Tuesday, January 11, 2011

Ezra Klein's Budgetary Scholasticism

Conservatives and liberals never tire of calling the other side’s self-proclaimed “deficit hawks” a bunch of hypocrites. Liberals can’t take conservative professions about fiscal responsibility seriously as long as they summarily take tax-increases off the table. Conservatives think that the liberal idea that repealing ObamaCare will add to deficit is a bad joke.

Ezra Klein suggests that we could identify genuine fiscal (ir)responsibility more accurately, if we used CBO numbers to hold politicians’ feet to the fire:
“When it comes to judging politicians [professing to care about the deficit] . . . all that empirical rigor goes out the window. It doesn't need to. Just as the AFL-CIO keeps track of how politicians vote on questions that are important to organized labor and the Chamber of Commerce keeps track of how politicians vote on issues of importance to the Chamber of Commerce, the deficit hawk groups should record the way every member of Congress votes on bills of importance to the deficit. Use the CBO's numbers, put them into a spreadsheet, and soon enough you'll be able to show whether this or that politician has been fiscally responsible or fiscally irresponsible over the last year -- and your metric will be whether they voted responsibly, not whether they spoke responsibly. Then you can give your awards out on merit, and they'd be very difficult to question.”
It’s hard not to sympathize with Klein’s desire to measure politician’s professions of fiscal responsibility against an objective standard. If you ask me, however, the idea that the CBO numbers are an instrument of “empirical rigor” that could supply that standard is a non-starter.

CBO numbers are generated through the application of accounting conventions.  As such, they’re designed to serve a function that’s roughly analogous to the role Generally Accepted Accounting Principles (“GAAP”) play in public capital markets.  The fact that a public accounting firm has signed off on a public company’s financial statements as GAAP-compliant enables people contemplating buying its bonds or common stock to make apples-to-apples comparisons between it and other companies from their respective financial statements. 

No one thinks, however, that an investor can make informed judgments about how much a company’s debt or equity is worth merely by looking at its financial statements. For that, a reasonable investor needs an actual empirical theory about how the relevant markets are likely to behave in the foreseeable future along with a seat-of-the-pants understanding of how much risk (or uncertainty) he's willing to tolerate that his predictions are wrong. We wouldn’t have capital markets if different reasonable investors, consulting the same financial statements, didn’t put a different value on the same company.

Similarly, Republicans and Democrats can use CBO scoring to make some worthwhile apples-to-apples comparisons of legislative alternatives. But, as long as they adhere to different macro-economic theories, they’re going to project different levels of government revenue and liabilities and reach inconsistent conclusions about the budgetary consequences of any significant public policy. Assessing politicians’ comparative seriousness about reducing the deficit solely by consulting the CBO scoring of the policies they support and oppose is a mistake akin to assuming that the market value of a company is the same thing as its book value.

But there’s at least one respect in which comparing CBO scoring to GAAP accounting is far too charitable to CBO scoring. GAAP includes a regulative principle that prohibits accountants from gaming accounting conventions so as materially to mislead investors about the financial condition of the company. When responsible auditors discover that a company has done that, even inadvertently, they refuse to sign off on its financial statements. When a company gets caught willfully issuing materially misleading financial statements its executives go to jail for securities fraud.

No Enron executive who ended up in jail would ever have dreamed of gaming GAAP as cynically as legislators, Republican and Democratic, routinely game CBO scoring conventions to mislead voters into thinking that they're fiscally responsible.  And unlike professional accountants, CBO scorers have to go along for the ride.

1 comment:

Anonymous said...

Good post. From now on maybe we should have CPAs audit CBO scoring. There have to be standards and comparability.