Congressional Budget Office
Director’s Blog

Today CBO released an updated report on the treatment of federal receipts and expenditures in the National Income and Product Accounts (NIPAs). The Congress, executive branch agencies, and the press generally focus on the accounting of government finances presented in the Budget of the United States Government, which is prepared by the Office of Management and Budget (OMB). The budget is structured to provide information that can assist lawmakers in their policy deliberations, facilitate the management and control of federal activities, and help the Treasury manage its cash balances and determine its borrowing needs.

In contrast, the NIPAs—produced by the Bureau of Economic Analysis (BEA), an agency within the Department of Commerce—are intended to provide a comprehensive measure of activity in the U.S. economy, of which the federal sector is one part. Because the aims of the NIPAs differ from those of the federal budget, the two accounting systems treat some of the government’s transactions very differently, as described in this report. Despite the accounting differences, the government budget numbers reported by the BEA are not all that different from those reported under the OMB framework.

Last week CBO released the Long-Term Budget Outlook. Under current law, the federal budget is on an unsustainable path: projected spending rises well above projected revenue, producing growing budget deficits and accumulating debt. Almost all of the projected growth in spending relative to GDP (other than interest payments on the debt) is attributable to Medicare, Medicaid, and Social Security. For these three programs together, the two health programs account for 80 percent of spending growth over the next 25 years and 90 percent over the next 70 years.

Two factors underlie the projected increase in federal spending on Medicare, Medicaid, and Social Security as a share of GDP: rapid growth in health care costs and an aging population. To demonstrate the relative importance of these factors, CBO calculated how much of the projected increase in federal spending for the three programs would be attributable to aging and “excess cost growth” (growth in age-adjusted health care costs per person that exceeds the growth of per capita GDP) under the extended-baseline scenario (see my June 26 blog entry on the fiscal gap for a description of our long-term scenarios). CBO did so by comparing the outlays projected under that scenario with the outlays that would occur under two alternative paths: one with an aging population but no excess cost growth for health programs and one with no aging but with excess cost growth.

The interaction between the aging of the population and excess cost growth accentuates their individual effects. Higher spending per person has a larger influence as the number of beneficiaries in Medicare and Medicaid rises. Conversely, having more beneficiaries in those programs imposes a larger budgetary cost when health care costs are growing. That interaction can be identified separately, or it can be allocated according to the shares attributable to aging and excess cost growth.

Aging is the more important factor over the next 25 years or so. If the interaction is allocated between the two factors, aging accounts for about 64 percent of the projected growth in spending on the major entitlements by 2035.

That result is not surprising because the aging of the baby-boom generation significantly expands the number of Medicare, Medicaid and Social Security beneficiaries. Over the longer term, however, the situation reverses: 56 percent of the growth in total federal spending for those three programs by 2080 is attributable to health care costs per person rising more rapidly than per capita GDP. (Of course, the growth of health care costs has no effect on spending for Social Security.)

Identifying the interaction separately from the direct effects of aging and excess cost growth gives a slightly different perspective. By 2035, aging alone accounts for 56 percent of the projected growth in spending for the three entitlement programs. Excess cost growth accounts for another 32 percent, and the interaction between the two factors causes the remaining 11 percent. For the period through 2080, the picture changes, as aging accounts for 32 percent of the increase in spending, excess cost growth accounts for 41 percent, and the interaction effect contributes 26 percent.

Looking only at Medicare and Medicaid, excess cost growth is the primary factor driving the growth of federal spending, even over the intermediate term. By 2035, excess cost growth by itself accounts for 46 percent of projected growth in federal spending on those two programs. Adding in that factor’s share of the interaction raises the contribution of excess cost growth to 56 percent. The figure for excess cost growth alone is similar in the long term and in the intermediate term (49 percent by 2080 and 46 percent by 2035). But with its share of the interaction included, excess cost growth is responsible for 70 percent of the projected growth in federal health care spending by 2080.

