How Economic Modeling Can Identify Trends | Kent Smetters

What Policymakers Can Learn From Economic Modeling

Dan Loney: Is it fair to say that we’re in a period of time where there is more interest in the economy than maybe we’ve seen in times past?

Kent Smetters: It’s definitely true. It’s been over 40 years since the last time we’ve really had this type of focus, especially given the focus on inflation. You have to go back to the early 1980s, Ronald Reagan’s first term, to really see this level of interest. People are understanding that inflation is this real phenomenon. It’s not just a textbook issue that the Federal Reserve has to worry about. It has a big pocketbook issue as well.

Loney: The Penn Wharton Budget Model started about seven years ago. How did it get started and what was the idea behind it?

Smetters: It was really members of Congress who I already was having conversations with. They wanted an analysis not after they wrote the legislation, not after it went to chairperson, maybe went over to the Congressional Budget Office or some of the other scoring agencies. They wanted analysis at the very beginning, while they’re actually writing legislation. They wanted to know what was the effects before they put their reputation on the line. What’s the effect on the budget? What’s the effect on the economy? What’s the effect on people? And that’s really how we operate very differently. We do a lot of analysis directly with policymakers on both sides of the aisle who just are looking for an understanding of the impact of their legislation before they put pen to paper, before they put their reputation on the line.

Loney: In Washington, what do you think the benefit has been of having a resource like that, to be able to bring this type of information forward?

Smetters: It’s ultimately about credibility. We’ve become known very much as the honest broker. At any point in time, one side may really dislike us for our analysis. There’s a lot of groups in D.C. that call themselves nonpartisan for tax purposes, because you can give to a nonpartisan, deduct the amount that you’re giving even though they’re doing a lot of advocacy. We are not just nonpartisan, we go one step further. We’re non-normative. What that simply means is that we’ll never advocate for a policy. We’ll simply do the analysis as best as possible and let the numbers just be what they are. Let the chips fall where they may. At any point in time, one party may love that number and another party might hate that number.

If you look at who asks us for numbers, it’s coming from both sides of the aisle now. If you look at our free certificate program that we do in Washington, D.C., that is available to anybody interested in policy, it’s basically evenly split between both parties. So yes, people on both sides have said that they find our numbers often scary when they’re writing legislation, but they still respect it.

How Penn Wharton Budget Model Stays Nonpartisan

Loney: Does your work have the unintentional effect of highlighting that political bias?

Smetters: There’s a lot of problems with the metrics that are traditionally used in Washington, D.C. Republicans typically focus on just the macro outcome, and Democrats on distributional outcome. Economists have never believed that either measure is the right one to look at a policy. We want to have things that are much more integrated. For example, something that may look bad for a low-income person simply because they happen to be young may actually be good for them over a lifetime, if it happens to grow the economy. So, we have a much more integrated approach that actually combines everything.

Also, we don’t truncate, like under current rules. A lot of analysis on the current law is done on their five-year or 10-year budget. Anything like a pre-K spending program is always going to look bad under a 10-year budget because you spend all the money up front, and those 4-year-olds are not going into the workforce until decades later. Whenever you truncate, you’re creating this bias. We really work hard to remove biases and focus on good economics and analysis.

In many ways what economists have focused on have been clever insights and so forth. They’ve never built their models to do real policy work, and the policy work that’s often done is from an advocacy perspective. We’re trying to make economics useful in many ways and bring the rigor of analysis. The process has to be rigorous, and let the chips fall where they may, and let economics be really useful.

Loney: Where does the funding come from for Penn Wharton Budget Model?

Smetters: It’s partly alumni, and partly that we get grants from different large organizations. We make it clear to everybody that our analysis is our analysis. For example, the Tax Cuts and Jobs Act was largely liked by Wall Street, but we came out and said it’s going to have very little effect on the economy. On top of that, it will cost a lot more than what the government’s official numbers were. And after it got passed, the government’s official numbers then came right up to ours. They did a technical revision, and it came right up to our numbers.

If you look at the infrastructure bill that was passed a couple of years ago, and then last year, the Inflation Reduction Act, our analysis really played a key role in those legislations. Both sides of the aisle said our analysis was pivotal for their members.

Both cases were highly cited by advocates of those policies. On the other hand, we showed that neither policy was going to energize the economy like the advocates were trying to say. Not terribly surprising, there’s lots of overstepping that happens in the political process.

Loney: Do you see interest from outside the political realm?

Smetters: We’re around 30 people with two offices in Philadelphia and D.C. We have to be somewhat focused. Our main policy audience has been policymakers themselves. Having said that, we have definitely tried to write briefs and articles on public legislation that are accessible on our website. But even there, I will admit that sometimes things can get a little dense when you’re trying to explain hard-to-understand concepts. We certainly are trying to do a better job of that over time and give people tools like simulators that they can try to understand things with. Our modeling often takes hours to run across 75,000 threads, in many cases running parallelized computing. Very detailed calculations. Trying to break that down and make it really understandable has always been a chore. We continue to make improvements, but we’re not there yet.

Using Economic Modeling to Address National Debt

Loney: One of the big stories right now is the national debt. How does Penn Wharton Budget Model try to address that?

Smetters: The debt continues to increase relative to the size of the economy. There’s no end in sight with that. And right now, neither side is proposing anything that will address that. That’s a very scary outlook, in the sense that it’s happening at the same time a large carbon debt is accumulating. If you think things are a little bit crazy now in politics and the world, and so forth, this is actually the good time. Because we are very capital-flush right now in the United States and the world, as a lot of people are going into retirement. A decade frow now, we’re going to see a lot of that saving has disappeared or will continue to disappear. We’re going to have this convergence between debt that’s spiraling out of control and carbon that’s still going to keep on going where it’s going. And then the resources of the capital that we have right now is going to go away.

We’re really trying to get people to look down the road a lot more than they currently are. Both sides have taken strict positions on what they’re willing and not willing to do. The fact of the matter is, if you’re not willing to raise taxes on those making less than $400,000 a year, which the Democrats have said, there’s not enough money left over in the high income, the high wealth, and so forth. Everybody thinks that there’s tons of money up there. They’re not understanding the size of the imbalance right now. There’s just not enough money up there. There has to be broad-based either increase in revenue or decrease in spending.

On the other side of the aisle, the Republicans are also taking positions about no new tax increases, but we’re not going to touch entitlement programs. Well, that doesn’t add up, either. Both sides really need to come to grips with the situation. In the past, we’ve created these different policy options. We’d lay out the options, and the policymakers a lot of times are picking one of those options, and that’s what they form into law.

What we’re going to be doing going forward is also creating policy bundles. Because there’s lots of interactions between things like what you do with Social Security and the rest of the economy, and the rest of the tax bases. We’re going to be looking at those big bundles and trying to show people, first, the path that we’re on is just not sustainable. It literally will collapse the economy if we don’t do something. But secondly, lay out different options for dealing with this, and they all have different trade-offs. Let’s be super transparent about that.

Usually, the politics is you try to be incremental, make small changes. The problem with incrementalism is, first of all, it’s too late for that in the United States. We’re really too far along on the debt path, so we need to make bigger changes sooner. But the second is, some people feel like what happens with those incremental changes is that you’ve had too many people who benefit from that particular tax provision or spending provision. They lobby intensely. And maybe now is the day for the big bundles that worked our way in, where everybody’s a loser in some ways today, but we’re making these investments for the future generations.