learn more about working at cbo and check out the agency’s career opportunities
data or technical information
January 3, 2011
read complete document (xls, kb)
Budget and Economic Outlook
CBO's Budget and Economic Outlook—usually produced in January each year and updated in August—includes projections of spending and revenues under current law over the next 10 years as well as an economic forecast for that period. CBO also typically prepares an update of its budget projections in March each year in conjunction with its analysis of the President's budgetary proposals. Those projections under current law provide the Congress with a benchmark against which to measure the effects of proposed changes in spending and tax laws.
Details of CBO's Year-by-Year Forecast and Projections for Calendar Years 2010 to 2021 - January 2011
Abstract
These spreadsheets reflect CBO's estimates, assumptions, and projections at the time the associated publication was released; that is, the spreadsheets are not continuously updated.
Full Text
- document
Additional Data
- Budget Projections
- Detailed Economic Projections, CY 2010-2021; Actual Data, 1950-2009 (xls)
- Key Assumptions in Projecting Potential Output (xls)
Supplemental Material
- Budget Projections
- Economic Projections
- Historical Budget Data
- Historical Budget Data
- economic tables
- Supplemental Data on Spending Projections
- Data Underlying Selected Economic Figures
Baseline Projections for Mandatory Spending Programs
- Child Nutrition Programs - January 2011 Baseline
- blog post
Budget and Economic Outlook: Fiscal Years 2011 to 2021
Highlights
The United States faces daunting economic and budgetary challenges. The economy has struggled to recover from the recent recession, which was triggered by a large decline in house prices and a financial crisis—events unlike anything this country has seen since the Great Depression. During the recovery, the pace of growth in the nation's output has been anemic compared with that during most other recoveries since World War II, and the unemployment rate has remained quite high.
For the federal government, the sharply lower revenues and elevated spending deriving from the financial turmoil and severe drop in economic activity—combined with the costs of various policies implemented in response to those conditions and an imbalance between revenues and spending that predated the recession—have caused budget deficits to surge in the past two years. The deficits of $1.4 trillion in 2009 and $1.3 trillion in 2010 are, when measured as a share of gross domestic product (GDP), the largest since 1945—representing 10.0 percent and 8.9 percent of the nation's output, respectively.
For 2011, the Congressional Budget Office (CBO) projects that if current laws remain unchanged, the federal budget will show a deficit of close to $1.5 trillion, or 9.8 percent of GDP. The deficits in CBO's baseline projections drop markedly over the next few years as a share of output and average 3.1 percent of GDP from 2014 to 2021. Those projections, however, are based on the assumption that tax and spending policies unfold as specified in current law. Consequently, they understate the budget deficits that would occur if many policies currently in place were continued, rather than allowed to expire as scheduled under current law.
The Economic Outlook
Although recent actions by U.S. policymakers should help support further gains in real (inflation-adjusted) GDP in 2011, production and employment are likely to stay well below the economy's potential for a number of years. CBO expects that economic growth will remain moderate this year and next. As measured by the change from the fourth quarter of the previous year, real GDP is projected to increase by 3.1 percent this year and by 2.8 percent next year. That forecast reflects CBO's expectation of continued strong growth in business investment, improvements in both residential investment and net exports, and modest increases in consumer spending. It also includes the impact of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (referred to in this report as the 2010 tax act), enacted in December, which provides a short-term boost to the economy by reducing some taxes, extending unemployment benefits, and delaying an increase in taxes that would otherwise have occurred in 2011. CBO projects that inflation will remain very low in 2011 and 2012, reflecting the large amount of unused resources in the economy, and will average no more than 2.0 percent a year between 2013 and 2016.
The recovery in employment has been slowed not only by the moderate growth in output in the past year and a half but also by structural changes in the labor market, such as a mismatch between the requirements of available jobs and the skills of job seekers, that have hindered the reemployment of workers who have lost their job. Payroll employment, which declined by 7.3 million during the recent recession, gained a mere 70,000 jobs (or 0.06 percent), on net, between June 2009 and December 2010. (By contrast, in the first 18 months of past recoveries, employment rose by an average of 4.4 percent.) Consequently, the rate of unemployment has fallen by only a small amount: After climbing to 10.1 percent of the labor force during 2009, the unemployment rate declined only to 9.4 percent by December 2010. Other measures of labor market conditions suggest even more slack than does the unemployment rate. For example, almost 9 million workers who have wanted full-time work in the past two years have been employed only part time.
