Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How The Budget Baseline Skews Fiscal Reality
Transcript
- Lucas: Let's talk about the single most confusing number in American public finance right now: the baseline budget projection. If you look at the Congressional Budget Office report released just last week, mid-October twenty-six, it suggests that federal deficits are stabilizing because revenue growth is outpacing spending increases. But here is the trap, and I see too many analysts fall into it every time this comes up. Luna: Which is that the baseline assumes current laws stay exactly as they are, ignoring how fast interest rates are actually compounding? Lucas: Exactly. The baseline is static. It treats tax credits like the child tax credit as if they expire next year unless Congress renews them, and it assumes mandatory spending grows only by inflation. In reality, those credits have been extended repeatedly for decades, and interest costs are soaring because the ten-year Treasury yield has hovered above four percent all quarter. So when the CBO says deficits are 'under control' relative to baseline, they are really saying 'under control relative to a fantasy scenario.' Luna: So the baseline isn't a prediction, it's a political scoreboard used to make bad policy look cheap. Lucas: Precisely. And the damage is real because policymakers use it to justify austerity measures that don't address the actual drivers of debt. Let's look at a concrete example. In the late nineties, the Clinton administration celebrated surpluses based on baseline projections. But when you adjust for dynamic scoring—accounting for how lower taxes might stimulate growth—the picture changes significantly. Today, we have the opposite problem. We are cutting discretionary spending based on baseline savings that never materialize because mandatory programs keep expanding faster than the baseline models predict. Luna: It feels like we are measuring our weight loss against a scale that keeps changing its calibration. Lucas: That is a perfect analogy. The baseline calibration shifts every time there is an unexpected shock. Think about the pandemic response or the recent infrastructure bills. Those were scored against old baselines, but now the baseline has absorbed those one-time costs into the recurring structure of the budget. This creates a ratchet effect where spending goes up easily but comes down hardly ever. The baseline makes it look like we are returning to normal, when we are actually building a higher floor for future obligations. Luna: Does this mean the public sector payroll data we discussed earlier is also skewed by these same baseline assumptions? Lucas: It does. When you look at government employment figures, you see headline numbers that seem stable. But if you strip away the temporary pandemic-era hiring and look at the core civil service, you find that wage growth is being driven by the need to compete with private sector tech salaries, not by bureaucratic bloat. The baseline doesn't capture that labor market pressure because it assumes federal pay scales move mechanically with civilian average earnings. They don't anymore. Federal workers are leaving for the private sector, and replacing them costs more per head than the baseline projects. Luna: So we are paying a premium for talent that the budget model thinks we are getting at a discount. Lucas: Right. And this brings us to the broader macro environment. As of today, October seventeenth, twenty-six, the market is pricing in a soft landing, but the fiscal backdrop is anything but soft. Investors are starting to realize that the baseline deficit reduction is illusory. When you add in the cost of servicing the national debt, which has tripled since twenty-twenty, the true deficit is much larger than what appears in the monthly treasury reports. This disconnect between accounting fiction and economic reality is what creates volatility in the bond market. Luna: I think a lot of listeners are confused by this distinction between statutory deficits and economic deficits. Can you clarify that simply? Lucas: Statutory deficit is what the law says we owe on a specific date. Economic deficit includes the hidden costs: the erosion of purchasing power due to inflation, the opportunity cost of capital tied up in government borrowing, and the long-term liability of unfunded pensions. The baseline focuses almost exclusively on the cash flow, ignoring the balance sheet deterioration. That is why you see pension funds in states like Illinois or New Jersey struggling even when their annual budgets appear balanced on paper. Luna: It reminds me of corporate accounting, where off-balance-sheet liabilities can sink a company quietly over years. Lucas: Spot on. Governments do the same thing with operating leases and healthcare obligations for retirees. These are massive commitments that don't show up in the annual appropriations bill until the cash actually leaves the account. By then, it is too late to adjust course. The baseline budget is a snapshot of today's cash flow, not a map of tomorrow's solvency. And that is dangerous because it encourages short-term thinking. Politicians get credit for keeping the statutory deficit low while pushing the hard choices into the future. Luna: So the baseline acts as a delay tactic rather than a planning tool. Lucas: It absolutely does. And the consequence is that when the inevitable crisis hits, the options are severely limited. We saw this during the debt ceiling fights of the past decade. The baseline suggested we had plenty of room to maneuver, but the underlying structural deficit meant that every dollar borrowed was adding to the interest burden. Now, with interest rates elevated, that compounding effect is accelerating. We are spending more to borrow money just to pay the interest on previous borrowing. It is a fiscal feedback loop that the baseline completely misses. Luna: This sounds like a classic case of looking at the symptom while ignoring the disease. Lucas: Exactly. The symptom is the monthly deficit number. The disease is the structural mismatch between revenue sources and expenditure mandates. Revenue has become volatile due to reliance on capital gains taxes, which boom and bust with the market. Expenditures, however, are sticky. Social Security, Medicare, and interest payments grow regardless of economic conditions. The baseline assumes revenue will grow steadily at two percent. In reality, it swings wildly. This volatility makes it impossible to plan effectively using static models. Luna: Are there any countries doing this better? Is there a model that accounts for this volatility? Lucas: Canada has made some interesting strides with multi-year fiscal frameworks. They don't just project one year ahead; they look at a ten-year horizon and stress-test their assumptions against different economic scenarios. The