Congressional Budget Office
Director's Blog

In a New York Times article this morning, Robert Pear summarizes recent research showing that the gap in life expectancy between high-income/better-educated people and low-income/less-educated people is expanding substantially. (That is, life expectancy is increasing on average, but it is increasing much more rapidly at the top of the socio-economic distribution than at the bottom — and some research suggests that life expectancy at the bottom is not even rising.) Increasing inequality in life expectancy may have important social implications. It also affects our public social insurance programs — for example, it may tend to shift the relative magnitudes of the lifetime benefits provided by Medicare and Social Security (because on average high-income beneficiaries increasingly collect benefits over a longer period of time than low-income beneficiaries).

CBO is undertaking further work on this topic, and will be issuing a short issue brief on it in the near future.

Last week, I gave a talk at Princeton and participated in some classes on health care taught at the Woodrow Wilson School by Bill Frist.  Here are the slides and video from the talk.  But the highlight of the trip was the classroom interaction with the students.  Their intelligence, diligence, and enthusiasm were quite encouraging, and I hope many of them will enter public service in some form and help to address the problems we discussed.

CBO released its full analysis of the President’s budget today, following up on a preliminary analysis we issued earlier this month.  The budget estimates are the same as in that preliminary analysis, but today’s report includes a discussion of macroeconomic effects of the President’s budget along with other details.

CBO’s estimates of the economic feedback associated with the President’s proposals may be of most interest—that is, how enacting those proposals might affect the nation’s economy and how those economic impacts, in turn, would affect the federal budget. We used five different economic models that focus on varying aspects of the economy to estimate those feedback effects.  Such estimates depend on a variety of specific assumptions, but under any of the assumptions incorporated into today’s analysis, economic feedback would modify the budgetary effects of the proposals only relatively modestly—and the potential effects could either expand or reduce the proposals’ net budget impact. Between 2009 and 2013, for example, CBO estimated that the President’s proposals would add to deficits or reduce surpluses by a total of $336 billion, without considering any economic effects.  Our analysis indicates that macroeconomic feedback effects could raise the proposals’ cumulative impact on the budget deficit to as much as $410 billion or reduce it to about $185 billion.

The reason that the macroeconomic feedback from President’s proposals is relatively modest is that over the medium to longer run those proposals have both a negative effect on economic growth (that is, by increasing the budget deficit) and a positive effect on economic growth (for example, by reducing marginal tax rates). The net effect of these countervailing forces tends to be small.

As is now widely recognized, the economy is currently experiencing significant short-term weakness. The short-term effects of many budget policies in this type of unusual condition can vary dramatically from their long-term effects —and indeed, the short-term impact can often be opposite in sign from the long-term impact.

Analysts in CBO’s Macroeconomic Analysis and Tax Analysis Divisions prepared the analysis of macroeconomic feedbacks.  Those sections of the report were written by Benjamin Page, and the modeling was performed by Robert Arnold, Paul Burnham, Ufuk Demiroglu, Mark Lasky, Larry Ozanne, Frank Russek, Marika Santoro, Kurt Seibert, and Sven Sinclair. 

Analysts in CBO’s Budget Analysis and Tax Analysis Divisions prepared the baseline estimates and estimated the impact of the President’s proposals in the absence of macroeconomic feedbacks.  (The Joint Committee on taxation prepared most of the estimates of revenue proposals.)  Those sections of the report were written by Barry Blom, Pamela Greene, Robert Arnold, and Amber Marcellino.  

CBO issued a letter today responding to a request from the Chairman of the House Budget Committee. In December 2007, we issued a report on the nation’s 75-year fiscal gap (roughly speaking, the gap between the present value of projected spending and projected revenue, as a share of GDP).

In today’s letter, we provide estimates of the impact on the 75-year fiscal gap from net spending under current law on Medicare Part D (the prescription drug benefit) and possible permanent extension of the individual income tax provisions enacted in 2001, 2003, and 2004 past their scheduled sunset in 2010. In particular:

• The effect of spending for Part D (net of income from premiums) on the 75-year fiscal gap amounts to 0.9 percent of GDP.
• The effect of extending the expiring individual income tax provisions would amount to 0.7 percent of GDP in the absence of further reform to the Alternative Minimum Tax (AMT) and 1.4 percent of GDP if the AMT ’s parameters were indexed to inflation.
• CBO limited its analysis to the estimated effects of extending the individual income tax provisions and did not assess the effects of permanently extending provisions applicable to the estate and gift tax. If the only result of extending the estate and gift tax provisions were to eliminate all revenues from those taxes from CBO’s long-term baseline, the fiscal gap would increase by an additional 0.7 percent of GDP over the next 75 years. Under that assumption and assuming the AMT is indexed to inflation, the combined effect of extending all the tax provisions (including the gift and estate tax ones) on the 75-year fiscal gap would amount to slightly over 2 percent of GDP.

