Congressional Budget Office
Director's Blog

I am speaking today to the Forecasters Club in New York. My remarks are the same as those I gave to Town Hall Los Angeles on Friday. You can read a summary in Friday’s blog posting or check out the slides.

Today I am speaking to a conference sponsored by the Schaeffer Center for Health Policy and Economics at the University of Southern California. My remarks review CBO’s analysis of the economic effects of the health legislation enacted in March. Those effects can be divided into two pieces: the effects on the five-sixths of the economy outside the health sector, and the effects on the health sector itself.

For the economy outside the health sector, the most significant impact of the legislation will be through the labor market—but that impact will probably be small, as we discussed in The Budget and Economic Outlook: An Update, which CBO issued in August. We estimated that the legislation, on net, will reduce the amount of labor used in the economy by roughly half a percent, primarily by reducing the amount that people choose to work. That net effect reflects changes in incentives that operate in both directions: Some provisions of the legislation will discourage people from working more hours or entering the workforce, and other provisions will encourage them to work more. Moreover, many people will face the same incentives regarding work as they do under current law. The net reduction in the supply of labor is largely attributable to the substantial expansion of Medicaid and the provision of subsidies through the new insurance exchanges. Other provisions in the legislation will also affect the supply of labor or firms’ demand for certain types of workers, but their impact is likely to be small in the aggregate as well.

Turning to the health sector, one effect of the March legislation will be to increase the amount of health care delivered to people who would have been uninsured in the absence of the law. CBO projected that 32 million fewer people will be uninsured in 2019 because of the legislation. Previous research suggests that, all else equal, gaining insurance coverage will increase an individual’s demand for health services by about 40 percent. By itself, this would represent an expansion of the health sector of the economy equal to an increase in total health services of a few percent.

Another effect of the March legislation will be to reduce unnecessary spending on health care for people who would be insured with or without the legislation—but probably only to a very limited extent, at least during the next decade. In particular:

• The legislation changed the regulation of private health insurance. Those changes will reduce administrative costs and increase competition among insurers in the nongroup market, as CBO discussed last fall. The overall effect on spending from those changes will be a very small reduction.
• The legislation imposed an excise tax on employment-based health insurance policies whose premium exceeds a specified threshold. Most employers will probably respond by offering policies with premiums at or below the threshold; plans will achieve lower premiums by reducing spending, primarily through greater cost sharing (which will also lower total spending on health care) and more stringent benefit management. However, the impact will be muted in the near term because the excise tax will not take effect until 2018.
• The legislation reduced payments to many Medicare providers relative to what the government would have paid under prior law. Those reductions will impose greater pressure on providers to increase efficiency in the delivery of care. As a result of those cuts in payment rates and the existing “sustainable growth rate” mechanism that governs Medicare’s payments to physicians, CBO projects that Medicare spending will increase significantly more slowly during the next two decades than it has increased during the past two decades (per beneficiary, after adjusting for overall inflation). We wrote last spring that it is unclear whether such a reduction in the growth rate of spending could be sustained, and if so, whether it would be accomplished through greater efficiencies in the delivery of health care or through reductions in access to care or the quality of care.
• The legislation set up a number of experiments in delivery and payment systems to induce providers to offer higher-quality and lower-cost care. However, for a number of reasons, it is unclear how successful the experiments will be: There is little reliable evidence about exactly how to move Medicare in the directions that many experts recommend; much more work needs to be done on measuring the quality and value of care; how federal agencies will administer the law is not knowable at this point; and the legislation included significant limitations on the experimentation that will occur. As a result, CBO projects limited savings from the experiments in delivery and payment systems during the next decade (taking into account the possibility that savings could be more or less than we anticipate).
   

Social Security is the federal government’s largest single program; outlays in fiscal year 2010 totaled $706 billion, roughly one-fifth of the federal budget. About 54 million people currently receive Social Security benefits. Most are retired workers, their spouses, their children or their survivors, who receive payments through Old-Age and Survivors Insurance (OASI). The remainder are disabled workers or their spouses and children, who receive Disability Insurance (DI) benefits.

