The Economic and Budget Outlook

CONGRESS OF THE UNITED STATESCONGRESSIONAL BUDGET OFFICE

The Economicand Budget Outlook

UPDATE

CBO Publication

CONGRESSIONAL

BUDGET OFFICE

Second and D Streets, S.W.

Washington, D.C. 20515

S U M M A R Y ^August 1995

THE ECONOMIC AND BUDGET OUTLOOK:AN UPDATE

In The Economic and Budget Outlook: An Update, the Congressional Budget Office (CBO) projects a lowerrate of economic growth and a smaller deficit for the current year than it had anticipated last winter. CBOnow estimates that the deficit for fiscal year 1995 will be $161 billion, the lowest since 1989 and the lowestas a percentage of gross domestic product (GDP) since 1979 (see the table on the reverse side). Otherwise,CBO's longer-term economic and budget projections, which assume no change in current laws and policies,are little different from those released earlier this year.

CBO forecasts that real GDP will grow by only 1.3 percent in 1995 (on a fourth-quarter-to-fourth-quarter basis), significantly lower than the 2.5 percent envisioned seven months ago. CBO believes theeconomy is fundamentally sound, however, and is more likely to grow at a faster rate in 1996 than to slipinto a recession. After 1996, CBO projects, the economy will grow in real terms at an average rate of 2.4percent a year.

CBO's estimated deficit for fiscal year 1995 of $161 billion-which is $13 billion lower than thatestimated in April—would mark the third straight year of declining deficits. Deficits will begin risingsteadily in 1996, however, if current policies remain unchanged. Assuming that discretionary spending risesat the rate of inflation after 1998 (the year that statutory caps on appropriations expire), CBO projects thatthe deficit will reach $462 billion (4 percent of GDP) by 2005. Alternatively, if discretionary spending isfrozen at the 1998 dollar level once the caps expire, the deficit will grow to $292 billion (2.5 percent ofGDP) at the end of 10 years.

500

450

400

350

300

250

200

150

100

50^0 h

CBO's Comparison of Projected Deficits(By fiscal year)

Billions of Dollars

Although CBO's projections arebased on a continuation of current pol-icies governing federal spending andrevenues, both the Congress and theAdministration have proposed signifi-cant changes to those policies in orderto balance the budget (see the figure).Consideration of these proposals willtake on increasing urgency as theTreasury approaches the statutorylimit on federal borrowing in Octoberor November. The budget resolutionpassed by the Congress proposeschanges in fiscal policies intended toeliminate the deficit by 2002. ThePresident's plan, by contrast, proposessmaller savings each year to balancethe budget by 2004. Since CBO's eco-nomic and budgetary assumptions areslightly less optimistic than the Administration's, CBO estimates that the President's plan would reduce thedeficit to about $200 billion in 2004 rather than eliminate it. The exact economic implications of balancingthe budget are difficult to gauge. However, CBO estimates that likely drops in interest rates and increasedreal growth would further improve the government's fiscal outlook by lowering federal interest paymentsand raising revenues.

Questions concerning the budget projections should be directed to CBO's Budget Analysis Division(202-226-2880) and inquiries about the economic forecast to the Macroeconomic Analysis Division (226-2750). The Office of Intergovernmental Relations is CBO's Congressional liaison office and can be reachedat 226-2600. For additional copies of the report, please call the Publications Office at 226-2809.

President's JulyBudget as

Estimated by CBOBudget ResolutionWithout Tax Cut or

Fiscal Dividend

-501995 1997 1999 2001 2003 2005

CBO's Budget Projections and Underlying Assumptions

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Budget Projections (By fiscal year)

In Billions of Dollars

161 189 218 229 261 288 308 340 375 414 462

161 189 218 229 243 250 247 256 264 275 292

s a Percentage of GDP

2.3 2.6 2.8 2.8 3.1 3.2 3.3 3.5 3.6 3.8 4.0

2.3 2.6 2.8 2.8 2.9 2.8 2.6 2.6 2.5 2.5 2.5

Baseline Total Deficit3

With discretionaryinflation after 1998

Without discretionaryinflation after 1998

Baseline Total Deficit3

With discretionaryinflation after 1998

Without discretionaryinflation after 1998

Nominal GDP(Billions of dollars)

Real GDP(Percentage change)

CPI-U (Percentagechange)6

Unemployment Rate(Percent)

Three-Month TreasuryBill Rate (Percent)

Ten-Year TreasuryNote Rate (Percent)

Economic Assumptions (By calendar year)

7,058 7,385 7,764 8,165 8,587 9,032 9,497 9,986 10,501 11,042 11,610

2.6 1.9 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4

3.1 3.4 3.4 3.3 3.2 3.2 3.2 3.2 3.2 3.2 3.2

5.7 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

5.4 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1

6.5 6.4 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7

SOURCE: Congressional Budget Office.

a. Caps on discretionary spending are set by law through 1998. Measures of the deficit "with discretionary inflation" assume that discretionaryspending grows at the rate of inflation after 1998. Measures of the deficit "without discretionary inflation" assume that discretionaryspending remains frozen in dollar terms at the level of the 1998 caps.

b. CPI-U is the consumer price index for all urban consumers.

THE ECONOMIC AND BUDGET OUTLOOK:AN UPDATE

The Congress of the United StatesCongressional Budget Office

For sale by the U.S. Government Printing OfficeSuperintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328

ISBN 0-16-048223-2

NOTES

Unless otherwise indicated, all years referred to in Chapter 1 are calendar years and all yearsin Chapter 2 are fiscal years.

Some figures in Chapter 1 indicate periods of recession using shaded vertical bars. The barsextend from the peak to the trough of the recession.

The economic outlook discussed in Chapter 1 is considered to be a forecast through the endof 1996 and a projection for 1997 through 2005. The forecast attempts to anticipate thecyclical movements in the economy and the effects of fiscal policy on the year-to-yearchanges in economic activity. The economic projection is designed to estimate the growthrates that will prevail on average for the entire period.

Unemployment rates throughout the report are calculated on the basis of the civilian laborforce.

Numbers in the text and tables may not add to totals because of rounding.

National income and product account data shown in the tables do not incorporate the datafor the second quarter of 1995, which were released on July 28, 1995.

Preface

T his volume is one of a series of reports on the state of the economy and the budgetthat the Congressional Budget Office (CBO) issues each year. It satisfies the re-quirement of section 202(f) of the Congressional Budget Act of 1974 for CBO to

submit periodic reports to the Committees on the Budget with respect to fiscal policy andto provide five-year baseline projections of the federal budget. In accordance with CBO'smandate to provide objective and impartial analysis, the report contains no recommenda-tions.

The analysis of the economic outlook presented in Chapter 1 was prepared by theMacroeconomic Analysis Division under the direction of Robert Dennis and John F.Peterson. Robert Arnold wrote the chapter. Matthew Salomon carried out the economicforecast and projections. Laurie Brown, Douglas Elmendorf, Victoria Farrell, DouglasHamilton, Adrienne Kearney, Kim Kowalewski, Joyce Manchester, Angelo Mascaro,Benjamin Page, Frank Russek, Matthew Salomon, John Sturrock, and Christopher Wil-liams provided comments and background analysis. Matthew Salomon and Laurie Brownwrote Appendix A, and John F. Peterson wrote Appendix B. Derek Briggs, John Romley,and Jennifer Wolfson provided research assistance.

The baseline outlay projections were prepared by the staff of the Budget AnalysisDivision under the supervision of Paul N. Van de Water, Robert Sunshine, Paul Cullinan,Peter Fontaine, James Horney, Michael Miller, and Murray Ross. The revenue estimateswere prepared by the staff of the Tax Analysis Division under the supervision of Rose-mary D. Marcuss and Richard Kasten. Jeffrey Holland wrote Chapter 2, with assistancefrom Susan Strandberg and Michael Simpson, and Chapter 4. Robert Dennis and JamesHorney wrote Chapter 3. Daniel Kowalski wrote Appendix C, Jeffrey Lemieux wroteAppendix D, and James Horney wrote the summary of the report.

An early version of the economic forecast underlying this report was discussed at ameeting of CBO's Panel of Economic Advisers. Members of this panel are MichaelBoskin, Barry P. Bosworth, Robert Dederick, Martin Feldstein, Benjamin Friedman, LyleE. Gramley, Robert E. Hall, Marvin Kosters, Anne Krueger, Burton Malkiel, GregoryMankiw, Allan Meltzer, Rudolph Penner, James Poterba, William Poole, RobertReischauer, Sherwin Rosen, Robert Solow, John Taylor, and James Tobin. RichardBerner, David Bradford, Enrique Mendoza, and Robert Van Order attended as guests.Although these outside advisers provided considerable assistance, this document does notnecessarily reflect their views.

Paul L. Houts and Sherry Snyder edited the report, with the assistance of ChristianSpoor. The authors owe thanks to Marion Curry, Dorothy Kornegay, and Linda Lewis,who assisted in the preparation of the report. Kathryn Quattrone prepared it for finalpublication.

June E. O'NeillDirector

August 1995

Contents

ONE

TWO

THREE

FOUR

SUMMARY

THE ECONOMIC OUTLOOK

Slowdown in the First Half 4The CBO Forecast for 1995 and 1996 5Alternative Outlooks 13Projection for the Years Beyond 1996 14

THE BASELINE BUDGET OUTLOOK

The Deficit Outlook 19Changes in the Budget Outlook Since April 21CBO Baseline Projections 24A Comparison with the Administration's

Projections 27The Federal Sector of the National Income

and Product Accounts 28

THE CONGRESSIONAL BUDGET RESOLUTIONAND THE ECONOMIC EFFECTS OF BALANCINGTHE BUDGET

The Budget Resolution 33Economic and Budgetary Implications of

Balancing the Budget 42

DEBT SUBJECT TO LIMIT

What the Debt Limit Covers 47What Are the Consequences of Not Raising

the Debt Limit? 49Important Upcoming Dates 49Treasury Options to Cope with Interruptions

in Borrowing Authority 52The Debt Limit and Deficit Reduction 54

XI

1

19

33

47

vi THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

APPENDIXES

A Evaluating CBO's Record of EconomicForecasts 57

B A More Accurate Measure of RealEconomic Growth 71

C Sequestration Update Report forFiscal Year 1996 75

D CBO Projections of National HealthExpenditures Through 2005 81

E Major Contributors to the Revenue andSpending Projections 87

CONTENTS

TABLES

S-l.