As the recovery continues, the economy will add roughly 2.5 million jobs per year over the 2011–2016 period, CBO estimates. However, even with significant increases in the number of jobs, a substantial reduction in the unemployment rate will take some time. CBO projects that the unemployment rate will gradually fall in the near term, to 9.2 percent in the fourth quarter of 2011, 8.2 percent in the fourth quarter of 2012, and 7.4 percent at the end of 2013. Only by 2016, in CBO's forecast, does it reach 5.3 percent, close to the agency's estimate of the natural rate of unemployment (the rate of unemployment arising from all sources except fluctuations in aggregate demand, which CBO now estimates to be 5.2 percent).
For the period beyond 2016, CBO's economic projections are based on trends in the factors that underlie potential output, including the labor force, capital accumulation, and productivity. The projections therefore do not explicitly incorporate fluctuations resulting from the business cycle. In CBO's projections, growth of real GDP averages 2.4 percent annually from 2017 to 2021, a pace that matches the growth of potential GDP over those years. The unemployment rate averages 5.2 percent in that same period.
The Budget Outlook
The recovery now under way might be expected to lessen the budget imbalance in 2011 by increasing tax revenues and decreasing spending for certain income-support programs, such as unemployment compensation. However, revenue growth will be restrained by the slow and tentative pace of the recovery and by the 2010 tax act.
Moreover, outlays for many programs are projected to continue to grow and more than offset the decreases in spending (for unemployment compensation, for example) yielded by improving economic conditions.
The resulting federal budget deficit of nearly $1.5 trillion projected for this year will equal 9.8 percent of GDP, a share that is nearly 1 percentage point higher than the shortfall recorded last year and almost equal to the deficit posted in 2009, which at 10.0 percent of GDP was the highest in nearly 65 years.
By CBO's estimates, federal revenues in 2011 will be $123 billion (or 6 percent) more than the total revenues recorded two years ago, in 2009. The continued slow improvement in economic conditions is anticipated to boost revenues from individual income taxes, corporate taxes, and other sources by nearly $200 billion between those two years; however, revenues from social insurance taxes are projected to decline by more than $70 billion relative to their level two years ago, mostly as a result of a one-year reduction in payroll taxes included in the 2010 tax act.
Spending, for the most part, has been growing faster than revenues. Programs related to the federal government's response to the problems in the housing and financial markets are an exception; outlays recorded for the Troubled Asset Relief Program (TARP), for example, will decrease by $176 billion from 2009 to 2011, CBO projects. But if current laws remain unchanged, federal outlays other than those for the TARP are projected to be $366 billion (or 11 percent) higher in 2011 than they were in 2009.
According to CBO's projections, mandatory spending excluding outlays for the TARP will increase by $191 billion (or 10 percent) between 2009 and 2011. Significant growth in many areas—in particular, for Social Security, Medicare, and Medicaid—is expected to be offset only partially by reductions in outlays for other programs, primarily for Fannie Mae, Freddie Mac, and deposit insurance. Discretionary spending will increase by an estimated $137 billion over the two-year period; about one-third of that increase stems from funding provided by the American Recovery and Reinvestment Act of 2009 (ARRA). In addition, outlays for net interest will rise by an estimated $38 billion from 2009 to 2011, mostly because of substantial increases in borrowing.
Under current law, CBO projects, budget deficits will drop markedly over the next few years—to $1.1 trillion in 2012, $704 billion in 2013, and $533 billion in 2014. Relative to the size of the economy, those deficits represent 7.0 percent of GDP in 2012, 4.3 percent in 2013, and 3.1 percent in 2014. From 2015 through 2021, the deficits in the baseline projections range from 2.9 percent to 3.4 percent of GDP.
The deficits that will accumulate under current law will push federal debt held by the public to significantly higher levels. Just two years ago, debt held by the public was less than $6 trillion, or about 40 percent of GDP; at the end of fiscal year 2010, such debt was roughly $9 trillion, or 62 percent of GDP, and by the end of 2021, it is projected to climb to $18 trillion, or 77 percent of GDP. With such a large increase in debt, plus an expected increase in interest rates as the economic recovery strengthens, interest payments on the debt are poised to skyrocket over the next decade. CBO projects that the government's annual spending on net interest will more than double between 2011 and 2021 as a share of GDP, increasing from 1.5 percent to 3.3 percent.
