
by entrepreneurship, which is promoted by lower tax rates; or 
increases or decreases in aggregate output caused by the 
effects of subsidies or taxes in changing the allocation of 
resources. Some analysts also suggest that it should include 
demand-side effects, such as when tax cuts or spending 
increases boost employment and economic activity during periods 
of recession and recovery.
    For the purposes of scoring legislation for recording the 
annual effects of a bill as it passes through the Congress, CBO 
and the Joint Committee on Taxation's formal estimates of the 
cost of legislative proposals do not--and I would suggest 
today, Mr. Chairman, cannot--include those macroeconomic 
effects in a useful and credible way. Why is that the case? 
Principally because the macroeconomic consequences of today's 
actions will be determined largely by future policy, by 
altering the budget resources that will be available.
    When policy decisions have budgetary implications, they 
affect future resources. For example, a spending increase or a 
tax cut now must be financed by either lower spending or higher 
taxes in the future. Those future decisions about that 
financing frequently determine the macroeconomic effect of 
today's policy changes. There is a fundamental difference 
between a tax cut financed by roughly contemporaneous cuts in 
spending and a tax cut financed by additional borrowing for 
some years and higher taxes in the future. The first may well 
increase GDP; the second is very likely to reduce it.
    Let me reiterate, Mr. Chairman, because this is a critical 
point for us. If you believe, as many of you do, that reducing 
taxes today will help hold down Federal spending in the future, 
then in general it is more likely that a tax cut will help the 
economy grow. If, however, you believe, as others of you do, 
that a tax cut today will need to be reversed in the near 
future, then future economic growth may well be diminished.
    By the way, the empirical evidence for either of those 
outcomes suggests that the effects, in any event, will be very 
small given the size of fiscal policy changes relative to the 
size of the economy.
    Any estimate of the macroeconomic impact of a policy 
proposal included in a cost estimate would have to make a 
specific and, I would argue, predictable assumption about those 
future policy actions. The ordinary conventions of the 
baseline, for example, would constrain the estimate to assuming 
that tax cuts would be financed by borrowing. Under that 
assumption, any positive effect of lower marginal tax rates 
could be partially or totally offset by the drag of debt on 
capital formation and growth. As a practical matter, under that 
assumption few tax cuts would have a positive effect on the 
economy.
    There is no objective way to make the choice, and differing 
assumptions produce opposite results. So CBO could make an 
assumption about what the next five Congresses and at least two 
Presidents will do, but doing so would subject us and, I would 
suggest, the results to a chorus of controversy. Although the 
lines are not bright, those possible assumptions, as is obvious 
to all, do tend to break down along partisan lines, which makes 
any choice arbitrary at best.
    In addition to the need to specify alternative political 
futures, the assessment of legislative effects on the economy 
is often complicated by offsetting effects and, often in the 
same bill, offsetting provisions. In general, reducing taxes 
results in increased after-tax income and, therefore, reduces 
the incentive to work. However, cuts in marginal rates, as most 
economists believe, will also increase the marginal payoff from 
work and, therefore, increase labor force participation.
    More specifically, in last year's tax legislation, the 
reduction in marginal rates should increase labor supply--an 
analysis we did for the July report last year suggested as 
much--but by small amounts, for two reasons. First, because of 
the small size of the tax reductions; and second because the 
alternative minimum tax will counteract the positive effects in 
later years. On the other hand, the increase in the child tax 
credit in the same bill will likely diminish labor force 
participation, predictably by second earners. So on balance 
some provisions will help, and some will hurt.
    Further, to attribute any short-run stimulative effects to 
legislation, monetary policy must be assumed to be constant; 
that is, it must be assumed that the Fed will not react to a 
change in fiscal policy, an assumption not likely to hold in 
reality.
    Finally, and potentially most important, the reaction of 
taxpayers to specific policy changes may be based as much on 
their perceptions as the reality. For example, do all taxpayers 
assume the expiration, or sunset of last year's changes will 
take place as scheduled? Or, will some provisions sunset, but 
not others? The perception of taxpayers and, therefore, their 
reaction to those reductions will be what drives our revenue.
    Although I believe it is impractical to incorporate 
information about macroeconomic impacts in formal cost 
estimate, that information can usefully be presented in other 
ways. CBO has frequently described the macroeconomic effects of 
both past and proposed legislation either in separate reports 
or in its description of the economic assumptions underlying a 
baseline. In such reports we are not constrained by the 
conventions of baseline estimating but can explore the 
implications of alternative assumptions. CBO can describe how 
the macroeconomic effects of a policy change depend on its 
financing.
    Returning, Mr. Chairman, to today's primary topic, that of 
accuracy, many analysts believe that including more dynamic 
effects in CBO's and joint committee's cost estimates would 
improve the accuracy of budget projections. Frankly, however, 
that does not seem to be the case. It is difficult to estimate 
precisely the fully dynamic effects of legislation, even after 
enactment. The underlying determinants of revenue program costs 
change for a variety of reasons, many of them hard to 
determine, and not just because of changes in legislation or 
policy. Even years later, there is rarely an actual figure that 
you could hang your hat on--that is a clear measure of what the 
legislation actually did--with which to compare our original 
estimates.
    Nevertheless, the history of CBO's projections certainly 
does not suggest that they would have been improved had the 
macroeconomic effects of policy changes been included in cost 
estimates. That was not surprising, frankly, because when CBO 
prepares its budget projections, it estimates the effects of 
current policy, including recently enacted law, on the economic 
outlook, including the effects of recent policy changes that 
may seem likely to be significant. So CBO's baselines are 
already a fully dynamic representation of the effects of 
current law.
    A comprehensive review of CBO's revenue baseline following 
changes in tax law shows no pattern of underestimating revenue 
following tax cuts or overestimating it following tax 
increases.
    In practice, inaccuracies in forecasting receipts appear 
largely to reflect difficulties in predicting turning points in 
the business cycle, shortcomings in the most recently available 
income measures that we use in our models, and inherently 
unpredictable events, such as shifts in the income distribution 
and rapid changes in stock prices.
    On the outlay side, estimating errors result from a variety 
of economic and technical factors. Interest rates, the 
unemployment rate, inflation, and economic growth may differ 
from CBO's forecast and, therefore, affect outlays for 
interest, Federal credit, unemployment compensation, and a 
whole host of programs. In general, those sources of errors do 
not seem to be related to any failure to predict the 
macroeconomic effects of legislative changes.
    In summary, Mr. Chairman, I do not believe that dynamic 
scoring by CBO and JCT in the formal sense of bill scoring--
incorporating the macroeconomic effects into the bill-costing 
process--would improve the analysis provided to Congress. There 
is no objective way that congressional staff can make 
assumptions about the current session, let alone future 
congressional actions, public expectations of those actions, or 
future monetary policy. Such assumptions in this case would 
drive results and undermine their credibility. Favorable scores 
would be sought for spending programs as well as for tax 
provisions.
    The current process may be far from perfect, and indeed 
that is why we are here today, but it is also better, I think, 
than one that would require dynamic scoring of legislation.
    With that, Mr. Chairman, I will conclude. Thank you.
    Chairman Nussle. Thank you. Thank you, Dan, for your 
testimony and your responsiveness to this committee.
    [The prepared statement of Mr. Crippen follows:]

 Prepared Statement of Dan L. Crippen, Director, Congressional Budget 
                                 Office

    Mr. Chairman and members of the committee, I am happy to appear 
before you this morning to discuss how the Congressional Budget Office 
(CBO) can best inform the Congress about its economic and budget 
projections and about the dynamic economic consequences of tax and 
spending proposals.

                        Summary and Introduction

    The Congressional Budget and Impoundment Control Act of 1974 set up 
a process that allows the Congress to take the primary role in 
formulating the budget a role that in previous years had been performed 
by the administration. That law assigns to CBO the tasks of making 
baseline projections of revenues and outlays and estimating the 
budgetary effects of the spending proposals reported by committees. It 
gives to the Joint Committee on Taxation (JCT) the job of preparing 
estimates for most revenue legislation. The two organizations 
coordinate their efforts on estimates for complex pieces of legislation 
that affect both revenues and outlays.
    CBO's and JCT's estimates play an important role in the legislative 
process, providing the Congress with the information it needs to 
evaluate budgetary proposals independently. Since the inception of the 
Congressional budget process in 1975, those estimates have been used to 
assess whether a bill will breach the limits in the budget resolution 
or be subject to a point of order on the floor of the House or Senate. 
Since the passage of the Budget Enforcement Act in 1990, the Congress 
has used those estimates to monitor compliance with discretionary 
spending caps and with the pay-as-you-go requirements for legislation 
that affects revenues or mandatory spending.
    Much of the body of Federal law and regulation affects the 
performance of the economy. In fact, changing how the economy works is 
the objective of many legislative proposals. Thus, information about 
the macroeconomic effects of proposed legislation and the implications 
of those effects for the budget may often be useful in the legislative 
process. (The term ``dynamic'' refers to those macroeconomic effects as 
well as to the microeconomic effects that are reflected in CBO's and 
JCT's cost estimates).
    In terms of projecting the cost of legislation as it passes through 
the Congress, CBO's and JCT's formal estimates do not and, I suggest, 
could not include those macroeconomic effects in a useful and credible 
way. There are four reasons:
    First, the macroeconomic consequences of today's actions will be 
determined by policy decisions that have not yet been made. When policy 
decisions have budgetary implications, they can affect future policy by 
altering the budgetary resources that will be available. For example, a 
current spending increase or tax cut must be financed with either lower 
spending or higher taxes in the future. Such future decisions about 
financing frequently determine the macroeconomic effects of today's 
policies. There is a fundamental difference between a tax cut financed 
by a roughly contemporaneous cut in spending and a tax cut financed by 
additional borrowing for several years and higher taxes after that. The 
first may well increase gross domestic product (GDP); the second is 
very likely to reduce it.
    Put another way, if you believe that cutting taxes today will help 
hold down Federal spending in the future, then in general, a tax cut is 
more likely to help the economy grow. If, however, you believe that a 
tax cut today will need to be reversed in a few years, then future 
economic growth may be diminished. In either case, the empirical 
evidence for those outcomes suggests that the effects would be small, 
given the size of fiscal policy changes relative to the size of the 
economy.
    Any estimate of the macroeconomic impact of a policy proposal that 
was included in a cost estimate would have to make a specific, 
conventional assumption about those future policy actions. The ordinary 
conventions of the baseline, for example, would constrain the estimate 
to assuming that tax cuts would be financed by borrowing. Under that 
assumption, any positive effect of lower marginal tax rates could be 
partially or totally offset by the drag of debt on capital formation 
(investment) and growth. As a practical matter, under that assumption, 
few tax cuts would be estimated to have a positive impact on the 
economy.
    There is no objective way to choose which assumption to use, and 
differing assumptions can produce opposite results. CBO could make an 
assumption about what the next five Congresses and at least two 
Presidents will do, but doing so would subject us and the results to a 
chorus of controversy. Although the lines between choices are not 
bright, those possible assumptions tend to break along partisan lines, 
making any choice arbitrary at best.
    Second, in addition to the need to specify alternative political 
futures, the assessment of legislative effects on the economy is often 
confounded by offsetting effects. In general, tax cuts result in 
increased after-tax income and therefore reduce the incentive to work. 
However, cuts in marginal rates also increase the marginal payoff from 
work and boost labor force participation.
    More specifically, the reduction in marginal rates enacted in last 
year's tax legislation should increase the labor supply, but by small 
amounts because of the small size of the reduction and because the 
alternative minimum tax will counteract the positive effects in later 
years. Conversely, the increase in the child tax credit will probably 
diminish labor participation by second earners.
    Third, to attribute any short-run stimulative effects to 
legislation, estimators must assume that monetary policy will remain 
constant (that the Federal Reserve will not react to a change in fiscal 
policy) an assumption not likely to prove true.
    Fourth, and potentially most important, the reaction of taxpayers 
to specific policy changes may be based as much on their perceptions of 
a change as on the objective reality of the provision. For example, do 
taxpayers assume that the sunset (expiration) of last year's tax cuts 
will take place as scheduled, or that some provisions will expire and 
not others?
    In short, integrating dynamic scoring into cost estimates would 
pose intractable problems. Before I go into detail about those 
problems, I want to describe how CBO prepares its economic and budget 
forecasts and what kind of dynamic effects are built into its cost 
estimates.

                 CBO'S Economic and Budget Projections

    In many cases, the accuracy of cost estimates is not very sensitive 
to the accuracy of the baseline economic and budget projections that 
underlie them. However, those baseline projections are important 
because they determine CBO's estimate of future budgetary trends under 
current policy.
                          the baseline concept
    Each year, CBO prepares a set of spending and revenue projections 
that assume the continuation of current laws and policies. Those 
projections are known as the baseline. Such a current-law baseline is 
not intended to be a prediction of Federal spending and receipts. After 
all, any such prediction would undoubtedly include some assumptions 
about potential changes in current laws. Instead, the baseline serves 
as a neutral benchmark against which lawmakers can gauge the effects of 
proposed changes in spending and revenue policies. It is constructed 
according to rules set forth in law, mainly in the Balanced Budget and 
Emergency Deficit Control Act of 1985 and the Congressional Budget Act 
of 1974.
    For revenues and mandatory spending, section 257(b) of the Deficit 
Control Act requires that the baseline be projected as though current 
laws will continue without change. In most cases, the laws that govern 
revenues and mandatory spending are permanent. The baseline projections 
therefore reflect only anticipated changes in the economy, 
demographics, and other relevant factors that affect the implementation 
of those laws.
    The rules differ for discretionary spending, which is governed by 
annual appropriation acts. Section 257(c) of the Deficit Control Act 
states that projections of discretionary budget authority after the 
current year should be adjusted to reflect inflation using specified 
indexes as well as a few other factors (such as the costs of renewing 
certain expiring housing contracts and of annualizing adjustments to 
Federal pay). Accordingly, CBO's baseline extrapolates discretionary 
spending from the current level, adjusting for projected rates of 
inflation and other specified factors over the next 10 years.
    That formulaic approach to developing baseline projections can be 
problematic. For example, all discretionary budget authority 
appropriated for the current year is inflated and extended through the 
entire projection period even if it was enacted for an emergency or 
other one-time event. Some emergency appropriations may not be 
repeated, but various types of emergencies that necessitate additional 
appropriations arise every year. Similarly, some appropriations will 
naturally vary from year to year, such as funding for the decennial 
census.
    The Deficit Control Act does not allow for any adjustments to that 
mechanical approach, but the Budget Committees have the flexibility of 
choosing different assumptions for a ``budget resolution baseline,'' 
and CBO has frequently provided the committees with alternative 
estimates to allow for such adjustments. In any case, the baseline is a 
reasonable starting point for the annual consideration of budgetary 
plans and specific policy options. Annual baseline projections 
represent CBO's best judgment about how the economy and other factors 
will affect Federal revenues and spending under existing laws and 
policies.
                    economic and budget projections
    CBO's baseline budget projections rely on the agency's economic 
forecasts. Those forecasts have been about as accurate, on average, as 
those of private forecasters and the administration. All forecasters 
have missed forecasts of recessions but the evidence shows that there 
is no reliable way to predict recessions. CBO has often been cautious 
in its projections, but that caution has sometimes served it well.
    Before the most recent recession, CBO anticipated a slowdown in the 
economy. Although CBO was not at all sure when that slowdown would 
occur, it was sure that the growth rates of more than 4 percent that 
had prevailed for 4 years could not continue without causing 
inflationary pressures in the labor market. CBO shared that view with 
many other forecasters, including those at the Federal Reserve. The 
first intimation that the slowdown could be serious came in January 
2001, when the Federal Reserve's Board of Governors began to lower 
interest rates. CBO instituted a ``recession watch'' at that point to 
ensure that it did not overlook any signs, either in official data or 
in anecdotal evidence, that might indicate that the slowdown was 
turning into a recession. At no time through the summer of 2001 did the 
recession-watch team think that the evidence supported much more than a 
50 percent probability of recession. Consequently, CBO's summer 2001 
economic update continued to forecast a slowdown without recession, 
although it did discuss the economy's unusually high vulnerability to 
recession.
    After the attacks of September 11, the economy turned down sharply 
enough to cause the slowdown already under way to be considered a 
recession. Like most forecasters, CBO anticipated that the recession, 
although mild by historical standards, would nevertheless be deep 
enough to slow revenue growth and to last for a couple of quarters. 
Whether CBO was right or wrong on that score remains unclear. The 
headline estimates of GDP growth and unemployment suggest that the 
recession was much milder than CBO had anticipated. However, taxable 
income seems to have taken a much more significant hit than the GDP 
figures suggest. And CBO received confirmation last week that the 
Bureau of Economic Analysis (BEA) significantly overestimated wage and 
salary income in 2001. As a result, even while BEA is releasing 
estimates of GDP growth of more than 5 percent for the first quarter of 
2002, revenues are coming in even weaker than CBO's January or March 
2002 forecasts anticipated.
    That episode illustrates several points. First, CBO's economic 
forecasts generally do not differ greatly from those of private 
forecasters. CBO regularly studies its own record and those of other 
forecasters to see what can be learned, and it publishes those 
analyses. Second, both CBO and private forecasters have to contend with 
changing and inconsistent data, which makes describing past events and 
forecasting future events difficult. Third, despite those difficulties, 
CBO's prediction last summer that the economy would barely avoid a 
recession would most likely have proved true had the attacks of 
September 11 not occurred.
    CBO has also attempted to evaluate the accuracy of its budget 
projections. That task is much more difficult than evaluating economic 
projections because, as noted above, CBO's baseline budget projections 
reflect the economic and budgetary consequences of current law at the 
time they are made and assume that current policies will not change. 
Policy changes are inevitable, however, which is why CBO removes the 
effects of those changes when it measures the accuracy of its budget 
projections. The result is the ``fan chart'' that CBO first published 
in January 2001 and updated and improved in January 2002 (see Figure 
1). That chart shows the range of uncertainty around CBO's baseline 
projections of the surplus or deficit based on the accuracy of its past 
projections. (The chart extends out only 5 years, because CBO has too 
short a record of 10-year forecasts to allow useful analysis).
    As expected, CBO's analysis shows that the accuracy of its budget 
projections is closely linked to the accuracy of its economic 
projections; that accuracy falls off quickly as the projection horizon 
extends. CBO has also learned from its analysis that cyclical movements 
in the economy have larger budgetary effects than can be attributed 
simply to the cyclical movement of major income categories. CBO is 
working to incorporate those additional cyclical movements such as 
changes in the proportion of total income going to highly taxed 
households into its projection models.
    Aside from CBO's own analyses, a number of outside economists have 
studied CBO's projections. In separate analyses, Rudolph Penner (a 
former CBO director) and Alan Auerbach found no evidence that CBO's 
budget projections have been biased that is, have been overly 
optimistic or overly pessimistic throughout the agency's history. Some 
strings of optimistic and pessimistic forecasts might suggest the 
possibility that certain information could have been better used. 
However, Penner suggested other reasons for such strings to occur, such 
as caution in identifying changes in trends. Stephen McNees, an analyst 
at the Federal Reserve Bank of Boston, tracked the accuracy of private 
and official economic forecasts for many years; his latest study, 
published in 1995, found that CBO's forecasts were as good as private 
forecasts and better than some alternative models.

    Notes.--This figure shows the estimated likelihood of alternative 
projections of the surplus or deficit under current policies. The 
calculations are based on CBO's past track record. CBO's January 2002 
baseline projections fall in the middle of the darkest area. Under the 
assumption that policies do not change, the probability is 10 percent 
that actual surpluses or deficits will fall in the darkest area and 90 
percent that they will fall within the whole shaded area.
    Actual surpluses or deficits will of course be affected by 
legislation enacted during the next 10 years, including decisions about 
discretionary spending. The effects of future legislation are not 
included in this figure.
    An explanation of how this probability distribution was calculated 
is available at www.cbo.gov.

    Source: Congressional Budget Office.

                How Dynamic Are Current Cost Estimates?

    Estimating the revenue effects of a tax proposal requires two 
pieces of information: the proposed change in the tax rate and the 
resulting change in the tax base. A static estimate assumes that the 
tax base does not change in response to a change in the tax rate. For 
example, a static revenue estimate of a proposed tax on luxury cars 
would simply multiply the tax rate by a baseline number of luxury cars 
sold. Such a static estimate would neglect the fact that the tax would 
discourage people from purchasing luxury cars, so it would probably 
overestimate the revenue increase from imposing the tax.
    Neither JCT, CBO, nor the administration actually produces static 
budget estimates. All revenue estimates used in the policy process 
include estimates of the effect on the tax base of changes in tax 
rates. JCT's and CBO's estimates of the budgetary impact of spending 
and tax proposals incorporate a wide variety of behavioral changes in 
response to economic incentives; those changes are often called dynamic 
effects.
    Revenue estimates typically include effects related to the timing 
of economic activity, effects related to shifting income between 
taxable and nontaxable categories, effects on supply and demand, and 
interactions with other taxes. For example, timing effects in a cost 
estimate of an increase in the capital gains tax account for the fact 
that taxpayers will accelerate their realizations of gains to avoid the 
higher tax rate. Similarly, the scheduled expiration of tax breaks that 
are not expected to be extended is usually accompanied by a temporary 
shift in economic activity. Cost estimates of a change in marginal 
income tax rates include the effect on the tax base that comes from 
recharacterizing compensation from taxable wages and salaries to 
nontaxable fringe benefits. Supply and demand effects show up in cost 
estimates for a gasoline tax; those estimates reflect the fact that 
higher tax rates induce consumers to buy less gasoline. Likewise, 
estimates of changes in the capital gains tax take account of the fact 
that taxpayers will (even apart from timing effects) realize more gains 
at lower tax rates.
    Policy changes can also have repercussions for taxes other than 
those they affect directly. For example, cost estimates of changes in 
depreciation schedules take into account the changes in payroll tax 
liabilities of self-employed people that result from their changed 
proprietorship income. Likewise, all estimates of changes in indirect 
taxes, such as excise taxes, reflect reductions in income taxes that 
result from the fact that excise taxes reduce other types of income.
    Those same principles apply to spending programs. If a proposal 
would alter a benefit program, CBO's cost estimate would reflect any 
change in participation that was likely to result. For example, CBO's 
estimate of the cost of a proposal to change Medicare payments to 
health care providers incorporates its estimate of resulting changes in 
the volume of services provided. Similarly, CBO's estimates for pending 
agriculture legislation include anticipated effects on crop prices and 
production.

