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April 17, 2012
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Budget Concepts and Process
Budget enforcement procedures, biennial budgeting, credit reform, capital budgeting, line-item veto, and fair-value accounting: Welcome to CBO's Inside Baseball category. This topic brings together the agency's work on budget concepts, the budget process, and possible budget reforms.
Supplemental Material
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Budget Infographic - Discretionary
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Budget Infographic - Mandatory
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Budget Infographic - Discretionary
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Budget Infographic - Revenues
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Budget Infographic - Mandatory
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Budget Infographic - Revenues
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Highlights
As required, the Congressional Budget Office (CBO) reports each January to the Congress on the following:
- All programs and activities funded for the current fiscal year for which authorizations of appropriations have expired, and
- All programs and activities for which authorizations of appropriations will expire during the current fiscal year.
Those requirements are specified in section 202(e)(3) of the Congressional Budget and Impoundment Control Act of 1974.
(Note: CBO publishes three versions of the report on Unauthorized Appropriations and Expiring Authorizations each year, which differ only in the way that Appendixes A and B are sorted. In those reports, the appendixes are sorted by House and Senate authorizing committees and by Appropriations subcommittee.)
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- August 2012 (5)
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Abstract
The United States is facing significant and fundamental budgetary challenges. The federal government's budget deficit for fiscal year 2011 was $1.3 trillion; at 8.7% of gross domestic product (GDP), that deficit was the third-largest shortfall in the past 40 years. (GDP is the sum of all income earned in the domestic production of goods and services. In 2011, it totaled $15.0 trillion.)
Highlights
Highlights
Discretionary outlays—the part of federal spending that lawmakers generally control through annual appropriation acts—totaled about $1.35 trillion in 2011, or close to 40 percent of federal outlays. Slightly more than half of that spending was for defense. The remainder went for a wide variety of government programs and activities, with the largest amounts spent for education, training, employment, and social services; transportation; income security (mostly housing and nutrition assistance); veterans' benefits (primarily for health care); health-related research and public health; international affairs; and the administration of justice.
Discretionary outlays declined from about 10 percent of gross domestic product (GDP) during much of the 1970s and 1980s to 6.2 percent in 1999, mostly because defense spending, as a share of GDP, declined over that period. Since then, discretionary outlays have risen relative to the size of the economy, totaling about 9 percent of GDP in 2010 and 2011, in part because of military operations in Afghanistan and Iraq and in part because of the discretionary funding provided by the American Recovery and Reinvestment Act of 2009 (ARRA, Public Law 111-5). The 2010 and 2011 figures were the highest in about 20 years.
However, lawmakers have already taken significant steps to constrain discretionary spending. Budget authority—the authority to incur financial obligations—provided for defense activities in 2011 was $3 billion (or less than 1 percent) below the amount provided the year before; budget authority for discretionary nondefense programs (plus the obligation limitations that govern spending for certain discretionary transportation programs whose budget authority is not classified as discretionary) was $39 billion (or 7 percent) below the amount provided in 2010. As a result, total discretionary funding (that is, budget authority plus obligation limitations) in 2011 was the lowest, as a share of GDP, since 2002. Nevertheless, discretionary outlays in 2011 were close to the amounts spent in 2010, the Congressional Budget Office (CBO) estimates, because of spending from funds appropriated in previous years.
In addition, the Budget Control Act of 2011 (P.L. 112-25) instituted statutory caps on discretionary appropriations for each of the fiscal years 2012 through 2021. (By contrast, in most recent years the total amount of annual appropriations—except for those designated as emergency requirements—was governed by annual funding allocations agreed to by the House of Representatives and the Senate but not enacted into law.) The new caps do not constrain spending for the war in Afghanistan or similar activities or for designated emergencies; however, if implemented as written in the act, the caps would keep other appropriations for 2012 and 2013 below the amounts provided for 2011 and would limit the growth of those appropriations to about 2 percent a year from 2014 to 2021. Compared with allowing nonwar discretionary appropriations to grow at the rate of inflation, the capped amount of discretionary budget authority would be about 4 percent lower in 2012 and 9 percent lower in 2021; as a result, budget deficits would be reduced by $778 billion between 2012 and 2021, CBO estimates (not counting the savings in interest payments resulting from lower outlays).
The future path of discretionary spending may be affected by the actions of the Joint Select Committee on Deficit Reduction. Under provisions of the Budget Control Act, legislation originating from this Committee could directly alter the path of such spending, for example, by changing the caps. Alternatively, if legislation originating from this Committee and estimated to produce at least $1.2 trillion in deficit reduction (including an allowance for interest savings) is not enacted by January 15, 2012, automatic procedures to cut spending will take effect in January 2013. CBO expects that 71 percent of the net savings from the automatic procedures would come from reductions in discretionary appropriations. If those procedures were triggered, appropriations for defense, excluding funding for overseas contingency operations (war-related funding), would be $110 billion—or 16 percent—lower by 2021 than they would be if they kept up with inflation; funding for nondefense activities would be $99 billion—or 15 percent—lower.
