Congressional Budget Office
Director's Blog

CBO has been asked for additional information about the projected effects of the Patient Protection and Affordable Care Act (PPACA), the pending health care reform legislation, on the federal budget and on the balance in the Hospital Insurance (HI) trust fund, from which Medicare Part A benefits are paid. Specifically, CBO has been asked whether the reductions in projected Part A outlays and increases in projected HI revenues under the legislation can provide additional resources to pay future Medicare benefits while simultaneously providing resources to pay for new programs outside of Medicare. Our answer is basically no.

How the HI Trust Fund Works

The HI trust fund, like other federal trust funds, is essentially an accounting mechanism. In a given year, the sum of specified HI receipts and the interest that is credited on the previous trust fund balance, less spending for Medicare Part A benefits, represents the surplus (or deficit, if the latter is greater) in the trust fund for that year. Any cash generated when there is an excess of receipts over spending is not retained by the trust fund; rather, it is turned over to the Treasury, which provides government bonds to the trust fund in exchange and uses the cash to finance the government’s ongoing activities. The resources to redeem government bonds in the HI trust fund and thereby pay for Medicare benefits in some future year will have to be generated from taxes, other government income, or government borrowing in that year.

The balance in the trust fund represents the accumulated difference between the fund’s receipts and outlays over time, including interest credited to the fund. Reports on HI trust fund balances from the Medicare trustees and others show the extent of prefunding of benefits that theoretically is occurring in the trust fund. However, because the government has used the cash from the trust fund surpluses to finance other current activities rather than saving the cash by running unified budget surpluses, the government as a whole has not been truly prefunding Medicare benefits.

The Impact of the PPACA on the HI Trust Fund and on the Budget as a Whole

In a report released this afternoon, CBO and the staff of the Joint Committee on Taxation (JCT) estimated that the PPACA, incorporating the manager’s amendment, would reduce Part A outlays by $245 billion and increase HI revenues by $113 billion during the 2010-2019 period. Those changes would increase the trust fund’s balances sufficiently to postpone exhaustion for several years. However, the improvement in Medicare’s finances would not be matched by a corresponding improvement in the federal government’s overall finances. CBO and JCT estimated that the PPACA as amended would add more than $400 billion ($245 billion + $113 billion + interest) to the balance of the HI trust fund by 2019, while reducing federal budget deficits by a total of $132 billion by 2019.

The reductions in projected Part A outlays and increases in projected HI revenues would significantly raise balances in the HI trust fund and create the appearance that significant additional resources had been set aside to pay for future Medicare benefits. However, the additional savings by the government as a whole—which represent the true increase in the ability to pay for future Medicare benefits or other programs—would be a good deal smaller.

The key point is that the savings to the HI trust fund under the PPACA would be received by the government only once, so they cannot be set aside to pay for future Medicare spending and, at the same time, pay for current spending on other parts of the legislation or on other programs. Trust fund accounting shows the magnitude of the savings within the trust fund, and those savings indeed improve the solvency of that fund; however, that accounting ignores the burden that would be faced by the rest of the government later in redeeming the bonds held by the trust fund. Unified budget accounting shows that the majority of the HI trust fund savings would be used to pay for other spending under the PPACA and would not enhance the ability of the government to redeem the bonds credited to the trust fund to pay for future Medicare benefits. To describe the full amount of HI trust fund savings as both improving the government’s ability to pay future Medicare benefits and financing new spending outside of Medicare would essentially double-count a large share of those savings and thus overstate the improvement in the government’s fiscal position.

CBO has discovered an error in the cost estimate released yesterday related to the longer-term budgetary effects of the manager’s amendment to the Patient Protection and Affordable Care Act. Correcting that error has no impact on the estimated effects of the legislation during the 2010–2019 period. However, the correction reduces the degree to which the legislation would lower federal deficits in the decade after 2019.

The legislation would establish an Independent Payment Advisory Board, which would be required, under certain circumstances, to recommend changes to the Medicare program to limit the rate of growth in that program’s spending. Those recommendations would go into effect automatically unless blocked by subsequent legislative action. In its original estimate, CBO wrote that: “Such recommendations would be required if the Chief Actuary for the Medicare program projected that the program’s spending per beneficiary would grow more rapidly than a measure of inflation (the average of the growth rates of the consumer price index for medical services and the overall index for all urban consumers).” That statement is correct for fiscal years 2015 through 2019. After 2019, however, the threshold for Medicare spending growth that would trigger recommendations for spending reductions would be higher—specifically, the rate of increase in gross domestic product (GDP) per capita plus 1 percentage point.