S-2.

S-3.

1.

2.

3.

4.

The CBO Forecast for 1995 and 1996

The Economic Forecast and Projections forCalendars Years 1995 Through 2005

CBO Deficit Projections

The CBO Forecast for 1995 and 1996

The Fiscal Policy Outlook

Comparison of Forecasts for 1995 and 1996

The Economic Forecast and Projections for

vii

xiii

xiv

XV

2

8

15

Calendar Years 1995 Through 2005 16

5. The Economic Forecast and Projections forFiscal Years 1995 Through 2005 17

6. CBO Deficit Projections 20

7. Changes in CBO Baseline Deficit ProjectionsSince April 1995 21

8. CBO Baseline Budget Projections with DiscretionaryInflation After 1998 22

9. The Budget Outlook Through 2005 Without DiscretionaryInflation After 1998 25

10. CBO Baseline Projections for Mandatory Spending 26

11. Comparison of CBO Baseline with OMB MidsessionReview Baseline 28

12. Relationship of the Budget to the Federal Sector of theNational Income and Product Accounts 29

13. Projections of Baseline Receipts and ExpendituresMeasured by the National Income and Product Accounts 30

14. Changes in the Budget Resolution from CBO's AprilBaseline 36

15. Budget Resolution Outlays, Revenues, and Deficits 37

16. Discretionary Outlay Savings in the Budget Resolution 38

viii THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

17. Change in the Deficit Resulting from the EconomicImpacts of Balancing the Budget by 2002 41

18. Potential Economic Impacts of Balancing the Budgetby 2002 Compared with CBO's JanuaryEconomic Forecast 43

19. Projections of Debt Subject to Limit Under theBudget Resolution 48

20. Calendar of Treasury Borrowing, September toNovember 1995 50

21. Relationship Between Debt Held by the Public andDebt Subject to Limit 51

22. Recent Increases in the Debt Limit 53

A-l. Comparison of CBO, Administration, and Blue ChipForecasts of Two-Year Average Growth Rates for Real Output 64

A-2. Comparison of CBO, Administration, and Blue ChipForecasts of Two-Year Average Inflation Rates in theConsumer Price Index 65

A-3. Comparison of CBO, Administration, and Blue ChipForecasts of Two-Year Average Interest Rates onThree-Month Treasury Bills 66

A-4. Comparison of CBO, Administration, and Blue ChipForecasts of Two-Year Average Long-Term Interest Rates 67

A-5. Comparison of CBO, Administration, and Blue ChipForecasts of Two-Year Average Real Interest Rates onThree-Month Treasury Bills 68

A-6. Comparison of CBO and Administration Projections ofFive-Year Average Growth Rates for Real GNP 69

B-1. Comparison of Growth Rates of Real GDP forRecent Quarters 73

C-l. CBO Estimates of Discretionary Spending Limits forFiscal Years 1995 Through 1998 76

C-2. Budgetary Effects of Direct Spending or ReceiptLegislation Enacted Since the Budget Enforcement Act 79

CONTENTS

D-l.

FIGURES

S-l.

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

D-l.

National Health Expenditures for Selected CalendarYears, by Source of Funds

Comparison of Projected Deficits

The Economic Forecast and Projections

Growth Patterns in Selected Sectors

The GDP Gap

Household Payments on Debt

Investment in Producers' Durable Equipment

Stock of Inventories Compared with Sales

Standardized-Employment Deficit

The Dollar Exchange Rate

Housing Affordability Index

Indicators of Monetary Policy

GDP and Potential GDP

Comparison of Projected Deficits

National Health Expenditures Under Alternative

83

xi

3

4

5

6

7

7

9

10

11

12

18

34

Scenarios for Growth in Private Health Spending 84

BOX

1. Certification of a Balanced Budget and Considerationof the Proposed Tax Cut 40

Summary

T he Congressional Budget Office (CBO) pro-jects that this year's deficit will be $161billion--the lowest in relation to the size of

the economy since 1979. Nevertheless, although thedeficit for fiscal year 1995 is $13 billion lower thanCBO estimated in April, CBO's longer-term projec-tions of federal spending and revenues under currentpolicies have changed little since it published itsApril baseline (see Summary Figure 1). CBO stillbelieves that, after declining for three consecutiveyears, the deficit will begin to grow again in fiscalyear 1996 if current laws affecting the budget do notchange. Assuming that discretionary spending in-creases at the rate of inflation after the statutory capson such spending expire in 1998, CBO projects thatthe deficit will rise to $462 billion in 2005. The in-crease is not as steep in those CBO projections thatassume discretionary spending is frozen at the nomi-

Summary Figure 1.Comparison of Projected Deficits (By fiscal year)

Billions of Dollars500

450

400

350

300

250

200

150

100

50

0

-50

CBO's April Baseline

Budget ResolutionWithout Tax Cut or

Fiscal Dividend

President's JulyBudget as

Estimated by CBO

1995 1997 1999 2001 2003 2005


nal 1998 level, but the deficit still climbs to $292billion in 2005.

In a similar vein, since its last forecast CBO haslowered its estimate of economic growth and interestrates for the current year, but it has not changed itsassessment of longer-term economic trends in anysignificant way. The real growth of only 1.3 percentnow forecast for calendar year 1995 represents a dra-matic slowdown from the 4.1 percent rate of growthexperienced during 1994. It is also markedly slowerthan the 2.5 percent CBO forecast last winter. Someanalysts fear that the slow growth recorded in thefirst half of 1995 might signal the early stages of arecession. Although CBO recognizes the possibilitythat a recession might occur, the economy appears tobe fundamentally sound and the usual signs of animpending recession are absent. CBO's forecast as-sumes that the pace of economic growth will pick upin 1996, with output increasing at a real (inflation-adjusted) rate of 2.3 percent.

Neither the recent performance of the economynor any other development prompted a substantialchange in CBO's longer-term economic projections.CBO projects that the economy will grow in realterms at an average rate of 2.4 percent a year after1996~the rate at which CBO estimates gross domes-tic product (GDP) can rise without triggering higherinflation.

CBO's economic and budget projections assumethat current laws and policies governing federalspending and revenues will continue unchanged. TheCongress and the President have separately advancedblueprints of major changes in those policies, butlaws have not yet been enacted to carry out their pro-posals. The Congress has adopted a plan—a budget

xii THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

resolution—to reach a balanced budget in 2002. Theplan assumes that discretionary spending in 2002 willbe below the nominal level of appropriations pro-vided for 1995 and that mandatory spending (exclud-ing interest payments) will be $161 billion lower in2002 than is projected under current law. The resolu-tion also allows a tax cut of $245 billion over sevenyears if CBO certifies that the rest of the budget planis being carried out as planned. In addition, the Pres-ident has proposed a plan that the Administrationestimates would produce a budget surplus in 2004and 2005. According to CBO's estimates, however,achieving the savings proposed by the President—which are much smaller than those assumed by thebudget resolution—would reduce the deficit to about$200 billion in those years.

Substantially slashing the deficit is likely to re-duce interest rates and slightly increase economicgrowth compared with CBO's baseline economic pro-jections. CBO has calculated that the economic im-provements from balancing the budget by 2002 couldcut interest costs and boost revenues for the federalgovernment by $50 billion in 2002 and by a total of$170 billion in 1996 through 2002. The budget reso-lution takes this so-called fiscal dividend into ac-count in calculating that the budget will be balancedeven if the contingent tax cut is enacted.

The Economic Outlook

CBO forecasts that the economy will grow slowlythis calendar year but will pick up next year. Theforecast reflects both actual growth in the first half of1995, which was slower than CBO expected in itswinter forecast, and CBO's assessment that the econ-omy is fundamentally sound. (CBO's winter forecastwas published in January 1995 in The Economic andBudget Outlook: Fiscal Years 1996-2000.) CBO'slonger-term economic projections are not substan-tially different than those it made in January. Theeconomic forecast is based on current fiscal policy-itdoes not reflect potential changes that the Congressand the President have proposed.

The Forecast for 1995 and 1996

Sluggish demand in interest-sensitive areas such asresidential construction and consumer durable goods(especially automobiles and furniture) held economicgrowth to an annual rate of 1.6 percent in the first sixmonths of 1995. As a result, CBO forecasts that realGDP will increase by only 1.3 percent in 1995, on afourth-quarter-to-fourth-quarter basis, which is sig-nificantly below the 2.5 percent envisioned for 1995in the winter forecast (see Summary Table 1). As didmost other forecasters, CBO considered whether thesteep falloff from the rapid growth experienced in1994 (4.1 percent) signaled a recession. CBO's fore-cast reflects the possibility that a recession could de-velop, but CBO has concluded that a higher probabil-ity exists that the economy will grow more rapidly in1996. There is little evidence of the imbalances—ris-ing inflation, swollen inventories, deteriorating bal-ance sheets—that usually precede recessions.

CBO expects that the economy will grow by 2.3percent in 1996. That rate is somewhat higher thanthe 1.9 percent it forecast last winter. CBO antici-pated at that time that growth in 1995 would leavethe economy a little above potential GDP (the levelof real GDP that is consistent with a stable rate ofinflation) and that a slight slowdown in 1996 broughton by restrictive monetary policy would bring it backin line with potential GDP. But slow growth in 1995is likely to leave GDP near its potential level so thatgrowth of 2.3 percent would not threaten an accelera-tion of inflation.

Interest rates on three-month Treasury bills haveincreased significantly from the unusually low 3.0percent in 1993, but the 5.4 percent average rate fore-cast for 1995 is 0.8 percentage points (80 basispoints) lower than CBO anticipated last winter. CBOexpects that the rate will decline to 5.1 percent in1996. The forecast for 10-year Treasury note rates-6.5 percent in 1995 and 6.4 percent in 1996-is alsolower than was expected last winter. Moreover,weaker growth in 1995 is likely to push the expectedunemployment rate somewhat higher than had beenanticipated—to 5.7 percent in 1995 and 6.0 percent in

SUMMARY

1996. The consumer price index for all urban con-sumers (CPI-U) is expected to increase at the moder-ate rate of 3.3 percent in 1995 and 3.4 percent in1996, about the same as in the winter forecast.