Moreover, for some programs, a comparison with inflation-adjusted funding understates the magnitude of reductions relative to the cost of maintaining current policies or plans. For example, implementing the Administration's multiyear defense plans would require nonwar defense spending to grow faster than the rate of inflation, and the demands for veterans' health care and Pell grants for higher education have also been growing more quickly than inflation. In contrast, the funding required for war-related activities—in Afghanistan and other countries—will be smaller than the amounts provided in recent years if the number of deployed troops is smaller and the pace of operations is diminished.
Regardless of the constraints placed on discretionary spending through the Budget Control Act or other actions taken by this Congress, subsequent Congresses will make the final decisions about future discretionary appropriations. Those decisions might or might not satisfy the constraints put in place by this Congress. Nevertheless, CBO assumes in its baseline projections that discretionary funding subject to the caps in the coming years will be equal to the amounts currently specified in law for those caps. As a result, legislation that reduced the funds available for a particular discretionary activity or achieved savings in undertaking a particular activity would only reduce projected total appropriations if the legislation also lowered the caps; without a reduction in the caps, funding for other discretionary activities would probably fill the gap created by the specific reduction or savings.
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H.R. 5297, Small Business Jobs and Credit Act of 2010
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H.R. 5297, Small Business Jobs and Credit Act of 2010
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Questions Regarding the CBO Cost Estimate for H.R. 5297 (Public Law 111-240), The Small Business Jobs Act of 2010
Estimated Impact of Automatic Budget Enforcement Procedures Specified in the Budget Control Act
Highlights
The Budget Control Act of 2011 (enacted on August 2 as Public Law 112-25) made several changes to federal programs and established budget enforcement mechanisms—including caps on future discretionary appropriations—that were estimated to reduce federal budget deficits by a total of at least $2.1 trillion over the 2012–2021 period. The caps on discretionary appropriations will decrease spending (including debt-service costs) by an estimated $0.9 trillion during that period, compared with what such spending would have been if annual appropriations had grown at the rate of inflation. At least another $1.2 trillion in deficit reduction was anticipated from provisions related to a newly established Congressional Joint Select Committee on Deficit Reduction. That committee is charged with proposing legislation to trim budget deficits by at least $1.5 trillion between 2012 and 2021. However, if legislation originating from the committee and estimated to produce at least $1.2 trillion in deficit reduction (including an allowance for interest savings) is not enacted by January 15, 2012, automatic procedures for cutting both discretionary and mandatory spending will take effect. The magnitude of those cuts would depend on any shortfall in the estimated effects of such legislation relative to the $1.2 trillion amount.
The automatic reductions—if triggered—would take the form of equal cuts (in dollar terms) in defense and nondefense spending starting in fiscal year 2013. Those cuts would be achieved by lowering the caps on discretionary budget authority specified in the Budget Control Act and by automatically cancelling budgetary resources (a process known as sequestration) for some programs and activities financed by mandatory spending. The law exempts a significant portion of mandatory spending from sequestration, however. The total savings attributed to the automatic procedures would include lower debt-service costs resulting from those cuts.
The Congressional Budget Office (CBO) has estimated the changes in discretionary and mandatory spending that would occur if the automatic enforcement mechanisms were triggered because no new deficit reduction legislation was enacted. CBO's analysis can only approximate the ultimate results; the Administration's Office of Management and Budget (OMB) would be responsible for implementing any such automatic reductions on the basis of its own estimates
CBO estimates that, if no legislation originating from the deficit reduction committee was enacted, the automatic enforcement process specified in the Budget Control Act would produce the following results between 2013 and 2021:
- Reductions ranging from 10.0 percent (in 2013) to 8.5 percent (in 2021) in the caps on new discretionary appropriations for defense programs, yielding total outlay savings of $454 billion.
- Reductions ranging from 7.8 percent (in 2013) to 5.5 percent (in 2021) in the caps on new discretionary appropriations for nondefense programs, resulting in outlay savings of $294 billion.
- Reductions ranging from 10.0 percent (in 2013) to 8.5 percent (in 2021) in mandatory budgetary resources for nonexempt defense programs, generating savings of about $0.1 billion.
- Reductions of 2.0 percent each year in most Medicare spending because of the application of a special rule that applies to that program, producing savings of $123 billion, and reductions ranging from 7.8 percent (in 2013) to 5.5 percent (in 2021) in mandatory budgetary resources for other nonexempt nondefense programs and activities, yielding savings of $47 billion. Thus, savings in nondefense mandatory spending would total $170 billion.
