Congressional Budget Office
Director’s Blog

Today’s Wall Street Journal quotes me saying that CBO has between 40 and 50 people working “more than full time” on health reform.  Yesterday’s Politico included me in an article about “Names, Faces to Watch for In Debate Over Care,” and the story referred to “Elmendorf and his team of anonymous analysts.”

Clearly, analyzing health reform proposals is a team effort. Indeed, projecting the behavioral consequences and budgetary impact of a variety of proposals to make major changes in a sector that accounts for one-sixth of the U.S. economy poses an enormous analytical challenge.  CBO is meeting that challenge because of the skill, knowledge, and hard work of our talented staff (and of our colleagues on the staff of the Joint Committee on Taxation, with whom we are collaborating in this effort). 

Because CBO believes that its estimating methodology should be as transparent as possible, perhaps our estimating team should be transparent as well.  In that spirit, here are the previously anonymous analysts at CBO who deserve a great deal of credit for their fine work analyzing health reform and related legislative proposals (I realize this list has more than 50 names; that’s because some of these people have other responsibilities beyond health reform):

Human activities around the world—primarily fossil fuel use, forestry, and agriculture—are producing growing quantities of emissions of greenhouse gases, other gases, and particulates and are also greatly altering the Earth’s vegetative cover. A strong consensus has developed in the expert community that if allowed to continue unabated, the accumulation of those substances in the atmosphere and oceans, coupled with widespread changes in patterns of land use, will have extensive, highly uncertain, but potentially serious and costly impacts on regional climate and ocean conditions throughout the world.

Today CBO released a paper presenting an overview of the current understanding of the impacts of climate change in the United States. CBO cannot independently evaluate the relevant scientific research, so our paper draws from numerous published sources to summarize the current state of climate science and provides a conceptual framework for addressing climate change as an economic concern. The paper was reviewed by several knowledgeable external reviewers and, as with all CBO analysis, makes no recommendations.

The paper discusses potential impacts on the physical environment (temperature, precipitation, severe storms, ocean currents, climate oscillations. sea level, and ocean acidification); biological systems(ecosystems and biological diversity, agriculture, forestry, and fisheries); and the economy and human health (water supply, infrastructure, human health, and economic growth).

The paper emphasizes the wide range of uncertainty about the magnitude and timing of impacts and the implications of that uncertainty for the formulation of effective policy responses. Uncertainty arises from several sources, including limitations in current data, imperfect understanding of physical processes, and the inherent unpredictability of economic activity, technological innovation, and many aspects of the interacting components (land, air, water and ice, and life) that make up the Earth’s climate system.  This does not imply that nothing is known about future developments, but rather that projections of future changes in climate and of the resulting impacts should be considered in terms of ranges or probability distributions. For example, some recent research suggests that the median increase in average global temperature during the 21st century will be in the vicinity of 9° Fahrenheit if no actions are taken to reduce the growth of greenhouse-gas emissions. However, warming could be much less or much greater than that median level, depending on the growth of emissions and the response of the climate system to those emissions.

Given current uncertainties, crafting a policy response to climate change involves balancing two types of risks: the risks of limiting emissions to reach a temperature target and experiencing much more warming and much greater impacts than expected versus the risks of incurring costs to limit emissions when warming and its impacts would, in any event, have been less severe than anticipated. Climate policies thus have a strong element of risk management: Depending on the costs of doing so, society may find it economically sensible to invest in reducing the risk of the most severe possible impacts from climate change even if their likelihood is relatively remote. In particular, the potential for unexpectedly severe and even catastrophic outcomes, even if unlikely, would justify more stringent policies than would result from simply balancing the costs of reducing emissions against the benefits associated with the expected or most likely resulting degree of warming. At the same time, the uncertainties in the link between emissions and climate change mean that even rigid quantitative targets are not likely to achieve a specific warming target.  Uncertainties may thus justify flexible mechanisms even though they may simultaneously justify relatively stringent policies.

The report was written by Bob Shackleton.  He has been at CBO for the past 10 years and working on climate issues here and elsewhere for nearly 20 years.  Bob holds a Ph.D. in economics from the University of Maryland.  In addition to his interest in climate issues, he satisfies his intellectual curiosity through a wide variety of pursuits including publishing original scholarly research on the history of American dialects and studying quantum mechanics in his free time.  In short, he is a true geek . . .