Tax revenues credited to the program totaled about $670 billion in fiscal year 2010, almost all from payroll taxes. A very small portion—about 3 percent—comes from income taxes on benefits. Revenues from taxes, along with intragovernmental interest payments, are credited to Social Security’s two trust funds—one for OASI and one for DI—and the program’s benefits and administrative costs are paid from those funds.

Today CBO released additional information about the long-term projections of the Social Security program’s finances that were included in The Long-Term Budget Outlook (June 2010, revised August 2010) and in Social Security Policy Options (July 2010). The methodology used to develop those projections is described in CBO’s Long-Term Model: An Overview, a background paper published in June 2009.

Today’s publication updates the projections included in CBO’s Long-Term Projections for Social Security: 2009 Update. As we reported in June 2010, the long-term gap between Social Security’s spending and revenues that CBO is currently projecting is larger than the shortfall projected in our August 2009 publication.

The first group of exhibits—exhibits 1 through 8—examines Social Security’s financial status from several vantage points. The second group—exhibits 9 through 16—examines the program’s effects on various categories of Social Security participants in terms of the average taxes and benefits for those groups.

As detailed in the first eight exhibits, CBO projects that:

• Over the next few years, the program’s tax revenues (that is, the trust funds’ receipts excluding interest) will be approximately equal to its outlays. However, starting in 2016, as more of the baby-boom generation enters retirement, outlays as scheduled under current law will regularly exceed tax revenues. As a result, under current law, both trust funds will gradually be depleted.
• The DI trust fund will be exhausted in 2018 and the OASI trust fund will be exhausted in 2042. It is a common analytical convention to consider the DI and OASI trust funds in combination. CBO projects that, if legislation to shift resources from the OASI trust fund to the DI trust fund was enacted, as has been done in the past, the combined trust funds would be exhausted in 2039. However, because of the uncertainty surrounding the various factors that affect the program’s revenues and outlays, that date could vary quite a bit.
• The resources dedicated to financing the program over the next 75 years fall short of the benefits that will be owed to beneficiaries by about 1.6 percent of taxable payroll. In other words, to bring the program into balance over the next 75 years, payroll taxes would have to be increased immediately from 12.4 percent to 14.0 percent and kept at that higher rate, or the benefits specified in law would have to be reduced by an equivalent amount, or some combination of those changes and others would have to be implemented.

As shown in subsequent charts beginning with exhibit 9, the amount of Social Security taxes paid by various groups of people differs, as do the benefits that different groups receive. For example:

• People with higher earnings pay more in Social Security payroll taxes than do lower-earning participants, and they also receive larger benefits. Because of the progressive nature of Social Security’s benefit formula, replacement rates—the amount of annual benefits as a percentage of annual lifetime earnings—are lower, on average, for workers who have had higher earnings.
• The amount of taxes paid and benefits received will be greater for people in later birth cohorts because they typically will have higher earnings over a lifetime, even after adjusting for inflation, CBO projects. However, replacement rates will be slightly lower, on average, for later birth groups because their full retirement age (the age at which they can receive unreduced retirement benefits) will be higher.

In many of the exhibits throughout the publication, we created a distribution of outcomes to quantify the amount of uncertainty in our Social Security projections. The analysis was based on 500 simulations in which most of the key demographic and economic factors in the analysis vary according to historical patterns. For example, we examined the percentage of simulations in which the trust funds are exhausted by a specific year. In 37 percent of CBO’s simulations, the funds are exhausted before 2035. In 84 percent of the simulations, the trust funds are exhausted by 2050. In 97 percent of the simulations, the trust funds are exhausted by 2084.

The analysis was prepared by Noah Meyerson, Charles Pineles-Mark, Jonathan Schwabish, Michael Simpson, and Julie Topoleski of CBO’s Long-Term Modeling Group under the supervision of Joyce Manchester.

I am honored to be speaking today to “Town Hall Los Angeles,” which has been providing a public forum for discussion of important issues since 1937. My remarks highlight aspects of my testimony to the Senate Budget Committee a few weeks ago. (Sorry, Town Hall LA does not use slides, so there is nothing to accompany this summary.)