With this corrected reading, savings from changes to the Medicare program (along with other changes to direct spending that are not associated directly with expanded insurance coverage) would increase at a rate that is between 10 percent and 15 percent per year during the 2020–2029 period, compared with a growth rate of nearly 15 percent reported in the initial estimate. The long-run budgetary effects of the other broad categories of the legislation are unchanged from the initial estimate. All told, CBO expects that the legislation, if enacted, would reduce federal budget deficits over the decade after 2019 relative to those projected under current law—with a total effect during that decade that is in a broad range between one-quarter percent and one-half percent of GDP. In comparison, the extrapolations in the initial estimate implied a reduction in deficits in the 2020–2029 period that would be in a broad range around one-half percent of GDP. The imprecision of these calculations reflects the even greater degree of uncertainty that attends to them, compared with CBO’s 10-year budget estimates. The expected reduction in deficits would represent a small share of the total deficits that would be likely to arise in that decade under current policies.

Based on this extrapolation, CBO expects that Medicare spending under the legislation would increase at an average annual rate of roughly 6 percent during the next two decades—well below the roughly 8 percent annual growth rate of the past two decades (excluding the effect of establishing the Medicare prescription drug benefit). Adjusting for inflation, Medicare spending per beneficiary under the legislation would increase at an average annual rate of roughly 2 percent during the next two decades—well below the roughly 4 percent annual growth rate of the past two decades. It is unclear whether such a reduction in the growth rate could be achieved, and if so, whether it would be accomplished through greater efficiencies in the delivery of health care or would reduce access to care or diminish the quality of care.

Addendum: The statements in CBO’s December 19th letter about the federal budgetary commitment to health care remain correct. After 2019, the effects of the proposal that would tend to decrease that commitment would grow faster than those that would increase it. As a result, CBO expects that the proposal would generate a reduction in the federal budgetary commitment to health care during the decade following the 10-year budget window. By comparison, CBO expected that the legislation as originally proposed would have no significant effect on that commitment during the 2020-2029 period; most of the difference in CBO’s assessment arises because the manager’s amendment would lower the threshold for Medicare spending growth that would trigger recommendations for spending reductions by the Independent Payment Advisory Board. The range of uncertainty surrounding these assessments is quite wide.

CBO and the staff of the Joint Committee on Taxation (JCT) have released an analysis of the budgetary effects of the Patient Protection and Affordable Care Act (PPACA), Senate Amendment 2786 in the nature of a substitute to H.R. 3590 (as printed in the Congressional Record on November 19, 2009), incorporating the effects of changes proposed in the manager’s amendment released earlier today. The estimate does not include the effects of other amendments adopted during the Senate’s consideration of the Patient Protection and Affordable Care Act; it also does not reflect an incremental effect on PPACA from Congressional action on H.R. 3326, the Department of Defense Appropriations Act, 2010, which was cleared earlier today. Throughout this blog entry, references to “the legislation” mean the act as originally proposed and incorporating the manager’s amendment.

The manager’s amendment would make a number of changes to the act as originally proposed. The changes with the largest budgetary effects include: expanding eligibility for a small business tax credit; increasing penalties on certain uninsured people; replacing the “public plan” that would be run by the Department of Health and Human Services (HHS) with “multi-state” plans that would be offered under contract with the Office of Personnel Management (OPM); deleting provisions that would increase payment rates for physicians under Medicare; and increasing the payroll tax on higher-income individuals and families.

Estimated Budgetary Impact

CBO and JCT estimate that the direct spending and revenue effects of enacting the Patient Protection and Affordable Care Act incorporating the manager’s amendment would yield a net reduction in federal deficits of $132 billion over the 2010-2019 period. Of that total amount of deficit reduction, the manager’s amendment accounts for about $2 billion, and the act as originally proposed accounts for the remaining $130 billion. (See our analysis released on November 18 of the act as originally proposed.)

The estimate includes a projected net cost of $614 billion over 10 years for the proposed expansions in insurance coverage. That net cost itself reflects a gross total of $871 billion in subsidies provided through the exchanges, increased net outlays for Medicaid and the Children’s Health Insurance Program (CHIP), and tax credits for small employers; those costs are partly offset by $149 billion in revenues from the excise tax on high-premium insurance plans and $108 billion in net savings from other sources. Over the 2010–2019 period, the net cost of the coverage expansions would be more than offset by the combination of other spending changes that CBO estimates would save $483 billion and other provisions that JCT and CBO estimate would increase federal revenues by $264 billion. In total, the legislation would increase outlays by $366 billion and increase revenues by $498 billion between 2010 and 2019.