Projections for the Years Beyond 1996

CBO projects that average annual real growth inGDP in 1997 through 2005 will be 2.4 percent-the

rate at which CBO estimates potential real GDP willincrease (see Summary Table 2). On average, theunemployment rate is expected to be about 6 percentduring that period, a rate CBO estimates is consistentwith steady inflation. Thus, CBO projects no addi-tional inflationary pressures on average during the1997-2005 period. The annual increase in the CPI-Uis actually projected to fall from 3.4 percent in 1997to 3.2 percent after 1998 because of a rebenchmark-ing of the index that the Bureau of Labor Statistics

Summary Table 1.The CBO Forecast for 1995 and 1996

1994a 1995Forecast

1996

Nominal GDPCBO summerCBO winter

Real GDPb

CBO summerCBO winter

Consumer Price Index0


Fourth Quarter to Fourth Quarter(Percentage change)

6.5 3.86.3 5.3

4.1 1.33.7 2.5

2.6 3.32.8 3.2

5.14.7

2.31.9

3.43.4

Calendar Year Average(Percent)

Civilian Unemployment RateCBO summerCBO winter

Three-Month Treasury Bill RateCBO summerCBO winter

Ten-Year Treasury Note RateCBO summerCBO winter

6.16.1

4.24.2

7.17.1

5.75.5

5.46.2

6.57.7

6.05.7

5.15.7

6.47.0

SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of LaborStatistics; Federal Reserve Boad.

a. The numbers for 1994 are actual values for CBO's summer forecast but are estimates for the winter forecast.

b. Based on constant 1987 dollars.

c. The consumer price index for all urban consumers (CPI-U).

xiv THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

has planned for that year. CBO projects that interestrates will hold steady throughout the 1997-2005 pe-riod at 5.1 percent for three-month Treasury bills and6.7 percent for 10-year Treasury notes. None ofthese projections represent a significant change fromCBO's winter assumptions. One indication of howlittle the projections have changed is that the currentprojection of real GDP in 2005 is $6,904 billion, only$7 billion higher than CBO projected last winter.

Those projections for 1997-2005 do not reflectany attempt to forecast cyclical fluctuations in theeconomy. Beyond the two-year forecast period(1995 and 1996), CBO projects a course for the econ-omy that will bring GDP to a level slightly belowestimated potential output, which is consistent withthe average historical relationship between actual and

potential GDP. CBO forecasts that actual real GDPwill reach that point at the end of 1996. Thus, realGDP is projected to grow at the same rate as poten-tial output during the 1997-2005 period. The projec-tion for potential GDP is based on an analysis of fun-damental factors such as growth in the labor force,productivity, and national saving.

The Budget OutlookAlthough CBO projects that the deficit will be $13billion less in fiscal year 1995 than it anticipated lastApril, the essential budget outlook under current lawhas not changed. (The April baseline was describedin CBO's An Analysis of the President's Budgetary

Summary Table 2.The Economic Forecast and Projections for Calendar Years 1995 Through 2005

Actual Forecast Projected1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Nominal GDP(Billions of dollars) 6,738 7,058 7,385 7,764 8,165 8,587 9,032 9,497 9,98610,501 11,042 11,610

Real GDP (Billions of1987 dollars) 5,344 5,481 5,584 5,715 5,851 5,992 6,135 6,282 6,432 6,586 6,743 6,904

Real GDP(Percentage change)

Implicit GDP Deflator(Percentage change)


Unemployment Rate(Percent)



4.1 2.6 1.9 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4

2.1 2.1 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7

2.6 3.1 3.4 3.4 3.3 3.2 3.2 3.2 3.2 3.2 3.2 3.2

6.1 5.7 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

4.2 5.4 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1

7.1 6.5 6.4 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7


a. CPI-U is the consumer price index for all urban consumers.

SUMMARY xv

Proposals for Fiscal Year 1996.} The deficit of $161billion that CBO projects for 1995 would be thesmallest since 1989. Measured as a percentage ofgross domestic product, the deficit, at 2.3 percent,would be the smallest since 1979. In addition, 1995will mark the third consecutive year the deficit hasdeclined since the record deficit of $290 billion wasposted in 1992. Unfortunately, CBO expects that itwill begin steadily rising again after 1995 if currentbudgetary policies are not changed, growing from$161 billion in 1995 to $189 billion in 1996 (seeSummary Table 3). Assuming that discretionaryspending increased at the rate of inflation after thecaps on it expire in 1998, the deficit would reach$462 billion in 2005.

CBO's baseline economic and budgetary projec-tions assume current policies will continue. In thecase of revenues and mandatory spending, CBO esti-

mates the receipts and outlays that will occur if nochanges are made in existing laws governing taxesand mandatory programs. In the case of discretion-ary spending, which is controlled by annual appropri-ation legislation, CBO assumes compliance with thestatutory limits that cap appropriations through 1998.For the years after 1998, CBO produces two projec-tions of discretionary spending. One projection as-sumes that total discretionary spending after 1998will equal the level of the 1998 limit adjusted for in-flation. The other projection assumes that discretion-ary spending will be frozen at the dollar level of the1998 limit.

In CBO's projections with discretionary inflationafter 1998, the deficit will reach $288 billion (3.2percent of GDP) by 2000. CBO's extended projec-tions of spending and revenues for the 2001-2005period show a deficit of $462 billion (4 percent ofGDP) in 2005. The projected deficit in CBO's base-

Summary Table 3.CBO Deficit Projections (By fiscal year)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005


161 189 218 229 261 288 308 340 375 414 462

161 189 218 229 243 250 247 256 264 275 292

As a Percentage of GDP

2.3 2.6 2.8 2.8 3.1 3.2 3.3 3.5 3.6 3.8 4.0

2.3 2.6 2.8 2.8 2.9 2.8 2.6 2.6 2.5 2.5 2.5

Baseline Total DeficitWith discretionary

inflation after 1998Without discretionary

inflation after 1998

Baseline Total DeficitWith discretionary

inflation after 1998Without discretionary

inflation after 1998


NOTE: Caps on discretionary spending are set by law through 1998. Measures of the deficit "with discretionary inflation" assume that discre-tionary spending grows at the rate of inflation after 1998. Measures of the deficit "without discretionary inflation" assume that discretion-ary spending remains frozen in dollar terms at the level of the 1998 caps.

xvi THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

line without discretionary inflation after 1998 alsogenerally continues to grow, although at a slowerrate. CBO projects that freezing discretionary spend-ing at the 1998 level would hold the deficit to $250billion in 2000 and $292 billion in 2005. As a per-centage of GDP, the deficit would grow to 2.8 per-cent in 2000 but then would decline to 2.5 percent in2005.

The rapid growth in spending for the two bigmandatory federal health programs (Medicare andMedicaid) continues to be the primary force drivingup the deficit in CBO's projections. CBO projectsthat spending for the two programs under currentlaws will increase at an average annual rate of about10 percent a year. By 2005, the combined spendingfor Medicare and Medicaid ($690 billion) will repre-sent more than one-quarter of total federal outlays,up from 18 percent in 1995. Projected spending forinterest on the federal debt will grow at a signifi-cantly slower rate (6 percent a year on average) butwill still increase substantially (from $233 billion in1995 to $415 billion in 2005). Other nondiscre-tionary spending in total will also grow at approxi-mately 6 percent a year, only about 1 percentagepoint faster than the nominal rate of growth of theeconomy.

Revenues are expected to total $1,357 billion in1995, equal to 19.4 percent of GDP. CBO projectsthat revenues under current laws will grow at slightlyless than a 5 percent average annual rate over the1995-2005 period, declining a little relative to thesize of the economy. By 2005, revenues will total$2,175 billion, or 19 percent of GDP.

The Budget Resolution and theEconomic Implications ofBalancing the Budget

The budget resolution adopted by the Congress inJune proposes dramatic changes in fiscal policy. Be-cause the laws needed to implement the Congres-sional plan have not yet been enacted, the proposedchanges are not reflected in CBO's baseline economicand budgetary projections.

The budget resolution assumes a balanced budgetin 2002. The President has also called for a balancedbudget in the July Mid-Session Review of the 1996Budget, although his target date is 2004. CBO pro-jects that the deficit will be close to $350 billion in2002 and more than $400 billion in 2004 if nochanges are made in current policy and if discretion-ary spending grows at the rate of inflation after thecaps expire in 1998. The budget resolution is essen-tially based on CBO's April 1995 baseline economicand budgetary projections (which, as explainedabove, differ little from CBO's revised baseline pro-jections that are detailed in Chapters 1 and 2). It ac-cepts, therefore, that substantial changes in currentpolicies are required to achieve budgetary balance in2002. By contrast, because the Administration be-lieves that deficits under current policies will be sub-stantially lower than CBO projects, the President hasproposed smaller savings. CBO estimates that, if thesavings proposed by the President are achieved, thedeficit would be reduced to about $200 billion in2004 instead of being eliminated.

The budget resolution proposes tight constraintson total discretionary spending. The outlays of $515billion that it proposes for 2002 would be $30 billionless than CBO estimates for 1995. Under the resolu-tion's plan, all of this cut would come in nondefenseprograms; defense spending in 2002 would be ap-proximately the same in nominal terms as in 1995.However, funds available for defense would be about17 percent below the amount needed to keep pacewith inflation. In inflation-adjusted terms, spendingproposed by the resolution for nondefense programsin 2002 would be more than 30 percent below currentspending for those activities.

Holding total discretionary spending to the $515billion proposed by the budget resolution for 2002would save $121 billion in that year compared withCBO's baseline with discretionary inflation. Thatrepresents a little less than one-third of the savingsneeded to balance the budget in that year. Under thebudget resolution, an additional $161 billion in sav-ings would come from changes in mandatory spend-ing programs. The resolution assumes that a total of$125 billion of those mandatory savings in 2002 willcome from Medicare ($71 billion) and Medicaid ($54billion), with additional savings in a number of otherprograms. The remaining $66 billion in deficit re-

SUMMARY

duction needed to reach a balanced budget in 2002will come from diminished interest payments if pol-icy changes reduce the deficit (and federal debt) bythe assumed amounts in 1996 through 2002. Thatreduction in debt-service costs does not include anysavings from lower interest rates that could resultfrom eliminating the deficit.

