Congressional Budget Office
Director’s Blog

The Troubled Asset Relief Program (TARP) gives the Department of the Treasury authority to purchase or insure up to $700 billion of outstanding assets at any one time.  Under the Emergency Economic Stabilization Act of 2008, which provided that authority, the federal budget is supposed to reflect an estimate of the ultimate net cost of the transactions for the TARP as opposed to recording the gross cash disbursements under the program (and later recording cash receipts for any earnings or purchase redemptions). Broadly speaking, the estimated net cost is the purchase cost minus the present value—calculated using an appropriate discount factor that reflects the riskiness of the assets—of any estimated future earnings from holding the assets and the proceeds from their eventual sale.

CBO currently estimates that the net cost of using the TARP’s full $700 billion in purchase authority will total $356 billion—$336 billion to be recorded in 2009 and $20 billion to be recorded in 2010. That estimate amounts to a roughly 50 percent net subsidy—that is, roughly one-half of the gross purchase authority. CBO’s most recent estimate of the TARP’s cost is higher than what we presented in January:  by $152 billion for this year and $15 billion for next year (at that time, our estimated net subsidy was approximately 27 percent of the $700 billion purchase authority).  The revisions stem from three factors:  changes in financial market conditions, new transactions, and a small shift in the anticipated timing of disbursements.

By the beginning of March, when CBO’s most recent estimate was completed, market yields on securities issued by the firms that had received TARP funds were higher than they were a few months earlier.  We use those yields in the present-value calculations to reflect the riskiness of the government’s loans and investments.  Because those yields have risen, the estimated subsidy cost of the Treasury’s purchases of preferred stock, asset guarantees, and loans to automakers has also increased. Also, during that period, the Treasury announced additional deals with Bank of America and American International Group (AIG), as well as participation of up to $50 billion in the Administration’s foreclosure mitigation plan, all of which involve higher expected subsidy rates than the 27 percent average subsidy in our January projections. Finally, CBO now assumes that more transactions would occur after October 1, which pushes the recognition of more of the subsidy cost into fiscal year 2010.

Because the ultimate cost of the TARP depends directly on market value of the financial assets involved, that net cost is very uncertain.  The eventual cost may well be significantly different than CBO’s current estimate, and could be either higher or lower than the roughly 50 percent subsidy embodied in our most recent projections.

Over the past several years, spurred by both rising gasoline prices and long-standing subsidies for producing ethanol, the use of ethanol as a motor fuel in the United States has grown at an annual average rate of nearly 25 percent.  U.S. consumption of ethanol last year exceeded 9 billion gallons–a record high.  CBO released a paper today that discusses the relationship between ethanol, greenhouse-gas emissions, food prices, and federal spending on nutrition programs.

Most ethanol in the United States is produced from domestically grown corn, and the rapid rise in the fuel’s production and usage means that roughly one-quarter of all corn grown in the U.S. (nearly 3 billion bushels) is now used to produce ethanol. The demand for corn for ethanol production has exerted upward pressure on corn prices and on food prices in general. CBO estimates that the increased use of ethanol accounted for about 10 percent to 15 percent of the rise in food prices between April 2007 and April 2008.

In turn, increases in food prices will boost federal spending for mandatory nutrition programs such as the Supplemental Nutrition Assistance Program (SNAP, formerly known as Food Stamps) and the school lunch program by an estimated $600 million to $900 million in fiscal year 2009. The Special Supplemental Assistance Program for Women, Infants, and Children—better known as WIC—is a discretionary program that provides a specific basket of goods to recipients rather than a set cash benefit, so changes in food prices in 2008 had an immediate impact on costs for the program.  Under the assumption that the effects are much the same, increased production of ethanol would have added less than $75 million in fiscal year 2008 to the cost of serving the same number of WIC participants as in 2007.

Last year the use of ethanol reduced gasoline usage in the United States by about 4 percent and greenhouse-gas emissions from the transportation sector by less than 1 percent. The future impact of ethanol on greenhouse-gas emissions is unclear. Research suggests that in the short run, the production, distribution, and consumption of ethanol will create about 20 percent fewer greenhouse gas emissions than the equivalent processes for gasoline. In the long run, if increases in the production of ethanol led to a large amount of forests or grasslands being converted into new cropland, those changes in land use could more than offset any reduction in greenhouse-gas emissions—because forests and grasslands naturally absorb more carbon from the atmosphere than cropland absorbs. In the future, the use of cellulosic ethanol, which is made from wood, grasses, and agricultural plant wastes rather than corn, might reduce greenhouse-gas emissions more substantially, but current technologies for producing cellulosic ethanol are not yet commercially viable.

