Congressional Budget Office
Director's Blog

Tonight I’m giving the Goldman Lecture in Economics at Wellesley College. (Here are the slides from my talk.)  The topic is climate change—starting with an overview of the problem and then discussing a range of possible approaches to reducing the risks involved.  As I’ve noted before with regard to health care, our political system doesn’t deal well with gradual, long-term problems. And climate change would definitely qualify as one of those gradual, long-term problems.  (More precisely, let’s hope climate change is a gradual long-term problem and doesn’t become a sudden crisis, as is possible given the potential nonlinearities involved.) 

Reducing the risks associated with climate change requires trading off up-front costs in exchange for long-term benefits.  Given the difficult political economy in such trade-offs, the Goldman lecture discusses ways of reducing the shorter-term economic cost of meeting whatever longer-term environmental objective we choose. 

Today, I will be delivering the Eighth Annual Marshall J. Seidman Lecture on Health Policy at Harvard Medical School.  (Here are the slides from my talk.)  The title of the lecture is “New Ideas About Human Behavior in Economics and Medicine,” and it builds upon a theme I have been speaking about over the past few months:  that just as the field of economics suffered for ignoring psychology for too long, so too has much of medical science and health policy largely ignored the crucial role of expectations, beliefs, and norms.  (The broader lesson is that the allure of pure science — which works beautifully in physics and some other fields — can go astray when the subject involves human beings.)  The placebo effect is perhaps the most compelling example — one that tends to be dismissed as a statistical annoyance rather than examined in and of itself, even though it is often more potent empirically.

Greater emphasis on the psychological and sociological influences on human health could lead to improvements in many areas of health care and medicine.  For example, ICU doctors in Michigan drastically reduced the rate of infections associated with catheterizations through a shift in professional norms brought about by the institution of a simple five-step checklist.  Setting default rules that are more in tune with the realities of human behavior in such diverse settings as doctors’ offices and federal nutrition programs might help to improve a range of health outcomes, from the adherence of patients to their doctors’ medication regimens to the proportion of Americans eating a healthier diet and exercising more.

Just as economists have put behavioral insights to use in the retirement and pensions fields to boost personal savings, especially among those at the lower ends of the socioeconomic spectrum, thinking carefully about these intersections between psychology and health care is vitally important because of a pair of disturbing trends in the United States today:  the rapidly rising share of the nation’s income devoted to health care costs, and the growing gap in life expectancy between those at the top of the socioeconomic distribution and those at the bottom.  Greater attention to the insights of behavioral economics in medical science and health policy may help to mitigate both of these trends.

The 2008 deficit totaled $455 billion, roughly $17 billion more than the $438 billion estimated by CBO on October 7th. That difference does not reflect any economic or programmatic developments; rather, it reflects an accounting adjustment by the Department of the Treasury, which increased the outlay and deficit figures for June 2008 by $17 billion. In fact, the surplus for the month of September that was reported in the Monthly Treasury Statement (MTS) was slightly more than CBO had estimated.

The accounting adjustment corrected the amounts reported by the Federal Communications Commission (FCC) for offsetting receipts from the March 2008 auction of licenses to use the electromagnetic spectrum made available by the transition to digital television.  Proceeds from that auction, which totaled nearly $19 billion, are deposited in the Digital Television Transition and Public Safety Fund administered by the Department of Commerce.

The Department of the Treasury adjusted the June outlay figures because the FCC had recorded receipts before it had issued the licenses to the winning bidders. Proceeds from such auctions, as well as from leasing activities and similar asset sales, are deposited in the Treasury soon after an auction closes but are not classified as federal receipts until the government awards the licenses. In this case, the FCC recorded the entire $19 billion in the June MTS in an effort to comply with a statutory directive to book those receipts by June 30, notwithstanding the fact that few licenses had been issued at that time. Because the receipts should not have been recorded at that time, the Treasury has reversed $17.2 billion of the $19 billion that was recorded in June, reducing the surplus for that month from $51 billion to $34 billion (see footnote 2 on Table 1 of in the MTS for September).

CBO anticipates that most or all of the pending licenses will be awarded in the near future and that the receipts will be recorded in fiscal year 2009.

