The Uncertainty of Long-Term Projections

Mar 29, 2013 | Budgets & Projections

The Economic Policy Institute's Ethan Pollack has a blog post questioning the accuracy and ultimate usefulness of long-term (75-year) budget projection, especially CBO's Alternative Fiscal Scenario (AFS). Pollack's post builds off an analysis from Michael Linden of the Center of American Progress, who shows that much of the deterioration in the AFS relative to CBO's current law baseline is due to assumptions about future fiscal irresponsibility from lawmakers which may be unfounded. This leads both Pollack and Linden to argue that the AFS projection may mislead lawmakers to think that there is a much bigger problem than there actually is. But while AFS may be a worst case scenario, more reasonable projections still show an unsustainable debt path that demands our attention.

Pollack points out that there is inherent uncertainty with any sort of projection, uncertainty which is only compounded when doing a projection with such a long timeframe.

Imagine trying to figure out how the 138th Congress that will govern in 2063—likely with many members that aren’t even born yet—will feel about marginal tax rates, or the cost of an MRI. Will we still even use MRIs? On the subject of healthcare, consider this: a device was recently developed that, once implanted into a patient’s body, can provide ongoing monitoring of various blood chemicals and report the findings to a smartphone. This could have a hugely transformative impact on our currently reactive health care system. But would it reduce or increase the share of the economy we spend on health care? Would health costs fall because visits to the doctor would be less frequent and diseases and emergencies would be detected early? Or would costs rise because every patient would start demanding what may be an expensive implant that ends up telling doctors nothing they don’t already know about 99 percent of their patients?

Linden has similar concerns about the assumptions of lawmakers' future actions:

It’s not unreasonable to assume that Congress will cut taxes and increase spending in the future, but that is not the same thing as projections based on underlying demographic or economic trends. Guesses about what policymakers will do a decade into the future are just that—guesses. It is just as reasonable to assume that in 2023—when the debt is already 80 percent of GDP—Congress won’t enact massive new tax cuts or spending increases without paying for them.

But it's worth noting that this is only one of CBO's two scenarios, the other being current law. CBO's Alternative Fiscal Scenario is their pessimistic projection of what could happen based on historical experience or trends, while current law is a more optimistic projection. Together, these baselines illustrate a range of possibilities, much like a confidence interval, but do not necessarily represent the most likely case. CRFB and many other think tanks including the BPC, CBPP, and Concord Coalition, have released more realistic baselines that include policies not in current law and also relax some of more unlikely assumptions in the AFS. CRFB has estimated what the long-term baseline would look like incorporating the legislative and technical adjustments since the last CBO Long-Term Outlook for the two CBO baselines and our own, seen below. All show an upward path for debt, as does Linden's own analysis.

[chart:8364]

Source: CRFB, CBO

While the AFS should be taken with a grain of salt, it doesn't mean more realistic projections should not concern lawmakers just because it is difficult to make predictions over a 75-year timeframe. While there is great uncertainty in many factors, there are also things we can predict with reasonable certainty. One area is demographics, which has a large effect on the budget going forward, accounting for a majority of the growth in entitlement spending in the next two decades. While health care cost growth has been subdued recently, we can reasonably predict some reversion to the trend we've seen in the past four decades as the economy recovers, with costs continuing to grow faster than GDP. We can also reasonably predict how much revenue will be raised if we continue to have the same tax code.

It's worth noting that all of the baselines may be too optimistic in one sense, given that their economic projections do not factor in recessions. We also showed earlier this week how sensitive budget projections are to interest rates, which could be higher than under CBO's projection if debt is allowed to rise unchecked. Given the pressures that will make it much more difficult to slow the growth of debt, it is better to get a running start by making changes to take effect later in the decade when the economy is better suited to handle them. Even if budget projections turn out to be too pessimistic, the political system has shown to be much better at giving away surpluses than it has at quickly getting to balance. Again, this does not mean having changes take effect now but planning to have them do so in the future. It is better to be cautious and agree upon a plan now rather than waiting for deteriorating projections.

Lawmakers have made notable progress since the last long-term outlook. The savings enacted under ATRA produced a debt path that is a little less worrisome than what was projected in last June (with the exception of current law). But that shouldn't lull anyone into a false sense of security. We still need to do more - lawmakers should look to find an additional $2.4 trillion in savings to put debt on a downward path.

So we agree with Pollack and Linden that CBO's projections are subject to a huge degree of uncertainty, and that AFS might not be the most likely scenario of what debt will be on our current path. But more modest projections of where we are heading given demographic pressures and continued excess health care cost growth still show debt on an upwards path. We should be prepared to deal with those pressures rather than having to scramble and enact changes quickly.