The revenue levels stated in the budget resolutiondiffer from current-law projections by about $1 bil-lion in total over the 1996-2002 period. The resolu-tion does, however, anticipate a tax cut that wouldreduce revenues by $50 billion in 2002 and $245 bil-lion in 1996 through 2002. But the budget resolutionprovides that the Congress may not consider the taxcut unless the other legislative proposals being con-sidered as part of the deficit reduction process wouldproduce a balanced budget in 2002.

Enacting the tax cut envisioned by the resolutionwould, of course, reduce revenues below the levelsstated in the budget resolution. The resolution as-sumes that the revenue loss will be offset by savingsresulting from the economic effects of balancing thebudget, which also were not included in the statedbudget resolution numbers. In its April 1995 report,An Analysis of the President's Budgetary Proposalsfor Fiscal Year 1996, CBO estimated that balancingthe budget by 2002 would over time lower interestrates by 100 to 200 basis points (1 to 2 percentagepoints) and increase the annual rate of real growth byabout 0.1 percentage point. The extent of those ef-fects is uncertain. However, CBO's estimates repre-sent the middle ground of economic analysis on thesubject. CBO calculates that such economic im-provements would produce a fiscal dividend—lowerfederal interest payments and higher revenues—thatwould reduce the deficit by $50 billion in 2002 and$170 billion over the 1996-2002 period. The budgetresolution assumes that this fiscal dividend wouldoffset the anticipated tax cut in 2002 and would par-tially offset it in earlier years.

The Debt Limit

Since the Second Liberty Bond Act was passed in1917, the Congress has enacted a series of statutory

limits on federal borrowing. The current debt limit is$4.9 trillion. The limit applies to virtually all debtissued by the Treasury, including debt held by trustfunds and other government accounts. CBO esti-mates that at the end of the current fiscal year debtsubject to the limit will total slightly less than $4.9trillion. Of that amount, $3.6 trillion is debt held bythe public. An additional $1.3 trillion will be heldby trust funds (the Social Security trust funds accountfor $0.5 trillion and the Civil Service Retirementtrust fund for $0.4 trillion), with the remaining debtheld in other government accounts. The debt limitmay have served a useful purpose in controlling defi-cits when most federal spending was subject to an-nual appropriations. But now that about two-thirdsof spending is mandatory, the debt limit is an ineffec-tive budgetary tool. In recent years, the need to in-crease the debt has primarily served to provide amust-pass vehicle to which other legislation can beattached.

Federal borrowing will push debt to the limitsometime early in fiscal year 1996. That borrowingis driven both by spending that exceeds revenues(even under the budget resolution, deficit spendingwill continue until 2002) and by trust fund surpluses(those will require increases in the debt limit evenafter the budget has been balanced). Under normaloperations, debt is likely to hit the ceiling sometimein October, though the Treasury may be able to delayany serious difficulties until November. At thatpoint, however, if the debt limit has not been in-creased, the government will have to choose betweendefaulting on its obligations (such as paying SocialSecurity benefits and interest on government securi-ties) or taking steps (such as disinvesting trust funds)to free up room under the limit to allow additionalborrowing from the public.

Debt has run up against the limit on a number ofprevious occasions. Those debt crises have beenshort-lived, however, and the Treasury has alwaysmanaged to deal with them without taking any ex-treme actions. The United States government hasnever been forced to default on any obligations. Adefault could have grave consequences, prompting aloss of confidence in the government and a perma-nent increase in federal borrowing costs as investorsdecide that government debt is no longer free of riskof default.

Chapter One

The Economic Outlook

A fter a strong performance during 1994, theU.S. economy slowed to a crawl during thefirst half of 1995. Growth of real (inflation-

adjusted) gross domestic product (GDP) averaged 4.1percent during 1994, well above the economy'snoninflationary growth potential, which the Congres-sional Budget Office (CBO) estimates to be 2.4 per-cent. Hence, some slowing was inevitable if a seri-ous upturn in inflation was to be avoided. Neverthe-less, the 1.6 percent rate of growth recorded duringthe first half of 1995 led some analysts to questionwhether the pause would be relatively brief orwhether it signaled the early stages of a recession.

In CBO's judgment, a recession is unlikely todevelop during 1995: aside from some pockets ofweakness, the economy appears to be fundamentallysound. Most important, many of the imbalances thattypically precede recessions—rising inflation, swolleninventory stocks, and deteriorating balance sheets-are absent from the economic landscape.

The Congressional Budget Office forecasts thatthe economy will continue to grow slowly for theremainder of the year, averaging 1.3 percent over thefour quarters of 1995, and will then grow at a rate of2.3 percent over 1996 (see Table 1 and Figure 1).CBO's forecast reflects the possibility that a reces-sion will develop, but also incorporates the strongerprobability that growth will be close to or even abovethe noninflationary potential for the economy. Withslow growth this year, the unemployment rate islikely to rise slightly-from 5.7 percent in the secondquarter to 6 percent in the middle of next year. Infla-tion is not likely to change much under those condi-tions, edging only marginally higher by the end of1996, while interest rates will ease modestly over thesame period.

CBO's current forecast is similar to the economicassumptions underlying the budget resolution that theCongress passed in June, which were nearly identicalto those CBO published in its winter report.1 Realgrowth is somewhat slower in 1995 and slightlyfaster in 1996 than the winter forecast projected, butthe average rate of growth during the whole periodfrom 1995 though 2002 is almost identical to that inthe winter forecast. Interest rates are substantiallylower than the winter forecast during 1995 and 1996,reflecting weaker growth in the near term, but risethereafter to the same levels as the winter forecast.CBO's forecast for inflation is almost exactly thesame as the winter forecast.

The Federal Reserve's tightening of monetarypolicy during 1994 slowed the economy sooner thanexpected, which caused the Federal Reserve to easerates slightly in July 1995. Between February 1994and February 1995, the Federal Reserve engineered asuccession of interest rate hikes, attempting to coolan economy that was in danger of overheating. Bytaking steps to slow the economy early, the FederalReserve hoped to avoid the severe tightening that hasoften preceded recessions in the past. On this occa-sion, the tightening of monetary policy affected theeconomy earlier than most analysts had anticipated.Last winter, CBO estimated that the tightening wouldbegin to slow the economy during the last half of1995; instead, the effects showed up during the first

The sole difference is that the budget resolution forecastincluded an adjustment for the anticipated revision to theconsumer price index beginning in 1998. See CongressionalBudget Office, The Economic and Budget Outlook: FiscalYears 1996-2000 (January 1995); and U.S. House of Repre-sentatives, Concurrent Resolution on the Budget for FiscalYear 1996, Conference Report 104-159, to accompany H.Con. Res. 67 (June 26, 1995), p. 61.

2 THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

Table 1.The CBO Forecast for 1995 and 1996

1994a 1995Forecast

1996

Nominal GDPCBO summerCBO winter

Real GDPb


Implicit GDP DeflatorCBO summerCBO winter




6.56.3

4.13.7

2.22.5

2.62.8

3.85.3

1.32.5

2.52.8

3.33.2

5.14.7

2.31.9

2.72.8

3.43.4


Real GDP Growthb


Civilian Unemployment RateCBO summerCBO winter

Three-Month Treasury Bill RateCBO summerCBO winter

Ten-Year Treasury Note RateCBO summerCBO winter

4.14.0

6.16.1

4.24.2

7.17.1

2.63.1

5.75.5

5.46.2

6.57.7

1.91.8

6.05.7

5.15.7

6.47.0

SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of LaborStatistics; Federal Reserve Board.

a. The numbers for 1994 are actual values for CBO's summer forecast but are estimates for the winter forecast.

b. Based on constant 1987 dollars.

c. The consumer price index for all urban consumers (CPI-U).

CHAPTER ONE THE ECONOMIC OUTLOOK 3

half of the year. The Federal Reserve reacted cau-tiously to the signs of weakness, trimming the federalfunds rate by only 25 basis points (a quarter of a per-centage point) in early July.

Although CBO foresees economic growth ap-proaching its potential rate by the middle of 1996, the

current outlook holds substantial uncertainties. Inparticular, CBO's forecast presumes that the weak-ness some sectors have already experienced will notspread. A worse outcome could follow if producers,worried by weak demand for their goods, cut produc-tion further to pare inventory stocks. Reductions inemployment and income could then prompt con-

Figure 1.The Economic Forecast and Projections

Real GDP Growth

Percent

1980 1985 1990 1995 2000

Inflation3

Percent12

Actual Projected

1980 1985 1990 1995 2000

Civilian Unemployment Rateb

Percent10

8

Projected

1980 1985 1990 1995 2000

Interest Rates

Percent15

10

Actual Projected

1980 1985 1990 1995 2000

SOURCES: Congressional Budget Office; Department of Labor, Bureau of Labor Statistics; Department of Commerce, Bureau of EconomicAnalysis; Federal Reserve Board.

NOTE: All data are annual values; growth rates are year over year.

a. Consumer price index for all urban consumers (CPI-U). The treatment of home ownership in the official CPI-U changed in 1983. Theinflation series in the figure uses a consistent definition throughout.

b. From 1994 on, the unemployment rate reported by the Bureau of Labor Statistics is not comparable with previous data. The discontinuityreflects an extensive revision of the survey's methodology. The CBO forecast is based on the new methods.


sumers to postpone purchases further, tipping theeconomy into recession.

Alternatively, the economy could roar back laterthis year. Economic growth of 4 percent would beeasy to attain if companies continued to invest attheir recent pace and if demand for consumer durablegoods or housing showed signs of life. The FederalReserve would then be likely to clamp down, raisinginterest rates to levels that would risk recession in1996 or 1997.

Assuming that both of those extremes areavoided, the stage could be set for a renewed periodof growth like that which followed the "growth reces-sions" of 1967 and 1986. In each of those years, theeconomy experienced a temporary slowdown, largelylimited to the manufacturing sector, that relieved in-flationary pressures and allowed several more yearsof economic expansion.

