Congressional Budget Office
Robert A. Sunshine, Acting Director
Director’s Blog

CBO just released an interim report on the VA health system. VA’s health care program has attracted lots of attention, and as part of CBO’s ongoing effort to expand our health-related activities, we are examining the evidence on the VA system — along with what lessons, if any, it may hold for other parts of the health care system.

In general, VA’s experience underscores the potential for improving performance in a large and relatively integrated system through a sustained and comprehensive effort that involves indicators of quality, financial incentives that are aligned with those objectives, and the use of health information technology. It is important to note, though, that the combination of these factors — a large, relatively integrated system; well-designed incentives; performance measurement; and health information technology — likely creates much more substantial opportunities for improvement than any of the pieces taken by themselves. The applicability of VA’s experience to other parts of the health system, which often have a much different structure than the VA system, is therefore unclear and will be explored in CBO’s final report (which will be published next year).

A few highlights of today’s interim report:

• On the quality of care delivered, VA tracks the quality of its medical care primarily through various process and satisfaction indicators (e.g., adherence to clinical guidelines and waiting times for access to services). These measures have generally improved in recent years.
  • CBO was unable, however, to identify directly comparable scores for other health care providers because the composite indexes used at the VA are not used elsewhere. In 2008, VA is planning to adopt more quality measures that are used industrywide, making it easier to compare with other parts of the health system.

• The published literature includes a number of studies that analyze the quality of VA’s health care. Although the studies face various challenges in comparing the VA system to other health care providers, they generally conclude that the VA’s performance has improved following the re-engineering of its system during the 1990s — and that it is now relatively good in adherence to clinical guidelines.

• The VA has implemented a capitation-based budget system called Veterans Equitable Resource Allocation (VERA).
  • Under that system, networks were initially given a fixed amount per enrolled veteran for “basic care” patients, and a higher fixed amount per enrollee for “complex care” patients. VERA has since been modified a number of times to define patient groups in greater detail, but retains its basic structure as a capitated budgeting system.
  • VERA was designed to provide managers with incentives to provide care to patients in the most cost-effective and medically appropriate settings. Because the budget allocated to a facility does not depend on the number of procedures performed, facilities do not have incentives to increase their capacity to produce billable services.

• For every patient, VA also has an electronic health record in its Veterans Health Information Systems and Technology Architecture (VistA) health information system. VistA is integral to VA’s system for providing care and its management of providers and executives. VistA is often cited by VA officials as a key to the department’s efforts to achieve high quality ratings and in helping to control medical care costs.
  • VA may be uniquely positioned to take advantage of health IT’s potential. Independent providers, who interact with a variety of insurance systems, may have a harder time realizing those benefits given challenges with interoperability, the standardization of formats and records, privacy, ownership and control, and the education of and compliance by providers.
  • An electronic health record is most useful when it contains all relevant medical information about a patient, including treatments or examinations received by outside providers. And even VistA has only a very limited ability to interact directly with or use information from other EHR systems, despite the fact that many VA patients receive a substantial portion of their care outside the department’s system.

The interim report was written by Allison Percy, a Principal Analyst in the National Security Division of the Congressional Budget Office. Her areas of expertise include military health care, veterans’ medical care, and veterans’ disability compensation.Before joining CBO in 2001, Allison was a postdoctoral fellow with the Department of Veterans Affairs in Philadelphia. She received her Ph.D. in health economics from the Wharton School at the University of Pennsylvania in 2000. Her dissertation examined the effect of regulatory reforms on health insurance markets. While in graduate school, she also conducted research on medical savings accounts and pharmaceutical productivity. Before pursuing her doctorate, she worked as a health financing analyst for John Snow, Inc., an international public health consulting firm, under contracts with the U.S. Agency for International Development, the Asian Development Bank, the World Bank, and others.

As you can imagine, CBO prides itself on its analytical capabilities — and its analysis is (justifiably, in my opinion!) widely respected. From time to time, though, criticisms of our analysis are raised. I won’t respond to most of these criticisms, but in some cases, it may be worth examining the issues raised in a critique of CBO’s analysis — and that’s what this post does.

A publication from a consulting firm claims that the discussion of housing price-rental ratios in recent CBO testimony was misleading.  (For an entry in the Wall Street Journal’s economics blog about the critique, see here.)  Those claims, though, rest on a number of misunderstandings, both of the CBO testimony and of the underlying data.

