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

CBO issued a letter today reviewing a new investment policy recently adopted by the Pension Benefit Guaranty Corporation (PBGC). As part of its analysis, CBO reviewed the assumptions underlying PBGC’s decision and assessed the revised policy’s potential for affecting the corporation’s ability to meet its obligation to retirees and for increasing costs to taxpayers.

• Prior to February of this year, PBGC’s investment strategy was to hold about 75 percent of its portfolio in bonds, with the duration of those assets matched to the corporation’s obligations. The remainder of the portfolio was invested in equities. PBGC’s new strategy reduces to 45 percent its allocation to fixed-income assets, in order to increase the proportion devoted to equities (45 percent) and to further diversify into alternative asset classes (10 percent).
• The change in investment strategy represents an effort on the part of PBGC to increase the expected returns on its assets and to diminish the likelihood that taxpayers will be called on to cover some of its liabilities. The new strategy is likely to produce higher returns, on average, over the long run. But the new strategy also increases the risk that PBGC will not have sufficient assets to cover retirees’ benefit payments when the economy and financial markets are weak. By investing a greater share of its assets in risky securities, PBGC is more likely to experience a decline in the value of its portfolio during an economic downturn — the point at which it is most likely to have to assume responsibility for a larger number of underfunded pension plans. If interest rates fall at the same time that the overall economy and financial markets decline, the present value of benefit obligations will increase, and the pension plans likely to be assumed by PBGC will be even more underfunded as a result.
• The effect on taxpayers of the change in PBGC’s investment strategy depends on assumptions about future premiums and benefits and expectations about the government’s ultimate responsibility to covered retirees. Although the Employee Retirement Income Security Act of 1974 (ERISA) explicitly states that the federal government does not stand behind PBGC’s obligations, an implicit expectation exists among many market participants and policymakers that taxpayers will ultimately pay for benefits should PBGC be unable to meet those obligations. If policies governing future premiums and benefits remain unaffected by the new investment policy, taxpayer’s increased risk of substantial losses will be balanced by the higher expected returns that the new policy allows. However, if the higher expected returns mean that premiums are reduced or benefits increased relative to what would otherwise occur, plan sponsors or beneficiaries will reap some of the benefits of the change in investment policy, but taxpayers will bear the added risks.

I am testifying this morning before the Senate Finance Committee on the implications of a cap-and-trade program for carbon dioxide emissions. The testimony is posted here. To view the hearing click here.

Global climate change is one of the nation’s most significant long-term policy challenges. Human activities are producing increasingly large quantities of greenhouse gases, particularly CO₂. The accumulation of those gases in the atmosphere is expected to have potentially serious and costly effects on regional climates throughout the world. The magnitude of such damage remains highly uncertain, but there is growing recognition of the risk that the damage may be extensive and perhaps even catastrophic.

The risk of potentially catastrophic damage associated with climate change can justify actions to reduce that possible harm in much the same way that the hazards we all face as individuals motivate us to buy insurance. Reducing greenhouse-gas emissions would help limit the degree of damage associated with climate change, especially the risk of significant damage. However, decreasing those emissions would also impose costs on the economy—in the case of CO₂, because much economic activity is based on fossil fuels, which release carbon in the form of carbon dioxide when they are burned. Most analyses suggest that a carefully designed program to begin lowering CO₂ emissions would produce greater benefits than costs.

One option for reducing emissions is to establish a “cap-and-trade” program. Under such a program, policymakers would set a limit on emissions and allow entities to buy and sell rights (referred to as allowances) to emit CO₂. In designing a cap-and-trade program to achieve emission reductions, policymakers would face a number of critical decisions, including whether to limit fluctuations in the price of allowances and whether to sell the allowances or give them away. If the government chose to sell them, decisions would also have to be made about whether to use the resulting revenue to offset other taxes, to assist workers or low-income households that might be adversely affected by the emission cap, to support other legislative priorities, or to reduce the deficit. My testimony makes the following key points about those issues:

• Market-oriented approaches to reducing carbon emissions (such as a cap-and-trade program or a carbon tax) are much more efficient than command-and-control approaches (such as regulations that require across-the-board reductions by all firms). The reason is that the market-oriented approaches create incentives and flexibility for emissions reductions to occur where and how they are least expensive to accomplish.
• Within the relatively efficient category of approaches that rely on the power of markets, a tax on emissions is generally more efficient than a cap-and-trade system. The reason is that although both a tax and a cap-and-trade system encourage firms to find the lowest-cost reductions at a particular point in time, a tax provides greater flexibility over time, allowing firms to achieve reductions when they are least expensive. In particular, a tax encourages firms to make greater reductions in emissions at times when the cost of doing so is low and allows them leeway to lessen their efforts when the cost is high. A cap-and-trade program can be designed to capture many of those time-related efficiencies by incorporating design features that prevent large fluctuations in the price of allowances (for example, a floor and a ceiling on allowance prices).
• A cap-and-trade program, like a tax on CO₂ emissions, could raise a significant amount of revenue because the value of the allowances created under such a program would probably be substantial. For example, in 2012, the value of the emission allowances that would be issued under S. 2191 would be roughly $145 billion, CBO estimates. As the cap that is included in that legislation became more stringent over time, the value of the allowances would grow. A key decision for policymakers is whether to sell emission allowances, thereby capturing their value in the form of federal revenue, or give them away.
• Under a cap-and-trade program, firms would not ultimately bear most of the costs of the allowances but instead would pass them along to their customers in the form of higher prices. Such price increases would stem from the restriction on emissions and would occur regardless of whether the government sold emission allowances or gave them away. Indeed, the price increases would be essential to the success of a cap-and-trade program because they would be the most important mechanism through which businesses and households would be encouraged to make investments and behavioral changes that reduced CO₂ emissions.
• Policymakers’ decisions about whether to sell or give away the allowances could significantly affect the overall economic cost of capping CO₂ emissions and the way gains and losses from such a program were distributed among U.S. households. A policy of giving away rather than selling a large share of the allowances could be more costly to the economy and impose disproportionately large burdens on low-income households.
  • Evidence suggests that the cost to the economy of a 15 percent cut in U.S. emissions (not counting any benefits from mitigating climate change) might be more than twice as large if policymakers gave allowances away than if they sold them and used the revenue to lower current taxes on capital that discourage economic activity.
  • In addition, providing allowances free of charge to energy producers and energy-intensive firms could create “windfall profits” for relatively high income shareholders of those companies, even though the emission cap would be likely to cause price increases that would disproportionately affect people at the lower end of the income scale. Further, allocating allowances without charge would not prevent the loss of jobs in affected industries because such firms would probably reduce their output in response to higher prices for carbon-intensive goods and services. Those job losses, in turn, would impose concentrated income losses in some households and communities. In contrast, if the government chose to sell emission allowances, it could use some of the revenue from those sales to offset the disproportionate economic burden that higher prices would impose on low-income households and to provide transitional assistance to dislocated workers.
• CBO has concluded that the federal budget should record the value of allowances that are given away by the government if the recipients of the allowances could readily convert them into cash. In particular, the budget should record the value of those allowances, when they are distributed, as both revenues and outlays. That procedure, which CBO has already applied in its estimates for S. 2191, underscores that giving away allowances is economically equivalent to auctioning the allowances and then dedicating the proceeds to the recipients.