CBO's baseline projections are not intended to be a forecast of future budgetary outcomes; rather, they serve as a neutral benchmark that legislators and others can use to assess the potential effects of policy decisions. Consequently, they incorporate the assumption that current laws governing taxes and spending will remain unchanged. In particular, the baseline projections in this report are based on the following assumptions:
- Sharp reductions in Medicare's payment rates for physicians' services take effect as scheduled at the end of 2011;
- Extensions of unemployment compensation, the one-year reduction in the payroll tax, and the two-year extension of provisions designed to limit the reach of the alternative minimum tax all expire as scheduled at the end of 2011;
- Other provisions of the 2010 tax act, including extensions of lower tax rates and expanded credits and deductions originally enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2003, and ARRA, expire as scheduled at the end of 2012; and
- Funding for discretionary spending increases with inflation rather than at the considerably faster pace seen over the dozen years leading up to the recent recession.
The projected deficits over the latter part of the coming decade are much smaller relative to GDP than is the current deficit, mostly because, under those assumptions and with a continuing economic expansion, revenues as a share of GDP are projected to rise steadily—from about 15 percent of GDP in 2011 to 21 percent by 2021.
As a result, the baseline projections understate the budget deficits that would arise if many policies currently in place were extended, rather than allowed to expire as scheduled under current law. For example, if most of the provisions in the 2010 tax act that were originally enacted in 2001, 2003, and 2009 or that modified estate and gift taxation were extended (rather than allowed to expire on December 31, 2012), and the alternative minimum tax was indexed for inflation, annual revenues would average about 18 percent of GDP through 2021 (which is equal to their 40-year average), rather than the 19.9 percent shown in CBO's baseline projections. If Medicare's payment rates for physicians' services were held constant as well, then deficits from 2012 through 2021 would average about 6 percent of GDP, compared with 3.6 percent in the baseline. By 2021, the budget deficit would be about double the baseline projection, and with cumulative deficits totaling nearly $12 trillion over the 2012–2021 period, debt held by the public would reach 97 percent of GDP, the highest level since 1946.
Beyond the 10-year projection period, further increases in federal debt relative to the nation's output almost certainly lie ahead if current policies remain in place. The aging of the population and rising costs for health care will push federal spending as a percentage of GDP well above that in recent decades. Specifically, spending on the government's major mandatory health care programs—Medicare, Medicaid, the Children's Health Insurance Program, and health insurance subsidies to be provided through insurance exchanges—along with Social Security will increase from roughly 10 percent of GDP in 2011 to about 16 percent over the next 25 years. If revenues stay close to their average share of GDP for the past 40 years, that rise in spending will lead to rapidly growing budget deficits and surging federal debt. To prevent debt from becoming unsupportable, policymakers will have to substantially restrain the growth of spending, raise revenues significantly above their historical share of GDP, or pursue some combination of those two approaches.
monthly archive
- May 2013 (2)
- April 2013 (14)
- March 2013 (22)
- February 2013 (10)
- January 2013 (11)
- December 2012 (4)
- November 2012 (10)
- October 2012 (4)
- September 2012 (6)
- August 2012 (5)
- July 2012 (11)
- June 2012 (8)
Abstract
Recently, the federal government has been recording the largest budget deficits, as a share of gross domestic product (GDP), since the end of World War II. As a result of those deficits, the amount of federal debt held by the public has soared--surpassing $9 trillion at the end of fiscal year 2010 and equal to 62 percent of GDP. The interest the government pays on that debt is currently low by historical standards as a percentage of GDP but is expected to grow rapidly over the next several years as interest rates rise. In response to a request from the Chairman and Ranking Member of the Senate Budget Committee, this study provides background material on federal debt and interest costs.
Highlights
The past few years have seen a sharp rise in the debt of the federal government. At the end of fiscal year 2008, debt held by the public amounted to $5.8 trillion--equal to 40 percent of the nation's annual economic output (gross domestic product, or GDP), a little above the 40-year average of 35 percent. Since then, debt held by the public has shot upward, surpassing $9 trillion by the end of fiscal year 2010--equal to 62 percent of GDP, the highest percentage since shortly after World War II. The surge in debt stems partly from lower tax revenues and higher federal spending related to the recent severe recession and turmoil in financial markets. However, the growing debt also reflects an imbalance between spending and revenues that predated those economic developments.
