CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

CBO

Reducing the 

Deficit: 

Spending and 

Revenue Options

MARCH 2011

© Shutterstock, LLC
Pub. No. 4212
The Congress of the United States O Congressional Budget Office

CBO

Reducing the Deficit: 

Spending and Revenue Options

March 2011
CBO

Notes

Unless otherwise indicated, all years referred to in this report are federal fiscal years, which run 

from October 1 to September 30. 

The numbers in the text and tables are in nominal (current year) dollars. Those numbers may 

not add up to totals because of rounding. 

The baseline budget projections discussed in this report are those published in Congressional 

Budget Office,The Budget and Economic Outlook: Fiscal Years 2011 to 2021 (January 2011).

The estimates for the various options shown in this volume may differ from any subsequent 

cost estimates for legislative proposals that resemble the options presented here.

On the cover: A U.S. Navy F/A-18F Super Hornet aircraft near Joint Base Pearl Harbor–

Hickam, Hawaii, July 2010, photo by Technical Sergeant Jacob N. Bailey, U.S. Air Force; 

other photos, copyright as indicated on the cover.
Preface

CBO

The Congressional Budget Office (CBO) regularly issues a compendium of budget 

options to help inform federal lawmakers about the implications of possible policy choices. 

This volume—one of several reports that CBO produces regularly for the House and Senate 

Committees on the Budget—presents more than 100 options for altering federal spending 

and revenues. Nearly all of the options would reduce federal budget deficits. From 1983 to 

1997, the reports in this series were titled Reducing the Deficit: Spending and Revenue Options.

In 2000, at a time of budget surpluses, the title was changed to Budget Options. This volume 

returns to the earlier title because the budgetary context has shifted dramatically since 2000. 

The report begins with an introductory chapter that describes the current budgetary picture 

and the uses and limitations of this volume. Chapters 2 and 3 present options that would 

reduce mandatory and discretionary spending, respectively. Chapter 4 contains options that 

would increase revenues from various kinds of taxes and fees. 

The options discussed in this report stem from a variety of sources, including legislative 

proposals, various Administrations’ budget proposals, Congressional staff, other government 

entities, and private groups. The options are intended to reflect a range of possibilities rather 

than to provide a ranking of priorities or a comprehensive list. The inclusion or exclusion 

of a particular policy change does not represent an endorsement or rejection by CBO. In 

keeping with CBO’s mandate to provide objective, impartial analysis, this report makes no 

recommendations.

Some previous reports in this series grouped spending options according to budget function 

(the 20 programmatic categories into which the government’s activities are frequently 

divided). This volume, however, groups spending options according to whether the funds are 

generally controlled through authorizing legislation (mandatory spending) or through the 

annual appropriation process (discretionary spending). An index listing the options by budget 

function appears in Appendix C.

This volume is the result of work by more than 130 people at CBO; those contributors are 

listed in Appendix E. The staff of the Joint Committee on Taxation prepared most of the 

revenue estimates. The report is available on CBO’s Web site (www.cbo.gov).

Douglas W. Elmendorf

Director

March 2011

Contents

CBO

1 Introduction 1

The Current Context for Making Decisions About the Budget 1

The Options in This Report 8

Caveats About This Report 9

2 Mandatory Spending Options 11

Trends in Mandatory Spending 11

Assumptions Underlying Projections of Mandatory Spending 12

Sources of Growth in Mandatory Programs 14

Approaches to Reducing Mandatory Spending 17

Mandatory Spending Options in This Chapter 17

3 Discretionary Spending Options 69

Trends in Discretionary Spending 71

Approaches to Reducing Discretionary Spending 72

Discretionary Spending Options in This Chapter 73

4 Revenue Options 129

Trends in Revenues 129

Considerations in Setting Tax Policy 130

Approaches to Increasing Revenues 135

Revenue Options in This Chapter 136
VI REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

A Options That Would Increase the Deficit 207

B Deficit Reduction Options with Smaller Budgetary Effects 219

C Options by Budget Function 223

D Options by Major Program or Category 229

E Contributors to This Volume 237
CONTENTS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS VII

CBO

Tables

1-1. CBO’s Baseline Budget Projections 4

2-1. CBO’s Baseline Projections of Mandatory Outlays 16

3-1. Discretionary Spending in 2010 69

4-1. CBO’s Baseline Projections of Revenues 132

Figures

1-1. Federal Debt Held by the Public Under CBO’s Baseline or with a Continuation of 

Certain Policies, Compared with Past Debt 2

1-2. Total Revenues and Outlays, 1971 to 2021 3

1-3. Federal Revenues and Spending in 2021 Under CBO’s Baseline or with a 

Continuation of Certain Policies 5

1-4. Breakdown of Federal Spending in 2010 9

2-1. Breakdown of Mandatory Spending in 2010 12

2-2. Mandatory Spending, 1971 to 2021 13

3-1. Breakdown of Defense and Nondefense Discretionary Spending in 2010 70

3-2. Discretionary Spending, 1971 to 2021 71

4-1. Breakdown of Revenues in 2010 130

4-2. Total Revenues, 1971 to 2021 131

4-3. Cumulative Budgetary Effect of Major Income Tax Expenditures, 2010 to 2014 133

4-4. Average Federal Tax Rates, by Income Quintile and Tax Source, 2007 135
VIII REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending

Defense

Option 1 Introduce Minimum Out-of-Pocket Requirements Under TRICARE For Life 19

Energy

Option 2 Transfer the Tennessee Valley Authority’s Electric Utility Functions and 

Associated Assets and Liabilities 20

Option 3 Reduce the Size of the Strategic Petroleum Reserve 22

Natural Resources and Environment

Option 4 Prohibit New Enrollment in the Conservation Stewardship Program 24

Option 5 Limit Enrollment in the Conservation Reserve Program 25

Agriculture

Option 6 Reduce the Premium Subsidy in the Crop Insurance Program 26

Option 7 Reduce by 20 Percentage Points the Share of a Farmer’s Base Acreage 

Eligible for USDA Payments 27

Housing Credit

Option 8 Lower the Loan Limits on Mortgages Guaranteed by Fannie Mae and 

Freddie Mac 28

Option 9 Increase Guarantee Fees Charged by Fannie Mae and Freddie Mac 30

Education

Option 10 Eliminate Subsidized Loans to Graduate Students 31

Option 11 Change the Interest Rate Structure for Student Loans 32

Health

Option 12 Add a “Public Plan” to the Health Insurance Exchanges 33

Option 13 Limit Medical Malpractice Torts 35

Option 14 Adopt a Voucher Plan and Slow the Growth of Federal Contributions for the 

Federal Employees Health Benefits Program 37

Option 15 Convert the Federal Share of Medicaid’s Payments for Long-Term Care 

Services into a Block Grant 39
CONTENTS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS IX

CBO

Option 16 Reduce the Floor on Federal Matching Rates for Medicaid Services 41

Option 17 Consolidate and Reduce Federal Payments for Graduate Medical Education 

Costs at Teaching Hospitals 43

Option 18 Raise the Age of Eligibility for Medicare to 67 45

Option 19 Impose Cost Sharing for the First 20 Days of a Stay in a Skilled Nursing 

Facility Under Medicare 47

Option 20 Require a Copayment for Home Health Episodes Covered by Medicare 48

Option 21 Reduce Medicare Costs by Changing the Cost-Sharing Structures for 

Medicare and Medigap Insurance 49

Option 22 Increase the Basic Premium for Medicare Part B to 35 Percent of the 

Program’s Costs 51

Option 23 Reduce Medicare’s Payment Rates Across the Board in High-Spending Areas 52

Option 24 Eliminate the Critical Access Hospital, Medicare-Dependent Hospital, and 

Sole Community Hospital Programs in Medicare 53

Option 25 Require Manufacturers to Pay a Minimum Rebate on Drugs Covered 

Under Medicare Part D for Low-Income Beneficiaries 54

Retirement and Social Security

Option 26 Base Cost-of-Living Adjustments for Federal Civilian and Military 

Pensions and Veterans’ Benefits on an Alternative Measure of Inflation 56

Option 27 Base Social Security Cost-of-Living Adjustments on an Alternative 

Measure of Inflation 58

Option 28 Link Initial Social Security Benefits to Average Prices Instead of 

Average Earnings 60

Option 29 Raise the Earliest Eligibility Age for Social Security 62

Option 30 Raise the Full Retirement Age in Social Security 63

Option 31 Lengthen by Three Years the Computation Period for Social Security Benefits 65

Option 32 Apply the Social Security Benefit Formula to Individual Years of Earnings 66

Options That Would Increase the Deficit

Option A-1 Extend the Requirement for States to Provide Transitional Medical Assistance 208

Option A-2 Permanently Extend Cost-Sharing Assistance for Qualifying Individuals 

Under Medicaid 209

Option A-3 Increase Social Security Benefits for Workers Who Have Low Earnings 

Over a Long Working Lifetime 210

Mandatory Spending (Continued)
X REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending

Defense

Option 1 Reduce the Growth in Appropriations for the Department of Defense 74

Option 2 Cap Increases in Military Basic Pay 76

Option 3 Increase Medical Cost Sharing for Military Retirees Who Are Not Yet 

Eligible for Medicare 78

Option 4 Limit the TRICARE Benefit for Military Retirees and Their Dependents 80

Option 5 Increase Cost Sharing for Pharmaceuticals Under TRICARE 82

Option 6 Consolidate the Department of Defense’s Retail Activities and Provide a 

Grocery Allowance to Service Members 84

Option 7 Replace the Joint Strike Fighter Program with F-16s and F/A-18s 86

Option 8 Cancel the Navy and Marine Corps’ Joint Strike Fighters and Replace 

Those Aircraft with F/A-18E/Fs 88

Option 9 Cut the Number of Aircraft Carriers to 10 and the Number of Navy Air 

Wings to 9 90

Option 10 Cancel the Expeditionary Fighting Vehicle 92

Option 11 Delay Fielding of the Army’s Ground Combat Vehicle 94

Option 12 Terminate the Medium Extended Air Defense System Program 96

Option 13 Terminate the Precision Tracking Space System Program 97

All Discretionary Activities Other Than Defense

Option 14 Reduce Growth in Appropriations for Agencies Other Than the 

Department of Defense 98

Energy

Option 15 Eliminate the Department of Energy’s Grants to States for 

Energy Conservation and Weatherization 100

Option 16 Reduce Department of Energy Funding for Energy Technology Development 101

Natural Resources and Environment

Option 17 Eliminate Federal Grants for Wastewater and Drinking Water Infrastructure 103

Option 18 Increase Fees for Use of the Inland Waterway System 105
CONTENTS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS XI

CBO

Commerce

Option 19 Eliminate the International Trade Administration’s Trade Promotion 

Activities or Charge the Beneficiaries 106

Transportation

Option 20 Limit Highway Funding to Expected Highway Revenues 107

Option 21 Eliminate Grants to Large and Medium-Sized Hub Airports 109

Option 22 Increase Fees for Aviation Security 110

Option 23 Eliminate Intercity Rail Subsidies 111

Option 24 Eliminate the Transit Starts Programs 112

Community and Regional Development

Option 25 Create State Revolving Funds to Finance Rural Water and Waste Disposal 113

Option 26 Drop Wealthier Communities from the Community Development 

Block Grant Program 114

Education and Social Services

Option 27 Eliminate Certain Grant Programs for Elementary and Secondary Education 115

Option 28 Restrict Pell Grants to the Neediest Students 116

Option 29 Eliminate Funding for National Community Service Programs 117

Option 30 Eliminate the Senior Community Service Employment Program 118

Option 31 Reduce Funding for the Arts and Humanities 119

Health

Option 32 Finance the Food Safety and Inspection Service Through Fees 120

Option 33 Reduce or Constrain Funding for the National Institutes of Health 121

Income Security

Option 34 Increase Payments by Tenants in Federally Assisted Housing 122

Discretionary Spending (Continued)
XII REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Veterans’ Benefits and Services

Option 35 End Enrollment in VA Medical Care for Veterans in Priority Groups 7 and 8 123

Administration of Justice

Option 36 Reduce Funding for Certain Department of Justice Grants 125

General Government

Option 37 Reduce the Across-the-Board Adjustment for Federal Civilian Employees’ Pay 126

Option 38 Impose Fees to Cover the Cost of Government Regulation and Charge for 

Services Provided to the Private Sector 127

Revenues

Individual Income Tax Rates

Option 1 Increase Individual Income Tax Rates 139

Option 2 Raise Tax Rates on Capital Gains 142

Individual Income Tax Base

Option 3 Use an Alternative Measure of Inflation to Index Some Parameters of the 

Tax Code 144

Option 4 Gradually Eliminate the Mortgage Interest Deduction 146

Option 5 Limit or Eliminate the Deduction for State and Local Taxes 148

Option 6 Curtail the Deduction for Charitable Giving 150

Option 7 Limit the Tax Benefit of Itemized Deductions to 15 Percent 151

Option 8 Include Employer-Paid Premiums for Income Replacement Insurance in 

Employees’ Taxable Income 153

Option 9 Include Investment Income from Life Insurance and Annuities in 

Taxable Income 155

Option 10 Tax Carried Interest as Ordinary Income 157

Option 11 Tax Social Security and Railroad Retirement Benefits in the Same 

Way That Distributions from Defined-Benefit Pensions Are Taxed 159

Option 12 Reduce Limits on Contributions to Retirement Plans 161

Option 13 Replace the Tax Exclusion for Interest Income on State and 

Local Bonds with a Direct Subsidy for the Issuer 163

Discretionary Spending (Continued)
CONTENTS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS XIII

CBO

Individual Income Tax Credits

Option 14 Modify or Eliminate the Child Tax Credit 165

Option 15 Eliminate Certain Tax Preferences for Education Expenses 167

Social Security Payroll Tax

Option 16 Increase the Maximum Taxable Earnings for the Social Security Payroll Tax 169

Option 17 Expand Social Security Coverage to Include Newly Hired State and 

Local Government Employees 171

Corporate Income Tax Rates

Option 18 Increase Corporate Income Tax Rates by 1 Percentage Point 173

Option 19 Set the Corporate Income Tax Rate at 35 Percent for All Corporations 175

Taxation of Income from Businesses and Other Entities

Option 20 Repeal the “LIFO” and “Lower of Cost or Market” Inventory 

Accounting Methods 177

Option 21 End the Expensing of Exploration and Development Costs for 

Extractive Industries 179

Option 22 Extend the Period for Depreciating the Cost of Certain Investments 180

Option 23 Repeal the Deduction for Domestic Production Activities 182

Taxation of Income from Worldwide Business Activity

Option 24 Eliminate the Source-Rules Exception for Exports 184

Option 25 Tax the Worldwide Income of U.S. Corporations As It Is Earned 186

Option 26 Exempt Active Foreign Dividends from U.S. Taxation and Change the 

Tax Treatment of Overhead Expenses 187

Consumption Taxes and Excise Taxes

Option 27 Impose a 5 Percent Value-Added Tax 189

Option 28 Increase Excise Taxes on Motor Fuels by 25 Cents 191

Option 29 Increase All Taxes on Alcoholic Beverages to $16 per Proof Gallon 193

Revenues (Continued)
XIV REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Health Care Provisions

Option 30 Accelerate and Modify the Excise Tax on High-Cost Health Care Coverage 195

Option 31 Increase the Payroll Tax Rate for Medicare Hospital Insurance by 

1 Percentage Point 197

Option 32 Repeal the Individual Health Insurance Mandate 199

Other Taxes and Fees

Option 33 Impose a Fee on Large Financial Institutions 201

Option 34 Reinstate the Superfund Taxes 203

Option 35 Impose a Price on Emissions of Greenhouse Gases 205

Options That Would Increase the Deficit

Option A-1 Permanently Extend the Individual Income Tax Provisions of the 

Tax Relief, Unemployment Insurance Reauthorization, and 

Job Creation Act of 2010 211

Option A-2 Provide Relief from the Individual Alternative Minimum Tax 214

Option A-3 Modify Estate and Gift Taxes 216

Revenues (Continued)
CHAPTER

CBO

1

Introduction

The choices facing the 112th Congress come at a 

time when the federal government’s debt has increased 

dramatically in the past few years and when large annual 

budget deficits are projected to continue indefinitely 

under current laws or policies. If current laws remain 

unchanged, deficits will total $7 trillion over the next 

10 years, the Congressional Budget Office (CBO) projects; if certain policies that are scheduled to expire under 

current law are extended instead, deficits may be much 

larger. Beyond the coming decade, the aging of the U.S. 

population and rising health care costs will put increasing 

pressure on the budget. If federal debt continues to 

expand faster than the economy—as it has since 2007—

the growth of people’s income will slow, the share of federal spending devoted to paying interest on the debt will 

rise more quickly, and the risk of a fiscal crisis will 

increase.

This report presents 105 illustrative options that would 

reduce projected budget deficits. As in past reports, the 

options cover an array of policy areas—from defense to 

energy to entitlement programs to provisions of the tax 

code. The budgetary effects shown for most options span 

the 10 years from 2012 to 2021 (the period covered 

by CBO’s January 2011 baseline budget projections), 

although many options would have longer-term effects 

as well. 

The options in this volume come from legislative proposals, various Administrations’ budget proposals, Congressional staff, other government entities, and private 

groups, among others. The options are intended to reflect 

a range of possibilities, not a ranking of priorities. The 

contents of this volume do not represent an endorsement 

or a rejection by CBO of any particular option, and the 

report does not recommend specific changes or provide 

an exhaustive list of policy alternatives. It also does not 

offer any comprehensive budget plans—although many 

of the options could be combined into broader plans.

This volume focuses to a greater extent than its recent 

predecessors did on options that would reduce the 

deficit—especially on changes that would have a relatively large budgetary impact. However, Appendix A contains six options that would increase rather than decrease 

the deficit; they are included here because of Congressional interest in them. In particular, some of the choices 

that lawmakers will face in the next few years involve tax 

provisions and mandatory spending programs that are 

scheduled to expire soon, and continuing those policies 

would have budgetary costs. Appendix B lists additional 

options that were presented in the most recent previous 

version of this report (issued in August 2009) but that 

were not updated for this volume.

The Current Context for Making 

Decisions About the Budget

The amount of federal debt held by the public has nearly 

doubled in the past three years.1

 At the end of fiscal year 

2007, debt held by the public totaled $5 trillion. That 

amount was equal to 36 percent of the nation’s annual 

economic output, or gross domestic product (GDP)—

close to the average ratio of debt to GDP over the past 

40 years, 37 percent. Since 2007, financial turmoil and a 

severe drop in economic activity, combined with various 

policies implemented in response to those conditions, 

have sharply reduced federal revenues and increased 

spending. Those changes added to the imbalance 

between revenues and spending that had existed before 

the recession, causing annual budget deficits to surge. 

As a result, debt held by the public grew to more than 

$9 trillion by the end of fiscal year 2010—equaling 

1. Debt held by the public consists primarily of securities that the 

Treasury issues to raise cash to fund the operations and pay off the 

maturing liabilities of the federal government that tax revenues are 

insufficient to cover. Such debt is held by investors outside the 

federal government and by the Federal Reserve System.
2 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Figure 1-1.

Federal Debt Held by the Public Under CBO’s Baseline or with a Continuation of 

Certain Policies, Compared with Past Debt

(Percentage of gross domestic product) 

Source: Congressional Budget Office (as of January 2011).

Note: The projection with the continuation of certain policies is based on several assumptions: first, that provisions of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) that originally were enacted in 2001, 2003, 

or 2009, or that modified estate and gift taxation do not expire on December 31, 2012, but instead continue; second, that the alternative minimum tax is indexed for inflation after 2011; and third, that Medicare’s payment rates for physicians are held constant at their 

2011 level.

62 percent of GDP, the highest percentage since shortly 

after World War II (see Figure 1-1). 

Under current law, the imbalance between spending and 

revenues will persist in the future, CBO estimates, even as 

the economy recovers and expands (see Figure 1-2). That 

imbalance is projected to worsen in coming decades as 

health care costs continue to rise and as more members of 

the baby-boom generation become eligible for certain 

federal benefits. Under current law, those factors will 

cause debt to keep growing relative to the size of the 

economy. 

Projected Budget Deficits

In CBO’s current-law baseline, the deficit is projected to 

equal 9.8 percent of GDP in 2011, shrink to 4.3 percent 

of GDP by 2013 (after certain tax provisions are scheduled to expire and the economy has recovered further 

from the recession), and then range between 2.9 percent 

and 3.4 percent of GDP through 2021—a little above the 

average of 2.8 percent seen over the past 40 years (see 

Table 1-1).2

 Those deficits would push total debt held by 

the public to 77 percent of GDP by 2021.

CBO’s baseline projections are predicated on the assumption that many policies now in place will be allowed to 

expire over the next decade, as scheduled under current 

law. If, instead, those policies were extended, budget 

deficits would be much larger than in the baseline. As 

an example, if many provisions of the 2010 tax act were 

extended rather than being allowed to expire on December 31, 2012,3

 and if the alternative minimum tax 

(AMT) was indexed for inflation, annual revenues would 

average about 18 percent of GDP through 2021 (equal to 

their 40-year average), rather than about 20 percent as 

shown in CBO’s baseline. If, in addition, Medicare’s 

1940 1949 1958 1967 1976 1985 1994 2003 2012 2021

0

20

40

60

80

100

120

0

20

40

60

80

100

120

Actual Projected

Baseline

Continuation

of Certain

Policies

2. See Congressional Budget Office, The Budget and Economic 

Outlook: Fiscal Years 2011 to 2021 (January 2011).

3. This statement applies to most of the provisions of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job Creation Act 

of 2010 (Public Law 111-312) that originally were enacted in 

2001, 2003, or 2009 or that modified estate and gift taxation.
CHAPTER ONE: INTRODUCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 3

CBO

Figure 1-2.

Total Revenues and Outlays, 1971 to 2021

(Percentage of gross domestic product) 

Source: Congressional Budget Office (as of January 2011).

payment rates for physicians’ services were held constant, 

rather than dropping next year as scheduled under current law, deficits from 2012 through 2021 would average 

about 6 percent of GDP—compared with 3.6 percent 

in the baseline—and the deficit in 2021 would equal 

6.6 percent of GDP (see Figure 1-3). Annual deficits 

would total nearly $12 trillion over the 2012–2021 

period, rather than $7 trillion, and debt held by the 

public would be 20 percentage points higher in 2021, 

reaching 97 percent of GDP (see Figure 1-1).

Over the longer term, the continued aging of the population and growth in health care costs will almost certainly 

push up federal spending significantly relative to GDP 

under current law. Without changes in law, CBO projects, spending on Social Security and the government’s 

major mandatory health care programs (Medicare, Medicaid, the Children’s Health Insurance Program, and 

health insurance subsidies to be provided through insurance exchanges) will increase from roughly 10 percent of 

GDP today to about 16 percent 25 years from now. If 

revenues remain near their past levels relative to GDP, 

that increase in spending will lead to rapidly growing 

budget deficits and mounting federal debt. 

In June 2010, CBO issued long-term budget projections 

under two scenarios reflecting different assumptions 

about future policies for revenues and spending.4

 The 

extended-baseline scenario was based on the assumption 

that, by and large, current law would continue without 

change—including the assumption that tax cuts enacted 

in 2001 and 2003 would expire as scheduled. Under 

those assumptions, revenues were projected to climb to 

23 percent of GDP by 2035. Even with those higher revenues, federal debt held by the public was projected to 

rise from 62 percent of GDP at the end of 2010 to about 

80 percent by 2035. 

CBO has not yet updated its long-term projections to 

reflect enactment of the 2010 tax act and other recent 

changes. But the 10-year baseline that the agency issued 

in January 2011, which does reflect those changes, shows 

larger budget deficits and accumulated debt over the 

next decade than the June 2010 projections did. Debt is 

now projected to equal 76 percent of GDP at the end of 

2020 under current law, compared with the June 2010 

projection of 66 percent.

CBO also prepared long-term budget projections last 

year under an alternative fiscal scenario. Whereas the 

extended-baseline scenario was predicated on current law, 

the alternative fiscal scenario incorporated several changes 

to current law that were widely expected to occur or that 

would modify some provisions of law that might be difficult to sustain for a long period. Those changes included

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021

0

14

16

18

20

22

24

26

28

0

14

16

18

20

22

24

26

28

Average Outlays,

1971 to 2010

Outlays

Average Revenues,

1971 to 2010

Actual Baseline Projection

Revenues

4. See Congressional Budget Office, The Long-Term Budget Outlook

(June 2010, revised August 2010).
4 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Table 1-1.

CBO’s Baseline Budget Projections

Source: Congressional Budget Office (as of January 2011).

Note: n.a. = not applicable.

Actual, 2012- 2012-

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2016 2021

899 998 1,128 1,516 1,671 1,829 1,967 2,105 2,231 2,365 2,509 2,662 8,110 19,983

865 819 943 1,029 1,092 1,148 1,204 1,256 1,309 1,364 1,424 1,484 5,416 12,253

191 201 279 343 428 398 370 413 417 420 420 437 1,817 3,923

207 211 205 203 251 276 292 301 318 340 359 380 1,227 2,925 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______

2,162 2,228 2,555 3,090 3,442 3,651 3,832 4,075 4,275 4,489 4,712 4,963 16,570 39,084

On-budget 1,530 1,662 1,887 2,358 2,673 2,840 2,977 3,178 3,336 3,508 3,687 3,893 12,735 30,338

Off-budget 632 566 668 732 769 811 855 897 938 981 1,025 1,069 3,835 8,745

1,910 2,108 2,038 2,106 2,203 2,346 2,538 2,647 2,757 2,964 3,138 3,333 11,230 26,070

1,349 1,375 1,352 1,364 1,378 1,397 1,426 1,453 1,482 1,524 1,562 1,600 6,917 14,538

197 225 264 325 394 459 527 592 646 697 751 792 1,969 5,447 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______

3,456 3,708 3,655 3,794 3,975 4,202 4,491 4,691 4,885 5,185 5,451 5,726 20,117 46,055

On-budget 2,901 3,210 3,073 3,150 3,294 3,481 3,730 3,884 4,029 4,276 4,485 4,702 16,727 38,103

Off-budget 555 498 581 644 682 721 761 807 856 909 966 1,024 3,390 7,952

-1,294 -1,480 -1,100 -704 -533 -551 -659 -617 -610 -696 -739 -763 -3,547 -6,971

-1,371 -1,548 -1,186 -792 -621 -641 -752 -706 -693 -768 -798 -808 -3,992 -7,765

77 68 86 88 87 90 94 90 82 73 59 45 445 794

9,018 10,430 11,598 12,386 12,996 13,625 14,358 15,064 15,767 16,557 17,392 18,253 n.a. n.a.

14,513 15,034 15,693 16,400 17,258 18,195 19,141 20,033 20,935 21,856 22,817 23,810 86,686 196,138

6.2 6.6 7.2 9.2 9.7 10.1 10.3 10.5 10.7 10.8 11.0 11.2 9.4 10.2

6.0 5.4 6.0 6.3 6.3 6.3 6.3 6.3 6.3 6.2 6.2 6.2 6.2 6.2

1.3 1.3 1.8 2.1 2.5 2.2 1.9 2.1 2.0 1.9 1.8 1.8 2.1 2.0

1.4 1.4 1.3 1.2 1.5 1.5 1.5 1.5 1.5 1.6 1.6 1.6 1.4 1.5 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

14.9 14.8 16.3 18.8 19.9 20.1 20.0 20.3 20.4 20.5 20.7 20.8 19.1 19.9

On-budget 10.5 11.1 12.0 14.4 15.5 15.6 15.6 15.9 15.9 16.0 16.2 16.4 14.7 15.5

Off-budget 4.4 3.8 4.3 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.4 4.5

13.2 14.0 13.0 12.8 12.8 12.9 13.3 13.2 13.2 13.6 13.8 14.0 13.0 13.3

9.3 9.1 8.6 8.3 8.0 7.7 7.4 7.3 7.1 7.0 6.8 6.7 8.0 7.4

1.4 1.5 1.7 2.0 2.3 2.5 2.8 3.0 3.1 3.2 3.3 3.3 2.3 2.8 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

23.8 24.7 23.3 23.1 23.0 23.1 23.5 23.4 23.3 23.7 23.9 24.0 23.2 23.5

On-budget 20.0 21.4 19.6 19.2 19.1 19.1 19.5 19.4 19.2 19.6 19.7 19.7 19.3 19.4

Off-budget 3.8 3.3 3.7 3.9 4.0 4.0 4.0 4.0 4.1 4.2 4.2 4.3 3.9 4.1

-8.9 -9.8 -7.0 -4.3 -3.1 -3.0 -3.4 -3.1 -2.9 -3.2 -3.2 -3.2 -4.1 -3.6

-9.4 -10.3 -7.6 -4.8 -3.6 -3.5 -3.9 -3.5 -3.3 -3.5 -3.5 -3.4 -4.6 -4.0

0.5 0.5 0.5 0.5 0.5 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.5 0.4

62.1 69.4 73.9 75.5 75.3 74.9 75.0 75.2 75.3 75.8 76.2 76.7 n.a. n.a.

On-budget 

Net interest

Social insurance taxes

Outlays

Discretionary spending

Mandatory spending

Corporate income taxes

Revenues

Individual income taxes

Other revenues

Total Revenues

Discretionary spending

Mandatory spending

Net interest

Total Outlays

Deficit (-) or Surplus

Corporate income taxes

Social insurance taxes

Other revenues

Total Revenues

Outlays

Total

Debt Held by the Public

Total Outlays

Deficit (-) or Surplus

On-budget 

Off-budget

In Billions of Dollars

As a Percentage of Gross Domestic Product

Off-budget

Debt Held by the Public

Memorandum:

Gross Domestic Product

Revenues

Individual income taxes
CHAPTER ONE: INTRODUCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 5

CBO

Figure 1-3.

Federal Revenues and Spending in 2021 Under CBO’s Baseline or with a 

Continuation of Certain Policies

Source: Congressional Budget Office (as of January 2011).

Note: GDP = gross domestic product.

a. The projection with the continuation of certain policies is based on several assumptions: first, that provisions of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (Public Law 111-312) that originally were enacted in 2001,

2003, or 2009, or that modified estate and gift taxation do not expire on December 31, 2012, but instead continue; second, that the 

alternative minimum tax is indexed for inflation after 2011; and third, that Medicare’s payment rates for physicians are held constant at 

their 2011 level.

an extension of the 2001 and 2003 tax cuts (except for 

rate reductions that applied to high-income taxpayers), 

broad relief from the AMT, growth in discretionary 

spending that matched the rate of growth in GDP, and 

increases in Medicare’s payment rates for physicians, 

among others. Under that scenario, U.S. debt was projected to rise to unprecedented levels by 2025—exceeding its past peak of about 110 percent of GDP—and continue growing to 185 percent by 2035. If that alternative 

fiscal scenario was updated to reflect the current 10-year 

outlook, the debt projections would be even worse.

The Fiscal Gap

To prevent federal debt from becoming unsupportable, 

lawmakers will have to restrain the growth of spending 

substantially, raise revenues significantly above their historical share of GDP, or pursue some combination of 

those two approaches. How much would policies have to 

change to avoid unsustainable increases in federal debt? 

Defense

Medicare

Social Security

Medicaid, Health

Insurance Subsidies, and

Other Health Programs

Total Spending

24.0% of GDP

Other Spending

Defense

Medicare

Social Security

Medicaid, Health

Insurance Subsidies, and

Other Health Programs

Other Spending

Total Revenues

20.8% of GDP

Total Spending

25.1% of GDP

Total Revenues

18.5% of GDP

Deficit

(6.6% of GDP)

Deficit

(3.2% of GDP) Net Interest

T l R

Social Insurance Taxes

Corporate Income Taxes

Other Revenues O h R

Individual

Income Taxes

T l R

Social Insurance Taxes

Corporate Income Taxes

Other Revenues Other Revenues

Individual

Income Taxes

Net Interest

Baseline Projection for 2021

(Current law)

Projection for 2021 with a 

Continuation of Certain Policiesa
6 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

A useful answer comes from looking at the so-called fiscal 

gap, which measures the immediate change in spending 

or revenues that would be necessary to keep debt at the 

same percentage of GDP at the end of a given period as at 

the beginning of the period. 

Last year, CBO estimated that the fiscal gap for the 

2010–2034 period would be 1.2 percent of GDP under 

the extended-baseline scenario or 4.8 percent under the 

alternative fiscal scenario. In other words, relative to the 

projections of the alternative fiscal scenario, an immediate and permanent cut in spending or increase in revenues equal to 4.8 percent of GDP—equivalent to almost 

$700 billion today—would be needed to create a sustainable fiscal path for the next quarter century. If that 

change came entirely from revenues, it would amount to 

roughly a one-quarter increase in revenues relative to the 

amount projected for 2020 and later years. If the change 

came entirely from spending, it would represent a cut of 

roughly one-fifth in all spending (except interest payments on federal debt) from the amount projected for 

2020 or a cut of one-sixth from the amount of such 

spending projected for 2035. Because of legislative 

actions taken since last summer, when those estimates 

were made, fiscal gaps based on the current 10-year 

budget outlook would be larger.

Effects of Waiting to Address the 

Budgetary Imbalance

Lawmakers must decide not only how to reduce budget 

deficits but also how quickly to act.5

 That decision 

involves difficult trade-offs. 

Implementing deficit reduction policies more slowly 

would lead to higher government debt, which would have 

several negative consequences:

B Reducing the amount of U.S. savings devoted to 

investment in productive capital. Increased government borrowing would crowd out private investment 

in productive capital, because the portion of private 

savings used to buy Treasury securities would not be 

available to fund such investment. The resulting 

decrease in the nation’s capital stock would lead to 

lower output and incomes in the long run than would 

otherwise be the case and would make future generations worse off. That crowding-out phenomenon is 

slow but inexorable: In any given year, the incremental 

effect on output is small, but the effects add up over 

time and can become substantial.

B Requiring greater federal spending on interest 

payments. With more resources devoted to servicing 

the debt, larger changes in revenues and noninterest 

spending would be needed to make fiscal policy sustainable. If those changes took the form of bigger cuts 

to spending programs, they would be harder for people to adjust to than smaller cuts would be. If the 

changes took the form of bigger increases in marginal 

tax rates (the rates that would apply to an additional 

dollar of a taxpayer’s income), they would create larger 

disincentives to work and save, which would reduce 

incomes more than smaller tax-rate increases would.

B Giving policymakers less flexibility to deal with 

unexpected problems. If federal debt had been bigger 

in 2008 than it was, the government would have had 

less flexibility to respond to the turmoil in financial 

markets and the slumping economy by using government funds to stimulate economic activity and stabilize the financial sector, while still continuing to fund 

other federal commitments. Similarly, larger debt 

would give the government less flexibility to raise 

spending in response to international events such as 

wars or humanitarian crises.

B Increasing the likelihood of a fiscal crisis. If federal 

debt continued to grow relative to the nation’s output 

and income, investors would require the government 

to pay higher interest rates on its securities to compensate for the risk that they might not be repaid or that 

the value of the securities might be eroded by inflation. Interest rates might rise only gradually to reflect 

such growing uncertainty—but other countries’ experiences suggest that a loss of investors’ confidence can 

occur abruptly and might well come during an economic downturn. To resolve the resulting fiscal crisis, 

lawmakers would need to make fiscal policy choices 

that would be much more drastic and painful than if 

policies had been adjusted sooner. 5. In a previous analysis, CBO examined the effects of different 6

choices about when to put the nation’s fiscal policy on a sustainable course by stabilizing the ratio of debt to GDP. See Congressional Budget Office, Economic Impacts of Waiting to Resolve the 

Long-Term Budget Imbalance, Issue Brief (December 2010).

6. See Congressional Budget Office, Federal Debt and the Risk of a 

Fiscal Crisis, Issue Brief (July 2010).
CHAPTER ONE: INTRODUCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 7

CBO

At the same time, implementing major budgetary 

changes gradually would have some advantages:

B Minimizing the drag of spending cuts or tax increases 

on the economic expansion. In times when the economy has substantial unemployment, as well as unused 

factories, offices, and equipment, running a deficit 

usually increases output and employment compared 

with what would occur under a balanced budget.7

 For 

example, during a recession, tax revenues automatically decline and government spending on certain 

benefits automatically increases relative to what would 

happen otherwise, thus widening deficits. Those 

“automatic stabilizers” help reduce the severity of a 

recession by offsetting some of the decline in people’s 

disposable income and thus supporting demand for 

goods and services. Similarly, during and immediately 

after a recession, fiscal stimulus measures financed 

with deficits—such as the spending increases and tax 

cuts in the American Recovery and Reinvestment Act 

of 2009 (Public Law 111-5)—usually keep output and 

employment higher than they would be otherwise.8

B Possibly helping older generations. A delay in putting the budget on a sustainable path would postpone 

the increases in taxes or the cuts in benefit payments 

and government services that people would face. With 

certain policies, the gains to older generations from 

such a delay would outweigh some of the resulting 

drawbacks—such as greater reductions in future 

incomes and larger ultimate changes to taxes and 

spending—because the effect of those drawbacks 

would be muted for people who have completed all 

or part of their working life. Whether the gains from 

waiting would outweigh the other drawbacks of higher 

debt for older generations is unclear.

B Providing time to adjust. Giving people, businesses, 

and state and local governments time to plan for 

changes would make the changes less disruptive. For 

example, if lawmakers chose to scale back benefit 

programs or modify tax preferences in the individual 

income tax, households would benefit from having 

time to alter their behavior. Similarly, if lawmakers 

changed corporate taxes or cut back on government 

contracts with private firms, the affected companies 

would benefit from advance notice. And if lawmakers 

reduced federal grants to state and local governments, 

those governments would prefer to have a chance to 

adjust their own spending and revenue plans.

Although there are trade-offs in choosing the timing of 

policy changes to reduce future deficits, such trade-offs 

do not apply to the timing of decisions about those 

changes. Rather, there are important benefits and few 

apparent costs to deciding soon what policy actions will 

be taken to resolve the long-term budgetary imbalance. 

Enacting policy changes soon, even if they are to be 

implemented later, would probably boost economic 

activity by providing more certainty about the nature and 

size of the changes and more assurance that the nation’s 

fiscal policy will be put on a sustainable path. Deciding 

on changes soon would also give lawmakers more flexibility in determining the timing of the changes while still 

limiting further increases in federal debt and the negative 

consequences that would flow from those increases. 

Examples of Plans to Reduce the Deficit

Putting fiscal policy on a sustainable course will require 

difficult decisions. Different types of spending cuts and 

tax increases would impose direct costs on different people and businesses; those policy changes could also affect 

the size of the economy. For instance, some choices about 

spending could influence investment, which would affect 

overall economic growth, and other spending options 

would involve transferring resources from one group to 

another. Likewise, some changes to the tax system (such 

as raising marginal tax rates) would tend to reduce economic growth, whereas other changes (such as broadening the base for a given tax) might not.

In recent months, a number of groups and individuals 

have released plans focused on reducing the deficit.9

The plans reflect widely varying priorities, with some 

emphasizing spending cuts and others emphasizing tax 

increases. As an example, members of the bipartisan 

7. See Congressional Budget Office, Policies for Increasing Economic 

Growth and Employment in 2010 and 2011 (January 2010).

8. See Congressional Budget Office, Estimated Impact of the American Recovery and Reinvestment Act on Employment and Economic 

Output from October 2010 Through December 2010 (February 

2011).

9. For a summary of the provisions of some of those plans, see Committee for a Responsible Federal Budget, “Summary Table of Fiscal Plans,” http://crfb.org/sites/default/files/CRFB_Summary_

Table_of_Fiscal_Plans.pdf. Also see the “You Fix the Budget” 

discussion at Economix blog, New York Times, http://economix

.blogs.nytimes.com/tag/you-fix-the-budget/.
8 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

National Commission on Fiscal Responsibility and 

Reform, created by the President, recently proposed a 

plan to balance the budget excluding interest payments 

by 2015 and to make meaningful improvements to the 

long-term fiscal outlook.10 The plan would reduce the 

costs of federal health care programs by altering the 

degree of cost sharing required of beneficiaries, changing 

malpractice laws, and limiting federal costs for prescription drugs. It would also decrease spending on Social 

Security, agriculture programs, and military and civil 

service retirement; reduce defense and nondefense discretionary spending; and increase revenues, mainly by eliminating various tax preferences (such as special exclusions, 

exemptions, and deductions) and thus broadening the tax 

base. The plan was endorsed by 11 of the commission’s 

18 members. (If it had received the support of 14 members, its recommendations would have been formally 

issued and, according to some Congressional leaders, 

would have been brought up for a vote in the Congress.)

The Options in This Report

The budget options presented in this volume do not constitute a comprehensive plan but rather a set of discrete 

policy actions that illustrate ways in which lawmakers 

could decrease federal spending or increase revenues. The 

options are grouped according to three major budget 

categories: 

B Mandatory Spending. Also known as direct spending, 

mandatory spending accounts for more than half of 

federal outlays (see Figure 1-4). The category includes 

spending for entitlement programs and certain other 

payments to people, businesses, nonprofit institutions, 

and state and local governments. The Congress generally determines spending for mandatory programs by 

setting eligibility rules, benefit formulas, and other 

parameters in authorizing legislation rather than by 

appropriating specific amounts each year. The largest 

mandatory programs are Social Security, Medicare, 

and Medicaid, which together accounted for 74 percent of mandatory spending in 2010 and are projected 

to account for 81 percent by 2021, under current law.

B Discretionary Spending. Nearly 40 percent of federal 

outlays stem from budget authority provided in 

annual appropriation acts, which is referred to as discretionary funding.11 In 2010, roughly half of discretionary spending went for defense, and the other half 

paid for a wide range of federal activities, including 

law enforcement, homeland security, transportation, 

national parks, disaster relief, scientific research, and 

foreign aid. In CBO’s baseline, discretionary spending 

is assumed to grow at the rate of inflation and thus is 

projected to decline as a share of the budget over the 

next decade, falling to 28 percent of total spending 

by 2021.

B Revenues. Federal revenues come from taxes on individual and corporate income, payroll taxes for social 

insurance programs (such as Social Security and 

unemployment compensation), excise taxes, estate and 

gift taxes, remittances from the Federal Reserve System, customs duties, and miscellaneous fees and fines. 

The two largest sources are individual income taxes 

and social insurance taxes, which together produce 

more than 80 percent of the government’s revenues 

(see Figure 4-1 on page 130).

Chapters 2 and 3 contain options to reduce mandatory 

and discretionary spending, respectively. Chapter 4 presents options to increase revenues. Each chapter begins 

with an introduction that describes overall budgetary 

trends in that category and some of the broad policy 

issues to consider when choosing among the options. 

Each option includes a brief discussion that provides 

background information about the issue, describes the 

policy change envisioned in the option, and summarizes 

arguments for and against the change. As appropriate, 

citations are given to related options and relevant CBO 

publications. 

For options that deal with mandatory spending, CBO 

estimated budgetary effects relative to the spending projected to occur under current law. For most options that 10. The commission was created by executive order in February 2010 

and included three House Republicans, three House Democrats, 

three Senate Republicans, three Senate Democrats, and six members appointed by the President. Its final report was published on 

December 1, 2010. See National Commission on Fiscal Responsibility and Reform, The Moment of Truth: Report of the National 

Commission on Fiscal Responsibility and Reform (December 2010).

11. In this report, spending generally refers to outlays, which are 

the disbursement of federal government funds. Funding (in the 

form of budget authority or obligation limitations) refers to the 

authority provided by law to incur financial obligations, which 

ultimately result in outlays.
CHAPTER ONE: INTRODUCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 9

CBO

Figure 1-4.

Breakdown of Federal Spending in 2010

Source: Congressional Budget Office.

involve discretionary spending, the effects of the changes 

were calculated relative to 2011 appropriation levels, as 

adjusted for inflation in later years.12 For options involving discretionary spending for defense procurement, budgetary effects were measured relative to the Department 

of Defense’s (DoD’s) projections of the costs of its plans 

for the coming 5 years.13 (Consequently, the estimates for 

those options cover only the next 5 years, whereas estimates for the other options cover the next 10 years.) 

Budgetary effects for most of the revenue options were 

estimated by the staff of the Joint Committee on Taxation (JCT).

Some options that involve collecting fees raise the question of whether the proceeds from those fees should be 

classified as revenues (governmental receipts) or as offsets 

to spending (offsetting receipts or offsetting collections). 

In classifying new fees for this volume, CBO generally 

followed the guidance of the 1967 President’s Commission on Budget Concepts, which indicates that receipts 

from a fee imposed pursuant to the federal government’s 

sovereign power should generally be recorded in the budget as revenues. (Sometimes, however, the Congress has 

legislated the budgetary classification of fees, requiring 

that they be recorded as offsets to spending when they 

would otherwise have been recorded as revenues.)

Caveats About This Report

Because the options in this volume are intended to help 

lawmakers review individual programs or tax provisions, 

they do not include large-scale budget initiatives, such as 

eliminating entire departments or agencies. Many of the 

Defense

Discretionary

(20%)

Mandatory

(55%)

Nondefense

Discretionary

(19%)

I

n

t

e

r

e

s

t

(6%)

12. Because full-year appropriations had not been enacted for 2011 

when this report was prepared, the estimates for discretionary 

spending options (other than those affecting defense procurement) were based on the annualized value of the funding provided 

in the Continuing Appropriations and Surface Transportation 

Extensions Act, 2011 (Public Law 111-322), the continuing 

resolution that ran through March 4, 2011.

13. For the 2012–2015 period, those costs come from DoD’s 2011 

Future Years Defense Program (FYDP), which was issued in April 

2010. For 2016, CBO constructed an extension of the FYDP 

starting with DoD’s cost estimates for 2015 and projecting the 

costs of DoD’s longer-term plans, which are available for all of 

the procurement programs analyzed. For further discussion of 

CBO’s extension of the FYDP, see Congressional Budget Office, 

Long-Term Implications of the 2011 Future Years Defense Program

(February 2011).
10 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

options could be combined to provide the building 

blocks for broader changes. In some cases, however, 

combining various spending or revenue options would 

produce different budgetary effects than the sums of the 

estimates shown here. The reason is that some options 

would overlap or would interact with one another in ways 

that would change their budgetary impact. Also, certain 

options would be mutually exclusive.

The estimates shown in this volume could differ from any 

later cost estimates by CBO or revenue estimates by JCT 

for legislative proposals that resemble these options. One 

reason is that the proposals on which those later estimates 

would be based might not precisely match the options 

presented here. Another reason is that the baseline budget 

projections against which such proposals would ultimately be measured might have been updated and thus 

would differ from the projections used for this report.

The estimated budgetary effects of options do not reflect 

the extent to which a policy change would affect interest 

payments on federal debt. Interest savings may be 

included as part of a comprehensive budget plan (such as 

the Congressional budget resolution), but CBO does not 

make such calculations for individual pieces of legislation 

or for options of the type discussed here.

CBO’s analyses also do not attempt to quantify the 

impact of options on states’ spending or revenues. However, some of the estimates in this volume depend on 

projections of states’ responses to federal policy changes, 

which can be difficult to predict and can vary over time 

with the fiscal conditions of states and other factors.

Some options that would affect other levels of government or the private sector might involve federal mandates. The Unfunded Mandates Reform Act of 1995 

defines mandates as including enforceable duties imposed 

on state, local, or tribal governments or the private sector, 

as well as certain types of provisions affecting large entitlement programs that provide funds to states. That law 

requires CBO to estimate the costs of any mandates that 

would be imposed by new legislation that the Congress is 

considering. The discussions of the options in this volume, however, do not address the costs of potential 

mandates.
CHAPTER

CBO

2

Mandatory Spending Options

Mandatory spending—which totaled about 

$1.9 trillion in 2010, or 55 percent of federal outlays—

consists of all spending (other than interest on federal 

debt) that is not subject to annual appropriations. The 

Congress generally determines spending levels for mandatory programs by setting the programs’ parameters, such 

as eligibility rules and benefit formulas, rather than by 

appropriating specific amounts each year. Mandatory 

spending also includes offsetting receipts, which consist 

of fees and other charges that are recorded as negative 

budget authority and outlays.1

Nearly all mandatory outlays occur through social insurance programs (programs in which most eligible people 

participate and to which they contribute at least part of 

the funding) or through means-tested programs (which 

link eligibility to people’s income). The largest mandatory programs are Social Security and Medicare (see 

Figure 2-1). Together, they accounted for 60 percent of 

mandatory outlays in 2010—or about one-third of all 

federal spending—shares that are expected to grow appreciably in coming years. Medicaid and other health programs accounted for about 15 percent of mandatory 

spending last year, and unemployment compensation, 

boosted by high unemployment and extended benefits, 

accounted for about 8 percent. 

The remaining mandatory spending goes to various 

income security programs—including the Supplemental 

Nutrition Assistance Program (SNAP), child nutrition 

programs, Temporary Assistance for Needy Families, and 

certain refundable tax credits—as well as to retirement 

benefits for civilian and military employees of the federal 

government, veterans’ benefits, deposit insurance (net of 

premiums that banks pay for such insurance), student 

loans, and support for agriculture.2

 In the past few years, 

mandatory spending has also included outlays for the 

Troubled Asset Relief Program (TARP) and subsidies for 

Fannie Mae and Freddie Mac (two institutions that facilitate the flow of funding for home loans nationwide). 

Trends in Mandatory Spending

Relative to the size of the economy, mandatory spending 

peaked in 2009 at 14.9 percent of gross domestic product 

(GDP), before dropping last year to 13.2 percent of GDP 

(see Figure 2-2). Much of the decline in spending in 2010 

resulted from unusually large negative outlays recorded 

for the TARP and deposit insurance, as well as from a 

drop in payments to Fannie Mae and Freddie Mac. Taken 

together, all other mandatory spending grew in 2010. 

If no new laws are enacted that affect mandatory programs, outlays for such programs will rise to 14.0 percent 

of GDP in 2011, the Congressional Budget Office 

(CBO) estimates.3

 Mandatory spending is then projected 

to decline to around 13.0 percent of GDP from 2012 to 

2018, as the economy grows and spending on income 

security programs such as unemployment compensation 

decreases. Thereafter, mandatory outlays are projected to 

increase steadily relative to GDP under current law—

reaching 14.0 percent again in 2021—because of the 

aging of the population, rising health care costs, and

1. Offsetting receipts differ from revenues in that revenues are collected through the exercise of the government’s sovereign powers 

(for example, levying income taxes), whereas offsetting receipts are 

generally collected from other government accounts or from 

members of the public through businesslike transactions (for 

example, collecting premiums for Medicare or rental payments 

and royalties for the extraction of oil and gas on public lands). 

Throughout the introduction to this chapter, spending for 

Medicare is reported net of offsetting receipts. 

2. Tax credits reduce a taxpayer’s overall tax liability (the amount 

owed); if a refundable credit exceeds that liability, the excess may 

be refunded to the taxpayer, in which case it is recorded in the 

budget as an outlay.

3. The baseline budget projections discussed in this report are from 

Congressional Budget Office, The Budget and Economic Outlook: 

Fiscal Years 2011 to 2021 (January 2011).
12 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Figure 2-1.

Breakdown of Mandatory Spending in 2010

Source: Congressional Budget Office.

Notes: Other health programs include the Children’s Health Insurance Program, some public health initiatives, and certain health programs 

for military retirees. 

Other mandatory spending includes outlays for federal civilian and military retirement, refundable tax credits, certain veterans’ 

benefits, the Supplemental Nutrition Assistance Program (formerly called Food Stamps), and a variety of other programs. 

other factors. By comparison, mandatory spending averaged 11.2 percent of GDP over the past 10 years and 

9.9 percent over the past 40 years.4

Those projections for total mandatory spending mask 

diverging trends for different components of such spending. CBO projects that spending for Social Security, 

Medicare, Medicaid, and other health care programs will 

grow from 9.9 percent of GDP in 2010 to 12.0 percent 

by 2021, driven largely by rapid growth in health care 

costs. At the same time, outlays for income security programs (such as unemployment compensation, SNAP, and 

certain refundable tax credits) will decline relative to 

GDP, from 3.0 percent in 2010 to 1.3 percent by 2021. 

That projected decline reflects an expected economic 

expansion, which will reduce the number of people 

eligible for many income security programs, and scheduled changes to tax provisions, which will reduce the 

refundability of some tax credits. The remaining portion 

of mandatory spending is projected to increase from 

0.2 percent of GDP in 2010 to 0.7 percent by 2021. 

Assumptions Underlying Projections of 

Mandatory Spending 

In creating its baseline budget projections, CBO generally assumes that existing laws will remain unchanged. 

That assumption applies to most, but not all, mandatory 

programs. Following long-standing Congressional procedures, CBO assumes that most mandatory programs that 

are scheduled to expire in the coming decade under current law will be extended instead. In particular, all such 

programs that predate the Balanced Budget Act of 1997 

and that have outlays in the current year greater than 

$50 million are presumed to continue under CBO’s baseline; for programs established after 1997, continuation is 

Medicare

(23%)

Medicaid and

Other Health

Programs

(15%)

Social

Security

(37%)

Other

(16%)

Unemployment

Compensation

(8%)

4. For a more detailed discussion of the components of mandatory 

spending and CBO’s projections for them, see Congressional 

Budget Office, The Budget and Economic Outlook: Fiscal Years 

2011 to 2021, Chapter 3.
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 13

CBO

Figure 2-2.

Mandatory Spending, 1971 to 2021

(Percentage of gross domestic product) 

Source: Congressional Budget Office (as of January 2011).

Note: Data include offsetting receipts (funds collected by government agencies from other government accounts or from the public in 

businesslike or market-oriented transactions that are recorded as offsets to outlays).

assessed on a program-by-program basis in consultation 

with the House and Senate Budget Committees. The 

assumption that expiring programs will continue has little effect on CBO’s projection of total mandatory spending for 2011. However, that assumption raises projected 

mandatory outlays by $118 billion (or about 3 percent) 

in 2021 and by a total of about $1.0 trillion between 

2012 and 2021. 

CBO’s baseline also incorporates the assumption that 

Medicare spending will be constrained beginning next 

year by the sustainable growth rate mechanism, which 

controls the fees paid for physicians’ services. Under current law, those fees will be reduced by about 28 percent in 

January 2012 and by additional amounts in subsequent 

years, CBO projects. If, however, future legislation overrides the scheduled reductions—as has happened every 

year since 2003—spending for Medicare may be greater 

than the amounts projected in the baseline. For example, 

if payment rates for physicians stayed at their 2011 dollar 

levels through 2021, Medicare outlays over the next 

decade (net of premiums paid by enrollees) would exceed 

the current baseline projections by about $250 billion (or 

3 percent). If payment rates were raised over time, the 

impact on Medicare outlays would be even greater.5

Some of the options for Medicare presented in this chapter might be implemented under current law and could 

be the means by which the growth of Medicare spending 

is limited to the amounts projected in the baseline. The 

reason is that the Patient Protection and Affordable Care 

Act (Public Law 111-148) created the Independent Payment Advisory Board (IPAB) and made it responsible for 

restraining the growth rate of Medicare spending per 

enrollee.6 If the growth of such spending is projected to 

exceed specified targets, the IPAB will be required to submit proposals to reduce it, and the Secretary of Health 

and Human Services must implement those proposals 

unless the Congress acts to change them or otherwise 

alter the IPAB process. The board is not allowed to make 

recommendations that would ration care, raise premiums, increase cost sharing, restrict benefits, or modify 

eligibility, leaving reductions in payments to health care 

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021

0

2

4

6

8

10

12

14

16

18

0

2

4

6

8

10

12

14

16

18

Actual Baseline Projection

5. For additional information on Medicare’s payments to physicians, 

see Congressional Budget Office, Factors Underlying the Growth in 

Medicare’s Spending for Physicians’ Services, Background Paper

(June 2007). 

6. For more details about the IPAB and its mandate, see David 

Newman and Christopher M. Davis, The Independent Payment 

Advisory Board, Report for Congress R41511 (Congressional 

Research Service, November 30, 2010).
14 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

providers as its major potential source of savings. CBO’s 

baseline projections incorporate an estimate that the 

IPAB process will reduce outlays for Medicare by a total 

of $14 billion between 2017 and 2021. 

Another assumption underlying CBO’s projections 

involves the role of trust funds. Payments for Social Security and Medicare are made from dedicated trust funds 

within the federal budget: Social Security’s Old-Age and 

Survivors Insurance (OASI) Trust Fund and Disability 

Insurance (DI) Trust Fund, and Medicare’s Hospital 

Insurance (HI) Trust Fund and Supplementary Medical 

Insurance (SMI) Trust Fund.7

 Revenues from specific 

payroll taxes go into the OASI, DI, and HI trust funds; 

those funds also receive some receipts from other sources 

specified in law. The SMI trust fund receives revenues 

from general government funds, premiums paid by 

enrollees, and other sources. CBO expects that under current law, receipts for the OASI, DI, and HI trust funds 

will not be sufficient at some points in the future to pay 

currently prescribed benefits. Specifically, CBO projects 

that under current law, the OASI trust fund will be 

exhausted in 2042, the DI trust fund in 2017, and the 

HI trust fund in 2021.8

 (Because the SMI trust fund can 

draw on general revenues without limit, its receipts will 

not fall short of benefit payments.) 

If a program’s trust fund is exhausted and the receipts 

coming into the fund during a given year are not sufficient to pay the full benefits scheduled under law that 

year, the program will not have the legal authority to pay 

full benefits. In that case, benefits will have to be reduced 

to bring outlays in line with receipts. Nonetheless, following long-standing Congressional procedures, CBO’s baseline incorporates the assumption that beneficiaries will 

receive the full payments or services to which they are 

entitled under Social Security and Medicare in coming 

years.

Trust funds are essentially accounting mechanisms. Any 

cash generated when annual receipts exceed annual 

spending is not retained by a trust fund. Rather, the 

money is turned over to the Treasury, which gives the 

trust fund government bonds in exchange and uses the 

cash to finance the government’s ongoing activities. 

Because trust funds are part of the government, transactions between them and the Treasury are intragovernmental and have no net impact on the overall budget or 

on federal borrowing from the public. The resources used 

to redeem a trust fund’s government bonds—and thus 

pay for benefits—in some future year will have to be generated from taxes, other government income, or government borrowing in that year. As a result, although trust 

funds have important legal meaning, they have little 

meaning for the overall federal budget or the economy. 

Sources of Growth in 

Mandatory Programs

A number of factors—such as changes in eligible populations, increases in health care costs, developments in the 

economy, and actions by state governments—influence 

growth in federal mandatory spending. The importance 

of specific factors varies among programs. 

Demographic Changes

Many mandatory programs provide benefits to specific 

populations, with eligibility a function of such criteria as 

age, income, and family status. People who meet those 

eligibility rules are typically entitled to benefits.9

 For such 

programs, an important factor in CBO’s baseline is the 

effect of demographic changes on the size of the population enrolled or participating in the program. For example, CBO’s projections of Medicare spending incorporate 

the impact of the aging of the baby-boom generation, 

whose oldest members are now reaching the age of eligibility for Medicare. CBO estimates that the number of 

enrollees in Medicare will grow from 45 million in 2010 

to almost 60 million by 2021.

7. The HI trust fund pays for care in hospitals and other institutions 

under Part A of Medicare; the SMI trust fund pays for care by 

physicians and other providers under Part B of Medicare and for 

prescription drugs under Part D of Medicare. In addition, both 

trust funds are used to pay benefits for people who join private 

Medicare Advantage plans under Part C of Medicare.

8. The DI trust fund has been close to exhaustion before. The 1994 

annual report of the Social Security Board of Trustees projected 

that it would be exhausted in 1995. That outcome was prevented 

by legislation that redirected revenue from the OASI trust fund to 

the DI trust fund. CBO projects that if legislation to shift 

resources from the OASI trust fund to the DI trust fund was 

enacted again, the combined OASDI trust funds would be 

exhausted in 2039.

9. Some mandatory programs are capped or are provided in the form 

of grants to states. In such cases, although a program’s funding 

is mandatory, there is not a specific individual entitlement to 

benefits or services. 
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 15

CBO

Similar demographic pressures will affect outlays for 

Social Security, the largest federal spending program. 

Those outlays rose by 3.4 percent in 2010, primarily 

because both the retirement (OASI) and disability (DI) 

components of the program saw increases in the number 

of people enrolled. Over the 2011–2021 period, as more 

baby boomers become eligible for OASI benefits, the 

number of people collecting those benefits will grow by 

about 3 percent per year, CBO estimates—from 44 million in 2010 to 59 million by 2021. In addition, average 

OASI benefits will rise over time, both because benefits 

for people who are already collecting them are subject to 

annual cost-of-living adjustments (COLAs) to keep pace 

with inflation and because initial benefits are based on 

individual earnings, which tend to grow with time. For 

all of those reasons, OASI outlays are projected to 

increase by about 6 percent a year in the coming decade 

(see Table 2-1).

The number of people receiving DI benefits jumped by 

almost 5 percent in 2010, to nearly 10 million. Higherthan-average increases in enrollment are expected to 

persist through 2012, largely because the high unemployment rate means that many disabled people will continue 

to face meager job prospects. After 2013, however, the 

annual growth rate of enrollment is projected to average 

1.2 percent, as a strengthening economy leads fewer people to seek disability benefits and as more people qualify 

for benefits under OASI. 

Growth in Health Care Spending per Person

In the case of health care programs, although demographics are a significant element of CBO’s projections, 

expected growth in health spending per person is also 

important. Enrollment in Medicare is projected to 

increase by about one-third between 2010 and 2021, and 

spending per Medicare beneficiary is expected to rise by 

about one-half over that period. Some of the latter rise 

stems from overall inflation, and some results from 

growth in spending per beneficiary over and above inflation. Altogether, CBO projects that spending for the 

Medicare program will roughly double between 2011 and 

2021 in dollar terms and will increase from 3.6 percent 

of GDP to 4.3 percent of GDP. Growth in health care 

spending per person will also boost spending on Medicaid and other mandatory federal health programs in the 

coming decade. 

Over the longer run, rising health care spending per 

person will continue to drive up federal health spending 

under current law. For the past several decades, the rate of 

growth of health care spending per person (adjusted for 

the effect of changes in the age composition of the population) has exceeded the growth of per capita GDP—a 

phenomenon referred to as “excess cost growth.” Between 

1985 and 2008, for example, excess cost growth averaged 

1.5 percentage points a year for Medicare, 1.2 percentage 

points for Medicaid, and 1.9 percentage points for other 

national health spending.10 CBO expects rates of excess 

cost growth to slow somewhat over time. Even so, it projects that spending for Medicare and Medicaid combined 

will climb from 5.5 percent of GDP today to 11 percent 

of GDP by 2035, with slightly more than half of that 

increase resulting from excess cost growth and slightly less 

than half from the aging of the population.

Economic Changes

Overall economic trends also influence CBO’s estimates 

of mandatory spending. Growth in productivity and 

GDP, changes in prices and wages, and other economic 

factors affect both the number of people who participate 

in mandatory programs and the cost of providing the 

benefits specified in current law. Therefore, CBO’s baseline budget projections depend on the agency’s economic 

projections. For example, a forecast of lower inflation 

would tend to restrain projections of mandatory spending, because of smaller COLAs for some programs and 

because of slower growth in input prices for other 

programs. 

The recent economic downturn had a significant impact 

on several mandatory programs. A decline in consumer 

prices precluded COLAs for Social Security benefits in 

2010 and 2011, so Social Security outlays were lower 

than they would have been otherwise. CBO expects 

Social Security COLAs to resume in 2012. Outlays for 

the Supplemental Nutrition Assistance Program doubled 

between 2007 and 2010, to $70 billion, as enrollment 

leapt from about 26 million people to 40 million. CBO 

estimates that spending for SNAP will increase by 

another 10 percent in 2011, to $77 billion, as the 

enrolled population continues to swell. SNAP enrollment 

is expected to decline in later years as the economy 

improves, falling back to roughly 31 million people by 

2021 in CBO’s baseline projections. Likewise, outlays

10. For additional discussion of excess cost growth, see Congressional 

Budget Office, The Long-Term Budget Outlook (June 2010, revised 

August 2010), Chapter 2.
16 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Table 2-1.

CBO’s Baseline Projections of Mandatory Outlays

(Billions of dollars)

Source: Congressional Budget Office (as of January 2011).

Notes: Spending for the benefit programs shown above generally excludes administrative costs, which are discretionary.

SNAP = Supplemental Nutrition Assistance Program.

a. Excludes offsetting receipts (premiums paid by Medicare enrollees and certain payments by states).

b. Includes health insurance subsidies, exchanges, and related spending under the Patient Protection and Affordable Care Act (Public Law 

111-148) and the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152); the Department of Defense’s Medicare-Eligible 

Retiree Health Care Fund; and the Children’s Health Insurance Program.

c. Includes Temporary Assistance for Needy Families and various programs that involve payments to states for child support enforcement 

and family support; child nutrition programs; foster care programs; and the Making Work Pay and other tax credits.

d. Includes veterans’ compensation, pensions, and life insurance programs, as well as education subsidies for veterans.

e. Includes the Troubled Asset Relief Program, Fannie Mae, Freddie Mac, deposit insurance, higher education programs, and agriculture 

programs.

f. Includes Medicare premiums, amounts paid by states from savings on Medicaid prescription drug costs, the federal share of federal 

employees’ retirement contributions, and other funds collected by government agencies from other government accounts or from the 

public in businesslike or market-oriented transactions that are recorded as offsets to outlays. 

Actual, 2012- 2012-

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2016 2021

701 727 761 799 842 889 940 997 1,059 1,126 1,196 1,267 4,231 9,876

520 572 566 610 645 679 738 771 806 885 949 1,021 3,238 7,670

273 274 264 278 329 371 416 447 474 508 544 587 1,659 4,219

17 24 27 27 52 78 101 118 126 137 144 155 286 966 ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____

810 870 858 915 1,027 1,128 1,256 1,337 1,407 1,529 1,636 1,764 5,183 12,856

70 77 80 80 71 69 68 67 65 64 64 63 368 691

159 129 87 64 61 58 53 52 54 56 58 60 324 604

47 53 46 52 53 54 60 57 53 60 62 69 265 566

77 77 77 77 46 46 45 45 46 46 46 46 290 520

84 73 54 55 54 55 56 58 59 61 62 64 274 578 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

438 409 343 327 285 282 284 279 278 287 292 302 1,521 2,958

139 146 141 149 154 158 168 168 169 180 185 192 770 1,665

58 78 64 70 72 74 81 78 75 82 84 87 360 765

-52 68 82 68 54 55 58 55 53 63 62 60 316 608

-184 -191 -211 -222 -230 -240 -249 -267 -285 -302 -317 -338 -1,151 -2,659 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

Total Mandatory Spending 1,910 2,108 2,038 2,106 2,203 2,346 2,538 2,647 2,757 2,964 3,138 3,333 11,230 26,070

Memorandum:

446 492 477 517 549 578 633 653 679 746 797 855 2,755 6,485

Otherb

Income Security Programs

SNAP

Unemployment compensation

Supplemental Security Income

Subtotal

Total

Social Security

Health Programs

Medicarea

Medicaid

Subtotal

Other Programse

Offsetting Receiptsf

Earned income and child tax credits

Otherc

Federal Civilian and Military Retirement

Veterans' Programsd

Spending for Medicare

Net of Offsetting Receipts
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 17

CBO

for unemployment compensation quadrupled between 

2008 and 2010, reaching $159 billion, because of high 

unemployment rates and legislation that enhanced 

benefits. CBO projects that outlays for unemployment 

compensation will return to prerecession levels as the 

economy improves, falling to $60 billion (roughly the 

2007 level) in 2021.

Actions by States

Among mandatory programs, both Medicaid and the 

Children’s Health Insurance Program (CHIP) are funded 

jointly by the federal government and the states. Federal 

funding matches a portion of state spending, within 

established rules (although total federal funds for CHIP 

are capped). Thus, federal spending on those programs is 

partly determined by states’ behavior, and the growth rate 

of spending (particularly for Medicaid) will depend on 

states’ decisions about eligibility criteria, the types of services that the programs will cover, and the prices that 

states will pay for those covered services. 

Approaches to Reducing 

Mandatory Spending

Because mandatory programs account for the majority of 

federal spending—and their share is expected to continue 

to rise—reducing the budget deficit significantly in both 

the short and long terms would be very difficult without 

restraining the growth of mandatory spending. Annual 

appropriations do not determine the amount of mandatory spending, so policymakers must look to different 

approaches to control such spending. Examples of possible approaches include modifying the automatic indexation of benefits, the populations entitled to benefits, or 

the federal government’s share of spending. 

Changing the Automatic Indexation of Benefits 

Many mandatory programs use some form of indexing 

for inflation to determine annual changes in benefits. 

Therefore, the choice of an index or inflation adjustor 

can have a significant impact on a program’s spending. 

Using a different measure of inflation or adjusting benefits by less than the full measured change in prices each 

year can generate savings that, because of the impact of 

compounding, will tend to grow over time. 

Changing the Populations Entitled to Benefits 

Mandatory programs that provide benefits to specific 

populations grow or contract with the size of the populations served. For example, people may enroll in income 

support programs during periods of economic dislocation 

and then leave once their situation improves. Consequently, in a downturn affecting the overall economy, the 

federal government may be faced with additional mandatory spending at the same time that revenues are lower. 

(Such changes in government spending and revenues are 

known as “automatic stabilizers” because they occur independent of any legislative action and tend to stabilize 

economic activity.) As another example, more people 

will enroll in mandatory programs over the next decade 

because the aging of the population will make a larger 

share of Americans eligible for Social Security, Medicare, 

and other programs that focus on older people. Moreover, 

increasing life expectancy means that many Americans 

will receive benefits from those programs for more years 

than people would have in the past. Policymakers could 

seek to mitigate the growth of mandatory spending by 

altering the criteria that determine eligibility for income 

support programs or by increasing the eligibility age for 

certain benefits. 

Changing the Federal Government’s 

Share of Spending 

Federal spending on mandatory programs can be lowered 

by reducing the federal government’s share of the programs’ spending and increasing the shares borne by state 

governments, program participants, and others. For 

example, in Medicaid and other programs that involve 

state matching funds, the federal commitment could be 

reduced, thus shifting costs to the states and encouraging 

states to trim spending on those programs. In health care 

programs such as Medicare, premiums or cost sharing 

could be increased, thus shifting costs to beneficiaries and 

encouraging them to restrain their use of services. Requiring people to pay more for a service would decrease federal costs and might lower the overall cost of providing 

that service if people responded by using less of it. 

Mandatory Spending Options in 

This Chapter

The options that follow encompass a broad range of 

mandatory spending programs. Although the options are 

grouped by program, some of the options for different 

programs are conceptually similar, in line with the 

approaches to reducing spending discussed above. For 

instance, two options address the effects of applying different inflation factors to the benefit formulas for certain 

programs. Other options would alter the balance of 
18 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

spending between the government and program participants or between the federal government and the states.

Of the 32 options in this chapter, 15 deal with spending 

for health care programs. Another 7 would make changes 

to Social Security or other retirement programs. The 

remaining options focus on Fannie Mae, Freddie Mac, 

and programs that deal with education, energy, or agriculture. The budgetary impact of each option is estimated independently, without consideration for potential 

interactions with other options. The table accompanying 

an option shows the option’s estimated budgetary effects 

in each of the next 10 years, as well as 5- and 10-year 

totals. Those effects are measured relative to the spending 

that CBO projects would occur under current law, as 

shown in the agency’s January 2011 baseline.

In addition to the options in this chapter, three more 

options—which would increase rather than decrease 

mandatory spending—are discussed in Appendix A. 

Those options relate to provisions of Medicaid, Medicare, 

and Social Security. They are included in this volume 

because CBO frequently receives requests for estimates of 

their budgetary effects.
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 19

CBO

Mandatory Spending—Option 1 Function 050

Introduce Minimum Out-of-Pocket Requirements Under TRICARE For Life

TRICARE For Life (TFL) was introduced in 2002 as a 

supplement to Medicare for military retirees and their 

family members who are eligible for Medicare. The program pays nearly all medical costs for acute care not covered by Medicare and requires few out-of-pocket fees. 

Because the Department of Defense (DoD) is a passive 

payer in the program—it neither manages care nor provides incentives for the cost-conscious use of services—

it has virtually no means of controlling the program’s 

costs. In contrast, most public and private programs that 

pay for health care either manage the care or require people receiving care to pay deductibles or copayments to a 

specified threshold. In 2010, DoD spent about $8.4 billion on Medicare-eligible beneficiaries (in addition to 

amounts spent for those individuals by Medicare). 

This option would introduce minimum out-of-pocket 

requirements for TFL beneficiaries. For calendar year 

2013, TFL would not cover any of the first $550 of an 

enrollee’s cost-sharing payments under Medicare and 

would cover only 50 percent of the next $4,950 in such 

payments. (Because all further cost sharing would be covered by TFL, enrollees would not be obliged to pay more 

than $3,025 in cost sharing in that year.) Those dollar 

limits would be indexed to growth in average Medicare 

costs for later years. Currently, military treatment facilities charge very small or no copayments for hospital 

services to TFL beneficiaries. To reduce beneficiaries’ 

incentive to switch to those facilities and avoid the outof-pocket costs of using civilian facilities, this option 

would require TFL beneficiaries seeking care from military treatment facilities to make payments that would be 

roughly comparable to the charges they would face at 

civilian facilities. 

This option would reduce spending for Medicare as well 

as for TFL because higher out-of-pocket costs would lead 

beneficiaries to use somewhat fewer medical services. 

Altogether, this option would reduce the federal spending 

devoted to TFL beneficiaries by about $15 billion 

through 2016 and by about $43 billion through 2021. 

Approximately 30 percent of those savings would come 

from a reduced demand for medical services; the rest represents a shift of spending from the government to military retirees and their families. 

An advantage of this option is that greater cost sharing 

would increase TFL beneficiaries’ awareness of the cost of 

health care and promote a corresponding restraint in 

their use of medical services. Research has generally 

shown that introducing modest cost sharing can reduce 

medical expenditures without causing measurable 

increases in adverse health outcomes for most people. 

Among its disadvantages, this option could discourage 

some patients (particularly low-income patients) from 

seeking preventive medical care or from managing their 

chronic conditions under close medical supervision, 

which might negatively affect their health.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays

Department of 

Defense 0 -2,100 -3,000 -3,300 -3,500 -3,700 -4,000 -4,300 -4,600 -5,000 -11,900 -33,500

Medicare 0 -600 -900 -900 -1,000 -1,100 -1,100 -1,200 -1,300 -1,400 -3,400 -9,500

Total 0 -2,700 -3,900 -4,200 -4,500 -4,800 -5,100 -5,500 -5,900 -6,400 -15,300 -43,000

RELATED OPTIONS: Discretionary Spending, Options 3 and 5

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; and The Effects of Proposals 

to Increase Cost Sharing in TRICARE, June 2009
20 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 2 Function 270

Transfer the Tennessee Valley Authority’s Electric Utility Functions and 

Associated Assets and Liabilities

In 1933, the Tennessee Valley Authority (TVA) was 

established as a federal agency to control flooding, 

improve navigation, and develop the hydroelectric 

resources of the Tennessee River for the benefit of a 

seven-state region in the southeastern United States. 

Since then, TVA has developed an extensive network 

of transmission facilities and nuclear- and fossil-fuelpowered electricity-generating plants. As one of the largest electric utilities in the nation, TVA accounted for 

5 percent of national electricity generation in 2010. To 

maintain sufficient capacity, TVA anticipates that it will 

need to make large capital expenditures in the next 

decade and beyond. TVA funds its investments primarily 

by issuing debt, and it services those debt obligations 

from revenues earned through electricity sales to customers over several decades. 

This option would transfer most of TVA’s electric utility 

functions and associated assets and liabilities to a nonfederal owner and operator—a private firm, for example, 

or to an entity owned by its distributors. That entity 

could be similar to the newly formed Seven States Power 

Corporation, a nonprofit electricity generation and transmission cooperative in the Tennessee Valley. The hydropower assets and liabilities would be retained by the government because they serve several other purposes, such 

as flood control and recreation. This option assumes that 

the transfer of TVA’s electric utility functions and associated assets and liabilities would be completed by the end 

of 2013. Such a transfer could be accomplished in different ways: TVA’s assets and liabilities could be conveyed 

free of charge, for example, or they could be sold in a 

competitive auction to a nonfederal entity. Proceeds from 

such an auction would depend on the terms and conditions of the sale. As a result, potential proceeds are not 

included in this estimate. 

Even in the absence of auction proceeds, the Congressional Budget Office estimates that implementing this 

option will reduce net outlays by about $1 billion over 

the 2012–2016 period and by nearly $4 billion over the 

2012–2021 period. Those savings reflect the estimated 

net outlays that TVA otherwise would have incurred to 

build new electric power facilities over the next 10 years. 

CBO’s estimate assumes that the current $30 billion ceiling on TVA’s borrowing would be maintained; if that 

ceiling was raised, the budgetary savings from this option 

would probably be greater over the 2012–2021 period.

The 10-year budgetary impact of such a capital transfer 

does not fully capture its long-term impact on the government. For example, although the government would 

avoid new capital outlays, it would also forgo a stream of 

future income that would accrue from those outlays. 

That income would not fully compensate for the upfront capital costs, however, because of the implicit 

subsidies conveyed to ratepayers in the region. By law, 

TVA’s rates are set to recover its costs and maintain an 

operating reserve. But the capital charge included in 

those rates is artificially low because, unlike private utilities, TVA does not have to provide a return to equity 

holders—in this case, the taxpayers, who are exposed to 

the risk of having to make up for future revenue shortfalls. In addition, TVA’s borrowing costs are relatively low 

because its status as a federal agency leads many creditors 

to assume that TVA’s obligations would be paid off in 

the event of default, even though existing law explicitly 

states that TVA’s debts are not guaranteed by the federal 

government. 

