November 16th, 2011
Econintersect: Douglas W. Elmendorf, Director of the CBO (Congressional Budget Office), presented a prepared statement to the Committee on the Budget, U.S. Senate on Tuesday, November 15, 2011. General statements were made that estimate how much support for increasing GDP and employment could come from such things as infrastructure spending, aid to states (with qualifications), reducing payroll taxes, extending unemployment benefits, repatriation of foreign profits, reducing business income taxes and extending full expensing of investment costs. The range of estimates are shown in Figure 1 and Table 1, reproduced at the end of this article. Follow up:
Follow up:Here is the report summary:
The U.S. economy has struggled to recover from the deep recession that began in December 2007 and ended in June 2009. Although total output started to expand again more than two years ago, the pace of the recovery in output and employment has been slow compared with the average recovery since World War II, and the economy remains in a severe slump. The Congressional Budget Office (CBO) expects that, under current law, economic growth will continue to be slow and real (inflation-adjusted) gross domestic product (GDP) will stay well below the economy’s potential—a level that corresponds to a high rate of use of labor and capital—for several years. As a result, a large portion of the economic and human costs of the recession and slow recovery remains ahead. Those costs fall disproportionately on people who lose their jobs, who are displaced from their homes, or who own businesses that fail.
The slow recovery of output and employment largely reflects the nature of the recession.
The collapse of house prices and the financial crisis—conditions unlike anything this country has seen since the Great Depression—pushed the economy into a deep recession. In the aftermath of such a crisis, it takes time for households to rebuild their wealth and pay down their debts, for financial institutions to restore their capital bases and the supply of credit, and for businesses to regain the confidence necessary to invest in new facilities and equipment.
CBO expects real GDP to grow in the vicinity of 1½ percent this calendar year (as measured by the change between the fourth quarter of 2010 and the fourth quarter of 2011) and around 2½ percent next year. With modest growth in output, CBO expects employment to expand very slowly during the rest of this year and next year, leaving the unemployment rate close to 9 percent through the end of 2012. Weakness in the demand for goods and services is the principal restraint on hiring, but structural impediments in the labor market—such as a mismatch between the requirements of existing job openings and the characteristics of job seekers (including their skills and geographic location)—appear to be restraining hiring as well.
So that CBO’s projections can serve as a benchmark for assessing the impact of legislative proposals, the agency’s economic forecast reflects the provisions of current law. Under current law, the expiration of tax cuts and constraints imposed by the recently enacted Budget Control Act of 2011 (Public Law 112-25)—along with automatic changes in the budget as the economy grows (namely, higher tax revenues and lower spending for some income support programs)—will cause federal fiscal policy to significantly restrain economic growth in 2012 and 2013.
Concerns that the economic recovery will continue to be slow and protracted have prompted the consideration of fiscal policy actions to spur economic growth and increase employment during the next few years. Three key criteria for evaluating such actions are:
- Timing—providing help when it is needed;
- Cost-effectiveness—generating a large amount of additional output and employment per dollar cost to the federal budget; and
- Consistency with long-term fiscal objectives—not worsening the long-run budget outlook.
Other considerations include who would be helped the most by the policy; what would be the value to society of any additional goods and services produced; and how uncertain would the outcomes be.1
This testimony assesses the potential impact of a variety of temporary fiscal policy actions that might be considered to promote economic growth and increase employment in the near term. CBO estimates that the policies analyzed here would raise real GDP in 2012 and 2013 by an amount ranging from as little as 10 cents per dollar of budgetary cost to as much as $1.90 per dollar of budgetary cost; the impact of the policies on employment would range from a marginal increase to an increase of as much as 19 years of full-time-equivalent (FTE) employment per million dollars of budgetary cost over that two-year span (see Figure 1). Thus, changes in fiscal policy, if appropriately designed, would promote economic growth and increase employment during the next few years.
Comparing the estimated effects of different policy actions shows the following:
- Policies that would have the largest effects on output and employment per dollar of budgetary cost in 2012 and 2013 are ones that would reduce the marginal cost to businesses of adding employees or that would be targeted toward people who would be most likely to spend the additional income. Such policies include reducing employers’ payroll taxes (especially if limited to firms that increase their payroll), increasing aid to the unemployed, and providing additional refundable tax credits in 2012 for lower- and middle-income households.
- Policies that would primarily affect businesses’ cash flow but would have little impact on their marginal incentives to hire or invest would have only small effects. Such policies include reducing business income taxes and reducing tax rates on repatriated foreign earnings.
Despite the near-term economic benefits that would arise from reductions in taxes and increases in government spending, such actions would add to the already large projected budget deficits, either immediately or over time. Unless offsetting actions were taken to reverse the accumulation of additional government debt, the nation’s capital stock, its future output, and people’s future incomes would tend to be lower than they otherwise would have been. If policymakers wanted to boost the economy in the near term while seeking to achieve long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade. Such an approach would work best if the future policy changes were sufficiently specific and widely supported so that households, businesses, state and local governments, and participants in financial markets believed that the future fiscal restraint would truly take effect.
Lawmakers could also influence economic growth and employment during the next few years by changing policies that do not involve, or whose scope extends well beyond, taxation and government spending. For example, legislation could modify existing or proposed regulations, significantly alter the government’s role in a particular sector of the economy, or change trade relationships with other countries. Other types of policy changes that do not require legislation, such as those related to monetary policy or those that can be implemented by federal agencies under current law, could also affect economic activity, but they are outside the scope of this testimony.
The near-term economic impact of changing a regulation or other policy apart from fiscal policy would depend importantly on how doing so affected businesses’ investment and hiring decisions. In addition, changes in policies that increased or decreased households’ purchasing power or wealth would influence how much they spend. Moreover, changes to regulations and other policies could affect expectations about future income or make businesses and households more or less uncertain about future government policies and economic conditions, which would affect economic growth and employment in the near term.
This testimony discusses some potential changes in regulatory policies and other policies related to energy and the environment, the financial and health care sectors, and international trade. But estimating the near-term effects on overall economic activity of such policy changes is exceedingly difficult, and few analytic tools are available for that purpose. Accordingly, CBO did not attempt to quantify the effects of those potential changes with any precision.
Some changes in policies that CBO considered would probably raise output and employment during the next few years; other changes would probably lower output and employment; and some changes would have effects on economic activity whose sign is difficult to determine. However, in CBO’s judgment, the economic effects of the specific changes in regulatory policies or other policies apart from fiscal policies that are discussed in this testimony probably would be too small or would occur too slowly to significantly alter overall output or employment in the next two years. (The policy changes examined here are illustrative rather than exhaustive; many others, which might have larger or smaller economic effects, are possible.) This testimony does not speak to other critical considerations in evaluating such policy changes, including the long-term effects on the economy, on people’s health, and on the environment.
1. See Congressional Budget Office, Options for Responding to Short-Term Economic Weakness (January
2008); and the Statement of Douglas W. Elmendorf, Director, Congressional Budget Office, before
the House Committee on the Budget, The State of the Economy and Issues in Developing an Effective
Policy Response (January 27, 2009).
Figures and Table
Source: CBO: Policies for Increasing Economic Growth and Employment in 2012 and 2013, November 15, 2011