At the same time, a sharp drop in interest rates has held down the amount of interest that the government pays on that debt. In 2010, net interest outlays totaled $197 billion, or 1.4 percent of GDP--a smaller share of GDP than they accounted for during most of the past decade.
The Congressional Budget Office (CBO) projects that, under current law, debt held by the public will exceed $16 trillion by 2020, reaching nearly 70 percent of GDP. CBO also projects that interest rates will go up. The combination of rising debt and rising interest rates is projected to cause net interest payments to balloon to nearly $800 billion, or 3.4 percent of GDP, by 2020.
Many other outcomes are possible, however. If, for example, the tax reductions enacted earlier in the decade were continued, the alternative minimum tax was indexed for inflation, and future annual appropriations remained the same share of GDP that they were in 2010, debt held by the public would total nearly 100 percent of GDP by 2020. Interest costs would be correspondingly higher.
This CBO study describes historical trends in borrowing by the federal government and the interest the government pays on that borrowing. The study takes an in-depth look at the most commonly used measure of the government's debt--debt held by the public--and also discusses several other measures of the debt, such as debt held by the public net of financial assets, gross federal debt, and debt subject to limit. In addition, the study examines the government's net interest costs and the types of transactions that generate interest payments and collections.
Debt Held by the Public
To finance the government's activities, the Treasury issues numerous types of securities that vary in their maturity, how they are sold, and how their payments are structured. Marketable securities--bills, notes, bonds, and inflation-protected securities--are auctioned at regular intervals during the year and accounted for nearly 95 percent of outstanding debt held by the public at the end of 2010. Nearly two-thirds of that marketable debt was in Treasury notes, which have an original maturity of 2 to 10 years.
A small percentage of debt held by the public is in the form of nonmarketable securities, which cannot be resold by the original purchasers. Those securities include savings bonds, securities issued to state and local governments, and securities used for investments of the government's Thrift Savings Plan (a retirement savings program for civil service employees and members of the uniformed services).
The government's net borrowing for each year (that is, the new cash it must raise, over and above the amount required to pay off maturing securities) is determined largely by the size of the federal deficit. However, a number of other factors--collectively labeled other means of financing and not directly included in budget totals--also affect the amount of debt that the government issues. Those factors include changes in the government's cash balances and the cash flows of federal credit programs (mostly programs that provide loans and loan guarantees).
Many investors consider federal debt to be an attractive investment, in part because it is essentially free of any risk of default. At the end of 2010, domestic entities owned about 53 percent of the outstanding public debt, and foreign entities owned about 47 percent. Central banks and private entities in China, Japan, and the United Kingdom are the largest foreign investors.
Other Measures of Federal Debt
In addition to debt held by the public, a number of other measures of federal debt are used for various purposes. Debt held by the public net of financial assets is a measure that reflects the fact that the government affects financial markets not only by borrowing but also by acquiring financial assets. Those assets affect the government's financial condition: If sold, the proceeds could be used to pay down a portion of the federal debt; if retained by the government, they will generate inflows from interest, dividends, and repayments of principal that will reduce the government's future borrowing needs.
Debt held by the public net of financial assets is calculated by subtracting from debt held by the public the value of assets the government has acquired through its various activities in the credit markets (such as loans made by federal programs) and through its efforts to address the recent financial crisis (such as preferred stock in financial institutions), as well as its cash balances. At the end of 2010, debt net of financial assets totaled $8.0 trillion--$1.0 trillion less than debt held by the public and 55 percent of GDP (compared with 62 percent of GDP when financial assets are not taken into account). Debt held by the public net of financial assets provides a more comprehensive picture of the government's financial condition and its overall impact on credit markets than debt held by the public, but calculating it is not straightforward because neither the universe of such assets nor the method for valuing them is well defined.
