CBO Director Lays Out Six Criteria for Evaluating Fiscal Plans
The non-partisan Congressional Budget Office (CBO) doesn't make recommendations for, or against, any fiscal plan, but that doesn't mean they can't help others do so. To that end, CBO director Doug Elmendorf recently suggested six criteria with which to evaluate the many plans out there. Of course, these criteria are not necessarily co-equal, but each are important. They are:
- Magnitude of Changes: Simply put, this criterion is about hitting a certain debt target, usually as defined by the debt-to-GDP ratio. Elmendorf states that "policymakers will need to make judgments about how much federal debt is acceptable" and choose a baseline to work off of. Moving from the clearly unsustainable "Alternative Fiscal Scenario"--in which current tax and spending policies are maintained--to current law would require $8 trillion of savings, but lawmakers could target a more modest goal of stabilizing debt to GDP or a more aggressive goal of getting debt back to its approximate average in recent decades of 40 percent of GDP. Whatever the goal, they will need to have enough deficit reduction to get there.
- Specificity: We have long extolled the virtues of being as specific as possible with budget plans, and the CBO director agrees, at least for the purposes of being able to evaluate the plan. Beyond that, he reiterates the announcement effect idea that "credible policy changes that would substantially reduce deficits later in the coming decade and beyond could boost the economic expansion in the next few years by holding down interest rates and increasing people's confidence in the nation's long-term economic prospects." Being specific is one of the key aspects to policy changes being credible in the eyes of the public.
- Amount and Composition of Federal Spending: Assuming that revenue will have to be kept roughly in line with spending (or at least close), a fiscal plan must make a decision about how large government is and what its priorities are as reflected in spending. Elmendorf notes that Social Security and health care programs are automatically set to rise in the coming decades due to demographic shifts and health care cost increases, but policymakers must decide how much of that increase they will tolerate when weighed against spending on the rest of the budget, or whether they will simply allow spending to rise as a percent of GDP. (We would add that politicians should also be concerned about the composition of the tax code -- how much it spends on tax expenditures, and to what end.)
- Short-Term Economic Impact: Considering the current economic environment, Elmendorf notes that policymakers must be careful with the timing of deficit reduction policies. He notes that these policies would be a drag on the economy in the short term through their effects on aggregate demand, but also that waiting too long to implement deficit reduction would result in higher debt. Still, in another nod to the announcement effect, he says, "despite those trade-offs, however, I am not aware of any benefit to delaying decisions about future changes in tax and spending policies. Indeed, as I noted above, credible policy changes that put the debt on a sustainable long-term path could boost the economy in the near term." Well said, Doug.
- Longer-Term Economic Impact: Policymakers should also consider the effects on the economy over the longer-term. Unlike with the short term, this criterion is more about the composition of policies rather than the timing. Reducing deficits, all else equal, will increase national savings and investment and thus grow the size of the nation's capital stock. But the composition of policy changes could boost or dampen the effect on long-term growth. For example, rate-reducing tax reform or an increase in the retirement age could encourage more work and investment, while raising tax rates or cutting infrastructure spending could partially mute the positive economic effects of deficit reduction.
- Distributional Effects: The policy composition of a fiscal plan determines who bears the burden of tax and spending changes. Elmendorf points out that this entails not only looking at the direct effects of policy changes, but also the indirect effects via the economy and its consequences for different people. Distributional analysis is most often associated with effects on people with different incomes, but could also be done by occupation, family/marriage status, or other distinctions that are relevant for policymakers.
Director Elmendorf's six criteria serve as a very useful checklist in evaluating the many fiscal plans that are floating around in the current debate. Check out our interactive comparison grid and apply the criteria yourself.