Congressional Budget Office
Director's Blog

Today CBO released an update to its February 2006 paper Immigration Policy in the United States. The publication is a collection of tables and figures with descriptive text (shown below). The update presents data through 2009 and makes comparisons with 2004, the most recent year for which most data were reported in the earlier paper. The first and largest group of exhibits—exhibits 1 through 13—provides statistics on admissions of foreign nationals as legal permanent residents of the United States. The second group—exhibits 14 through 18—presents data on temporary residents and visitors. The third set—exhibits 19 and 20—provides information on naturalization of residents, and the final set—exhibits 21 and 22—shows data on enforcement of immigration laws.

A national of a foreign country granted permanent admission to the United States is formally classified as a legal permanent resident (LPR) and receives a document, commonly known as a green card. (Generally, such foreign nationals must initially obtain a visa to enter the country.) In 2009, the United States granted legal permanent resident status to more than 1.1 million people. About two-thirds of those people were admitted to the United States on the basis of family connections to current U.S. citizens or residents. LPRs are eligible to live and work in the United States, and eventually, they may apply to become naturalized citizens. Today’s report notes that:

• Of the 1.1 million people granted LPR status in 2009, about 463,000 (or 41 percent) were first-time entrants to the United States, and about 668,000 (or 59 percent) were already inside the United States when they were granted LPR status. 
• The total number of permanent admissions was about the average for the previous four years but 18 percent more than were granted such status in 2004.
• In 2009, foreign nationals who were born in Asia accounted for 37 percent of the people granted LPR status, and people who were born in North America (including Central America) accounted for 33 percent. 
• The number of individuals admitted on the basis of employment preferences decreased slightly between 2004 and 2009 and accounted for 13 percent of admissions. The category of people admitted for humanitarian reasons, which constituted 17 percent of the permanent admissions in 2009, grew by almost 60 percent from its level five years earlier.

Visas for temporary admission to the United States are granted to foreign nationals who seek entry for a limited time and for a specific purpose, such as tourism, diplomacy, or study. In addition, foreign nationals who meet certain criteria may be permitted to work in the United States for a limited time that depends on the type of visa they receive. Foreign nationals with temporary visas are not eligible for citizenship, and to remain in the United States on a permanent basis they would be required to apply for permanent admission. CBO’s publication reports that: 

• About 5.8 million visas for temporary admission were issued in 2009, of which 24 percent were for temporary residents and 76 percent were for visitors. 
• Although the number of visas issued was 15 percent higher than the number in 2004, it was down by almost 800,000 (or 12 percent) from the 6.6 million visas issued in 2008. The decrease was most likely a result of the global recession: Fewer visas were issued for business, for tourism, and for employment.
• The number of legal temporary admissions is much greater than the number of visas because many people do not need visas or had multiple admissions. In 2009, there were about 163 million legal temporary admissions, the lowest number since the Department of Homeland Security began reporting those data in 2003. About 135 million of those admissions were people from North America (including Central America).

Legal permanent residents may become citizens of the United States through a process known as naturalization. To become a naturalized citizen, an applicant must fulfill certain requirements set forth in the Immigration and Nationality Act. The report shows:

• About 744,000 people became naturalized U.S. citizens last year, which is well below the number naturalized in 2008 but close to the average for the past five years. Of the 2009 total, the largest percentages of people were born in Mexico (15 percent) and India (7 percent).

The Department of Homeland Security (DHS) is responsible for enforcing immigration law and arrests, detains, returns, and removes foreign nationals who violate U.S. laws. CBO’s report indicates that:

• In 2009, about 580,000 people who were arrested or detained returned voluntarily under the supervision of a DHS official to their home country or to another country, a figure that is well below the number in recent years. 
• About 393,000 people were ordered removed in 2009, which is 63 percent more than were ordered removed in 2004. In 2009, about two-thirds of total removals were for noncriminal violations, such as a lack of proper documentation, and the other one-third were for criminal violations of U.S. laws.

The updated study is one of a series of updates of earlier CBO immigration studies. All of CBO’s immigration publications can be found here. This update was prepared by Paige Piper/Bach and Brian Prest of CBO’s Microeconomic Studies Division.

