Sept. 24 (Bloomberg) -- The Congressional Budget Office estimated in 2003 that a new Medicare drug benefit would cost $518 billion. The price tag, slightly more than three years later: $382 billion, the agency reported.

The CBO predicted in 2008 that a plan to fight the housing crisis would help 400,000 Americans refinance $68 billion worth of mortgages; it ended up helping just a few dozen. And the budget office said it would cost $25 billion to keep Fannie Mae and Freddie Mac afloat. It underestimated the cost by a factor of more than 10.

CBO’s projections matter because lawmakers are required to use them as they weigh various measures, including the plans to remake the U.S. health-care system. Yet the more sweeping the proposal, the more likely its estimates will miss the mark because on such legislation the agency has the least amount of data, CBO Director Doug Elmendorf said.

“When Congress is considering incremental changes to policies, and especially incremental changes that are similar to ones that have been made before, then there’s a history that we and other analysts can consult,” Elmendorf, 47, said in an interview. With “more dramatic or novel changes in policy, there’s no previous experience to refer to.”

As the nonpartisan agency reviews plans to carry out the most extensive overhaul of the medical-care system in more than four decades, “the range of uncertainty around our estimates of health-reform proposals is very large,” he said.

Uncharted Territory

While CBO can look to places such as Massachusetts where some of the ideas such as requiring people to get insurance have been tried, “what happens when a whole set of reforms is put together, as many proposals now before Congress would do, is much more uncertain,” he said.

President Barack Obama and congressional Democrats are trying to pass legislation to cover most of the 46 million people in the U.S. without insurance and rein in health spending. Among the most contentious issues is the cost.

CBO estimates have helped shape the debate. In June, when the agency delivered an informal cost estimate of $1.6 trillion for a measure being debated by the Senate Finance Committee, it set back progress on the legislation for weeks after lawmakers protested the price tag.

The CBO said last week a draft offered by finance panel Chairman Max Baucus would meet Obama’s demand that any plan not add to the federal deficit.

Ignoring Political Pressure

The CBO has been praised for a willingness to ignore political pressure and tell lawmakers their plans would cost more than anticipated. In calculations for major legislation, though, it must rely on a host of assumptions: how the economy will perform, how agencies will regulate the programs, how Americans will respond.

The cost estimates “often depend on projections of economic or political developments that are very hard to foresee,” said Elmendorf, an economist.

Peter Orszag, the agency’s head until Obama named him director of the White House Office of Management and Budget, agreed that far-reaching legislation tests the limits of CBO projections.

“Any set of analysts, whether they’re at CBO or elsewhere, find it easier to assess marginal changes -- a little tweak here, a little tweak there -- within the bounds of historical experience,” he said in an interview. “It’s harder to evaluate and quantify things that transform systems.”

Underestimating Competition

The CBO’s projection for the prescription drug measure enacted in 2003 overestimated how many people would sign up for the benefit and how many expensive new drugs would emerge from the industry.

The agency underestimated how fiercely companies would compete to participate in the program, which drove down costs. The result: in 2007, the CBO concluded its predicted price tag had been too high by $136 billion.

Douglas Holtz-Eakin, who headed the agency then, said “it’s hard to anticipate the cost-cutting implications that come out of the private sector -- they’re fundamentally imaginative, they have a lot on the line and they do better than you would guess sometimes.”

The agency’s cost estimates for the financial bailout fluctuated. In January, it said the Troubled Asset Relief Program would cost $189 billion. In March, the figure jumped to $356 billion. Last month, it dropped to $241 billion.

Market Volatility

“Financial markets are very volatile and the larger the role the government plays in the financial system, the more that volatility will show through in the government’s budget,” Elmendorf said.

Last year, CBO said it would cost $25 billion to save mortgage financiers Fannie Mae and Freddie Mac. It also said that after examining thousands of scenarios, the chance that losses would exceed $100 billion was less than 5 percent. Last month, it said total costs would likely top $300 billion.

The program designed to allow struggling homeowners to refinance mortgages into government-backed loans helped only a handful of people because lenders balked at the terms.

“In an ideal world,” said former CBO Director Rudy Penner, “Congress would recognize the uncertainty around these numbers and a good part of the debate would be, ‘What will we do if the cost of this turns out to be higher than CBO estimated?’ But there doesn’t seem to be time for that sort of debate.”

To contact the reporter on this story: Brian Faler in Washington at bfaler@bloomberg.net.

Last Updated: September 24, 2009 16:25 EDT