CBO has released an updated report on the cyclically adjusted and standardized budget. The new report is a companion to the baseline budget projections published in CBO’s March 2008 Analysis of the President’s Budget.

The purpose of the companion report is to examine the budget balance after temporary factors, such as the effects of the business cycle or onetime shifts in the timing of federal tax receipts and spending, are removed. (For example, during recessions, the budget deficit tends to increase because of the automatic stabilizers built into the budget: tax revenue tends to decline and certain forms of government spending, such as outlays for food stamps and unemployment benefits, tend to increase.)

The report presents estimates of two adjusted budget measures: the cyclically adjusted deficit or surplus (which attempts to filter out the effects of the business cycle) and the standardized- budget deficit or surplus (which removes the effects of other factors in addition to those of the business cycle).

Under CBO’s baseline budget assumptions (which assume continuation of current laws and policies), the cyclically adjusted budget deficit–the total baseline budget deficit after adjusting for the effects of the business cycle–will rise from 0.9 percent of potential GDP in 2007 to 2 percent in 2008, in large part because of the intended effect of the Economic Stimulus Act, and then decrease in 2009 to 0.6 percent, in part from the removal of the effects of the stimulus legislation and also from an increase in revenue from the Alternative Minimum Tax (which would occur under current law). The standardized-budget deficit will increase by somewhat more, climbing from 1.1 percent of potential GDP in 2007 to 2.5 percent in 2008 (after which it declines to 0.9 percent in 2009).

Despite some suggestions in the press to the contrary, CBO has not yet issued a cost estimate for the FHA-related housing proposal that is under discussion in the House of Representatives. A bill sponsored by Mr. Frank was introduced late today and CBO is reviewing it. CBO will issue a cost estimate for the legislation soon after it is approved by the House Committee on Financial Services, and I will post a link to the cost estimate when we issue it.

In a report issued last week, CBO noted the following about many of the FHA-related proposals under discussion:

“The number of borrowers that could be assisted by such proposals would depend directly on the amount of mortgage insurance subsidy that the government provides. With moderate refinancing fees, as embodied in most recent proposals, the federal subsidy would probably amount to less than 5 percent of the new loan principal, on average. Given that scale of subsidy, CBO expects that perhaps several hundred thousand borrowers would benefit from expanded FHA-insured refinancings over the next few years. Generating higher levels of participation would require substantially deeper subsidies, which would in turn significantly increase the federal budget cost. (Under current law, any subsidy costs for FHA loan guarantees are subject to appropriation of the necessary funds. Annual appropriation acts also generally limit the dollar amount of new federal loan guarantees that FHA can enter into for a given year.)”

Today, CBO released a new issue brief on increasing disparities in life expectancy. Here I provide a brief summary of the brief (yes, I recognize the irony in that phrasing):

• Life expectancy has been steadily increasing in the United States for the past several decades. Recent gains in life expectancy have not, however, been shared equally across socioeconomic groups. Although the gaps between women and men and between whites and African Americans have narrowed somewhat, differences by educational attainment and income have been growing. In other words, socioeconomic status has become an increasingly important determinant of life expectancy.
  • In 1980, life expectancy at birth was 2.8 years longer for the highest economic group than for the lowest economic group. By 2000, this gap had increased to 4.5 years. The change in the gap of 1.7 years is more than half of the increase in average life expectancy at birth between 1980 and 2000.
  • In 1980, the difference in life expectancy at age 65 between the highest and lowest economic groups was 0.3 years; by 2000, the difference had increased to 1.6 years. This increase in the gap is more than 80 percent of the increase in average life expectancy at age 65 over this period.
• The implications of a continued widening of the gap in life expectancy by socioeconomic status are clear for Social Security but less so for Medicare.
  • For Social Security, a widening gap would worsen the long-term shortfall in financing and reduce the program’s progressivity—the extent to which it redistributes resources from high-income to low-income people.
  • For Medicare, it is not clear whether a widening gap would exacerbate the cost increases that will result from increasing longevity. How the share of Medicare spending on low-income individuals would change depends on the relative proportional changes in life expectancy.

The brief was written by Joyce Manchester and Julie Topoleski from our outstanding long-term modeling group.

This morning, CBO released a new study on policy options for the housing and mortgage markets. The paper discusses the potential for federal intervention to ameliorate the situation, by encouraging and removing impediments to private mortgage restructuring or by providing federal financial support. (It does not, however, address the question of what regulatory changes might be warranted over the longer term, either to address the problems that led to the current situation or to support any wider federal role in the financial markets.) CBO finds that:

• The current economic situation is quite fragile, largely as a result of the difficulties in mortgage markets and other financial markets. Much of that fragility arises from falling house prices, which affect consumers through their housing wealth and lenders through their loss of collateral. It is exacerbated by the growing complexity of financial instruments and entities, which may make it difficult for participants to know what risks they are assuming, and by the leverage of both borrowers and financial market intermediaries, which means that it is difficult to prevent liquidity and solvency problems from spreading throughout the financial markets.
• Foreclosures are an expensive way to resolve delinquencies. A large number of foreclosures is also likely to reduce the demand for houses, as potential purchasers conclude it would be better to wait until prices stop falling. Thus, excessive foreclosures could trigger a downward spiral of house prices that could take them below what would be justified on the basis of normal relationships to income and production costs. Such a downward spiral would exacerbate the problems in the financial markets, and by reducing household wealth, could reduce consumption spending, increasing the likelihood and severity of a recession. While actions could be taken to limit the risk of such a downward spiral in housing prices, it is not feasible for policy interventions to stabilize house prices at current levels since such prices are strongly influenced by the significant inventory of unoccupied houses for sale.
• Significant impediments stand in the way of private market resolution of the difficulties in the mortgage market. In order for large numbers of mortgages to be restructured, procedures must be developed to secure the agreement of the institutions that hold second mortgages. Because most mortgages are securitized, resolution procedures also have to respect the limits of securitizing agreements. Without committing resources, the Congress could provide a standard for mortgage restructuring that might assist agreement among the first and second lien-holders and simplify the decisions lenders have to make. Legislation could also change the treatment of mortgages in bankruptcy, which would help borrowers and might increase the pressure on lenders to voluntarily restructure loans outside of bankruptcy; such a change, however, might also lead to higher interest rates on future mortgages.
• Direct federal provision or guaranteeing of credit to mortgage markets could help avoid foreclosures and ease the downward pressure on house prices, helping the market to adjust in an orderly manner. It would also shift part of the cost of mortgage losses from current lenders and investors to taxpayers. The number of borrowers that could be assisted by such steps would depend directly on the amount of mortgage insurance subsidy that the government provides. With the range of refinancing fees embodied in most recent proposals, the federal subsidy would probably average less than 5 percent of the loan principal. Given that scale of subsidy, CBO expects that perhaps several hundred thousand borrowers would benefit from expanded FHA refinancings over the next few years. Generating higher levels of participation would require substantially deeper subsidies, which would in turn significantly increase the federal budget cost.

