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Under the American Recovery and Reinvestment Act of 2009 (ARRA), also known as the economic stimulus package, certain recipients of funds appropriated in ARRA (most grant and loan recipients, contractors, and subcontractors) are required to report the number of jobs funded through the law after the end of each calendar quarter. ARRA also requires CBO to comment on those reported numbers. In its latest report, issued today, CBO provides estimates of ARRA’s overall impact on employment and economic output in the third quarter of calendar year 2010. CBO’s current estimates differ slightly from those presented in its previous report (issued in August 2010), reflecting small revisions to its earlier projections of the timing and magnitude of changes to federal revenues and spending under ARRA.

When ARRA was being considered, CBO and the staff of the Joint Committee on Taxation estimated that it would increase budget deficits by $787 billion between fiscal years 2009 and 2019. CBO now estimates that the total impact over the 2009–2019 period will amount to $814 billion. By CBO’s estimate, close to half of that impact occurred in fiscal year 2010, and about 70 percent of ARRA’s budgetary impact was realized by the close of that fiscal year.

CBO’s Estimates of ARRA’s Impact on Employment and Economic Output

Looking at recorded spending to date along with estimates of the other effects of ARRA on spending and revenues, CBO has estimated the law’s impact on employment and economic output using evidence about the effects of previous similar policies and drawing on various mathematical models that represent the workings of the economy. Because those sources indicate a wide range of possible effects, CBO provides high and low estimates of the likely impact, aiming to encompass most economists’ views about the effects of different policies. On that basis, CBO estimates that ARRA’s policies had the following effects in the third quarter of calendar year 2010:

• They raised real (inflation-adjusted) gross domestic product by between 1.4 percent and 4.1 percent,
• Lowered the unemployment rate by between 0.8 percentage points and 2.0 percentage points,
• Increased the number of people employed by between 1.4 million and 3.6 million, and
• Increased the number of full-time-equivalent (FTE) jobs by 2.0 million to 5.2 million compared with what would have occurred otherwise. (Increases in FTE jobs include shifts from part-time to full-time work or overtime and are thus generally larger than increases in the number of employed workers).

The effects of ARRA on output peaked in the first half of 2010 and are now diminishing, CBO estimates. The effects of ARRA on employment and unemployment are estimated to lag slightly behind the effects on output; they are expected to wane gradually beginning in the fourth quarter. CBO projects that the number of FTE jobs resulting from ARRA will drop to between 1.2 million and 3.6 million, on average, during 2011.

Limitations of Recipients’ Estimates

CBO’s estimates differ substantially from the reports filed by recipients of ARRA funding. During the third quarter of 2010, recipients reported, ARRA funded more than 670,000 full-time-equivalent (FTE) jobs. Those reports, however, do not provide a comprehensive estimate of the law’s impact on U.S. employment, which could be higher or lower than the number of FTE jobs reported, for several reasons (in addition to any issues concerning the quality of the reports’ data):

• Some of the jobs included in the reports might have existed even without the stimulus package, with employees working on the same activities or other activities.
• The reports cover employers that received ARRA funding directly and those employers’ immediate subcontractors (the so-called primary and secondary recipients of ARRA funding) but not lower-level subcontractors.
• The reports do not attempt to measure the number of jobs that were created or retained indirectly as a result of recipients’ increased income, and the increased income of their employees, which could boost demand for other products and services as they spent their paychecks.
• The recipients’ reports cover only certain ARRA appropriations, which encompass about one-fifth of the total either spent by the government or conveyed through tax reductions in ARRA; the reports do not measure the effects of other provisions of the stimulus package, such as tax cuts and transfer payments (including unemployment insurance payments) to individual people.

Consequently, estimating the law’s overall effects on employment requires a more comprehensive analysis than the recipients’ reports provide.

The report was prepared by Ben Page of CBO’s Macroeconomic Analysis Division.

Today I spoke to the National Tax Association in Chicago and earlier this week I spoke to the Society of Government Economists in Washington, D.C.  This week’s presentations are quite similar to those that I gave last month in Los Angeles and New York. (See my posts on October 27 and October 21.)  I highlighted aspects of my testimony to the Senate Budget Committee in late September, reviewing CBO’s recent analyses of the economic outlook and the potential impact on the economy of various fiscal policy options that CBO studied earlier in the year. I also discussed CBO’s estimates of the economic impact of extending some or all of the 2001 and 2003 tax cuts that are scheduled to expire at the end of the year.