In addition to the information provided in my testimony yesterday, you can find further information on trends in federal revenues and how changes to U.S. tax law would affect the behavior of taxpayers and the economy in the following CBO publications:

• Trends and projections of federal revenues are discussed in The Budget and Economic Outlook: An Update (August 2010); and Sources of the Growth and Decline in Individual Income Tax Revenues Since 1994 (May 2008).
• Analyses of the effects of tax policy options on economic activity are discussed in Statement of Douglas W. Elmendorf, Director, Congressional Budget Office, before the Senate Committee on the Budget, The Economic Outlook and Fiscal Policy Choices (September 28, 2010); An Analysis of the President’s Budgetary Proposals for Fiscal Year 2011 (March 2010); and Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates (December 2005).
• The effects of tax rates on economic activity are examined in The Effect of Tax Changes on Labor Supply in CBO’s Microsimulation Tax Model, Background Paper (April 2007); Computing Effective Tax Rates on Capital Income, Background Paper (December 2006); Effective Marginal Tax Rates on Labor Income (November 2005); and Taxing Capital Income: Effective Rates and Approaches to Reform (October 2005).
• Subsidies to expenditures through the tax code are discussed in An Overview of Federal Support for Housing, Issue Brief (November 3, 2009); Key Issues in Analyzing Major Health Insurance Proposals (December 2008), pp. 29–37; The Deductibility of State and Local Taxes (February 2008); and Statement of Peter R. Orszag, Director, Congressional Budget Office, before the House Committee on the Budget, Performance Budgeting: Applications to Health Insurance Programs and Tax Policy (September 20, 2007).
• Supplemental analyses and detailed data on average federal tax rates and income, by income category, for 1979 to 2007, are available at www.cbo.gov/publications/collections/collections.cfm?collect=13.
• Issues involving tax rates and how household income changes over time are discussed in Effective Tax Rates: Comparing Annual and Multiyear Measures (January 2005).

Today I testified before the Senate Finance Committee on historical trends in federal tax revenues and rates. My written testimony is a collection of tables and figures with descriptive text (shown below). It addresses three broad topics: revenues collected by the federal government, how taxes affect economic activity, and the tax burden and who bears it.

Federal Revenues: Trends and Projections

Total federal revenues as a percentage of gross domestic product (GDP) change over time because the size of the tax base for each source changes relative to GDP, because changes in the distribution of income can raise or lower average tax rates, and because changes in tax law affect the amount of revenues collected from a particular tax base. As detailed in the first three exhibits:

• Over the past 40 years, federal revenues have ranged from nearly 21 percent of GDP in fiscal year 2000 to less than 15 percent in fiscal years 2009 and 2010, averaging 18 percent of GDP over that span. Most of the revenues—about 82 percent in 2010—come from the individual income tax and the payroll taxes used to finance Social Security, Medicare, and the federal unemployment insurance program (see Exhibit 1).
• Under current law, revenues will rise significantly from their recent low relative to GDP as the economy recovers from the recession and the tax reductions enacted in 2001, 2003, and 2009 expire. We project that under current law, federal revenues will reach 21 percent of GDP in fiscal year 2020, just above their peak share reached 10 years ago (see Exhibit 2).
• We also project that under current law, federal spending will reach nearly 24 percent in 2020—slightly lower than the peak level of almost 25 percent in fiscal year 2009 but well above the average of roughly 21 percent over the past four decades. Compared with that historical experience, the components of federal spending that are projected to be unusually large relative to GDP by 2020 are the expenditures for Social Security and the federal health programs.
• Even with the projected substantial increase in revenues, under current law deficits between 2015 and 2020 will range between 2.6 percent and 3.0 percent of GDP. If the Congress extended most or all of the 2001 and 2003 tax cuts and made no other changes to taxes and spending, revenues would be lower and deficits would be significantly larger (see Exhibit 3).

How Taxes Affect Economic Activity: Marginal Tax Rates and Tax Expenditures

Taxes raise the price of taxed activities and thereby lower the relative price of other activities. In particular, the income tax and payroll tax reduce the returns from working, and the income tax reduces the returns from saving. One measure of the effect of taxes on the returns from working and saving is the marginal tax rate—that is, the tax paid per dollar of extra earnings or dollar of extra income from savings. Exhibits 4 through 6 present information about marginal tax rates, including the following points:

• The highest marginal income tax rate (the tax rate that applies to the top tax bracket) was as high as 70 percent as recently as 1980, although a lower maximum rate applied to earnings in that year. Since 1988, the highest marginal income tax rate has ranged from 28 percent to 39.6 percent.
• For a representative family of four with median income, the marginal tax rate on earnings (combining the rates for both income and payroll taxes) has remained at about 30 percent since the mid-1980s.

