Congressional Budget Office
Director's Blog

Federal laws try to protect taxpayers and recipients of government benefits from the effects of rising prices by specifying that dollar amounts in many parts of the tax code and in some programs be automatically adjusted—or indexed—for inflation. Without such indexing, a rise in the general level of prices would alter the effects of federal policies even in the absence of action by lawmakers. For example, if a Social Security beneficiary’s payment remained the same over time (in other words, not indexed for inflation), the value of goods and services that the beneficiary could purchase would go down.

Many federal programs and parts of the tax code are currently indexed to increases in the consumer price index (CPI), a measure of inflation calculated by the Bureau of Labor Statistics (BLS). According to many analysts, however, the CPI overstates increases in the cost of living because it does not fully account for the fact that consumers generally adjust their spending patterns as some prices change relative to other prices. One option for lawmakers, as discussed in a brief released today, would be to link federal benefit programs and tax provisions to another measure of inflation—the chained CPI—that is designed to account fully for changes in spending patterns. (CBO previously discussed the possibility of using the chained CPI in its August 2009 Budget Options volume.) The chained CPI grows more slowly than the traditional CPI does: by an average of 0.3 percentage points per year over the past decade. As a result, using that measure to index benefit programs and tax provisions would reduce federal spending (especially on Social Security and federal pensions) and increase revenues. A separate appendix to the brief explains the methods and calculations that could be used to index the federal tax system, Social Security benefits, and federal pension benefits for the growth in the chained CPI.

Although many analysts consider the chained CPI a more accurate measure of the cost of living, using it for indexing could have disadvantages. Because the values of the chained CPI for a given month are revised over a period of one to two years, the tax code and affected programs would have to be indexed to a preliminary estimate of the chained CPI that is subject to estimation error. Also, the chained CPI may understate growth in the cost of living for some groups, such as older people.

This brief was prepared by Noah Meyerson of CBO’s Health and Human Resources Division.

CBO is celebrating its 35th birthday! The agency was created by the Congressional Budget and Impoundment Control Act of 1974 (P.L. 93-344) and officially opened for business on February 24, 1975, when Alice Rivlin became its first director. Since then, under eight different directors, the agency has provided the Congress with objective, non-partisan budget and economic information on a wide variety of issues. I am delighted to have the privilege of leading such a superb organization and the opportunity to work with such a skilled and dedicated staff. CBO looks forward to many more years of serving the Congress as it grapples with the important issues facing the nation.

I testified this morning before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. This hearing was originally scheduled for several weeks ago but then canceled because of the snow. My prepared remarks today were essentially the same as those released a few weeks ago and were based on CBO’s January report on this topic and a follow-up letter to Senator Casey.

My comments emphasized three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. In particular, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to near its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates that we believe encompass most economists’ views about the effects of each type of policy. Still, we think there would be significant differences in the cost-effectiveness of different policies (as measured in our analysis by years of full-time-equivalent employment per million dollars of total budgetary cost).

Policies that would have the largest effects on output and employment in 2010 and 2011 per dollar of budgetary cost would be those that could be implemented relatively quickly or targeted toward people whose consumption tends to be restricted by their income—for example, reducing payroll taxes for firms that increase payroll or boosting aid to the unemployed. The following figure summarizes the estimated effects of various policies on employment in 2010 and 2011.

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

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 how previous similar policies have affected the economy and various mathematical models that represent the workings of the economy. On that basis, CBO estimates that in the fourth quarter of calendar year 2009, ARRA added between 1.0 million and 2.1 million to the number of workers employed in the United States, and it increased the number of full-time-equivalent (FTE) jobs by between 1.4 million and 3.0 million. 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. CBO also estimates that real (inflation-adjusted) gross domestic product (GDP) was 1.5 percent to 3.5 percent higher in the fourth quarter than would have been the case in the absence of ARRA.

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 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. Economic output and employment in 2009 were lower than CBO had projected at the time of enactment. But in CBO’s judgment, that outcome reflects greater-than-projected weakness in the underlying economy rather than lower-than-expected effects of ARRA.

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 600,000 fulltime-equivalent (FTE) jobs during the fourth quarter of 2009. 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-fifth of the total amount spent by the government or conveyed through tax reductions in ARRA during the fourth 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.

This morning the Obama Administration released a description of its health care proposal, and CBO has already received several requests to provide a cost estimate for that proposal. We had not previously received the proposal, and we have just begun the process of reviewing it—a process that will take some time, given the complexity of the issues involved. Although the proposal reflects many elements that were included in the health care bills passed by the House and the Senate last year, it modifies many of those elements and also includes new ones. Moreover, preparing a cost estimate requires very detailed specifications of numerous provisions, and the materials that were released this morning do not provide sufficient detail on all of the provisions. Therefore, CBO cannot provide a cost estimate for the proposal without additional detail, and, even if such detail were provided, analyzing the proposal would be a time-consuming process that could not be completed this week.

