Congressional Budget Office
Director's Blog

Colleges and universities enjoy a variety of federal tax preferences that are designed to support a broader public purpose—the advancement of higher education and research. Not only are institutions of higher learning exempt from paying federal income taxes, they also are eligible to receive tax-deductible charitable contributions and allowed to use tax-exempt debt to finance capital expenditures. According to the staff of the Joint Committee on Taxation, the cost of allowing institutions of higher learning to borrow using such debt—measured in terms of the revenues that could have been collected if those institutions had borrowed using taxable debt—will be about $5.5 billion in 2010.

The use of proceeds from lower-cost tax-exempt bonds to directly finance the purchase of higher-yield securities—a practice known as tax arbitrage—is prohibited by law. Nevertheless, as discussed in a CBO study released today, the law as currently implemented allows many colleges and universities to use tax-exempt debt to finance investments in operating assets (buildings and equipment) while, at the same time, they hold investment assets that earn a higher return. (Investment assets are publicly traded and privately held securities, as well as land or buildings held for investment purposes.) To the extent that colleges and universities can earn untaxed returns on investments that are higher than the interest they pay on tax-exempt debt, they are benefiting from a form of “indirect” tax arbitrage.

Using data from information returns filed with the Internal Revenue Service by institutions of higher learning and by issuers of tax-exempt debt, CBO developed measures of tax arbitrage under a broader definition of the term that encompasses both direct and indirect tax arbitrage. Under one such definition, nearly all of the tax-exempt bonds that 251 colleges and universities issued in 2003 would be classified as earning profits from tax arbitrage. If some investment assets were set aside in a reserve, which would be excluded from the arbitrage measure under an alternative expanded definition, the amount of debt earning returns from arbitrage would be lower; even so, about 75 percent of bonds issued in 2003 would still be classified as earning arbitrage profits under that expanded definition.

By either measure, the amount of debt issued by colleges and universities that earns arbitrage profit would be considerably larger than that issued by nonprofit hospitals (which was the subject of a previous CBO study). Over time, if legislators were to expand the definition of tax arbitrage and thereby eliminate some of the benefits of tax-exempt financing, nonprofit institutions would probably respond by reducing the issuance of tax-exempt debt. That response, in turn, would decrease the cost to the federal government of the tax preference.

This study was prepared by Kristy Piccinini of CBO’s Tax Analysis Division.

To attract and retain the military personnel it needs, the Department of Defense (DoD) must offer a competitive compensation package—one that adequately rewards service members for their training and skills as well as for the rigors of military life, particularly the prospect of wartime deployment. This morning CBO senior analyst Carla Tighe Murray testified before the Senate Armed Services Committee’s Subcommittee on Personnel to discuss compensation for members of the armed forces.

The best barometer of the effectiveness of DoD’s compensation system may be how well the military attracts and retains high-quality personnel. Between 2005 and 2008, the services periodically had trouble recruiting or retaining all of the high-quality personnel they needed. To address those problems, the Congress authorized increases in both cash compensation (such as pay raises and bonuses) and noncash compensation (such as expanded education benefits for veterans and their families). All of the services met their recruiting and retention goals in 2009 and are continuing to do so in 2010. However, the relationship between specific changes in pay rates and benefits and the amount of recruiting and retention is not clear. In particular, a variety of factors—including economic conditions—may have significant effects on DoD’s ability to recruit and retain personnel during a given period.

Another way to determine whether military compensation is competitive is to compare it with civilian compensation. Today’s testimony focused primarily on such comparisons—which can be useful but not definitive, in part because of the significant differences in working conditions and benefits between military and civilian jobs. The testimony addressed three questions:

How does military cash compensation compare with civilian wages and salaries?

CBO’s most recent analysis, for calendar year 2006, found that average cash compensation for service members (including tax-free cash allowances for housing and food) was greater than that of more than 75 percent of civilians of comparable age and educational achievement. Since then, military pay raises have continued to exceed the increases of civilian wages and salaries, so that finding has not changed.

Is there a “gap” between civilian and military pay raises over the past few decades?