Provisions of the tax code can also affect economic activity by subsidizing certain types of spending. Revenues forgone because of certain special features of the tax code are known as tax expenditures. Tax expenditures have helped to accomplish various goals, but because they reduce the base to which tax rates apply, tax rates must be higher to collect the same amount of revenues that would be collected in the absence of those subsidies. Exhibits 7 through 10 present information about tax expenditures, including the following points:

• The two largest tax expenditures are the deduction of mortgage interest on owner-occupied residences and the exclusion of employers’ contributions for health care, health insurance premiums, and long-term care insurance premiums from the individual income tax. Each of those results in forgone revenues equal to about 9 percent of individual income tax revenues.
• There are significant corporate tax expenditures as well.

The Tax Burden and Who Bears It

The final set of charts beginning with Exhibit 11 shows the impact of federal taxes on various categories of households, which bear the economic cost of taxes that they pay directly as well as taxes paid by businesses. One measure of the tax burden is the average tax rate, which equals taxes paid as a share of income. Federal taxes are progressive, meaning that average federal tax rates generally rise with income. Specifically:

• In 2007, households in the bottom fifth, or quintile, of the income distribution paid about 4 percent of their income in federal taxes, while the middle quintile paid 14 percent, and the highest quintile paid 25 percent.
• The individual income tax has average tax rates that rise rapidly with income. Payroll taxes have average tax rates that vary little across most income groups but fall for the highest quintile because earnings above a certain threshold are not subject to the Social Security payroll tax and because earnings are a smaller portion of total income for that group. The average social insurance tax rate is higher than the average individual income tax rate for all income groups except the highest quintile.
• Between 1979 and 2007, the average tax rate for federal taxes declined for all income groups.
• The share of taxes paid by the top fifth of the population grew sharply between 1979 and 2007. Almost all of that growth can be attributed to an increase in that group’s share of before-tax income. In 2007, households in the highest quintile earned 55 percent of before-tax income and paid almost 70 percent of federal taxes; for all other quintiles, the share of federal taxes was less than the share of income.

Today CBO released the fourth of its statutory reports on transactions undertaken as part of the Troubled Asset Relief Program (TARP)—the program established in October 2008 to enable the Department of the Treasury to promote stability in financial markets through the purchase and guarantee of “troubled assets.” The report discusses CBO’s estimate of the costs of transactions completed, outstanding, and anticipated under the TARP as of November 18, 2010. The report also provides a comparison of CBO’s estimate with that published by the Office and Management and Budget (OMB) in October.

CBO estimates that the cost to the federal government of the TARP’s transactions (also referred to as the subsidy cost), including grants that have not been made yet for mortgage programs, will amount to $25 billion. That cost stems largely from assistance to American International Group (AIG), aid to the automotive industry, and grant programs aimed at avoiding mortgage foreclosures: CBO estimates a cost of $45 billion for providing those three types of assistance. Other transactions will, taken together, yield a net gain of $20 billion to the federal government, CBO estimates.

It was not apparent when the TARP was created two years ago that the costs would be this low. At that time, the financial system was in a precarious condition, and the transactions envisioned and ultimately undertaken through the TARP engendered substantial financial risk for the federal government. However, the cost has come out toward the low end of the range of possible outcomes anticipated when the program was launched. Because the financial system stabilized and then improved, the amount of funds used by the TARP was well below the $700 billion initially authorized, and the outcomes of most transactions made through the TARP were favorable for the federal government.

CBO’s current estimate of the cost—$25 billion—is substantially less than the $66 billion estimate incorporated in the agency’s latest baseline budget projections (issued in August 2010) and the $109 billion estimate shown in the agency’s previous report on the TARP (issued in March 2010).  The reduction in estimated cost over the course of this year stems from several developments:

• Additional repurchases of preferred stock by recipients of TARP funds; 
• A lower estimated cost for assistance to AIG and to the automotive industry; 
• Lower expected participation in mortgage programs;
• The elimination of the opportunity to use TARP funds for new purposes (because of the passage of time and the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act). 

