CBO Testified on Policies to Promote Economic Growth and Employment in 2012 and 2013

November 15, 2011

This morning I testified before the Senate Budget Committee on policies to promote economic growth and employment in 2012 and 2013. During the past two years, CBO has produced several publications focused on options that are available to lawmakers for spurring the economy through changes in taxation and government spending. Today’s testimony updates that discussion but also considers the effects of other legislative policy options—those that do not involve, or whose scope extends well beyond, fiscal policy.

Key Points of the Testimony

The Economic Outlook
  • CBO expects that real (inflation-adjusted) gross domestic product (GDP) will stay well below the economy’s potential for several years. GDP growth will be in the vicinity of 1½ percent this calendar year and around 2½ percent next year.
  • CBO expects employment to expand very slowly, leaving the unemployment rate close to 9 percent through the end of 2012.
Fiscal Policy Options
  • Policies that would reduce the marginal cost of adding employees or would be targeted toward people who would be most likely to spend the additional income would have the largest effects on output and employment. Those policies include reducing employers’ payroll taxes and providing aid to the unemployed.
  • Policies that would give little incentive for firms to hire or invest—such as reducing business income taxes and reducing tax rates on repatriated foreign earnings—would have small effects.
  • Achieving both short-term stimulus and long-term sustainability would require a combination of policies: changes in taxes and spending that would widen the deficit now but reduce it later in the decade.
Potential Changes in Regulatory Policy
  • In CBO’s judgment, the economic effects of certain changes in regulatory policies probably would be too small or would occur too slowly to significantly alter overall output or employment in the next two years.

The Details

The U.S. economy has struggled to recover from the deep recession. Although total output started to expand again more than two years ago, the pace of the recovery has been slow compared with the average recovery since World War II, and the economy remains in a severe slump. We expect that, under current law, growth in output will continue to be slow, and, as a result, job gains will be limited.

CBO’s economic projections included in the testimony are unchanged from those published in September. CBO’s new economic forecast will be available in January with the release of our Budget and Economic Outlook.

Given CBO’s outlook for the economy, which is similar to that of private forecasters, a large portion of the economic and human costs of this downturn remains ahead. We think that the economy is only about halfway through the cumulative shortfall in output relative to its potential level that will result from the recession and weak recovery. The costs of that shortfall are immense in total, and they fall disproportionately on people who lose their jobs, who are displaced from their homes, or who own businesses that fail. For example, even among workers who find new jobs, experience suggests that many will end up with lower earnings, not only in the short term but for many years to come.

Considerations in Designing Fiscal Policy

Three key criteria for evaluating policies to increase employment and output are:

  • Timing—providing help when it is needed;
  • Cost-effectiveness—generating a large amount of additional output and employment per dollar cost to the federal budget; and
  • Consistency with long-term fiscal objectives—not worsening the long-run budget outlook.
Policies That Would Promote Economic Growth and Employment in 2012 and 2013

In this testimony, CBO assesses the potential impact of a variety of temporary changes in tax or spending policy that might be considered to promote economic growth and increase employment in the near term. The policies fall in three broad categories: assistance to households; support of businesses; and aid to states or spending on infrastructure. For each option, we used evidence from empirical studies and econometric models to estimate the impact of the policy on output (GDP) and on employment in 2012 and 2013.

The potential impacts vary greatly: By our estimates, the policies analyzed here would raise real GDP in 2012 and 2013 by an amount ranging from as little as 10 cents per dollar of budgetary cost to as much as $1.90 per dollar of budgetary cost. (We measured budgetary cost as the amount of additional government spending or reduction in taxes.)

The impact of the policies on employment—shown in the figure below—would range from a marginal increase to an increase of as much as 19 years of full-time-equivalent (FTE) employment per million dollars of budgetary cost over that two-year span. For each policy we show a range of estimates, reflecting the uncertainty that accompanies any analysis of this sort.

Ranges of Cumulative Effects of Policy Options on Employment in 2012 and 2013
Ranges of Cumulative Effects of Policy Options on Employment in 2012 and 2013

Despite the near-term economic benefits, such actions would add to the already large projected budget deficits, either immediately or over time. To achieve long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade. Such an approach would work best if the future policy changes were sufficiently specific and widely supported so that households, businesses, state and local governments, and participants in financial markets believed that the future fiscal restraint would truly take effect.

Other Legislative Policy Options

Lawmakers could also influence economic growth and employment during the next few years by changing policies that do not involve, or whose scope extends well beyond, taxation and government spending. For example, legislation could modify existing or proposed regulations, alter the government’s role in a sector of the economy, or change trade relationships with other countries.

CBO considered some potential changes of those types in policies related to energy and the environment, the financial and health care sectors, and international trade. The near-term economic impact of such changes would depend on how they affected businesses’ investment and hiring decisions, households’ purchasing power and wealth, and people’s expectations and uncertainty about future government policies and economic conditions.

There are few analytic tools for estimating the near-term effects on overall economic activity of such changes, so we did not attempt to quantify the effects of those potential changes with any precision. In our judgment, however, the effects of the specific changes in regulatory policies or other policies apart from fiscal policies that we considered probably would be too small or would occur too slowly to significantly alter overall output or employment in the next two years.

I should emphasize that the policy changes examined in today’s testimony are illustrative rather than exhaustive; many others, which might have larger or smaller economic effects, are possible. Moreover, our analysis does not address other critical considerations in evaluating such policy changes, including the long-term effects on the economy, on people’s health, and on the environment.