Congressional Budget Office
Director’s Blog

CBO released a new report this morning, prepared at the request of the Chairman of the House Committee on the Budget, analyzing the advantages and disadvantages of adopting a capital budget at the federal level. In addition, I am testifying on infrastructure spending this morning before a joint hearing of the House Committee on the Budget and the Committee on Transportation and Infrastructure. That testimony covers a broader array of topics related to infrastructure spending; a short summary is available here.

The capital budgeting report makes the following key points:

• The federal budget, which presents the government’s expenditures and revenues for each fiscal year, serves many purposes. It enables policymakers to allocate resources to serve national objectives, provides the basis for agencies’ management of federal programs, gives the Treasury needed information for its management of cash and the public debt, and provides businesses and individuals with information to make an informed assessment about the government’s stewardship of the public’s money and resources. Inflows and outflows are recorded mostly on a cash basis because those transactions are readily verifiable and they provide policymakers and the public with a close approximation of the government’s annual cash deficit or surplus.
• Some observers have proposed modifying the budgeting system by implementing a capital budget for the federal government, which would distinguish certain types of investments from other expenditures in the budget. One commonly discussed approach would segregate cash spending on capital projects in a capital budget and report in the regular budget the depreciation on federal capital assets, thus allocating current costs to future time periods. Such an approach—which would move from the current, primarily cash-based budgeting system to one that relies more on accrual-based accounting—would be similar to private-sector accounting in that it would spread capital costs over the period when benefits are accruing from the investment.
• Proponents of capital budgeting assert that the current budgetary treatment of capital investment creates a bias against capital spending and that additional spending would benefit the economy by boosting productivity. They note that capital budgeting could better match budgetary costs with benefit flows and eliminate some of the spikes in programs’ budgets from new investments. The existence and extent of any such bias, however, depends on how differently policymakers would behave with a capital budget instead of the existing budgetary treatment of capital investments. Furthermore, although evidence suggests that additional capital spending could have larger economic benefits than costs, the economic benefits of increasing capital spending by the federal government would partly depend on how well the additional funds were targeted to high-value projects and on the extent to which they would displace spending that would otherwise be undertaken by the private sector or other levels of government.
• Moving to a budget that is more reliant on accrual-based accounting could increase complexity, diminish transparency, and make the federal budget process more sensitive to small changes in assumed parameters, such as depreciation rates. (Indeed, other nations have considered adopting capital budgets, but generally decided against it for those same reasons.) Adopting an accrual approach to only one aspect of the budget could raise concerns as to whether the budgeting system would provide a fair basis for allocating the government’s resources among competing priorities. In addition, providing special treatment to certain areas of the budget, such as capital spending, could make the process more prone to manipulation. For example, arriving at a definition of capital for budgeting purposes could be a significant challenge. Concerns about such issues largely explain why previous groups charged with exploring budgetary concept issues—including the 1967 President’s Commission on Budget Concepts and the 1999 President’s Commission to Study Capital Budgeting—have rejected the idea of a separate capital budget for the federal government.
• More limited changes to the current process might still accomplish the goal of focusing on capital investment but be simpler to implement than a capital budget as traditionally defined. One approach would be to create a category for capital spending as part of a restoration of the statutory budget enforcement procedures that expired in 2002. Such a category within overall discretionary spending limits could help to highlight important policy goals. By carving out separate limits for certain programs, however, lawmakers could forgo flexibility to make budgetary trade-offs as needs change in the future. Another alternative, which would address concerns about the management of assets rather than their reporting in the budget, might be to attribute a portion of the cost of assets each year (in the form of depreciation) to the programs that use them. Requiring users to pay the costs might improve incentives for agencies to sell assets that are no longer appropriate to their needs.

The paper was written by Jeffrey Holland and David Torregrosa, with contributions from Sheila Campbell, Kathy Gramp, Amber Marcellino, Nathan Musick, and David Newman. Elizabeth Cove wrote the appendix. Robert Dennis, Peter Fontaine, Theresa Gullo, Kim Kowalewski, and Leo Lex directed the research.

I am testifying this morning before a joint hearing of the House Committee on the Budget and the Committee on Transportation and Infrastructure. To view the hearing click here.

The testimony defines “infrastructure” as including transportation, utilities, and some other public facilities. The United States currently invests more than $400 billion per year in infrastructure defined this way, and about $60 billion of that amount—mostly for highways and other transportation networks—is financed by the federal government each year.