The economic forecast and projections presentedin this chapter assume current fiscal policy; that is,they do not reflect the effects of the deficit reductionsimplied by the budget resolution. Chapter 3 exam-ines the resolution and how implementing the fiscalpolicy it proposes might affect the economy.

CBO's next Economic and Budget Outlook, to bepublished in January or February of 1996, will incor-porate new measures of real GDP. The Bureau ofEconomic Analysis at the Department of Commerce,the keepers of the national income and product ac-counts, will switch to a measure that is more sensi-tive to the changing nature of the economy. Fordetails about the new measure of real GDP, see Ap-pendix B.

Slowdown in the First Half

The U.S. economy slowed dramatically during thefirst half of 1995, growing at a 1.6 percent rate sinceJanuary, down from its brisk pace of 4.1 percent dur-ing 1994. During the first two quarters of 1995, theslowing of demand was concentrated in sectors of theeconomy that are sensitive to changes in interestrates, such as residential construction and consumer

durables, especially autos and furniture (see Figure2). That pattern suggests that the weaker pace ofeconomic activity resulted largely from the FederalReserve's tightening of monetary policy during 1994and early 1995. Producers reacted to slower demandby cutting back their investment in inventories-which had been very strong during 1994 and early1995—to prevent stocks of unfinished goods frommounting.

Some analysts were concerned that the signs ofweakening might be signaling the start of a recession.Indicators such as the index of industrial production,housing starts, and vehicle sales all reached peaksand started to decline during the first quarter of 1995.Broader-based measures from the labor market--hours worked, employment, and the unemploymentrate—hinted at softer demand for labor during the firsthalf of the year. By midyear, however, many ofthose indicators showed renewed strength, decreasingthe likelihood of a significant unwinding of economicactivity.

Financial markets responded to the slowing ofthe economy by driving down interest rates—particu-larly long-term rates-during the first half of 1995.The rate on 10-year Treasury notes, for example,dropped 160 basis points, retracing nearly four-fifthsof its 1994 run-up. The efforts of the Federal Re-serve to maintain the federal funds rate at its 6 per-

Figure 2.Growth Patterns in Selected Sectors(By half years, at annual rates)

Percent

1st Half 1994 2nd Half 1994 1st Half 1995

• Real GDP0 Consumer Durables and Residential Constructionn Other Sectors

SOURCES: Congressional Budget Office; Department of Com-merce, Bureau of Economic Analysis.


Figure 3.The GDP Gap

Percentage of Potential GDP

-5 -

-101970 1975 1980 1985 1990 1995


NOTE: The GDP gap is GDP minus potential GDP expressed asa percentage of potential GDP.

cent target level prevented short-term rates from de-clining as much. Nevertheless, slower economicgrowth, combined with the expectation of an easingof monetary policy, forced down yields at shortermaturities, and the three-month Treasury bill rate fellby 30 basis points during the first half of the year.

Financial markets welcomed the news of slowergrowth because, by most estimates, the economy isstraining its productive capacity. Real GDP sur-passed potential output, the level of output that isconsistent with a stable rate of inflation, during thethird quarter of 1994 and remained above that levelthrough early 1995 (see Figure 3). Other measures ofinflationary pressure tell the same story as potentialoutput-the capacity utilization index is close to thelevel normally associated with a pickup in the growthof prices, and the unemployment rate is below CBO'sestimate of the nonaccelerating inflation rate of un-employment (or NAIRU). Slower growth cheers thebond market because it reduces the risk of an in-crease in inflation and the likelihood of a furthertightening of monetary policy.

The pattern of declining interest rates since Feb-ruary, when the Federal Reserve last raised the fed-eral funds rate, has narrowed the spread betweenlong- and short-term interest rates and flattened theyield curve. Such a narrowing typically indicatesslower growth ahead, whereas inversions of the yield

curve (when short-term rates climb above long rates)are usually followed by recessions. However, theevents of 1995 differ from most episodes in whichthe yield spread has narrowed in that long-term ratesdropped but short-term rates fell only slightly. Usu-ally, the yield curve flattens when interest rates arerising and tight monetary policy drives short-termrates above long-term rates. The most likely expla-nation for this year's events is that slower growtheased fears of inflation among participants in the fi-nancial markets and lowered the likelihood of furtherFederal Reserve tightening. Those forces reducedlong-term rates and would have lowered short-termrates sharply had the Federal Reserve not drainedreserves from the banking system.

The progress made by the Congress toward defi-cit reduction may also have contributed to the declinein long-term interest rates. Early in the year, finan-cial market participants seemed skeptical that theRepublican majorities could hold together to passlegislation to reduce the deficit substantially. As thebudget resolution and other legislation incorporatingsuch reductions progressed through the House andSenate, markets may have changed their views andbid down rates.

The CBO Forecast for1995 and 1996

The economy is likely to weather the current periodof weakness and return to a sustainable path ofgrowth next year. The softening of interest-sensitivesectors caused by tight monetary policy could persistthrough the end of 1995. It need not, however, causea dramatic weakening of employment or income andtherefore would not spread to other sectors of theeconomy. CBO foresees a period of slow growth inreal GDP this year and a gradual return toward itspotential rate of growth during 1996.

Significant slowdowns do not necessarily fore-shadow recession. For example, a period of slowgrowth interrupted the expansion of the 1980s rela-tively late in the business cycle. During 1986, thegrowth of real GDP was negative in the second quar-ter, remained sluggish for the remainder of the year,


but then snapped back in 1987. A similar pause oc-curred in 1967. Those brief pauses probably pro-longed the expansions by reducing inflationary pres-sures, thereby delaying the point at which the FederalReserve needed to act aggressively to head off infla-tion. The comparison between the episodes is notperfect—the current slowing can probably be attrib-uted to the Federal Reserve's preemptive strikeagainst inflation during 1994, whereas the slowing in1986 occurred at a time when the Federal Reservewas easing rates. However, the current slowdown,like those of 1967 and 1986, will probably be mild,relieve pressure on capacity, and help to prevent theeconomy from overheating.

The Economy Has EnoughFundamental Strength toAvoid Recession

The pockets of weakness that emerged during thefirst half of 1995 are isolated and are not likely tocause the downward spiral of cuts in production andemployment that characterizes recessions. Manyfundamental factors support growth: consumer andbusiness balance sheets are healthy; banks do notappear to be overextended; corporate cash flow isstrong; inventory stocks do not generally appear to bebloated; the exchange value of the dollar is down;and growth abroad looks solid on average.

Balanced against those sources of strength is thetightening of monetary policy that occurred during1994 and early 1995, which clearly began to slow theeconomy during the first half of 1995 and may yetslow it further. On seven previous occasions sinceWorld War II, the federal funds rate rose by at least180 basis points within four quarters, as it did in1994 and early 1995. After two of those seven epi-sodes, the economy was in recession within a year,and after another four episodes, the economy was inrecession within two years. However, interest ratesare still lower now than in past episodes of tighten-ing, perhaps because the Federal Reserve began totighten earlier in the business cycle than it did manytimes in the past.

Consumers Will Not Retrench. Consumer spend-ing grew at a 2.0 percent annual rate during the first

half of 1995, slipping from its 3.3 percent pace dur-ing the previous two years. Thus far, the weakness inconsumption has been concentrated in areas that aresensitive to changes in interest rates, including dura-ble goods such as autos and furniture. In CBO'sview, the weakness in spending for durable goodswill continue into 1996, but will not spread to de-mand for nondurables—such as food and clothing—orto demand for services.

The outlook for growth in personal income,though not as strong as its robust pace during the lat-ter half of 1994, is favorable enough to support con-tinued growth in consumer spending. CBO expectsdisposable personal income, adjusted for inflation, togrow at an average rate of 1.7 percent through theend of 1996. Unfettered by a heavy burden of debtrepayment, consumers should react to such growth inincome by increasing their consumption spending ata similar rate (see Figure 4). The surge in stock andbond prices during the first half of 1995 will alsosupport consumer spending, though only modestly.

Business Investment Cools. Growth of businessinvestment, which has advanced at a 10 percent ratesince the beginning of 1994, is expected to slow dra-matically during the remainder of the year and into1996. Spending for capital equipment, which hasbeen an important engine of growth during the cur-rent business cycle, is expected to lead the slow-

Figure 4.

Household Payments on Debt

19

18

17

16

15

14

Percentage of Disposable Personal Income

nT. . . . i . . . . i . . . . i . . . . i . . . . i . . . . i . . . . i , r1960 1970 1980 1990

SOURCES: Congressional Budget Office; Department of Com-merce, Bureau of Economic Analysis; Federal Re-serve Board.


Figure 5.Investment in Producers' Durable Equipment

Percentage of Real GDP

1950 1960 1970 1980 1990


down (see Figure 5). Although CBO expects thatcompanies will respond to the slower pace of sales bytrimming their capital-spending plans, several factorsargue against a collapse in business investment: fac-tory operating rates continue to be high, thus puttingpressure on companies to expand capacity; corporatecash flows and profits are strong; business balancesheets are not loaded down with debt; and financingcosts are falling as interest rates sag and the stockmarket surges.

One source of concern is the rapid pace of inven-tory accumulation during 1994 and the first quarterof 1995. Investment in inventories accounted for asignificant share of the growth of real GDP duringthose quarters—0.6 percentage points of an overallgrowth rate of 3.8 percent. That pace of accumula-tion did not concern analysts during 1994, when thegrowth of demand was brisk. However, inventorystocks mounted when sales slowed during the firsthalf of 1995, especially in the housing and auto sec-tors, in which the shortfall in demand was concen-trated. When production fell off during the secondquarter in response to a growing stock of unsoldgoods, analysts became concerned about the possibil-ity that large inventories could induce recession.

CBO does not forecast such a cycle because theinventory buildup—with the exception of a few sec-tors-is not especially large compared with the recentlevel of sales. Indeed, the overall inventory-to-sales

ratio showed a very mild increase during the first halfof 1995 (see Figure 6). In addition, manufacturershave already begun to align their inventories withsales by slowing production during the second quar-ter. CBO projects that the investment in inventorieswill remain slow during the second half of the yearand that inventories will be in line with sales by early1996.

