“Analyzing the effects on the overall economy of changes in federal fiscal policies—that is, policies governing taxes and spending—requires complex modeling and a significant amount of time. CBO undertakes such analyses in certain reports and for some major pieces of legislation; some of those analyses include the feedback effects of changes in the economy on the federal budget. CBO estimates the economic effects of changes in fiscal policies in both the short term and the longer term. The agency conducts its analyses using evidence about the effects of similar policies that have been implemented previously and using results from a variety of economic models. In the short term, changes in fiscal policies affect the overall economy primarily by influencing the demand for goods and services by consumers, businesses, and governments, which leads to changes in output relative to potential (maximum sustainable) output. For example, decreases in taxes and increases in government spending generally boost demand, which encourages businesses to gear up production and hire more workers than they otherwise would; tax increases and spending cuts generally reduce demand, which has the opposite effects. In addition, changes in the supply of labor (the number of hours of labor that workers would like to provide) can affect output in the short term if the labor market is sufficiently tight—that is, if the demand for workers is high relative to the supply. In the longer term, changes in fiscal policies primarily affect output by altering people’s incentives to work and save as well as businesses’ incentive to invest, thereby changing potential output. For example, policy changes that reduce marginal tax rates—the percentage of an additional dollar of earnings that is unavailable to a taxpayer because it is paid in taxes—generally encourage more work and saving. As another example, policy changes that reduce the federal deficit typically lead to more national saving (the total amount of saving by households, businesses, and governments) and investment, ultimately boosting output and income. Changes to fiscal policies may also affect potential output by altering the amount of government investment (for example, spending or tax subsidies for infrastructure, education and training, or research and development).”