The answer depends on how narrowly military cash pay is defined. One common method of comparison is to calculate the cumulative difference between increases in military and civilian pay using military basic pay, a narrow measure of cash compensation that does not include, for example, tax-free allowances for housing and food. Applying that method would indicate that, cumulatively, civilian pay rose by about 2 percent more than military pay between 1982 and the beginning of 2010. But that measure does not encompass the full scope of military cash compensation. Using a broader measure that includes cash allowances for housing and food indicates that the cumulative increase in military compensation has exceeded the cumulative increase in private-sector wages and salaries by 11 percent since 1982. That comparison excludes the value of noncash and deferred benefits, which would probably add to the cumulative difference, because benefits such as military health care have expanded more rapidly than corresponding benefits in the private sector.

How would the costs of using bonuses to enhance recruiting and retention compare with the costs of adding more to basic pay?

Traditionally, service members receive an across-the-board increase in basic pay each calendar year, and proposals are frequently made to boost the rate of increase. Changing the basic-pay raise that would take effect on January 1, 2011, from the 1.4 percent requested by the President and DoD to 1.9 percent, for example, would increase DoD’s costs by about $350 million in 2011 and by a total of about $2.4 billion through 2015, CBO estimates. A larger pay raise would probably enhance recruiting and retention, although the effect would be small. One possible alternative would be to increase cash bonuses by enough to achieve the same recruiting and retention effects as a higher across-the-board pay raise. That approach would have a smaller impact on DoD’s costs because bonuses can be awarded only to the types of service members the military needs most. Bonuses can also be focused on current personnel or potential enlistees who are at the point of making career decisions. Unlike pay raises, bonuses do not compound from year to year (a higher pay raise in one year will cause the following year’s raise to be applied to a higher base), and bonuses do not affect retirement pay and other elements of compensation.

This afternoon I participated in a panel discussion about “Fiscal Strategies after the Global Crisis” at the International Monetary Fund. My short presentation focused on some familiar themes:

Given current law and certain possible changes to that law that are generally supported by the Administration and many Members of Congress, the budget deficit and debt are on a worrisome path—unsustainable in the long run and posing growing risks even during the next several years.

The following picture shows CBO’s March projections of debt relative to gross domestic product (GDP) under current law (the budget “baseline”) and under an alternative scenario in which the 2001 and 2003 tax cuts are extended and the alternative minimum tax (AMT) is indexed for inflation. The President’s budget would extend most of the 2001 and 2003 tax cuts, index the AMT for inflation, and make a variety of other changes in law. CBO’s projection of the debt under that budget is quite similar to our projection under the alternative scenario shown below. If that debt indeed rises toward 90 percent of GDP, it would be entering territory that is unfamiliar to us and to most developed countries in recent years.

Debt Held by the Public as a Percentage of GDP

 Putting U.S. fiscal policy on a safe path would probably require significant changes in spending, revenue, or both. In thinking about changes that might be made, it’s important to understand where most of the revenue will be coming from and where most of the spending will be going.

CBO’s March projection under current law shows that, in 2020, about one-half of federal revenue will come from individual income taxes, about one-third will be from payroll taxes, and the rest will be from corporate profits taxes and other sources. The same projection shows that roughly three-quarters of spending will go to just five areas—Social Security, Medicare, Medicaid, defense, and net interest—with the remaining one-quarter of spending covering all other federal programs. The following chart provides more details:

Shares of Federal Spending Projected for 2020 in CBO’s March Baseline

Changes of the magnitude required to put U.S. fiscal policy on a safe path could have important economic and social effects. Given the political and substantive difficulties in making significant policy changes, determining what those changes will be is an urgent task for policymakers.

Yesterday CBO released a cost estimate for S. 3217, the Restoring American Financial Stability Act of 2010, as ordered reported by the Senate Committee on Banking, Housing, and Urban Affairs on March 22, 2010. S. 3217 would grant new federal regulatory powers and reassign existing regulatory authority among federal agencies with the aim of reducing the likelihood and severity of financial crises.

The legislation would establish a program to facilitate the resolution of large financial institutions that become insolvent or are in danger of becoming insolvent when their failure is determined to threaten the stability of the nation’s financial system (such institutions are known as systemically important firms). The program would be funded by fees assessed on certain large financial companies; an Orderly Liquidation Fund (OLF) of $50 billion would be accumulated, and in the event of a costly resolution, the fund would be replenished over time with future assessments. CBO estimates that receipts to the fund would exceed its expenditures during the 2011-2020 period, reducing deficits by a total of about $18 billion over that period. In later years, expenses of the OLF would exceed income from new assessments paid by financial firms, resulting in an increase in the deficit in those years.