As I discussed yesterday, I participated in two panels at the Milken Institute’s Global Conference in Los Angeles on Monday.  The second panel was about “Infrastructure Projects as Economic Stimulus.” You can view the slides and webcast.

My main observations at this second panel were:

• Some of the infrastructure spending in the stimulus package would pass a cost-benefit test even apart from the recession.  For example, CBO’s analysis of infrastructure investment last year concluded that “additional spending of up to tens of billions of dollars each year on transportation infrastructure projects” could be justified as having benefits that exceed the costs.  We warned that economic returns on specific projects vary widely, so specific investments should be selected carefully.  In addition, we explained that some of the additional spending could be avoided by creating incentives to use existing infrastructure more efficiently—such as congestion pricing, which we analyzed more fully earlier this year.  Still, additional targeted infrastructure investment could be appropriate even in normal times. Moreover, these are not normal times, and it may be appropriate to undertake more immediate infrastructure spending than otherwise in order to put idle resources to use.

• CBO projected that infrastructure spending approved in the stimulus legislation would generate outlays—and thus economic stimulus—only gradually.  For example, we are looking for increases in federal highway spending to be 10 percent of the amount appropriated in the rest of fiscal year 2009, 25 percent in FY 2010, 20 percent in FY 2011, and a declining share thereafter.  Although the sluggishness of this projected spend-out surprised some observers, we explained that the need to draft plans, solicit bids, enter into contracts, and then to undertake the work (during appropriate weather) had led previous increases in budgetary resources for highways to be followed by increases in                                      

            Budgetary Resources and Outlays for Highways 

Source: Congressional Budget Office

outlays with a measurable lag. Lags in other areas of infrastructure spending can be even longer, especially where programs are new or receive significant boosts in funding relative to recent years—descriptions that fit provisions in the stimulus package focused on weatherization and broadband expansion among others.  CBO projects that total infrastructure outlays resulting from the stimulus package will peak in 2010 and 2011 but will remain significant for a number of years.  

Infrastructure Outlays as a Result of the American Recovery and Reinvestment Act



Source: Congressional Budget Office

• Very early data on the use of funds approved in the stimulus package are consistent with this perspective.  For example, the Department of Transportation has reported that $7 billion has been obligated for highway spending but only a few million federal dollars have been spent.

On Monday I participated in two panels at the Milken Institute’s Global Conference in Los Angeles.  I was honored to be invited, and I enjoyed the spirited and insightful discussions. You can view my slides and a webcast.

The first panel addressed the topic “U.S. Overview: When Will Growth Resume?”  My comments stressed four points:

• Even if economic growth resumes later this year, as a large majority of forecasters expects, the unemployment rate is likely to remain high for several years.  According to CBO’s March forecast, real GDP will begin to grow again in the second half of the year and will expand at a brisk 4 percent pace in both 2010 and 2011.  However, under our projections, the shortfall of actual GDP relative to its potential (that is, the “output gap”) will be so large by the end of this year—roughly 8 percent of GDP—that even this rapid growth rate will leave a measurable output gap through 2012.  The implication for economic policy is that actions to narrow that gap and bring the economy back to full employment more quickly are likely to receive serious consideration in the next few years.  (Read a longer discussion of our economic forecast.)

• The persistence of high unemployment in CBO’s forecast does not stem from a “failure” of fiscal stimulus.  We believe that last year’s tax rebates had a measurable impact on the economy, and that this year’s stimulus legislation will have a significant impact as well. CBO had expected that about 40 percent of last year’s tax rebates would be spent.  Although some economists have argued that the lack of a jump in consumption last year contradicts that expectation, we and other analysts think the data are quite consistent with it.  For example, see this illustration of actual consumption and disposable income (that is, income after taxes) compared with an estimate of what consumption and

  The Effect of Rebates on Disposable Income and Consumption (Monthly)

  

Source: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.    (April 27, 2009)

spending from this year’s stimulus package has just begun. Once the spending and tax effects kick in, CBO expects that the package will boost GDP a little more than dollar-for-dollar of reduced tax collections and increased outlays—in other words, that the overall “multiplier” will be a little larger than 1.  Nevertheless, as large as the stimulus package is, the contraction in underlying demand is far larger, so the stimulus will offset only part of the contraction.