Effects of Provisions Regarding Insurance Coverage

By 2019, CBO and JCT estimate, the number of nonelderly people who are uninsured would be reduced by about 31 million, leaving about 23 million nonelderly residents uninsured (about one-third of whom would be unauthorized immigrants). Under the legislation, the share of legal nonelderly residents with insurance coverage would rise from about 83 percent currently to about 94 percent. Approximately 26 million people would purchase their own coverage through the new insurance exchanges, and there would be roughly 15 million more enrollees in Medicaid and CHIP than is projected under current law. Relative to currently projected levels, the number of people purchasing individual coverage outside the exchanges would decline by about 5 million. The number of people obtaining coverage through their employer would be about 4 million lower in 2019 under the legislation, CBO and JCT estimate.

The proposal would call on OPM to contract for two national or multi-state health insurance plans—one of which would have to be nonprofit—that would be offered through the insurance exchanges. Whether insurers would be interested in offering such plans is unclear, and establishing a nationwide plan comprising only nonprofit insurers might be particularly difficult. Even if such plans were arranged, the insurers offering them would probably have participated in the insurance exchanges anyway, so the inclusion of this provision did not have a significant effect on the estimates of federal costs or enrollment in the exchanges.

Effects on Health Insurance Premiums

On November 30, CBO released an analysis prepared by CBO and JCT of the expected impact on average premiums for health insurance in different markets of the  as originally proposed. Although CBO and JCT have not updated the estimates provided in that letter, the effects on premiums of the legislation incorporating the manager’s amendment would probably be quite similar. Replacing the provisions for a public plan run by HHS with provisions for a multi-state plan under contract with OPM is unlikely to have much effect on average insurance premiums because the existence of that public plan would not substantially change the average premiums that would be paid in the exchanges. The provisions contained in the manager’s amendment to regulate the share of premiums devoted to administrative costs would tend to lower premiums slightly, and the provisions prohibiting the imposition of annual limits on coverage would tend to raise premiums slightly.

Effects of the Legislation Beyond the First 10 Years

Although CBO does not generally provide cost estimates beyond the 10-year budget projection period (2010 through 2019 currently), many Members have requested CBO analyses of the long-term impact of broad changes in the nation’s health care and health insurance systems. A detailed year-by-year projection, like those that CBO prepares for the 10-year budget window, would not be meaningful because the uncertainties involved are simply too great. CBO has therefore developed a rough outlook for the decade following the 10-year budget window.

All told, the legislation incorporating the manager’s amendment would reduce the federal deficit by $16 billion in 2019, CBO and JCT estimate. In the decade after 2019, the gross cost of the coverage expansion would probably exceed 1 percent of gross domestic product (GDP), but the added revenues and cost savings would probably be greater. Consequently, CBO expects that the legislation, if enacted, would reduce federal budget deficits over the ensuing decade relative to those projected under current law—with a total effect during that decade that is in a broad range around one-half percent of GDP. The imprecision of that calculation reflects the even greater degree of uncertainty that attends to it, compared with CBO’s 10-year budget estimates. The expected reduction in deficits would represent a small share of the total deficits that would be likely to arise in that decade under current policies.

Relative to the legislation as originally proposed, the expected reduction in deficits during the 2020–2029 period is larger for the legislation incorporating the manager’s amendment. Most of that difference arises because the manager’s amendment would lower the threshold for Medicare spending growth that would trigger recommendations for spending reductions by the Independent Payment Advisory Board.

Many Members have expressed interest in the effects of reform proposals on various other measures of spending on health care. One such measure is the “federal budgetary commitment to health care,” a term that CBO uses to describe the sum of net federal outlays for health programs and tax preferences for health care—providing a broad measure of the resources committed by the federal government that includes both its spending for health care and the subsidies for health care that are conveyed through reductions in federal taxes. Under the legislation, CBO estimates that the federal budgetary commitment to health care during the next 10 years would be about $200 billion higher than under current law, driven primarily by the gross cost of the coverage expansions (including increases in both outlays and tax credits). Beyond 2019, the effects of the proposal that would tend to decrease the federal budgetary commitment to health care would grow faster than those that would increase it. As a result, CBO expects that the proposal would generate a reduction in the federal budgetary commitment to health care during the decade following the 10-year budget window.

