Congressional Budget Office
Douglas W. Elmendorf
Director’s Blog

I am testifying before the Committee on Ways and Means this morning at a hearing on promoting the adoption and use of health information technology. A link to the testimony can be found here. (The testimony is a reprise of CBO’s recent health IT report, which I blogged about here).

In general, health IT can be an essential component of efforts to improve the efficiency of the health care system, but by itself is often not sufficient to reduce costs. Perhaps the most significant — and most under-examined — potential benefit of health IT is its complementarity with comparative effectiveness research. By making clinical data easier to collect and analyze, widespread use of health IT systems could support rigorous studies on the comparative effectiveness of different treatments; such systems then could facilitate a feedback loop to disseminate the outcome of these studies to providers. Such comparative effectiveness research could lead to reductions in overall health care spending, particularly when linked to financial incentives for providers.

To get to these outcomes, widespread adoption of health IT is necessary. Providing modest bonus payments to Medicare providers who adopt electronic health records could spur some increases in adoption; mandating their use as a condition of payment under Medicare would likely have an even larger effect.

CBO released a letter this morning that analyzes the Administration’s July 14th proposal to provide temporary authority to the Secretary of the Treasury to purchase obligations and other securities issued by Fannie Mae, Freddie Mac, and the Federal Home Loan Banks. The authority provided under this proposal would expire on December 31, 2009. (The Congress may consider a slightly modified version of the proposal, but it is unlikely that the modifications would have a significant effect on the estimated costs.)

1. CBO estimates the expected federal budgetary cost (that is, taking into account the probability of various possible outcomes) from enacting this proposal would be $25 billion over fiscal years 2009 and 2010.
2. Using historical and industry estimates of the expected losses on the different types of credit risk that the GSEs face in their current portfolios, CBO estimated the firms’ possible credit losses under thousands of possible future market conditions for housing prices. That analysis suggested that there was more than a 50 percent chance that the GSEs’ future losses would not exceed those already recognized, but there was almost a 5 percent chance that the added losses will total more than $100 billion. Given that distribution of possible future losses, CBO then evaluated how much assistance might need to be provided to the GSEs to allow them to continue operating in the capital markets.
3. In particular, CBO assumed that the Secretary would want the GSEs to continue to have the ability to tap the capital markets after the temporary authority expired and that financial markets would provide such capital to the GSEs only if market participants perceived the GSEs to be sufficiently capitalized in terms of the value of their assets relative to their liabilities. Evaluating what financial markets would view as “sufficiently capitalized” requires judgment; CBO’s approach is described in more detail in the letter. In other words, if the value of the GSEs’ assets was perceived to be insufficient relative to their liabilities, the Secretary would have to provide equity capital or subsidized debt to the GSEs before the temporary authority expired. CBO’s estimate of $25 billion in costs over the 2009–2010 period reflects a probability-weighted average of how large those injections might need to be, including zero as a potential outcome.

CBO’s estimate reflects the current budgetary treatment and existing scorekeeping conventions for federal credit assistance and equity purchases and does not necessarily measure the underlying change in the federal government’s financial condition as a result of this legislation. On the one hand, the acquisition of financial assets like equities is recorded as an outlay in the budget even though such purchases may not change the government’s underlying financial condition. On the other hand, even if enacting this legislation would not result in outlays over the near term, it might effectively strengthen the linkages between the GSEs and the federal government and thereby increase the government’s underlying exposure to the risks associated with the GSEs’ activities.

A final point to note is that a strong argument can be made that if the Treasury used the proposed authority, the GSEs’ operations should be incorporated directly into the federal budget. That is, the proposal, especially to the extent it would result in any government acquisition of an equity stake in the GSEs, raises a significant budgetary question. Currently, data on the GSEs are reported along with federal budget information each year, but the activity of those entities is not encompassed within the budget. That treatment could change if the federal government’s financial stake or control changes in a significant way. For the purposes of this cost estimate, CBO did not incorporate any change in the underlying budgetary treatment of the GSEs, in part because the proposed authority would be temporary; if it is not used, the relationship between the GSEs and the federal government would presumably return to one consistent with current budgetary treatment after the temporary authority expires.