• The U.S. financial system is hardly out of the woods.  Despite the hundreds of billions of dollars of losses recognized by U.S. financial institutions in the past few years, most experts believe that hundreds of billions of dollars of further losses on mortgage-related assets and other assets will ultimately be incurred.  Unless the economy and real estate markets rebound more quickly than most forecasters predict, these further losses will be a drag on new lending for some time.  And international evidence on financial crises suggests that the crimp in lending caused by past losses can impede economic recovery for years.  Therefore, despite the vigorous and creative actions already taken by the Federal Reserve and Treasury, further actions are likely to be needed to return the economy to sustained growth. (See my testimony from January on options for dealing with the financial crisis.)

• The outlook for the federal budget over the next decade is grim.  To be sure, economic recovery and the waning of countercyclical tax, spending, and financial policies will cause the budget deficit to diminish sharply from its record-setting level this year if tax and spending policies set by current law are maintained.  In fact, CBO’s baseline projection, which follows current law, shows the deficit in the later part of the decade running just below 2 percent of GDP—a level that crowds out some private capital but allows debt to fall over time relative to GDP.  However, current law would lead to a significant increase in tax revenue relative to GDP (as the 2001-2003 tax cuts expire and as more households become subject to the Alternative Minimum Tax) and a significant decrease in defense and non-defense discretionary  spending relative to GDP (because the baseline assumes that these categories just keep pace with inflation).  If these components of the budget were instead maintained at their historical relationship to GDP, then the continued surge in spending on Medicare and Medicaid under current law would push the budget deficit to unsustainable levels.  (More discussion of this topic appeared in the blog last week.)

The current outbreak of swine flu in the United States, Mexico, and other countries has raised concerns among policymakers and public health experts about the possibility of a pandemic and about the nation’s ability to blunt the effects of such an event. (A pandemic arises when a new virus emerges that has not previously circulated among the human population; that virus causes significant illness in humans; and the virus is easily transmitted from one person to another.) Beyond the human suffering that a pandemic would engender, policymakers are also concerned about the potential for economic disruptions that might be layered on top of an economy already in recession.

The current outbreak is evolving rapidly, and the risk that it poses is not yet fully understood.  The World Health Organization has not declared the current outbreak to be a pandemic.  However, if the current strain were to cause a pandemic, it has the potential to slow the pace of the economic recovery that CBO expects to take hold later this year. The consequences of past episodes provide a basis for assessing the potential seriousness of a pandemic, particularly in light of the current economic downturn. In a May 2006 analysis, CBO considered the possible economic effects of a range of influenza pandemics. On the basis of an analysis of past pandemics, CBO devised two scenarios to illustrate the possible economic effects of an influenza pandemic. In a “mild-pandemic” scenario, resembling the pandemics in 1957 and 1968, about 75 million people would be infected in the United States, and about 100,000 of them would die (in a typical year seasonal influenza causes about 36,000 deaths in the United States). In that scenario, the pandemic would reduce real (inflation-adjusted) gross domestic product (GDP) by about 1 percent relative to what would have happened without the pandemic. In a “more severe” scenario, roughly similar to the 1918-1919 Spanish flu outbreak, about 90 million people would become infected, and 2 million people would die in the United States; in CBO’s estimation, real GDP would be about 4-1/4 percent lower over the subsequent year than it would have been had the outbreak not taken place.  Of course, there have been widespread changes since 1918 that may change the severity of an outbreak.  Faster international travel may mean faster transmission, but better antibiotics mean less risk of complications which were often proximate causes of death in the 1918-1919 outbreak.

In a paper released in September 2008, CBO focused on the government’s role in the vaccine market that stems from a 2005 plan by the Department of Health and Human Services (HHS) to prepare for and combat an influenza pandemic. That plan, although developed in response to the threat of the H5N1 virus, or “avian flu,” sheds light on the nation’s ability to respond to the current swine flu outbreak and will probably be the subject of public discussion in the coming months.

Because of the time it takes to produce a flu vaccine using current technology, a pandemic could circle the globe more quickly than vaccines could be produced. For the next several months, the nation’s response to the swine flu outbreak will be limited to measures that might reduce the spread of the virus through “social distancing,” strategic use of antiviral medications from existing stockpiles, and the capacity of the existing public and private health systems to treat infected people.