CBO and most private forecasters expect that the economic recovery will proceed at a modest pace during the next few years. In the forecast that we completed this summer, the unemployment rate remains above 8 percent until 2012. Two key factors influence that forecast. First, international experience suggests that recoveries from recessions that were spurred by financial crises tend to be slower than average. Following such a crisis, it takes time for consumers to rebuild their wealth, for financial institutions to restore their capital bases, and for nonfinancial firms to regain the confidence required to invest in new plant and equipment; all of those forces tend to restrain spending. Second, our projection is conditioned on current law, under which both the waning of fiscal stimulus and the scheduled increases in taxes (resulting from the expiration of previous tax cuts) will temporarily subtract from growth, especially in 2011.

Weak economic growth has serious social consequences. About 9½ percent of the labor force is officially unemployed, but many other people are underemployed or have become discouraged and left the labor force. The increase in unemployment is not uniform across demographic groups or regions; rather, the unemployment rate has risen disproportionately for less-educated workers, for men, and for people living in certain states. Moreover, the incidence of unemployment lasting longer than 26 weeks has been the highest by far in the past 60 years. CBO published an issue brief in April about the personal consequences of job losses.

Policymakers cannot reverse all of the effects of the housing and credit boom, the subsequent bust and financial crisis, and the deep recession. However, in CBO’s judgment, there are both monetary and fiscal policy options that, if applied at a sufficient scale, would increase output and employment during the next few years. In a report last January, we analyzed a diverse set of temporary policies and reported their two-year effects on the economy per dollar of budgetary cost, what one might call the “bang for the buck.” The overall effects of those policies would depend also on the scale at which they were implemented; making a significant difference in an economy with an annual output of nearly $15 trillion would involve a considerable budgetary cost.

In brief, CBO found the following: A temporary increase in aid to the unemployed would have the largest effect on the economy per dollar of budgetary cost. A temporary reduction in payroll taxes paid by employers would also have a large bang-for-the-buck, as it would both increase demand for goods and services and provide a direct incentive for additional hiring; this approach also could be scaled to a significant magnitude. Temporary expensing of business investments and providing aid to states would have smaller effects, and yet smaller effects would arise from a temporary increase in government spending on infrastructure or a temporary across-the-board reduction in income taxes.

However, there would be a price to pay for fiscal stimulus: Those same fiscal policy options would increase federal debt, which is already larger relative to the size of the economy than it has been in more than 50 years—and is headed higher. If policymakers wanted to achieve both stimulus and sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it relative to baseline projections after a few years.

To illustrate this point, we analyzed both the short-term and longer-term effects of various options for extending the 2001 and 2003 tax cuts, extending higher exemption amounts for the AMT, and reinstating the estate tax as it stood in 2009 (adjusted for inflation). As I reported in the recent testimony, permanently or temporarily extending all or part of the expiring income tax cuts would boost income and employment in the next few years relative to what would occur under current law. That would occur because, all else being equal, lower tax payments increase demand for goods and services and thereby boost economic activity. That increase in demand is crucial because we think that economic growth in the near term will be restrained by a shortfall in demand. A permanent extension of the tax cuts would provide a larger boost to income and employment in the next two years than would a temporary extension. In addition, an extension of all of the provisions would provide a larger boost than would an extension of all provisions except those applying only to high-income taxpayers.

But the effects of extending those tax cuts on the economy in the longer term would be very different from their effects during the next two years. The longer-term effects would be the net result of two competing forces: All else being equal, lower tax revenues increase budget deficits and thereby government borrowing, which reduces economic growth by crowding out investment. At the same time, lower tax rates boost growth by increasing people’s saving and work effort. Those effects on the supply of labor and capital are crucial because we think that economic growth over that longer horizon will be restrained by supply factors. For some of the options, our estimates of the net effect of these forces based on different models and assumptions span a broad range. But the averages of the estimates across different models and assumptions indicate that all four of the options we analyzed—permanently or temporarily extending all or part of the expiring income tax cuts—would probably reduce national income in 2020 relative to what would otherwise occur. Beyond 2020, the reductions in income from all four of the policy options would become larger—especially for the permanent extensions.

Similarly, permanent large increases in spending that were not accompanied by reductions in other spending or tax increases would also put federal debt on an unsustainable path. For example, if discretionary appropriations apart from those for operations in Iraq and Afghanistan increased at the rate of growth of nominal GDP, rather than increasing just with inflation as assumed in our baseline, debt held by the public would reach nearly 80 percent of GDP by 2020.