These longer-term calculations assume that the provisions are enacted and remain unchanged throughout the next two decades. However, the legislation would maintain and put into effect a number of procedures that might be difficult to sustain over a long period of time. Under current law and under the proposal, payment rates for physicians’ services in Medicare would be reduced by about 21 percent in 2010 and then decline further in subsequent years. At the same time, the legislation includes a number of provisions that would constrain payment rates for other providers of Medicare services. In particular, increases in payment rates for many providers would be held below the rate of inflation. The projected longer-term savings for the legislation also assume that the Independent Payment Advisory Board is fairly effective in reducing costs beyond the reductions that would be achieved by other aspects of the legislation.

Based on the longer-term extrapolation, CBO expects that inflation-adjusted Medicare spending per beneficiary would increase at an average annual rate of less than 2 percent during the next two decades under the legislation—about half of the roughly 4 percent annual growth rate of the past two decades. It is unclear whether such a reduction in the growth rate could be achieved, and if so, whether it would be accomplished through greater efficiencies in the delivery of health care or would reduce access to care or diminish the quality of care.

The federal government uses a linked set of three taxes on estates, gifts, and generation-skipping transfers to tax transfers of wealth at each generation and to limit the extent to which wealth can be given away during life to avoid taxation at death. A scheduled temporary repeal of the estate tax in 2010 has raised interest in modifying such taxes on transfers of wealth. Already, the House has passed legislation (H.R. 4154) that would permanently extend estate and gift tax law as it stands in 2009. Today CBO released a brief discussing the existing taxes on transfers of wealth and policy options for changing them.

How the United States Taxes Transfers of Wealth

The federal government levies three types of taxes on transfers of wealth:

• An estate tax on the net value of assets transferred to other individuals when a person dies,
• A gift tax on the value of gifts that a person gives to others during that person’s lifetime, and
• A generation-skipping transfer tax on some transfers of wealth at death to certain heirs.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) reduced revenue from the estate tax relative to previous law beginning in 2001, primarily by increasing the amount of an estate that is effectively exempt from taxation and by reducing the top marginal tax rate (the rate that applies to the last dollar of an estate). Under that law, the effective exemption amount rose from $675,000 in 2001 to $3.5 million in 2009, and the top marginal tax rate dropped from 55 percent to 45 percent. In 2010, the estate tax is temporarily repealed. Starting in 2011, the estate tax is reinstated with an exemption amount of $1 million and a maximum marginal tax rate of 55 percent (plus a 5 percent surtax on taxable transfers between $10.0 million and $17.184 million, which was also in effect in 2001).

Estate and Gift Tax Collections

Since 1977, less than 2 percent of adults who die each year typically leave estates large enough to be taxable. Because of recent increases in the amount of an estate that is exempt from taxation, a relatively small percentage of estates are taxable today. Federal transfer taxes have historically made up a relatively small share of total federal revenues—accounting for 1 percent to 2 percent of total revenues in most of the past 60 years.

Under current law, revenues from estate and gift taxes will total $420 billion, 1.2 percent of revenues, over the 2010–2019 period, CBO forecasts. About $364 billion (87 percent) of that total is from estate tax receipts, and the remaining $56 billion (13 percent) is from gift tax receipts.  Estate and gift tax receipts as a percentage of total receipts will drop over the next two years (see Figure 1) and, because of the changes currently set in law, the pattern of receipts will be irregular.

Estate and Gift Tax Receipts As A Percentage of Total Receipts, Fiscal Years 1945-2019

Receipts from estate taxes will decline in 2010 and almost disappear in 2011, before rising to about $32 billion in 2012, CBO estimates.  In contrast, gift tax receipts will probably surge to a very high level in 2011, reflecting the scheduled decline—in 2010—of the top rate for gift taxes from 45 percent to 35 percent. After the enactment of EGTRRA in 2001, taxpayers cut their taxable giving of gifts by more than half, partly in anticipation of the repeal of the estate and generation-skipping transfer taxes and the reduction in the tax rate on gifts to 35 percent in 2010. CBO’s forecast of gift tax receipts reflects the reversal of that behavior in 2011, when the tax on gifts given in 2010 will be due.

