The fantastic assumptions of the “The People’s Budget” by House Democrats

May 9, 2011

What’s the true opposite of Rep. Paul Ryan’s “Path to Prosperity” budget plan?  Well, there’s the Obama “Framework,” but that is little more than a speech and a bunch of bullet points.  For a more serious and comprehensive liberal response, take a look at the “People’s Budget” produced by the Congressional Progressive Caucus.

Here’s the short version of the plan: It claims to achieve primary balance (not counting interest costs) by 2014 and overall balance by 2021. It does this via huge tax hikes (on income, corporate profits and investments) and by cutting defense spending by $2.3 trillion over a decade – and then shifting $1.7 trillion of those savings into nondefense outlays.  Those nearly $2 trillion in new “investments” would boost the growth potential of the economy by 0.3 percentage point per year over the next decade. Or so the CPC and the Economic Policy Institute claims.

The economic consulting firm Macroeconomic Advisers is dubious, to say the least, that the Peoples’ Budget would boost growth rather than kill it. Among its criticisms (as excerpted by me):

1) The analysis ignores near-term fiscal drag sure to arise if the plan is implemented when the Federal Open Market Committee has little room to accommodate a strong fiscal contraction.

2) Nor does it even mention the potential deleterious supply-side effects of raising marginal tax rates

3) The $1.7 trillion is nominal, not real, spending. Furthermore, in the CBO baseline inflation averages 2% per year. Adjusting for inflation reduces the $1.7 trillion in current dollars to $1.5 trillion in 2005 dollars.

4) This is gross investment, some of which depreciates away over time. The average or effective depreciation rate on private nonresidential fixed capital is about 7.5% per year. Assuming this rate of depreciation, and then accumulating the real gross investment flows by perpetual inventory into a net stock leads to an increase of roughly $0.7 trillion in the level of the real capital stock over the coming decade.

5) In our own long-run forecast, the real private nonresidential capital stock is roughly $21 trillion at the end of 2021, of which $0.7 trillion would represent an increase of about 3%.

6) This is for the private nonfarm business sector, which accounts for only three-fourths of total GDP. Hence the impact on the level of GDP at the end of ten years would be 0.75 times 1%, or 0.75%.

7)  When this increase is spread over ten years, the average impact on growth is less than 0.1 percentage point per year, or only about a third of the impact the EPI analysis suggests would result from the federal government spending the same amount of money on nondefense activities.

But wait, there’s more:

There are additional reasons to be suspicious. Much of the literature estimating the return to public investments focuses on the productivity of tangible investment like infrastructure, in part because there are data on the tangible public capital stock that facilitate such research. However, of the $1.7 trillion of new nondefense spending proposed in the People’s Budget, only $0.2 billion is specifically earmarked for physical infrastructure that would be included in official estimates of the public capital stock. The remaining $1.5 trillion is for “job creation, education, clean energy and broadband infrastructure, housing, and R&D.” Our National Accounts would count almost all of this either as current consumption or current transfers, not gross investment, and certainly there must be some consumption element in such spending. Do we really think that an increase in “foreign assistance” delivers the same productivity gain as expanding or repairing the inter-state highway system?

In addition, the analysis doesn’t argue that the $2.3 trillion of cuts in defense spending are a reduction in public investment that reduces economic growth. In essence, the EPI analysis implies that, at the margin, nondefense spending is all investment but that defense spending is all consumption. Both sides of this proposition might be closer to the truth than not, but if some nondefense spending is consumption and some defense spending is investment, the EPI calculus on the growth effects of the People’s Budget can be quickly undermined.[7] Suppose, for example, that 75% of the extra nondefense outlays really are new investments, but that 25% of the proposed savings in the defense budget actually reflects cuts in public investment. Then, the net change in public investment is reduced from the $1.7 trillion advanced in the People’s Budget to just $0.7 trillion (=.75*$1.7 trillion – .25*$2.3 trillion).


One comment

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Fine fine. I don’t doubt all these numbers. That’s why it’s called a *Peoples’ Budget*, not a real budget and don’t forget, it was put together by the *Progressive Caucus*. Lefties never give up. A simple laugh and a wave of the hand at this budget proposal would have been adequate.

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