Many Hill staffers, policy analysts, reporters, and others are interested in some of the details behind our most recent budget projections. We have posted a variety of such additional detail. For example, many observers over the past few weeks and months have become interested in what we assume about administrative regulatory actions in Medicare, Medicaid, and SCHIP in our baseline; information about those assumptions is posted here.

We are posting this information in the hope that such transparency will further understanding of our baseline and estimates.

As I have noted earlier, I will occasionally use this blog to clarify misinterpretations of our work. On that note, some recent blog postings seem to warrant a clarification of the main points in CBO’s study, Policy Options for Reducing CO₂ Emissions, regarding what policy analysis has to say about the trade-off among different policies to reduce carbon emissions.

CBO’s study evaluated a variety of incentive-based approaches—including taxes on carbon dioxide emissions and several variants of cap-and-trade programs—that policymakers might use to achieve long-term emission reduction targets. Key conclusions include:

• Policies that keep emission reductions on a downward trajectory—but allow firms’ emission reduction efforts to vary from year to year—can achieve equivalent benefits at significantly lower economic costs than policies that impose less flexible annual emission caps.
• Policies that allow emissions to vary from year to year do not necessarily imply weak long-term emission reduction targets. Flexible policies can be designed to achieve either modest or ambitious long-term targets. Indeed, flexibility from year to year in emission reductions reduces the cost of achieving a given long-term target and may therefore facilitate stricter long-term targets than would otherwise be feasible.
• A cap-and-trade program that included both a ceiling and a floor on the price of allowances or an emissions tax would be the most cost-effective policies.
• Allowing firms to bank or borrow emission allowances would be more efficient than less flexible cap-and-trade designs, but would offer less cost savings than other approaches.

The Value of Allowing Year-to-Year Flexibility in Emissions. Limiting future changes in the earth’s climate requires restricting the stock of carbon dioxide and other greenhouse gases in the atmosphere, but the year-to-year path of emissions reductions is relatively unimportant. For example, a policy that required firms to reduce emissions by 10 tons each year for 20 years would yield roughly the same ultimate environmental benefits as a policy that achieved the same 200 ton reduction in a 20-year period, but allowed firms to reduce their emissions by more than 10 tons in some years and less than 10 tons in other years. Yet flexibility with regard to the year-to-year path of emissions reductions can significantly reduce the economic costs involved, because in some years it can turn out to be substantially less expensive to reduce emissions than in others (for example, due to weather, conditions in energy markets, economic activity, and the availability of technologies at different points in time). As a result, flexible policies have the potential to achieve the same environmental benefits at a lower economic cost. (In contrast, an efficient approach to controlling a toxic pollutant might provide firms with little or no flexibility to shift emission reductions across time periods because variations in emissions at any given point in time can lead to large differences in environmental harm.)

How much can providing year-to-year flexibility in emission reductions reduce cost? Analysts conclude that providing flexibility in the year-to-year path of emissions would offer large cost savings by allowing firms to make greater cuts in emissions when costs are low and fewer when costs are high. Leading researchers have concluded that a rising tax (which would provide the most flexibility about how emission reductions could be allocated across time) would be roughly five times more efficient than a declining cap that did not offer any year-to-year flexibility. (As described below, flexible cap designs are possible that approach the efficiency of a tax. Either would be more efficient than an inflexible cap.) Researchers have found this conclusion to be robust even when they altered important assumptions, such as the form of cost uncertainty, the degree to which costs are correlated across time, and the period of time over which the choice of policy instrument could not be altered (1 year, 10 years, or 100 years).¹

Year-to-Year Emission Fluctuations and Tipping Points. Some analysts believe that studies concluding that flexible policies are more efficient than inflexible ones fail to account for the potential existence of “tipping points” (critical temperature increases beyond which there could be sharp increases in the damage from climate change). Examples of tipping points are temperature increases that might lead to the melting of the West Antarctic ice sheet—triggering a large rise in sea level—or a shut-down of an important circulation pattern in the Atlantic Ocean. This assertion, however, is unfounded. Specifically, researchers find that the potential existence of tipping points (also referred to as thresholds, or “kinks” in the damage function) will not justify an inflexible policy unless there is certainty about where the kink is located and the threshold is sufficiently near to current concentration levels that policymakers would want to virtually shut down emissions—regardless of the cost—to avoid, or delay, crossing it.² Although there is a genuine concern about the existence of tipping points, there is a great deal of uncertainty about what temperature increases will trigger them, as well as basic uncertainty about the relationship between annual emission flows and future temperature changes.³ In its most recent report, the Intergovernmental Panel on Climate Change concluded that there has been “little advance on…the proximity to thresholds and tipping points.” (p. 77) In addition, uncertainty about abrupt changes and the process that would lead up to them were featured in the report’s description of the two most important climate-science-related needs.⁴ Despite that uncertainty about the potential damage from climate change and the proximity of the current global temperature to tipping points, most analyses suggest that a carefully designed program to begin lowering emissions of carbon dioxide would produce greater benefits than costs. Reducing the risk of triggering large damages will require substantially reducing the flow of carbon dioxide into the atmosphere.