The paper updates and expands upon the discussion of the housing and mortgage markets in an earlier CBO analysis of policy options for addressing the general weakness of the economy (Options for Responding to Short-term Economic Weakness, January 2008). It expands upon that earlier work in a number of ways. First, it discusses in depth the market developments and failures that led to the current situation. Second, it discusses options for influencing the mortgage markets, especially those that might help arrest the downward spiral of house prices. Some of those options would require a federal commitment of funds, in the form of either credit guarantees or direct subsidies. Finally, it considers the advantages and disadvantages of establishing a new agency to assist in the restructuring of mortgages. The study was written primarily by analysts in CBO’s Macroeconomic Analysis Division, with Kim Kowalewski coordinating and leading the effort.

CBO has issued a cost estimate of S. 2191, the America’s Climate Security Act of 2007, as ordered reported by the Senate Committee on Environment and Public Works in December 2007. We’ve also issued a cost estimate on a slightly amended version of the legislation that was transmitted to us on April 9, 2008.

The legislation would create a cap-and-trade system for carbon dioxide and other greenhouse gases. (Technically, there would be two separate cap-and-trade programs—a bigger one covering most types of greenhouse gases and a smaller one covering hydrofluorocarbons.) Some of the permits would be auctioned — through a new entity, the Climate Change Credit Corporation — and the remaining permits would be distributed at no charge to states and other recipients. Over the 40 years that the proposed cap-and-trade programs would be in effect, the number of allowances and emissions of the relevant gases would be reduced each year.

CBO estimates that enacting S. 2191 as it was ordered reported would increase revenues by about $1.2 trillion over the 2009-2018 period. Over that period, we estimate that direct spending from distributing those proceeds would also total about $1.2 trillion, but more than the revenues. The net effect of the original legislation (as ordered reported) would be to increase deficits (excluding any effects on future discretionary spending) by an estimated $15 billion over the next 10 years; the amended version would instead reduce future deficits (again excluding any effects on future discretionary spending) by roughly $80 billion over the next ten years. In addition, assuming appropriation of the necessary amounts, CBO estimates that implementing S. 2191 would increase discretionary spending by about $4 billion under the original legislation and about $80 billion under the amended version over the 2009-2018 period.

The estimates for the two versions of the bill differ because the amendment would increase the portion of allowances that would be auctioned, deposit some of the auction proceeds into a Climate Change Deficit Reduction Fund, and make spending from that fund subject to appropriation.

This complex legislation posed several scoring questions and challenges:

• The first involved how to treat the corporation it creates; the Climate Change Credit Corporation would be responsible for auctioning the allowances created by the federal government and for spending the resulting proceeds on various initiatives. How to treat the Corporation, though, seemed relatively straightforward: The Corporation would be part of the federal government, and the cash flows associated with auctioning the allowances and spending the proceeds should therefore be recorded in the federal budget.

• A second scoring question involved the emissions allowances that are given away at no charge. In CBO’s view, these should also be recorded in the budget as revenues and outlays. The government is essential to the existence of the allowances and is responsible for their readily realizable monetary value through its enforcement of the cap on emissions. The allowances would trade in a liquid secondary market since firms or households could buy and sell them, and thus they would be similar to cash. CBO estimates that the value of the market created by the major cap-and-trade program would be large, exceeding $100 billion in 2012. Therefore, CBO considers the distribution of such allowances at no charge to be functionally equivalent to distributing cash.

In our view, this scoring approach best illuminates the trade-offs between different policy choices. Distributing allowances at no charge to specific firms or individuals is, in effect, equivalent to collecting revenue from an auction of the allowances and then distributing the auction proceeds to those firms or individuals. In other words, the government could either raise $100 by selling allowances and then give that amount in cash to particular businesses and individuals, or it could simply give $100 worth of allowances to those businesses and individuals, who could immediately and easily transform the allowances into cash through the secondary market. Treating allowances that are issued at no charge as both a revenue and an outlay would mean that those two equivalent transactions were reflected in parallel ways in the scoring process.

In contrast, the proceeds associated with the allowances allocated for free to producers and importers under the smaller cap-and-trade program covering hydrofluorocarbons should not be recorded on the budget in CBO’s view, primarily because we expect that the market created for such allowances would be relatively small and illiquid. Based on information from industry representatives, CBO estimates that fewer than 30 entities would be considered covered entities under this program. And given our estimate of the price for consumption allowances, CBO expects that the size and value of the overall market created by the cap-and-trade program for hydrofluorarbons would be small—less than $2 billion annually in most years. Therefore, unlike the allowances for the other greenhouse gases, these allowances would not be sufficiently cash-like to merit inclusion in the federal budget, in CBO’s view.

• A third scoring challenge involved the technical process of estimating the permit price for the main cap-and-trade program, which would cover carbon dioxide and other greenhouse gases. Based on an analysis of the results of several economic models, our estimates suggest that under the legislation, the auction price of emission allowances for these greenhouse gases would rise from about $23 per metric ton of carbon dioxide equivalent (mt CO₂e) emissions in 2009 to about $44 per mt CO₂e in 2018. (In 2006 dollars, the auction price per mt CO₂e would rise from about $21 in 2009 to $35 in 2018.) Covered emissions of group I gases would decline by 7 percent in 2012 and by 17 percent in 2018 from base-case emissions (that is, those that would occur under current law); over the entire 2012-2050 period, they would decline by 42 percent from the base case.