In many settings, prizes can be an efficient way of encouraging new breakthroughs.  (For a paper exploring the use of prizes to encourage technological innovation, see here.)  I was therefore particularly encouraged to see that the X-Prize Foundation and Wellpoint have created a competition with a prize of at least $10 million for innovative approaches to addressing health care problems and improving the sector’s efficiency — which is a key issue for our long-term fiscal and economic future.  Wellpoint has committed to testing the ideas in its state markets.  Details about the competition will be finalized in early 2009.  CBO will be watching the results closely.

The Institute of Medicine of the National Academies of Sciences announced its new members this morning. I’m quite honored to be included in this group — along with Jose Escarce, who is on CBO’s Panel of Health Advisers. I view my inclusion as testimony to what the outstanding CBO health staff has taught me about health care and health policy, and look forward to continuing to learn from them and other innovators in the field.

While I’m on the topic of health care, I’d like to make a point related to the current turmoil in financial markets. Many observers have noted that addressing the problems in financial markets and the risks to the economy may displace health care reform on the policy agenda — and that may well be the case for some period of time. (As a small example, I know that over the past few months I have been spending less time on health care because the turmoil in financial markets and associated issues have consumed much more of our time and attention at CBO. This displacement is a matter of finite time and energy, not budgetary resources.)

Although it may not seem immediately relevant given our current difficulties, it will be crucial to address the nation’s looming fiscal gap — which is driven primarily by rising health care costs — as the economy eventually recovers from this current downturn. Indeed, our ability to address our current economic difficulties (through both financial market interventions and potential additional fiscal stimulus) would be severely impaired if investors were not so willing to invest substantial sums in Treasury securities without charging much higher interest rates. That willingness reflects the (currently accurate) view among investors that Treasury securities are extremely safe investments.

If we fail to put the nation on a sounder fiscal course over the next few decades, though, we will ultimately reach a point where investors would lose confidence and no longer be as willing to purchase Treasury debt at anything but exorbitant interest rates. If that were to occur, we would lack the kind of maneuvering room that we currently enjoy to address problems in the financial markets and the economy. So if you think the current economic crisis is serious, and it is, imagine what it would be like if we didn’t have the ability to undertake aggressive and innovative policy interventions because creditors were effectively unwilling to lend substantial additional sums to the Federal government…

Yesterday’s testimony on the effects of recent financial market turmoil on pension assets has generated a significant amount of interest, so I wanted to follow up on one topic: overinvestment in an employer’s stock.

Many participants in retirement plans appear to be taking on unnecessary risk by investing in individual stocks rather than a diversified portfolio. The result is that those workers assume excessive risk for which they do not receive a higher expected return. (Those workers may feel they have inside information or insights that will allow them to outperform the market with particular investment choices, but the evidence suggests that unless you’re Warren Buffett, trying to outguess the market usually doesn’t work.)  Investing excessively in one stock that also happens to be your employer’s stock is even riskier — if the company runs into trouble, both your retirement assets and your job may be in danger.

Despite those risks (again, for which workers don’t receive higher expected returns on their investments, on average), a significant number of 401(k) participants hold the bulk of their assets in company stock. According to calculations by the Employee Benefits Research Institute, 47 percent of 401(k) participants were enrolled in plans that offered company stock as an option as of the end of 2006. Of those participants, 7.3 percent held more than 90 percent of their assets in company stock, and over 15 percent held over half their assets in company stock. (See page 33 of EBRI Issue Brief 308, “401(k) Asset Allocation, Account Balances, and Loan Activity in 2006.”) At yesterday’s hearing, I didn’t make clear that the 7.3 percent figure applied only to those who were in plans offering company stock. So the overall share of 401(k) participants with 90 percent or more of their assets invested in company stock is more like .47*7.3=3.4 percent. It’s still too high.

The good news is that the trend is towards less investment in company stock. For example, in 1999 EBRI estimated that 19.1 percent of all 401(k) assets were held in company stock. (See figure 20 on page 26 of EBRI issue brief 308.) By 2006, that share had fallen to 11.1 percent, undoubtedly driven in part by the example of the collapse of Enron and other corporate failures. In addition, provisions of the Pension Protection Act of 2006 limit the amount of time that an employer may insist participants keep assets in company stock.

Despite these auspicious trends, there remains substantial scope to improve the balance of risk and return for participants in defined-contribution pension plans, including through increased use of low-cost diversified index funds.

