Estimating the Cost of One-Sided Bets: How CBO Analyzes the Effects of Spending Triggers
When analyzing proposals and programs whose costs depend on whether or not some uncertain variable reaches a specified trigger level, CBO considers a range of possible outcomes and their associated probabilities.
All legislative proposals involve some uncertainty about their implementation and effects. In many cases, the uncertainty is limited, and the congressional budget Office can estimate the costs by focusing on a small range of possible outcomes. For some proposals, however, producing a meaningful estimate requires CBO to consider the probabilities of multiple outcomes with costs that might differ significantly. Accounting for such possibilities can have a significant impact on the estimate of the proposal’s budgetary effect; in some cases, it can be the difference between an estimate of zero cost and one of a positive cost.
One key category of proposals for which CBO must consider the likelihood and costs of multiple outcomes comprises proposals with a particular structural feature: Their legislative language makes their effects sensitive to whether some uncertain variable—for example, the price of crude oil or an inflation or unemployment rate—passes a “trigger” threshold value. CBO refers to such trigger provisions as one-sided bets because they affect costs on only one side of the trigger value.
As illustrated in the examples presented in this report, CBO measures the cost of proposals involving new or existing one-sided bets—and of ongoing programs that involve such bets—as the estimated probability-weighted average of the costs of the full range of possible outcomes, also known as the expected-value cost. That is, CBO calculates its estimate of the cost of such a proposal or program by estimating the cost for each of the possible outcomes, assigning each outcome a weight on the basis of the probability that it occurs, and taking the weighted average of those costs. The key step in the analysis is determining the appropriate probabilities of outcomes driven by one or more variables, each of which typically can take on a range of values. The examples illustrate the possibility that even if the trigger of a one-sided bet was not reached in CBO’s baseline projections, the agency would nevertheless estimate that the bet would impose a cost because the trigger could be reached.
CBO’s weighted-average estimates are not predictions of actual future costs. Even if the agency’s analysis of all the possible outcomes and their probabilities was completely accurate, the actual cost would most likely still differ from the estimate because of the randomness of the uncertain variable. Consequently, CBO expects most weighted-average estimates to end up being either too high or too low. The agency’s goal in making such estimates is to be correct on average.