• A final issue involved the longstanding methodology in the federal budget process to assume that overall economic activity (GDP) is held constant.  Under that assumption, higher amounts of indirect business charges reduce other income in the economy. (For example, if firms that must purchase allowances would be unable to pass those costs along, their profits would fall. More likely, some substantial portion would be passed along to others in the economy, such as consumers and employees, and other income would fall. Either way, the result would be lower taxable income in the economy, which would reduce federal revenues from income and payroll taxes.)  The tradition is to assume that 25 percent of any change in indirect business charges is offset by changes in income and payroll taxes (25 percent is an approximate marginal tax rate).  For this estimate, CBO did not apply the 25 percent reduction to all of the gross revenues, however, depending on how those revenues would be used:
  • To the extent that the revenues would be used in ways that would generate new taxable income, such uses would offset the loss of income and payroll taxes that would result from the initial purchase of allowances.  Therefore, CBO did not apply the 25 percent reduction to any revenues that would be used to make transfer payments to taxable entities without any conditions placed on the recipient regarding the use of those payments. While such transfer payments do not directly affect GDP because they are not made in exchange for goods or services, they are typically taxable. Thus, providing transfers to taxable entities generates additional federal revenue that would essentially offset the 25 percent reduction in revenue collections. Most of the estimated revenues from allowances given away under S. 2191 would be used for such purposes.
  • CBO also did not apply the 25 percent reduction in revenues to any allowances that would be given away under the bill and would not be immediately taxable to the individuals or businesses that receive them, but would generate taxable income when they were used or sold to others. Such allowances include those given away to facilities that generate electric power from fossil fuels and to facilities that produce or import petroleum-based fuel.
  • In contrast, we applied the 25 percent reduction to any revenues that would be spent by the government on goods and services (for example, on research and development activities) because such government spending would substitute for other economic activity (under the assumption that GDP is unchanged by the bill). As a result, revenue used in this way would not generate any new taxable income. All of the proceeds from the auction of allowances would be used for those purposes.

The two cost estimates provide much more information about the legislation and its projected effects.

Analyzing a complicated piece of legislation like this requires resources from across the agency. CBO has formed a climate change team, and more information about CBO’s activities on climate change can be found here. The cost estimates and the associated mandate statements were prepared by Mark Booth, Susanne S. Mehlman, Deborah Reis, Megan Carroll, Kathleen Gramp, Tyler Kruzich, Robert G. Shackleton Jr., Mark J. Lasky, Terry Dinan, Natalie Tawil, Neil Hood, and Amy Petz.

I am testifying this afternoon before the Senate Finance Committee this afternoon on the State Children’s Health Insurance Program (SCHIP), crowd-out (that is, the substitution of public insurance coverage for private insurance coverage), and the August 17th directive from the Administration to state health officials (which has generated significant controversy). The testimony is posted here. To view the hearing click here.

The testimony makes the following main points:

• SCHIP has significantly reduced the number of low-income children who lack health insurance coverage. According to CBO’s estimates, the percentage of children in families with income between 100 percent and 200 percent of the poverty level who are uninsured fell by about 25 percent between 1996 (the year before SCHIP was enacted) and 2006. In contrast, the uninsurance rate among higher-income children remained relatively stable during that period. The difference likely reflects the impact of the SCHIP program.

• The states’ outreach efforts and simplified enrollment processes for SCHIP appear to have also increased the share of eligible children who participate in Medicaid. The result has contributed to a decline in the percentage of children below the poverty level who are uninsured.

• The enrollment of children in public coverage as a result of SCHIP has not led to a one-for-one reduction in the number of low-income children who are uninsured, however. Almost any increase in government spending or tax expenditures intended to expand health insurance coverage will displace private insurance coverage to some degree. In the specific case of SCHIP, the program provides a source of coverage that is less expensive to enrollees and often provides a broader range of benefits than alternative coverage. As a result, the program displaces—or “crowds out”—private coverage to some extent. Based on a review of the research literature, CBO has concluded that for every 100 children who gain public coverage as a result of SCHIP, there is a corresponding reduction in private coverage of between 25 and 50 children.

• CBO’s analysis of the Children’s Health Insurance Reauthorization Act of 2007, as passed by the House of Representatives, suggested that legislation would result in 5.8 million children gaining coverage under Medicaid or SCHIP in 2012. Of that total, CBO estimated that 3.8 million children would otherwise have been uninsured, and 2.0 million children would otherwise have had private coverage In other words, about one-third of the children who would be newly covered under SCHIP and Medicaid would otherwise have had private coverage. These crowd-out rates are probably about as low as feasible for a voluntary program, given the size of the proposed coverage expansion. (It is possible to implement policies to reduce crowd-out below that level, but those policies would most likely also reduce the number of children enrolled in the program who would otherwise be uninsured.)

• On August 17, 2007, the Administration issued a directive to state health officials that imposes certain minimum requirements on states seeking to enroll children in SCHIP whose families have income above 250 percent of the poverty line. Much ambiguity surrounds how the directive will be implemented, but CBO’s analysis suggests that its impact on enrollment is likely to be relatively modest under the official baseline, in which funding for the program is significantly lower than what would be required to maintain current programs. The directive could have a substantially greater impact on SCHIP enrollment and cost if the the Congress expanded the program significantly beyond this baseline. (Interestingly, new research by Jonathan Gruber and Kosali Simon raises questions about whether many of the steps states have adopted and that are called for under the directive — such as waiting periods and cost-sharing — are actually effective in reducing crowdout rates.)

The U.S. military invaded Iraq in March 2003, and the conflict there has continued for the ensuing five years. In September 2002, CBO published its first projection of the costs associated with a U.S. invasion of Iraq. CBO has subsequently provided the Congress with numerous updates of funding provided to date for that conflict, as well as projections of future costs under several alternative scenarios. Indeed, in part because the Defense Department has never published its own long-range timetable for future U.S. troop levels in the region, the “CBO troop scenarios” have been used as a basis for cost estimates and other discourse by many other organizations and individual researchers.

A new book about the cost of the war, “The Three Trillion Dollar War: The True Cost of the Iraq Conflict,” by Nobel-prize winning economist Joseph Stiglitz of Columbia University and his colleague Linda Bilmes of Harvard University’s Kennedy School of Government, has received significant attention. (To disclose any potential conflict, I am a friend and coauthor of Stiglitz.)  In contrast to the cost figure in the title of the Stiglitz-Bilmes book, CBO’s most recent testimony suggests that cumulative budgetary costs for the combined conflicts in Iraq and Afghanistan might total between $1.2 trillion and $1.7 trillion through 2017.

A natural question (and one that several people have indeed asked me) is why such a large disparity exists between CBO’s projections and those of Stiglitz and Bilmes.