Factors Explaining Future Federal Spending on Medicare, Medicaid, and Social Security

(Percentage of gross domestic product)

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Regarding the proposed cap-and-trade program being considered by the House of Representatives, a number of people have inquired as to whether it is correct to say, as is currently being circulated, that “the Congressional Budget Office estimates that cost impacts could be as much as $.77 per gallon for gasoline, $.83 per gallon for jet fuel, and $.88 per gallon for diesel fuel, all ultimately borne by the consumer.”

CBO’s cost estimate for the legislation did not include an estimate of increases in the price of particular products, such as gasoline or diesel fuel.  The numbers being circulated were produced by the American Petroleum Insititute (API).  CBO analysts have been in contact with the API  analyst that produced them to understand how they constructed those numbers.

According to API, it produced those numbers by assuming that there would be no offsets available (see note below), an assumption that we did not make when estimating the cost of the bill.  For the purposes of sensitivity analysis, CBO ’s estimate of an earlier version of the bill (H.R. 2454) reported how the allowance prices would have changed under a variety of different assumptions, including the elimination of offsets as well as changes in other parameters.  Accordingly, CBO indicated that the availability of offsets had a significant effect on the allowance price, reducing it by 70 percent.  Taking the inverse of that reduction, API concluded that, without offsets, our allowance price would have been over three times higher.

API translated allowance prices into the prices of particular products, such as gasoline, using emission coefficients from EPA.  Given those emission coefficients, the $16 and $26 allowance prices that CBO predicted for 2012 and 2019 , respectively, would imply gasoline price increases of $0.14 and $0.23, respectively.   But, under the extreme assumption of no offsets (and correspondingly higher allowance prices of $53 and $87 in 2012 and 2019, respectively), API calculated gasoline price increases of $0.47 in 2012 and $0.77 in 2019.

Because the bill provides for the use of both international and domestic offsets and CBO concluded that firms would be able to make use of such offsets when complying with the provisions of the bill (taking into account available information on both the supply of those offsets and competing demands for them), it is a misrepresentation of our work to say that the  $0.77 per gallon for gasoline, $0.83 per gallon for jet fuel, and $0.88 per gallon for diesel fuel are consistent with our cost estimate for the legislation.

NOTE: API states that it is assuming no international offsets, but the numbers that it presents actually correspond to the case with neither domestic nor international offsets. There was a typo in the initial release of our cost estimate that could have caused confusion about this, but soon after that release the typo was corrected on the web version of the cost estimate.

Yesterday CBO released the Long-Term Budget Outlook. Under current law, the federal budget is on an unsustainable path—meaning that federal debt will continue to grow much faster than the economy over the long run.

How much would policies have to change to avoid unsustainable increases in government debt? A useful answer comes from looking at the so-called fiscal gap. The gap represents the extent to which the government would need to immediately and permanently raise tax revenues, cut spending, or undertake some mix of both to make the government’s debt the same size (relative to the size of the economy) at the end of a given period as prevailed at the beginning of the period.

The fiscal gap is a present-value measure of the nation’s fiscal imbalance. A present-value calculation adjusts future payments for the time value of money to make them comparable with payments today. CBO calculates the present value of a stream of future revenues by taking the revenues for each year, discounting each value to 2009 dollars, and then summing the resulting series. The same method is applied to the projected stream of outlays. CBO also computes a present value for future gross domestic product (GDP) so it can calculate the present value of outlays and revenues as a share of the present value of GDP.

CBO performed such calculations for two different scenarios that represent, in different ways, a continuation of current policies. The “extended-baseline scenario” adheres most closely to current law and assumes that many policy adjustments that lawmakers have routinely made in the past will not occur. The “alternative fiscal scenario” represents another interpretation of what it would mean to continue today’s underlying fiscal policy; it incorporates some policy changes that are widely expected to occur and that policymakers have regularly made in the past. For example, under the latter scenario, the changes in tax rates enacted in 2001 and 2003, now scheduled to expire in December 2010, would be extended and the alternative minimum tax would be indexed to inflation.

Under the extended-baseline scenario, the fiscal gap would amount to 2.1 percent of GDP over the next 25 years and 3.2 percent of GDP over the next 75 years. In other words, under that scenario (ignoring the effects of debt on economic growth), an immediate and permanent reduction in spending or an immediate and permanent increase in revenues equal to 3.2 percent of GDP would be needed to create a sustainable fiscal path for the next three-quarters of a century. (That amount would come to about $450 billion in 2009.) If the policy change was not immediate, the required percentage would be greater.