To improve the nation’s capacity to respond to a pandemic, HHS’s plan calls for an enlarged role of the federal government in promoting private-sector development of new vaccines, expanding the capacity of the industry to manufacture them, and procuring stockpiles of prepandemic vaccines. (Prepandemic vaccines are developed from strains that public health officials believe have the most potential to cause an influenza pandemic.) The prepandemic vaccine that has been stockpiled to date is an H5N1 vaccine and is unlikely to offer protection against the current swine flu outbreak.

HHS’s plan has multiple objectives, including to:

• Increase manufacturing capacity by refurbishing and expanding plants that produce vaccines using traditional egg-based processes (developed in the 1940s) and increasing the availability of  more costly cell-based manufacturing technology and
• Make vaccines available more quickly. The plan takes two approaches to meet this objective. First, it calls for stockpiling a relatively small amount of prepandemic vaccine that could diminish the worst effects of a pandemic by protecting particularly vulnerable groups and first responders. However, none of the stockpiled vaccine is likely to provide protection against the current swine flu outbreak. Second, it aims to develop so-called next-generation vaccines that can be produced more rapidly than currently available vaccines to more efficiently meet long-term needs.

Ongoing research has changed the environment in which HHS’s plan was originally formulated in at least one important regard. Adjuvants—substances that may be added to influenza vaccines to reduce the amount of active ingredient (called antigen) needed per dose of vaccine—are showing promise in clinical trials in the United States; some of them have been approved for limited uses in Europe. If a safe and effective adjuvanted swine flu vaccine can be developed, manufacturers may be able to provide enough vaccine for the entire U.S. population within a span of several months thereafter.

Specifically, CBO reached the following conclusions in its September 2008 paper:

• The manufacturers of currently approved vaccines made in the United States cannot produce vaccines of sufficient effectiveness, in sufficient quantities, or in the time required to meet public health needs in the event of an influenza pandemic.
• In the short term, adjuvanted vaccines offer the best hope for achieving HHS’s goal of having enough vaccine to protect 300 million people within six months of the outbreak of an influenza pandemic.  The manufacturing capacity that is needed to produce pandemic-influenza vaccine exceeds what is required to make seasonal vaccine; ongoing federal support may be required to meet and maintain the necessary capacity.

Adjuvants developed since 2005 could substantially reduce the amount of antigen needed per dose, raising the question about whether HHS’s current policy is the most cost-effective approach to meeting its vaccine-production goals. In light of this, the September 2008 paper briefly examined several other options to consider if adjuvanted vaccines prove successful, including reducing the capacity targeted for manufacturing cell-based influenza vaccines while expanding resources available to support the development of next-generation vaccines, entering into advance supply agreements (an approach used by several European nations that allows countries to make advance payments to manufacturers in exchange for a guaranteed supply of vaccine in the event of a pandemic), and modifying the size of the planned vaccine stockpile.

At a meeting of the Social Security Advisory Board, on April 21st, CBO staff presented four charts comparing our March 2008 and March 2009 projections of the income and spending of the Social Security trust funds. Those baseline projections cover 10 years and assume no changes in current law. (This summer, CBO will issue new projections of the long-term budget outlook, spanning 75 years.)

Over the 10-year period from 2009 through 2018, projected income and outlays have both declined significantly from our projections of a year ago—income is down by about $1.2 trillion (about 11 percent) and outlays are down by about $250 billion (about 3 percent) for that 10-year period (see Chart 1). Nearly all of the adjustments stem from changes in CBO’s economic forecast: our projections for inflation, real GDP, and interest rates have all declined relative to those underlying our March 2008 baseline. Lower inflation affects both revenues and outlays through lower payroll taxes and smaller cost-of-living adjustments (COLAs). Similarly, lower real GDP would imply lower real wages—and therefore less revenue from payroll taxes and, over time, a lower initial benefit amount for new beneficiaries. Finally, because projected interest rates are lower, the trust funds are expected to earn less interest income. Outlays projected for the first few years are now higher than we estimated in 2008 because of the larger-than-expected COLA (5.8 percent) that took effect in January 2009. (For a discussion of CBO’s projected COLA increases, see my recent blog. ) The decline in projected income and outlays has affected our projections of the trust funds’ annual surpluses and balances (see Charts 2-4). 

Current projections of total surpluses of the two trust funds—for Old Age and Survivors Insurance (OASI) and Disability Insurance (DI)—are much lower than last year’s estimates (see Chart 2). In 2018, for example, the trust funds are now projected to record a surplus (total income less expenditures) of $133 billion, compared with last year’s estimate of a $246 billion surplus.