CBO released its Monthly Budget Review today. Based on data from the Daily Treasury Statements, CBO estimates that the federal budget deficit was about $438 billion in fiscal year 2008, $276 billion more than the shortfall recorded in 2007. (The Treasury Department will report the actual deficit for fiscal year 2008 later this month.)

Relative to the size of the economy, that deficit was equal to 3.1 percent of gross domestic product, up from 1.2 percent in 2007. (The average deficit over the preceding five years, 2002-2006, was 2.6 percent of GDP.) The $438 billion figure is about $31 billion more than the $407 billion deficit CBO projected this summer, primarily because revenues are lower than we anticipated and spending for defense and deposit insurance is turning out to be higher.

CBO estimates that receipts in 2008 were about $44 billion (or 1.7 percent) below receipts in 2007, falling from 18.8 percent of GDP in 2007 to about 17.7 percent of GDP in 2008. Corporate income taxes declined the most, falling by about $65 billion (18 percent), due largely to weakness in corporate earnings throughout the fiscal year. Individual income tax receipts declined by about $19 billion (or 1.6 percent) relative to receipts in fiscal year 2007, reflecting $62 billion in tax rebates (from the economic stimulus legislation) that were recorded as offsets to revenues. In contrast, receipts of social insurance (payroll) taxes rose by about $31 billion (or 3.5 percent), and other receipts increased by about $9 billion (or 5.4 percent).

Spending rose by about 8 percent. Contributing significantly to the growth in spending were outlays for tax rebates (those rebates that were recorded on the spending side of the budget because they exceeded the recipients’ income tax liability), for deposit insurance, and for national defense.

I am testifying before the House Committee on Education on Labor this afternoon on the effects of recent financial market developments on pensions; click here for the testimony.

The key points of the testimony include:

• The turmoil in financial markets has affected many aspects of the economy, including pensions. The most direct effect on pensions is through the prices of financial assets such as corporate equities and bonds. The Standard & Poor’s 500 stock market index, for example, has fallen by more than 25 percent over the past year as the outlook for the economy and corporate profits has worsened. Because the majority of pension assets are held in equities, drops in stock prices have had a significant adverse effect on pension plans.

• Data from the Federal Reserve suggest that the decline in the value of financial assets cost pension funds roughly $1 trillion—almost 10 percent of their assets—from the second quarter of 2007 to the second quarter of 2008, the latest period for which data are available. There has been a significant further drop in asset prices since the end of the second quarter, and it is plausible that the cumulative decline in pension assets over the past year and a half amounts to about $2 trillion.

• In a defined-benefit pension plan, benefits are specified by a fixed formula unrelated to the value of the pension fund. The sponsor of the plan is generally responsible for financing the benefits and must therefore make larger contributions when the value of the assets held by the pension fund declines. By CBO’s estimates, the value of the assets held by defined-benefit plans has declined by roughly 15 percent over the past year. Because of the way the obligations of the plans are calculated, their funding position (that is, the relationship between their assets and liabilities) is also affected by the level of interest rates. Those rates have increased over the past year, lowering the discounted value of plans’ liabilities by roughly 5 percent to 10 percent and partially offsetting the drop in asset values. Overall, according to CBO’s estimates, defined-benefit plans’ assets net of liabilities may have decreased by 5 percent to 10 percent over the past year.

• Changes in asset prices have also affected the value of assets in defined-contribution pension plans. In those plans, the resources available to workers upon retirement depend directly on the value of assets in their plan account. Defined-contribution plans apparently are more heavily weighted toward stocks than defined-benefit plans are; over two-thirds of the assets in defined-contribution plans are invested in equities (either directly or through mutual funds). Because of that heavy emphasis on equities, the value of assets in defined-contribution plans may have declined by slightly more than that of assets in defined-benefit plans.

• Some people on the verge of retirement might respond to a decline in financial markets by working longer. In 2006, 36 percent of people age 65 and older were in families with earnings; that share could rise somewhat over the next few years, both because of underlying trends in the labor market and because of the recent turmoil in financial markets.

• Although severe stresses in financial markets almost inevitably cause wrenching adjustments by workers and employers, the risks can be attenuated by sensibly designing pension plans. For example, although workers enrolled in defined-contribution plans may not be able to avoid bearing the risks associated with broad price changes in financial markets, they can avoid unnecessary risks associated with a lack of diversification. Such unnecessary risks can arise, for example, by overweighting portfolios with individual stocks rather than diversified index funds.

