Baseline projections

What Are Baseline Projections?

Baseline projections are forward-looking estimates of economic and budgetary outcomes, assuming that current laws and policies remain unchanged. Within the realm of Public Finance and Economic Policy, these projections serve as a neutral benchmark against which the potential effects of proposed policy changes can be measured. They are not predictions of what will happen, but rather what would happen if no new legislative action were taken. This distinction is crucial for policymakers and analysts to evaluate the fiscal implications of various decisions. Baseline projections often encompass key economic indicators such as Gross Domestic Product (GDP) growth, inflation, interest rates, and unemployment, as well as detailed breakdowns of government revenues and spending.

History and Origin

The practice of systematic economic forecasting gained traction in the early 20th century, with early 20th century entrepreneurs developing methods to predict business cycles and market trends.¹² In the United States, the formalization of baseline projections within government budgeting largely traces back to the Congressional Budget Act of 1974. This act established the Congressional Budget Office (CBO) with the mandate to provide Congress with independent analyses of budgetary and economic issues.¹¹ A core part of the CBO's responsibility is to produce annual baseline projections for federal spending, revenues, deficits, and debt over a ten-year period.¹⁰ This institutionalization provided a consistent, non-partisan foundation for legislative discussions, allowing Congress to assess the impact of proposed legislation against a common, policy-neutral starting point.

Key Takeaways

• Baseline projections estimate future economic and budgetary conditions under the assumption that current laws and policies remain unchanged.
• They serve as a neutral benchmark for evaluating the budgetary impact of proposed legislation.
• Key components often include forecasts for GDP, inflation, interest rates, unemployment, and detailed breakdowns of government revenues and expenditures.
• Major institutions like the Congressional Budget Office (CBO) and the International Monetary Fund (IMF) regularly publish baseline projections.
• These projections are a foundational tool in fiscal planning and policy analysis, distinct from general economic forecasts.

Formula and Calculation

While there isn't a single universal "formula" for baseline projections, they are constructed through complex economic models and statistical analysis. For governmental bodies like the CBO, the process involves combining economic forecasts with detailed projections of various spending and revenue streams.

The CBO's baseline, for instance, typically has five major components:

1. Economic Forecast: Projections of macroeconomic variables.
2. Mandatory spending: Outlays for programs like Social Security and Medicare, which operate under existing law without annual appropriation action.
3. Discretionary spending: Outlays controlled by annual appropriation acts, projected based on current law adjusted for inflation.
4. Revenues: Projections of tax and fee collections based on current tax law and economic activity.
5. Net interest costs: Projections of the government's interest payments on its government debt.⁹

These components are often aggregated from highly detailed, account-level projections. For example, individual income taxes are projected using microsimulation models based on tax returns, while mandatory spending programs are estimated based on statutory parameters and demographic trends.⁸

Interpreting Baseline Projections

Interpreting baseline projections requires understanding their inherent assumptions and purpose. These projections are explicitly "policy-neutral," meaning they do not anticipate future policy changes. They provide a "current law" outlook, acting as a reference point for policymakers. When a new bill is proposed, its budgetary impact is often measured as a difference from the baseline, highlighting how the proposed changes would alter the trajectory of revenues and expenditures. This allows for clear comparisons of alternative fiscal policy choices.

For instance, if a baseline projects a growing budget deficit over the next ten years, and a proposed policy aims to reduce it, analysts would show the projected deficit under the new policy compared to the existing baseline. This approach helps in evaluating the fiscal consequences and sustainability of government programs.⁷

Hypothetical Example

Consider a hypothetical country, "Econland," whose Ministry of Finance is preparing its annual baseline projections for the upcoming fiscal year and the subsequent five years.

1. Economic Assumptions: The ministry first establishes an economic forecast. Based on current trends, they project average annual GDP growth of 2.5%, inflation at 2.0%, and a stable unemployment rate of 4.5%. They also factor in current interest rates on government bonds.
2. Revenue Projections: They project tax revenues based on the economic forecast and existing tax laws. If income tax rates are fixed and GDP is expected to grow, income tax receipts would naturally increase. Similarly, sales tax collections would rise with projected consumer spending.
3. Spending Projections:
   • Mandatory Programs: For programs like universal healthcare and pensions, which are dictated by current law, spending is projected based on demographic changes (e.g., aging population leading to higher pension outlays) and benefit formulas. This is mandatory spending.
   • Discretionary Programs: For areas like defense or education, whose budgets are set annually, the baseline assumes these budgets will grow with inflation from their last appropriated levels, reflecting the "current law" assumption for discretionary spending.
4. Net Interest: Calculations are made for the cost of servicing existing government debt, factoring in projected interest rates.