United States mostly operates on a two-year cycle for the budget resolution, which is barely enough time to implement a policy, let alone evaluate its impact. The Canadian approach forces politicians to confront the long-term consequences of their decisions immediately. Here, we defer that pain until the next election cycle. Luna: It seems like the lack of long-term visibility is a feature, not a bug, for incumbent politicians. Lucas: You hit the nail on the head. It is politically expedient to promise benefits now and pay for them later, especially when the later part is buried in a baseline projection that no one reads carefully. But for investors and businesses, this uncertainty is a major risk factor. If you are running a manufacturing plant in Ohio, you cannot build your supply chain on the assumption that tax credits will remain constant. You have to hedge against the possibility that the baseline will shift when the political winds change. Luna: So business leaders need to treat government forecasts with extreme skepticism. Lucas: Skepticism is an understatement. They need to build contingency plans for worst-case scenarios. If the baseline says deficits will shrink, assume they will expand instead. If the baseline says interest rates will stabilize, assume they will rise. This kind of prudent caution protects companies from being caught off guard by fiscal shocks. It is about managing risk, not predicting the future. The baseline is not a prediction; it is a political statement dressed up in technical jargon. Luna: I wonder if this distortion affects how everyday consumers view their own finances too. Lucas: It does profoundly. Households often make decisions based on nominal income without adjusting for inflation or changing tax brackets. Similarly, voters judge fiscal health by whether they feel richer or poorer, not by the structural integrity of the budget. When the baseline shows a surplus, people celebrate. When it shows a deficit, they panic. Neither reaction is rational because the baseline doesn't reflect the true economic position. We need a new metric, something like a primary surplus adjusted for cyclicality and demographic shifts, to give us a clearer picture. Luna: A cyclically adjusted primary surplus—that sounds like the kind of metric that would cut through the noise. Lucas: It would. It strips out the temporary effects of the business cycle and focuses on the underlying policy stance. If you run a surplus in this metric, you are truly reducing debt relative to the economy. If you run a deficit, you are accumulating obligations that will burden future generations. The current baseline system hides this truth behind layers of accounting gymnastics. Until we adopt a more robust framework, we will continue to be misled by superficial numbers. Luna: It is frustrating because the solution is technically simple, but politically difficult. Lucas: Complexity is often a shield for avoidance. The simpler the metric, the harder it is to hide the gap between rhetoric and reality. That is why independent agencies like the Congressional Budget Office are so important, but even they are constrained by the rules set by Congress. They can provide the analysis, but they cannot force the political process to use it. Change has to come from voters demanding transparency and accountability. Luna: Do you think the upcoming elections will bring any real discussion on this, or will it stay buried in committee reports? Lucas: History suggests it stays buried. Candidates rarely campaign on budget mechanics. They campaign on outcomes: jobs, prices, security. The baseline debate is too dry for the general electorate. But when the bill comes due—and it always does—the conversation becomes urgent. We are heading toward a period where interest payments will exceed defense spending. That is a milestone that will force a reckoning. Until then, the baseline remains a convenient fiction. Luna: A convenient fiction that we are all living inside of. Lucas: We certainly are. And navigating it requires a bit of financial literacy and a healthy dose of skepticism. If you want to support this deep dive into the mechanics of the economy, consider buying us a coffee. It helps us keep producing ad-free content that explains the world around you. Luna: If walking through the economy with us has made something click, finding a way to support the work directly is a great choice. You can visit buy me a coffee dot com slash fexingo to help keep these episodes going. Lucas: Thanks for the support. It means a lot to keep the lights on and the research thorough. Back to the fiscal reality check. Luna: Let's go back to that Canadian model you mentioned. Do you think the US could ever adopt a multi-year framework? Lucas: It would require a fundamental shift in how Congress operates. Currently, the budget process is fragmented across dozens of committees. Consolidating that authority into a unified long-term view would be a massive institutional challenge. But given the trajectory of debt, it may be the only path forward. Short-termism is killing long-term viability. We need to break the cycle of annual brinkmanship. Luna: Brinkmanship that the baseline helps sustain by providing cover. Lucas: Exactly. It provides cover for both sides. Democrats can claim they are protecting social programs, Republicans can claim they are cutting waste. Meanwhile, the structural deficit grows unchecked. The baseline allows both parties to claim victory while delivering defeat. It is the ultimate lose-lose situation for the taxpayer. Luna: So the baseline is less of a guide and more of a smokescreen. Lucas: A very effective smokescreen. And that is why understanding it matters. You are not just learning about government accounting; you are learning how to see through the narrative. Once you understand that the baseline is a static artifact, you start asking better questions about policy impacts. You stop accepting headlines at face value and start digging into the underlying assumptions. Luna: That shift in perspective changes how you watch the news entirely. Lucas: It does. And it empowers you to make smarter decisions, whether you are voting, investing, or just trying to understand why your taxes are changing. The baseline is a tool, but it is a blunt one. We need sharper instruments to measure the health of our economy. Until then, we have to do the work ourselves. Luna: And that is exactly what this show aims to do, arm you with the tools to look closer. Lucas: Absolutely. So as you go about your week, ask yourself: what is the baseline assumption in my own life? Are you planning for the status quo, or preparing for the shock? Because in both politics and personal finance, the status quo is rarely stable for long. Luna: A thoughtful question to carry into the weekend. Thanks for the clarity, Lucas. Lucas: Always, Luna. See you next time.