Policy Options for Changing the Taxation of Wealth Transfers

The repeal of the estate tax in 2010 followed by the reversion to a $1 million exemption amount has led many policy makers to seek changes to current law. The House-passed legislation (H.R. 4154) would permanently retain the estate and gift taxes at the parameters in place for 2009. In its August 2009 report Budget Options, Volume 2, CBO discussed a number of other options for modifying estate and gift taxes, including permanently extending the law in effect in 2009 (but unlike H.R. 4154, adjusting the exemption amounts for the estate and GST taxes for inflation) and permanently repealing the estate tax. The brief discusses those options, as well as an option to replace the estate tax with an inheritance tax. Adopting one of those options for modifying estate and gift taxes would reduce federal revenues by amounts ranging from $234 billion to more than $500 billion over the 2010-2019 period, according to estimates by the staff of the Joint Committee on Taxation.

This brief was prepared by Pamela Greene of CBO’s Tax Analysis Division.

Yesterday CBO released a cost estimate for S. 1733, the Clean Energy Jobs and American Power Act, which was ordered reported by the Senate Committee on Environment and Public Works on November 5, 2009.  This legislation would make a number of changes in energy and environmental policies largely aimed at reducing emissions of gases that contribute to global warming. The bill would limit or cap the quantity of certain greenhouse gases (GHGs) emitted from facilities that generate electricity and from other industrial activities beginning in 2012.

Under the bill, the Environmental Protection Agency (EPA) would establish two separate regulatory initiatives known as cap-and-trade programs—one covering emissions of most types of GHGs and one covering hydrofluorocarbons (HFCs). EPA would issue allowances to emit those gases under the cap-and-trade programs. Some of those allowances would be auctioned by the federal government, and the remainder would be distributed at no charge. The legislation also would authorize the establishment of a Carbon Storage Research Corporation to support research and development of carbon capture and sequestration (CCS) technology. Funding for the corporation would largely be derived from assessments on utilities enforced by the federal government.

CBO and the staff of the Joint Committee on Taxation estimate that over the 2010-2019 period enacting this legislation would:

• Increase federal revenues by about $854 billion; and
• Increase direct spending by about $833 billion.

In total, those changes would reduce budget deficits (or increase future surpluses) by about $21 billion over the 2010-2019 period. In years after 2019, direct spending would be less than the net revenues attributable to the legislation in each of the 10 year periods following 2019. Therefore, CBO estimates that enacting S. 1733 would not increase the deficit in any of the four 10-year periods following 2019.

The legislation also would authorize appropriations for various programs to be operated by EPA, the Department of Energy (DOE), and other agencies. If those funds were appropriated, CBO estimates that implementing S. 1733 would increase discretionary spending by about $29 billion over the 2010-2019 period. Most of that funding would stem from spending auction proceeds associated with the HFC cap-and-trade program.

Differences Between S. 1733 and H.R. 2454, the American Clean Energy and Security Act of 2009

S. 1733 is similar to H.R. 2454, which was passed by the House, but there are some significant differences that result in lower estimates of revenues and direct spending under S. 1733. Specifically, several energy-related provisions in H.R. 2454 that CBO estimated would increase direct spending (such as the renewable-electricity standard and the establishment of a Clean Energy Deployment Administration) are not included in S. 1733. Also contributing to lower spending under the Senate bill are the different amounts of proceeds from allowance auctions that are not spent. (See CBO’s cost estimate for H.R. 2454 as passed by the House on June 26.  CBO and JCT estimate that over the 2010-2019 period, the House bill would increase federal revenues by about $873 billion and increase direct spending by about $864 billion, reducing budget deficits over that period by about $9 billion.)

In addition, differences between the two versions of the legislation would result in higher allowance prices under S. 1733.  CBO estimates that prices for emission allowances would be about 15 percent higher under S. 1733 than under H.R. 2454, as passed by the House, because S. 1733:

• Contains a more stringent emissions cap in 2014 and between 2017 and 2029;
• Contains different allocations for distributing emission allowances and auction revenues; and
• Places greater restrictions on the amount of international offsets that can be used towards an entity’s compliance obligation.

CBO’s Work on Climate Change

CBO has done extensive work on issues surrounding climate change.  Earlier this month, CBO’s Assistant Director for Microeconomic Studies, Joseph Kile, testified on the use of agricultural offsets as part of a cap-and-trade program for reducing greenhouse gases. Last month, CBO released a brief about the economic costs of reducing greenhouse-gas emissions in the United States.  That brief highlighted more than a dozen of CBO’s cost estimates and publications related to the issues of climate change and legislative proposals to reduce greenhouse gases. 