CBO released a brief today on climate-change policy and CO2 emissions from passenger vehicles (for the PDF, click here).

Discussions about addressing climate change (e.g., through a cap-and-trade program or a carbon tax) often focus on the transportation sector. The brief argues, however, that most of the reduction in CO2 emissions would occur in other sectors (e.g., the electricity sector) and that the effects on vehicle emissions would be modest, especially in the shorter run.

To be sure, a cap-and-trade system or a carbon tax would raise the price of gasoline, encouraging consumers to drive less and to buy more fuel-efficient cars– but the magnitude of these effects would be relatively small. For example, CBO has estimated that a price of $28 per metric ton of CO2 in 2012 would lead to a reduction of about 10 percent in total U.S. emissions compared with a no-action scenario. Vehicle emissions, though, would remain relatively constant in the short run, and even over time they would decline only by around 2.5 percent — much less than the 10 percent reduction in overall emissions.

Several factors account for the relatively small influence that a price on CO2 emissions would have on passenger vehicles and driving behavior. First, a CO2 price of $28 per metric ton would raise gas prices by about 25 cents per gallon, far less of an increase than consumers have recently born with little behavioral result. (Between 2003 and 2007, gas prices increased from $1.50 to more than $3.00 per gallon. Vehicle miles driven, driving speeds, and the purchase of larger vehicles have all responded only modestly despite the dramatic increase in prices.) An increase in gas prices of 25 cents or so per gallon is unlikely to generate massive changes in driving behavior.

In addition, recent changes to corporate average fuel economy (CAFE) standards will require substantial gains in fuel economy over the next dozen years. Especially over the longer term, gas price increases are not likely to have a large effect beyond what CAFE standards will require.

Finally, cultural, historic, and geographic considerations drive the extent to which Americans have become dependent on automobile travel, and their choices tend towards larger and more powerful (and less fuel efficient) automobiles. While dramatic increases in gasoline prices (or shifts in cultural norms) might eventually influence these considerations, the magnitude of gas price increases under most legislation under consideration would likely have little effect.

The brief was written by David Austin of our Microeconomic Studies Division.

CBO has just issued its analysis of the financial rescue legislation released by the Senate today. This legislation includes the rescue package considered by the house earlier this week, a temporary increase in deposit insurance, and certain tax provisions including an extension of Alternative Minimum Tax (AMT) relief. The pdf of our analysis is posted here. The text of our analysis is pasted below.

October 1, 2008

Honorable Christopher J. Dodd
Chairman
Committee on Banking, Housing, & Urban Affairs
United States Senate
Washington, DC  20510

Dear Mr. Chairman:

The Congressional Budget Office (CBO) has reviewed the financial rescue legislation to be considered by the Senate.  That legislation contains three separate parts; the bill refers to these three components as “divisions.”

Division A is the Emergency Economic Stabilization Act of 2008, most of which is identical to the financial rescue bill considered by the House of Representatives earlier this week.  In addition to creating a Troubled Asset Relief Program (TARP), under which the Secretary of the Treasury would be authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages issued prior to March 14, 2008, Division A also includes a provision that would provide for a temporary increase in federal deposit insurance coverage.

Division B is entitled the Energy Improvement and Extension Act of 2008. It contains numerous tax provisions related to energy production, transportation, and energy conservation.  Division C extends various expiring tax provisions, including alternative minimum tax relief.

Although significant uncertainty surrounds the precise net budgetary impact from Division A of the bill, CBO expects that the bill as a whole (including Divisions B and C) would increase the budget deficit over the next decade.

Division A – Emergency Economic Stabilization Act of 2008

In addition to the TARP, the Senate legislation includes an expansion in deposit insurance.   This section describes and analyzes the provisions of Division A, beginning with the changes to deposit insurance.

Deposit Insurance

Section 136 would provide for a temporary increase in the amount of deposits insured by the Federal Deposit Insurance Corporation (FDIC) and the National Credit Union Administration (NCUA), raising the limit for each insured account from $100,000 to $250,000 through December 31, 2009. Both agencies would be authorized to borrow such sums as may be necessary to cover any additional costs incurred as a result of the expanded coverage.  The legislation also directs the agencies to exclude the increase in insurance coverage when assessing insurance premiums in the near term.