One rationale for this option is that transferring ownership could give state regulatory agencies and TVA’s customers more control over future costs. TVA is exempt 

from most state regulatory review because of its status as a 

federal agency. Its operations are sheltered from competition, moreover, because federal law requires customers in 

its service area to purchase virtually all of their electricity 

from TVA. Increased competition, proponents would 

argue, could produce greater efficiency and improve cost 

control. In addition, many would argue that the generaTotal

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 5 20 -100 -500 -500 -500 -500 -500 -500 -500 -1,075 -3,575
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 21

CBO

tion and transmission of electricity are fundamentally 

private-sector activities. A final rationale is that it would 

eliminate the implicit subsidies that the government now 

provides to the region’s ratepayers.

An argument against this option is that TVA’s contribution to the economic development of its seven-state 

region could be diminished if TVA was under nonfederal 

ownership. For example, a new owner might reduce 

expenditures on efforts to attract new businesses to the 

communities in TVA’s service area. Furthermore, a reduction in public subsidies would probably cause an increase 

in electricity prices. Finally, regulatory and other constraints on the new owner and operator of TVA’s system 

could limit the potential benefits of a transfer.

RELATED CBO PUBLICATION: Should the Federal Government Sell Electricity? November 1997
22 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 3 Function 270

Reduce the Size of the Strategic Petroleum Reserve

The Strategic Petroleum Reserve (SPR) is a stock of crude 

oil that the government owns and stores at four underground sites along the Gulf of Mexico. The SPR, which 

can hold about 727 million barrels of oil, was established 

in 1975 to help insulate the United States against a severe 

disruption in oil supplies. With a final shipment of about 

half a million barrels, the SPR was filled to capacity in 

December 2009. The Department of Energy (DOE) is 

authorized to expand the SPR’s capacity to 1 billion barrels. DOE can draw oil from the reserve at a maximum 

sustained rate of 4.4 million barrels per day (or about 

44 percent of average daily U.S. oil imports and about 

22 percent of average daily U.S. petroleum consumption) 

for about 90 days; after that, the maximum draw rate is 

less.

This option would reduce the SPR’s holdings by about 

10 percent during the 2012–2016 period and then 

maintain a reserve of 650 million barrels. In the Congressional Budget Office’s estimation, selling the excess holdings—about 75 million barrels of oil—would generate 

$700 million in 2012 and roughly $6 billion over five 

years, net of estimated decommissioning costs. That estimate assumes that DOE will receive slightly more than 

$90 per barrel, consistent with CBO’s January 2011 economic projection. The estimate does not include savings 

from forgoing expansion of the SPR.

Oil has seldom been withdrawn from the SPR. In 1996, 

DOE sold 28 million barrels at the direction of lawmakers in order to reduce the federal budget deficit. 

DOE also sold a combined 5 million barrels in test sales 

in 1985 and 1990. Since 1996, DOE has released—to 

respond to temporary supply disruptions or to exchange 

one grade of crude oil for another—a total of about 

68 million barrels to private firms through negotiated 

exchange agreements under which the companies have 

later replaced the oil, with interest. Only twice has oil 

been sold from the SPR in response to an emergency, 

and each of those sales involved only a small fraction of 

the reserve’s holdings. Citing the risk of economically 

threatening disruptions in supply, DOE sold about 

17 million barrels during the 1991 Gulf War and about 

11 million barrels after Hurricane Katrina in 2005.

Most arguments in favor of this option concern changes 

over time in the benefits and costs associated with the 

reserve. The increasing diversity of world oil supplies and 

growing integration of the economies of oil-producing 

and oil-consuming nations have probably lessened the 

risk of a sustained, widespread disruption. Large structural shifts in energy markets and in the U.S. economy 

since 1975 have moderated the likely costs of a disruption in oil supplies and, thus, the benefits that might 

accrue from releasing oil in a crisis. In addition, the government’s ability to smooth oil prices by selling oil from 

the SPR at times of increasing world oil prices, or by purchasing oil for the SPR when world oil prices are declining, may be limited because SPR sales or purchases would 

represent only a very small fraction of world oil consumption. Moreover, the cost of maintaining SPR facilities has 

escalated as those facilities have aged. Finally, analysis of 

past sales and withdrawals from the SPR suggests that a 

10 percent reduction in its holdings probably would not 

compromise its ability to address the types of problems 

that have triggered past releases.

Several arguments can be made against this option. If the 

capacity of the SPR is not expanded and U.S. demand for 

oil continues to grow, the SPR will eventually be unable 

to hold the equivalent of 90 days’ worth of net oil 

imports in reserves of oil or petroleum products. (The 

United States and other nations have made a commitment to the International Energy Agency to hold reserves 

in at least that amount.) In 2010, the SPR held the equivalent of about 79 days’ worth of net oil imports. Estimates in the Energy Information Agency’s (EIA’s) Annual 

Energy Outlook 2011 suggest that the SPR will hold, at 

capacity, between 65 and 105 days’ worth of net oil 

imports in 2021, depending on future crude oil prices 

and associated demand. The EIA’s central projection of 

future oil demand implies an 82-day supply in the SPR 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -700 -1,300 -1,400 -1,400 -1,400 -700 0 0 0 0 -6,200 -6,900
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 23

CBO

in 2021. Also arguing against the option are several 

factors—instability in the supply of oil from the Persian 

Gulf and other regions; expected growth in U.S. reliance 

on oil imports, particularly from the Middle East; and 

the possibility of terrorist attacks on the oil system—that 

suggest that the benefit of maintaining the SPR to guard 

against supply disruptions may be increasing.

RELATED CBO PUBLICATIONS: The Economic Effects of Recent Increases in Energy Prices, July 2006; and Rethinking Emergency Energy Policy,

December 1994
24 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 4 Function 300

Prohibit New Enrollment in the Conservation Stewardship Program 

The Conservation Stewardship Program (CSP) gives agricultural producers financial and technical help with conserving and improving soil, water, air, energy, and plant 

and animal life on agricultural lands. Under the CSP, producers enter into five-year contracts (in some cases, those 

contracts may be extended for an additional five years) 

with the Department of Agriculture (USDA) to undertake various conservation measures—such as enhancing 

wildlife habitats or renovating windbreaks—in exchange 

for annual payments. For every acre enrolled in the CSP, 

a producer receives compensation for carrying out and 

maintaining new conservation activities and for improving, maintaining, and managing existing conservation 

practices. Current law limits new enrollment in the CSP 

to 12.769 million acres per year, at an average cost of 

$18 per acre.

This option would prohibit new enrollments in the Conservation Stewardship Program beginning in 2012. Land 

currently enrolled in the CSP would be eligible to continue to receive payments until the contract expired. By 

the Congressional Budget Office’s estimates, this change 

would reduce spending by about $2 billion over 5 years 

and by almost $11 billion over 10 years.

One argument for phasing out the CSP is that some provisions of the program limit its effectiveness. For example, paying producers for conservation practices they have 

already adopted does not enhance the nation’s conservation efforts. The criteria used by USDA to determine 

whether improvements in existing conservation practices 

have been made are not clear, and the absence of such 

objective measurements could result in higher payments 

than necessary to encourage adoption of new conservation measures.

An argument in favor of continuing the CSP is that it 

may be a way to support agriculture that provides more 

environmental benefits than traditional crop-based subsidies do. Conservation practices often impose significant 

up-front costs, and those expenditures can reduce the net 

economic output of agricultural land; CSP payments 

help offset those costs. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -35 -255 -479 -706 -899 -1,185 -1,411 -1,634 -1,860 -2,087 -2,374 -10,549

RELATED OPTION: Mandatory Spending, Option 5
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 25

CBO

Mandatory Spending—Option 5 Function 300

Limit Enrollment in the Conservation Reserve Program

The Department of Agriculture’s Conservation Reserve 

Program (CRP) is intended to promote soil conservation, 

improve water quality, and protect wildlife habitat by 

removing land from active agricultural production. Landowners sign contracts with the Department of Agriculture to keep land out of production—usually for 10 to 

15 years; in exchange, the department provides annual 

payments and cost-sharing grants to establish appropriate 

conservation practices on land enrolled in the program. 

Acreage may be added to the CRP through general 

enrollments, which are held periodically for larger tracts 

of land, or through continuous enrollments, which are 

available at any time during the year for smaller tracts of 

land. An example of an effective type of acreage for those 

purposes is conservation buffers—narrow strips of land 

that are maintained in permanent vegetation and are 

designed to intercept pollutants, reduce erosion, and provide other environmental benefits. Acreage is accepted 

into the CRP on the basis of an evaluation of the costs 

and potential environmental benefits of a landowner’s 

plan for the land. Under current law, total enrollment is 

capped at 32 million acres, and about 31 million acres are 

enrolled. The Department of Agriculture spends about 

$2.4 billion per year on the CRP. 

Prohibiting new general enrollments (including reenrollments), beginning in 2012, would reduce spending by 

$3 billion over the 2012–2016 period, the Congressional 

Budget Office estimates, and by about $9 billion over the 

2012–2021 period. Under this approach, the amount of 

land enrolled in the CRP would drop significantly, to 

11.9 million acres by 2021.

Although there is widespread agreement about the need 

to take some environmentally sensitive land out of production, an advantage of scaling back the CRP is that the 

land could become available for other uses that would 

provide greater environmental benefits. Another advantage of limiting the program could be that retiring less 

cropland in a given area might enhance economic activity 

(for example, by increasing the demand for seed, fertilizer, and other farm supplies), thus helping rural communities. Also, reducing CRP enrollment could free more 

land to produce crops and biomass needed for renewable 

energy products.

A disadvantage of scaling back the CRP could be that the 

Department of Agriculture’s existing plan to accept only 

the most environmentally sensitive land in future enrollments might turn out to be a cost-effective way to protect 

fragile lands. Studies have indicated that the CRP yields 

high returns—in enhanced wildlife habitat, improved 

water quality, and reduced soil erosion—for every dollar 

it spends.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -300 -800 -800 -1,100 -1,000 -1,100 -1,000 -1,200 -1,200 -3,000 -8,600

RELATED OPTION: Mandatory Spending, Option 4
26 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 6 Function 350

Reduce the Premium Subsidy in the Crop Insurance Program

The Federal Crop Insurance Program protects farmers 

from losses caused by drought, floods, pest infestation, 

other natural disasters, and low market prices. Farmers 

can choose various amounts and types of insurance 

protection—for example, they can insure against losses 

caused by poor crop yields, low crop prices, or both. 

Premium rates for federal crop insurance are set by the 

Department of Agriculture (USDA) so that the premium 

equals the expected payment to farmers for crop losses. 

The federal government pays about 60 percent and 

farmers pay about 40 percent of the total premium. 

Insurance policies purchased through the program are 

sold and serviced by private insurance companies, which 

receive a federal reimbursement for their administrative 

costs. Those businesses also share in insurance gains and 

losses through reinsurance agreements with the federal 

government.

This option would reduce the federal government’s subsidy to 50 percent of the crop insurance premium. The 

Congressional Budget Office estimates that under current 

law, federal spending for crop insurance will total $35 billion over the 2012–2016 period; reducing the crop insurance premium subsidy would save more than $5 billion 

over the same period and almost $12 billion over the 

2012–2021 period, CBO estimates.

An argument in favor of this option is that lawmakers 

could probably cut the premium subsidy without substantially affecting the level of participation in the program, partly because of linkages between crop insurance 

and other assistance programs offered by USDA and 

partly because private lenders increasingly view insurance 

as a way for farmers to ensure that they can repay their 

loans. Those producers who did reduce their crop insurance coverage or dropped out of the program would continue to receive substantial crop and income support 

from other federal farm programs.

An argument against this option is that federal funding 

for the program has already been reduced by about 

5 percent through changes in the 2008 farm bill and by 

an additional estimated 5 percent through changes in the 

reinsurance agreements with private companies in 2010. 

Further cuts, some argue, would threaten farmers’ access 

to insurance. If participation in the crop insurance program declines significantly, opponents say, lawmakers 

would be more likely to resort to special-purpose relief 

programs when disaster strikes, reducing the savings from 

cutting the premium subsidy. (Such ad hoc disaster assistance programs for farmers have cost an average of about 

$700 million annually over the past five years.) 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -0.4 -1.2 -1.2 -1.2 -1.3 -1.3 -1.3 -1.3 -1.3 -1.3 -5.3 -11.8
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 27

CBO

Mandatory Spending—Option 7 Function 350

Reduce by 20 Percentage Points the Share of a Farmer’s Base Acreage 

Eligible for USDA Payments 

The Department of Agriculture’s (USDA’s) direct and 

countercyclical payments to agricultural producers for 

certain commodities (cotton, feed grains, oilseeds, peanuts, wheat, and rice) are expected to cost $51 billion 

over the next 10 years. Beginning with the 2012 crop 

(harvested in fiscal year 2013), those payments will be 

calculated, in part, on 85 percent of a producer’s base 

acreage, which in general is determined by the average 

number of acres planted with each eligible crop between 

1998 and 2001.

This option would reduce the portion of a producer’s 

base acreage eligible for direct or countercyclical payments by 20 percentage points. The option would reduce 

spending for farm programs by $4 billion over the 2012–

2016 period and by about $10 billion over the 2012–

2021 period, the Congressional Budget Office estimates.

The primary advantage of reducing the portion of a producer’s base acreage that is eligible for payments is that 

the reduction would affect all participants in the program 

in proportion to their expected payments instead of disproportionately affecting the producers of any particular 

commodity. 

One disadvantage of this option is that producers would 

receive less income from the government. Another is that 

other USDA payments, such as marketing loan benefits, 

essentially guarantee minimum prices for certain crops 

and therefore tend to send more market-distorting signals 

to producers than direct and countercyclical payments 

do. Consequently, some would argue that changing other 

USDA payments would be a better approach because it 

could generate greater reductions in market distortions. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -1.0 -1.0 -1.0 -1.1 -1.1 -1.1 -1.1 -1.1 -1.1 -4.1 -9.5
28 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 8 Function 370

Lower the Loan Limits on Mortgages Guaranteed by Fannie Mae and 

Freddie Mac 

The Federal National Mortgage Association (Fannie 

Mae) and the Federal Home Loan Mortgage Corporation 

(Freddie Mac) are government-sponsored enterprises 

(GSEs) that were federally chartered to help ensure a stable supply of financing for residential mortgages, including those for low- and moderate-income borrowers. Over 

the past 40 years, Fannie Mae and Freddie Mac have carried out that mission in two main ways: by issuing and 

guaranteeing mortgage-backed securities (MBSs) and 

by buying mortgages and MBSs to hold in their portfolios. Under current law, the entities are temporarily able 

to purchase and guarantee mortgages in amounts up to 

$729,750 in areas with high housing costs, although that 

limit will fall to $625,500 after September 30, 2011. The 

limit outside of high-cost areas currently is $417,000, 

and regulators can raise that limit if house prices rise. The 

two GSEs provided credit guarantees for over 60 percent 

of home mortgages originated in 2010, and they also purchased and retained mortgages. 

In September 2008, the federal government took control 

of Fannie Mae and Freddie Mac in a conservatorship process after falling housing prices and rising mortgage delinquencies threatened the GSEs’ solvency, impairing their 

ability to ensure a steady supply of financing to the secondary mortgage market. With that shift in control, the 

Congressional Budget Office concluded that the institutions had effectively become government entities whose 

operations should be reflected in the federal budget. 

This option would set a maximum loan limit of 

$417,000 nationally beginning in 2013 and freeze 

that limit going forward. The option would retain the 

scheduled reduction—to $625,500 starting October 1, 

2011—in the loan limit for high-cost areas; thus, no savings would be realized in 2012. Lower loan limits would 

reduce federal subsidies for the GSEs by roughly $1 billion over the 2012–2016 period and by almost $4 billion 

from 2012 to 2021. For consistency, similar changes 

could be made to the Federal Housing Administration’s 

(FHA’s) loan limits. Lower limits for FHA loans would 

affect discretionary spending subject to appropriations, 

but the effects of such changes are not included in these 

estimates.

The major advantages of this option are that it could provide a transition path from conservatorship and restore a 

role for the private sector in the secondary mortgage market while reducing taxpayers’ exposure to the risk of 

defaults. Current loan limits, which are high compared 

with the median price of about $170,000 for an existing 

single-family residence in 2010, leave little scope for a 

private secondary market, which had been significant 

before the financial crisis. The option would also lower 

subsidies to affluent borrowers, for whom home ownership is already subsidized through the tax code. Another 

advantage of the option is that it would probably reduce 

the amount of capital allocated to housing and shift it 

toward other investments that would be more productive. 

One disadvantage of this option is that housing markets 

remain fragile and any reduction of federal support might 

further weaken those markets. The effects would be 

greatest in high-cost areas, although some of the negative 

effects might be mitigated through increased reliance on 

FHA loans. Another disadvantage is that mortgage markets might become more prone to disruptions in the 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -400 -300 -300 -300 -400 -400 -400 -500 -500 -1,300 -3,500
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 29

CBO

supply of credit during periods of acute financial stress. 

Reducing the subsidies would also mean that some borrowers would pay more for mortgages; in particular, once 

markets stabilized, borrowers seeking mortgages in 

amounts between $417,000 and $625,500 would pay 

interest rates that would probably be about a quarter of a 

percentage point higher than under current law.

RELATED OPTION: Mandatory Spending, Option 9

RELATED CBO PUBLICATIONS: Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market, December 2010; Letter to the 

Honorable Barney Frank about the budgetary impact of Fannie Mae and Freddie Mac, September 16, 2010; and CBO’s Budgetary Treatment of 

Fannie Mae and Freddie Mac, Background Paper, January 2010 
30 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 9 Function 370

Increase Guarantee Fees Charged by Fannie Mae and Freddie Mac

The Federal National Mortgage Association (Fannie 

Mae) and the Federal Home Loan Mortgage Corporation 

(Freddie Mac) are government-sponsored enterprises 

(GSEs) that were federally chartered to help ensure a stable supply of financing for residential mortgages, including those for low- and moderate-income borrowers. Over 

the past 40 years, Fannie Mae and Freddie Mac have carried out that mission in two main ways: by issuing and 

guaranteeing mortgage-backed securities (MBSs) and by 

buying mortgages and MBSs to hold in their portfolios. 

The two GSEs provided credit guarantees for more than 

60 percent of home mortgages originated in 2010, and 

they also purchased and retained mortgages. 

In September 2008, the federal government took control 

of Fannie Mae and Freddie Mac in a conservatorship process after falling housing prices and rising mortgage delinquencies threatened the GSEs’ solvency, impairing their 

ability to ensure a steady supply of financing to the secondary mortgage market. With that shift in control, the 

Congressional Budget Office concluded that the institutions had effectively become government entities whose 

operations should be reflected in the federal budget. 

This option would require Fannie Mae and Freddie Mac 

to raise the average guarantee fee they assess on loans in 

the MBSs they issue by 5 basis points (100 basis points 

are equivalent to 1 percentage point) and to raise the 

effective guarantee fee on loans acquired for their portfolios by the same amount. Those increases, constituting 

roughly a 20 percent rise in fees, would reduce federal 

costs for the GSEs by $11 billion over the 2012–2016 

period and by about $27 billion from 2012 to 2021. 

The main advantage of raising guarantee fees would be to 

reduce the projected costs of conservatorship. CBO estimates that the mortgage guarantees the GSEs issue over 

the 2012–2021 period will cost the federal government 

nearly $50 billion on a fair-value basis with fees at their 

current levels. (That amount reflects the estimated federal 

subsidies inherent in the guarantees at the time they are 

made—that is, the up-front payment that a private entity 

in an orderly market would require to assume the federal 

responsibility for the GSEs’ obligations.) Increased fees 

on the guarantees would reduce those costs. The higher 

fees would probably flow through to borrowers in the 

form of higher mortgage rates; however, rates on 30-year 

fixed-rate mortgage loans eligible for purchase by Fannie 

Mae and Freddie Mac are relatively low, about 5 percent, 

in early 2011. This option would provide the GSEs with 

flexibility in setting fees for particular borrowers, so the 

potential would exist to minimize the adverse effects of 

the higher fees on low- and moderate-income borrowers. 

Coordination with the GSEs’ regulator, the Federal 

Housing Finance Agency, would be necessary to ensure 

that the increase in average fee income represented an 

increase in the rates charged to borrowers with particular 

risk characteristics and not a shift toward lending to riskier borrowers, who already pay higher-than-average rates. 

Another advantage of this option is that it would help 

address the current underpricing of risk, which could 

shift the allocation of capital too far toward housing and 

away from more productive activities.

The main disadvantage of raising guarantee fees would be 

the consequent increase in the cost of borrowing, which 

could somewhat reduce demand for housing. Another 

drawback would be more limited refinancing opportunities, which might constrain spending by consumers. Both 

of those concerns would be particularly salient as long as 

housing markets and the economy remain weak. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -1.2 -2.5 -2.5 -2.5 -2.5 -2.7 -3.0 -3.1 -3.2 -3.3 -11.2 -26.5

RELATED OPTION: Mandatory Spending, Option 8

RELATED CBO PUBLICATIONS: Fannie Mae, Freddie Mac, and the Federal Role in the Secondary Mortgage Market, December 2010; Letter to the 

Honorable Barney Frank about the budgetary impact of Fannie Mae and Freddie Mac, September 16, 2010; and CBO’s Budgetary Treatment of 

Fannie Mae and Freddie Mac, Background Paper, January 2010
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 31

CBO

Mandatory Spending—Option 10 Function 500

Eliminate Subsidized Loans to Graduate Students 

The federal government operates programs to help students and their parents pay for postsecondary education. 

Subsidized Stafford loans help students with demonstrated financial need pay for their education, and unsubsidized Stafford loans are available, without regard to 

need, to any student. (The labels “subsidized” and 

“unsubsidized” refer to the terms of the loans, not to 

whether the federal government incurs subsidy costs for 

the program.) Borrowers of both subsidized and unsubsidized loans benefit from interest rates that are not generally available to those without a demonstrated credit history or collateral and from deferment of repayment until 

six months after a student leaves school. Students with 

subsidized loans benefit further because the government 

also forgives interest on those loans while the students 

are enrolled and for six months after they leave school. 

Also, most loan programs offer flexible repayment plans 

that allow for extended repayment periods or that cap 

required monthly payments at an amount intended to be 

manageable, based on income and family size.

This option would end, in 2012, the practice of making 

new subsidized loans to graduate students, on the presumption that those students would generally take out 

unsubsidized loans instead. The option would reduce 

federal outlays by more than $8 billion from 2012 to 

2016 and by about $18 billion from 2012 to 2021. (The 

Federal Credit Reform Act of 1990 requires that the federal budget record all costs and collections associated with 

a new loan in the year in which the loan is disbursed.)

An argument for this option is that graduate students 

who lose access to subsidized loans would be able to take 

out unsubsidized federal loans for the same amount and 

still benefit from few or no requirements with respect to 

credit history or collateral and from repayment options 

that take into account borrowers’ financial circumstances. 

Another argument in favor of this option is that it would 

help focus federal student aid on the area that some people believe is the federal government’s primary responsibility—making a college education available to all high 

school graduates. According to that rationale, graduate 

students have already received the benefit of higher 

education.

An argument against this option is that graduate students 

often amass large amounts of debt because of the number 

of years of schooling required to complete advanced 

degrees. Without the benefit of interest forgiveness while 

they are enrolled in school, that debt would be substantially larger when they entered the repayment period 

because the cumulative interest on the money borrowed 

over the years would be added to loan balances. Also, 

opponents of this option might argue that federal support 

for graduate students is no less important than support 

for undergraduates because graduate students are most 

likely to effect scientific, technological, and other 

advances that will benefit the nation as a whole. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -0.7 -1.7 -2.0 -2.0 -1.9 -1.9 -2.0 -2.0 -2.1 -2.1 -8.3 -18.4

RELATED OPTIONS: Mandatory Spending, Option 11; Discretionary Spending, Option 28; and Revenues, Option 15
32 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 11 Function 500

Change the Interest Rate Structure for Student Loans

The federal government operates several loan programs to 

help students and their parents pay for postsecondary 

education. The terms and eligibility for loans made under 

those programs vary widely. Subsidized loans feature 

interest forgiveness while students are enrolled and for six 

months after they leave school, but those loans are available only to those with demonstrated financial need. 

Unsubsidized loans, without interest forgiveness, are 

available to any student regardless of need. PLUS loans 

are available to parents of dependent students and to 

graduate and professional students; their terms are similar 

to those of unsubsidized loans, except that interest rates 

are higher. Regardless of the type of loan, borrowers benefit from few or no requirements with respect to credit history or collateral and from repayment options that take 

into account the borrowers’ financial circumstances.

Currently, the interest rate on all new unsubsidized and 

subsidized loans to nonundergraduate students is 6.8 percent. On all new PLUS loans, the interest rate is 7.9 percent. For the 2011–2012 academic year, the interest rate 

on new subsidized loans to undergraduate students will 

be 3.4 percent, but for all subsequent years, that rate will 

be 6.8 percent because of the expiration of a provision in 

the College Cost Reduction and Access Act of 2007. 

This option would change the structure of interest rates 

on federal student and parent loans to resemble those on 

fixed-rate mortgage loans. In particular, the interest rate 

on new loans would depend on conditions in financial 

markets at the time of origination but remain fixed for 

the life of the loan. Under this option, the interest rate on 

all new federal student and parent loans would be set to 

the interest rate on 10-year Treasury notes at the beginning of the academic year in which the loan is originated 

plus 3 percentage points. This option would reduce federal outlays by $900 million from 2012 to 2016 and by 

$52 billion from 2012 to 2021, the Congressional Budget Office estimates. (The Federal Credit Reform Act of 

1990 requires that the federal budget record all costs and 

collections associated with a new loan in the year in 

which the loan is disbursed.)

The large jump in savings between the first and second 

halves of the 10-year estimating window reflects CBO’s 

projections of a steady increase in Treasury interest rates 

over the first few years of the 2012–2021 period. Initially, 

interest rates on certain student loans under this option 

would be lower than under current policies, generating 

some costs for the government. As interest rates rise, however, the rates on student loans under this option would 

grow to be higher than under current policies, generating 

large savings.

A rationale for this option is that it would focus the loan 

programs’ role on providing access to financing for all 

students at an interest rate not generally available to borrowers who have neither a demonstrated credit history 

nor collateral. (The Federal Pell Grant Program would 

continue to provide tuition relief to students with the 

greatest financial need.) In addition, the interest rate on 

student and parent loans would adjust to conditions in 

financial markets at the time a loan was originated, making the government subsidy equally valuable in relatively 

high and relatively low interest rate environments. However, borrowers would continue to benefit from predictable monthly payments because of the fixed interest rate 

over the life of a loan. 

An argument against this option is that, given CBO’s 

projections of the interest rates on 10-year Treasury notes 

from 2012 to 2021, the option would raise the expected 

average interest rate on student and parent loans. Consequently, for most loans, the interest accrued and monthly 

payments when borrowers left school would be greater 

than under current policies. The anticipation of higher 

debt payments might limit the fields of study students 

would consider and the types of jobs they would seek. 

Also, borrowers who were in school during times of tight 

financial markets would pay higher interest rates than 

borrowers who were in school during other times. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 2.1 3.0 0.9 -2.0 -4.9 -8.0 -10.0 -10.7 -11.0 -11.4 -0.9 -52.0

RELATED OPTIONS: Mandatory Spending, Option 10; Discretionary Spending, Option 28; and Revenues, Option 15
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 33

CBO

Mandatory Spending—Option 12 Function 550

Add a “Public Plan” to the Health Insurance Exchanges 

Starting in 2014, health insurance exchanges will be 

established through which individuals and families may 

purchase private coverage. In general, people who are not 

offered coverage through their employer and purchase 

coverage through an exchange will be eligible for federal 

subsidies on a sliding scale if their income is between 

138 percent and 400 percent of the federal poverty level. 

The amount of the subsidies will be based in part on the 

premium of the second cheapest plan offered through the 

exchange in an enrollee’s area of residence. Small employers will have the option to allow their workers to buy coverage through the exchanges, and beginning in 2017, 

states may grant large employers that choice as well. In 

those cases, the affected workers will not receive exchange 

subsidies, but the costs of their coverage will be excluded 

from income and payroll taxation, just as the costs of 

other employment-based health coverage are currently 

excluded. 

Under this option, the Secretary of Health and Human 

Services would establish and administer a public health 

insurance plan that would be offered alongside private 

plans through the exchanges beginning in 2014. The 

public plan would have to charge premiums that fully 

covered its costs for benefit payments and administrative 

expenses. The plan’s payment rates for physicians and 

other practitioners would be set to exceed Medicare’s 

rates in 2010 by 5 percent and would rise annually 

through 2014 and beyond to reflect estimated increases 

in physicians’ costs; those payment rates would not be 

subject to the future reductions required by Medicare’s 

sustainable growth rate formula. The public plan would 

pay hospitals and other providers the same amounts that 

would be paid under Medicare, on average, and would 

establish payment rates for prescription drugs through 

negotiation. Health care providers would not be required 

to participate in the public plan in order to participate in 

Medicare.

In the Congressional Budget Office’s estimation, the public plan’s premiums would be 5 percent to 7 percent 

lower, on average, than the premiums of private plans 

offered in the health insurance exchanges. The differences 

between the premiums of the public plan and the average 

premiums of private plans would vary across the country, 

largely because of geographic differences in the plans’ relative payment rates for providers. Those differences in 

average premiums would also reflect differences in the 

other factors that affect all health insurance premiums, 

including administrative costs, the degree of benefit management applied to control spending, and the characteristics of the enrollees (the effects of which would be partly 

offset by the risk-adjustment mechanism that will be used 

in the exchanges).

This option, CBO and the staff of the Joint Committee 

on Taxation estimate, would reduce federal budget deficits by about $88 billion over the 2012–2021 period. 

That reduction is the combination of an almost $27 billion reduction in outlays (mostly from a reduction in 

exchange subsidies) and a $61 billion increase in tax revenues (mostly from changes in employment-based insurance coverage). Those estimates include effects on other 

outlays and revenues related to insurance coverage (such 

as Medicaid outlays and penalties on employers and 

uninsured individuals).

Overall, exchange subsidies would be reduced by $35 billion over the 2014–2021 period. (Although the exchange 

subsidies for premiums are structured as refundable tax 

credits, most of the resulting costs are classified as outlays 

because the payments will usually exceed their recipients’ 

total income tax liability.) That decline in subsidies is the 

net effect of several influences. By CBO’s estimates, the 

public plan’s premium in many parts of the country 

would be lower than the second-lowest premium among 

private plans; the introduction of the public plan in those 

places would therefore reduce federal subsidies that are 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 0 -0.9 -2.4 -2.4 -3.4 -4.0 -4.8 -4.6 -4.2 -5.8 -26.7

Change in Revenues 0 0 2.3 3.5 5.8 7.9 9.5 10.4 10.7 11.2 11.6 61.2

Net Effect on the Deficit 0 0 -3.2 -5.9 -8.3 -11.3 -13.5 -15.2 -15.3 -15.3 -17.4 -88.0
34 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

tied to that benchmark. The existence of a public plan 

with substantial enrollment would also, CBO expects, 

place additional competitive pressure on private plans 

operating in the exchanges to lower their premiums to 

some degree, thereby producing a further reduction in 

federal subsidies. Partly offsetting those two sources of 

federal savings would be higher enrollment in exchange 

plans, which would increase subsidy payments.

The increase in tax revenues under this option results primarily from changes in employment-based coverage, 

which is offset in part by an increase in costs for providing tax credits to small employers. Two developments 

would result in a greater share of employees’ compensation taking the form of taxable wages and salaries (rather 

than nontaxable health benefits), thereby resulting in 

higher revenues. First, because the public plan would 

make the exchanges more attractive to individual purchasers, some employers would forgo offering coverage 

altogether, thus reducing their spending on employmentbased health insurance and increasing the share of compensation devoted to taxable wages and salaries. Second, 

the availability of a relatively inexpensive public plan 

would also lead some employers to purchase lower-cost 

coverage for their employees through the exchanges. The 

resulting reduction in spending on employment-based 

coverage would further increase the share of total compensation devoted to taxable wages and salaries. Those 

budgetary effects would be partly offset by the reduction 

in revenues that would occur as more small employers 

took advantage of the tax credits that will be available 

when purchasing coverage through the exchanges.

Enrollment in the public plan would be affected by several considerations, including its relative premium and 

the number and types of providers that decided to participate in it. On the basis of all relevant factors, CBO estimated that, on average, about 13 million people—about 

one-third of the estimated 38 million that would obtain 

coverage through the insurance exchanges—would enroll 

in the public plan in the 2017–2021 period. Of that 

number, on average, about 25 million people would purchase coverage individually, and about 13 million people 

would obtain employment-based coverage through the 

exchanges. (Given all of the factors at work, however, 

those estimates are subject to an unusually high degree of 

uncertainty.) 

Compared with projections of health insurance coverage 

under current law for the 2017–2021 period, under this 

option, about one and a half million more people would 

obtain individually purchased coverage, CBO estimates, 

and about one and a half million fewer would have 

employment-based coverage. The option would have 

minimal effects on the number of people with other 

sources of coverage and the number of people who would 

be uninsured.

Supporters of this option might point to the federal savings that would result. In addition, because the public 

plan would be one of the lowest-cost plans in many areas, 

the option would help reduce premiums for some individuals, families, and employers who purchase insurance 

through the exchanges but do not receive exchange subsidies. Another argument for this option is that a public 

plan would increase the competitive pressure on private 

plans, leading them to reduce their premiums.

Opponents might be concerned that the public plan’s 

payment rates would be substantially lower than rates for 

private plans in many parts of the country, which could 

lead some providers who participated in the public plan 

to reduce the quality of care they furnished. Although 

providers’ participation in the public plan would be voluntary, opponents might anticipate that enrollment in 

the plan could be sufficiently large that providers would 

face substantial pressure to participate.

Another concern is that the federal government would 

have to finance the public plan’s losses if the plan 

attracted high-cost enrollees and was unable to collect 

enough in premiums to cover its costs. (The public plan 

would be required to build up a contingency fund.) More 

generally, opponents might object to a greater federal role 

in providing health insurance. 

RELATED OPTIONS: Revenues, Options 30 and 32

RELATED CBO PUBLICATION: Letter to the Honorable Fortney Pete Stark about CBO’s analysis of a proposal to offer a public plan through the new 

health insurance exchanges, July 22, 2010
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 35

CBO

Mandatory Spending—Option 13 Function 550

Limit Medical Malpractice Torts

Note: * = between zero and -$50 million.

a. Estimates include potential savings by the U.S. Postal Service, whose spending is classified as off-budget. 

b. Estimates include the effects on Social Security payroll tax receipts, which are classified as off-budget.

Individuals may pursue civil claims against physicians, 

hospitals, and other health care providers for alleged torts, 

which are breaches of duty that result in personal injury. 

That system of tort law has twin objectives: deterring 

negligent behavior on the part of providers and compensating claimants for losses they incur (including lost 

wages, medical expenses, and pain and suffering) as the 

result of an injury caused by negligence. Malpractice 

claims are generally pursued through the state courts, and 

states have established various rules by which those claims 

are adjudicated. Nearly all health care providers obtain 

malpractice insurance to protect against the risk of having 

to pay a very large malpractice claim. The cost of that 

insurance results in higher medical costs because, in order 

to pay for the premiums, providers charge their patients 

higher fees. Furthermore, research suggests that placing 

limits on malpractice torts will reduce the quantity of 

prescribed health care services by a small amount.

This option would impose certain nationwide curbs on 

medical malpractice torts. Many states have enacted some 

or all of these limits, whereas others have very few restrictions on malpractice claims. The tort limits include caps 

on noneconomic damages (also known as pain and suffering) and on punitive damages; a shortened statute of 

limitations; restrictions on the use of joint-and-several liability; and changes to rules regarding collateral sources of 

income.1

 The specific components of medical malpractice 

tort reform under this option are as follows:

B A cap of $250,000 on awards for noneconomic 

damages;

B A cap on awards for punitive damages of $500,000 or 

two times the value of awards for economic damages, 

whichever is greater;

B A statute of limitations of one year from the date of 

discovery of the injury for adults, and three years for 

children;

B A fair-share rule (replacing the rule of joint-andseveral liability) under which a defendant in a lawsuit 

would be liable only for the percentage of the final 

award that was equal to that defendant’s share of 

responsibility for the injury; and

B Permission to introduce evidence of income from 

collateral sources (such as life insurance payouts and 

health insurance) at trial.

Malpractice tort limits would reduce total health care 

spending in two ways. First, by reducing the average size 

of malpractice awards, tort limits would reduce the cost 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Mandatory Outlaysa -100 -600 -1,900 -3,600 -5,400 -6,400 -7,000 -7,600 -8,200 -8,700 -11,600 -49,500

Change in Revenuesb 0 200 600 1,100 1,600 1,800 1,800 1,900 1,900 2,000 3,500 12,900

Net Effect on the Deficit -100 -800 -2,500 -4,700 -7,000 -8,200 -8,800 -9,500 -10,100 -10,700 -15,100 -62,400

Change in Discretionary 

Spending

Budget authority * * -100 -100 -200 -200 -200 -200 -300 -300 -400 -1,600

Outlays * * -100 -100 -200 -200 -200 -200 -300 -300 -400 -1,600

1. Under the joint-and-several liability rule, all of the defendants in a 

lawsuit are individually responsible for the entire amount of the 

award. An example of a collateral source of income is the amount 

paid by a plaintiff’s health insurer to cover health care services 

provided to a patient as a result of an injury resulting from malpractice.
36 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

of malpractice insurance premiums. That reduced cost of 

malpractice insurance paid by providers would flow 

through to health plans and patients in the form of lower 

prices for health care services. Second, as noted above, 

tort limits would also reduce utilization of health care services by a small amount as practitioners prescribed somewhat fewer services when faced with less pressure from 

potential malpractice claims. In the estimation of the 

Congressional Budget Office, the combined effect of 

those two factors would be a reduction of about 0.5 percent of total health care spending. For this option, CBO 

assumed that a change enacted in October 2011 would 

have an impact that increased over time, achieving its full 

effect after four years, as providers gradually changed 

their practice patterns. In terms of federal health care 

spending, the percentage decline in spending for Medicare is estimated to be larger than the decline in spending 

for other federal health programs or for national health 

spending. That estimate is based on empirical evidence 

showing that the impact of tort reform on the use of 

health care services is greater for Medicare than for the 

rest of the health care system.

By reducing spending on health care in the private 

sector, this option would also affect federal revenues. 

Much private-sector health care is provided through 

employment-based insurance that represents nontaxable 

compensation. Because premiums paid by employers for 

health insurance are excluded from employees’ taxable 

income, reducing such premiums would, on average, 

increase the share of employees’ compensation that was 

taxable and thereby increase federal tax revenues by an 

estimated $13 billion over the next 10 years.

This option would reduce mandatory spending for 

Medicare, Medicaid, the Children’s Health Insurance 

Program, subsidies for coverage purchased through health 

insurance exchanges, and the Federal Employees Health 

Benefits program by a total of roughly $50 billion from 

2012 to 2021. Discretionary savings would amount to 

$400 million over the 2012–2016 period and $1.6 billion over the 2012–2021 period, if the amounts appropriated for federal agencies were reduced accordingly.

An argument in favor of this option is that it would 

reduce spending for health care services. Another rationale is that, by reducing premiums for medical malpractice insurance, the option could help alleviate shortages of certain types of physicians in some areas of the 

country. For example, annual malpractice premiums for 

obstetricians exceed $100,000 in some areas. Such high 

premiums may deter some obstetricians from practicing 

in those areas or from practicing at all.

An argument against this option is that tort limits could 

prevent those who have suffered substantial harm as a 

result of medical negligence from obtaining full compensation for their injuries. In addition, reducing the amount 

of money that could be collected in the case of a medical 

injury might cause providers to exercise less caution, 

resulting in an increase in the number of medical injuries 

attributable to negligence.

The evidence is mixed on whether tort limits have an 

adverse effect on health outcomes. Some researchers who 

have observed a reduction in the use of health care services as the risk of litigation falls have also found that 

reducing that risk produces a small increase in the mortality rate. Another study found that reform of joint-andseveral liability had positive impacts on health but caps 

on noneconomic damages had negative impacts. Other 

studies have concluded that tort limits have no effect on 

mortality or other measures of health.

RELATED CBO PUBLICATIONS: Letter to the Honorable Bruce L. Braley responding to questions on the effects of tort reform, December 29, 2009; 

Letter to the Honorable John D. Rockefeller IV providing additional information on the effects of tort reform, December 10, 2009; Letter to the 

Honorable Orrin G. Hatch about CBO’s analysis of the effects of proposals to limit costs related to medical malpractice (“tort reform”), 

October 9, 2009; and Key Issues in Analyzing Major Health Insurance Proposals, December 2008
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 37

CBO

Mandatory Spending—Option 14 Function 550

Adopt a Voucher Plan and Slow the Growth of Federal Contributions for the 

Federal Employees Health Benefits Program 

a. Estimates include potential savings by the U.S. Postal Service, whose spending is classified as off-budget. 

The Federal Employees Health Benefits (FEHB) program 

provides health insurance coverage to approximately 

4 million federal workers and annuitants as well as to 

approximately 4 million of their dependents and survivors. In 2011, those benefits are expected to cost the government almost $41 billion (including amounts paid by 

the U.S. Postal Service). Policyholders are required to pay 

25 percent of the premium for the lowest-cost plans available and generally a larger share for higher-cost plans; the 

federal government pays the remainder of the premium. 

Retired enrollees pay the same premiums that active 

employees pay, and the federal government typically 

shares in the cost of the premiums to the same extent for 

both groups. That premium-sharing structure provides 

some incentive for federal employees to switch from 

higher-premium to lower-premium plans, although the 

incentive is less than it would be if employees realized the 

full savings from choosing a less expensive plan. The 

premium-sharing structure also imposes some competitive pressure on plans to hold down premiums.

This option would offer a voucher for the FEHB program that would cover roughly the first $5,000 of an 

individual premium or the first $11,000 of a family premium beginning on January 1, 2013. Those amounts, 

which are based on the Congressional Budget Office’s 

estimate of the government’s average expected contribution in 2012, would increase annually at the rate of inflation as measured by the consumer price index for all 

urban consumers, rather than at the average weighted rate 

of change in FEHB premiums. According to CBO’s estimates, indexing vouchers to inflation rather than to the 

growth of premiums would produce budgetary savings 

because FEHB premiums are predicted to grow significantly faster than inflation. (The expected cost growth in 

FEHB premiums is similar to expected growth in other 

private insurance premiums.) 

This option would reduce discretionary spending by federal agencies (because of lower payments for FEHB premiums for current employees and their dependents) by 

an estimated $8 billion over the 2012–2016 period and 

by $42 billion over the 2012–2021 period, under the 

assumption that appropriations reflect the reduced costs. 

The option would also reduce mandatory on- and offbudget spending because of lower payments from the 

Treasury and the U.S. Postal Service for FEHB premiums 

for retirees. Estimated savings from those reductions 

would be roughly $6 billion over the 2012–2016 period 

and about $32 billion over the 2012–2021 period.

In addition, CBO anticipates, the option would cause 

some FEHB participants to leave the program and enroll 

in health insurance exchanges starting in 2014.1

 As a 

result, health exchange subsidy costs would increase by 

$100 million over the 2012–2016 period and $500 million over the 2012–2021 period, and revenues would fall 

by about $30 million over the 2012–2016 period and 

about $150 million over the 2012–2021 period. Also, 

some FEHB annuitants could leave the program and 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Mandatory Outlaysa 0 -300 -1,100 -1,700 -2,400 -2,800 -3,900 -5,100 -6,400 -7,800 -5,500 -31,500

Change in Revenues 0 0 -10 -10 -10 -10 -20 -20 -30 -40 -30 -150

Net Effect on the Deficit 0 -300 -1,090 -1,690 -2,390 -2,790 -3,880 -5,080 -6,370 -7,760 -5,470 -31,350

Change in Discretionary Spending

Budget authority 0 -500 -1,700 -2,400 -3,000 -4,100 -5,500 -6,800 -8,200 -9,700 -7,600 -41,900

Outlays 0 -500 -1,700 -2,400 -3,000 -4,100 -5,500 -6,800 -8,200 -9,700 -7,600 -41,900

1. In general, individuals with an offer of insurance coverage from an 

employer are not eligible for exchange subsidies. However, an 

affordability exemption exists for individuals who face an 

employee contribution for health insurance that exceeds a specified percentage of their income. As a result, the increase in the 

enrollee premium contribution under this option would boost the 

number of federal employees eligible for exchange subsidies 

through the affordability exemption.
38 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

enroll in Medicare Part D (the prescription drug benefit) 

to obtain drug coverage that they had previously had 

through the FEHB program. As a result, Medicare spending would increase by an estimated $100 million over the 

2012–2016 period and $500 million over the 2012–

2021 period. Overall, the option would reduce mandatory spending, on net, by an estimated $6 billion over 

5 years and almost $32 billion over 10 years. 

Under this option, employees who selected plans that 

cost more than the voucher amount would pay the full 

additional cost of the plan. Therefore, this option would 

increase the incentive to choose lower-premium plans 

and would strengthen price competition among health 

care plans participating in the FEHB program. In particular, because enrollees would pay nothing for plans that 

cost as much as the value of the voucher, insurers would 

have a greater incentive to offer lower-premium plans 

whose cost approached or matched that value. 

This option could have several drawbacks. First, because 

the federal contribution would grow more slowly over 

time than premiums, the option would reduce benefits. 

Participants would eventually pay more for their health 

insurance coverage; the FEHB enrollee premium contribution would increase by more than $2,000, on average, 

by 2021, CBO estimates. Some employees and annuitants who would be covered under current law might 

decide to forgo coverage altogether. For the most part, 

large private-sector companies currently provide health 

care benefits for their employees that are comparable to 

benefits that the government provides; under this option, 

government benefits could be less attractive than privatesector benefits, making it harder for the government to 

attract highly qualified workers. Finally, this option 

would cut benefits that many current federal retirees and 

federal employees looking ahead to retirement may 

believe they have already earned.

RELATED CBO PUBLICATIONS: Characteristics and Pay of Federal Civilian Employees, March 2007; The President’s Proposal to Accrue 

Retirement Costs for Federal Employees, June 2002; and Comparing Federal Employee Benefits with Those in the Private Sector,

August 1998
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 39

CBO

Mandatory Spending—Option 15 Function 550

Convert the Federal Share of Medicaid’s Payments for 

Long-Term Care Services into a Block Grant 

Note: ECI = employment cost index. 

The Medicaid program funds coverage for two different 

types of health care: acute care (including inpatient hospital stays, visits to physicians’ offices, and prescription 

drugs) and long-term care (services such as nursing home 

care and home- and community-based services). The program is financed jointly by the states and the federal government, with the federal government’s share equal to a 

percentage determined by a formula defined in law. The 

formula assigns a higher federal reimbursement rate to 

states that have lower income per capita (and vice versa). 

Currently, that share—referred to as the federal medical 

assistance percentage (FMAP)—is approximately 57 percent, on average across the states. 

The Congressional Budget Office estimates the federal 

share of Medicaid outlays in 2011 to be $155 billion for 

acute care and $71 billion for long-term care, excluding 

the enhanced federal matching funds established in the 

American Recovery and Reinvestment Act of 2009 

(ARRA, Public Law 111-5) and extended under subsequent legislation. 

This option would convert the federal share of Medicaid 

payments for long-term care services, as well as a portion 

of the federal share of Medicaid administrative costs, into 

a block grant to each state, as previous legislation did 

with funding for welfare programs. Starting in 2012, a 

state’s block grant for each fiscal year would apply to 

long-term care services for all of its Medicaid beneficiaries, but acute care would continue to receive funding as 

it does under current law. This option includes two alternatives for structuring the block grants, differentiated by 

how they would adjust the amount of the block grant 

annually. Specifically, a state’s block grant would equal its 

2010 federal Medicaid payment for long-term care services (excluding the enhanced matching provided in 

ARRA) indexed annually to one of the following factors:

B The employment cost index. Indexing each state’s 

block grant to annual increases in the employment 

cost index (ECI)—which reflects changes in labor 

costs such as benefits, wages, and salaries—would 

reduce federal outlays by $73 billion from 2012 to 

2016 and by $287 billion from 2012 to 2021. That 

would represent a 25 percent reduction in estimated 

federal spending on long-term care over the 2012–

2021 period relative to current law. This alternative 

would generate savings because federal payments for 

Medicaid are projected under current law to grow 

faster than the cost of labor as a result of both rising 

costs per beneficiary and an increasing number of 

beneficiaries. 

B The ECI and changes in the number of aged, blind, 

and disabled people enrolled in Medicaid. If block 

grants were indexed to the ECI and also to changes in 

the size of the Medicaid aged, blind, and disabled populations, savings would be somewhat lower than those 

generated by the first alternative because the Medicaid 

aged, blind, and disabled populations are expected to 

increase over the next 10 years. Under this approach, 

savings would total $41 billion for the 2012–2016 

period and $187 billion for the 2012–2021 period. 

That would represent a 16 percent reduction in estimated long-term care spending by the federal government during that decade relative to current law. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays

Index the grant to changes in the ECI -3.8 -10.8 -15.2 -19.3 -24.3 -29.3 -35.3 -42.1 -49.5 -57.9 -73.3 -287.4

Index the grant to changes in the ECI 

and in the Medicaid aged, blind, and 

disabled populations -1.9 -5.1 -8.1 -11.0 -14.8 -18.6 -23.3 -28.5 -34.3 -40.9 -41.0 -186.6
40 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

CBO’s estimates represent weighted averages of possible 

savings because changes in these index factors and 

changes in federal spending on long-term care under current law are both uncertain. If the adjustment was based 

on the ECI alone, states that had faster growth in their 

aged, blind, and disabled populations would need to 

make larger reductions in the long-term care benefits they 

provide to each Medicaid beneficiary or undertake larger 

increases in their own spending to compensate for the gap 

in federal funding. At the same time, states with slower 

growth in their aged, blind, and disabled populations 

would be in a better position to manage the long-term 

care benefits they provide or reduce the amount of money 

they allocate to long-term care services. If the adjustment 

also took into consideration changes in the size of states’ 

populations of aged, blind, and disabled Medicaid enrollees, then states’ financial circumstances would not be 

affected by the growth of those groups. That alternative 

would not produce as high a level of savings, however. 

A rationale for this option is that a block grant would 

provide greater predictability in federal spending for 

long-term care services, which represents a large portion 

of total Medicaid spending. Furthermore, it would eliminate the federal subsidy for each additional dollar that 

states spend on long-term care services, thereby providing 

a greater incentive for states to find more cost-effective 

ways to care for individuals who need long-term care. 

Another rationale is that, if the block grant policy was 

coupled with reductions in federal program requirements, 

states would have greater flexibility to design and administer long-term care benefits in ways that might better 

serve their populations. With greater freedom to tailor 

their own programs, states could modify program eligibility and the benefits provided, including the types and settings of services offered. An additional rationale for this 

option is that converting the federal contribution to a 

block grant would reduce states’ ability to obtain more 

federal assistance than intended under the law. For example, in the past, some states have inflated Medicaid payments to institutional facilities and then required those 

facilities to pay special state taxes. That strategy boosted 

states’ federal matching funds without a corresponding 

increase in their net costs for the program. Over the past 

10 years, the Congress and the Department of Health 

and Human Services have acted to rein in that practice.

An argument against this option is that converting longterm care payments into a block grant would shift some 

of the burden of Medicaid’s growing costs to the states. 

Depending on the extent of flexibility provided in the 

legislation that would create the block grant, states could 

drop optional Medicaid services. Ending federal matching payments for long-term care services would eliminate 

the existing incentive for states to spend more on longterm care, possibly reducing the options available to people in need of those services. Another argument against 

the option is that distinguishing between long-term care 

and acute care could be difficult administratively, especially in cases where individuals receive both types of care. 

For example, hospital patients who receive acute care services often require additional post-acute services after 

they are released; those services may be provided in the 

same venues in which long-term care services are delivered and by the same providers. Thus, rules would need 

to be established to define when long-term care services 

would be covered by the block grant and when such services would be covered by the acute care part of the Medicaid program. A further argument against this option is 

that greater discretion for the states in how they structure 

their Medicaid programs creates the potential for 

increased disparity from one state to another in eligibility 

criteria and benefit packages. 
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 41

CBO

Mandatory Spending—Option 16 Function 550

Reduce the Floor on Federal Matching Rates for Medicaid Services

The federal government pays a share of the costs that 

states incur for providing health care services through the 

Medicaid program. For most medical services that Medicaid covers, the percentage of costs paid by the federal 

government is determined by the federal medical assistance percentage (FMAP). The FMAP is based on a formula that assigns a higher federal reimbursement rate to 

states that have lower income per capita, and vice versa. 

(Per capita income serves as a proxy for a state’s financial 

resources.) By law, a state’s FMAP rate can be no less than 

50 percent and no more than 83 percent. On average, the 

federal matching rate is 57 percent, and states pay the 

remaining 43 percent of the cost of services. Beginning in 

2009 and continuing through the third quarter of 2011, 

the American Recovery and Reinvestment Act of 2009 

(Public Law 111-5) specified that the federal government 

pay a larger share of Medicaid costs, averaging between 

about 65 percent and 68 percent, depending on the year.

Starting in 2014, the federal government will pay a different matching rate, specified in law, for the cost of services 

incurred by enrollees made newly eligible for Medicaid 

under the Patient Protection and Affordable Care Act 

(PPACA, P.L. 111-148), as amended by the Health Care 

and Education Reconciliation Act of 2010 (P.L. 111-

152). The matching rates for those enrollees will vary 

from 90 percent to 100 percent, depending on the year, 

and are not affected by the FMAP rate formula. Also 

starting in 2014, for certain childless adults that some 

states made eligible for Medicaid prior to the passage of 

PPACA, the federal government will pay a specified percentage of the difference between the states’ FMAP rates 

(as determined by the aforementioned formula) and the 

rates paid on behalf of those made newly eligible under 

PPACA. 

Although matching rates are set through formulas specified in statute, states generally determine the amount of 

Medicaid’s spending because they pay health care providers and then submit claims to the federal government for 

reimbursement at the appropriate FMAP rate. Medicaid 

spending is therefore driven by the choices that states 

make regarding payment rates for providers, the coverage 

of optional benefits, and the eligibility thresholds for the 

program.

This option would lower the 50 percent floor on federal 

matching rates to 45 percent starting in 2012 for all 

Medicaid-covered services that are reimbursed at the 

FMAP rate; the option would not affect the matching 

rates for newly eligible enrollees under PPACA. The 

affected states would be those with high per capita 

income relative to the national average that, in the 

absence of the floor, would have FMAP rates lower than 

50 percent. Lowering the floor to 45 percent would 

reduce FMAP rates for 14 states such that the new rates 

would range from 45.0 percent to 49.6 percent. Federal 

matching rates would not change for the remaining 

37 states and the District of Columbia. 

If the federal government reduced the share of Medicaid 

that it reimbursed, states would be faced with a choice. At 

one extreme, they could substitute additional state spending for all of the lost federal funding and thereby maintain their Medicaid programs’ payment rates, covered services, and enrollment levels. At the other extreme, they 

could provide no additional state funding and reduce the 

size of their Medicaid programs. For this estimate, the 

Congressional Budget Office assumed that states would 

increase their contributions to make up for some of the 

reduced federal funding, but not by enough to prevent a 

decline in the size of their Medicaid programs. 

This option would reduce federal outlays by $75 billion 

during the 2012–2016 period, CBO estimates, and by 

$181 billion from 2012 through 2021.

A rationale for lowering the floor on the federal matching 

rate is to decrease federal spending for the Medicaid program by reducing payments to states that have the greatest financial resources available to fund their programs. 

The FMAP formula is designed to provide a larger federal 

contribution for states that have lower income per capita 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -13.0 -14.0 -15.0 -16.0 -17.0 -18.0 -20.0 -21.0 -23.0 -25.0 -75.0 -181.0
42 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

and a smaller federal contribution for states that have 

higher income per capita. However, the floor of 50 percent provides a number of states with FMAP rates above 

the rates they would be assigned in the absence of such a 

floor. Lowering the current floor would require states that 

have higher income per capita to pay a greater share of 

the cost of Medicaid services for their populations. 

An argument against the option is that it would concentrate significant reductions in federal spending among a 

fairly small number of states. The 14 states affected by 

the option would generally have several mechanisms for 

reducing expenditures in their Medicaid programs: They 

could cut their payment rates to providers; they could 

reduce the kinds and amounts of medical benefits they 

provide; or they could cover fewer people by reducing 

outreach efforts that encourage enrollment or by increasing administrative requirements for enrollment. States 

that faced significant reductions in their FMAP rates 

would probably respond by using a combination of those 

cost-cutting approaches. 
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 43

CBO

Mandatory Spending—Option 17 Function 570

Consolidate and Reduce Federal Payments for Graduate Medical Education 

Costs at Teaching Hospitals

Under Medicare’s prospective payment system for 

inpatient medical services, hospitals with teaching programs receive additional funds for costs related to graduate medical education (GME). One component of that 

additional funding, direct graduate medical education 

(DGME), covers a portion of a teaching hospital’s costs 

for compensation of physicians serving as medical residents and for institutional overhead. DGME payments 

are based on a hospital’s 1984 costs per resident (indexed 

for changes in consumer prices), the number of residents, 

and Medicare’s share of total inpatient days at that hospital. The other component, indirect medical education 

(IME), is intended to cover teaching-related costs that are 

not attributable either to residents’ compensation or to 

other direct costs of running a residency program. Examples of IME costs are the added demands placed on staff 

as a result of teaching activities and the greater number of 

tests and procedures ordered by residents as part of the 

learning and teaching process. Teaching hospitals also 

tend to treat a larger proportion of severely ill patients, 

which raises costs. Under current law, for every increase 

of 0.1 in the ratio of full-time residents to the number of 

beds, the IME adjustment provides teaching hospitals 

with about 5.5 percent more in payments. However, the 

Medicare Payment Advisory Commission (MedPAC) has 

consistently found that the IME calculation overstates the 

effect of teaching status on incurred costs. In its most 

recent (March 2010) report to the Congress on Medicare’s payment policy, MedPAC estimates that an IME 

adjustment of about 2 percent more closely reflects the 

indirect costs that teaching hospitals actually incur. 

Teaching hospitals also receive GME payments from both 

the federal government and the states through the Medicaid program. The Congressional Budget Office estimates 

that total mandatory federal spending for hospital-based 

GME in 2010 was about $10 billion—$9.5 billion 

through Medicare and $500 million through Medicaid. 

This option would consolidate all mandatory federal 

spending for GME into a grant program for teaching 

hospitals. Total funds available for distribution would be 

based on the 2011 aggregate payments for DGME and 

Medicaid GME plus the 2011 aggregate payments for 

IME reduced to reflect a 2.2 percent IME adjustment. 

Total funding for the grant program would grow with 

inflation as measured by the consumer price index for all 

urban consumers minus 1 percentage point per year. Payments would be apportioned according to the number of 

residents at a hospital and the portion of the hospital’s 

inpatient days accounted for by Medicare and Medicaid 

patients. 

In CBO’s estimation, this option would save approximately $25 billion over the 2012–2016 period and 

roughly $69 billion over the 2012–2021 period. By 

2021, the annual savings would represent about 

60 percent of federal spending for GME projected 

under current law. 

If the discretionary funds for graduate medical training 

currently provided by the Health Resources and Services 

Administration of the Department of Health and Human 

Services were also included in the mandatory grant 

pool, total available funding would rise by an estimated 

$300 million in 2013. If that component of the funding 

was also automatically indexed to inflation (instead of 

remaining subject to annual appropriations), the option 

would decrease mandatory spending by about $66 billion 

over the 2012–2021 period. 

An argument for reducing the subsidy for GME is that 

federal payments under current law exceed hospitals’ 

actual teaching costs. As MedPAC’s analysis suggests, a 

smaller subsidy would create savings for the federal budget without unduly affecting hospitals’ teaching activities. 

A smaller subsidy would also remove an incentive for hospitals to have a greater number of residents than may be 

necessary. If hospitals responded to the reduction in the 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -5.2 -5.8 -6.4 -7.2 -7.8 -8.3 -8.9 -9.5 -10.3 -24.6 -69.4
44 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

subsidy by lowering residents’ compensation, residents 

would bear more of the cost of their medical training, 

which might deter some people from entering the medical profession. However, medical training enables individuals to earn a significantly higher income in the 

future, and market incentives appear to be sufficient to 

encourage people to become physicians. 

An argument against this option is that reducing the federal subsidy for GME could lead some teaching hospitals 

to train fewer residents or devote less time and fewer 

resources to beneficial educational activities. Also, to the 

extent that some teaching hospitals use a portion of their 

additional payments to fund care for uninsured individuals, decreasing those payments could reduce the number 

of patients that hospitals treat or lower the quality of care 

that those hospitals provide. Another argument against 

the option is that states could lose some discretion to 

direct Medicaid GME payments to hospitals because the 

federal government would be administering the grant 

program. Finally, even if payments were initially equal to 

hospitals’ costs, the payments would grow more slowly 

than inflation and thus might not keep pace with 

increases in costs. 
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 45

CBO

Mandatory Spending—Option 18 Function 570

Raise the Age of Eligibility for Medicare to 67

The usual age of eligibility for Medicare benefits is 65, 

although certain people qualify for coverage earlier. 

(Medicare is available to persons under age 65 who have 

been eligible for disability benefits under Social Security 

for at least 24 months and to those with end-stage renal 

disease or amyotrophic lateral sclerosis.) Because of 

increases in life expectancy, the average length of time 

that people are covered by Medicare has risen significantly since the program began in 1965. That trend, 

which increases the program’s costs, is expected to 

continue.

This option would raise the age of eligibility for Medicare 

by two months every year beginning with people who 

were born in 1949 (who will turn 65 in 2014) until the 

eligibility age reached 67 for people born in 1960 (who 

will turn 67 in 2027). Thereafter, the eligibility age 

would remain at 67. Those increases are similar to those 

already under way for Social Security’s full retirement age 

(FRA)—that is, the age at which workers become eligible 

for full retirement benefits—except that scheduled 

increases in the FRA include a 12-year period during 

which the FRA remains at 66. (Unlike Medicare, with its 

single eligibility age, Social Security allows workers to 

receive a reduced retirement benefit as early as age 62. 

The vast majority of the eligible population chooses to 

claim Social Security benefits before reaching the FRA.) 

The eligibility age for Medicare would remain below 

Social Security’s FRA until 2020, when both would be 

age 66 for people born in 1954; from that point on, the 

two would be identical.

By the Congressional Budget Office’s estimates, this 

option would reduce federal spending by about $18 billion over the 2012–2016 period and by roughly $125 billion over the 2012–2021 period. Those estimates primarily reflect a reduction in federal spending on Medicare 

and a slight reduction in outlays for Social Security retirement benefits. Those reductions would be partially offset 

by an increase in federal spending on Medicaid and an 

increase in federal subsidies to purchase health insurance 

through the new insurance exchanges that are scheduled 

to be established in 2014. 

The option would reduce outlays for Social Security 

retirement benefits by inducing some people to delay 

their application for such benefits (some people apply for 

Social Security benefits at the same time they apply for 

Medicare) and by encouraging some people to delay 

retirement to maintain their employment-based health 

insurance coverage until they became eligible for Medicare. The option could also affect the number of people 

who apply for disability benefits; those effects are 

expected to be quite small and are not included in this 

estimate.

The increase in Medicare’s eligibility age would boost federal spending on Medicaid in two ways. First, some of the 

people who were no longer receiving Medicare benefits 

would have income below 138 percent of the federal poverty level and would therefore sign up for and receive 

Medicaid benefits instead. (Under current law, that 

income threshold applies only to people under age 65, 

but for this option CBO assumed that that age limit 

would increase in tandem with the Medicare eligibility 

age.) Second, people over 65 who would have been 

enrolled in both Medicare and Medicaid (those for whom 

Medicaid pays Medicare’s premiums and cost sharing, 

and covers certain services not covered by Medicare) 

would instead have Medicaid as their primary source 

of coverage until they reached the new Medicare eligibility age. 

Subsidies for insurance coverage purchased in the new 

health insurance exchanges would also increase under this 

option because some of the people whose eligibility for 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays

Medicare 0 0 -3.5 -7.4 -11.6 -16.0 -20.8 -27.4 -34.0 -41.7 -22.5 -162.4

Other 0 0 0.3 1.3 2.7 3.7 5.1 6.6 8.0 9.9 4.3 37.6

Total 0 0 -3.2 -6.1 -8.9 -12.3 -15.7 -20.8 -26.0 -31.8 -18.2 -124.8
46 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Medicare was delayed would receive those subsidies 

instead. 

Federal revenues under this option would decrease by a 

small amount over the 2012–2021 period; however, those 

effects are not included in this estimate. That decline in 

revenues would occur primarily because some employees 

and retirees whose eligibility for Medicare was delayed 

would accept coverage through their employer instead. 

(Active workers who are eligible for Medicare have the 

option of accepting or rejecting coverage from their 

employer; for those who accept such coverage, Medicare 

is the secondary payer.) Most of the resulting increase in 

employers’ spending on health insurance would lead to 

reductions in taxable wages for active workers or would 

reduce employers’ taxable profits; the remainder would 

probably be passed along to enrollees in the form of 

higher premiums. In addition, employers that provided 

retiree coverage to former workers before they became eligible for Medicare would incur higher costs to the extent 

that they provided such coverage over a longer period. 

Although the option could induce some employers to 

reduce or eliminate such retiree coverage, no changes of 

that sort are incorporated in this estimate. Federal revenues also would be reduced because a small portion of 

the subsidies provided through the health insurance 

exchanges are tax expenditures rather than outlays. CBO 

did not estimate any increase in tax revenues resulting 

from workers who delay retirement because total employment in the economy was assumed to remain unchanged; 

that assumption is consistent with CBO’s standard 

approach to cost estimates.

By 2035, Medicare’s spending under this option is estimated to be about 7 percent below what it would be in 

the absence of this policy change—5.5 percent of gross 

domestic product rather than 5.9 percent. On the basis of 

estimates for the 2012–2021 period, CBO anticipates 

that about one-quarter of those Medicare savings would 

be offset by the increases in federal spending described 

above. 

A rationale for this option is that it would raise the eligibility age for Medicare to accompany increases in life 

expectancy. The option would restrain the growth of 

spending for Medicare. In addition, a higher age threshold for Medicare eligibility would reinforce the incentive 

to delay retirement created by increases in Social Security’s FRA.

An argument against this option is that it would shift 

costs that are now paid by Medicare to individuals and to 

employers that offer health insurance to their retirees. 

States’ spending on Medicaid would also be higher. 

RELATED OPTION: Revenues, Option 31

RELATED CBO PUBLICATION: The Long-Term Budget Outlook, June 2010
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 47

CBO

Mandatory Spending—Option 19 Function 570

Impose Cost Sharing for the First 20 Days of a Stay in a Skilled Nursing Facility 

Under Medicare

For enrollees who have been hospitalized and need continuing skilled nursing care or rehabilitation services on a 

daily basis, Medicare currently covers up to 100 days of 

care in a skilled nursing facility (SNF) for each episode of 

care. There is no deductible for SNF care and no copayment for the first 20 days of each stay. A daily copayment 

is required for days 21 through 100; that copayment is set 

at 12.5 percent of the hospital inpatient deductible and is 

projected to be about $148 in 2013. A substantial share 

of Medicare SNF stays are shorter than 20 days and 

therefore do not require any copayment. The Congressional Budget Office projects that total Medicare spending 

for SNF services will rise from about $30 billion in 2012 

to $60 billion in 2021.

Beginning in 2013, this option would impose a copayment for each of the first 20 days of care in a skilled nursing facility equal to 5 percent of the inpatient deductible; 

that copayment is projected to be about $59 per day in 

2013. The maximum additional liability for each SNF 

stay would thus equal the inpatient deductible, which 

CBO projects will be $1,184 in 2013. Imposing that 

copayment would reduce federal outlays by about $8 billion over the 2012–2016 period and by $21 billion over 

the 2012–2021 period.

The effect of this option on the use of SNF services and 

on beneficiaries’ out-of-pocket payments would depend 

on whether participants had supplemental coverage. 

Most individual medigap policies include full coverage of 

current SNF copayments, so most beneficiaries with such 

policies would be insulated from the direct impact of the 

higher copayments—but they would face higher medigap 

premiums to reflect the average cost of covering those 

payments. Employers’ spending on supplemental coverage for their retirees would also probably increase, and 

those costs could be passed on to enrollees in the form of 

higher premiums. This option would not directly affect 

Medicare beneficiaries who receive full Medicaid benefits 

or those considered qualified Medicare beneficiaries 

because Medicaid would be responsible for the additional 

copayments under this option. The savings shown in this 

option are net of the additional federal Medicaid spending that would occur as a result.

An argument in favor of this option is that it would discourage some use of Medicare-covered SNF services that 

may have limited value. For those beneficiaries who 

would incur higher out-of-pocket costs under this option, 

the absence of cost sharing under current law for the first 

20 days of SNF care encourages additional use of those 

services, some of which may not be clinically necessary.

One argument against this option is that the added 

copayment could lead some beneficiaries to forgo services 

that would help avoid further complications from surgery 

or improve their health in other ways. Some beneficiaries 

would probably choose instead to receive similar services 

through other benefits in Medicare, such as the home 

health care benefit, that currently have no cost sharing 

and would not have any cost sharing under this option. 

In addition, expenditures for states would rise as a result 

of the increase in copayments that Medicaid would cover. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -1.5 -2.1 -2.2 -2.3 -2.4 -2.5 -2.6 -2.8 -2.9 -8.1 -21.3
48 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 20 Function 570

Require a Copayment for Home Health Episodes Covered by Medicare

The Congressional Budget Office projects that the use of 

home health services, and the resulting costs to the Medicare program, will grow rapidly over the next 10 years, 

rising from about $23 billion in 2012 to $52 billion in 

2021. One reason for the high level of spending is that 

Medicare beneficiaries are not required to pay any of the 

costs of home health services covered by the program.

This option would charge Medicare beneficiaries a copayment amounting to 10 percent of the total cost of each 

home health episode—a 60-day period of services—

starting on January 1, 2013. That change would yield net 

federal savings of $14 billion over the 2012–2016 period 

and $40 billion over the 2012–2021 period. For Medicare beneficiaries who use home health services, the average increase in Medicare copayments in 2013 would be 

about $600. 

An argument in favor of this option is that it would 

directly offset a portion of Medicare’s home health outlays and encourage some beneficiaries to use those services in a cost-conscious manner. The use of services 

would also decrease, most likely among the approximately 10 percent of beneficiaries with fee-for-service 

Medicare only—that is, beneficiaries who do not have 

supplemental insurance, such as medigap or “wraparound” retiree coverage, and who are not enrolled in 

Medicaid or a health maintenance organization.

An argument against this option is that it would increase 

the risk of significant out-of-pocket costs for the 10 percent of Medicare enrollees who have fee-for-service coverage only—a population that tends to have lower income 

than do beneficiaries with private supplemental insurance. As a result, implementing the option could cause 

some of those individuals to forgo beneficial care. Among 

the majority of enrollees who have supplemental insurance, little or no drop in use would be expected because 

their supplemental policies would presumably be 

expanded to cover the home health copayment proposed 

in this option. For that reason, the approximately 25 percent of enrollees with individually purchased medigap 

policies would probably face higher premiums, and the 

costs of employment-based supplemental policies could 

also rise. Finally, this option would result in increased 

spending by Medicaid for home health care for individuals who have both Medicare and Medicaid coverage; the 

federal share of higher Medicaid outlays is included in the 

estimated change in outlays.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -2.6 -3.6 -3.8 -4.1 -4.4 -4.7 -5.2 -5.7 -6.1 -14.0 -40.1
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 49

CBO

Mandatory Spending—Option 21 Function 570

Reduce Medicare Costs by Changing the Cost-Sharing Structures for 

Medicare and Medigap Insurance

In Medicare’s traditional fee-for-service program—that is, 

services covered under Part A (primarily hospital and 

post-acute care) and Part B (physicians’ and other outpatient services)—enrollees’ cost sharing varies significantly depending on the type of service provided. For 

example, enrollees must pay a Part A deductible, which 

the Congressional Budget Office estimates will be $1,184 

in 2013, for each “spell of illness” or injury for which 

they are hospitalized; in addition, enrollees are subject to 

substantial daily copayments for extended hospital and 

skilled nursing care. Meanwhile, the annual deductible 

for outpatient services covered under Medicare’s Part B is 

estimated to be $163 in 2013. Beyond that deductible, 

enrollees generally pay 20 percent of allowable costs for 

most Part B services, but cost sharing is higher for some 

outpatient hospital care. At the same time, certain services that are covered by Medicare, such as home health 

visits and laboratory tests, require no cost sharing at all. 

As a result of those variations, enrollees lack consistent 

incentives to weigh relative costs when choosing among 

options for treatment. Moreover, if Medicare patients 

incur extremely high medical costs, they may face a significant amount of cost sharing because the program does 

not place a limit on those expenses.

Because the cost-sharing requirements in Medicare’s feefor-service program can be substantial, about 90 percent 

of enrollees obtain supplemental coverage. About 15 percent of fee-for-service enrollees have Medicaid coverage as 

well, and about 40 percent also have coverage through an 

employer. About another 30 percent of fee-for-service 

enrollees buy medigap policies—individual insurance 

policies that are designed to cover most or all of Medicare’s cost-sharing requirements. Studies have found 

that medigap policyholders use about 25 percent more 

services than Medicare enrollees who have no supplemental coverage and about 10 percent more services than 

enrollees who have supplemental coverage from a former 

employer (which tends to reduce, but not eliminate, their 

cost-sharing liabilities). Those differences probably arise 

in part because of the incentive effects of cost sharing and 

in part because of differences in health status and attitudes toward health care. Because Medicare enrollees 

with supplemental coverage are liable for only a portion 

of the costs of those additional services, it is taxpayers 

(through Medicare) and not supplemental insurers or the 

policyholders themselves who bear most of the resulting 

costs. Federal costs for Medicare could be reduced if 

medigap plans were restructured so that policyholders 

faced some cost sharing for Medicare services but still had 

a limit on their out-of-pocket costs.

This option presents three alternatives to reduce Medicare costs by modifying the cost sharing that Medicare 

beneficiaries face. The first alternative would replace 

Medicare’s current mix of cost-sharing requirements with 

a single combined annual deductible of $550 covering all 

Part A and Part B services, a uniform coinsurance rate of 

20 percent for amounts above that deductible (including 

inpatient expenses), and an annual cap of $5,500 on each 

enrollee’s total cost-sharing liabilities. If this option took 

effect on January 1, 2013, and the various thresholds 

were indexed to growth in per capita costs for the Medicare program in later years, federal outlays would be 

reduced by about $13 billion over the 2012–2016 period 

and by about $32 billion over the 2012–2021 period.

The second alternative would bar medigap policies from 

paying any of the first $550 of an enrollee’s cost-sharing 

liabilities for calendar year 2013 and would limit coverage 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays

Establish uniform cost sharing only 0 -2.7 -3.6 -3.3 -3.2 -3.4 -3.8 -4.0 -4.1 -4.1 -12.8 -32.2

Restrict medigap plans only 0 -3.7 -5.1 -5.4 -5.7 -6.0 -6.3 -6.7 -7.1 -7.5 -19.9 -53.4

Establish uniform cost sharing and 

restrict medigap plans 0 -6.9 -9.4 -9.3 -9.7 -10.1 -10.9 -11.6 -12.1 -12.6 -35.2 -92.5
50 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

to 50 percent of the next $4,950 in Medicare cost sharing. (All further cost sharing would be covered by the 

medigap policy, so enrollees in such policies would not 

pay more than about $3,025 in cost sharing in that year.) 

If this option took effect on January 1, 2013, and the 

various thresholds were indexed as specified in the 

first alternative, federal outlays would be reduced by 

about $20 billion over the 2012–2016 period and by 

roughly $53 billion over the 2012–2021 period.

The third alternative combines the restructuring parameters for the first two. Therefore, medigap plans would be 

prohibited from covering any of the new $550 combined 

deductible—which would apply to both Part A and 

Part B of Medicare’s fee-for-service program. Under this 

combined option, the level of beneficiary spending at 

which the medigap policy’s cap on out-of-pocket costs 

was reached would be equal to the level at which the 

Medicare program’s cap was reached. For spending 

between the deductible and the cap on the out-of-pocket 

expenditures, medigap policyholders would face a uniform coinsurance rate of 10 percent for all services; 

Medicare beneficiaries without other types of supplemental coverage would face a uniform coinsurance rate of 

20 percent for all services. If this option took effect on 

January 1, 2013, and the various thresholds were indexed 

to growth in per capita costs for the Medicare program in 

later years, federal outlays would be reduced by about 

$35 billion over the 2012–2016 period and by roughly 

$93 billion over the 2012–2021 period. Those savings do 

not equal the sum of the savings that would result from 

the first two alternatives because of the interactions 

between their effects.

An argument in favor of this option is that it would 

appreciably strengthen incentives for more prudent use of 

medical services—both by raising the initial threshold of 

health care costs that most Medicare beneficiaries face 

and by ensuring that more enrollees pay at least a portion 

of all subsequent costs up to the out-of-pocket limit. 

Because medigap plans would be barred from paying the 

first $550 of an enrollee’s cost-sharing liabilities (under 

the second and third alternatives), the costs borne by 

medigap plans would decrease, and therefore so would 

the premiums that the medigap plans charge. Another 

argument in support of this option is that it would provide greater protection against catastrophic costs. Capping enrollees’ out-of-pocket expenses would especially 

help people who develop serious illnesses, require 

extended care, or undergo repeated hospitalizations but 

lack supplemental coverage for their cost sharing.

An argument against the option is that it would boost 

cost-sharing liabilities for most Medicare enrollees. 