           Assessing the Macroeconomic Impacts of Legislation

    Information about the macroeconomic effects of proposed legislation 
and the budgetary implications of those effects could often be useful 
in the legislative process. Such information would include the effects 
of tax changes on saving or labor supply (and therefore on growth). It 
also might include effects from additional income generated when lower 
tax rates promote entrepreneurship, or increases or decreases in output 
caused by the impact of subsidies or taxes on the allocation of 
resources among various activities. Some analysts also suggest 
including demand-side effects, such as the increased employment and 
economic activity during periods of recession and recovery that stems 
from tax cuts or spending hikes.
    Although those macroeconomic effects are important, it may be 
impossible to incorporate them in budget scoring in a way that is 
credible. Any forecast of the economy involves judgments about many 
complex issues, and CBO routinely has to make assumptions on the basis 
of incomplete information and its best judgment. Nevertheless, dynamic 
scoring involves more-fundamental problems than do most of the other 
types of analyses for which CBO is responsible. One of the most serious 
conceptual problems is that the predicted macroeconomic effects of a 
particular piece of legislation will depend critically on the analyst's 
assumptions about how the change will influence future policy 
decisions.
    Any estimate of the macroeconomic impact of a policy proposal 
included in a cost estimate would have to make a specific, conventional 
assumption about future policy actions. For example, the ordinary 
conventions of the baseline would constrain the estimate to assuming 
that tax cuts would be financed by borrowing. Thus, any positive effect 
from lower marginal tax rates could be partially or totally offset by 
the drag of debt on investment and growth. In practice, because most 
tax bills include provisions other than cuts in marginal rates, few of 
those bills would have a positive estimated effect on the economy under 
baseline conventions.
    Information about macroeconomic impacts can be more usefully 
presented in other ways than in a cost estimate. CBO has frequently 
described the macroeconomic effects of both past and proposed 
legislation either in separate reports or in its description of the 
economic assumptions underlying a baseline (for various examples, see 
the appendix). In those reports, CBO is not constrained by the 
conventions of baseline estimating and can explore the implications of 
alternative assumptions. Thus, CBO can describe how the macroeconomic 
effects of a policy change depend on its financing.
    CBO faces some of the same problems in constructing its baseline, 
which also has to reflect estimates of the macroeconomic effects of 
policy in this case, of the taxes and spending programs currently in 
place. Those estimates are difficult to make, in large part because of 
uncertainties about the future policy implications of current policy. 
However, uncertainties about the macroeconomic effects of fiscal 
policy, although important, probably do not loom large in the broad 
context of an economic forecast. CBO's analysis of its past forecasting 
inaccuracies does not suggest that better estimates of the effects of 
policy on the economy would have significantly improved its record of 
forecasting revenues.
    The rest of this section of my statement examines the problems of 
policy analysis in greater detail, first reviewing the ways in which 
policy can affect the economy and then discussing the interactions with 
future policy that make assessing macroeconomic impacts difficult. 
CBO's analysis of the Economic Growth and Tax Relief Reconciliation Act 
of 2001 (EGTRRA) illustrates the types of problems that arise and shows 
why a meaningful assessment of the macroeconomic consequences cannot be 
captured in a single number used as an input in a cost estimate.
                   effects on saving and labor supply
    The main macroeconomic effects that current procedures leave out of 
cost estimates are those that affect the level of production through 
saving and labor supply. Tracing the effects of changes in taxes or 
spending on labor supply and saving, and consequently on GDP and 
receipts, is complicated by several factors.
    First, the effects could go in either direction depending on the 
particulars of the policy change. For example, an increase in the child 
tax credit would tend to reduce the labor supply because it would raise 
families' after-tax income. In turn, that boost in income might lessen 
some people's incentive to work, especially second earners in families 
with one person already working full time. In contrast, the effect on 
labor supply of cutting marginal tax rates is theoretically ambiguous. 
Although such a cut would increase after-tax pay from work, thus giving 
people an incentive to work more, it would also increase families' 
after-tax income, which could decrease work. Empirical studies suggest 
that, in total, cutting marginal tax rates probably increases labor 
supply modestly.
    Second, the economic effects of a tax cut or a spending increase 
also depend on how the policy would redistribute resources among 
generations and income groups. For example, a Social Security reform 
that reduced current workers' expectations of the benefits that will be 
paid to them when they retire would be likely to reduce current 
consumption and increase saving.
    Third, tracking effects on national saving is complex because there 
are offsetting influences to consider. For instance, a tax cut would 
normally reduce revenues and government saving (unless spending cuts 
followed). Depending on the details of the proposal, however, it might 
increase or decrease private saving.
                      effects on entrepreneurship
    Tax policy can also affect the economy more subtly, by changing the 
environment for entrepreneurship and innovation. By that route, higher 
tax rates could slow economic growth and reduce tax receipts below what 
would be estimated under current procedures.
    Quantifying effects on entrepreneurship is difficult, however. A 
few recent studies measuring the willingness of people to leave 
salaried jobs and start small businesses have found some evidence 
suggesting that the progressivity of the tax system (that is, the 
extent to which taxes increase as incomes rise) diminishes 
entrepreneurship. How that effect translates into innovation and 
improvements in productivity remains to be established. Moreover, 
because tax evasion appears to be greater among noncorporate firms than 
among corporate ones, it is even more difficult to determine whether 
revenues would be increased or decreased as a result.
                     effects on economic efficiency
    Many legislative proposals take the form of tax preferences or 
subsidies, so they alter the allocation of labor and capital in the 
economy, sometimes adversely and sometimes favorably. Consequently, 
even if a given tax preference or subsidy increases investment (capital 
formation), it can also have the effect of reducing how productive that 
capital is by shifting resources from more-productive to less-
productive activities.
    Those impacts affect GDP and the tax base, but they can be 
difficult to quantify. Their effects can also be counterintuitive. A 
subsidy designed to offset a problem that exists in a market can 
introduce other inefficiencies; similarly, a tax preference can have 
unintended effects that result in diverting capital and labor to less-
productive uses.
    Other types of legislation besides those that mainly alter taxes or 
government spending can significantly affect efficiency and output. For 
example, changes in laws that affect regulation of the economy such as 
environmental or worker safety laws, airline or telecommunications 
deregulation, changes in the minimum wage, or bankruptcy reform could 
also alter business decisions. Such legislation would be very hard to 
analyze perhaps impossible, because in many cases its effect would 
depend on the details of implementing regulations but it could 
certainly alter the performance of the economy.
                           effects on demand
    The previously mentioned effects are ways in which budget policy 
can influence the supply side of the economy. However, when people talk 
about using a tax cut to avoid or climb out of a recession, they are 
describing another way in which fiscal policy affects the economy 
through its short-term impact on overall spending, or demand-side 
effects. (Those are often called Keynesian effects, after the economist 
who first pointed out their significance).
    Demand-side effects tend to have a temporary impact on real income 
and employment, but only to the extent that the economy is below its 
normal capacity to produce. Once output and employment reach their 
long-term sustainable levels, additional stimulus tends to translate 
into higher inflation. So the effect of budget legislation on 
macroeconomic demand depends critically on where the economy is in the 
business cycle and where it will be throughout the 10-year budget 
window. CBO makes no attempt to forecast the business cycle more than 
18 months to 2 years ahead.
    Including demand-side effects in cost estimates would present 
severe problems. To begin with, several different pieces of legislation 
might each have the potential by itself to boost demand and therefore 
output. But if the House or Senate passed one of those pieces of 
legislation, the others would have less of a problem to remedy. That 
situation creates the possibility of substantial double-counting of the 
same output gains.
    In addition, figuring out the likely effect of fiscal policy on 
short-run spending is complicated by the possible responses of the 
Federal Reserve, which is also implementing policy to achieve its own 
targets for output and unemployment. Chairman Alan Greenspan and the 
Federal Open Market Committee navigate between recession and inflation 
by controlling economy-wide spending, but they use monetary rather than 
fiscal policy to do so. The Federal Reserve takes fiscal policy into 
account, along with other factors, in determining the need for 
additional monetary actions. Thus, instead of assuming that fiscal 
policy affects spending independent of monetary policy, one might 
reasonably assume that changes in fiscal policy are changes in policy 
that the Federal Reserve no longer has to undertake. The fiscal policy 
change might therefore be credited with little or no incremental effect 
on demand. Depending on which of those views one takes, the demand-side 
effects of fiscal policy will appear very different.
    The appropriate assumption about how monetary policy will respond 
to changes in fiscal policy is something that could evolve over time, 
even with respect to a particular piece of legislation. Business-cycle 
conditions change, as does the aggressiveness with which the Federal 
Reserve uses monetary policy to counter business cycles. Any assumption 
about the way in which monetary policy would respond is highly 
speculative, requiring guesses about not only the Federal Reserve's 
behavior but also the challenges it will face.
               what does a legislative proposal displace?
    The difficulty of assessing interactions of fiscal and monetary 
policy is just one example of a pervasive problem with dynamic scoring: 
how to determine a proposal's broader policy consequences. Even when 
CBO knows all of the details of a proposed policy change, such as a tax 
cut, it still does not know what would happen to fiscal policy without 
the tax cut. Would spending be higher now or in the future, or would 
there be a tax cut later? Would a tax cut now be reversed in a decade? 
Would only government borrowing change within the budget window? The 
answers to those questions are often crucial to evaluating the 
macroeconomic impact of proposed legislation.
    Finding agreement on the most likely course of future policy is 
unlikely. Some people argue that cutting taxes now is good for the 
economy because otherwise the size of the surplus will encourage 
additional government spending. Others argue that too large a tax cut 
is bad for the economy because it uses up surpluses that could be 
available to pay retirement and health costs and other needed 
government expenses. Those arguments turn on different assumptions 
about what other policy changes would follow from a tax cut, and they 
reflect fundamentally different views of the political process. 
Macroeconomic models suggest that those different assumptions would 
produce very different macroeconomic outcomes.
    To forecast the effect of such policy changes on the economy, CBO 
would not only have to forecast the implications for future government 
policy decisions but also need to guess what individuals and business 
leaders believe those implications will be. Economists agree that 
expectations have a significant effect on economic responses. A tax cut 
that is believed to be permanent, for instance, is likely to have very 
different implications for spending and labor-supply decisions than one 
that is believed to be transitory.
                         the example of egtrra
    CBO's and JCT's analyses of the Economic Growth and Tax Relief 
Reconciliation Act of 2001 illustrate the extent to which estimates are 
already dynamic. They also demonstrate the difficulties of estimating 
the dynamic macroeconomic effects of legislation. JCT's estimators were 
responsible for including many of the microdynamic effects. CBO's 
analysis, completed after passage of the legislation, added its 
assessment of the macrodynamic effects to JCT's analysis. The two 
analyses together suggest that even such a large package of measures as 
EGTRRA probably has only relatively small implications for incentives 
to work and to save, in part because the package contains provisions 
with opposite implications. CBO's analysis also underscored the 
sensitivity of those conclusions to assumptions about how other 
policies would be affected by the law's changes.
    JCT's cost estimate included that agency's best estimate of several 
behavioral responses to the law. Those responses included the shift of 
a portion of compensation into taxable wages and salaries and away from 
nontaxable fringe benefits in response to EGTRRA's reduction in 
marginal tax rates. (Nontaxable fringe benefits include items such as 
employers' contributions to retirement plans and employer-paid health 
insurance). That shift offset a portion of the budgetary cost of 
EGTRRA. JCT also included estimates for a number of changes in the way 
people plan their estates, such as choosing to give different amounts 
of taxable gifts.
    CBO's estimate of the macroeconomic effects of EGTRRA appeared not 
in a cost estimate but in its update of the economic outlook published 
in the summer of 2001. Consistent with the rules for producing the 
baseline, the base-case analysis assumed no change in future tax or 
spending policies as a result of the legislation the tax reductions 
were assumed to be offset by a decrease in budget surpluses. However, 
the economic analysis deviated from normal budget rules in that it did 
not consider the effects of the law's scheduled sunset in 2010.
    Effects on Work and Private Saving. CBO found that EGTRRA contained 
a number of provisions with different, and sometimes opposing, 
macroeconomic effects that were not part of JCT's cost estimate. Some 
of those provisions created incentives for people to work more or to 
save more.
    By CBO's estimate, EGTRRA will reduce the average effective 
marginal tax rate on income from labor in 2006 by about 1.8 percentage 
points (or one-twentieth of the current tax rate) and the average 
effective marginal rate on capital income by 0.5 percentage points (or 
one-fortieth of the current tax rate). Other provisions will have the 
opposite effect. For example, boosting the child tax credit will 
probably reduce the supply of labor by raising families' after-tax 
income, thereby lessening the incentive for possible second earners in 
those families to work. CBO estimated that if the law did not expire, 
the net effect of all those factors would be to increase labor supply 
after a decade by between 0.1 percent and 0.4 percent.
    CBO also concluded that under base-case assumptions, EGTRRA will 
probably increase private saving because it reduces marginal tax rates 
on capital income and thus enhances the incentives for people to save. 
The legislation may also increase saving among some low-income people 
through its nonrefundable credit for contributions to individual 
retirement accounts or 401(k) plans. However, increases in private 
saving are likely to be quite small, given the small reduction in the 
effective tax rate on capital income.
    Effects on Demand. CBO's analysis of EGTRRA focused on the law's 
long-term macroeconomic effects, even though the perceived need for a 
short-term economic stimulus to lessen an impending recession may have 
played an important part in its passage. As it turned out, the 
components of the law aimed at promoting short-term stimulus were 
perhaps uniquely well timed (in comparison with other efforts to use 
fiscal policy to combat recession). Most important, the law provided an 
initial rebate of taxes payable on income earned in 2001. Although 
initial surveys could not find any evidence that the rebates increased 
consumption when they were issued in the third quarter of 2001, they 
were in place to help consumers weather the difficult period after 
September 11 and may have contributed to the continued strength of 
consumer spending.
    As noted above, assessing the amount of macroeconomic stimulus 
provided by any fiscal policy package is complicated by the need to 
guess what the Federal Reserve's response might be. Indeed, views of 
what actions the Federal Reserve might take have changed in the period 
since EGTRRA was enacted. Last summer, CBO and most other forecasters 
anticipated a relatively mild slowdown in the economy, which might not 
have dipped into recession. However, that projection reflected both the 
stimulus in EGTRRA and monetary policy actions. The Federal Reserve had 
already acted vigorously early in 2001 to lower interest rates, and in 
the absence of fiscal stimulus, it might have lowered rates even 
further.
    After September 11, most forecasters switched to believing that the 
economy was entering at least a moderate and possibly a severe 
recession. In those circumstances, the fact that fiscal policy was 
fortuitously providing a stimulus at exactly the right moment was 
presumably very helpful to the Federal Reserve, which faces constraints 
on the effectiveness of monetary policy when economic conditions 
deteriorate sharply.
    The recession, however, has proved to be the mildest on record, and 
many forecasters now anticipate the moment when monetary policy may 
begin to tighten. It is once again plausible to imagine that had EGTRRA 
provided no fiscal stimulus, the Federal Reserve would have lowered 
rates more and kept them down longer.
    Some analysts have suggested that EGTRRA may have actually 
contracted demand in the short run by raising long-term interest rates 
(in response to smaller expected future surpluses). But it is not clear 
that EGTRRA reduced expected future surpluses. Well before the tax 
legislation was under consideration, many market participants assumed 
that such large surpluses would not materialize. Consequently, they did 
not expect EGTRRA to increase future borrowing requirements 
significantly, and accordingly they did not alter their expectations of 
future interest rates.
    Implications for Future Policy. In its analysis of EGTRRA, CBO 
emphasized that the quantitative conclusions about the law's 
macroeconomic effects are very sensitive to assumptions about policy 
responses as well as to the public's expectations about those 
responses. Ordinary baseline assumptions are inadequate for such an 
analysis. One example was noted in the preceding paragraph: EGTRRA's 
actual effect on interest rates reflected not how the law deviated from 
a constant-policy baseline but how it changed people's expectations 
about future policy. More generally, analyzing EGTRRA as if, without a 
tax cut, no other policies would ever change implies the unlikely 
outcome that the tax cut will permanently reduce revenues relative to 
spending.
    CBO concluded that the law might either increase or decrease GDP 
depending, among other things, on assumptions about its implications 
for future policy. If the tax cuts in EGTRRA are accompanied by a 
comparable reduction in government spending, GDP is likely to be higher 
than it would have been without EGTRRA, and revenue increases from that 
additional growth will offset a portion of the law's budgetary cost. By 
contrast, if EGTRRA turns out to reduce the government's surplus, 
national saving and GDP are likely to fall, and the budgetary cost of 
the law will most likely be larger than JCT estimated.
    Because the tax cuts are scheduled to expire, people's beliefs 
about whether they will indeed end will determine much of the course of 
the economy in the later years of the estimate. That problem has 
implications for both the dynamic effects normally included in cost 
estimates and the macroeconomic feedback effects that are not. Because 
of the sunset, EGTRRA provides for one of the largest tax increases 
ever in 2011. If the public believes that the increase is likely to 
occur, that belief can change substantially the extent to which people 
try to take advantage of the lower tax rates in the interim. Similarly, 
the chance that scheduled cuts in tax rates may not take place can 
alter behavior now.

                       Other Types of Legislation

    Much of the discussion of dynamic scoring has been limited to 
revenues. But all the concepts that apply to receipts apply to outlays 
as well. Indeed, many of the same principles apply to nonbudgetary 
legislation. So as not to distort policy choices, CBO and JCT should 
inform the Congress about the likely macroeconomic effects of both tax 
and spending proposals and how those effects reflect on the budget.
    A large number of spending proposals are rooted in claims that they 
will increase output. Education, research, and infrastructure spending 
are all examples of outlays that, because they are by their nature 
investment, can potentially boost output and generate more receipts. 
Advocates of other outlays, such as health care, could make similar 
claims. In addition to the potential supply-side effects on output, all 
outlays can lay claim to demand effects. Those effects are generally 
regarded as even stronger for spending than for taxes.
    Incorporating a full range of dynamic effects in cost estimates for 
outlays is especially problematic with regard to appropriations. Unlike 
the laws that affect entitlement programs, appropriation legislation 
does not extend across the entire budget horizon. Decisions about 
discretionary spending are made 1 year at a time. It would make little 
sense to try to analyze the macroeconomic effect of each additional 
year of spending rather, any useful analysis would have to make broad 
assumptions about what spending would be in the future. But the 
difficulty of analyzing discretionary spending does not mean that it 
has no effect on the economy: it is still one-third of the budget and a 
crucial determinant of that budget's balance and thus of government 
saving. Although including discretionary spending in a prospective 
analysis of the macroeconomic effects of fiscal policy would pose 
severe problems, leaving it out would tend to bias the information 
provided to the Congress about the effects of policy.
    Further complicating cost estimates of spending is the fact that 
the effects are not confined to outlays. By their very nature, economic 
changes that stem from policy decisions on the spending side of the 
budget play out on the revenue side. As a result, a fully dynamic 
estimate for a reform of Social Security could, if the reform was 
likely to alter national saving and growth, affect estimates of the 
Federal tax base and Federal revenues in the long run.
    The effect could also go in the other direction, influencing 
distant parts of the spending side of the budget. Almost any large 
policy change that affected the economy significantly would affect 
interest rates. Besides debt-service costs, changes in interest rates 
would alter spending for a number of programs that involve lending or 
borrowing.
    Because the macrodynamic effects of revenues affect spending and 
vice versa, including them creates jurisdictional problems for the 
Congressional budget process itself. Once macroeconomic effects are 
taken into account, a spending bill has revenue implications, 
potentially causing a piece of spending legislation to be of concern to 
the tax-writing committees. Committee allocations under the Budget Act 
would probably need to reflect the effects of spending legislation on 
revenues and the effects of tax legislation on outlays, which would add 
a great deal of complexity to the budget process. And to incorporate 
such interactions into the estimate of a bill's cost, it might be 
necessary to make changes to the laws governing the budget process.

      Can CBO Improve Its Baseline Projections By Accounting for 
             Macroeconomic Feedbacks in Its Cost Estimates?

    Some people believe that including more dynamic effects in CBO's 
and JCT's cost estimates would improve the accuracy of CBO's baseline 
budget projections, but that does not seem to be the case.
    When CBO prepares its baseline budget projections, its economic 
forecast incorporates the effects of current policy. So CBO's baselines 
are already a fully dynamic representation of the effects of current 
policy. Moreover, there is no evidence that CBO is making any 
systematic mistakes in its assessment of the effects of policy in the 
baseline. A comprehensive review of CBO's revenue baselines after 
changes in tax law shows no pattern of underestimating revenue 
following tax cuts or overestimating it following tax increases.
    It is difficult to estimate precisely the full dynamic effects of 
legislation on program costs or on revenues, even after enactment. The 
underlying determinants of revenues and program costs change for a 
variety of reasons, many of which are hard to identify. Even years 
later, there is rarely an ``actual'' figure an indisputable measure of 
what the legislation actually did with which to compare an estimate.
    In practice, inaccuracies in forecasting receipts appear largely to 
reflect difficulties in predicting turning points in the business 
cycle, shortcomings in the most recently available income measures used 
in CBO's models, and inherently unpredictable events such as shifts in 
the distribution of income and rapid changes in stock prices. On the 
outlay side, errors in estimating result from various economic and 
technical factors. Interest rates, the unemployment rate, inflation, 
and economic growth may differ from CBO's forecast and thereby affect 
outlays for interest, Federal credit programs, unemployment 
compensation, benefit programs that are indexed to inflation, and 
means-tested entitlement programs. In general, those sources of error 
do not seem to be related to any failure to predict the macroeconomic 
effects of legislative changes.
    CBO regularly reviews the accuracy of its budget projections to 
improve its forecasting methods. When actual data differ significantly 
from projections, CBO analyzes the reasons underlying the differences 
and makes changes on the basis of those findings. For example, 
forecasts of capital gains receipts have contributed in both directions 
to inaccuracies in revenue forecasts. Capital gains realizations were 
below what CBO had expected in 1989 and the early 1990s but above 
expectations in 1996, 1998, and 1999. On those occasions, CBO reviewed 
and revised its methods for forecasting capital gains receipts. In no 
instance did the analysis of errors or the revision in methodology 
suggest that the errors had resulted from a failure to account for the 
macroeconomic feedbacks of capital gains legislation.