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.

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.

I testified this morning to the Senate Budget Committee about the economic outlook and CBO’s analysis of the potential impact on the economy of various fiscal policy options. You can read a summary of my testimony (the full version, which is rather long, is also available), or you can glance at the slides I used, which are below.

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. But there would be a price to pay: 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 assist policymakers in their decisions, CBO has quantified the effects of some alternative fiscal policy options. 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. Temporary expensing of business investment and providing aid to states would have smaller effects, and yet smaller effects would arise from a temporary increase in infrastructure investment and a temporary across-the-board reduction in income taxes.

Today’s testimony went on to address the effects of another set of fiscal policy options. At the request of the Chairman of the Senate Budget Committee, we have now estimated the short-term and longer-term effects of extending the 2001 and 2003 tax cuts, extending higher exemption amounts for the alternative minimum tax, and reinstating the estate tax as it stood in 2009 (adjusted for inflation). The methodology for this analysis was quite similar to the methodology that CBO follows in analyzing the President’s budget each spring; we used several different models and made different assumptions about people’s behavior.

We examined four alternative approaches to extending the tax cuts: a “full permanent extension” that would extend all of the provisions permanently; a “partial permanent extension” that would extend permanently all of the provisions except those applying only to high-income taxpayers; a “full extension through 2012” that would extend all provisions but only through 2012; and a “partial extension through 2012” that would extend through 2012 all provisions except those applying only to high-income taxpayers. As shown in the following figure, all four of the options would raise national income, output, and employment during the next two 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.

Ranges of Effects of Four Tax Policy Options on Real GNP in 2011 and 2012

But the effects of those policy options on the economy in the longer term would be very different from their effects during the next two years. The averages of the estimates across different models and assumptions indicate that all four of the options would probably reduce income relative to what would otherwise occur in 2020 (see the figure below). Those effects are largely 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.

Effects of Four Tax Policy Options on Real GNP in 2020

Beyond 2020, and again relative to what would occur under current law, the reductions in income from all four of the policy options would become larger. Either a full or a partial extension of the tax cuts through 2012 would reduce income by much less than would a full or partial permanent extension.

In sum, and as CBO has reported before: 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. However, even a temporary extension would add to federal debt and reduce future income if it was not accompanied by other changes in policy. A permanent extension of all of those tax cuts without future increases in taxes or reductions in federal spending would roughly double the projected budget deficit in 2020; a permanent extension of those cuts except for certain provisions that would apply only to high-income taxpayers would increase the budget deficit by roughly three-quarters to four-fifths as much. As a result, if policymakers then wanted to balance the budget in 2020, the required increases in taxes or reductions in spending would amount to a substantial share of the budget—and without significant changes of that sort, federal debt would be on an unsustainable path that would ultimately reduce national income. Similarly, even temporary increases in government spending would add to federal debt and reduce future income, and permanent large increases in spending that were not accompanied by other spending reductions or tax increases would put federal debt on an unsustainable path. Compared with the options examined here for extending the expiring tax cuts, various other options for temporarily reducing taxes or increasing government spending would provide a bigger boost to the economy per dollar of cost to the federal government.

I’m speaking this afternoon to the Washington Policy Seminar sponsored by the Macroeconomic Advisers forecasting firm.  My presentation draws on several reports that CBO has released over the course of this year and emphasizes these points:

• CBO and most private forecasters expect that the economic recovery will proceed at a modest pace during the next few years. For example, in the forecast that we completed in early July, the unemployment rate remains above 8 percent until 2012. In addition, the economic data released since we finished that forecast have been weaker than we had expected, so if we were to construct a new forecast today, we would project slightly slower growth in the near term.
• 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 left the labor force. The increase in unemployment is not uniform across demographic groups or regions, with larger run-ups for less-educated workers, men, and people living in certain states. The incidence of unemployment lasting longer than 26 weeks has been the highest by far in the past 60 years. As discussed in our April issue brief, the short-term and long-term impact on people of losing a job during a recession can be very significant.
• Some observers have argued that there is not much that policymakers can do about the weakness of the recovery. That is not our view at CBO. Although there are no magic cures, we do think 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 (but not overnight). Such options would have costs though—in particular, expansionary fiscal policy would increase federal budget deficits and debt relative to current baseline projections, which are already quite worrisome.
• One key question I’ve been asked in the debate about fiscal policy: What sorts of fiscal policies would actually encourage greater economic activity and more employment? Fiscal policy can affect behavior through several channels: by changing direct demand for goods and services, changing people’s current and/or expected income, changing the payoff from extra work effort and saving, changing the cost of investment, and so on. Predicting the effects of particular policies is difficult, and estimates are quite uncertain.
• In January of this year, we published a study titled Policies for Increasing Economic Growth and Employment in 2010 and 2011. We studied temporary policy changes to be enacted in early 2010, because most observers were interested in the question of how to provide a short-term boost to the economy without significantly worsening the medium- and long-term budget situation. In most cases, permanent changes would generate larger short-term stimulus but would have substantially larger medium- and long-term budget and economic costs. We estimated the “bang for the buck” of different policies; of course, the effect on the economy would also depend on the scale of the policies. This graph summarizes our estimates:

Cumulative Effects of Policy Options on Employment in 2010 and 2011, Range of Low to High Estimates

• The other key question I’ve been asked: How can short-term fiscal stimulus be reconciled with the imperative—and it is a critical imperative—to put fiscal policy on a sustainable medium-term and long-term path? As I said to the Fiscal Commission at the end of June, there is no intrinsic contradiction between providing additional fiscal stimulus today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential.
• If taxes were cut or government spending were increased permanently that would worsen the already worrisome fiscal outlook, as shown in the graph below.  Even if changes were temporary, the additional debt accumulated during that temporary period would weigh on the budget and the economy in the future. Achieving both stimulus and sustainability would require a combination of policies. If policymakers wanted to avoid worsening the large medium-term and long-term imbalance between federal spending and revenue, any policies that widened budget deficits in the near-term would need to be accompanied by specific policies to reduce spending or increase revenue over time.

Rising Burden of Federal Debt Held by the Public

• In summary, the economic recovery will probably proceed at a modest pace—leaving total output well below its sustainable level, and the unemployment rate well above its sustainable level, for a number of years. In CBO’s judgment, the available monetary and fiscal tools, if applied at sufficient scale, would improve economic conditions during the next few years—though with costs and risks in the medium and long term. Policymakers need to address those trade-offs.
   

Under the American Recovery and Reinvestment Act of 2009 (ARRA), also known as the economic stimulus package, certain recipients of funds appropriated in ARRA (most grant and loan recipients, contractors, and subcontractors) are required to report the number of jobs funded through ARRA after the end of each calendar quarter. The law also requires CBO to comment on those reported numbers. A CBO report released this afternoon satisfies that requirement and under the law is required to be submitted no later than today. The report provides CBO’s estimates of ARRA’s overall impact on employment and economic output in the second quarter of calendar year 2010. The most recent estimates for the second quarter and beyond vary only slightly from those in our quarterly ARRA report released in May.

When ARRA was being considered, CBO and the staff of the Joint Committee on Taxation estimated that it would increase budget deficits by $787 billion between fiscal years 2009 and 2019. CBO now estimates that the total impact over the 2009–2019 period will amount to $814 billion. Close to half of that impact is estimated to occur in fiscal year 2010, and about 70 percent of ARRA’s budgetary impact will have been realized by the close of that fiscal year.

CBO’s Estimates of ARRA’s Impact on Employment and Economic Output

Looking at recorded spending to date as well as estimates of the other effects of ARRA on spending and revenues, CBO has estimated the law’s impact on employment and economic output using evidence about the effects of previous similar policies on the economy and using various mathematical models that represent the workings of the economy. On that basis, CBO estimates that in the second quarter of calendar year 2010, ARRA’s policies:

• Raised the level of real (inflation-adjusted) gross domestic product (GDP) by between 1.7 percent and 4.5 percent,
• Lowered the unemployment rate by between 0.7 percentage points and 1.8 percentage points,
• Increased the number of people employed by between 1.4 million and 3.3 million, and
• Increased the number of full-time-equivalent (FTE) jobs by 2.0 million to 4.8 million compared with what those amounts would have been otherwise. (Increases in FTE jobs include shifts from part-time to full-time work or overtime and are thus generally larger than increases in the number of employed workers.)