Allowing Year-to-Year Flexibility in Emission Reductions Need Not Imply Weak Policies. Taxes, inflexible caps, or flexible caps can all be designed to achieve either modest or ambitious multiyear emission reduction targets. Regardless of the target, however, the cost of achieving it will be far less if firms are given flexibility as to how reductions can fluctuate from year to year (while maintaining the necessary downward trend) than if they are not given such flexibility.

The Choice is Not Between Taxes and Inflexible Caps: Cap-and-Trade Programs Can Offer Varying Degrees of Flexibility. Policymakers can provide firms leeway in annual emission reductions in a variety of ways while ensuring that total emissions follow a desired long-term trajectory. Rising taxes are one method. Tax rates would need to be adjusted over time if they failed to induce the desired cumulative reduction in emissions over multiple years. Alternatively, a cap-and-trade program that included both a price floor and a price ceiling could achieve much of the efficiency advantages of a tax. The rate at which the cap declines—and that the price floor and ceiling increase—could be set to aim for a cumulative long-term emission reduction target. The policy could include provisions that would trigger a more rapid rise in the price floor and ceiling if it was failing to provide the desired cumulative emission reductions over a multiyear period. Finally, allowing firms to bank and borrow allowances can help reduce the cost of achieving a long-term emission reduction target relative to a system of inflexible annual caps. Those provisions, however, are unlikely to provide cost savings as substantial as those that might result from the alternative approaches.

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[1] For example, see Willam A. Pizer, “Combining Price and Quantity Controls to Mitigate Global Climate Change,” Journal of Public Economics 85 (2002) pp. 409-434; Richard G. Newell and William A. Pizer, “Regulating Stock Externalities Under Uncertainty” Journal of Environmental Economics and Management 45 (2003) pp. 416-432; Michael Hoel and Larry Karp, “Taxes and Quotas for a Stock Pollutant with Multiplicative Uncertainty,” Journal of Public Economics 83 (2001) pp. 91-114.

[2] See William A. Pizer, Climate Change Catastrophes, Resources for the Future Discussion Paper (May 2003); Willam A. Pizer, “Combining Price and Quantity Controls to Mitigate Global Climate Change,” Journal of Public Economics 85 (2002) pp. 409-434.

[3] For example, see Stephen H. Schneider and others, “An Overview of Dangerous Climate Change” in Avoiding Dangerous Climate Change, edited by Hans Joachim Schellnhuber and others, (Cambridge University Press, 2006).

[4] See Technical Summary of Working Group II of the Intergovernmental Panel on Climate Change, pp. 77-78, available at www.ipcc.ch.

CBO, with contributions from the Joint Committee on Taxation, released an analysis of the President’s budget submission for fiscal year 2009 this morning. (I will be summarizing our analysis at a conference held by the National Association for Business Economists today.) A report that presents the full analysis of the President’s budget, including CBO’s assessment of its macroeconomic effects, will be published on March 19.

 

CBO’s analysis indicates that:

 

• If the President’s proposals were enacted, the federal government would record deficits of $396 billion in 2008 and $342 billion in 2009. Those deficits would amount to 2.8 percent and 2.3 percent, respectively, of gross domestic product (GDP). By comparison, the deficit in 2007 totaled 1.2 percent of GDP.

 

• Under the President’s proposals, the deficit would steadily diminish from 2009 through 2012, at which point the budget would be balanced; it would remain close to balance in most years through 2018. Several key factors contribute to these outcomes, however. In particular, the President’s proposals exclude funding for military operations in Iraq and Afghanistan after 2009, incorporate significant reductions in discretionary spending relative to the size of the economy, and project a substantial expansion of the impact of the alternative minimum tax (AMT).

 

• The President’s budgetary proposals would result in revenues that were $2.1 trillion below CBO’s baseline projections over the 2009–2018 period, largely because of proposed extensions of various provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). The proposals also would lead to outlays that were below CBO’s baseline projections—by an estimated $1.1 trillion over 10 years—because of a smaller amount of funding for discretionary programs and reductions in mandatory spending, particularly in spending for Medicare.

 

• CBO’s analysis reflects the recent enactment of the Economic Stimulus Act of 2008. The analysis also takes into account recent revisions to CBO’s economic forecast.