The testimony makes the following key points, among others:

• Growing delays in air travel and surface transportation, bottlenecks in transmitting electricity, and inadequate school facilities all suggest that some targeted additional infrastructure spending could be economically justifiable.
• Federal spending on infrastructure is dominated by transportation. Although capital spending on transportation infrastructure already exceeds $100 billion annually, studies from the Federal Highway Administration, the Federal Aviation Administration, and elsewhere suggest that it would cost roughly $20 billion more per year to keep transportation services at current levels. Those studies also suggest that substantially more than $20 billion in additional capital spending per year on transportation — and perhaps as much as $80 billion per year or so — would be justified on economic grounds if well targeted (because such spending would generate benefits whose value would exceed its cost).
• In some other types of infrastructure outside transportation, such as systems for wasterwater and drinking water, additional spending is needed to maintain current services or allow modest improvements.
• Although the economic rationale for some additional infrastructure spending is strong, the economic returns on specific projects vary widely. Carefully ranking and funding projects to implement those with the highest net benefits would yield a disproportionate share of the total possible benefits at a fraction of the total spending that is potentially economically justifiable. A related point is that the aggregate estimates do not justify increases of those amounts in infrastructure spending unless such spending is carefully targeted to economically efficient projects. Otherwise, the spending would not generate the same benefits as the estimates suggest—and indeed it could produce costs that exceed the benefits.
• The estimates of infrastructure spending that are needed to maintain current performance or that could generate larger economic benefits than costs, furthermore, can be substantially affected by how existing infrastructure is priced.
  • The estimates for highways, for example, assume no expansion in the use of congestion pricing—that is, tolls that are higher during peak times and lower during off-peak times.
  • The Federal Highway Administration, though, estimates that widespread implementation of congestion pricing would reduce the investment needed to maintain the highway system by $20 billion annually.
• Studies suggesting the need for or benefits of additional infrastructure spending do not provide policy guidance about how such spending should be financed. The “benefits principle” suggests that federal taxpayers are often the least efficient source of financial support for an infrastructure investment — after the direct beneficiaries of the investment and local or state taxpayers. Even when federal support for a given type of infrastructure is justified in principle, implementation problems might make it undesirable in practice. The GAO, for example, found that states offset roughly half of the increases in federal highway grants between 1982 and 2002 by reducing their own spending, and that the rate of substitution increased during the 1980s.
• Although many advocates of additional federal infrastructure spending seem interested in complex and sometimes opaque structures through which to channel such federal support, the fundamental question is how much support the federal government will provide and the efficiency with which such support is provided. On the latter point, the federal government could substantially increase the efficiency with which it subsidizes debt financing of state and local spending.
  • For example, state and local tax-exempt bonds will cost the federal government an average of $31.2 billion per year between 2007 and 2011. Yet in 2006 and 2007, observed yield spreads suggest that any bonds purchased by taxpayers in a marginal tax bracket above 21 percent cost the federal government more in forgone tax revenues than they save state and local governments in reduced interest cost.
  • A more efficient approach could involve tax-credit bonds, which allow bond purchasers to receive credits against federal income tax liability (rather than excluding interest payments from federal income taxation).
  • To illustrate, assume that the inefficiency associated with current tax-exempt financing is between 10 percent and 20 percent, so that 80 percent to 90 percent of the federal tax expenditures actually translates into lower borrowing costs for states and localities. Then, if the outstanding stock of tax-exempt debt during the 2007–2011 period instead took the form of tax-credit bonds designed to deliver the same amount of federal subsidy, the federal government would save between $3 billion and $6 billion per year.
• The federal government can also encourage the use of “asset management” to maximize the benefit from existing and future infrastructure. Asset management relies on monitoring the condition of equipment and the performance of systems and analyzing the discounted costs of different investment and maintenance strategies.
  • As one example, the federal government reduce total investment and operating costs by changing the way it acquires, manages, and disposes of property — a topic explored in a box in the testimony.
• The testimony also discusses capital budgeting, a topic that is the subject of a separate report being published by CBO today. A short summary is available here.

CBO released a new monthly budget review today. During the first seven months of fiscal year 2008, CBO estimates that the federal government ran a deficit of $151 billion — $70 billion more than during the same period in 2007.  Outlays are roughly 7 percent higher than last year, whereas revenue is up by only about 3 percent.  (Corporate income tax revenue is down by more than 13 percent.)

Receipts from tax returns filed by the April 15 deadline were about 6 percent higher than such receipts last year, about what CBO anticipated when it prepared its most recent budget projections in March. 

Last week, the LBJ School at the University of Texas-Austin held a conference on the history and future of Medicare, as part of a series of activities to commemorate Lyndon Johnson’s 100th birthday. (The conference was co-sponsored by the Center for Health and Social Policy at LBJ School, Commonwealth Fund, and the Robert Wood Johnson Foundation.) The conference brought together many of the nation’s leading health policy thinkers, and I was honored to give a lunch-time talk there. The video is posted here.