I was scheduled to testify a few days ago before the Joint Economic Committee about policies to increase economic growth and employment in 2010 and 2011. The hearing was canceled because of the snow, but we released my prepared remarks today. The testimony was based on CBO’s January report on Policies for Increasing Economic Growth and Employment in 2010 and 2011 and on CBO’s follow-up letter last week to Senator Casey, which provided additional information about options for reducing employers’ payroll taxes.

The testimony emphasizes three points:

First, although the economy is starting to recover from the most severe recession since the 1930s, CBO and most private forecasters expect a slow rebound in output and employment. Often, severe economic downturns sow the seeds of robust recoveries. During a slump in economic activity, consumers defer purchases, especially for housing and durable goods, and businesses postpone capital spending and try to cut inventories. Once demand in the economy picks up, spending by consumers and businesses can accelerate rapidly—which in turn generates demand for workers. CBO expects that the current recovery will be spurred by that dynamic, but in all likelihood the recovery will also be dampened by a number of factors. Those factors include the continuing fragility of some financial markets and institutions; declining support from fiscal and monetary policy; and limited increases in households’ spending because of slow income growth, lost wealth, and a large number of vacant houses.

Therefore, as shown in the following figure, CBO projects that the unemployment rate will average slightly above 10 percent in the first half of this year, fall below 8 percent only in 2012, and return to its long-run sustainable level of 5 percent only in 2014. As a result, more of the pain of unemployment from this downturn lies ahead of us than behind us.

Unemployment Rate (Percent)

Second, fiscal policy actions, if properly designed, would promote economic growth and increase employment in 2010 and 2011. However, despite the potential economic benefits in the short run, such actions would add to the already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Third, different policies that have received public attention would have quite different effects on output and employment per dollar of lost tax revenue or additional government spending. To be sure, significant uncertainty attends any quantitative estimates of the effects of particular policies, and CBO has emphasized that uncertainty by reporting ranges of estimates. Still, significant differences can be seen in the following figure, which shows the cumulative effect of a variety of different policy options on employment in 2010 and 2011, measured in years of full-time-equivalent employment per million dollars of total budgetary cost.

The largest effects on employment this year and next would probably arise from increasing aid to the unemployed, reducing employers’ payroll taxes in general, and reducing employers’ payroll taxes for firms that increase their payroll. Somewhat smaller effects would probably be produced by reducing employees’ payroll taxes, providing an additional one-time Social Security payment, allowing full or partial expensing of investment costs, investing in infrastructure, providing aid to states for purposes other than infrastructure, and providing additional refundable tax credits for lower- and middle-income households in 2011. Still smaller effects would probably be generated by extending higher exemption amounts for the AMT in 2010 or reducing income taxes in 2011.

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

Much of CBO’s extensive analysis and writing on this topic in the past few months has been done by Janet Holtzblatt, Mark Lasky, Ben Page, and Susan Yang.

Last week I had the opportunity to speak at Morehouse College in Atlanta, Georgia. David Poyer, an associate professor in the economics department at Morehouse, spent last summer working at CBO, and he asked if I would be interested in coming down to Morehouse sometime. I told him that I would be delighted to come, and I was pleased to receive an official invitation from Morehouse president Robert Franklin.

I spoke to Morehouse students about CBO’s recent Budget and Economic Outlook: Fiscal Years 2010 to 2020. My slides highlighted:

• The slow and protracted recovery that CBO expects for the U.S. economy and labor market, including the likely effects in the next few years of the unusually large jump in the share of unemployed workers whose previous jobs have been permanently lost and the unusually sharp drop in people’s participation in the labor force as workers became discouraged from looking for a job.
• The notable deficits that CBO projects under current law, the significantly larger deficits that CBO projects under some policy alternatives that have received a good deal of attention (including extending the 2001 and 2003 tax cuts, indexing the alternative minimum tax to inflation, and increasing discretionary spending faster than price increases alone), and the sources of those deficits relative to past budget outcomes.

After my prepared remarks, four students joined me on stage and asked challenging questions about the future of health care reform, how to address the budget deficit, and other current issues. I then had a chance to talk with them and other students informally, wrapping up a very enjoyable visit.

The federal government incurred a budget deficit of $434 billion in the first four months of fiscal year 2010, CBO estimates in its latest Monthly Budget Review, almost $40 billion more than the shortfall recorded in the same period last year. Although spending is lower than it was at this time last year, the deficit is still higher because revenues have fallen by 11 percent. Assuming that no other legislation affecting spending or revenues is enacted, CBO expects that the federal government will end fiscal year 2010 with a deficit of about $1.35 trillion, slightly below the $1.4 trillion deficit recorded in 2009. (See The Budget and Economic Outlook: Fiscal Years 2010 to 2020 for more details on CBO’s estimate for 2010 and its most recent 10-year projections.)