The effects of ARRA on output and employment are expected to gradually diminish during the second half of 2010 and beyond. The effects of ARRA on employment and unemployment are expected to lag slightly behind the effects on output; they are expected to wane gradually in 2011 and beyond.

Although CBO has examined data on output and employment during the period since ARRA’s enactment, those data are not as helpful in determining ARRA’s economic effects as might be supposed because isolating the effects would require knowing what path the economy would have taken in the absence of the law. Because that path cannot be observed, the new data add only limited information about ARRA’s impact.

Limitations of Recipients’ Estimates

CBO’s estimates differ substantially from the reports filed by recipients of ARRA funding. Those recipients reported that ARRA funded nearly 750,000 FTE jobs during the second quarter of 2010. Such reports, however, do not provide a comprehensive estimate of the law’s impact on employment in the United States. That impact may be higher or lower than the reported number for several reasons (in addition to any issues about the quality of the data in the reports):

• Some of the reported jobs might have existed in the absence of the stimulus package.
• The reports cover employers that received ARRA funding directly and those employers’ immediate subcontractors (the so-called primary and secondary recipients of ARRA funding) but not lower-level subcontractors.
• The reports do not attempt to measure the number of jobs that were created or retained indirectly as a result of recipients’ increased income, and the increased income of their employees, which could boost demand for other products and services as they spent their paychecks.
• The recipients’ reports cover only certain ARRA appropriations, which encompass about one-fifth of the total either spent by the government or conveyed through tax reductions in ARRA during the second quarter; the reports do not measure the effects of other provisions of the stimulus package, such as tax cuts and transfer payments (including unemployment insurance payments) to individual people.

Consequently, estimating the law’s overall effects on employment requires a more comprehensive analysis than the recipients’ reports provide.

The report was prepared by Ben Page of CBO’s Macroeconomic Analysis Division.

CBO estimates, in its annual summer update of the budget and economic outlook, that the federal budget deficit for 2010 will exceed $1.3 trillion—$71 billion below last year’s total and $27 billion lower than the amount that CBO projected in March 2010 when it issued its previous estimate. Relative to the size of the economy, this year’s deficit is expected to be the second largest shortfall in the past 65 years: At 9.1 percent of gross domestic product (GDP), it is exceeded only by last year’s deficit of 9.9 percent of GDP. As was the case last year, this year’s deficit is attributable in large part to a combination of weak revenues and elevated spending associated with the economic downturn and the policies implemented in response to it.

This report presents CBO’s updated budget and economic projections spanning the 2010–2020 period. Those projections reflect the assumption that current laws affecting the budget will remain unchanged—and thus the projections serve as a neutral benchmark that lawmakers can use to assess the potential effects of policy decisions. As such, CBO assumes that tax reductions enacted earlier in this decade that are currently set to expire at the end of this year do so as scheduled; it also assumes that no new legislation aimed at keeping the alternative minimum tax (AMT) from affecting many more taxpayers is enacted. In addition, CBO assumes that the measures enacted in the past two years to provide fiscal stimulus to the weakened economy will expire as currently scheduled and that future annual appropriations will be kept constant in real (inflation-adjusted) terms. Under those assumptions, the federal budget deficit would decline substantially over the next two years—to 4.2 percent of GDP in 2012—and, consequently, the budget would provide much less support to the economy than has been the case for the past two years.

According to CBO’s projections, the recovery from the economic downturn will continue at a modest pace during the next few years. Growth in the nation’s output since the middle of calendar year 2009 has been anemic in comparison with that of previous recoveries following deep recessions, and the unemployment rate has remained quite high, averaging 9.7 percent in the first half of this year. Such weak growth is typical in the aftermath of a financial crisis. The considerable number of vacant houses and underused factories and offices will be a continuing drag on residential construction and business investment, and slow income growth as well as lost wealth will restrain consumer spending.

All of those forces, along with the waning of federal fiscal support, will tend to restrain spending by individuals and businesses—and, therefore, economic growth—during the recovery. CBO projects that the economy will grow by only 2.0 percent from the fourth quarter of 2010 to the fourth quarter of 2011; even with faster growth in subsequent years, the unemployment rate will not fall to around 5 percent until 2014.