                               Conclusion

    CBO does not believe that ``dynamic scoring'' by it and JCT, 
incorporating the macroeconomic effects of legislative changes into the 
process of estimating a bill's cost, would improve the analysis 
provided to the Congress. There is no objective way that Congressional 
staff can make assumptions about the actions of current and future 
Congresses, about public expectations of those actions, or about future 
monetary policy. Such assumptions would drive results and undermine 
their credibility. Favorable estimates would be sought for spending 
programs as well as for tax provisions. The current process may be far 
from perfect, but it is also far better than one that would require 
dynamic scoring.
    The Congress needs complete information about the budgetary effects 
of any tax or spending legislation. Given the nature of the budget 
process and the fundamental limitations of macroeconomic analysis, 
however, that information is most appropriately provided not in cost 
estimates but in separate reports and analyses that are not required to 
fit into the straitjacket of assumptions necessary for cost estimates.

  Appendix: Past Estimates of the Macroeconomic Impacts of Legislation

    The Congressional Budget Office has consistently published 
assessments of the macroeconomic effects of major policy actions or 
proposals, although it has not incorporated those assessments into cost 
estimates of proposed legislation for scoring purposes. For example:
     CBO has regularly included in its annual budget and 
economic outlook a discussion of the effects of major budgetary changes 
on its macroeconomic forecast. Last summer, for example, CBO published 
its analysis of how the Economic Growth and Tax Relief Reconciliation 
Act of 2001 would affect the long-term economic outlook. In previous 
years, CBO published estimates of the macroeconomic effects of welfare 
reform and of the reconciliation package of 1997.
     CBO provided a detailed analysis of the likely 
macroeconomic effects of a proposed cut in capital gains taxes in a 
paper requested by the chairman of the House Ways and Means Committee.
     CBO published its analysis of the potential macroeconomic 
effects of major tax reform (flattening rates and broadening the base 
of the income tax as well as substituting a consumption tax for the 
income tax). In addition, CBO contributed papers to a conference on tax 
reform that JCT held in 1997.
     CBO's analyses of the many health proposals made in 1994 
included discussions of probable macroeconomic effects.
     In 1995, 1996 and 1997, CBO indicated in broad terms in 
its economic and budget outlooks how a smaller deficit might contribute 
to growth by increasing national saving (the so-called fiscal 
dividend).
     CBO recently published a report analyzing approaches to 
providing short-term economic stimulus through tax-related options. It 
concluded that most of the tax cuts that the report analyzed were 
unlikely to generate large first-year increases in gross domestic 
product.

                    Charts Presented at the Hearing

    Chairman Nussle. Because this is the first opportunity to 
do this, I would like to fly at about 30,000 feet. I am not 
sure I would like to--flying at 100 feet is probably not wise 
at this moment. Let us take it from a little bit higher vantage 
point to start with.
    First, with regard to accuracy and static versus dynamic, 
as I have told you before, I don't pray at one particular altar 
or the other, in part because I don't care what we call it. We 
can call it static, dynamic. You can call it whatever you want. 
I just want it to be the most accurate way of accomplishing the 
goals here, and that is to give us good information not only 
from which to make decisions, but also good information to give 
us information about the results of those decisions, period. 
And if that happens to be called dynamic or static or something 
in between, that is fine with me. I just want it to be 
accurate.
    So I don't see a real separation between the two, I guess, 
to start with, and I have a list of questions, and I think 
these are 30,000-feet kind of questions, and what I would like 
to do, because there is probably never going to be enough time 
to cover them all, is I would like to submit them to you and 
give you some time to look at them, because as we are looking 
down the road not only at CBO, but at the potential in the 
future for changes in some of the key positions, I think this 
would be good just for us to consider, for all of the committee 
to consider. So I am going to submit a list of questions to you 
for that purpose.
    But let me just start with some basics. What should be the 
core role of a Congressional Budget Office? When this was 
accomplished, we thought we knew, and maybe that has changed. 
Based on your vantage point, what should be the core role of 
CBO, and should it be simply to provide budgetary information 
in support of the legislative process, or should it include 
more than that, stretching maybe the bounds of current 
jurisdiction or even for that matter current technical or 
professional ability within the Congressional Budget Office? So 
just generally from 30,000 feet, what should your role be, and 
is that something that you are currently able to accomplish?
    Mr. Crippen. Mr. Chairman, after I got to CBO, I spent at 
least a year or so--I mean, I went in with a bias toward maybe 
making some changes, because the agency hadn't changed 
dramatically in any sense certainly since 1975. The original 
design, however, I think was very strong, and still very 
useful. That is, half of our professionals, if you will, are 
involved in the day-to-day crunching of numbers, putting price 
tags on legislation reported from committees, helping 
committees think about the costs of various alternatives. The 
other half of the professionals contribute greatly to those 
considerations. The idea was that budget analysts would not 
have much time to respond to congressional needs for numbers 
and that the so-called program divisions could take a longer 
view of the world and take a little time to assess the critical 
assumptions that our budget analysts must make about how the 
world works. That was the division of responsibility initially, 
and it remains roughly that way today.
    We count as program divisions our tax analysis division and 
our macroeconomic division, both of which contribute most of 
the work on the initial baseline forecast. So for doing just 
the baseline as required by law, those divisions are meeting 
budgetary requirements, things that we are charged to do by you 
and by the statute. In fact, up to 90 percent of what we do is 
required.
    But the point, I think, that your question tries to raise 
is: Should we have the ability to take a longer view of some of 
these issues, analyze very specific things, often taking months 
to do so, and publish for committees--or others at the request 
of committees--the results? And I think the answer has to be 
yes, because most of those issues--in fact, I would suggest all 
of them--are very pointedly aimed at our ability to answer 
questions about the budgetary implications of Federal policy 
changes.
    Now, we also do things on State and local mandates and 
private sector mandates, but in the main our day-to-day task is 
to put price tags on legislation. The program divisions, those 
folks who spend a little longer on specific issues, enlighten 
and inform that process. If we want to test critical 
assumptions, those are the folks who can do it for us, and as a 
result, you see the published results. Now, those published 
results may look rather arcane in some cases or very narrow in 
others, but they also give everyone involved in the process the 
ability to very clearly see what our assumptions are, how we 
arrived at them, and what the analysis is. Thus, if there was 
any bias or, in fact, ignorance in that process, in those 
assumptions, they are publicly available for all interested 
parties to comment on and help us improve.
    So it is a very valuable piece of what we do, and it 
doesn't so much expand the boundaries in the sense I think that 
you might mean as take very specific issues, like revenue 
forecasting, tear them apart and spend time looking at them. We 
have had some guest fellows and scholars join us over the past 
few years who have done exactly that for us; taken a piece of 
the revenue model say, capital gains realizations, tear it 
completely apart, try other means of estimating in hopes of 
improving our processes. So it is very critical, I think, that 
the program divisions feed into our assumptions as well as all 
of our daily work.
    Chairman Nussle. My understanding is that the ratio is--at 
least I have been told the ratio is close to \2/3\:\1/3\.
    Mr. Crippen. It is probably the other way around, \1/3\:\2/
3\. The reason for that is if you look at just what we call the 
budget analysis division, you can come up with a number that 
looks like one-third. But there is also, for example, the 
division that does mandates on State and local governments. All 
of the private sector mandates are done in the program 
divisions, because they have the knowledge about how the 
private sector works much more than the budget analysts who 
know how Federal programs work. The tax analysis division, as I 
said, does much of their work in support of our baseline 
development and helps other areas of the budget analysis 
division as well.
    So the division that one would make by looking just at 
budget analysis, I think, is a bit misleading. It is more like 
two-thirds involved in the day-to-day crunching of numbers. For 
example, the health division, which I hope we talk more about, 
is counted as a program division, but they do the lion's share 
of work on new benefits, such as the pharmaceutical benefit, 
because it is largely a private sector impact. That is, people 
are currently getting pharmaceuticals, paid largely for by 
either insurance companies or other sources, and so it is the 
private sector response that is going to drive the Federal 
costs here, and it is a whole new benefit. None of our budget 
analysts have ever dealt with a pharmaceutical benefit. So the 
health and human resources program division is the one 
responsible largely for developing the models, building the 
databases, and thinking hard about how those things might work 
where we have no experience with them in the past. That is the 
only reason it takes a long time. But in the main, I would say 
that two-thirds of the activity in the organization is driven 
by the day-to-day need to produce estimates for Congress.
    [Mr. Crippen's letter following up on Chairman Nussle's 
question regarding resource allocation:]

                               Congressional Budget Office,
                                      Washington, DC, May 16, 2002.
Hon. Jim Nussle,
Chairman, House Committee on the Budget, Washington, DC.
    Dear Mr. Chairman: In the hearing before the House Budget 
Committee on May 2, 2002, you cited a figure for the proportion 
of our resources (one-third) which we expend on budget analysis 
work directly related to our statutory mandates. Although I 
provided an answer during the hearing, the question of how we 
use our resources in support of the budget process is so 
important, that I felt it warranted a more detailed response. 
Overall, roughly three-quarters of our resources go to directly 
supporting the day-to-day cost estimating, scorekeeping, budget 
projections and other mandated functions that form the core of 
our mission.
    The figure you cited at the hearing no doubt comes from our 
appropriation request which shows that roughly one-third of our 
staff work in the Budget Analysis Division. What is not clear 
from our budget justification, however, is that two other 
divisions (Tax Analysis and Macroeconomic Analysis, comprising 
roughly one-sixth of our resources) devote nearly all of their 
time to planning for, developing models for, and participating 
in the construction of our budget and economic projections. In 
addition, each of our program divisions devotes considerable 
effort to the day-to-day cost estimating and analysis of state, 
local, and private sector mandates. For example, much of the 
cost estimating for complex bills proposing pharmaceutical 
benefits under Medicare is carried out in our Health and Human 
Resources Division. Likewise, our private sector mandate 
estimates are prepared by staff in our Microeconomic and 
Financial Studies Division.
    When overhead and administrative support are added, we 
conclude that at least three-quarters of our resources go 
directly to our core budget related functions, while much of 
the remaining one-quarter goes to addressing significant budget 
issues in response to the Budget, Appropriations, Senate 
Finance, and House Ways and Means Committees.
    I would ask that this additional information be inserted in 
the hearing record.
            Sincerely,
                                            Dan L. Crippen,
                                                          Director.