Another argument against the option (specifically, under 

the second and third alternatives) is that the restructuring 

of medigap coverage would mean that people would not 

be able to purchase policies with the low levels of cost 

sharing for which they have revealed a preference in the 

past. Even with the new cap on out-of-pocket expenses, 

some enrollees would object to any policy that denied 

them access to full supplemental coverage for their cost 

sharing. Furthermore, in any given year, some enrollees 

would see their combined payments for premiums and 

cost sharing rise.
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 51

CBO

Mandatory Spending—Option 22 Function 570

Increase the Basic Premium for Medicare Part B to 35 Percent of the 

Program’s Costs

Medicare Part B allows beneficiaries to obtain coverage 

for physicians’ and other outpatient services by paying a 

monthly premium. When the program began in 1966, 

the premium was intended to finance 50 percent of 

Part B costs per aged enrollee, with the remainder funded 

by general revenues. Subsequent legislation, however, 

reduced that share, and premium collections fell to less 

than 25 percent of program spending. The Balanced 

Budget Act of 1997 permanently set the Part B premium 

at about 25 percent of Part B spending per aged enrollee. 

General revenues still fund the remainder of Part B 

spending. (These calculations are based on costs for 

enrollees age 65 and older and do not include costs for 

people who qualify for Medicare before age 65 because of 

a disability.)

The basic monthly Part B premium increased from 

$96.40 in 2009 to $110.50 in 2010. However, the majority of beneficiaries who enrolled prior to 2010 were not 

affected by that increase, because there was no cost-ofliving adjustment (COLA) to Social Security benefits for 

2010 and a “hold-harmless” provision protects beneficiaries from a drop in their monthly net Social Security payment if an increase in the Part B premium exceeds the 

Social Security COLA. Since January 2007, higherincome enrollees have faced greater premiums for Part B 

than other enrollees have, but the basic premium of 

25 percent still applies to about 95 percent of enrollees. 

The Patient Protection and Affordable Care Act (Public 

Law 111-148) froze, through 2019, the thresholds at 

which income-related premiums begin—at the 2010 levels of $85,000 for single beneficiaries and $170,000 for 

couples. Thus, the share of enrollees that will be subject 

to income-related premiums will increase over time 

owing to growth in beneficiaries’ incomes.

This option would gradually raise the basic Part B premium from 25 percent to 35 percent of the program’s 

costs for enrollees ages 65 and older over a five-year 

period, beginning in 2012. The premium share would 

increase by 2 percentage points per year through 2016 

and then remain at 35 percent, preserving the thresholds 

at which income-related premiums begin as specified in 

current law. Also, the hold-harmless provision would be 

preserved; that provision would apply to more enrollees 

in 2012 because of the initial increase in premiums under 

this option. This option, the Congressional Budget 

Office projects, would result in estimated savings of 

about $71 billion over the 2012–2016 period and about 

$241 billion over the 2012–2021 period. 

One rationale for this option is that it would ease the 

budgetary pressures posed by rising costs in the Part B 

program, which will climb faster as members of the babyboom generation reach age 65. Even under this option, 

the public subsidy for most Part B enrollees—65 percent 

when fully phased in—would be greater than the 50 percent that was intended at the program’s outset. Also, 

because Medicaid pays the premiums for certain lowincome Part B enrollees with limited assets, about 18 percent of Medicare beneficiaries would be unaffected. 

An argument against this option is that it would reduce 

disposable income for many Part B enrollees. Also, higher 

premiums might lead to a decline in Part B enrollment; if 

such an effect materialized, however, it would most likely 

be small because the subsidy would remain quite large. In 

addition, expenditures by states would rise because states 

would pay higher premiums for people eligible for coverage through both Medicare and Medicaid. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -3.5 -8.3 -13.6 -19.5 -26.4 -29.4 -31.0 -33.5 -36.2 -39.8 -71.3 -241.2
52 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 23 Function 570

Reduce Medicare’s Payment Rates Across the Board in High-Spending Areas

In some parts of the country, Medicare’s spending per 

beneficiary is unusually high, a circumstance that appears 

to be attributable, at least in part, to differences in local 

patterns and professional norms of medical practice, and 

not just to higher local prices for “inputs” (goods and services used in the production of services, such as professional labor, office space, and so forth) or to unusually 

sick populations. Researchers have questioned whether 

the additional services provided in such high-spending 

areas produce improvements in patients’ health that are 

commensurate with their cost.

In parts of the country where per-beneficiary spending is 

unusually high, after accounting for differences in prices 

and beneficiaries’ health status, this option would apply 

across-the-board reductions to Medicare payment rates 

for services covered under Parts A and B (the fee-forservice parts of the program). The first step in determining those reductions would be to define the geographic 

areas to be used for measuring and comparing spending 

per beneficiary; the size of such areas has a substantial 

effect on the amount of change in mandatory spending 

that the option would produce. For this option, each 

metropolitan statistical area (MSA) designated by the 

Office of Management and Budget would constitute an 

area. Then, in each state, all nonmetropolitan regions—

all parts of the state not included in an MSA—would 

constitute a single additional area. 

Payment rates in the fee-for-service program would 

depend on each area’s “relative spending”—defined as the 

spending per beneficiary in that area, adjusted to reflect 

the price of inputs and the health status of beneficiaries in 

that area, divided by the average spending per beneficiary 

nationwide. (Adjustments for health status would be 

based on Medicare’s hierarchical condition categories, 

which are currently used to adjust payment rates for 

Medicare Advantage plans.) Fee-for-service payment rates 

under this option would be reduced in areas where relative spending exceeded 1.1—that is, where adjusted 

spending was at least 10 percent higher than the national 

average; reductions would equal one-half of the difference 

between the region’s relative spending and the threshold 

of 1.1. For example, a region with relative spending of 

1.2—that is, adjusted spending 20 percent above the 

national average—would have Medicare payment rates 

reduced by 5 percent, or 1.2 minus 1.1, divided by 2.

The reduction in payment rates in high-spending areas 

would be phased in over five years and capped at 20 percent. It would apply to all payments—including those to 

hospitals, physicians, and providers of post-acute care—

made on the basis of a fee schedule. Moreover, the reduction in fee-for-service payment rates would indirectly 

reduce Medicare’s payments to private Medicare Advantage plans by reducing the benchmark payment rates for 

those plans. If implemented, this option would reduce 

Medicare spending by an estimated $12 billion over 

5 years and by almost $48 billion over 10 years. 

An argument in favor of this option is that it would bring 

about more equity among regions in Medicare’s spending. The option also might encourage initiatives in highspending areas to reduce the utilization of health care 

resources, especially services thought to have only marginal benefits for patients, and would encourage providers to deliver services more efficiently. Reductions in 

Medicare’s Part B expenditures would also lower beneficiaries’ premiums and out-of-pocket payments. 

An argument against this option is that it would not target specific medical providers or specific types of services. 

In high-spending areas, all medical providers would face 

reductions in payment rates, regardless of whether their 

practice patterns contributed to the area’s unusually high 

level of spending. Thus, payments for all services, regardless of a service’s value to a patient, would be reduced. 

Medicare beneficiaries might face difficulties in obtaining 

certain medical services if providers became less willing to 

offer them. In addition, by reducing the revenue of providers, this option might limit their ability to deliver 

high-quality care. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 -1.1 -2.2 -3.4 -4.9 -6.2 -6.4 -7.0 -7.5 -8.0 -11.6 -47.6

RELATED CBO PUBLICATION: Geographic Variation in Health Care Spending, February 2008
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 53

CBO

Mandatory Spending—Option 24 Function 570

Eliminate the Critical Access Hospital, Medicare-Dependent Hospital, and 

Sole Community Hospital Programs in Medicare

Hospitals designated as critical access hospitals (CAHs), 

Medicare-dependent hospitals (MDHs), and sole community hospitals (SCHs) are exempt from the Inpatient 

Prospective Payment System (IPPS) through which 

Medicare pays for services provided by most acute care 

hospitals. Eligibility for the CAH, MDH, and SCH designations is based on several factors, including size and 

location. Most of the hospitals exempt from the IPPS are 

small, rural facilities. Some of those hospitals receive payments equal to 101 percent of the costs of providing care, 

while others receive payments based on a blend of IPPS 

rates and their costs. Hospitals benefiting from the special 

adjustments for CAHs, MDHs, and SCHs are paid about 

25 percent more, on average, for inpatient and outpatient 

services than the payments that would otherwise apply. 

Currently, one-third of hospitals benefit from those designations and account for about 10 percent of total Medicare spending for hospital inpatient services.

This option would eliminate the CAH, MDH, and SCH 

programs and end the higher Medicare payments made to 

those facilities. Instead, payment to those hospitals, as 

with other hospitals paid through the IPPS, would be 

determined prospectively on the basis of the following: 

patients’ diagnoses and the severity of their illness or 

injury; geographic variations in hospital “input” costs (for 

example, for professional labor or medical supplies); and 

certain other hospital- and patient-specific factors, such 

as the hospital’s teaching status and Medicaid caseload. 

By eliminating the CAH, MDH, and SCH programs and 

the higher payments to hospitals participating in those 

programs, this option would reduce federal outlays by 

$23 billion over the 2012–2016 period and by approximately $62 billion over the 2012–2021 period.

An argument in favor of eliminating the CAH, MDH, 

and SCH programs is that doing so would move Medicare toward a payment structure that compensates all hospitals in a consistent manner. Smaller rural hospitals 

would no longer be able to participate in programs that 

compensated them at relatively higher rates. Additionally, 

this option might improve efficiency in the health care 

system. IPPS payments are intended to encourage efficiency by compensating hospitals for the costs that reasonably efficient providers would incur in furnishing 

high-quality care (including adjustments for local input 

costs). By placing CAHs, MDHs, and SCHs under the 

IPPS, those hospitals would face greater incentives to 

provide efficient care. 

A potential drawback of this option is that the special 

payments currently made to the CAHs, MDHs, and 

SCHs may offset the higher costs of operating smaller 

facilities in rural areas. If those hospitals are not able to 

reduce their costs under the IPPS, the increased financial 

pressure resulting from the elimination of special payments to CAHs, MDHs, and SCHs might force some of 

those hospitals to convert to outpatient facilities or even 

to close. To the extent that occurred, patients who reside 

in those areas might have difficulty getting access to care. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -3.8 -4.1 -4.5 -5.0 -5.6 -6.3 -7.0 -7.8 -8.6 -9.5 -23.0 -62.2
54 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 25 Function 570

Require Manufacturers to Pay a Minimum Rebate on Drugs Covered Under 

Medicare Part D for Low-Income Beneficiaries

Note: * = between zero and $500 million.

Medicare’s voluntary outpatient drug benefit, known as 

Part D, is delivered by private drug plans; federal subsidies for that coverage, net of the premiums that enrollees 

pay, totaled $52 billion in 2010. (Those subsidies include 

payments to stand-alone prescription drug plans and prescription drug plans associated with Medicare Advantage 

plans, but they exclude subsidies provided to employers 

for prescription drug coverage provided by their retiree 

health plans.) One way that those drug plans limit the 

cost of the Part D benefit is by negotiating rebates from 

the manufacturers of brand-name drugs in return for 

favorable coverage of those drugs, such as lower copayments for preferred drugs. That strategy is most likely to 

be effective for “single-source” drugs that are not available 

in generic form but face competition from other brandname drugs to treat the same medical condition. The 

Congressional Budget Office estimates that in 2008, 

rebates under Part D averaged about 14 percent of gross 

spending on all brand-name drugs and a slightly higher 

percentage of spending on single-source brand-name 

drugs. 

Prior to the establishment of Part D in 2006, Medicare 

beneficiaries who were also eligible for full benefits under 

Medicaid—known as “dual eligibles”—received drug 

coverage through Medicaid. Drug manufacturers are 

required to pay a significant rebate on their sales to Medicaid enrollees. In 2010, the minimum rebate in the 

Medicaid program was increased from 15.1 percent to 

23.1 percent of the average manufacturer price (AMP)—

that is, the price that manufacturers receive for sales to 

retail pharmacies; additional rebates are required if a 

drug’s price rises faster than general inflation. When 

Part D was established, dual eligibles were enrolled automatically in a low-income-subsidy (LIS) program, which 

typically covers the premiums and most of the cost sharing required under the basic Part D benefit. Overall, LIS 

beneficiaries account for about 40 percent of Part D 

enrollees and about 56 percent of Part D spending; most, 

but not all, LIS recipients are dual eligibles. Currently, 

the prices and rebates for drugs used by LIS enrollees are 

established in the same way as those for other Part D 

enrollees—that is, through negotiations between Part D 

plans and drug makers. 

This option would require manufacturers of brand-name 

drugs to pay the federal government a rebate on drugs 

purchased by enrollees in the LIS program, starting in 

2013. The program would reflect the current rebate system for Medicaid: Manufacturers would be responsible 

for a total rebate of at least 23.1 percent of the AMP, plus 

an additional rebate for price increases that exceeded the 

rate of inflation since the drug’s introduction.1

 The difference between that amount and the amount of discounts 

and rebates that manufacturers already provide to Part D 

drug plans (as defined below) would be paid to the federal government. If the average Part D rebate for a given 

drug already exceeded the sum of 23.1 percent of the 

AMP plus the inflation-based rebate, however, no rebate 

would be paid to the federal government for that drug. 

Manufacturers would be required to participate in the 

new Part D rebate program in order for their drugs to be 

covered by Parts B and D of Medicare, by Medicaid, and 

by the Veterans Health Administration. To reduce the 

amount of rebates owed to the federal government, 

rebates provided to Part D plans would have to apply to 

all drug purchases by all Part D enrollees. Therefore, if 

manufacturers set different rebate levels for different subgroups of beneficiaries, only the lowest rebate provided 

would be subtracted when determining the amount 

owed to the federal government on purchases by LIS 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays * -4.0 -10.0 -12.0 -12.0 -13.0 -14.0 -14.0 -15.0 -18.0 -38.0 -112.0

1. Unlike the current Medicaid rebate, this option would not have a 

“best price” feature. That provision in Medicaid requires manufacturers to pay a rebate that exceeds 23.1 percent of the AMP if the 

difference between the AMP and the best price obtained by a 

private purchaser (net of certain private rebates) is larger than 

23.1 percent of the AMP. 
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 55

CBO

beneficiaries. In particular, under this option, the 

50 percent discount on brand-name drugs that manufacturers now have to provide for certain drug purchases 

would not reduce the rebate owed to the federal government on purchases by LIS beneficiaries because that 

50 percent discount applies only to a subgroup of drug 

purchases (those made by beneficiaries who are not 

enrolled in the LIS program for drugs purchased within a 

specified range of spending). 

Under this option, manufacturers would continue to 

have an incentive to provide rebates to drug plans in 

exchange for preferred coverage of brand-name drugs, but 

that incentive would be smaller than under current law 

because the federal rebate would make the additional 

sales that would result from preferred coverage less profitable. The rebates obtained by drug plans for purchases 

by Part D enrollees would therefore be reduced, CBO 

expects. Moreover, drug makers would be expected to set 

higher “launch” prices for new drugs to limit the impact 

of the new rebate, particularly for new drugs that do not 

have close substitutes. Higher launch prices in response to 

a minimum rebate requirement in Part D would have 

varying effects on other drug purchasers. Employmentbased health insurance plans would probably negotiate 

for larger rebates to offset the higher launch prices, but 

state Medicaid programs would pay a higher price for 

new drugs. Even after accounting for such offsets, CBO 

estimates that this option will generate savings to the federal government—about $38 billion over the 2012–2016 

period and about $112 billion over the 2012–2021 

period. 

The main advantage of this option is that Medicare 

would pay less for drugs used by LIS beneficiaries in 

Part D. Advocates of this option might argue that manufacturers previously paid a rebate to Medicaid for drugs 

purchased by the dual-eligible population (who constitute the majority of LIS beneficiaries) before those beneficiaries were reassigned to the Part D benefit, so there 

is a recent precedent for requiring such rebates for that 

population. 

A disadvantage of the option is that the net reduction in 

the prices paid for drugs under Part D might reduce the 

amount of funds that manufacturers invest in research 

and development of new products. Relative to current 

law, the option would not significantly reduce the incentive to develop “breakthrough” drugs because those drugs 

could be launched at prices that were high enough to 

largely offset the rebate. However, the new rebate would 

apply to LIS beneficiaries who are not dual eligibles, so 

the magnitude of the total required rebates would be 

larger than when dual eligibles received their drug coverage from Medicaid; consequently, the adverse impact on 

manufacturers’ incentives would probably be larger than 

it was prior to the creation of Part D. 

RELATED CBO PUBLICATIONS: Letter to the Honorable Paul Ryan about the effect of the March health legislation on prescription drug prices, 

November 4, 2010; and Effects of Using Generic Drugs on Medicare’s Prescription Drug Spending, September 2010 
56 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 26 Function 600

Base Cost-of-Living Adjustments for Federal Civilian and Military Pensions and 

Veterans’ Benefits on an Alternative Measure of Inflation

In 2010, the federal government paid $69 billion in pension benefits to 2.5 million civilian retirees and their 

survivors, as well as $51 billion to 2.2 million military 

retirees and their survivors. The government also paid 

$43 billion in compensation to 3.5 million disabled veterans and their survivors and $4 billion in pension benefits to about 500,000 veterans and their survivors. All of 

those benefits are linked to the CPI-W (the consumer 

price index for urban wage earners and clerical workers), 

but the extent of inflation protection varies from one program to the next, as does the age at which benefits are 

payable.

Pensions paid under the Civil Service Retirement System 

(CSRS) are subject to annual cost-of-living adjustments 

(COLAs) that provide complete protection against 

increases in the CPI-W. Pensions paid under the newer 

Federal Employees Retirement System (FERS) are fully 

protected only when that increase is less than 2 percent 

per year. If the percentage increase in the CPI-W is 

between 2 percent and 3 percent, FERS annuitants 

receive a COLA of 2 percent; if the increase exceeds 

3 percent, the COLA is the percentage increase in the 

CPI-W minus 1 percentage point. Unless they retire 

on disability, FERS annuitants receive COLAs only at 

ages 62 and above, whereas all CSRS annuitants receive 

COLAs. CSRS and FERS participants generally can 

begin to receive pension benefits at age 60 with 20 years 

of service or at age 62 with 5 years of service. Participants 

with 30 years of service are eligible to receive benefits 

even if they retire before the age of 60.

Pensions for military personnel hired before August 1, 

1986, garner COLAs that provide complete protection 

against increases in the CPI-W. People who entered service after that date have a choice: They may elect to stay 

under the old system and receive a full COLA, or they 

can accept a $30,000 bonus after 15 years of service and 

receive reduced annual COLAs that equal the percentage 

increase in the CPI-W less 1 percentage point. Those 

who choose the latter arrangement receive an increase in 

their pension at age 62, restoring the annuity to what it 

would have been had the full COLA been paid. After age 

62, retirees again receive the reduced COLA (but from a 

higher base because of the increase at age 62). Most military personnel have declined the 15-year bonus and 

retained eligibility for the full COLA. Active-duty military personnel are eligible to receive pension benefits after 

completing 20 years of service, regardless of age; reservists 

are not eligible for retirement annuities until they reach 

age 60; and personnel with fewer than 20 years of service 

generally are not eligible for any benefits unless they retire 

on disability.

Full COLAs are attached to veterans’ disability compensation and pensions. Disability compensation is paid to 

veterans with certified disabilities, in amounts that 

depend on the severity of the disability. Veterans also are 

eligible for means-tested pensions. 

This option would replace the CPI-W with the chained 

CPI-U (the chained consumer price index for all urban 

consumers) as the index by which federal civilian, military, and veterans’ benefits are adjusted for inflation. The 

Congressional Budget Office estimates that, on average, 

the chained CPI-U will grow 0.25 percentage points per 

year more slowly than the CPI-W over the next 10 years. 

Under this option, annual COLAs would equal the 

increase in the chained CPI-U for CSRS annuitants, military retirees, and veterans. Comparable adjustments 

would be made for FERS annuitants when the increase in 

the chained CPI-U was less than 2 percent a year. FERS 

annuitants would receive a COLA of 2 percent when the 

increase in the chained CPI-U was between 2 percent and 

3 percent and a COLA 1 percentage point below the 

increase in the chained CPI-U when that increase 

exceeded 3 percent. Military retirees who chose the 

$30,000 bonus under the new system would receive a 

reduced COLA equal to the percentage growth in the 

chained CPI-U minus 1 percentage point.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -300 -800 -1,300 -1,700 -2,200 -2,600 -3,000 -3,600 -4,000 -4,500 -6,300 -24,000
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 57

CBO

The chained CPI-U is initially published as a preliminary 

value and then revised over the following two years. As a 

result, implementing this option would require the use of 

preliminary data. CBO discussed the details of the 

approach in a Web-only technical appendix released with 

its February 2010 issue brief, Using a Different Measure of 

Inflation for Indexing Federal Programs and the Tax Code.

CBO estimates that those changes would decrease mandatory outlays by about $6 billion between 2012 and 

2016 and by $24 billion from 2012 through 2021. 

On average, a CSRS annuitant would receive about 

$3,900 less over 10 years than under current law; a 

FERS annuitant would receive about $1,000 less. The 

average military retiree would receive roughly $3,000 less 

over 10 years relative to current law, veterans’ disability 

compensation would be about $1,500 less, and veterans’ 

pensions would be about $1,200 less. (Using the chained 

CPI-U for all federal benefit programs that are indexed 

for inflation, including Social Security, would reduce outlays by about $36 billion through 2016 and by about 

$145 billion through 2021.)

A rationale for this option is that the CPI-W overstates 

increases in the cost of living, so using the chained CPI-U 

would reduce federal outlays while still ensuring that benefits do not fall relative to the cost of living after a recipient becomes eligible for those benefits. The CPI-W measures inflation on the basis of price changes for a fixed 

basket of goods that is periodically updated. The chained 

CPI-U provides a more accurate measure of changes in 

the cost of living by more quickly capturing the extent to 

which households adjust their consumption when relative 

prices change. Another argument in favor of this option is 

that federal pension plans would still offer more protection against inflation than most private pension plans do. 

According to a 2001 survey, fewer than 15 percent of 

private-sector plans gave annuitants formal annual 

COLAs, and another 25 percent made ad hoc cost-ofliving adjustments. 

An argument against reducing the COLA is that the 

prices faced by annuitants could rise faster than the prices 

faced by the population at large. In particular, annuitants 

are likely to spend more than younger people do for medical care, the price of which generally grows faster than 

the prices of many other goods and services. An experimental price index for goods and services purchased by 

the elderly (the CPI-E) grew an average of 0.27 percentage points per year faster than the CPI-W from 1982 to 

2010. Thus, the benefits received by retirees may decline 

over time in real terms under current law, and using the 

chained CPI-U would accentuate that decline. CSRS 

annuitants would be particularly affected because they are 

most dependent on their pensions: CSRS annuitants typically receive larger pensions than FERS annuitants do, 

but CSRS annuitants did not receive the matching contributions to their Thrift Savings Plan accounts for which 

FERS annuitants were eligible. Moreover, CSRS annuitants may have declined to switch to FERS because they 

believed that they would always have the protection 

against inflation offered by the current COLA rules. Also, 

because military personnel can retire earlier and receive 

immediate pensions after just 20 years of service, their 

lower COLAs would have larger effects over longer periods. Finally, because current and prospective employees 

would be expected to analyze retirement benefits when 

comparing alternative wage and benefit packages, reducing federal retirement benefits could hamper the government’s ability to recruit and retain a highly qualified 

workforce. 

RELATED OPTIONS: Mandatory Spending, Option 27; and Revenues, Option 3

RELATED CBO PUBLICATIONS: Using a Different Measure of Inflation for Indexing Federal Programs and the Tax Code, Issue Brief, 

February 2010; Assessing Pay and Benefits for Military Personnel, Issue Brief, August 2007; Characteristics and Pay of Federal Civilian 

Employees, March 2007; Comparing the Pay of Federal and Nonfederal Law Enforcement Officers, August 2005; Measuring Differences 

Between Federal and Private Pay, November 2002; and The President’s Proposal to Accrue Retirement Costs for Federal Employees,

June 2002
58 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 27 Function 650

Base Social Security Cost-of-Living Adjustments on an Alternative 

Measure of Inflation

As specified by law, the Social Security Administration 

increases recipients’ monthly benefits in most years. For 

example, the 5.8 percent cost-of-living adjustment 

(COLA) that went into effect in January 2009 was based 

on the increase in the consumer price index for urban 

wage earners and clerical workers (CPI-W) between the 

third quarters of 2007 and 2008. That index is calculated 

by the Bureau of Labor Statistics, or BLS. Although 

declines in overall consumer prices between the third 

quarters of 2008 and 2010 meant no COLAs were provided in 2010 or 2011, the Congressional Budget Office 

projects that there will be one in 2012.

The CPI-W, however, tends to overstate inflation because 

it does not fully account for changes in patterns of spending. This option would set the COLA equal to the 

growth in the chained consumer price index for all urban 

consumers (chained CPI-U). The chained CPI-U is an 

alternative measure of inflation, also calculated by BLS, 

that more fully incorporates the effects of changes in patterns of spending. CBO estimates that, on average, the 

chained CPI-U is likely to grow 0.25 percentage points 

per year more slowly than the CPI-W over the next 

10 years. Using the chained CPI-U to set Social Security 

COLAs would reduce federal outlays by about $27 billion over five years and by $112 billion through 2021, 

CBO estimates. By 2050, such action would have 

reduced Social Security outlays by 3 percent—from 

5.9 percent to 5.7 percent of gross domestic product.

Some other policy changes that would reduce Social 

Security outlays—by constraining the increase in initial 

benefits, for example, or by raising the full retirement age 

(Mandatory Spending—Options 28 and 30, respectively)—would affect future beneficiaries only. This 

option, by contrast, would reduce benefits to current 

beneficiaries so that current and future generations would 

bear the reductions more equally. 

The chained CPI-U is initially published as a preliminary 

value and then revised over the following two years. As a 

result, implementing this option would require the use of 

preliminary data. CBO discussed the details of the 

approach in a Web-only technical appendix released with 

its February 2010 issue brief, Using a Different Measure of 

Inflation for Indexing Federal Programs and the Tax Code.

A rationale for this option is that the CPI-W overstates 

increases in the cost of living. Specifically, the CPI-W 

measures inflation on the basis of price changes for a fixed 

basket of goods and services that is periodically updated, 

whereas the chained CPI-U more quickly captures the 

extent to which households adjust their consumption 

when relative prices change. (Technically, the chained 

CPI-U avoids the so-called “substitution bias” that arises 

from the use of a fixed basket of goods in computing the 

CPI-W. Some analysts also conclude that neither the 

CPI-W nor the chained CPI-U fully accounts for 

increases in the quality of existing products or the value 

of new products.) Therefore, using the chained CPI-U 

would reduce federal outlays but ensure that, after adjusting for overall inflation, benefits remain at the same level 

as they are when a recipient becomes eligible for benefits.

An argument against reducing the COLA is that the 

prices faced by Social Security beneficiaries could rise 

faster than prices faced by the population at large. For 

example, beneficiaries are likely to spend more than 

younger people do for medical care, the price of which 

generally outpaces the prices of many other goods and 

services. BLS computes an experimental consumer price 

index for the elderly (the CPI-E) that aims to track inflation for the population ages 62 and older. From December 1982 through December 2010, the CPI-E grew faster 

than the CPI-W by an average of 0.27 percentage points 

per year. Another potential drawback of this option is 

that a reduction in the COLA would generally have larger 

effects on the oldest beneficiaries and on those who 

initially became eligible for Social Security on the basis of 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -1.4 -3.3 -5.3 -7.5 -9.8 -12.1 -14.5 -16.9 -19.3 -21.9 -27.3 -112.0
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 59

CBO

a disability. For example, if benefits were adjusted every 

year by 0.25 percentage points less than the increase in 

the CPI-W, beneficiaries would face a reduction in retirement benefits at age 75 of about 3 percent compared with 

what they would receive under current law; at age 95, 

they would face a reduction of about 8 percent. To protect vulnerable populations, lawmakers might choose to 

reduce the COLA only for beneficiaries whose income or 

benefits were greater than specified amounts. Doing so, 

however, would reduce the budgetary savings from the 

option. 

RELATED OPTIONS: Mandatory Spending, Option 26; and Revenues, Option 3

RELATED CBO PUBLICATIONS: Social Security Policy Options, July 2010; and Using a Different Measure of Inflation for Indexing Federal 

Programs and the Tax Code, Issue Brief, February 2010
60 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 28 Function 650

Link Initial Social Security Benefits to Average Prices Instead of 

Average Earnings 

Social Security benefits for retired and disabled workers 

are based on those individuals’ average earnings over a 

lifetime. The Social Security Administration uses a statutory formula to compute a worker’s initial benefit, and 

through a process known as wage indexing, the benefit 

formula changes each year to account for economywide 

growth of wages. Average initial benefits for Social Security recipients therefore tend to grow at the same rate as 

do average wages, and such benefits replace a roughly 

constant portion of wages. (After people become eligible 

for benefits, their monthly benefits also are adjusted 

annually to account for increases in the cost of living.) 

One way to constrain the growth of Social Security benefits would be to change the initial benefit computation so 

that the real (inflation-adjusted) value of average initial 

benefits did not rise over time. That approach, often 

called “price indexing,” would allow increases in real 

wages to result in higher real Social Security payroll taxes 

but not in higher real benefits. Specifically, beginning 

with participants who became eligible for benefits in 

2012, this option would link the growth of initial benefits to the growth of prices (as measured by changes in the 

consumer price index) rather than to the growth of average wages. (The calculation of average indexed monthly 

earnings, a key step in the statutory formula for determining Social Security benefits, would continue to 

involve wage indexing. However, the benefit would be 

multiplied by the ratio of a price index to an average wage 

index—where the indexes are set to be equal in 2011.) 

Switching to indexing initial benefits on the basis of 

prices rather than wages—a “pure price-indexing” 

approach—would reduce federal outlays by about 

$13 billion over five years and by almost $137 billion 

over the next decade. By 2050, scheduled Social Security 

outlays would be reduced by 29 percent relative to what 

would occur under current law—from 5.9 percent to 

4.2 percent of gross domestic product.

Under pure price indexing, the reduction in payments 

relative to those that are scheduled to be paid under current law would be larger for each successive cohort of 

beneficiaries; the extent of the reduction would be determined by the growth of real wages. For example, if real 

wages grew by 1.3 percent annually (approximately the 

rate used in the Congressional Budget Office’s long-term 

Social Security projections), workers who were first eligible for benefits in 2012 would receive about 1.3 percent 

less than they would have received under the current 

rules; those becoming eligible in 2013 would receive 

2.6 percent less; and so on. In reality, however, the incremental reduction would vary from year to year, depending on actual growth in real earnings. If real earnings 

shrank during a period—that is, if average wages grew 

more slowly than prices—then benefits would grow faster 

than they would under current law. Those eligible for 

benefits in 2030, CBO estimates, would experience a 

reduction in benefits of about 25 percent relative to benefits scheduled under current law, and the reduction 

would grow to more than 40 percent by 2050. 

An alternative approach, called “progressive price indexing,” would retain the current formula for workers who 

had lower earnings and would reduce the growth of initial benefits only for workers who had higher earnings. 

Currently, the formula for calculating initial Social Security benefits is structured so that workers who have higher 

earnings receive higher benefits, but the benefits paid to 

workers with lower earnings replace a larger share of their 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays

Implement pure 

price indexing -100 -600 -1,800 -3,800 -6,800 -11,000 -16,600 -23,300 -31,500 -41,100 -13,100 -136,600

Implement 

progressive price 

indexing -100 -400 -1,200 -2,400 -4,200 -6,700 -10,200 -14,400 -19,600 -25,400 -8,300 -84,600
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 61

CBO

earnings. Under the specifications for progressive price 

indexing in this option, initial benefits for the 30 percent 

of workers with the lowest lifetime earnings would 

increase with average wages, as they are currently slated to 

do, whereas initial benefits for higher-income workers 

would increase more slowly, at a rate that depended on 

their position in the distribution of earnings. For example, for workers whose earnings put them at the 31st percentile of the distribution, benefits would rise only 

slightly more slowly than wages, whereas for the highest 

earners, benefits would rise with prices—as they would 

under pure price indexing. Thus, under progressive price 

indexing, the initial benefits for most workers would 

increase more quickly than prices but more slowly than 

average wages. As a result, the benefit formula would 

gradually become flatter, and after about 60 years, everyone in the top 70 percent of earners would receive the 

same monthly benefit. A partially flat benefit formula 

would represent a significant change from Social Security’s traditional structure, under which workers who pay 

higher taxes receive higher benefits.

Progressive price indexing would reduce scheduled Social 

Security outlays less than would pure price indexing, and 

beneficiaries with lower earnings would not be affected. 

Real annual average benefits would still increase for all 

but the highest-earning beneficiaries. Benefits would 

replace a smaller portion of affected workers’ earnings 

than they do today but a larger portion than they would 

under pure price indexing. 

A switch to progressive price indexing would reduce federal outlays by more than $8 billion over 5 years and by 

about $85 billion over 10 years. By 2050, outlays for 

Social Security would be reduced by 18 percent, or from 

5.9 percent to 4.8 percent of gross domestic product.

Under both approaches, the reductions in benefits relative to current law would be greatest for beneficiaries in 

the distant future. Those beneficiaries, however, would 

have had higher real earnings during their working years 

and thus a greater ability to save for retirement.

An advantage of both approaches in this option is that, 

although they would reduce outlays for Social Security 

compared with those scheduled to be paid under current 

law, average inflation-adjusted benefits in the program 

would not decline over time. If the pure price-indexing 

approach was followed, future beneficiaries would generally receive the same real monthly benefit paid to current 

beneficiaries, and they would, as average longevity 

increased, receive a larger total lifetime benefit. 

A disadvantage of both approaches is that because benefits would no longer be linked to wages, affected beneficiaries would no longer share in overall economic growth. 

As a result, benefits would replace a smaller portion 

of workers’ earnings than they do today. Another disadvantage is that relative to currently scheduled benefits, 

reductions would be largest during periods of high wage 

growth. Finally, the options would continue to reduce the 

rate of growth of scheduled benefits beyond what is 

needed to bring Social Security outlays in line with 

revenues.

RELATED CBO PUBLICATIONS: Social Security Policy Options, July 2010; Letter to the Honorable Paul Ryan concerning CBO’s analysis of the 

Roadmap for America’s Future Act of 2010, January 27, 2010; “Long-Term Analysis of S. 2427, the Sustainable Solvency First for Social Security 

Act of 2006,” attachment to a letter to the Honorable Robert F. Bennett, April 5, 2006; and “Long-Term Analysis of Plan 2 of the President’s 

Commission to Strengthen Social Security,” attachment to a letter to the Honorable Larry E. Craig, July 21, 2004
62 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 29 Function 650

Raise the Earliest Eligibility Age for Social Security

Although the full retirement age for Social Security beneficiaries is now 66 and will rise to 67 for people born in 

1960 and later, eligible workers may choose to receive 

benefits at age 62. About 40 percent do so, and nearly all 

claim benefits by 66. The age at which people claim benefits affects the amount they receive monthly and the 

duration of their benefits. People who claim benefits 

before the full retirement age receive less each month, but 

typically they receive benefits for a longer period; conversely, people who wait to claim benefits until they are 

older (up to age 70) receive higher monthly payments but 

for fewer years. The adjustment for the age of claiming 

benefits is currently actuarially fair, on average, so a person’s total lifetime benefits have an approximately equal 

value regardless of the age at which he or she begins to 

collect them.

This option would increase the earliest age of eligibility 

by two months per year, beginning with people born in 

1950 (who turn 62 in 2012); by 2025, the age would be 

64 for people born in 1961 and later. The result is that 

federal outlays would be reduced by about $33 billion 

over five years and by nearly $144 billion through 2021. 

Because this option would have little effect on lifetime 

benefits for the average beneficiary, its main budgetary 

effect would be a shift in the timing of outlays, which 

would be slightly lower than under current law from 

2012 to about 2035 and would be slightly higher thereafter. There are three complicating factors, however. First, 

a higher earliest eligibility age would induce some people 

to work longer, increasing the size of the workforce and 

boosting federal revenues from income and payroll taxes. 

Second, the additional work would result in higher future 

Social Security benefits, although the increase in benefits 

would be smaller than the increase in revenues. The 

10-year estimates for this option do not include those 

two effects. Third, changing the earliest eligibility age 

would have a small effect on the number of people who 

applied and qualified for Social Security disability insurance as well as on the timing of applications for disability 

benefits. The estimates take that effect into account; 

however, it does not significantly change the projected 

savings. 

An argument in favor of the option is that the older population is becoming healthier and able to work longer and 

therefore many people do not need benefits at as early an 

age as workers did in the past. The change also would 

increase annual benefits for some beneficiaries, reducing 

poverty among older people. Under current law, the penalty for claiming benefits early is increasing as the full 

retirement age rises. For example, people born before 

1938 who claimed benefits at age 62 received 80 percent 

of the full benefit (the amount that they would have 

received had they waited until the full retirement age). 

That fraction is decreasing under current law, to 70 percent for people born after 1959 who claim benefits at 62. 

If the earliest age of eligibility was 64, all retirees would 

receive at least 80 percent of their full monthly benefit.

An argument against the option is that it would increase 

financial hardship for some people who do not qualify for 

Social Security disability benefits and would have to wait 

until age 64 to claim retirement benefits. In addition, 

forcing people with lower-than-average life expectancies 

to delay claiming benefits would reduce their lifetime 

benefits. For example, someone who died at 68 would 

collect benefits for four years rather than six. And because 

people with lower earnings tend to have shorter life 

expectancies, they would be more likely to be harmed by 

the change.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -1,700 -3,900 -6,300 -8,900 -11,900 -15,000 -18,400 -22,400 -26,000 -29,400 -32,700 -143,900

RELATED OPTION: Mandatory Spending, Option 30

RELATED CBO PUBLICATION: Social Security Policy Options, July 2010
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 63

CBO

Mandatory Spending—Option 30 Function 650

Raise the Full Retirement Age in Social Security 

The age at which workers become eligible for full retirement benefits—the full retirement age, also called the 

normal retirement age—depends on their year of birth. 

For workers born before 1938, that age was 65. The age 

of eligibility increased in two-month increments until it 

reached 66 for workers born in 1943. For workers born 

between 1944 and 1954, the age holds at 66, but it 

increases again in two-month increments until reaching 

67 for workers born in 1960 or later. Workers who turn 

62 in 2022 or later will be subject to a full retirement age 

of 67. Workers will continue to be able to receive benefits 

at age 62, but at that age, the amount of benefits is 

smaller than the amount they would receive by waiting 

until the full retirement age to claim benefits. 

Under this option, the full retirement age would increase 

by two-month increments for 6 years, rising to 66 years 

and 2 months for workers born in 1950 (who turn 62 in 

2012) and reaching 67 for workers who were born in 

1955 or later (who turn 62 in 2017 or later). Thereafter, 

it would continue to increase by two months per year 

until reaching 70 for workers born in 1973 (who turn 62 

in 2035). As under current law, workers could still choose 

to begin receiving reduced benefits at 62, but the reductions would be larger. The benefits of workers who qualify for disability insurance would not be reduced under 

this approach.

This approach to constraining growth is equivalent in its 

effects on benefits to reducing earnings-replacement 

rates. (Mandatory Spending—Option 28 offers an alternative method of reducing those rates.) Depending on 

the age at which a worker claims benefits, a one-year 

increase in the full retirement age is equivalent to a reduction in a retired worker’s monthly benefit of between 

5 percent and 8 percent. Because many workers retire at 

the full retirement age, increasing that age is likely to 

result in beneficiaries’ making claims later than they 

would if a policy with identical benefits at each age was 

implemented through adjustments in the benefit formula. For the same reason, this option also would probably lead workers to remain employed longer, which 

would increase the size of the workforce and boost federal 

revenues from income and payroll taxes. Moreover, the 

additional work would result in higher future Social 

Security benefits, although the increase in benefits would 

be smaller than the increase in revenues. The 10-year estimates for this option do not include those two effects. 

This option would shrink federal outlays by about 

$12 billion over 5 years and by nearly $120 billion over 

10 years. By 2050, the option would reduce Social Security outlays relative to what would occur under current 

law by 12 percent—from 5.9 percent to 5.2 percent of 

gross domestic product. 

A rationale for this option is that people who turn 65 

today will, on average, collect Social Security benefits for 

significantly longer than retirees did in the past and the 

average life span in the United States is expected to continue to lengthen. In 1940, life expectancy at age 65 was 

11.9 years for men and 13.4 years for women. The Social 

Security trustees estimate that life expectancy has risen by 

more than 5 years for 65-year-olds, to 17.3 years for men 

and 19.7 years for women, and that those figures will 

increase to 19.0 years and 21.1 years by 2035. Therefore, 

a commitment to provide retired workers with a certain 

monthly benefit beginning at age 65 in 2035 is significantly more costly than is that same commitment made 

to today’s recipients. 

An argument against this option is that it would reduce 

resources provided to older people, relative to those that 

are scheduled to be provided under current law. In addition, it would create a somewhat stronger incentive for 

older workers nearing retirement to apply for disability 

benefits. Under current law, workers who retire at age 62 

in 2035 will receive 70 percent of their primary insurance 

amount (the benefit they would have received if they 

had claimed benefits at their full retirement age); if they 

qualify for disability benefits, however, they will receive 

100 percent of that amount. Under this option, workers 

who retired at 62 in 2035 would receive only 55 percent 

of their primary insurance amount; they would still 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -100 -600 -1,600 -3,200 -6,700 -11,200 -16,200 -21,600 -27,300 -31,400 -12,200 -119,900
64 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

receive 100 percent if they qualified for disability benefits. The estimates of the budgetary effects of this option 

account for the effect on the Social Security Disability 

Insurance program. To eliminate that added incentive to 

apply for disability benefits, policymakers could narrow 

the difference by also reducing scheduled disability payments—for example, by setting the benefits for disabled 

workers at the amount they would have received upon 

retiring at age 65. 

RELATED OPTION: Mandatory Spending, Option 29

RELATED CBO PUBLICATIONS: Social Security Policy Options, July 2010; and Jae Song and Joyce Manchester, Have People Delayed Claiming 

Retirement Benefits? Responses to Changes in Social Security Rules, Working Paper 2008-04, May 2008
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 65

CBO

Mandatory Spending—Option 31 Function 650

Lengthen by Three Years the Computation Period for Social Security Benefits 

As required by law, the Social Security Administration 

calculates retirement benefits on the basis of a worker’s 

wage history, using the worker’s average indexed monthly 

earnings, or AIME. The current formula computes the 

AIME on the basis of a worker’s earnings in his or her 

35 years of highest earnings that are subject to Social 

Security taxes. If a worker has worked for fewer than 

35 years, the average includes years with zero earnings.

This option would gradually lengthen the AIME computation period to 38 years for people who turn 62 in 2014 

and beyond. The extended averaging period would generally reduce benefits by requiring that additional years of 

lower earnings be factored into the benefit computation. 

The option would not change the number of years used 

to compute AIMEs for disabled workers; only retirement 

benefits would be affected.

The option would have the largest effect on people who 

worked for fewer than 38 years, because they would have 

additional years with no earnings included in the calculation of their benefits. However, the option would reduce 

benefits even for workers who worked 38 years or more, 

because those people would almost always have had lower 

average earnings in the additional computation years than 

they would have had in the 35 years of their highest 

earnings. 

Lengthening the period by three years would reduce federal outlays by almost $7 billion through 2016 and by 

roughly $51 billion through 2021. By 2050, Social Security outlays would be reduced by 2 percent—from 

5.9 percent to 5.8 percent of gross domestic product.

An argument in support of expanding the computation 

period considers increased life expectancy: Because people now live longer, lengthening the period would 

encourage them to remain in the labor force longer and 

extend the amount of time they pay into the Social Security system, boosting federal revenues from income and 

payroll taxes. Additional work would also result in higher 

future Social Security benefits. The 10-year estimates for 

this option do not include those two effects.

Extending the computation period also would reduce the 

advantage currently enjoyed by workers who postpone 

entering the labor force—for instance, while they pursue 

advanced education. People with more education generally earn more than their counterparts who enter the 

labor force sooner; because many years of low or no earnings can now be ignored in calculating the AIME, the 

former group experiences little or no loss of benefits for 

any additional years spent not working and thus not paying Social Security taxes. 

An argument against this option is that some beneficiaries retire early because of circumstances they do not control, such as poor health or job loss, and this option could 

adversely affect those recipients who were not able to continue working for 38 years. Other disproportionately 

affected workers would be parents who interrupted a 

career to raise children or workers who experienced long 

stretches of unemployment. On average, the benefit 

reduction would be larger for women than for men, 

because women tend to spend more years out of the 

workforce. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -100 -400 -1,000 -1,900 -3,100 -4,800 -6,700 -8,800 -11,100 -13,500 -6,500 -51,400

RELATED CBO PUBLICATION: Social Security Policy Options, July 2010
66 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option 32 Function 650

Apply the Social Security Benefit Formula to Individual Years of Earnings

A two-step process is used to calculate Social Security 

benefits. First, a worker’s average indexed monthly earnings, or AIME, is computed. For a retired worker, the 

AIME is calculated on the basis of the highest 35 years of 

earnings on which Social Security taxes were paid, with 

earnings included up to the taxable maximum, which in 

2011 is $106,800. Earnings before age 60 are adjusted by 

growth in the average wage index (AWI), which is the 

average of all earnings in the U.S. economy; earnings 

after age 59 enter the computations as actual amounts. 

(As a result, for someone born in 1925 or later, earning 

$10,000 in 1974 had the same effect on benefits as earning $20,000 in 1984 because the AWI doubled over the 

course of that period.) Second, a progressive benefit formula is applied to the AIME to arrive at the primary 

insurance amount (PIA), the sum that is payable each 

month to a worker who begins receiving Social Security 

retirement benefits at the full retirement age, currently 

66. For workers who turn 66 in 2011, the PIA formula is 

90 percent of the first $680 of the AIME, plus 32 percent 

of the AIME between $680 and $4,100, plus 15 percent 

of the AIME above $4,100.

Under the PIA formula, benefits replace a larger share of 

average career earnings for people with lower earnings 

than they do for people with higher earnings. For example, the benefit for someone with very low earnings is 

90 percent of that person’s AIME, but the benefit for 

someone with earnings above the taxable maximum for 

35 years is about 28 percent of the AIME.

This option would essentially reverse the order of the 

computation: A progressive benefit formula would be 

applied to each year of indexed earnings, and the PIA 

would be equal to the average of the annual PIAs. As 

under current law, this option’s benefit formula is progressive, although it would apply that progressivity to 

annual earnings rather than to lifetime earnings. The 

change would reduce federal outlays by about $15 billion 

over five years and by almost $89 billion through 2021. 

By 2050, Social Security outlays would be reduced by 

5 percent—from 5.9 percent to 5.6 percent of gross 

domestic product.

Under this option, almost all workers’ PIAs would be 

lower than they are under current law, but the reduction 

would be steeper for people whose earnings varied more 

from year to year, including people who were out of the 

workforce for many years. There would be no change in 

benefits for a worker whose earnings were equal to (or a 

constant proportion of) the AWI in every year of work. 

But benefits would fall substantially for someone with 

high earnings in some years and no earnings in others. 

For example, compare the case of a “steady earner” who 

has earnings equal to the AWI for 35 years or more with 

the case of a “short-career worker” who earns the same 

average wage when working but works for only 10 years. 

Even though that worker has average earnings during 

10 years of employment, his or her lifetime earnings are 

quite low because of the 25 years of zero earnings. Under 

current law, the progressive benefit formula is applied to 

that low level of lifetime earnings (as measured by the 

AIME), and the short-career worker’s Social Security benefit will replace almost 80 percent of his or her average 

lifetime earnings. Under this option, the benefit formula 

would be applied to the worker’s average earnings while 

working, and the progressive benefit formula would 

replace just 45 percent of those earnings. Thus, this 

option would have no effect on the steady earner, but it 

would reduce the benefits of the short-career worker by 

more than 40 percent.

A rationale for this option is that it would encourage 

some people to work longer, which would increase the 

size of the workforce and boost federal revenues from 

income and payroll taxes. Also, the additional work 

would result in higher future Social Security benefits. 

The 10-year estimates for this option do not include 

those two effects. 

When weighing the decision to retire, people may consider how the timing of retirement will affect Social 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays -0.3 -1.2 -2.5 -4.2 -6.4 -8.9 -11.7 -14.6 -17.8 -20.9 -14.6 -88.5
CHAPTER TWO: MANDATORY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 67

CBO

Security benefits. Under current law, one additional year 

of work by someone who had worked for fewer than 

35 years would in most cases increase annual benefits by 

32 percent or 15 percent of the year’s earnings divided 

by 35, because most workers have an AIME that is in the 

32 percent or 15 percent bracket of the PIA formula. 

Under this option, the worker’s benefit would increase by 

a larger amount, because at least part of the earnings in 

that additional year would fall in the 90 percent bracket. 

Consider a worker who worked 34 years at average wages. 

Under current law, a 35th year of work would increase 

annual benefits by about $375, but under this option it 

would increase benefits by about $525.

An argument against this option is that a worker’s ability 

to save for retirement depends on lifetime earnings, not 

annual earnings. People with more volatile earnings histories, who would experience the largest reductions in benefits, tend to have low lifetime earnings. Benefits would 

decline by about 15 percent, on average, for beneficiaries 

in the lowest quintile—or fifth—of lifetime household 

earnings. In contrast, benefits would fall by about 8 percent for people in the second-lowest earnings quintile and 

by 5 percent for groups with higher lifetime household 

earnings.

RELATED CBO PUBLICATION: Social Security Policy Options, July 2010 

CHAPTER

CBO

3

Discretionary Spending Options

Discretionary spending—the part of federal spending that lawmakers control through annual appropriation 

acts—totaled more than $1.3 trillion in 2010, or nearly 

40 percent of federal outlays. Just over half of that discretionary spending ($689 billion) went to defense programs, mainly for operation and maintenance, military 

personnel, and procurement (see Table 3-1). The rest 

($660 billion in 2010) paid for an array of nondefense 

activities. Some fees and other charges that are triggered 

by appropriation action are classified in the budget as offsetting collections and are credited against discretionary 

spending. 

Seven broad budget categories (called “budget functions”) 

accounted for more than 75 percent of the spending for 

nondefense discretionary activities last year. The largest of 

those functions is the category covering education, training, employment, and social services; it is followed in size 

by the functions for transportation, income security programs (mostly housing), and health-related research and 

public health.1

 Functions with smaller amounts of discretionary spending include administration of justice (for 

law enforcement activities), veterans’ benefits and services 

(mostly for health care), and international affairs (see 

Figure 3-1).

The discretionary budget authority provided in appropriation acts translates into outlays when the money is 

spent. Some appropriations (such as for employees’ salaries) are spent quickly, but others (such as for major construction projects) are disbursed over several years. Thus, 

Table 3-1.

Discretionary Spending in 2010

(Billions of dollars)

Source: Congressional Budget Office.

a. Includes spending for overseas contingency operations such as 

the wars in Afghanistan and Iraq. 

b. Includes spending for research, development, test, and evaluation; military construction; and family housing. Also includes 

spending on certain defense-related activities by government 

entities other than the Department of Defense (such as the 

Departments of Energy, Transportation, and Justice).

c. Includes spending for certain ground and air transportation programs governed by obligation limitations set in appropriation 

acts.

d. Includes spending for general science, space, and technology; 

energy; natural resources and environment; agriculture; commerce and housing credit; community and regional development; administrative activities for Medicare and Social Security; 

and general government. 

1. For some major transportation programs, budget authority (the 

authority provided by law to incur financial obligations) is considered mandatory, but the outlays resulting from that authority are 

discretionary. The reason is that such programs receive budget 

authority through authorizing legislation, but annual appropriation acts limit how much of that budget authority the Department of Transportation can obligate. Those obligation limitations 

are treated as a measure of discretionary budgetary resources, and 

the resulting outlays are classified as discretionary.

275

151

134

129 ____

689

134

90

71

65

52

51

46

151 ____

660

Total 1,349

Defensea

Subtotal

Subtotal

Military personnel

Procurement

Otherb

Operation and maintenance

Education, training, employment, and social services

Transportation

Income security

Health

Nondefensec

Outlays

Veterans' benefits and services

International affairs

Administration of justice

Otherd

2010
70 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Figure 3-1.

Breakdown of Defense and Nondefense Discretionary Spending in 2010

Source: Congressional Budget Office.

Notes: Other defense spending includes outlays for research, development, test, and evaluation; military construction; and family housing; as 

well as spending on some defense-related activities by government entities other than the Department of Defense. 

Other nondefense discretionary spending includes outlays for general science, space, and technology; energy; natural resources and 

environment; agriculture; commerce and housing credit; community and regional development; Medicare and Social Security (for 

administrative activities); and general government.

Nondefense discretionary spending for health excludes care provided by the Veterans Health Administration. Outlays for that care are 

included under veterans’ benefits and services.

Military

Personnel

(22%)

Procurement

Operation and (19%)

Maintenance

(40%)

Other

(19%)

Transportation

(14%)

Income

Security

(11%)

Veterans’

Benefits and

Services

(8%)

International

Affairs

(7%)

Other

(23%)

Health

(10%)

Defense

Nondefense

Education, Training,

Employment, and

Social Services

(20%)

Administration

of Justice

(8%)
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 71

CBO

Figure 3-2.

Discretionary Spending, 1971 to 2021

(Percentage of gross domestic product) 

Source: Congressional Budget Office (as of January 2011).

in any given year, discretionary outlays include spending 

both from new budget authority and from budget 

authority provided in previous appropriations. 

Trends in Discretionary Spending 

Relative to the size of the economy, total discretionary 

outlays have been rising for much of the past decade, 

following a long period of decline. Such outlays equaled 

about 10 percent of gross domestic product (GDP) during much of the 1970s and 1980s, then gradually fell to 

6.2 percent of GDP in 1999 (see Figure 3-2). Thereafter, 

discretionary outlays began increasing relative to GDP—

reaching 7.0 percent in 2002 and 7.9 percent by 2008—

partly because of actions taken in response to the terrorist 

attacks of September 11, 2011, and subsequent military 

operations in Afghanistan and Iraq. In the past few years, 

discretionary spending has been boosted by funding provided in the American Recovery and Reinvestment Act of 

2009 (ARRA, Public Law 111-5) and by policy responses 

to the recent turmoil in financial markets. Discretionary 

outlays rose to 8.8 percent of GDP in 2009 and to 9.3 

percent last year—the highest share of GDP since 1988.

When this report was prepared, discretionary budget 

authority for 2011 had been provided only through early 

March, at a rate that would total $1,255 billion for the 

entire fiscal year: $710 billion for defense and $545 billion for nondefense activities. Those amounts are about 

the same as the discretionary budget authority provided 

last year. Because of funding from previous appropriations, however, the Congressional Budget Office (CBO) 

projects that discretionary outlays will increase this year, 

to $1,375 billion from $1,349 billion in 2010. That 

increase is concentrated in defense spending, which is 

projected to rise by $23 billion (from $689 billion last 

year to $712 billion this year), while nondefense outlays 

are expected to inch up by $3 billion (from $660 billion 

to $663 billion). 

CBO’s baseline budget projections depict a path for discretionary spending over the next 10 years as directed by 

section 257 of the Balanced Budget and Emergency 

Deficit Control Act of 1985.2

 That law stated that current appropriations should be assumed to continue in 

later years, with adjustments to keep pace with projected 

inflation. The measures of inflation that CBO uses for its 

baseline are the ones specified in that law: the employment cost index for wages and salaries (applied to spending for federal personnel) and the GDP price index (for 

other spending). One exception to the approach of 

extrapolating current appropriations was made after the 

enactment of ARRA in early 2009. By agreement among 

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021

0

2

4

6

8

10

12

0

2

4

6

8

10

12

Nondefense

Defense

Total Discretionary

Actual Baseline Projection

2. Although the law’s provisions expired at the end of September 

2006, CBO continues to follow them in preparing its baseline for 

discretionary spending. The baseline projections discussed in this 

report were published in Congressional Budget Office, The Budget 

and Economic Outlook: Fiscal Years 2011 to 2021 (January 2011).
72 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

CBO and the House and Senate Committees on the 

Budget, the additional funding provided by ARRA was 

not assumed to continue in later years in CBO’s baseline 

projections; instead, subsequent baseline projections were 

based on non-ARRA appropriations. 

CBO’s current baseline for 2011 to 2021 represents an 

extrapolation of the annualized rate of discretionary 

funding provided through early March of this year in the 

Continuing Appropriations and Surface Transportation 

Extensions Act, 2011 (P.L. 111-322). As a share of the 

economy, total discretionary outlays are projected to 

decrease to 9.1 percent of GDP in 2011 (from 9.3 percent last year) as spending stemming from the provisions 

of ARRA wanes. Other than outlays resulting from 

ARRA, discretionary spending would equal the same 

share of GDP in 2011 that it did last year: 8.6 percent. 

In the coming decade, if discretionary funding grew at 

the rate of inflation—the assumption used in CBO’s 

baseline—outlays would reach $1.6 trillion by 2021. 

Because the economy is expected to grow at a faster rate 

than inflation, however, discretionary outlays would 

decline as a share of GDP, from 9.1 percent in 2011 to 

6.7 percent in 2021.

Of the total discretionary spending projected for 2021 

under CBO’s baseline, nondefense outlays would amount 

to $731 billion, or about 3.1 percent of GDP—the lowest share in more than four decades—and defense outlays 

would amount to $869 billion, or about 3.6 percent of 

GDP. That projection incorporates the assumption that 

funding for overseas contingency operations (such as the 

wars in Afghanistan and Iraq) will continue at the 2011 

level in future years, with adjustments for inflation. 

Under an alternative scenario for defense, in which the 

number of military personnel deployed for such operations would decline from an average of about 180,000 in 

2011 to 45,000 by 2015, outlays for defense would 

amount to $716 billion in 2021, or 3.0 percent of GDP.3

That scenario would leave defense spending in 2021 at 

roughly the same share of GDP experienced during the 

1999–2001 period—the lowest percentage of GDP since 

the beginning of World War II. 

Another approach to projecting defense spending is to 

estimate the cost of the plans described in the annual 

Future Years Defense Program (FYDP) prepared by the 

Department of Defense (DoD). The 2011 FYDP—

which was released in April 2010 and was the most recent 

plan available when this report was prepared—outlines 

DoD’s intended funding requests for the 2011–2015 

period, based on the Administration’s plans for personnel 

levels, procurement and maintenance of weapon systems, 

operational intensity, and so forth. (CBO used related 

DoD planning documents to project a funding level for 

2016.) Unlike CBO’s baseline, the 2011 FYDP does not 

include funding for overseas contingency operations. 

CBO’s own estimate of the cost of plans in the FYDP is 

roughly $41 billion greater per year, on average, than the 

comparable amounts in CBO’s baseline.4

Approaches to Reducing 

Discretionary Spending 

Because the Congress sets funding for discretionary programs each year, cutting spending through the regular 

appropriation process can ensure only short-term savings. 

An approach that has been used in the past to try to 

ensure longer-term savings is to set overall limits on discretionary spending for future years. Statutory caps on 

discretionary spending were imposed in 1990, and 

extended in 1993 and 1997, before expiring in 2002. 

The caps were enforced through the threat of automatic 

across-the-board spending cuts, a process known as 

sequestration. Many observers agree that as long as a consensus remained to rein in budget deficits, the spending 

caps helped curb the growth of discretionary spending. 

Such spending increased at an average rate of only 

1.6 percent a year during the 1990s. When budget 

deficits gave way to surpluses late in the decade, however, 

the caps were overridden in the appropriation process 

and later allowed to expire. Since 2001, discretionary 

spending has increased at an average annual rate of 

8.2 percent.

Whether lawmakers opt to reduce spending annually or 

on a multiyear basis, they could choose blunt, across-theboard mechanisms, or they could prioritize spending 

decisions and make choices about where limited resources 

should be directed. Such choices would involve difficult 

trade-offs. 

3. Ibid., pp. 21–22. 

4. For a comparison of projections of DoD’s costs and CBO’s baseline, see Congressional Budget Office, Long-Term Implications 

of the 2011 Future Years Defense Program (February 2011), 

Appendix A.
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 73

CBO

Assessing large and sustained reductions in defense 

spending would involve weighing their effects on military 

capabilities. Cuts could be targeted toward personnel 

levels, pay rates, and benefits; training and supplies; dayto-day operating and administrative costs; procurement, 

operation, and maintenance of existing weapon systems; 

and research and development related to more-advanced 

weapon systems. Such reductions in funding could 

require changes in broad strategic objectives—such as the 

number of simultaneous conflicts in which the military 

could engage and their intensity, duration, and overlap—

or changes in how the nation seeks to achieve those broad 

objectives. Trade-offs could involve, for example, the 

choice between fielding a smaller force with more-capable 

weapon systems and maintaining the current number of 

units but forgoing some of the upgrades to their weapon 

systems. A smaller force might not be able to handle as 

many conflicts at the same time, but it could be structured to maximize its flexibility to engage a variety of 

opponents with different capabilities or in different parts 

of the world. Conversely, a larger force would be better 

able to sustain longer-term counterinsurgency or peacekeeping operations.

Similarly, cuts in nondefense discretionary spending 

could affect a broad range of activities, and decisions 

about particular programs have impacts that would need 

to be weighed against the effects of alternative decisions. 

Many programs—especially in the areas of education and 

transportation—involve financing from federal, state, 

and local governments. Reducing federal support for such 

activities would force other levels of government to make 

decisions about decreasing the scope of the activities, 

increasing their own funding, or some combination of 

the two. 

Lowering pay rates for federal civilian employees would 

hamper efforts to recruit and retain workers (particularly 

in some occupations), which would reduce the overall 

skill level of the federal workforce over time. Having 

fewer federal workers would probably lower the levels of 

service that federal agencies provide to the public, unless 

cuts in the agencies’ workforces were accompanied by 

actions to enhance productivity. Charging users—such as 

drivers on highways, air travelers, users of waterways, and 

so forth—for services they receive from federal programs 

could allow service levels to be maintained while government spending was reduced. Of course, such charges 

would impose added burdens on users, compared with 

current arrangements. 

Federal income support payments and education grants 

to low-income households could be reduced or provided 

to smaller sets of households, which would mean less 

assistance for people who may value those benefits highly. 

A variety of federal activities could simply be curtailed—

ranging from research by the National Institutes of 

Health to export promotion by the Department of 

Commerce—so the value of those activities would need 

to be carefully assessed.

Whatever approaches lawmakers choose, making frequent large changes to funding for discretionary programs would probably disrupt the effective administration of those programs and the planning of the people, 

businesses, and governments that the programs affect. 

The programs would be more effective if lawmakers 

viewed significant changes in discretionary funding as 

part of a longer-term plan spanning several years.

Discretionary Spending Options in 

This Chapter

Two of the options in this chapter (Options 1 and 14) 

present possible alternatives for freezing or reducing total 

discretionary spending. The other 36 options cover a 

broad array of defense and nondefense discretionary 

programs. Most options are accompanied by a table 

showing their projected budgetary impact in each of the 

next 10 years (2012 to 2021), as well as 5- and 10-year 

totals. Except for options related to defense procurement 

programs, the budgetary effects were calculated relative to 

CBO’s baseline projections—that is, annualized appropriation levels for 2011, adjusted for projected inflation 

in later years. 

The budgetary effects of options that involve defense 

spending for procurement were measured relative to 

DoD’s 2011 Future Years Defense Program. CBO 

determined that it would be more informative to estimate 

the effects of procurement options relative to DoD’s published plan because CBO’s baseline for defense procurement is not based on detailed plans for weapon systems. 

Because the 2011 FYDP extends for only five years, 

however, the tables in the procurement options show just 

five years of costs or savings. The text of each procurement option discusses the effect of the option on DoD’s 

long-term acquisition plans.
74 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Defense Discretionary Spending—Option 1 Function 050

Reduce the Growth in Appropriations for the Department of Defense

The Department of Defense (DoD) receives just over 

50 percent of all discretionary appropriations. It would 

be difficult, therefore, to achieve a significant reduction 

in discretionary spending if DoD appropriations were 

excluded from consideration. The breadth of DoD’s portfolio provides many options for absorbing budget cuts of 

various magnitudes: It employs nearly 1.5 million military personnel and 785,000 civilians; operates nearly 

500,000 buildings and facilities on approximately 5,000 

installations; manages 87 major defense acquisition programs; and spends about $200 billion annually to 

develop and acquire weapons and equipment. 

This option includes three alternative paths for reducing 

the growth in DoD’s appropriations (excluding appropriations related to operations in Iraq and Afghanistan) 

relative to the amounts in the baseline budget projections 

of the Congressional Budget Office: 

B Limit the rate of growth in defense appropriations 

beginning in 2012 to an average of 1.4 percent a 

year—1 percentage point less than the rate of growth 

in CBO’s baseline—and thereby reduce outlays by 

about $286 billion (or 5 percent) over the 2012–2021 

period. 

B Freeze defense appropriations at the annualized level 

for 2011 under the continuing resolution that was in 

effect in February 2011, thus reducing outlays by 

about $611 billion (or 10 percent) over the 2012–

2021 period. 

B Reduce defense appropriations by 1 percent annually 

from the 2011 level, thereby decreasing outlays by an 

estimated $862 billion (or 15 percent) over the next 

10 years. Under that alternative, DoD’s appropriations 

would return to their 2007 funding level—in nominal 

terms—by 2021. If those reductions were distributed 

proportionally, a decrease of 400,000 active-duty personnel (about 25 percent of active and reserve personnel) could be required.

Funding for DoD’s regular activities (excluding appropriations for overseas contingency operations) has increased 

by approximately 75 percent over the past 10 years, or by 

about 40 percent adjusted for inflation. Thus, DoD 

would have more buying power than it had a decade ago 

even if its regular budget was reduced substantially relative to the amounts in CBO’s baseline. If regular defense 

appropriations had grown at the rate of inflation since 

2001 and continued to do so through 2021, budget 

authority in 2021 would total $465 billion, $200 billion 

less than the amount in the baseline. Even if those 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Reduce Growth by 1 Percentage Point Annually

Change in Spending

Budget authority -5.3 -10.7 -16.2 -22.0 -28.0 -34.3 -40.9 -47.8 -54.9 -62.2 -82.2 -322.3

Outlays -3.3 -7.9 -13.1 -18.6 -24.4 -30.5 -36.9 -43.5 -50.4 -57.5 -67.3 -286.1

Freeze Funding at 2011 Level

Change in Spending

Budget authority -8.7 -19.6 -31.4 -43.7 -57.3 -73.0 -89.4 -106.1 -122.7 -139.4 -160.7 -691.3

Outlays -5.5 -14.3 -25.0 -36.6 -49.4 -63.9 -79.5 -95.8 -112.1 -128.6 -130.8 -610.7

 Reduce Funding by 1 Percent Annually

Change in Spending

Budget authority -13.9 -30.0 -47.1 -64.4 -83.1 -103.8 -125.2 -146.8 -168.2 -189.8 -238.5 -972.3

Outlays -8.8 -22.1 -37.7 -54.3 -72.1 -91.5 -112.1 -133.2 -154.4 -175.7 -195.0 -861.9
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 75

CBO

appropriations were reduced by 1 percent per year from 

the current level (as described in the third alternative), 

funding would still be $10 billion more in 2021 than it 

would have been if appropriations had grown with inflation since 2001.

An argument for reducing defense spending is that doing 

so could reduce the deficit and promote economic 

growth by redirecting resources from soldiers and weapons to more-productive uses. Furthermore, U.S. defense 

expenditures are almost as large as the combined defense 

expenditures of all other nations. Proponents of this 

option might contend, therefore, that the United States 

could still field a relatively robust military force on a 

smaller budget. Moreover, many beneficiaries of U.S. 

defense spending, such as allied nations in Europe, have 

economies large enough to pay for more of their own 

defense.

An argument against cutting the growth in DoD’s appropriations is that the nation needs to maintain or increase 

defense spending to counter the increasingly sophisticated threats posed by current and potential adversaries. 

Weapon systems and facilities are aging, and the costs of 

replacing them with more-capable systems have grown. 

Further, the armed forces require sufficient military personnel to defend the nation’s interests abroad without 

overburdening service members with too-frequent 

deployments. In addition, the costs of military compensation, particularly health care costs, have been growing 

rapidly and will probably continue to do so. By CBO’s 

estimates, the multiyear plans that DoD had in place in 

2010 would involve costs that are almost $600 billion 

more than CBO’s baseline projections over the 2012–

2021 period.

RELATED CBO PUBLICATION: Long-Term Implications of the 2011 Future Years Defense Program, February 2011
76 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 2 Function 050

Cap Increases in Military Basic Pay

Between 2001 and 2009, per capita spending on three 

major components of cash compensation for active military personnel rose by 37 percent in inflation-adjusted 

dollars. Those components are basic pay and the basic 

allowances for housing and subsistence, of which basic 

pay is the largest element, averaging more than 70 percent of the total. Lawmakers typically use the percentage 

increase in the employment cost index (ECI) for privatesector workers’ wages and salaries as a benchmark for 

setting the annual increase in basic pay. In the 1990s, the 

military pay raise was generally set equal to the increase 

in the ECI or 0.5 percentage points below that amount. 

Over the past decade, in each calendar year from 

2001 through 2010, lawmakers approved pay raises—

including across-the-board increases and, on occasion, 

amounts targeted toward certain seniority levels—that 

exceeded the ECI by 0.5 percentage points for the average 

service member. Those pay increases boosted outlays not 

only in the years in which they took effect but also in 

subsequent years as the raises compounded.

Another element of cash compensation is the selective 

reenlistment bonus (SRB), an incentive typically offered 

to qualified enlisted personnel working in occupational 

specialties that have high training costs or demonstrated 

shortfalls in retention. Each service branch regularly 

adjusts its SRBs to address current retention problems, 

adding or dropping eligible specialties and raising or 

lowering bonuses. In addition, the Army pays a locationspecific SRB to all eligible soldiers who reenlist while they 

are deployed to certain locations, such as Afghanistan, 

Iraq, or Kuwait. Depending on the service branch, eligible personnel either receive the bonuses in a lump sum 

when they reenlist or receive half at reenlistment and the 

remainder in annual installments over the course of the 

additional obligation.

This option would cap the basic pay increase over a fouryear period: Specifically, from 2012 through 2015, basic 

pay raises would be set at a rate 0.5 percentage points 

below the increase in the ECI. Implementing this option 

would require new legislation to override current law, 

which stipulates that annual pay raises match the increase 

in the ECI. Although the prospect of lower basic pay 

raises would probably adversely affect retention, the effect 

is likely to be small. To alleviate any effect on retention 

during those four years, the service branches could 

increase bonuses for enlistment and reenlistment, step up 

recruiting efforts, or offer other benefits to service members. In estimating the budgetary impact of this option, 

the Congressional Budget Office assumed that the service 

branches would be able to keep overall retention constant 

through 2015 by boosting their spending on reenlistment 

bonuses while removing current restrictions on the 

maximum size of each bonus award. 

If implemented, the option would generate net savings of 

about $6 billion between 2012 and 2016 and $17 billion 

over the 2012–2021 period. Included in those figures are 

added costs for bonuses totaling about $920 million 

between 2012 and 2015 to offset the effects on retention 

of the lower pay raises for service members who had 

enlisted or previously reenlisted during the earlier period 

when pay was rising at the ECI rate or faster. Service 

members eligible for the additional bonuses between 

2012 and 2015 would receive higher overall pay than 

would be the case had pay kept pace with the ECI. After 

the four-year transition period, people would base their 

reenlistment decisions on a level of pay that was lower 

than would otherwise have prevailed. Although the lower 

pay could adversely affect recruiting and retention levels 

in future years, based on the success of DoD’s personnel 

management over the past several years—and the decline 

in the number of personnel deployed to Iraq and 

Afghanistan—CBO anticipates that DoD would be 

able to attain the desired levels in 2016 and beyond 

without continuing to pay the additional bonuses.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -280 -700 -1,130 -1,580 -2,090 -2,160 -2,240 -2,340 -2,450 -2,530 -5,780 -17,500

Outlays -270 -680 -1,100 -1,550 -2,060 -2,150 -2,230 -2,330 -2,430 -2,520 -5,660 -17,320
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 77

CBO

The rationale for this option is that, although DoD must 

offer a competitive compensation package to attract and 

retain the military personnel it needs, the annual increase 

in the ECI is not an appropriate benchmark for setting 

pay raises over the long run. The comparison group for 

the ECI includes a broad sample of civilian workers who, 

on average, are older than military personnel and more 

likely to have college degrees. Those workers have historically received larger pay increases than the younger workers who more closely match the demographic profile of 

military personnel. According to CBO’s analysis, median 

cash compensation for military personnel—including the 

tax-free cash allowances for food and housing—exceeds 

the salaries of most civilians who have comparable education and work experience. 

Another advantage of this option is that, by using SRBs 

to direct compensation to service members who are at a 

career decision point, as well as to specific occupational 

categories that are experiencing shortages, this option 

could maintain retention goals at a lower cost than the 

current plan that uses across-the-board pay raises to 

achieve retention (and other) goals. General pay increases 

would alleviate shortages in some occupations but would 

worsen surpluses in others. Also, unlike pay increases, 

bonuses would be more easily adjusted from year to year 

to match recruiting and retention goals. Finally, bonuses 

would avoid the added cost of elements of compensation, 

such as retirement benefits, that are tied to basic pay.

An argument against this option is that expansion of 

reenlistment bonuses at the expense of across-the-board 

increases in basic pay would amplify pay differences 

that exist among occupations and thus counter the military tradition of paying similar amounts to personnel 

with similar levels of responsibility. Capping basic pay 

would also reduce other benefits—including retirement 

annuities—that service members would receive throughout their career. Another argument is that the risks service 

members may be exposed to when overseas contingency 

operations are under way justify the across-the-board pay 

increases specified in current law.

RELATED CBO PUBLICATIONS: Statement of Carla Tighe Murray, Analyst, Congressional Budget Office, before the Subcommittee on Personnel, 

Senate Committee on Armed Services, Evaluating Military Compensation, April 28, 2010; Evaluating Military Compensation, June 2007; and 

Recruiting, Retention, and Future Levels of Military Personnel, October 2006
78 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 3 Function 050

Increase Medical Cost Sharing for Military Retirees Who Are Not Yet 

Eligible for Medicare

a. The Congressional Budget Office estimates that the actual increase in mandatory spending from implementing this option would be about 

$600 million over the 2012–2021 period. However, CBO’s January 2011 baseline reflects an assumption that there is some probability 

that the Department of Defense—without any Congressional action—will increase fees and copayments; therefore, some of the potential 

mandatory costs from implementing this option are already incorporated in the baseline projections. If the Congress enacted legislation 

mandating the policies discussed in this option, the mandatory cost relative to CBO’s baseline would be as shown in the table.

In the mid-1990s, the Department of Defense (DoD) 

created the TRICARE program to reform its system for 

providing health care for members of the military and 

their dependents, as well as for eligible military retirees 

and their families. About 15 percent of enlisted service 

members and approximately 50 percent of officers 

remain in the military for an entire career and therefore 

qualify for health care benefits as retirees. Because most 

military personnel enter the armed forces between the 

ages of 18 and 22 and are able to retire after serving 

20 years, they become eligible for retiree health care benefits at a relatively young age (as early as age 38) and retain 

some form of eligibility for the remainder of their lives.

TRICARE offers participants three different alternatives 

for obtaining health care coverage: a plan that operates 

like a health maintenance organization (HMO), called 

TRICARE Prime; a plan that operates as a preferredprovider network, called TRICARE Extra; and a traditional fee-for-service plan, called TRICARE Standard. 

Military retirees who are not yet eligible for Medicare 

(generally those ages 38 to 64) may enroll in TRICARE 

Prime by paying an annual enrollment fee of $230 (for 

single coverage) or $460 (for family coverage). In addition, those Prime enrollees make a $12 copayment for 

each outpatient visit to a civilian physician or other civilian health care provider. (Visits to military providers are 

free.) Retirees who do not choose to enroll in TRICARE 

Prime may receive benefits under TRICARE Extra or 

Standard without paying an enrollment fee. Participants 

in those plans must pay an annual deductible of $150 

(for single coverage) or $300 (for family coverage) before 

typical cost-sharing rates apply. TRICARE enrollment 

fees, copayments, and deductibles have not changed since 

1995.

Military retirees enrolled in TRICARE Prime incur 

smaller costs than they would owe under typical civilian 

plans for which they might be eligible (through their 

current employers, for example). DoD has estimated 

that, in 2009, a typical military retiree and his or her 

family who enrolled in the Prime plan incurred about 

$860 in annual out-of-pocket costs (that is, TRICARE 

copayments and the enrollment fee). By contrast, again 

according to DoD’s estimates, a similar retiree with family coverage who enrolled in an HMO through a civilian 

employment-based plan typically paid $5,200 in premiums (not including the share paid by his or her employer) 

and copayments. TRICARE Prime beneficiaries also use 

the system more than do comparable civilian beneficiaries: DoD estimates that Prime enrollees use services at 

rates that are higher by 77 percent for inpatient services 

and 55 percent for outpatient services than the rates for 

civilian HMO enrollees.1

This option would raise the enrollment fees, copayments, 

and deductibles for younger military retirees—those 

younger than 65—who wished to use TRICARE. Beneficiaries with single coverage could enroll in TRICARE 

Prime by paying a $550 annual fee, and those with family 

coverage could enroll for $1,100 annually. The family 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Discretionary Spending

Budget authority -900 -1,800 -2,500 -2,700 -3,000 -3,200 -3,500 -3,800 -4,000 -4,300 -10,900 -29,700

Outlays -700 -1,500 -2,300 -2,600 -2,900 -3,100 -3,300 -3,600 -3,900 -4,200 -10,000 -28,100

Change in Mandatory Outlaysa 10 20 40 40 40 50 50 60 60 70 150 440

1. Department of Defense, Evaluation of the TRICARE Program: 

FY2010 Report to Congress (February 28, 2010).
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 79

CBO

enrollment fee of $1,100 per year is approximately equivalent to the $460 fee first instituted in 1995, after adjusting for the nationwide growth in health care spending per 

capita. Under this option, each medical visit to a Prime 

provider in the civilian network would entail a copayment of $30, which, again, is approximately equivalent to 

the amount that was established in 1995. Copayments 

for mental health visits and inpatient care would also be 

adjusted accordingly. Single retirees (or their surviving 

spouse) who used TRICARE Standard or Extra would 

face an annual deductible of $350; the annual deductible 

for families would be $700. Those increases would also 

be consistent with the nationwide growth in per capita 

health care spending. In addition—and for the first 

time—users of TRICARE Standard or Extra would be 

required to enroll and pay a $50 annual fee for single coverage or a $100 annual fee for family coverage. All of 

those new or increased fees, copayments, and deductibles 

would be indexed in the future to reflect the nationwide 

growth in per capita spending for health care.