A second new program would expand the authority of the Federal Deposit Insurance Corporation (FDIC) to provide government guarantees on a broad array of financial obligations of banks and bank holding companies if federal officials determine that market conditions are impeding the normal provision of financing to creditworthy borrowers (known as a liquidity crisis). Under the bill, participants in the program would be charged fees designed to recover the costs of the government guarantees. CBO estimates a net cost of less than $1 billion for that program over the next 10 years.

Other provisions of S. 3217 would change how financial institutions and securities markets are regulated, create a new Bureau of Consumer Financial Protection as an autonomous entity within the Federal Reserve, broaden the authority of the Commodity Futures Trading Commission and the Securities and Exchange Commission, establish a grant program to encourage the use of traditional banking services, expand the supervision of firms that settle payments between financial institutions, and make many other changes to current laws. For example, it would abolish the Office of Thrift Supervision and reduce the number of firms regulated by the Federal Reserve, shifting more responsibility to the Office of the Comptroller of the Currency and the FDIC. It would also establish a Financial Stability Oversight Council, led by the Secretary of the Treasury, which would be responsible for identifying risks to the nation’s financial stability and for facilitating information sharing and setting oversight priorities among regulators.

In total, CBO estimates that enacting S. 3217 would increase federal revenues by about $75 billion and direct spending by $54 billion over the 2011-2020 period. (Direct spending is spending that does not require any subsequent appropriation legislation.) As a result, those changes would decrease budget deficits by an estimated $21 billion over that 10-year period. In addition, CBO estimates that implementing the bill would increase spending subject to appropriation by $13 billion over the 2011-2020 period.

Under the legislation, as under current law, there is some probability that, at some point in the future, large financial firms will become insolvent and liquidity crises will arise, and that those financial problems will present significant risks to the nation’s broader economy. The cost of addressing those problems under current law is unknown and would depend on how the Administration and the Congress chose to proceed when faced with financial crises in the future; they could, for example, change laws, create new programs, appropriate additional funds, and assess new fees. Depending on the effectiveness of the new regulatory initiatives and new authorities to resolve and support a broad variety of financial institutions contained in S. 3217, enacting this legislation could change the timing, severity, and federal cost of averting and resolving future financial crises. However, CBO has not determined whether the estimated costs under the bill would be smaller or larger than the costs of alternative approaches to addressing future financial crises and the risks they pose to the economy as a whole.

The bill would impose intergovernmental and private-sector mandates, as defined in the Unfunded Mandates Reform Act (UMRA), on banks and other private and public entities that participate in financial markets. The bill also would impose mandates on states by prohibiting them from taxing and regulating certain insurance products issued by companies based in other states and by preempting certain state laws.

CBO has also prepared an estimate of the direct spending and revenue effects of a related House bill, the Wall Street Reform and Consumer Protection Act of 2009 (H.R. 4173).

Each year, even when the economy is growing, millions of people lose a job for reasons other than poor performance or misconduct. In an issue brief released today, CBO reviews the research on the short- and long-term effects of involuntary job loss for reasons other than poor performance or misconduct on people’s future employment and earnings. In light of the recession that began in December 2007 and CBO’s projection that, under current law, the unemployment rate will remain elevated for a number of years, the brief focuses on the effects of involuntary job loss during periods of weak economic activity. The brief also summarizes some of the government programs that help people who have lost their job.

Many people who lose a job involuntarily find a new job, some quite quickly (within a month or so) and others after more time. For example, among people who were displaced from their job in 2003—when the unemployment rate peaked at 6 percent—and were reemployed by January 2006, CBO found that 10 percent were reemployed within a week. Another 25 percent found a job within a month. In contrast, 25 percent were jobless (although not necessarily searching for work) for six months or more.

In late 2009, about 4 percent of the labor force consisted of unemployed people who had been out of work for 27 weeks or more—well above the previous peak, which occurred after the back-to-back recessions of the early 1980s, and a substantial fraction of all of those who were unemployed. A shift away from temporary layoffs and toward permanent layoffs has contributed to the increased duration of unemployment in recent decades.