CBO estimates that the deposit insurance funds would incur larger losses in the near term as a result of higher coverage levels and the associated increase in insured deposits.  (When institutions fail, the FDIC and NCUA pay for covered deposits and liquidate the assets held by the institution.  Raising the amount of insured deposits would increase payments to depositors without affecting recoveries from liquidating assets, thereby increasing the net loss to the funds.)  Such near-term losses would, however, be offset over the long term by higher insurance premiums because the agencies are required by law to restore the deposit insurance funds to certain levels over time, so any additional losses from the temporary expansion in coverage will gradually be offset by higher future premiums.

The effects of this provision on outlays over the next year or two are difficult to predict precisely because of uncertainty about the volume and distribution of insured deposits that would be added by this bill. Based on preliminary information from the FDIC, however, CBO estimates that raising the limit to $250,000 through 2009 would boost insured deposits nationwide by about 15 percent.  (As of June 30, 2008, deposits at FDIC-insured institutions totaled about $7 trillion, of which $2.6 trillion were uninsured.  The FDIC estimate suggests that this provision would extend coverage to about $700 billion of those uninsured deposits.)

Overview of TARP

The bill would appropriate such sums as are necessary, for as many years as necessary, to enable the Secretary to purchase or insure troubled assets and to cover all administrative expenses of purchasing, insuring, holding, and selling those assets.  Under the legislation, the authority to enter into agreements to purchase such troubled assets would initially be set to expire on December 31, 2009, but could be extended through two years from the date of enactment upon certification by the Secretary that such an extension is necessary.  The purchase price of all such assets outstanding at any one time could not exceed $700 billion (though cumulative gross purchases could exceed $700 billion as previously purchased assets are sold).  Purchases would be limited as follows:

-Authority for purchases of $250 billion in assets would be available upon enactment;

-The authority would increase to $350 billion if the President submits to the Congress a written notification that the Secretary is exercising authority to purchase an additional $100 billion of assets; and

-The authority would increase to $700 billion if the President submits a report detailing a plan to use the remaining $350 billion in purchase authority; that expansion would be subject to a 15-day Congressional review for potential disapproval of the plan.

The bill would also enable the federal government, under terms and conditions to be developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions.  The $700 billion limit would be reduced by the excess of obligations to net premiums, if any, under this insurance program.

To facilitate these activities, the federal debt limit would be increased by $700 billion. If, five years after enactment of the bill, the Director of the Office of Management and Budget in consultation with the Director of the Congressional Budget Office determines that the TARP has incurred a net loss, the President would be required to submit a legislative proposal to recoup that shortfall from entities benefiting from the TARP.

Cost of Division A

Under the TARP, the Secretary would have the authority—if deemed necessary to promote stability in the financial markets—to purchase any financial asset at any price and to sell that asset for any price at any future date. That lack of specificity regarding how the authority would be implemented and even what types of assets would be purchased makes it impossible at this point to provide a meaningful estimate of the ultimate impact on the federal budget from enacting this legislation. Although it is not currently possible to quantify the net budget impact given the lack of details about how the program would be implemented, CBO has concluded that enacting Division A would likely entail some net budget cost—which would, however, be substantially smaller than $700 billion. The net budget cost would reflect several factors:

Net gains or losses on the TARP transactions. As noted in CBO’s recent testimony before the House Budget Committee, the net gain or loss on the TARP transactions would reflect the degree to which the federal government sought to obtain, and succeeded in receiving, a fair market price for the assets it purchased, and the degree to which, because of severe market turmoil, market prices would be lower than the underlying value of the assets.

Although some classes of assets and purchase mechanisms are conducive to determining a fair market price, it is unlikely that the program would be limited exclusively to those classes of assets and purchase mechanisms. The program would probably include assets that have the worst credit risks and hence are difficult to price, making it likely that the government would, in some cases, pay prices that fail to cover those risks. Although it is possible that future increases in asset values would generate gains even on assets for which the government initially overpays, an overall net loss is more likely if the government initially overpays.

The bill includes a provision intended to protect against such future net losses by requiring that firms selling troubled assets to the government also provide warrants or senior debt instruments.  CBO anticipates that this provision would not have a substantial effect on the net cost of the TARP, however.  On the one hand, warrants or senior debt instruments might reduce the incentive for sellers to overcharge for low-quality assets.  On the other hand, since the warrants or debt instruments would have value, Treasury would generally face higher prices because sellers would seek compensation for both the value of the troubled asset and the value of the warrant or debt instrument.  In addition, the warrants or senior debt instruments may be difficult for the government to value, complicating even those auctions in which the government is otherwise most likely to obtain a fair market price.