The Congressional Budget Office estimates that if 

TRICARE fees, copayments, and deductibles were modified according to this option, discretionary outlays for 

DoD’s TRICARE program would be reduced, on net, by 

about $28 billion over the 2012–2021 period, assuming 

that appropriations would be reduced accordingly. But 

the option could cause some eligible retirees to switch to 

other federal programs, such as Medicaid (if the individual has low income), the Federal Employees Health Benefits (FEHB) program (if the person is employed as a civilian by the federal government), or programs of the 

Veterans Health Administration. This option would 

increase mandatory spending for Medicaid and for FEHB 

annuitants by about $440 million over the same period. 

(Total additional costs would be greater, but some have 

already been incorporated in the baseline. See the note to 

the above table.) The estimates do not include the reduction in individual income and payroll tax revenues that 

might result from a shift of some labor compensation 

from a taxable to a nontaxable form.

One rationale for this option is that TRICARE coverage 

and space-available care at military treatment facilities 

were originally considered a supplement or a safety net to 

ensure the availability of health care for military retirees 

and their dependents, not as a replacement for benefits 

offered by postservice civilian employers. The migration 

of retirees from civilian to TRICARE coverage is one 

factor behind the rapid increase in TRICARE spending 

since 1999, which may mean that fewer resources are 

available for DoD to purchase and maintain weapon 

systems and other equipment or for other defense 

priorities. This option would begin to curtail the growth 

in health care costs, freeing those resources for other 

important uses.

An argument against changing access to TRICARE coverage for military retirees and their dependents is that 

those retirees made decisions about continuing their 

period of active-duty service with the understanding that 

they would receive medical care free or at a very low cost 

after retiring from the military. Significant limitations on 

TRICARE coverage for military retirees and their dependents would impose a financial cost on many of those 

beneficiaries and could adversely affect military retention. 

Another potential disadvantage of this option is that the 

health of users who remained in TRICARE might suffer 

if they were discouraged from seeking health care or treating their illnesses in a timely manner because of higher 

copayments. However, their health might not be affected 

significantly if the higher copayments fostered more disciplined use of medical resources and only discouraged 

the use of low-value health care. 

RELATED OPTIONS: Discretionary Spending, Option 5; and Mandatory Spending, Option 1

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; The Effects of Proposals to 

Increase Cost Sharing in TRICARE, June 2009; and Growth in Medical Spending by the Department of Defense, Issue Brief, September 2003
80 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 4 Function 050

Limit the TRICARE Benefit for Military Retirees and Their Dependents

a. The Congressional Budget Office estimates that the actual increase in mandatory spending from implementing this option would be about 

$4.5 billion over the 2012–2021 period. However, CBO’s January 2011 baseline reflects an assumption that there is some probability that 

the Department of Defense—without any Congressional action—will increase fees and copayments; therefore, some of the potential 

mandatory costs from implementing this option are already incorporated in the baseline projections. If the Congress enacted legislation 

mandating the higher cost sharing discussed in this option, the mandatory cost in comparison with CBO’s baseline would be as shown in 

the table.

The Department of Defense (DoD) provides medical 

care to military beneficiaries through the TRICARE program, which combines access to military hospitals and 

clinics with coverage for services received from civilian 

health care providers. Currently, military retirees and 

their dependents who are not yet eligible for Medicare 

represent about 40 percent of the TRICARE-eligible 

population. Those beneficiaries may use one of three 

plans: TRICARE Standard (a fee-for-service plan allowing free choice of providers but subject to coinsurance 

and deductibles), TRICARE Extra (a preferred provider 

plan offering lower coinsurance when using network providers), or TRICARE Prime (a managed care plan with 

lower out-of-pocket costs but a small annual enrollment 

fee).1

 About three-quarters of all retired military beneficiaries not yet eligible for Medicare have access to 

employer-sponsored insurance through civilian employment.2

 Because the out-of-pocket cost of TRICARE coverage has grown much more slowly since 1995 than the 

corresponding costs under insurance provided by most 

civilian employers, many of those beneficiaries have 

dropped their employer-sponsored coverage in favor of 

full-time reliance on TRICARE. In 1999, 55 percent of 

military retirees and their dependents had signed up for 

other health insurance, but by 2009 that figure had 

dropped to 29 percent. TRICARE spending more than 

doubled in real terms over that same 10-year period.

This option would preclude military retirees and their 

dependents from enrolling in TRICARE Prime, which is 

the TRICARE option with the lowest out-of-pocket 

cost.3

 Military retirees and their dependents could enroll 

in TRICARE Standard or Extra during the annual open 

enrollment period or when a life event occurred (for 

example, a change in marital status, birth of a child, or 

change in employment status). Enrollees would pay a 

monthly enrollment fee that would be set at 28 percent of 

the cost of providing benefits for that group, to be 

updated annually based on the average cost the group 

incurred in the previous year. In addition, the catastrophic cap (maximum out-of-pocket expenses) for military retirees and their dependents would be raised from 

the current $3,000 per family to $7,500 per family, the 

level at which it was set before January 2002. That catastrophic cap would increase in future years, with changes 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Discretionary 

Spending

 Budget authority -3,000 -6,800 -10,100 -10,800 -11,500 -12,200 -13,000 -13,700 -14,600 -15,400 -42,200 -111,100

 Outlays -2,300 -5,800 -9,100 -10,300 -11,100 -11,800 -12,500 -13,300 -14,100 -14,900 -38,600 -105,200

Change in Mandatory Outlaysa 100 200 400 400 400 500 500 600 600 600 1,500 4,300

1. While beneficiaries must enroll (and pay the enrollment fee) to 

use TRICARE Prime, enrollment is not required for beneficiaries 

choosing TRICARE Standard or Extra. Beneficiaries over age 65 

or otherwise eligible for Medicare may be covered by TRICARE 

For Life, a plan designed to wrap around the Medicare program. 

See Mandatory Spending—Option 1. 

2. When beneficiaries have other health insurance, TRICARE currently acts as second payer to the other insurance plan. Whether a 

bill is handled under TRICARE Extra or Standard depends on 

whether or not the provider is a part of one of the regional 

TRICARE provider networks.

3. Active-duty personnel would continue to be enrolled automatically in TRICARE Prime, and Prime enrollment would remain 

available for dependents of active-duty personnel. The enrollment 

fee and most cost sharing would continue to be waived for activeduty service members and their dependents. 
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 81

CBO

indexed to nationwide growth in per capita health care 

spending.

Military retirees and their dependents would still have the 

option of seeking care at no cost on a space-available basis 

at military treatment facilities. However, such patients are 

considered lower priority than active-duty service members and their dependents, and as a result, they might 

have difficulty obtaining such space-available care. For 

that reason, military retirees and their dependents would 

have an incentive to obtain other coverage rather than 

rely on military treatment facilities as their main source of 

medical care.

Those changes in TRICARE coverage options for military retirees and their families would bring the value of 

TRICARE coverage closer to that of health plans available through civilian employment. The Congressional 

Budget Office anticipates that among this group of beneficiaries, the share relying entirely on TRICARE would 

drop by half, from 71 percent to 35 percent. In addition, 

for those who did not enroll and pay an annual premium, 

TRICARE would no longer act as secondary payer to 

civilian health insurance, thereby reducing federal outlays 

for the 29 percent of beneficiaries who currently have 

civilian health insurance (and who presumably would 

continue that coverage). For those who do enroll in 

TRICARE, the higher cost sharing under TRICARE 

Standard or Extra (as compared with TRICARE Prime) 

would reduce the use of health care services by many beneficiaries. However, some retirees and their dependents 

might turn to other federal programs for which they may 

be eligible rather than to private civilian options. As a 

result, CBO anticipates that some additional costs would 

be incurred by the Veterans Health Administration, the 

Medicaid program, and the Federal Employees Health 

Benefits plan. 

CBO estimates that this change would reduce discretionary outlays by $39 billion over the 2012–2016 period 

and by $105 billion over the 2012–2021 period. 

CBO projects that approximately 35 percent of military 

retirees and their dependents would sign up for 

TRICARE under the new rules outlined in this option 

and that increases in cost sharing would also result in a 

decrease in DoD’s per capita spending on that group of 

beneficiaries. CBO estimates that the change would 

increase mandatory spending for the Medicaid program 

and for health benefits for annuitants by $4 billion over 

the 2012–2021 period. (Total costs would be greater, but 

some have already been incorporated in the baseline. See 

the note to the above table.) The estimates do not include 

the reduction in the individual income and payroll tax 

revenues that might result from a shift of some labor 

compensation from a taxable to a nontaxable form.

One rationale for this option is that TRICARE coverage 

and space-available care at military treatment facilities 

were originally considered a supplement or a safety net to 

ensure the availability of health care for military retirees 

and their dependents, not as a replacement for benefits 

offered by postservice civilian employers. The rapid 

increase in TRICARE spending since 1999 can be traced 

in part to a migration of retirees from civilian to 

TRICARE coverage. In an era of fiscal constraint, rapidly 

rising health care costs may result in fewer resources available for DoD to purchase and maintain weapon systems 

and other equipment or to use for other defense budget 

priorities. This option would begin to curtail the growth 

in health care costs, freeing those resources for other 

important uses.

An argument against changing access to TRICARE coverage for military retirees and their dependents is that 

those retirees made decisions about continuing their 

period of active-duty service with the understanding that 

they would receive free or very low-cost medical care after 

retiring from the military. Significant limitations on TRICARE coverage for military retirees and their dependents 

would impose a financial cost on many of those beneficiaries and could adversely affect military retention.

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; The Effects of Proposals to 

Increase Cost Sharing in TRICARE, June 2009; and Growth in Medical Spending by the Department of Defense, Issue Brief, September 2003
82 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 5 Function 050

Increase Cost Sharing for Pharmaceuticals Under TRICARE

a. The Congressional Budget Office estimates that the actual savings in mandatory spending from implementing this option would be about 

$20 billion over the 2012–2021 period. However, CBO’s January 2011 baseline reflects an assumption that there is some probability that 

the Department of Defense—without any Congressional action—will increase copayments for prescription drugs; therefore, some of the 

potential savings from implementing this option are already incorporated in the baseline projections. If the Congress enacted legislation 

mandating the higher cost sharing discussed in this option, the savings relative to CBO’s baseline would be as shown in the table.

The TRICARE program provides health care for the military’s uniformed personnel and retirees and for their 

dependents and survivors. In total, more than 9 million 

people are eligible to use TRICARE’s integrated system 

of military health care facilities and regional networks of 

civilian providers under contract to the Department of 

Defense (DoD). Beneficiaries may take their prescriptions to military pharmacies, which fill prescriptions 

written by any qualified provider, whether military or 

civilian, in or outside of TRICARE’s network. Beneficiaries who prefer not to use military pharmacies may take 

prescriptions to retail pharmacies in the TRICARE network or use TRICARE’s mail-order pharmacy. In 2009, 

DoD spent more than $8 billion on outpatient pharmacy 

benefits. 

Cost sharing for pharmaceuticals—in the form of a 

copayment for each prescription filled—varies not only 

by the type of drug but also by where the prescription is 

filled. Beneficiaries pay nothing for prescriptions filled at 

military pharmacies, although those facilities tend to be 

located on military bases and may be less convenient than 

a retail pharmacy for some beneficiaries. Military pharmacies carry only generic drugs and brand-name drugs in 

the TRICARE formulary (the list of drugs that the plan 

covers). Beneficiaries who fill their prescriptions at retail 

pharmacies pay $3 for a 30-day supply of generic drugs, 

$9 for the same supply of brand-name drugs in the 

TRICARE formulary, and $22 if the drug is not listed in 

the formulary. Alternatively, they may order a 90-day 

supply by mail; copayments for mail-order prescriptions 

are also $3, $9, or $22 for generic, formulary, or nonformulary drugs, respectively, but the beneficiary receives 

a 90-day supply for that copayment, compared with a 30-

day supply from retail pharmacies. Finally, beneficiaries 

who choose to fill prescriptions at retail pharmacies that 

are not part of the TRICARE network must meet a 

deductible (which varies by military rank) and bear 

greater cost sharing than beneficiaries who choose other 

alternatives.

This option would raise the copayments for pharmaceuticals under the TRICARE plan. Active-duty service 

members would continue to receive their prescriptions at 

no cost from those pharmacies, but all other beneficiaries 

would pay $3 for generics and $9 for brand-name pharmaceuticals on the TRICARE formulary when purchasing the drugs from military pharmacies. Prescriptions 

filled at participating network retailers would cost the 

beneficiaries $15, $25, or $45 for a 30-day supply of 

generic, formulary, or nonformulary pharmaceuticals, 

respectively. Prescriptions filled by mail order would cost 

$9, $27, or $45 for a 90-day supply of generic, formulary, 

or nonformulary pharmaceuticals, respectively.

The Congressional Budget Office estimates that this 

option would save about $10 billion over the period from 

2012 to 2016 and about $26 billion over the next 

10 years, relative to CBO’s baseline projections. (Total 

savings would be greater, but some are already incorporated in the baseline. See the note to the above table.) 

About half of the savings would be attributed to pharmacy spending by beneficiaries eligible for Medicare and 

would be classified as mandatory. The other half of the 

savings would be subject to annual appropriation acts. 

DoD’s outlays would be reduced, in part, because the 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Discretionary Spending

Budget authority -600 -1,000 -1,100 -1,100 -1,200 -1,300 -1,500 -1,600 -1,700 -1,900 -5,000 -13,000

Outlays -500 -900 -1,000 -1,100 -1,200 -1,300 -1,400 -1,600 -1,700 -1,800 -4,700 -12,500

Change in Mandatory Outlaysa -500 -900 -1,000 -1,100 -1,300 -1,400 -1,500 -1,700 -1,900 -2,000 -4,800 -13,300
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 83

CBO

increased cost-sharing payments would directly offset 

some of the government’s cost for the pharmaceuticals. 

In addition, the higher copayments would induce some 

people who otherwise would have used the TRICARE 

program to rely instead on a civilian pharmacy benefit—

one available through their spouse’s employment, for 

example.

A rationale for this option is that larger copayments 

would foster more disciplined use of medical resources 

and discourage low-value treatments. In an era of fiscal 

constraint, rapidly rising health care costs may result in 

fewer resources available for DoD to purchase and 

maintain weapon systems and other equipment. This 

option would begin to curtail the growth in health care 

costs, freeing those resources for other defense priorities. 

An argument against this option is that the larger copayments might impose a financial strain on some beneficiaries, who might terminate their use of the TRICARE 

pharmacy benefit and risk harming their health. The 

health of people who continue to use the TRICARE benefit, moreover, might suffer if they are discouraged from 

treating their illnesses with pharmaceuticals in a timely 

manner or from completing a drug treatment regimen in 

the face of higher copayments.

RELATED OPTIONS: Discretionary Spending, Option 3; and Mandatory Spending, Option 1

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; The Effects of Proposals to 

Increase Cost Sharing in TRICARE, June 2009; and Growth in Medical Spending by the Department of Defense, Issue Brief, September 2003
84 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 6 Function 050

Consolidate the Department of Defense’s Retail Activities and Provide a Grocery 

Allowance to Service Members

The Department of Defense (DoD) operates four retail 

systems on military bases: a network of grocery stores 

(commissaries) that serves all branches of the armed 

forces and three separate chains of general retail stores 

(exchanges). One system of exchanges serves the Army 

and Air Force, a second serves the Navy, and a third serves 

the Marine Corps. This option would consolidate those 

systems into a single retail system that would operate 

more efficiently and without any appropriated subsidy. 

Like the current separate systems, the consolidated system would give military personnel access to low-cost groceries and other goods at all DoD installations, including 

those in isolated or overseas locations.

The existing commissary and exchange systems operate 

under very different funding mechanisms. The commissary system, which is run by the Defense Commissary 

Agency (DeCA), has yearly sales of about $6 billion, but 

it also receives an annual appropriation of about $1.3 billion. The three exchange systems have annual sales that 

total about $12 billion. They receive no direct appropriations; instead, they rely on sales revenue to cover most of 

their costs. A relatively small portion of their costs, such 

as expenses for transporting merchandise overseas, is paid 

from appropriations elsewhere in the defense budget.

The exchanges can operate without an appropriated subsidy because they charge customers a higher markup over 

wholesale prices than commissaries do. Also, because the 

exchange systems are nonappropriated-fund (NAF) 

entities—that is, they rely mostly on funds generated 

from sales to finance their operations instead of appropriations from the federal government—they have more 

flexibility in business practices for personnel and procurement. By contrast, DeCA’s employees are civil service 

personnel, and it must follow standard federal procurement practices. This option is based on the assumption 

that consolidating the four retail systems would eliminate 

duplicative administrative functions and that DeCA’s 

civil service employees would be converted to the NAF 

workforce.

Under this option, the commissary and exchange systems 

would be consolidated over a five-year period. At the end 

of that period, the budget authority required to operate 

the combined system would be lower by almost $2 billion per year. This option would return about a third of 

that amount to active-duty service members through a 

tax-free grocery allowance to each of the roughly 1.4 million active-duty service members. The grocery allowance 

would be phased in to coincide with the consolidation of 

commissary and exchange stores at each base. The net 

annual savings in budget authority by 2016 would be a 

little over $1 billion. Outlay savings to DoD over the 

next decade would total about $8 billion.

To operate within budget and without appropriated 

funds, the consolidated system would have to charge 

about 7 percent more for groceries and other merchandise. At the current volume of sales at the commissaries 

and exchanges, a 7 percent increase in prices would cost 

military personnel—active-duty, reserve, and retired—

and their families an additional $1.4 billion annually.

Active-duty members and their families would pay about 

$400 more per year, on average, but that amount would 

be offset by the new grocery allowance. Cash allowances 

would be particularly attractive to personnel who lived 

off base and could shop more conveniently near home or 

online. All military families would benefit from longer 

store hours, one-stop shopping, access to private-label 

groceries (which are not currently sold in commissaries), 

and the greater certainty inherent in a military shopping 

benefit that did not depend on the annual appropriation 

process. Another advantage is that the $400 average 

grocery allowance could be targeted toward specific pay 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority 0 -200 -500 -900 -1,200 -1,200 -1,200 -1,300 -1,300 -1,300 -2,800 -9,100

Outlays 0 -100 -400 -700 -1,000 -1,200 -1,200 -1,200 -1,300 -1,300 -2,200 -8,400
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 85

CBO

grades or groups, with larger allowances given to enhance 

retention or to benefit junior enlisted members with large 

families, for example.

DoD’s retail system would benefit as well. Commissaries 

and exchanges must now compete with online retailers 

and the large discount chains that have opened discount 

grocery and general merchandise stores just outside the 

gates of many military installations. Recent tightening of 

base security procedures and changes in the civilian retail 

industry have made it more difficult and costly for DoD’s 

fragmented retail systems to provide those services. This 

option would allow a consolidated system staffed by NAF 

employees to better compete with civilian alternatives.

One argument against consolidation is that about 

$750 million of the price increases would be borne by the 

military retirees who shop in commissaries and exchanges 

but who, under the option, would not receive grocery 

allowances. The average family of a retired service member would pay about $325 more per year for groceries.

RELATED CBO PUBLICATIONS: Statement of Carla Tighe Murray, Analyst, Congressional Budget Office, before the Subcommittee on Personnel, 

Senate Committee on Armed Services, Evaluating Military Compensation, April 28, 2010; and Evaluating Military Compensation, June 2007
86 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 7 Function 050

Replace the Joint Strike Fighter Program with F-16s and F/A-18s

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The F-35 Joint Strike Fighter (JSF) program is the military’s largest aircraft development program. The program’s objective is to design and produce three versions of 

the stealthy aircraft: a conventional takeoff version for the 

Air Force; a carrier-based version for the Navy; and a 

short takeoff vertical landing (STOVL) version for the 

Marine Corps. The Departments of the Navy and the Air 

Force placed orders for 101 F-35s from 2007 through 

2011 and anticipate purchasing 2,342 more from 2012 

through 2035. The Department of Defense (DoD) has 

estimated that, including the cost to complete development, the remaining cost for those purchases will amount 

to about $260 billion. (All three versions of the aircraft 

are still in the developmental stage and will not enter 

operational service for several years.)

Under this option, DoD would cancel the F-35 program 

and instead purchase the most advanced versions of 

fighter aircraft already in production: the Lockheed Martin F-16 for the Air Force, and the Boeing F/A-18 for the 

Navy and Marine Corps. If those aircraft were purchased 

at the rates planned for the F-35, the option would 

decrease outlays by about $27 billion over the next five 

years. Over the longer term, the option would save 

$48 billion through 2021 and $78 billion if the entire 

planned fleet of F-35s—not all of which would be purchased within the 10-year budget window—was replaced 

with F-16s and F/A-18s.

The Congressional Budget Office’s estimate of savings 

under this option is based on information from DoD’s 

latest available Selected Acquisition Report. Since that 

report was prepared, DoD has announced that the JSF 

program has experienced substantial cost increases and 

schedule delays. CBO lacked sufficient details about 

those changes to produce a revised estimate of the 

savings that could be realized under this option. Savings 

from canceling the F-35 program would probably be 

significantly greater than CBO’s estimate for the entire 

production run (now likely to include purchases beyond 

2035, if production quantities remain unchanged). How 

much the potential savings over the next 5 or 10 years 

will change depends on the degree to which purchases are 

postponed to accommodate delays in development and 

increases in cost.

An argument in favor of this option is that—if equipped 

with upgraded modern radar, precision weapons, and 

digital communications—new F-16s and F/A-18s would 

be sufficiently advanced to meet the threats that the 

nation is likely to face in the foreseeable future. The 

extreme sophistication of the F-35 and the additional 

technical challenge of building three distinct types of aircraft with a common airframe and engine have resulted in 

significant cost growth and schedule delays. Although the 

F-35 program was recently restructured and further 

changes have been announced, additional cost growth 

and schedule delays remain a possibility. The cost of 

upgrading the other aircraft also could escalate, but their 

lesser technical challenges relative to the F-35 would 

make comparable cost growth unlikely. Because the Air 

Force and the Navy project that planned production rates 

for the F-35 would be insufficient to meet inventory 

goals as older aircraft needed to be retired, schedule 

delays for that aircraft could be particularly problematic.

A disadvantage of this option is that F-16 and F/A-18 aircraft lack the stealth design features that would help the 

F-35 evade enemy radar and hence operate more safely in 

the presence of enemy air defenses. The services would 

maintain some stealth capability, however, with the B-2 

bomber and F-22 fighters already in the force. Any 

greater need for stealth capabilities that might arise in the 

future could be addressed with new, highly stealthy 

unmanned fighters and long-range bombers that the services plan to develop. Another potential disadvantage of 

(Billions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -8.5 -10.0 -7.1 -6.1 -4.4 -36.1

Outlays -1.9 -4.9 -7.1 -7.0 -6.0 -26.9
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 87

CBO

this option is that substituting F/A-18s for the F-35B—

the Marine Corps’ STOVL version of the F-35—would 

remove that service’s capability to operate fixed-wing 

fighters from the amphibious assault ships in naval expeditionary strike groups, a capability currently provided by 

the AV-8B Harrier. Those strike groups would be left to 

rely on armed helicopters (which lack the range, speed, 

payload, and survivability of the F-35) or on other forces, 

such as aircraft from aircraft carrier strike groups. 

RELATED OPTION: Discretionary Spending, Option 8

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; Strategies for Maintaining 

the Navy’s and Marine Corps’ Inventories of Fighter Aircraft, May 2010; and Alternatives for Modernizing U.S. Fighter Forces, May 2009
88 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 8 Function 050

Cancel the Navy and Marine Corps’ Joint Strike Fighters and Replace Those 

Aircraft with F/A-18E/Fs

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The Department of the Navy currently plans to purchase 

680 Joint Strike Fighters (JSFs) in two variants: the 

F-35B short takeoff vertical landing (STOVL) aircraft for 

the Marine Corps and the F-35C carrier-based aircraft 

for the Navy. (The Air Force is purchasing F-35As, which 

are conventional land-based fighters.) The department 

has already placed orders for 53 F-35s through 2011 and 

anticipates purchasing 627 more F-35s from 2012 

through 2026. The department has estimated that, 

including costs to complete development, the remaining 

cost for those purchases will amount to $82 billion. The 

F-35B and F-35C are still in the developmental stage and 

will not enter service for several years.

Under this option, the Department of the Navy would 

cancel its plans for further development and fielding of 

the F-35B and F-35C and instead purchase additional 

F/A-18E/F fighters currently in production. If those aircraft were purchased at the same rates planned for the 

department’s F-35s, the option would decrease outlays by 

$12 billion over the next five years and save nearly 

$18 billion through 2021. The projected savings take 

into account increased costs for the 660 F-35As the Air 

Force plans to purchase from 2012 through 2021. 

(Because the option would affect the JSF program as a 

whole—resulting in reduced annual production rates and 

fewer total aircraft being purchased—the Air Force’s costs 

for the F-35A would increase accordingly.) Including the 

higher estimated costs for the Air Force’s F-35As in years 

after 2021 reduces the projected long-term net savings 

under this option to $6 billion.

The Congressional Budget Office’s estimate of savings 

under this option is based on data from the latest available Selected Acquisition Report. Since that report was 

prepared, the Department of Defense has announced that 

the JSF program has experienced substantial cost growth 

and schedule delays. CBO lacked sufficient details about 

those developments to produce a revised estimate of the 

savings that could be realized under this option. Savings 

from canceling the program would probably be significantly greater than CBO’s estimate for the entire JSF production run (now likely to include purchases beyond 

2026 for the Navy and Marine Corps, if production 

quantities remain unchanged). How much the potential 

savings over the next 5 or 10 years would change depends 

on how purchase schedules change—specifically, to what 

extent purchases are postponed to accommodate schedule 

delays and cost increases.

An argument for this option is that because of the 

F/A-18E/F’s relatively new design, that aircraft is 

capable of meeting likely threats in the foreseeable 

future. In addition, the costs of producing the F/A-18E/F 

are well understood. Moreover, further delays in the production of F-35s could pose significant difficulties 

because the Navy is already projecting that production 

rates will not be sufficient to match the retirement rate 

of F/A-18A/B/C/D fighters, which are approaching the 

end of their structural service life. A middle course—

augmenting F-35B/C production with enough 

F/A-18E/F purchases to maintain inventory—would 

require higher than planned near-term funding to support the simultaneous production of both aircraft.

An argument against this option is that even though the 

F/A-18E/F was designed to incorporate stealth features 

that the smaller F/A-18C/D does not have, it is still far 

less stealthy than the F-35. Consequently, canceling the 

F-35 could limit naval aviation operations early in a conflict before enemy air defenses have been suppressed. 

That shortcoming could be mitigated if the Navy’s efforts 

to develop stealthy unmanned combat aircraft are 

successful. Another disadvantage of the option is that 

(Billions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -3.7 -5.4 -2.1 -1.7 -1.6 -14.5

Outlays -0.9 -2.6 -3.5 -2.8 -2.2 -12.0
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 89

CBO

substituting F/A-18s for the STOVL F-35B would mean 

that the Marine Corps could no longer operate fixedwing fighters from the amphibious assault ships in naval 

expeditionary strike groups or from locations ashore that 

cannot accommodate conventional fighters—capabilities 

that are currently offered by the AV-8B Harrier. In 

the absence of support by carrier- or land-based aircraft, 

the strike groups would have to rely on armed helicopters 

that do not have the same range, speed, payload, and 

survivability as the F-35. 

RELATED OPTION: Discretionary Spending, Option 7

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; Strategies for Maintaining 

the Navy’s and Marine Corps’ Inventories of Fighter Aircraft, May 2010; and Alternatives for Modernizing U.S. Fighter Forces, May 2009
90 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 9 Function 050

Cut the Number of Aircraft Carriers to 10 and the Number of Navy Air Wings to 9

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program. 

The Administration’s 2011 budget called for maintaining 

a fleet of 11 aircraft carriers and 10 active-duty naval air 

wings. For the 2013–2015 period, the number of carriers 

will temporarily fall to 10 as a result of the three-year gap 

between the decommissioning of the USS Enterprise in 

early 2013 and the commissioning of its replacement, the 

USS Gerald R. Ford, in late 2015. (The number of active 

air wings is one less than the number of carriers because, 

at any particular time, one of the Navy’s carriers is usually 

undergoing a major overhaul.) Aircraft carriers are also 

accompanied by a mix of surface combatants (usually 

cruisers and destroyers) and submarines to defend against 

aircraft, ships, and submarines that might threaten the 

carrier. The Navy calls such a force a carrier strike group.

This option would permanently reduce the carrier force 

to 10 and the number of air wings to 9. It would do so 

primarily by retiring a Nimitz class carrier, the USS 

George Washington, in 2016, when it is scheduled to 

undergo various maintenance activities and have its 

nuclear reactors refueled, an expensive and timeconsuming process. Those changes would save the refueling and overhaul costs that the Navy expects to incur 

between 2012 and 2017 (the Navy begins purchasing 

long-lead items several years before the refueling is scheduled), as well as the operating costs associated with the 

ship between 2017 and 2021 and thereafter. Overall, this 

option would save about $620 million in outlays over the 

2012–2016 period and about $7 billion over the 2012–

2021 period.

The savings in this option reflect the assumption that the 

Navy would permanently reduce the size of its force by 

5,600 sailors after the George Washington is decommissioned in 2016. Those savings would be partially offset, 

however, by the cost of decommissioning a Nimitz class 

nuclear-powered aircraft carrier, which involves removing 

the two nuclear reactor plants from the ship and placing 

them at a permanent storage site, as well as dismantling 

the ship. Decommissioning a Nimitz class carrier would 

eventually cost a total of about $2 billion, although only 

about $1 billion would be spent through 2021. 

Under this option, the other ships associated with a carrier strike group would be retained and deployed to support other Navy missions, so no additional savings related 

to other types of ships would be realized from the decommissioning. In addition, although the administrative 

structure of the retired air wing would be eliminated, the 

aircraft would be retained to reduce the shortfall between 

the Navy’s goals and the number of planes in its inventory. About 8 percent of the savings from this option 

would come from smaller accrual payments to the military retirement and health care trust funds as a result of 

the reduction in Navy personnel associated with removing the ship from the fleet. Although those accrual payments are intragovernmental transfers that would not 

represent current savings to the federal government, they 

are shown in the budget as savings to the Department of 

the Navy and represent long-term savings to the federal 

government as a whole.

The rationale for this option is that the Navy could carry 

out its mission with fewer aircraft carriers. Recent experience suggests that the Navy mobilizes 5 to 7 carriers to 

fight a major war, and the 10 carriers remaining in the 

fleet under this option would still provide a force of at 

least 5 or 6 carriers within 90 days to fight such a war. In 

addition, although the Navy would lose some ability to 

provide a carrier presence overseas, 10 carriers would be 

enough to provide full-time coverage in the western 

Pacific and the Arabian Sea, as well as coverage in the 

Mediterranean Sea for two or three months of the year. 

Some analysts have argued that because the Mediterranean region is more secure than it was during the Cold 

War, it no longer requires the continuous or nearly 

continuous presence of an aircraft carrier. Should the 

need for a carrier arise in the Mediterranean, the one in 

(Millions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -10 -250 -330 -470 -750 -1,810

Outlays 0 -30 -100 -180 -310 -620
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 91

CBO

the Arabian Sea could be sent there quickly via the Suez 

Canal, or a carrier could depart from Norfolk and arrive 

near Europe within 35 days.

An argument against this option is that having one less 

aircraft carrier increases the operational risk the Navy is 

taking because that carrier could be valuable in the event 

of a major conflict—in part because it has the flexibility 

to operate anywhere in the world without the permission 

of another country. Further, the U.S. military’s European, 

Central (Middle East), and Pacific Commands each have 

goals for full-time carrier presence in their respective 

regions. Under current crewing and operating practices, 

15 carriers would be needed to achieve that presence, and 

having one less carrier would move even farther away 

from that goal. In addition, the two wars since 1990 in 

the Mediterranean area (Bosnia and Kosovo) that 

involved the support of carrier strike groups, and the 

political unrest in that area, may indicate that having a 

carrier presence there would be particularly valuable.

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; and An Analysis of the 

Navy’s Fiscal Year 2011 Shipbuilding Plan, May 2010
92 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 10 Function 050

Cancel the Expeditionary Fighting Vehicle

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The Marine Corps’ expeditionary fighting vehicle (EFV) 

is a tracked armored vehicle that can travel at high speed 

through the water from a ship to land. The Marine Corps 

regards the EFV as essential for the conduct of amphibious warfare in the future, particularly for its concept of 

operational maneuver from the sea, in which troops 

deploy from ships and move directly to their intended 

objective far inland without pausing to build up additional forces on the beach. In a major amphibious assault 

from the sea, six brigades of Marines would deploy from 

amphibious ships to attack the enemy position. Four of 

those brigades would be equipped with EFVs, and the 

other two brigades would deploy from aircraft. According 

to the Marine Corps, the EFV represents a significant 

improvement over the existing amphibious assault vehicles (AAVs). The EFV is more survivable and can deploy 

with higher speed and from much greater distances than 

the AAVs. In particular, the EFV is intended to deploy 

from amphibious ships that are 25 nautical miles from 

the shore compared with only a few miles for the AAV. 

The higher speed and range provide the Marines with 

more flexibility as to where and when they land, making 

it more difficult for the enemy to defend against the 

assault. 

The Marine Corps plans to begin procuring the EFV in 

2012. Annual procurement costs would range from about 

$500 million to $1 billion between 2013 and 2025, when 

the program would end. The entire program would 

involve 574 EFVs at a total procurement cost of about 

$12 billion. The Marine Corps has already spent about 

$3 billion to develop the vehicle.

This option would cancel the program but provide a 

stream of research and development funds—and, eventually, procurement funds—that would enable the Marine 

Corps to come up with an alternative to the EFV. This 

option does not specify which alternative the Marine 

Corps would pursue in lieu of the EFV but simply 

reserves research, development, and procurement funding 

for an alternative. Such an alternative could involve a different tracked amphibious vehicle that “swims” ashore 

but is better suited for ground combat, for example, or a 

new ground combat vehicle that is ferried to shore by a 

high-speed, ship-to-shore connector craft. Savings over 

the 2012–2016 period would total about $2 billion. Savings over a longer period would depend on which alternative system emerged from research and development.

An argument for this option is that when the EFV was 

first conceived as a replacement for the AAV two decades 

ago, the prospective combat environment was very different. At that time it was thought that the proliferation of 

antiship cruise missiles would compel naval forces to 

operate 25 nautical miles from the shore; an amphibious 

vehicle would therefore need high speed and greater range 

to deploy from its ship. However, many supporters of this 

option observe that over the past 20 years the shore-based 

threats to naval forces have grown more diversified, 

sophisticated, and numerous; as a result, naval forces in 

the future may have to operate much farther than 25 nautical miles from an enemy shore to be able to protect 

themselves from antiship threats. In addition, new enemy 

tactics and threats have emerged from the insurgency 

campaigns in Iraq and Afghanistan that make the EFV 

particularly vulnerable during operations on land. To 

achieve high speed in getting ashore, the EFV is designed 

with a flat bottom. Once ashore, however, that flatbottom design, as well as other features of the EFV—its 

flat sides, low ground clearance, light armor, small interior space, and many hydraulic pressure lines throughout 

the inside—make the vehicle particularly vulnerable to 

tactics that employ improvised explosive devices (IEDs), 

mines, and antiarmor weapons. In short, optimizing the 

vehicle to get to shore quickly makes it much more vulnerable in a fight once it has reached land. Supporters of 

this option also argue that if the objective is to use the 

EFV’s range to land in places that are not heavily 

(Millions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -160 -520 -580 -590 -640 -2,490

Outlays -60 -160 -350 -480 -540 -1,590
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 93

CBO

defended, speed may be less important than the ability to 

engage in effective ground combat once the force has 

landed. In addition, the growing cost of the program 

could make it difficult for the Marine Corps to buy other 

needed ground equipment. 

An argument against this option is that the major criticisms of the EFV’s capabilities are overstated and that 

canceling the EFV is tantamount to abandoning the concept of major amphibious warfare. Under that argument, 

what is needed is an amphibious vehicle with the capability to get to shore quickly and then immediately move 

out and fight. Canceling the EFV now would at best 

mean relying on the aging AAV for years to come. Redesigning the EFV to make it less vulnerable to IEDs or 

mines would mean forgoing the flat bottom of the vehicle 

needed to achieve the high speed from the ship to shore. 

A better solution to the vehicle’s vulnerabilities, supporters of the EFV argue, would be to use more blast-resistant 

material in constructing the vehicle and to employ bolton armor when needed. Furthermore, the threat of IEDs 

and mines would be mitigated by the range of the EFV, 

which makes it difficult for the enemy to predict where 

the vehicle would land and therefore where to place IEDs 

and mines.

RELATED CBO PUBLICATION: Long-Term Implications of the 2011 Future Years Defense Program, February 2011
94 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 11 Function 050

Delay Fielding of the Army’s Ground Combat Vehicle

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The Ground Combat Vehicle (GCV) program is the 

Army’s latest attempt to design and field a new combat 

vehicle. Its previous attempt, the manned vehicle program that was part of the Army’s larger Future Combat 

Systems program was canceled in the spring of 2009. 

Army officials have stated that the service needs a vehicle 

large enough to carry and protect a full squad of nine 

infantry soldiers at one time. In order to meet its goal 

of fielding units equipped with GCVs beginning in 

2017, the Army would require appropriations totaling 

more than $10 billion through 2016: $8.6 billion for 

development—that is, to design, test, and evaluate the 

vehicle— plus almost $2 billion to procure the items 

needed to begin production. After 2016, the Army 

could need as much as $3 billion in funding annually 

to purchase 200 vehicles each year.

This option would delay the initial fielding of the GCV 

until 2025. From 2012 through 2021, funds currently 

planned for developing the GCV would be reduced to 

roughly $600 million per year, thereby decreasing the 

need for appropriations by more than $2 billion. Under 

this option, no procurement funding for the GCV would 

be provided between 2012 and 2021, which would 

reduce the need for appropriations by an additional 

$14 billion. Some of the savings would be used to 

develop and purchase upgrades for Bradley Fighting 

Vehicles because they will remain in the Army’s inventory 

through at least 2025, whether or not this option is 

implemented. Consequently, the total reduction in 

appropriations associated with this option would be 

roughly $7 billion through 2021, mostly between 2012 

and 2016. In total, this option would lower outlays by 

about $5 billion through 2016 and by almost $6 billion 

over the 2012–2021 period.

An argument in favor of this option is that it would give 

the Department of Defense and the Congress time to 

evaluate the need for the proposed GCV and to consider 

alternative vehicles, as some defense experts have suggested. Under the Army’s plan, GCVs would replace only 

about 25 percent of the armored vehicles that the service 

uses to transport soldiers on the battlefield. The Army 

would still rely on older vehicles that are based on the 

chassis of the M113 armed personnel carrier and on 

Bradley Fighting Vehicles to provide the bulk of its 

armored combat vehicles. The Army has already invested 

$27 billion between 2004 and 2010 to upgrade existing 

Abrams tanks and Bradley Fighting Vehicles and to purchase new Stryker vehicles, and continuing upgrades 

would still be required even if the Army proceeded with 

the GCV program.

An argument against this option is that if the Army eventually purchased some form of the GCV—because that 

vehicle would better meet the demands of current and 

future operations—delaying those purchases would push 

the costs out further into the future and perhaps increase 

the total costs over the very long run. It would also delay 

the fielding of a combat vehicle with greater capabilities 

than those currently available. For instance, the Bradley 

Fighting Vehicle cannot carry its own crew and a full 

infantry squad at the same time. Keeping a squad 

together, which the GCV would allow, would facilitate 

tactical planning while the force was moving. That capability would allow a squad to better synchronize its 

actions when it left the vehicle. In addition, the greater 

protection afforded by the GCV—especially against 

improvised explosive devices—would enhance the safety 

of soldiers who conduct the types of close operations 

among civilian populations that are becoming increasingly common. This option could increase the total cost 

of the program by adding eight extra years of research and 

development before achieving those goals.

A further argument against this option is that the Army 

has not fielded a new combat vehicle since the early 

1990s. Delaying the fielding of the GCV would mean 

(Millions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -1,600 -1,900 -1,100 -1,100 -300 -6,000

Outlays -600 -1,400 -1,400 -1,000 -700 -5,100
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 95

CBO

that an even larger portion of the Army would continue 

to use systems originally developed in the 1980s or earlier 

(although those systems have been updated several times 

since then). Some of those armored vehicles, notably the 

Abrams tank, are not fuel-efficient and require intensive 

maintenance. Improving the data processing and connectivity of those older systems would require that newer 

components be integrated into older frames, which can 

be a difficult process (although the exact costs are not easily estimated and are not included in the above estimate). 

Finally, retaining old systems might eventually cause the 

Army to lose its technological edge and compromise the 

service’s dominance on the battlefield.

RELATED CBO PUBLICATIONS: Long-Term Implications of the 2011 Future Years Defense Program, February 2011; and An Analysis of the 

Army’s Transformation Programs and Possible Alternatives, June 2009
96 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 12 Function 050

Terminate the Medium Extended Air Defense System Program

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The Medium Extended Air Defense System (MEADS) is 

an air and missile defense system under joint development by the United States, Germany, and Italy. It is 

intended to provide low- and medium-altitude defense 

against attack by short-range ballistic missiles, cruise missiles, unmanned aerial vehicles, and other airborne weapons. The program includes two types of radar, as well as 

command-and-control systems, missile launchers, and an 

interceptor missile. MEADS is slated to replace and 

improve on the capabilities of the Patriot system, which is 

approaching the end of scheduled production of its interceptor missiles. As a result of delays in the development 

of the MEADS interceptor, production of the Patriot 

Advanced Capability-3 (PAC-3) interceptor was extended 

into 2011, two years beyond its planned end date. 

This option would terminate MEADS development. 

In place of the new system, the option would continue 

production of Patriot interceptors and initiate an engineering effort to maintain and improve the Patriot 

system. To estimate the savings from canceling MEADS, 

the Congressional Budget Office has relied on plans 

described in the December 2009 Selected Acquisition 

Report for MEADS, which calls for procurement of 

about 1,000 interceptors and 16 complete fire units over 

the next 10 years. CBO estimates that canceling MEADS 

would save about $4 billion in outlays over the next five 

years and $13 billion over a decade. The 10-year savings 

would come from discontinuing research and development for the MEADS system (about $3 billion) and ending the procurement of MEADS equipment (almost 

$11 billion). In this option, the 5- and 10-year savings 

would be partially offset by continuing to improve and 

procure Patriot systems, including ground equipment; 

CBO has assumed that nearly $400 million per year 

would be spent on that effort, sufficient to procure 

40 interceptors per year and provide $100 million per 

year for engineering support and upgrades. CBO 

estimates that the net savings for this option would be 

about $3 billion over the next five years and nearly 

$10 billion over a decade. In a February 2011 fact sheet, 

the Department of Defense (DoD) indicated that it may 

end participation in MEADS development after 2013 

and not procure any operational MEADS systems; under 

those circumstances, CBO’s estimates of savings would 

change. CBO’s estimates do not include any costs associated with canceling the contract.

An argument in favor of this option is that the program 

has experienced technical difficulties, and development of 

the MEADS interceptor has exceeded DoD’s thresholds 

for both cost growth and schedule delay. In addition, 

some critics of the program argue that MEADS may not 

provide effective protection. Defense Daily, for example, 

on August 27, 2010, cited an internal Army memo that 

advocates “harvesting MEADS technologies and improving the Patriot program it was designed to replace,” on 

the basis of concerns that MEADS technical requirements do not address current and emerging threats.

An argument against this option is that the capability 

improvements intended for MEADS may be valuable for 

addressing the ballistic and cruise missile threats that U.S. 

forces may face in the future. In its 2009 report, Ballistic 

and Cruise Missile Threat, DoD’s National Air and Space 

Intelligence Center concluded that “ballistic and cruise 

missiles present a significant threat to U.S. and Allied 

forces” that “continues to increase with the proliferation 

of missile technology.” Also, because MEADS involves 

international collaboration, canceling the program would 

require negotiations with the program partners, which 

might prove diplomatically sensitive.

(Millions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -730 -630 -610 -740 -1,630 -4,340

Outlays -250 -500 -550 -570 -970 -2,840

RELATED CBO PUBLICATION: Long-Term Implications of the 2011 Future Years Defense Program, February 2011
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 97

CBO

Discretionary Spending—Option 13 Function 050

Terminate the Precision Tracking Space System Program

Note: Estimates of savings displayed in the table are based on the fiscal year 2011 Future Years Defense Program and CBO’s extension of 

that program.

The Precision Tracking Space System (PTSS), currently 

being designed by the Missile Defense Agency (MDA), is 

intended to be a constellation of low-Earth-orbit satellites 

that track enemy ballistic missiles and distinguish enemy 

warheads from decoys (a process known as discrimination). The newest in a set of evolving concepts for missile 

defense that relies on satellite-based infrared tracking, the 

program supersedes the Space Tracking and Surveillance 

System (STSS) program. The design of PTSS will draw 

on knowledge gained from two STSS demonstration satellites, which were launched in September 2009 and are 

gathering data that will be used to assess the performance 

of onboard sensors. Existing plans call for one or more 

PTSS prototypes to be fielded initially, followed shortly 

by an operational constellation of 6 to 12 satellites.

This option would terminate the PTSS program. To estimate the savings from ending the program, the Congressional Budget Office assumed that the operational constellation would consist of 9 satellites, with the first to be 

launched in about 2019. Estimated savings would be 

about $1 billion over the next five years and about 

$7.5 billion over a decade. The 10-year savings would be 

realized by not starting research and development for the 

new satellites (about $2.5 billion) and by not buying, 

launching, and operating them (almost $5 billion). 

CBO’s estimates do not include any savings that might 

arise from not building and launching replacement satellites after the initial constellation reached the end of its 

design life. (Construction of replacement satellites would 

begin within the next decade if the design life of the 

PTSS satellite was less than seven years.)

An argument in favor of this option is that the feasibility 

of operating infrared sensors in space for the purposes of 

discrimination has not yet been established. Another 

argument is that the constellation might not provide 

enough added value to justify the cost because programs 

that MDA and the Air Force plan to operate simultaneously with the PTSS also would provide some ability to 

track and discriminate enemy warheads. MDA has 

recently developed and fielded deployable surface-based 

radars for missile defense, including the Sea-Based 

X-Band (SBX) and the AN/TPY-2 radar systems, and has 

upgraded several early-warning radars to enhance the 

nation’s ability to track ballistic missiles. MDA’s plans to 

deploy surface-based radar close to Iran and North Korea 

will provide tracking and discrimination information 

much earlier in the flight of ballistic missiles from those 

countries than have previous approaches. MDA has also 

begun research into using infrared sensors onboard 

unmanned aerial vehicles to track ballistic missiles. In 

addition, the Air Force is improving its missile-warning 

capability with the Space-Based Infrared System (SBIRS)-

High constellation—satellites in highly elliptical orbits 

are currently in operation, and the first launch of a 

SBIRS-High GEO (geosynchronous) satellite is planned 

for 2011. The sensors on those satellites will also be able 

to track ballistic missiles early in their flight.

An argument against this option is that the data being 

gathered from the STSS demonstration satellites might 

show that space-based infrared sensors would be effective 

and valuable for tracking and discriminating warheads 

launched on enemy ballistic missiles. Reliance on a combination of ground-based radars and airborne infrared 

systems would probably not match the broad geographic 

coverage offered by a full constellation of PTSS satellites 

and thus would reduce the nation’s ability to track ballistic missiles through all phases of flight for some missile 

trajectories. The PTSS may also have greater capability to 

track missile salvos—multiple missiles launched nearly 

simultaneously—than those other systems.

(Millions of dollars) 2012 2013 2014 2015 2016 Total, 2012–2016

Change in Spending

Budget authority -120 -180 -350 -480 -450 -1,580

Outlays -60 -140 -250 -380 -440 -1,270

RELATED CBO PUBLICATION: Long-Term Implications of the 2011 Future Years Defense Program, February 2011
98 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

All Discretionary Activities Other Than Defense Discretionary Spending—Option 14 Multiple Functions

Reduce Growth in Appropriations for Agencies Other Than the 

Department of Defense

The budgets of 14 cabinet-level agencies (excluding the 

Department of Defense [DoD]); 21 large independent 

agencies; and more than 80 commissions, boards, foundations, and other federal entities account for almost 

50 percent of all discretionary resources.1

 The Departments of Health and Human Services, Education, Transportation, Veterans Affairs, and Homeland Security 

received just over half of those funds in 2010. 

Aside from DoD and Postal Service personnel, the federal 

government spent approximately $175 billion in 2010 on 

about 1.3 million civilian employees, the large majority 

of whom were paid with discretionary appropriations. 

The federal government also makes about $250 billion in 

discretionary grants to state and local governments. The 

variety of programs that federal agencies administer 

provide a wide range of options for absorbing budget cuts 

of various magnitudes. Those cuts could be targeted 

toward selected agencies, leaving most federal programs 

unaffected, or they could be distributed more evenly 

among many of them, avoiding the need to drastically 

reduce or eliminate any particular program.

This option includes three broad alternatives for reducing 

the growth in discretionary funding for nonmilitary 

departments and agencies—that is, excluding appropriations for DoD—relative to the baseline budget projections of the Congressional Budget Office:2

B Limit the rate of growth in non-DoD discretionary 

resources to an average of 1.2 percent a year, beginning in 2012; that rate of growth is 1 percentage point 

less than the rate of growth in CBO’s baseline and 

would reduce outlays by just over $325 billion (or 

5 percent) over the 2012–2021 period. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Reduce Growth by 1 Percentage Point Annually

Change in Spending

Budget authority -6.2 -12.6 -19.2 -26.0 -33.0 -40.4 -48.0 -56.0 -64.2 -72.8 -97.0 -378.4

Outlays -3.4 -8.6 -14.7 -21.1 -27.8 -34.9 -42.2 -49.9 -57.9 -66.2 -75.6 -326.7

Freeze Funding at 2011 Level

Change in Spending

Budget authority -7.5 -19.4 -33.0 -46.7 -62.0 -79.5 -97.6 -116.2 -134.6 -153.4 -168.6 -749.9

Outlays -4.1 -12.7 -24.3 -37.0 -51.1 -67.1 -84.2 -102.2 -120.3 -139.0 -129.2 -642.0

Reduce Funding by 1 Percent Annually

Change in Spending

Budget authority -13.8 -31.8 -51.5 -71.3 -92.5 -116.0 -139.9 -164.4 -188.5 -213.1 -260.9 -1,082.8

Outlays -7.5 -21.3 -38.5 -57.1 -77.1 -99.0 -122.0 -145.7 -169.6 -194.0 -201.5 -931.8

1. Discretionary resources include budget authority and limitations 

on the availability of mandatory budget authority (called obligation limitations) that are provided in appropriation acts.

2. This option considers changes in discretionary funding for all 

agencies other than the Department of Defense. Thus, the option 

includes funding for agencies that receive some appropriations 

that are classified under national defense (budget function 050)—

for example, certain activities of the Departments of Energy, 

Homeland Security, and Transportation—as well as most other 

budget functions. 
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 99

CBO

B Freeze those discretionary resources at the annualized 

level for 2011 under the continuing resolution that 

was in effect in February 2011, thereby reducing 

outlays by $642 billion (or 10 percent) over the 2012–

2021 period. 

B Reduce those resources by 1 percent each year from 

the 2011 level, thus decreasing outlays by about 

$932 billion (or 15 percent) over the same period. 

Under that alternative, non-DoD discretionary 

resources would be reduced to their 2008 funding 

level—in nominal terms—by 2021. Appropriations in 

2021 would be reduced by $213 billion (or 27 percent) compared with the baseline amount. That 

reduction is roughly equivalent to the total discretionary resources projected under CBO’s baseline assumptions for the Departments of Health and Human 

Services, Veterans Affairs, and Agriculture. 

Over the past 10 years, discretionary funding (other than 

for DoD) has increased by about 60 percent, or by more 

than 30 percent after adjusting for inflation. Thus, federal agencies would have more buying power than they 

had a decade ago even if their budgets were reduced substantially relative to the amounts in CBO’s baseline. If 

those discretionary resources had grown at the rate of 

inflation since 2001 and continued to do so through 

2021, they would total $592 billion in 2021—$185 billion less than the baseline amount. If those resources were 

reduced by 1 percent annually from the current level (as 

described in the third alternative), budget authority in 

2021 would be $27 billion less than it would have been if 

funding had grown with inflation since 2001. 

One rationale for reducing discretionary spending is that 

it has been growing faster than inflation and the size of 

the economy, thereby diverting ever more resources from 

the private sector, restraining economic growth, and contributing to the increase in federal deficits and debt. Discretionary outlays for programs other than DoD’s averaged 3.7 percent of gross domestic product (GDP) in the 

1990s and climbed to 4.7 percent of GDP in 2010; those 

outlays would decline to between 2.4 percent and 

2.9 percent of GDP in 2021 under the alternatives in this 

option. Furthermore, some observers believe that many 

programs spend money ineffectively and that there is little relationship between expenditures and results; thus, 

reductions could be made with little negative impact on 

individuals or on the economy.

An argument against cutting non-DoD discretionary 

funding is that it supports important programs such as 

education, infrastructure, housing, and law enforcement, 

among others. Providing those services to a growing 

population could be difficult if spending declined to 

historically low levels as a percentage of GDP, as it would 

under the alternatives in this option. In the current 

budget environment, state and local governments would 

have difficulty compensating for reductions in federal 

expenditures. Implementation could be challenging as 

well; discretionary appropriations, which are comparable 

in amount with DoD’s appropriations, are widely distributed among more than 100 agencies. Implementing welltargeted cuts in those appropriations would therefore be 

much more challenging than making such cuts in DoD’s 

spending.
100 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Energy Discretionary Spending—Option 15 Function 270

Eliminate the Department of Energy’s Grants to States for 

Energy Conservation and Weatherization

The Weatherization and Intergovernmental Program, 

which is administered by the Department of Energy 

(DOE), provides grants that help fund state and local 

government programs for energy conservation and the 

weatherization of buildings. Some grants provide lowincome households with insulation, storm windows, and 

weather stripping. Institutional grants help reduce energy 

use at educational, municipal, and health care facilities 

and fund local efforts to encourage private investment in 

building improvements. Other grants support efforts by 

state and municipal governments to establish energyefficiency standards for new and remodeled buildings 

and to promote energy-saving practices such as carpooling and the use of public transportation. In 2010, 

DOE received regular appropriations of about $230 million to provide grants to states and municipalities for 

energy conservation and building weatherization. The 

American Recovery and Reinvestment Act of 2009 

(ARRA, Public Law 111-5) provided an additional 

$8.1 billion.

This option would eliminate new funding for the grants 

that DOE provides to state and local governments 

through its Weatherization and Intergovernmental 

Program. Ending that funding would save about 

$900 million over the next five years and more than 

$2 billion over the 2012–2021 period.

One rationale for eliminating new funding for the grants 

is that the funding provided in 2009 should be sufficient 

to cover several years’ worth of weatherization activity; 

the appropriation provided by ARRA was roughly eight 

times the normal amount of funding provided in an average year for weatherization activities across all federal 

programs. Another rationale is that other federal 

programs—such as the Low Income Home Energy 

Assistance Program, which is administered by the 

Department of Health and Human Services, and DOE’s 

own Building Energy Codes Program—are doing similar 

work. Moreover, direct federal funding may encourage 

state and local governments to reduce their own support 

for energy conservation and weatherization and to 

redirect that support to other uses. In the extreme, if 

federal funding simply substituted dollar-for-dollar for 

what a state or local government otherwise would have 

spent, then that federal spending would have no net 

effect on energy conservation.

One argument against such a policy change is that many 

states rely heavily on federal grants to improve the energy 

efficiency of low-income housing and public institutions. 

Eliminating DOE’s energy conservation and weatherization grants could make it harder for states to continue to 

promote such efforts. A second argument is that the 

grants support policies the federal government should 

consider a priority—specifically, those designed to reduce 

emissions of greenhouse gases and other air pollutants 

from natural gas and electric power generation. Eliminating the DOE grant program could result in fewer 

resources being allocated for such purposes. Finally, 

weatherization and energy conservation limit the effects 

that higher energy prices have on public and household 

budgets. Ending DOE’s grants would have a particularly 

adverse impact on the programs’ beneficiaries—primarily 

low-income households (who devote a larger-thanaverage share of their income to energy bills) and public 

institutions—especially if energy prices were to rise over 

time.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -253 -257 -261 -266 -271 -277 -283 -288 -294 -300 -1,308 -2,750

Outlays -73 -138 -193 -239 -264 -269 -274 -280 -285 -291 -907 -2,306
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 101

CBO

Discretionary Spending—Option 16 Function 270

Reduce Department of Energy Funding for Energy Technology Development

Since 1978, the Department of Energy (DOE) has spent 

more than $45 billion to develop new technologies in the 

areas of fossil fuels, nuclear power, and energy efficiency 

and renewable energy (EERE). Currently, a variety of 

DOE programs support research and development 

(R&D) of those energy technologies and their commercial demonstration. Spending for such efforts peaked in 

the 1980s and declined during the following 20 years, 

but funding began to increase again in 2006. Many lawmakers have questioned the value of those technology 

development programs and have considered whether 

DOE should cut back on programs to develop near-term 

energy technologies and concentrate instead on basic 

research in those fields.

This option would reduce spending for technology development in the fossil, nuclear, and EERE R&D programs 

to 25 percent of their 2011 levels. The Congressional 

Budget Office estimates that, in total, those reductions 

would reduce discretionary outlays by about $4 billion 

over the 2012–2016 period and by about $11 billion over 

10 years. The specific activities that would be eliminated 

in those programs are those that focus on the later stages 

of technology development, the demonstration of commercial feasibility, and the deployment of new technologies. (This option would not affect funds for technical 

assistance and financial assistance, such as weatherization 

services for low-income families. See Discretionary 

Spending—Option 15.)

An argument for this option is that some of DOE’s activities are better undertaken by the private sector, which 

has an advantage in the development, demonstration, 

and deployment of new energy technologies. Generally, 

the direct feedback that the markets provide to private 

investors has proved more cost-effective than the judgment of government managers in selecting which technologies will be successful in the market. The limits on 

the government’s ability to foster new energy technologies 

are illustrated by DOE’s Partnership for a New Generation of Vehicles (PNGV). The original goal of PNGV 

research was a production-ready vehicle powered by a 

hybrid (diesel and electric) motor for U.S. automakers. 

Foreign car manufacturers, pursuing similar technologies 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Reduce Funding for Fossil Energy Research, Development, and Demonstration

Change in Spending

Budget authority -110 -223 -340 -346 -352 -360 -367 -375 -382 -390 -1,371 -3,245

Outlays -22 -75 -158 -233 -287 -319 -339 -351 -358 -366 -775 -2,508

Reduce Funding for Nuclear Energy Research, Development, and Demonstration

Change in Spending

Budget authority -125 -255 -389 -396 -403 -412 -421 -430 -440 -449 -1,568 -3,720

Outlays -75 -188 -318 -376 -398 -408 -417 -426 -435 -444 -1,355 -3,485

Reduce Funding for Energy Efficiency and Renewable Energy Research, Development, and Demonstration

Change in Spending

Budget authority -245 -498 -759 -773 -788 -805 -823 -841 -859 -877 -3,063 -7,268

Outlays -71 -205 -374 -496 -578 -653 -721 -773 -807 -829 -1,724 -5,507

Total, All of the Above Programs

Change in Spending

Budget authority -480 -975 -1,488 -1,515 -1,543 -1,577 -1,612 -1,645 -1,681 -1,716 -6,001 -14,232

Outlays -168 -468 -850 -1,105 -1,263 -1,380 -1,477 -1,550 -1,600 -1,639 -3,854 -11,500
102 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

in a small-sized car, were ultimately the first to supply—

and subsequently dominate—the U.S. market for small 

hybrid cars. Similarly, in the area of fossil energy development, DOE has long sought to introduce new energy 

technologies through expensive technology demonstration plants that have often failed to deliver commercially 

useful knowledge. Accordingly, proponents of this option 

would scale back DOE’s efforts to support applied 

research and the commercialization of new technologies 

and shift resources to favor DOE’s support of basic and 

early applied research, which is less likely to be undertaken by the private sector. 

Another argument for this option is that federal agencies 

have too many conflicting policy goals to implement a 

program of investments efficiently, as would be required 

for large technology demonstration projects. The 

Government Accountability Office (GAO) has long 

been critical of DOE’s project management, pointing to 

inadequate oversight of contractors and to projects that 

failed to meet expectations for costs or schedules. Despite 

DOE’s attempts at reform, GAO concluded in 2007 that 

DOE’s performance had not improved substantially 

because new management processes had not been applied 

consistently. 

Other arguments focus on the merits of specific programs. Regarding R&D related to nuclear energy in 

particular, some observers question the wisdom of pursuing new technologies as long as electric utilities—the 

intended recipients—are not building new nuclear 

plants. Since many state policymakers moved to 

deregulate the electricity-generation market in the 1990s, 

investors have generally shied away from building capitalintensive generating facilities, preferring to rely on less 

expensive natural gas facilities instead. Recent developments suggest that the natural gas required to power 

those new generators will remain cheap and plentiful for 

the foreseeable future, casting further doubt on the financial viability of nuclear-powered generators. 

In the EERE area, which includes energy conservation as 

well as solar, wind, and other renewable energy sources, 

the federal government provides support through other 

means. Many of the technologies whose development is 

supported by the EERE programs also receive the tax 

credit for renewable electricity production or conservation-related tax credits. Furthermore, several of the EERE 

industries enjoy high rates of growth. Given the tax preferences and the high level of market penetration, some 

analysts argue that it may be time to begin withdrawing 

federal commitments for further technology development 

in those areas. 

An argument against this option is that federal support 

may be needed because the prices businesses and consumers pay for energy do not compensate for the potentially 

large long-run costs of climate change. Reducing emissions of greenhouse gases would diminish those costs, but 

because those costs are not reflected in current energy 

prices, producers and consumers have little incentive to 

manufacture or purchase products that reduce energy 

consumption or produce energy with minimal greenhouse gas emissions. Thus, some observers argue that 

DOE’s energy technology development programs fill a 

gap left by the market by providing the resources and 

incentives necessary to develop new technologies to 

produce and conserve energy. 

In addition, most analysts agree that investors in many 

sectors, not just energy, do not receive all the benefits of 

investment in R&D because others also benefit from the 

knowledge gained. That result suggests a possible need 

for federal support to ensure that adequate R&D takes 

place. Because society gains even if the original investor 

does not capture all the benefits, it is argued, the federal 

government should invest in R&D to compensate for the 

gap between all the benefits that accrue to society and 

those that the original investors receive. 

Finally, some analysts assert that DOE’s technology 

development programs are a worthwhile activity on their 

own merits. Panels convened by the National Academy of 

Sciences have estimated that some of DOE’s technology 

development programs, especially in the area of energy 

efficiency, have provided substantial benefits that exceed 

their costs.
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 103

CBO

Discretionary Spending—Option 17 Function 300

Eliminate Federal Grants for Wastewater and Drinking Water Infrastructure 

To protect the quality of the nation’s waters and the safety 

of its drinking water, the Environmental Protection 

Agency (EPA) administers provisions of the Clean Water 

Act of 1972 (CWA) and the Safe Drinking Water Act of 

1974 (SDWA). Both laws authorize the federal government to provide grants that capitalize state revolving 

funds (SRFs). SRFs, in turn, offer financial assistance—

market-rate and subsidized loans, loan or bond guarantees, and bond purchases, for example—to communities 

building or replacing wastewater and drinking water systems to meet or maintain federal standards. For 2010, 

EPA received an appropriation of about $3.6 billion for 

such grants, including $2.1 million for clean-water SRFs, 

$1.3 billion for drinking water SRFs, and $200 million 

for grants to specific communities and locales. This 

option would phase out EPA’s grants to SRFs over three 

years, reducing federal outlays by $6 billion through 

2016 and by $25 billion over 10 years.

In 1987, amendments to the CWA phased out a program 

of direct construction grants for wastewater treatment 

facilities and replaced it with SRFs. States match federal 

contributions to the SRFs at a rate of 20 cents on the dollar and operate them within broad limits, defining eligible projects, choosing the terms of assistance, and setting 

priorities. In 2009, 78 percent of the loans—23 percent 

of total funding from clean-water SRFs—went to communities with populations under 10,000. Authorization 

for the SRF program under the CWA has expired, but the 

Congress continues to provide annual appropriations for 

grants, allocating them to states according to the shares 

specified in the 1987 amendments. 

Amendments to the SDWA in 1996 authorized EPA to 

make grants to capitalize SRFs for drinking water systems. Although generally modeled on the wastewater 

program, the SDWA program allocates funding using a 

formula based on the results of EPA’s quadrennial 

“Drinking Water Infrastructure Needs Survey.” States 

must establish a priority-setting system that focuses on 

reducing the greatest health risks and achieving compliance with SDWA standards, taking into account the 

financial needs of local water systems. 

One justification for this option is that the grants could 

encourage inefficient decisions about water infrastructure 

because they allow states to lend money at below-market 

interest rates, which in turn reduces incentives for local 

governments to find the least costly ways to control water 

pollution and provide safe drinking water. Another 

rationale is that responsibility for water systems properly 

lies with state and local governments. Federal contributions to wastewater SRFs originally were viewed as a temporary step on the way to full state and local financing. 

Moreover, those contributions may not increase total 

investment in water systems if they merely replace funding that state and local sources would have provided 

otherwise. 

An argument against such cuts is that the need to replace 

aging infrastructure, improve the safety of the drinking 

water, and protect the nation’s waters is so great that federal aid should be increased, not reduced. In particular, 

given the budgetary pressures on states, water systems in 

many small or economically disadvantaged communities 

could not maintain the quality of their service and

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1,490 -2,260 -3,840 -3,900 -3,970 -4,050 -4,130 -4,210 -4,300 -4,380 -15,460 -36,530

Outlays -60 -420 -1,100 -2,010 -2,810 -3,330 -3,610 -3,770 -3,890 -3,990 -6,400 -24,990
104 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

comply with the CWA’s and the SDWA’s new and forthcoming requirements without federal funding. Another 

argument against this option is that eliminating the federal grants would force even large systems, which tend to 

have lower costs because of economies of scale, to charge 

rates that would pose significant hardships for low- and 

moderate-income households.

RELATED CBO PUBLICATIONS: Trends in Public Spending on Transportation and Water Infrastructure, 1956 to 2004, August 2007; Letter to the 

Honorable Don Young and the Honorable James L. Oberstar regarding future spending on water infrastructure, January 31, 2003; and Future 

Investment in Drinking Water and Wastewater Infrastructure, November 2002
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 105

CBO

Discretionary Spending—Option 18 Function 300

Increase Fees for Use of the Inland Waterway System 

Note: Fees collected under this option could be recorded in the budget as offsetting collections (discretionary), offsetting receipts (usually 

mandatory), or revenues, depending on the legislative language used for their establishment.

The Army Corps of Engineers spent about $900 million 

in 2010 on the nation’s system of inland waterways. 

About 30 percent of those expenditures were devoted to 

the construction of new navigation channels, locks, and 

other infrastructure, and about 70 percent paid for the 

operation and maintenance of existing infrastructure. 

Current law allows up to half of the Corps’ new construction on inland waterways to be funded with revenues 

from a tax on fuel consumed by towboats (which use 

most segments of the system); the remaining costs of construction and expenditures for operation and maintenance are financed through appropriations not tied to the 

revenue source. 

This option would set fees high enough to cover all the 

costs of constructing, operating, and maintaining inland 

waterways. Those fees could take the form of higher fuel 

taxes, charges for the use of locks, or assessments based on 

the weight of transported goods and the distance those 

goods travel. If implemented, the option would boost 

collections (and thus reduce net spending) by $2 billion 

over five years and by $4 billion through 2021.

The principal rationale for this option is that it would 

increase economic efficiency. Imposing fees on the basis 

of the actual cost associated with keeping the inland 

waterway system open would encourage firms that 

arrange for goods to be shipped—producers or logistics 

specialists—to choose the most efficient routes and 

modes of transportation (which in some cases might 

involve transport by rail or highway or by another water 

route). In addition, more efficient use of existing waterways could alleviate congestion and perhaps curtail the 

demand for new construction. Any congestion that 

remained when fees covered costs would serve as a useful 

signal of market demand, giving the Corps better information about which additional construction projects 

would be likely to provide the greatest net benefits. 

The effects of such fees on efficiency would depend 

largely on whether they were set at the same rate for all 

segments of a waterway or were based on each segment’s 

operating costs. Because costs vary substantially from one 

segment to another, systemwide fees would offer weaker 

incentives for the efficient use of resources. 

An argument against this option is that higher fees might 

slow economic development in some regions that depend 

on waterway commerce. Although the increase could be 

phased in to ameliorate those effects, doing so would 

reduce revenues in the near term. Imposing higher fees 

also would reduce the income of barge operators and 

shippers in some areas, although those losses would be 

small in the context of overall regional economies. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -109 -228 -355 -483 -494 -506 -518 -531 -544 -558 -1,669 -4,326

Outlays -109 -228 -355 -483 -494 -506 -518 -531 -544 -558 -1,669 -4,326

RELATED CBO PUBLICATION: Paying for Highways, Airways, and Waterways: How Can Users Be Charged? May 1992
106 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Commerce Discretionary Spending—Option 19 Function 370

Eliminate the International Trade Administration’s Trade Promotion Activities or 

Charge the Beneficiaries

The Manufacturing and Services unit of the International 

Trade Administration (ITA) in the Department of Commerce strives to enhance the competitiveness of U.S. 

industries and to increase exports. ITA also operates the 

U.S. Commercial Service, which is the trade promotion 

arm of the agency. The service counsels domestic businesses on issues related to exports and engages in trade 

advocacy for U.S. companies. It charges fees for those services, but the fees do not cover the costs of all activities. 

This option encompasses two alternatives: eliminating 

ITA’s trade promotion activities or charging the beneficiaries for those services. Either change would save about 

$2 billion through 2016 and almost $4 billion over the 

2012–2021 period. 

The principal rationale for eliminating ITA’s trade promotion activities is that such business activities are usually better left to the companies and industries that are 

likely to benefit rather than to a government agency. In 

addition, having the government engage in such activities 

(without charging the beneficiaries for their full cost) is 

an expensive means of helping U.S. businesses because 

the benefits are partially passed on to consumers and 

firms abroad in the form of lower prices for U.S. exports. 

Hence, the cost to taxpayers is likely to be larger than the 

benefit to U.S. businesses. Furthermore, in its 2008 evaluation using the Program Assessment Rating Tool, the 

Office of Management and Budget concluded that 

businesses can obtain services similar to those offered by 

ITA from state, local, and private-sector entities. 

An argument against eliminating ITA’s trade promotion 

activities is that they may be subject to some economies 

of scale, so having one entity (the federal government) 

counsel exporters about foreign legal and other requirements, disseminate information about foreign markets, 

and promote U.S. products abroad might make sense. 

An alternative way to reduce net federal spending but 

continue ITA’s activities would be to charge the beneficiaries for their full costs. Fully funding ITA’s trade promotion activities through voluntary charges, however, could 

prove difficult. In many cases, it would be impossible to 

promote the products of selected businesses that were 

willing to pay for such promotion without also promoting the products of other companies in the same industry. 

In those circumstances, there would be little incentive for 

companies to purchase ITA’s services because they would 

probably accrue benefits regardless of whether they paid 

for them. Consequently, if the federal government 

wanted to charge beneficiaries for ITA’s services, it might 

have to require that all companies in an industry (or the 

industry’s national trade group) decide collectively 

whether to buy the services. If an industry chose to purchase the services, all of the companies in the industry 

would be required to pay according to some equitable 

formula. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -335 -343 -352 -362 -373 -385 -399 -412 -425 -438 -1,765 -3,824

Outlays -285 -332 -347 -357 -367 -380 -393 -406 -419 -432 -1,688 -3,718

RELATED CBO PUBLICATIONS: The Decline in the U.S. Current-Account Balance Since 1991, Issue Brief, August 2004; and Causes and 

Consequences of the Trade Deficit: An Overview, March 2000
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 107

CBO

Transportation Discretionary Spending—Option 20 Function 400

Limit Highway Funding to Expected Highway Revenues

Note: Outlays for the highway program are controlled by limitations on obligations set in appropriation acts rather than by contract authority 

(a mandatory form of budget authority) set in authorizing law. This option assumes that the contract authority is reduced to equal the 

obligation limitations presented here.

The Federal-Aid Highways Program provides grants to 

states for highway and other surface transportation projects. The last reauthorization for the highway program—

the Safe, Accountable, Flexible, Efficient Transportation 

Equity Act of 2005 (Public Law 109-59)—expired in 

2009 and has been temporarily extended several times 

since then. Highway funding is provided as contract 

authority, a type of mandatory budget authority. However, most spending from the program is controlled by 

annual limitations on obligations set in appropriation 

acts. 

Historically, most of the funding for highway programs 

has come from the Highway Trust Fund, which has two 

accounts. In 2010, the fund’s highway account spent 

$32.0 billion and was credited with $30.2 billion in 

revenues. The fund also includes a mass transit account. 

Revenues credited to both accounts are generated by the 

federal taxes on gasoline and diesel fuels, as well as other 

federal taxes related to highway transportation. Since 

2001, outlays from the highway account have been outpacing revenues credited to it by an average of about 

$2.8 billion per year. Because of that gap, the Congress 

has supplemented revenues dedicated to the trust fund 

with three separate transfers totaling $29.7 billion from 

the Treasury’s general fund. In addition, the American 

Recovery and Reinvestment Act of 2009 (P.L. 111-5) 

appropriated $27.5 billion for highway programs from 

the general fund. About half of that amount—$14.2 billion—was spent in 2009 and 2010; the Congressional 

Budget Office estimates that the remaining amount will 

be spent over the next several years.

This option would reduce federal funding for the highway system, starting in fiscal year 2012, by lowering the 

obligation limitation for the Federal-Aid Highways 

Program to the amount of projected revenues going to 

the highway account of the Highway Trust Fund. The 

federal taxes that directly fund the Highway Trust Fund 

would not change. CBO estimates that this option would 

reduce resources provided for the highway program by 

almost $48 billion from 2012 through 2016 and by 

about $108 billion over 10 years. Outlays would decrease 

by about $33 billion over the 2012–2016 period and 

$86 billion over the 2012–2021 period, CBO estimates.

A key rationale for this option is that federal funding for 

highways should come from highway users, not general 

taxpayers: first, because it is fairer if those who benefit 

from government spending pay for those benefits; and 

second, because resources are allocated most efficiently 

when beneficiaries pay and will therefore consider those 

user costs when determining their behavior. In that view, 

if the Congress believes that higher levels of federal support for highways are appropriate, it should increase the 

taxes that are credited to the Highway Trust Fund. 

Another rationale for this option is that shifting more 

responsibility for highway construction and maintenance 

costs to the states not only would give the states stronger 

incentives to focus on projects with the greatest net benefits but also could reduce the substitution of federal 

spending for spending by state and local governments. 

(The Government Accountability Office reported in 

2004 that the existence of federal highway grants has 

encouraged state and local governments to reduce their 

own spending on highways and to allocate those funds 

for other uses.) Supporters of this option might also contend that the revenues credited to the highway account of 

the trust fund are sufficient to fund an appropriate share 

of all highway projects with true interstate significance—

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -9.3 -9.3 -9.4 -9.6 -9.9 -10.6 -11.4 -12.1 -12.9 -13.6 -47.5 -108.1

Outlays -2.3 -6.2 -7.6 -8.1 -8.7 -9.2 -9.8 -10.6 -11.2 -11.9 -32.9 -85.6
108 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

and those are the projects that should be the primary 

responsibility of the federal government. 

An argument against this option is that the government 

should spend more on roads and bridges to offset the 

effects of aging and increased traffic. Federal support for 

the road network as a whole is appropriate, moreover, 

because even local roads support interstate commerce and 

strengthen the national economy—for example, by 

allowing Internet retailers to operate with large economies of scale. Another argument against this option is 

that the use of general taxpayer funds to supplement 

trust fund revenues from highway users is appropriate 

because money from the Highway Trust Fund is spent 

on nonhighway projects and purposes, such as public 

transit, sidewalks, bike paths, recreational trails, scenic 

beautification, and preservation of historic transportation 

structures. 

RELATED CBO PUBLICATIONS: Spending and Funding for Highways, Issue Brief, January 2011; Using Pricing to Reduce Traffic Congestion, 

March 2009; Issues and Options in Infrastructure Investment, May 2008; and Statement of Donald B. Marron, Acting Director, Congressional 

Budget Office, before the Subcommittee on Highways, Transit, and Pipelines, House Committee on Transportation and Infrastructure, CBO’s 

Projections of Revenues for the Highway Trust Fund, April 4, 2006
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 109

CBO

Discretionary Spending—Option 21 Function 400

Eliminate Grants to Large and Medium-Sized Hub Airports

Note: Outlays for the grants to large and medium-sized airports are controlled by limitations on obligations set in annual appropriation acts 

rather than by contract authority (a mandatory form of budget authority) set in authorizing law. This option assumes that the contract 

authority is reduced to equal the obligation limitations presented here.

Under the Airport Improvement Program (AIP), the 

Federal Aviation Administration (FAA) provides grants 

to airports to expand runways, improve safety and 

security, and make other capital investments. In 2010, 

about 30 percent of that money went to airports that 

are classified, on the basis of the number of passenger 

boardings, as large and medium-sized. Those airports—

currently, there are 65, although the number fluctuates 

from year to year—account for nearly 90 percent of 

passenger boardings.