The federal government’s fiscal year 2010 has come to a close, and CBO estimates, in its latest Monthly Budget Review, that the federal budget deficit for the year was slightly less than $1.3 trillion, $125 billion less than the shortfall recorded in 2009. Relative to the size of the economy, the 2010 deficit was the second-highest shortfall—and 2009 the highest—since 1945. The 2010 deficit was equal to 8.9 percent of gross domestic product (GDP), CBO estimates, down from 10.0 percent in 2009 (based on the most current estimate of GDP). CBO’s deficit estimate is based on data from the Daily Treasury Statements and CBO’s projections; the Treasury Department will report the actual deficit for fiscal year 2010 later this month.

The estimated deficit is about $50 billion less than CBO projected in its August Budget and Economic Outlook. Outlays turned out to be lower and revenues higher than CBO anticipated.

Outlays

Outlays ended the year about 2 percent below those in 2009, CBO estimates. That decline resulted primarily from a net reduction in outlays for three items related to the financial crisis: the costs of the TARP ($262 billion lower than in 2009), payments to Fannie Mae and Freddie Mac ($51 billion lower), and federal deposit insurance ($55 billion lower). Excluding those three programs, spending rose by about 9 percent in 2010, somewhat faster than in recent years.

Payments for unemployment benefits rose by 34 percent in 2010 because of high unemployment and increased benefits provided by various laws, including the American Recovery and Reinvestment Act (ARRA). Other ARRA provisions led to double-digit growth in spending for a number of programs—particularly the State Fiscal Stabilization Fund, refundable tax credits, and certain education programs. In contrast, defense spending grew more slowly than in recent years, increasing by about 5 percent in 2010 after rising by an average of 8 percent annually from 2005 through 2009. Medicare and Social Security outlays rose by about 5 percent this year, somewhat less than in most recent years. The 9 percent increase in Medicaid outlays partly reflects a temporary increase in the federal share of Medicaid assistance authorized in ARRA; excluding ARRA-related expenditures, Medicaid outlays rose by about 6 percent.

Receipts

CBO estimates that total receipts rose by 3 percent in 2010, following declines in each of the prior two years. Growth in receipts of corporate income taxes and remittances from the Federal Reserve more than offset reduced collections of individual income and payroll taxes in 2010.

Corporate income tax receipts rose by $53 billion (or 39 percent) in 2010; improved economic conditions and the expiration of legislation that allowed taxpayers to take higher depreciation charges in 2009 has resulted in higher taxable profits in 2010. Receipts from the Federal Reserve increased by $42 billion this year, to more than double the amount received in 2009. The central bank’s increased profits resulted from an enlarged portfolio and a shift to riskier and thus higher-yielding investments in support of the housing market and the broader economy.

Those increases were partially offset by a drop in the total of individual income and payroll taxes, which were about $43 billion (or 2 percent) less than those receipts in 2009. That result occurred primarily because withheld income and payroll taxes declined by about $13 billion (or 1 percent), and nonwithheld receipts fell by about $35 billion (or 10 percent). In both instances, the declines occurred early in the fiscal year and were largely attributable to lower collections of tax liabilities incurred in 2009. Collections of income and payroll taxes in the past five months are 4 percent above the amounts collected during the same period in 2009.

The Monthly Budget Review was prepared by Elizabeth Cove Delisle and Daniel Hoople of CBO's Budget Analysis Division, and by Barbara Edwards and Joshua Shakin of our Tax Analysis Division.
 

The Department of Veterans Affairs (VA) provides health care at little or no charge to more than 5 million veterans annually. VA is operating its medical care system and associated research program with a budget of $48 billion for 2010, a rise of 8 percent in nominal terms (without adjusting for inflation) from 2009. That budget grew at an average nominal rate exceeding 9 percent annually between 2004 and 2009. Unlike programs like Medicare and Medicaid, VA’s health care program receives its funding through the annual appropriation process. VA’s health care budget will face continued pressure over the next few years: Additional veterans are likely to seek care from VA, and cost increases in medical care are expected to continue to outpace cost increases for other goods and services.