Investment in nonresidential structures is ex-pected to provide a mild boost to the economythrough the end of 1996. After three years in the dol-drums, that sector perked up in 1994 and posted a 17percent rate of growth during the first half of 1995.Growth in nonresidential construction was surpris-ingly broad-based during the first six months of1995, encompassing industrial buildings (includingfactories and warehouses), commercial real estate(including retail and wholesale space, hotels and mo-tels, and even office buildings), mining, and con-struction by utilities. Spending for structures de-pends less on the ups and downs of the business cyclethan other investment and therefore may continue itsmodest growth even if investment in equipmentslows.

Baseline Fiscal Policy Is Not a Factor. CBO's eco-nomic assumptions normally reflect the federal fiscalpolicies—that is, tax policies and spending plans—thathave already been passed into law. The current-lawforecast embodies a fiscal policy that scarcely re-

Figure 6.Stock of Inventories Compared with Sales

Ratio

.T. . . . i . . . . i . . . . i . . . . i i . . . i . r1970 1975 1980 1985 1990 1995



strains economic activity in 1995 and 1996. Actualfiscal policy is likely to be more restrictive than cur-rent law, however, since both the Congress and theAdministration have indicated a desire to reduce thedeficit for 1996 and beyond on the way to budgetarybalance (see Chapter 3).

CBO gauges the stance of fiscal policy using thestandardized-employment deficit, which removes

outlays for deposit insurance and the effects of thebusiness cycle from the budget deficit. Deposit in-surance is removed because those outlays are gener-ally considered to be exchanges of existing assets andhave little effect on output and employment. Thecyclical component of the deficit is removed becauseit is not the result of policy changes. Fiscal policy isstimulative in a given year if the standardized-employment deficit rises relative to potential GDP in

Table 2.The Fiscal Policy Outlook (By fiscal year)

Actual1994 1995 1996 1997 1998 1999 2000


With Discretionary Inflation After 1998

Total Budget DeficitStandardized-employment deficit3

Cyclical deficit


Cyclical deficit

Memorandum:Deposit Insurance

203194

16

161189

189188

9

Without Discretionary Inflation After 1998

203194

16

161189

-16

189188

9

218211

12

218211

12

229221

13

229221

13

-5

261251

13

243233

13

-3

288277

14

250239

14

-2

As a Percentage of Potential GDP

With Discretionary Inflation After 1998


Cyclical deficit

3.02.90.2

2.32.7

-0.2b

2.62.60.1

Without Discretionary Inflation After 1998

2.82.70.2

2.82.70.2

3.12.90.2

3.23.10.2


Cyclical deficit

3.02.90.2

2.32.7

-0.2b

2.62.60.1

2.82.70.2

2.82.70.2

2.82.70.2

2.82.70.2


NOTE: Caps on discretionary spending are set by law through 1998. Measures of the deficit "with discretionary inflation" assume thatdiscretionary spending grows at the rate of inflation after 1998. Measures of the deficit "without discretionary inflation" assume thatdiscretionary spending remains frozen in dollar terms at the level of the 1998 cap.

a. Excludes cyclical fluctuations and outlays for deposit insurance.

b. Surplus.


that year and restrictive if it falls relative to potentialGDP. Otherwise fiscal policy is said to be neutral ifthe ratio remains constant.

Under current law, the standardized-employmentdeficit will remain roughly constant as a share of po-tential GDP between 1995 and 1998 (see Table 2 andFigure 7). Its course thereafter depends on whetherdiscretionary spending grows with inflation or re-mains constant after the current caps on such spend-ing expire. If discretionary spending was allowed togrow with inflation, the standardized-employmentdeficit would also grow as a share of potential GDPbetween 1998 and 2000. After 2000, rising spendingfor health programs would drive up the deficit evenmore. If discretionary spending was held constant atits 1998 dollar level, the standardized-employmentdeficit would be a roughly constant share of potentialGDP between 1998 and 2000. From a longer-runpoint of view, however, baseline fiscal policy wouldbe a source of concern because federal borrowingwould continue to crowd out private investment.

Net Exports Show Modest Improvement Throughthe End of 1996. The U.S. trade balance, which de-teriorated as a result of a sharp decline in exports toMexico during the first half of 1995, should improvein the remainder of 1995 and into 1996. Faster

Figure 7.Standardized-Employment Deficit(By fiscal year)

Percentage of Potential GDP

1960 1970 1980 1990 2000


growth abroad combined with slower growth at homeis largely responsible for improving the trade bal-ance. In addition, the exchange value of the dollarplunged sharply during the first quarter of 1995, pro-viding a further reason to expect improvement in thetrade picture.

Growth in world output should outpace growth inthe United States during the rest of 1995 and 1996,averaging 3 percent in both years. Economic recov-ery is firmly established in Canada, Germany, andthe United Kingdom—three of the top five tradingpartners of the United States—though slower growthin the United States seems to have dampened pros-pects in Canada. Growth in the newly industrializedcountries of Asia, though moderating from its re-markable 7.6 percent rate in 1994, is projected to re-main much faster than the growth of the U.S. econ-omy during 1995 and 1996.

The notable exceptions to that rosy picture areJapan and Mexico-the second and third largest trad-ing partners of the United States—which are currentlyexperiencing low or negative growth in output. Theeconomic recovery in Japan, which has been limpingalong for the last two years, was further battered bythe Kobe earthquake in January and an appreciationof the yen during the first half of 1995. Economicactivity in Japan during this business cycle has beenhampered from the start by sluggish lending bybanks, which are struggling to crawl out from under amountain of bad loans caused by the collapse ofprices in real estate and financial assets. One of theactions undertaken by banks (and insurers) is the saleof marketable assets, which forces the prices of equi-ties and property down further. Although the econ-omy seems to have recovered quickly from the ef-fects of the earthquake (rebuilding work could bestimulating growth at this point), the effects of theyen's appreciation make it less likely that foreign de-mand will boost the economy in the near term. Inaddition to decreasing the competitiveness of Japan'sexporters in foreign markets, the yen's appreciationhas spurred cost-cutting measures by firms that haveslowed—and will continue to slow—the growth in em-ployment, wages, and consequently consumer de-mand. Some analysts are worried that Japan will slipback into recession, but a consensus forecast envi-


Figure 8.The Dollar Exchange Rate

160

140

120

100

Index: March 1973 = 100

80 _i1970 1975 1980 1985 1990 1995

SOURCES: Congressional Budget Office; Federal Reserve Board.

NOTE: Trade-weighted index relative to the currencies of 10countries: Belgium, Canada, France, Germany, Italy,Japan, the Netherlands, Sweden, Switzerland, and theUnited Kingdom.

sions Japan's output growing at about 0.5 percent in1995 and 1.2 percent in 1996.2

Mexico's currency crisis subsided in March aftera package of international aid and loan guarantees,combined with the Mexican government's austerityprogram, restored confidence in the peso. By mid-July, Mexico's first debt offering since the crisis wasgreeted by strong demand in the private capital mar-ket; $1 billion of new two-year notes was sold, twicethe targeted amount. However, the crisis itself,which cut off the flow of international investment,and the actions taken by President Zedillo to addressthe crisis—holding down wage growth, reducing gov-ernment spending, and selling government enter-prises—will depress growth in the near term. TheMexican economy is expected to contract by nearly3.5 percent in 1995 but is expected to bounce back in1996, when the impact of the austerity program haspassed its peak.

Bolstering the effect of relative growth rates onthe trade picture is the depreciation of the dollar,which declined 8 percent during the first half of 1995when measured against a 10-country, trade-weightedbasket of currencies (see Figure 8). The weaker dol-

2. Consensus Economics, Inc., Consensus Forecasts (July 10,1995).

lar will improve the U.S. real trade balance by mak-ing foreign goods more expensive for U.S. residentsand domestic goods cheaper abroad. Analysts havegenerally attributed the fall in the exchange value ofthe dollar to the expectation by currency traders ofslower growth (and lower interest rates) in the UnitedStates. Lower interest rates make investments indollar-denominated assets less attractive to for-eigners.

Residential Construction Will Stabilize. Construc-tion of residential housing was decidedly weak dur-ing early 1995, after a surge in the last quarter of1994. Although most analysts expected that sector tosoften during 1995, the degree of weakness was asurprise. The decline in long-term interest rates thatoccurred during the first half of the year will help thissector, but only with a lag. CBO expects that resi-dential construction will decline further during theremainder of 1995 and early 1996, before turningaround midway through next year.

The level of interest rates is the most importantshort-term influence on housing construction, and therun-up in rates during 1994 certainly contributed tothe falloff in housing construction earlier this year.The average interest rate on 30-year fixed-rate mort-gages climbed 2 percentage points during 1994,peaking at over 9 percent in December. The increasein fixed rates precipitated a shift toward adjustable-rate mortgages, but rates on those mortgages climbedtoo, rising from 5.6 percent in early 1994 to 7.0 per-cent in mid-1995. Increases in mortgage rates makea home more expensive to finance, and indeed mea-sures of housing affordability fell as rates increased(see Figure 9). However, the 120 basis-point declinein the interest rate on fixed-rate mortgages during1995 had the opposite effect, arresting the decline inthe index of housing affordability. Although it willoperate with a lag, the decline in rates will serve tostimulate housing construction—or at least temper itsfall.

The longer-term outlook is for modest growth atbest in the housing sector. The most important influ-ence on residential construction over the longer termis the number of new households formed, particularlythose in which the head of the household is betweenthe ages of 25 and 34. The dearth of births during the"baby-bust" generation of the late 1960s and 1970s is


now showing up as a slowdown in the formation ofhouseholds by that age group-a trend that is ex-pected to continue through the end of the decade.Spending on renovations has supported spending forresidential construction during recent years, however,and that spending could accelerate if baby boomersdecide to renovate their houses rather than try to sellthem to a smaller pool of first-time buyers.

Pressure on Wages and PricesEases During 1995 and 1996

Despite weakness this year, the economy is operatingat high levels of resource use, creating upward pres-sure on wages and prices. CBO expects that the un-derlying rate of inflation—measured using the con-sumer price index for all urban consumers (CPI-U)excluding food, energy, and used cars—will average3.3 percent between the fourth quarters of 1994 and1995, slightly above the rate in 1994, and will inchup to 3.5 percent in 1996.

