July 25, 2013
Projections of income earned by individuals and businesses are an integral part of the Congressional Budget Office’s (CBO’s) regular 10-year projections of the economy and a key component of its projections of federal revenues and outlays. CBO projects all the major income measures that are presented in the Commerce Department’s national income and product accounts (NIPAs). The total of those measures is gross national income (GNI), which can be broken down into gross domestic income (GDI) and net income from the rest of the world. GDI consists primarily of the income earned by labor and capital in the production of goods and services in the United States, and net income from the rest of the world consists of labor and capital income from the rest of the world minus payments of labor and capital income to the rest of the world. Using the NIPAs framework ensures that CBO’s projections of income are consistent with its projections of gross domestic product (GDP), which measures overall economic output produced in the United States for final use (consumer spending, private investment, government spending, and net exports).
Three broad categories of income are central to CBO’s projections of income and revenues:
- Income earned by labor in the production of goods and services in the United States,
- Income earned by the owners of capital in the production of goods and services in the United States, and
- Net income from the rest of the world.
CBO projects those income categories separately because they are driven by different fundamental forces and because they are taxed differently and therefore affect revenues and spending in different ways. CBO’s methods for projecting income also differ between the near term and medium term. In this analysis, the near term corresponds to the current business cycle, and the medium term refers to the remainder of the 10-year projection period, when output is forecasted to equal CBO’s estimate of potential (or maximum sustainable) output. The agency does not attempt to project future business cycles.
How Does CBO Project the Labor Income Component of GDI?
CBO uses different methods to project the labor income component of GDI in the near term and in the medium term. For the near term, labor income and its components (such as wages and salaries) reflect the agency’s projections of economic measures that vary over the business cycle (such as employment, wage rates, and productivity growth). For the medium term, CBO projects the labor share of GDI on the basis of its historical pattern, taking into account any special factors that could affect labor’s share in the future.
In its most recent forecast, published in February 2013, CBO projects that the labor share will rise with the continuing economic expansion, increasing from 59.4 percent of GDI in 2012 to 61.0 percent in 2023, but will remain below its average since 1980 of 61.5 percent (see figure below). CBO’s near-term projection reflects stronger demand for labor between 2013 and 2017, resulting in faster growth in overall compensation and labor income. CBO’s medium-term projection, which extends from 2018 through 2023, reflects both the low level of the labor share since the recession began and the possibility that the effects of several factors that may have depressed the labor share in recent years (such as technological change and globalization) will not fade away.
How Does CBO Project the Capital Income Component of GDI?
CBO determines the capital income component of GDI in the near term and the medium term by projecting the individual components of capital income (such as corporate profits and rental income). As with labor income, CBO’s forecasts of the components of capital income reflect the projections of other measures (including interest rates, depreciation rates, and growth in the capital stock) but are constrained by the requirement that they add up to a capital share consistent with the projection of the labor share. With the exception of profits, the components of capital income are generally much less sensitive to business-cycle fluctuations than are the components of labor income, so CBO uses the same procedures for projecting most components of capital income in the near term and medium term. (For CBO’s current projection of corporate profits, see the figure below.)
For CBO’s projections of the various categories of income to be consistent with one another, the sum of the projected components of nonlabor income relative to GDI—which consists primarily of the capital share of GDI—must vary inversely with the projected labor share. In its forecast process, the agency usually adjusts the projected components of capital income to ensure that this condition is satisfied. In its most recent forecast, CBO projects that capital income will decline as a share of GDI between 2012 and 2023, mirroring the increase in the labor share.
How Does CBO Project Net Income From the Rest of the World?
CBO separately projects income receipts from foreigners and income payments to foreigners. CBO projects income receipts as the product of its projections of U.S. owned assets abroad and the rate of return on those assets; it projects income payments as the product of its projections of foreign-owned assets in the United States and the rate of return on those assets. (CBO does not project the wage and salary component of net income from the rest of the world because that component has historically been a very minor share of the total.) The near-term and medium-term projections of the level and composition of U.S.-owned and foreign-owned assets are based on projections of the exchange rate, the current-account balance, and the federal debt. In its most recent forecast, CBO projects that net income from the rest of the world will fall as a share of GDI between 2012 and 2023 as income payments to foreign investors rise faster than income receipts from foreigners.