In CBO’s current-law projections, once the economy has recovered, the federal budget deficit amounts to between 2.5 percent and 3.0 percent of GDP from 2014 to 2020. Projected deficits total $6.2 trillion for the 10 years starting in 2011, raising federal debt held by the public to more than 69 percent by 2020, almost double the 36 percent of GDP observed at the end of 2007.

Those projections, which are similar in many respects to the ones that CBO prepared in March, reflect assumptions about spending and revenues that may significantly underestimate actual deficits. Because the projections presume no changes in current tax laws, they result in estimates of revenues that, as a percentage of GDP, would be quite high by historical standards. Because of the assumption that future annual appropriations are held constant in real terms, the projections yield estimates of discretionary spending relative to GDP that would be low by historical standards. Of course, many other outcomes are possible. If, for example, the tax reductions enacted earlier in the decade were continued, the AMT was indexed for inflation, and future annual appropriations remained the share of GDP that they are this year, the deficit in 2020 would equal about 8 percent of GDP, and debt held by the public would total nearly 100 percent of GDP.

A different fiscal policy would also yield different economic outcomes. For example, CBO estimates that under an alternative fiscal path similar to the one mentioned above, real growth of GDP in 2011 would be 0.6 to 1.7 percentage points higher than it is in the baseline forecast, and the unemployment rate at the end of 2011 would be 0.3 to 0.8 percentage points lower. However, later in the coming decade, real GDP would fall below the level in CBO’s baseline because the larger budget deficits would reduce investment in productive capital.

Beyond the 10-year budget window, the nation will face daunting long-term fiscal challenges posed by rising costs for health care and the aging of the population. Continued large deficits and the resulting increases in federal debt over time would reduce long-term economic growth. Putting the nation on a sustainable fiscal course will require policymakers to restrain the growth of spending substantially, raise revenues significantly above their average percentage of GDP of the past 40 years, or adopt some combination of those approaches.
 

In fiscal crises in a number of countries around the world, investors have lost confidence in governments’ abilities to manage their budgets, and those governments have lost their ability to borrow at affordable rates. With U.S. government debt already at a level that is high by historical standards, and the prospect that, under current policies, federal debt would continue to grow, it is possible that interest rates might rise gradually as investors’ confidence in the U.S. government’s finances declined, giving legislators sufficient time to make policy choices that could avert a crisis. It is also possible, however, that investors would lose confidence abruptly and interest rates on government debt would rise sharply, as evidenced by the experiences of other countries.

Unfortunately, there is no way to predict with any confidence whether and when such a crisis might occur in the United States. In a brief ("Federal Debt and the Risk of a Fiscal Crisis") released today, CBO notes that there is no identifiable “tipping point” of debt relative to the nation’s output (gross domestic product, or GDP) that would indicate that such a crisis is likely or imminent. However, in the United States, the ratio of federal debt to GDP is climbing into unfamiliar territory—and all else being equal, the higher the debt, the greater the risk of such a crisis.
 
Over the past few years, U.S. government debt held by the public has grown rapidly. According to CBO’s projections, federal debt held by the public will stand at 62 percent of GDP at the end of fiscal year 2010, having risen from 36 percent at the end of fiscal year 2007, just before the recession began. In only one other period in U.S. history—during and shortly after World War II—has that figure exceeded 50 percent.

Further increases in federal debt relative to the nation’s output almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending, measured as a percentage of GDP, well above the levels experienced in recent decades. Unless policymakers restrain the growth of spending, increase revenues significantly as a share of GDP, or adopt some combination of those two approaches, growing budget deficits will cause debt to rise to unsupportable levels, as shown in the figure below. (For more details, see CBO’s recent report The Long-Term Budget Outlook.)

Note: The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections through 2020 (with adjustments for the recently enacted health care legislation) and then extending the baseline concept for the rest of the long-term projection period. The alternative fiscal scenario incorporates several changes to current law that are widely expected to occur or that would modify some provisions that might be difficult to sustain for a long period.