This option would eliminate the AIP’s grants to large and 

medium-sized airports but would continue to provide 

grants to smaller airports in amounts that match funding 

in 2010. That year, smaller airports received $2.4 billion, 

more than two-thirds of the $3.5 billion available under 

the program. Retaining only that portion of the program 

would reduce federal outlays by about $4 billion through 

2016 and by almost $10 billion over the 2012–2021 

period. 

The AIP, like some other transportation programs, is 

treated in an unusual way in the budget. The program’s 

budget authority is provided in authorization acts as contract authority, a mandatory form of budget authority. 

But because the spending of contract authority is subject 

to obligation limitations contained in appropriation acts, 

the resulting outlays are categorized as discretionary. 

The main rationale for this option is that federal grants 

simply substitute for funds that larger airports could raise 

from private sources. Because those airports serve many 

passengers, they generally have been able to finance 

investments through bond issues as well as passenger 

facility charges and other fees. Smaller airports may have 

more difficulty raising funds for capital improvements, 

although some have been successful in tapping the same 

sources of funding as their larger counterparts. By eliminating grants to larger airports, this option would focus 

federal spending on airports that appear to have the 

fewest alternative sources of funding.

One argument against ending federal grants to large and 

medium-sized airports is that those airports currently lack 

the flexibility to substitute private sources of funding for 

reduced federal grants because of provisions of federal law 

that limit the amount that airports can charge passengers 

to finance capital projects.

Another argument against ending such grants is that they 

allow the FAA to retain greater control over how those 

airports spend their funds by imposing conditions for aid.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1,070 -1,090 -1,100 -1,120 -1,140 -1,170 -1,190 -1,220 -1,240 -1,270 -5,520 -11,610

Outlays -200 -660 -900 -1,020 -1,110 -1,140 -1,160 -1,180 -1,210 -1,230 -3,890 -9,810

RELATED CBO PUBLICATIONS: Financing Small Commercial-Service Airports: Federal Policies and Options, April 1999; and The Economic 

Effects of Federal Spending on Infrastructure and Other Investments, June 1998
110 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 22 Function 400

Increase Fees for Aviation Security

Note: Fees collected under this option could be recorded in the budget as offsetting collections (discretionary), offsetting receipts (usually 

mandatory), or revenues, depending on the legislative language used for their establishment.

The attacks of September 11, 2001, led to sweeping 

changes to increase security in the nation’s transportation 

systems. One major change occurred when the Aviation 

and Transportation Security Act of 2001 made the federal 

government, rather than airlines and airports, responsible 

for screening passengers, carry-on luggage, and checked 

baggage. Implementing the new standards required the 

hiring of screeners who were more highly qualified and 

trained, necessitating increased compensation and raising 

overall security costs. 

To help pay for increased security, the law directed 

airlines to charge passengers a fee, remitted to the government, of $2.50 for a one-way trip with no stops and 

$5.00 for a trip with one or more stops. The 2001 law 

also authorized the government to impose fees on the 

airlines themselves and to reimburse airlines, airport 

operators, and service providers for the costs of security 

enhancements. In 2010, the Transportation Security 

Administration collected $2.1 billion from the fees on 

passengers and airlines—less than half of the $5.5 billion 

federal aviation security budget that year.

This option would increase fees to cover a greater portion 

of the federal government’s costs for aviation security. 

Passengers would pay a flat fee of $5 per one-way trip 

because travelers typically pass through security screening 

only once per one-way trip. Implementing the option 

would boost collections (and thus reduce net spending) 

by about $10 billion through 2016 and by almost 

$21 billion over the 2012–2021 period. Under standard 

budgetary treatment, the collections would be classified 

as revenues, but because the Aviation and Transportation 

Security Act requires that revenues from the existing fees 

be recorded as offsets to federal spending, the budgetary 

impact of this option is presented that way. 

The arguments for and against this option rest on the 

principle that the beneficiaries of a service should pay for 

it. The differences lie in who is seen as benefiting from 

such measures. A justification for the option is that the 

primary beneficiaries of transportation security enhancements are the users of the system. Security is viewed as a 

basic cost of airline transportation in the same way that 

fuel and labor costs are. The current situation, in which 

those costs are covered partly by taxpayers in general and 

partly by users of the aviation system, provides a subsidy 

to air transportation. 

Conversely, an argument against higher fees is that the 

public in general—not just air travelers—benefits from 

improved airport security. To the extent that greater security reduces the risk of terrorist attacks, the entire population is better off. That reasoning suggests that the federal 

government should fund at least part of the enhanced 

transportation security measures without collecting additional funds directly from the airline industry or its 

customers.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1.9 -1.9 -2.0 -2.0 -2.1 -2.1 -2.1 -2.2 -2.2 -2.3 -9.9 -20.8

Outlays -1.9 -1.9 -2.0 -2.0 -2.1 -2.1 -2.1 -2.2 -2.2 -2.3 -9.9 -20.8
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 111

CBO

Discretionary Spending—Option 23 Function 400

Eliminate Intercity Rail Subsidies

Including funds appropriated in the American Recovery 

and Reinvestment Act (ARRA, Public Law 111-5), the 

Congress appropriated more than $14 billion to subsidize 

intercity passenger rail services in 2009 and 2010. About 

$4 billion has been allocated for the National Railroad 

Passenger Corporation—or Amtrak—and about $10 billion is available both to Amtrak and to state and local 

governments to fund high-speed and intercity regional 

rail service. In 1970, when the Congress established 

Amtrak, it anticipated subsidizing the railroad only for a 

short time, until it became self-supporting. Over the past 

40 years, however, the federal subsidy to Amtrak has 

amounted to approximately $40 billion cumulatively. 

This option would eliminate federal subsidies not only 

for Amtrak but also for high-speed and other intercity rail 

service, yielding savings of $11 billion over the next 

5 years and $30 billion over 10 years. (Not included in 

those estimates are potential savings that could be 

obtained by rescinding unobligated funds provided in 

ARRA. The savings would depend on the amount of 

funds still unobligated when the legislation was enacted, 

but could be on the order of $1 billion to $2 billion.)

An argument in favor of this option is that intercity 

passenger rail service should be provided only if it is a 

self-supporting commercial service. It is also argued that 

current federal spending represents just a small down 

payment on a much larger expenditure that would be 

necessary to build a large high-speed rail system—such as 

one that would meet the Administration’s goal of making 

high-speed rail available to 80 percent of Americans—

and that the total costs of the system would exceed its 

benefits, both of which are highly uncertain. 

With respect to Amtrak, a rationale for this option is that 

eliminating its federal subsidy would encourage its managers to cut unprofitable services and routes and focus 

instead on those that are profitable and in high demand. 

One example of an unprofitable service that could be cut 

is sleeper-class service. The Inspector General of the 

Department of Transportation estimates that eliminating 

sleeper service would save Amtrak $75 million to 

$158 million annually, net of lost revenues from customers who would no longer travel by train if sleeper service 

was discontinued. Large savings could also accrue from 

eliminating unprofitable routes. According to Amtrak’s 

Performance Tracking System, the five most unprofitable 

routes account for combined annual losses of roughly 

$260 million, although some of that amount represents 

allocated overhead costs that would continue to be 

incurred if the lines were eliminated. 

An argument against eliminating support for intercity 

passenger rail is that the amount of such support needs to 

be analyzed in the context of the budgetary and social 

costs of travel by highways and air—namely, that highway and air travel are subsidized even though they involve 

higher safety risks and greater emissions of greenhouse 

gases. Also, eliminating federal support could require 

Amtrak to greatly reduce its route network. Some opponents of this option regard rail service as a public service 

that should be widely available. They maintain that passengers on lightly traveled routes have few transportation 

alternatives and that Amtrak is vital to the survival of 

small communities along those routes. Continuing federal support could help Amtrak and other passenger rail 

carriers improve service, attract more passengers, and 

make rail transportation more viable economically.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -4.1 -4.2 -4.2 -4.3 -4.4 -4.5 -4.6 -4.7 -4.8 -4.9 -21.2 -44.7

Outlays -1.6 -1.8 -2.0 -2.3 -2.8 -3.3 -3.6 -3.9 -4.2 -4.4 -10.5 -29.9

RELATED CBO PUBLICATIONS: Effects of Gasoline Prices on Driving Behavior and Vehicle Markets, January 2008; The Past and Future of 

U.S. Passenger Rail Service, September 2003; and A Financial Analysis of H.R. 2329, the High-Speed Rail Investment Act of 2001, 

September 2001
112 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 24 Function 400

Eliminate the Transit Starts Programs

Under the New Starts program, the Department of 

Transportation funds the construction or expansion of 

rail and other fixed-guideway systems—mass transit systems that use exclusive or controlled rights of way. A 

related program, Small Starts, makes discretionary grants 

to public transportation capital projects that cost less 

than $250 million and require less than $75 million in 

federal funding. For 2010, the Congress appropriated a 

total of $2 billion for both programs, of which $200 million was designated for Small Starts. 

This option would eliminate both the New Starts and the 

Small Starts programs. The Congressional Budget Office 

estimates that this option would save about $6 billion 

over 5 years and $16 billion over 10 years.

One rationale for ending the programs is that the 

federal government should not be funding rail transit 

systems because their benefits are primarily local. A 

second rationale is that if the federal government is to 

support local public transit, there is no reason to focus 

on new rail transit systems, which tend to provide less 

value per dollar spent than bus systems do. Bus systems 

require much less capital and offer more flexibility in 

the adjustment of schedules and routes to meet changing 

demands. Even without New Starts, state and local 

governments could use federal aid distributed by formula 

grants (noncompetitive awards based on a formula) for 

new rail projects if they determined, on the basis of local 

circumstances, that those projects would make the best 

use of the funds. In 2010, for example, the federal 

government provided $8.4 billion in formula funding 

for transit projects, of which about $4.1 billion was 

allocated in broad “urbanized area” grants for existing 

and new systems, and $1.6 billion was designated for 

the maintenance and improvement of existing fixedguideway systems. The remaining $2.7 billion was 

distributed among a variety of smaller grant programs.

One argument against this option is that the New Starts 

program seeks to identify the most promising rail transit 

projects from a long list of candidates. Many supporters 

of rail transit systems contend that rail transit will 

become increasingly valuable as gasoline prices continue 

their long-term upward trend. They also assert that building new roads does not alleviate urban congestion or pollution but leads only to greater decentralization and 

sprawl. New rail transit systems, by contrast, could help 

channel future commercial and residential development 

into corridors where public transportation is available, 

offering people convenient, affordable, and reliable 

transportation. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -2,020 -2,050 -2,090 -2,120 -2,160 -2,200 2,250 -2,290 -2,340 -2,380 -10,440 -21,900

Outlays -240 -790 -1,210 -1,530 -1,800 -2,010 -2,130 -2,170 -2,210 -2,260 -5,570 -16,350

RELATED CBO PUBLICATION: Issues and Options in Infrastructure Investment, May 2008
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 113

CBO

Community and Regional Development Discretionary Spending—Option 25 Function 450

Create State Revolving Funds to Finance Rural Water and Waste Disposal 

The Department of Agriculture assists rural communities 

through a program that provides loans, loan guarantees, 

and grants for water and waste-disposal projects. It also 

offers grants for solid-waste management, emergency 

community water assistance, and technical assistance. For 

fiscal year 2010, $551 million was appropriated for the 

program to fund its grants and cover the cost of its loans 

and loan guarantees. (The cost of loans is defined under 

the Federal Credit Reform Act of 1990 as the present 

value of interest rate subsidies and expected defaults.) 

The program’s funds generally are allocated to each state 

on the basis of its rural population and the number of 

rural families with income below the poverty level. The 

Department of Agriculture distributes the funds allocated 

to each state on the basis of competitive proposals from 

eligible state and local agencies, recognized Native American tribes, and nonprofit organizations. The terms of 

assistance generally depend on the median household 

income in a grant recipient’s area. Thus, the interest rates 

on direct loans for water and waste-disposal projects 

range from 60 percent to 100 percent of the market yields 

on municipal bonds covering similar numbers of years. 

Areas that are particularly needy may apply for grants or 

for combinations of grants and loans. 

This option would reduce federal spending by providing 

an initial infusion of capital for state revolving funds 

devoted to rural water and waste disposal and then ending federal assistance. The revolving funds would be 

modeled on those established under amendments to the 

Clean Water Act in 1987 and under amendments to the 

Safe Drinking Water Act in 1996. The federal savings 

would depend on the amount and timing of the contributions to the revolving funds. Specifically, under this 

option, the federal government would provide $550 million annually for five years and then end assistance beginning in 2017. The option would save $54 million over 

five years and about $2 billion through 2021. (The 

details of the option are illustrative; the same basic 

approach could be implemented with different capitalization amounts or periods, yielding different savings.) The 

capitalization of the state revolving funds would not by 

itself allow states to offer the same amount of assistance 

currently provided by the federal grants and loans, but 

the Congress could allow the revolving funds to use their 

capital as collateral to leverage private-sector financing. 

The rationale for this option is that the federal government should not bear indefinite responsibility for local 

development; programs that benefit communities, 

whether urban or rural, should be funded by state or local 

governments. The rationale for the specific approach in 

this option is that it is reasonable to provide funding for a 

few years to capitalize revolving funds before they become 

self-sustaining. 

One argument against this option is that states might 

change their aid formulas (substituting loans for grants 

or high-interest loans for low-interest loans) to avoid 

depleting the funds and to recoup the costs of leveraged 

financing. That action could price the aid out of reach of 

needier communities.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -7 -16 -25 -35 -45 -607 -620 -632 -645 -657 -128 -3,289

Outlays -1 -4 -9 -16 -24 -88 -258 -407 -490 -558 -54 -1,855
114 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 26 Function 450

Drop Wealthier Communities from the Community Development 

Block Grant Program

The Community Development Block Grant (CDBG) 

program provides annual grants to communities to aid 

low- and moderate-income households, eliminate municipal blight, meet emergency needs, rehabilitate housing, 

improve infrastructure, and promote economic development. Under one component of the program, which is 

administered by the Department of Housing and Urban 

Development (HUD), grants go directly to cities and 

urban counties, referred to as entitlement communities. 

(Other CDBG funds are allocated to states, which typically distribute them through a competitive process to 

smaller, more rural communities known as nonentitlement areas.) Funds from the entitlement component also 

may be used to repay bonds issued by local governments 

and guaranteed by the federal government under the 

Section 108 Loan Guarantee Program (established along 

with the CDBG program by the Housing and Community Development Act of 1974). For 2010, $4.0 billion 

was appropriated for the CDBG program, of which 

$2.8 billion was designated for entitlement communities. 

Under current law, the CDBG entitlement program is 

open to all urban counties, principal cities of metropolitan areas, and cities with a population of at least 50,000. 

The program allocates funds according to a formula 

based on a community’s population, the number of residents in poverty, the number of housing units with more 

than one person per room, the number of housing units 

built before 1940, and the extent to which population 

growth since 1960 is below the average for all metropolitan cities. The formula does not require a certain community poverty rate, nor does it exclude communities 

with high average income. In an analysis conducted in 

2003, HUD showed that when population data and 

other information were updated using results from the 

2000 census, funding provided on the basis of the formula shifted from poorer to wealthier communities, as 

measured by average poverty rates. 

This option would reduce funding for CDBG entitlement grants and direct the remaining funding to needier 

communities. The option could be implemented in a 

variety of ways, but one approach would be to exclude 

communities with per capita income that exceeded the 

national average by more than a specified percentage—

for example, the communities with per capita income 

greater than 105 percent of the national average, which 

accounted for 23.4 percent of the entitlement funds in 

2010. The option presented here illustrates the general 

approach without specifying a particular form of implementation: It would cut funding for the entitlement 

grants by 20 percent, saving about $2 billion over 5 years 

and about $5 billion over 10 years. 

One argument in favor of this option, or of a more substantial reduction, is that it is not appropriate to use federal funds for local development. An alternative argument 

is that even if the program is viewed as meeting national 

needs that some local governments cannot address adequately, that rationale does not justify redirecting money 

to wealthier communities. 

The main argument against this option is that dropping 

wealthier communities from the CDBG program could 

reduce efforts to aid low-income households within those 

communities unless local governments reallocated their 

own funds to offset the lost grants.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -565 -574 -583 -593 -603 -616 -628 -641 -654 -666 -2,918 -6,123

Outlays -5 -150 -445 -550 -570 -585 -600 -615 -625 -640 -1,720 -4,785
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 115

CBO

Education and Social Services Discretionary Spending—Option 27 Function 500

Eliminate Certain Grant Programs for Elementary and Secondary Education

The Department of Education distributes funding for 

more than 50 discretionary grant programs to state and 

local educational agencies. Eleven of those programs 

address the physical, emotional, and social well-being of 

students both inside and outside the school environment. 

Those grants are allocated to state and local educational 

agencies on the basis of a formula or are competitively 

awarded to local educational agencies and nonprofit entities. Funding for those grant programs totaled $1.5 billion in 2010. The largest grant program in this group is 

the 21st Century Community Learning Centers program, which accounted for $1.2 billion of the $1.5 billion in funding in 2010. That program awards grants to 

states according to a formula based on the number of 

poor students in the state. States then award competitive 

grants to local educational agencies or community-based 

organizations to establish or expand centers that offer 

educational services and opportunities outside normal 

classroom hours. 

This option would eliminate those 11 grant programs. 

The Congressional Budget Office estimates that doing so 

would reduce federal outlays by about $6 billion through 

2016 and by $14 billion through 2021. 

An argument in favor of this option is that an evaluation 

of the 21st Century Community Learning Centers program found that those centers were not attaining their 

stated goals. That evaluation, funded by the Department 

of Education, concluded that programs funded by those 

grants had no significant impact on the academic 

achievement, parental involvement, or homework completion of participating students relative to similar students not participating in the program.1

 More broadly, 

some people argue that educating children is primarily a 

responsibility of state and local governments, that the 

federal government’s involvement should be minimal, 

and that grant programs such as the ones this option 

would eliminate go beyond an appropriate role for the 

federal government. 

An argument against this option is that federal funding is 

necessary to augment state and local efforts to educate 

children growing up in poor families; for those families, 

federal resources help compensate for a lack of resources 

in their home environment. Opponents of this option 

may also point to research that has shown that increasing 

the social, physical, and emotional health of students 

helps them become higher achievers. Particularly relevant 

to the 21st Century Community Learning Centers program is a body of research (compiled by the Harvard 

Family Research Project) that found that children who 

participate in well-implemented, high-quality afterschool programs make larger cognitive gains while they 

are enrolled and exhibit better educational outcomes after 

leaving the program than do children who receive no 

such intervention.2

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1,600 -1,600 -1,600 -1,600 -1,700 -1,700 -1,700 -1,800 -1,800 -1,800 -8,100 -16,900

Outlays -30 -900 -1,400 -1,600 -1,600 -1,700 -1,700 -1,700 -1,800 -1,800 -5,530 -14,230

1. Susanne James-Burdumy and others, When Schools Stay Open 

Late: The National Evaluation of the 21st Century Community 

Learning Centers Program: Final Report (report submitted by 

Mathematica Policy Research, Inc., to the Department of Education, Institute of Education Sciences, April 2005).

2. Heather B. Weiss and others, The Federal Role in Out-of-School 

Learning: After-School, Summer Learning, and Family Involvement 

as Critical Learning Supports (research review paper submitted by 

the Harvard Family Research Project to the Center on Education 

Policy project, Rethinking the Federal Role in Elementary and 

Secondary Education, February 2009).
116 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 28 Function 500

Restrict Pell Grants to the Neediest Students

The Pell Grant program is the single largest source of federal grant aid to low-income students for postsecondary 

undergraduate education. For the 2010–2011 academic 

year, the program is estimated to provide almost $37 billion in aid to about 8.9 million students. A student’s Pell 

Grant eligibility is chiefly determined on the basis of 

Expected Family Contribution (EFC), a federal calculation of his or her family’s ability to pay for postsecondary 

education. The EFC is based on factors such as the student’s income and assets and, for dependent students (in 

general, unmarried undergraduate students under the age 

of 24), the parents’ income and assets, as well as the number of other dependent children in the family attending 

postsecondary schools. Generally, families with high 

EFCs have less financial need than those with low EFCs 

and are able to contribute more to their child’s education.

Since 2008, funding for the Pell Grant program has had 

both a discretionary and a mandatory component. Mandatory funding supports automatic increases to the maximum award set in each fiscal year’s appropriation act. The 

automatic increase for the 2010–2011 award year is 

$690, which, when added to the maximum award of 

$4,860 set in the appropriation act, results in a total maximum award of $5,550.

Under current law, students with an EFC exceeding 

95 percent of the total maximum Pell grant award 

($5,273 for academic year 2010–2011) are ineligible for a 

grant. This option would make students with an EFC 

exceeding $2,500 ineligible for a Pell grant. Assuming 

that, under current law, the maximum discretionary 

award level specified in appropriation acts would remain 

at $4,860 in future years, the Congressional Budget 

Office estimates that this option would yield discretionary savings of $2 billion through 2016 and $7 billion 

through 2021, along with accompanying mandatory savings of about $1 billion through 2016 and $5 billion 

through 2021.

A rationale in favor of this option is that it would focus 

federal aid on those students with the greatest need. Furthermore, students who lose eligibility under the option 

would probably still be able to afford a public two-year 

college according to federal needs analysis. Tuition and 

fees at public two-year colleges for the 2008–2009 academic year averaged about $2,140, which is still below 

the EFC of students who would lose eligibility under this 

option. Those students may also be eligible for $3,500 or 

more in federal student loans that are interest-free while 

students are enrolled.

An argument against the option is that among Pell grant 

recipients with an EFC above $2,500, significant educational expenses are not covered by their EFC or by 

federal, state, institutional, or other aid. For example, 

70 percent of those students had expenses that were not 

covered by those sources. Denying Pell grants to those 

students would further increase the financial burden of 

obtaining an undergraduate education and might cause 

some to choose less postsecondary education or to forgo 

it altogether. The amount of postsecondary education 

received is an important determinant of future wages. In 

2009, for example, the median wage for men ages 16 to 

64 with bachelor’s degrees was 72 percent more than the 

median wage for men with only high school diplomas or 

GEDs.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Discretionary Spending

Budget authority -400 -400 -500 -700 -700 -800 -900 -1,000 -1,000 -1,100 -2,700 -7,500

Outlays -100 -400 -500 -600 -700 -800 -900 -900 -1,000 -1,000 -2,300 -6,900

Change in Mandatory Outlays -40 -200 -200 -300 -400 -600 -700 -800 -900 -1,000 -1,140 -5,140

RELATED OPTIONS: Mandatory Spending, Options 10 and 11; and Revenues, Option 15

RELATED CBO PUBLICATIONS: Changes in the Distribution of Workers’ Hourly Wages Between 1979 and 2009, February 2011; and Costs and 

Policy Options for Federal Student Loan Programs, March 2010
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 117

CBO

Discretionary Spending—Option 29 Function 500

Eliminate Funding for National Community Service Programs 

National community service programs provide financial 

assistance to students and other volunteers who aid their 

communities in the areas of education, public safety, the 

environment, and health care, among others. In fiscal 

year 2010, appropriations for national service programs 

totaled about $1.1 billion, which supported the following 

initiatives: the AmeriCorps Grants Program, the AmeriCorps National Civilian Community Corps (NCCC) 

program, the AmeriCorps Volunteers in Service to America (VISTA) program, Learn and Serve America, the 

National Senior Service Corps, and the National Service 

Trust. In addition, AmeriCorps receives supplemental 

funding from state and local governments and from private sources for service projects that, in many cases, build 

on existing federal, state, and local programs. Participants 

in the AmeriCorps Grants Program, NCCC, and VISTA 

may receive an educational allowance, a stipend for living 

expenses, and access to health insurance and child care 

subsidies. Learn and Serve America participants generally 

do not receive such stipends or awards. 

This option would eliminate federal funding for national 

service programs, reducing outlays by $4 billion through 

2016 and by $10 billion over the coming 10 years. 

(Those estimates account for the administrative costs 

associated with terminating the programs.) 

An argument in favor of this option is that funding community service programs by local governments might be 

more efficient than funding them at the federal level 

because the benefits of community service accrue locally 

rather than nationally. From that standpoint, decisions 

about such programs—the types of service projects to 

undertake and the amount of funding to provide, for 

instance—would be made more efficiently by the community that receives the benefits. Another rationale for 

eliminating student-focused national service programs is 

that a goal of federal aid to students is to provide lowincome people with access to postsecondary education. 

Because participation in those programs is not based on 

family income or assets, funds do not necessarily go to 

the poorest students. 

An argument against implementing this option is that the 

programs provide opportunities for participants of all 

socioeconomic backgrounds to engage in public service. 

In addition, relative to other approaches, the programs 

may offer a cost-effective way of providing community 

services because of the low budgetary cost per hour of 

service provided.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1,150 -1,160 -1,180 -1,180 -1,180 -1,200 -1,230 -1,250 -1,280 -1,310 -5,850 -12,120

Outlays -270 -780 -940 -1,020 -1,050 -1,090 -1,130 -1,160 -1,180 -1,320 -4,060 -9,940

RELATED OPTION: Discretionary Spending, Option 30
118 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending—Option 30 Function 500

Eliminate the Senior Community Service Employment Program 

The Senior Community Service Employment Program 

(SCSEP) funds part-time jobs for low-income people 

age 55 or older who have poor prospects for other 

employment. Participation in the program in 2010 

was limited to people whose annual income was below 

125 percent of the federal poverty level (for someone 

living alone, $13,500). SCSEP grants are competitively 

awarded to nonprofit organizations and state agencies 

that hire SCSEP participants to work in part-time community service jobs. In 2010, $825 million was appropriated for the program. That appropriation included 

$225 million to fund a one-time expansion for the 2009–

2010 and 2010–2011 program years ($66 million and 

$159 million, respectively). 

Participants in the program are paid the federal or state 

minimum wage or the prevailing local wage for similar 

employment, whichever is higher. They are offered 

annual physical examinations as well as training, counseling, and assistance with moving into unsubsidized jobs 

when they complete their projects. The Department of 

Labor estimates that SCSEP had about 99,000 participants in 2009 working in schools, hospitals, and senior 

citizens’ centers and on beautification and conservation 

projects. 

This option would eliminate the SCSEP, reducing federal 

outlays by about $4 billion through 2016 and by about 

$8 billion over the 2012–2021 period. 

An argument in support of this option is that the cost of 

subsidizing program participants’ wages and the other 

benefits they receive for their services could be borne by 

the organizations that gain from their work; under current law, those organizations usually bear just 10 percent 

of such costs. Shifting the full cost of the services to the 

organizations would increase the likelihood that only the 

most highly valued services would be provided.

An argument against this option is that eliminating 

SCSEP, which is a major federal jobs program for lowincome older workers, could cause serious hardship for 

some people. Although, in general, older workers are less 

likely than younger workers to be unemployed, if they are 

without a job it can take longer for them to find work, 

particularly during periods of high unemployment.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -834 -847 -861 -876 -891 -909 -928 -946 -965 -984 -4,309 -9,041

Outlays -142 -811 -841 -859 -874 -889 -907 -926 -944 -963 -3,527 -8,156

RELATED OPTION: Discretionary Spending, Option 29
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 119

CBO

Discretionary Spending—Option 31 Function 500

Reduce Funding for the Arts and Humanities 

In 2010, combined federal funding for several arts and 

humanities programs that received federal subsidies was 

just over $1.8 billion. Recipients of the subsidies included 

the Smithsonian Institution ($761 million), the Corporation for Public Broadcasting ($506 million), the National 

Endowment for the Humanities ($168 million), the 

National Endowment for the Arts ($168 million), the 

National Gallery of Art ($167 million), and the John F. 

Kennedy Center for the Performing Arts ($40 million). 

This option would cut support for those programs by 

25 percent and hold future appropriations constant at 

those nominal amounts. Federal outlays would be 

reduced by about $2 billion between 2012 and 2016 and 

by $5 billion over the 2012–2021 period. 

One argument in favor of this option is that such programs may not provide social benefits that equal or 

exceed their costs. Another argument is that certain 

practices—such as charging admission at museums—

could be more widely used to help mitigate the effects of 

a reduction in federal funding and that funding could be 

obtained from other sources. 

An argument against such a policy change is that a 

decline in federal support would reduce activities that 

preserve and advance the nation’s culture and that introduce the arts and humanities to people who might not 

otherwise have access to them. The effect on the arts and 

humanities nationwide would depend in large part on the 

extent to which other sources of funding—such as state 

and local governments, individual or corporate donors, 

and foundations—boosted their contributions. But alternative sources might not fully offset a drop in federal 

funding; most state and local governments, for example, 

are themselves facing tight budgetary constraints. Subsidized projects and organizations in rural or low-income 

areas might find it especially difficult to garner increased 

private backing or sponsorship. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -477 -487 -498 -509 -521 -536 -550 -565 -580 -595 -2,492 -5,318

Outlays -349 -439 -478 -497 -510 -524 -538 -553 -568 -583 -2,273 -5,039
120 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Health Discretionary Spending—Option 32 Function 550

Finance the Food Safety and Inspection Service Through Fees

Note: Fees collected under this option could be recorded in the budget as offsetting collections (discretionary), offsetting receipts (usually 

mandatory), or revenues, depending on the specific legislative language used for their establishment.

The Food Safety and Inspection Service (FSIS), an 

agency within the Department of Agriculture (USDA), 

provides mandatory and continuous inspection services 

involving meat, poultry, and processed egg products. The 

scope of those services is explicitly defined by the statutes 

that give FSIS its inspection authority. Meat inspection is 

restricted to species defined as amenable species, such as 

cattle, sheep, and swine; catfish were added to that list in 

the 2008 farm bill (Public Law 110-246). Poultry and 

processed egg products subject to inspection are also 

explicitly specified. In addition, FSIS runs a voluntary 

inspection service for animals not listed in the statutes for 

producers who wish to sell their products in interstate 

commerce. Those services are provided on a fee-forservice basis and are paid by the producers. 

FSIS employs about 8,000 full-time in-plant inspectors 

and other front-line inspectors who are responsible for 

the mandatory inspection of the nation’s commercial supply of meat, poultry, and processed egg products. Meat 

and poultry are inspected before they enter or exit the 

slaughterhouse and before they are transferred to a processing facility. Egg processing plants are subject to continuous inspection whenever the plant is in operation. 

Inspectors are also responsible for monitoring adherence 

to regulations that govern areas such as sanitary conditions, recordkeeping, packaging, and ingredient lists. The 

majority of those services are funded through annual 

appropriations, with the exception of the voluntary 

inspection services noted above and inspections performed during holidays or overtime shifts, which are 

funded by user fees. In 2010, FSIS appropriations totaled 

approximately $1 billion.

This option would finance all mandatory federal inspections of meat, poultry, and processed egg products with 

fees paid by the processing facilities. The Congressional 

Budget Office estimates that this option would increase 

collections by about $5 billion over 5 years and by 

$12 billion over 10 years.

An argument in favor of this option is that users of government services should pay for them. Federal inspections 

benefit producers and consumers of meat, poultry, and 

egg products because they prevent diseased animals and 

adulterated egg products from being sold for human consumption.1

 The meat and poultry industries also benefit 

in other ways. For example, they can advertise that their 

products have passed USDA inspection, which some consumers consider to be an important affirmation of the 

safety of the products they purchase.

An argument against this option is that the federal government should protect the public at large through 

inspections that ensure the safety of the nation’s food supply; it should therefore be the responsibility of the taxpayers to pay for those inspections. Another argument 

against this option is that the fees imposed on food producers would probably be passed along to consumers in 

the form of higher prices for meat, poultry, and egg 

products.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -1.0 -1.0 -1.1 -1.1 -1.1 -1.2 -1.2 -1.3 -1.3 -1.3 -5.3 -11.6

Outlays -1.0 -1.0 -1.1 -1.1 -1.1 -1.2 -1.2 -1.3 -1.3 -1.3 -5.3 -11.6

1. Under federal laws that govern inspection of the nation’s food supply, the term “adulterated” applies to meat, poultry, and egg products that are found to contain poisonous substances, pesticides, or 

chemicals, for example, or are determined to have been prepared 

under unsanitary conditions.

RELATED OPTION: Discretionary Spending, Option 38
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 121

CBO

Discretionary Spending—Option 33 Function 550

Reduce or Constrain Funding for the National Institutes of Health

The budget of the National Institutes of Health (NIH) 

has grown significantly over the past 15 years, primarily 

because of the large increases in NIH’s appropriations (or 

budget authority) during the 1998–2003 period, when 

funding nearly doubled. In addition, NIH received 

$10 billion in supplemental funding provided in the 

American Recovery and Reinvestment Act of 2009 

(ARRA, Public Law 111-5). In 2010, over half of all 

nondefense discretionary spending for health research 

and development went to NIH. 

This option presents two alternatives that would reduce 

NIH’s appropriations relative to the amounts in the baseline budget projections of the Congressional Budget 

Office. One alternative would restrict the rate of growth 

in appropriations to 1 percent per year. That alternative 

would reduce projected appropriations by about $2 billion over 5 years and by about $13 billion over 10 years, 

thereby reducing federal outlays by about $1 billion and 

about $10 billion, respectively. The other alternative 

would reduce NIH’s fiscal year 2012 appropriation to the 

amount provided in 2003, the last year in which NIH 

had a large increase in its appropriation; after that, funding would grow at the rate of inflation assumed in CBO’s 

baseline projections. Such a one-time cut of about 13 percent would reduce projected appropriations by about 

$20 billion over 5 years and about $43 billion over 

10 years, thus cutting federal outlays by about $16 billion 

and $38 billion, respectively. 

An argument in support of this option is that such reductions would encourage increased efficiencies throughout 

NIH and more careful focus on priorities that will 

provide the greatest benefits. NIH has 27 institutes and 

centers that fund research across a wide array of healthrelated topics. In addition, it supports more than 

300,000 scientists and research personnel affiliated with 

more than 3,100 organizations worldwide. Furthermore, 

spending by NIH nearly tripled from 1997 to 2010. 

With such a broad range of personnel and activities and a 

large increase in funding, inefficiencies and duplicative or 

wasteful efforts are likely. In a 2009 report (GAO-09-

687), the Government Accountability Office “found gaps 

in NIH’s ability to monitor key aspects of its extramural 

funding process.” Thus, some costs could probably be 

reduced or eliminated without harming high-priority 

research. 

An argument against this option is that more than 

80 percent of NIH’s funding supports extramural 

research activities (research that is not conducted by NIH 

staff or on the main NIH campus) that are critical to 

improving the nation’s health care, which accounts for a 

large and growing share of the economy. Reducing NIH’s 

funding would probably result in decreased support for 

extramural research. Because NIH is a major source of 

funding for academic biomedical research, deep cuts to 

its budget could disrupt funding for programs already 

under way. Furthermore, while having more focused priorities is beneficial, it is difficult to know in advance 

which projects will yield the most useful results. As a 

result, large cuts to the NIH budget could discourage 

innovation in agency-supported medical technologies 

that have the potential to improve people’s health.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Restrict Funding Growth to 1 Percent

Change in Spending

Budget authority -60 -280 -370 -620 -940 -1,340 -1,780 -2,200 -2,630 -3,060 -2,270 -13,280

Outlays -20 -110 -260 -400 -640 -960 -1,350 -1,770 -2,190 -2,610 -1,430 -10,310

Reduce 2012 Funding Level and Allow Growth at Rate of Inflation

Change in Spending

Budget authority -3,930 -4,000 -4,050 -4,120 -4,200 -4,300 -4,390 -4,490 -4,590 -4,680 -20,300 -42,750

Outlays -1,020 -3,160 -3,800 -3,980 -4,080 -4,170 -4,260 -4,350 -4,450 -4,540 -16,040 -37,810
122 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Income Security Discretionary Spending—Option 34 Function 600

Increase Payments by Tenants in Federally Assisted Housing

Most low-income tenants who qualify for federal rental 

assistance receive aid through the Housing Choice 

Voucher Program (sometimes called Section 8), the 

Public Housing Program, or project-based assistance programs (which designate privately owned, governmentsubsidized units for low-income tenants). Funded by the 

Department of Housing and Urban Development 

(HUD), those programs usually require that tenants pay 

30 percent of their gross monthly household income 

(after certain adjustments) for rent; the federal government subsidizes the difference between that amount and 

the maximum allowable rent. In 2010, the Congressional 

Budget Office estimates, the average combined federal 

expenditure for all of HUD’s rental housing assistance 

programs was roughly $7,500 per household. That 

amount includes the housing subsidies and fees paid to 

the agencies that administer the programs. 

This option would gradually increase tenants’ rental 

contributions from 30 percent of adjusted gross family 

income to 35 percent over the 2012–2016 period. 

Provided that federal appropriations were reduced 

accordingly, those higher rent contributions would 

reduce outlays by a total of about $8 billion over 5 years: 

about $4 billion for the Housing Choice Voucher Program, almost $2 billion for the Public Housing Program, 

and about $2 billion for project-based assistance 

programs. Savings would total about $25 billion over 

10 years.

An argument in support of this option is that, on 

average, renters not currently receiving vouchers or rent 

subsidies—“unassisted” renters—whose income is comparable with that of assisted renters spend roughly 40 percent of their income on rent. Even if the contribution 

requirement for subsidized renters increased to 35 percent of family income, that contribution would still be 

below the amount that unassisted renters currently spend 

on rent. Furthermore, households that received assistance 

would continue to benefit from paying a fixed percentage 

of their income toward housing, whereas unassisted renters with similar family income could confront increases in 

housing costs relative to their income.

An argument against implementing this option is that 

housing costs for most renters who currently receive assistance would rise, and even a modest increase in rent 

could be difficult to manage for households with very low 

income. In addition, by increasing the proportion of 

income that tenants are required to pay in rent, the 

option would reduce some participants’ incentive to 

increase their income by working more.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -580 -1,180 -1,810 -2,470 -3,170 -3,260 -3,350 -3,450 -3,540 -3,630 -9,210 -26,440

Outlays -420 -1,020 -1,640 -2,290 -2,980 -3,230 -3,320 -3,420 -3,510 -3,610 -8,350 -25,440
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 123

CBO

Veterans’ Benefits and Services Discretionary Spending—Option 35 Function 700

End Enrollment in VA Medical Care for Veterans in Priority Groups 7 and 8

Note: Discretionary savings accrue to the Department of Veterans Affairs; increases in mandatory outlays are projected for the Medicare and 

Medicaid programs and for federal subsidies to participate in health insurance exchanges.

Veterans who seek medical care from the Department of 

Veterans Affairs (VA) are enrolled in one of eight prioritycare groups that are defined on the basis of income, disability status, and other factors. Veterans in priority 

group 8 do not have service-connected disabilities, and 

their annual income or net worth exceeds both VA’s 

means-testing thresholds and VA’s geographic income 

thresholds, which are updated annually. Veterans enrolled 

in priority group 7 have no service-connected disabilities, 

and their income is above the VA’s means-testing threshold but below the VA’s geographic index. About 2.3 million veterans who are currently enrolled in the VA health 

care system have been assigned to priority groups 7 and 8; 

not all of those veterans seek medical care from VA in any 

given year.

Although veterans in those groups pay no annual enrollment fees, they make copayments for their care; if they 

have private health insurance, VA bills those insurance 

plans for reimbursement. Copayments and private-plan 

billings cover about 18 percent of the cost of those veterans’ care. In 2009, VA incurred $4.4 billion in net costs 

for those patients, or about 11 percent of the department’s total appropriations for medical care (excluding 

the medical care collections fund, in which amounts collected or recovered from first- or third-party payers are 

deposited and used for medical services for veterans). 

When the priority system was established in law in 1996, 

the Secretary of the Department of Veterans Affairs was 

given the authority to decide which priority groups VA 

could serve each year. By 2003, VA could no longer adequately serve all enrollees, prompting the department to 

cut off new enrollment of veterans in priority group 8. 

Veterans who were already enrolled were allowed to 

remain in the program. VA eased that restriction in 2009 

to allow some additional enrollment of priority group 8 

veterans. 

This option would close enrollment for priority groups 

7 and 8 and cancel the enrollment of all veterans currently in those two groups. Such action would curtail 

VA’s health care spending for veterans who do not have 

service-related medical needs and who are not poor. To be 

eligible for VA medical services under this option, a veteran would have to qualify for a higher priority group 

by demonstrating a service-connected disability, by 

documenting income and assets that were below the 

means-testing thresholds, or by qualifying under other 

criteria (such as exposure to Agent Orange, status as a 

Purple Heart recipient or a former prisoner of war, 

eligibility for Medicaid, or catastrophic non-serviceconnected disability). 

Disenrolling all priority groups 7 and 8 veterans would 

reduce discretionary outlays on net by almost $30 billion 

between 2012 and 2016 and by about $62 billion 

between 2012 and 2021. Those estimates reflect the 

assumption that appropriations would be reduced 

accordingly. However, because this option would result in 

greater use of other government health care programs, 

implementing the option would increase mandatory 

spending for Medicare and Medicaid and for federal subsidies provided through health insurance exchanges by 

about $15 billion between 2012 and 2016 and by 

$34 billion between 2012 and 2021. 

An advantage of this option is that it would refocus 

VA’s attention and services on its traditional group of 

patients—those with the greatest needs or fewest financial resources. Higher-income veterans without serviceconnected disabilities gained access to the VA system only 

in the mid-1990s, when the federal budget was under less 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Discretionary Spending

Budget authority -5.6 -5.9 -5.9 -6.1 -6.2 -6.4 -6.6 -6.8 -7.0 -7.2 -29.7 -63.7

Outlays -5.0 -5.8 -5.9 -6.0 -6.2 -6.3 -6.5 -6.7 -6.9 -7.1 -28.9 -62.4

Change in Mandatory Outlays 2.8 3.0 3.1 3.2 3.3 3.4 3.5 3.7 3.8 3.9 15.4 33.7
124 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

strain and experiencing less demand for services by 

higher-priority veterans. In 2007, 90 percent of enrollees 

in priority groups 7 and 8 had other health care coverage, 

most notably Medicare and private health insurance. As a 

result, the vast majority of the veterans who would lose 

VA coverage under this option would have continued 

access to other sources of coverage, and veterans without 

other health insurance options could be eligible to obtain 

coverage through health insurance exchanges in future 

years.

A disadvantage of the option is that veterans enrolled in 

priority groups 7 and 8 who have come to rely on VA for 

at least part of their medical care might find their health 

care disrupted by the change in enrollment rules. Some of 

those veterans—particularly those whose income was just 

above the income thresholds—might have difficulty 

identifying other sources of care. In addition, because of 

the relatively low out-of-pocket cost to veterans for VA 

health care, veterans switching to alternative sources of 

care might pay more than they would have paid at VA. 

RELATED CBO PUBLICATIONS: Potential Costs of Veterans’ Health Care, October 2010; Statement of Allison Percy, Analyst, Congressional Budget 

Office, before the Subcommittee on Military Construction, Veterans Affairs, and Related Agencies, House Committee on Appropriations, Future 

Medical Spending by the Department of Veterans Affairs, February 15, 2007; and “Potential Growth Plans for Medical Spending by the 

Department of Veterans Affairs,” attachment to a letter to the Honorable Larry E. Craig, July 14, 2006
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 125

CBO

Administration of Justice Discretionary Spending—Option 36 Function 750

Reduce Funding for Certain Department of Justice Grants

The Department of Justice (DOJ) carries out law 

enforcement activities directly, but it also has five grant 

programs that assist nonprofit community organizations 

and state and local law enforcement agencies, each of 

which is funded in a separate account in the federal budget. The programs are as follows: State and Local Law 

Enforcement Assistance, Justice Assistance, Juvenile Justice, Community Oriented Policing Services (COPS), 

and Violence Against Women. 

Funding for those programs totaled about $2.5 billion 

annually over the 2006–2008 period; nearly $7 billion in 

2009, including $4.0 billion provided in the American 

Recovery and Reinvestment Act of 2009 (Public Law 

111-5); and $3.3 billion in 2010. In its baseline projection, the Congressional Budget Office estimates that 

spending will be $4.2 billion in 2011 if full-year funding 

is equal to the appropriation for the first several months 

annualized. This option would reduce financial assistance 

from the five grant programs by 25 percent relative to 

CBO’s baseline projection for the next 5 years, reducing 

spending by almost $3 billion between 2012 and 2016 

and by about $7 billion over 10 years.

Grant recipients currently use these funds for an array of 

activities, including the purchase of body armor and 

other equipment for law enforcement officers and the 

improvement of DNA analysis and other forensic activities conducted by state and local police agencies. Other 

supported activities include substance abuse treatment 

programs for prisoners; funding for Boys and Girls 

Clubs; research, development, and evaluation of state justice programs; and the collection and analysis of statistics 

and information on the judiciary. For some grants, recipients must contribute funds toward the total cost of the 

program. Under this option, those activities would be 

scaled back or funded in other ways.

An argument in favor of the option is that the five grant 

programs address law enforcement issues that are primarily local, and therefore funding at the local level would 

lead to a more efficient allocation of resources. Another 

argument is that resources provided by these programs in 

the past may have been used inefficiently and that future 

financial assistance could be scaled back substantially 

with few consequences for the nation’s law enforcement 

capabilities. For example, the Government Accountability Office has reported that grants awarded through the 

COPS program made only a modest contribution to 

declines in crime in the 1990s. 

An argument against the option is that given the financial 

constraints facing state and local governments, it would 

be difficult for them to compensate for the loss of federal 

funds. The problems the grant programs address have 

national elements, and state and local governments might 

neglect such problems because of the scarcity of 

resources. Therefore, some people argue, such federal 

assistance helps make many communities safer.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority -834 -847 -861 -876 -891 -909 -928 -946 -965 -985 -4,309 -9,042

Outlays -154 -401 -589 -738 -865 -880 -896 -914 -932 -951 -2,747 -7,320
126 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

General Government Discretionary Spending—Option 37 Multiple Functions

Reduce the Across-the-Board Adjustment for Federal Civilian Employees’ Pay 

Under the Federal Employees Pay Comparability Act of 

1990 (FEPCA), most federal civilian employees receive 

an annual adjustment to their pay each January. As specified by that law, the size of the adjustment is set at the 

annual rate of increase of the employment cost index 

(ECI) for wages and salaries minus one-half of a percentage point.1

 The across-the-board increase as spelled out 

under FEPCA, however, does not always occur. For 

example, the President can limit the size of the increase if 

he determines that a national emergency exists or that 

serious economic conditions call for such action. (Similarly, the Congress can authorize an adjustment that differs from the one sought by the President.) Legislation 

forgoing across-the-board adjustments for 2011 and 

2012 was recently enacted in the Continuing Appropriations and Surface Transportation Extensions Act, 2011 

(Public Law 111-322). 

Under this option, the annual across-the-board adjustment that would be expected to occur under FEPCA 

would be reduced by 0.5 percentage points each year 

from 2013 through 2021. Under such a scenario, federal 

civilian salaries (as well as benefits directly tied to salaries) 

would not be affected in 2011 and 2012 because the 

annual pay adjustment has already been canceled for 

those years. Assuming that appropriations were reduced 

by a commensurate amount, federal outlays would be 

reduced by almost $10 billion over 5 years and by 

$50 billion over 10 years.

One rationale for this option is that compensation costs 

for federal civilian employees make up roughly 15 percent of federal discretionary spending, and therefore any 

significant reduction in that category of spending would 

require that personnel costs be constrained. In addition, 

it would signal that the federal government and its workers were sharing in the sacrifices that many beneficiaries 

of federal programs may be asked to make in the name of 

deficit reduction. Similarly, it would demonstrate that 

federal workers have not been shielded from the impacts 

of the economic downturn, which has resulted in large 

numbers of workers in the private sector either losing 

their job or having their wages remain flat or decline.

An argument against this option is that it would make 

it more difficult for the federal government to recruit 

qualified employees. That effect might be pronounced 

for federal agencies that require workers with advanced 

degrees and professional skills. Recent research suggests 

that although federal workers with less education are 

paid more than private-sector workers with comparable 

characteristics, federal workers with professional and 

advanced degrees are paid less than comparable workers 

in the private sector. Thus, lower across-the-board 

increases in federal pay might bring federal and private 

pay closer to parity for less educated workers but at the 

same time widen the gap between federal employees and 

private-sector employees working in jobs that require 

high levels of education. For federal employees who are 

eligible to retire but have not done so, such action could 

also reduce their incentive to continue working. If a significant number of those workers decided to retire as a 

result of smaller increases in pay, increased retirement 

costs could offset some of the payroll savings produced by 

the policy change.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Budget authority 0 -780 -1,840 -2,960 -4,130 -5,370 -6,690 -8,110 -9,620 -11,210 -9,710 -50,710

Outlays 0 -740 -1,800 -2,920 -4,090 -5,320 -6,640 -8,050 -9,560 -11,140 -9,550 -50,260

1. The law specifies that the increase should be calculated by measuring the annual growth in the ECI in the third quarter that ended 

15 months earlier. For example, in 2010 the law set the adjustment at the rate of increase between the ECI in the third quarter 

of 2007 and the third quarter of 2008, minus 0.5 percentage 

points. The law also sought to reduce the disparity between the 

salaries of federal workers and private-sector workers in similar 

occupations and locations by granting locality adjustments 

designed to reduce the gap to no more than 5 percent within nine 

years. However, those locality adjustments have not been fully 

implemented.
CHAPTER THREE: DISCRETIONARY SPENDING OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 127

CBO

Discretionary Spending—Option 38 Multiple Functions

Impose Fees to Cover the Cost of Government Regulation and Charge for 

Services Provided to the Private Sector

Note: Fees collected under this option could be recorded in the budget as offsetting collections (discretionary), offsetting receipts (usually 

mandatory), or revenues, depending on the specific legislative language used in establishing the fees.

Federal law imposes a variety of regulations on private 

individuals and businesses to ensure the health and safety 

of the public and to facilitate commerce. The federal government also provides the private sector with a wide array 

of services and allows the use of public assets that have 

economic value, such as navigable waterways and grazing 

land. This volume includes a number of budget options 

that would raise substantial amounts of income over five 

years by imposing fees on users of certain services or 

otherwise charging for those services. For example, 

Discretionary Spending—Option 22, would increase the 

fees that cover the cost of aviation security by about 

$10 billion over five years; and Discretionary Spending—

Option 32 would support the regulatory functions performed by the Food Safety and Inspection Service by 

expanding collections, which would raise $5 billion from 

2012 through 2016. A number of other fees or taxes that 

raise smaller amounts could be imposed either to cover 

the cost to the government of administering regulations 

or to ensure that the government is compensated for the 

value of services currently provided to the private sector. 

Those fees could be applied across a wide array of federal 

agencies and through a variety of programs. 

This option encompasses an illustrative group of relatively small fees and taxes that could be implemented 

independently. However, if all were put in place, they 

could increase income to the government by $3 billion 

from 2012 through 2016 and by $8 billion over the 

2012–2021 period. Each of the fees in that group 

appeared as an individual option in CBO’s Budget 

Options: Volume 2 (August 2009). 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Spending

Increase fees for permits issued 

by the Army Corps of Engineers -23 -50 -53 -55 -57 -59 -61 -63 -65 -68 -238 -554

Authorize maintenance and 

location fees for hardrock mining 

on federal lands -54 -53 -53 -53 -53 -52 -52 -52 -52 -51 -266 -525

Use state formulas to set grazing 

fees for federal lands -3 -5 -8 -11 -14 -17 -20 -24 -27 -31 -41 -160

Impose fees on users of the 

St. Lawrence Seaway -17 -35 -35 -36 -36 -37 -38 -39 -40 -41 -159 -354

Impose fees that recover the 

costs of pesticide and newchemical registration -50 -51 -80 -83 -89 -89 -92 -92 -95 -95 -353 -816

Charge fees to offset the cost of 

federal rail safety activities -91 -185 -188 -191 -194 -198 -203 -206 -211 -215 -849 -1,882

Charge transactions fees to fund 

the Commodity Futures Trading 

Commission -173 -177 -183 -188 -194 -201 -209 -217 -224 -232 -915 -1,998

Increase registration fees for 

the Federal Aviation 

Administration -46 -47 -49 -50 -52 -54 -55 -57 -59 -61 -244 -530

Collect new fees for the Food and 

Drug Administration -71 -74 -77 -79 -82 -86 -88 -92 -95 -99 -383 -843
128 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Depending on the way the legislation was written, the 

fees included in this option could be recorded as revenues 

or as collections that would then be subtracted from 

either discretionary or mandatory spending. Several of 

the specific fees listed in this option would normally be 

classified as revenues, consistent with the guidance provided by the 1967 President’s Commission on Budget 

Concepts. That guidance indicates that receipts from a 

fee that is imposed under the federal government’s sovereign power to assess charges for governmental activities 

should generally be recorded as revenues. If that treatment were to apply to any of these specific fee options, 

the amounts shown in the table would be recorded as revenues and adjusted downward to account for their effect 

of shrinking the tax base for income and payroll taxes 

and, thus, of reducing revenues from those sources. However, the Congress has sometimes legislated the budgetary 

classification of fees, specifying that they be recorded as 

offsets to spending when they otherwise would have been 

recorded as revenues. 

A rationale for user charges is that private businesses 

should cover all of their costs of doing business, including 

the costs of ensuring the safety of their activities and 

products—for example, the Federal Railroad Administration’s costs for rail safety activities, and the Environmental Protection Agency’s costs to register pesticides and 

new chemicals. In addition, the private sector should 

compensate the government for the market value of services it benefits from, such as the dredging of the inland 

waterway system, and for using or acquiring resources on 

public lands, such as grasslands for grazing and mineral 

deposits. In that view, it is unfair to taxpayers and a net 

drain on the productivity of the economy for businesses 

to provide products or services that cannot be priced high 

enough to cover those costs. 

An argument against setting fees to cover the cost of regulation and recover the value of public services and 

resources is that some of the products and services provided by private businesses are beneficial to people not 

involved in producing or consuming those products and 

services; thus, it is both fair and efficient for taxpayers to 

subsidize the provision of those benefits. For example, by 

lowering the cost of rail transportation, taxpayers’ support for rail safety activities reduces highway congestion 

and emissions of greenhouse gases; support for the registration of new chemicals reduces the use of older chemicals that may be more damaging to public health and to 

the environment; and not charging tolls on the portion of 

the St. Lawrence Seaway that is controlled by the United 

States supports the economies of port communities on 

the Great Lakes.

RELATED OPTION: Discretionary Spending, Option 32
CHAPTER

CBO

4

Revenue Options

In 2010, the federal government collected roughly 

$2.2 trillion in revenues. Individual income taxes were 

the largest source, accounting for nearly 42 percent of 

total revenues. Social insurance taxes (primarily payroll 

taxes collected to support Social Security and Medicare) 

provided another 40 percent. About 9 percent of revenues last year came from corporate income taxes, with 

other receipts—from excise taxes, estate and gift taxes, 

earnings of the Federal Reserve System, customs duties, 

and miscellaneous fees and fines—making up the remaining 10 percent (see Figure 4-1).

Trends in Revenues

Relative to the size of the economy, federal revenues are 

currently at their lowest level in 60 years. In both 2009 

and 2010, revenues equaled 14.9 percent of gross domestic product (GDP). By comparison, they averaged about 

18 percent of GDP between 1971 and 2010, peaking at 

20.6 percent of GDP in 2000 (see Figure 4-2).

The variation in total revenues as a percentage of GDP 

over time has resulted primarily from ups and downs in 

individual income tax receipts and, to a lesser extent, 

from swings in corporate income tax receipts. Revenues 

from individual income taxes, which have averaged about 

8 percent of GDP since 1971, have ranged from a high of 

10.2 percent (in 2000) to a low of 6.2 percent (in 2010). 

The volatility of those revenues stems from two factors. 

First, a substantial share of the base for individual income 

taxes is nonwage income (such as capital gains realizations 

and noncorporate business income), which varies widely 

over the business cycle.1

 Second, legislative changes often 

produce significant shifts in individual income taxes. 

Receipts from corporate income taxes are also quite 

volatile over the business cycle. They have changed especially dramatically in the past few years—from 2.7 percent of GDP in 2007, the largest share in almost 30 years, 

to 1.0 percent of GDP in 2009, the smallest share since 

the 1930s. Because corporate income tax receipts have 

averaged only 2 percent of GDP over the past 40 years, 

however, their swings generally have a much smaller 

impact on total revenues than do the ups and downs in 

individual income tax receipts. 

Social insurance taxes, by contrast, have been a fairly 

stable source of federal revenues over the years. Receipts 

from those taxes increased as a percentage of GDP during 

the 1970s and 1980s as tax rates, the number of people 

required to pay those taxes, and the share of wages subject 

to the taxes grew. For the past two decades, however, legislation has not had a substantial effect on social insurance taxes, and the primary base for those taxes—wages 

and salaries—has varied less as a share of GDP than have 

other sources of income. 

Revenues from other taxes and fees declined relative to 

the size of the economy over the 1971–2010 period. The 

main reason is that receipts from excise taxes—which are 

levied on such goods and services as gasoline, alcohol, 

tobacco, and air travel—have steadily dwindled as a share 

of GDP over time, largely because most of those taxes are 

levied on the quantity rather than the value of goods, and 

rates have generally not kept up with inflation.

Looking ahead, revenues are projected to grow at a slower 

pace than GDP this year and then at a much faster rate. 

The Congressional Budget Office (CBO) estimates that 

if current laws remain unchanged, revenues will increase 

by 3 percent in 2011, to more than $2.2 trillion (see 

Table 4-1). As a share of GDP, however, they will fall 

slightly, to 14.8 percent. Thereafter, revenues are projected to rise rapidly under current law, reaching 

19.9 percent of GDP by 2014. About three-quarters of 

1. The business cycle refers to fluctuations in overall business 

activity, which are typically accompanied by swings in the 

unemployment rate, interest rates, and corporate profits. 
130 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Figure 4-1.

Breakdown of Revenues in 2010

Source: Congressional Budget Office.

Note: Other sources of revenues include excise taxes, estate and gift taxes, earnings of the Federal Reserve System, customs duties, and 

miscellaneous fees and fines.

that increase stems from the effects of scheduled changes 

to the tax code, including the following:

B A one-year reduction in the payroll tax and a two-year 

extension of provisions designed to limit the reach of 

the alternative minimum tax (AMT) are due to expire 

at the end of calendar year 2011. 

B Other provisions of the 2010 tax act (the Tax Relief, 

Unemployment Insurance Reauthorization, and Job 

Creation Act of 2010, Public Law 111-312) are set to 

expire at the end of 2012. They include extensions of 

significant tax provisions that were originally enacted 

in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Jobs and Growth 

Tax Relief Reconciliation Act of 2003 (JGTRRA), 

and the American Recovery and Reinvestment Act 

of 2009 (ARRA, P.L. 111-5).

B New tax provisions are scheduled to take effect over 

the next three years. They include most of the revenue 

provisions in the major 2010 health care legislation 

(the Patient Protection and Affordable Care Act of 

2010, P.L. 111-148; and the Health Care and Education Reconciliation Act of 2010, P.L. 111-152). 

The rest of the projected increase in revenues as a percentage of GDP through 2014 is largely attributable to 

the effects of improvement in the economy. CBO expects 

that as the economy continues to recover from the 

recession, wages and salaries, capital gains realizations, 

and other taxable income will grow more rapidly than 

GDP.

Under the current-law assumptions of CBO’s baseline 

projections, revenues will keep outpacing GDP for the 

remainder of the 10-year projection period. By 2021, 

total revenues are projected to rise to 20.8 percent of 

GDP, just surpassing their 2000 peak.

Considerations in Setting Tax Policy

The primary aim of a tax system is to raise enough 

revenues to pay for government spending. Taxes vary, 

however, in their effects on individuals and on the economy as a whole. When choosing among tax policies, 

Social

Insurance

Taxes

(40%)

Individual

Income

Taxes

(42%) Other

Revenues

(10%)

Corporate

Income

Taxes

(9%)
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 131

CBO

Figure 4-2.

Total Revenues, 1971 to 2021

(Percentage of gross domestic product) 

Source: Congressional Budget Office (as of January 2011).

economists often evaluate the performance of a tax 

according to three criteria:

B Efficiency—the impact of the tax on economic 

activity;

B Equity—the fairness of a tax with respect to who bears 

its burden; and 

B Simplicity—the costs of complying with and collecting the tax.

Because those criteria can conflict with each other, 

lawmakers often face difficult choices when setting tax 

policy.

Other considerations may also come into play. Many 

observers view the tax system as a means of achieving 

social policy goals—for example, by targeting tax hikes or 

tax preferences toward certain groups or activities. As a 

result, the current U.S. tax system contains many provisions whose main goal is to encourage certain types of 

desired behavior, such as buying health insurance, saving 

for retirement, or owning a home. Those goals can sometimes clash with the objective of raising revenues in an 

efficient, equitable, and simple manner.

The Effect of Taxes on Economic Activity 

Taxes influence the economy by causing people to alter 

their behavior, which generally results in a less efficient 

allocation of resources. People can respond to taxes in several ways: by changing the timing of their activities (such 

as accelerating bonus payments or asset sales into a certain year if they think tax rates on earnings or capital 

gains will rise in future years); by adjusting the form of 

their activities (such as substituting tax-preferred fringe 

benefits for cash wages if the tax rate on wages goes up); 

or by changing more-fundamental aspects of their behavior (such as choosing to work or save less if tax rates on 

earnings or capital income rise).2

Those behavioral changes occur because taxes raise the 

price of taxed activities and thereby lower the relative 

prices of other things. In particular, the individual 

income tax and payroll taxes reduce the returns from 

working (after-tax wages), which increases the return 

from other activities relative to working. Those taxes 

also reduce the returns from saving (the after-tax rate of 

return), which lowers the price of spending now relative 

to saving to spend in the future.

One measure of the effect of taxes on the returns from 

working and saving is the marginal tax rate—the tax paid 

per dollar of extra earnings or extra income from saving. 

1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021

0

14

16

18

20

22

0

14

16

18

20

22

Actual Baseline Projection

Average, 1971–2010

2. For more details, see the statement of Douglas W. Elmendorf, 

Director, Congressional Budget Office, before the Senate Committee on Finance, Trends in Federal Tax Revenues and Rates

(December 2, 2010). 
132 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Table 4-1.

CBO’s Baseline Projections of Revenues

(Billions of dollars)

Source: Congressional Budget Office (as of January 2011).

a. Receipts from Social Security payroll taxes.

For individuals, the marginal tax rate that applied to the 

top income tax bracket was 91 percent in the late 1950s 

and early 1960s and 70 percent as recently as 1980.3

Today, the top statutory marginal tax rate for most types 

of income (other than capital gains and dividends) is 

35 percent; with the expiration of the 2001 and 2003 

tax cuts, that rate is scheduled to rise to 39.6 percent in 

2013. Most taxpayers are not in the highest rate brackets, 

however. For a representative family of four with median 

income, the marginal tax rate on earnings (counting both 

income and payroll taxes) was about 20 percent from 

1955 to 1975. That marginal rate climbed over the following 10 years because of rising payroll tax rates and 

inflation-driven increases in nominal income, which 

pushed median-income families into higher tax brackets. 

Following a reduction in income tax rates in 1986, the 

marginal tax rate for a representative family has remained 

at about 30 percent.

Changes in marginal tax rates have two different types of 

effects on people. On the one hand, the lower those tax 

rates are, the greater the share of the returns from additional work or saving that people can keep, thus encouraging them to work and save more. On the other hand, 

because lower marginal tax rates increase after-tax 

income, they make it easier for people to attain their consumption goals with a given amount of work or saving, 

thus possibly causing people to work and save less. On 

balance, the evidence suggests that reducing tax rates 

boosts work and saving relative to what would occur 

otherwise, if budget deficits remain the same. But without other changes to taxes or spending, reducing tax rates 

from current levels would generally decrease revenues and 

increase deficits; higher deficits, even with lower tax rates, 

can reduce economic activity over the longer term.

Changes in marginal tax rates can also affect businesses—

by encouraging them to alter the size and location of 

investments or to engage in tax-avoidance activities (such 

as shifting income from high-tax countries to low-tax 

countries solely to reduce the amount of tax they owe 

worldwide). Many observers have expressed concern that 

the U.S. corporate income tax hampers competitiveness 

because its top statutory rate (35 percent) is one of the 

highest among countries in the Organisation for 

Actual, 2012- 2012-

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2016 2021

899 998 1,128 1,516 1,671 1,829 1,967 2,105 2,231 2,365 2,509 2,662 8,110 19,983

865 819 943 1,029 1,092 1,148 1,204 1,256 1,309 1,364 1,424 1,484 5,416 12,253

191 201 279 343 428 398 370 413 417 420 420 437 1,817 3,923

67 73 80 86 95 100 102 106 110 113 116 120 463 1,028

19 11 12 14 42 48 53 57 61 65 69 73 168 492

76 80 63 51 39 36 37 33 38 44 50 54 225 445

25 29 31 33 36 40 44 49 52 56 60 64 185 467

20 18 19 20 39 51 55 55 57 62 64 69 184 493 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

207 211 205 203 251 276 292 301 318 340 359 380 1,227 2,925

2,162 2,228 2,555 3,090 3,442 3,651 3,832 4,075 4,275 4,489 4,712 4,963 16,570 39,084

On-budget 1,530 1,662 1,887 2,358 2,673 2,840 2,977 3,178 3,336 3,508 3,687 3,893 12,735 30,338

Off-budgeta 632 566 668 732 769 811 855 897 938 981 1,025 1,069 3,835 8,745

Total

Other Revenues

Total Revenues

Individual Income Taxes

Social Insurance Taxes

Corporate Income Taxes

Subtotal

Excise taxes

Estate and gift taxes

Federal Reserve earnings

Customs duties

Miscellaneous fees and fines

3. Different rate schedules have applied to some types of income at 

different points in time. Since 1955, the maximum rate for longterm capital gains has been lower than the maximum rate for ordinary income. Other sources of income have been subject to alternative rate schedules for shorter periods. For example, between 

1971 and 1986, a lower maximum tax rate applied to earned 

income. 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 133

CBO

Figure 4-3.

Cumulative Budgetary Effect of Major Income Tax Expenditures, 2010 to 2014

Source: Joint Committee on Taxation.

Economic Co-operation and Development.4 Those 

statutory rates, however, do not reflect differences among 

various countries’ tax bases and rate structures and thus 

do not indicate the actual tax rates that multinational 

companies face.5

Some features of the tax code affect the economy by subsidizing certain types of activities. Those subsidies often 

take the form of special exclusions, exemptions, or deductions from gross income; preferential tax rates; special tax 

credits that offset tax liabilities (the amount people owe); 

or deferrals of tax liabilities. Such subsidies are referred to 

as “tax expenditures,” and their costs to the federal government are measured in terms of forgone revenues, 

which total hundreds of billions of dollars each year.6

According to estimates by the staff of the Joint Committee on Taxation, the three largest tax expenditures 

in income tax law are the ones that provide preferential 

treatment for employment-based health insurance, 

retirement savings, and home ownership (see Figure 4-3). 

Each of those tax expenditures may help achieve certain 

societal goals: a healthier population, adequate financial 

resources for retirement, and stable communities of 

homeowners. But uncapped tax expenditures may also 

encourage overconsumption of the favored good or 

subsidize activity that would have taken place without 

the tax incentives. For example, those three income tax 

expenditures may prompt people to consume more 

health services than are necessary, reallocate existing savings from accounts that are not tax-preferred to retirement accounts, and acquire mortgages and purchase 

homes beyond their needs. 

The Tax Burden and Who Bears It 

Households generally bear the economic cost, or burden, 

of the taxes that they pay themselves, such as individual 

income taxes and employees’ share of payroll taxes. But 

Deduction of Nonbusiness State and

 Local Government Income Taxes,

Sales Taxes, and Personal Property Taxes 

Earned Income Tax Credit 

Reduced Rate of Taxation on Long-Term

Capital Gains and Dividends 

Deduction of Mortgage Interest on

Owner-Occupied Residences 

Net Exclusion of Pension

Contributions and Earnings 

Exclusion of Employers' Contributions for

Health Care, Health Insurance Programs, and

Long-Term Care Insurance Premiums 

0 100 200 300 400 500 600 700

Billions of Dollars

4. See Organisation for Economic Co-operation and Development, 

“OECD Tax Database: Corporate and Capital Income Taxes,” 

www.oecd.org/ctp/taxdatabase.

5. See Congressional Budget Office, Corporate Income Tax Rates: 

International Comparisons (November 2005).

6. The Congressional Budget and Impoundment Control Act of 

1974 requires that a list of tax expenditures be included in the federal budget, and each year the Administration publishes estimates 

of those expenditures (prepared by the Treasury’s Office of Tax 

Analysis) for provisions that affect individual and corporate 

income taxes. The Congress’s Joint Committee on Taxation 

also publishes estimates of individual and corporate income tax 

expenditures each year, most recently in Estimates of Federal Tax 

Expenditures for Fiscal Years 2010–2014, JCS-3-10 (December 15, 

2010). Neither the committee nor the Treasury issues estimates of 

tax expenditures for social insurance or other federal taxes.
134 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

households also bear the burden of the taxes paid by businesses. In the judgment of CBO and most economists, 

the employers’ share of payroll taxes is passed on to 

employees in the form of lower wages. In addition, 

households bear the burden of corporate income taxes, 

although the extent to which they do so as owners of 

capital, as workers, or as consumers is not clear.

One measure of the tax burden on households is the average tax rate—that is, taxes paid as a share of income. Federal taxes are progressive, meaning that average tax rates 

generally rise with income. In 2007, households in the 

bottom one-fifth (quintile) of the income distribution 

(those with an average income of $18,400, under a broad 

definition of income) paid about 4 percent of their 

income in federal taxes; those in the middle quintile, with 

an average income of $64,500, paid 14 percent; and 

those in the highest quintile, with an average income of 

$264,700, paid 25 percent. Average tax rates continued 

to rise within the highest quintile. Households in the top 

1 percent of the income distribution faced an average tax 

rate of about 30 percent.7

Much of the progressivity of the federal tax system derives 

from the largest source of revenues, the individual income 

tax, for which average tax rates rise with income. The 

next largest source of revenues, social insurance taxes, 

has average tax rates that vary little across most income 

groups—although the average rate is lower for higherincome households, because earnings above a certain 

threshold are not subject to the Social Security payroll 

tax and because earnings are a smaller portion of total 

income for that group. The average social insurance tax 

rate is higher than the average individual income tax rate 

for all income quintiles except the highest one (see 

Figure 4-4). The impact of corporate taxes on households 

also rises with household income—with the largest effect 

by far on the top quintile (under the assumption that the 

corporate tax reduces after-tax returns on capital). By 

contrast, the average excise tax rate falls as income rises.

Between 1979 and 2007, the average rate for all federal 

taxes combined declined for every income group. The 

average individual income tax rate also dropped over 

that period, with the lowest quintile seeing the greatest 

decrease. (The decline in average tax rates is based on 

a comparison of rates for different income groups at 

different points in time; it does not reflect the experiences 

of particular households, which may move up or down 

the income scale over the years.)

Another way to describe the distribution of the tax burden is to compare different groups’ shares of before-tax 

income with their shares of taxes paid. The share of taxes 

paid by the top quintile grew sharply between 1979 and 

2007, almost entirely because of an increase in that 

group’s share of before-tax income. In 2007, households 

in the highest quintile earned 55 percent of the nation’s 

before-tax income and paid almost 70 percent of federal 

taxes. For all other quintiles, the share of federal taxes was 

less than the share of income. 

Collection Costs and Complexity 

Collection costs include both the costs that the government incurs in administering the tax code and the costs 

that the public incurs in complying with it. In 2005, the 

Department of the Treasury estimated those costs at 

nearly $150 billion a year, including the cost of operating 

the Internal Revenue Service (IRS), taxpayers’ out-ofpocket expenses on such items as paid tax preparers and 

software, and the value of the time that taxpayers spend 

on tax preparation (from learning about tax law to gathering records of income and expenses to completing and 

submitting their returns).8

Collection costs reflect the complexity of the tax system. 

Complexity is also a factor underlying the “tax gap”—the 

difference between the amounts of tax that people owe 

under the tax code and the amounts they actually pay. 

The IRS estimated that the net tax gap (after accounting 

for recoveries from its enforcement activities) totaled 

$290 billion in tax year 2001, equivalent to a net 

noncompliance rate of 14 percent.9

The complexity of the tax system partly results from tax 

expenditures that are designed to affect behavior by 

taxing some endeavors more or less than others. Those 

tax expenditures include tax exemptions for some activities, deductions for various preferred items, and credits 

for undertaking certain actions. As a consequence, 

7. See Congressional Budget Office, Average Federal Tax Rates in 

2007 (June 2010).

8. President’s Advisory Panel on Federal Tax Reform, Simple, Fair, 

and Pro-Growth: Proposals to Fix America’s Tax System (November 

2005).

9. Internal Revenue Service, Reducing the Federal Tax Gap: A Report 

on Improving Voluntary Compliance (August 2007).
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 135

CBO

Figure 4-4.

Average Federal Tax Rates, by Income Quintile and Tax Source, 2007

(Percent) 

Source: Congressional Budget Office.

Note: For information about the calculation of average tax rates, the ranking of households by fifths (quintiles) of the income distribution, 

and the allocation of taxes for this figure, see the statement of Douglas W. Elmendorf, Director, Congressional Budget Office, before 

the Senate Committee on Finance, Trends in Federal Tax Revenues and Rates (December 2, 2010).

many of the same aspects of the tax system that reduce 

economic efficiency also increase complexity.

Complexity also arises from efforts to achieve certain 

equity goals. Provisions that phase out various tax credits 

and deductions at higher income levels are designed to 

target benefits toward people with the greatest need, but 

they make taxes more difficult to calculate. Similarly, 

refundable tax credits—such as the earned income tax 

credit and the child tax credit—provide cash assistance to 

low-income workers with children, but their eligibility 

rules are often difficult to administer. In addition, the 

alternative minimum tax is intended to limit the use of 

tax preferences by higher-income taxpayers, but it 

requires people to recalculate their tax liability in an 

entirely different way and then pay the larger of the 

regular tax or the AMT.

Approaches to Increasing Revenues

Although revenues are projected to reach historically high 

levels as a percentage of GDP by 2021, there are various 

reasons why lawmakers may want to consider options 

that would raise revenues. First, those anticipated levels 

may not be reached. CBO’s projections of revenue 

growth assume that current laws remain unchanged. 

If, instead, a number of expiring tax provisions that have 

been extended in the past were made permanent—

including the income tax provisions enacted in 

EGTRRA, JGTRRA, and ARRA and recently extended 

by the 2010 tax act; relief from the AMT; and temporary 

changes to estate and gift taxes—revenues would rise 

more slowly than in CBO’s projections: to about 19 percent of GDP by 2021 rather than about 21 percent. Second, lawmakers may not want to cut spending enough to 

put fiscal policy on a sustainable path without increasing 

revenues as well. 

Lawmakers could raise revenues by modifying existing 

taxes—either by increasing tax rates or by expanding tax 

bases (the measures on which assessments of tax liabilities 

are made). Alternatively, they could impose new taxes on 

income, consumption, or particular activities. All of those 

approaches would have consequences not only for the 

amount of revenue collected but also for economic activity, tax burdens, and the complexity of the tax system.

An advantage of raising tax rates is that such a change 

would be simpler to implement than many of the alternative approaches to boosting revenues. Unlike other types 

of changes, an increase in rates generally does not require 

new reporting requirements, additional instructions, and 

Lowest Quintile Second Quintile Middle Quintile Fourth Quintile Highest Quintile

10

-5

0

5

10

15

20

Income Tax Social Insurance Taxes Corporate Tax Excise Taxes
136 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

more tax forms. However, as explained above, raising 

marginal tax rates would cause people and businesses to 

change their behavior in ways that affect economic activity. Raising rates would also have implications for the 

progressivity of the tax system, although those implications would depend on the types of taxes and taxpayers 

affected. 

Other approaches to raising revenues would expand the 

base of existing taxes—for example, by increasing the 

types of income, the number of goods, or the number of 

people subject to those taxes. One comprehensive strategy that has received much attention lately would expand 

the tax base by eliminating or curtailing tax expenditures, 

often as part of a plan that would change the structure of 

the tax system as well as increase revenues. For instance, 

the National Commission on Fiscal Responsibility and 

Reform, which was established by the President, recently 

issued a report that called for eliminating or cutting tax 

expenditures—with some of the savings devoted to reducing tax rates.10 One argument for eliminating tax expenditures is that doing so would not only raise substantial 

revenues but could also improve economic efficiency and 

simplify the tax code. At the same time, however, eliminating tax expenditures might raise concerns about fairness and other policy goals that those tax preferences were 

designed to achieve.

Like altering current taxes, imposing a new tax—perhaps 

on people’s and business’s consumption rather than on 

their income—might also require trade-offs between various policy goals. An argument in favor of creating a consumption tax rather than increasing income tax rates is 

that it would raise revenues without discouraging saving. 

A consumption tax would also prompt concerns about 

fairness, however, because lower-income people—who 

consume a greater share of their income than wealthier 

people do—would pay a larger percentage of their annual 

income in consumption taxes than other people would. 

Another approach to raising revenues is to improve the 

collection of taxes that are owed, but not paid, under 

current law. Efforts to reduce the tax gap, however, may 

require additional reporting by taxpayers and businesses, 

thus raising their costs of complying with the tax system. 

Increasing funding for IRS enforcement can also narrow 

the tax gap, but the revenue gains are highly uncertain.

Revenue Options in This Chapter

This chapter presents 35 separate options to increase 

revenues. They are grouped in a number of broad categories according to the part of the tax system they would 

target:

B Individual income tax rates,

B The individual income tax base,

B Individual income tax credits,

B The Social Security tax base,

B Corporate income tax rates,

B Taxation of income from businesses and other entities,

B Taxation of income from worldwide business activity,

B Consumption and excise taxes,

B Health care provisions, and

B Other taxes and fees.

If combined, the options might interact with one another 

in ways that could alter their revenue effects as well as 

their impact on households and the economy. 

Each option is accompanied by a table showing its estimated budgetary effects over each of the next 10 years, as 

well as 5- and 10-year totals. Nearly all of the estimates 

were prepared by the staff of the Joint Committee on 

Taxation. For simplicity in presentation, some of the 

changes in revenues shown in the tables represent the net 

effects of an option on revenues and outlays combined. 