Without any shocks—for example, to oil prices—the primary force that influences the rate of inflationis the growth of labor costs, the largest component ofmost companies' total expenses. The growth rate ofemployee compensation, as measured by the employ-

Figure 9.Housing Affordability Index

160

140

120

100

80

Index

601970 1975 1980 1985 1990 1995

SOURCES: Congressional Budget Office; National Associationof Realtors.

NOTE: The index equals 100 when median family income is justsufficient to qualify the family to purchase a median-priced home.

ment cost index, is no longer falling and is expectedto step up slightly during 1996. That pattern reflectsthe normal lag between the time that excess demandappears in labor markets-late in 1994-and the timethat costs begin to accelerate. The rate of capacityutilization has fallen over the last six months, but it isstill near the level at which the rate of inflation formanufactured goods would climb. However, the ex-pected uptick in prices of manufactured goods hasnot yet been observed. The tumble in the exchangevalue of the dollar will also tend to pump up inflationthrough import prices, but the effect on the CPI islikely to be small.

Some analysts have argued that the Federal Re-serve's focus on fighting inflation has been overdonebecause the underlying rate of inflation did not in-crease during the first half of 1995. Those analystssuggest that conventional measures of capacity are nolonger relevant in today's economic environment ofrelentless corporate cost-cutting, heavy investment incomputers, and increasing global competition. It istoo soon to tell whether that argument is valid be-cause the forces that spur inflation operate with along lag—anywhere from six months to two years.Since the unemployment rate only breached the levelof the NAIRU—CBO's preferred measure of capacityin the labor market—during the fourth quarter of1994, it is not surprising that inflation in consumerprices has yet to tick up. However, some evidence ofprice rises exists, and clearly the growth of wagesand prices is no longer slipping as it had been since1990.

Monetary Policy Is Expectedto Ease Further

The Federal Reserve progressively tightened mone-tary policy during 1994 and early 1995 but is nowcautiously loosening the degree of restraint. Citingthe easing of inflationary pressure, the Federal Re-serve cut the target federal funds rate by 25 basispoints, from 6 percent to 53/4 percent, in early July.Despite that cut, monetary policy is still relativelytight, and CBO expects that the Federal Reserve willease policy even further during the second half of1995 to achieve its goal of sustainable growth withlow inflation.


Will the Federal Reserve Achieve a Soft Landing?The strength of economic growth during 1994 led toa succession of increases in interest rates—the lastincrease occurred in February 1995. Those hikes inrates were part of the Federal Reserve's continuingeffort to head off any increase in inflation. Nonethe-less, the weakening of economic growth that oc-curred during the first half of 1995 caught manyeconomic forecasters off guard—most had expectedthe slower growth to occur later in the year. Theminutes of the May 23 meeting of the Federal OpenMarket Committee suggest that its members weresurprised by the weakening of the economy duringthe first half of the year, but they clearly viewed theslowdown as a temporary falter rather than the har-binger of a recession. In early July, the committeedecided that the degree of inflationary pressure hadsubsided enough that it could trim the federal fundsrate slightly, which it did by 25 basis points.

Economic conditions during the first half of 1995could help the Federal Reserve move toward its goalsof low inflation and sustainable economic growth fortwo reasons. First, slowing economic activity re-lieved some of the tightness in labor and productmarkets, meaning that inflationary pressures are notas strong as feared. Second, the decline in long-terminterest rates experienced during the first half of 1995means that the weakness in interest-sensitive sectorswill be self-correcting to some degree (though theeffect may not be realized until 1996).

Monetary policy, though restrictive, is not as re-strictive as it has been before past recessions. Forexample, real short-term interest rates peaked at 2.5percent during early 1995, about 1.5 percentagepoints above their level at the beginning of 1994, butwell below the levels attained before the recession of1990 (see Figure 10). Another indicator, the slope ofthe yield curve, tells the same story: the curve hasflattened, which usually foreshadows a slowing ofgrowth, but has not suffered the inversion that oftenprecedes recessions.

Short-Term Rates Decline Further. CBO expectsthat the Federal Reserve will allow short-term inter-est rates to drift gradually down through the end of1996. The rate on three-month Treasury bills, forexample, is expected to drop from 5.5 percent in mid-

1995 to 5.1 percent by the end of 1995. The federalfunds rate is expected to decline in a similar manner:from 53/4 percent to 51/2 percent by the end of 1996.Those paths for short-term interest rates hinge onCBO's forecast for growth of real GDP during the

Figure 10.Indicators of Monetary Policy

Real Short-Term Interest Rates3

Percent

1960 1970 1980 1990

The Interest Rate Spreadb

Percentage Points

1960

SOURCES:

1970 1980 1990

Congressional Budget Office; Department of Com-merce, Bureau of Economic Analysis; Federal Re-serve Board.

a. The real short-term interest rate is calculated by subtractingfrom the three-month Treasury bill rate the growth (on an an-nual basis) of the consumer price index for all urban consum-ers (CPI-U) over the subsequent three-month period. For thesecond quarter of 1995, the real interest rate is based onCBO's forecast of the growth of the CPI-U for the third quarterof 1995.

b. The interest rate spread is the yield on 10-year Treasury notesminus the three-month Treasury bill rate.


same period. If economic growth was to be muchstronger than CBO envisions, rates would not declineas much, if at all. If growth was to come in muchweaker than anticipated, rates could fall morequickly.

Long-Term Rates Rebound Slightly. CBO's base-line forecast assumes that long-term interest rateswill rise slightly over the forecast period. The 10-year Treasury note rate is forecast to be about 50 ba-sis points higher at the end of 1996 than its level inJuly of 6.1 percent. In CBO's view, slower economicgrowth during the first half of 1995 drove long-termrates below the level that is consistent with current-law fiscal policy. Therefore, long-term rates risegently in this forecast in response to faster growth.However, implementation of the budget resolution-which markets may already expect—would changethat outlook, producing lower interest rates (seeChapter 3 for a discussion of the effects of the budgetresolution on interest rates and economic growth).

Alternative OutlooksCBO's forecast reflects a likely path for the economy.As usual, however, the barometers of future eco-nomic activity are difficult to read. The stance ofmonetary policy shifted toward restraint during 1994,and the timing of the effects of such a shift in policyare hard to gauge. The effect on output appears tohave come earlier than it has in the past; the mag-nitude of the effect might possibly have beenmisestimated. The size of the effect depends on howconsumers and businesses react to the pockets ofweakness in the economy; their reaction could bestronger or weaker than in the past. The outlook willalso depend on the response of the economy to anychanges to fiscal policy enacted by the Congress.Any of those factors could cause economic growth tobe significantly weaker or stronger than CBO pro-jects (see Appendix A for an analysis of how accu-rate CBO's forecasts have been since 1976).

A Deeper Downturn

The weakness during the first half of 1995 took ana-lysts by surprise—most expected the economy to slow

later in the year, based on the average lag betweentightening monetary policy and economic growth.Moreover, the weakness in demand may be more ex-tensive than current statistics indicate. If so, produc-ers may respond to falling orders by further slowingthe pace of production to pare their stocks of invento-ries, or they could decide to delay the purchase ofcapital goods even more than CBO anticipates. Inthat way, the falloff in demand in the interest-sensi-tive sectors of the economy could lead to layoffs andcuts in production in other sectors later in the year.Similarly, the scattered cutbacks in production wit-nessed thus far could, by shaking consumer or busi-ness confidence, cause consumers to retrench or busi-nesses to slash capital-spending plans, resulting inthe same downward spiral of cuts in production, in-comes, and spending.

If the full effects of the tightening of monetarypolicy have yet to be felt, then the weakness in theeconomy could be more pronounced than CBO ex-pects. CBO estimates that the delay between achange in monetary policy and the effects on theeconomy usually ranges from nine to 18 months.Since monetary policy shifted from one of ease totightness during the middle of 1994, the effects of thechange would be expected to occur during the secondhalf of 1995. However, the economy began toweaken during the first quarter and slowed muchmore than CBO had expected. Based on the normaldelay between the change in policy and the effects onthe economy, further effects of the tightening thatoccurred during the latter half of 1994 and early 1995may yet be felt.

Fiscal policy could also affect the near-term out-look. The Congress appears ready to alter the courseof fiscal policy for the next decade, based on the bud-get resolution passed in June. If that effort is sus-tained, the standardized-employment budget deficitcould fall by almost 0.5 percent of GDP on averageper year through 2002. Monetary policy could offsetsuch restraint, but the restraint would add to the riskof slower growth. Failure to deliver significant re-duction might also create a risk. If fiscal policy ac-tions failed to persuade financial markets that signifi-cant deficit reduction was imminent, then long-terminterest rates could rise. Any increase in rates couldexacerbate the existing weakness in the economy.


Global events are another source of uncertaintyabout the outlook. The most immediate concern isthat growth abroad will be more tepid than antici-pated, which could weaken U.S. exports in the nearterm. The outlook for Japan is extremely uncertainbecause it is still wrestling with the effects of deflat-ing asset prices. Although the consensus forecast forJapan's growth is still positive, many analysts havehighlighted the very real possibility that further loansmight go bad and that Japan could relapse into reces-sion. The high yen (caused in part by Japanese banksand insurers selling off foreign assets to maintainadequate capital reserves) heightens the problem bymaking Japanese goods more expensive in the UnitedStates and other foreign countries.

A Cycle of Boom and Bust

Another interpretation of the recent data is that theweakness experienced during the first half of 1995 isoverstated and that the economy will grow vigor-ously during the remainder of the year. The weak-ness could be overstated for various reasons. Sea-sonal effects in the data may not have been removedcorrectly, or the slowing of demand for housing andautos may be temporary. A return to growth fasterthan the economy's long-run potential could occur ifdemand for autos and housing picks up slightly andcompanies replenish their inventory stocks. Thosefactors, combined with a steady growth in demandfor consumer nondurables and services as well as animproving trade picture, could easily support growthof real GDP above 4 percent in the near term.

Strong growth for any of those reasons risks pre-cipitating a harsh response from the Federal Reserveand a hard landing later. The Federal Reserve hasstated repeatedly that it will act quickly to preventinflationary pressures from boiling over. Even afterthe slowing during the first half of the year, the econ-omy is at a very high level of resource use and risksoverheating. In the face of growth above potential—about 2!/2 percent—monetary policy is likely totighten further, perhaps aggressively. If that scenariooccurred, then the probability of a recession during1996 or 1997 would increase dramatically.