CBO sent a letter today to Senator Conrad estimating the long-term fiscal effect of two personal income tax proposals. The first would index the Alternative Minimum Tax (AMT) for inflation beginning in 2008. The second would, in addition to indexing the AMT for inflation, also permanently extend the personal income tax provisions of the Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA) and Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) that otherwise would expire in 2010.

Budgetary impacts

1. Compared with the extended-baseline scenario in our long-term budget scenario, indexing the AMT, by itself, would reduce revenues by 2.5 percent of GDP in 2050 and by 2.6 percent in 2082. If those revenue losses were not offset by other changes in policy, the budget deficit would grow to 10 percent of GDP in 2050 and 30 percent of GDP in 2082 (relative to 5 percent and 18 percent, respectively, under the extended baseline scenario).
2. Extending EGTRRA and JGTRRA in addition to indexing the AMT would reduce revenues by about 4 percent of GDP in both 2050 2082. If not offset by other changes in policy, this would result in budget deficits of 15 percent of GDP in 2050 and 39 percent in 2082. Under these policies, federal debt held by the public would increase to 190 percent of GDP in 2050 and to more than 600 percent in 2082 (relative to 50 peercent and 240 percent, respectively, under the extended baseline scenario).

Economic effects

1. To assess the economic effects, CBO compared a scenario with the tax changes financed through deficits with an alternative scenario in which the tax changes were financed fully from the start via changes in other policies. Because the analysis assumes that the tax changes are enacted in either case, the difference between the two scenarios highlights the effects of using deficits to finance them.
2. For example, simulations using one model—a textbook growth model that incorporates the assumption that deficits affect capital investment in the future as they have in the past—indicate that the rising federal budget deficits created by deficit financing of the indexation of the AMT would reduce real GNP per person by 6 percent in 2050 and by about 37 percent in 2080. If both the AMT were indexed and EGTRRA’s and JGTRRA’s personal income tax provisions were extended, and those changes were financed by additional borrowing, the economic costs would be even larger. By CBO’s estimates, real GNP per person would decline by 13 percent in 2050. Beyond 2073, projected deficits under those tax policies would become so large and unsustainable that the model cannot calculate their effects.
3. Despite the substantial economic costs generated by deficits in that model, such estimates may significantly understate the potential loss to economic growth under deficit financing of the tax changes. In particular, the estimates are based on a model in which people do not anticipate future changes in debt; as a result, the model predicts a gradual change in the economy as federal debt rises. In reality, the economic effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario. Simulations using CBO’s other economic models (which are more responsive to changes in tax rates than CBO’s textbook growth model) also show that the outcomes could be worse than the textbook growth model indicates.

Rapid growth in imports of merchandise from the People’s Republic of China over the past decade has posed a challenge for competing U.S. manufacturers. Some observers believe that the Chinese government has contributed to growth in U.S. imports by maintaining an undervalued currency, and there have been calls for China to revalue its currency, the renminbi—that is, to raise its value (or allow it to rise) relative to the dollar—as a way to level the playing field for U.S. manufacturers.

In a paper released today, CBO examines two important determinants of how appreciation of the renminbi against the dollar might affect competition in U.S. markets.

The first determinant is the portion of the value of Chinese exports that is produced in China—that is, the value of the exports minus the value of the imported inputs (such as parts and raw materials) used to produce them. That portion is often called the domestic value added, or the domestic content. A evaluation of the renminbi would affect the dollar price of only the domestic content of China’s exports. It would not affect the portion of the exports’ value attributable to the cost of imported inputs—often called the foreign content—unless the countries that supply those inputs allowed their currencies to rise in value as well.