- About $31 billion in outlays stemming from the reductions in premiums for Part B of Medicare and other changes in spending that would result from the sequestration actions.
- An estimated reduction of $169 billion in debt-service costs.
In all, those automatic cuts would produce net budgetary savings of about $1.1 trillion over the 2013–2021 period, CBO estimates. That amount is lower than the $1.2 trillion figure for deficit reduction in the Budget Control Act for three reasons. First, because of the lag in timing between appropriations and subsequent expenditures, part of the savings from the automatic cuts in budgetary resources would occur after 2021. Second, CBO expects that some reductions—particularly those related to Medicare—would have other effects that would boost net spending (by the $31 billion mentioned above). Third, CBO estimates that the reduction in debt-service costs would be lower than the amount of such savings stipulated in the Budget Control Act.
The majority of the savings from the automatic spending reductions would stem from further cuts in discretionary spending (beyond those embodied in the new law's caps on discretionary budget authority). CBO expects that about 71 percent of the net savings from the automatic procedures would come from lowering the caps on discretionary appropriations, 13 percent would come from a net reduction in mandatory spending, and 16 percent would result from lower debt-service costs.
Of course, the Budget Control Act could produce outcomes that are very different than the figures outlined above. The Congress could enact legislation originating from the deficit reduction committee that would produce $1.2 trillion in savings through changes that differ significantly from the automatic reductions that would be required in the absence of such legislation. Or such legislation could yield some savings, but less than $1.2 trillion, so the automatic procedures would have a smaller impact than CBO has estimated here. Alternatively, the deficit reduction committee could recommend, and the Congress could enact, legislation saving significantly more than $1.2 trillion. (The Budget Control Act states that the committee's goal is to achieve at least $1.5 trillion in savings over the 2012–2021 period.)
Federal Loan Guarantees for the Construction of Nuclear Power Plants
Abstract
CBO's analysis examines the main factors that influence the cost to the federal government of providing loan guarantees for the construction of nuclear power plants. It includes illustrative cost estimates using the methodology specified by the Federal Credit Reform Act of 1990, which determines the budgetary cost of the program, and also estimates prepared on a fair-value basis, which provide a more comprehensive measure of cost. CBO found that the expected cost to the federal government of guaranteeing a nuclear construction loan varies greatly depending on a project's characteristics. Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates. However, because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee, either under credit reform or on a fair-value basis.
Highlights
Among the goals often posited for federal energy policy are to enhance energy security by diminishing the nation's reliance on foreign oil, to meet a growing demand for electricity, and to reduce greenhouse gas emissions by encouraging investment in clean energy production and technologies. To help further such objectives, the Energy Policy Act of 2005 (Public Law 109-58) established incentives to encourage private investment in innovative technologies, including advanced nuclear energy facilities. Much of the support for such investment is provided under title XVII of that legislation, which offers federal loan guarantees for the construction of nuclear power plants and other types of "alternative" energy facilities.
Administered by the Department of Energy (DOE), the loan guarantee program encourages private investment in nuclear energy by lowering the cost of borrowing and possibly increasing the availability of credit for project sponsors—usually an individual utility, a consortium of utilities, or a merchant power producer. In exchange for providing a loan guarantee, DOE is authorized to charge sponsors a fee that is meant to recover the guarantee's estimated budgetary cost.
However, budgetary cost estimates—which are calculated as required under the Federal Credit Reform Act of 1990 (FCRA)—are not a comprehensive measure of the cost to taxpayers of those guarantee commitments. Specifically, FCRA estimates do not recognize that the government's assumption of financial risk has costs for taxpayers that exceed the average amount of losses that would be expected from defaults; those additional costs arise because a borrower is most likely to default on a loan and fail to make the promised payments of principal and interest during times of economic stress, when the losses are especially painful for taxpayers. Consequently, the estimated budgetary cost of a guarantee is generally lower than its estimated "fair-value" cost, which approximates the market price that a private guarantor would charge for an obligation with similar risk and expected returns.
Because budgetary cost estimates are not a comprehensive measure of the taxpayer resources committed, and because of concerns about the accuracy of the methods and assumptions that DOE uses to forecast default rates and recovery values, some commentators have suggested that federal loan guarantees for the construction of nuclear power plants are being systematically underpriced, whereas others believe they are being overpriced.