Today CBO released the latest Monthly Budget Review, reflecting an analysis of budget data through the end of March 2009. CBO estimates that the Treasury Department will report a deficit of about $953 billion for the first six months of fiscal year 2009, $640 billion more than the deficit recorded through March 2008.

Budget accounting issues are clouding the deficit forecasts for this year. The above estimate of this year’s deficit to date includes outlays of about $290 billion for the Troubled Asset Relief Program (TARP). Although the Treasury has been recording most spending for the TARP on a cash basis, CBO believes that the budget should record the program’s activities on a net present-value basis adjusted for market risk. Using that approach, CBO estimates that outlays of $140 billion should be recorded for the TARP through March. That approach would yield an estimated deficit of $803 billion for the first half of the year.

March receipts were estimated to be about 30 percent lower than receipts in March 2008. More than half of the decline reflects a drop in net corporate income tax receipts, which fell by 90 percent from March of last year, in part because firms may be applying current-year losses to obtain refunds of taxes paid in previous years.

Federal outlays were $89 billion (or 39 percent) more than those last March, by CBO’s estimates. About half of the increase in spending comes from $46 billion in cash infusions to Fannie Mae and Freddie Mac (now taken over by the government); another $10 billion was lent to credit unions by an arm of the Treasury, and Medicaid spending rose by $10 billion, of which $8.5 billion was due to provisions in the economic stimulus legislation. Outlays for unemployment benefits increased by $7 billion, defense spending by $5 billion, and Social Security benefits by $4 billion.

In March, CBO issued new estimates for the budget outlook for fiscal year 2009. We project that the deficit for 2009 will be $1.7 trillion under current laws and policies and $1.8 trillion if the President’s proposals for the current fiscal year are enacted. (Click here to link to A Preliminary Analysis of the President’s Budget and an Update of CBO’s Budget and Economic Outlook).

Today CBO released an update to its estimates of effective federal tax rates, which now incorporate data for the 2006 calendar year.  Those data, the most current available, reflect tax returns filed in 2007 and became available for analysis in 2008.  The effective tax rates in 2006 differed only slightly from those in 2005.  CBO’s analysis indicates that:

• The overall effective federal tax rate (the ratio of federal taxes to household income) was 20.7 percent in 2006. Individual income taxes, the largest component, were 9.1 percent of household income. Payroll taxes were the next largest source, with an effective tax rate of 7.5 percent. Corporate income taxes and excise taxes were smaller, with effective tax rates of 3.4 percent and 0.7 percent.
• The overall federal tax system is progressive—that is, effective tax rates generally rise with income. Households in the bottom fifth of the income distribution paid 4.3 percent of their income in federal taxes, while the middle quintile paid 14.2 percent, and the highest quintile paid 25.8 percent. Average rates continued to rise within the top quintile, with the top 1 percent facing an effective rate of 31.2 percent.
• Higher-income groups pay a disproportionate share of federal taxes because they earn a disproportionate share of pretax income and because effective tax rates rise with income. In 2006, the highest quintile earned 55.7 percent of pretax income and paid 69.3 percent of federal taxes, while the top 1 percent of households earned 18.8 percent of income and paid 28.3 percent of taxes. In all other quintiles, the share of federal taxes was less than the income share. The bottom quintile earned 3.9 percent of income and paid 0.8 percent of taxes, while the middle quintile earned 13.2 percent of income and paid 9.1 percent of taxes.
• Effective tax rates in 2006 changed only slightly compared with their levels in 2005. There were no significant changes in the tax law between those years, and changes in the income distribution were not enough to cause large movements in effective rates. The overall effective rate was 0.1 percentage point higher in 2006 than in 2005. And the effective tax rate for each of the four taxes was within 0.1 percentage point of its 2005 level. Similarly, no income quintile saw its total effective tax rate change by more than 0.1 percentage point, though in some cases the rate for specific taxes differed by 0.2 points. On average, the top 1 percent of households saw their effective tax rate decline by 0.4 percentage point (from 31.6 percent to 31.2 percent), primarily because of a drop in the average rate for their individual income taxes.

Special thanks to Ed Harris of our Tax Analysis Division for preparing these estimates.