The Congress requires the Congressional Budget Office, to the greatest extent practicable, to assess the effects on the economy of “major” legislation that Congressional authorizing committees approve and to incorporate those effects into the agency’s 10-year cost estimates. CBO has previously explained how it incorporates such dynamic effects into its estimates in general and how it analyzes the macroeconomic and budgetary effects of changes in federal investment specifically. This blog post expands on the discussion of the effects of changes in federal investment by explaining in detail how CBO would assess the effects on the economy of changes in subsidies for one component of federal investment—education and job training. Education funding includes funding for preschool, grades K–12, and higher education (college and graduate school). Job training would include programs such as those authorized by the Workforce Innovation and Opportunity Act.
The purpose of this blog post is similar to that of earlier posts—for instance, a post on health insurance coverage—in that it provides more information about the basis for CBO’s estimates and the research that informs CBO’s judgments about the effects of federal subsidies for education and job training. The agency incorporated such effects into its macroeconomic analysis of the President’s budget last year—finding that they were very small—and expects to do so in its analyses of the proposals in future budgets.
Increases in existing federal subsidies for education and job training—in the form of either spending or tax preferences—would raise the skills of the U.S. workforce and ultimately increase average earnings and gross domestic product (GDP). However, the effects on the economy and the budget would be complicated—and could be negative. On the basis of evidence from the research literature, CBO expects larger subsidies for education and job training to have the following effects:
- People whose education or job training was subsidized by federal programs would ultimately have greater earnings than they otherwise would, on average, although the effect for any particular individual or program would vary.
- Some of those increased earnings would not occur until well into the future because, in some cases, recipients of subsidized education or job training would not enter the labor force for many years.
- Even though the gains in earnings from increased education would generally persist throughout recipients’ careers, the gains from job training would, on average, dissipate after a few years.
- Increases in subsidies for some types of education and job training would temporarily reduce the supply of labor because students typically work less while they are in school than they would otherwise.
- In the long term, a more skilled workforce would increase labor productivity—the amount of output per hour worked—and the supply of labor, which would tend to boost the capital stock, interest rates, wages, and GDP.
- The ultimate effect on GDP and the feedback of macroeconomic effects into the federal budget would depend on the overall amount of additional earnings and on how such subsidies were financed, on average.
Decreases in existing federal subsidies for education and job training would have the opposite effects.
- How Would Larger Federal Subsidies for Education and Job Training Increase Earnings?
- How Long Would It Take for Those Subsidies to Increase Earnings?
- How Long Would the Effects on Earnings Last?
- How Would Larger Federal Subsidies for Education and Job Training Affect the Supply of Labor?
- How Would Those Subsidies Affect Productivity?
- What Are the Macroeconomic Effects of Larger Federal Subsidies for Education and Job Training?
- How Would the Macroeconomic Effects of Larger Federal Subsidies for Education and Job Training Affect the Federal Budget?
CBO expects that recipients of larger federal subsidies for education and job training would earn more, on average, than they would without those bigger subsidies. Those increased earnings would result both from a greater labor supply and from increased annual earnings among those who work. The size of the increase in earnings would vary by type of program—early childhood, K–12, and higher education, as well as job training—and among individuals.
One factor affecting the size of that increase in future earnings is the number of additional years (or the increase in the quality of those years) of education and job training that would result from that increase in federal spending. The number of additional years in turn depends on the extent to which federal spending substitutes for money that would have been spent anyway by state and local governments or by the private sector. For instance, CBO expects that the number of years of higher education paid for by the federal government would substantially exceed the number of additional years of education that would occur because of that spending.
Another factor affecting the size of the average increase in future earnings is the amount by which each year of additional education and training (or increase in its quality) boosts earnings later in life. The research that CBO reviewed provided a wide range of estimates of those effects. That wide range reflects, in part, individual variation in responses to changes in federal spending for education and job training. CBO will continue to follow developments in the research literature.
Increases in federal subsidies for education and job training could take many years to boost earnings, and hence GDP, for two reasons. First, for spending programs, lags typically exist between when money is made available through appropriations and when it is spent (that is, when outlays are made) to pay for education or job training. Although those lags vary among programs and can depend on the amount of funding, most increases in appropriations for education would be spent by the federal government within a few years.
Second, subsidies would not affect earnings or GDP until recipients of those subsidies entered the workforce (or reentered it after completing an education or training program), which would not happen for some recipients until many years after the spending occurred. The longest such lag is for preschool funding, as recipients do not enter the labor force, on average, until roughly 14 years after they exit a preschool program.
Lags would be shorter for Title I spending, which goes to schools with large shares of economically disadvantaged students. CBO expects that, on average, for an increase in Title I spending in a given year, beneficiaries of that spending would begin to enter the labor force about eight years after the spending occurred. For that year’s 12th graders, entry into the labor force could begin as soon as the following year. Students in lower grades would enter the labor force over the subsequent 13 years.
The lags between federal subsidies for higher education and job-training programs and any subsequent increase in earnings would be much shorter than those lags for preschool and K–12 education—two years, on average, for higher education and one year for job training.