Most importantly, CBO restricts its estimates to Federal budgetary costs, whereas Stiglitz and Bilmes include many other types of costs borne by veterans, their families, and U.S. taxpayers. The CBO testimony notes that the Congress had provided total funding of $604 billion through October 2007 (in “then-year” or “nominal” dollars without making any adjustment for inflation), not only for military operations but also for indigenous security forces, diplomatic operations and foreign aid, and medical care and disability compensation for veterans of the conflicts in Iraq and Afghanistan. Stiglitz and Bilmes report a comparable total of $646 billion when inflated to 2007 dollars.  So there’s not that big a difference when the two sets of estimates are put on a comparable basis.

Below, I go into more detail about all this.

Military costs (not including veterans benefits)

CBO’s analysis suggested that, depending on the rates at which U.S. troops are withdrawn from the region under two illustrative scenarios, costs of future military operations (including costs such as combat pay for deployed troops, fuel and transportation, and contractor support in the wartime theater, but excluding costs on medical care and disability benefits provided by the Department of Veterans’ Affairs, which were tallied separately) through 2017 could total between $485 billion and $966 billion. Using essentially the same “CBO scenarios,” Stiglitz and Bilmes project future costs of between $521 billion and $913 billion. The similarity of these figures is somewhat misleading, since we are measuring costs in different units. Again, CBO sums up “then-year” or “nominal” dollars without making any adjustment for inflation or the time value of money. Stiglitz and Bilmes instead use a present-value approach, in which they effectively discount the flow of future costs at a nominal interest rate of 4.5 percent to reflect the time value of money. Most economists prefer present-value figures, which is why Stiglitz and Bilmes undertook their analysis that way; the Federal budget process, however, is based on nominal dollars, which is why CBO undertook our analysis in the manner we did.

Notwithstanding those differences, the estimates of past and future costs of military operations that CBO has published are in rough agreement with Stiglitz and Bilmes’ estimates, which account for about half of their $3 trillion estimate of the total cost of the war.

Other costs

Beyond the costs of military operations, the remaining types of costs that Stiglitz and Bilmes consider can be classified into three broad categories: other government spending that could be attributed to the military operations; interest payments made by the Treasury to finance war-related debt; and costs outside the federal budget, which are borne by military veterans who served in Iraq or Afghanistan, their family members or, in the case of reservists, their employers, or U.S. citizens more broadly. Stiglitz and Bilmes track the costs of military operations through 2017, but track veterans’ disability and medical costs through 2046.

1. Other non-interest government spending

Within the category of other government spending, perhaps the most notable differences between CBO’s estimates and those from Stiglitz and Bilmes involve the cost of medical care and disability compensation provided by the Department of Veterans’ Affairs (VA).

For example, Stiglitz and Bilmes estimate that monthly compensation paid by the VA to disabled veterans of the conflicts in Iraq and Afghanistan could total between $277 billion and $388 billion over the next 40 years. (CBO truncates its corresponding estimates after 2017, but I will use the 40-year horizon throughout this discussion to maintain consistency with Stiglitz and Bilmes’ basic framework.)

• Stiglitz and Bilmes base their estimate on the experience of veterans from the first Gulf War, about 40 percent of whom applied for VA disability compensation since that war ended in 1991 and had their applications approved — that is, they were “rated.”  One-quarter of those veterans, however, were rated for conditions that are zero-percent disabling; Stiglitz and Bilmes assign those veterans the average benefit level even though they are not currently drawing any benefits. (VA sometimes uses a zero-percent disability rating as a placeholder to acknowledge that a disability first manifested during a period of active military service, although the disability does not yet adversely affect the veteran’s earning potential.)

• Furthermore, it is unclear whether Stiglitz and Bilmes adjusted for the number of veterans of the current conflict who might have become disabled as a result of their military service even if they had never deployed to the war zone; those veterans should be subtracted out when estimating the incremental cost of the war.  Their footnote 48 (p. 259) outlines a method for making that adjustment, though they begin that discussion by stating, “We have not adjusted for incremental cost — that is, the number of veterans who may have claimed disability even during peacetime.” Even if they did make the indicated adjustment, their method would not allocate enough of the disabilities to the peacetime baseline, and would instead attribute too many disabilities to the war.

• In summary, we estimate that the incremental number of veterans who are or will draw disability benefits may be only half of what Stiglitz and Bilmes estimate, in which case their costs would be too high by between about $150 billion and $200 billion.

Differences also arise between CBO’s and Stiglitz and Bilmes’ estimates of VA medical costs (as opposed to disability benefits) to treat veterans of the conflicts in Iraq and Afghanistan.

• In their higher case, Stiglitz and Bilmes apply to veterans of those recent conflicts the $5,765 average amount that VA spent in 2006 to treat veterans of all eras, including the aging Vietnam-era population. Stiglitz and Bilmes then increase the larger amount in subsequent years at a medical-specific inflation rate equal to twice the rate of general inflation. The VA, though, estimates that it spent less than half that initial amount — an average of $2,610 in 2006 — to treat veterans returning from Iraq and Afghanistan. It may appear surprising to some readers, but veterans of the recent conflicts on average require less medical care from VA than veterans of earlier conflicts such as the Vietnam War do today. (By contrast to recent veterans, many Vietnam-era veterans are now age 60 years or older and are being treated for age-related chronic conditions that demand more resources, on average, from the VA.)

• It is difficult to project how rapidly VA’s medical costs for recent veterans will grow in the future. The growth in costs will depend on how many veterans enter or remain in the VA medical system, as opposed to going elsewhere for their care, and on the change in the average annual cost for veterans who continue to use the system. Some veterans may migrate to other sources of medical coverage, such as employer-sponsored health insurance, for some or all of their care when they assimilate back in to civilian society. Others may find that their medical conditions are resolved satisfactorily with the care that they received at the VA and the passage of time; while they remain reliant on the VA, their demand for medical services will decline. Indeed, some data that we have obtained from the VA indicate that utilization of a variety of medical services tends to decline after a veteran’s first 3 to 6 months in the VA system (though a few medical services, such as residential rehabilitation for post-traumatic stress disorder or PTSD, show an increasing trend as discussed below). On the other hand, the medical costs for veterans who remain in the VA system or who enroll later will continue to grow as those veterans age, as has been the case for Vietnam-era veterans. It is uncertain how much of the long-run growth in cost should be attributed to the recent veterans’ service in Iraq or Afghanistan as opposed to aging.

• Because we believe that the short-term average annual cost ($5,765) in Stiglitz and Bilmes’ “high” case is about twice the appropriate value, and in light of the uncertainty in projecting both the average cost and number of veterans of the current conflicts who will utilize VA medical care in the future, Stiglitz and Bilmes’ projection of up to $285 billion for VA medical costs may be overestimated by at least $100 billion.