This report was prepared by Avi Lerner of CBO’s Budget 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 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.

The nation’s transportation and water infrastructure—its highways, airports, water supply systems, wastewater treatment plants, and other facilities—plays a vital role in the economy. Private commercial activities and the daily lives of individuals depend on that physical infrastructure, which is provided by all levels of government in the United States. In fiscal year 2007—the most recent year for which data on combined spending by the federal government and by state and local governments are available—total public spending for transportation and water infrastructure was $356 billion, or 2.4 percent of the nation’s economic output.

Concerns about the nation’s infrastructure have prompted calls for greater spending. The Congress is considering the funding level for the next several years for federal infrastructure programs, such as highways, mass transit, and aviation. In response to a request from the Senate Finance Committee, CBO prepared a study that analyzes recent developments in spending on transportation and water infrastructure, trends in spending for capital and for operations and maintenance, and the rationale for public spending on infrastructure. This study updates a previous report CBO published in August 2007, Trends in Public Spending on Transportation and Water Infrastructure, 1956 to 2004.

Recent Developments in Public Spending for Transportation and Water Infrastructure

Between 2003 and 2007, real (inflation-adjusted) public spending on transportation and water infrastructure declined by $23 billion, or 6 percent. That decline, which reflects a decrease in real capital spending, especially by the federal government, stands in contrast to the fairly steady increase in spending for such infrastructure during the previous two decades. The drop was primarily the result of a sharp increase in prices for materials used to build such infrastructure—an increase that outpaced the growth of nominal (current-dollar) spending on water and transportation infrastructure.

In 2009, the federal government spent $87 billion on transportation and water infrastructure, $6 billion more than it spent in 2007. Of those outlays, about $4 billion was made available through the American Recovery and Reinvestment Act of 2009 (ARRA). In total, lawmakers appropriated $62 billion for transportation and water infrastructure under that legislation. CBO expects that, in nominal terms, federal spending for transportation and water infrastructure under ARRA will total $54 billion through 2013, by which time almost 90 percent of the funds made available for infrastructure through ARRA will have been spent.

The Composition of Public Spending for Transportation and Water Infrastructure

State and local governments account for about 75 percent of total public spending on transportation and water infrastructure—excluding the share of their spending financed by grants and loan subsidies provided by the federal government—and the federal government accounts for the other 25 percent. That split has remained roughly constant for several decades.

In recent years, not quite half of total public funding for transportation and water infrastructure in the United States has been devoted to capital spending for activities such as construction and equipment purchases. State and local governments have accounted for about 60 percent of those capital expenditures, and the federal government has accounted for 40 percent.

A little more than half of total public spending for such infrastructure has been used for operation and maintenance, of which state and local governments have provided about 90 percent. Although the federal government has played a limited role in such funding overall, it has provided much of the resources for operating and maintaining the nation’s air traffic control system.

Spending on highways at all levels of government accounted for 43 percent of expenditures for transportation and water infrastructure in 2007. Expenditures on water supply and wastewater treatment systems accounted for 28 percent of spending; aviation, mass transit and rail made up 23 percent; and the remaining categories of water transportation and water resources accounted for 5 percent.

The Role of Government in Funding Transportation and Water Infrastructure

In the United States, the public sector rather than the private sector typically provides funding for transportation and water infrastructure. Whether it is more efficient for the federal government to provide that funding depends on the type of infrastructure and the likelihood that such infrastructure will be undersupplied if its provision is left to state and local governments or to the private sector.

Evidence suggests that spending for carefully selected infrastructure projects can contribute to long-term economic growth by increasing the nation’s capital stock and raising productivity. Realizing the potential gains depends crucially on identifying projects with benefits to society that will outweigh their costs, but identifying such projects is difficult. The federal government could make its current funding more effective by ensuring that the costs of infrastructure projects are borne by different levels of government on the basis of where the benefits are expected to accrue.

This study was prepared by Nathan Musick of CBO’s Microeconomic Studies Division.