Assessing the government's overall financial condition requires accounting not only for debt that the government has already incurred (and financial assets it has acquired) but also for commitments the government has made for the future. Debt held by the public, with or without an adjustment for the government's financial assets, does not account for such future obligations. One useful barometer of the future fiscal situation is projections of changes in debt held by the public relative to GDP; that measure indicates whether the government's participation in credit markets is expected to grow faster or slower than economic output. Another useful gauge is the fiscal gap, which measures the immediate change in spending or revenues that would be necessary to keep the projected debt-to-GDP ratio the same at the end of a given period as at the beginning of the period. The fiscal gap quantifies the projected long-term shortfall of revenues relative to outlays in present-value terms--that is, as a single number that describes a flow of future revenues or outlays in terms of an equivalent lump sum received or spent today. These forward-looking measures are not addressed in this study but are used extensively in other CBO publications.
Gross debt, which comprises federal debt held by the public plus Treasury securities held by federal trust funds and other government accounts, is sometimes used to evaluate the government's overall fiscal situation. At the end of 2010, gross federal debt totaled $13.5 trillion--the $9.0 trillion in debt held by the public plus $4.5 trillion in debt held by government accounts. More than half of the latter amount is held by the Social Security trust funds. Because those trust funds and other government accounts are part of the federal government, transactions between them and the Treasury are intragovernmental; that is, the government securities in those funds are an asset to the individual programs but a liability to the rest of the government. The resources needed to redeem the government securities in the trust funds and other accounts in some future year must be generated from taxes, income from other government sources, or borrowing by the government in that year.
Gross debt is not a good indicator of the government's fiscal condition, however (nor is debt subject to limit, the amount of federal debt that is subject to the overall limit set in law and is roughly equal to gross debt). The value of Treasury securities held by trust funds and other government accounts measures only some of the commitments the government has made for the future, and it includes some amounts that may not represent future obligations at all. Moreover, because those securities represent internal transactions of the government, they have no direct effect on credit markets.
Interest Payments and Receipts
The government pays and collects interest in various ways. Its net interest outlays are equal to the interest it pays minus the interest it receives. Net interest outlays are dominated by the interest paid to holders of the debt that the Treasury issues to the public. Although the Treasury also issues debt to trust funds and other government accounts, the payment of interest to those accounts is an intragovernmental transaction that has no effect on net interest outlays or on the budget deficit.
The federal government's interest payments depend primarily on interest rates and the amount of debt held by the public. Other factors, such as the rate of inflation and the maturity structure of outstanding securities, also affect interest costs (for example, long-term bonds generally carry higher interest rates than do short-term bills). Interest rates are determined by a combination of market forces and the policies of the Federal Reserve. Debt held by the public is determined mostly by cumulative budget deficits, which depend on policy choices about spending and revenues and on economic conditions and other factors.
Although the federal government has increased its net borrowing by more than $3 trillion in the past two years, net interest costs dropped from $253 billion in 2008 to $197 billion in 2010 because of remarkably low interest rates. The amounts of net interest shown in the budget include interest paid on all Treasury securities ($413 billion in 2010), minus the portion of that interest that is received by trust funds ($186 billion in 2010) and the net amount of other interest received by the government ($30 billion in 2010). The last category consists primarily of net receipts to the Treasury from the financing accounts for federal loan programs (those accounts are not included in the federal budget).
In CBO's most recent projections, which assume that current laws remain the same, annual deficits decline from the $1.3 trillion recorded in 2010, but the cumulative deficit from 2011 through 2020 exceeds $6.2 trillion. Borrowing to finance that deficit--in combination with an expected rise in interest rates--would lead to a fourfold increase in net interest payments over the next 10 years, from $197 billion in 2010 to $778 billion in 2020. As a percentage of GDP, net interest outlays would more than double during that period, rising from 1.4 percent to 3.4 percent.
monthly archive
- May 2013 (2)
- April 2013 (14)
- March 2013 (22)
- February 2013 (10)
- January 2013 (11)
- December 2012 (4)
- November 2012 (10)
- October 2012 (4)
- September 2012 (6)
- August 2012 (5)
- July 2012 (11)
- June 2012 (8)
Trends in Federal Tax Revenues and Rates
Abstract
This testimony addresses revenues collected by the federal government, how taxes affect economic activity, and the tax burden and who bears it. Other elements of the current tax system--such as its complexity and the resulting costs of compliance--are also important but are not addressed here.