Further, finding a job may require substantial effort and flexibility, especially when openings are scarce, and the need to shift from one industry or occupation to another to gain a new job is partly responsible for workers’ prolonged unemployment. One analysis of data from 1978 to 1990 found that in some states with high rates of unemployment, that rate decreased only when many of the unemployed people moved to a different state. Now, when many homeowners owe more on their mortgage than their house is worth, many people may not be able to make such moves.

Some people who lose a job involuntarily do not find a new job. Some of those people may decide not to look for a new job, while others may look for a job but be unsuccessful in their search. Among those who lost a job involuntarily between 1981 and 2003, three groups of workers—women, older people, and less-educated people—were more likely to leave the labor force than were others who lost a job.

In both the short and the long term, people who lose a job for reasons other than poor performance or misconduct and then find a new job see their earnings decline, on average. Short-term declines in earnings—those in the first few years after a job loss—tend to be larger for people who lose a job during or shortly after a recession. For example, those who lost jobs from 2001 through 2003 experienced a 14 percent decline in earnings. The average decline in earnings associated with a job loss in periods of stronger economic activity between 1984 and 2000 was smaller.

For people who have acquired a substantial amount of firm-specific knowledge, the loss of a job can be associated with a relatively large decline in earnings in both the short term and the long term. Among men who lost their jobs in a mass layoff during the 1982 recession, older workers (those ages 50 to 55) experienced earnings declines in the year following their job loss that were more than 40 percent higher than the earnings declines of men in their 20s and 30s. Initial declines in earnings associated with losing a job during a recession may persist for many years. The new job might have both lower earnings and less potential for earnings growth in the future than the lost job. Among the men who lost their job in a mass layoff during the 1982 recession, earnings 15 to 20 years later were about 20 percent lower than those of similar men who did not lose their job.

A number of government programs are available to help people who have lost their job, such as unemployment insurance (UI) and the Supplemental Nutrition Assistance Program (formerly called the Food Stamp program). Disability Insurance and Supplemental Security Income are also available to some people who are unable to work because of a severe health problem. Training and education programs as well as provisions of the Consolidated Omnibus Budget Reconciliation Act of 1985 (known as “COBRA”)—which makes possible the continuation of health coverage at group rates for individuals—are also helpful to some people. Some of the programs are available only to people who have lost their job involuntarily and others are designed to help people, with or without jobs, who are experiencing misfortune (especially financial distress) for various reasons.

During the recent economic downturn, the federal government has expanded eligibility or increased the amount of benefits available through some of those programs, including the UI program. In fiscal year 2009, outlays for UI benefits totaled $119 billion. That represents a substantial increase over spending for UI in 2007, which totaled $33 billion.

This brief was prepared by Molly Dahl and Joyce Manchester of CBO’s Health and Human Resources Division.

This morning CBO released a letter responding to a request from Representative Christopher Smith for additional information on the costs that H.R. 2454, the American Clean Energy and Security Act of 2009 (as passed by the House of Representatives), would impose on households as a result of the legislation’s primary cap-and-trade program, which would regulate greenhouse gas emissions. The legislation would set annual limits, or caps, on total emissions between 2012 and 2050 and would require regulated entities—including producers and importers of petroleum-based liquids, natural gas distributers, and large electricity generators—to hold rights, or allowances, to emit greenhouse gases. After allowances were initially distributed, entities would be free to buy and sell them (the trade part of the program). Regulated entities could comply with the policy by reducing their emissions, holding allowances for greenhouse gases that they emitted, and/or acquiring “offset credits” (referred to here as offsets) for greenhouse gases that they emitted.

This letter supplements CBO’s previous work by providing estimates of the loss in purchasing power that households would experience in each year between 2012 and 2050. Previously, CBO estimated the average loss in purchasing power that households would experience between 2012 and 2050; CBO also examined how that loss would vary across households with different levels of income in 2020 and 2050.

A rough indication of the direct effect on households of the primary cap-and-trade program is the resulting loss in their purchasing power. That loss equals the costs of complying with the policy minus the compensation that would be received as a result of the policy. Households would bear compliance costs and receive compensation in their various roles as consumers, workers, shareholders, taxpayers, and recipients of government services, so accounting for the net effect of the act on purchasing power is not straightforward.