CBO expects that, on average, students whose education was supported by larger federal subsidies would experience increased earnings throughout the rest of their working life. Those effects on earnings would rise in dollar terms over time as workers’ earnings grew with their experience on the job, in CBO’s estimation.
Recipients of federally funded job training, however, would see only a temporary boost in their earnings, CBO projects. After four years, on average, recipients’ earnings would return to the path they would have been on in the absence of the job-training programs, CBO estimates.
Larger federal subsidies for education and job training would affect how much people worked while they were receiving their additional education and training. Each additional year of higher education that federal assistance helped people obtain would temporarily remove those people from the labor force. Thus, increased spending on education would tend to reduce the labor supply in the short term, which would tend to dampen output. Certain training programs—although not others—also would temporarily decrease the labor supply. In contrast, higher federal spending for preschool or K–12 education would not affect the labor supply right away, because most people would not be in the workforce when they were directly benefiting from that spending.
In addition, CBO projects that larger federal subsidies for education and job training would affect how much people worked after they completed their additional education, on average. Some people would obtain more education than they would have otherwise, removing them from the labor force at that time. But after that time, those increases in education or training would generally boost the supply of labor, CBO estimates. People who have received education or training—of any type—generally work more because of it. As with earnings, the effects on the supply of labor are more persistent for education than for job training.
In CBO’s assessment, larger subsidies for education in a given year would boost the economy’s productivity in the long term, but the productivity effects of an increase in subsidies for job-training programs during any given year would dissipate over time. In the long term, a more skilled workforce would increase labor productivity and the supply of labor, which would tend to increase the capital stock, interest rates, wages, and GDP. That outcome would occur because higher labor productivity and a greater supply of labor would make capital more productive, implying a higher rate of return from private capital investment.
A higher return from capital would have two effects. First, it would increase incentives to invest in private capital, which would raise the capital stock. A larger capital stock would allow workers to produce more output and, in return, would boost wages. Together with a larger capital stock, an increase in labor productivity and in the supply of labor would tend to increase GDP. Second, a higher return from capital would tend to increase interest rates because other types of investments would compete for investors’ money.
The method of financing those subsidies would determine the extent to which factors other than those related to the supply of labor or to productivity affected the economy, in CBO’s view. If an increase in subsidies was financed by an offsetting reduction in other spending that did not directly affect the supply of labor or workers’ productivity, the changes in the size of the workforce and the skills and earning capacity of the subsidies’ recipients would account for most of the effects on the capital stock, interest rates, wages, and GDP. If that increase was financed by higher taxes, the impact on the economy would also depend on the timing of those taxes and their effects on people’s incentives to work and save.
If the increase in subsidies was financed by federal borrowing (rather than by offsetting changes in other spending or by higher taxes), several other factors—in addition to the effects on productivity—would influence the economic impact. In the short term, increased subsidies for education would add to overall demand (as would increases in other types of government spending) and consequently boost the production of goods and services, thereby making GDP higher than it would have been otherwise. The size of that effect would depend on the state of the economy. The effect would be larger if GDP was below its potential (maximum sustainable) level and smaller if output was at or above that level. If GDP was at or above its potential, the Federal Reserve would probably raise short-term interest rates to prevent inflation from rising above the central bank’s long-term goal, thereby restraining the boost to output. The increase in output would also be smaller if state and local governments reduced their spending in response to changes in federal funding for education. In the long term, an increase in federal borrowing would reduce the amount of money available for private investment, dampening and possibly eliminating the subsidies’ positive effect on GDP.
How Would the Macroeconomic Effects of Larger Federal Subsidies for Education and Job Training Affect the Federal Budget?
If an increase in subsidies was financed by an offsetting reduction in other spending that did not directly affect the supply of labor or workers’ productivity, the macroeconomic feedback of those subsidies would reduce budget deficits in the long term, although a reduction in the supply of labor stemming from the subsidies could boost deficits in the short term. If an increase in subsidies was financed by higher taxes, the impact on the budget—like that on the economy—would depend on the timing of those taxes and their effects on people’s incentives to work and save, as well as the subsidies’ effects on productivity.
If the increase in spending for education and job-training programs was financed by federal borrowing, the resulting short-term boost in GDP would raise taxable income and therefore increase federal revenues in the short term. That effect, however, would subside over the medium term as the temporary boost in economic activity from additional spending gradually weakened. Over the long term, the macroeconomic feedback from increased spending on education financed by borrowing could increase or decrease deficits, but the precise effect is unclear. Higher wages and profits would increase federal revenues, but higher interest rates would raise interest payments on existing and new debt. Indeed, if higher spending for education was paid for mostly through new federal debt, the negative budgetary effects of the increase in interest payments might exceed the positive budgetary effects from higher wages and profits.
Keith Hall is CBO’s Director. Contributions to this post were made by Sheila Campbell and William Carrington, analysts in CBO’s Microeconomic Studies Division; Devrim Demirel, an analyst in CBO’s Macroeconomic Analysis Division; and Felix Reichling, Chief of the Fiscal Policy Studies Unit in that division.