With respect to the testimony, CBO used a figure — showing the ratio of house prices to rents — as a short-hand indicator to support the idea that housing prices were high relative to underlying fundamentals, particularly in 2005-2006, and that there was a general expectation that housing prices would be weak in the future. The figure was not used to say that the ratio of housing prices would necessarily fall back to the average of earlier periods in the near future. Here is the section of CBO’s most recent testimony that referenced the figure:

“The outlook for home prices is highly uncertain, but it seems likely that house prices and, consequently, housing wealth will continue to fall next year. The inventory of unsold homes stands at high levels, which will place continued downward pressure on house prices in many regions of the country. Moreover, the ratio of housing prices to rents still seems very high relative to its history (Figure 4). To be sure, homebuyers’ expectations of home prices may deviate from long-term fundamentals for extended periods of time, and the price–rental ratio may therefore not provide a reliable guide to potential changes in prices over relatively short periods of time.”

The section then references a 2004 paper from the New York Federal Reserve that discusses the pros and cons of using the ratio to determine whether the economy was in the midst of a housing price boom at that time.

With regard to the data used in the chart, some measurement issues have indeed been raised with regard to both the numerator (the OFHEO price index for houses) and the denominator (the PCE price index for owner-occupied non-farm dwellings, which is essentially the same as the owners’ equivalent rent index in the CPI-U). The indexes used by CBO, however, are both widely accepted as useful indicators of what they purport to measure despite their limitations.

The critique of CBO’s presentation centers on the owners’ equivalent rent measure, so I will focus on that index. (For a brief explanation of the PCE rental measure, see here.) Although researchers have raised concerns about the index, little hard evidence exists about the magnitude of any problems associated with it — and it remains widely used by analysts and government agencies. As some examples, the Bureau of Labor Statistics (BLS) stands behind the index, the Bureau of Economic Analysis uses it as a price index for a large category of personal consumption expenditures, and it accounts for about 12 percent of the core PCE price index that the Federal Reserve has indicated plays an important factor in its policy decisions.

The critique suggests that the rent index is somehow distorted because “when capital gains are high, a low rent is adequate to make the profits from renting a house equal to the interest that could be earned by selling it and investing the proceeds.” That’s not a distortion, though: it is simply another way of saying that when house prices are rising a lot, we should expect to see a large discrepancy between house prices and rents, as the figure in CBO’s testimony illustrates.

Although the rental measure is widely used and thought to be a valuable indicator, researchers have raised some concerns about it. The most serious issue appears to be associated with its sample.

• The current BLS sample is based on 33,000 units and some cities are not included at all. (Data from cities that are sampled within a region are ascribed to similar-sized cities in the region.) Some researchers are concerned about the sample at the top end of the distribution. For example, the 2004 paper mentioned above found that a rent measure constructed for the 1990s using data from the American Housing Survey moved in concert with the BLS owners’ equivalent rent measure for the first half of the 1990s, but diverged during the second half. The paper’s summary noted that the differences may have occurred because the BLS sample of rental units is thin at the upper portion of the distribution. For the top-most portion of the distribution of home values, there are often few equivalent rental units in the same neighborhood.

• The BLS, though, argues that the sampling limitations do not undermine the usefulness of the index.

• A more significant concern may be that the sample was set in 1999 — and there has been no updating of the sample since then, so it may no longer be representative of the mix of renters. BLS is concerned about this, but has not received funding to create panels and rotate the sample. (Virtually all other samples in the CPI are continuously updated.)

The key point, again, is that CBO used widely accepted indexes, which are known to have limitations but are still viewed as valid indicators, as an illustration of how housing prices appear to have diverged from underlying fundamentals. Even then, the testimony did not suggest that the ratio of housing prices to rents was necessarily a reliable predictor of future price movements in the near term.

As I mentioned in a previous post, corporate tax receipts have recently appeared relatively weak: in each of the past five months, payments of corporate receipts have experienced notable year-over-year declines.  December may turn out to reverse that trend, however, and December is a relatively important month for corporate receipts.