CBO has released a cost estimate of HR 5830, the FHA Housing Stabilization and Homeownership Retention Act of 2008. We estimate that the legislation would cost about $2.7 billion over the 2008-2013 period, assuming future appropriations consistent with the provisions in the bill. The bulk of that — about $1.7 billion — would be needed for the estimated subsidy cost of insuring mortgages under a new FHA program. (Loan guarantees are scored in the federal budget at their estimated subsidy cost.)

The value of the subsidy reflects the value of the insurance provided by the federal government net of the fees charged for that insurance. CBO estimates an estimated average subsidy cost under the new FHA loan-guarantee program of about 2 percent of the loan principal. We also estimate that FHA would insure about 500,000 loans over the 2008-2013 period under the program. The $1.7 billion cost comes from combining the 2 percent subsidy rate with the roughly 500,000 loans and an average loan amount of about $170,000 (after writedown of existing mortgages).

In addition, the legislation establishes an Office of Housing Counseling within the Department of Housing and Urban Development, authorizes appropriation of funds for the Department of Justice to support efforts to combat mortgage fraud, and includes other provisions.

CBO issued a study today examining possible future private investment in new nuclear power plants. The extent of such investment depends not only on possible charges for carbon dioxide (if the Congress adopts climate change legislation) but also on existing incentives provided for such plants in the Energy Policy Act (EPAct) of 2005.

The Energy Information Administration (EIA) projects that demand for electricity in the United States will increase by 20 percent by the end of the next decade. Most of the additional demand would likely be met by conventional fossil-fuel technologies without the incentives in EPAct or the prospects of a market price on carbon emissions.

• Carbon dioxide charges of about $45 per metric ton would probably make nuclear generation competitive with conventional fossil fuel technologies as a source of new capacity and could lead utilities to build new nuclear plants that would eventually replace existing coal power plants. At charges below that threshold, conventional gas technology would probably be a more economic source of baseload capacity than coal technology. Below about $5 per metric ton, conventional coal technology would probably be the lowest cost source of new capacity.
• EPAct incentives would probably make nuclear generation a competitive technology for limited additions to base-load capacity, even in the absence of carbon dioxide charges. However, because some of those incentives are backed by a fixed amount of funding, they would be diluted as the number of nuclear projects increased; consequently, CBO anticipates that only a few of the currently proposed plants would be built if utilities did not expect carbon dioxide charges to be imposed.
• Uncertainties about future construction costs or natural gas prices could deter investment in nuclear power. In particular, if construction costs for new nuclear power plants proved to be as high as the average cost of nuclear plants built in the 1970s and 1980s (adjusted for inflation), or if natural gas prices fell back to the levels seen in the 1990s, then new nuclear capacity would not be competitive, regardless of the incentives provided by EPAct. Such variations in construction or fuel costs would be less likely to deter investment in new nuclear capacity if investors anticipate a carbon dioxide charge, but those charges would probably have to exceed $80 per metric ton in order for nuclear technology to remain competitive under a scenario with high construction costs and low natural gas prices.

The study was written by Justin Falk of our Microeconomic Studies Division.

CBO released a paper today on trends in individual income tax revenue. Such revenue has fluctuated significantly since the early 1990s, increasing by 85 percent between fiscal years 1994 and 2000, then declining by 21 percent between 2000 and 2003, and then increasing by 47 percent between 2003 and 2007.

Income tax revenues generally rise and fall with the economy, but even as a share of gross domestic product (GDP), the recent changes in individual income tax revenue have been dramatic. Between 1994 and 2000, for example, the ratio of income taxes to GDP rose by 2.5 percentage points—from 7.8 percent to just over 10.3 percent, a historic high. In the following four years, that trend reversed, and individual income taxes dropped precipitously, falling to 7.0 percent of GDP by 2004, the lowest level in more than 50 years. Revenues rebounded in the next three years, rising to 8.5 percent of GDP by 2007. The paper explores the causes of these changes in individual income tax revenues relative to the economy. The key factors include:

• A rising and falling income tax base, resulting from growth in wages and capital gains realizations that first exceeded and then lagged behind overall economic growth;
• A rising and falling effective tax rate on adjusted gross income, caused by changes in real (inflation-adjusted) bracket creep (that is, increases in real incomes that shift more taxable income into higher marginal tax brackets) and THE the concentration of income in higher tax brackets
• Tax legislation, which was a major factor in the decline in income taxes relative to GDP from 2000 to 2004, but had little to do with the increase from 1994 to 2000.