For example, options that would directly or indirectly 

affect refundable tax credits would generally cause a 

change in outlays because those credits are usually paid as 

tax refunds when their amounts exceed people’s income 

tax liabilities. Options that would expand the base for 

Social Security taxes would also affect outlays: Because 

those options would require some or all workers to contribute more to the Social Security system, higher benefits 

would have to be paid out when the affected workers 

retired or became disabled. 

10. National Commission on Fiscal Responsibility and Reform, The 

Moment of Truth: Report of the National Commission on Fiscal 

Responsibility and Reform (December 2010).
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 137

CBO

Although most of the spending options in this report 

would take effect on October 1, 2011 (the beginning of 

the next fiscal year), many of the revenue options would 

take effect on January 1, 2012 (the beginning of the next 

tax year). Some revenue options would have later effective 

dates. For example, an option to create a value-added tax 

would take effect somewhat later to give the IRS enough 

time to implement the new tax. Other options—such 

as changes to the child tax credit or the education tax 

credits—would not take effect until the tax cuts extended 

in the 2010 tax act expire (currently scheduled for the 

end of 2012).

In addition to the 35 options presented in this chapter, 

three more options—which would reduce revenues rather 

than raise them—are discussed in Appendix A. Those 

options relate to tax provisions that are scheduled to 

expire in the next few years.

CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 139

CBO

Revenues—Option 1

Increase Individual Income Tax Rates 

Source: Joint Committee on Taxation.

Notes: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

AMT = alternative minimum tax.

Under current law, ordinary taxable income earned by 

most individuals through 2012 will be taxed at the following six statutory rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent. (Income 

from long-term capital gains, which is taxed under a separate schedule, is excluded from ordinary income. For tax 

years 2011 and 2012 only, dividends are also excluded 

from ordinary income because they are subject to a separate rate schedule for those years.) After 2012, those rates 

are scheduled to revert to the rates that were in effect 

before 2001: 15 percent, 28 percent, 31 percent, 36 percent, and 39.6 percent. The lower rates were originally 

enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 and were scheduled to expire at the 

end of 2010. They were extended for two years by the 

Tax Relief, Unemployment Insurance Reauthorization, 

and Job Creation Act of 2010 (Public Law 111-312).

Under the tax code, different tax rates apply at different 

levels of ordinary taxable income. (Taxable income generally is gross income minus allowable adjustments, exemptions, and deductions.) Tax brackets—the income ranges 

to which the different rates apply—vary depending on 

whether a taxpayer files singly or jointly. (See the table on 

page 140 for a list of the six tax brackets for both single 

and joint filers and the corresponding statutory tax rates.) 

In 2011, for example, a person filing singly with taxable 

income of $40,000 would pay a tax rate of 10 percent on 

the first $8,500 of taxable income, 15 percent on the next 

$26,000, and 25 percent on the remaining $5,500 of taxable income. The starting points for those income ranges 

are indexed to increase with inflation each year. Taxpayers 

who are subject to the alternative minimum tax (AMT) 

face statutory rates of 26 percent and 28 percent. (Federal 

tax liability is computed differently under the AMT than 

it is under the regular income tax because the former 

allows a more limited set of exemptions, deductions, and 

tax credits; taxpayers pay the higher of their regular tax or 

the AMT.) 

Income from long-term capital gains is taxed under a 

separate rate schedule, with a maximum statutory rate of 

15 percent; that rate will remain in effect through 2012 

and then rise to 20 percent in ensuing years. Income from 

dividends is currently subject to the same rate schedule 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

Raise all tax rates on ordinary 

income by 1 percentage point 18.6 40.3 47.8 49.7 51.5 52.8 53.8 54.5 55.2 56.1 207.9 480.4

Raise all ordinary tax rates and AMT 

rates by 1 percentage point 36.9 57.0 61.6 65.5 69.6 73.5 77.8 82.2 86.7 91.5 290.6 702.4

Raise all ordinary tax rates, AMT 

rates, and dividend and capital gains 

rates by 1 percentage point 37.3 59.0 61.1 66.9 71.0 75.0 79.3 83.8 88.3 93.2 295.3 715.0

Raise the top ordinary tax rate by 

1 percentage point 2.8 5.3 6.5 7.4 8.4 9.2 9.9 10.6 11.4 12.3 30.4 83.9

Raise the top two ordinary tax rates 

by 1 percentage point 3.5 7.3 9.2 10.3 11.5 12.5 13.6 14.6 15.7 16.8 41.8 115.0

Raise the top three ordinary tax 

rates by 1 percentage point 3.9 9.1 11.5 12.8 14.1 15.2 16.4 17.5 18.7 19.9 51.4 139.1
140 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

that applies to long-term capital gains; however, after 

2012, dividends will be taxed as ordinary income.1

This option includes four alternative approaches for 

increasing statutory rates under the individual income 

tax. Those approaches are as follows: 

B Raise all tax rates on ordinary income (income subject 

to the regular rate schedule) by 1 percentage point. 

Consistent with current law, this option would not 

apply to dividends earned in 2012.

B Raise all ordinary tax rates and AMT rates by 1 percentage point.

B Raise all ordinary tax rates, AMT rates, and the separate rates on dividends and capital gains by 1 percentage point.

B Raise the top tax rate, the top two tax rates, or the top 

three tax rates on ordinary income by 1 percentage 

point.

Raising all statutory tax rates on ordinary income by 

1 percentage point would increase revenues by a total of 

$208 billion from 2012 through 2016 and by $480 billion from 2012 through 2021. If this alternative was 

implemented, for example, the top rate of 35 percent that 

is scheduled to be in effect in 2012 under current law 

would increase to 36 percent; and the top rate of 

39.6 percent that is scheduled to be in effect starting in 

2013 would increase to 40.6 percent. Rates for the AMT 

would remain the same as they are under current law. 

Thus, the impact on revenues of raising all ordinary tax 

rates would diminish over time relative to the size of the 

economy because, under current law, a greater share of 

taxpayers would become subject to the AMT and therefore would not be affected by the increase in regular rates. 

Raising AMT rates along with all of the regular tax rates by 

1 percentage point would increase revenues by $291 billion from 2012 through 2016 and by $702 billion over 

the 2012–2021 period. Unlike the first approach, this 

alternative would impose higher rates on all ordinary 

taxable income, regardless of whether those rates were 

applied according to the regular or AMT schedule. Consequently, the amount of additional revenues would not 

be greatly affected by the growing number of taxpayers 

subject to the AMT because those taxpayers would face 

higher statutory tax rates, too. 

If, in addition to raising the ordinary and AMT rates, lawmakers boosted the separate tax rates on capital gains and 

dividends by 1 percentage point, federal revenues would 

increase by a total of $295 billion over the next five years 

and by $715 billion over the 2012–2021 period. 

Alternatively, lawmakers could target specific individual 

income tax rates. For example, boosting only the top statutory rate on ordinary income by 1 percentage point would 

raise revenues by $30 billion from 2012 through 2016 

and by $84 billion over the 10-year period. Because most 

people who are subject to the top rate in the ordinary 

schedule are not subject to the alternative minimum tax, 

the AMT would not significantly limit the effect of that 

increase in regular tax rates. Raising the rates for the top 

two or three brackets would generate more revenues.

As a way to boost revenues, an increase in tax rates would 

offer some administrative advantages over other types of 

tax increases because it would require only relatively 

minor changes to the current tax system. Rate hikes also 

would have drawbacks, however. Higher tax rates would 

Starting Points for Tax Brackets (2011 dollars) Statutory Tax Rate on Ordinary Taxable Income (Percent)

Single Filers Joint Filers 2011–2012 After 2012

0 0 10 15

8,500 17,000 15 15

34,500 69,000 25 28

83,600 139,350 28 31

174,400 212,300 33 36

379,150 379,150 35 39.6

1. After 2012, income from dividends and capital gains, along 

with other investment income received by higher-income taxpayers, will be subject to an additional tax of 3.8 percent as a 

result of the Health Care and Education Reconciliation Act of 

2010 (Public Law 111–152).
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 141

CBO

reduce people’s incentive to work and save. In addition, 

they would encourage taxpayers to shift income from 

taxable to nontaxable forms and to increase spending 

on tax-deductible items, such as home mortgage interest. 

In those ways, higher tax rates would cause economic 

resources to be allocated less efficiently than they might 

be otherwise. 

The estimates shown here reflect the assumption that taxpayers would respond to higher rates by shifting income 

from taxable to nontaxable or tax-deferred forms. (Such a 

shift might involve substituting tax-exempt bonds for 

other investments or opting for more tax-free fringe benefits instead of cash compensation.) However, the estimates do not incorporate potential changes in how much 

people would work or save in response to higher statutory 

tax rates. Such changes are difficult to predict and would 

depend in part on whether the federal government used 

the added tax revenues to reduce deficits or to finance 

increases in spending or cuts in other taxes. 

RELATED OPTIONS: Revenues, Option 2; and Revenues, Options A-1 and A-2

RELATED CBO PUBLICATIONS: Statements of Douglas W. Elmendorf, Director, before the Senate Committee on Finance, Trends in Federal Tax 

Revenues and Rates, December 2, 2010; and the Senate Committee on the Budget, The Economic Outlook and Fiscal Policy Choices,

September 28, 2010; “Average Federal Taxes by Income Group,” Web document, June 2010; The Individual Alternative Minimum Tax, Issue 

Brief, January 2010; Analyzing the Economic and Budgetary Effects of a 10 Percent Cut in Income Tax Rates, Issue Brief, December 2005; 

and How CBO Analyzed the Macroeconomic Effects of the President’s Budget, July 2003
142 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 2

Raise Tax Rates on Capital Gains

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

When individuals sell an asset for more than the purchase 

price, they generally realize a capital gain that is subject to 

taxation. Most taxable capital gains are realized from the 

sale of corporate stocks, other financial assets, real estate, 

and unincorporated businesses. Long-term capital 

gains—those realized on assets held for more than a 

year—are taxed at various rates, most of them below the 

rates applied to other types of income (typically referred 

to as ordinary income). The tax rate depends on the year 

in which the taxpayer realizes the gain, the type of asset, 

how long the asset has been held, and the taxpayer’s other 

income. 

For example, in 2013, under current law, a taxpayer who 

is in the 28 percent tax bracket, or higher, for ordinary 

income and who sells corporate stock owned for more 

than a year will pay a basic tax rate of 20 percent on the 

realized gain.1

 For taxpayers in the 15 percent tax bracket, 

the comparable basic rate is 10 percent. If the stock has 

been held for more than five years, special tax rates 

apply—generally, 18 percent for higher-income taxpayers 

and 8 percent for taxpayers in the lowest tax bracket. 

The tax rate on gains realized from many other assets is 

the same as that for corporate stock. However, special tax 

treatment is allowed under certain circumstances: 

B Lower rates apply to gains on the sale of stock of certain small businesses that are held for more than five 

years, and gains from the sale of such stock can be 

deferred if other small-business stock is purchased.

B Under certain circumstances, taxpayers (including 

corporations) can defer paying taxes on gains from the 

sale of assets held for “productive use or investment” 

(rental cars or real estate, for instance), if they purchase a similar—“like-kind”—property.

B When real estate is sold, the capital gain is measured as 

the difference between the sale price and the adjusted 

basis, which is the purchase price less deductions for 

depreciation that were previously claimed. (Generally, 

taxpayers cannot claim deductions for depreciation on 

owner-occupied housing.) The portion of the gain 

that is equal to the deductions for depreciation is taxed 

at ordinary rates up to a maximum rate of 25 percent. 

(The remaining gains are taxed in the same manner as 

corporate stocks.) 

B Profits from the sale of livestock are taxed as capital 

gains, even though such income—usually earned in 

the course of operating a business—is similar to other 

types of ordinary income earned by businesses.

Beginning in 2013, this option would raise the basic tax 

rates on realized gains by 2 percentage points—from 

20 percent to 22 percent for people in the 28 percent tax 

bracket or higher and from 10 percent to 12 percent for 

those in the 15 percent bracket. The special rates for 

assets held for more than five years, including those for 

small-business stock, would be repealed. Gains realized 

after the sale of an asset that was held for productive use 

or investment could no longer be deferred when the taxpayer purchased a like-kind asset; similarly, no deferral 

would be allowed when an investor purchased equity in a 

small business after selling stock in another small firm. 

The recapture of depreciation from real estate gains 

would be taxed as ordinary income, without any ceilings 

on the tax rates. Finally, profits from the sale of livestock 

also would be treated as ordinary income and taxed as 

such. If implemented, the changes outlined in this option 

would raise revenues by a total of $10 billion from 2012 

through 2016 and by $49 billion from 2012 through 

2021. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0.4 2.0 -0.3 3.7 4.3 4.9 6.0 7.2 9.1 11.4 10.1 48.5

1. The effective tax rate on capital gains would be increased by 

3.8 percentage points for higher-income taxpayers subject to the 

“unearned income” surtax, which was enacted in the Health Care 

and Education Reconciliation Act of 2010 (Public Law 111-152). 

The surtax takes effect in 2013.
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 143

CBO

An advantage of disallowing special tax treatment for certain types of assets is that it could improve economic efficiency by encouraging investors to focus more on economic factors than on the tax advantages associated with 

different types of investments. When tax rates are lower 

on assets held for at least five years, taxpayers may hold 

on to those assets longer just to lower their tax liability—

even though it might make sense to sell sooner, given 

economic conditions. Another example is that current 

law allows taxpayers to defer gains when switching from 

one real estate investment to another, thus encouraging 

investment in land and buildings rather than in stocks 

and other financial assets where deferral is not allowed. In 

addition, recapturing depreciation deductions as ordinary 

income would reduce the tax advantage accorded to people in the highest tax brackets who invest in real estate. 

Simplification of the tax system is another argument for 

eliminating the special treatment of various assets; with 

fewer exceptions, most people would find it easier to 

compute capital gains taxes.

Increasing the basic tax rates on capital gains from corporate stock and most other assets—rather than on ordinary 

income—also could encourage people to base investment 

decisions on economic factors rather than on tax advantages. For example, the tax code will encourage businesses 

to retain profits rather than paying them out as dividends 

after 2012, when dividends will once again be taxed as 

ordinary income. By raising the rates on capital gains, 

the option would reduce that incentive to retain profits. 

Furthermore, by reducing the difference between the tax 

rates on ordinary income and those on realized capital 

gains, people would have less incentive to engage in tax 

planning to characterize compensation and profit as a 

capital gain.

Raising the rates at which capital gains were taxed also 

could have a negative effect on economic efficiency, however, even if those rates were applied uniformly. Raising 

rates would discourage some people from selling assets 

when doing so makes sense for economic reasons. 

Instead, people would hold on to the assets longer to 

defer the tax—or they might avoid taxes altogether by 

passing the asset on to their heirs when they die. (The 

resulting decline in the sales of assets would also reduce 

the amount of revenue that could potentially be collected 

from the higher capital gains tax rates.) 

Another disadvantage of the option is that lower rates on 

certain types of capital gains may reduce barriers to 

investment. Capital gains from the sale of a stock often 

occur because a corporation reinvested profits—which 

were already taxed under the corporate income tax—in 

the business. A lower tax rate on such gains would mitigate that double taxation of profits, which discourages 

equity investment in the corporate sector. Yet another 

reason for taxing some forms of capital gains at lower 

rates is that investors may view certain investments—

such as starting a new business or investing in a new technology—as too risky and thus undervalue their benefits 

for the economy. A drawback of recapturing the depreciation deductions on real estate is that some depreciation 

probably occurred, reducing the value of the property 

since the time of purchase. Finally, denying deferral on 

like-kind exchanges would increase the tax burden on 

people who rent out property in their own community 

but must sell it when they have to move to another 

community.

RELATED OPTION: Revenues, Option 1
144 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 3

Use an Alternative Measure of Inflation to Index Some Parameters of the 

Tax Code

Source: Joint Committee on Taxation. [The estimates presented in the table were revised by JCT on June 10, 2011.]

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Several parameters of the tax code change every year with 

the price of goods and services, as measured by the consumer price index for all urban consumers (CPI-U). 

Among the tax parameters that change are the amounts 

of personal and dependent exemptions; the size of the 

standard deductions; the income thresholds that divide 

the rate brackets for the individual income tax; the 

amount of annual gifts exempt from the gift tax; and the 

thresholds and phaseout boundaries for the earned 

income tax credit, the child tax credit, and several other 

credits. Indexing is intended to keep those amounts relatively stable in real (inflation-adjusted) terms.

Indexing is accomplished by adjusting each parameter 

from its value in a base year by the percentage change in 

the CPI-U between that base year and the most recent 

year for which information is available. The period used 

for the calculation is not a calendar year but the 12 

months that elapse from September to August. The value 

of the CPI-U in August becomes available in September, 

which allows enough time to index the tax parameters 

and prepare the necessary forms for the coming year. 

Adjustments in parameters of the tax code are calculated 

as follows: In the base year of 1987, for example, the standard deduction for a single tax filer was $3,000. Between 

1987 and 2010, the CPI-U increased by 93.9 percent; 

correspondingly, the standard deduction (rounded to the 

lowest $50 increment) increased to $5,800 for 2011. 

The standard CPI-U, however, overstates changes in the 

cost of living by not fully accounting for the extent to 

which households substitute one product for another 

when the relative prices of products change. The Bureau 

of Labor Statistics created the chained CPI-U to explicitly 

address that “substitution bias” in the standard CPI-U. 

Whereas the standard CPI-U uses a basket of products 

reflecting consumption patterns that are as much as two 

years old, the chained CPI-U incorporates adjustments 

that people make in the types of products they buy from 

one month to the next. Although the chained CPI-U 

corrects for the substitution bias in the standard CPI-U, 

neither the chained nor the standard CPI-U perfectly 

captures changes in the cost of living because neither fully 

accounts for increases in the quality of existing products 

or the value of new products.

This option would use the chained CPI-U instead of the 

standard CPI-U to adjust various parameters of the tax 

code. The Congressional Budget Office estimates that the 

chained CPI-U is likely to grow at an average annual rate 

that is 0.25 percentage points less than the standard 

CPI-U over the next decade. Therefore, using the 

chained CPI-U to index tax parameters would increase 

the amount of income subject to taxation and result in 

higher tax revenues. Furthermore, the effects of instituting such a policy would grow over time. The net revenue 

increase would be about $700 million in 2012 but would 

reach $14 billion in 2021. Net additional revenues would 

total $17 billion over the 2012–2016 period and would 

sum to $72 billion from 2012 through 2021. 

An argument in favor of using the chained CPI-U to 

index tax parameters is that this approach would more 

accurately adjust people’s tax liability to reflect changes in 

the cost of living than the standard CPI-U. The chained 

CPI-U provides a better measure of changes in the cost of 

living by more quickly capturing the extent to which 

households adjust their consumption in response to 

changes in relative prices. 

An argument against implementing this option is that 

only an initial estimate of the chained CPI-U is available 

on a monthly basis; a final and more accurate estimate 

is delayed because it is more complicated and timeconsuming to compute the chained CPI-U than it is to 

compute the standard index. (The Congressional Budget 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0.7 1.6 3.1 5.2 6.8 7.8 9.8 11.0 12.3 13.7 17.3 71.8
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 145

CBO

Office discussed the details of this approach in a Webonly technical appendix released with its February 2010 

issue brief Using a Different Measure of Inflation for Indexing Federal Programs and the Tax Code.) At the start of 

every year, all of the initial estimates for the prior year are 

revised, and one year later those interim estimates are further revised and made final. Because of those delays, the 

initial and interim estimates of the chained CPI-U, which 

typically contain errors, would need to be used to index 

the parameters in the tax code. Since the chained CPI-U 

was first published in 2002, however, the changes 

between the initial and final values have been relatively 

small. If the adjustment for each year was based on the 

index value from an earlier base year, those small errors 

would not accumulate beyond the current year. Furthermore, because the initial and interim estimates of the 

chained CPI-U have been closer to the final version of the 

chained CPI-U than the existing CPI-U has been, those 

estimates still reflect the basic improvement attributable 

to the chained CPI-U.

RELATED OPTIONS: Mandatory Spending, Options 26 and 27

RELATED CBO PUBLICATION: Using a Different Measure of Inflation for Indexing Federal Programs and the Tax Code, Issue Brief, 

February 2010
146 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 4

Gradually Eliminate the Mortgage Interest Deduction

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

The tax code treats investments in owner-occupied housing more favorably than it does other investments. For 

example, the owner of a rental house can deduct various 

expenses, such as mortgage interest, property taxes, 

depreciation, and maintenance, but has to pay taxes on 

the rental income—net of those expenses—and on any 

capital gain when the house is sold. In contrast, homeowners can deduct mortgage interest and property taxes 

from their income when they compute their income tax 

liability, even though they do not have to pay tax on the 

net rental value of their home. (Other housing-related 

expenses cannot be deducted from homeowners’ 

income.) Homeowners also can exclude from taxation 

capital gains of up to $250,000 ($500,000 for joint filers) 

when they sell their primary residence.

Current law limits the total amount of mortgage debt 

that can be included in the calculation of an interest 

deduction to $1.1 million: $1 million for debt that a 

homeowner incurs to buy, build, or improve a first or second home; and as much as $100,000 in other debt (such 

as a home-equity loan) for which the owner uses the 

home as security, regardless of the purpose of that loan. 

Beginning in 2013, with the expiration of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job 

Creation Act of 2010 (Public Law 111-312), the total 

value of certain itemized deductions—including the 

mortgage interest deduction—will be reduced if the 

taxpayer’s adjusted gross income is above a specified 

threshold.1

This option would phase out the mortgage interest 

deduction, beginning in 2014. By that time, the 

Congressional Budget Office forecasts, foreclosures 

will have subsided, construction will have returned to 

normal levels, and housing prices will have begun to 

recover. The option would reduce the maximum mortgage eligible for the interest deduction from $1.1 million 

in 2013 to zero in 2024 in annual increments of 

$100,000. That change would boost revenues by only 

$14 billion from 2012 through 2016 but by $215 billion 

through 2021 and by increasing amounts relative to the 

size of the economy through 2024.

One argument in favor of the option is that it would 

improve the allocation of resources in the economy. The 

current deduction encourages home buyers who can 

itemize deductions to buy houses when they might otherwise rent or, especially, to buy bigger houses than they 

would buy if all investments were taxed equally. As a 

result, it is argued, homeowners invest too much in their 

houses and too little elsewhere. Reducing the maximum 

amount of mortgage debt on which interest could be 

deducted—and then eliminating that deduction 

entirely—should make many people more willing to 

invest in stocks, bonds, savings accounts, or their own 

businesses rather than in housing. Between 1950 and 

2009, about 36 percent of net private domestic investment went into owner-occupied housing. That share is 

large enough that a reduction in investment in owneroccupied housing could eventually boost the amount of 

capital available to other sectors of the economy and 

increase total economic output. 

Another argument in favor of this option is that eliminating the mortgage interest deduction would curtail the tax 

advantage for homeowners who borrow against their 

homes to buy other goods or to fund tax-favored retirement savings accounts, such as 401(k) plans and individual retirement accounts. Allowing homeowners to deduct 

interest for loans used to finance other consumption 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0 0 0.7 4.5 8.4 14.3 23.3 35.7 52.6 75.1 13.6 214.6

1. In 2009—the last year that the provision to reduce itemized 

deductions was in effect—itemized deductions began to be 

reduced when adjusted gross income was greater than $166,800. 

As was the case before 2010, the income thresholds will be 

adjusted for inflation when that provision is reinstated in 2013. 

The Congressional Budget Office estimates that in 2013 that 

threshold will be about $174,500.
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 147

CBO

distorts their choices between saving and consuming and 

probably reduces national saving. The deduction also 

favors owners over renters, who cannot deduct interest on 

normal consumer loans (such as automobile loans or 

credit card debt). Furthermore, allowing homeowners to 

deduct interest on mortgage loans at the same time that 

they contribute to tax-favored savings plans enables 

homeowners to take advantage of tax savings on both 

transactions. It thus provides an incentive for people to 

pay down mortgage debt more slowly and contribute 

more to retirement accounts than they would if mortgage 

interest was not deductible. Such transactions reduce 

federal tax revenues without increasing net saving because 

the higher retirement contributions are offset by larger 

amounts of outstanding mortgage debt.

A drawback of eliminating the deductibility of mortgage 

interest is that it could delay the recovery of home values, 

home construction, and home mortgage lending from 

their currently depressed levels. Even though the option 

would not take effect until 2014 and would be implemented gradually over a 10-year period, housing markets 

might begin to feel the effects sooner, as buyers anticipated the reduction—and eventual elimination—of the 

mortgage interest deduction. That would create new 

hardships, in addition to those already plaguing the housing market, for people who own homes (particularly 

those currently “under water” because they owe more on 

their mortgage than the house is worth), home builders, 

and lenders. 

Another drawback is that this option might adversely 

affect individuals and their communities by reducing the 

rate of home ownership, particularly among younger and 

less wealthy people who must borrow in order to buy. 

Owning a home has been found to increase people’s 

involvement in their community and local government. 

Moreover, it motivates people to better maintain their 

property, which benefits their neighbors as well as themselves. Even though such actions benefit communities, 

individuals typically do not consider those benefits when 

deciding whether to rent or own a home. Subsidies to 

encourage home ownership might offset that omission.

Although some incentive to become a homeowner may 

benefit communities, the mortgage interest deduction 

may be ineffective in that capacity. Despite the favorable 

tax treatment that mortgage interest receives in the 

United States, the rate of home ownership here is similar 

to that in Australia, Canada, and the United Kingdom, 

and none of those countries currently offers a tax deduction for mortgage interest. The effect of the deduction on 

people’s decisions about whether to buy a house may be 

small because lower-income people—who face the greatest challenges in their efforts to become homeowners—

get the least benefit from the deduction. There are two 

reasons for that disparity. First, lower-income people may 

not have sufficient deductions to make itemizing worthwhile. Second, the value of an itemized deduction is 

greater for people in higher income tax brackets and with 

larger mortgages. 

RELATED OPTION: Revenues, Option 6

RELATED CBO PUBLICATION: Taxing Capital Income: Effective Rates and Approaches to Reform, October 2005
148 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 5

Limit or Eliminate the Deduction for State and Local Taxes 

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

In determining their taxable income, taxpayers may 

choose the standard deduction when they file their tax 

returns or they may itemize and deduct certain expenses 

(including state and local taxes on income, real estate, 

and personal property) from their adjusted gross income 

(AGI). Under the American Jobs Creation Act of 2004, 

taxpayers who itemized were allowed to deduct state and 

local sales taxes, which previously had not been deductible, instead of state and local income taxes. The Tax 

Relief, Unemployment Insurance Reauthorization, and 

Job Creation Act of 2010 (Public Law 111-312, referred 

to in this report as the 2010 tax act) extended that provision through 2011. Beginning in 2013, with the expiration of the 2010 tax act, the total value of certain itemized deductions—including the deduction for state and 

local taxes—will be reduced if the taxpayer’s AGI is above 

a specified threshold.1

This option would change the deductibility of state and 

local tax payments, either by eliminating the deduction 

or by restricting it to an amount equal to or less than 

2 percent of AGI. Eliminating the deduction would 

increase federal revenues by $345 billion from 2012 

through 2016 and by $862 billion from 2012 through 

2021. Capping the deduction at 2 percent of AGI would 

increase revenues by $253 billion over five years and by 

$629 billion over 10 years.

Those revenue estimates reflect the assumption that the 

alternative minimum tax (AMT) would continue to 

operate as it does under current law. (Federal tax liability 

is computed differently under the AMT than it is under 

the regular income tax because the former allows a more 

limited set of exemptions, deductions, and tax credits; 

taxpayers pay the higher of their regular tax or the AMT.) 

Because the deduction for state and local taxes is the largest item that must be added back into income under the 

AMT, assumptions regarding the AMT have a substantial 

effect on the revenue estimates for this option. Under 

current law, the number of taxpayers who pay the AMT 

will grow each year because the exemption amounts and 

brackets for the AMT are not indexed for inflation. As 

the scope of the AMT expands, fewer people will benefit 

from the deduction for state and local taxes. However, 

policymakers have routinely changed the requirements to 

limit the number of taxpayers affected by the AMT. If 

legislation that limited AMT liability was already in 

place, more taxpayers would benefit from the deduction 

for state and local taxes—and eliminating that deduction 

would result in a larger revenue gain than would be the 

case under current law. 

The deduction for state and local taxes is effectively a federal subsidy to state and local governments. As such, it 

indirectly finances spending by those governments at the 

expense of other uses of federal revenues. Either variation 

of this option would substantially reduce the incentive 

that the current subsidy provides for state and local government spending, although some research indicates that 

total state and local spending is not sensitive to that 

incentive.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

End the current itemized 

deduction 11.3 55.9 88.7 92.7 96.5 99.6 101.7 103.6 105.0 107.1 345.1 862.2

Cap the deduction at 

2 percent of adjusted 

gross income 7.8 39.8 66.1 68.4 70.9 72.8 74.1 76.2 76.2 78.0 253.0 629.3

1. In 2009—the last year that the provision to reduce itemized 

deductions was in effect—itemized deductions began to be 

reduced when adjusted gross income was greater than $166,800. 

As was the case before 2010, the income thresholds will be 

adjusted for inflation when that provision is reinstated in 2013. 

The Congressional Budget Office estimates that in 2013 that 

threshold will be about $174,500.
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 149

CBO

An argument in favor of curtailing the deduction is that 

the federal government should not subsidize state and 

local governments through the tax deduction because 

state and local taxes are largely paid in return for services 

provided to the public. If that is the case, such taxes are 

analogous to spending on other types of consumption, 

which are nondeductible. Another argument is that the 

deduction largely benefits wealthier localities, where 

many taxpayers itemize, are in the upper income tax 

brackets, and enjoy more abundant state and local 

government services. Because the value of an additional 

dollar of itemized deductions increases with the marginal 

tax rate (the rate on the last dollar of income), the deductions are worth more to taxpayers in higher income tax 

brackets than they are to those in lower income brackets. 

Additionally, the deductibility of taxes could deter states 

and localities from financing services with nondeductible 

fees, which could be more efficient.

An argument against eliminating or restricting the current deduction involves the equity of the tax system. A 

person who must pay relatively high state and local taxes 

has less money with which to pay federal taxes than does 

someone with the same total income and smaller state 

and local tax bills. The validity of that argument, however, depends at least in part on whether people who pay 

higher state and local taxes also benefit more from goods 

and services provided by states and localities. 

RELATED OPTION: Revenues, Option 6

RELATED CBO PUBLICATION: The Deductibility of State and Local Taxes, February 2008
150 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 6

Curtail the Deduction for Charitable Giving

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Current law allows taxpayers who itemize to deduct the 

value of their contributions to qualifying charitable 

organizations. By lowering the after-tax cost of donating 

to charities, the deduction provides an added incentive 

to donate. In 2008 (the most recent year for which data 

are available), taxpayers claimed $173 billion in charitable contributions on 39 million tax returns.

The deduction is restricted in two ways. First, charitable 

contributions may not exceed 50 percent of a taxpayer’s 

adjusted gross income (AGI) in any one year. Second, 

beginning in 2013, with the expiration of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job 

Creation Act of 2010 (Public Law 111-312), the total 

value of certain itemized deductions—including the 

deduction for charitable donations—will be reduced if 

the taxpayer’s AGI is above a specified threshold.1

This option would further curtail the deduction for charitable donations while preserving a tax incentive for 

donating. Only contributions in excess of 2 percent of 

AGI would be deductible for a taxpayer who itemizes. 

That amount would still be subject to the additional 

reduction described above for higher-income taxpayers in 

2013 and later. Limiting the deduction to contributions 

in excess of 2 percent of AGI would match the treatment 

that now applies to unreimbursed employee expenses, 

such as job-related travel costs and union dues. Such a 

policy change would increase revenues by $86 billion 

from 2012 through 2016 and by $219 billion from 

2012 through 2021. 

An argument in favor of this option is that, even without 

a deduction, a significant share of charitable donations 

would probably still be made. Therefore, allowing taxpayers to deduct contributions is economically inefficient 

because it results in a large loss of federal revenue for a 

very small increase in charitable giving. For taxpayers who 

contribute more than 2 percent of their AGI to charity, 

this option would maintain the current incentive to 

donate but at much less cost to the federal government. 

People who make large donations often are more responsive to that tax incentive than people who make small 

contributions. Moreover, smaller contributions are apt to 

be a source of abuse among taxpayers because donations 

that are under $250 do not require the same degree of 

documentation as those that are larger.

A potential disadvantage of this option is that total charitable giving would decline, albeit by only a small amount. 

People who contribute less than 2 percent of their AGI 

would no longer have a tax incentive to donate, and 

many of them could reduce their contributions. 

Although larger donors would still have an incentive to 

give, they would have slightly lower after-tax income 

because of the smaller deduction and thus might reduce 

their contributions as well (although by a lesser percentage than smaller donors). Another effect of creating the 

2 percent floor is that it would encourage taxpayers 

who had planned to make gifts over several years to combine donations into a single tax year to qualify for the 

deduction.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 3.7 18.7 20.0 21.3 22.5 23.8 25.1 26.5 28.0 29.4 86.2 219.0

1. In 2009—the last year that the provision to reduce itemized 

deductions was in effect—itemized deductions began to be 

reduced when adjusted gross income was greater than $166,800. 

As was the case before 2010, the income thresholds will be 

adjusted for inflation when that provision is reinstated in 2013. 

The Congressional Budget Office estimates that in 2013 that 

threshold will be about $174,500.

RELATED OPTION: Revenues, Option 7

RELATED CBO PUBLICATIONS: The Estate Tax and Charitable Giving, July 2004; and Effects of Allowing Nonitemizers to Deduct Charitable 

Contributions, December 2002
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 151

CBO

Revenues—Option 7

Limit the Tax Benefit of Itemized Deductions to 15 Percent

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

When preparing their returns, taxpayers may choose the 

standard deduction or they may itemize and deduct certain expenses (including state and local taxes, mortgage 

interest, charitable contributions, and some medical 

expenses) to determine their taxable income. Taxpayers 

benefit from itemizing when their itemized deductions 

exceed the amount of the standard deduction. For some 

types of expenses (such as medical expenses), only the 

amount that exceeds a given percentage of the taxpayer’s 

adjusted gross income may be deducted. Beginning in 

2013, with the expiration of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 

2010 (Public Law 111-312), the total value of certain 

itemized deductions will be reduced if the taxpayer’s 

adjusted gross income is above a specified threshold.1

As with any deduction, the benefit of itemizing increases 

with a taxpayer’s marginal tax rate (the rate that applies to 

the last dollar of income). For instance, $10,000 in 

deductions reduces tax liability by $1,500 for someone in 

the 15 percent tax bracket but by $2,800 for someone in 

the 28 percent tax bracket. 

This option would limit the extent to which taxes can 

be reduced by itemizing to 15 percent of the deductions’ 

value, thus increasing revenues by $460 billion from 

2012 through 2016 and by $1,181 billion over 10 years. 

It would raise taxes for people in marginal tax brackets 

above 15 percent who itemize deductions. Most taxpayers, however, do not itemize deductions. Among the 

36 percent who do, about 75 percent receive a tax benefit 

from itemizing that is worth more than 15 percent of 

their deductions. Thus, the option would affect about 

one out of four taxpayers. 

An argument in favor of the option is that the current 

rules for itemizing deductions lead to too much spending 

on tax-favored activities because they effectively reduce 

the after-tax price of such activities. For example, the 

deduction for mortgage interest may cause homeowners 

to invest too much in their houses and too little elsewhere. From that perspective, reducing the benefit 

derived from itemizing deductions would lessen the 

incentive to spend money on deductible activities. That 

could improve the allocation of society’s resources in cases 

in which the current subsidy has led to too much spending on those activities. But some deductions are intended 

to subsidize activities that have widespread benefits to the 

public, such as the work of charitable organizations; 

under certain circumstances, curtailing those deductions 

could worsen the allocation of resources.

Another argument in favor of the option concerns equity. 

The current system provides a greater tax reduction per 

dollar of deductible expense to higher-income taxpayers 

than to those with lower income. By weakening the link 

between deductible expenses and a household’s marginal 

tax bracket, the option would subsidize those expenses 

more equitably among households with different 

incomes. Weakening that link could also reduce the 

extent to which resources are misallocated. For a given 

amount of subsidies, a system of uniform subsidies generally distorts taxpayer behavior less than does a system in 

which subsidies are large for some households and small 

for others. 

However, in cases in which higher-income taxpayers 

are more sensitive than lower-income taxpayers to the 

after-tax price of a subsidized activity that has widespread 

benefits to society, eliminating the link between deductions and a household’s marginal tax bracket could 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 23.4 77.6 112.0 119.6 127.5 134.7 140.6 145.3 148.7 151.5 460.1 1,180.8

1. In 2009—the last year that the provision to reduce itemized 

deductions was in effect—itemized deductions began to be 

reduced when adjusted gross income was greater than $166,800. 

As was the case before 2010, the income thresholds will be 

adjusted for inflation when that provision is reinstated in 2013. 

The Congressional Budget Office estimates that in 2013 that 

threshold will be about $174,500.
152 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

worsen economic efficiency by reducing the amount of 

resources those taxpayers allocate to such activities. 

An argument against the option is that some deductions 

are intended to yield a measure of taxable income that 

more accurately reflects a person’s ability to pay taxes. For 

example, taxpayers with large medical expenses or casualty and theft losses may have fewer resources than taxpayers with similar income and smaller expenses. Under 

this option, taxpayers subject to the limitation would not 

have those expenses fully subtracted from their taxable 

income.

Limiting the tax benefit of itemized deductions would 

alter relative tax burdens. Reducing the benefit from 

itemized deductions would raise average tax rates more 

for upper-income taxpayers than for those with lower 

incomes. It would also raise average tax rates more 

for people who incurred large deductible expenses than 

for those with smaller expenses.

RELATED OPTIONS: Revenues, Options 4, 5, and 6
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 153

CBO

Revenues—Option 8

Include Employer-Paid Premiums for Income Replacement Insurance in 

Employees’ Taxable Income

Sources: Joint Committee on Taxation and Congressional Budget Office.

Notes: To the extent that the option would affect refundable tax credits, the revenue estimates include effects on outlays.

To the extent that the option would affect Social Security payroll taxes, a portion of the revenues is off-budget. The outlays are 

associated with payments of Social Security benefits and are classified as off-budget.

Benefits that replace income for the unemployed, injured, 

or disabled are currently subject to different tax treatments. Whereas unemployment benefits are fully taxable, 

benefits paid under workers’ compensation programs 

(for work-related injuries or illnesses) are tax-exempt. 

Disability benefits (for non-work-related injuries) may be 

taxable, depending on who paid the premiums for the 

disability insurance. If the employer paid the premiums, 

the benefits are taxable (although the recipient’s tax liability can be offset partly by special income tax credits for 

elderly or disabled people). If the employee paid the premiums out of after-tax income, the benefits are not taxed.

This option would eliminate existing taxes on income 

replacement benefits but would include in employees’ 

taxable income the value of several taxes, premiums, and 

other contributions paid by employers. Specifically, all 

of the following would be subject to the individual 

income tax and the payroll taxes for Social Security and 

Medicare: the taxes that employers pay under the Federal 

Unemployment Tax Act and to various state unemployment programs; 60 percent of premiums that employers 

pay for workers’ compensation (excluding the 40 percent 

that covers medical expenses); and the portion of insurance premiums or contributions to pension plans that 

employers pay to fund disability benefits. Together, those 

changes would increase revenues by $136 billion from 

2012 through 2016 and by $316 billion over the 2012–

2021 period. Over the long term, the gain in revenues 

would result almost entirely from adding workers’ compensation premiums to taxable income. Including those 

various items in employees’ taxable income, and thus 

in the wage base from which Social Security benefits are 

calculated, also would increase federal spending for Social 

Security. On net, the option would reduce federal budget 

deficits by $135 billion from 2012 through 2016 and by 

$312 billion from 2012 through 2021.

An advantage of this option is that it would treat different 

kinds of income replacement insurance similarly and 

thereby eliminate the somewhat arbitrary discrepancies 

that currently exist. For example, people who are unable 

to work because of an injury would not be taxed differently on the basis of whether their injury was related to a 

previous job. In addition, the option would spread the tax 

burden among all workers covered by such insurance 

rather than placing the burden solely on those who need 

the benefits, as is presently the case with unemployment 

insurance and employer-paid disability insurance. 

A disadvantage of this option is that it would not eliminate all disparities in the way income replacement benefits are treated. For example, the income replacement 

portion of adjudicated awards and out-of-court settlements for injuries not related to work and not covered 

by insurance would remain entirely exempt from taxation. Also, recipients of the supplemental unemployment benefits that the government sometimes provides 

during economic downturns would receive those benefits 

tax-free, even though no amount corresponding to an 

employer’s contribution had ever been included in the 

recipients’ taxable income. 

Another disadvantage of the option is that it would 

initially exempt from taxation the benefits received by 

people whose premiums were not taxed, providing particularly large benefits to that cohort relative to earlier 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0 0.1 0.2 0.2 0.3 0.4 0.6 0.7 0.9 1.1 0.8 4.4

Change in Revenues 13.0 28.9 29.8 31.5 32.6 33.8 35.0 36.0 37.2 38.0 135.8 315.9

Net Effect on the Deficit -13.0 -28.8 -29.7 -31.3 -32.3 -33.4 -34.5 -35.3 -36.3 -36.9 -135.0 -311.5
154 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

or subsequent cohorts. Transition rules could be devised 

to limit or prevent such gains, but those rules would 

probably be complicated and difficult to implement.

The option would reduce nearly every worker’s takehome pay but by a relatively small amount—less than 

one-half of one percent, on average. For some workers, 

that reduction in after-tax income would be somewhat 

mitigated because any unemployment benefit or 

employer-financed disability insurance, received at some 

future date, would no longer be taxable. 

RELATED OPTION: Revenues, Option 30
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 155

CBO

Revenues—Option 9

Include Investment Income from Life Insurance and Annuities in Taxable Income

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Certain types of life insurance policies and annuities 

combine features of insurance and tax-favored savings 

accounts. (An annuity is a contract with an insurance 

company under which, in exchange for premiums, the 

company agrees to make fixed or variable payments 

to a person at a future time, usually during retirement.) 

Portions of the premiums paid for certain types of insurance policies, such as whole-life polices, and for annuities 

are invested and earn interest, dividends, and other types 

of investment income. (A whole-life policy is a contract 

with an insurance company that provides life insurance 

coverage throughout the policyholder’s lifetime—not 

just for a specified period, as is the case with term life 

insurance.) That investment income, sometimes called 

inside buildup, is generally not included in taxable 

income until it is paid out to the policyholder as a return 

of cash value or as a recurring payment. If the inside 

buildup is used to reduce premiums in later years (as 

occurs with whole-life policies) or is paid out because of 

the death of the insured, it can escape taxation under the 

income tax. 

Under this option, life insurance companies would 

inform policyholders annually of the investment income 

their accounts have realized, just as mutual funds do now, 

and policyholders would include those amounts in their 

taxable income for that year. In turn, the cash value from 

life insurance policies and recurring payments from 

annuities would not be taxed when they were paid out. 

That approach would make the tax treatment of investment income from life insurance and annuities match the 

treatment of income from bank accounts, taxable bonds, 

or mutual funds. (Taxes on investment income from 

annuities purchased as part of a qualified pension plan or 

qualified individual retirement account would still be 

deferred until benefits were paid.) Such changes in tax 

treatment would increase revenues by $117 billion from 

2012 through 2016 and by $260 billion from 2012 

through 2021. Those revenue gains would diminish 

over time, however, relative to the size of the economy, 

because taxes paid on the inside buildup would mean that 

future payouts were tax-exempt.

By taxing the investment income from life insurance and 

annuities as it was realized, this option would eliminate a 

tax incentive to purchase such insurance products. 

Whether that outcome would be a benefit or a drawback 

depends on whether the current incentive is considered 

beneficial. Encouraging the purchase of life insurance is 

useful if people buy too little because they underestimate 

the financial hardship that their death will impose on 

their families. Encouraging the purchase of annuities is 

helpful if people tend to underestimate their retirement 

spending or life span and thus buy too little annuity 

insurance to protect against outliving their assets. 

However, scant evidence exists about how successful 

the current tax treatment is in encouraging people to 

obtain adequate amounts of insurance.

If providing an incentive to purchase life insurance is 

indeed considered a useful part of the tax system, an 

alternative approach would be to encourage such purchases directly by giving people a tax credit for their life 

insurance premiums or by allowing them to deduct part 

of those premiums from their taxable income. Either 

alternative would encourage people to purchase term 

insurance as well as whole-life policies. (Term insurance, 

which accounts for a large proportion of all life insurance 

policies, earns no inside buildup and so does not benefit 

from the same favorable tax treatment. Term insurance 

provides coverage for a specified period and pays benefits 

only if the policyholder dies during the term. Otherwise, 

the policy expires without value.) 

A disadvantage of taxing inside buildup is that the people 

who would be affected would not have access to the 

buildup to pay the tax. People who had accumulated 

considerable savings from contributions to whole-life 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 12.5 25.3 25.8 26.3 26.9 27.4 28.0 28.5 29.1 29.7 116.8 259.5
156 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

policies or annuities could owe substantial amounts of 

taxes relative to the cash income from which they would 

have to pay the taxes. (That is one reason inside buildup 

is currently taxed in a manner that is similar to the treatment of capital gains, in that the gains are not taxed until 

the investor sells the asset.)

RELATED OPTIONS: Revenues, Options 11 and 12
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 157

CBO

Revenues—Option 10

Tax Carried Interest as Ordinary Income

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Investment funds—such as private equity, real estate, and 

hedge funds—are typically organized as partnerships with 

one or more general partners managing the fund. The 

general partners determine investment strategy; solicit 

capital contributions; acquire, manage, and sell assets; 

arrange loans; and provide administrative support for all 

of those activities. Such partnerships also typically 

include limited partners, who contribute capital to the 

partnership but do not participate in the fund’s management. General partners can invest their own financial 

capital in the partnership, but such investments usually 

represent a small share of the total funds invested. 

General partners typically receive two types of compensation for managing a fund: a fee tied to some percentage of 

the fund’s assets under management; and a profit share, 

or “carried interest,” tied to some percentage of the profits generated by the fund. A common compensation 

agreement gives general partners a 2 percent fee and 

20 percent in carried interest. The fee, less the fund’s 

expenses, is taxed as ordinary income (and thus is subject 

to regular income tax rates). In contrast, the carried interest that general partners receive is taxed in the same way 

as the investment income passed through to the limited 

partners. For example, if that investment income consists 

solely of capital gains, the carried interest is taxed only 

when those gains are realized and at the lower capital 

gains rate. Until 2013, the general partners’ share of dividends is also taxed at the lower rate.

This option would treat the carried interest that partners 

receive for performing investment management services 

as ordinary income. Income those partners received as a 

return on their own capital contribution would not be 

affected. The change would produce $10 billion in revenues from 2012 through 2016 and $21 billion from 

2012 through 2021. 

Arguments in favor of this option reflect the view that 

carried interest should be considered performance-based 

compensation for management services rather than a 

return on the financial capital invested by the general 

partner. In accordance with that viewpoint, the option 

would eliminate two notable differences in the way 

carried interest and comparable forms of income are 

currently taxed. First, taxing carried interest as ordinary 

income would make its treatment consistent with that 

applied to many other forms of performance-based 

compensation, such as bonuses and most stock options. 

Second, the option would equalize the tax treatment of 

income that partners receive for performing investment 

management services and the treatment of income earned 

by corporate executives who do similar work. (The managers of publicly traded mutual funds, for example, also 

invest in a variety of assets. And the executives of many 

corporations direct investment, arrange financing, purchase other companies, or spin off components of their 

enterprises.) 

Arguments against the option reflect the view that at least 

a portion of carried interest represents a return on the 

financial capital invested by the general partner. From 

that perspective, carried interest is the equivalent of an 

interest-free nonrecourse loan from the limited partners 

to the general partner. That loan is equal to the agreedupon share of the partnership’s assets (commonly 20 percent), with the requirement that the loan proceeds be 

reinvested in the fund. (A borrower is not personally liable for a nonrecourse loan beyond the pledged collateral, 

which in this case would be the general partner’s claim on 

future profits.) When the partnership sells its assets, it is 

argued, any gain realized or loss incurred by the general 

partner on his or her share (after the loan was paid back) 

could be legitimately viewed as a capital gain or loss.

Furthermore, this option would treat the income of partners who provide investment management services differently from that earned by entrepreneurs who start a new 

business, contribute both labor services and capital, and 

then sell the business. Profits from such sales generally are 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 2.2 2.2 1.9 1.7 1.7 2.2 2.5 2.4 2.3 2.3 9.7 21.4
158 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

taxed as capital gains, even though some of those profits 

represent a direct return on specific labor services provided by the owners. 

Another argument against such a policy change is that, 

if at least a portion of carried interest is presumed to be 

a return on the general partner’s investment, it would 

reduce the incentive for general partners to undertake 

risky investments that can lead to innovation, new products, and more-efficient markets and businesses. It is not 

clear, however, to what extent a lower rate on capital gains 

contributes to such outcomes, or even whether promoting risky investment offers more economic advantages 

than disadvantages. 

An alternative option, which presupposes that carried 

interest is neither entirely a return on capital nor entirely 

labor compensation, would explicitly recognize carried 

interest as an interest-free nonrecourse loan from the 

limited partners to the general partner. Under current tax 

rules, the implicit interest on that (nominally interestfree) loan would be determined by the interest rate on 

federal securities with the same duration and would be 

taxed as ordinary income. At the time the partnership 

sold its assets, any gains realized or losses incurred by the 

general partner (after the loan was repaid) would be 

treated as a capital gain or loss. The general partner 

would typically pay more in taxes than is assessed under 

current law but less than would be assessed if all carried 

interest was treated as ordinary income.

An advantage of the alternative option is that it would 

apply full taxation to at least some performance-based 

compensation without changing the underlying 

economics of the partnership arrangement. However, 

the approach is complex, which could make it particularly difficult to implement. 

RELATED CBO PUBLICATION: Statement of Peter R. Orszag, Director, Congressional Budget Office, before the House Committee on Ways and Means, 

The Taxation of Carried Interest, September 6, 2007
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 159

CBO

Revenues—Option 11

Tax Social Security and Railroad Retirement Benefits in the Same Way That 

Distributions from Defined-Benefit Pensions Are Taxed

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Under current law, less than 30 percent of the benefits 

paid by the Social Security and Railroad Retirement programs is subject to the federal income tax. Recipients 

with income below a specified threshold pay no taxes on 

those benefits. Most recipients fall in that category, which 

constitutes the first tier of a three-tiered tax structure. If 

the sum of their adjusted gross income, their nontaxable 

interest income, and one-half of their Social Security and 

Tier I Railroad Retirement benefits exceeds $25,000 (for 

single taxpayers) or $32,000 (for couples filing jointly), 

up to 50 percent of the benefits are taxed. Above a higher 

threshold—$34,000 for single filers and $44,000 for 

joint filers—as much as 85 percent of the benefits are 

taxed. 

By contrast, distributions from defined-benefit plans are 

taxable except for the portion that represents the recovery 

of an employee’s “basis”—that is, his or her after-tax contributions to the plan. In the year that distributions 

begin, the recipient determines the percentage of each 

year’s payment that is considered to be the nontaxable 

recovery of previous after-tax contributions, based on the 

cumulative amount of those contributions and projections of his or her life expectancy. Once the recipient has 

recovered his or her entire basis tax-free, all subsequent 

pension distributions are fully taxed. (Distributions from 

traditional defined-contribution plans and from individual retirement accounts, to the extent that they are 

funded by after-tax contributions, are also taxed on 

amounts exceeding the basis.)1

This option would treat the Social Security and Railroad 

Retirement programs in the same way that definedbenefit pensions are treated by defining a basis and 

taxing only those benefits that exceed that amount. For 

employed individuals, the basis would be the payroll taxes 

they paid out of after-tax income to support those programs (but not the equal amount that employers paid 

on their workers’ behalf). For self-employed people, the 

basis would be the portion (50 percent) of their selfemployment taxes that is not deductible from their taxable income. Revenues would increase by $184 billion 

from 2012 through 2016 and by $438 billion from 

2012 through 2021. 

An argument in favor of this option concerns equity. 

Taxing benefits from the Social Security and Railroad 

Retirement programs in the same way as those from 

defined-benefit pensions would make the tax system 

more equitable in at least two ways. First, it would eliminate the preferential treatment given to Social Security 

benefits but not to pension benefits—a preference that is 

minimal for higher-income taxpayers but much larger for 

low- and middle-income taxpayers. Second, it would 

treat elderly and nonelderly taxpayers with comparable 

income the same way. For people who pay taxes on 

Social Security benefits under current law, the option 

could also simplify the preparation of tax returns because 

the Social Security Administration—which would have 

information on their lifetime contributions and life 

expectancy—could compute the taxable amount of 

benefits and provide that information to beneficiaries 

each year. 

This option also has drawbacks. A greater number of 

elderly people would have to file tax returns than do so 

now. People with incomes below $44,000, including 

some who depend solely on Social Security or Railroad 

Retirement for their support, would have their taxes 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 16.1 36.8 42.2 43.7 45.2 46.9 48.8 50.7 52.8 55.0 184.0 438.4

1. Distributions from Roth plans, which allow after-tax contributions only, are entirely tax-exempt—a more favorable treatment 

than the tax-free recovery of basis only. If Social Security benefits 

were treated like distributions from Roth plans, half the benefits 

would be exempt from taxation, reflecting the share financed by 

employees’ contributions, which are after-tax (or, in the case of the 

self-employed, the share of their contributions that is not 

deducted from their taxable income).
160 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

increased by the greatest percentage. In addition, raising 

taxes on Social Security and Railroad Retirement benefits 

would be equivalent to reducing those benefits and could 

be construed by some retirees—as well as people nearing 

retirement—as violating the implicit promises of those 

programs, especially because the option would provide no 

opportunity for them to adjust their saving or retirement 

strategies to mitigate the impact. Finally, calculating the 

percentage of each recipient’s benefits that would be 

excluded from taxation would impose an additional 

burden on the Social Security Administration. 

RELATED OPTIONS: Revenues, Options 9 and 12

RELATED CBO PUBLICATION: Social Security Policy Options, July 2010
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 161

CBO

Revenues—Option 12

Reduce Limits on Contributions to Retirement Plans 

Source: Joint Committee on Taxation.

Note: To the extent that the options would affect refundable tax credits, the estimates include effects on outlays.

Current law allows taxpayers to make contributions to 

certain types of tax-preferred retirement plans up to a 

limit that varies depending on the type of plan and the 

age of the taxpayer. The most common such vehicles are 

401(k) plans, which are sponsored by employers, and 

individual retirement accounts (IRAs), which are maintained by the participants themselves. 

Individuals under the age of 50 may contribute up to 

$16,500 to 401(k) and similar employment-based plans 

in 2011; participants ages 50 and above are also allowed 

to make “catch-up” contributions of up to $5,500, 

enabling them to make as much as $22,000 in total 

contributions in 2011. In general, those limits apply to 

contributions to all types of employment-based plans 

combined. However, contributions to 457(b) plans, 

available primarily to employees of state and local governments, are subject to a separate limit. As a result, employees who are enrolled in both 401(k) and 457(b) plans can 

contribute the maximum amount to both plans, thereby 

allowing some people to make tax-preferred contributions of as much as $44,000 in a single year. 

In 2011, IRA contribution limits are $5,000 for those 

under age 50 and $6,000 for those ages 50 and above. 

The limits on deductible amounts are phased out above 

certain income thresholds if either the taxpayer or the 

taxpayer’s spouse is covered by an employment-based 

plan. Contribution limits for all types of plans are 

indexed for inflation but increase only in $500 

increments.

This option would reduce contribution limits, regardless 

of a taxpayer’s age, to $14,850 for 401(k)–type plans and 

$4,500 for IRAs. Furthermore, it would suspend the 

indexing of those limits for five years. Finally, it would 

require all contributions to employment-based plans—

including 457(b) plans—to be subject to a single combined limit. If implemented, the option would increase 

revenues by $16 billion from 2012 through 2016 and by 

$46 billion from 2012 through 2021. 

One argument in favor of this option centers on fairness. 

The tax savings associated with these retirement plans—

particularly the employment-based plans that do not have 

income restrictions—increase with the participant’s 

income tax rate and the amount of his or her contribution. Thus, a worker in the 15 percent tax bracket defers 

taxes of 15 cents on each dollar contributed to a 401(k) 

plan, while an employee in the 35 percent tax bracket 

defers taxes of 35 cents. That larger tax benefit per dollar 

saved is enhanced for higher-income taxpayers because 

they tend to save more. Consequently, the taxpayers who 

would be most affected by the option are primarily 

higher-income individuals. The limits on 401(k) contributions affect few taxpayers—only 5 percent of participants in 2003—but of those affected, 64 percent had 

income in excess of $160,000 that year. The option also 

would level the playing field between those who currently 

benefit from higher contribution limits (people ages 50 

and over and employees of state and local governments) 

and those subject to lower limits. 

In addition to enhancing fairness, the option would 

improve economic efficiency. A goal of tax-preferred 

retirement plans is to increase private saving (although at 

the cost of some public saving). However, the higherincome individuals who are constrained by the current 

limits on contributions are most likely to be those who 

can fund the tax-preferred accounts out of existing savings without responding to the intended incentive to 

actually save more. Thus, the option would increase 

public saving—by reducing the deficit—at the cost of 

very little private saving. 

The main argument against this option is that it would 

reduce the retirement saving of a significant number of 

people, particularly those who find it difficult to save 

because of income constraints or family responsibilities. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 1.5 2.6 3.1 3.9 4.7 5.0 5.6 6.1 6.3 7.1 15.8 45.9
162 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Although only 5 percent of workers with income under 

$80,000 in 2003 contributed to IRAs, more than 40 percent of those people contributed the maximum amount 

permitted. Those workers generally have relatively little 

in accumulated savings and are more likely to respond 

to the incentive to save than are people in higher-income 

groups. Eliminating the catch-up contribution limits 

would adversely affect those ages 50 and over who might 

have failed to save enough for a comfortable retirement 

while raising their families. The amount they could 

contribute to tax-preferred retirement accounts would be 

cut at precisely the time when reduced family obligations 

and impending retirement make them more likely to 

respond to tax incentives to save more.

RELATED OPTIONS: Revenues, Options 9 and 11

CBO PUBLICATION: Utilization of Tax Incentives for Retirement Saving: Update to 2003, Background Paper, March 2007
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 163

CBO

Revenues—Option 13

Replace the Tax Exclusion for Interest Income on State and Local Bonds with a 

Direct Subsidy for the Issuer 

Source: Joint Committee on Taxation.

Note: These estimates represent the change in the overall budget balance that results from the sum of changes to revenues and outlays.

The federal tax code offers several types of tax preferences 

for bonds issued by state and local governments. First, 

interest income from governmental bonds—those that 

state and local governments issue to finance their own 

activities—can be excluded from a bondholder’s adjusted 

gross income (AGI). As a result, the interest earned 

on those bonds is exempt from the federal income tax. 

Second, the interest earned on qualified private activity 

bonds—which states and localities can issue to finance 

certain types of socially beneficial projects undertaken by 

private entities, such as the construction of hospitals and 

schools—can also be excluded from a bondholder’s AGI. 

(In some cases, however, that income may be subject to 

the alternative minimum tax.)1

 As a result of those tax 

preferences, borrowers pay less interest than they would 

on comparable bonds with taxable interest. The revenue 

forgone by the federal government effectively pays part of 

the borrowing costs of state and local governments and 

of those private entities whose bonds qualify for a tax 

preference.

For governmental and qualified private activity bonds 

issued in 2012 and afterward, this option would replace 

the exclusion for interest income with a subsidy paid 

directly to the issuers of the bonds. Under the option, 

borrowers would make taxable interest payments to 

bondholders; in turn, state and local issuers of those 

bonds would receive a subsidy payment directly from the 

federal government equal to 15 percent of the interest 

paid on the bonds. (States and localities that issued 

qualified private activity bonds would pass the subsidy 

payment on to the corresponding borrower in the private 

sector.) The option would retain restrictions that apply to 

governmental bonds, such as those on arbitrage earnings. 

In addition, it would not alter any of the limits—such 

as volume caps—currently imposed on the issuance of 

qualified private activity bonds. If implemented, such a 

policy change would increase federal revenues by more 

than it would increase federal outlays, for a net saving of 

$31 billion from 2012 through 2016 and of $143 billion 

from 2012 through 2021.

Making subsidy payments to borrowers for the bond 

interest they pay could have several advantages. First, 

switching from a tax exclusion to a subsidy payment for 

bond interest would be a more cost-effective way of 

providing a subsidy to borrowers. Only a portion of the 

federal revenue currently forgone through a tax exclusion 

on bond interest income actually lowers financing costs; 

in contrast, borrowers would receive all of the benefits 

of direct subsidy payments for bond interest. The tax 

exclusion on interest income is less cost-effective because 

some of the federal revenue forgone through the tax 

exclusion goes to bondholders in higher tax brackets. 

They receive gains that exceed the investment return 

necessary to clear the market for such bonds—that is, to 

attract enough buyers so that the demand for bonds 

matches the amount supplied. (In order to attract sufficient buyers in lower tax brackets to sell all of the bonds, 

issuers have to offer higher yields than are necessary to 

attract at least some of the buyers in higher tax brackets.)

Second, the amount of the federal subsidy for borrowing 

would be explicit and unaffected by other federal policy 

decisions. Currently, for example, the savings in financing 

costs that are realized by issuing governmental or qualified private activity bonds are largely determined indirectly by other features of the federal tax code (such as 

bond buyers’ tax brackets, which are an important determinant of the demand for such debt). 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0.4 2.9 6.0 9.0 12.2 15.5 19.0 22.5 25.9 29.3 30.5 142.7

1. Tax liability under the alternative minimum tax, or AMT, is 

computed differently than it is under the regular income tax 

because the former allows a more limited set of exemptions, 

deductions, and tax credits; taxpayers pay the higher of their 

regular tax or the AMT. 
164 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Third, making subsidy payments to the issuers of bonds 

could improve federal budgeting practices. The subsidies 

provided under current law are not readily visible in the 

budget; in contrast, under this option, the federal government would know the exact amount of financing subsidies it was providing in a given fiscal year. As a result, 

policymakers would be able to accurately assess the cost 

of the subsidies in comparison with the cost of other 

types of assistance to state and local governments and 

other spending more generally. 

A disadvantage of the option is that it could raise borrowing costs for issuers of tax-preferred debt and thereby 

deter some investment that might have national benefits 

or place greater burdens on already strained state and 

local budgets. A subsidy payment rate of 15 percent is 

at the lower end of the range of estimated annual reductions in interest payments attributable to the exclusion 

of bondholders’ income from federal taxes. Thus, state 

and local governments and some private entities would 

probably have to pay more to borrow, which in turn 

could cause them to reduce their spending on capital 

projects, such as schools and roads, and on existing 

programs (because general tax revenues are often used 

both to pay principal and interest on debt and to fund 

ongoing government operations). Borrowing costs could 

rise even further if lenders became fearful that transforming the subsidy from a tax exclusion to a more visible 

expenditure program would lead to further reductions 

(and potentially elimination) of the subsidy in the future 

and, as a consequence, charged higher rates of interest. 

However, the option could increase or decrease demand 

for tax-preferred debt, and it is therefore unclear whether 

borrowing costs would fall or rise. On the one hand, 

offering a taxable—and thus higher—yield on bonds 

issued by state and local governments would make that 

debt attractive to new types of bond buyers (such as 

managers of pension funds and foreign investors, who 

generally do not pay U.S. taxes). The demand created by 

those purchasers could lower borrowing costs. On the 

other hand, the demand for tax-preferred bonds could fall 

as a result of converting the tax exclusion on interest 

income into a direct subsidy payment. That is because 

the option would reduce the after-tax returns on such 

bonds for people who are in higher tax brackets (although 

the yield would be higher, they would pay taxes on all of 

the interest income they received) and, as a result, could 

lead them to buy fewer of those bonds.

If a 15 percent credit were to result in higher borrowing 

costs that deterred investments considered desirable 

by the federal government, the amount of the subsidy 

payment could be increased, either overall—say, from 

15 percent to 20 percent or 25 percent—or in a way that 

depended upon the purpose for which a bond was issued. 

However, increasing the subsidy rate would yield less 

savings for the federal government. 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 165

CBO

Revenues—Option 14

Modify or Eliminate the Child Tax Credit

Source: Joint Committee on Taxation.

Note: These estimates represent the change in the overall budget balance that results from the sum of changes to revenues and outlays.

The child tax credit, first enacted in the Taxpayer Relief 

Act of 1997, allows taxpayers to claim a credit against 

their federal income tax liability for each eligible child. To 

qualify, the child must be 16 or younger at the close of 

the tax year, and the taxpayer must be able to claim the 

child as a dependent. The credit phases out for single 

filers whose adjusted gross income is more than $75,000 

and for joint filers whose income is above $110,000. The 

Economic Growth and Tax Relief Reconciliation Act of 

2001 (EGTRRA) and other laws increased the credit 

from $500 to $1,000 per child. Most recently, the Tax 

Relief, Unemployment Insurance Reauthorization, and 

Job Creation Act of 2010 (Public Law 111-312, referred 

to in this report as the 2010 tax act) extended the $1,000 

per child credit through 2012. Starting in 2013, however, 

the credit amount will return to its pre–EGTRRA 

amount of $500 per child. 

The child tax credit is partially refundable, which means 

that families whose income tax liability (before the credit 

is applied) is less than the total amount of the credit may 

receive all or at least a portion of the credit as a payment. 

Before 2001, only taxpayers with three or more children 

were eligible for a refundable child tax credit, and the 

refund was limited to the amount by which their Social 

Security taxes exceeded the earned income tax credit, or 

EITC. (The earned income tax credit is a fully refundable 

credit designed to supplement the wages of low-income 

families.) EGTRRA made the credit refundable for taxpayers with one or two children and also introduced a 

new formula for computing the refund. Under the new 

formula, the refund could not exceed 15 percent of the 

taxpayer’s earned income above an established threshold. 

That threshold was initially set at $10,000 in 2001 and 

indexed for inflation; but it has been temporarily reduced 

to $3,000 by legislation several times over the past few 

years. Although smaller families must use the newer 

method to calculate the refundable credit, taxpayers with 

three or more children can choose the method that yields 

the larger refund. Beginning in 2013, with the expiration 

of the 2010 tax act, the criteria for receiving refunds will 

revert to those in effect before 2001: Only taxpayers with 

three or more children will be eligible for a refund, which 

in turn, will be limited to the amount that taxpayers’ 

Social Security taxes exceed their EITC. 

Starting in 2013, the first variant of this option would 

eliminate the portion of the child tax credit that is 

refundable. The second variant would eliminate the child 

tax credit altogether. The first approach would reduce the 

deficit by $11 billion from 2012 through 2016 and by 

$27 billion over the 10-year projection period; the second 

would reduce the deficit by $48 billion from 2012 

through 2016 and by $117 billion from 2012 through 

2021.

One argument for curtailing or eliminating the child tax 

credit is that other features of the individual income 

tax—such as the standard deduction for heads of households, personal exemptions, the dependent care tax 

credit, and the EITC—already provide significant tax 

preferences to families with children. (For example, a 

typical single parent with two children is projected to 

receive up to nearly $5,300 from the EITC in 2013.) 

Moreover, the credit does not benefit many of the poorest 

families because they have no income tax liability—when 

the credit reverts to its pre–EGTRRA form in 2013, 

only a handful of taxpayers with three or more children 

will be eligible for a refundable credit. (Even under the 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

Eliminate the 

refundable portion of 

the child tax credit 0 0.4 3.3 3.4 3.4 3.4 3.4 3.3 3.3 3.2 10.5 27.1

Eliminate the child 

tax credit 0 3.1 15.3 15.1 14.9 14.7 14.2 13.7 13.2 12.6 48.4 116.7
166 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

provisions of law that will be in place in 2012—specifically, as outlined by the 2010 tax act—a household’s 

earnings will have to exceed a minimum threshold to be 

eligible for the refundable credit.) Another argument for 

the option is that having children represents a family’s 

decision about how to spend its income—a choice that 

could be considered analogous to other decisions about 

spending. 

Either alternative would also simplify the tax code. The 

phaseout of the child tax credit at higher income levels 

requires taxpayers to complete a separate worksheet and 

perform additional computations. The computation of 

the refundable portion of the credit for families with 

three or more children is particularly complex. If policymakers believe that some families do not receive sufficient 

assistance through the tax system, then a simpler way to 

provide benefits would be through expansions of the 

other child-related tax benefits. 

An argument against reducing or eliminating the child 

tax credit is that the other preferences in the tax code may 

not fully compensate families for the extra costs of raising 

children. And eliminating the portion of the tax credit 

that is refundable, in particular, would limit compensation to those families least able to bear those additional 

costs. Raising children is an investment that may benefit 

all of society when those children become productive 

adults. With additional resources, parents could invest 

more in child rearing and benefit society as a whole. 

Those social benefits could take many forms, such as a 

better educated and more productive workforce, a healthier population, or a more civically engaged electorate. 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 167

CBO

Revenues—Option 15

Eliminate Certain Tax Preferences for Education Expenses

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Federal support for higher education takes many forms, 

including grants, subsidized loans, and tax preferences. 

Since the enactment of the Taxpayer Relief Act of 1997, 

however, assistance provided through the tax system has 

increased and expanded to families higher up the income 

distribution. 

In addition to several tax-advantaged accounts that allow 

families to save for their child’s postsecondary education, 

taxpayers can also benefit from several education-related 

credits and deductions. One of those allows taxpayers to 

deduct up to $4,000 from their taxable income for qualifying tuition and fees, whether they itemize deductions or 

not. That deduction, which expired at the end of 2009, 

was reinstated by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 

(Public Law 111-312). It is currently scheduled to expire 

at the end of 2011. Another tax preference, the American 

Opportunity Tax Credit (AOTC), covers up to $2,500 in 

educational expenses (100 percent of the first $2,000 and 

then 25 percent of the next $2,000) and is available for 

up to four years of postsecondary education. Up to 

40 percent of the credit (or $1,000) is refundable for 

lower-income families. That credit is scheduled to expire 

at the end of 2012. 

Three other tax preferences will be in effect through the 

end of the 10-year projection period under current law: 

B The Hope tax credit was replaced by the American 

Opportunity Tax Credit in 2009 but will be reinstated 

in 2013 when the AOTC is scheduled to expire. In 

2008, the last year it was available, the Hope credit 

was equal to 100 percent of the first $1,200 of qualifying tuition and fees and 50 percent of the next $1,200 

for a maximum credit of $1,800 per year. As was the 

case before the Hope credit expired, the parameters 

used to calculate the credit amount will be indexed for 

inflation when the credit is reinstated. On the basis 

of that adjustment, the Congressional Budget Office 

estimates that the maximum credit in 2013 will be 

$1,950. The Hope credit is nonrefundable (that is, the 

credit amount may not exceed the filer’s income tax 

liability). It can be claimed only for expenses incurred 

in the first two years of a postsecondary degree or certificate program, and the student must be enrolled at 

least half-time during that period. In 2008, the Hope 

tax credit began to phase out for joint filers when their 

modified adjusted gross income (MAGI) exceeded 

$96,000 and for single filers when their MAGI 

exceeded $48,000.1

 As with the parameters used to 

calculate the credit amount, the income thresholds 

for the Hope tax credit are also adjusted for inflation. 

CBO estimates those thresholds will be $104,000 for 

joint filers and $52,000 for single filers when the 

Hope tax credit is reinstated in 2013. 

B The nonrefundable Lifetime Learning tax credit provides up to $2,000 for qualifying tuition and fees. 

(The credit equals 20 percent of each dollar of qualifying expenses up to a maximum of $10,000.) Only one 

Lifetime Learning credit may be claimed per tax 

return per year, but the expenses of more than one 

family member (a taxpayer, spouse, or dependent) 

may be included in the calculation. In 2011, the 

Lifetime Learning tax credit begins to phase out for 

joint filers whose MAGI is more than $102,000 and 

for single filers whose MAGI exceeds $51,000. As 

with the Hope tax credit, those income thresholds 

are also adjusted for inflation. Unlike the Hope credit, 

the Lifetime Learning credit can be used after the 

first two years of postsecondary education and by 

students who attend school less than half-time. 

Taxpayers may not, however, claim both credits for the 

same student in the same year.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0 1.3 6.2 6.1 6.0 5.9 5.8 5.6 5.5 5.3 19.6 47.7

1. Several foreign income and foreign housing exclusions are added 

to adjusted gross income (AGI) to calculate the modified AGI 

measure used to determine eligibility for education-related tax 

credits.
168 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

B A tax deduction of up to $2,500 per year for interest 

payments on student loans may be taken by itemizers 

and nonitemizers alike. In 2011, the interest deduction for student loans begins to phase out for joint filers with MAGI above $120,000 and for single filers 

with MAGI above $60,000. Although the maximum 

deduction is not indexed for inflation, the income 

thresholds for the phaseout ranges are adjusted for 

inflation.

This option would eliminate the Hope tax credit and the 

Lifetime Learning tax credit beginning in 2013. The 

option would also gradually eliminate the deductibility 

of interest expenses for student loans. Because students 

borrowed money with the expectation that a portion of 

the interest would be deductible over the life of the loan, 

the interest deduction for student loans would be phased 

out in annual increments of $250 over a 10-year period. 

If implemented, this option would raise revenues by 

$20 billion from 2012 through 2016 and by $48 billion 

over the 2012–2021 period.

An argument in favor of the option is that the current tax 

benefits are not targeted to those who need assistance the 

most. Many low-income families do not have sufficient 

income tax liability to claim all—or in some cases, any—

of the education-related tax benefits. However, the cost of 

higher education may impose a greater burden on those 

families as a proportion of their income. Further, some 

research indicates that lower-income individuals and families may be more sensitive to the cost of higher education 

than those with higher income and thus more likely to 

enroll in higher education programs if tuition and fees are 

subsidized. 

A second rationale in favor of the option concerns the 

administration of education benefits through the income 

tax system. Education benefits administered through the 

tax system are poorly timed because families must pay 

tuition and fees before they can claim the benefits on 

their tax returns. In contrast, federal spending programs 

such as the Pell Grant program are designed to provide 

assistance when the money is needed—at the time of 

enrollment. Further, providing education assistance 

through various credits and deductions, each with slightly 

different eligibility rules and benefit amounts, makes it 

difficult for families to determine which tax preferences 

provide the most assistance. As a result, some families 

may not choose the most advantageous educational benefits for their particular economic circumstances. 

A drawback of this policy option is that some households 

would not receive as much assistance for educational 

expenses unless federal outlays for education assistance 

were expanded. The option would increase the financial 

burden on families with postsecondary students—

particularly middle-income families who do not qualify 

for current federal spending programs. Another drawback 

is that despite the current system’s complexity—which 

creates overlapping tax benefits—some families may find 

it easier to claim benefits on their tax returns (on which 

they already provide information about their family 

structure and income) than to fill out additional forms 

for assistance through other federal programs.

RELATED OPTIONS: Mandatory Spending, Options 10 and 11; and Discretionary Spending, Option 28

RELATED CBO PUBLICATIONS: Costs and Policy Options for Federal Student Loan Programs, March 2010; and Private and Public Contributions 

to Financing College Education, January 2004
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 169

CBO

Revenues—Option 16

Increase the Maximum Taxable Earnings for the Social Security Payroll Tax 

Sources: Joint Committee on Taxation and Congressional Budget Office.

Notes: To the extent that the option would affect refundable tax credits, the revenue estimates include effects on outlays.

Most of the revenues are off-budget. To the extent that the option would affect individual income tax revenues, a portion is on-budget. 

The outlays are associated with payments of Social Security benefits and are classified as off-budget.

Social Security—which consists of Old-Age, Survivors, 

and Disability Insurance (OASDI)—is financed by payroll taxes on employers, employees, and the selfemployed. Only earnings up to a maximum, which is 

$106,800 in 2011, are subject to the tax. That maximum 

usually increases each year by the growth rate of average 

wages in the economy.1

When payroll taxes for Social Security were first collected 

in 1937, about 92 percent of earnings from jobs covered 

by the program were below the maximum taxable 

amount. During most of the program’s history, the maximum was increased only periodically, so the percentage 

varied greatly. It fell to 74 percent in 1965 and, by 1977, 

was 87 percent. Amendments to the Social Security Act 

in 1977 boosted the amount of covered taxable earnings, 

which reached 91 percent in 1983. That law also indexed 

the taxable maximum to match annual growth in average 

wages. Despite those changes, the percentage of taxable 

earnings has slipped in the past decade because earnings 

for the highest-paid workers have grown faster than the 

average. Thus, in 2009, about 83 percent of earnings 

from employment covered by OASDI fell below the maximum taxable amount.

This option would increase the share of total earnings 

subject to the Social Security payroll tax to 90 percent by 

raising the maximum taxable amount to $170,000 in 

2012. (After being increased, the maximum would continue to be indexed as it is now.) Implementing such a 

policy change would increase revenues by $182 billion 

from 2012 through 2016 and by $468 billion over the 

2012–2021 period. (The estimates include the reduction 

in individual income tax revenues that would result from 

a shift of some labor compensation from a taxable to a 

nontaxable form.)

Because Social Security’s retirement benefits are tied to 

the amount of income on which taxes are paid, however, 

some of the increase in revenues from this option would 

be offset by the additional retirement benefits paid to 

people with income above the current maximum taxable 

amount. On net, the option would reduce federal budget 

deficits by $180 billion over the 5-year period and by 

$457 billion over the 10-year period. 

Enacting this option would enhance the long-term viability of the Social Security program, which, according to 

the Congressional Budget Office’s projections, will not 

have sufficient income to finance the benefits that are 

due to beneficiaries under current law. CBO projects 

that, in combination, the two Social Security trust funds 

will be exhausted in the late 2030s. Under this option, 

exhaustion of the combined trust funds would be delayed 

until after 2050.