For most corporations, the fourth quarterly payment of estimated taxes was due on December 17. (Most corporations pay their estimated taxes in April, June, September, and December.)  Over the last three business days, including the day that corporate estimated tax payments were due, corporate income tax payments to the federal government amounted to $82.3 billion, compared to $79.4 billion on comparable days last year.  (See here for the underlying data.)   So far this month, gross corporate tax receipts are running slightly ahead of last year.  Corporate refunds this month have also been running ahead of those seen last December, but those are much smaller than receipts.

CBO just released a report on comparative effectiveness research. Such research holds the potential to reduce health care costs over the long term — possibly by substantial amounts if it is done rigorously and if its results are ultimately tied to changes in financial incentives for providers and consumers.

Since health care costs represent the nation’s central fiscal challenge (see here), today’s report — and others on options to reduce health care costs that CBO will be putting out over the next year or so — seem particularly important. What’s perhaps most interesting about the health care challenge and its fundamental role in the nation’s fiscal future is that a variety of evidence suggests that opportunities exist to constrain health care costs both in the public programs and in the rest of the health system without adverse health consequences (see discussion here and in today’s report). Comparative effectiveness research may help policymakers capture those opportunities.

One of the reasons that opportunities exist to reduce costs without harming quality is that hard evidence is often unavailable about which treatments work best for which patients and whether the added benefits of more-effective but more-expensive services are sufficient to warrant their added costs — yet the current health system is geared toward adopting more expensive treatments even when evidence about their impact is lacking.

Generating evidence that compares treatments is what research on “comparative effectiveness” does. Today’s report makes several key points:

• Although some comparative effectiveness research is currently conducted by health plans and others, private-sector entities have only a limited incentive to produce or pay for research that could benefit others-including competitors. In addition, the federal government’s health insurance programs themselves play a significant role in medical care and the budget, so the government has an interest in generating evaluations of the effectiveness of different approaches to health care — but to date has generally not demanded such research. These observations provide a motivation for a larger federal role in coordinating and funding (although not necessarily conducting) such research.
• Policymakers wanting to expand federal efforts to study comparative effectiveness could organize it in different ways-augmenting an existing agency, establishing a new agency, supporting an existing quasi-governmental organization, or creating a new public-private partnership. In evaluating these options, note that trade-offs could arise between the entity’s independence from political pressure and its accountability to policymakers and other interested parties. And the comparative effectiveness effort is more likely to have an impact on medical practice if the organization is respected and trusted by doctors and other professionals in the health sector.
• In terms of the actual research, synthesizing existing studies or analyzing available (and non-randomized) data on medical claims would be less expensive than conducting new head-to-head clinical trials to compare treatments but could also yield less definitive results-and therefore might have a smaller impact on medical practice. Randomized clinical trials can be more persuasive, but there is a practical limit to how many comparative trials could be undertaken effectively at any given time — so some reliance on non-randomized studies is probably required to cover a wide array of topics. Having more health records available in electronic form would facilitate the use of such data for this type of research (and indeed any cost savings from electronic health records and health information technology may ultimately be derived mostly from their indirect contribution to identifying and encouraging higher-value types of care).
• To affect medical treatment and reduce health care spending in a meaningful way, comparative effectiveness research would have to change the behavior of doctors, other health professionals, and patients. For example, the higher-value care identified by comparative effectiveness research could be promoted in the health system through financial incentives-the payments doctors receive or the cost sharing that patients face. Making substantial changes in payment policies or coverage rules under the Medicare program to reflect information on comparative effectiveness would almost certainly require legislation. Making such substantial changes in the delivery of health care will undoubtedly prove difficult and controversial.
• Generating additional information about comparative effectiveness and making corresponding changes in incentives seems likely to reduce health care spending over time-potentially to a substantial degree. But given the time necessary to conduct the research, to alter incentives in a manner reflecting the results, and to affect behavior through those changes, any potential for substantial cost savings would probably take a decade or more to materialize. Even so, generating the additional information would tend to reduce federal health spending somewhat in the near term-but probably not by enough to offset the full costs of that research over the same time period.