In a report mandated in the Consolidated Appropriations Act, 2008, CBO examines, under two different scenarios discussed below, prospective demands on VA’s health care system and the potential budgetary implications of meeting veterans’ health care needs over the 2011–2020 period. CBO projects that the future costs for VA to treat enrolled veterans will be substantially higher than recent appropriations for that purpose. CBO finds that the cost (in 2010 dollars) of providing health care services to all veterans who would seek treatment at VA facilities would range from $69 billion to $85 billion in 2020, representing a cumulative increase of roughly 45 percent to 75 percent over the funding provided in 2010. The projections for both scenarios exceed CBO’s baseline projections for such health care spending, which assume that future appropriations are equal to the most recent appropriation with adjustments for inflation.

One group of veterans—those who have deployed or will deploy to overseas contingency operations (OCO), including those in Iraq and Afghanistan—will represent a growing share of enrollments in VA’s health care system over the next decade. However, the share of VA’s resources devoted to the care of those veterans is likely to remain small through 2020, in part because they are typically younger and healthier than the average VA enrollee.

Scenarios

To account for possible policy changes, uncertainty about the number of veterans who will be enrolled, and growth of medical expenditures per enrollee, CBO analyzed two scenarios to capture some of the range of possible outcomes. The scenarios differ in their assumptions about the number of enrollees in VA’s health care system and the costs of providing medical services.

Scenario 1. Scenario 1 was crafted under assumptions that generate lower resource requirements than Scenario 2. The assumptions about factors affecting enrollment include the following:

• VA’s eligibility, cost-sharing, and other policies at the beginning of 2010 remain in effect through the projection period. Those policies include the easing of enrollment restrictions that began in 2009 for certain veterans who have no compensable service-connected disabilities and whose income is no more than 10 percent above VA’s income thresholds.
• The number of troops deployed to overseas contingency operations drops to 30,000 by 2013 and remains at that number throughout the next decade.
• VA’s medical expenditures per enrollee for each priority group grow in nominal terms at slightly more than 5 percent per year, about the same rate as that anticipated in the general population over the decade.

Scenario 2. CBO developed the second scenario to illustrate potential policy changes and other outcomes that may result in higher resource needs for VA’s health care services. The assumptions for this scenario are as follows:

• VA changes its eligibility rules to allow veterans who have no compensable service-connected disabilities and whose income is no more than 30 percent above VA’s income thresholds to enroll.
• The number of troops deployed to overseas contingency operations declines more slowly than in Scenario 1, dropping to 60,000 by 2015 and remaining at that number through the rest of the decade.
• VA’s medical expenditures per enrollee for each priority group grow initially at the rate VA assumed in preparing the Administration’s 2011 budget request that was transmitted in February 2010 and, in subsequent years, at an annual rate that is about 30 percent higher than that anticipated in the general population.

Potential Future Costs

Under Scenario 1, CBO estimates that total enrollment would grow from 8.0 million in 2009 to more than 8.8 million by 2016—an increase of about 10 percent—but would edge down to 8.7 million in 2020. The costs of treating all enrolled veterans would be about $69 billion (in 2010 dollars) in 2020.

Under Scenario 2, enrollment would be 620,000 higher in 2020 than in Scenario 1, with 340,000 new enrollees resulting from VA’s further relaxation of the restrictions on enrollment and 280,000 from the higher troop deployments. The costs of treating all enrolled veterans would reach nearly $85 billion in 2020, or 22 percent more than under Scenario 1. The disparity between the growth rates of medical expenditures per enrollee in the two scenarios accounts for the lion’s share of the difference—$13 billion.

CBO also estimated the portion of VA’s costs that would be incurred to treat veterans of OCO. CBO estimates that between the time hostilities began and the end of 2020, VA would enroll a total of 1.4 million or 1.7 million OCO veterans under Scenarios 1 and 2, respectively. The annual costs (in 2010 dollars) of treating OCO veterans would increase from an estimated $2.0 billion in 2010 to $5.4 billion in 2020 under Scenario 1 and to $8.3 billion under Scenario 2. In either case, the cost to treat OCO veterans accounts for 10 percent or less of VA’s costs in 2020.

This study was prepared by Heidi Golding of CBO’s National Security Division.