The trust funds’ total surplus includes interest credited to the trust funds, based on the balances accumulated over many years.  That interest is an intragovernmental transaction and doesn’t affect the budget deficit. Another measure to assess the financial condition of the program is the primary surplus, which excludes interest credited to the trust funds. The projected primary surplus dips to $3 billion in 2010, recovers for the next several years, and then falls below zero beginning in 2017 (see Chart 3). When the primary surplus disappears, Social Security benefits exceed Social Security’s income from the public, and the operations of the Social Security system increase the federal deficit.

The projected balance in the OASI trust fund continues to grow throughout the 10-year period, albeit at a slower rate than CBO projected a year ago, reaching $3.9 trillion by 2019 (see Chart 4). In contrast, we expect that the DI trust fund balance will decline each year. CBO now anticipates that the DI trust fund will be exhausted in 2019, with available funds falling $29 billion below projected expenditures. At that time, absent a change in law, Social Security could not pay DI beneficiaries the full benefits to which they are entitled under the Social Security Act.

The 111th Congress is taking up the issue of addressing the risks associated with climate change, a task that would entail the regulation of emissions of a variety of greenhouse gases from a variety of sources. The Environmental Protection Agency estimates that, in 2006, households and businesses in the United States emitted nearly 7.1 billion metric tons of carbon dioxide equivalent of greenhouse gases. Those emissions were partially offset by the net absorption of roughly 900 million metric tons of carbon dioxide  by the nation’s forests and soils.

Several different approaches, or combinations of approaches, could be used to manage emissions, including direct regulations, cap-and-trade restrictions, and taxes that would directly raise the price of emitting gases. A program based on such approaches could be used to regulate any or all of those emissions.

CBO has previously produced several estimates of the budgetary impact of policies designed to mitigate emissions of greenhouse gases and will produce additional estimates during the current Congress. To do so, CBO undertakes a detailed analysis of the specific provisions of the legislation. In particular, it must estimate the marginal, or incremental, cost of reducing emissions of a number of different greenhouse gases at various levels of mitigation and at different points in the future.

On Friday, CBO released a paper describing the methodology that it uses to estimate the costs of mitigating emissions. In preparing its estimates, CBO uses projections of mitigation costs that, by construction, are in the middle of the range of estimates produced by current state-of-the-art energy-economy models. CBO can use its approach to calculate the amount of emissions generated at a given price or tax, or to determine the price or tax required to achieve a given emissions target.

The methodology involves several steps. CBO first projects a base case that serves as a marker against which to measure the effects of the proposed policies; that base case encompasses projections of future greenhouse-gas emissions and future prices of fossil fuels, electricity, and other products and services closely associated with such emissions—all assuming no new federal policies to control those emissions.  For its base-case projections, CBO relies primarily on projections from the Energy Information Administration of the Department of Energy.

Then, CBO estimates how firms and households will respond to the proposed regulatory program. In the case of a cap-and-trade system, CBO determines how the proposals would affect the prices of emission allowances, and estimates how those allowance prices would filter through to prices of fuels and other emission-intensive products, affecting the aggregate demand for such goods and services.

CBO draws on a variety of sources to calculate how sensitive emissions are likely to be to changes in the allowance price. That sensitivity is, in effect, an elasticity of emissions with respect to the price. (An elasticity is a measure of the response of one variable to changes in another; for example, the elasticity of household demand for electricity measures how much an increase in the price of electricity would reduce households’ electricity consumption.) To develop its measures of price sensitivity, CBO applies six different models, available from government agencies, academic institutions, and other researchers, that represent the current state of the art.

CBO’s estimate implicitly includes the sensitivity of end-use energy demand to changes in allowance prices as well as the amount of substitution that might occur among energy sources. For example, rising prices for fossil fuels would lead electric utilities to substitute some sources for others, by using more natural gas or wind and using less coal to generate electricity, but would also lead households and firms to consume less electricity. Both types of responses are implicitly built into CBO’s estimates.