CBO has released a letter responding to questions posed by Senator Rockefeller about our recent analysis of the budgetary effects of proposals to limit costs related to medical malpractice (“tort reform”), as described in a letter to Senator Hatch on October 9. Today’s letter addresses questions about how recent empirical studies affected CBO’s analysis, why CBO’s latest estimates of the budgetary effects of tort reform are larger than the agency’s previous estimates, and whether tort reform would have a negative impact on patients’ health.

Recent Research Findings

CBO’s latest assessment of the effects of tort reform on spending for health care draws on a considerable amount of analysis that the agency has undertaken during the past several years and a stream of recent research studies that have used a variety of data and empirical techniques. Despite that analysis, estimates of the budgetary effects of tort reform are unavoidably uncertain, as is true for many other issues that CBO studies. In dealing with uncertainty, the agency consistently strives to produce estimates that lie in the middle of the distribution of plausible outcomes based upon available knowledge. After a careful evaluation of the research relevant to tort reform, along with discussions with members of the agency’s Panel of Health Advisers who have particular expertise in this topic, CBO concluded that the weight of empirical evidence now demonstrates a link between tort reform and the use of health care services.

CBO’s Updated Estimates of the Budgetary Effects of Tort Reform

CBO had previously estimated that enacting a common package of tort reform proposals would reduce federal deficits by $4 billion from 2010 to 2019, but CBO now estimates that those proposals would reduce federal deficits by about $54 billion during that period. The latest estimates are substantially larger for four principal reasons:

• The estimates include a larger effect of tort reform on medical malpractice costs;
• The estimates incorporate the effect of a gradual reduction in the utilization of health care services resulting from changes in the practice patterns of providers;
• The estimated effect on federal revenues was substantially smaller in the previous estimate (which reflected only a reduction in malpractice costs) than the estimated effect on revenues in the current estimate (which reflects the combined effects of the reduction in malpractice costs and the change in spending attributable to changes in practice patterns); and
• The reduction in utilization is projected to generate a proportionately larger reduction in federal spending on health care than in other spending on health care.

Effects of Tort Reform on Patients’ Health

The potential impact of tort reform on the quality of health care and on health outcomes is an important consideration for policymakers. CBO’s letter to Senator Hatch observed that imposing limits on suits for damages resulting from negligent health care might be expected to have a negative impact on health outcomes. However, the limited evidence currently available about the effects of tort reform on health outcomes is much more mixed than the larger collection of evidence currently available about the effects of tort reform on health care spending.

Yesterday CBO issued a cost estimate for H.R. 4173, the Wall Street Reform and Consumer Protection Act of 2009, as amended and reported on Tuesday by the House Committee on Rules. In the letter transmitting our estimate, we explained that the estimated savings from the bill’s provision for reducing the maximum amount that may be outstanding under the Troubled Asset Relief Program (TARP) may be attributable to the improvement in financial conditions this year rather than enactment of the legislation.

The TARP was created by the Emergency Economic Stabilization Act of 2008 (EESA) in October 2008 to promote stability in financial markets through the purchase and insurance of “troubled assets.” Currently, the Secretary of the Treasury has the authority to purchase and hold up to $699 billion in assets at one time (the original level of $700 billion was reduced by the Helping Families Save Their Homes Act of 2009). Initially, that authority was set to expire on December 31, 2009; however, in a letter addressed to the Speaker of the House and the Senate Majority Leader yesterday, the Secretary exercised the option provided in EESA to extend TARP authority until October 3, 2010.

The version of H.R. 4173 approved by the House Committee on Rules includes a provision that would reduce the maximum amount that may be outstanding at any time under the TARP by $20.8 billion. In its March 2009 baseline projections, CBO expected that the Treasury would use all of the authority available under the TARP. That baseline was adopted as the Congress’s budget resolution baseline for scorekeeping purposes and is used by CBO for estimating the budgetary impact of legislation until the Congress adopts a new baseline for scorekeeping purposes. Using the March baseline’s estimated average subsidy of 50 percent for the use of uncommitted TARP authority, the current legislation’s proposed reduction in authority of $20.8 billion would result in outlay savings of $10.4 billion.