Today’s report was written by Philip Ellis, who joined CBO in 2002 and is currently a Senior Analyst. Phil recently coauthored two articles in the New England Journal of Medicine with me (see here and here). He was one of the primary analysts of proposals for a Medicare drug benefit and wrote a detailed report explaining the assumptions and methods CBO used in determining the effects of that legislation. His other work has spanned a variety of health care topics including disease management, the Medicaid program, and Medicare reform, and he recently completed a report on consumer-directed health plans and their potential effects on health spending and outcomes (see here). Prior to joining CBO, he worked on Medicare reform and other health care issues at the Treasury Department and in the office of the Assistant Secretary for Planning and Evaluation at the Department of Health and Human Services.

A life-long fan of the Dallas Cowboys and New York Mets, Phil received his undergraduate training at Stanford University and holds a Master’s degree in public policy from Harvard and a Ph.D. in economics from MIT.

CBO has posted a score of the Medicare, Medicaid, and SCHIP Extension Act of 2007….

CBO released today an updated analysis of the implications of the nation’s long-term defense plans. National defense decisions made today—including those regarding weapon systems, military compensation, and numbers of personnel—can have long-lasting effects on the composition of U.S. armed forces and the budgetary resources needed to support them. What we’re trying to do in this report is evaluate the costs involved.

• In particular, CBO’s analysis evaluates the costs of carrying out the plans in the Administration’s Future Years Defense Program (FYDP), which is prepared by the Department of Defense (DoD) and submitted to the Congress each fiscal year.
  
  • The 2008 FYDP — and therefore also CBO’s projections of its long-term implications — excludes potential future supplemental or emergency appropriations. The President, however, has indicated that at least $189 billion in such appropriations will be needed to pay for military operations in Iraq, Afghanistan, and other locations in the war on terrorism in fiscal year 2008.

• CBO’s projections find that under DoD’s current plans, defense resources will average about $521 billion annually (in 2008 dollars) from 2014 to 2025 — or about 8 percent more than the total obligational authority for defense requested by the Administration for 2008.
  

• Considering potential unbudgeted costs increases the projected long-term demand for defense funding to an annual average of about $621 billion through 2025, or 29 percent more than the Administration’s 2008 request of about $482 billion (excluding funding for war-related activities).
  
  • CBO’s analysis of unbudgeted costs included several possibilities: that the costs of weapon systems now under development would exceed early estimates, as they have in the past; that medical costs might rise more rapidly than DoD has assumed; and that DoD would continue to conduct contingency military operations overseas as part of the war on terrorism, albeit at reduced levels relative to current operations in Iraq and Afghanistan.

CBO’s analysis was led by Adam Talaber in our National Security Division. Adam has played a key role in many of our most noteworthy defense analyses. (One example is our analysis early in the year about the implications of the so-called surge in troop levels in Iraq. For a discussion of CBO’s analysis during a recent Congressional hearing, click here and see the exchange starting at roughly 2 minutes 45 seconds into the clip.)

This morning, CBO released its new long-term budget outlook and I am testifying before the House Budget Committee on our report. The report presents 75-year projections of federal spending and revenues under two alternative sets of assumptions, each of which represents a possible interpretation of current fiscal policy.

Given the reputation of economics as the “dismal science” (which itself originated in part from flawed long-term predictions…), it is important to recognize that the budget outlook presents the implications of current fiscal policy — and does not represent a prediction of the future that policymakers are powerless to affect. The adverse consequences of the nation’s current long-term fiscal trajectory are serious, but they can be addressed through changes in spending and revenue policies. (In addition, any projections that go out far into the future are subject to vast economic and technical uncertainty. Nevertheless, the implications of these projections are clear and daunting.)

The outlook makes several key points:

• Under any plausible scenario, the federal budget is on an unsustainable path over the long term. In the absence of significant changes in policy, rising costs for health care and the aging of the U.S. population will cause federal spending to grow rapidly. If federal revenues as a share of GDP remain at their current level, that rise in spending will eventually cause government debt to increase to unprecedented and implausible levels.
• The rate at which health care costs grow relative to national income—rather than the aging of the population—will be the most important determinant of future federal spending. The Congressional Budget Office (CBO) projects that under current law, federal spending on Medicare and Medicaid measured as a percentage of GDP will rise from 4 percent today to 12 percent in 2050 and 20 percent around 2080.
• The aging of the population, though not the primary factor driving higher government spending in the future, will nonetheless exacerbate fiscal pressures. For example, future growth in spending on Social Security will largely reflect demographic changes; CBO projects that such spending will increase from about 4 percent of GDP today to 6 percent in 30 years and then will roughly stabilize at that rate thereafter.
• Substantial budget deficits would reduce national saving, which would lead to an increase in borrowing from abroad and lower levels of domestic investment that in turn would constrain future income growth.