Various media reports are incorrectly attributing to CBO a figure (that the average driver would save about $30 this summer) associated with a gas tax holiday. CBO has not published such a figure and the citations to CBO are inaccurate.

This misattribution raises a larger point.  CBO is a nonpartisan organization, and we are not in the business of scoring or evaluating campaign proposals. In some cases, CBO may have previously estimated or evaluated a proposal similar to one subsequently proposed in a campaign and those estimates generally are available on our website.

The bottom line: If you read something suggesting that we have issued numbers or an analysis about a campaign proposal, you should be skeptical — and also let us know.

CBO and the Joint Committee on Taxation have been working closely together to analyze a modified version of S. 334, the Healthy Americans Act. This morning Edward Kleinbard (the staff director of the JCT) and I sent the letter below to Senators Wyden and Bennett about the modified proposal. (Many comprehensive health reform proposals involve complicated interactions between the spending and revenue sides of the budget, and the close working relationship that has developed between the staffs at JCT and CBO on health care is particularly important and valuable as we analyze these types of proposals. )

May 1, 2008

Dear Senators:

At your request, the staffs of our two organizations have collaborated on a preliminary analysis of a modified proposal for comprehensive health insurance based on S. 334, the “Healthy Americans Act,” which you introduced last year. That modified proposal includes various clarifications and changes that you have indicated you would like to examine as part of the consideration of that bill. Attachment A summarizes our understanding of your modified proposal.

The staffs of the Congressional Budget Office (CBO) and the Joint Committee on Taxation (JCT) have worked closely together for the past several months to analyze your modified proposal; this collaboration reflects both the novelty of the undertaking and the intimate connection between the revenue and expenditure components of this proposal. We have summarized our conclusions in this joint letter; its purpose is to give you preliminary guidance regarding an approximate range of revenue and cost results that might be expected from your modified proposal. This joint letter does not constitute and should not be interpreted as a formal estimate of your proposal’s budgetary impact, which—for the purposes of scoring under the Congressional Budget Act—would ultimately be provided by CBO and would incorporate revenue estimates prepared by the JCT staff.

The basic thrust of your modified proposal is to require individuals to purchase private health insurance and to establish state-run purchasing pools and a system of federal premium collections and subsidies to facilitate those purchases. The system’s premium collection and subsidy mechanisms would be based largely on income tax filings, and the required benefits would initially be based on the Blue Cross/Blue Shield standard plan offered to federal workers in 2011 and then allowed to grow at the rate of growth of the economy. Although employers would have the option of continuing to offer coverage to their workers, nearly all individuals who were not enrolled in Medicare would obtain their basic health insurance coverage through this new system. Most enrollees in Medicaid and all enrollees in the State Children’s Health Insurance Program (SCHIP) would have their primary insurance coverage shifted to the new system.

Your proposal also would replace the current tax exclusion for employer-based health insurance premiums with a fixed income tax deduction for health insurance. (In addition, employers that had provided health insurance would be expected to “cash out” their workers––that is, to increase workers’ wages by the average contribution that the employers would have made for their health plan.) The proposal also would require new tax payments from employers to the federal government and further would seek to recapture the savings to state governments from reduced expenditures on Medicaid and SCHIP.

There are several important distinctions between the proposal we analyzed and S. 334 as it was introduced. For example, our analysis was limited to the operation of the new health insurance purchasing system and did not take into account most of S. 334’s provisions regarding the Medicare program or other provisions that would not directly affect the new system. More fundamentally, the modified proposal would tie the premiums collected through the tax system—as well as the premium subsidies for lower-income households—to the cost of the least expensive health plan available in an area that provided required benefits, not to the average premium amount, as under S. 334. Furthermore, the value of the new tax deduction would not vary with the premium of the insurance policy that was actually purchased, and the schedule of employers’ payment rates would range from 3 percent to 26 percent (rather than 2 percent to 25 percent) of the average premium. Attachment B describes in more detail the main differences between your modified proposal and S. 334.

The preliminary analysis reflected in this letter is subject to three important limitations. First, the staffs of both JCT and CBO are in the process of enhancing our capabilities to estimate the effects of comprehensive health care proposals. Improvements in our methodologies or more careful analysis of your modified proposal’s provisions—particularly as you translate those concepts into formal legislative language—could change our assessment of its consequences.

Second, any formal budget estimate will reflect the macroeconomic assumptions and the baseline projections of current-law tax and spending policies in effect at the time it is issued. That baseline could differ materially from today’s baseline.