CBO has a panel of economic advisers that includes many distinguished economists (some of whom are former CBO directors). We host periodic meetings of the advisers at our office and solicit the advisers’ views between meetings via email exchanges and phone calls. Through these interactions, we benefit from the advisers’ understanding of cutting-edge research, current economic conditions and the economic outlook, and the budget and economic policy process. As a result of the advisers’ comments, the quality of CBO’s economic analysis is greatly enhanced. The advisers for 2009 are:

We appreciate these advisers’ contribution to our work, and we look forward to continuing to benefit from their knowledge and experience.

In yesterday’s blog, I discussed CBO’s projection that the recent decline in consumer prices and low expected inflation during the next few years will mean no COLAs in Social Security benefits until 2013. A zero Social Security COLA would have significant implications for the premiums charged to enrollees in Medicare Part B. 

Part B of the Medicare program covers physician services and outpatient care, including durable medical equipment, laboratory services, some physical and occupational therapists’ services, and some home health care.  Most beneficiaries pay a monthly Part B premium that is set to cover about 25 percent of the costs of Part B, with the balance coming from the general fund of the Treasury. 

Hold Harmless Provision.  Most Medicare enrollees have their Part B premium withheld from their monthly Social Security benefit. For those individuals, a “hold-harmless” provision guarantees that a benefit check will not decrease as a result of an increase in the Part B premium. The dollar increase in the Part B premium for a year is compared to the dollar increase in the Social Security monthly benefit. If the dollar increase in the premium is larger than the dollar increase in the Social Security benefit, then the increase in the Part B premium paid by the beneficiary is limited to the dollar increase in the Social Security benefit.

The hold-harmless provision does not apply to about one-quarter of Part B enrollees:

• New enrollees in Part B (because they did not have the premium withheld from their Social Security benefit in the prior year),
• Higher-income enrollees who are subject to an income-related premium, and
• Individuals who do not have the Part B premium withheld from their Social Security benefit, nearly all of whom have their premiums paid by Medicaid.

In most years, the hold-harmless provision has very little impact. For example, a 2 percent increase in a Social Security benefit of $1,000 per month results in a $20.00 benefit increase. (The average Social Security benefit for a retired worker is about $1,150 per month.) A 7 percent increase in the Part B premium (similar to benefit growth in recent years), applied to the current premium of $96.40, would increase the premium by $6.75—well under that benefit increase—and the hold-harmless provision would have no effect.

Under current law, however, CBO projects no benefit increase for Social Security beneficiaries from 2010 through 2012. As a result, by CBO’s estimate, almost three-quarters of Part B enrollees will have their premiums limited by the hold-harmless provision each year during that period.

The Role of Part B Premiums in Medicare Trust Fund Financing. The major components of income to the Part B trust fund account are premiums and a matching contribution that is transferred from the general fund of the Treasury. For aged enrollees, that matching contribution is $3 for every $1 in premium collections; there is a similar matching contribution for enrollees who are under 65.

The amount of the monthly premium is set so that total annual revenue to the Part B trust fund account (from premiums, matching contributions, and interest) is sufficient to cover annual expenditures from the trust fund and to maintain a contingency reserve of about two months of spending. Under normal circumstances, the premium is set to cover about 25 percent of the average cost per enrollee of Part B benefits (because the matching contribution covers the remainder). 

However, because almost three-quarters of Part B enrollees will be subject to the hold-harmless provision, the increase in premium revenue needed to draw matching contributions sufficient to cover the growth in annual spending and maintain the contingency reserve will have to be collected from the one-quarter of enrollees who are not eligible for the protection of the hold-harmless provision. As a result, the current-law increase in the monthly Part B premium for those individuals will be nearly four times the increase that would be required if no enrollees were subject to the hold-harmless provision.

Projected Part B Premiums in 2010 and Subsequent Years. CBO estimates that the Part B trust fund account will require about $220 billion in income from premium collections and matching contributions in 2010 to cover expenditures and maintain a contingency reserve, with larger premium collections required in subsequent years. CBO estimates that the hold-harmless provision, in conjunction with the zero COLAs projected for Social Security benefits, will result in the monthly Part B premium for beneficiaries not subject to the hold-harmless provision increasing to $119 in 2010, $123 in 2011, and $128 in 2012 (see note below).  Without the hold-harmless provision, CBO estimates that the monthly premium would be $103 in 2010 and would grow to about $109 in 2012, so the interaction of the hold-harmless provision and projected zero COLAs for Social Security will add significantly to the increases called for under current law. There is no effect on Part D premiums because there is no hold-harmless provision in Part D.