However, that reduction in spending relative to the March baseline might occur even in the absence of this legislation because financial conditions have improved considerably since March. CBO’s August report updating the budget outlook reduced the projected use of TARP funds, but that August baseline is not used for Congressional scorekeeping purposes. Moreover, the Secretary of the Treasury noted in his letter yesterday that “beyond these limited new commitments, we will not use remaining [TARP] funds unless necessary to respond to an immediate and substantial threat to the economy stemming from financial instability.” If CBO were to estimate the impact of the TARP provision in this legislation taking into account current financial conditions, the agency would not expect that the full amount available under the TARP’s ceiling on outstanding investment would be fully utilized. Thus, the savings estimated relative to the budget resolution baseline arise from a reduction in the Secretary’s authority to commit funds that would probably not be committed anyway.

Last week, I gave a presentation on the “Exit Strategy for Fiscal Policy” at the fall meeting of the Group of Thirty, an international group of current and former policymakers and academic researchers that meets twice a year to discuss economic, financial, and policy developments around the world. Other presenters discussed exit strategies for monetary policy; the term “exit strategy” refers to the course of policy as the economy exits the recession. My comments were based on CBO’s August economic and budget projections.

I explained that, given the likely evolution of the U.S. economy, the current path of fiscal policy poses two central challenges to macroeconomic stability, one over the next few years and another over the longer term:

• Fiscal stimulus will be withdrawn very rapidly between 2010 and 2012.

• Fiscal stimulus will not be reduced any further after 2012.

On the first point, I noted that fiscal stimulus can be measured in different ways, but I showed that the simplest measure—the budget deficit—would fall by about 6 percent of GDP between fiscal years 2010 and 2012 under current law. At the current level of GDP, that decline would represent a withdrawal of stimulus over two years of nearly $1 trillion on an annual basis; if underlying private demand for goods and services did not increase by that amount over the same period, total output and income would fall rather than rise. I also listed some of the options now being considered by fiscal policymakers to boost output and employment in the next few years.

On the second point, I showed that budget deficits after 2012 would remain above 3 percent of GDP under current law and would be close to 6 percent of GDP if the 2001 and 2003 tax cuts were extended and the threshold for the Alternative Minimum Tax were indexed to inflation. Under this latter scenario, publicly held federal debt would be nearly 90 percent of the size of GDP in 10 years—and continuing to rise due to the budget pressures generated by the aging of the population and rising health care spending.

I explained to the group that CBO had estimated that the health reform proposals that have passed the House and that are being considered by the Senate would reduce budget deficits slightly in the current decade and the following decade. I also mentioned some commonly expressed concerns about the effects of those proposals on budget deficits and described my reaction to those concerns:

• First, some analysts argue that CBO is underestimating the ultimate costs of the new subsidies to buy health insurance. My response was that the budgetary impact of broad changes in the nation’s health care and health insurance systems was very uncertain, but that CBO staff, in consultation with outside experts, has devoted a great deal of care and effort to this analysis, and the agency strives to have its estimates reflect the middle of the distribution of possible outcomes. CBO’s estimates of subsidy costs may turn out to be too low, but they could also turn out to be too high.

• Second, some observers argue that CBO’s estimates are unrealistic because Congress will not allow the Medicare spending cuts in the proposals to take effect. My response was that CBO estimates the effects of proposals as written and does not forecast future legislation, but that the agency does try to provide information about the consequences of implementing proposals. Our cost estimate for the Senate proposal and our cost estimate for the House bill said that inflation-adjusted Medicare spending per beneficiary would slow sharply under those proposals. For example, growth in such spending under the Senate proposal would drop from about 4 percent per year for the past two decades to roughly 2 percent per year for the next two decades; whether such a reduction could be achieved through greater efficiencies in the delivery of health care or would reduce access to care or diminish the quality of care is unclear. In addition, relaxing previously enacted constraints on Medicare spending can add significantly to long-run budget deficits, as we wrote in answer to a question about the effects of combining the House bill with a change in the so-called Sustainable Growth Rate mechanism for Medicare physician payments.

• Third, some analysts argue that the pending proposals will hamper future efforts at deficit reduction by using spending cuts and new revenues to pay for a new entitlement rather than to cover the costs of existing entitlements. My response was, again, that CBO does not and should not forecast future legislation; its cost estimates address the specific legislation at hand and do not speculate about the possible impact of a bill on future legislative actions. However, our June analysis of health reform and the federal budget noted that using savings in certain programs to finance new programs instead of reducing the deficit would ultimately necessitate even stronger policy actions in other areas of the budget.