Highlights
Federal Revenues: Trends and Projections
Over the past 40 years, federal revenues have ranged from nearly 21 percent of gross domestic product (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. Other sources of revenues include corporate income taxes, excise taxes, estate and gift taxes--all together about 13 percent of revenues in 2010--and nontax revenues such as earnings of the Federal Reserve System, customs duties, fines, and various fees. Variation in individual income tax receipts, stemming from both policy changes and economic developments, has generated the largest fluctuations in revenues as a percentage of GDP.
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. The Congressional Budget Office (CBO) projects that under current law, federal revenues will reach 21 percent of GDP in fiscal year 2020, just above their peak share of 10 years ago.
Slides from the Director's Testimony
Trends in Federal Tax Revenues and Rates
View more presentations from Congressional Budget Office.
View Related CBO Analyses
CBO also projects that under current law, federal spending will decline for a few years relative to GDP and then increase again, reaching 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, under current law, to be unusually large relative to GDP by 2020 are the expenditures for Social Security and the federal health programs (including spending for Medicare, Medicaid, and the subsidies to be provided in the new insurance exchanges); other nondefense spending is projected to roughly equal its historical share of GDP, and defense spending is projected to be a smaller share of GDP.
As a result, 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 lawmakers 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.
How Taxes Affect Economic Activity: Marginal Tax Rates and Tax Expenditures
Taxes have an effect on the economy in addition to the revenues collected because they cause people to alter their economic behavior, which generally results in a less efficient allocation of resources. Taxpayers can respond in three general ways to taxes: They can change the timing of their activities, for example by accelerating bonus payments or the sale of assets into this year if they think tax rates on earnings or capital gains will increase next year; they can adjust the form of their activities, for example by substituting tax-preferred fringe benefits for cash wages if the tax rate on wages increases; or they can change more fundamental aspects of their behavior, for example by working or saving less if tax rates on earnings or capital income increase.
The crucial point is that taxes raise the price of taxed activities and thereby lower the relative price of other things. In particular, the income tax reduces the returns from working (the after-tax wage), which lowers the price of other activities relative to working; it also reduces the returns from saving (the after-tax rate of return), which lowers the price of current spending relative to saving for spending in the future.
One measure of the effect of taxes on the returns from working and saving is the marginal tax rate--the tax paid per dollar of extra earnings or dollar of extra income from savings. The highest marginal income tax rate (the tax rate that applies to the top income tax bracket) was 91 percent in the late 1950s and early 1960s and 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) during the period from 1955 to 1975 was around 20 percent. That rate climbed over the next 10 years as a result of rising payroll tax rates and inflation-driven increases in nominal incomes, which pushed median-income families into higher tax brackets. Following a reduction in income tax rates in 1986, the marginal tax rate for a representative median-income family has remained at about 30 percent.
Changes in marginal tax rates have two different types of effects on people. The lower that tax rates are, the more people can keep of the returns from additional work or saving, thus boosting people’s incentives to work and save. But lower rates also have a countervailing effect: By raising after-tax income, they make it easier for people to attain their consumption goals with a given amount of work or savings, thus possibly causing people to work and save less. On balance, the evidence suggests that reducing tax rates boosts work and saving relative to what would occur otherwise, if budget deficits are held the same. But without any other changes in taxes or spending, reducing tax rates from current levels will generally lower revenues and increase budget deficits. Increased deficits, even with lower tax rates, can reduce economic activity over the longer term.
Provisions of the tax code can also affect economic activity by subsidizing certain types of expenditures. Until recently, most federal support for homeownership was provided through the tax code in the form of tax expenditures, which are revenues that are forgone because of special exclusions, exemptions or deductions from gross income, special credits, preferential tax rates, or deferrals of tax liabilities aimed at subsidizing certain activities. The largest and most widely used tax expenditure in the housing area is the deduction from taxable income for mortgage interest on owner-occupied homes, which results in an estimated $573 billion in forgone revenues from 2009 to 2013. That deduction encourages homeowners to buy homes and to take out larger mortgages than they might otherwise be able to afford, resulting in higher household debt, higher home prices in areas where the supply of housing is fixed, and less investment in other assets.
Another substantial tax expenditure is the exclusion of employers’ contributions for health insurance premiums from income and payroll taxes. That exclusion encourages employers to offer health insurance to their workers and to pay their workers a larger share of their compensation in that form; the resulting higher levels of insurance increase demand for health care services. Tax expenditures have helped to accomplish various goals, but because they reduce the base to which taxes apply, tax rates must be higher to collect the same amount of revenues that would be collected in the absence of those subsidies.