    Chairman Nussle. Well, let us talk about the health 
division for a second. I think you are aware of some of the 
criticism that is--and we can be specific, but----
    Mr. Crippen [continuing]. I am.
    Chairman Nussle. We would be happy to, but I think probably 
just to speak generally for a moment, why is that such a 
challenge? It is just a huge complaint that we continue to 
hear.
    Mr. Crippen. It is, and it is understandable, and we need 
to do better. For one thing, it is hard to find good health 
care analysts, frankly, especially Ph.D.'s. There is a huge 
demand for folks who know anything about how the Federal health 
care system works, so it is not uncommon to have very large 
salaries be offered to fairly junior members.
    There is a difficulty in finding people, but I think that 
we have in the past year or so filled most of what we thought 
we wanted or needed for resources, and we are dedicating more 
resources to health care than we did 3 or 4 years ago.
    But in the main, it comes down to the complexity of the 
proposals. Because the proposals are new, they tend to have 
lots of variations on themes that interact with each other, and 
the problem, frankly, Mr. Chairman, often is that the staff and 
the members of other committees don't know what they want to 
do. They have a monetary or budgetary goal in mind. They have a 
policy objective, say--providing pharmaceuticals to elderly 
Medicare beneficiaries.
    But having said those two things, the filling in-between 
takes a very long time for committee and staffs to develop. 
They leave holes in the legislation until toward the end of the 
process. So it is an iterative process, in which we give them a 
gross first impression, and then later do something a little 
more refined. For example, a good recent example is when you 
all had the stimulus bill on the floor, we didn't get 
legislation on some of the provisions until 10 o'clock the 
night before. Now, that is not a comment about anybody's 
capabilities. It is simply a fact of the way Congress works. So 
our response is necessarily dictated in part by when we get 
legislative language. Often in these very complex pieces of 
legislation, we can't do anything until we actually see the 
bill. We can't do much, because the details change the outcome 
dramatically.
    But a drug estimate takes at least a week and sometimes 
longer. If you gave me a fully formed proposal today that 
looked at least somewhat like some that we have seen in the 
past, we could probably tell you in a week or so with about 10 
or 15 people working on it what we think the impact would be.
    There are just so many pieces. We have here a benefit that 
will cost hundreds of billions of dollars in a market currently 
of, or a baseline for spending of, well over a trillion 
dollars. So to try and put fine points on it in a way that 
makes sense to you and us takes time. That is not an excuse. It 
is not a good answer. Obviously, if you put 30 people to work 
on an estimate, you might be able to get it in three or four 
days, but for some of those provisions, as you have 
experienced, and the complaints we have heard, the final 
determination is not made until right before you are ready to 
go to the floor, and it is part of the process.
    For example--in another area, the farm bill--last Friday we 
read widely that everyone was waiting for CBO's estimates on 
the farm bill. We got the farm bill language yesterday at noon, 
we got the conference report. Now, we have seen much of it 
before. It is not going to take days, perhaps more than a day 
or two or maybe less when we get down to it, but very often, of 
course, committees, Members and staff haven't quite finished 
what they have in mind, and we get cited as the holdup. I 
understand that, it is fine, but we can't and won't put numbers 
on things we haven't seen, and that becomes a real impediment 
in part of this process when you are moving very quickly from 
your conference to a committee, to the floor, and especially 
with big pieces of legislation. We can't keep up, and I don't 
know that anybody could. It is not just a matter of resources.
    Chairman Nussle. Let me ask one more, and it is just 
something you mentioned in your testimony that goes right back 
to what I was frustrated about earlier this year. You mentioned 
that the supplemental, which costs somewhere roughly--you said 
$30 billion--has a 10-year effect of $500 billion in the 
budget. Who said that? I mean, 30 times 10 is 300 to start 
with, No. 1. And No. 2, this is to fight a war, and, I mean, so 
you used an example that is the most--probably one of my 
biggest frustrations in your testimony, and that is how can 
anybody say that a one-time emergency spending bill for 
emergency items 10 years from now is going to cost us $500 
billion when this is, in fact, one-time expenses?
    Mr. Crippen. What I was trying to say, and I obviously 
didn't do a good job of it, is that by the rules, by the Budget 
Act, that $30 billion will, in our next baseline, get 
translated into roughly $500 billion more over the 10 years. It 
is not only 30 times 10, it is 30-plus inflation times 10, plus 
whatever debt-service costs will be associated with additional 
borrowing or less deficit--or less surplus. And so the net 
result is going to be a $500 billion hit on the 10-year total 
for surpluses or deficits.
    As I said in my testimony, I agree with you that one-time 
spending probably shouldn't be built into a baseline. But I 
don't know how much of that supplemental spending--and Mr. 
Spratt may have a better idea than either of us--for defense or 
for homeland defense is going to be one time and how much of it 
will go on. I don't know that, but we can obviously work 
together and develop criteria and change the Budget Act so that 
it wouldn't be included.
    I am not predicting, Mr. Chairman, that we will need to 
spend or indeed will necessarily spend an additional $500 
billion or $300-plus billion over the 10 years, but that is how 
the baseline will reflect the supplemental spending bill you 
are about to pass.
    Chairman Nussle. But that information is used in different 
ways by different committees, and you ask why I am interested 
in looking for a different channel or why anybody from time to 
time is interested in looking at a different channel. If we 
have got to change the Budget Act, I suppose good luck right 
now doing anything with budget enforcement.
    Mr. Spratt mentioned he is watching the demise of the 
budget process in part because we do have to make some of those 
enforcement changes, but we need to get some recommendations 
from you on how to do a better job of this, because it is 
just--we can't have that situation where we have $30 billion of 
emergency ``invade Afghanistan'' kind of money assumed to be 
invading Afghanistan, you know, 8 years from now, 10 years from 
now. That doesn't make any sense. Or rebuilding New York 10 
years from now. I mean, heaven help us if that is what we are 
doing 10 years from now.
    So at any rate, I know you are frustrated about that, too. 
We have got to work together to change the rules.
    Mr. Crippen. Part of the answer, and it is not specific to 
your example here, but part of the answer is, we would just as 
soon not do 10-year forecasts or baselines. If we take a $500 
billion number, two-thirds of that increase occurs in the last 
5 years, years 6 through 10. You don't get that kind of 
multiplier effect over the first few years, the way you do when 
you look at a very long-time horizon. We would be perfectly 
content doing 4- or 5-year forecasts and baselines, and I 
suspect you might be as well. But we don't have that luxury at 
the moment. If we can get the Senate to change its rules and 
requirements, we could.
    So a suggestion for when you are thinking about changing 
things this year would be to reel that time frame back in. 
There were reasons for initially extending it. I understand 
them. But, frankly, people have been able to blow through the 
10-year horizon just as easily as they blew through a 5-year 
horizon to stage execution of legislation beyond the window. So 
I don't know that it has been that much more informative, and 
it certainly makes our job a lot harder, and we are subject to 
more criticism because of the uncertainty over 10 years.
    Chairman Nussle. There are other members who have 
questions. I apologize to them for going so far over. These are 
obviously some areas that we want to talk about.
    Mr. Spratt.
    Mr. Spratt. I thought you had a good line of questioning 
going. Let me follow up on your discussion of the risk inherent 
in the whole exercise of forecasting and projecting.
    You have got the chapter in your book, I think you have 
done that at least 3 years in a row now, but that chapter tends 
not to be read. The chart we have all seen, but nevertheless we 
get in mind a fixed number, 5.6 percent.
    I can't tell you what the percentage likelihood of that is. 
I guess it is somewhere around a median percentage of your 
chart, but that is what gets fixed in everybody's mind. The 
bottom-line black number that you project and all of these 
contingencies get forgotten.
    One of your predecessors, Bob Reischauer, recommended that 
we have some way to wait or discount the outyear projections of 
the surplus, or really a surplus is what he was talking about. 
Do the same thing for a deficit, but namely, if it was a year 
out, you would maybe have a 20 percent discount; 2 years out, 
20 percent; 3 years out, 30 percent; and 10 years out, the 
discount might be as deep as 70 or 80 percent.
    You simply wouldn't for budget purposes, either taxing or 
spending, book that projection until you got much closer to it.
    Is that: No. 1, is that a worthy idea? No. 2, is it a 
feasible idea?
    Mr. Crippen. I think it is a worthy idea.
    I think it is not feasible, although you could do that as 
an addendum to the other things we do as another piece of 
information. I think it is not feasible because you need a 
baseline against which to measure policy changes. And unless 
you apply the same kind of uncertainty rules, if you will, to 
those policies, you wouldn't want to say that a tax cut in year 
5 or 10 was this amount of revenue lost times 0.2 because we 
were uncertain.
    The range is plus or minus, and the nice thing about 
looking at just a budget total is that it is the sum of all of 
the budget; when you have a surplus or deficit, that is the 
final bottom line if you are looking at unified totals. So it 
is a little easier to think about how you might take 
uncertainty into account there.
    But I think it is harder when you are developing a baseline 
against which you want to measure legislative changes, so I 
don't know that it would help to show uncertainty more than we 
do now, but it may; and it may be another number that would get 
added into the debate. But I don't think it is feasible to use 
it as a baseline.
    Mr. Spratt. At least it would postpone, if it worked. If it 
were accompanied by some kind of effective or strength or 
limitation curve, it would keep us from betting on the come, on 
future year projections, and keep us confined to what we saw in 
the near term; and as we approached the outyear surpluses, if 
we were realizing projections, fine, then next year we could 
have a deeper tax cut or a bigger spending increase, one or the 
other.
    Our biggest concern is what happened in 2001 when both OMB 
and CBO converged on an estimate of $5.6 billion. That was 
about a billion dollar increase in the 10-year total, different 
10 years, between July and January, and it was about a $600-
million increase over and above OMB's estimate just weeks 
before. By August, you were acknowledging that it was off by 35 
to 40 percent due to economic and technical miscalculations.
    How did that happen? How do you prevent it from happening 
again?
    Mr. Crippen. In general, it happened, I think, because the 
budget and the economy beat all of us over the head for 3 or 4 
years and produced a lot more revenues than anybody projected, 
because productivity was higher. And it is clearly a judgment 
call that we make and others make as to when we start 
incorporating some of those apparently changed circumstances. 
Do we assume that changes in productivity go on forever?
    And we have been more cautious than most forcasters--
certainly than some private forecasters--in taking our time and 
incorporating some of those apparent changes into projections. 
It is one thing to report that we have more productivity; it is 
quite another to say that we understand fully why we do and 
that we expect that growth to go on forever.
    So, frankly, come January 2001, we had seen all these 
productivity increases and, therefore, revenue increases, and 
there was no reason to believe that productivity was going to 
decline substantially; therefore, economic growth was probably 
going to be higher, on average, than we had been forecasting.
    That alone didn't capture all of the change that was 
happening with revenues, because again we were getting more 
revenues than any model we had or history would have suggested 
for that level of growth in the economy. There was more revenue 
from real bracket creep, that pushed more income into higher 
tax brackets. But there was also higher capital gains 
realizations, and other things that we didn't fully understand. 
So we didn't include all of that either in our forecast. We 
held back some, and it turns out we maybe should have held back 
more.
    Not only did we get the economic forecast wrong, itself 
wrong, and we had a recession we didn't foresee, but also the 
advent of more revenues per dollar of GDP now, at least 
certainly today, looks to be reversed--perhaps not completely, 
but again we don't know enough today to say that this decline 
in revenue relative to GDP is permanent. My suspicion is that 
it is not, but I don't have any evidence for that.
    So the question becomes: How soon do we start factoring the 
recent past into our projections of the future?
    We had hesitated for a long time before including, as an 
institution, a lot of those productivity changes in our 
forecast. But come that January or before that was when we had 
the meeting--and I think you were in it for a while--at which 
our outside advisers, although they suggested we don't go quite 
as far with an increase as we initially thought, were 
comfortable in saying those productivity increases are probably 
sustainable and therefore we are going to have more growth. No 
one knew all of the reasons why we were getting more revenue, 
so continuing that part of the growth seemed to be reasonable 
as well.
    There was a confluence of events then, just as there may be 
hitting us now, with a reversal of some of those same things. 
We have seen productivity be very strong during this recession, 
which is unusual. Again, there is no reason to think that 
productivity is going to decline over the near term, and I 
wouldn't change our outyear forecast of productivity at this 
point for any reason I can think of. But again the revenue per 
dollar of GDP, at least this month, looks to be well below what 
history would suggest.
    I don't think that will continue, but we have had the 
confluence of events that produced the January estimate. We 
then had the passage of legislation that cost a couple of 
trillion dollars. We then had a recession, and we are seeing 
some things with this recession and revenues that are unusual, 
as well.
    So the combination of losing, if you will, $4 trillion, 
half of that was the result of legislation and therefore not a 
surprise; the other half was a surprise in the economic 
performance and the amount of revenue. So what we saw happening 
for several years, some of which we ignored for a while, we 
eventually incorporated; and that appears to have been a 
mistake today, but I am not sure that come next January we will 
say the same thing.
    Again, this is only the second year of this 10-year 
forecast of $5.6 trillion, minus $2 trillion for legislation 
and the economy; and the revenues may fool us again, and come 
next January, we may have recovered part of that missing $2 
trillion due to economic and technical changes, and so make our 
10-year forecast.
    This is the first year after, and it looks much different 
today than it did a year ago. About a year from now--I am not 
predicting for you--we are going to recover that $2 trillion. 
In fact, given current revenue trends, we may be worse off--a 
little. But this is only the first year after a 10-year 
forecast too, and things are going to happen between now and 
year 10 that we certainly didn't foresee, and it may put us 
back on the other side of our forecast.
    Mr. Spratt. Last year, there were some early warning signs. 
One was that for an unprecedented period of time, tax revenues 
had grown at a faster rate than taxable income. You weren't 
completely sure in your report why. There were some obvious 
reasons; whether or not they were the complete reason was 
another matter. One was that we had more income gains in the 
upper bracket because they pay higher rates. That explained 
part of it.
    Part of what we did in 1993 was rebuild the revenue base in 
the Federal Government, make it more progressive, and then when 
the economy produced higher gains in upper brackets, we were 
rebounded from that benefit. But I remember reading your 
report. You were saying, ``obviously this can't go on forever; 
we just don't know when it comes to an end.'' So you tempered a 
bit the income growth rate, but you also continued to expect 
growth of revenues above the rate of growth in incomes, as I 
recall.
    Mr. Crippen. We certainly can and do anticipate in the 
forecast real bracket creep. It is one of the phenomena we know 
about; we know that more people get pushed into higher brackets 
as real income increases, and that should be, to the extent it 
occurred, permanent, and we can anticipate it relative to a 
forecast. So, yes, some of that was built in permanently.
    Mr. Spratt. The other thing was that you showed--the same 
chapter--that from 1995 to 2000 capital revenues had grown from 
$40 billion to about $120 billion, a threefold increase over a 
5-year period of time; and the market by January was already 
headed downward and looking ominous. You didn't really take the 
capital gain revenue down by a significant amount. You simply 
assumed it would not keep growing at the rate it had grown, and 
it would hover at a range of 105 to 110 and gradually climb 
back up to about $118 billion, as I recall.
    Mr. Crippen. Right.
    Mr. Spratt. But that, itself, was a risky assumption, given 
the storm clouds that were gathering over the economy, 
particularly the stock market then.
    Looking back on it, were those assumptions erroneous?
    Mr. Crippen. Probably, measured relative to what we know 
today; but we don't know a lot yet because, as you know, the 
tax data lagged for a year. We don't know exactly what revenue 
has disappeared on us for the moment. But what we did in the 
kind of steady state you are seeing in the numbers belies the 
two changes.
    One, we said we thought capital gains realizations in taxes 
were higher than could be sustained relative to the size of the 
economy; and we actually, over several years, took that back 
down to what the historical average of capital gains were to 
the size of the economy. But at the same time, of course, the 
economy is growing, so that the nominal number starts to come 
down but then stabilizes and then ultimately goes back up. We 
took capital gains receipts down, I think in our assumption, by 
about 20 percent this year, and we assumed it would continue 
down relative to a given size of the economy until it was back 
to historical averages.
    Now, we may not have taken it down fast enough, and that 
may account for some of the effects we are seeing right now. 
Frankly, one of the big determinants to a realization of equity 
gains is not the market going up inexorably, but volatility; 
and the trading volume may be as important in the booking of 
losses and gains as the actual change at any market indexes. 
Again, what causes taxpayers and corporations to realize what 
are trillions of dollars in unrealized gains out there and, 
therefore, subject them to tax is something we don't know very 
well.
    Mr. Spratt. That is another thing that--I guess the first 
year I occupied this position as ranking member was 1997, and 
we had a big dispute between OMB and CBO as to what revenue 
projections were for the next 5 years. CBO finally conceded to 
OMB. It turned out OMB was correct, and that increment that you 
added across the bottom line to your revenue projection really 
made possible the Balanced Budget Agreement of 1995. I think it 
was a $57 billion----
    Mr. Crippen. It was $45 billion a year.
    Mr. Spratt [continuing]. A $45 billion annual increase each 
year.
    But it was revolutionary to me then to find out how 
primitive our methods of projecting and analyzing tax revenues 
were. Even after the money comes into Treasury in April, it 
takes us a good period of time to know what is capital gains 
and what is actual income, which brackets it is coming from, 
and what is corporate and individual. It takes at least a year 
before, apparently, you get a definitive statement on that.
    Is there some way to make our analyses of tax flows better 
and more timely than we have got right now?
    Mr. Crippen. I think there is. It may by itself get better 
in the sense that the more technology the IRS has in service, 
the more people submit on-line returns. Those kinds of things 
should improve our data processing.
    But reporting, too, is a bit archaic. Corporations pay 
revenues, but there is no distinction initially between payroll 
taxes and income taxes.
    It happens with other taxes as well. When we see an amount 
of revenue coming into the Treasury, we don't know whether that 
is payroll taxes or income taxes. We certainly don't know the 
composition of the income taxes until we see the returns.
    I think calendar year 1999 is the most recent data 
available from the statistics of income----
    Mr. Spratt. Three years, 1999.
    Mr. Crippen. Calendar year 1999, I think. Right?
    Yes.
    Mr. Spratt. Are you watching the flows coming in on the 
daily Treasury reports now?
    Mr. Crippen. Yes, sir. Unfortunately, yes.
    Mr. Spratt. What is happening?
    Mr. Crippen. That is what I was trying to address a little 
earlier. Clearly we are well below what we expected and what 
Treasury expected.
    Apparently what is happening is that the tax base, both 
taxable income and corporate profits, is not growing. In fact, 
it is at the moment probably declining a bit, certainly not 
growing anywhere near what the GDP numbers look like.
    We had, as you know, a 5-plus percent growth in what GDP 
reported for the first quarter, some of which was inventory 
balance, but still some positive, real GDP growth. That is not 
being reflected certainly in the tax revenues and, therefore, 
not in the tax base. We expect that there is a significant 
change in the so-called ``statistical discrepancy'' between GDP 
and income. There will be a downward revision, we think a 
substantial one, in July in both of the historical tax base 
numbers.
    Assuming that revenue collection is roughly contemporaneous 
with the development of the tax base, what we are seeing is a 
much weaker recovery than the GDP numbers so far have 
indicated. Again, we are not sure--I don't know if anybody is--
that that is a one-time temporary phenomenon that happened to 
be this month, when we expected more revenues, or whether it is 
going to persist through the year.
    My expectation is that this will, of course, change. We 
aren't going to lower the tax base throughout the course of the 
year, but it will mean we are going to start again growing 
revenues from a lower base than we expected, which will give us 
fewer revenues over the next year or two, at least as we look 
forward.
    So the historical numbers are going to be adjusted down; 
the tax bases are not growing as fast as the GDP numbers.
    Mr. Spratt. But you can't tell now whether or not we have 
lost that lucky phenomenon of taxable revenues growing faster 
than taxable incomes?
    Mr. Crippen. We cannot.
    Mr. Spratt. Capital gains flows, one last question. Bill 
Gale will testify in a little while, and he will say that one 
of the problems we built into law, the Budget Enforcement Act 
and elsewhere, namely, we have defined how you baseline and 
project such that we artificially misstate the budget.
    For example, we assume that expiring tax provisions that 
are popular and almost always renewed will not be renewed; and 
when you have something like the tax termination in EGTRA, that 
has major implications, particularly for the outyears.
    We ignore the trust funds. We treat the trust funds--we 
amalgamate them, consolidate them with everything else, and 
treat them as though they were ordinary revenues; and then 
finally we have got a cash budget. And yet we have programs 
that are like defined benefit programs, refused, unfunded 
liabilities, and we don't have any kind of institutional means 
of sort of backdropping the budget against those long-term 
liabilities and informing the process every year of what looms 
in the near future in the way of future liabilities.
    Would you agree that those are deficiencies in the budget, 
and if so, is there a way we can fix them?
    Mr. Crippen. I would agree there are different deficiencies 
in an ideal world. You are tempting me to put up my usual chart 
of how much Medicare and Social Security are going to cost us 
in the long run, but I won't do that right now.
    There certainly can be changes. You and the chairman agree 
that things like one-time expenditures misstate what the 
baseline is, or expiration of tax provisions that everyone 
knows, in some sense, are going to be renewed.
    But I don't know that, again, you want us trying to make 
those determinations. I think you may want to change the rules 
to give us some criteria for making determinations about what 
you consider to be one-time expenditures or what you consider 
in the tax code to be more or less permanent no matter what the 
expiration date.
    Let me give you an example, though, of the kind of 
uncertainty for many real world things we would face. The 
alternative minimum tax, affects something like 2 million 
taxpayers now--there was a slight fix in last year's bill that 
expires, I think, in 2004. But if I recall our projections, we 
are going to end up, without a change in law, with something 
like 30 million taxpayers--the number rises from 2 million to 
32 million--covered by the alternative minimum tax. That is, I 
assume, an outcome that is not politically palatable.
    Something will happen to the AMT to mitigate that increase, 
but what? A complete repeal? A modification? When will it take 
place? To whom will it apply? Those are all questions in the 
political process that you will answer, but I am not sure we 
are in a very good position to predict what, where, and when.
    So certainly, in that sense, the criticism of our baseline 
about its being unrealistic, which is often the term used, is 
true. It doesn't include what may be apparent political 
predictions that others can and do make, but I don't know that 
you want us making them.
    Mr. Spratt. Thank you very much.
    Chairman Nussle. Thank you, Mr. Spratt.
    I hope your testimony particularly on the receipts coming 
in is communicated over to the ongoing process with the 
supplemental appropriation, because if this isn't the mother of 
all warning signals to the spenders around here about keeping 
that bill within the fences, I don't know what is.
    Mr. Gutknecht.
    Mr. Gutknecht. Mr. Chairman, I apologize. I have been in--
we have a debate going on on the floor, and I have another 
meeting I have to go to.
    But I want to thank you, Dr. Crippen, for coming up here. 
It is sort of like that ad we used to have for the after shave 
where they got slapped in the face and the fellow says, 
``Thanks, I needed that.'' I want to echo what the chairman 
just said, because it is almost like one of those monster 
movies, as we watch the development of this, quote, ``emergency 
supplemental bill.''
    It certainly is a supplemental bill. I am not sure what is 
an emergency, but it seems to be growing by the hour; and what 
I have learned in my time on the Budget Committee is, we do 
seem to have some control over how much we spend. It really is 
debatable how much control we have in terms of the revenue that 
comes in.
    We can pass tax relief. Clearly, I think--in view of what 
has happened and what is happening in the economy--it would be 
stupid for us to even consider the idea of raising taxes. I 
think that would make a bad situation worse. But I do think we 
have a lot of control over spending, and I suspect that, or my 
view is that we ought to revisit even our own budget resolution 
and make some adjustments in terms of how much we are going to 
appropriate over the next several years.
    Because I do agree that my view--and since most of what I 
have heard so far today is more opinion than fact--opinions are 
like belly buttons, everybody has one--so I will share mine.
    I think we have lived in somewhat of a false economy for 
several years, especially as it related to revenues, and I 
think it was generated in part by what we might call the ``dot 
com'' phenomenon. I am familiar, for example, with one example 
in my home State where if you guys invested probably less than 
a million dollars, within 12 months they essentially sold the 
idea for $450 million.
    Now, that story actually got repeated more often than you 
might think in the last several years, and I think that was 
artificial. I don't know if that idea was worth $450 million. 
Maybe it was; it certainly isn't today. And we saw an awful lot 
of that, and as a result, a number of those people who cashed 
in on those deals paid a lot of money in taxes. I think those 
days are behind us.
    But I think the other story that we need to bear in mind, 
and I think it is a bigger story than anybody has talked about, 
is the amazing resiliency of the American people and the 
American economy. If you think about where we were back on 
September 15, let us say, with what was happening in the world, 
what was happening here in Washington, and what had happened in 
New York City and the fact that we were already probably well 
into at least an economic slowdown, whether we used the term 
``recession'' or not--but clearly, when you look at the 
situation we were in then, it is amazing to see where we are 
today.
    I don't know if the economy really grew at 5.8 percent in 
the last quarter, but it is clear that it did grow much faster 
than people imagined.
    You mentioned productivity. I think that, in fact, 
productivity, there is almost an inverse relationship with 
unemployment. I look at, for example, the airlines. Virtually 
every plane that I get on right now is absolutely full, 
virtually every seat is full; and I think the reason is, the 
airlines have cut down the number of flights to some degree, 
and the number of passengers is going up. So you are going to 
see the efficiency of the American economy probably look 
better.
    But as we go forward--and I agree with the chairman--we 
have got to get this message over to the congressional 
leadership on both the House and Senate side, to the 
appropriators on both the House and Senate side, because the 
idea that we can afford to just pass 31, 32--it is almost like 
an auction--tomorrow it will be a $33 billion emergency 
supplemental. I think we have got to have some long discussions 
about that.
    I appreciate your testimony. Again, I would remind you that 
it might be helpful for you to visit with one of our former 
colleagues, a Congressman from the State of Wisconsin, who 
historically actually did a better job than almost anybody of 
predicting where the economy was going. He actually turned 
relatively bearish about mid-year last year. I don't know if 
investors followed his advice, but if they did, they came out 
very well. But Congressman Neumann did a very effective job of 
charting where revenues were going and where they will go in 
the future.
    We hope, as you go forward you, will update your models, 
using some kind of regression analysis.
    The most disturbing thing I have learned today is how far 
behind we are in terms of getting accurate data of where we 
think we are today; and without accurate data--I mean, we make 
bad enough decisions with good data. When we are 3 months, 6 
months, 12 months behind, it makes it really difficult.
    So I think, mostly, the questions I was going to ask have 
been asked, particularly by the ranking member, so I thank you 
for coming up, and we look forward to working with you.
    Chairman Nussle. Just in case I didn't do it earlier, 
members by unanimous consent will have 7 legislative days to 
submit questions for the record.
    Mr. Price.
    Mr. Price. Thank you, Mr. Chairman.
    Welcome back to the committee, Dr. Crippen.
    Mr. Crippen. Always good to be here.
    Mr. Price. Glad to have you here.
    Let me take up this dynamic scoring issue in one of its 
aspects, and that is the degree of uncertainty that accompanies 
these techniques and the implications they have for your work. 
I think almost anybody would agree that dynamic scoring would 
be a good thing if we could do it precisely.
    If we could know the economy's actual response to policy 
changes with certainty, that would be useful. However, 
economics is often not that precise, and macroeconomics is one 
of its least precise branches.
    Budget scoring rules, unfortunately, don't allow for much 
certainty. The budget process is premised on point estimates 
for budgetary costs rather than the ranges within which costs 
might fall--triggers, caps, targets, et cetera, they are either 
met or not. The rules don't allow one merely to come close to 
meeting these various standards, or at least they should not. 
Of course, budget decisions are made in a highly charged 
political environment, and the combination of the imprecision, 
often, of economics and the budget rules requiring precision 
creates a volatile situation.
    There is a great temptation to claim dynamic benefits for 
any and all policy proposals. Advocates of a particular policy 
could use adulterated economic analysis, competing experts or 
sheer obfuscation to pressure CBO to score their proposals 
favorably. Stakes in the game are especially high, because 
relatively small changes in projected growth have huge 
consequences for outyear deficits. And the politics are 
especially dangerous because the largest budgetary consequences 
do not occur until long after the policy changes are made.
    So, with those comments, those observations, let me ask you 
some questions about how much consensus exists within the 
economic profession about the economic effects of tax changes, 
for example, on productivity growth; or is there a range of 
opinions? For example, do economists have a fairly precise 
estimate of the effect of the so-called ``supply side'' tax 
cuts of the early 1980s, the effect they had on productivity 
growth, or is there a wide range of opinion?
    Mr. Crippen. There is certainly a range of opinion and 
estimates. I think, if I might add to your question just 
slightly, the ability to make those assessments even after the 
fact is limited because you have a confluence of a lot of 
events; and to know what caused what is very difficult because 
of, as you said, the imprecision of our forecasting or 
estimating capabilities. And there are anecdotal relationships, 
but we don't know that they are correlated.
    I mean, the tax cut of 1981 was followed by a tax increase 
in 1982, which was followed by the second longest peacetime 
expansion in history. Now, what caused what? Certainly most 
economists wouldn't say that tax increases help economic growth 
in the long run, but there is at least that juxtaposition of 
occurrences.
    But in addition to the imprecision of our ability to 
estimate the relationships, which is what you were getting to, 
it is true that that is theory. The models all require that you 
make assumptions about future fiscal policy, and I think that 
is probably the hardest thing.
    We could, perhaps, with enough regressions and enough 
computer capacity, ferret out some of the effects of marginal 
rate cuts on productivity and other things and be confident, or 
somewhat confident, about the numbers we attach to them. But 
that won't do us any good unless we know what future fiscal 
policy is going to be in the counter-factual scenario one must 
develop.
    So it is not just the imprecision that you allude to that 
is there--we could overcome some of that, perhaps--but it is 
the inability or probably the inappropriateness of our making 
political predictions about what the next 10 years will look 
like in terms of fiscal policy.
    Mr. Price. What about the investment side or spending side? 
Do we know the effects of public investment with any greater 
precision than we know the effects of various kinds of tax 
policy? Is the situation here the same as with taxes where some 
say the effects are large and others say they are small or 
nonexistent?
    Mr. Crippen. We found, I think, a 1995 analysis by CBO that 
looked at productivity or the economic effects, macroeffects, 
of public investment. A lot of it focused on infrastructure 
because, you may recall, the debate at the time was that we 
needed more infrastructure, spending on highways and those 
kinds of things. We found very little relationship between 
public Federal spending on infrastructure and any effects on 
the economy.
    There are certainly things that you would think as a matter 
of common sense and theory helped, whether it is investment in 
education, maybe human capital and other things, but that is 
even harder to measure than anything we try to measure now. So, 
at the moment, there is probably, if I had to make a guess, 
less evidence on the spending side for macroeconomic 
stimulation or improvement than there is on the tax side.
    Mr. Price. Mr. Chairman, if I may wrap up with one comment 
and a final question.
    In the face of this kind of imprecision both on the tax 
side and the spending side, I think the temptation is all the 
greater on the part of legislators to justify their proposals 
on the basis of wondrous but unproven projected benefits.
    Is it your view that it is more prudent to stick with the 
current procedures, which are conservative in the truest sense 
of the word? Perhaps there we are risking the possibility that 
we will be pleasantly surprised that the budget isn't better 
than expected if these supply side benefits actually 
materialize.
    Mr. Crippen. I do, Mr. Price. That is not to say that we 
can't improve what we do now in the scoring of bills, but I 
also think it is important that we continue to provide and do a 
better job, if we can, of reporting to Congress what the likely 
macroeconomic effects of different legislative proposals might 
be. That is different from making a firm, precise prediction of 
how much the economy is going to grow because you are going to 
do something today, and how much effect that will have on the 
budget.
    What I am suggesting is, we can give you analysis of what 
kinds of tax cuts are likely to help the economy grow, what 
effects big pieces of legislation might have, but not put 
precise numbers down for every year for the next 10 years as 
some kind of feedback or offset for any revenue loss or 
spending increase. I think what we do now is better than trying 
to include dynamic effects in the scoring process itself, but 
we can do a better job of informing Congress of what some of 
those dynamic effects might be.
    Mr. Price. Thank you.
    Thank you, Mr. Chairman.
    Chairman Nussle. Thank you, Mr. Price.
    A couple of things that have come up in some of the 
questions. One is going back to the issue of CBO requiring a 
change in the law in order to consider, for instance, one-time 
expenditures. Let us assume for a moment that that is difficult 
to achieve, in other words, some type of a one-size-fits-all 
provision that defines how----
    Mr. Crippen. Yes.
    Chairman Nussle [continuing]. I think that is what you were 
saying, that is hard to do. What would be a fall back position? 
Would it be appropriate, for instance, to insert in an 
emergency supplemental--let us take the one we are talking 
about now--that the following items are one-time expenses and 
the other items are proved--or whatever the right technical, 
legal-beagle language you have got to put in, are proved for 
the purposes of computing the baseline? What does CBO need to 
see in order for you to make a change?
    Mr. Crippen. Like you, I am not sure what the exact words 
are, but something that said these are to be considered as one-
time expenditures in CBO's development of a baseline, I think, 
would probably cover us.
    Is that right? Because it would be signed by the President.
    Chairman Nussle. We won't hold to you that head nod, but I 
am sure there are other people we----
    Mr. Crippen. That would go a very long way because you will 
have said we expect this, we, the Congress, are voting for and 
enacting this expenditure on the basis that it is one time.
    Chairman Nussle. Why isn't the emergency designation itself 
enough because of the definition of being one-time, 
unanticipated, et cetera, et cetera, kinds of expenditures?
    Mr. Crippen. Currently, we are not given the leeway, if you 
will, to say an emergency appropriation will not be repeated. 
It gets by the rules, by the law, and gets built into the 
baseline.
    Chairman Nussle. The one rule was written before the 
current rule on emergencies.
    Mr. Crippen. Yes.
    Chairman Nussle. So why wouldn't the fact that we now have 
a new procedure called ``emergencies,'' that is defined as a 
one-time expenditure, not be enough?
    Mr. Crippen. It didn't change the manner by which we build 
the baseline. Essentially, you take this year's expenditures in 
total, whether they are emergency or nonemergency doesn't 
matter, and inflate that total because it is taken as current 
policy.
    Chairman Nussle. The other question I have is--and I 
appreciate that. I just am searching for----
    Mr. Crippen. I understand. And that would tell us what you 
consider to be one time and that would certainly meet our 
standards.
    Chairman Nussle. Going to what Mr. Price was saying, and 
maybe this is not what he was on to, but it did ring with me in 
a particular way. There are some States in the country that 
budget based on a percentage of the overall, whatever it is, 
last year's revenue take or some dynamic of some sort that 
measures that, some formula; and you have talked about the fact 
that while inaccurate, we are talking about very small 
percentages here. Obviously, those percentages add up to a huge 
amount of money, but in the context of the overall dynamic of 
$20 trillion you were talking about, we have a fairly small 
percentage.
    Would there be any industry at all, in considering using 
some formulation of a budget that only provided for the use of 
a certain percentage of the revenue, where that was determined 
by actuals rather than projections?
    Mr. Crippen. Sure. Unfortunately, I suspect you are more 
correct than not that the current budget process has had its 
25- or 27-year run, and it is going to be replaced with 
something or mutated into something different. Some of the 
things you may well want to consider are those kinds of things.
    The Budget Committee currently has the authority, of 
course, to tell CBO to develop an alternative baseline. What 
you use is up to you, in effect. So you could say for your 
purposes, for the budget resolution purposes, you want a 
revenue number based on last year's revenues, plus or minus. 
That wouldn't preclude us from doing something different as a 
baseline, but the baseline is really less to forecast this 
year's revenue than it is to measure changes against it. So it 
wouldn't, I think, impede the process.
    I don't know if my colleagues are shaking their heads or 
not behind me, but----
    Chairman Nussle. Actually they all left. They are outside 
the door now.
    Mr. Crippen. I expect there are several of those kinds of 
things you could do now that may be very useful as an 
alternative to the kind of budget process we have had, if we 
can't pass budget resolutions in their current form. We need 
something to replace it, and maybe something that you are 
suggesting here would be a useful place to start those changes.
    Chairman Nussle. One other thing that came to mind, I 
think, during Mr. Gutknecht's questions, when you and others 
reported last year prior to September 11 and prior to a clearer 
understanding of the direction of the economy vis-a-vis the 
recession that many now are pinpointed to March, April or May 
of 2001, when you reported to us the baseline and projections, 
we were told within the fan chart, as I recall, that there was 
built into those projections about a $100 billion revenue loss 
based on a perceived or potential recession.
    So I guess part of what I am--and maybe this isn't a 
question, but a concern--is that you might be off, plus or 
minus, based on actuals. But it was also a projection that 
built in a certain amount of fudge factor, so that it was 
further away to some extent than even we are talking about here 
today, because built into that was a mild--at that point, 
determined a mild or moderate recession.
    I don't want to put words into anybody's mouth, but it is a 
concern that the recession last year--Mr. Spratt was on this 
line of questioning, that the projection was even arguably 
further away, based on the fact that there was some give in the 
numbers on this $100 billion revenue hit based on this 
recession.
    Do you have any comment on that?
    Mr. Crippen. As a matter of process, we can't and don't try 
to predict turns of the economy, a recession or recovery, the 
points of that; but over a 10-year span we expect there is 
going to be one recession as a rule of thumb. And what we did 
for the baseline that you are referring to is we took the 1991-
92 recession roughly and said, ``What if that happens sometime 
during this 10 years?'' And I suspect we did a mid-year, 5-, 6-
, 7-year, somewhere in there----
    Chairman Nussle. Actually, my understanding, it was years 1 
and 2.
    Mr. Crippen. More important--was it one or two?
    Chairman Nussle. That is what concerns me and others.
    Mr. Crippen. In fact, if we hadn't done that, our 
projections would have been even further off.
    Chairman Nussle. That is what I mean.
    Mr. Crippen. Yes. So the question is whether that modeled 
recession, as typical, is a good one, and we don't know.
    One of the things we changed here, that we modeled, was the 
change in the tax base--how much taxable income, wages and 
salaries and corporate profits, would go down during a 
recession. But what is happening to us now, with revenue 
dropping even faster than the tax base, means we are changing 
effective tax rates. We didn't model, nor do I know we could, 
the changes in effective tax rates we have seen here.
    Every recession is unique. This one is particularly so 
because it wasn't initiated--the catalyst wasn't the tightening 
of monetary policy that we typically see that kicks the 
economy. It was caused by a fall-off of capital investment, 
mostly by corporations. Consumer demand was actually relatively 
robust and, as we have seen, productivity is relatively robust.
    But something is happening that we don't yet know in terms 
of the effective tax rate or the average tax rate of these 
revenue sources, and in this recession they changed much more 
dramatically than in 1991-92. So we modeled or included that 
past recession, but it was obviously not emblematic of what we 
are experiencing now.
    Chairman Nussle. Even before--and this is maybe more candid 
than I ought to be, but I was using your argument trying to do 
battle with John Spratt, saying, ``wait a minute, you don't 
have to be quite that pessimistic even though he was warning 
us, because we built into this a $100 billion recession,'' 
which was--1990-92, I don't think anybody would have said that 
was a mild recession. That was a pretty significant recession, 
or at least moderate, recession; let us call it that, middle of 
the road.
    So in making those projections, if you build that into it, 
that is pretty good wiggle room, so to speak. At least we 
thought so in January. So that is why, I guess, when we talk 
about projections and accuracy, using those arguments, building 
in a certain amount of fudge factor for the economy, knowing 
that it could in fact be a problematic recession, we are using 
those as we are making arguments and making decisions. And when 
we are wrong--in this instance, it was really wrong, and that 
was even prior to September 11. Certainly, September 11, nobody 
is predicting--you don't have any analysts who can predict 
that.
    Mr. Crippen. I hope not.
    Chairman Nussle. But at least from a recession standpoint 
those were arguments and those were issues that were used and 
relied upon, and it has made it, obviously, very difficult.
    So do other members wish to inquire? If not, this is a 
start, as we said.
    Mr. Crippen. Sure.
    Chairman Nussle. As I said before to you, and to your top 
staff in particular, we appreciate the responsiveness that you 
always give to us on these big questions. We want to get into 
the weeds a little bit further as we go, and I will have some 
questions that I would like to submit for the record so that we 
can talk about some more of these topics. But we appreciate the 
time you have given us today and the chance to review some of 
these topics and we will continue to do this on an ongoing 
basis.
    Mr. Crippen. As your schedule permits, I would like to take 
you up on your offer to come over and have lunch with all of 
us, and put some faces on names and things like that, and see 
what the Ford House Office Building looks like. You might bring 
your colleague, Mr. Spratt, along.
    Chairman Nussle. I think that would be a useful exercise. 
Thank you very much, and again thank you to the many CBO 
employees that are here today to listen and participate in 
this. So thank you.
    For the next panel we have invited three very distinguished 
folks to come, and I think all three have testified before this 
committee. First will be Rudolph Penner from the Urban 
Institute; Kevin Hassett and William Gale will be here as well. 
As is unfortunate at this time in Congress, because of the work 
week, we have a number of markups and hearings and other 
meetings that are occurring, so we have, actually, quite a bit 
of demands on some of these witnesses to testify; and so they 
will be along at some point in the very near future.
    But in the meantime, we have Dr. Penner, who is a Senior 
Fellow from the Urban Institute here to visit with us.
    We welcome you. Your entire testimony will be made part of 
the record and you may summarize as you would like. Thank you 
and welcome.