Before leaving the topic of VA medical care, I need to touch upon the incidence of PTSD among recent veterans.

• It is not clear how many veterans suffer from PTSD. DoD has collected data on the incidence of PTSD from the post-deployment health assessment (PDHA) and post-deployment health reassessment (PDHRA) surveys it administers to troops immediately upon return from deployment and again about 6 months later. A series of studies by Army Colonel Charles Hoge, M.D. and his colleagues have used data from those surveys to study the effects of deployments on the incidence of PTSD. Those studies are reporting positive screens for PTSD among 17 percent of active Army soldiers and 25 percent of Army National Guard and Army Reserve personnel. (One of the studies found higher PTSD screening rates for soldiers who had deployed more than once. The rates just cited include some such soldiers: CBO estimates that 27 percent of current active Army soldiers have deployed more than once and 7 percent more than twice. Some 9 percent of current Army reservists have deployed more than once and 2 percent more than twice).

• Two points should be noted when interpreting the screening rates for PTSD. First, those rates are particular to the Army; while we might expect similar screening results for Marines, we would not for Air Force or Navy personnel who do not participate in direct combat to the same degree as soldiers and Marines. As a lower bound, if all soldiers and Marines (the majority of the deployed forces) experienced the rates quoted above but the rates were zero for Air Force and Navy personnel, the overall screening rate among military personnel who have deployed would be about 10 percent. Second, a positive screen for PTSD on the PDHA or the PDHRA survey does not necessarily imply a diagnosis of PTSD; treatment is largely optional and not all soldiers who screen positive either seek or receive any treatment. Psychiatrists at DoD and VA have advised us that survey responses do not constitute a diagnosis — PTSD is not definitive until it is confirmed at two consecutive medical visits.

• VA, too, collects data on the incidence of PTSD. Their data through October 2007 indicate nearly 50,000 initial diagnoses of PTSD among the 264,000 veterans of Iraq and Afghanistan who have been treated at VA medical facilities — an apparent incidence rate of 18 percent. However, their report notes that, “up to one-third of coded diagnoses may not be confirmed when initially coded because the diagnosis is ‘rule-out’ or provisional, pending further evaluation.” Removing up to one-third of provisional diagnoses yields an adjusted PTSD incidence rate perhaps as low as 12 percent, roughly consistent with the DoD figures cited in the previous paragraph. VA estimates that it spent $35 million in 2007 to treat PTSD (including provisional cases) among veterans of Iraq and Afghanistan (an average of $700 per patient). That sum represents one-half of one percent of total VA medical costs for veterans of those conflicts.

Debt service costs

Another category of budgetary costs that Stiglitz and Bilmes examine is the cost of debt service.  In part to separate the costs of government activities from the financing mechanism (issuing debt versus raising taxes versus crowding-out other programs), CBO does not typically include debt service in its cost analyses. However, at the specific request of the House Budget Committee, CBO calculated the debt-service costs of the war on terrorism under the assumption that all spending for those operations, both past and present, was financed with federal borrowing. Under that assumption, CBO estimates that interest payments on spending thus far would total $415 billion over the 2001–2017 period. The path of spending generated by CBO’s first scenario would contribute an additional $175 billion in interest payments from 2008 through 2017. Under the second scenario, interest outlays would increase by a total of $290 billion over that 10-year period. CBO’s range of $590 billion to $705 billion (in undiscounted dollars) over the entire period contrasts with Stiglitz and Bilmes estimate of $613 billion to $816 billion (over the same time period but expressed in discounted present-value dollars — their undiscounted totals would be higher).

Other costs beyond the Federal budget

As noted at the beginning of this post, Stiglitz and Bilmes do not limit themselves to federal budgetary costs — and that explains a substantial amount of the difference between their estimates of the cost of the war and CBO’s.

For example, in an attempt to measure the costs of deaths or injuries not compensated by any government agency, Stiglitz and Bilmes apply the economic construct of “value of statistical life” (VSL). Although the VSL calculation is a legitimate attempt to monetize one type of cost, none of the estimates that CBO has published or on which CBO has testified have included the VSL. The reason is that CBO’s charter generally restricts our cost estimates of legislative provisions to the Federal budgetary costs (except that, in accordance with the Unfunded Mandates Reform Act of 1995, we also estimate any mandates that legislation reported from a Congressional committee would impose on state, local, or tribal governments or on the private sector).

Stiglitz and Bilmes assign a VSL of $7.2 million (in 2007 dollars) to each death of a U.S. service member, and a prorated fraction of that amount to each serious injury. Although CBO does not promulgate or endorse any particular value for the VSL, I would note that the Stiglitz and Bilmes’ estimate is based on guidance that the Environmental Protection Agency promulgated in 2000. However, the EPA selected that value from a survey of 26 studies that estimated VSLs ranging from $0.7 million to $21 million in 2007 dollars; the bulk of those estimates fell within the narrower range of about $4 million to $8 million.

Finally, Stiglitz and Bilmes estimate macro-economic costs such as the effects on the U.S. economy of increased oil prices (to the extent those are a result of the war). The addition of those costs in their most-inclusive accounting, with all of their other assumptions set to “high,” leads to their estimate of $5 trillion for the total cost of the war. One could debate at length the causality between the war in Iraq and oil prices on the world market; Stiglitz and Bilmes attribute between $5 per barrel and $10 per barrel of the price increase to the war. They translate those price increases into total oil-related macro-economic costs to the U.S. economy of $187 billion and $800 billion, respectively.  CBO does not include these types of macro-economic effects in any of our formal cost estimates.

Summary

The bottom line, as it were, is that the war in Iraq and Afghanistan has clearly involved significant costs for the federal budget, as well as for soldiers and their families.  (The potential benefits are for others to debate.)  The Stiglitz-Bilmes estimates of the budgetary costs are likely at least somewhat high, but the biggest difference between our estimates and theirs is that they go beyond the cost to the federal government.

Much of CBO’s work in this area has been undertaken by outstanding analysts in our National Security Division (including Matthew Goldberg, the deputy director of that division, and Heidi Golding) and the national security team within our Budget Analysis Division (including Sarah Jennings, who runs that unit, and David Newman).

The Environmental Law Institute and Vanderbilt Law School are holding a conference on several important environmental topics this week. Terry Dinan of CBO and I are commenting on a climate change article written by Cass Sunstein. Our written comment is below.