CBO expects that monthly premiums will be lower than $128 for a few years after 2012, as the number of beneficiaries subject to the hold-harmless declines. We estimate that the monthly Part B premium will decline to $114.50 in 2016 and then rise in subsequent years, reaching $135 in 2019. 

Note: Under current law, Medicare’s payment rates for physicians’ services are scheduled to be reduced by 21 percent in 2010 and by about 6 percent a year for several years thereafter. CBO’s premium projections assume that the premium for 2010 will be set to maintain an adequate contingency reserve in 2010 in the event that legislation to eliminate that 21 percent reduction is enacted after the premium is announced.  (The premium for 2010 will be announced in September 2009.) The projections also assume that the reductions in payment rates for physicians’ services that are scheduled for 2010 and subsequent years will go into effect, and that premiums in 2011 and subsequent years will reflect those reductions in payment rates.

The Social Security Administration (SSA) generally adjusts benefits payable each January based on the annual change in the consumer price index for urban wage earners (CPI-W) through the third quarter of the previous calendar year.  (More information about the CPI is available from the Bureau of Labor Statistics     <http://www.bls.gov/cpi/cpifaq.htm>.)  The index is based on a starting point of 100 for the 1982-1984 period.  In January 2009, Social Security beneficiaries received a benefit increase (often referred to as a cost-of-living adjustment or COLA) of 5.8 percent. That COLA reflected the increase in the CPI-W from 203.4 in the third quarter of 2007 to 215.2 in the third quarter of 2008 (215.2 divided by 203.4 equals 1.058, or a 5.8 percent change for that year-over-year comparison).

From the third quarter of 2008 to the first quarter of 2009, the CPI-W has fallen (by about 4 percent) to 206.5 largely reflecting the decline in energy prices from their historically high levels in 2008. Even though CBO anticipates that the CPI-W will rise a bit over the next several months, we project that it will be 209.5 for the third quarter of 2009, lower than the 215.2 CPI-W for the third quarter of 2008. By law, Social Security benefits are unchanged in years in which the change in CPI-W since the previous adjustment to benefits is zero or less than zero. Thus, CBO anticipates no COLA in January 2010.

Moreover, CBO projects that inflationary pressures will be very low over the next few years—in particular, our March 2009 economic forecast says that the CPI-W will not reach the level it attained in the third quarter of 2008 until late in 2011. (Under current laws and policies, CBO anticipates third-quarter-over-third-quarter increases in the CPI-W of 1.1 percent each year from 2010 to 2012.) As noted, a Social Security COLA will not be triggered until the CPI-W for the third quarter of a year exceeds its level in the third quarter of 2008. We project that the CPI-W will reach 217.0 in the third quarter of 2012, triggering a 0.8 percent COLA payable in January 2013. Thus, even though CBO is projecting price increases in fiscal years 2010 and 2011, those annual price increases would not be large enough to offset the price declines that have already taken place in recent months. Beneficiaries in other federal programs, including civil service and military retirement, and those drawing veterans’ compensation and pensions, also will not receive COLAs in 2010, 2011, or 2012, by CBO’s projections, because their COLAs are tied to Social Security’s under current law.

The absence of COLAs will affect payments of Social Security taxes and the base for calculating benefits for new beneficiaries because it will affect the maximum amount of wages that are subject to Social Security, known as the taxable maximum. The Social Security Act specifies that the taxable maximum increases only in years in which a COLA occurs. Thus, under CBO’s forecast, that maximum will be frozen until 2013. At that time, the contribution and benefit base will increases by the change in the national wage index since the last time a COLA was triggered. Following those current-law rules, CBO anticipates the base will hold steady at $106,800 for 2009 through 2012, and then jump to $118,200 in 2013, reflecting the cumulative change in the national wage index during the period of no COLAs.

In contrast, CBO projects that the initial benefits for newly eligible beneficiaries will continue to rise each year because those benefit calculations are linked to the annual growth in earnings and not tied to COLAs. Wage-indexing is applied to a person’s earnings history, and the dollar values in the three-bracket benefit formula are adjusted by the annual percentage change in average earnings.  (The adjustments to the national wage index are permitted to be negative if wages were to decline.)

Tomorrow’s blog will discuss the implications of the projected zero COLAs for the premiums charged to enrollees in Medicare Part B.