• Fourth, some experts argue that the proposals are missing opportunities to reform health care delivery and reduce spending more significantly. My response was that it is not CBO’s role to make such judgments, but that our December volume on Budget Options included a wide range of alternatives for changing the nation’s health care and health insurance systems. Those options covered many different types of reforms and included reforms with different degrees of aggressiveness in altering existing systems and pursuing cost-saving goals.

Just before Thanksgiving, I was the opening speaker at the fall symposium of the AABPA. My presentation on “The Economic and Budget Outlook” drew on our August report The Budget and Economic Outlook: An Update, our June report The Long-Term Budget Outlook, and the most recent Treasury budget data for fiscal year 2009. (CBO is currently in the process of updating its economic forecast and budget projections for release in the next Budget and Economic Outlook in late January.)

My comments emphasized three points:

• Like most other analysts, we anticipate a relatively slow and tentative economic recovery. The unemployment rate is likely to rise above its current reading of 10 percent in coming months; the percentage of unemployed people who have experienced a permanent layoff is now around 55 percent, well above the peak values in previous recessions; and the percentage of unemployed people who are finding jobs has plummeted. In August, we expected that creating new jobs to replace the millions lost in this recession would take a number of years, and that the unemployment rate would not be back at its sustainable long-run level until 2014. Unfortunately, much more of the pain of unemployment from this recession lies ahead of us than behind us.
• As GDP strengthens and spending related to the economic stimulus package abates, the federal budget deficit will shrink from the nearly 10 percent of GDP recorded in fiscal year 2009. In August, CBO projected that, under current law, the deficit would remain close to 10 percent of GDP in fiscal year 2010 but would fall below 4 percent of GDP in fiscal year 2012.
• Over the medium term and longer term, the federal fiscal situation remains grim. As I have said on several occasions: Current budget policy as perceived by many people (in particular, the personal income tax rates now in effect) would generate much larger deficits than current law as captured in CBO’s baseline. In addition, federal debt is already very large relative to GDP by historical standards. Moreover, the aging of the population and rising health care spending will continue to push up federal spending.

The federal budget deficit was $292 billion for the first two months of fiscal year 2010, CBO estimates in its latest monthly budget review, about $11 billion greater than the shortfall recorded through November of last year. Although spending related to turmoil in the financial markets was sharply reduced compared with that in the first two months of last year, the deficit is higher because of increased spending on unemployment benefits and certain other entitlement programs and reduced individual income tax receipts.

The federal government recorded $84 billion in spending for the Troubled Asset Relief Program (TARP) and for payments to Fannie Mae and Freddie Mac in the first two months of fiscal year 2009, but recorded only $2 billion for those purposes so far this year. Excluding spending for the TARP, Fannie Mae, and Freddie Mac, the deficit during the first two months of fiscal year 2010 was over $90 billion greater than the shortfall recorded during the same period last year.

Outlays

By CBO’s estimate, spending for the first two months of fiscal year 2010 totaled $559 billion, down $31 billion (or 5 percent) from last year. However, excluding outlays for the TARP and net cash infusions for Fannie Mae and Freddie Mac, spending in 2010 rose by $51 billion (or 10 percent). Driving that increase are additional outlays for Social Security benefits, Medicaid, Medicare, and unemployment benefits.

Specifically, Social Security benefits rose by $11 billion (or 10 percent). The number of recipients grew as the first of the baby boomers begin to collect benefits; in addition, the average benefit has risen significantly because of the large cost of living increase (5.8 percent) that was effective in January 2009. Medicaid spending grew by $9 billion (or 25 percent). Spending from the American Recovery and Reinvestment Act (ARRA) temporarily increased the share of Medicaid paid by the federal government, accounting for around two-thirds of the year-over-year increase in federal Medicaid spending. Medicare payments rose by $7 billion (or 11 percent), resulting from noticeably higher spending in Medicare’s prescription drug program. Outlays for unemployment benefits through November more than doubled compared with spending last year. The additional $14 billion in payments reflects higher unemployment and legislated increases in both the amount and duration of benefits.

Revenues

In the first two months of this fiscal year, revenues were about $42 billion (or 14 percent) lower than they were in 2009. The three primary sources of receipts showed declines relative to last year: Individual income taxes decreased by $37 billion (or 26 percent), corporate income taxes fell by $10 billion, and social insurance taxes fell by about $1.5 billion (or 1 percent). Offsetting those declines was an increase of $7 billion in receipts from the Federal Reserve, primarily because of a shift in its portfolio to higher-yielding investments.