Federal Budget Lessons From the Iceland Volcano

Posted April 26, 2010 at 6:44pm

Correction Appended

No, this is not a column about the airlines and travel industries requesting some type of emergency federal aid because of the volcano in Iceland that wreaked havoc over the past few weeks on flights to and from Europe. Instead, the volcano may have erupted just in time to help settle one of the longest-running annual budget fights in Washington: the use of a baseline.

[IMGCAP(1)]At some point in the coming weeks as the Senate continues to consider a budget resolution for fiscal 2011 and the House ponders whether to consider one at all, someone on Capitol Hill is going to say something to the effect that only in Washington could a spending increase be considered a cut. As the volcano demonstrated, and then some, that will be completely wrong.

A baseline is simply an expectation of what will occur under certain conditions. Contrary to what some experts state at this time of year, the use of a baseline is anything but unique to Washington and federal budgeting. A projection of 100 wins by the New York Yankees by a sports columnist, an estimate of the earnings per share of a company by a Wall Street analyst and the par on a golf course are all examples of baselines routinely used outside the Beltway to talk about things other than what Washington spends and collects.

But whether you’re talking about getting a double bogie on the eighth hole, corporate earnings or the total amount of revenues that will be paid to the federal government this year, the principle is exactly the same. A company projected to earn $3.50 a share this quarter but which actually reports $3.40 could trigger a round of selling on Wall Street. Even though the company may have earned more per share than it did the previous quarter and is actually doing quite well, if the results fell below expectations — that is, below the baseline — they may disappoint investors. In other words, the increase in earnings actually is considered a reduction.

The federal budget uses a baseline that estimates what it would cost the government to continue doing everything it’s doing this year. The baseline basically assumes that appropriations will grow at the rate of inflation to maintain a constant level of buying power, benefit programs will increase or decrease to match the number of people eligible next year under existing law, and revenues will increase or decrease depending on existing law and how the economy performs.

That means, for example, if inflation is forecast to be 3 percent, military spending is projected to grow from, say, $500 billion in 2010 to $515 billion in 2011. Appropriating $510 billion would clearly provide the Pentagon with more money than it received the year before, but just like the company and its actual-versus-projected earnings, that level may well disappoint some who think of it as a cut from the baseline.

This is where the Iceland volcano enters the picture. The airlines claimed a few weeks ago that the canceled flights were costing them $200 million or so a day. But before anyone starts proposing aid because of how much was lost, we have to know what baseline was used to make the calculation.

One possibility is that the airlines compared the lost revenue from the volcano-caused canceled flights to a baseline that assumed what would have been earned had every plane left as scheduled with every flight at 100 percent capacity and every passenger paying the full listed fare. But some of those flights might not have been full or might have had a preponderance of passengers with discount fares. It’s also possible that some of the flights might not have flown at all because of weather, mechanical or other problems. Each of these adjustments is a different baseline that changes how much the airlines appeared to lose while the volcano was spewing ash over the north Atlantic.

This is almost precisely what the federal budget baseline dispute is about as well. Some people argue that spending and revenues should only be compared with what was actually spent or collected the previous year. All they are really doing, however, is simply demanding that a different baseline be used.

Although the demand may be made for what is said to be good budget reasons, in reality the proposed change is almost always for political purposes. In the example above, even though it’s clearly more than what was spent the year before, some would criticize an appropriation of $510 billion for the Pentagon as a cut and using a different baseline makes that possible. Similarly, Medicare opponents may want to say that, for example, $10 billion more than last year is actually an increase even though it may also be $5 billion less than what’s needed under the existing baseline.

Like an active volcano, the federal baseline dispute usually gets very heated and, although flights won’t be canceled around Washington, it typically creates its own type of havoc as the budget debate gets muddled. But when the baseline debate erupts, as it almost inevitably will do in the weeks ahead, it will be invective rather than ash that gets spewed.

Stan Collender is a partner at Qorvis Communications and founder of the blog Capital Gains and Games. He is also the author of “The Guide to the Federal Budget.”

Correction: April 27, 2010

The article misstated how much money the airline industry claimed to be losing each day because of flights canceled by the volcanic ash. The figure is $200 million.