The unemployment rate averaged 9.3 percent in 2009, more than double what it was in 2007 and the highest it had been since 1983. In 2009, nearly one in four people (including children) lived in a family in which at least one family member was unemployed at some time during the year. Among people living in a family with income below the poverty threshold, one in three lived in a family in which at least one person was unemployed at some point.

The unemployment insurance (UI) program provides a weekly benefit to qualified workers who lose their job and are actively seeking work. The amount of that benefit is based in part on a worker’s past earnings. The composition of the worker’s family and the income of the family as a whole are not generally taken into account. Nevertheless, the worker’s whole family is likely to be affected both by the spell of unemployment itself and by the support that the UI benefit provides.

Outlays for UI benefits totaled $120 billion in fiscal year 2009, a substantial increase over the amount two years earlier, which was $33 billion. Spending on UI benefits in fiscal year 2010 was even higher than in fiscal year 2009, totaling nearly $160 billion, and CBO projects that under current law, such spending in fiscal year 2011 will be $93 billion. (Under current law, federally funded extensions of benefits will begin to phase out on December 1, 2010.)

CBO examined the role of UI benefits in supporting the income of families in which at least one person was unemployed at some point in 2009. The analysis addressed how that role varied with the amount of family income and the number of weeks of unemployment for all family members. CBO also examined how the poverty rate and related indicators of financial hardship would have differed in the absence of the UI program. Although CBO’s calculations are based on data about individual people, the results are presented in terms of families, both to focus on the effects on families and for ease of exposition.

The major findings are:

• Almost half of families in which at least one person was unemployed received income from UI in 2009. In 2009, the median contribution of UI benefits to the income of families that received those benefits was $6,000, accounting for 11 percent of their family income that year.
• Both the percentage of families receiving UI benefits and the median annual benefits received by those families over the course of the year were larger for families with more weeks of unemployment than for families with fewer weeks of unemployment.
• In 2009, about 14 percent of families had income below the federal poverty threshold; those families received about 8 percent of total UI benefits paid out during the year. In contrast, 67 percent of families in 2009 had income more than twice the poverty threshold; those families received about 70 percent of total UI benefits. The higher-income families received a larger share of benefits for several reasons: because only people with sufficient recent work histories qualify for benefits, benefit levels rise with previous earnings, and receiving benefits tends to push families into higher income groups.
• Without the financial support provided to families by UI benefits (and under an assumption of no change in employment or other sources of income associated with the absence of that support), the poverty rate and related indicators of financial hardship would have been higher in 2009 than they actually were. For instance, in 2009 the poverty rate was 14.3 percent, whereas without UI benefits and under the assumption mentioned, it would have been 15.4 percent.

In assessing the role of UI benefits in supporting family income in 2009, CBO accounted only for people who received those benefits, the amount of benefits they received, and the other income they and their families received. CBO did not consider any changes in employment or other sources of income that might have occurred if those benefits were not available; a more-complete analysis of the effects of UI benefits on family income would incorporate such behavioral responses.

This analysis was prepared by Gregory Acs and Molly Dahl of CBO’s Health and Human Resources Division.

The accumulation of greenhouse gases in the atmosphere could cause costly changes in regional climates throughout the world and has led policymakers and analysts to consider policies to restrict emissions of those gases. One option for reducing emissions in a cost-effective manner would be to establish a cap-and-trade program for those gases. Such a program would limit the number of tons of greenhouse gases emitted by setting gradually tightening annual caps, which, when added together, would set a cumulative cap over the duration of the policy. The government could distribute allowances, which would be rights to emit those gases, by selling them, possibly through an auction, or giving them away. Then firms could trade allowances, “bank” unused allowances for future use, or “borrow” allowances allocated for future years in order to reduce the cumulative cost of complying with the caps.

The price of allowances would vary on the basis of current conditions, such as the weather and the economy, and firms’ expectations about factors affecting their compliance costs over the duration of the policy. Unexpectedly high (or low) allowance prices would make the cost of meeting the caps much higher (or lower) than policymakers had expected, which could alter the tradeoff between costs and benefits that policymakers had anticipated when they selected the caps. Because they cannot know in advance how high or low allowance prices would be in any given year, policymakers might consider including mechanisms in a cap-and-trade program that would help limit the range of potential allowance prices.