Under the alternative fiscal scenario, the fiscal gap is greater: 5.4 percent of GDP over the next 25 years (equivalent to about $750 billion in 2009) and 8.1 percent over the next 75 years.

Today CBO released the second of our statutory reports on transactions undertaken as part of the Troubled Asset Relief Program (TARP). The assessment discusses the costs of purchases and guarantees of troubled assets taken to date, as well as the information and valuation methods used to calculate those costs.

The TARP’s transactions through June 17, 2009, included net disbursements, guarantee agreements, and loans totaling $369 billion. Valuing the assets using procedures similar to those specified in the Federal Credit Reform Act, but adjusting for market risk as specified in the Emergency Economic Stabilization Act, CBO estimates that the subsidy cost of the transactions (broadly speaking, the difference between what the Treasury paid for the investments or lent to the businesses and the market value of those transactions, including repayments) amounts to $159 billion.

Currently, the Secretary of the Treasury has the authority to purchase and hold up to roughly $699 billion in assets at one time. Of the $329 billion in authority remaining for the TARP, $142 billion has yet to be allocated to any of the existing or pending activities announced by the Treasury.

Today CBO released the Long-Term Budget Outlook.  Under current law, the federal budget is on an unsustainable path—meaning that federal debt will continue to grow much faster than the economy over the long run. Although great uncertainty surrounds long-term fiscal projections, rising costs for health care and the aging of the U.S. population will cause federal spending to increase rapidly under any plausible scenario. Unless tax revenues increase just as rapidly, the rise in spending will produce growing budget deficits and accumulating debt. Large budget deficits would reduce national saving, leading to more borrowing from abroad and less domestic investment, which in turn would depress income growth in the United States.

Keeping deficits and debt from reaching levels that could cause substantial harm to the economy would require increasing revenues significantly as a percentage of gross domestic product (GDP), decreasing projected spending sharply, or some combination of the two. Making such changes sooner rather than later would lessen the risks that current fiscal policy poses to the economy.  Although the policy choices that will be necessary are difficult, CBO’s long-term budget projections make clear that doing nothing is not an option: Legislation must ultimately be adopted that raises revenue or reduces spending or both. Moreover, delaying action simply exacerbates the challenge, as is discussed in the report.

For decades, spending on the federal government’s major health care programs, Medicare and Medicaid, has been growing faster than the economy (as has health care spending in the private sector). CBO projects that if current laws do not change, federal spending on Medicare and Medicaid combined will grow from almost 5 percent of GDP today to almost 10 percent by calendar year 2035 and to more than 17 percent of GDP by 2080. That projection means that in 2080, if there are no changes in policy, the federal government would be spending almost as much, as a share of the economy, on just its two major health care programs as it has spent on all of its programs and services in recent years.  Constraining the costs of those health care programs will be a key to developing a sustainable fiscal policy. Social Security has a smaller effect on the budget outlook: CBO projects that Social Security spending will increase from less than 5 percent of GDP today to about 6 percent in 2035 and then roughly stabilize at that rate through 2080.

The current recession contributes to the long-term fiscal imbalance by raising the debt burden of the federal government and shortening the period during which policymakers can enact measures that would correct the imbalances.  CBO estimates that in the next two years, the federal government will record its largest budget deficits as a share of GDP since shortly after World War II. As a result of those deficits, federal debt held by the public will soar from 41 percent of GDP at the end of fiscal year 2008 to 60 percent at the end of fiscal year 2010. The higher debt results in permanently higher spending to pay interest on that debt (unless the debt is later paid off).

Last Friday, CBO released an analysis of the average cost per household that would result from the greenhouse-gas (GHG) cap-and-trade program in the American Clean Energy Security Act of 2009 (H.R. 2454). In that analysis, CBO examined the effects of the bill as it would apply in 2020 but described those effects in the context of the current economy: that is, as if the 2020 policy were in effect in 2010. Describing the effects in 2010 allows a more direct comparison of the costs with current household incomes.  The blog entry provides more detail on how CBO derived the estimate of the costs of emission allowances and offsets for 2010.