More specifically, CBO examines two scenarios. (In its previous long-term budget outlook, CBO analyzed six scenarios, but many observers viewed the multiplicity of scenarios as too confusing. So this report focuses on two.)

• The extended-baseline scenario adheres closely to current law, following CBO’s 10-year baseline budget projections from 2008 to 2017 and then extending the baseline concept in its projections for the rest of the years in the period, to 2082.
• The alternative fiscal scenario represents one interpretation of what it would mean to continue today’s underlying fiscal policy. It incorporates some changes in policy that many observers believe likely to occur and that policymakers have regularly made in the past (such as adjusting provisions of the AMT).

A useful metric for the size of the adjustments in either spending or revenues required to avoid unsustainable increases in government debt is provided by the so-called “fiscal gap.” The gap measures the immediate and permanent change in spending or revenues necessary to avoid a rise in debt as a share of GDP over a given period.

• Under the extended-baseline scenario, the fiscal gap would amount to 0.6 percent of GDP through 2050 and 1.7 percent of GDP through 2082.
• Under the alternative fiscal scenario, the fiscal gaps would be much larger, amounting to 5.2 percent of GDP through 2050 and 6.9 percent through 2082. (Only about 20 to 30 percent of that long-term fiscal gap through 2082 is attributable to the direct and pure effect of an aging population.)

The report was put together mostly by our Long Term Modeling Group (LTMG) within the Health and Human Resources Division at CBO. Joyce Manchester, who had been a senior official at the Social Security Administration, recently joined CBO and assumed leadership of this group. Many outstanding analysts within LTMG and elsewhere in CBO contributed to the report — Noah Meyerson, Julie Topoleski, Douglas Hamilton, Michael Simpson, Sven Sinclair, Ralph Smith, Lyle Nelson, Sam Papenfuss, and David Weiner all played key roles in writing the report, and many others worked on the simulations contained in it.

A report of this size and complexity also involves a substantial editing challenge. We have an exceptional editing team, which is led by John Skeen; Christine Bogusz and Leah Mazade worked on editing this report. The editors often have to struggle not only with tight deadlines but also the need to help us translate complex economic and budget concepts into what we hope becomes clear writing. And then there’s catching those inevitable typos!

Those of you who have recently been following CBO’s work on health care will see many familiar themes in this oped in today’s Wall Street Journal…

CBO released an update on effective tax rates today, which provides data for the 2005 calendar year.

• In 2005, the overall effective tax rate (the ratio of federal taxes to household income) rose to 20.5 percent from 20.1 percent in 2004, reflecting a rise in the effective individual income tax rate and the effective corporate income tax rate.
• The rise in the effective individual income tax rate resulted from several factors. Real bracket creep (which is the tendency for overall real income growth to shift income into higher marginal tax brackets) and a rise in income concentration (which, for any given total income, also shifts income toward higher marginal tax brackets) increased the effective rate. The effects of those factors more than offset a reduction in the effective income rate due to a shift in income toward capital gains (which faces lower tax rates than other forms of income).
• The increase in the effective corporate income tax rate is consistent with the surprising rise in corporate tax receipts as a share of GDP between 2003 and 2006. In fiscal year 2004, such receipts amounted to 1.6 percent of GDP; in fiscal year 2005, they amounted to 2.3 percent of GDP. (The rise in corporate income tax revenue as a share of the economy explains a significant share of the improvement in the fiscal deficit since 2003, as CBO described in a letter to Senator Conrad earlier this year. More recently, corporate tax revenue has softened, as mentioned in a previous post.)
• The share of total federal tax liabilities paid by the top 1 percent of the population rose from 25.4 percent in 2004 to 27.6 percent in 2005. That increase occurred despite a slight decline in the effective tax rate applied to income among the top 1 percent (from 31.4 percent to 31.2 percent) because the share of pretax income accruing to that part of the income distribution rose from 16.3 percent in 2004 to 18.1 percent in 2005.