The second determinant is the degree to which Chinese exports to the United States compete with other countries’ exports rather than with the products of U.S. manufacturers. In general, a decline in U.S. imports from China would be offset to some extent by an increase (or more rapid growth) in imports from elsewhere.

In brief, CBO finds the following:

1. A review of the relevant literature indicates that the average domestic value added of Chinese exports to the United States is probably between 35 percent and 55 percent. As a result, a 20 percent revaluation of the renminbi (for example) would cause the average price of imports from China to rise by roughly 7 percent to 11 percent if Chinese exporters continued to fully pass through their costs and previous rates of profit after the revaluation. The increase would be smaller if the exporters reduced their profit margins to maintain their share of the market, as firms often do when their currencies appreciate. The increase could be larger if the other countries that supply inputs to China’s exports allowed their own currencies to appreciate in response to the Chinese revaluation.
2. By CBO’s estimate, roughly one-third of the increase in the share of U.S. imports from China from 1998 through 2005 was offset by reductions in the shares of imports from the rest of the world. However, slight variations in CBO’s estimating methodology lead to meaningful differences in the estimate; thus, the actual offset could be somewhat higher or lower. CBO’s estimate is considerably lower than the 75 percent to 90 percent reported in two previous studies for periods between 1988 and 1997. The lower value probably reflects, at least in part, a decline in the offset over time as China has developed economically and technologically and its exports have become more similar to the output of U.S. manufacturers and less similar to U.S. imports from elsewhere. The lower value may also stem in part from differences in methodology.

I am testifying before the Senate Finance Committe today on overuse, underuse, and misuse of health care.  The webcast is posted here.

Today’s remarks focus on several key points:

1. Rising health care costs represent the central fiscal challenge facing the country, exerting a larger influence on the long-term fiscal balance than other commonly cited concerns such as the aging of the population.
2. Spending for health care varies substantially across the United States, mostly because of variation in the intensity of services provided, but Medicare enrollees in areas with higher spending do not appear to have better health outcomes on average than those in areas with lower spending. Those observations suggest that substantial opportunities exist to reduce costs without harming health overall, but capturing those opportunities will be technically challenging to bring about through changes in policy and may also prove to be controversial.
3. Expanded use of health information technology (IT) and electronic medical records has the potential to improve the quality and efficiency of the care that patients receive, but realizing that potential would require broader changes in the health care system (including, especially, changes in the financial incentives for doctors).
4. One reason that the most appropriate care is not always provided is that, for many conditions, evidence is limited about which treatments work best for which patients and whether the benefits of more expensive therapies warrant their additional costs. More information about the comparative effectiveness of medical treatments would help to address that problem, especially if the findings were linked to Medicare’s payment rates or cost-sharing requirements.
5. A growing body of research on behavioral economics suggests that, in addition to financial incentives, norms and default options can exert a strong influence on individuals’ choices. Such findings could inform efforts to improve efficiency in the health sector.
6. Given the importance of health care issues, CBO is devoting increasing resources to that topic. As part of that effort, CBO is in the process of analyzing a number of options that could improve the efficiency of health care delivery and possibly reduce geographic variation in Medicare spending—including greater bundling of payments and stronger incentives to provide effective care—and plans to release the results of its analysis by the end of the year.

Today I’m delivering testimony before the House Budget Committee on increasing the value of federal spending in health care. The webcast is posted here. This is the first of two hearings this week on health costs — tomorrow I’ll address similar issues before the Senate Finance Committee.

My statements will be familiar to those who have followed CBO’s work on health care: they highlight evidence of the potentially substantial inefficiencies in health care and discuss potential pathways for reducing them.

I am increasingly convinced that a key problem is that our political system does not deal effectively with gradual long-term problems, and that a key impediment to improving the efficiency of our health care system is that most of us don’t realize how much the system is currently costing (because the cost of employer contributions for health insurance is not salient to workers, even though that cost is passed along to workers in the form of reduced take-home pay).