The Tax Burden and Who Bears It
Households generally bear the economic cost, or burden, of the taxes that they pay directly, such
as individual income taxes (including taxes paid on dividends, interest, and capital gains) and employees’ share of payroll taxes. Households also bear the burden of the taxes paid by businesses. In particular, in CBO’s judgment (and that of most economists), employers’ share of payroll taxes is passed on to employees in the form of lower wages. In addition, households bear the burden of corporate income taxes, but the extent to which they bear that burden as owners of capital, workers, or consumers is not clear.
One measure of the tax burden is the average tax rate--that is, the taxes paid as a share of income. Federal taxes are progressive: Average federal tax rates generally rise with income. In 2007, households in the bottom fifth, or quintile, of the income distribution (with average income of $18,400, under a broad definition of income) paid about 4 percent of their income in federal taxes, while the middle quintile, with average income of $64,500, paid 14 percent, and the highest quintile, with average income of $264,700, paid 25 percent.
The largest source of federal revenues, the individual income tax, has average tax rates that rise rapidly with income. The next largest source of revenues, social insurance taxes, has average tax rates that vary little across most income groups--although the average rate falls for higher-income households, 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 combined declined for all income groups. The average individual income tax rate also declined over those years; the largest decrease occurred for the fifth of the population with the lowest income. (That decline in average tax rates is based on a comparison of rates for different income groups at different points in time but does not reflect the experience of particular households, which may move up or down the income scale over time.)
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.
Related CBO Analyses
Further information about many of these issues is available in other 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/topics/taxes/distribution-of-federal-taxes.
- Issues involving tax rates and how household income changes over time are discussed in Effective Tax Rates: Comparing Annual and Multiyear Measures (January 2005).
monthly archive
- May 2013 (2)
- April 2013 (14)
- March 2013 (22)
- February 2013 (10)
- January 2013 (11)
- December 2012 (4)
- November 2012 (10)
- October 2012 (4)
- September 2012 (6)
- August 2012 (5)
- July 2012 (11)
- June 2012 (8)
Report on the Troubled Asset Relief Program -- November 2010
Abstract
In October 2008, the Emergency Economic Stabilization Act of 2008 established the Troubled Asset Relief Program (TARP) to enable the Department of the Treasury to purchase or insure troubled assets as a way to promote stability in financial markets. Section 202 of that legislation requires the Congressional Budget Office (CBO) to prepare a report on those transactions within 45 days of a report issued by the Office of Management and Budget (OMB) on the TARP's activities. This fourth statutory report from CBO on the TARP's transactions follows the report that OMB submitted to the Congress on October 15, 2010.
Highlights
In October 2008, the Emergency Economic Stabilization Act of 2008 (Division A of Public Law 110-343) established the Troubled Asset Relief Program (TARP) to enable the Department of the Treasury to promote stability in financial markets through the purchase and guarantee of "troubled assets." Section 202 of that legislation requires the Office of Management and Budget (OMB) to submit semiannual reports on the costs of the Treasury's purchases and guarantees of troubled assets. The law also requires the Congressional Budget Office (CBO) to prepare an assessment of each OMB report within 45 days of its issuance. That assessment must discuss three elements:
- The costs of purchases and guarantees of troubled assets,
- The information and valuation methods used to calculate those costs, and
- The impact on the federal budget deficit and debt.
To fulfill its statutory requirement, CBO has prepared this report on transactions completed, outstanding, and anticipated under the TARP as of November 18, 2010. 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 (see Table 1). That cost stems largely from assistance to American International Group (AIG), aid to the automotive industry, and grant programs aimed at avoiding foreclosures. Other transactions with financial institutions will, taken together, yield a net gain to the federal government, CBO estimates.
CBO's current estimate of the cost of the TARP's transactions 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; and 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, P.L. 111-203). CBO's current estimate is also well below OMB's latest estimate, $113 billion, because the market value of assets held by the government has increased and several recipients of TARP funds — most notably General Motors and AIG &mdash have significantly restructured the Treasurys investment since May 31, 2010, the date used as the basis for OMB's analysis.
Clearly, it was not apparent when the TARP was created two years ago that the cost would turn out to be this low. At that time, the U.S. 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.