   STATEMENT OF RUDOLPH G. PENNER, SENIOR FELLOW, THE URBAN 
                           INSTITUTE

    Mr. Penner. Mr. Chairman and Mr. Spratt.
    Chairman Nussle. There is a button on your microphone you 
need to push, I believe.
    Mr. Penner. Mr. Chairman, Mr. Spratt, Mr. Price, thank you 
for the opportunity to testify.
    Few countries give their legislatures as much budgeting 
power as that enjoyed by the Congress of the United States, but 
it is my experience that any legislature will have more 
influence over budget decisions if it can draw on the analysis 
of expert staff. And I think there are major advantages in 
keeping that staff nonpartisan. It lends more stability as 
political power shifts, and that allows the development of 
specialized skills in different areas of public policy.
    A nonpartisan staff often has more credibility with 
outsiders, and although there are exceptions, those analysts 
who try to combine rigorous policy analysis with political 
judgments typically don't do very well with either.
    I am, of course, biased, but I have little doubt that the 
existence of the CBO has greatly increased the Congress' 
capacity to budget and enhance its influence vis-a-vis the 
executive branch. CBO's forecasts give Congress an alternative 
view of the economic and budgetary future. Its cost estimates 
guard against the Congress unwittingly adopting programs whose 
costs are very different in the long run and in the immediate 
future, and its policy analysis helps the Congress decide what 
works and what doesn't work.
    It is inevitable that some of CBO's output will be wrong 
and some of it will be annoying to one political party or 
another, either because mistakes were made or good analysis was 
badly timed. But if one adds up the impressive volume of CBO 
cost estimates, analysis and forecasts, a remarkably high 
portion is noncontroversial and a remarkably low portion 
actually makes people angry.
    I will concentrate the rest of my testimony on a very few 
areas of the CBO responsibility where I have strong views, but 
I would be happy to answer questions about other areas as well. 
I shall focus on CBO's projections of budget aggregates that 
are used to formulate budget resolutions and on the issue of 
dynamic scoring of tax and expenditure policy changes.
    No one forecasts anything very well. That is true whether 
one looks at pundits forecasting the course of the war in 
Afghanistan, demographers forecasting worldwide birth rates or 
pollsters forecasting the French presidential election.
    I recently studied the history of budget forecasting 
errors, and they are pretty discouraging. The average error 
made in the forecast of the budget balances used to formulate 
the budget resolution is over $100 billion for the first year 
covered by the resolution and over $400 billion 5 years out. 
These are errors made because of flaws in economic and 
technical assumptions and don't include the effect of policy 
changes.
    Ten-year projections were initiated only in 1997, so we 
can't test them against reality. But the projection for the 
budget balance in 2007 changed over $800 billion between early 
1997 and the summer of 2000, and if we make the same kind of 
error in our current view of the 2012 budget balance--or I 
should say, change it by as much--it will be altered by a cool 
$1 trillion for that single year.
    Now, the importance of errors of this type depends on how a 
forecast is used. Flaws in economic forecasts are unlikely to 
obscure the qualitative nature of the budget effects of a tax 
cut or entitlement increase; that is to say, if an entitlement 
increase is shown to cost very much more in year 7 than in year 
4 by a good forecast, the same pattern of cost is likely to be 
revealed by a bad forecast as well.
    However, 10-year projections of the budget balance are not, 
in my view, accurate enough for the purpose of formulating a 
budget resolution; and I would very much agree with Dan 
Crippen's sentiment that we should shorten the horizon again to 
5 years. Even that is somewhat tenuous. If you did that, there 
is nothing to prevent the Congress from requesting that CBO do 
an economic forecast for years 6 through 10 that could be 
buried in an appendix somewhere and used to estimate the 
effects of a particular tax or entitlement measure that would 
allow the nature of phase-ins to be observed.
    Because forecasting is inherently difficult, there is not 
much that CBO, the Congress or anyone else can do to greatly 
increase the accuracy of budget forecasts. However, there are 
actions that you can take that might result in minor 
improvements.
    A major frustration facing revenue forecasters that we have 
heard several times today is that it takes a very long time to 
get detailed information on recent tax receipts. CBO and OMB 
will have little information on the causes of the recent 
surprising shortfall in revenues by the time they have to do 
their summer updates of the budget aggregates; and different 
causes for that shortfall will have very different implications 
for long-run revenues.
    Detailed information on 2001 tax returns will not be 
available until October or November, and even that data is not 
accurate. As we heard before, it will take 3 years to have 
really reliable data from those tax returns. Changes in 
reporting could help a lot, and I make some specific 
suggestions in my complete testimony.
    And, in addition, I don't believe that our statistical 
agencies have the budgets necessary to produce high-quality 
statistics. It is very difficult to make a decent forecast of 
the future if you can't even forecast the past; and we see huge 
revisions in the official data from time to time.
    Many of the deficiencies in official estimates that are 
related to budget forecasting could be ameliorated with minor 
infusions of money. The administration has requested a healthy 
increase in the Department of Commerce budget this year for 
statistical purposes, and I hope that this committee can use 
its influence with appropriations to see that go through.
    Again, I want to emphasize that better and more timely 
historical data will not enormously improve the accuracy of 
forecasts. It won't help us predict another terrorist attack or 
a Mideast oil embargo or things of that nature that have a huge 
influence on the future, but it may occasionally save us from 
making some very big mistakes; and in my view, that would be 
worthwhile.
    Turning to dynamic projections, for many years the Congress 
has been frustrated by the inability of the Joint Committee on 
Taxation or the CBO to provide a complete accounting of revenue 
and outlay effects of behavior responses to policy changes. It 
is commonly believed that no behavioral responses are 
considered. That is not true. For example, revenue estimators 
would take account of an effect of the change in the gasoline 
tax on the demand for gasoline, but they do not go further and 
estimate the impact on GDP or the CPI or on other macro-
variables.
    There is nothing to prevent CBO from doing studies to 
inform the Congress of the findings of academics and others as 
to the complete dynamic effects of specific policy changes, and 
in fact, CBO has done such studies on capital gains tax rate 
changes and other things.
    But in addition to the problems raised by Dan Crippen, I 
would like to emphasize some real practical management problems 
involved in doing dynamic scoring for a complex tax or 
reconciliation bill.
    Such a bill usually contains numerous provisions, some pro-
growth, others anti-growth. Dozens of technicians often work on 
different provisions of the bill simultaneously at Joint Tax 
and at CBO. If he is doing a dynamic scoring, analyst A may 
decide that his provisions increase the GDP growth rate next 
year by a tenth of a percent. That should force every other 
analyst working on the bill to change their estimates.
    Two hours later, analyst B might decide that her provision 
reduces growths by two-tenths of a percent. Again everybody, 
including analyst A, should be changing their estimate. 
Moreover, every change in the assumed GDP or CPI or the 
unemployment rate will affect almost every other type of 
estimate made throughout the budget, whether or not it is 
affected by the legislation under consideration.
    The budget baseline would have to be recomputed with every 
significant piece of legislation, and as Dan emphasized, the 
management problem is made even more difficult by the fact that 
the Congress often makes important changes in the language of 
bills at the last minute, and much of the CBO scoring effort 
takes place very late at night and sometimes lasts through the 
dawn.
    Congress would, I think, find it difficult to deal with an 
ever-changing baseline. Before Gramm-Rudman, the Congress used 
to change its baseline with the summer budget update provided 
by CBO, but that would change the estimates attached to all 
pieces of legislation then being considered. It was decided 
this was too disruptive to bargaining over the details of 
bills, so the Congress decided at that point to keep the spring 
baseline through the whole year.
    Mr. Penner. Apparently there are discussions about adding 
statements to the text of cost and revenue estimates where 
there might be an important effect on macro-variables. These 
would be separate from official numerical estimates. Probably 
it will be practically necessary to confine those statements to 
qualitative rather than quantitative statements; nevertheless, 
that may be helpful to the Congress.
    If CBO and Joint Tax start making judgments about 
macrovariables that would supplement official cost and revenue 
estimates, they will have one more activity that will make 
people angry. They will have to make some very unpopular 
statements. For example, good analysis will show that there are 
some tax cuts that decrease growth and some tax increases that 
increase growth.
    I am thankful that I won't be answering questions from 
members about such judgments. Thank you very much.
    Mr. Sununu [presiding]. Thank you very much, Mr. Penner.
    [The prepared statement of Rudolph Penner follows:]

   Prepared Statement of Rudolph G. Penner, Senior Fellow, the Urban 
                               Institute

    Mr. Chairman, Mr. Spratt and members of the committee, thank you 
for the opportunity to testify.
    Since leaving the Congressional Budget Office (CBO), I have had the 
opportunity to work on budgeting issues in a number of countries. It is 
remarkable how many different constitutional arrangements exist for 
dividing budgeting power between the executive and legislative branches 
of government. But few countries give their legislatures as much 
budgeting power as that enjoyed by the Congress of the United States.
    Regardless of a legislature's constitutional power, its actual 
influence over budget decisions can be enhanced if it can draw on 
analyses done by an expert staff. That is true even in parliamentary 
systems where the executive branch has most constitutional power. But 
obviously, the analytic input from such a staff is most crucial where 
it is the legislature that is most important in making budget 
decisions.
    There are major advantages in keeping the expert staff nonpartisan. 
It lends more stability as political power shifts and that allows the 
development of specialized skills in different areas of public policy. 
A nonpartisan staff often has more credibility with outsiders, and 
although there are exceptions, those analysts who try to combine 
rigorous policy analysis with political judgments typically do not do 
well with either. It is better to let analysts be analysts and to let 
elected politicians decide which of the analytic results can be sold to 
the voters.
    I am, of course, biased, but I have little doubt that the existence 
of CBO has greatly increased the Congress's capacity to budget and 
enhanced its influence vis-a-vis the executive branch. CBO's forecasts 
give the Congress an alternative view of the economic and budgetary 
future; its cost estimates guard against the Congress unwittingly 
adopting programs whose costs are very different in the long run than 
in the immediate future; and its policy analysis helps the Congress 
decide what works and what doesn't work.
    It is inevitable that some of CBO's output will be wrong and some 
of it will be annoying to one political party or the other, either 
because mistakes were made or good analysis was badly timed. But if one 
adds up the impressive volume of CBO cost estimates, analyses, and 
forecasts, a remarkably high portion is non-controversial and a 
remarkably low portion really makes someone angry.
    I shall concentrate the rest of my testimony on a very few areas of 
CBO responsibility where I have strong views, but I would be happy to 
answer questions about other areas as well. I shall focus on CBO 
projections of budget aggregates that are used to formulate budget 
resolutions and on the issue of dynamic scoring of tax and expenditure 
policy changes.
                            budget forecasts
    No one forecasts anything very well. That is true whether one looks 
at pundits forecasting the course of the war in Afghanistan, 
demographers forecasting worldwide birth rates, or pollsters 
forecasting the French presidential election. It is particularly 
difficult to forecast the budget balance, because one does not forecast 
it directly. One forecasts two much larger numbers--revenues and 
outlays--and takes the difference. Relatively small percentage errors 
in forecasting revenues and outlays thus imply very much larger 
percentage errors in forecasting surpluses or deficits. For example, in 
2001, revenues totaled $2 trillion and the surplus $127 billion. Every 
1 percent error in forecasting the former implied a 16 percent error in 
forecasting the latter.
    I recently studied the history of errors and I would like to submit 
my results for the record. They are pretty discouraging. The average 
error made in the forecast of the budget balance used to formulate the 
budget resolution is over $100 billion for the first year covered by 
the resolution and over $400 billion 5 years out. These are errors made 
because of flaws in economic and technical assumptions and do not 
include the effect of policy changes. (They are also adjusted for the 
growth in the economy). Ten-year projections were initiated only in 
1997; so we cannot test them against reality. But the projection for 
the budget balance in 2007 changed over $800 billion between early 1997 
and the summer of 2000--an amount equal to more than five times the 
value of the 2001 tax cut in 2007. If our view of the 2012 budget 
balance changes by a comparable amount over the next 3\1/2\ years 
relative to GDP, it will be altered by a cool $1 trillion for that 
single year.
    The importance of errors of this type depends on how a forecast is 
used. The 75-year forecast used by the Social Security trustees is 
bound to be off by huge amounts in dollar terms, but it is unlikely to 
be wrong about its basic qualitative conclusion that the economic 
burden of supporting the Social Security system will rise rapidly 
between 2010 and 2030. Similarly, flaws in economic forecasts are 
unlikely to obscure the qualitative nature of the budget effects of a 
tax cut or an entitlement increase. That is to say, if an entitlement 
increase is shown to cost very much more in year 7 than in year 4 by a 
good forecast, roughly the same pattern of costs is likely to be 
revealed by a bad forecast as well. Put yet another way, forecasts of 
changes in a baseline due to policy changes are likely to be more 
accurate than forecasts of the baseline itself.
    But I believe that the Congress asks for too much when they ask CBO 
for a 10-year projection of the budget balance for the purpose of 
formulating a budget resolution. The projected budget balance is too 
erratic from year to year to be used for that purpose. Five years is 
about the outside limit for a budget resolution and even that is 
tenuous. (I realize that the House emphasized the first 5 years in this 
year's resolution). There is nothing to prevent the Congress from 
requesting that CBO do an economic forecast for years 6 through 10 that 
would be hidden in an appendix somewhere and pulled out to estimate the 
effects of a particular tax or entitlement measure. That would allow 
the nature of phase-ins to be observed. But I would not compute a 
budget balance 10 years hence and put it in a budget resolution, 
because that is essentially a useless exercise.
    Although errors in forecasts are likely to be huge, there is one 
custom that tends to make forecasts seem even more volatile than they 
really are. CBO, the press and the public discuss the cumulative budget 
balance over five or 10 years. That is likely to change by hundreds of 
billions from forecast to forecast and that seems like a lot of money. 
But adding the budget balance for 1 year out to that for 5 years out 
makes no sense, because the latter is so much less reliable than the 
former. It is truly adding apples and oranges. I wish CBO would expunge 
the columns from their tables that indicate cumulative totals, but the 
custom of using them has become so entrenched that I know that I am 
fighting a losing cause.
                       improving budget forecasts
    Because forecasting is inherently difficult, there is not much that 
CBO, the Congress, or anyone else can do to greatly increase the 
accuracy of budget forecasts. However, there are actions that might 
result in minor improvements.
    A major frustration facing revenue forecasters is that it takes a 
very long time to get information on recent tax receipts. CBO and OMB 
will have little information on the causes of the recent surprising 
shortfall in revenues by the time that they have to provide budget 
updates next summer. Different causes can have very different long-term 
implications, detailed information on 2001 tax returns will not be 
available until October or November, and even that data will not be 
perfectly accurate.
    Changes in reporting could help a lot. For example, corporations do 
not immediately divide their tax payments between payroll and profit 
taxes. If they were asked to report HI tax collections--a proportional 
tax--revenue estimators would immediately have valuable information on 
total earnings in the corporate sector. Further valuable information 
would come from reporting stock options on W-2's for individuals or in 
the aggregate for a corporation. Of course, any increase in reporting 
comes with a compliance cost imposed on business, but I believe that 
these suggestions would not be very costly. It is also possible that a 
small infusion of money into the IRS could expedite the processing of 
returns, so that revenue estimators would not have to wait so long for 
basic information.
    In my view, our statistical agencies do not have the budgets 
necessary to produce high quality statistics. Canada does better. 
Fundamentally, the Bureau of Economic Analysis (BEA) and the Bureau of 
Labor Statistics (BLS) should have more resources for basic research, 
so that their data collection techniques could keep up better with the 
rapidly changing structure of our economy. Of more immediate interest, 
the income side of our GDP accounts that is vital to revenue estimators 
is not given the same attention as the product side that is of more 
interest to business economists and other observers of the economy. 
Although the two sides should be equal in theory, there have been major 
statistical discrepancies in recent years. It is very difficult to make 
a decent forecast, if we have bad information on past history.
    One could go on and on about deficiencies in official statistics 
deficiencies that could be ameliorated with minor infusions of money. 
The administration requests a healthy increase in the BEA budget this 
year. I hope that the Appropriations Committees find a way to fund the 
administration's request.
    Again, I want to emphasize that better and more timely historical 
data will not enormously improve the accuracy of forecasts. It won't 
help us predict another terrorist attack or a Mideast oil embargo. But 
it may occasionally save us from a big mistake and that would be 
worthwhile.
              estimating revenue and expenditure feedbacks
    For many years, the Congress has been frustrated by the inability 
of the Joint Committee on Taxation or the CBO to provide a complete 
accounting of the revenue and outlay effects of behavioral responses to 
policy changes. It is commonly believed that no behavioral responses 
are considered. That is not true. Micro responses play a role in making 
estimates. For example, revenue estimators would take account of the 
effects of a change in gasoline taxes on the demand for gasoline when 
they make the revenue estimate that appears in the report on the 
legislation. They would not go further and estimate the impact on GDP 
or on the CPI or on other macro variables. Thus they miss the impact on 
other revenues because of the effects on GDP growth or tax indexing 
changes, and the impact on outlays because of changes in unemployment 
compensation or because of changes in COLA effects on indexed programs 
like Social Security or food stamps.
    There is nothing to prevent CBO from doing studies to inform the 
Congress of the findings of academics and others as to the complete 
dynamic effects of specific policy changes. In fact, CBO has done such 
studies on capital gains tax rate changes and other things. The 
Congress will probably be disappointed by the wide range of uncertainty 
on such matters, but it is no wider than CBO has to deal with when 
forecasting the economy more generally.
    The real practical problems come if CBO is asked to do dynamic 
scoring for a complex tax or reconciliation bill. Such a bill usually 
contains numerous provisions--some pro-growth and others anti-growth. 
Dozens of technicians often work on different provisions of the bill 
simultaneously at JCT and CBO. If he is doing dynamic scoring, analyst 
A may decide that his provision increases the GDP growth rate next year 
by 0.1 percent. That should force every other analyst to re-estimate 
the effects of their provision whether or not they think their 
provision has any effect on growth. Two hours later Analyst B may 
decide that her provision reduces growth 0.2 percent. Again, everyone, 
including Mr. A should redo their estimates. Moreover, every change in 
the assumed GDP or the CPI or the unemployment rate will affect almost 
every other type of tax revenue and entitlement outlay, whether or not 
it is affected by the legislation. The budget baseline would have to be 
recomputed with every significant piece of legislation. The implied 
management problem is made even more difficult by the fact that the 
Congress often makes important changes in the language of bills at the 
last minute and much of the CBO scoring effort takes place very late at 
night and can last until dawn. Careful dynamic scoring would only be 
possible if Congress allowed several days for scoring instead of 
several hours, and even then it would be extremely difficult, if not 
impossible.
    Another problem is that Congress would find it difficult to deal 
with an ever changing baseline. Before Gramm-Rudman the Congress used 
to change its baseline with the summer budget update provided by CBO. 
That would change the estimates attached to all pieces of legislation 
then being considered. But it was decided that this was too disruptive 
to bargaining over the details of bills. The Congress decided to let 
the earlier baseline be used throughout the year.
    The Congress could do dynamic scoring of individual bills without 
changing the baseline, but this would often lead to illogical and 
inaccurate results. The effect of one program change on the cost of 
other programs can often be substantial. For example, anything that 
changes the CPI has a relatively large impact on outlays for indexed 
entitlement programs and personal income tax revenues.
    Apparently, there are discussions about adding statements to the 
text of cost and revenue estimates where there might be an important 
effect on macro variables. These would be separate from official 
numerical estimates. Probably it will be practically necessary to 
confine the discussion most of the time to qualitative rather than 
quantitative statements. Nevertheless, such statements may be helpful 
to the Congress. Although I bemoan the recent ineffectiveness of the 
Budget Enforcement Act, it must be admitted that pay-as-you-go rules 
created a tyranny of numbers that did not allow the Congress to apply 
much judgment in assessing the value of tax and entitlement measures. 
Now the Congress has more room to decide whether a provision is better 
or worse than the partially static, numerical estimates imply.
    If CBO and JCT start making judgments about macro variables that 
would supplement official cost and revenue estimates, they will have 
one more activity that will make people angry. They will have to make 
some very unpopular statements. For example, good analysis will 
counter-intuitively show that there are some tax cuts that decrease 
growth, and some tax increases that increase growth. I am happy that I 
will not be answering phone calls from Members after such judgments are 
made.