Although deficits during or shortly after a recession generally hasten economic recovery, persistent deficits and continually mounting debt would have several negative economic consequences for the United States. Some of those consequences would arise gradually—but a high level of federal debt, combined with an unfavorable long-term budget outlook, would also increase the probability of a sudden fiscal crisis prompted by investors’ fears that the government would renege on the terms of its existing debt or that it would increase the supply of money to finance its activities or pay creditors and thereby boost inflation. The resulting abrupt rise in interest rates would create serious challenges for the U.S. government. For example, a 4-percentage-point across-the-board increase in interest rates would raise federal interest payments next year by about $100 billion; if those higher rates persisted, net interest costs in 2015 would be nearly double the roughly $460 billion that CBO currently projects for that year. Such an increase in rates could also precipitate a broader financial crisis because it would reduce the market value of outstanding government bonds, inflicting losses on mutual funds, pension funds, insurance companies, banks, and other holders of federal debt.

Options for responding to a fiscal crisis would be limited and unattractive. The government would need to undertake some combination of three actions. One action could be changing the terms of its existing debt. This would make it difficult and costly to borrow in the future. A second action could be adopting an inflationary monetary policy by increasing the supply of money. However, this approach would have negative consequences for both the economy and future budget deficits. A third action could be implementing an austerity program of spending cuts and tax increases. Such budgetary adjustments, in the face of a fiscal crisis, would be more drastic and painful than those that would have been necessary had the adjustments come sooner.

This brief was prepared by Jonathan Huntley of CBO’s Macroeconomic Analysis Division.
 

Under the American Recovery and Reinvestment Act of 2009 (ARRA), also known as the economic stimulus package, certain recipients of funds appropriated in ARRA (most grant and loan recipients, contractors, and subcontractors) are required to report the number of jobs they created or retained with ARRA funding after the end of each calendar quarter. The law also requires CBO to comment on those reported numbers. Today CBO released a report to satisfy that requirement.

CBO’s Estimates of ARRA’s Impact on Employment and Economic Output

Looking at recorded spending to date as well as estimates of the other effects of ARRA on spending and revenues, CBO has estimated the law’s impact on employment and economic output using evidence about the effects of previous similar policies on the economy and using various mathematical models that represent the workings of the economy. On that basis, CBO estimates that in the first quarter of calendar year 2010, ARRA’s policies:

• Raised the level of real (inflation-adjusted) gross domestic product (GDP) by between 1.7 percent and 4.2 percent,
• Lowered the unemployment rate by between 0.7 percentage points and 1.5 percentage points,
• Increased the number of people employed by between 1.2 million and 2.8 million, and 
• Increased the number of full-time-equivalent (FTE) jobs by 1.8 million to 4.1 million compared with what those amounts would have been otherwise. (Increases in FTE jobs include shifts from part-time to full-time work or overtime and are thus generally larger than increases in the number of employed workers.)

The effects of ARRA on output and employment are expected to increase further during calendar year 2010 but then diminish in 2011 and fade away by the end of 2012.

Data on actual output and employment during the period since ARRA’s enactment are not as helpful in determining ARRA’s economic effects as might be supposed, because isolating those effects would require knowing what path the economy would have taken in the absence of the law. Because that path cannot be observed, there is no way to be certain about how the economy would have performed if the legislation had not been enacted, and data on its actual performance add only limited information about ARRA’s impact.

Limitations of Recipients’ Estimates

CBO’s estimates differ substantially from the reports filed by recipients of ARRA funding. Those recipients reported that ARRA funded nearly 700,000 FTE jobs during the first quarter of 2010. Such reports, however, do not provide a comprehensive estimate of the law’s impact on employment in the United States. That impact may be higher or lower than the reported number for several reasons (in addition to any issues about the quality of the data in the reports):

• Some of the reported jobs might have existed in the absence of the stimulus package, with employees working on the same activities or other activities. 
• The reports filed by recipients measure only the jobs created by employers who received ARRA funding directly or by their immediate subcontractors (so-called primary and secondary recipients), not by lower-level subcontractors.
• The reports do not attempt to measure the number of jobs that may have been created or retained indirectly as greater income for recipients and their employees boosted demand for products and services. 
• The recipients’ reports cover only certain appropriations made in ARRA, which encompass about one-sixth of the total amount spent by the government or conveyed through tax reductions in ARRA during the first quarter; the reports do not measure the effects of other provisions of the stimulus package, such as tax cuts and transfer payments (including unemployment insurance payments) to individuals.

Consequently, estimating the law’s overall effects on employment requires a more comprehensive analysis than the recipients’ reports provide.

The report was prepared by Ben Page of CBO’s Macroeconomic Analysis Division.