Third, we focused our analysis on a single future year in which the proposed system would be fully implemented. For that purpose, we settled on 2014, the sixth year of the current 2009–2018 budget window. Under an assumption that the proposal is enacted in 2008, that timeline for full implementation seems to us to be achievable but could be optimistic, as we expect that it would probably take until 2012 for the new system to begin operation, and several years after that for various phase-ins and behavioral adjustments to take place. The new system would involve temporary net budgetary costs in its initial years; we have not analyzed the magnitude of those early-year transition costs.

Overall, our preliminary analysis indicates that the proposal would be roughly budget-neutral in 2014. That is, our analysis suggests that your proposal would be essentially self-financing in the first year that it was fully implemented. That net result reflects large gross changes in federal revenues and outlays that would roughly offset each other.

More specifically, under your proposal, most health insurance premiums that are now paid privately would flow through the federal budget. As a result, total federal outlays for health insurance premiums in 2014 would be on the order of $1.3 trillion to $1.4 trillion. Those costs would be approximately offset by revenues and savings from several sources: premium payments collected from individuals through their tax returns; revenue raised by replacing the current tax exclusion for health insurance with an income tax deduction; new tax payments by employers to the federal government; federal savings on Medicaid and SCHIP; and state maintenance-of-effort payments of their savings from Medicaid and SCHIP. Attachment C provides more information about the approximate magnitudes of those components.

For the years after 2014, we anticipate that the fiscal impact would improve gradually, so that the proposal would tend to become more than self-financing and thereby would reduce future budget deficits or increase future surpluses. That improvement would reflect two features of the proposal. First, the amount of the new health insurance deduction would grow at the rate of general price inflation and thus would increase more slowly than the value of the current tax exclusion. Second, the minimum value of covered benefits that all participating health plans had to provide would initially be set at the level of the Blue Cross/Blue Shield standard option offered to federal workers in 2011 (we assume that the system’s inaugural year would be 2012); but under your proposal that average value would from that point forward be indexed to growth in gross domestic product per capita rather than growth in health care costs. Because federal premium subsidies would be based on the cost of providing that level of coverage, the cost of those subsidies would grow more slowly over time.

We hope this analysis is useful to you. Not surprisingly, a number of uncertainties arise in attempting to predict the effects of such large-scale changes to the current health insurance system. Although we have provided a range of results that reflect our current expectations about likely outcomes, actual experience—and the results of a formal cost estimate—could differ substantially in either direction.

Attachments

CBO issued a letter today reviewing a new investment policy recently adopted by the Pension Benefit Guaranty Corporation (PBGC). As part of its analysis, CBO reviewed the assumptions underlying PBGC’s decision and assessed the revised policy’s potential for affecting the corporation’s ability to meet its obligation to retirees and for increasing costs to taxpayers.

• Prior to February of this year, PBGC’s investment strategy was to hold about 75 percent of its portfolio in bonds, with the duration of those assets matched to the corporation’s obligations. The remainder of the portfolio was invested in equities. PBGC’s new strategy reduces to 45 percent its allocation to fixed-income assets, in order to increase the proportion devoted to equities (45 percent) and to further diversify into alternative asset classes (10 percent).
• The change in investment strategy represents an effort on the part of PBGC to increase the expected returns on its assets and to diminish the likelihood that taxpayers will be called on to cover some of its liabilities. The new strategy is likely to produce higher returns, on average, over the long run. But the new strategy also increases the risk that PBGC will not have sufficient assets to cover retirees’ benefit payments when the economy and financial markets are weak. By investing a greater share of its assets in risky securities, PBGC is more likely to experience a decline in the value of its portfolio during an economic downturn — the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans. If interest rates fall at the same time that the overall economy and financial markets decline, the present value of benefit obligations will increase, and the pension plans likely to be assumed by PBGC will be even more underfunded as a result.
• The effect on taxpayers of the change in PBGC’s investment strategy depends on assumptions about future premiums and benefits and expectations about the government’s ultimate responsibility to covered retirees. Although the Employee Retirement Income Security Act of 1974 (ERISA) explicitly states that the federal government does not stand behind PBGC’s obligations, an implicit expectation exists among many market participants and policymakers that taxpayers will ultimately pay for benefits should PBGC be unable to meet those obligations. If policies governing future premiums and benefits remain unaffected by the new investment policy, taxpayer’s increased risk of substantial losses will be balanced by the higher expected returns that the new policy allows. However, if the higher expected returns mean that premiums are reduced or benefits increased relative to what would otherwise occur, plan sponsors or beneficiaries will reap some of the benefits of the change in investment policy, but taxpayers will bear the added risks.