    Mr. Sununu. Mr. Hassett.

    STATEMENT OF KEVIN A. HASSETT, PH.D., RESIDENT SCHOLAR, 
                 AMERICAN ENTERPRISE INSTITUTE

    Mr. Hassett. Thank you very much. It is a great privilege 
to have the opportunity to appear before you today, and I come 
today to provide thoughts on the key considerations associated 
with accounting for all of the dynamic effects with scoring, 
spending and tax proposals. And I have submitted testimony that 
is a good deal longer than what I am about to say, so I 
encourage you to go there if you have questions about things I 
have left out.
    For the majority of proposals, current procedures are quite 
sound. Most new policies are small enough that they would not 
plausibly have a large impact on the economy as a whole. 
However, for some policies, a static procedure clearly provides 
an inaccurate picture.
    The recent debate over the stimulus package provides an 
interesting case in point. The measures adopted were in part 
designed to help the economy recover from recession. The cost 
of the policies, however, was conditioned on the assumption 
that there would be no effect on the economy. If such an 
assumption were reasonable, then the stimulus package would be 
a bad idea. Static scoring methods may bias policy makers away 
from measures that reduce taxes by making the revenue loss 
associated with reductions appear too high, and this is an 
argument we have heard often in town.
    I think, to think about this question, we need to 
understand better perhaps the uses of scoring. Scoring of a 
proposal has two objectives. The first is to provide policy 
makers with a prospective on the likely impact of any proposal. 
The second is to provide policy makers with hard budget numbers 
that can be used when constructing prudent rules to constrain 
irresponsible spending or excessive tax reductions.
    It is worth mentioning that these two objections are often 
in conflict. There is a small body of evidence, for example, 
that positive surprises to government revenue may lead to 
higher government spending. If Congress were to rely upon a 
dynamic score for a tax bill and that score allowed for GDP 
and, therefore, tax revenue to be higher, then one might 
predict that government spending in the current year would be 
less constrained by a dynamic score than it would be by a 
static score.
    Another conflict between the two objectives strikes at the 
core of the responsibility of this committee. A budget rule 
requires the choice of some number, but in order to think 
rationally about the likely impact of a tax policy, one would 
like to be presented with a broad range of estimates, each 
accompanied by a careful explanation of the sources of 
disagreement between it and the other estimates. One would then 
apply one's own judgment when deciding the proper course of 
action, perhaps after consultation with a disinterested 
professional expert--from the CBO, perhaps.
    Such a procedure is commonly relied upon by the Federal 
Reserve when evaluating the impact of both monetary and fiscal 
policy. I used to do it myself when I was there. Professional 
staffers provide board members with careful and neutral 
analysis, often even presenting them with more than one 
estimate--perhaps almost always presenting them with more than 
one estimate. The members ultimately decide for themselves how 
to vote.
    You know, this is worth repeating. The Fed's models are 
subject to the same uncertainties as the CBO's, but they are 
constantly used to influence policy. And why are the Fed's 
procedures so reasonable and those that we currently use to 
evaluate tax policies so unreasonable? I think it is most 
likely because the Fed is more insulated from political 
pressures, and they are not trying to make one number do too 
many things.
    Mr. Penner, in his testimony, talked about the problems 
with dynamic scoring, how if one person changes something, then 
everybody else has to change. But I can tell you that for every 
green book forecast that the Fed does, that is exactly the 
process that people go through, and they keep going until they 
converge and nobody has to change anymore; and so it is not to 
complex you can't do it.
    So it is easy to see, given these conflicting forces, how 
we could arrive at a place where we use a flawed system; but 
the flawed system has real consequences, and it must be 
improved.
    Now, some observers will certainly argue that static 
scoring leads to a world with too few tax reductions, and 
others will argue that static scoring leads to a world with too 
little government spending. If the negative long-run growth 
effects of government spending we accounted for, it might even 
be argued that static scoring leads to too much government 
spending.
    All of these arguments, however, miss the important 
distortion caused--or the most important distortion caused by 
our current system. Because economic analysis is not used to 
demonstrate the benefits of tax and spending proposals, there 
is virtually no force present disciplining policy makers to 
adopt economically sound proposals; we see the unfortunate 
results of this quite often.
    Economists are, I believe, unanimous in the view that a 
well-designed tax system will have as broad a base and as low a 
marginal rate as possible, given a set of revenue and social 
welfare objectives. They believe this because such a system has 
important, positive economic effects. A tax reform like the 
1986 Tax Reform Act, that moves us toward the economic ideal, 
will have positive, long-run growth effects. Alternatively, a 
proposal that narrows the tax base and raises marginal tax 
rates, something that is accomplished by many tax credit 
programs like the ones in the current energy bills, might well 
have negative dynamic effects.
    If decision makers relied upon accurate scores of the two 
types of proposals, then it would be much harder than it is 
today to make their own choice, and a prudent tax policy would 
have a much higher chance of gaining bipartisan support.
    So I have a few recommendations, and these considerations 
suggest, I believe, a number of positive steps that could be 
taken. And my first recommendation is that Congress, as a 
whole, take a cue from the Federal Reserve and rely more 
heavily on its professional staff. When the literature provides 
differing opinions as to the efficacy of a certain policy, 
there is no substitute for a disinterested, professional 
observer who can serve as a referee. The CBO already serves 
this function, updating its forecasts--for example, after the 
President's tax proposal became law last year, and providing a 
dynamic score of its effects after the debate was over.
    Congress could immediately begin a process whereby dynamic 
scores of new proposals are requested in a timely fashion so 
that they can impact the political debate. While the CBO is 
certainly not perfect, the able men and women in the agency 
would certainly respond to criticisms of their approaches over 
time to the extent that the criticisms contained academic 
merit. Any move in this direction, by the way, should include a 
request that the CBO's methods be more transparent than they 
currently are.
    Congress should also recognize--and this is more relevant 
for this committee--that revenue estimates currently serve two 
purposes, and that this double duty is not necessary or 
advisable. The optimal procedure for information revelation may 
be quite different from the optimal procedure for establishing 
budget rules. Absent budget rules, however, the imprecise 
scoring mechanism may have more influence than it should.
    One could think of any number of reasonable rules, for 
example, that would constrain the growth of government spending 
without relying explicitly on real-time revenue forecasts of 
the tax cut of the day. If, for example, spending growth 
targets were set on an ex anti basis, then spending would be 
far less likely to respond positively to positive revenues.
    When setting these limits, this committee would have to 
debate the optimal level of government spending and adjust 
estimates of this level over time in response to new 
circumstances. For example, a reconsideration of the spending 
caps might be mandatory if a deficit larger than some agreed 
upon size emerged. Such careful monitoring creates the 
conditions wherein reliance upon dynamic scoring for decision 
making is quite feasible and would likely be an important part 
of any optimal budget system.
    Thank you very much.
    Mr. Sununu. Thank you very much, Mr. Hassett.
    [The prepared statement of Kevin Hassett follows:]

Prepared Statement of Kevin A. Hassett, Resident Scholar, the American 
                          Enterprise Institute

                              introduction
    Mr. Chairman and members of the committee, it is a great privilege 
to have the opportunity to appear before you today. I am an economist 
who works at the Washington-based think tank, the American Enterprise 
Institute. I have spent a good deal of my research time since I 
completed my dissertation studying the effects of taxation on the 
economy. I come to you today to provide thoughts on the key 
considerations associated with accounting for all of the dynamic 
effects when scoring spending and tax proposals.
                               background
    When the Joint Committee on Taxation (JCT) and the Congressional 
Budget Office (CBO) provide estimates to Congress of the revenue impact 
of a tax package, behavioral effects are only partially accounted for. 
Policy changes are not scored as having an impact on the total level of 
aggregate activity, a key cornerstone of the budget projection. Policy 
changes are scored, however, as having an effect on the composition of 
that activity. For example, if Congress were to consider a bill that 
provided a tax credit for a particular type of equipment, then the JCT 
might assume that firms would employ more of that type of equipment and 
less of a type that does not qualify when calculating the cost of the 
proposal. Total investment spending in the economy, however, would be 
left unchanged by the policy.
    For the majority of proposals, such a procedure is quite sound. 
Most new policies are small enough that they would not plausibly have a 
large impact on the economy as a whole. However, for some policies, 
this procedure clearly provides an inaccurate picture. The recent 
debate over the stimulus package provides an interesting case in point. 
The measures adopted were, in part, designed to help the economy 
recover from recession. The cost of the policies, however, was 
conditioned on the assumption that there would be no effect on the 
economy. If such an assumption were reasonable, then the stimulus 
package would be a bad idea. When designing policy, policymakers must 
keep a careful eye on their cost. Presumably, the stimulus package was 
the size that it was because of the fear that the budgetary 
implications of larger measures might be negative. If a more realistic 
scoring approach had been adopted, the stimulus bill might well have 
been larger.
    Opponents of dynamic scoring most often argue that there is too 
much uncertainty concerning the effects of economic policies for one to 
expect revenue estimates to be reliable enough to make there use 
advisable. They sometimes also argue that political pressure might be 
used to influence the scorers. Others note, however, that this aversion 
to seeking the truth is accompanied by a cost. Static scoring methods 
may bias policymakers away from measures that reduce taxes, by making 
the revenue loss associated with reductions appear too high.\1\ Because 
of this, an increasing amount of attention has been paid to the 
question of dynamic scoring, and a significant amount of progress has 
been made by those investigating these issues.
                          the uses of scoring
    Scoring of a proposal has two objectives. The first is to provide 
policymakers with a perspective on the likely impact of any proposal. 
The second is to provide policymakers with hard budget numbers that can 
be used when constructing prudent rules to constrain irresponsible 
spending or excessive tax reductions. As you know, rules that 
effectively require special overriding actions have often constrained 
Congress's ability to adopt policies that have significant negative 
effects on the budget balance.
    It is worth mentioning that these two objectives are often in 
conflict. There is a small body of evidence, for example, that positive 
surprises to government revenue may lead to higher government 
spending.\2\ If Congress were to rely upon a dynamic score for a tax 
bill, and that score allowed for GDP and therefore tax revenue to be 
higher, then one might predict that government spending in the current 
year would be less constrained by a dynamic score than it would be by a 
static score.
    Another conflict between the two objectives strikes at the core of 
the responsibility of this committee. In order to think rationally 
about the likely impact of a tax policy, one would like to be presented 
with a broad range of estimates, each accompanied by a careful 
explanation of the sources of disagreement between it and the other 
estimates. One would then apply one's own judgment when deciding the 
proper course of action, perhaps after consultation with a 
disinterested professional expert (from the CBO perhaps). Such a 
procedure is commonly relied upon by the Federal Reserve when 
evaluating the impact of both monetary and fiscal policy. Professional 
staffers provide Board members with careful and neutral analysis, often 
even presenting them with more than one estimate. The members 
ultimately decide for themselves how to vote. This is worth repeating. 
The Fed's models are subject to the same uncertainties as the CBO's, 
but they are constantly used to influence policy. Why are the Fed's 
procedures so reasonable and those used to evaluate tax policy so 
unreasonable? Most likely because the Fed is more insulated from 
political pressures, and these make the issue much more complicated.
    In the political process, the opposing sides may decide to agree to 
the use of a specific number for the purposes of debate. Often, the 
competition for the title of ``best estimate'' is extremely tight, and 
the choice of a single number by the professional adviser is an 
unpleasant task. Again, any accurate statement about the likely impact 
of major policy changes will provide a diversity of opinion. If we are 
going to adopt budget rules that rely on one number, which should we 
chose? There are significant costs and benefits associated with any 
number-picking strategy. In particular, the choice of best strategy for 
the purposes of constructing a budget rule appears to have a strong 
impact on the perceptions of policymakers concerning the likely impact 
of the policy. Opponents of President Bush's tax proposal last year, 
for example, often spoke as if the static score of that bill were an 
unambiguous fact established by the JCT. That is, the choice of a 
specific number for revenue estimating purposes necessarily imbues that 
number with too much credibility.
    One additional point is worth making. Supporters of tax reforms 
have often been the strongest advocates of dynamic scoring, but one 
should note that the issue of dynamic scoring is not necessarily 
limited to tax reduction scenarios. The economic literature implies 
that higher government spending can increase short-run economic growth, 
while providing a long-run drag on the economy. If one has a short 
enough time horizon, it is easy to envision scenarios where the dynamic 
positive feedback from higher spending would be scored to be quite 
significant. Again, this suggests that there is a conflict between the 
two objectives. An accurate picture of the effect of spending policies 
would likely relax constraints on government spending that are 
associated with revenue estimates. One could even imagine short-run 
spending binges occurring because of dynamic scoring, whereby higher 
government spending increases estimated GDP and revenue, thereby 
leading to a further increase in government spending.
                       effects of a flawed system
    It is easy to see, given these conflicting forces, how we could 
arrive at a place where we use a flawed system, even before 
consideration of the role of uncertainty. The estimates are used for 
several purposes that are often in conflict. But the flawed system has 
real consequences, and it must be improved.
    Some observers will certainly argue that static scoring leads to a 
world with too few tax reductions. Others will argue that static 
scoring leads to a world with too little government spending. If the 
negative long run growth effects of government spending were accounted 
for, it might even be argued that static scoring leads to too much 
government spending. All of these arguments, however, miss the most 
important distortion caused by our current system. Because economic 
analysis is not used to demonstrate the benefits of tax (and perhaps 
spending) proposals, there is virtually no force present disciplining 
policy makers to adopt economically sound proposals. We see the 
unfortunate results of this quite often.
    Economists are, I believe, unanimous in the view that a well-
designed tax system will have as broad a base and as low a marginal 
rate as possible, given a set of revenue and social welfare objectives. 
They believe this because such a system has important positive economic 
effects. A tax reform like the 1986 Tax Reform Act, that moves us 
toward the economic ideal will have positive long-run growth effects. 
Alternatively, a proposal that narrows the tax base and raises marginal 
tax rates--something accomplished by the many tax credit programs--
might well have negative dynamic effects. If decision-makers relied 
upon accurate scores of the two types of proposals, then it would be 
much harder than it is today to make the wrong choice, and a prudent 
tax policy would have a much higher chance of gaining bipartisan 
support.
                        the role of uncertainty
    There is a great deal of uncertainty among economists concerning 
the likely impact of any specific tax proposal on the economy. 
Consider, for example, the 1997 JCT Tax Symposium, where many of the 
economics profession's most distinguished modelers calculated the 
economic effects of a switch to a consumption tax. Estimates of the 
impact of such a change on real GDP in 2010 ranged from a low of 1 
percent higher GDP to a high of 16.9 percent higher GDP. The mean 
estimate of the impact of such a change was 5 percent, and the mean 
excluding the highest estimate was 2.1 percent. Obviously, the work of 
these scholars defines a fairly wide range of possibilities. Some argue 
that uncertainty concerning these estimates is too large for them to be 
useful. However, if Congress were to consider the adoption of a 
consumption tax, the current system would require the policy to be 
scored using an estimate (zero) that is outside of the range of 
estimates of our best models, effectively substituting an answer we are 
confident is wrong for our best guess.
    When might such caution be sensible? Economists who have studied 
the impact of uncertainty on optimal decision making have found that it 
is also important to track the effect that errors might have in each 
direction. If an error in one direction can lead to an extreme negative 
consequence, for example, then it will be optimal to be very cautious 
and err in the other direction. Such effects are largest in economic 
models that do not allow agents to change their behavior over time. If 
policy decisions today were irreversible, then it might be optimal for 
us to rely upon extremely conservative revenue projections when setting 
future spending, especially if it is believed that negative 
consequences result from high deficits. As it is, however, policy 
changes every year, and a misstep today can easily be reversed in the 
future. In such a circumstance, Congress should optimally consider 
policies that maximize our expected welfare, and not be as excessively 
risk averse as it is under the current system. This reasoning also 
suggests that attempts to commit future Congresses to specific policy 
paths fundamentally alter the problem, and create a world where it is 
more likely to be optimal to be extremely risk averse and rely on 
static scoring.
                            recommendations
    These considerations suggest a number of positive steps. My first 
recommendation is that Congress take a cue from the Federal Reserve and 
rely more heavily on its professional staff. When a literature provides 
differing opinions as to the efficacy of a certain policy, there is no 
substitute for a disinterested professional observer who can serve as a 
referee. The CBO already serves this function, updating its forecast, 
for example, after the President's tax proposal became law last year, 
and providing a dynamic score of its effects. Congress could 
immediately begin a process whereby dynamic scores of new proposals are 
requested in a timely enough fashion that they could have an impact on 
the political debate. While the CBO is certainly not perfect, the able 
men and women of the agency would certainly respond to criticisms of 
their approaches over time to the extent that the criticisms contained 
academic merit. Any move in this direction, by the way, should include 
a request that the CBO's methods be more transparent than they 
currently are.
    Congress might alternatively consider setting up an independent 
body for fiscal policy evaluation, modeled after the Federal Reserve's 
staff. Such a measure may significantly reduce the chance that 
political influence could have an impact on the analysis of the 
economic staff, and might also restrain the tendency for the economic 
analysis to be tied to unrealistic projections of future policies, as 
is now sometimes the case.
    Congress should also recognize that revenue estimates currently 
serve two purposes and that such double duty is not necessary or 
advisable. The optimal procedure for information revelation may be 
quite different from the optimal procedure for establishing budget 
rules. Absent budget rules, however, the imprecise scoring mechanism 
may have more influence than it should. One could think of any number 
of reasonable rules, for example, that would constrain the growth of 
government spending without relying explicitly in real time on revenue 
forecasts. If, for example, spending growth targets were set on an ex 
ante basis, then spending would be far less likely to respond 
positively to a positive revenues. When setting these limits, this 
committee would have to debate the optimal level of government 
spending, and adjust estimates of this level over time in response to 
new circumstances. For example, a reconsideration of the spending caps 
might be mandatory if a deficit larger than some agreed upon size 
emerged. Such careful monitoring creates the conditions wherein 
reliance upon dynamic scoring is quite feasible, and would likely be an 
important part of any optimal budget system.
                                endnotes
    1. From this perspective, the partial dynamic scoring methods used 
may be more biased than a strict static score. For example, an 
Investment Tax Credit for a type of equipment would have a higher cost 
after the Joint Tax Committee accounted for substitution into that type 
of equipment than would be implied by a static score.
    2. Von Furstenberg, Green, and Jeong (Review of Economics and 
Statistics, 1986) use U.S. Federal budget data from 1954-82 to explore 
the relationship of causality between tax revenues and expenditures. 
They find that spending does not respond to changes in taxes but that 
higher spending leads to higher taxes in the future. Anderson, Wallace, 
and Warner (Southern Economic Journal, 1986) use U.S. Federal budget 
data from 1946-83, and also conclude that spending causes taxes. In 
contrast, Manage and Marlow (Southern Economic Journal, 1986) use U.S. 
data from 1929-82 and find that the evidence supports the taxes lead to 
spending hypothesis. Ram (Southern Economic Journal, 1988) uses both 
annual data from 1929-83 and quarterly data from 1947-83, and concludes 
that causality runs from revenue to expenditure. Calomiris and Hassett 
(National Tax Journal, 2002) found that revisions to CBO budget 
forecasts had a significant effect on subsequent spending decisions.

