Prisoners of Their Own Device

April 6, 2023

HOWEVER ESSENTIAL TO THE CRAFT OF LEGISLATION, projecting policy outcomes is a notoriously fraught human enterprise. As the authors of a leading graduate-school textbook on the subject bluntly assert, “even veteran policy analysts do not do it very well” and many “often duck it entirely, disguising their omission by a variety of subterfuges.”

To see why, let’s imagine a hypothetical legislative proposal to invest $50 billion in federal grants-in-aid per year over the next ten years—all of which would be financed through federal borrowing. Roughly half of this investment would go to fixing the country’s crumbling transportation infrastructure. The other half would be divided almost evenly between investments in education and R&D.

Given the poor—often perilous—conditions of American highways and railroads, one might assume that this kind of investment would be a boon to the economy. Yet, according to the CBO, this is not the case. At best, the policy would have a negligible positive impact on gross domestic product. To see why, we can consult CBO’s 2016 report on “The Macroeconomic and Budgetary Effects of Federal Investment,” which argues that the average short-run rate of return for federal investment is roughly 5 percent; this is one-half as large as the return on investment in the private sector.

CBO makes this claim for two reasons. First, the average productivity of investments by federal, state, and local government, the report asserts, is 8 percent—three-fourths as high as the average productivity of private investments. Second, each dollar of investment by the federal government increases total public investment by only two-thirds of a dollar. That is because federal spending generally leads to a decrease in state and local spending. The rest, we are told, is simple multiplication: “Two-thirds times three-fourths equals one-half.”

It all sounds simple enough. Yet scratch the surface even slightly, says Rutgers University economist Mark Paul, and CBO’s assumptions turn out to be “very wrong.”

One fundamental flaw, Paul suggests, is CBO’s claim that a dollar of public-sector investment is far less productive than an equivalent level of investment in the private sector. “In fact,” he points out, “the evidence shows that public investment often has a higher economic rate of return than private investment.” The evidence in question is not a cherry-picked set of outliers. It is a widely cited survey of 68 studies published between 1983 and 2008. That review, published by economists Pedro Bom and Jenny Ligthart in the Journal of Economic Surveys, finds that the average rate of return for public investment is 10 percent in the short run and 16 percent in the long run. That is double the rate the CBO model employs. When Bom and Ligthart narrow the inquiry to examine only “core” public investments—in roads, highways, airports, and utilities—they find that the rate of return is higher still...

While CBO’s assumptions are often “wildly out of line with empirical studies,” Paul says, they are still very much in line with what gets taught in graduate macroeconomics courses, which have not yet caught up to the literature. In the midst of this disciplinary chaos, conventional wisdom dies hard—especially inside CBO.

Economists, Paul suggests, need to admit that “we’re not great at forecasting the economic effects of policies.” While he acknowledges that CBO has improved its efforts at transparency in recent years, the budget office “has to do a better job at educating people on the assumptions its models use” and how the models contain a “lot more uncertainty” than CBO reports portray…

However hard-won, the CBO’s reputation as an honest broker of hard truths in a polarized age—or, as one Washington Post editorial put it, a “skunk at the congressional picnic”—has had costs of its own. It is far easier to report the office’s point estimates as stylized facts rather than what they are: conditional, assumption-laden projections of the future. “The fact that CBO is just so solidly in Wonkville,” as economist Mark Paul puts it, “makes it harder to go after and also it looks more partisan going after it,” even when its assumptions are off base. “In reality,” Paul says, “how you crunch the numbers is a deeply political question.”, April 6, 2023

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