In any case, the ultimate cost to the government on the transactions would not be the total amount spent to purchase assets—limited to $700 billion outstanding at any one time—but rather the difference between the amount spent by the government and the amount received in earnings and sales proceeds when all of the assets are finally sold, presumably some years from now. That net cost is likely to be substantially less than $700 billion but is more likely than not to be greater than zero.

Recoupment mechanism. The recoupment mechanism is designed to offset any net losses the government experiences on the TARP transactions. The mechanism, however, requires only that the President submit a proposal to offset such costs after five years. Even if it would be fully effective in offsetting any net losses, the President’s proposal would require a future act of Congress to be implemented. Any savings from such legislation would be estimated when the proposal is considered and would be credited to that legislation for Congressional scorekeeping purposes.

Administrative costs. Beyond the effect of any gains or losses on the transactions under the TARP and the recoupment mechanism, the programs authorized by this bill would involve administrative costs. For example, the government would have to compensate the private asset managers hired by the Treasury. Those administrative costs are not included in the $700 billion limit on asset purchases. Even if the transactions and the recoupment mechanism combined resulted in neither a gain nor a loss for the government, the administrative costs would expand the budget deficit.

The legislation includes a variety of other provisions that would, on net, add to the budget deficit. A number of those provisions are discussed below.

Other Major Provisions of Division A

In addition to the expansion in FDIC insurance limits and the provisions of the TARP discussed above, Division A also contains provisions that would:

-Change the tax treatment of certain types of income, losses, or deductions of corporations or individuals;

-Require that certain financial institutions seeking to sell assets through the TARP meet appropriate standards for senior executive officers’ compensation, as determined by the Secretary of the Treasury;

-Require the Secretary of the Treasury to take steps to maximize assistance for homeowners, including encouraging servicers of the underlying mortgages to take advantage of the Hope for Homeowners Program under section 257 of the National Housing Act;

-Allow the Federal Reserve System to pay interest on certain reserves of depository institutions that are held on deposit at the Federal Reserve, starting on October 1, 2008;

-Direct the Federal Housing Finance Agency, the Federal Deposit Insurance Corporation, and the Federal Reserve Board to implement various measures with regard to residential loans and securities under their control in order to reduce the number of foreclosures, which could include modifying the terms of such loans; and

-Establish Congressional oversight and reporting requirements related to implementation of the legislation, along with a Financial Stability Oversight Board with responsibility for overseeing operations of the program.

The bill would require that the federal budget display the costs of purchasing or insuring troubled assets using procedures similar to those specified in the Federal Credit Reform Act, but adjusting for market risk (in a manner not reflected in that law). In particular, the federal budget would not record the gross cash disbursements for purchases of troubled assets (or cash receipts for their eventual sale), but instead would reflect the estimated net cost to the government of such purchases (broadly speaking, the purchase cost minus the present value, adjusted for market risk, of any estimated future earnings from holding those assets and the proceeds from the eventual sale of them).

Impact on Federal Finances

CBO expects that the Treasury would use most or all of the $700 billion in purchase authority within two years (after which the authority to enter into agreements to purchase various troubled assets would expire). To finance those purchases, the Treasury would have to sell debt to the public. Federal debt held by the public would therefore rise by about $700 billion, although the government would also acquire valuable financial assets in the process.  As noted above, CBO expects that since the acquired assets would have some value, the net budget impact would be substantially less than $700 billion; similarly, net cash disbursements under the program would also be substantially less than $700 billion over time because, ultimately, the government would sell the acquired assets and thus generate income that would offset much of the initial expenditures.

In addition to any net gain or loss on the purchase of $700 billion or more in assets, the government also would incur administrative costs for the proposed program. Those costs would depend on the kinds of assets purchased or insured. On the basis of the costs incurred by private investment firms that acquire, manage, and sell similar assets, CBO expects that the administrative costs of operating the program could amount to a few billion dollars per year, as long as the government held all or most of the purchased assets.

