Author: Llad Phillips

The Congressional Budget Office (CBO) released its 2011 Long Term Budget Outlook in June of this year. There is an Abstract, a Summary, a Full Summary and the entire report (in pdf format) available at http://www.cbo.gov/doc.cfm?index=12212 . There is also a testimony of the Director of the CBO before the House Budget Committee on June 23, 2011. The report has many facets but the focus is on forecasts of federal revenue and outlays for fiscal years 2011 though 2021, the corresponding deficits, and the impact of the debt. We address them here as these are major issues for economic policy and for political discussion.

The results of the report are summarized below in Table 1 and in Figure 1. Revenue is predicted to recover quickly, reaching over three trillion by 2013. As a consequence the deficit shrinks to half a trillion by 2014, a little more than a third of the deficit forecast for the current year (2011 federal fiscal year begins October1, 2010 and ends September 30, 2011). Is the CBO’s future rosy scenario perhaps too good to be true?

For the most part, forecasting is using past experience to forecast the future. This can be particularly hazardous in today’s times since we have just experienced the worst recession since World War II, with a scale not comparable to previous recessions. This concept of incomparability is depicted visually from the following two figures for real GDP and publicly held federal debt from the Cooley-Rupert blog linked to on our homepage.

The methodology used in the aforementioned graphs is to compare previous recessions by normalizing them all to start at the peak of the previous cycle. The current cycle is displayed in royal blue, and is very clearly different than the other recessions it is being compared to. This can make forecasting from historical numbers a tricky and daunting task.

The approach adopted here is to establish our own benchmarks against which the CBO forecasts can be compared. If our results also forecast a ‘rosy scenario,’ perhaps the CBO’s predictions will hold more weight. The first benchmark we chose was already mentioned above, revenue as a percentage of GDP (Figure 1). The historical data from 1971 through 2010 was included as Appendix E to the CBO report. It is also available in Excel tables at http://www.cbo.gov/doc.cfm?index=12039. In our analysis, revenue as a percentage of GDP was regressed against the rate of growth of real GDP for the current year, as well as the previous two years, from 1971 through 2010. Economics jargon aside, we did a comparable measure. This result was used to forecast for the years 2011-2014. (The annual data for real GDP was obtained from the Federal Reserve Economic Data at http://research.stlouisfed.org/fred2/series/GDPCA)

Our forecast was then compared to the CBO forecast. Our findings of revenue as a percentage of GDP rise more rapidly for 2011 and 2012 but then level off at 18.4 percent in 2013 and 2014. The CBO forecast reaches 19.9 by 2014 and continues rising, reaching 20.8 by 2021. This is well beyond the average of 18 percent experienced in the years 1971-2010, depicted directly above in Figure 1. The level of 20.0 percent revenue to GDP is higher than any year experienced between 1971 and 2010 with the exception of one year, 2000, when it reached 20.8 percent. This is the first part of the CBO’s predicted ‘rosy scenario.’

The second part of the rosy scenario is the forecasts of the rate of GDP growth. We used the data from the Survey of Professional Forecasters, Third Quarter of 2011, which can be obtained at http://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/. This table compares the forecasts from the Survey, available at the link above , with forecasts of the CBO reported in Table D-1. (Appendix D of the CBO report provides details of the CBO’s economic projections for 2010 to 2021.) The CBO has GDP recovering much more rapidly.

Forecasts of Year Over Rates of Growth of Real GDP

To be fair, the third quarter forecasts of real GDP growth by the professional forecasters were revised downward, but that just underscores the exceptionally ‘rosy’ predictions made by the CBO.

The perceivable ‘over-estimates’ by CBO of GDP growth and revenue as a percent of GDP combine by 2014 to produce a forecast for federal revenue of $3.442 trillion, an over-estimate of 258 billion. By 2015, this over-estimate grew to $390 billion. These discrepancies are based on the more reasonable forecasts of revenue as a percent of GDP, as discussed above, and by forecasts of nominal GDP by the Survey of Professional Forecasters and by the International Monetary Fund’s World Economic Outlook. There has been considerable inflation since Senator Everett Dirkson’s day, but to alter the quote by a factor of 1000, “A [trillion] here, a [trillion] there, and pretty soon you’re talking about real money.”

Total federal outlays (expenditures) as a percentage of GDP was also forecast by the CBO for 2011-2021. Once again, the approach adopted in this blog was to forecast this variable for comparison. Outlays as a percentage of GDP was regressed against the rate of growth of real GDP for the current year, as well as the previous year, from 1971 through 2010. This result was used to forecast for the years 2011-2015. The CBO forecast remains high, near the 2009-2010 levels, compared to the forecast in this blog which compares to the levels from 1980-1986, but exceeds all other percentages from 1971 through 2008, as illustrated in the following graph.

These forecasts of outlay as a percentage of GDP were multiplied by the forecasts of nominal GDP from the Survey of Professional Forecasters and from the IMF World Economic Outlook to obtain projections of Outlays for the years 2011-2015. These projections of outlay are compared to the CBO forecasts of outlay in the next table.

Our projections (in green) of the deficit are more optimistic for 2011 and 2012 than those by CBO, although still severe by historical standards. CBO’s relative optimism in this valley of gloom overtakes ours and by 2015, their forecast of the federal budget deficit is nearly a quarter trillion less than ours.

The Office of Management and Budget, the White House office responsible for devising and submitting the president’s annual budget proposal to Congress, also has forecasts of revenue, outlays and deficits for the years 2011-2016. It is remarkably surprising that their predictions are so close to that of the Congressional Budget Office’s. For example, in 2015 they only differ by 68 billion out of about 3,600 billion dollars of revenue, less than two percent of the amount being forecasted. As a benchmark, the CBO forecast for nominal GDP differs from that of the Survey of Professional Forecaster by 98 billion for 2011, and that is this year!

All of the forecasts by the CBO and the OMB of revenue and outlays are close (revenue more so than outlays), yet we face a great deal of uncertainty, both economically and politically. We may be to steadfast in our suspicions, but this closeness in forecasts makes it appear that the CBO is carrying water for the White House rather than serving as a check and a balance.

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