Compliance costs include the cost of purchasing allowances and offsets and the cost of reducing emissions. Although those costs would initially be borne by businesses, they would generally pass them along to households in the form of higher prices for goods and services. Compensation comprises the receipt of allowances at no cost, the receipt of proceeds from the sale of allowances (including the benefits received from government programs funded by the sale of allowances), and the profits earned from producing offsets. Much of that compensation would initially be received by businesses or governments but would be passed along to households.

The loss in a household’s purchasing power would be modest as a share of gross domestic product (GDP) in all years between 2012 and 2050, but it would rise over that period as the cap became more stringent and more resources were dedicated to cutting emissions. The loss would equal about 0.1 percent of GDP in 2012, about 0.5 percent in 2030, and about 0.8 percent in 2050, CBO estimates; the average loss per year over the entire 2012–2050 period would be about 0.4 percent. Measured in terms of 2010 income, the average loss per household would be $90 in 2012, $550 in 2030, and $930 in 2050; it would average about $460 per year over the 2012–2050 period.

This morning I made a presentation to the World Health Care Congress on the effects of the recently enacted health reform legislation on the federal budget. Everything that I said was drawn from cost estimates and other letters that CBO has released.

I began by reviewing the budget estimates done by CBO and the staff of the Joint Committee on Taxation (JCT):

• In combination, the initial legislation and the subsequent reconciliation act that modified it will generate changes in direct spending and revenue that will reduce federal deficits by $143 billion during the 2010-2019 period.
• The legislation will increase the size of the federal budget by increasing outlays by $411 billion and revenues by $525 billion over the next 10 years (excluding the provisions of the reconciliation act related to education, which will reduce spending by about $19 billion over that period).
• The legislation will increase the federal budgetary commitment to health care (the sum of net federal outlays for health programs and tax preferences for health care) by $390 billion over the next 10 years.
• The legislation will reduce federal deficits during the decade beyond the 10-year budget window relative to those projected under current law—with a total effect in a broad range around one-half percent of GDP.

Then I discussed a number of challenges to those estimates: 

• Some observers have asserted that CBO and JCT have misestimated the effects of the changes in law. Concerns have been expressed in different directions—for example, some believe that subsidies will be more expensive than we project, while others maintain that Medicare reforms will save more money than we project.

• Some observers have asserted that budget conventions hide or misrepresent certain effects of the law, such as its impact on future discretionary spending, its effect on the government’s ability to pay Medicare benefits, and its effects on the economy.

• Some observers have asserted that the law will be changed in the future in ways that will make deficits worse.

In addition, some observers believe that, whether CBO and JCT’s estimates of the effects of the health reform legislation are accurate or not, the law misses critical opportunities to reduce future deficits. For example, some say that the legislation will hamper future deficit reduction by using spending cuts and extra revenues to pay for a new entitlement rather than existing entitlements, or that the legislation should have reformed health care delivery more significantly.

Of course, CBO does not make policy judgments or recommendations. However, we have frequently noted the long-run unsustainability of the nation’s current budgetary policies and indicated that using savings in existing programs to finance new programs would necessitate even stronger policy actions in other areas. In December 2008, CBO released a report that included a wide range of options for changes in health policy, and in 2009, we published a volume presenting a variety of options for policy changes in other areas.

The federal government incurred a budget deficit of $714 billion in the first half of fiscal year 2010, CBO estimates in its latest monthly budget review, about $67 billion less than the shortfall recorded in the same period last year. That improvement stems largely from a net decline of $223 billion in outlays for the Troubled Asset Relief Program (TARP), from $115 billion in outlays in the first six months of last year to net receipts (that is, negative outlays) of $109 billion so far this year. The amount this year is negative because the Treasury is expected to report a reduction of $114 billion in outlays for that program in March, reflecting a significant decline in its estimate of the net costs that will ultimately result from that program’s transactions. Also contributing to the smaller deficit so far this year was a $69 billion decline in spending for federal deposit insurance, reflecting in part the prepayments by financial institutions of future years’ assessments.