By summing these components, the ministry produces a comprehensive baseline projection showing the expected path of revenues, outlays, and the resulting budget balance or deficit for Econland over the next five years, assuming no new policies are enacted. This allows the government to then propose and evaluate new initiatives, showing how they would deviate from this "do-nothing" baseline.

Practical Applications

Baseline projections are fundamental to various aspects of financial planning and governance:

• Government Budgeting: They are the starting point for national budget processes, providing a clear picture of future fiscal trends under current law. This informs the annual budget resolution and helps legislative bodies like the U.S. Congress analyze budgetary trends and the effects of proposed legislation.⁶
• Policy Evaluation: When new legislation is considered, its cost or savings are often calculated as a deviation from the baseline. This allows policymakers to understand the net impact of changes in fiscal policy. For instance, the CBO uses CBO's baseline projections as a benchmark.
• International Economic Analysis: Organizations like the International Monetary Fund (IMF) produce baseline projections for global and regional economies. Their IMF's World Economic Outlook reports include baseline forecasts for growth, inflation, and other indicators, providing a common reference for international discussions and policy coordination.⁵
• Long-Term Planning: Beyond the immediate budget cycle, baseline projections help governments assess the long-term sustainability of entitlement programs and overall government debt. They highlight potential future imbalances that may require policy adjustments.

Limitations and Criticisms

While essential, baseline projections have inherent limitations and face criticism. Their core assumption—that current laws remain unchanged—means they do not account for future legislative actions or unforeseen economic shocks. This "current law" assumption can lead to projections that diverge significantly from actual outcomes, especially over longer horizons.

One common criticism regarding the accuracy of economic forecasts in general is their poor record in predicting significant economic turning points, such as recessions or periods of unexpectedly high inflation. Thi⁴s applies to baseline projections as well, as they are built upon underlying economic forecasts. If the economic assumptions prove inaccurate, the entire baseline projection will be off. For example, economists have frequently failed to predict recessions, and their forecasts can be overly confident in their precision, even if overall direction is sometimes correct.,

F³u²rthermore, the very act of publishing baseline projections can influence behavior, creating a feedback loop. For example, if a baseline projection indicates future fiscal strain, it might spur policymakers to act, thereby invalidating the original "no policy change" assumption. The complexity of modern economies also means that small changes in variables can lead to vastly different outcomes, making highly accurate long-term projections challenging. Ana¹lysts often use scenario analysis to illustrate how outcomes might differ under alternative assumptions, addressing some of these uncertainties and allowing for better risk assessment.

Baseline Projections vs. Economic Forecasting

While closely related, baseline projections and general economic forecasting serve distinct purposes and operate under different assumptions.

The confusion often arises because baseline projections incorporate an underlying economic forecast. However, the critical distinction lies in the "current law" assumption of baseline projections. A general economic forecast might predict, for example, that the central bank will raise interest rates, or that a new trade agreement will boost GDP. A baseline projection, conversely, would only incorporate such changes if they are already mandated by existing law, or if the economic forecast explicitly assumes a continuation of current monetary policy without any future shifts that aren't already baked in.

FAQs

What is the main difference between a baseline projection and a target?

A baseline projection is a neutral forecast of what would happen if current laws and policies continue without change. It's a starting point for analysis. A target, on the other hand, is a desired future outcome that policymakers aim to achieve, such as a specific unemployment rate or a balanced budget. Policies are often designed to move outcomes from the baseline projection closer to the desired target.

Are baseline projections always accurate?

No, baseline projections are not always accurate in predicting actual future outcomes. They are built on a set of assumptions about current laws and economic trends, which may not materialize as expected. Unforeseen events, legislative changes, or shifts in monetary policy can cause actual outcomes to diverge from the baseline. They are a tool for analysis, not a crystal ball.

Who produces baseline projections?

In the United States, the Congressional Budget Office (CBO) is a primary producer of baseline projections for the federal budget and economy. Other institutions, such as the Office of Management and Budget (OMB) within the executive branch, and international bodies like the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD), also generate similar types of economic outlooks and projections that serve as baselines for their respective analyses.