Today CBO released a study—prepared at the request of the Chairman of the Senate Committee on Energy and Natural Resources—that examines the potential effects of certain mechanisms that would help manage allowance prices, and thus the cost of complying with a cap-and-trade program, by altering the number of allowances available to firms at various prices. CBO examined the effects of three such mechanisms: a price ceiling, an allowance reserve, and a price floor. Actual experience in managing allowance prices through the approaches that CBO examined is quite limited, and they could have effects other than those identified here.

A Price Ceiling

Policymakers could set an upper limit, or ceiling, on allowance prices by allowing firms to buy an unlimited number of allowances, in addition to those permitted under the cumulative cap, at a specified “ceiling price.” Such a policy would have the following consequences:

• It would provide an upper limit on allowance prices but not on emissions, meaning emissions could exceed the cap.
• The higher the ceiling price was set above the projected path of allowance prices, the less likely it would be that firms would buy additional allowances, and if they did buy them, the fewer they would buy. As a result, a higher ceiling would generally lead to fewer additional emissions than would arise under a lower ceiling.
• Provided that firms were able to shift allowances from one year to another—that is, bank and borrow allowances—a ceiling could dampen the price of allowances, even when their market price was below the ceiling price.
• If the ceiling lowered allowance prices, it would diminish firms’ incentives to invest in equipment that reduced emissions and in efforts to develop new lower-cost technologies for reducing emissions. That decrease in investment would lower firms’ spending for emissions reductions in the near term but could increase it in the future, when their compliance costs rose.

An Allowance Reserve

Alternatively, policymakers could offer to sell firms a limited number of allowances at or above a given price. Such an “allowance reserve” would have the following effects:

• It would impose an upper limit on emissions—which might be different from the cumulative cap—but would not set an upper limit on the price of allowances.
• A reserve created by adding to the number of allowances supplied under the cap would allow a limited loosening of the cap when costs were high. Such a reserve would tend to increase emissions and lower allowance prices relative to a policy with the same cap but no reserve.
• A reserve created by withholding allowances that would otherwise be distributed under the cap could increase firms’ compliance costs but allow fewer emissions than those under a program with the same cap but no reserve.
• The effect of a reserve on emissions and allowance prices might be greater but would be less certain if regulators could restock the reserve by using offset credits, which reflect reductions in domestic or overseas emissions that would not otherwise be subject to the cap.
• If the federal government used auctions to sell the reserve allowances it created, it would capture their full value. Alternatively, if the reserve allowances were distributed by offering firms options to purchase them at a fixed price, the government and firms would share the allowances’ value.

A Price Floor

Another approach, a price floor, would set a lower limit on the price of all traded allowances. With a “hard” price floor, the simplest form of such an approach, the government would be required to purchase an unlimited number of allowances at a predetermined price. Broadly speaking, including a price floor in a cap-and-trade program would tend to boost allowance prices in the near term but would probably not result in fewer emissions over the duration of the policy if firms were permitted to bank allowances. CBO’s analysis also indicates the following:

• The further below the projected path of allowance prices that the floor price was set, the less likely it would be that the floor would become binding—that is, prevent any further decline in prices.
• At a time when it was binding, a price floor would increase firms’ compliance costs, relative to a policy with the same cap and no price floor, because it would require firms to reduce emissions more than they otherwise would.
• To the extent that a price floor increased the price of allowances, it would strengthen firms’ incentives to invest in emissions-reducing equipment and to develop new lower-cost technologies for reducing emissions. Those investments would boost firms’ spending in the near term but decrease their compliance costs (and lower allowance prices) in the future.
• If firms could shift allowances from one period to another (by banking and borrowing allowances), a price floor would probably not result in cumulative emissions over the life of the policy (typically several decades) that were less than the amount permitted under the policy’s cap. Instead, it would shift reductions forward in time.
• Policymakers could try to set a lower limit on the price of allowances by establishing a minimum bid price for the allowances sold in a government-run auction. But that bid price would establish a floor for prices in the secondary market only if the demand for allowances was great enough that firms would want to buy at least some of the allowances being auctioned.

This study was prepared by Terry Dinan of CBO’s Microeconomic Studies Division.