Other provisions in Division A would on net increase the budget deficit.  For example, the legislation would allow the Federal Reserve to pay interest immediately on certain reserve balances of depository institutions, rather than starting on October 1, 2011, as allowed under current law.  CBO estimates that, over the next three years, the provision would reduce the Federal Reserve’s payments of its profits to the Treasury, which are classified as revenue in the federal budget.

In addition, a number of provisions Division A would affect federal revenues by changing tax law, including provisions that would limit the deductibility of executive compensation for certain firms selling assets; allow losses incurred by certain taxpayers on preferred stock in Fannie Mae and Freddie Mac to be treated as ordinary rather than capital losses; and exclude from income amounts attributable to the cancellation of mortgage debt of individuals in certain circumstances. The Joint Committee on Taxation estimates that, on net, these provisions in Division A would reduce federal revenues.

Enacting Division A could also affect other federal spending—including, for example, outlays from the operations of Fannie Mae, Freddie Mac, federal housing programs, and deposit insurance. Some of those effects would be related to how TARP would be used to purchase assets (including what kinds of assets would be acquired and from what types of institutions), and how successful the program would be in restoring liquidity to the nation’s financial markets.

Division B – Energy Improvement and Extension Act of 2008

Division B of the bill would provide a number of tax incentives related to energy and fuel production and energy conservation.  It also includes several provisions that would raise revenue, with the largest effect from a modification of the requirements imposed on brokers for the reporting of their customers’ basis in securities transactions.  CBO and the Joint Committee on Taxation (JCT) estimate that, over the 2009-2013 period, Division B would reduce revenues by $6.8 billion, increase outlays by about $0.2 billion, and increase projected deficits by about $7 billion.  CBO and JCT estimate that, over the 2009-2018 period, Division B would increase revenues by about $0.3 billion, increase outlays by about $0.2 billion, and reduce projected deficits by less than $0.1 billion.

Division C – Tax Extensions and Alternative Minimum Tax Relief

Division C would extend relief from the alternative minimum tax for 2008, extend and modify a number of other expiring tax provisions, provide tax relief for regions of the country affected by severe storms earlier this year, make other changes to tax law, and provide payments to state and local governments for support to rural schools and other county programs.  It also would modify the tax treatment of deferred compensation paid by certain foreign entities.  CBO and JCT estimate that, over the 2009-2013 period, Division C would reduce revenues by about $105.2 billion, increase outlays by $7.1 billion, and increase projected deficits by about $112.3 billion.  CBO and JCT estimate that, over the 2009-2018 period, Division C would reduce revenues by about $99.5 billion, increase outlays by about $7.5 billion, and increase projected deficits by about $107.1 billion.

Intergovernmental and Private-Sector Mandates

The non-tax provisions of the legislation contain no intergovernmental mandates as defined in the Unfunded Mandates Reform Act (UMRA).

The non-tax provisions do, however, contain private-sector mandates as defined in UMRA, and CBO estimates that the aggregate cost of those mandates would exceed the annual threshold established in UMRA ($136 million in 2008, adjusted annually for inflation).

Division C, section 512 would impose a private-sector mandate on group health plans and issuers of group health insurance by prohibiting them from imposing treatment limitations or financial requirements for mental health benefits that differ from those placed on medical and surgical benefits. CBO estimates that the direct costs of the private-sector mandate would significantly exceed the annual threshold established in UMRA in each of the first five years that the mandate would be in effect.

Division A, section 136 could impose a private-sector mandate to the extent that deposit insurance premiums are higher than they would be in the absence of  this bill. Most depository institutions (commercial banks, savings associations, and credit unions) are required by law to have federal deposit insurance. CBO, therefore, considers changes in the federal deposit insurance system that increase requirements on those institutions to be private-sector mandates under UMRA. The cost of the mandate would be the additional premiums assessed during each of the first five years the mandate is in effect. While CBO expects that any additional losses from the temporary expansion in coverage would gradually be offset by higher future premiums, we cannot estimate the cost of the mandate because of uncertainty about the timing of the losses and whether or by how much premiums would increase during those first five years.

I hope this information is helpful to you. If you have further questions about CBO’s analysis, do not hesitate to contact me.

Sincerely,

Peter R. Orszag
Director

cc:

Honorable Richard C. Shelby
Ranking Member

Honorable Kent Conrad
Chairman
Committee on the Budget

Honorable Judd Gregg
Ranking Member

Honorable Max Baucus
Chairman
Committee on Finance

Honorable Charles E. Grassley
Ranking Member