This morning I’m testifying before the Senate Finance Committee on infrastructure investment. My statement can be found here, and the webcast is posted here.

The testimony occurs at a time when burgeoning congestion on the nation’s transportation networks and concerns that the nation is underinvesting in its physical infrastructure have focused attention on the federal government’s role in sustaining that infrastructure.

The testimony defines “infrastructure” as including transportation, utilities, and some other public facilities. The nation currently invests more than $400 billion per year in infrastructure defined this way, and about $60 billion of that amount is funded by the federal government each year, primarily for highways and other transportation networks.

The testimony makes the following key points:

• Estimates from the Federal Highway Administration (FHWA) and other sources indicate that additional spending of up to tens of billions of dollars each year on transportation infrastructure projects could be justified. Some of that spending would simply maintain the current performance of existing infrastructure; other projects would improve performance to the extent that the economic benefits
  exceeded the costs (although some projects would have net benefits that were smaller than those that could be obtained from spending on items besides infrastructure).
• Although the rationale for some additional spending is probably strong, the economic returns on specific projects vary widely. Accordingly, even if the Congress were to increase spending, it would be important to identify which projects provided the largest potential benefit from limited budgetary resources.
• Some of the demand for additional spending on infrastructure could be met by providing incentives to use existing infrastructure more efficiently and by devoting current budgetary resources to their highest valued uses. For example, the Department of Transportation has reported that the demand for new spending on highways could be reduced by as much as $20 billion annually if congestion pricing were implemented to encourage efficient use of existing infrastructure.
• A special-purpose entity, such as a federally chartered infrastructure bank, could provide funding for infrastructure outside of the annual appropriation process but would not be a source of “free money”: Any reduction in the federal shares of project costs (obtained by reducing grant sizes or by shifting from grants to loans or loan guarantees with smaller subsidy costs) would require greater shares to be borne by project users, state or local taxpayers, or both.

In addition, attentive readers will note that in what I believe to be a first for CBO, the testimony includes a few lines of poetry (see footnote 47). These lines appear in response to a comment from David Brooks of the New York Times at a public forum that CBO reports don’t have enough “romance” in them; when I asked him what he possibly meant by that comment, he suggested that CBO documents could include some poetry. Footnote 47 was the best we could do for now.

CBO has been doing a significant amount of analytical work on climate change, and I wrote an oped for today’s Washington Post on the topic.

The piece notes that the economic cost of emission reductions will depend on the degree to which flexibility is provided on when emission reductions can occur and what policymakers do with the valuable emission allowances created under a cap-and-trade program.

The first point — that timing flexibility matters — is based on the observation that, as the oped points out, changes in climate reflect the accumulation of greenhouse gases in the atmosphere over long periods. The environmental impact depends little on year-to-year fluctuations in emissions. By contrast, the economic cost of reducing emissions can vary a lot from year to year — because of factors such as weather, economic activity or the state of technology. Flexibility regarding the timing of emissions reductions matters because of this disconnect between the environmental dynamic, which depends on total emissions reductions over an extended period, and the economic dynamic.

The second point has been discussed at length in numerous CBO documents. For more on CBO’s climate work, see here.

CBO released its monthly budget review today. During the first nine months of FY 2008, the federal government incurred a deficit of $268 billion according to CBO estimates — $148 billion more than the shortfall recorded during the same period in 2007. About $79 billion of that change is due to the tax rebates enacted in the Economic Stimulus Act of 2008. Compared with their level in 2007, outlays have risen by more than 6 percent, whereas revenues have declined by about 1 percent.

I was on a panel this morning at the Aspen Ideas Festival on the future of health care reform. For video from the panel, see here .

During a session earlier in the conference, David Brooks delivered an important talk about how policymakers should pay more attention to neuroscience, emotion, peer effects, and other related factors in the design of public policies. Many of his themes are echoed in, and reflect, the growing field of behavioral economics (see here for a related discussion).