Comment on “Of Montreal and Kyoto: A Tale of Two Protocols”

By

Peter R. Orszag and Terry M. Dinan

Congressional Budget Office

In “Of Montreal and Kyoto: A Tale of Two Protocols,” Cass Sunstein compares the political economy dynamics leading up to the signing and ratification of the Montreal Protocol (governing substances that deplete the ozone layer) and the Kyoto Protocol (governing substances that contribute to global warming). He observes that the United States was a strong and early supporter of the control of ozone-depleting substances but has generally opposed binding controls on greenhouse gases. In contrast, Britain was significantly more reluctant to agree to limits on ozone-depleting substances but has actively supported restrictions on greenhouse gases. Sunstein attributes that contrast to differences in the two nations’ perceptions of domestic benefits and costs from environmental action, and he concludes that the key to obtaining a global agreement on greenhouse gases will involve raising perceived benefits within the United States from such an agreement while reducing its perceived domestic costs. He suggests that motivating developing countries to agree to emission limits and achieving such reductions through an incentive-based global approach—such as a global tax on carbon dioxide (CO₂) emissions or a global cap-and-trade program—are the most promising approaches to altering U.S. perceptions of domestic benefits and costs.

It is undoubtedly correct that perceptions of domestic benefits and costs are important determinants of countries’ willingness to enter into international agreements (including those about limits on global pollutants).^[1] As we discuss in Section A below, however, if one accepts Professor Sunstein’s perspective and measures of the domestic benefits of greenhouse gas emissions reductions, his proposed approaches would be unlikely to motivate the United States to enter into such agreements. Specifically, those approaches would actually serve to increase costs to the United States while doing little to increase its perception of domestic benefits (based on the benefits measures that Professor Sunstein uses). While incentive-based approaches are likely to be important components of a cost-effective approach to reducing greenhouse gas emissions, we point out in Section B that Professor Sunstein does not give sufficient attention to the serious implementation challenges that would be associated with a global cap-and-trade program. Finally, we suggest in Section C that the measures of domestic benefits that Professor Sunstein presents do not adequately incorporate a primary motivation for agreeing to greenhouse gas restrictions: reducing the possibility that the buildup of those gases could lead to extremely large, potentially even catastrophic, damage that could not easily be allocated among countries.^[2]

A. Distribution of Costs and Benefits in a Global Emissions-Reductions Scheme

Any effort to make meaningful reductions in global emissions of greenhouse gases would have to involve the world’s five major emitters: the United States, China, the European Union (EU), Russia, and India (see Table 1). As Professor Sunstein points out, available estimates of the damage that the United States and China would incur (inadequately accounting for the uncertain possibility of catastrophic outcomes, as discussed below) as a result of a 2.5 ^oC increase in average global temperature may provide an insufficient incentive for either the United States or China to agree to incur significant costs to reduce emissions.^[3] Further, China may be less willing to shoulder even more modest costs given its low per capita income. Among those five top emitters, India is predicted to benefit the most from reduced warming, but like China, it has far fewer economic resources to devote to the problem than either the United States or the EU. Among the key players, the countries in the EU stand out as likely to benefit significantly from reduced warming (again, in expected value terms and without accounting for very uncertain but potentially very large damage), having sufficient per capita income so that reasonable levels of emission reductions would not pose undue hardship, and having contributed significantly to the stock of emissions in the past.

Sunstein observes that changing the dynamics of international negotiation would require a method of increasing perceived benefits and reducing perceived costs for some of the major emitters. He suggests that a global tax or cap-and-trade program might help achieve such an outcome. We agree that a global incentive-based approach would lower the aggregate cost of reducing emissions and could lead to greater total reductions. It would be much less likely, however, to alter the distribution of potential benefits (as indicated by the distribution of expected damage presented in Table 1), which is independent of where and how emission reductions occur.^[4]

Sunstein also suggests that major emitters with sufficient means could increase the benefits that China would receive from restricting emissions by paying it to undertake reductions, and that such payments could be built into a global cap-and-trade program through the allocation of allowances (that is, rights to emit).^[5] If China were given enough allowances to cover its anticipated growth in emissions, any reductions in its emissions relative to that baseline would free up allowances that it could sell at a profit. However, giving China enough allowances to provide it with unrestricted growth potential would mean that other major emitters, such as the United States, would need to receive far fewer allowances than their business-as-usual baseline. The result would, therefore, essentially transfer income from the United States to China—improving the benefit-to-cost ratio for China but worsening it for the United States.

B. Implementation Challenges of a Global Cap-and-Trade Program

Linking the cap-and-trade programs of various countries could help minimize the overall cost of reducing emissions but could also create significant concerns. Competitive forces would equalize the price of allowances among countries, a desirable outcome in that it is a necessary condition for global cost-minimization. However, countries would have to give up sovereignty over the price of allowances traded in their programs as well as control over the standards governing emissions reductions. Lax monitoring or enforcement by any one country would lessen the incentive to cut emissions in other participating countries and could undermine the integrity of the whole system. Including developing countries in a cap-and-trade program could increase the likelihood of that outcome since such nations may lack the institutional structures necessary for successful monitoring and enforcement.^[6]

A harmonized tax—implemented in different countries at an agreed-upon rate—could avoid one of the potential problems of a linked cap-and-trade program: lax monitoring and enforcement in one country would not undermine the integrity of the tax system in other countries.^[7] If such a tax were agreed to by developed countries, some of the revenue proceeds could be used to fund emission reductions in developing countries in ways that would depend less on the ability of the country to monitor and enforce an incentive-based policy.^[8] For example, China could agree to require new electricity-generating facilities to meet certain efficiency standards, which would be funded by proceeds from the tax on CO₂ emissions in developed countries.

A similar outcome could be achieved through a system of harmonized domestic cap-and-trade programs. In that case, countries could agree to: adopt equivalent domestic cap-and-trade programs (with similar expected allowance prices), sell a share of the allowances and use some of the auction proceeds to fund emission reductions in developing countries.^[9]

Either the harmonized tax and transfer—or the harmonized cap-and-trade and transfer—policy described above could reduce the problem of system integrity associated with a global cap-and-trade program, but neither would create a more favorable benefit-to-cost ratio for the United States, based on the distribution of expected damage (and, thus, potential benefits) presented in Table 1. Those measures do not, however, reflect the fundamental uncertainties associated with climate change and, as a result, may not adequately capture a primary motivation for limiting greenhouse gas emissions.