    Mr. Sununu. Welcome, Mr. Gale. I was caught off guard when 
I came in, to see you sitting on my right; but I am pleased to 
have you here, and I look forward to your testimony.

    STATEMENT OF WILLIAM G. GALE, PH.D., SENIOR FELLOW, THE 
                     BROOKINGS INSTITUTION

    Mr. Gale. Thank you very much, Mr. Chairman, Mr. Spratt. It 
is a pleasure to be here. I would like to take my comments in 
reverse order of my written testimony, having heard Dr. Penner 
and Dr. Hassett speak.
    Let me start by saying that I agree with everything that 
Rudy Penner said about CBO: the professionalism, the quality. I 
think they do a tremendous job under sometimes very difficult 
circumstances. And I also want to echo Kevin Hassett's comment 
that the more authority, the more responsibility that is placed 
with CBO or with the independent experts, I think the better 
the outcome will be. You may not always like the budget 
message, but it would be a mistake to blame the messenger for 
that.
    I want to talk about three things. One is whether the 
budget horizon should be shortened to 5 years. Second is a 
variety of issues on scoring. And the third, which I think is 
the most important, but I will save for last, is that, to me, 
the real budget problem is the way we do the baseline, not the 
scoring issues.
    On the budget horizon issue, I think it would be a huge 
mistake to shorten the horizon to 5 years, and think that for 
four reasons.
    One is that in the past year, it is actually the 1 and 5 
year forecasts that have jumped all around, much more than the 
10-year forecast has, and the 10-year forecast, to the extent 
that it did jump, jumped for legislative reasons, whereas the 1 
and 5 year jumped mainly for economic and technical reasons. So 
if uncertainty in the forecast is the criteria, that would 
militate against using the 1 and 5-year forecasts based on 
recent evidence and in favor of the 10-year forecasts. I am not 
arguing that; I am just saying that the uncertainty in the 10-
year forecast is not a good reason to move away from the 10-
year forecast.
    The second reason not shorten the horizon to 5 years is 
that there are events beyond 10 years that we know that we need 
to pay attention to. Social Security and Medicare are two of 
them. To argue that forecasts are just too uncertain suggests 
we could just simply ignore those issues now. I don't think 
anyone takes that view seriously with regard to Social Security 
and Medicare; and if you go out far enough, Social Security and 
Medicare are almost all of government. So if it matters for 
Social Security and Medicare, it matters for the government 
budget as a whole.
    The third problem with shortening the budget horizon to 5 
years is exemplified by the administration's budget this year. 
The administration wants to shorten the budget horizon to 5 
years, but then they propose several hundred billion dollars of 
tax cuts that don't take effect until after the 5-year window 
is over. If you consider shortening the budget window, there 
needs to be some provision that you simply can't propose tax 
cuts that occur after the fact or after the window closes. And 
so I think keeping it at a 10-year window is a sounder decision 
for that reason.
    So for all of these reasons, plus the fact that the Social 
Security and Medicare problems and the long-term fiscal 
problems that they create are long-term, shortening the budget 
horizon is not only a bad idea, it is exactly the wrong way to 
go right now.
    I think the real issue shouldn't be that the budget 
forecasts are uncertain. Everything is uncertain. The real 
issue is how Congress uses those forecasts.
    For example, families have to forecast their financial 
situation 20, 30 years into the future, but no family 
responsibly decides now that they are going to spend all of 
their future income. And so the issue isn't whether you look 
forward. More information has to be better. The issue is how 
Congress uses that information. And I would suggest recognizing 
that the surpluses are uncertain and adopting a proposal that 
Robert Reich suggested last year, which was just to say that as 
you go farther and farther out into the outyears, Congress is 
only allowed to allot a smaller and smaller proportion of the 
surpluses, thereby recognizing that the surpluses are 
uncertain.
    But I don't see any reason why Congress should throw away 
information, especially information that is very useful, given 
the current taxing fiscal situation.
    Alright, let me move to scoring issues. Everyone would like 
to see the cost and benefits of tax and spending proposals 
marked down better. I think there are three issues here, in 
declining order of importance.
    The most important one is interest costs. A proposal that 
raises spending or cuts taxes forces the government to raise 
interest payments because it increases Federal debt. Those 
interest costs are big. If you have a $1-a-year tax cut for the 
next 10 years, the interest costs over the next 10 years are 30 
percent as large as the actual tax cut. And it is very simple 
to add those to the cost of the program; instead of scoring 
that as a $10 tax cut, you would score it as costing $13. I 
think that would be a huge improvement. It would reward 
fiscally sound programs, and I think that that is a very easy, 
simple change that would make a big difference.
    A second issue on scoring is that the budget rules or the 
laws that govern scoring let Congress get away with all sorts 
of timing and budget gimmicks, including slow phase-ins, early 
phase-outs, shifting revenues from 1 year to the next, not 
adjusting the AMT. The tax cut that Congress passed last year 
set appallingly low standards in each of these areas, and there 
is no need for that.
    It would be very simple to fix these by scoring all 
temporary provisions as if they were permanent, by scoring all 
programs as if they were fully phased in within 3 to 5 years, 
and by requiring that tax changes create conforming changes to 
the alternative minimum tax, so a tax cut doesn't push millions 
of taxpayers on the AMT.
    The third issue, and I think the least important with 
respect to scoring, is dynamic scoring. Current budget 
estimates include the impact of taxes on a variety of 
behavioral responses, but not on macroeffects. There is no 
doubt that the macroeffects of policies are important 
considerations. Everyone I know thinks that policy makers 
should consider the macroeffects of tax cuts or spending 
changes absolutely essential.
    The question is whether these macroeffects should be 
crammed into the straitjacket of the budget revenue estimating 
procedures; and my view is that the answer is no, essentially 
because our methods are not ready for prime time. It would take 
a remarkable amount of effort to do, and I think there are two 
other reasons to mention. One is that moving to dynamic scoring 
would exacerbate the tendency to have temporary programs, 
because temporary programs have bigger effects than permanent 
programs within the time period. So it would exacerbate an 
already troubling budget trend. And the other reason is that a 
full dynamic score in most cases just wouldn't make much 
difference.
    My testimony includes estimated dynamic scores of last 
year's tax cut and of fundamental tax reform, and shows that 
the change in tax rates that you get out of dynamic scores is 
basically zero. Maybe you get a half a percentage point. But if 
you are going to do a full dynamic score, you want to include 
the interest costs, as well as the effect on GDP; and for 
example, under almost any reasonable estimate of the economic 
growth effect of last year's tax cut, the interest cost effect 
alone dominates the increased revenues that you get from higher 
GDP.
    So I think it is a low priority to put dynamic scoring in 
the formal revenue process, but I certainly believe that we 
should consider the growth effects of tax and spending policies 
as front and center.
    Let me close with just a couple of words on the baseline 
budget. I think the single most critical budget problem facing 
the Federal Government is that the standard Federal budgeting 
methods seriously misrepresent the financial status of the 
government. I don't want to be melodramatic about it, but we 
have seen in the Enron scandal how private accounting practices 
can seriously misrepresent private financial statuses; and the 
way the government reports its budget is also highly 
misleading.
    My testimony mentions three problems: One is that we 
measure retirement programs on a cash flow basis over 10 years 
and so omit the long-term costs. Second, we have a built-in 
assumption that real discretionary spending will decline 1 
percent per year on a per person basis, which strikes me as a 
shrinking government as a baseline. Third, we assume all the 
temporary tax provisions expire as scheduled, and we assume 
that obvious problems, such as the AMT, will not be addressed. 
Together, these problems lead to vast understatements of the 
likely cost of current policies and vast overstatement of the 
funds that are truly available for new programs and tax cuts.
    I will refer you to a table and a figure in my testimony 
which show that adjusting for these three things changes the 
budget outcome by $5 trillion over the next 10 years, and the 
figure at the back of my testimony shows that in 2012, the 
difference from these three provisions alone is over a trillion 
dollars. And the most remarkable thing, I think, about Figure 1 
in the testimony is that the official baseline is sort of up 
and going up farther over time, whereas the adjusted baseline 
falls and actually declines over time.
    So I think the baseline is not only off, but it is giving a 
very misleading view of what the financial status of the 
government is. And, to me, that is a first-order budget 
problem. The other scoring issues I mentioned are second order, 
dynamic scoring is third order.
    Thank you.
    Mr. Sununu. Thank you very much, Mr. Gale.
    [The prepared statement of William Gale follows:]

   Prepared Statement of William G. Gale, Ph.D., Senior Fellow, the 
                         Brookings Institution

    Mr. Chairman and members of the committee, thank you for giving me 
the opportunity to discuss issues concerning budget reform. As a long-
time advocate of budget reform, whose proposals in this regard are 
usually greeted with the response that ``accounting is boring,'' I am 
pleased to see the committee focus on these issues.
    The importance of budget reform issues is gaining widespread 
recognition. Part of this trend is due to the large gyrations in budget 
surpluses over the last several years, and the obvious fact that how 
the budget is presented has a significant influence on the policies 
that are chosen. In addition, the Enron scandal has shown that standard 
private accounting practices may not be the most revealing way to 
present the financial status of corporations, which naturally leads to 
questions about whether standard Federal accounting practices are the 
most appropriate way to examine public finances.
    The case for budget reform is simple and straightforward. First, 
the methods used currently to estimate the baseline budget seriously 
distort the government's true financial status. Likewise, the methods 
used to score new programs sometimes distort those costs as well. 
Second, some relatively simple changes could resolve many of the 
biggest problems. Third, these changes would likely lead to better and 
more informed public policies.
    My testimony covers several topics, including problems in the 
formulation of the budget baseline and the scoring of new programs, the 
debate over whether the official budget window should be reduced from 
10 years to 5 years, and the role of the Congressional Budget Office. 
It concludes with a series of recommendations for budget reform.

                         I. The Budget Baseline

    The single, most critical budget problem currently facing the 
Federal Government is that standard Federal budgeting methods seriously 
misrepresent the financial status of the government. The CBO budget 
baseline is intended to serve as a ``neutral benchmark * * * 
constructed according to rules [that are] set forth in law and long-
standing practices and are designed to project Federal revenues and 
spending under the assumptions that current laws and policies remain 
unchanged'' (CBO 2002, p. xiii). These rules and practices, however, 
are not necessarily the most useful or appropriate choices if one 
wishes to gauge the government's fiscal condition or to estimate the 
funds that might reasonably be considered available to finance tax cuts 
or new spending initiatives. Indeed, the official baseline seems 
particularly biased now, given the sunsets embodied in EGTRRA (which 
artificially increase the revenue figures shown in the official 
baseline projections).\3\
                     a. fixing the 10-year baseline
    At least three major problems exist within the current 10-year 
budget forecasts. First, by measuring cash-flow over a 10-year horizon, 
the budget significantly misrepresents the financial status of 
retirement programs for Social Security, Medicare and government 
pensions. Second, by assuming that real discretionary spending will 
remain constant, the budget builds in about a 1 percent annual decline 
in per capita current services. Third, by assuming that all temporary 
tax provisions expire as scheduled, and by assuming that obvious 
problems--such as the AMT--will not be addressed, the budget creates 
huge incentives for budget gimmicks. Together, these three problems 
lead to vast understatements of the likely cost of current policy 
trajectories and vast overstatements of the funds that are truly 
available for new programs or tax cuts.
    Correcting these three problems leads to massive revisions in the 
budget outlook. For example, the official January 2002 CBO baseline 
shows a surplus of $2.3 trillion over the 2003-12 period. Adjusting for 
the three factors noted above--by removing retirement trust balances, 
holding real discretionary spending constant on a per capita basis, 
extending the expiring tax provisions and holding the share of AMT 
taxpayers constant at 2 percent--creates a deficit exceeding $3 
trillion over the same period (Table 1). That is, these three problems 
overstate Federal resources by more than $5 trillion over the next 
decade alone. Moreover, the difference between the official and 
adjusted baselines rises dramatically over time, reaching more than $1 
trillion in 2012 alone (Figure 1).
                     b. using longer time horizons
    In several respects, the 10-year horizon itself is a problem. For 
example, although the adjusted budget measures in Table 1 and Figure 1 
are easily comparable to existing official figures and provide a more 
accurate picture of the government's underlying financial status, they 
ignore the long-term implications of current fiscal choices. As noted 
above, Social Security and Medicare face substantial deficits over the 
next 75 years (and beyond). In the context of an aging population and 
rapidly rising medical care costs, incorporating the future imbalances 
is necessary to obtain an accurate picture of the fiscal status of the 
government as a whole. One way to recognize these problems but still 
maintain cash-flow accounting is to extend the planning horizon to 
include the years when the liabilities come due.
    Extending the budget horizon to include the years when the baby 
boomers retire and start collecting Social Security and Medicare 
benefits presents a much bleaker situation. Under current 
circumstances, the fiscal gap over the next 75 years is about 3.3 
percent of GDP under the CBO baseline and more than 5 percent of GDP if 
the revenue and spending adjustments noted above are made.
                     c. do the adjustments matter?
    While each set of adjustments mentioned above--fixing the 10-year 
baseline and looking at longer time horizons--can be justified by 
various theoretical arguments, the threshold question is whether these 
changes would matter. The answer is a resounding ``yes.'' The 
differences between the official budget baseline and the various 
adjusted baselines above have sweeping implications for current and 
future fiscal policy.
    The fundamental result is that the adjusted 10-year measures and 
the long-term fiscal gaps imply the need for massive increases in 
future taxes or reductions in future spending given the current 
trajectory of fiscal policy. These results not only do not appear in 
the official baseline, but the baseline shows the budget outlook 
improving over time (Figure 1).
    Most generally, the alternatives presented above show that tax cuts 
are not simply a matter of returning unneeded or unused funds to 
taxpayers, but rather a choice to require other, future taxpayers to 
cover a substantial long-term deficit that last year's tax cut 
significantly exacerbates. Likewise, the notion that the surplus is 
``the taxpayers' money'' and should be returned to them omits the 
observation that the fiscal gap is ``the taxpayers' debt'' and should 
be paid by them. Thus, the issue is not whether taxpayers should have 
their tax payments returned, but rather which taxpayers--current or 
future--will be required to pay for the liabilities and spending 
obligations incurred by current and past taxpayers.
    More specifically, a common justification for last year's tax cut 
was that it was affordable, since official surpluses were projected to 
be so high over the next decade. As noted above, however, the official 
figures are (and were) misleading. In fact, last March, I testified 
before this committee that although the official surplus was $5.6 
trillion over the next decade, the adjusted 10-year budget faced a 
surplus of just $1 trillion, and the government was running a 
significant long-term fiscal gap even before EGTRRA was implemented 
(Gale 2001b).
    The adjusted budget measures also show that some common claims made 
by the administration and by prominent tax cut advocates are mutually 
inconsistent. One recent claim was that large current surpluses make 
tax cuts affordable now (Bush 2001, Feldstein 2001 and Hassett 2001a). 
The second claim is that Social Security faces a significant long-term 
deficit (Bush 2001, Feldstein and Samwick 1997, Hassett 2001b). The 
problem with making both claims simultaneously is that the ``surplus'' 
that allegedly made tax cuts affordable existed only because budgeting 
procedures ignore the long-term deficit in Social Security and 
Medicare.
    Another set of inconsistent claims is that making the tax cut 
permanent would be a moderate change, but fixing Social Security 
requires large infusions of funds. For example, when the House recently 
voted on making last year's tax cut permanent, the revenue cost was 
scored at under $400 billion over the next decade (JCT 2002). However, 
over the next 75 years, extending the tax cut would cost over 1.4 
percent of GDP. This is twice the size of the Social Security shortfall 
over that period, 0.7 percent of GDP.\4\ The funds that would be used 
to finance making the tax cut permanent could cover the entire Social 
Security imbalance plus 70 percent of the Medicare trust fund imbalance 
through 2075. The magnitude of the savings available from curtailing 
the tax cut relative to the Social Security and Medicare shortfalls may 
seem surprising. But that is just because tax cut figures are often 
presented over 10 years, while the trust fund imbalances are reported 
over 75 years, and because the administration has often argued that the 
tax cut is moderate while the Social Security shortfall is huge. In 
fact, making the tax cut permanent would have substantial long-term 
fiscal implications that are completely hidden by the existing budget 
framework.