Ed Harris of our Tax Analysis Division prepared these estimates. Ed has been at CBO since 2000, working on receipts forecasting, tax modeling, and individual income tax issues. Prior to joining CBO, he worked for the IRS. He holds a master’s degree in public policy from Duke University and a bachelor’s degree from the State University of New York at Albany.

Questions and answers about the effective tax rate calculations

Some observers have raised questions about CBO’s methodology in calculating these effective tax rates. Below I have therefore provided a set of questions and answers about the data and methodology.

Which taxes does CBO include in its analysis?

In its analysis, CBO estimates effective tax rates for the four largest sources of federal revenues—individual income taxes, social insurance (payroll) taxes, corporate income taxes, and excise taxes—as well as the total effective rate for the four taxes combined. Those taxes account for over 95 percent of total federal revenues. The analysis does not include federal estate and gift taxes, customs duties, and other miscellaneous receipts. Nor does it include state and local taxes.

What assumptions does CBO make about the incidence of those taxes?

CBO’s analysis of effective tax rates assumes that households bear the economic cost of the taxes that they pay directly: individual income taxes (including taxes paid on dividends, interest, and capital gains) and employees’ share of payroll taxes. CBO also assumes—as do most economists—that the employers’ share of payroll taxes is passed on to employees in the form of lower wages than would otherwise be paid. Therefore, the amount of those taxes is included in employees’ income, and the taxes are counted as part of employees’ tax burden.

The analysis assumes that the economic costs of excise taxes fall on households according to their consumption of taxed goods (such as tobacco and alcohol). Excise taxes on intermediate goods, which are paid by businesses, are attributed to households in proportion to their overall consumption. CBO’s analysis assumes that each household spends the same amount on taxed goods as a similar household with comparable income in the Consumer Expenditure Survey.

In its analysis of effective tax rates, CBO assumes that owners of capital bear the economic burden of corporate income taxes in proportion to their income from capital, measured as interest, dividends, rents, and adjusted capital gains. Adjusted capital gains are used in place of actual realizations to smooth out large year-to-year variations in the total amount of gains realized.

The ultimate incidence of income taxes levied on capital income, though, is uncertain. Although CBO’s assumptions in this area are in line with those often adopted in this type of analysis by other economists, they are subject to some debate. In particular, if tax rates on different types of assets are not the same, households will shift resources to assets that are taxed at lower rates. This will have the effect of lowering the before-tax rate of return on those lightly taxed assets, shifting part of the economic cost of the tax to their owners. A similar uncertainty about the distribution of taxes on capital income applies to corporate income taxes. Only in the very short term are owners of corporate equity likely to bear most of the economic burden of the tax. Over the longer term, as capital markets adjust, the economic burden of the tax is spread across all types of capital. And over time, at least some of the economic burden could also be shifted to wage earners, although the degree of such shifting is uncertain.

What is the unit of analysis?

CBO uses households as the unit of analysis. A household includes all people living in a single housing unit. The presumption is that households make joint economic decisions, which may not be true in every case (a group house for example). Households may comprise more than one taxpaying unit, such as a married couple and their adult children living at home.

How are households ranked?

For this purpose, CBO groups households into quintiles on the basis of their income and tabulates the income and taxes for each quintile. CBO adjusts for household size by dividing household income by the square root of household size, to take account of the differing needs of larger and smaller households. CBO then ranks households by their (adjusted) income and groups them in quintiles (fifths of the distribution). The quintiles contain equal numbers of people, but because households vary in size, quintiles generally contain unequal numbers of households. CBO then tabulates overall income and taxes for each quintile as well as for smaller groupings at the top of the distribution.

How does CBO measure household income?

The Current Population Survey (CPS) and the Statistics of Income (SOI) are the primary sources of data for CBO’s estimates of population and household income. The SOI, produced by the Internal Revenue Service, reports much of the information that taxpayers provide on their individual income tax returns. It over-samples high-income returns, enhancing the richness of the data at the high end of the income distribution. The March supplement to the CPS contains survey data on both the demographic characteristics and income of a large sample of households.

CBO statistically matches each SOI record to a corresponding CPS record on the basis of demographic characteristics and income. Some types of income, such as most transfer payments and in-kind benefits, appear only in the CPS; values for those items are drawn directly from that survey. Because not all households have to file tax returns, some households do not appear in the SOI; the information for non-filing households comes from the CPS.

Why doesn’t CBO just use the SOI or the CPS?