In addition to improving Social Security’s long-term 

financial outlook, this option would make the payroll tax 

less regressive. People whose income is above the ceiling 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0.1 0.2 0.4 0.5 0.8 1.1 1.4 1.8 2.2 2.7 2.0 11.1

Change in Revenues 8.7 40.0 40.8 44.3 48.3 50.6 53.4 57.4 60.8 63.5 182.1 467.8

Net Effect on the Deficit -8.6 -39.8 -40.4 -43.8 -47.5 -49.6 -52.0 -55.7 -58.6 -60.8 -180.1 -456.7

1. The Social Security Act specifies that the taxable maximum rises 

only in those years in which benefits increase to reflect changes in 

the consumer price index for urban wage earners and clerical 

workers (often referred to as a cost-of-living adjustment or 

COLA). Because there was no COLA in 2010 or 2011, the taxable maximum has remained at its 2009 level. The Congressional 

Budget Office projects that there will be COLAs beginning in 

2012 and continuing throughout the budget period, causing the 

taxable maximum to once again increase annually.
170 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

now pay a smaller percentage of their total income in 

payroll taxes than do people whose total earnings are 

below the maximum. Making more earnings taxable 

would increase payroll taxes for those high-income 

earners. (Although that change also could lead to higher 

benefit payments for people with earnings above the current maximum, the additional benefits would be modest 

relative to the additional taxes those earners would pay.) 

An argument against this option is that raising the earnings cap would weaken the link between the taxes that 

workers pay into the system and the benefits they receive 

(because the addition to benefits would be modest 

relative to the increase in taxes). That link has been an 

important aspect of Social Security since its inception. 

Another drawback is that people whose earnings fall 

between the existing and proposed taxable limits would 

earn less after taxes for each additional hour worked, 

which would reduce the incentive to work and encourage 

taxpayers to substitute tax-exempt fringe benefits for 

taxable wages. People whose earnings are well above the 

proposed limit would not see any reduction in the return 

on their additional work, but they would have less 

income after taxes, which would encourage more work.

RELATED OPTION: Revenues, Option 17

RELATED CBO PUBLICATIONS: Social Security Policy Options, July 2010; The Long-Term Budget Outlook, June 2010; and CBO’s Long-Term 

Projections for Social Security: 2009 Update, August 2009 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 171

CBO

Revenues—Option 17

Expand Social Security Coverage to Include Newly Hired State and 

Local Government Employees

Source: Joint Committee on Taxation.

Note: Most of the revenues are off-budget. To the extent that the option would affect individual income tax revenues, a portion is on-budget.

Unlike nearly all private-sector workers and federal 

employees, some workers employed by state and local 

governments—about 25 percent—are not covered by 

Social Security. Under federal law, state and local governments can opt to enroll their employees in the Social 

Security program or they can opt out if they provide a 

separate retirement plan for those workers instead. State 

and local governments may also have their employees 

participate in Social Security and be part of a separate 

retirement plan. In contrast, all federal employees hired 

after December 31, 1983, are covered by Social Security 

and pay the associated payroll taxes. Furthermore, 

all state and local government employees hired after 

March 31, 1986, and all federal government employees 

are covered by Medicare and pay taxes for Hospital 

Insurance (Medicare Part A). 

Under this option, Social Security coverage would be 

expanded to include all state and local government 

employees hired after December 31, 2011. Consequently, 

all newly hired state and local government employees 

would pay the Social Security payroll tax, which 

funds the Old-Age, Survivors, and Disability Insurance 

programs. In 2012 and thereafter, that tax will be 

12.4 percent of earnings, half of which is deducted from 

employees’ paychecks and half of which is paid by 

employers. (As a result of the Tax Relief, Unemployment 

Insurance Reauthorization, and Job Creation Act of 2010 

[Public Law 111-312], the share of the Social Security 

tax that employees pay was reduced from 6.2 percent 

of covered earnings to 4.2 percent for 2011 only.) If 

implemented, this option would increase revenues by 

$24 billion from 2012 through 2016 and by a total of 

$96 billion over the 2012–2021 period. (The estimates 

include the reduction in individual income tax revenues 

that would result from a shift of some labor compensation from a taxable to a nontaxable form.)

Paying the Social Security payroll tax for 10 years generally qualifies workers (and their dependents) to receive 

Social Security retirement benefits; other work requirements must be met for employees to qualify for disability 

benefits or, in the event of their death, for their dependents to qualify for survivors’ benefits. Although extending such coverage to all newly hired state and local 

employees would eventually increase the number of 

Social Security beneficiaries, that increase would have 

little impact on the federal government’s spending for 

Social Security in the short term. Over the 2012–2021 

period, outlays would increase only by a small amount 

because most people who would be hired by state and 

local governments over that period would not begin 

receiving Social Security benefits for many years. (The 

estimates do not include any effects on outlays.) 

In the long term, the additional benefit payments for the 

expanded pool of beneficiaries would be only about half 

the size of the additional revenues. That is largely because 

most of the newly hired workers would receive Social 

Security benefits anyway under current law for one of 

two possible reasons: They may have held other covered 

jobs in the past, or they were covered by a spouse’s 

employment. As a result, this option would slightly 

enhance the long-term viability of the Social Security 

program, which faces the prospect that income from 

Social Security payroll taxes will not be sufficient to 

finance the benefits that are due to beneficiaries under 

current law.

Another rationale for the option concerns fairness. Social 

Security benefits are intended to replace only a percentage of a worker’s pre-retirement earnings. That percentage (referred to as the replacement rate) is higher for 

workers with low career earnings than for workers with 

higher earnings. But the standard formula for calculating 

Social Security benefits does not distinguish between 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 1.0 2.8 4.7 6.6 8.6 10.5 12.5 14.4 16.5 18.5 23.7 96.0
172 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

people whose career earnings are low and those who just 

appear to have low career earnings because they spent a 

portion of their career working in jobs that were not covered by Social Security. To make the replacement rate 

more comparable for workers with similar earnings histories, current law reduces the standard benefits for retired 

government employees who have worked a substantial 

portion of their career in employment that is not covered 

by Social Security. However, that adjustment is imperfect 

and can affect various public employees differently: specifically, it can result in higher replacement rates for some 

public employees who were not covered by Social Security throughout their career and in lower replacement 

rates for other public employees. This option would eliminate the inequities of the current system. 

Implementing this option would also provide better 

retirement and disability benefits for many workers who 

move between government jobs and other types of 

employment. By facilitating job mobility, the option 

would enable some workers—who would otherwise stay 

in state and local jobs solely to maintain their publicemployee retirement benefits—to move to jobs in which 

they could be more productive. Many state and local 

employees are reluctant to leave their jobs because pensions are structured to reward people who spend their 

entire careers in the same pension system. If their government service was covered by Social Security, there would 

be fewer disincentives to moving because they would 

remain in the Social Security system. State and local governments, however, might respond to greater turnover by 

reducing their investment in workers—by cutting training programs, for example—causing the productivity of 

state and local employees to decline.

An argument against such a policy change is that it might 

place an added burden on some state and local governments, which already face significant budgetary challenges. State and local pension plans are generally 

designed to be prefunded so that participants’ contributions can be invested to pay future benefits. As long as the 

plans are fully funded, transferring new employees to the 

Social Security system would not cause any problems. 

However, many plans are underfunded and depend on 

the contributions from new participants to make up the 

shortfall. Under this option, the affected state and local 

governments would probably restructure their plans in 

one of two ways. First, they might exclude newly hired 

state and local employees from participation—thereby 

forgoing a possible source of new funding—which would 

place an additional burden on those governments. Second, they might choose to supplement the Social Security 

coverage for new employees, but costs to state and local 

governments would have to increase to provide an 

equivalently valued benefit package that included Social 

Security. Total costs would be higher because the cost per 

dollar of Social Security benefits for state and local 

government employees would probably exceed the cost 

per dollar for pensions provided by state and local governments. Social Security costs would be greater because 

that program initially paid benefits to recipients who had 

not contributed much to the system and because Social 

Security redistributes benefits to workers with low career 

earnings. Delaying implementation of the option for a 

few years would provide state and local governments time 

to restructure their pension plans. Nevertheless, costs to 

the affected state and local governments would probably 

rise.

RELATED OPTION: Revenues, Option 16

RELATED CBO PUBLICATIONS: Social Security Policy Options, July 2010; The Long-Term Budget Outlook, June 2010; and CBO’s Long-Term 

Projections for Social Security: 2009 Update, August 2009
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 173

CBO

Revenues—Option 18

Increase Corporate Income Tax Rates by 1 Percentage Point

Source: Joint Committee on Taxation.

Most corporations subject to the corporate income tax 

calculate their tax liability according to a progressive rate 

schedule. The first $50,000 of corporate taxable income 

is taxed at a rate of 15 percent; income of $50,000 

to $75,000 is taxed at a 25 percent rate; income of 

$75,000 to $10 million is taxed at a 34 percent rate; 

and income above $10 million is generally taxed at a 

rate of 35 percent.1

Although most corporate income falls in the 35 percent 

tax bracket, the average tax rate on corporate income 

(corporate taxes divided by corporate income) is lower 

than 35 percent because of allowable deductions, exclusions, tax credits, and the lower tax rates that apply to the 

first $10 million of income. For example, corporations 

can deduct business expenses, including interest paid to 

holders of the firm’s bonds, from gross income to compute taxable income. (Dividends paid to shareholders, 

however, are not deductible.) Most income earned by the 

foreign subsidiaries of U.S. corporations is not subject to 

U.S. taxation until it is repatriated in the form of dividends paid to the parent corporation. To prevent income 

earned abroad from being subject to both foreign and 

U.S. taxation, the tax code gives U.S. corporations a 

credit that reduces their U.S. tax liability on that income 

by the amount of income and withholding taxes they 

have paid to foreign governments. The foreign tax credit 

is subject to limits that are designed to ensure that the 

amount of credits taken does not exceed the amount of 

U.S. tax that otherwise would have been due.

This option would increase all corporate income tax rates 

by 1 percentage point. For example, the corporate 

income tax rate would increase to 36 percent for taxable 

income above $10 million. The option would increase 

revenues by $47 billion from 2012 through 2016 and by 

$101 billion over the 2012–2021 period.

The major argument in favor of the option is its simplicity. As a way to raise revenue, increasing corporate 

income tax rates would be easier to implement than most 

other types of business tax increases because it would 

require only minor changes to the current tax collection 

system. 

The option would also increase the progressivity of the 

tax system to the extent that the corporate income tax is 

largely borne by owners of capital, who tend to have 

higher incomes than other taxpayers. But the extent to 

which the financial burden of the tax ultimately falls on 

the owners of corporations, owners of all capital assets, or 

workers is unclear. The United States is an open economy, in which many firms engage in international trade. 

Because labor tends to be less mobile than capital in open 

economies, some of the corporate income tax burden 

might be passed back to workers through reductions in 

their compensation over a number of years—making an 

increase in corporate tax rates somewhat less progressive.

An argument against the option is that it would further 

reduce economic efficiency. The current corporate 

income tax system already distorts firms’ choices about 

how to structure the business (for example, whether to 

operate as a C corporation, an S corporation, a partnership, or a sole proprietorship) and whether to finance 

investment by issuing debt or by issuing equity. Increasing corporate income tax rates would make it even more 

advantageous for firms to expend resources to qualify as 

an S corporation solely as a way to reduce their tax liabilities. That is because net income from C corporations—

those subject to the corporate income tax—is first taxed 

at the business level and then again at the individual level 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 5.9 9.5 10.1 10.6 10.7 10.5 10.6 10.5 10.8 11.5 46.8 100.6

1. Under current law, surtaxes are imposed on some amounts of 

corporate income. Income between $100,000 and $335,000 is 

subject to a surtax of 5 percent, and an additional 3 percent tax is 

levied on income between $15 million and $18.3 million. Those 

surtaxes effectively phase out the benefit of the three lower tax 

rates for corporations with income above certain amounts. As a 

result, a company that reports more than $18.3 million in taxable 

income effectively faces a statutory rate equal to 35 percent of its 

total corporate taxable income.
174 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

after it is distributed to shareholders or investors. By contrast, income from S corporations—which can have no 

more than 100 owners and are subject to other restrictions—is generally free from taxation at the business level 

but is taxed under the individual income tax, even if 

the income is reinvested in the firm. Raising corporate 

tax rates would also encourage companies to increase 

their reliance on debt-financing because interest payments, unlike dividend payments to shareholders, can 

be deducted. Carrying more debt might increase some 

companies’ risk of default. Moreover, the option could 

cause businesses to decrease the amounts they invest, 

hindering the growth of the economy. An alternative to 

this option that would reduce such incentives would be 

to lower the tax rate while broadening the tax base.

Another concern raised about the option is that it would 

increase the tax rate that corporations—those based in 

the United States and those based in foreign countries—

face when they earn income in the United States. Such 

an increase would cause the top marginal tax rate (that 

applied to the last dollar of income) in the United States 

to be higher than the top marginal tax rates that most 

other countries have adopted. That would be of concern 

if it were to discourage investment in the United States. 

Those statutory rates, however, do not reflect the differences in various countries’ tax bases and rate structures 

and therefore do not represent the true average tax rates 

that multinational firms face. Other factors, such as the 

skill level of a country’s workforce and its capital stock, 

also affect corporations’ decisions about where to incorporate and invest. 

RELATED OPTION: Revenues, Option 19

RELATED CBO PUBLICATIONS: Jennifer C. Gravelle, Corporate Tax Incidence: Review of General Equilibrium Estimates and Analysis, Working 

Paper 2010-03, May 2010; William C. Randolph, International Burdens of the Corporate Income Tax, Working Paper 2006-09, August 2006; 

and Corporate Income Tax Rates: International Comparisons, November 2005
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 175

CBO

Revenues—Option 19

Set the Corporate Income Tax Rate at 35 Percent for All Corporations 

Source: Joint Committee on Taxation.

Most corporations subject to the corporate income tax 

calculate their tax liability according to a progressive 

rate schedule. That tax is assessed at the following 

rates: 15 percent for the first $50,000 of taxable income; 

25 percent for income from $50,000 to $75,000; 

34 percent for income from $75,000 to $10 million; 

and 35 percent for income above $10 million. 

This option would set a single statutory rate of 35 percent 

for all corporate taxable income, increasing revenues by 

$12 billion from 2012 through 2016 and by $24 billion 

from 2012 through 2021. 

Under current law, surtaxes are imposed on some 

amounts of corporate income. Income between $100,000 

and $335,000 is subject to a surtax of 5 percent (increasing the tax rate on income in that range from 34 percent 

to 39 percent), and an additional 3 percent tax is levied 

on income between $15 million and $18.3 million 

(increasing the tax rate on income in that range from 

35 percent to 38 percent). Those taxes effectively phase 

out the benefit of the three lower tax rates for corporations with income above certain amounts. As a result, a 

company that reports more than $18.3 million in taxable 

income effectively faces a statutory tax rate equal to 

35 percent of its total corporate taxable income.1

 Because 

the surtaxes would also be eliminated, this option would 

not alter the taxes those businesses pay, nor would it 

affect businesses that operate as S corporations or as limited liability companies. (Owners of those enterprises do 

not pay corporate taxes but instead pay taxes on their 

total business income under the individual income tax.) 

A primary benefit of the progressive rate schedule for 

the corporate income tax is that it lessens the “double 

taxation” of profits earned by small and medium-sized 

companies. Double taxation occurs when the government 

taxes the earnings of C corporations once at the corporate 

level and again at the individual level when those earnings 

are distributed to households. Of the 500,000 to 1 million corporations that typically owe corporate income 

taxes each year, all but a few thousand pay only the lower 

rates that apply to lower amounts of income. (Because the 

companies that benefit earn only about 10 percent to 

15 percent of all taxable corporate income, however, the 

reduced rates have a limited effect on tax revenues.) 

One argument for creating a flat corporate income tax is 

that many of the companies that benefit from the current 

rate structure are not small or medium-sized. Under 

current law, large corporations can reduce their taxable 

income for certain years by sheltering some of it or by 

controlling when they earn income and incur expenses. 

Another argument is that the current rate structure creates opportunities for individuals to shelter income in 

closely held corporations (that is, corporations whose 

shares are held by one individual or a closely knit group 

of shareholders and whose shares are not publicly traded). 

People avoid paying individual income taxes on that 

income if the corporation retains the earnings—which 

may be taxed at the lower corporate rates—rather than 

paying them out as dividends. (That benefit does not 

apply to owners of personal-services corporations—such 

as physicians, attorneys, and consultants—whose companies are already taxed at a flat rate of 35 percent.) 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 1.5 2.8 2.7 2.6 2.5 2.5 2.5 2.5 2.5 2.4 12.1 24.4

1. Although most corporate income falls in the 35 percent tax 

bracket, the average tax rate on corporate income (corporate taxes 

divided by corporate income) is lower than 35 percent, chiefly 

because of allowable deductions, exclusions, and tax credits.
176 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

An argument against this option is that it would reduce 

the amount the affected companies would invest and 

distort the way in which those businesses finance their 

remaining investments. Investment capital would be 

more costly for businesses affected by the higher tax rates. 

Consequently, instead of issuing as much stock, those 

companies would either increase their use of debt financing (because the interest is tax-deductible) or decrease the 

amounts they invest. Carrying more debt would increase 

some companies’ risk of default.

RELATED OPTION: Revenues, Option 18
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 177

CBO

Revenues—Option 20

Repeal the “LIFO” and “Lower of Cost or Market” Inventory Accounting Methods 

Source: Joint Committee on Taxation.

To compute its taxable income, a business must first 

deduct from its receipts the cost of purchasing or producing the goods it sold during the year. Determining those 

costs requires that the business identify and attach a value 

to its inventory. Most companies calculate the cost of the 

goods they sell in a year using the accrual method of 

accounting, adding the value of the inventory at the 

beginning of the year to the cost of goods purchased or 

produced during the year and then subtracting from that 

total the value of the inventory at the end of the year. 

The tax code allows firms to choose among several 

approaches for identifying and determining the value of 

the goods included in their inventory. For itemizing and 

valuing goods in stock, firms can use the “specific identification” method. That approach, however, requires a 

very detailed physical accounting in which each item in 

inventory is matched to its actual cost. An alternative 

approach—“last in, first out” (LIFO)—also allows firms 

to value their inventory at cost but, in addition, permits 

them to assume that the last goods added to inventory 

were the first ones sold. Under that assumption, the cost 

of those more recently produced goods should approximate current market value (that is, the cost of replacing 

the inventory). 

Yet another alternative approach—“first in, first out” 

(FIFO)—is based on the assumption that the first goods 

sold from a business’s inventory have been in that inventory the longest. Like firms that adopt the LIFO method, 

firms using the FIFO approach can also value their goods 

at cost. But firms that use the FIFO approach have still 

another choice—the “lower of cost or market” (LCM) 

method. Instead of assessing their existing inventory at 

cost, they can assess that inventory on the basis of its market value and then choose whichever valuation is lower. 

In addition, if a business’s goods cannot be sold at market 

prices because they are damaged or flawed, firms that use 

the FIFO approach can qualify for the “subnormal 

goods” method of inventory valuation. 

This option would eliminate the LIFO method of identifying inventory, as well as the LCM and subnormalgoods methods of inventory valuation. Businesses would 

be required to use the specific-identification or FIFO 

methods to account for goods in their inventory and to 

set the value of that inventory on the basis of cost. Those 

changes—which would be phased in over a period of 

four years—would increase revenues by $72 billion from 

2012 through 2016 and by a total of $98 billion over the 

2012–2021 period. 

The main rationale for this option is to align the tax 

accounting rules with how businesses probably sell their 

goods. Under many circumstances, firms probably prefer 

to sell their oldest inventory first—among other reasons, 

to minimize the risk that the product becomes obsolete or 

damaged during storage. Under those circumstances, 

allowing firms to use alternative methods to identify and 

to value their inventories for tax purposes allows them to 

reduce their tax liabilities without any change in their 

economic behavior. 

An argument for eliminating the LIFO method is that 

it allows companies to defer taxes on real (inflationadjusted) gains when the prices of their goods are rising 

relative to general prices. Firms that use LIFO can assume 

that the goods that are sold are from newer—and 

costlier—inventory when, in fact, the items may have 

been in inventory for some time and were produced 

when costs were lower. By deducting those higher costs as 

the price of production, firms are able to defer taxes on 

the amount by which the value of their goods has appreciated, until those goods are sold.

An argument against disallowing the LIFO accounting 

method is that such a policy change could also result in 

the taxation of income that arises from inflation. The 

gains that would be taxed if the LIFO method was terminated could be attributable to inflation and, therefore, 

would not represent real changes in a firm’s resources and

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 9.2 16.5 17.3 17.8 11.2 5.9 4.6 4.8 5.0 5.2 72.0 97.5
178 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

its ability to pay taxes. However, other elements of the 

corporate income tax do not correct for inflation and 

therefore gains attributable to inflation are taxed.

An argument for eliminating the LCM method of inventory valuation under FIFO is that, when prices are falling, it provides a tax advantage for goods that have not 

been sold. The LCM method allows a business to compare the market value of each item in its inventory with 

the item’s cost and then set the lower of the two as the 

item’s value. The year-end inventory will have a lower 

total value under LCM than under the cost method if the 

market value of any item in the inventory is less than its 

cost. Using the LCM method when prices are falling 

allows the firm to claim a larger deduction for the costs of 

goods sold, causing the firm’s taxable income to fall as a 

result. In effect, that method allows a firm to deduct from 

its taxable income the losses it incurred from the decline 

in the value of its inventory. (That deduction is allowed 

even though the firm has not sold the goods.) A firm, 

however, is not required to recognize gains in the value 

of its inventory when prices are rising, which means that 

gains and losses are taxed differently. Similarly, firms that 

use the subnormal goods method of inventory valuation 

can immediately deduct the loss, even if the company 

later sells the good at a profit. 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 179

CBO

Revenues—Option 21

End the Expensing of Exploration and Development Costs for 

Extractive Industries

Source: Joint Committee on Taxation.

Current tax law treats the extractive industries that produce oil, natural gas, and minerals more favorably than it 

does most other industries. One incentive designed to 

encourage exploration for and development of oil, gas, 

and hard minerals allows producers to “expense” rather 

than capitalize some of their costs. Expensing allows companies to fully deduct the costs of exploration and development from taxable income as they are incurred rather 

than waiting to deduct those costs over time as the 

income they produce is generated. 

Other industries, by contrast, must deduct costs more 

slowly, according to prescribed rates of depreciation or 

depletion. The Tax Reform Act of 1986 established uniform capitalization rules that require certain direct and 

indirect costs related to property either to be deducted 

when the property is sold or to be depreciated over several 

years. In either case, the businesses involved must postpone the deduction of those costs from their taxable 

income. Intangible costs (such as maintaining a workingcapital fund) that are related to drilling and development 

and the costs for mine development and exploration are 

exempt from those rules. The ability to expense such 

costs gives extractive industries a tax advantage that other 

industries do not have. 

The costs that companies can expense include those 

incurred for excavating mines, drilling wells, and prospecting for hard minerals. The rules do not apply across 

the board to producers of oil and natural gas, however. 

Although current law allows independent oil and gas 

producers and noncorporate mineral producers to fully 

expense their costs, that practice is limited to 70 percent 

of costs for “integrated” oil and gas producers (companies 

with substantial retailing or refining activity) and for corporate mineral producers. Those companies must deduct 

the remaining 30 percent of their costs over 60 months. 

This option would replace the expensing of exploration 

and development costs for oil, gas, and minerals with the 

standard capitalization rules set in the Tax Reform Act of 

1986, increasing revenues by $8 billion from 2012 

through 2016 and by a total of $10 billion over the 

2012–2021 period. (Those amounts reflect the assumption that businesses could still expense some of their 

costs, including those associated with unproductive wells 

and mines.)

An argument in favor of this option is that expensing distorts the allocation of society’s resources in several ways. 

First, it encourages the use of resources for drilling and 

mining that might be employed more productively elsewhere in the economy. Second, it could influence the way 

resources are allocated within the extractive industries. 

A company could decide what to produce not on the 

basis of factors related to economic productivity but on 

the basis of the size of the advantage that expensing provides (for example, the difference between the immediate 

deduction and the deduction over time, which reflects 

the true useful life of the capital involved). Such decisions 

also could rest on whether the producer must pay the 

alternative minimum tax, under which expensing is 

limited. Third, expensing encourages producers to extract 

more resources in a shorter time. That, in the short run, 

could make the United States less dependent on imported 

oil; but, in the long run, it could deplete the nation’s store 

of oil for extraction and cause greater reliance on foreign 

producers. 

An argument against such a policy change is that exploration and development costs should be expensed because 

they are ordinary operating expenses. Supporters of 

expensing also argue that the tax advantage is necessary to 

encourage producers to continue exploring and developing the strategic resources that are essential to the nation’s 

energy security.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 1.3 1.8 1.7 1.5 1.3 1.1 0.6 0.3 0.2 0.2 7.6 10.0

RELATED CBO PUBLICATION: Reforming the Federal Royalty Program for Oil and Gas, November 2000
180 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 22

Extend the Period for Depreciating the Cost of Certain Investments

Source: Joint Committee on Taxation.

When calculating their taxable income, companies can 

deduct the expenses they incurred when producing goods 

or services for sale, including depreciation (the drop in 

the value of a productive asset over time). The tax code 

sets the number of years over which the value of different 

types of investments can be deducted from taxable 

income. 

This option would extend the lifetime of equipment and 

certain structures placed into service after December 31, 

2012, for purposes of tax depreciation. Specifically, where 

the tax code currently stipulates a lifetime of 3, 5, 7, 10, 

15, or 20 years, this option would raise the lifetime to 

4, 8, 11, 20, 30, or 39 years, respectively.1

 Those changes 

would increase revenues by a total of $79 billion from 

2012 through 2016 and by $241 billion over the 2012–

2021 period. 

An argument in favor of this option is that the current 

rates of tax depreciation overstate the decline in the 

economic value of assets because they do not accurately 

reflect the rate of inflation that is likely to occur over the 

asset’s lifetime. Because rates of depreciation are set by the 

tax code and depreciation deductions are not indexed 

for inflation, the real (inflation-adjusted) value of the 

depreciation allowed by tax law depends on the rate of 

inflation. 

Most rates of depreciation in the tax code today were set 

in the Tax Reform Act of 1986 and would approximate 

economic depreciation (the decline in an asset’s economic 

value, including the impact of inflation over time) if 

the average rate of inflation had been 5 percent during 

that 25-year period. The Congressional Budget Office 

estimates, however, that inflation over the next decade 

will average about 2 percent annually. That difference of 

about 3 percentage points means businesses can deduct 

larger amounts of depreciation from taxable income—

and thus have a lower tax liability—than they could if the 

deduction accurately measured economic depreciation.

Another argument in favor of this option is that it would 

equalize effective tax rates—the total amount of tax 

liability divided by income—on the income from different types of investment. Equipment and structures are 

two of the main types of tangible capital for which businesses take depreciation deductions, and the effective tax 

rates are currently quite different. Deductions for equipment generally contribute more to the understatement of 

taxable income than do deductions for structures; equipment has a shorter service life (the time over which depreciation deductions can be taken), so changes in inflation 

have a greater effect on deductions for equipment. Since 

1986, policymakers have extended the useful lifetime of 

some kinds of structures for calculating depreciation. 

In contrast, recent legislation allows firms to accelerate 

depreciation deductions for equipment. The Tax Relief, 

Unemployment Insurance Reauthorization, and Job 

Creation Act of 2010 (Public Law 111-312) allows firms 

to expense—that is, immediately deduct from taxable 

income—100 percent of the costs of investment in 

equipment made between September 8, 2010, and 

December 31, 2011. For equipment acquired between 

January 1, 2012, and December 31, 2012, firms will be 

able to immediately deduct 50 percent of the cost. After 

2012, current tax law will revert to the typical rules, 

which allow no expensing (except in limited cases) and 

generally require firms to deduct their equipment investment over a number of years.

Under the law currently in effect for 2013, if inflation 

remained at 2 percent and the real discount rate (which 

adjusts for the change in the value of a dollar over time) 

for businesses was 5 percent, the average effective tax 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0 5.2 16.8 26.4 30.4 34.1 36.2 33.9 30.3 28.1 78.8 241.4

1. Most structures—including residential and office buildings— 

have a lifetime that is greater than 20 years and thus would be 

unaffected by this option. However, some structures—such as 

electric power plants and barns—have a shorter lifetime under 

current law; the option would extend the lifetime of those structures as well.
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 181

CBO

rates on income from corporate investment would be 

25 percent for equipment and 30 percent for structures. 

In contrast, under this option, those rates would be 

33 percent for equipment and 32 percent for structures. 

That near parity would mitigate the incentive that 

exists in the tax code for companies to invest more in 

equipment and less in structures than they might if 

investment decisions were based on economic returns. 

Such an incentive distorts choices between investing in 

equipment and investing in structures, thus reducing 

economic efficiency. 

Those average tax rates would differ if inflation was 

different, however. If the rate of inflation was a percentage point lower, the average effective tax rate under 

this option would be 30 percent for equipment and 

31 percent for structures. Conversely, if inflation was 

a percentage point higher, the rates for equipment 

and structures would be 35 percent and 33 percent, 

respectively. Therefore, if inflation differed from CBO’s 

expectations, new distortions between investment in 

equipment and structures would emerge over the long 

run. 

An argument against this option is that low tax rates on 

capital may encourage investment. From that perspective, 

the current tax treatment could be equalized by easing 

taxation on all forms of capital rather than by raising the 

effective tax rate on a type of capital that is now favored. 

In addition, under this option, there would continue to 

be substantial variation in the effective tax rates for equipment with different service lives.

RELATED CBO PUBLICATIONS: Computing Effective Tax Rates on Capital Income, Background Paper, December 2006; and Taxing Capital 

Income: Effective Rates and Approaches to Reform, October 2005
182 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 23

Repeal the Deduction for Domestic Production Activities

Source: Joint Committee on Taxation.

The American Jobs Creation Act of 2004 allows businesses to deduct from their taxable income a percentage 

of what they earn from qualified domestic production 

activities. Set at 3 percent for tax years 2005 and 2006, 

the deduction rose to 6 percent for tax years 2007 

through 2009 and to 9 percent for tax year 2010 and 

thereafter. The Emergency Economic Stabilization Act of 

2008 reduced the deduction rate for oil-related qualified 

production activities to 6 percent for tax years after 2009. 

Various activities qualify for the deduction: 

B Lease, rental, sale, exchange, or other disposal of tangible personal property, computer software, or sound 

recordings, if they are manufactured, produced, 

grown, or extracted in whole or significant part in the 

United States; 

B Production of films (other than those that are sexually 

explicit); 

B Production of electricity, natural gas, or potable water; 

B Construction or renovation; and 

B Performance of engineering or architectural services. 

The list of qualified activities specifically excludes the sale 

of food or beverages prepared at retail establishments; the 

transmission or distribution of electricity, natural gas, or 

potable water; and many activities that would otherwise 

qualify except that the proceeds come from sales to a 

related business. 

The deduction for domestic production activities was created in part to replace the tax code’s extraterritorial 

income exclusion—which allowed businesses to exclude 

income from certain types of transactions that generate 

receipts from trade with foreign countries. According to 

the World Trade Organization, that exclusion violated its 

agreements by subsidizing exports. The deduction was 

intended to reduce the taxes on income from domestic 

production without violating the organization’s rules.

This option would repeal the deduction for domestic 

production activities. Doing so would increase revenues 

by $67 billion from 2012 through 2016 and by $163 billion from 2012 through 2021. 

One argument in favor of this option is that it would 

reduce economic distortions. Although the deduction is 

targeted toward investments in domestic production 

activities, it does not apply to all domestic production. 

Whether a business activity qualifies for the deduction is 

unrelated to the economic merits of the activity. Thus, 

the deduction gives businesses an incentive to invest in a 

particular set of domestic production activities and to 

forgo other, perhaps more economically beneficial, 

investments in domestic production activities that do not 

qualify. 

In addition, to comply with the law, businesses must satisfy a complex and evolving set of statutory and regulatory rules for allocating gross receipts and business 

expenses to the qualified activities. Companies that want 

to take full advantage of the deduction may incur large 

tax-planning costs (for example, fees to tax advisers). 

Moreover, the complexity of the rules can cause conflict 

between businesses and the Internal Revenue Service 

regarding which activities qualify under the provision. 

An argument against implementing this option is that 

simply repealing the deduction for domestic production 

activities would increase the cost of domestic business 

investment and could reduce the amount of such investment. Alternatively, the deduction could be replaced with 

a revenue-neutral reduction in the top corporate tax rate

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 5.3 14.3 15.2 15.9 16.7 17.5 18.3 19.1 19.9 20.9 67.4 163.1
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 183

CBO

(a cut that would reduce revenues by the same amount 

that eliminating the deduction would increase them). 

That alternative would end the current distortions 

between activities that qualify for the deduction and 

those that do not. It also would reduce the extent to 

which the corporate tax favors noncorporate investments 

over investments in the corporate sector and foreign 

activities over domestic business activities. 
184 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 24

Eliminate the Source-Rules Exception for Exports 

Source: Joint Committee on Taxation.

To prevent the income that U.S. corporations earn 

abroad from being subject to both foreign and U.S. taxation, the federal government provides a credit that 

reduces those companies’ domestic tax liability by the 

amount of income and withholding taxes they have paid 

to foreign governments. Under the rules governing that 

foreign tax credit, it cannot exceed the amount of U.S. 

tax those businesses otherwise would have owed, nor can 

it be used to reduce taxes on the income they earned in 

the United States. If a corporation pays more foreign tax 

on its foreign income than it otherwise would have paid 

on identical domestic income, it accrues what is known as 

excess foreign tax credits under the U.S. tax code. 

Unlike income from overseas operations, income from 

goods that are produced domestically but sold abroad 

results almost entirely from the value created or added in 

the United States. Hence, the income that U.S. corporations receive from exports typically is not taxed by foreign 

nations. But, according to the tax code, if a firm produces 

its goods within the United States and then sells its inventory abroad as exports, only half of the income is allocated to the United States; the other half is governed by 

the U.S. tax code’s “title passage rule” and allocated to the 

jurisdiction in which the sale took place. (The title passage rule specifies that, when a firm’s inventory is sold, 

the income from that sale is treated as earned in the country in which the sale occurred—and is subject to that 

country’s tax laws.) In practice, if the company’s inventory is produced in the United States and sold elsewhere, 

half of the income from those sales is treated as originating abroad, even if the company has no branch or subsidiary located in the place of sale and the foreign jurisdiction does not tax the income. 

The result is that a business can classify more of its 

income from exports as foreign than could be justified 

solely on the basis of where the underlying economic 

activity occurred. A multinational corporation can then 

use any excess foreign tax credits to offset U.S. taxes on 

that income. About half of the export income that companies with such excess credits receive is effectively 

exempted from U.S. taxation, and the income allocation 

rules give those companies an incentive to produce goods 

domestically for sale by their overseas subsidiaries. 

This option would eliminate the title passage rule and 

require taxpayers to allocate income for the purpose of 

taxation on the basis of where the economic activity actually occurs. That change would increase revenues by 

$21 billion from 2012 through 2016 and by $54 billion 

over the 2012–2021 period. 

One rationale in favor of the option is that export incentives, such as those embodied in the title passage rule, 

do not boost domestic investment and employment overall or affect the trade balance. They do increase profits—

and thus investment and employment—in industries that 

sell substantial amounts of their products abroad. However, the value of the U.S. dollar is boosted as a result, 

making foreign goods cheaper and thereby reducing profits, investment, and employment for U.S. companies 

whose products compete with imported goods. Thus, 

export incentives distort the allocation of resources by 

misaligning the prices of goods relative to their production costs, regardless of where the goods are produced. 

This option also would end a feature of U.S. tax law 

that allows businesses to avoid taxes on certain types of 

income earned abroad. Foreign tax credits were intended 

to prevent the income of U.S. businesses from being 

taxed twice. But the title passage rule allows domestic 

export income that is not usually subject to foreign taxes 

to be exempted from U.S. taxes as well, so the income 

escapes corporate taxation altogether. 

An argument against this option is that the title passage 

rule gives U.S. corporations an advantage over foreign 

companies operating in the same markets. (However, 

enterprises that lack excess foreign tax credits—such as 

some U.S. multinationals and U.S. exporters that carry 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 2.1 4.1 4.5 4.9 5.3 5.7 6.1 6.5 7.0 7.5 20.9 53.7
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 185

CBO

out all of their production domestically—receive no such 

advantage.) Some opponents of this option also argue 

that allocating income under the title passage rule is less 

complicated than doing so under the normal rules for 

income allocation.

RELATED OPTIONS: Revenues, Options 25 and 26

RELATED CBO PUBLICATIONS: William C. Randolph, International Burdens of the Corporate Income Tax, CBO Working Paper 2006-09, 

August 2006; Corporate Income Tax Rates: International Comparisons, November 2005; and Causes and Consequences of the Trade 

Deficit: An Overview, CBO Memorandum, March 2000
186 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option 25

Tax the Worldwide Income of U.S. Corporations As It Is Earned

Source: Joint Committee on Taxation.

The income that U.S. businesses earn at home and 

abroad is taxed by the federal government and may also 

be subject to taxation in the country in which it is earned. 

To prevent such double taxation, U.S. companies are 

allowed to claim a foreign tax credit, which reduces their 

domestic tax liability by the amount of any income and 

withholding taxes they pay to foreign governments. The 

foreign tax credit is subject to limits that are designed to 

ensure that the amount of credits taken does not exceed 

the amount of U.S. tax that otherwise would have been 

due. Those limits also are intended to prevent corporations from using foreign tax credits as a way to reduce 

taxes on income earned in the United States. For computing those limits, the overhead expenses (such as interest 

costs) that a U.S. parent company incurs for its operations must be allocated between domestic and foreign 

activities. Most of the income that foreign subsidiaries of 

U.S. corporations earn is not subject to U.S. taxation 

until it is repatriated in the form of dividends that those 

subsidiaries pay to the parent corporation. 

Under this option, all income earned by the foreign subsidiaries of U.S. companies would be subject to U.S. taxes 

as it was earned, regardless of when it was repatriated. To 

prevent double taxation, foreign tax credits would still be 

allowed. For determining the limit on those credits, however, the U.S. parent corporation’s overhead expenses 

would no longer be allocated between domestic and foreign activities because all income would be treated identically and taxed concurrently. Together, those changes 

would increase revenues by $50 billion from 2012 

through 2016 and by $114 billion over the 2012–2021 

period.

An argument in favor of this option is that by not taxing 

income until it is repatriated as dividends, the current 

system reduces the cost of foreign investment relative to 

that of domestic investment. This option would eliminate that bias and thus increase domestic investment, 

which in turn would make U.S. workers more productive 

and boost their earnings. 

Other arguments focus on how such a policy change 

would simplify the tax system. Eliminating the rules for 

allocating overhead expenses and the provisions that distinguish between “active” foreign income (which is not 

taxed until it is repatriated) and “passive” foreign income 

(which is generally taxed as it is earned) would make 

international tax rules less complex. In addition, the costs 

of tax planning also would decline for U.S. multinational 

corporations, which would no longer need to plan the 

repatriation of dividends from their foreign subsidiaries. 

Finally, enforcing tax rules would be less costly because 

U.S. companies would not be able to reduce their worldwide taxes by treating U.S. income as foreign income.

An argument against this approach is that it would put 

U.S. multinational corporations at a competitive disadvantage: Whereas the cost of foreign investments would 

increase for U.S. multinationals, similar investment costs 

for foreign multinationals would remain the same. Such a 

competitive disadvantage, it is argued, would shift market 

share and production toward businesses controlled by 

foreign multinationals. Those concerns could be 

addressed by reducing U.S. corporate tax rates if such a 

policy change was implemented.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 4.7 10.8 11.1 11.4 11.7 12.1 12.5 12.9 13.3 13.7 49.7 114.2

RELATED OPTIONS: Revenues, Options 18, 19, 24, and 26

RELATED CBO PUBLICATION: Corporate Income Tax Rates: International Comparisons, November 2005
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 187

CBO

Revenues—Option 26

Exempt Active Foreign Dividends from U.S. Taxation and Change the 

Tax Treatment of Overhead Expenses

Source: Joint Committee on Taxation.

The federal government taxes the income that U.S. businesses earn both at home and abroad. Most of the income 

that U.S. corporations earn from their foreign subsidiaries’ business activities is not subject to taxation in the 

United States until it is repatriated in the form of dividends that the subsidiaries pay to their parent company. 

Other forms of foreign income, such as royalties, interest, 

and “passive” income—that is, income derived from business assets by investors with little or no personal participation in the business—are subject to U.S. tax as that 

income is earned. 

To prevent income earned abroad from being subject to 

both foreign and U.S. taxation, the tax code gives U.S. 

corporations a credit that reduces their domestic tax liability by the amount of income and withholding taxes 

they have paid to foreign governments. The foreign tax 

credit is subject to limits that are designed to ensure that 

the value of the credits taken does not exceed the amount 

of U.S. tax that otherwise would have been due. Those 

limits also are intended to prevent corporations from 

using foreign tax credits as a way to reduce taxes on 

income earned in the United States. For computing those 

credit limits, the overhead expenses (such as interest 

costs) that a U.S. parent company incurs for its operations must be allocated between domestic and foreign 

activities. (When computing taxable income, however, 

firms can deduct total overhead expenses, regardless of 

the source.)

This option would exempt from U.S. taxation “active” 

dividends—those that U.S. corporations earn from the 

business operations of their foreign subsidiaries or foreign 

branches. All other foreign income (including royalties, 

interest, and income from passive activities) would be 

taxed in the current manner—as it is earned. Foreign 

tax credits would be allowed so that companies could 

offset any foreign income taxes or withholding taxes paid 

on foreign income that was still subject to U.S. taxation. 

Overhead costs, such as interest expenses, of a U.S. parent company would be allocated between the company’s 

U.S. and foreign activities, as is the case under current 

law for purposes of computing the foreign tax credit. In a 

departure from current law, however, overhead expenses 

allocated to foreign income would no longer be deductible from U.S. income. Those changes would increase 

revenues by a total of $32 billion from 2012 through 

2016 and by $76 billion over the 2012–2021 period. 

The revenue lost by exempting active dividends from 

U.S. taxation would be more than offset by increases in 

taxes on other sources of income. Specifically, taxes on 

U.S. income would rise because overhead expenses allocated to exempt foreign income could no longer be 

deducted from U.S. income. In addition, companies that 

paid high foreign income taxes could no longer use the 

foreign tax credits associated with repatriated dividends 

to shield other low-tax foreign income, such as royalties 

and export income, from U.S. taxes.

An argument in favor of this option is that such a change 

would reduce the complexity of the tax system. Current 

rules allow U.S. multinational corporations to reduce 

their worldwide taxes by carefully planning how and 

when to repatriate dividend income from their foreign 

subsidiaries. Researchers have estimated the total costs of 

such planning to be more than $1 billion per year. This 

option would eliminate those planning costs. It is also 

argued that this option would allow foreign tax-credit 

rules to be simplified because many of those rules would 

no longer apply to active dividend income.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 3.3 6.5 6.9 7.3 7.7 8.1 8.5 8.9 9.3 9.7 31.7 76.2
188 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

An argument against such a policy change is that it 

would have the same effect as the current tax system, 

causing U.S. corporations to favor foreign investment 

over U.S. investment and thus reducing the amount 

of capital available for production in the United States. 

RELATED OPTIONS: Revenues, Options 24 and 25

RELATED CBO PUBLICATION: Corporate Income Tax Rates: International Comparisons, November 2005
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 189

CBO

Revenues—Option 27

Impose a 5 Percent Value-Added Tax 

Source: Congressional Budget Office.

A value-added tax (VAT) is a type of consumption tax 

that is collected at each stage of a commodity’s production and distribution. Although a VAT is typically 

administered by taxing the total value of a business’s sales 

of a particular product or service, the business can claim 

a credit for the taxes it paid on the “inputs”—such as 

materials and equipment—it used to make the product 

or provide the service. 

More than 140 countries—including all members of the 

Organisation for Economic Co-operation and Development (OECD), except for the United States—have 

adopted VATs. However, the tax bases and rate structures 

differ greatly among countries. Most European countries 

have implemented VATs that have a narrow tax base, with 

certain categories of goods and services—such as food, 

education, and health care—either exempted from the 

tax or taxed at lower rates than other goods and services. 

In Australia and New Zealand, the VAT has a much 

broader tax base, with exemptions generally limited only 

to those goods and services for which it is difficult to 

determine a value. As of January 1, 2010, the average 

VAT rate for OECD countries was 18 percent, ranging 

from 5 percent in Japan to 25.5 percent in Iceland. All 

OECD countries that impose a VAT also collect revenues 

from taxes on income and profits. 

This option would impose a 5 percent VAT in one of two 

ways. The first alternative would apply the VAT to a 

broad base that would include most goods and services. 

Because their value is difficult to measure, certain 

items—such as financial intermediation services, existing 

housing services, primary and secondary education, and 

other services provided by government agencies and nonprofit organizations for a nominal or no fee—would be 

excluded from the base. (Existing housing services 

encompass the monetary rents paid by tenants and rents 

imputed to owners who reside in their own homes.) 

Although existing housing services would be excluded 

under this alternative, the broad base would include all 

future consumption of housing services by taxing the 

purchase of new residential housing. The broad base 

would also exclude government-reimbursed expenditures 

for health care (primarily costs paid by Medicare and 

Medicaid). 

The option would become effective on January 1, 

2013—a year later than most of the revenue options presented in this volume—to provide the Internal Revenue 

Service sufficient time to set up and administer a VAT. 

The first approach would increase revenues by 

$950 billion from 2012 through 2016 and by $2.5 trillion over the 2012–2021 period. (Because a VAT reduces 

the tax base of income and payroll taxes, the imposition 

of a VAT would lead to reductions in revenues from 

those sources. The estimates shown here reflect those 

reductions.) 

Under the second alternative, the 5 percent VAT would 

apply to a narrower base. In addition to those items 

excluded under the broad base, the narrow base would 

exclude purchases of new residential housing, food 

purchased for home consumption, health care, postsecondary education, and all other financial services. 

This approach would increase revenues by $530 billion 

from 2012 through 2016 and by $1.4 trillion over the 

2012–2021 period.

One argument in favor of imposing a VAT, as an alternative to increasing income tax rates, is that such action 

would raise revenues without discouraging saving and 

investment. Through tax credits, deductions, and exclusions, the individual income tax provides incentives that 

encourage saving, but those types of provisions—each 

with their own eligibility rules and income phaseouts—

make the tax system more complicated. By taxing 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

Broad base 0 180 240 260 270 290 300 310 320 330 950 2,500

Narrow base 0 100 140 140 150 160 160 170 180 190 530 1,390
190 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

consumption only, a VAT would exempt saving in a 

simpler, more direct fashion.

A drawback of the option is that it would require the federal government to establish a new system to monitor and 

collect the tax. As with any new tax, a VAT would impose 

additional administrative costs on the federal government 

and additional compliance costs on businesses. Because 

such costs are typically higher for smaller businesses, 

many countries, including the United Kingdom, exempt 

some small businesses from the VAT. A study conducted 

by the Government Accountability Office (GAO) in 

2008 showed that all of the countries evaluated—

Australia, Canada, France, New Zealand, and the 

United Kingdom—devoted significant resources to 

addressing and enforcing compliance. However, the 

GAO study also found that a VAT might be less expensive to administer than an income tax. For example, the 

tax administration agency in the United Kingdom estimated administrative costs for the VAT to be 0.55 percent of revenue collected, whereas the cost of administering the income tax was 1.27 percent. 

Another argument against imposing a VAT is that it 

might increase the prices consumers have to pay for goods 

and services relative to the after-tax price sellers would 

otherwise receive for providing those goods and services. 

Therefore, adopting a VAT would cause an initial jump 

in the overall consumer price index because that index is 

computed on a tax-inclusive basis. The increase in the 

price level, however, would not necessarily lead to further 

inflation. If the Federal Reserve adjusted the money 

supply in a way that maintained current-dollar income, 

little inflation, beyond the initial price jump, would 

occur. (If there was an initial increase in the price level, 

federal spending for mandatory programs with benefits 

that are affected by inflation, such as Social Security, 

could increase; parameters of the tax system that are 

indexed to inflation could also be affected. However, the 

estimates shown here correspond to the standard estimating convention of holding macroeconomic aggregates—

such as gross domestic product and the overall price 

level—unchanged.)

Yet another drawback of imposing a VAT is that the tax 

is regressive when its burden is measured on an annual 

basis. In any given year, lower-income families—who 

consume a greater share of their income than higherincome families—would pay a larger share of their annual 

income in consumption taxes than other families. A VAT 

appears to be less regressive when its burden is measured 

over a longer period. 

The choice between the two alternatives—a broad base 

and a narrow base—presents certain trade-offs. A VAT 

could be made less regressive by adopting a narrow base 

and thus granting tax preferences for the goods and services that command a relatively larger proportion of 

budgets for low-income individuals and families. Those 

preferences, however, would substantially increase the 

costs of enforcement and compliance, and they would 

reduce revenues. In addition, a narrow-based VAT with 

exemptions would distort economic decisions to a greater 

degree than would a VAT with a broader base. 

Policymakers could offset some of the regressive impact 

of a VAT by allowing additional exemptions or refundable credits under the federal income tax for individuals 

and families with lower income. That approach could 

be specifically targeted to lower- and middle-income 

families, but such provisions could add to the complexity 

of the individual income tax.

RELATED CBO PUBLICATIONS: The Economic Effects of Comprehensive Tax Reform, July 1997; and Effects of Adopting a Value-Added Tax,

February 1992
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 191

CBO

Revenues—Option 28

Increase Excise Taxes on Motor Fuels by 25 Cents

Source: Joint Committee on Taxation.

Revenues from federal excise taxes on motor fuels are 

credited to the Highway Trust Fund to pay for highway 

construction and maintenance as well as for investment 

in mass transit. Those taxes currently are set at 18.4 cents 

per gallon of gasoline and 24.4 cents per gallon of diesel 

fuel produced. (State and local excise taxes bring total 

average tax rates nationwide to about 48 cents per gallon 

of gasoline and 54 cents per gallon of diesel fuel.) 

This option would increase federal excise taxes on gasoline and diesel fuel by 25 cents per gallon, to 43.4 cents 

per gallon of gasoline and 49.4 cents per gallon of diesel 

fuel. That change would increase federal revenues by 

$140 billion from 2012 through 2016 and by a total 

of $291 billion over 10 years. (Because excise taxes 

reduce the tax base for income and payroll taxes, higher 

excise taxes would lead to reductions in revenues from 

those sources. The estimates shown here reflect those 

reductions.) 

A rationale for increasing excise taxes on motor fuels is 

that the rates currently in effect are not sufficient to fully 

fund the federal government’s spending on highways. In 

addition, economic efficiency is promoted when users of 

highway infrastructure are charged according to the marginal (or incremental) costs of their use, including the 

“external costs” that are imposed on society. Because the 

current fuel taxes do not cover all of those marginal costs, 

higher fuel taxes could more accurately reflect the external costs created by the consumption of motor fuel. Some 

of those costs—including the costs of pollution, climate 

change, and dependence on foreign oil—are directly associated with the amount of motor fuel consumed. But the 

larger fraction of those costs is related to the number of 

miles that vehicles travel, usage that results in road congestion, noise, pavement damage, and accidents. 

If the cost of fuel was higher, people would drive less or 

purchase vehicles that used fuel more efficiently, thus 

reducing some of the external costs. (In contrast, paying 

for highways and mass transit through general revenues 

provides no incentive for the efficient use of those systems.) Various studies suggest that, in the absence of a tax 

on motor fuels or the number of vehicle miles traveled, 

the external costs of motor fuels amount to at least $1 per 

gallon, indicating that for drivers to cover the costs they 

impose on society, excise tax rates on motor fuels would 

have to be substantially higher than the current rates. 

Under this option, tax rates on motor fuels would more 

closely reflect those external costs. In addition, this 

option would have relatively low collection costs.

An argument against this option is that it could be more 

economically efficient to base a tax on the number of 

miles that vehicles travel. (Such a usage fee could be 

assessed on its own or in conjunction with taxes on motor 

fuels.) For example, imposing tolls or implementing congestion pricing (charging fees for driving at specific times 

in given areas) could be better ways to alleviate congestion. Similarly, a levy on the number of miles driven 

could be structured to correspond more closely to the 

costs of repairing damaged pavement than could a tax on 

motor fuels. However, creating the systems necessary to 

administer a tax on the number of vehicle miles traveled 

would be more complex than increasing the existing 

excise taxes on fuels. 

Other arguments against raising taxes on motor fuels 

involve issues of fairness. Such taxes impose a proportionately larger burden, as a share of income, on middleand lower-income households (particularly those not 

well-served by public transit) than they do on upperincome households. Similarly, those taxes impose a 

disproportionate burden on rural households because 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 20.9 29.4 29.7 30.0 30.2 30.2 30.2 30.2 30.1 30.0 140.2 291.0
192 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

the benefits of reducing vehicle emissions and congestion 

are greatest in densely populated, mostly urban, areas. 

Finally, to the extent that the trucking industry passed the 

higher cost of fuel on to consumers—in the form of 

higher prices for transported retail goods, for instance—

those higher prices would further increase the relative 

burden on low-income and rural households.

RELATED CBO PUBLICATIONS: Spending and Funding for Highways, Issue Brief, January 2011; Using Pricing to Reduce Traffic Congestion, 

March 2009; Effects of Gasoline Prices on Driving Behavior and Vehicle Markets, January 2008; and The Economic Costs of Fuel Economy 

Standards Versus a Gasoline Tax, December 2003
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 193

CBO

Revenues—Option 29

Increase All Taxes on Alcoholic Beverages to $16 per Proof Gallon

Source: Joint Committee on Taxation.

In 2009, the federal government collected $9.6 billion in 

revenue from excise taxes on distilled spirits, beer, and 

wine. The different alcoholic beverages are taxed at different rates. Specifically, the alcohol content of beer and 

wine is taxed at a much lower rate than the alcohol content of distilled spirits because the taxes are determined 

on the basis of different liquid measures. Distilled spirits 

are measured in proof gallons (a standard unit for measuring the alcohol content of a liquid). The current excise 

tax levied on those spirits, $13.50 per proof gallon, translates to about 21 cents per ounce of alcohol. Beer, by contrast, is measured by the barrel, and the current tax rate of 

$18 per barrel translates to about 10 cents per ounce of 

alcohol (under the assumption that the average alcohol 

content of beer is 4.5 percent). The current levy on wine 

is $1.07 per gallon, or about 8 cents per ounce of alcohol 

(assuming an average alcohol content of 11 percent). 

This option would standardize the base on which the federal excise tax is levied by using the proof gallon as the 

measure for all alcoholic beverages. The tax would be 

raised to $16 per proof gallon, thus increasing revenues 

by about $29 billion over the 2012–2016 period and by 

$60 billion over the 2012–2021 period. (Because excise 

taxes reduce producers’ and consumers’ income, higher 

excise taxes would lead to reductions in revenues from 

income and payroll taxes. The estimates shown here 

reflect those reductions.) 

A tax of $16 per proof gallon would equal about 25 cents 

per ounce of alcohol. Under this option, the federal excise 

tax on a 750-milliliter bottle (commonly referred to as a 

fifth) of distilled spirits would rise from about $2.14 to 

$2.54. The tax on a six-pack of beer would jump from 

about 33 cents to 81 cents, and the tax on a 750-milliliter 

bottle of wine would increase by a similar amount, from 

about 21 cents to 70 cents. 

Experts agree that the consumption of alcohol creates 

costs for society that are not reflected in the pretax price 

of alcoholic beverages. Examples of those “external costs” 

include spending on health care that is related to alcohol 

consumption and covered by the public, losses in productivity stemming from alcohol consumption that are borne 

by others besides the consumer, and the loss of lives and 

property that results from alcohol-related accidents and 

crime. Calculating such costs is difficult. However, a 

study conducted for the National Institute on Alcohol 

Abuse and Alcoholism estimated that the external economic costs of alcohol abuse exceeded $100 billion in 

1998—an amount far greater than the revenues currently 

derived from taxes on alcoholic beverages.1

 When 

adjusted for inflation, current excise tax rates on alcohol 

are far lower than historical levels. In the 1950s, excise 

taxes accounted for nearly half of the pretax price of 

alcohol; they now account for between 10 percent and 

20 percent of the pretax price. 

One argument in favor of raising excise taxes on alcoholic 

beverages is that they would reduce alcohol use—and 

thus the external costs of that use—and make consumers 

of alcoholic beverages pay a larger share of such costs. 

Research has consistently shown that higher prices lead to 

less alcohol consumption, even among heavy drinkers.

Moreover, raising excise taxes to reduce consumption 

might be desirable, regardless of the effect on external 

costs, if lawmakers believed that consumers underestimated the harm they do to themselves by drinking. 

Heavy drinking is known to cause organ damage and 

cognitive impairment; and the links between highway 

accidents and drinking, which are especially strong 

among the young, are well-documented. Substantial evidence also indicates that the use of alcohol from an early 

age can lead to heavy consumption later in life. When 

deciding how much to drink, people—particularly young 

people—may not adequately consider such long-term 

risks to their health. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 4.8 5.8 5.9 6.0 6.0 6.1 6.2 6.3 6.4 6.4 28.5 59.9

1. See National Institute on Alcohol Abuse and Alcoholism, Updating Estimates of The Economic Costs of Alcohol Abuse in The United 

States: Estimates, Update Methods, and Data (December 2000).
194 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

An increase in taxes on alcoholic beverages would have 

disadvantages as well. It would make a tax that is already 

regressive—one that takes up a greater percentage of 

income for low-income families than for middle- and 

upper-income families—even more so. In addition, it 

would affect not only problem drinkers but also drinkers 

who imposed no costs on society and who thus would be 

unduly penalized. Furthermore, higher taxes would 

reduce consumption by some moderate drinkers whose 

intake of alcohol is believed to have health benefits. 

(Moderate alcohol consumption, particularly of wine, has 

been linked to lower incidence of heart disease, obesity, 

and stroke and to increases in life expectancy in middle 

age.) Finally, with regard to the argument that some 

drinkers underestimate the personal costs of alcohol 

consumption, some opponents of raising taxes on alcohol 

argue that the government should not try to modify 

consumers’ private behavior. 
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 195

CBO

Revenues—Option 30

Accelerate and Modify the Excise Tax on High-Cost Health Care Coverage

Sources: Joint Committee on Taxation and Congressional Budget Office. 

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

Although employer-paid premiums for health insurance 

are part of many employees’ total compensation, those 

premiums are generally exempt from individual income 

taxes and payroll taxes. Employees at firms offering 

“cafeteria plans”—plans that allow employees to choose 

between taxable cash wages and nontaxable fringe 

benefits—can pay their share of premiums for employment-based health insurance with pretax earnings. In 

addition, contributions to certain other types of 

employee accounts, which can be used to pay for many 

health care costs not covered by insurance, may be 

exempt from income and payroll taxes. Those include 

employers’ contributions to health reimbursement 

accounts (HRAs), employees’ contributions to flexible 

spending accounts (FSAs), and employers’ and employees’ contributions to health savings accounts (HSAs). 

Starting in 2018, an excise tax will be imposed on 

employment-based health care coverage if the total value 

of that coverage—including employers’ and employees’ 

contributions for health insurance and contributions 

made through HRAs, FSAs, or HSAs for other health 

care costs—exceeds a certain threshold. The tax will be 

equal to 40 percent of the difference between that total 

value and the threshold. In 2018, the annual threshold 

will be $27,500 for family coverage and $10,200 for individual coverage (which could be adjusted upward to 

reflect faster-than-expected growth in health care costs 

between 2010 and 2018). In 2019, the thresholds will 

change in accordance with the rate of growth in the consumer price index for all urban consumers (CPI-U) plus 

1 percentage point. In 2020 and subsequent years, the 

thresholds will be indexed solely on the basis of the 

CPI-U. Higher thresholds will apply to retirees between 

the ages of 55 and 64 and to workers engaged in certain 

high-risk professions. Employees participating in unionsponsored plans will be subject only to the family thresholds. Finally, in determining the amount of the tax, 

employers will be allowed to adjust the cost of health 

insurance coverage if the distribution of their workforce 

by age and gender differs from that of a national risk 

pool.

Under this option, implementation of the excise tax 

would be accelerated and the thresholds would be lowered. In 2014, the 40 percent excise tax would apply to 

qualifying contributions that together exceeded $21,000 

a year for family coverage and $8,200 for individual 

coverage. Beginning in 2015, the thresholds—which are 

based on the 80th percentile for health insurance premiums paid by or through employers—would be indexed 

for inflation using the CPI-U. Similar to the provisions of 

current law, the thresholds would be 10 percent higher 

for retirees ages 55 to 64 and for workers in designated 

high-risk professions; however, the other adjustments 

provided under current law would be eliminated. The 

option would increase revenues from income and payroll 

taxes by a total of $100 billion over the 2012–2016 

period and by $310 billion over the 2012–2021 period.

As is the case under current law, the modified excise tax 

would increase revenues in two ways. First, for employment-based plans that remained above the thresholds, it 

would generate additional excise tax revenues. Second, 

many individuals and employers would probably respond 

to the presence of the excise tax by shifting to lower-cost 

insurance plans—plans with premiums below the tax 

threshold—to avoid paying the excise tax. As a result, 

total payments of health insurance premiums for those 

individuals would be less than they would have been in 

the absence of the tax. Because total compensation paid 

by employers would not be affected over the long term, 

lower expenditures for health insurance would mean 

higher taxable wages for employees and, consequently, 

higher revenues from income and payroll taxes.1

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 0 0 32.4 30.6 37.1 44.3 39.3 42.4 41.3 42.1 100.1 309.5

1. The increase in Social Security payments that would result from 

including more employers’ contributions for health care coverage 

in employees’ taxable income—and thus in the wage base from 

which Social Security benefits are calculated—is not included in 

the estimates.
196 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

An argument in support of this option is that it could 

dampen health care spending and thus restrain the 

growth of health care costs. Many analysts maintain that 

the tax preference for employment-based health insurance distorts the markets for health insurance and health 

care. That tax preference provides incentives for health 

insurance plans to cover routine expenses as well as large, 

unexpected costs because routine charges are subsidized 

(through the tax exclusion) only if they are paid for 

through an insurance plan (or other type of tax-favored 

health plan, such as an FSA). Under this option, more 

employees and their employers would have an incentive 

to buy less-expensive health insurance and to reduce contributions to FSAs and other tax-favored plans for health 

care spending—which could reduce upward pressure on 

costs for health care and encourage greater use of costeffective types of care. Those incentives would also grow 

under current law but would be greater under this option 

because the tax would start sooner and would apply to 

a larger share of employment-based plans. Another 

argument for this option is that it would simplify the 

computation of the excise tax by eliminating adjustments 

for the age and gender of a firm’s workforce.

An argument against this option is that it would probably 

increase the financial burden on people with substantial 

health problems. Employers might seek to avoid the tax 

by shifting to plans that have lower premiums and higher 

cost-sharing requirements, which would increase out-ofpocket costs for those workers, and the dependents of 

those workers, who use more services. In some cases, 

those higher cost-sharing requirements might lead enrollees to forgo care that would be beneficial to their health. 

Another argument against this option is that more firms 

would be subject to the tax simply because they had lesshealthy workers or because they operated in an area with 

above-average costs for health care. In addition, by eliminating the adjustment for age, the option would make 

some firms liable for the tax if they had an older-thanaverage workforce.

RELATED OPTIONS: Mandatory Spending, Option 12; and Revenues, Options 8 and 32
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 197

CBO

Revenues—Option 31

Increase the Payroll Tax Rate for Medicare Hospital Insurance by 

1 Percentage Point

Source: Joint Committee on Taxation.

Note: To the extent that the option would affect refundable tax credits, the estimates include effects on outlays.

The primary source of financing for Hospital Insurance 

(HI) benefits provided under Medicare Part A is the HI 

payroll tax.The HI tax is currently 2.9 percent of earnings, half of which is deducted from employees’ paychecks and half of which is paid by employers. Selfemployed individuals pay 2.9 percent of their net income 

in HI taxes. Unlike the payroll tax for Social Security, 

which applies to earnings up to an annual maximum 

($106,800 in 2011), the HI tax is levied on total 

earnings.

Under the Patient Protection and Affordable Care Act of 

2010 (Public Law 111-148), the portion of the HI tax 

that employees pay will increase by 0.9 percent of earnings in excess of $200,000, beginning in 2013. For a married couple filing an income tax return jointly, the surtax 

will apply to the couple’s combined earnings above 

$250,000. 

In recent years, expenditures for the HI program have 

grown at a much faster pace than revenues derived from 

the payroll tax. The Congressional Budget Office estimates that, in fiscal year 2011 and in most years thereafter, expenditures for HI will exceed the program’s total 

income (including interest credited to the trust fund), 

which will necessitate that balances in the HI trust fund 

be drawn down. CBO projects that the balances will fall 

sharply during the 10-year budget period and will be 

exhausted in 2021. 

This option would replace the 0.9 percent surtax on 

high-income taxpayers with a 1.0 percentage point 

increase in the total HI tax on all earnings. The HI tax 

rate for both employers and employees would increase by 

0.5 percentage points to 1.95 percent, resulting in a combined rate of 3.9 percent. The rate paid by self-employed 

people would also rise to 3.9 percent. For taxpayers with 

income above $200,000 ($250,000 for married couples 

filing jointly), the portion of the HI tax that employees 

pay on income in excess of the surtax threshold would 

effectively be reduced from 2.35 percent to 1.95 percent; 

the portion that employers pay would increase from 

1.45 percent to 1.95 percent. 

If implemented, the option would increase revenues by 

$286 billion over the 2012–2016 period and by $651 billion over the 2012–2021 period. (The estimates include 

the reduction in individual income tax revenues that 

would result from a shift of some labor compensation 

from a taxable to a nontaxable form.)

The main argument for the option is that the HI payroll 

tax is currently not sufficient to cover the costs of the program, as indicated by the prospective insolvency of the 

HI trust fund. Increasing that tax would boost the revenues that flowed to the HI trust fund to a substantial 

degree and keep the fund solvent for a longer period. A 

commonly used measure of the long-term financial status 

of Medicare Part A is the actuarial balance—that is, the 

present value of revenues (primarily from payroll taxes) 

plus the current trust fund balance minus the present 

value of outlays for the program and the desired trust 

fund outlays (one year’s worth) at the end of a specified 

period.1

 CBO projects that the actuarial imbalance for 

the HI trust fund over the next 75 years is 2.4 percent of 

taxable payroll, which is the difference between projected 

income— 4.2 percent of taxable payroll—and projected 

costs—6.5 percent of taxable payroll. Eliminating a gap 

of that size would require, as an example, either an immediate increase in the HI payroll tax rate, from its current 

2.9 percent to 5.3 percent, or an immediate cut of about 

one-third in spending on Part A. By raising the HI tax by 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 48.6 53.1 58.6 61.4 64.2 66.9 70.0 73.1 76.0 79.0 285.9 650.8

1. Present value is a single number that expresses a flow of current 

and future income, or payments, in terms of an equivalent lump 

sum received or paid today. Here, it is calculated over 75 years 

using a long-term 3 percent real (inflation-adjusted) discount rate.
198 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

1 percentage point for most people (and by 0.1 percentage point for higher-income individuals), the option 

would delay the exhaustion of the HI trust fund by several decades but would not entirely eliminate the longterm gap between projected income and projected costs.

Another argument in favor of the option concerns tax 

administration. An increase in the overall payroll tax 

would be simpler to administer than the surtax that will 

go into effect in 2013. Another advantage of the option 

is that it would eliminate the marriage penalties that will 

result after the new surtax goes into effect. Under the 

surtax, two single people can each earn up to $200,000—

for a combined total of $400,000—without becoming 

subject to the higher tax rate in 2013. However, if 

they were to marry, the two workers would be subject to 

the surtax on their combined earnings in excess of 

$250,000. Because the HI payroll tax is based on individual earnings, increasing the HI tax rate—instead of 

imposing the surtax—would eliminate that penalty.

The option would have several drawbacks. When the surtax goes into effect in 2013, it will encourage taxpayers 

with income above the thresholds to reduce the hours 

they work or to shift their compensation away from taxable earnings to nontaxable forms of compensation. 

Increasing the HI tax rate, as called for under the option, 

would extend those disincentives to all workers. When 

employees reduce the hours they work or change the 

composition of their earnings, economic resources are 

allocated less efficiently than would be the case in the 

absence of the higher tax rate. 

Another drawback of the option is that an increase in the 

HI payroll tax rate, combined with the elimination of the 

surtax, would be relatively more burdensome for low- and 

middle-income workers than for higher-income earners. 

First, low- and middle-income workers and their employers would face larger rate increases relative to current law 

than would higher-income earners (whose rates have just 

increased as a result of the health care legislation) and 

their employers. Second, taxable wages make up a smaller 

proportion of income for higher-income earners than for 

low- and middle-income workers. Although all workers 

would pay the same percentage of earnings in HI taxes, 

higher-income households would pay a smaller percentage of their total income because those households derive 

a greater share of income from sources other than wages 

(such as capital income and rental income), which are not 

subject to the HI payroll tax. 

RELATED OPTION: Mandatory Spending, Option 18
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 199

CBO

Revenues—Option 32

Repeal the Individual Health Insurance Mandate 

Sources: Joint Committee on Taxation and Congressional Budget Office. 

Note: These estimates represent the change in the overall budget balance that results from the sum of changes to revenues and outlays.

Two laws enacted in March 2010—the Patient Protection 

and Affordable Care Act (Public Law 111-148) and 

the Health Care and Education Reconciliation Act 

(P.L. 111-152)—require that nearly every resident of 

the United States have health insurance coverage by 

January 1, 2014. People who do not comply with the 

mandate may be charged a penalty that is the greater of a 

flat dollar amount or a percentage of their income. The 

penalty will be assessed through the individual income 

tax. The flat amount per uninsured adult will start at 

$95 in 2014 but rise to $695 by 2016 and be adjusted for 

inflation after that. The percentage of income—which 

applies to income that exceeds the threshold for mandatory filing of an income tax return (projected to be about 

$10,000 for a single filer and about $18,000 for a married couple in 2014)—will start at 1.0 percent but rise to 

2.5 percent in 2016. Exemptions from the penalties are 

provided for several categories of people, including those 

with taxable income below the filing threshold, unauthorized immigrants, members of certain religious 

groups, and those who obtain a hardship waiver. 

Overall, the Congressional Budget Office and the staff of 

the Joint Committee on Taxation (JCT) project that the 

federal government will collect $27 billion in penalty 

payments from uninsured people through 2021. The 

existence of the mandate and its associated penalties will 

also affect the federal budget by encouraging people to 

obtain federally subsidized insurance coverage through 

Medicaid, newly created health insurance exchanges, or 

an employment-based plan (which would be subsidized 

indirectly because almost no premiums for that coverage 

are treated as taxable compensation). Moreover, in a 

competitive labor market, the existence of the mandate 

will encourage employers to offer coverage to their 

workers, thus reducing penalty payments from larger 

businesses that do not offer insurance and increasing 

payments of tax credits to certain small businesses that 

provide coverage. 

The option would eliminate the requirement that individuals obtain health insurance, while maintaining other 

provisions of the new health care legislation. The loss of 

revenues from eliminating the individual mandate penalties would increase the deficit; but the estimated savings 

from reduced subsidies are greater—yielding net savings 

of about $282 billion over the 2012–2021 period. Most 

savings (about $149 billion) would come from lower 

Medicaid enrollment. On balance, federal subsidies for 

the purchase of insurance through the exchanges would 

be about $69 billion lower. Primarily because reductions 

in employer coverage would result in more taxable compensation for employees, the removal of the mandate 

would increase tax revenues by about $80 billion. The 

remainder of the budgetary effect would come from a 

modest increase (about $8 billion) in employer penalties 

and a modest reduction (about $3 billion) in tax credits 

for small businesses. 

CBO and JCT estimate that repealing the mandate 

would substantially reduce the number of people with 

health insurance coverage. Under current law, about 

23 million nonelderly residents are projected to be uninsured in 2021. If this option was implemented, about 

39 million people would be uninsured that year. The 

increase in the number of people without insurance 

would stem from the following changes: About 4 million 

fewer people would have employment-based coverage; 

about 6 million fewer people would obtain coverage in 

the individual market (including individual policies purchased in the newly established exchanges or directly 

from insurers in the nongroup market); and about 6 million fewer people would have coverage under Medicaid or 

the Children’s Health Insurance Program. 

In the absence of the mandate, CBO estimates, health 

insurance premiums for individually purchased coverage 

would be higher than they are projected to be under 

current law. Insurers would still be required to provide 

coverage to any applicant, could not vary premiums to 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Net Effect on the Deficit 0 0 -16.0 -25.0 -33.0 -36.0 -39.0 -41.0 -43.0 -49.0 -74.0 -282.0
200 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

reflect enrollees’ health status or limit coverage of preexisting medical conditions, and could adjust premiums 

on the basis of age only to a limited degree. Relative to 

current law, the elimination of the mandate would tend 

to reduce insurance coverage among healthier people 

more than it would reduce coverage among less healthy 

people. However, those “adverse selection” effects would 

be mitigated somewhat by other factors—including the 

new subsidies for insurance purchased through the 

exchanges (which may make health insurance less costly) 

and the annual open enrollment periods in the individual 

market (which may make it difficult for people to wait 

until they become ill in order to obtain coverage). Moreover, because the subsidies will limit the share of income 

that enrollees have to pay for coverage, the impact on 

payments by subsidized enrollees would be minimal if 

overall premiums rose because of adverse selection. CBO 

estimates that such adverse selection would increase premiums for policies in the individual market, whether purchased through the insurance exchanges or not, by 

15 percent to 20 percent, relative to current law. 

Many proponents of this option argue that the decision 

to obtain health insurance is a private matter and that the 

government should not force people to acquire coverage.

(Some advocates also argue that the mandate is unconstitutional, but CBO is not in a position to assess that argument.) Another argument in the option’s favor is that the 

mandate and its associated penalty would make some 

people worse off—either because they would have to 

obtain more health insurance than they otherwise would 

have chosen to purchase on their own or because they 

would have to pay a penalty instead. Another concern is 

that using the Internal Revenue Service to enforce the 

mandate will increase the complexity of the tax system 

and interfere with efforts to fairly administer that system. 

In addition, the mandate necessitates new reporting 

requirements that will increase the costs of complying 

with the tax code for both individuals and their insurers.

Many opponents of the option point to the reductions in 

coverage and increases in premiums that are likely to 

occur and argue that it is appropriate for the government 

to require people to have health insurance in order to prevent those outcomes. Another argument is that imposing 

a penalty on people who do not obtain coverage could 

improve economic efficiency. In particular, by increasing 

the private costs of being uninsured, the mandate—to the 

extent that it encourages people to obtain coverage—may 

reduce the social costs of caring for the uninsured. In 

many cases, uninsured people pay much less than the 

costs of the care they receive, resulting in lower payments 

to providers or higher costs for others. In the absence of 

a mandate, those social costs would probably increase 

relative to what would occur under current law. 

RELATED OPTIONS: Mandatory Spending, Option 12; and Revenues, Option 30

RELATED CBO PUBLICATIONS: David Auerbach and others, Will Health Insurance Mandates Increase Coverage? Synthesizing Perspectives from 

the Literature in Health Economics, Tax Compliance, and Behavioral Economics, Working Paper 2010-05, August 2010; “Effects of 

Eliminating the Individual Mandate to Obtain Health Insurance,” Web document, June 2010; Key Issues in Analyzing Major Health Insurance 

Proposals, December 2008
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 201

CBO

Revenues—Option 33

Impose a Fee on Large Financial Institutions 

Source: Joint Committee on Taxation. 

During the financial crisis that occurred between 2007 

and 2009, concern about the impact of the failure of large 

financial institutions on the financial markets and on the 

broader economy prompted federal action. The government provided substantial assistance to major financial 

institutions through the Troubled Asset Relief Program, 

the Federal Reserve System, and the Federal Deposit 

Insurance Corporation (FDIC). That action effectively 

protected many uninsured creditors of large financial 

institutions from losses but at great potential cost to taxpayers. It also reinforced investors’ perceptions that large 

financial firms are “too big to fail”—that is, so important 

to the financial system that their creditors are likely be 

protected by the federal government in case of large 

losses. 

Banks and other large financial institutions benefit from a 

federal financial safety net, but they do not bear the full 

cost of that protection. The vast majority of the funds 

that financial institutions lend is obtained from creditors, 

which for commercial banks include insured and uninsured depositors, and purchasers of bank commercial 

paper (short-term debt obligations) and other bank debt 

(such as bonds). Deposits (saving and checking accounts 

and certificates of deposit) are one of the most important 

sources of funding for small and medium-sized banks and 

are insured against losses (generally up to $250,000 per 

account) by the FDIC. Banks pay a premium for FDIC 

insurance and also are obligated to make up for losses that 

exceed the reserves of the FDIC. Large financial institutions, including big banks, are much more likely than 

smaller banks to obtain financing from sources other than 

insured deposits. They also are more likely to be perceived as too big to fail. Those implicit federal guarantees, which large financial institutions do not pay for 

under current law, give them a cost advantage over 

smaller banks in the form of lower borrowing costs.1

This option would assess an annual fee on banks, thrifts, 

brokers, security dealers, and U.S. holding companies 

that control such entities. The fee would apply only to 

firms with consolidated assets of more than $50 billion. 

(Consolidated assets include all assets controlled by the 

financial institution’s parent company and all of its subsidiaries.) The option would impose a fee at an annual 

rate of 0.15 percent on the firm’s total liabilities as 

reported in their financial statements, excluding deposits 

insured by the FDIC (for banks) and certain reserves 

required by insurance policies (for insurance companies). 

If implemented, such a policy change would generate 

$31 billion in revenue from 2012 through 2016 and 

$71 billion from 2012 through 2021. (Such fees would 

reduce the tax base of income and payroll taxes, leading 

to reductions in income and payroll tax revenues. The 

estimates shown here reflect those reductions.)

