Battle of the State Finance Commissioners

In the battle over forecast inflation just who is really being naive?

A recent point/counterpoint exchange in the Star Tribune once again brought a long-simmering public finance topic back into the spotlight -- whether or not to include spending inflation in the economic forecast.  Make no mistake, this rather wonky debate is a serious issue not just because of its influence on state budgeting but also because of its huge effect on public perceptions and attitudes about the state budget.

In the initial submission, Peter Hutchinson, who served as finance commissioner in the early 90s, points out one of the most commonly expressed criticisms -- that counting inflation in revenue forecasts but not in spending forecasts is somehow imbalanced and dishonest -- has a conceptual flaw.  With respect to the actual "inflation in or out" decision he acknowledges there are strengths and weaknesses to each approach, provides the rationale for each, but ultimately argues keeping it out is preferable because including it tends to protect the status quo of what we buy with our tax dollars and how we buy it. 

In their response, a "tripartisan" quintet of former state finance commissioners don't hold back, calling Hutchinson's argument "specious," "wholly inappropriate," "counterproductive," and "naive" and concluding "it's time to end the charade."  (We note such phrases join a long list of rhetorical blackjacks used in the past against those who have dared to question the wisdom of inflating spending projections such as "inane," "fiscally irresponsible," and "intellectually bankrupt.")  Their argument is simple -- there is a difference between planning and budgeting.  The economic forecast is a tool for the former, modestly acting as a "reference document" for fiscally responsible budgeting.  It should present the best and most accurate estimate possible of what will happen if nothing changes, and, like it or not, inflation is a part of future reality.  Just because a forecast includes inflation does not introduce spending bias. They argue lawmakers are free to enact whatever combination of spending and tax changes they deem appropriate.  (For the record, M.S. 16A.103, Subd. 1a, which specified formal recognition of general inflation in forecasted expenditures, only existed from the early 1990s to 2002.  Minnesota has been irresponsible and intellectually bankrupt through most of its 160 year history.)

We've weighed in on this debate many times in the past, but the respondents use of the word "naive" to criticize Hutchinson triggered an especially strong reaction from us.  Because for all the legitimate points these finance commissioners made in their counterpoint, it's the political naivete of imagining there is some bright line of demarcation between the economic activity called “planning” and the political activity called “budgeting" behind their argument that causes our heads to spin:

It's naive to not recognize that the economic forecast is also very much a budgeting tool.  No one has ever captured this reality more simply and succinctly than the Minnesota House's  Fiscal Analysis Department in their 2002 review of the history of planning estimate inflation:

“Planning estimate inflation has also been a tool to provide more flexibility for a Governor and Legislature in assembling a new budget. The inflation creates a cushion of several hundred million dollars that is already counted as spending in the budget forecast.” 

That "several hundred million" is $1 billion today.  If we want to serve the cause of intellectual honesty, we should recognize that including inflation enables considerable spending on new or expanded programs without ever having to properly recognize it as “new government spending."

It's naive to not recognize the powerful role spending forecast inflation would play in influencing public perceptions about the adequacy of state taxes and spending.  As Hutchinson points out, when appropriations grow year on year but fall shy of forecasted spending as adjusted for inflation, politicians are quick to label such increases -- often in the hundreds of millions of dollars -- as “cuts.”  

It's naive to think that including forecast inflation won't have some impact in inflationary trends of government's primary purchased input.  The state budget "cannot pretend that forest rangers aren't going to get raises" but also cannot pretend a Consumer Price Index forecast reflects the reality of collectively bargained compensation agreements.  As a planning tool, inflation-adjusted spending amounts might estimate the cost of keeping the existing government employee base whole.  As a budgeting tool, cost of living adjustments already baked into the forecast as a “given” would pressure negotiators to begin from that base.

It's naive to think that spending inflation in the forecast accurately communicates the "real cost" of government services.  Rather it communicates the cost of how these services are currently provided; a mechanical calculation of the cost of maintaining the status quo in government service delivery.

Many "inflation includers" envision government straight out of a civics and public finance textbook -- a world where, when presented with planning information, policy makers can and do change course with the objectivity, responsiveness and nimbleness of a sailboat tacking in the winds.  "Inflation excluders" tend to see government as a giant aircraft carrier of inertia -- a collection of interests highly resistant to any necessary course corrections and who interpret planning information exclusively through the lens of the fuel gauge as they try to keep moving forward in the same direction.

Completely ignoring the effects of inflation may be disingenuous and be a detriment to responsible fiscal planning.  But having a biennial budget framed and negotiations proceed in a context where every dollar of government spending is effectively indemnified against inflation doesn’t exactly serve the cause of acknowledging reality or better government either.  If inflation is going to be included in spending forecasts it needs to be done very thoughtfully, very carefully, and very, very judiciously.