Economy & Business

The CBO Needs to Do Dynamic Scoring Right

When Republicans took over Congress this year, they asked the Congressional Budget Office, the federal government’s budget referee, to use dynamic scoring methodology — incorporating economic feedback effects — in analyzing the prospective cost of certain legislation.

For instance, some government spending, like well-targeted infrastructure, can cost less on net than anticipated because it raises future economic growth. But it’s important to recognize that all government spending reappropriates money that could go into private investment, meaning it had better be pretty good for growth.

That’s a lesson that isn’t fully recognized by a new report from former CBO director Douglas Holtz-Eakin and Michael Mandel, a liberal economist, on one way the CBO could apply dynamic scoring to federal transportation spending proposals.

Dynamic scoring of major spending proposals, such as transportation bills, is a good idea. But to provide Congress with the most complete information on, say, the economic impact of more transportation spending, the CBO needs to update its methodology, and the model Holtz-Eakin and Mandel put forth needs to be improved.

First, the CBO’s current dynamic scoring model fails to take into account the negative economic impact of depriving the private market of funds so that the government can spend them. A truly meaningful analysis would reveal the opportunity costs of public “investments,” comparing their returns to the returns that would have been realized had the private sector invested the money instead.

Congress should fund only those transportation projects whose returns will exceed what could be generated in the private sector.

The principle here is simple: Congress should fund only those transportation projects whose returns will exceed what could be generated in the private sector. To do otherwise is to reduce economic growth.

Unfortunately, Holtz-Eakin and Mandel’s report doesn’t take this principle into account. The authors use a standard methodology that estimates the revenue feedback from increased transportation spending. But their analysis stops there. They do not explicitly state the rate of return from the higher spending, nor do they account for the opportunity cost.

Their core finding is this: “$100 billion in new infrastructure spending could generate an extra $62.5 to $165.5 billion in national output over the next twenty years . . . [which] would generate a 20-year revenue offset ranging from $12.5 to $33.1 billion.”

At first glance, that seems impressive. Yet the high end of their estimate — a $165.5 billion increase in output over 20 years — translates to only a 2.6 percent annual rate of return. This is well below the average rate of return earned by businesses in non-financial industries. And new private-sector projects typically average a much higher return than that.

Moreover, the maximum rate of return implied by Holtz-Eakin and Mandel assumes an optimal investment environment: a slow-growing economy, slack labor markets, and bureaucrats unerringly green-lighting only the most efficient projects on the drawing boards. The 2009 stimulus shows this last assumption to be unrealistically generous.

So, what if the federal “investment” occurs in less-than-perfect conditions, as it usually does? Their lower-bound estimate assumes a full-employment economy and officials funding their fair share of transportation boondoggles. In that scenario, spending an additional $100 billion on new infrastructure yields an annual return of negative 2.3 percent.

#related#At the end of the day, this analysis shows that a $100 billion boost in federal transportation could increase the size of the economy and tax receipts, provided everything goes right. However, the federal government would likely be better off leaving that money in the private sector. Why? Because the private sector would invest it more efficiently, earning a higher rate of return and growing the economy even larger. Businesses would create more jobs, incomes would grow more, and tax-revenue feedback would be greater.

One final quibble with the Holtz-Eakin–Mandel report: It assumes a slightly positive short-term multiplier for transportation spending. While the authors stipulate that government spending comes with opportunity costs, they do not account for that in their model. If they had done so, their estimates of the positive benefits would have fallen markedly, revealing with great clarity the relative advantage of private-sector investment over government transportation spending.

The CBO can improve on the Holtz-Eakin–Mandel model by comparing the rates of return the spending would generate with private rates of return and by accounting for opportunity costs. This would give members of Congress a better sense of the total costs of increasing transportation spending — which, after all, is the point of dynamic scoring in the first place.

— Curtis Dubay is a research fellow specializing in tax and economic policy at the Heritage Foundation’s Roe Institute of Economic Policy Studies. 

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