Spending for the first four months of fiscal year 2010 was $44 billion (or 4 percent) lower than it was last year through January. Spending for the Troubled Asset Relief Program decreased by $105 billion and net spending by the Federal Deposit Insurance Corporation was down by $44 billion because of higher receipts from the prepayment of insurance premiums. Increased spending for other programs offset part of that reduction. Outlays in the rest of the budget are up by $127 billion (or 12 percent), after adjusting for shifts in the timing of certain payments.

Specifically, spending for unemployment benefits rose by $28 billion, doubling the spending in the first four months of last year, because of continued high unemployment and the payment of extended benefits. Medicaid spending rose by $18 billion (or 25 percent). A provision of the American Recovery and Reinvestment Act (ARRA) that increased federal payments to states for Medicaid accounted for about $13 billion of that growth. That legislation also resulted in significant increases in spending by the Department of Education and for food and nutrition assistance. Social Security benefit payments also rose by $18 billion (or 9 percent). A large cost-of-living increase provided in January 2009 combined with rising numbers of recipients fueled that increase. Adjusted for timing shifts, Medicare spending rose by $7 billion (or 5 percent). Outlays for net interest on the public debt grew by $20 billion, mostly because of higher costs for inflation-indexed securities.

Receipts for the first four months of fiscal year 2010 were about $83 billion (or 11 percent) lower than receipts during the comparable period last year. Nearly two-thirds of that decline stems from lower withholding from employees’ paychecks for income and payroll taxes. The $50 billion (or 8 percent) drop in withholding results primarily from the Making Work Pay credit enacted in ARRA and from lower wages and salaries. Nonwithheld receipts, which largely reflect nonwage income, are also down—by about $14 billion (or 16 percent). Net corporate receipts declined by $18 billion (or 34 percent), because of a combination of higher refunds and lower payments of estimated taxes. The decline in net corporate receipts can be attributed to weak corporate profits and the effects of recent legislation that extended the period over which corporations can apply current-year losses to offset income in previous years.

In contrast, the Treasury’s receipts from the Federal Reserve have grown by about $13 billion, reflecting a shift in the Fed’s portfolio to longer-term, riskier, and thus higher-yielding investments in support of the housing market and the broader economy.

Today CBO released a letter to Senator Robert Casey, Jr., in response to questions he asked about policies that could be adopted to increase employment.  Specifically, Senator Casey was interested in a policy option to reduce employers’ payroll taxes for firms that increase their payroll, and how different design elements of this type of policy might affect its impact on employment.

In CBO’s January 2010 publication, Policies for Increasing Economic Growth and Employment in 2010 and 2011, the agency analyzed the effects on employment of several policy options, including giving employers a one-year, nonrefundable credit against their payroll tax liability for increasing their payrolls in 2010 from their 2009 levels. (To finance Social Security, employers and employees each pay 6.2 percent of an employee’s annual earnings up to a maximum.) Such a tax cut would lead to increased employment through a number of channels. For example, some firms would hire more people because hiring would be less expensive; others would lower prices to increase sales, thus spurring production and increasing the demand for labor; still others would increase compensation for employees, which would encourage more spending.

CBO measured the effect of that policy (and others) on employment as the cumulative effect on years of full-time-equivalent employment for each dollar of a policy’s total budgetary cost.  (A year of full-time-equivalent employment is 40 hours of employment per week for one year.) CBO estimated that, through its effects on wages, prices, and profits, the policy would add 8 to 18 cumulative years of full-time-equivalent employment in 2010 and 2011 per million dollars of total budgetary cost, measured in terms of lost revenues. Thus, the budgetary cost of increasing employment by one full-time person for one year would probably be between $56,000 and $125,000. Although such a policy would have economic benefits in the short run, it would also add to already large projected budget deficits. Unless offsetting actions were taken to reverse the accumulation of additional government debt, future incomes would tend to be lower than they otherwise would have been.

Policymakers could structure legislation that reduced payroll taxes for firms that increase employment using various combinations of caps on the total amount of the tax benefit a firm could receive, limits on the size of firms that would receive the tax cut, methods of measuring payroll growth, and other elements. In today’s letter, CBO separately analyzed several key policy design elements and concluded that, per dollar of budgetary cost:

• Capping the size of the tax cut for individual firms would decrease the employment effect; 
• Restricting eligibility to small firms would decrease the employment effect; 
• Limiting the eligible wage base would not change the employment effect, but would alter the types of employment fostered by the policy; 
• Basing the tax cuts on the total payroll in 2010 for new hires rather than on the net change in a firm’s payroll from 2009 to 2010 would have a similar effect on employment; 
• Offering larger tax cuts in economically depressed areas would probably not significantly alter the effect on employment; 
• Raising awareness of the tax change would increase the employment effect; and 
• Increasing the complexity of the tax change would reduce the employment effect.