Spending other than that for the TARP and deposit insurance was $187 billion (or 11 percent) higher in the first six months of this year than during the same period last year. Outlays for several major entitlement programs have increased significantly: Spending for unemployment benefits rose by $39 billion (or 83 percent) because of high unemployment and the extension of eligibility for such benefits. Medicaid rose by $17 billion (or 15 percent). More than $10 billion of that growth stemmed from a provision in the American Recovery and Reinvestment Act (ARRA) that increased federal payments to states beginning in February 2009. Payments for Social Security benefits increased by $23 billion (or 7 percent) and outlays for Medicare rose by $12 billion (or 6 percent). Outlays for net interest on the public debt grew by $26 billion (or 31 percent) compared to the first six months of fiscal year 2009. That increase is largely attributable to adjustments for inflation to indexed securities, which were negative early last year. Spending has also risen for a variety of other programs, including food and nutrition assistance, the State Fiscal Stabilization Fund (created by ARRA), student financial aid, and veterans’ programs. In contrast, federal assistance to Fannie Mae and Freddie Mac has totaled about $34 billion less so far this year than last year at this time. 

CBO estimates that total receipts were about $37 billion (or 4 percent) lower in the first half of this fiscal year than collections in the first half of 2009. Withheld income and payroll taxes declined by about $45 billion (or 5 percent), reflecting both lower wages and salaries and the impact of the Making Work Pay credit enacted in ARRA. Nonwithheld individual income and payroll taxes also declined—by about $14 billion (or 13 percent). Net corporate income tax payments were about $3 billion (or 5 percent) lower than in the first half of fiscal year 2009.

A $26 billion increase in receipts to the Treasury from the Federal Reserve partially offset the decline in other receipts. The unusual increase in receipts from the central bank resulted from the shift in the Federal Reserve’s portfolio to longer-term, riskier, and thus higher-yielding investments in support of the housing market and the broader.

The next several weeks will provide important information about receipts this year. Final payments for 2009 individual income tax returns are due this month, and individuals and corporations alike will make quarterly estimated payments of income taxes in April.

The federal government—through laws and regulations—sometimes requires state, local, and tribal governments and various entities in the private sector to expend resources to achieve national goals. In 1995, the Unfunded Mandates Reform Act (UMRA) became law, aimed at ensuring that, during the legislative process, the Congress receives information about such proposed requirements, known as federal mandates, before enacting a piece of legislation.

UMRA defines a legislative provision as a mandate if that provision, when enacted, would

• Impose an enforceable duty on state, local, or tribal governments or on private-sector entities;
• Reduce or eliminate funding authorized to cover the costs of complying with existing mandates; or
• Increase the stringency of conditions that apply to the distribution of funds through certain mandatory programs or make cuts in federal funding for those programs.

The law requires CBO to prepare “mandate statements” for bills that are approved by authorizing committees. Those statements address whether the direct costs of a bill’s federal mandates would be greater than the annual thresholds specified in UMRA and identify any funding that the bill would provide to cover those costs. In a report released yesterday, CBO reviews its activities under UMRA for calendar year 2009. The report, which is published annually, covers public laws enacted and legislation considered by the Congress that would impose federal mandates on state, local, or tribal governments or on the private sector.

Most of the legislation that the Congress considered in 2009 did not contain federal mandates as defined in UMRA. Historically, CBO has reviewed an average of about 580 pieces of legislation per year and has identified intergovernmental and private-sector mandates in an average of 13 percent and 16 percent of them, respectively. In 2009, CBO reviewed fewer pieces of legislation (419) and identified about the same number of mandates as in previous years. Therefore, the percentages of bills containing intergovernmental or private-sector mandates in 2009 are slightly higher than the historical averages. Of the bills that CBO reviewed, 17 percent contained intergovernmental mandates and 25 percent contained private-sector mandates.

As in previous years, few laws enacted in 2009 contained mandates whose costs, in CBO’s estimation, would exceed UMRA’s thresholds. In 2009, those thresholds, which are adjusted annually for inflation, were $69 million for intergovernmental mandates and $139 million for private-sector mandates. Specifically, no laws contained intergovernmental mandates with costs estimated to exceed the threshold, and 14 laws (11 percent of the total enacted) contained private-sector mandates with such costs. Historically, CBO has identified intergovernmental mandates with costs estimated to exceed the threshold in less than 1 percent of public laws and private-sector mandates with such costs in less than 5 percent of public laws.

This report was prepared by Leo Lex, Unit Chief of CBO’s State and Local Government Cost Estimates Unit, and Amy Petz, of CBO’s Microeconomic Studies Division, with assistance from CBO’s mandate analysts.