At 0.15 percent, the fee would probably not be so high as 

to cause financial institutions to significantly change their 

financial structure or activities. The fee could affect to 

some extent institutions’ tendency to take various risks, 

but the net direction of that effect is uncertain. On the 

one hand, the fee could reduce the profitability of larger 

institutions, which might create an incentive for them to 

take greater risks in pursuit of higher returns to offset 

their higher costs. On the other hand, the fee would provide an incentive for larger financial institutions to reduce 

their dependence on liabilities subject to the fee. To the 

extent that institutions increased their reliance on equity 

and did not change their investment strategies, the risk 

of future losses would be reduced. The amount of the 

fee could vary with the amount of risk an institution 

undertakes, but it might be difficult to measure those risk 

factors precisely.

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 4.1 6.4 6.7 6.9 7.2 7.4 7.7 7.9 8.2 8.4 31.3 70.9

1. Under the Dodd-Frank Wall Street Reform and Consumer 

Protection Act of 2010 (Public Law 111-203), the government 

is required to recover the cost of resolving the failure of a large 

financial institution by charging an assessment on other large 

financial institutions in future years. 
202 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

The fee also might affect the market concentration of the 

financial industry. Banks would have an incentive to keep 

assets below the $50 billion threshold, which could 

reduce the number of large institutions. The fee also 

would improve the relative competitive position of small 

and medium-sized banks.

The main advantage of this option is that it would help 

compensate taxpayers for the cost of providing large institutions with a financial safety net. It would also create a 

more level playing field for large and small financial institutions, by charging the largest institutions for the greater 

government protection they receive. By applying the fee 

to noninsured liabilities, the option would allocate costs 

from government rescue actions more evenly across the 

sources of funding. 

The option would also have several disadvantages. The 

fee might be borne by unintended groups: Large financial 

institutions could pass much of the cost to their customers, employees, and investors, but the precise incidence 

among those groups is uncertain. In addition, unless 

the fee was risked-based, stronger financial institutions 

that pay lower interest rates on their debt would face a 

proportionally greater increase in funding costs than 

would weaker financial institutions. Furthermore, morestringent regulations such as those in the Dodd-Frank 

Wall Street Reform and Consumer Protection Act of 

2010 and those in the international Basel III agreement 

could better protect taxpayers from the risks of large-bank 

failures than would be the case under previous rules. 

If so, those regulations would reduce the need to charge 

large banks a fee to offset the potential costs of being 

“too big to fail.”

RELATED CBO PUBLICATIONS: Report on the Troubled Asset Relief Program—November 2010, November 2010; The Budgetary Impact and 

Subsidy Costs of the Federal Reserve’s Actions During the Financial Crisis, May 2010; and Letter to the Honorable Charles E. Grassley 

providing information on the president’s proposal for a financial crisis responsibility fee, March 4, 2010
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 203

CBO

Revenues—Option 34

Reinstate the Superfund Taxes

Source: Joint Committee on Taxation.

The Superfund program and its associated trust fund 

were established in 1981 to clean up the nation’s worst 

hazardous waste sites. By statute, the cost of cleanup is to 

be borne by the parties responsible for the contamination, but the Environmental Protection Agency (EPA), 

which administers the program, pays for the cleanup 

when liable parties cannot be identified, no longer exist, 

or are unwilling or unable to undertake the job.

EPA-led cleanups and other Superfund activities are 

funded by an annual appropriation, which lawmakers 

designate as having two sources: One portion comes from 

the general fund of the Treasury, and the other portion 

is drawn from balances in the program’s trust fund. In 

2010, the total appropriation was $1.3 billion, and net 

outlays were $1.0 billion.

Originally, revenues designated for the trust fund were 

derived mainly from taxes on petroleum and various 

industrial chemicals and from a corporate environmental 

income tax. However, authorization for those taxes 

expired in December 1995. The trust fund continues to 

receive some money from liable parties who pay interest 

and penalties and reimburse EPA for its cleanup costs; 

but the program is now financed largely from the general 

fund. 

This option would reinstate the taxes that expired at the 

end of 1995: the Superfund excise tax of 9.7 cents per 

barrel of crude oil or refined oil product, an excise tax of 

$0.22 to $4.87 per ton on various chemicals, and a corporate income tax of 0.12 percent on corporations’ modified alternative minimum taxable income above $2 million. (The latter is computed by disallowing certain tax 

preferences allowed under the regular corporate income 

tax and by making other adjustments, both positive and 

negative, to the firm’s taxable income.) Together, those 

taxes would yield revenues of $9 billion between 2012 

and 2016 and $19 billion from 2012 through 2021. 

(Because excise taxes reduce the tax base of income and 

payroll taxes, additional excise taxes would lead to reductions in revenue from income and payroll taxes. The estimates shown here reflect those reductions.) 

An argument in favor of the option is that reauthorizing 

the dedicated taxes to finance the Superfund program, 

rather than continuing to rely on general funds, is more 

consistent with the principle that entities that contribute 

to pollution should pay to clean up the resulting problems. Because petroleum products and various chemical 

feedstocks and derivatives are common sources of contamination at Superfund sites, and because hazardous 

chemicals are used by many medium-sized and large corporations, having producers and users of those substances—as well as corporations more broadly—pay 

much of the cleanup bill would be fairer than having all 

taxpayers bear those costs. A second rationale is that having a stable source of funding would help maintain EPA’s 

long-term efforts at the worst sites and continue to give 

responsible parties reason for concern that EPA will conduct its own cleanups and seek to recover the costs from 

them if they do not undertake the work themselves. 

An argument against the option is that taxing all companies in an industry or all corporations above a particular 

size, regardless of those companies’ past or current wastedisposal practices, would not provide incentives for 

companies to handle waste carefully or, in fact, to avoid 

creating it in the first place. Instead, companies would be 

subject to the tax without regard to their role in creating 

future hazardous waste sites. The tax would distort economic decisions, thus hampering rather than promoting 

efficiency. Another argument against the option is that it 

could unfairly tax current stakeholders of a business (its 

customers, employees, and investors) who were not 

responsible for and did not benefit from earlier polluting 

activities. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 1.4 1.9 2.0 2.0 2.0 2.1 2.1 2.1 2.1 2.2 9.1 19.4
204 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

A third argument against the option is that some research 

indicates that the administrative and compliance costs of 

such levies are out of proportion with the relatively small 

amounts of revenue they raise. Also, because Superfund 

spending (including spending from the trust fund) has 

always been subject to annual appropriations, dedicated 

taxes would provide no guarantee of stable funding.
CHAPTER FOUR: REVENUE OPTIONS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 205

CBO

Revenues—Option 35

Impose a Price on Emissions of Greenhouse Gases

Source: Congressional Budget Office.

The accumulation of greenhouse gases in the atmosphere—particularly carbon dioxide (CO2) released as a 

result of deforestation and the use of fossil fuels—could 

create costly changes in regional climates throughout the 

world. The damage could include water shortages, the 

loss of land in coastal areas because of rising sea levels, 

acidification of the world’s oceans, and the extinction of 

various species. Concern about such damage has led policymakers and analysts to consider policies designed to 

reduce emissions of those gases. 

Greenhouse gas emissions could be reduced by requiring 

emitters of large amounts to pay a price to emit those 

gases. Such a policy could be instituted as a tax on emissions or as part of a cap-and-trade system. In either case, 

the cost of producing and consuming goods and services 

would increase in proportion to the amount of greenhouse gases emitted as a result of that production and 

consumption. Ultimately, those costs would be passed on 

to consumers in the form of higher prices. Those higher 

prices, in turn, would create incentives throughout the 

U.S. economy to reduce emissions of greenhouse gases.

This option would establish a cap-and-trade program 

governing emissions of greenhouse gases in the United 

States. Emissions would be measured in CO2 equivalents 

(CO2e)—that is, the amount of carbon dioxide that 

would cause an equivalent amount of warming. Under 

such a program, a decreasing number of allowances—

which would convey the right to emit 1 metric ton of 

CO2e apiece—would be sold at open auction, beginning 

in 2012 and ending in 2050. According to estimates by 

the Congressional Budget Office, emissions from the sectors that were subject to the cap-and-trade policy would 

fall by roughly 20 percent from their projected amounts 

in 2025 and by 50 percent from their projected amounts 

in 2050. Firms would be allowed to shift their use of 

allowances from one year to another by “banking” 

unused allowances or by “borrowing” allowances from 

future allocations for current use. However, firms would 

not be allowed to comply with the cap by submitting 

“offset credits,” which reflect reductions in emissions 

from sectors that otherwise would not be subject to the 

cap. 

If implemented, this option would raise revenues by 

close to $500 billion from 2012 through 2016 and by 

$1.2 trillion from 2012 through 2021. (Because it 

would reduce the tax base of income and payroll taxes, 

the option would lead to reductions in revenue from 

those sources. The estimates shown here reflect those 

reductions.) 

Those revenue estimates are based on an estimated allowance price in 2012 of $20 that would increase at an 

annual rate of 5.6 percent. Such a price would motivate 

firms and households to undertake reductions that cost 

up to $20 per metric ton of CO2e to achieve in the initial 

year of the policy. The reductions would be economically 

justified if those costs were less than the long-term benefits of each ton of emissions that was reduced. An interagency federal analysis published in 2010 estimated the 

value of the benefit (that is, the damage that would be 

avoided) from reducing baseline emissions—those that 

would have occurred in the absence of any policy limiting 

emissions—by 1 metric ton. According to that study, 

the value of that benefit would range from an estimated 

$5 to $40 per metric ton in 2012.1

An argument that is made in favor of a cap-and-trade 

program such as the one described here is that an initial 

allowance price of $20 would be justified by the benefits 

resulting from the program. In addition to the direct benefits from reducing the damage associated with climate 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues 88.2 93.4 99.4 105.3 112.2 119.5 127.2 135.7 144.4 153.6 498.5 1,178.9

1. That estimate is expressed in present-value terms, which indicates 

the value today of an amount of money in the future, given a set 

rate of return. For more information on the benefit range, see 

Department of Energy, Technical Support Document: Social Cost of 

Carbon for Regulatory Impact Analysis Under Executive Order 

12866 (February 2010), www.epa.gov/oms/climate/regulations/

scc-tsd.pdf.
206 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

change, such a program would generate “co-benefits.” 

Co-benefits would occur when measures taken to reduce 

emissions—such as generating electricity from natural gas 

rather than from coal—reduced other pollutants not 

explicitly limited by the cap, thereby reducing the harmful effects associated with those emissions. The magnitude of those co-benefits is uncertain and depends on 

which standards were already in place to limit such pollutants. However, in terms of the benefits to human 

health, a literature survey published in 2010 indicates 

that the reductions in other pollutants that would occur 

as a by-product of limiting CO2 emissions could be as 

large as, or larger than, the direct benefits of reducing 

CO2 emissions.2

Another argument in favor of the option is that setting an 

economywide price on emissions of greenhouse gases 

would impose a smaller cost on the economy than the 

alternative approach of achieving the same reductions 

through various provisions in the existing Clean Air Act 

(CAA). Setting an economywide price on greenhouse gas 

emissions would lower the cost of reducing emissions by 

allowing market forces to determine where, how, and—to 

some extent—when such reductions could be achieved. 

In contrast, standards issued under the CAA (for example, specifying an emissions rate for a plant or an energy 

efficiency standard for a given product) would offer less 

flexibility and, as a result, would achieve emission reductions at a higher cost. Finally, an economywide tax or 

cap-and-trade program would provide a potential source 

of revenue for the federal government, an option that 

would not be available under the existing CAA. The government could use some of those revenues to accomplish 

various goals such as reducing taxes, offsetting the costs of 

the cap-and-trade program for certain groups or industries that are put at a competitive disadvantage by the 

program, or reducing the federal deficit. 

An argument that is made against policies that limit emissions is that any attempt to curtail U.S. emissions in the 

near term would burden the economy by raising prices 

for emissions-intensive goods and services while yielding 

benefits of an uncertain magnitude. In addition, most 

of those benefits might occur outside the United States, 

particularly in developing countries. It is also argued that 

reductions in domestic emissions could be offset by 

increases in emissions overseas if carbon-intensive industries relocated to countries that did not impose restrictions on emissions. Another argument against the option 

is that the budgetary savings from a cap-and-trade program would be diminished if the revenues were used to 

fund generous subsidies to industries and households 

affected by the program. Moreover, averting the risk of 

future damage caused by climate change would depend 

on collective global efforts to cut emissions. Most analysts 

agree that if other countries with high levels of emissions 

do not cut those pollutants over the same period that the 

United States does and by roughly the same percentage, 

efforts in this country would produce small climaterelated benefits.

2. See G.F. Nemet, T. Holloway, and P. Meier, Environment Research 

Letters, vol. 5, “Implications of Incorporating Air-Quality 

Co-Benefits into Climate Change Policymaking” (January-March 

2010).

RELATED CBO PUBLICATIONS: Evaluating Limits on Participation and Transactions in Markets for Emissions Allowances, December 2010; 

Managing Allowance Prices in a Cap-and-Trade Program, November 2010; How Policies to Reduce Greenhouse Gas Emissions Could Affect 

Employment, Issue Brief, May 2010; The Costs of Reducing Greenhouse-Gas Emissions, Issue Brief, November 2009; The Economic Effects 

of Legislation to Reduce Greenhouse-Gas Emissions, September 2009; Potential Impacts of Climate Change in the United States, May 2009; 

Cost estimate for S. 1733, Clean Energy Jobs and American Power Act, December 16, 2009; and Cost estimate for H.R. 2454, American Clean 

Energy and Security Act of 2009, June 5, 2009, with an amendment June 26, 2009
APPENDIX

CBO

A

Options That Would Increase the Deficit

Unlike the other options in this volume, the six 

options in this appendix would add to federal budget deficits. The first three would make changes to mandatory 

programs; they are included because the Congressional 

Budget Office frequently receives requests for estimates of 

their budgetary effects. The other three options involve 

tax provisions that are scheduled to expire in the next few 

years; they are included because of the high level of public 

interest in those provisions.
208 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option A-1 Function 550

Extend the Requirement for States to Provide Transitional Medical Assistance

Current law allows certain Medicaid beneficiaries who 

would otherwise lose eligibility because of increased earnings to retain their Medicaid coverage for a limited period 

of time following their increase in income. Beneficiaries 

who qualify for that extension of coverage—known as 

transitional medical assistance (TMA)—are usually former recipients of funds from the Temporary Assistance 

for Needy Families program, which provides time-limited 

cash assistance, child care, and training opportunities to 

low-income families with dependent children. Through 

TMA, parents and children in eligible families qualify 

for at least 6 months and up to 12 months of Medicaid 

coverage if their family income rises above the eligibility 

threshold for families but is still below 185 percent of the 

federal poverty level. This mandatory eligibility category, 

which has been extended several times, is currently 

authorized through December 31, 2012.1

This option would extend the TMA eligibility category 

through the end of 2013. Beginning in January 2014, the 

population currently eligible for TMA will have access to 

subsidized health care coverage under the Patient Protection and Affordable Care Act (Public Law 111-148) as 

modified by the Health Care and Education Reconciliation Act of 2010 (P.L. 111-152). The Congressional 

Budget Office estimates that this option would increase 

federal spending by about $3 billion through 2015, with 

no effect on federal spending after that. 

A rationale for extending TMA through 2013 is that it 

would provide low-income working families with health 

insurance when their income rose above levels that would 

otherwise make them ineligible for Medicaid. In the 

absence of TMA in 2013, Medicaid coverage will be lost 

when family incomes rise because of increased earnings 

from work. Individuals from low-income working families often have jobs that do not offer employer-sponsored 

health insurance, and they may feel unable to afford 

health insurance when their employer does offer it. 

Therefore, the loss of Medicaid coverage provides a disincentive for low-income families to pursue increased 

earnings through additional hours of work or higherpaying jobs.

An argument against this option is that some people who 

would qualify for TMA would be eligible for employersponsored insurance, and TMA would serve as a disincentive for them to enroll in available private coverage. 

CBO estimates that about 22 percent of adults and 

17 percent of children whose family income is below 

185 percent of the federal poverty level are covered by 

employer-sponsored insurance. Although coverage rates 

are lower than for higher-income groups—in part 

because of the availability of Medicaid—employersponsored insurance would be available for some 

potential TMA enrollees. 

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 200 1,100 1,200 200 0 0 0 0 0 0 2,700 2,700

1. States have some discretion in determining which groups their 

Medicaid programs will cover; however, to be eligible to receive 

federal funds, states are required to provide Medicaid coverage to 

certain groups commonly referred to as mandatory eligibility 

categories. 
APPENDIX A: OPTIONS THAT WOULD INCREASE THE DEFICIT REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 209

CBO

Mandatory Spending—Option A-2 Function 570

Permanently Extend Cost-Sharing Assistance for Qualifying Individuals 

Under Medicaid

Under Medicare Savings Programs (MSPs), state Medicaid agencies provide cost-sharing assistance for certain 

low-income Medicare beneficiaries who qualify for various levels of assistance on the basis of their income. To be 

considered for the Qualifying Individual (QI) program—

one of the MSPs—an individual must have income 

between 120 percent and 135 percent of the federal 

poverty level and meet certain requirements related to 

the assets he or she owns. Qualifying individuals receive 

assistance only for premiums for Part B of Medicare 

(which pays for physicians’ and other outpatient services). 

Other MSPs, such as the Qualified Medicare Beneficiary 

program and the Specified Low-Income Medicare 

Beneficiary program, apply to people whose income is 

below 100 percent and 120 percent of the federal poverty 

level, respectively. Those programs cover some or all 

of the costs of Medicare premiums, deductibles, and 

coinsurance. In calendar year 2010, about 450,000 

people were enrolled in the QI program, at an estimated 

gross cost to the federal government of $570 million 

(Part B premiums paid by other Medicare beneficiaries 

offset about 25 percent of that amount). 

Unlike other MSPs, the QI program does not have permanent funding and is subject to an annual funding cap. 

Assistance was established by the Balanced Budget Act 

of 1997 and initially funded through the end of 2002; 

policymakers have extended funding several times. Under 

the latest extension, enacted in the Medicare and Medicaid Extenders Act of 2010 (Public Law 111-309), the 

funding is set to expire on December 31, 2011. Although 

administered by the states through Medicaid, the QI program is funded by the Medicare Supplementary Medical 

Insurance Trust Fund, and consequently the states are not 

required to provide matching funds. Another aspect of 

the QI program is its annual funding cap, which is set at 

roughly $1 billion in calendar year 2011; once that cap is 

reached, no additional enrollment is permitted. The cap, 

however, has traditionally been set at a level that allows 

states to cover all eligible individuals who are expected 

to enroll. A new funding cap has been set with each 

extension of the provision. 

This option would permanently fund the QI program 

and eliminate the annual funding cap. The Congressional 

Budget Office estimates that this option would increase 

spending for Medicare by $4 billion over the 2012–2016 

period and by $13 billion during the 2012–2021 period.

An argument in support of this option is that it would 

ensure that qualifying individuals would receive coverage 

for their Medicare Part B premiums to the same extent as 

people covered by other MSPs. In addition, enrollment in 

an MSP triggers automatic enrollment in the LowIncome Subsidy (LIS) of Medicare Part D (the prescription drug program). By making the QI program permanent, these individuals would have continuity of coverage 

in the LIS rather than being required to reapply annually 

(the budgetary effect of that change is included in the 

estimates shown here).

An argument against this option is that the existing limits 

on both the duration of the QI provision and the amount 

of its available funding force policymakers to periodically 

consider whether the funding for QIs is the best use of 

scarce resources.

Total

(Millions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 500 780 900 1,030 1,180 1,360 1,560 1,760 1,970 2,190 4,390 13,230
210 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending—Option A-3 Function 650

Increase Social Security Benefits for Workers Who Have Low Earnings 

Over a Long Working Lifetime 

Social Security benefits generally are calculated on the 

basis of a worker’s average wages over the course of his 

or her career. Under the standard formula, retired people 

who have had low lifetime earnings receive the same benefits regardless of whether they were out of the workforce 

for some period (perhaps because they were raising children) or they consistently received low earnings over the 

course of a career. Recognizing that retirees who had 

consistently low annual earnings are more likely to be in 

financial need than are people who worked intermittently 

but for high annual earnings, policymakers established a 

second formula in 1972, the “special minimum benefit,” 

to give participants the higher of the standard benefit 

or the special minimum benefit. Unlike the standard 

formula, in which average benefits grow with average 

wages, the special minimum formula is indexed to prices. 

Because wages generally grow faster than prices, the gap 

between the two formulas is continually shrinking. Each 

year, fewer people gain from the special minimum benefit, and those who do, gain less. The special minimum 

benefit is projected to provide no advantage to those who 

become eligible in 2013 and later.

This option would replace the special minimum benefit 

with an increase in the standard benefit for workers who 

have both low lifetime average earnings and at least 

20 years of covered earnings. Specifically, it would raise 

the standard benefit for qualified workers by a specified 

percentage that would depend on the number of years 

with earnings above a threshold—currently about 

$4,500—and a worker’s average indexed monthly earnings (AIME). The largest benefit increase would be 

40 percent for someone with 35 or more years in the 

workforce and an AIME below that of someone who 

had worked full time and earned the minimum wage for 

30 years. The benefit increase would be smaller for people with fewer years of work or higher AIMEs, and there 

would be no increase for people whose AIME exceeded 

that of a worker with 35 years of earnings above the 

threshold or who earned, on average, an amount equal 

to or greater than the average wage index (the average 

amount of total earnings in the United States in a year). 

The provision would apply to workers who become 

eligible to claim benefits in 2012 and later.

This option would increase federal outlays by $31 billion 

over 5 years and by $178 billion over 10 years, reflecting 

both higher benefit payments and some offsetting savings 

in the federal share of the Supplemental Security Income 

and Medicaid programs. By 2050, the option would 

increase Social Security outlays by 8 percent—from 

5.9 percent to 6.4 percent of gross domestic product. 

Although this option would help workers the special 

minimum benefit also was designed to assist—those with 

a history of consistently low annual earnings—a drawback is that it would not distinguish between workers 

who had low annual earnings because they earned low 

hourly wages and those who had higher hourly wages but 

worked for only part of the year. 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Outlays 0.6 2.5 5.5 9.2 13.5 18.3 23.5 29.0 34.9 40.9 31.2 177.8

RELATED CBO PUBLICATION: Social Security Policy Options, July 2010 
APPENDIX A: OPTIONS THAT WOULD INCREASE THE DEFICIT REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 211

CBO

Revenues—Option A-1

Permanently Extend the Individual Income Tax Provisions of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job Creation Act of 2010

Source: Joint Committee on Taxation.

Notes: EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 

2003; ARRA = American Recovery and Reinvestment Act of 2009; EITC = earned income tax credit; AMT = alternative minimum tax; 

* = between -$50 million and zero.

These estimates represent the change in the overall budget balance resulting from the sum of changes to revenues and outlays. 

[The estimate of the change in revenues in 2021 from expanding the child tax credit was corrected as of March 30, 2011.]

Several laws enacted since 2001 have substantially altered 

the individual income tax system. The Economic Growth 

and Tax Relief Reconciliation Act of 2001(EGTRRA) 

reduced statutory tax rates, created a 10 percent tax 

bracket, increased the value of the child tax credit, provided tax relief to married couples filing joint returns, 

prevented more taxpayers from becoming subject to the 

alternative minimum tax (AMT), and made many 

smaller changes to the tax code. The Jobs and Growth 

Tax Relief Reconciliation Act of 2003 (JGTRRA) 

accelerated the phasing in of some provisions of 

EGTRRA, extended others through 2010, and made 

some permanent. It also reduced the tax rate on income 

from capital gains and certain dividends. The American 

Recovery and Reinvestment Act of 2009 (ARRA, Public 

Law 111-5) provided further tax relief by expanding the 

child and earned income tax credits and creating a new 

partially refundable education tax credit, among other 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Extend Individual Income Tax Provisions of EGTRRA

Change in Revenues

Statutory rate changes 0 -37.1 -57.0 -62.2 -67.7 -72.5 -77.3 -81.7 -86.3 -91.2 -224.0 -633.0

10 percent bracket 0 -31.9 -46.0 -46.2 -46.3 -46.2 -46.1 -46.4 -46.5 -46.2 -170.4 -401.6

Expanded child tax credit 0 -7.0 -35.3 -36.0 -36.7 -37.2 -37.7 -38.1 -38.4 -38.8 -115.0 -305.4

Marriage penalty relief 0 -5.1 -12.3 -12.1 -12.1 -11.9 -11.7 -11.5 -11.4 -11.4 -41.6 -99.6

Limits on personal exemptions 

and itemized deductions 0 -5.9 -12.6 -14.1 -15.4 -16.6 -17.8 -18.9 -20.1 -21.4 -48.0 -142.8

Extend Individual Income Tax Provisions of JGTRRA

Change in Revenues

Dividends and capital gains 

rates -1.6 -13.0 -11.7 -30.0 -31.7 -33.6 -35.4 -36.9 -38.2 -39.9 -88.0 -271.9

Extend Certain Individual Income Tax Provisions of ARRA

Change in Revenues

American Opportunity Tax Credit 0 -0.9 -4.4 -4.4 -4.6 -4.9 -4.9 -5.3 -5.4 -5.6 -14.3 -40.4

Expanded child tax credit 0 0 -10.2 -10.2 -10.1 -10.0 -10.0 -9.9 -9.8 -9.8 -30.5 -79.9

Expanded EITC 0 * -1.7 -1.7 -1.7 -1.7 -1.7 -1.8 -1.8 -1.9 -5.1 -14.0

AMT relief -8.9 -108.1 -96.8 -107.0 -118.7 -131.3 -145.5 -162.0 -179.0 -196.6 -439.5 -1,253.9

Extend All of the Above Provisions

Change in Revenues -10.5 -209.0 -288.0 -323.9 -345.0 -365.9 -388.1 -412.5 -436.9 -462.8 -1,176.4 -3,242.5
212 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

provisions. Most of the changes instituted by those laws 

were originally slated to expire after 2010 but were 

subsequently extended through 2012 by the Tax Relief, 

Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-312, referred to in this report 

as the 2010 tax act). 

This option would make permanent the provisions of 

EGTRRA, JGTRRA, and ARRA that were extended 

through 2012 by the 2010 tax act. Additionally, the 

AMT exemption levels in effect in 2011would be indexed 

for inflation beginning in 2012 (see the discussion in 

Revenues—Option A-2). Together, those changes would 

increase the deficit by $1.2 trillion from 2012 through 

2016 and by $3.2 trillion from 2012 through 2021. 

Extending the provisions of the 2010 tax act would affect 

the economy in several ways. Over the first several years, 

while the economy is operating below its potential, extension would increase households’ after-tax income and 

demand for goods and services, thus encouraging stronger economic activity. Lower marginal tax rates (which 

apply to a taxpayer’s last dollar of income) would also 

encourage economic growth over a longer period. Unlike 

lower average tax rates (the amount of tax paid as a share 

of total income), which can encourage people to work 

and save less, lower marginal tax rates can encourage people to work and save more. The net economic impact of 

lower tax rates, however, would depend on how the rate 

reductions were financed. Financing tax cuts through 

higher budget deficits, for example, would reduce 

national saving, which would impair economic growth 

over the long term and could eventually offset any positive economic effects resulting from lower tax rates. 

Lower tax rates can also help the economy by encouraging people to make decisions based on the economic benefit rather than the tax benefit, resulting in a more efficient use of economic resources and, thus, leaving people 

better off. Higher marginal tax rates can, for example, 

encourage people to shift income from taxable to nontaxable forms (which could be accomplished by substituting tax-exempt bonds for other investments or tax-free 

fringe benefits for cash compensation). Higher rates also 

can motivate people to spend more on tax-deductible 

items, such as home mortgage interest. 

Extending the lower tax rates on capital gains and dividends could also contribute to greater efficiency in the 

economy in other ways. For example, corporate profits 

are taxed once through the corporate income tax and 

again when they are paid out as dividends or reinvested in 

the business and later realized as capital gains. Reducing 

the extent of that double taxation would reduce the bias 

that now exists in the tax code against equity investments 

in corporations, lessening distortions in investment decisions. As with other types of income, the net effects of 

lower tax rates on efficiency would depend on how the 

lower rates on capital gains and dividends were financed. 

Permanently extending the individual income tax provisions in the 2010 tax act would have mixed effects on the 

complexity of the tax system. Although some provisions, 

such as relief from the AMT, would simplify the tax code 

for some taxpayers, other provisions, such as expanding 

tax-favored accounts for education savings, would 

complicate the tax code. 

In addition to the effects that a particular tax policy 

might have on economic efficiency and the complexity of 

the tax code, another key consideration is how the policy 

would affect the tax burden of people at different income 

levels. Although the various provisions of the 2010 tax act 

have varying effects, the act’s individual income tax provisions as a whole reduce income taxes by a larger percentage of after-tax income for higher-income households 

than for lower-income households. And although the tax 

reductions relative to income would be greater for higherincome households, extending the act’s provisions would 

not significantly alter the share of income taxes paid by 

different households at various income levels. 

An alternative approach would limit the extension of the 

provisions that reduced tax rates to taxpayers with income 

below certain thresholds. Taxpayers with income above 

those thresholds would see their top statutory rates rise 

and would face increases in the tax rate on income from 

dividends and capital gains, as scheduled under current 

law. Those taxpayers would still see reductions in their 

taxes, however, because the portion of their income that 

fell into the lower tax brackets would benefit from the 

rate reductions set by EGTRRA for those brackets. That 

alternative approach would increase the deficit by less 

than would fully extending all of the tax changes. At the 

same time, it would also shrink any economic effects
APPENDIX A: OPTIONS THAT WOULD INCREASE THE DEFICIT REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 213

CBO

from extending the law. The improvements in incentives 

to work and save would be lessened, as would the 

negative economic effects from reduced national saving. 

Compared with full extension of the 2010 tax act, partial 

extension would provide high-income taxpayers with 

smaller tax cuts.

RELATED OPTIONS: Revenues, Options 1 and 2; and Revenues, Option A-2

RELATED CBO PUBLICATIONS: Statement of Douglas W. Elmendorf, Director, Congressional Budget Office, before the Senate Committee on the 

Budget, The Economic Outlook and Fiscal Policy Choices, September 28, 2010; and Policies for Increasing Economic Growth and 

Employment in 2010 and 2011, January 2010
214 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option A-2

Provide Relief from the Individual Alternative Minimum Tax

Source: Joint Committee on Taxation.

Note: AMT = alternative minimum tax.

For the past four decades, the federal individual income 

tax has consisted of two parallel tax systems: the regular 

tax and an alternative minimum tax (AMT). Tax liability 

is computed differently for the AMT than for the regular 

income tax because the AMT allows a more limited set of 

exemptions, deductions, and tax credits than are allowed 

under the regular income tax. Taxpayers pay the higher of 

their regular tax or the AMT. 

When they calculate their liability under the AMT, taxpayers cannot claim some items that are deductible from 

income under the standard income tax, such as personal 

exemptions, the standard deduction, or (if they itemize 

deductions) state and local taxes. Also disallowed under 

the AMT are some tax preferences that apply only to 

taxpayers with complex financial situations, such as the 

deduction for some intangible costs associated with drilling for oil and gas. Under the AMT, all of those adjustments are replaced with a single exemption that phases 

out at higher incomes. Taxpayers subtract the exemption 

from their income to determine their taxable income, 

which is taxed at 26 percent for the first $175,000 and at 

28 percent for the remainder. 

Unlike the tax brackets and exemptions for the individual 

income tax, those for the AMT are not indexed for inflation. Thus, if a taxpayer’s nominal income grows at the 

rate of inflation, that taxpayer’s liability under the regular 

income tax will grow at the same rate as his or her income 

over time as the values of the standard deduction, personal exemptions, and the beginning and endpoints of 

the tax brackets also rise with inflation. Because the 

parameters of the AMT are not indexed, that taxpayer’s 

liability under the AMT will grow faster than his or her 

income. As a result, more taxpayers will be subject to the 

alternative tax as their nominal income grows with 

inflation. 

In recent years, lawmakers have enacted temporary measures to stem the growth in the number of people subject 

to the tax. The AMT exemptions were temporarily 

increased by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Several times since 

then, the higher exemption amounts have been extended 

for a year or two and increased, most recently by the Tax 

Relief, Unemployment Insurance Reauthorization, and 

Job Creation Act of 2010 (Public Law 111-312, referred 

to in this report as the 2010 tax act). Before 2001, the 

exemptions were $33,750 for single filers and $45,000 

for joint filers. The 2010 tax act raised them to $48,450 

and $74,450 for 2011. Under current law, the exemptions will revert to their pre–EGTRRA amounts in 2012.

This option encompasses two approaches that would provide permanent relief from the AMT. The first approach 

would limit the effects of the tax by making the exemption amounts for 2011 permanent and indexing those 

amounts, along with the AMT brackets, for inflation 

after 2011. This approach would reduce revenues by 

$240 billion from 2012 through 2016 and by $683 billion over the 10-year period. If this approach was 

adopted, 5 million taxpayers would pay the AMT in 

2012—rather than the 33 million who would be subject 

to the tax under current law. 

The second approach would simply eliminate the AMT. 

Eliminating the alternative tax would reduce revenues by 

$308 billion from 2012 through 2016 and by $814 billion over 10 years. All 33 million taxpayers who would 

have been subject to the AMT in 2012 would, instead, 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

Make the 2011 exemption amounts 

permanent and index the AMT for 

inflation -9.0 -92.8 -39.5 -45.4 -53.1 -61.8 -73.1 -86.7 -102.2 -119.4 -239.8 -683.0

Eliminate the AMT -12.4 -126.3 -49.5 -55.9 -64.1 -73.5 -85.3 -99.4 -115.1 -132.8 -308.2 -814.3
APPENDIX A: OPTIONS THAT WOULD INCREASE THE DEFICIT REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 215

CBO

pay the regular income tax. (The revenue estimates for 

both approaches are based on the assumption that other 

provisions of current law would remain in effect, including those specifying that most of the tax reductions 

enacted since 2001 would expire at the end of 2012. If 

the lower tax rates and other expiring provisions were 

extended, the AMT would apply to more people and 

more income, and the revenue loss from the two AMT 

alternatives would be considerably higher. Similarly, other 

changes to the regular income tax could change the 

impact of AMT relief.)

One rationale for this option is that the AMT, if left 

unchanged, will apply to more and more taxpayers—an 

estimated 45 million by 2021. That was not the original 

purpose of the tax, which was first enacted in 1969 to 

address concerns that a small number of wealthy taxpayers were using provisions of the regular tax code to 

greatly reduce their tax liability—in some cases, to zero. 

Because the values of the standard deduction and personal exemption under the regular tax system will rise 

with inflation while the AMT exemption amounts 

remain constant after 2011, the AMT will increasingly 

affect taxpayers who do not itemize their deductions, 

effectively limiting the value of the standard deduction 

and personal exemption under the regular income tax. 

And among taxpayers who itemize, many will become 

subject to the AMT not because they shelter income but 

because they have large families (and can currently make 

use of the personal exemptions), incur high medical 

expenses, or reside in areas with high state and local taxes 

(medical expenses and state and local taxes are deductible 

for purposes of the regular income tax but not for the 

AMT).

Another benefit of either approach described in this 

option would be simplification. Taxpayers who are now 

or who might be subject to the AMT must calculate their 

tax liability twice. As that group expands, an increasing 

number of people will confront more complex calculations when preparing their tax returns and making tax 

plans. This option would simplify the tax system by 

making fewer taxpayers subject to the AMT. 

An argument against this option is that without the 

AMT, more taxpayers would be eligible for certain deductions, exclusions, and credits available under the ordinary 

income tax, which could worsen the allocation of 

resources in the economy. For example, by disallowing 

the deduction on second homes and certain other mortgage debt, the AMT encourages taxpayers to invest in 

other assets rather than in additional housing; and by disallowing the deduction for state and local taxes, the AMT 

limits subsidies to certain state and local governments 

and treats otherwise similar taxpayers in different locations more comparably. (If those limits were considered 

desirable, however, they could be incorporated into the 

regular income tax even if the AMT was modified or 

eliminated.)

This option would raise issues of fairness because it 

would primarily benefit higher-income taxpayers. The 

option would also have economic effects. Relief from the 

AMT would alter the marginal tax rate that applies to 

taxpayers who currently are subject to the alternative tax. 

(The marginal tax rate applies to a taxpayer’s last dollar of 

income.) Some taxpayers would see their marginal rates 

increase, but more would see their marginal rates decline, 

which would encourage them to work and save more. 

AMT relief would also reduce some people’s tax liability, 

allowing them to achieve the same amount of after-tax 

income with less income before taxes, and might diminish their incentive to work. On balance, it is not clear 

how the changes in this option would influence incentives to work and save; the overall effect would depend on 

taxpayers’ responsiveness to those incentives. 

RELATED OPTIONS: Revenues, Options 1 and 2; and Revenues, Option A-1

RELATED CBO PUBLICATIONS:The Individual Alternative Minimum Tax, Issue Brief, January 2010; and Statement of Douglas Holtz-Eakin, 

Director, Congressional Budget Office, before the Subcommittee on Taxation and IRS Oversight, Senate Committee on Finance, The Individual 

Alternative Minimum Tax, May 23, 2005
216 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Revenues—Option A-3

Modify Estate and Gift Taxes 

Source: Joint Committee on Taxation.

When someone dies, a federal estate tax is imposed on the 

value of assets that are transferred at his or her death. In 

addition, a gift tax is assessed on the value of taxable gifts 

that were made during that person’s lifetime. Currently, 

only the portion of an estate that exceeds $5 million is 

subject to the estate tax, and that amount is taxed at a rate 

of 35 percent. Likewise, only taxable gifts that exceed the 

effective lifetime exemption amount, now $5 million, are 

subject to the gift tax, and they are also taxed at a rate of 

35 percent. The two exemptions are not cumulative, 

however: The effective exemption amount under the 

estate tax is reduced by any exemption used under the gift 

tax. Gifts and bequests between spouses and bequests to 

charities are not subject to taxation. The executor of an 

estate can deduct the total amount of taxes paid to a state 

after the property owner’s death. Besides the estate and 

gift taxes, a generation-skipping transfer (GST) tax 

applies at the tax rate of 35 percent on transfers to an heir 

who is more than one generation younger than the decedent, such as a grandchild.

Current provisions of the estate and gift tax—which 

went into effect with the enactment of the Tax Relief, 

Unemployment Insurance Reauthorization, and Job 

Creation Act of 2010 (Public Law 111-312)—expire after 

2012. In 2013, estates and gifts will be subject to the tax 

laws that were in effect before the enactment of the Economic Growth and Tax Relief Act of 2001 (EGTRRA). 

Estates and gifts will still be subject to a unified tax, but 

with a graduated rate schedule (topping at a marginal tax 

rate of 55 percent) and a combined effective exemption 

amount of $1 million. A 5 percent surcharge will apply to 

wealth transfers between $10 million and $17 million, 

and instead of deducting from the value of the estate the 

amount of estate and inheritance taxes owed at the state 

level, the estate will be able to claim a credit for those 

taxes (but only up to a certain amount). In addition to 

the estate and gift taxes, a GST tax will apply at the highest estate tax rate (55 percent in 2013) on transfers to an 

heir who is more than one generation younger than the 

decedent.

Certain provisions of the individual income tax, particularly taxes on capital gains realizations, also affect the tax 

treatment of estates. Under the tax code, a capital gain or 

loss is measured as the difference between the cost of purchasing the asset (its basis) and the value of the asset 

when the gain is realized. Basis comes into play when 

inherited assets are eventually sold and capital gains (or 

losses)—and any applicable taxes—are calculated. Currently, basis is generally measured as an asset’s fair market 

value on the date of the property owner’s death or on an 

alternative valuation date, as specified by law. This 

method is often referred to as stepped-up basis. An alternative treatment is carry-over basis, in which the inherited asset retains the same basis it had prior to the date 

of death.

This option encompasses three methods of modifying the 

estate, gift, and GST taxes, beginning in 2013. The first 

two alternatives would retain those taxes but set the 

exemption amounts, tax rates, and other parameters at 

either their 2012 or 2009 levels (with the exemption 

indexed for inflation); the third alternative would permanently repeal the estate tax and the GST tax in the same 

manner that EGTRRA did for 2010. 

B Alternative 1 would permanently extend the unified 

estate and gift tax law that is currently in place for 

2012. Under this alternative, the estate tax and gift tax 

exemption amounts would be $5 million (with the 

effective exemption indexed for inflation from 2011 

onward), and the tax rate would be 35 percent. This 

alternative would allow a deduction for inheritance 

and estate taxes paid to state governments, rather than 

a credit. In addition, stepped-up basis would continue 

Total

(Billions of dollars) 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2012–2016 2012–2021

Change in Revenues

Alternative 1 -0.7 -4.8 -30.8 -36.9 -41.3 -45.1 -48.2 -51.3 -54.5 -57.9 -114.6 -371.4

Alternative 2 -0.3 -0.7 -22.1 -26.6 -28.7 -31.1 -33.5 -35.9 -38.5 -41.2 -78.4 -258.1

Alternative 3 -2.6 -8.5 -47.4 -56.5 -61.7 -66.3 -70.3 -74.3 -78.4 -82.8 -176.9 -549.0
APPENDIX A: OPTIONS THAT WOULD INCREASE THE DEFICIT REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 217

CBO

to apply to assets transferred from a decedent. Those 

changes would reduce revenues by $115 billion from 

2012 through 2016 and by $371 billion over 10 years. 

About 5,000 estates would pay some federal estate tax 

in 2021 under this alternative, compared with about 

90,000 under current law.

B Alternative 2 would permanently adopt 2009 estate 

tax law as specified in EGTRRA, starting in 2013, but 

would also index the effective exemption amounts for 

inflation. Under this alternative, the effective estate tax 

exemption would be $3.5 million with an adjustment 

for inflation since 2009, and the tax would be assessed 

at a rate of 45 percent. The gift tax exemption amount 

would be $1 million (also with an adjustment for 

inflation since 2009) with a top tax rate of 45 percent. 

As under Alternative 1, estates would be allowed a 

deduction for state inheritance and estate taxes, rather 

than a credit, and stepped-up basis would continue to 

apply to assets transferred from a decedent. Those 

changes would reduce revenues by $78 billion over 

five years and by $258 billion over 10 years. About 

9,800 estates would pay some federal estate tax in 

2021 under this alternative.

B Alternative 3 would implement certain provisions in 

effect in 2010 under EGTRRA, permanently repealing the estate and GST taxes starting in 2013 and taxing cumulative gifts in excess of $1 million at a rate of 

35 percent. In addition, this alternative would permanently put in place the modified carryover basis that 

EGTRRA specified in 2010 for transferred assets. 

Under pure carryover basis, the basis of assets in the 

hands of an heir is generally the same as it was for the 

decedent. Under modified carryover basis, selected 

assets have their basis stepped up by up to $1.3 million and by an additional $3.0 million for assets left to 

a surviving spouse. The basis of any assets that do not 

receive that stepped-up treatment is generally measured as the price that the decedent originally paid 

for the asset. Together, those changes would reduce

revenues by $177 billion from 2012 through 2016 

and by $549 billion over 10 years. No estate would 

pay federal estate taxes in 2021.

One argument in favor of such changes is that each alternative would exempt smaller estates—or, in the case of 

Alternative 3, all estates—from filing estate tax returns, 

which would reduce both the taxes and the filing burden 

for some taxpayers and their heirs. Smaller estates would 

be less likely to incur estate tax liability, which could 

reduce the slight possibility of the heirs having to liquidate a small business to pay estate taxes after the owner’s 

death. Increasing the exemption levels, rather than repealing the estate tax entirely, would still largely exempt small 

estates and closely held businesses (such as family-owned 

enterprises) from the tax. Another argument is that the 

estate tax represents a form of double taxation: During 

their lifetime, people pay taxes on their income, a portion 

of which they save; but when they bequeath those savings 

to their heirs, it is taxed again under the estate tax. Those 

bequests, however, often include unrealized capital gains 

that were never taxed under the individual income tax 

during the decedent’s lifetime.

One argument that is made against reducing or repealing 

estate and gift taxes is that the progressive nature of those 

taxes lessens the concentration of wealth in the United 

States. Another concern is that charitable giving could 

decline because taxpayers would no longer have a deduction for leaving bequests to charities. Yet another consideration is that repealing the federal estate tax would not 

completely eliminate the filing burden because the executors of many estates would still have to file returns and 

pay taxes at the state level. 

Analysts hold a variety of views about how estate and gift 

taxes affect saving, the accumulation of capital, and economic growth. Research in those areas is inconclusive. To 

the extent that inherited wealth is seen as a windfall to the 

recipient, taxing it may have less of an effect on work, 

saving, and capital accumulation than do taxes on 

income.

RELATED CBO PUBLICATIONS: Federal Estate and Gift Taxes, Issue Brief, December 2009; Effects of the Federal Estate Tax on Farms and Small 

Businesses, July 2005; and The Estate Tax and Charitable Giving, July 2004

APPENDIX

CBO

B

Deficit Reduction Options with

Smaller Budgetary Effects

In compiling this volume, the Congressional Budget 

Office (CBO) focused mainly on options that would, in 

its estimation, reduce the deficit by at least several billion 

dollars over five years. CBO recognizes that some spending and revenue options with effects below that threshold 

are also of interest to policymakers. This appendix lists a 

selection of such options that were presented in the previous version of this report—Budget Options, Volume 2 

(August 2009)—and that could be implemented in 

future years essentially as described in that report.

In this list, the options affecting mandatory and discretionary spending are grouped by budget function, with 

their potential savings estimated in the following ranges:

less than $500 million over five years, between $500 million and $1 billion over five years, or more than $1 billion over five years.1

 Those savings may differ from the 

amounts shown in the 2009 report. The potential budgetary impacts of the options affecting revenues are not 

shown.

1. Budget functions are the 20 general-subject categories into which 

budgetary resources are grouped so that all budget authority and 

outlays can be presented according to the national interests being 

addressed. There are 17 broad budget functions, including 

national defense, international affairs, energy, agriculture, health, 

income security, and general government. Three other functions—net interest, allowances, and undistributed offsetting 

receipts—are included to complete the budget. 
220 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Table B-1. 

Selected Options That Appeared in CBO’s August 2009 Budget Options Report

Continued

Savings Over Five Years

Option Title

Budget 

Function—

2009 Option 

Number

Less Than

$500 Million

Between 

$500 Million and 

$1 Billion

Between

$1 Billion and 

$5 Billion

Mandatory Spending Options

Modify the Assessment Base and Increase the Federal Insurance 

Premium for Private Pension Plans 600-1 

Modify the Formula Used to Set Federal Pensions 600-2 

Target the Subsidy for Certain Meals in Child Nutrition Programs 600-6 

Eliminate the Exclusion for Unearned Income Under the Supplemental 

Security Income Program 600-7 

Create a Sliding Scale for Children’s Supplemental Security Income 

Benefits Based on the Number of Recipients in a Family 600-8 

Remove the Ceiling on the Collection of Overpayments from the 

Supplemental Security Income Program 600-9 

Reduce the Spousal Benefit in Social Security from 50 Percent to 

33 Percent 650-5 

Eliminate the Social Security Lump-Sum Death Benefit 650-6 

Require Children Under Age 18 to Attend School Full Time as a Condition 

of Eligibility for Social Security Benefits 650-7 

Eliminate Social Security Benefits for Children of Early Retirees 650-8 

Require State and Local Pension Plans to Share Data with the 

Social Security Administration 650-9 

Require the IRS to Deposit Fees for Its Services in the Treasury as 

Miscellaneous Receipts 800-2 

Discretionary Spending Options

Ease Restrictions on Contracting for Depot Maintenance 050-22 

Eliminate National Science Foundation Spending on Elementary and 

Secondary Education 250-1 

Reduce Funding for Research and Development Programs in the Science 

and Technology Directorate of the Department of Homeland Security 250-3 
APPENDIX B: DEFICIT REDUCTION OPTIONS WITH SMALLER BUDGETARY EFFECTS REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 221

CBO

Table B-1. Continued

Selected Options That Appeared in CBO’s August 2009 Budget Options Report

Continued

Savings Over Five Years

Option Title

Budget 

Function—

2009 Option 

Number

Less Than

$500 Million

Between 

$500 Million and 

$1 Billion

Between

$1 Billion and 

$5 Billion

Discretionary Spending Options (Continued)

Eliminate Federal Funding for Beach Replenishment Projects 300-2 

Reduce Funding for Timber Sales That Lose Money 300-4 

Eliminate the Energy Star Program 300-10 

Eliminate the Environmental Protection Agency’s Science to Achieve 

Results Grant Program 300-11 

Eliminate the National Park Service’s Local Funding for Heritage Area 

Grants and Statutory Aid 300-15 

Eliminate the Hollings Manufacturing Extension Partnership and the 

Baldridge National Quality Program 370-2 

Eliminate the Essential Air Service Program 400-5 

Eliminate NeighborWorks America 450-2 

Eliminate the Community Development Financial Institutions Fund 450-3 

Eliminate Regional Development Agencies 450-5 

Restrict First-Responder Grants to High-Risk Communities 450-6 

Eliminate Administrative Fees Paid to Schools in the Campus-Based 

Student Aid and Pell Grant Programs 500-8 

Eliminate the Leveraging Educational Assistance Partnership Program 500-9 

Reduce Rent Subsidies for Certain One-Person Households 600-5 

Eliminate the Legal Services Corporation 750-2 

Eliminate the National Youth Anti-Drug Media Campaign 800-4 

Raise the Threshold for Coverage Under the Davis-Bacon Act 920-1 

Reduce Benefits Under the Federal Employees’ Compensation Act 920-2 
222 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Table B-1. Continued

Selected Options That Appeared in CBO’s August 2009 Budget Options Report

Source: Congressional Budget Office, Budget Options, Volume 2 (August 2009).

Note: The options listed here had budgetary effects below the threshold generally used for the present report. The effects that would be 

estimated for these options now might differ from the amounts estimated in 2009.

Option Title

2009 Option 

Number

Revenue Options

Include Social Security Benefits in Calculating the Phase-Out of the EITC 24

Tax the Income Earned by Public Electric Utilities 34

Disallow Tax-Free Conversions of Large C Corporations to S Corporations 35

Cap Nonprofit Organizations’ Outstanding Stock of Tax-Exempt Bonds 39

Tax Qualified Sponsorship Payments to Postsecondary Sports Programs 43

Require Self-Employed People and Employees to Pay the Same Amounts in 

Payroll Taxes 46

Increase Federal Employees’ Contributions to Pension Plans 47

Impose a Tax on Emissions of Sulfur Dioxide 55

Charge for Examinations of State-Chartered Banks 61
APPENDIX

CBO

C

Options by Budget Function

Function 050: National Defense

Mandatory Spending, Option 1 Introduce Minimum Out-of-Pocket Requirements Under TRICARE 

For Life 19

Discretionary Spending, Option 1 Reduce the Growth in Appropriations for the Department of Defense 74

Discretionary Spending, Option 2 Cap Increases in Military Basic Pay 76

Discretionary Spending, Option 3 Increase Medical Cost Sharing for Military Retirees Who Are Not Yet 

Eligible for Medicare 78

Discretionary Spending, Option 4 Limit the TRICARE Benefit for Military Retirees and Their 

Dependents 80

Discretionary Spending, Option 5 Increase Cost Sharing for Pharmaceuticals Under TRICARE 82

Discretionary Spending, Option 6 Consolidate the Department of Defense’s Retail Activities and Provide 

a Grocery Allowance to Service Members 84

Discretionary Spending, Option 7 Replace the Joint Strike Fighter Program with F-16s and F/A-18s 86

Discretionary Spending, Option 8 Cancel the Navy and Marine Corps’ Joint Strike Fighters and Replace 

Those Aircraft with F/A-18E/Fs 88

Discretionary Spending, Option 9 Cut the Number of Aircraft Carriers to 10 and the Number of Navy 

Air Wings to 9 90

Discretionary Spending, Option 10 Cancel the Expeditionary Fighting Vehicle 92

Discretionary Spending, Option 11 Delay Fielding of the Army’s Ground Combat Vehicle 94

Discretionary Spending, Option 12 Terminate the Medium Extended Air Defense System Program 96

Discretionary Spending, Option 13 Terminate the Precision Tracking Space System Program 97

Function 270: Energy

Mandatory Spending, Option 2 Transfer the Tennessee Valley Authority’s Electric Utility Functions 

and Associated Assets and Liabilities 20

Mandatory Spending, Option 3 Reduce the Size of the Strategic Petroleum Reserve 22
224 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Discretionary Spending, Option 15 Eliminate the Department of Energy’s Grants to States for Energy 

Conservation and Weatherization 100

Discretionary Spending, Option 16 Reduce Department of Energy Funding for Energy Technology 

Development 101

Function 300: National Resources and Environment

Mandatory Spending, Option 4 Prohibit New Enrollment in the Conservation Stewardship Program 24

Mandatory Spending, Option 5 Limit Enrollment in the Conservation Reserve Program 25

Discretionary Spending, Option 17 Eliminate Federal Grants for Wastewater and Drinking Water 

Infrastructure 103

Discretionary Spending, Option 18 Increase Fees for Use of the Inland Waterway System 105

Function 350: Agriculture

Mandatory Spending, Option 6 Reduce the Premium Subsidy in the Crop Insurance Program 26

Mandatory Spending, Option 7 Reduce by 20 Percentage Points the Share of a Farmer’s Base Acreage 

Eligible for USDA Payments 27

Function 370: Commerce and Housing Credit

Mandatory Spending, Option 8 Lower the Loan Limits on Mortgages Guaranteed by Fannie Mae and 

Freddie Mac 28

Mandatory Spending, Option 9 Increase Guarantee Fees Charged by Fannie Mae and Freddie Mac 30

Discretionary Spending, Option 19 Eliminate the International Trade Administration’s Trade Promotion 

Activities or Charge the Beneficiaries 106

Function 400: Transportation

Discretionary Spending, Option 20 Limit Highway Funding to Expected Highway Revenues 107

Discretionary Spending, Option 21 Eliminate Grants to Large and Medium-Sized Hub Airports 109

Discretionary Spending, Option 22 Increase Fees for Aviation Security 110

Discretionary Spending, Option 23 Eliminate Intercity Rail Subsidies 111

Discretionary Spending, Option 24 Eliminate the Transit Starts Programs 112

Function 270: Energy (Continued)
APPENDIX C: OPTIONS BY BUDGET FUNCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 225

CBO

Function 450: Community and Regional Development

Discretionary Spending, Option 25 Create State Revolving Funds to Finance Rural Water and Waste 

Disposal 113

Discretionary Spending, Option 26 Drop Wealthier Communities from the Community Development 

Block Grant Program 114

Function 500: Education, Training, Employment, and Social Services

Mandatory Spending, Option 10 Eliminate Subsidized Loans to Graduate Students 31

Mandatory Spending, Option 11 Change the Interest Rate Structure for Student Loans 32

Discretionary Spending, Option 27 Eliminate Certain Grant Programs for Elementary and Secondary 

Education 115

Discretionary Spending, Option 28 Restrict Pell Grants to the Neediest Students 116

Discretionary Spending, Option 29 Eliminate Funding for National Community Service Programs 117

Discretionary Spending, Option 30 Eliminate the Senior Community Service Employment Program 118

Discretionary Spending, Option 31 Reduce Funding for the Arts and Humanities 119

Function 550: Health

Mandatory Spending, Option 12 Add a “Public Plan” to the Health Insurance Exchanges 33

Mandatory Spending, Option 13 Limit Medical Malpractice Torts 35

Mandatory Spending, Option 14 Adopt a Voucher Plan and Slow the Growth of Federal Contributions 

for the Federal Employees Health Benefits Program 37

Mandatory Spending, Option 15 Convert the Federal Share of Medicaid’s Payments for Long-Term 

Care Services into a Block Grant 39

Mandatory Spending, Option 16 Reduce the Floor on Federal Matching Rates for Medicaid Services 41

Discretionary Spending, Option 32 Finance the Food Safety and Inspection Service Through Fees 120

Discretionary Spending, Option 33 Reduce or Constrain Funding for the National Institutes of Health 121

Function 570: Medicare

Mandatory Spending, Option 17 Consolidate and Reduce Federal Payments for Graduate Medical 

Education Costs at Teaching Hospitals 43

Mandatory Spending, Option 18 Raise the Age of Eligibility for Medicare to 67 45
226 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Mandatory Spending, Option 19 Impose Cost Sharing for the First 20 Days of a Stay in a Skilled 

Nursing Facility Under Medicare 47

Mandatory Spending, Option 20 Require a Copayment for Home Health Episodes Covered by 

Medicare 48

Mandatory Spending, Option 21 Reduce Medicare Costs by Changing the Cost-Sharing Structures for 

Medicare and Medigap Insurance 49

Mandatory Spending, Option 22 Increase the Basic Premium for Medicare Part B to 35 Percent of the 

Program’s Costs 51

Mandatory Spending, Option 23 Reduce Medicare’s Payment Rates Across the Board in High-Spending 

Areas 52

Mandatory Spending, Option 24 Eliminate the Critical Access Hospital, Medicare-Dependent 

Hospital, and Sole Community Hospital Programs in Medicare 53

Mandatory Spending, Option 25 Require Manufacturers to Pay a Minimum Rebate on Drugs Covered 

Under Medicare Part D for Low-Income Beneficiaries 54

Function 600: Income Security

Mandatory Spending, Option 26 Base Cost-of-Living Adjustments for Federal Civilian and Military 

Pensions and Veterans’ Benefits on an Alternative Measure of Inflation 56

Discretionary Spending, Option 34 Increase Payments by Tenants in Federally Assisted Housing 122

Function 650: Social Security

Mandatory Spending, Option 27 Base Social Security Cost-of-Living Adjustments on an Alternative 

Measure of Inflation 58

Mandatory Spending, Option 28 Link Initial Social Security Benefits to Average Prices Instead of 

Average Earnings 60

Mandatory Spending, Option 29 Raise the Earliest Eligibility Age for Social Security 62

Mandatory Spending, Option 30 Raise the Full Retirement Age in Social Security 63

Mandatory Spending, Option 31 Lengthen by Three Years the Computation Period for Social Security 

Benefits 65

Mandatory Spending, Option 32 Apply the Social Security Benefit Formula to Individual Years of 

Earnings 66

Function 570: Medicare (Continued)
APPENDIX C: OPTIONS BY BUDGET FUNCTION REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 227

CBO

Function 700: Veterans Benefits and Services

Discretionary Spending, Option 35 End Enrollment in VA Medical Care for Veterans in Priority Groups 7 

and 8 123

Function 750: Administration of Justice

Discretionary Spending, Option 36 Reduce Funding for Certain Department of Justice Grants 125

Multiple Budget Functions

Discretionary Spending, Option 14 Reduce Growth in Appropriations for Agencies Other Than the 

Department of Defense 98

Discretionary Spending, Option 37 Reduce the Across-the-Board Adjustment for Federal Civilian 

Employees’ Pay 126

Discretionary Spending, Option 38 Impose Fees to Cover the Cost of Government Regulation and 

Charge for Services Provided to the Private Sector 127

APPENDIX

CBO

D

Options by Major Program or Category

Business and Finance

Education

Discretionary Spending, Option 18 Increase Fees for Use of the Inland Waterway System 105

Discretionary Spending, Option 19 Eliminate the International Trade Administration’s Trade Promotion 

Activities or Charge the Beneficiaries 106

Revenues, Option 18 Increase Corporate Income Tax Rates by 1 Percentage Point 173

Revenues, Option 19 Set the Corporate Income Tax Rate at 35 Percent for All Corporations 175

Revenues, Option 20 Repeal the “LIFO” and “Lower of Cost or Market” Inventory 

Accounting Methods 177

Revenues, Option 21 End the Expensing of Exploration and Development Costs for 

Extractive Industries 179

Revenues, Option 22 Extend the Period for Depreciating the Cost of Certain Investments 180

Revenues, Option 23 Repeal the Deduction for Domestic Production Activities 182

Revenues, Option 24 Eliminate the Source-Rules Exception for Exports 184

Revenues, Option 25 Tax the Worldwide Income of U.S. Corporations As It Is Earned 186

Revenues, Option 26 Exempt Active Foreign Dividends from U.S. Taxation and Change 

the Tax Treatment of Overhead Expenses 187

Revenues, Option 33 Impose a Fee on Large Financial Institutions 201

Mandatory Spending, Option 10 Eliminate Subsidized Loans to Graduate Students 31

Mandatory Spending, Option 11 Change the Interest Rate Structure for Student Loans 32

Discretionary Spending, Option 27 Eliminate Certain Grant Programs for Elementary and Secondary 

Education 115

Discretionary Spending, Option 28 Restrict Pell Grants to the Neediest Students 116

Revenues, Option 15 Eliminate Certain Tax Preferences for Education Expenses 167
230 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Energy

Health

Mandatory Spending, Option 2 Transfer the Tennessee Valley Authority’s Electric Utility Functions 

and Associated Assets and Liabilities 20

Mandatory Spending, Option 3 Reduce the Size of the Strategic Petroleum Reserve 22

Discretionary Spending, Option 15 Eliminate the Department of Energy’s Grants to States for Energy 

Conservation and Weatherization 100

Discretionary Spending, Option 16 Reduce Department of Energy Funding for Energy Technology 

Development 101

Revenues, Option 21 End the Expensing of Exploration and Development Costs for 

Extractive Industries 179

Mandatory Spending, Option 12 Add a “Public Plan” to the Health Insurance Exchanges 33

Mandatory Spending, Option 13 Limit Medical Malpractice Torts 35

Mandatory Spending, Option 14 Adopt a Voucher Plan and Slow the Growth of Federal Contributions 

for the Federal Employees Health Benefits Program 37

Mandatory Spending, Option 15 Convert the Federal Share of Medicaid’s Payments for Long-Term 

Care Services into a Block Grant 39

Mandatory Spending, Option 16 Reduce the Floor on Federal Matching Rates for Medicaid Services 41

Mandatory Spending, Option 17 Consolidate and Reduce Federal Payments for Graduate Medical 

Education Costs at Teaching Hospitals 43

Mandatory Spending, Option 18 Raise the Age of Eligibility for Medicare to 67 45

Mandatory Spending, Option 19 Impose Cost Sharing for the First 20 Days of a Stay in a Skilled 

Nursing Facility Under Medicare 47

Mandatory Spending, Option 20 Require a Copayment for Home Health Episodes Covered by 

Medicare 48

Mandatory Spending, Option 21 Reduce Medicare Costs by Changing the Cost-Sharing Structures for 

Medicare and Medigap Insurance 49

Mandatory Spending, Option 22 Increase the Basic Premium for Medicare Part B to 35 Percent of the 

Program’s Costs 51

Mandatory Spending, Option 23 Reduce Medicare’s Payment Rates Across the Board in High-Spending 

Areas 52

Mandatory Spending, Option 24 Eliminate the Critical Access Hospital, Medicare-Dependent 

Hospital, and Sole Community Hospital Programs in Medicare 53

Mandatory Spending, Option 25 Require Manufacturers to Pay a Minimum Rebate on Drugs Covered 

Under Medicare Part D for Low-Income Beneficiaries 54
APPENDIX D: OPTIONS BY MAJOR PROGRAM OR CATEGORY REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 231

CBO

Health (Continued)

Housing

Income Security

Indexation Factors

Discretionary Spending, Option 32 Finance the Food Safety and Inspection Service Through Fees 120

Discretionary Spending, Option 33 Reduce or Constrain Funding for the National Institutes of Health 121

Revenues, Option 29 Increase All Taxes on Alcoholic Beverages to $16 per Proof Gallon 193

Revenues, Option 30 Accelerate and Modify the Excise Tax on High-Cost Health Care 

Coverage 195

Revenues, Option 31 Increase the Payroll Tax Rate for Medicare Hospital Insurance by 1 

Percentage Point 197

Revenues, Option 32 Repeal the Individual Health Insurance Mandate 199

Mandatory Spending, Option 8 Lower the Loan Limits on Mortgages Guaranteed by Fannie Mae and 

Freddie Mac 28

Mandatory Spending, Option 9 Increase Guarantee Fees Charged by Fannie Mae and Freddie Mac 30

Discretionary Spending, Option 34 Increase Payments by Tenants in Federally Assisted Housing 122

Revenues, Option 4 Gradually Eliminate the Mortgage Interest Deduction 146

Mandatory Spending, Option 26 Base Cost-of-Living Adjustments for Federal Civilian and Military 

Pensions and Veterans’ Benefits on an Alternative Measure of Inflation 56

Discretionary Spending, Option 34 Increase Payments by Tenants in Federally Assisted Housing 122

Revenues, Option 8 Include Employer-Paid Premiums for Income Replacement Insurance 

in Employees’ Taxable Income 153

Mandatory Spending, Option 26 Base Cost-of-Living Adjustments for Federal Civilian and Military 

Pensions and Veterans’ Benefits on an Alternative Measure of Inflation 56

Mandatory Spending, Option 27 Base Social Security Cost-of-Living Adjustments on an Alternative 

Measure of Inflation 58

Revenues, Option 3 Use an Alternative Measure of Inflation to Index Some Parameters of 

the Tax Code 144
232 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Medicaid

Medicare

Military Personnel and Veterans

Mandatory Spending, Option 15 Convert the Federal Share of Medicaid’s Payments for Long-Term 

Care Services into a Block Grant 39

Mandatory Spending, Option 16 Reduce the Floor on Federal Matching Rates for Medicaid Services 41

Mandatory Spending, Option 17 Consolidate and Reduce Federal Payments for Graduate Medical 

Education Costs at Teaching Hospitals 43

Mandatory Spending, Option 17 Consolidate and Reduce Federal Payments for Graduate Medical 

Education Costs at Teaching Hospitals 43

Mandatory Spending, Option 18 Raise the Age of Eligibility for Medicare to 67 45

Mandatory Spending, Option 19 Impose Cost Sharing for the First 20 Days of a Stay in a Skilled 

Nursing Facility Under Medicare 47

Mandatory Spending, Option 20 Require a Copayment for Home Health Episodes Covered by 

Medicare 48

Mandatory Spending, Option 21 Reduce Medicare Costs by Changing the Cost-Sharing Structures for 

Medicare and Medigap Insurance 49

Mandatory Spending, Option 22 Increase the Basic Premium for Medicare Part B to 35 Percent of the 

Program’s Costs 51

Mandatory Spending, Option 23 Reduce Medicare’s Payment Rates Across the Board in High-Spending 

Areas 52

Mandatory Spending, Option 24 Eliminate the Critical Access Hospital, Medicare-Dependent 

Hospital, and Sole Community Hospital Programs in Medicare 53

Mandatory Spending, Option 25 Require Manufacturers to Pay a Minimum Rebate on Drugs Covered 

Under Medicare Part D for Low-Income Beneficiaries 54

Revenues, Option 31 Increase the Payroll Tax Rate for Medicare Hospital Insurance by 1 

Percentage Point 197

Mandatory Spending, Option 1 Introduce Minimum Out-of-Pocket Requirements Under TRICARE 

For Life 19

Discretionary Spending, Option 2 Cap Increases in Military Basic Pay 76

Discretionary Spending, Option 3 Increase Medical Cost Sharing for Military Retirees Who Are Not Yet 

Eligible for Medicare 78
APPENDIX D: OPTIONS BY MAJOR PROGRAM OR CATEGORY REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 233

CBO

Military Personnel and Veterans (Continued)

Military Procurement

Natural Resources, Environment, and Agriculture

Discretionary Spending, Option 4 Limit the TRICARE Benefit for Military Retirees and Their 

Dependents 80

Discretionary Spending, Option 5 Increase Cost Sharing for Pharmaceuticals Under TRICARE 82

Discretionary Spending, Option 6 Consolidate the Department of Defense’s Retail Activities and Provide 

a Grocery Allowance to Service Members 84

Discretionary Spending, Option 35 End Enrollment in VA Medical Care for Veterans in Priority Groups 7 

and 8 123

Discretionary Spending, Option 7 Replace the Joint Strike Fighter Program with F-16s and F/A-18s 86

Discretionary Spending, Option 8 Cancel the Navy and Marine Corps’ Joint Strike Fighters and Replace 

Those Aircraft with F/A-18E/Fs 88

Discretionary Spending, Option 9 Cut the Number of Aircraft Carriers to 10 and the Number of Navy 

Air Wings to 9 90

Discretionary Spending, Option 10 Cancel the Expeditionary Fighting Vehicle 92

Discretionary Spending, Option 11 Delay Fielding of the Army’s Ground Combat Vehicle 94

Discretionary Spending, Option 12 Terminate the Medium Extended Air Defense System Program 96

Discretionary Spending, Option 13 Terminate the Precision Tracking Space System Program 97

Mandatory Spending, Option 4 Prohibit New Enrollment in the Conservation Stewardship Program 24

Mandatory Spending, Option 5 Limit Enrollment in the Conservation Reserve Program 25

Mandatory Spending, Option 6 Reduce the Premium Subsidy in the Crop Insurance Program 26

Mandatory Spending, Option 7 Reduce by 20 Percentage Points the Share of a Farmer’s Base Acreage 

Eligible for USDA Payments 27

Discretionary Spending, Option 15 Eliminate the Department of Energy’s Grants to States for Energy 

Conservation and Weatherization 100

Discretionary Spending, Option 17 Eliminate Federal Grants for Wastewater and Drinking Water 

Infrastructure 103

Discretionary Spending, Option 18 Increase Fees for Use of the Inland Waterway System 105

Revenues, Option 21 End the Expensing of Exploration and Development Costs for 

Extractive Industries 179

Revenues, Option 28 Increase Excise Taxes on Motor Fuels by 25 Cents 191
234 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Natural Resources, Environment, and Agriculture (Continued)

Private Health Insurance

Retirement

Social Security

Revenues, Option 34 Reinstate the Superfund Taxes 203

Revenues, Option 35 Impose a Price on Emissions of Greenhouse Gases 205

Mandatory Spending, Option 12 Add a “Public Plan” to the Health Insurance Exchanges 33

Mandatory Spending, Option 13 Limit Medical Malpractice Torts 35

Revenues, Option 30 Accelerate and Modify the Excise Tax on High-Cost Health Care 

Coverage 195

Revenues, Option 32 Repeal the Individual Health Insurance Mandate 199

Mandatory Spending, Option 26 Base Cost-of-Living Adjustments for Federal Civilian and Military 

Pensions and Veterans’ Benefits on an Alternative Measure of Inflation 56

Revenues, Option 9 Include Investment Income from Life Insurance and Annuities in 

Taxable Income 155

Revenues, Option 12 Reduce Limits on Contributions to Retirement Plans 161

Mandatory Spending, Option 27 Base Social Security Cost-of-Living Adjustments on an Alternative 

Measure of Inflation 58

Mandatory Spending, Option 28 Link Initial Social Security Benefits to Average Prices Instead of 

Average Earnings 60

Mandatory Spending, Option 29 Raise the Earliest Eligibility Age for Social Security 62

Mandatory Spending, Option 30 Raise the Full Retirement Age in Social Security 63

Mandatory Spending, Option 31 Lengthen by Three Years the Computation Period for Social Security 

Benefits 65

Mandatory Spending, Option 32 Apply the Social Security Benefit Formula to Individual Years of 

Earnings 66

Revenues, Option 11 Tax Social Security and Railroad Retirement Benefits in the Same Way 

That Distributions from Defined-Benefit Pensions Are Taxed 159
APPENDIX D: OPTIONS BY MAJOR PROGRAM OR CATEGORY REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 235

CBO

Social Security (Continued)

Transportation

Revenues, Option 16 Increase the Maximum Taxable Earnings for the Social Security 

Payroll Tax 169

Revenues, Option 17 Expand Social Security Coverage to Include Newly Hired State and 

Local Government Employees 171

Discretionary Spending, Option 20 Limit Highway Funding to Expected Highway Revenues 107

Discretionary Spending, Option 21 Eliminate Grants to Large and Medium-Sized Hub Airports 109

Discretionary Spending, Option 22 Increase Fees for Aviation Security 110

Discretionary Spending, Option 23 Eliminate Intercity Rail Subsidies 111

Discretionary Spending, Option 24 Eliminate the Transit Starts Programs 112

Revenues, Option 28 Increase Excise Taxes on Motor Fuels by 25 Cents 191

APPENDIX

CBO

E

Contributors to This Volume

The spending estimates that appear in this report were prepared by the staff of the Congressional 

Budget Office’s (CBO’s) Budget Analysis Division (supervised by Peter Fontaine, Theresa Gullo, 

Holly Harvey, Tom Bradley, Kim Cawley, Jean Hearne, Jeffrey Holland, Sarah Jennings, and 

Sam Papenfuss)—with important contributions from the staff of the Health and Human Resources 

Division (supervised by Bruce Vavrichek and James Baumgardner) and the Financial Analysis Division 

(supervised by Deborah Lucas and Damien Moore). 

Most of the revenue estimates were prepared by the staff of the Joint Committee on Taxation. 

The discussions of the options were written and reviewed by analysts and managers throughout 

CBO: the three divisions just mentioned, the Microeconomic Studies Division (supervised by 

Joseph Kile and David Moore), the National Security Division (supervised by David Mosher and 

Matthew Goldberg), and the Tax Analysis Division (supervised by Frank Sammartino and 

David Weiner). Altogether, more than 130 people throughout the agency contributed to the 

volume.

Chapter 1

Jeffrey Kling wrote Chapter 1.

Chapter 2

Lara Robillard of the Budget Analysis Division coordinated work on the options for mandatory 

spending, with assistance from Nabeel Alsalam of the Health and Human Resources Division, 

Matthew Goldberg of the National Security Division, David Moore of the Microeconomic Studies 

Division, Lyle Nelson of the Health and Human Resources Division, and David Torregrosa of the 

Financial Analysis Division. Lara Robillard wrote the introduction to the chapter. The following 

analysts contributed to the discussions and budget estimates in the chapter:

David Austin Stuart Hagen

Stephanie Cameron Tamara Hayford

Anna Cook Gregory Hitz

Sheila Dacey Emily Holcombe

Sean Dunbar Paul Jacobs

Justin Falk Jimmy Jin

Kathleen Gramp Deborah Kalcevic
238 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Chapter 2 (Continued)

Chapter 3

Matthew Pickford of the Budget Analysis Division coordinated work on the options for discretionary 

spending, with assistance from Nabeel Alsalam of the Health and Human Resources Division, 

Matthew Goldberg of the National Security Division, and David Moore of the Microeconomic 

Studies Division. Theresa Gullo and Matthew Pickford wrote the introduction to the chapter. The 

following analysts contributed to the discussions and budget estimates in the chapter:

James Langley Lara Robillard

Noah Meyerson Matthew Schmit

Jamease Miles Robert Stewart

Alexandra Minicozzi Andrew Stocking

Lyle Nelson Aurora Swanson

Kirstin Nelson David Torregrosa

Andrea Noda Ellen Werble

Allison Percy

Adebayo Adedeji Eric Labs

Christina Hawley Anthony Jeff LaFave 

Bruce Arnold Frances Lussier

David Arthur Susanne Mehlman

David Austin Jamease Miles

Sarah Axeen David Moore

Perry Beider Carla Tighe Murray

Michael Bennett David Newman

Barry Blom Allison Percy

Megan Carroll Sarah Puro

Chad Chirico Dawn Sauter Regan

Julia Christensen Matthew Schmit

Ann Futrell Alan Stoffer

Heidi Golding Aurora Swanson

Mark Grabowicz Philip Webre

Raymond Hall Ellen Werble

Daniel Hoople Jason Wheelock

Justin Humphrey Susan Willie

Jimmy Jin
APPENDIX E: CONTRIBUTORS TO THIS VOLUME REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS 239

CBO

Chapter 4

Janet Holtzblatt of the Tax Analysis Division coordinated work on the options for revenues. She also 

wrote the introduction to the chapter. The following analysts wrote the discussions of the options or, 

in a few cases, estimated the budgetary effects:

Appendix A

Janet Holtzblatt and Lara Robillard compiled Appendix A. The following analysts contributed to the 

discussions and budget estimates in the appendix:

Appendix B

Janet Holtzblatt and Lara Robillard compiled Appendix B, with assistance from these analysts:

Perry Beider Noah Meyerson

Mark Booth Alexandra Minicozzi

Paul Burnham Shannon Mok

Francesca Castelli Nathan Musick

Sheila Dacey Athiphat Muthitacharoen

Terry Dinan Kirstin Nelson

Grant Driessen Larry Ozanne

Barbara Edwards Kalyani Parthasarathy

Jennifer Gravelle Kevin Perese

Pamela Greene Kurt Seibert

Ed Harris Joshua Shakin

Janet Holtzblatt Robert Stewart

Paul Jacobs Andrew Stocking

Elias Leight Steven Weinberg

Robert McClelland David Weiner

Pamela Greene David Rafferty

Ed Harris Lisa Ramirez-Branum

Noah Meyerson Joshua Shakin

Andrea Noda Rebecca Yip

Christina Hawley Anthony Jeff LaFave

Megan Carroll Amber Marcellino

Chad Chirico Susanne Mehlman
240 REDUCING THE DEFICIT: SPENDING AND REVENUE OPTIONS

CBO

Appendix B (Continued)

Editing and Production

Loretta Lettner and Juyne Linger edited the report, with assistance from Chris Howlett, Kate Kelly, 

Leah Mazade, John Skeen, and Sherry Synder. Maureen Costantino, with contributions from 

Leigh Angres and Jeanine Rees, created the figures. Maureen Costantino also oversaw the production 

of the volume and designed the cover, with help from Allan Keaton, Rick Quatro, and Jeanine Rees. 

Monte Ruffin printed the initial copies of the report, and Linda Schimmel handled the print distribution. Annette Kalicki, Joe Miller, and Simone Thomas prepared the electronic version of the report for 

CBO’s Web site (www.cbo.gov).

Kent Christensen Matthew Pickford

Sheila Dacey David Rafferty

Kathleen FitzGerald Aurora Swanson

Emily Holcombe Martin von Gnechten

Daniel Hoople Susan Willie

Justin Humphrey