                      II. Scoring of New Programs

    A second set of problems concerns how the budget and legislative 
process records the costs of new programs. These problems are worth 
addressing, but they are much less important than getting the baseline 
right.
                           a. interest costs
    Programs that reduce taxes or raise spending increase government 
borrowing and hence impose added interest payments on the Federal 
budget. Under current procedures, the interest cost is not assessed as 
part of the revenue score. Yet the costs can be significant. A program 
that gives a $1 tax cut in each year for a decade, for a total tax cut 
of $10, will generate interest costs of about $3 in interest payments 
over the decade, under current interest rate forecasts. Including the 
interest payments raise the cost of this hypothetical program by 30 
percent.
    Including the interest costs in the budget score would be a simple 
and accurate way of reflecting the cost of the program. It would also 
reward fiscally sound programs. The increase in the surplus that they 
provide would reduce interest payments and hence reduce the recorded 
(and actual) cost of the program. Note that this effect does not depend 
on the effect of the policy on interest rates, just the effect of the 
policy on government borrowing requirements.
                     b. timing and budget gimmicks
    Another problem is that current procedures can be exploited to 
misrepresent the costs of particular proposals. For example, by using 
slow phase-ins, politicians can reduce a proposal's official cost even 
though the long-term cost might be huge. For example, a proposal to 
leave the estate tax alone for 10 years and abolish it in year 11 would 
have significant long-term costs but would cost virtually nothing in 
the 10-year budget window.\5\ This budget gimmick is probably so 
transparent that it could never happen. But in 2001, the House of 
Representatives passed a bill to phase out and then abolish the estate 
tax, with a 10-year cost of $185 billion. Abolishing the tax 
immediately would have cost $662 billion over the next decade. So the 
House went 70 percent of the way toward the budget gimmick noted above. 
The key point is that the only reason to design a tax proposal with 
those timing features is to hide the true costs. This very fact should 
exclude such proposals from consideration.
    Other budget gimmicks include proposing tax programs that expire 
after short periods of time, shifting revenues from the current year to 
the next year (so that the revenues will be ``inside the budget 
window''), and not adjusting the alternative minimum tax. The tax cut 
enacted last year set new and appallingly low standards in each of 
these areas, including the provision that the entire tax cut expires in 
2010, and the provision that AMT relief expires in 2004 (thus leading 
to the projection that 35 million taxpayers will be on the AMT by 
2010).\6\ To be clear, I am not advocating making the full tax cut 
permanent, which would be fiscally irresponsible. Rather, my point is 
that enacting policies that contain budget gimmicks is bad budget 
policy, bad tax policy and bad economic policy.
    It would be simple to fix these problems, by not allowing revenue 
shifts from the current year into the budget window, by scoring all 
temporary provisions as if they were permanent, by requiring all 
programs to be fully phased in within a set period, say 3 or 5 years, 
and by requiring that tax changes create conforming changes to the AMT 
so that regular income tax cuts do not push people onto the AMT.
                           c. dynamic scoring
    A third scoring issue is so-called ``dynamic'' scoring. Current 
budget estimates include a the impact of tax changes on a variety of 
microeconomic behavioral responses, but do not macroeconomic changes. 
Critics argue that this creates a bias against programs that would 
raise economic growth. and argue for inclusion of such effects in the 
revenue estimates.
    There is no doubt that the effects of policies on the size and 
growth rate of the economy are relevant concerns. Just as policy makers 
learn important information from both the distributional analysis and 
the revenue estimates of tax bills, information on the impact of 
proposed legislation on overall economic activity is central to the 
evaluation of policy alternatives. Thus, there is no that such analysis 
should be, and is, undertaken all the time, and policy makers are well 
aware of the macroeconomic implications of proposed laws.
    The real question is whether such estimates should be incorporated 
into the formal revenue estimates that guide the budget procedures. 
Many previous authors have discussed dynamic scoring.\8\ Rather than 
review this literature, I will focus on a few main points. In an ideal 
world with unlimited resources and perfect knowledge about the relevant 
behavioral parameters and structure of the economy, all proposals would 
be officially dynamically scored. But in a world of limited resources 
(including time between a proposal and a vote) and limited and 
controversial knowledge, formally incorporating dynamic scoring into 
budget estimates is the least urgent and most difficult change to make 
of the items discussed in this testimony.
    Dynamic scoring is difficult to perform well for several reasons. 
The underlying behavioral responses are uncertain and may vary across 
households. The underlying structure of the economy, and any reactions 
by the monetary authority or foreign governments are uncertain, but are 
critical components of a macro response. Dynamic scoring would have to 
be done for all tax and spending programs to be done correctly. 
Omitting spending programs would create biases. Likewise, omitting 
small programs would create biases: what matters is the macroeconomic 
effect relative to the size of the program, not relative to the size of 
the economy. The dynamic feedback effect, relative to current method 
cost estimates, can be just as important for small programs, even if 
the aggregate impact is tiny.
    Dynamic scoring is the least urgent of the scoring changes noted 
above for two reasons. First, it would actually exacerbate the tendency 
to propose temporary programs, since they have bigger effects, within a 
given period of time, than permanent ones. Second, a full dynamic score 
should include all of the effects of the proposed legislation on the 
budget, not just the effect of higher (or lower) GDP. As a result, it 
seems unlikely that dynamic scoring would have very large effects, at 
least for substantial tax changes. For example, table 2 provides 
several rough dynamic scores of last year's tax cut. These score 
include the effects on revenues of the change in GDP, and the effects 
on Federal interest payments of the increase in government debt and the 
increase in interest rates. Even if the tax cut raised GDP by 1 percent 
immediately and permanently, the overall dynamic score would be higher 
than the JCT score used last year. CBO (2001) estimated that the tax 
cut would change GDP by plus or minus 0.5 percent by 2011. Allowing the 
maximum effect posited by CBO to phase in slowly over time raises the 
dynamic cost even more. Gale and Potter (2002) estimate that EGTRRA 
will reduce the size of the economy in 2011 by 0.3 percent, which 
creates even a higher dynamic score.
    Some have claimed that in certain situations, analysts are certain 
that tax changes will raise economic growth and therefore that not 
scoring such effects is extremely conservative and biased. Often times, 
fundamental tax reform is offered as such a candidate policy. Table 3 
shows that if the pure flat tax were dynamically scored, the net effect 
would be to reduce the revenue-neutral tax rate by just 0.7 percentage 
points. If the flat tax were coupled with transition relief, the 
required tax rate is virtually unchanged under the dynamic or the 
static score, because the growth effect is so small.
    These small effects are consistent with historical evidence on the 
lack of impact of taxes on growth (see Gale and Potter 2002 for a more 
complete review of the evidence). Historical data show huge shifts in 
taxes with no observable shift in growth rates (table 4). Most 
strikingly, from 1870 to 1912 the U. S. had no income tax and tax 
revenues were just 3 percent of GDP. From 1947 to 2000, the highest 
income tax rate averaged 66 percent and revenues were 18 percent of 
GDP. Nevertheless, the growth rate of real GDP per capita was identical 
in the two periods. In formal tests, Stokey and Rebelo (1995) find no 
evidence of a break in growth patterns around World War II. Obviously, 
many factors affect economic growth rates, but if taxes were as crucial 
to growth as is sometimes claimed, the large and permanent historical 
increases in tax burdens and marginal tax rates should appear in growth 
statistics. In addition, studies of the impact of previous tax reforms 
suggest small effects. For example, Feldstein (1986) and Feldstein and 
Elmendorf (1989) find that the 1981 tax cuts had virtually no net 
impact on economic growth.

       III. The Budget Horizon and the Use of Projected Surpluses

    Recent proposals would eliminate the 10-year budget horizon and 
replace it with a 5-year window (Penner 2001, OMB 2002). The motivation 
for this change is the claim that 10-year budget horizons are too 
uncertain to be useful for budgeting. The Bush administration, for 
example, notes that ``the 2003 Budget parts ways with Washington's 6 
year experiment with 10 year forecasting. Previous budgets' attempts to 
look out a decade in the future have varied wildly from year to year. 
But 2001 showed finally how unreliable and ultimately futile such 
estimates are'' (OMB 2002).
    I believe that reducing the budget window to 5 years (indeed, 
shortening the window at all) would be a significant mistake, for 
several reasons. First, although 10-year budget forecasts are indeed 
uncertain, budget estimates over shorter horizons can be even more 
uncertain. Table 5 shows that from January 2001 to January 2002, the 
10-year surplus (for 2002-11) fell by 71 percent. In contrast, the 5-
year surplus (for 2002-11) fell by 87 percent and the 1-year surplus 
(for 2002) fell by more than 100 percent. Moreover, most of the change 
in the 1- and 5-year surplus was due to economic and technical changes; 
the very uncertainty that the administration is referring to. In 
contrast, a minority of the change in the 10-year surplus was economic 
and technical changes. Most, instead, was due to legislative changes, 
principally the tax cut enacted last year. On an overall basis, 
economic uncertainty caused only a 28 percent shift in the 10-year 
surplus, but an 80 percent shift in the 1-year forecast and a 44 
percent shift in the 5-year forecast. Thus, it is difficult to see why 
the 2001 experience should lead one to place more emphasis on the 1-
year or 5-year budget figures. It is also disingenuous for the 
administration to claim that the large change in the 10-year surplus 
justifies ignoring the 10-year budget window, when its own policies 
were the major cause of the change in the 10-year budget surplus.
    A second concern is that suggesting that events taking place over 
the next 10 years are too uncertain to be used for policy forecasts 
implies that one should ignore the looming financing problems in Social 
Security and Medicare. But virtually all responsible observers believe 
those problems should be addressed sooner rather than later.
    Third, at the same time that it proposes shortening the budget 
horizon to 5-years, the administration proposes important new proposals 
that do not begin to take place until well beyond the 5-year horizon, 
as highlighted by the proposal to eliminate the 2010 sunset in EGTRRA. 
The administration budget contains a proposed $1.2 trillion reduction 
in surplus in the second 5 years of the decade. If the 10-year budget 
outlook is so uncertain as to undermine the benefits of presenting 10-
year numbers, it is unclear why it is certain enough to facilitate 
policy proposals. Policy makers should link budgeting choices to the 
budget horizon, rather than presenting budget figures for one horizon 
and then proposing items that have substantial revenue or outlay 
implications that take effect outside that horizon.
    For all of these reasons, plus the fact that the long-term budget 
gap does not reveal itself fully until an extended period of time, it 
is hard to imagine a more inappropriate budget ``reform'' than 
shortening the budget window.
    The real problem is not that budget forecasts are uncertain, but 
that Congress feels compelled to allocate every last dollar of the 
reported surplus. Families, for example, make financial forecasts of 
their future income and spending, but they do not (responsibly) attempt 
to spend all future income in the current period. Likewise, Congress 
should welcome the longer-run budget estimates as providing useful 
information for budget planning, but also enact rules that set aside a 
portion of future projected surpluses as a reserve fund, with the share 
that is set aside rising as a function of the distance between the 
current date and the date of the projected surplus. This is, in 
essence, a proposal put forth last year by Robert Reischauer and 
discussed further below.

            IV. The Role of the Congressional Budget Office

    Whatever problems there might be in the budget process, the 
performance of the CBO is not one of them. CBO provides remarkably 
competent, honest, and timely output in its budget and economic 
forecasts. Despite sometimes being subjected to extreme, blatant, and 
politically-motivated pressure to change its forecasts or methods, CBO 
has been able to maintain a very high degree of professional standards. 
Moreover, its professionally-based forecasts are highly respected 
precisely because it has been able to withstand such pressure. In 
considering budget reform issues and options, it would be a gigantic 
mistake to blame the messenger.

                           V. Recommendations

    Federal budgeting methods do not accurately reflect the financial 
status of the government or the costs and benefits of new proposals. 
Getting these issues exactly right would prove very difficult, as it 
would require highly detailed and technical calculations, a series of 
judgment calls, and considerable uncertainty. Nevertheless, a few 
simple and understandable rules could address the major problems noted 
above and thus provide most of the benefits of an ideal accounting 
system accurate measures of the government's fiscal situation and of 
the costs and benefits of new programs with few of the costs.
    The first change involves the baseline budget calculation. Congress 
should remove accumulations in trust funds for Social Security, 
Medicare and government pensions from the baseline budget, and commit 
not to spend any of these resources on anything other than previously 
legislated benefits. The baseline could also provide more realistic and 
plausible projections of future policy by adjusting real discretionary 
spending for population growth rather than allowing it to fall on a per 
person basis, assuming that temporary provisions will be extended and 
stipulating that the percentage of tax filers facing the AMT will be 
held fixed over time.
    The second change would set some of the baseline surplus ``off 
limits'' for allocation to new tax and spending programs in case the 
underlying tax and spending projections are not realized. Robert 
Reischauer, currently the President of the Urban Institute and formerly 
the Director of the Congressional Budget Office, has proposed that 
Congress should commit only a given percentage of future surpluses to 
tax cuts or new spending, with the percentage lower for surpluses 
farther in the future (Reischauer 2001). For example, Congress might 
commit 80 percent of surpluses projected for the first 2 years of the 
10-year budget projection, 70 percent of surpluses in the next two, and 
so on, down to 40 percent in the last 2 years. The Reischauer rule 
essentially provides a reserve fund. The rule recognizes that budget 
projections and economic forecasts are subject to considerable 
uncertainty, that uncertainty rises with the time horizon, that new and 
unforeseen contingencies will arise, and that policy reversals may 
prove difficult.
    The third change would improve estimates of the costs or benefits 
of new tax and spending initiatives to prevent manipulation of the 10-
year budget estimates. Stipulating that all tax or spending programs 
must be scored as fully phased in within, say, 5 years would allow some 
time for gradual adjustment but would ensure that 10-year costs remain 
valid indicators of the long-term effects. Temporary tax or spending 
policies should be scored as permanent, and the costs of tax changes 
should include the cost of changes in the AMT to ensure that the tax 
cut does not raise the number of AMT filers. Finally, including the 
interest costs due to higher Federal debt associated with higher 
spending or lower taxes would provide a truer measure of the cost of 
the plan. Although dynamic scoring has received substantial attention, 
it is, in the grand scheme of budget reform, a relatively minor item 
that would not affect many proposals and that would prove expensive and 
controversial.
    Fourth, although the current budget rules concerning PAYGO 
restrictions and discretionary spending caps have many evident defects, 
they likely contributed to the successful fiscal discipline in the 
1990s. The rules, however, expire at the end of this fiscal year. 
Abandoning them without an adequate replacement would be a mistake.
    Fifth, the relevance of longer-term budget outcomes could be raised 
by having CBO report its long-term forecast at the same time, and in 
the same document, as the 10-year forecasts that are produced every 
winter in the Economic and Budget Outlook and every summer in the 
Update.
    Other recently discussed rules are less promising. The balanced 
budget amendment has received much attention over the past several 
years. But if the underlying baseline budget has little economic 
significance (as argued above), it is not at all clear why balancing it 
is a good idea. The recent proposal to tie tax cuts to a trigger 
mechanism, based on the prior year's surplus, is well intended but not 
useful. It would create uncertainty and invite budget gimmickry, it 
would attempt to determine whether future tax cuts are affordable by 
looking at last year's--rather than projected--surpluses, and it would 
correct none of the problems noted above.
    In concluding, it is useful to distinguish two broad points: the 
need for an improved set of budgetary rules, and the desirability of 
the particular set of rules motivated and examined above. The need for 
changes in the budget rules seems clear. The current cash flow 
surpluses mask a much more troubling long-term financial picture. 
Current scoring method omit important considerations. And the spending 
and PAYGO rules expire shortly. The particular recommendations proposed 
above would address many of the major problems in the budget process 
with a few simple, plausible rules and would dramatically improve 
understanding of the real fiscal status of the government and the real 
costs of new tax proposals.

                               References

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                                endnotes
    1. My previous work on budget reform includes Gale (1990, 2001a), 
Auerbach and Gale (1999, 2000, and 2001) and Auerbach, Gale and Orszag 
(2002).
    2. This section is based on Auerbach, Gale and Orszag (2002).
    3. Reischauer (2002) expresses the view that ``Rarely have the 
policies underlying the baseline projections been as disconnected from 
the policy makers' agendas as they are today.''
    4. See Board of Trustees, Federal Old Age and Survivors Insurance 
and Disability Insurance Trust Funds (2001, table VI.E5, p. 150) and 
Kogan, Greenstein and Orszag (2001). Over an infinite horizon, the 
extended tax cut is about the same size as the Social Security 
shortfall.
    5. The revenue cost in the 10-year window would presumably not be 
exactly zero because JCT would allow for changes in gift giving 
behavior as households delayed making potentially taxable inter vivos 
gifts in order to maximize their soon-to-be untaxed bequests.
    6. Friedman, Kogan, and Greenstein (2001) noted that EGTRRA ``* * * 
appears to contain more budget gimmicks than any tax bill, and quite 
possibly any major piece of legislation, in recent history.'' Crenshaw 
(2001) notes that, because of these gimmicks, ``the new tax law doesn't 
make planning unnecessary, it just makes it impossible.''
    7. This section is based on Potter (2002).
    8. See, for example, Aaron (1995), Auerbach (1996), Boskin (1995), 
Feldstein (1995), Gravelle (1994), Lyon (1995), and Tyson (1995).

    Mr. Sununu. Mr. Spratt, do you have any questions?
    Mr. Spratt. Just a few, and I would like to thank you all 
for providing, in every case, some valuable ideas and 
observations. Every time we deal with this problem, when we try 
to come up with solutions, somebody has this platonic notion of 
perhaps having a commission of gray beards, distinguished 
economists.
    I think, Mr. Hassett, you would compare them to the Federal 
Reserve staff or something like that, who might sit in judgment 
on budget estimates and decide rather disinterestedly which 
were the right ways to go--OMB, CBO, whatever.
    And every time we even give any thought to that, you 
recognize that those boards tend to get as politicized as 
everything else. And each party, each branch, tries to get its 
people on there, tries to get a point of view represented; and 
balancing that all out and really getting professional judgment 
is a problem.
    But one of the things you mentioned was the quality of 
economic data that everybody has got to deal with, coming from 
BLS and BEA. I believe it was your testimony. It might have 
been Rudy Penner's testimony, but would you amplify on that, 
because 5 years ago when we were trying to get the CPI problems 
ironed out, we went down to BLS and told them, tell us how much 
money you need--we are talking small sums of money--to give you 
the resources you need to make major decisions that will have 
huge impacts on the budget. What is lacking there? What do they 
need that they don't have?
    Mr. Penner. I think two things, Mr. Spratt.
    One, I don't believe they have the money to do the basic 
research necessary to keep up with the changing structure of 
the economy, which should of course affect the way they collect 
basic data.
    Secondly, with minor inclusions of money, I think you could 
increase the accuracy of specific types of data.
    For example, in the effort to put together the GDP, I think 
most of the resources go to estimating the product side of the 
accounts, because that is of most interest to business and most 
business economists. But the revenue estimator depends on the 
income side of the accounts--the wages and salaries, profits 
and so forth.
    I think, with little extra money, they could put more 
resources into that. We have seen huge discrepancies between 
the two sides of the account.
    Mr. Spratt. So part of this problem of the lag and long 
delay in getting an accurate analysis, a definitive analysis of 
our revenues, could be cured if we put some more resources into 
it?
    Mr. Penner. Absolutely, and resources, I think, into the 
IRS as well. And I suggest in my complete testimony some 
reporting changes that would help a lot.
    For example, if corporations recorded specifically the HI 
they withheld, it would give revenue estimators a very quick 
estimate of total earnings because it is a proportional tax. 
But we have to recognize that things like that create a cost on 
business, too, but I think most of the things I suggest would 
be fairly cheap.
    Mr. Spratt. Any other observations from the rest of you 
about the quality of data and ways we can improve it, 
particularly revenue forecasting?
    Mr. Hassett. And can I also respond to the gray beard 
point?
    Mr. Spratt. Sure.
    Mr. Hassett. Rudy would be my choice, but he doesn't have--
but the gray, I guess, I won't comment on. I think the 
interesting question is that--would the--if we ask people to 
provide an analysis of any policy if we do this, what happens, 
I think that public scrutiny would constrain to a great effect, 
a great deal what they could do in a political way. And so if 
you had a team of economists whose reputation was on the line, 
if they are putting out a document that says, ``here is what we 
think the profession believes about what happens,'' then if 
they have spelled out why they believed that, then if it is 
crazy and partisan, then you had better believe you will be 
reading about it in the newspaper, and then folks won't listen 
to them anymore.
    And so I think it would be very easy, and I, as Bill and 
Rudy do, have great regard for the CBO staff's ability to get 
stuff right. I mean, sure they make mistakes, but I don't see 
them as being influenced politically; and, goodness knows, 
there are folks who would like to do that.
    Mr. Spratt. Well, in dealing with the CPI, we went down to 
see Mr. Greenspan and asked him if they would like to be 
intermediaries in trying to help us get the Bureau of Labor 
Statistics to finish about four or five different studies that 
would have adjusted small components of the CPI. And while he 
was willing to lend us his resources so that we could 
understand the problem better, he really did not want to get 
his economic staff involved in policy mediation within the 
Federal Government for reasons I guess you can appreciate.
    But at that time there was an idea floated, discussed, 
about having a commission of distinguished economists which 
would sit in judgment on the CPI. They would gather all the 
data. They would take all the information that the BLS 
generated. They would put it through their models, and then 
they would decide exactly what sort of adjustment needed to be 
made to bring it down to the most realistic rate of increase in 
cost.
    Fortunately, I think that never happened. Instead, the BLS 
went ahead and completed the work, and by the end of last year, 
they had effectively adjusted the CPI by a substantial amount.
    Mr. Gale.
    Mr. Gale. Thank you. There are two issues floating around. 
One is the public versus private, and one is the CPI kind of 
fix, which is a one-time thing, versus dynamic revenue scores, 
which must be an every week, every month type of thing.
    I think if you do something like the CPI, which is, you 
organize a panel, you do it once. They issue their report like 
the Social Security commission. That works for sort of a one-
time thing.
    But for revenue scores, you would be needing to do it every 
day, every week; and a panel like that if the Fed staff does 
that, they do it privately to the governors. They don't have to 
release information. In fact, the Fed is famous for not saying 
what it is doing or why. It is all kept in-house.
    I think that model works if you are willing to go with 
those public information requirements. But if you want a panel 
to do dynamic scores or to pronounce on the growth effects of 
policies, and they have to defend publicly every judgment that 
they make, that is a recipe for failure. I don't think that 
would happen.
    Mr. Spratt. Mr. Penner, you commented--somebody used the 
phrase, ``the tyranny of numbers,'' I believe it was your 
phrase dealing with the PAYGO rule. You go back yourself to the 
1980s when we were struggling, trying to get our hands around 
the deficit.
    And one of the solutions was Gramm-Rudman-Hollings, and the 
target on which GRH was focused was a projected deficit. Each 
year we were trying to take it down by $36 billion. And we 
monkeyed around with that for about 4 or 5 years and finally 
figured out that that projection was an economist's construct 
and you could get different constructs for the future easily 
enough and you could sort of forecast away the deficit. But it 
obviously didn't go away; you keep forecasting and rewriting 
the Gramm-Rudman budget. And we came to the conclusion in 1990 
that we just need simple, hard numbers, a discrete number for 
what discretionary spending is going to be, not a projection of 
what you have to hit as a summation of all policies, but this 
is it.
    We also said, if you want an increase in the entitlement, 
you have got to pay for it one way or another. If you want to 
cut taxes, you have got to offset it one way or the other, 
either by entitlement cuts or by the taxable revenue increases.
    What is your assessment of the 1990s? Don't you think, for 
a while at least through the 1990s, those simple rules worked 
better than the more complicated effort of trying to hit an 
economist's projection of the deficit?
    Mr. Penner. Oh, absolutely, Mr. Spratt. The problem with 
Gramm-Rudman is that it made the focus of policy the numerical 
value of the deficit, and that from year to year is affected 
much more by wiggles in the economy and other things than it is 
by policy. So the Congress created a very rapidly moving 
target, which it was just politically impossible to hit. It 
wouldn't have been a problem, except it was enforced so 
rigorously with sequestering mechanisms.
    So certainly, what was constructed in 1990 was superior. 
The Congress created rules that governed its own actions, 
things that it controlled, like appropriations and entitlement 
law and so forth, instead of trying to control something it 
couldn't control in the very short run. So the new rules were a 
big improvement in my view. They helped greatly in eliminating 
the deficit over the long run.
    I was just trying to suggest in my testimony that they also 
had some bad effects. They probably made policy making a little 
more mechanical than it should have been, but in my view, that 
cost was worth it at the time because of the huge deficits. And 
we have got to remember, the 1983 deficit would be $600 billion 
now, if adjusted for the size of the economy.
    With those huge deficits that extended into the 1990s, the 
rules were very worthwhile.
    And more generally, though, I think there is a tendency to 
try and cure every budget problem by promulgating a rule, and 
the budget process has gotten complex as a result of that--
frankly, I don't understand it anymore, and I don't think there 
are many single human beings who can keep it all straight. So I 
do think that a lot of judgment is necessary to supplement 
rules like PAYGO or the spending caps or what have you.
    Mr. Spratt. Mr. Sununu.
    Mr. Sununu. Thank you Mr. Spratt, and I do want to thank 
each of our panelists for their time and their testimony. Thank 
you very much. We are adjourned.
    [Whereupon, at 12:35 p.m., the committee was adjourned.]

                                
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