Both the SOI and the CPS lack important information needed for estimating and comparing effective tax rates over time. The SOI lacks information on non-filers, does not report all income from government cash transfer programs, has no information on the receipt of in-kind transfers and benefits, and uses tax returns rather than households as the reporting unit. The CPS lacks rich information on high-income tax households, does not report capital gains, under reports other income from capital, and lacks information on deductions and adjustments necessary to compute taxes.

How does CBO treat pension income?

In the analysis of effective tax rates, CBO measures pension income when families receive pension benefits. A comprehensive measure of income would include the value of pensions when benefits accrue rather than when received. For participants in defined-benefit plans, in which benefits are specified according to a formula based on years of service and salary at retirement, accrued pension income would include the increase in the future value of benefits (properly discounted by time until retirement and the probability of actually receiving those benefits) attributable to working an additional year. For participants in defined-contribution plans, current income would include pension contributions plus the yield on accumulated funds in the retirement account.

Counting benefits when they are received rather than when they accrue is consistent with current tax treatment. It matches the timing of tax payments with the timing of income receipt. If pension income were measured on an accrual basis, actual tax payments would exceed measured income for some elderly households.

How does CBO treat capital gains?

In the effective tax rate tables, CBO includes realized capital gains in household income. A comprehensive measure of income would instead include capital gains as increases in household wealth at the time gains accrue (as opposed to when they are realized). Including realized gains raises a number of issues. First, a large fraction of accrued gains are never realized and thus are missing from household income altogether. Second, many factors affect the timing of realization — including changes in tax rates. Thus, measured household income in a particular year reflects a response to that year’s tax system.

Realized gains are used because of the difficulty in measuring accrued gains. Omitting capital gains entirely would understate income for many households, particularly upper-income households.

Does CBO’s income measure misrepresent income growth because of a shift in the organizational form of corporations?

Since the Tax Reform Act of 1986, the share of business income earned through pass -through entities (such as S corporations, limited-liability companies, and partnerships,) has risen and the share earned through C corporations has declined. Because the income of pass-through entities shows up on individual income tax returns, it has been suggested that some of the income growth at the high end of the income distribution observed in the CBO data is the result of this shift. This observation would be correct if CBO’s income measure did not include income that passes from C corporations to households; most of that income, however, is captured in our measures. First, corporate dividends paid to households are reported on the SOI. Second, CBO distributes corporate tax payments to households and includes those taxes as part of household income. The only missing piece is therefore after-tax corporate retained earnings. In the long term, after-tax profits retained by corporations should be reflected in higher corporate stock values and eventually in capital gains realized by households on corporate stock, although these certainly will not match up in any particular year.

Does CBO adjust for year-to-year income volatility?

In its analysis of effective tax rates, CBO measures household income in a single year. Income averaged over a number of years would better represent a household’s true economic circumstances, but those data are not as timely and comprehensive as annual measures. In a particular year, household income may be lower than normal because of unemployment, poor investment returns, or a cyclical downturn in the economy. Capital gains realizations are particularly volatile, and may be exceptionally high for a particular household. CBO’s analysis of long-term income shows somewhat less dispersion in the distribution of income and the distribution of effective tax rates.

Throughout this year, the Congress has been considering possible extensions of the State Children’s Health Insurance Program (SCHIP). CBO today released new estimates of the federal SCHIP funding necessary to maintain the current programs operated by states — which some observers refer to as the SCHIP “shortfall” — relative to the baseline funding level of $5.0 billion.

If 2008 funding is maintained at the $5 billion level, CBO expects that about 21 states will have insufficient federal funds to continue their current SCHIP programs; the first states to exhaust their funding are projected to do so in March 2008. CBO estimates that an additional $1.4 billion in federal funds would be necessary to maintain current SCHIP programs in fiscal year 2008. Providing this additional funding, though, would reduce spending on Medicaid — since some of the SCHIP money would cover beneficiaries who would otherwise shift onto Medicaid. The net increase in federal spending to maintain current SCHIP programs would therefore be approximately $0.8 billion in 2008 (once expected Medicaid savings are taken into account).

CBO has released various analyses of issues associated with the existing SCHIP program and possible reauthorization of it. CBO’s SCHIP analyses and cost estimates are posted on the SCHIP page on our website.