CBO estimates that the price of an allowance, which would permit one ton of GHG emissions measured in carbon dioxide equivalents, would be $28 in 2020 (measured in 2020 dollars). CBO also estimates that nearly 5 billion allowances would be issued in 2020 (after subtracting allowances set aside for a strategic reserve) and that the costs of international and domestic offsets purchased in 2020 would be $20 billion, yielding a total cost of allowances and offsets of about $160 billion.

CBO modeled the 2020 policy in 2010 by maintaining the same relationship between the total value of allowances and the size of the economy (as measured by gross domestic product) in 2010. On that basis, CBO estimates that the equivalent cost of allowances and offsets would be roughly $105 billion in 2010. CBO projects that GDP in 2010 will be about one-third below the level projected for 2020 and thus the 2020 allowance value is reduced by about one-third so that its value relative to the size of the economy remains the same.  CBO made a similar adjustment to the 2020 estimate of the resource costs associated with the policy.

To measure the impact across households in 2010, CBO used an estimate of the distribution of spending on goods that have carbon dioxide emissions associated with their production or consumption across household income groups in that year. The database for the analysis was constructed by statistically matching income information from the Statistics of Income data from the Internal Revenue Service, households’ characteristics from the Current Population Survey reported by the Bureau of the Census, and data on households’ expenditures from the Consumer Expenditure Survey by the Bureau of Labor Statistics. The data are from 2006, the latest year for which the data from all three sources are available, and thus reflect the patterns of income and consumption in that year. CBO adjusted the data to 2010 levels by the estimated overall growth in population and income.  CBO did not attempt to project how the distribution across household income groups or composition by source of income or expenditures would change between 2006 and 2010.

While not working hard to produce estimates of varying kinds for the U.S Congress, the Congressional Budget Office’s staff often uses its formidable energies to help charitable organizations. As part of their ongoing commitment to the fight against breast cancer, members of our staff, friends, and family members participated in the Susan G. Komen Race for the Cure by walking or running the 5K race around the National Mall or by making pledges to the team or to individual team members. As a result of staff participation in fundraising, which included a CBO office bake sale, CBO was ranked number one in the Congressional category, surpassing 20 Congressional teams for top honors by raising a total of $3,578.50. CBO’s team was led by Simone Thomas, a CBO webmaster and cancer survivor, who has led annual efforts to raise funds for this important cause.

Today CBO released an updated report on the effects of the business cycle on the federal budget.

For example, during recessions, the budget deficit tends to increase because of the automatic stabilizers built into the budget: tax revenue tends to decline and certain forms of government spending, such as outlays for food stamps and unemployment benefits, tend to increase.

A budget measure that filters out cyclical factors is useful in several ways. For example, some analysts use such a measure to discern underlying trends in government saving or dissaving (that is, surpluses or deficits). Others use it to approximate whether the influence of the budget on aggregate demand and on the growth of real (inflation-adjusted) income in the short run is positive or negative. More generally, the measure helps analysts estimate the extent to which changes in the budget are caused by movements of the business cycle and thus are likely to prove temporary. The usefulness of the cyclically adjusted budget measure for such purposes is hampered by large but temporary federal measures, such as the Troubled Asset Relief Program (TARP).

Under CBO’s baseline assumptions, the cyclically adjusted budget deficit will rise sharply in 2009, to 9 percent of potential GDP (from 2.6 percent in 2008), but then decrease in 2010 and 2011 to 4.7 percent and 2.2 percent of potential GDP, respectively. Those deficits are smaller than the unadjusted deficit estimates because the latter include the automatic responses of revenues and outlays to the current recession. CBO expects that economic output will be much farther below its potential level in 2009, 2010, and 2011 than it was in 2008, which is to say that effects of the business cycle will substantially increase the federal budget deficit in those years. According to CBO’s baseline projections, in 2009 and 2010 the cyclical contribution to the budget deficit will climb to roughly 2.1 percent and 2.6 percent of potential GDP and in 2011 it will decrease to 2.2 percent.

Budget Deficits and Surpluses as Percentage of Potential GDP