For this study, the Congressional Budget Office (CBO) reviewed the many factors that can influence the cost to the government of guaranteeing loans for the construction of advanced nuclear facilities; developed a model to estimate guarantee costs for a representative loan using both FCRA-based and fair-value methodologies; performed a sensitivity analysis of those estimated costs to changes in assumptions about key drivers of cost; and explored the challenges inherent in attempting to charge borrowers the full cost of a loan guarantee. CBO's findings are as follows:
- The expected cost to the federal government of guaranteeing a nuclear construction loan will vary greatly depending on a project's characteristics and on the economic and regulatory environment in which the project will operate. Important considerations include capital structure (the mix of debt and equity used to finance the project); ownership structure (whether it is a stand-alone project or part of a diversified company); whether construction costs may be passed on to utility ratepayers or local taxpayers; the regulatory environment; the degree of uncertainty about construction costs; the cost of competing generation technologies; and the demand for electricity. Although a serious nuclear accident could entail extremely large costs to investors and society, that risk has a small effect on the direct cost to the government of providing a guarantee because liability under the guarantee is limited to the amount of the debt, and the probability that such an accident will occur is low.
- Default rates and recovery rates are likely to vary considerably, both across projects and over the lifetime of a given project. CBO does not have enough information to independently estimate an average recovery rate for nuclear construction loans. However, assigning a similar expected recovery rate as a starting point for all projects—which is DOE's current practice—does not appear to make full use of the information available to DOE through its detailed project assessment process. For example, when sponsors of stand-alone projects cannot pass on construction costs to rate-payers, very low recoveries may result if bankruptcy occurs during the construction phase. By contrast, recovery rates may be considerably higher once projects become operational.
Using a single recovery rate tends to increase the variability of estimated guarantee costs relative to their true values, which increases the government's exposure to a phenomenon known as adverse selection. Adverse selection occurs when borrowers are better able than the government to assess the value of a guarantee offer and take advantage of their superior information at the government's expense. For nuclear construction loans, borrowers will tend to turn down a guarantee if they believe the fee set by DOE is too high but go forward if they consider it fair or underpriced, which increases the likelihood that DOE's portfolio will include more projects for which the subsidy fee has been underestimated than overestimated. - When credit ratings are used to assess default probabilities, cost estimates will vary widely with the assigned ratings category, the assumed recovery rate, and whether Treasury interest rates or estimated market interest rates are used for discounting. CBO relied on the information in historical credit ratings to impute default probabilities (as does DOE) and considered a range of recovery rates that might apply to different projects depending on their characteristics. As required under FCRA, budgetary estimates use Treasury interest rates for discounting future cash flows; fair-value estimates rely on estimates of the applicable market interest rates for discounting.
- Budgetary estimates of guarantee costs are significantly lower than the corresponding fair-value estimates, which provide a more comprehensive measure of the cost to taxpayers. CBO used the credit rating associated with a project to derive the discount rate the market would most likely assign to the loan cash flows. For example, if the risks associated with a guaranteed loan are in the range of those posed by bonds rated A (less risky) and bonds rated BB (riskier), and if 55 percent of the amount owed is expected to be recovered in the event of a default, the budgetary cost, measured on a FCRA basis, ranges from 1 percent to 6 percent of the principal loaned. In contrast, the fair value of the guarantee ranges from 9 percent to 21 percent of the principal loaned.
- Because of the high degree of uncertainty involved, it may not be possible to charge borrowers the full cost of a loan guarantee. When adverse selection is severe, attempts to offset expected losses with an increase in fees can backfire because the higher fees drive away creditworthy borrowers, making it impossible to provide a loan guarantee that does not involve a subsidy.
CBO relied on a credit-ratings-based approach to evaluate the probability of default rather than on the historical experience of the nuclear industry, for which not enough data exist to draw quantitative inferences. However, historical experience suggests that investing in nuclear generating capacity engenders considerable risk. One study found that of the 117 privately owned plants in the United States that were started in the 1960s and 1970s and for which data were available, 48 were canceled, and almost all of them experienced significant cost overruns. As a consequence, most of the utilities that undertook nuclear projects suffered ratings downgrades—sometimes several downgrades—during the construction phase.
However, bondholders experienced losses from defaults in only a few instances. Losses for the most part were borne by the projects' equity holders, the regions' electricity ratepayers, and the government. Supporters of nuclear power argue that newer plant designs and changes in the regulatory environment make nuclear investments less risky now, but recent experience abroad suggests that cost overruns and delays are still common phenomena, and concerns remain about an uncertain regulatory environment and changes in demand for electricity.
Finally, although the federal budget is intended to account for the costs of federal activities, it does not account for the benefits of such activities. As is the case with other types of federal spending, loan guarantees for the construction of nuclear plants might increase well-being by supporting activities that are valuable to society but that are unlikely to be economically viable without governmental support. In assessing the value of the program, such benefits must be weighed against the costs of those activities. However, an analysis of the benefits of loan guarantees for nuclear construction is beyond the scope of this study.