This morning, CBO issued its Monthly Budget Review, which summarized the end-of-year budget results reported by the Treasury for fiscal year 2010. In that year, which ended on September 30, the federal government recorded a total budget deficit of $1.3 trillion, $122 billion less than the deficit incurred in 2009. The deficit fell as a share of the nation’s gross domestic product (GDP) from 10.0 percent in 2009 to 8.9 percent in 2010—the second-highest deficit as a share of GDP since 1945 and about four times the average deficit as a share of GDP recorded between 2005 and 2008.

The large deficits in 2009 and 2010 reflect a combination of factors: an imbalance between revenues and spending that predates the recent recession, sharply lower revenues and elevated spending associated with those economic conditions, and the costs of federal policies implemented in response to those conditions. Revenues in 2010 were 16 percent below the peak amount reached in fiscal year 2007 and only slightly above the amount collected in 2005. Total revenues in both 2009 and 2010 were 14.9 percent of GDP, the lowest share since 1950. In contrast, outlays in 2010 were 27 percent more than spending in 2007.

Receipts and Outlays
As a Percentage of GDP

Sources: Department of the Treasury; CBO

The deficit was smaller in 2010 than in 2009 because revenues increased and spending declined. Receipts in 2010 rose for the first time in three years, reaching $2,162 billion, up 3 percent from collections in 2009. Expenditures decreased by $64 billion (or 2 percent) from 2009 to 2010.

On the revenue side, corporate income tax receipts showed the largest gain in dollar terms from 2009 to 2010—$53 billion (or 38 percent). Despite the gain, those receipts were just over half as large as in 2007 and 37 percent below the amount collected in 2008. The gain in corporate income tax receipts can be attributed to higher taxable profits resulting from both improved economic conditions and the temporary lapse of provisions that allowed taxpayers to take higher depreciation charges in 2009. Receipts from the Federal Reserve also rose substantially, increasing by almost $42 billion to an amount more than double the 2009 receipts. The central bank’s increased profits resulted from an enlarged portfolio and a shift to riskier and thus higher-yielding investments.

Those gains in 2010 receipts were partially offset by declines in receipts from social insurance (payroll) taxes of $26 billion (or 3 percent) and individual income taxes of $17 billion (or 2 percent). Receipts during the first several months of the fiscal year were below those during the same period in 2009. But in the last five months of fiscal year 2010, collections of withheld and nonwithheld taxes, which were based on taxable incomes in 2010, were 4 percent higher than in the same period in 2009.

Spending related to the financial crisis dropped sharply in 2010. Net outlays recorded for the Troubled Asset Relief Program (TARP), federal deposit insurance, and Treasury payments to Fannie Mae and Freddie Mac were $367 billion lower in 2010 than in 2009. Conversely, spending associated with the American Recovery and Reinvestment Act (ARRA)&emdash;the stimulus bill&emdash;rose by approximately $110 billion to a total of roughly $225 billion.

Outlays for defense rose by 4.7 percent in 2010, lower than the previous year’s increase of 7.1 percent and about half the average annual growth rate of 8.8 percent over the past decade. The 3.4 percent rise in spending for procurement was markedly lower than recent double-digit growth, and spending on research and development declined by 2.6 percent—the first drop since 1999. Nearly one-quarter of military spending in 2010 was associated with operations in Iraq and Afghanistan—about the same portion as in 2008 and 2009, CBO estimates.

Outlays for the three largest entitlement programs—Social Security, Medicare, and Medicaid (not including spending from ARRA)—rose by 5.4 percent in 2010. That increase was smaller than the 7.0 percent average annual growth over the past five years. Nevertheless, Social Security outlays as a share of the economy grew for the fifth consecutive year, rising from 4.1 percent of GDP in 2006 to 4.8 percent of GDP in 2010. Spending for Medicare and Medicaid (excluding the effects of ARRA) represented 4.7 percent of GDP, compared with an annual average of 4.1 percent of GDP experienced over the past five years.

Payments for unemployment benefits were one-third greater in 2010 than in 2009. Those payments totaled $162 billion (or 1.1 percent of GDP), more than triple the amount paid in 2008. Spending for net interest on the public debt also increased to 1.6 percent of GDP, up from 1.4 percent of GDP in 2009. Spending on the wide variety of other federal programs accounted for about 30 percent of the budget and was equal to 7.2 percent of GDP, slightly more than spending in 2009 and the average over the past five years.