C. The Uncertain Possibility of Catastrophic Consequences

Estimating the damage that might result from unrestrained growth in emissions of greenhouse gases is complicated by several factors. Once emitted, greenhouse gases can linger for a very long time in the atmosphere (for example, each ton of CO₂ generates a rise in the average global temperature that peaks about 40 years after the CO₂ is emitted and then dissipates slowly, with a half-life of about 60 years), and the damage that they create could be irreversible.^[10] Further, analysts face profound uncertainties about baseline emissions, the physical processes leading to changes in the average global temperature, the resulting changes in regional climates, and ecological and human responses to changes in regional climates.^[11] Potential outcomes from unrestricted emissions include a much larger temperature increase than the 2.5 ^oC value on which the Table 1 damage estimates are based; a weakening of the Gulf Stream, resulting in a much colder climate in Europe; rapidly rising sea levels, with resulting land losses; and far more rapid warming than anticipated (making adaptation much more difficult) as a result of strong positive feedback effects, such as the release of large quantities of methane (a potent greenhouse gas) due to melting permafrost. Yet, scientists have been unable to determine what level of greenhouse gas buildup would trigger such outcomes, and the risk of them occurring is captured very imprecisely in the damage estimates presented in Table 1. Specifically, those highly uncertain, but potentially extremely large, losses are essentially translated into much smaller, but certain, losses.^[12]

Critics of the damage estimates presented in Table 1 suggest that alternative ways of incorporating the profound uncertainties associated with climate change (methods that better reflect the variation in possible outcomes around expected outcomes) would result in far higher potential damage estimates.^[13] In fact, some analysts suggest that reducing the risk of catastrophic outcomes is the primary motivation for restricting emissions.^[14] Further, if damage in individual regions grew to very large levels, the spillover effects to other regions could be large, making the allocation of catastrophic damage across different countries more difficult.^[15] If the uncertain possibility of extremely large losses was better accounted for and the potential for spillover effects was taken into account, the motivation for countries, such as the United States, to agree to emissions restrictions could be much greater than the damage estimates presented in Table 1.

Scientists will continue to work at improving their understanding of the conditions under which catastrophic outcomes might occur while analysts strive to develop better methods of incorporating uncertainty into analyses of the costs and benefits of restricting emissions. Meanwhile, policymakers must grapple with these uncertainties and understand the limitations of available damage estimates. Applying an insurance framework to policy decisions might be helpful; while imposing costs on the economy, restricting emissions could be viewed as a method of buying a reduction in the risk of triggering much larger losses than those presented in Table 1 (or of being in position to reduce emissions much more quickly should scientists judge that the concentration of emissions in the atmosphere was approaching a critical threshold that would trigger those very large losses). Adopting that insurance perspective could cause major emitters to revise their perceptions of domestic costs and benefits and provide a foundation for a global agreement.

^[1] This observation holds regardless of which level of government adopts the policy intervention. For a discussion of how the distribution of costs and benefits among states affects the likelihood of reaching an agreement on the control of tropospheric ozone, see Terry Dinan & Natalie Tawil, Solving Environmental Problems with Regional Decision-Making: A Case Study of Ground-Level Ozone, 56 Nat’l Tax J. 1 (March 2003). We also note that many analyses that consider emissions restrictions from a global perspective suggest that well-designed policy actions to slow climate change would produce larger benefits than costs.

^[2] While Professor Sunstein has written extensively about the role that concern about catastrophic outcomes plays in shaping climate policy, the expected value measures of damage that he presents here do not adequately represent those outcomes. See Cass R. Sunstein, Worst-Case Scenarios (2007).

^[3] In reality, the increase in the average global temperature resulting from unchecked emissions may be much larger than 2.5 ^oC. Further, preventing an increase of 2.5 ^oC may not feasible given the emissions that have already occurred. However, the pattern of relative damage across countries is likely to provide insight into the pattern of relative benefits for policies that restrict emissions.

^[4] A global incentive-based approach could affect the distribution of benefits only if it led to much larger emission reductions than would have occurred under non-linked programs. In that case, adopting a global approach could alter the types of damages that would be avoided and, as a result, the distribution of benefits.

^[5] Others have suggested a similar approach. See, e.g., Robert Stavins, Brookings Institution, A U.S. Cap-and-Trade System to Address Global Climate Change (2007), available at http://www.brookings.edu/papers/2007/10climate_stavins.aspx.

^[6] See Table 1 for a cross-country comparison of governance indicators.

^[7] In addition, countries would have a greater incentive to enforce a harmonized tax than a global cap-and-trade program. For a discussion of this point, see William D. Nordhaus, To Tax or Not to Tax: Alternative Approaches to Slowing Global Warming, 1 Rev. Envtl. Econ. & Pol’y 26, 33 (Winter 2007).

^[8] See Joseph E. Aldy, Peter R. Orszag, & Joseph E. Stiglitz, Climate Change: An Agenda for Global Collective Action (paper prepared for the Pew Center on Global Climate Change Workshop on the Timing of Climate Change Policies, October 11–12, 2001), available at http://www.sbgo.com/Papers/Aldy-Orszag-Stiglitz_5.pdf; Joseph E. Aldy, Scott Barrett, and Robert N. Stavins, Thirteen Plus One: A Comparison of Global Climate Change Policy Architectures (Kennedy Sch. Gov’t Working Paper Series, Paper No. RWP03-012; FEEM Working Paper No. 64.2003, July 2003), available at http://ssrn.com/abstract=385000.

^[9] Assuring that emitters face similar incentives to reduce their emissions would be more difficult under a system of harmonized cap-and-trade programs than under a harmonized tax, however, because allowance prices would fluctuate with changes in underlying market conditions in individual countries.

^[10] See William A. Pizer, Combining Price and Quantity Controls to Mitigate Global Climate Change, 85 J. Pub. Econ. 416 (2002).

^[11] For an excellent discussion of how these factors, as well as uncertainty and irreversibility on the cost side, affect policymaking, see Robert S. Pindyck, Uncertainty in Environmental Economics, 1 Rev. Envtl. Econ. & Pol’y 45 (Winter 2007).

^[12] The potential for catastrophic losses of the type described above are represented as a single probability (derived from a survey of subjective probability estimates provided by experts) of a 25% loss in global income under a 2.5 ^oC increase in temperature. That aggregate loss was then distributed across countries on the basis of other damage estimates. See William D. Nordhaus & Joseph Boyer, Warming the World: Economic Models of Global Warming, 160-165 (2000).

^[13] See, e.g., Martin L. Weitzman, On Modeling and Interpreting the Economics of Catastrophic Climate Change (working paper, January 14, 2008), available at http://www.economics.harvard.edu/faculty/weitzman/papers_weitzman).

^[14] Robert Pindyck, Presentation at the International Monetary Fund (January 24, 2008).

^[15] Professor Sunstein raises a related point, referred to as “social amplification of risk,” in Worst-Case Scenarios. Sunstein, supra note 3, at 138.