02 May 2011

Budgets and Economic Assumptions

Today we hear about deficit reduction budgets from both sides of the aisle. But what is never discussed are the economic assumptions that accompany deficit reductions. Here is a very good article by James Pethokoukis about economic assumptions and their affects on projections. This opinion draws heavily upon his article.

About Obama's budget speech he gave last week (13 Apr 11): "When he made his big budget speech last week, it wasn't at all clear from where his numbers were coming - nor in what direction they were heading. A "fact sheet" on his "Framework for Shared Prosperity and Shared Fiscal Responsibility" gave a few more specifics, but little or no context to make real sense of them. Even for seasoned budget experts, it was a puzzlement."

Budget experts think Obama used his own more optimistic forecast numbers. From 2012-2015, Obama sees the economy growing at a pace of 3.6 percent, 4.4 percent, 4.3 percent and 3.8 percent. The CBO sees slower growth, 3.1 percent, 3.1 percent, 3.5 percent, 3.8 percent. For the rest of the decade, Obama assumes GDP growth an average of 0.2 percentage point faster than the CBO. When CBO ran Obama's numbers with its own growth forecast, it found that Obama raised $1.7 trillion less than his OMB had predicted. Obama also assumes those higher growth rates would be possible despite the heavier tax burden. When Goldman Sachs looked at the numbers and they think Obama was measuring his savings against the CBO's estimate of what it considers the most likely budget path. Over ten years, Obama's plan saves about $2.2 trillion less than Ryan's - and that's still giving Obama his rosy economic forecast from above. But Obama's assumptions were based on no tax increase impact. Obama reiterated his pledge to let $1 trillion worth of top-end Bush tax cuts expire. That means Obama is actually calling for $2 trillion worth of tax hikes, not $1 trillion.

Finally, Obama's budget calls for a 12-year budget instead of a customary 10-year plan. Former Bush II economic adviser Keith Hennessey said: "He wanted to claim that he was "matching" the Ryan plan in deficit reduction, but was just achieving that same goal in a better way. Matching Republican deficit reduction is a lynchpin of the President's fiscal argument. He was short by a trillion dollars or more, so he and his team decided to measure his proposal over a different timeframe and hope no one would notice."

So there you have it. The Obama deficit reduction plan makes some unrealistic (?) assumptions and tries to sneak in a time-line change.

As Thomas Sowell points out in this article, "Anyone who says that we don't have the money to pay what was promised is accused of trying to destroy Social Security, Medicare or ObamaCare - or whatever other unfunded promises have been made. It is like blaming the bank for saying the check bounced."

And, he continues, states are not doing much better. He offers the state of Florida as an example. Florida's own estimate of its pension fund's shortfall is based on assuming that they will receive a rate of return of 7.75%. But what if it turns out that they don't get that high a return? A 6% rate of return would more than triple the size of Florida's unfunded liability for its employees' pension. The actual rate of return that Florida has received over the past decade has been only 2.6%. In other words, by simply assuming a far higher future rate of return on their investments than they have received in the past, Florida politicians can deceive the public as to how deep a hole the state's finances are in. (emphasis mine)

So what does all of this mean? The next time you see a projection, ask (specifically) on what assumptions was the projection made. Then ask yourself: "Are those assumptions realistic?"

But that's just my opinion.

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