CBO's forecast assumes that the economy avoidsboth of those extremes and that growth continues

during the second half of the year and through 1996.That outlook assumes the Federal Reserve has suc-ceeded in guiding the economy between the risk ofrecession and that of accelerating inflation, therebyachieving its stated goal of monetary policy: sustain-able economic growth and moderate inflation.

The Blue Chip, Administration, andFederal Reserve Forecasts

The Blue Chip consensus, derived from a monthlysurvey of about 50 private-sector forecasters, expectsa milder slowdown and a more rapid pickup in eco-nomic growth during the next year and a half thandoes CBO. The consensus forecast for growth in realGDP is 2 percent in 1995 and 2.5 percent in 1996,compared with 1.3 percent and 2.3 percent for CBO(see Table 3). Despite the different view of growthduring the next two years, little difference exists be-tween the two forecasts on inflation or the unemploy-ment rate. Interest rates are slightly higher in theBlue Chip consensus. Short-term rates decline from5.6 percent in 1995 to 5.4 percent in 1996, and long-term rates moderate from 6.7 percent in 1995 to 6.5percent in 1996; CBO expects short-term rates to fallfrom 5.4 percent to 5.1 percent and long-term rates toslip from 6.5 percent to 6.4 percent between 1995and 1996.

CBO's forecast is also similar to the forecasts ofthe Administration and the Federal Reserve. Both ofthose alternatives foresee slightly faster real growthduring the next two years than CBO does, but theirassumptions about inflation and the unemploymentrate are quite close to CBO's.

Projection for the YearsBeyond 1996

CBO projects that growth of real GDP will average2.4 percent between 1997 and 2005 and that the rateof unemployment will hold steady at about 6 percentduring the same period (see Tables 4 and 5 on pages16 and 17). The growth of the CPI-U is projected todecline slightly during the medium term, down from


Table 3.Comparison of Forecasts for 1995

Nominal GDPCBOBlue ChipAdministrationFederal Reserve3

Real GDPb

CBOBlue ChipAdministrationFederal Reserve3

Implicit GDP DeflatorCBOBlue ChipAdministrationFederal Reserve3


CBOBlue ChipAdministrationFederal Reserve3

Civilian Unemployment RateCBOBlue ChipAdministrationFederal Reserve3

Three-Month Treasury Bill RateCBOBlue ChipAdministrationFederal Reserve3

Ten-Year Treasury Note RateCBOBlue Chip*AdministrationFederal Reserve3

SOURCES: Congressional Budget Office;

and 1996

Actual1994


6.56.56.56.5

4.14.14.14.1

2.32.32.32.3

2.62.62.62.6

Average Level in the Fourth Quarter(Percent)

5.65.65.65.6


4.34.34.34.3

7.17.17.17.1

Forecast1995

3.84.34.7

41/4 to 43/4

1.32.01.9

11/2to2

2.52.22.8

*

3.33.33.2

31/e to 3%

5.95.76.0

53/4 to 61/8

5.45.65.7

*

6.56.76.6

*

Eggert Economic Enterprises, Inc., Blue Chip Economic Indicators (August 10

1996

5.15.45.5

43/4 to 53/8

2.32.52.5

21/4 to 23/4

2.72.92.9

*

3.43.43.2

27/8 to 31/4

6.05.85.8

53/4 to 6V8

5.15.45.5

*

6.46.56.8

it

, 1995); Off ice ofManagement and Budget; Federal Reserve Board.

NOTES: * = not applicable. The Blue Chip forecasts through 1996 are based on a survey of 50 private forecasters.a. The Federal Reserve figures are the ranges-known as the central tendency-that include the majority of the forecasts

Market Committee members and otherb. Based on constant 1987 dollars.c. The consumer price index for all urban

Federal Reserve Bank presidents.

consumers (CPI-U).d. Blue Chip does not forecast a 10-year note rate. The values shown here for the 10-year note rate are based on the Blue

the Aaa bond rate, adjusted by CBO to

of Federal Open

Chip forecasts ofreflect the estimated spread between Aaa bonds and 10-year Treasury notes.


3.4 percent in 1996 to 3.3 percent in 1998, and 3.2percent thereafter. Interest rates will remain steadyin the years after 1996: the three-month Treasury billrate will average 5.1 percent through 2005, and the10-year Treasury note will average 6.7 percent dur-ing the same period.

CBO's medium-term projections do not reflectany attempt to estimate cyclical movements of the

economy during the 1997-2005 period or the effectsof fiscal policy on the year-to-year changes in eco-nomic activity. Instead, the projections are designedto approximate the level of economic activity on av-erage, including the possibility of above- or below-average rates of growth, inflation, and interest. CBOuses historical relationships to identify trends in fun-damental factors underlying the economy, includinggrowth of the labor force, the rate of national saving,

Table 4.The Economic Forecast and Projections for Calendar Years 1995 Through 2005



Nominal GDP(Percentage change)

Real GDP(Percentage change)3



UnemploymentRate (Percent)



Tax Bases(Percentage of GDP)

Corporate profits

6,738 7,058 7,385 7,764 8,165 8,587 9,032 9,497 9,986 10,501 11,042 11,610

6.2 4.7 4.6 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2

4.1 2.6 1.9 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4

2.1 2.1 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7

2.6 3.1 3.4 3.4 3.3 3.2 3.2 3.2 3.2 3.2 3.2 3.2

6.1 5.7 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

4.2 5.4 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1

7.1 6.5 6.4 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7

8.1 8.0 7.9 7.8 7.6 7.5 7.3 7.1 7.0 6.9 6.8 6.7Other taxable income 20.2 20.7 20.5 20.4 20.4 20.4 20.4 20.5 20.5 20.5 20.5 20.5Wage and salary

48.7 48.8 48.7 48.6 48.6 48.6 48.6 48.5 48.5 48.5 48.5 48.5disbursements

Total 76.9 77.5 77.1 76.8 76.6 76.4 76.3 76.1 76.0 75.9 75.8 75.7

SOURCE: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of LaborStatistics; Federal Reserve Board.

a. Based on constant 1987 dollars.



and growth of productivity. The projections of vari-ables such as real GDP, inflation, and real interestrates are then based on their historical norms. Theprojections do not include the effects of policies con-tained in the budget resolution and are more nearlyconsistent with the policies embodied in CBO's base-line projections of spending and revenues.

The Projection for Growth

The forecast for economic growth during the nearterm leaves real GDP just below the level of potentialreal GDP (see Figure 11). In fact, the gap in outputat the end of 1996 would be equal to the average gapthat existed during the period since 1960, and thatgap is held constant throughout the projection

Table 5.The Economic Forecast and Projections for Fiscal Years 1995 Through 2005



Nominal GDP(Percentage change)

Real GDP(Percentage change)3



UnemploymentRate (Percent)



Tax Bases(Percentage of GDP)

Corporate profits

6,634 6,992 7,295 7,667 8,062 8,479 8,918 9,379 9,862 10,370 10,904 11,465

5.9 5.4 4.3 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2

3.8 3.3 1.6 2.3 2.4 2.4 2.4 2.4 2.4 2.4 2.4 2.4

2.0 2.1 2.6 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7 2.7

2.6 2.9 3.3 3.4 3.3 3.2 3.2 3.2 3.2 3.2 3.2 3.2

6.1 5.6 5.9 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0 6.0

3.7 5.5 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1 5.1

6.5 6.9 6.3 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7 6.7

8.1 8.1 7.9 7.9 7.7 7.5 7.3 7.2 7.0 6.9 6.8 6.7Other taxable income 20.1 20.7 20.6 20.4 20.4 20.4 20.4 20.5 20.5 20.5 20.5 20.5Wage and salary

disbursements

Total

48.6 48.8 48.7 48.6 48.6 48.6 48.6 48.6 48.5 48.5 48.5

76.8 77.5 77.2 76.9 76.6 76.5 76.3 76.2 76.0 75.9 75.8 75.7

SOURCE: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of LaborStatistics; Federal Reserve Board.

a. Based on constant 1987 dollars.



period. Thus, CBO projects that real GDP will growat the same rate as potential real GDP during the1997-2005 period-that is, about 2.4 percent.

The growth of real GDP during the medium termis little changed from last winter's report because theoutlook for the factors that underlie the growth ofpotential output are little changed. The labor force isexpected to grow by 1.1 percent annually during the1997-2005 period, about the same rate that was as-sumed last winter. That rate reflects an increase inthe rate of labor force participation during the me-dium term, though at a slower rate than during the1970s and 1980s. The rate of national saving, whichaverages about 13 percent of GDP during the me-dium term, supports a rate of capital accumulation ofnearly 3 percent on average between 1997 and 2005,about the same as CBO assumed last winter. Growthof total factor productivity averages 0.7 percent ayear, which is almost identical to the rate assumedlast winter.

The Projection for Inflation

Since the level of real GDP is about equal to the levelof potential GDP at the end of 1996, there is no fur-ther upward pressure on the rate of inflation in wagesand prices. The same story is told by the unemploy-ment gap, which is the difference in percentage

Figure 11.GDP and Potential GDP

Billions of 1987 Dollars

1985 1990 1995 2000

points between the unemployment rate and theNAIRU. Therefore, CBO projects that the rate ofinflation will remain steady during the 1997-2005period. When measured using the implicit GDP de-flator, inflation averages 2.7 percent a year and theCPI-U grows at an average rate of 3.2 percent duringthe period.

CBO has reduced its projection for the CPI-U by0.2 percentage points beginning in 1998 to accountfor the planned rebenchmarking of the CPI-U.3 TheBureau of Labor Statistics has announced that it willreweight the CPI-U to reflect the cost of a typicalmarket basket of goods purchased by urban consum-ers during the 1993-1995 period, switching fromweights computed using expenditures from the 1982-1984 period. Updating the weights in that fashionwill place a heavier weight on goods with lower ratesof price increase. Consequently, the new measurewill grow more slowly than the old. CBO estimatesthat the rebenchmarking will slow the measured rateof inflation by 0.2 percentage points.

The Projection for Interest Rates

To project interest rates, CBO combines its projec-tion for inflation with a projection of real interestrates. Real interest rates are projected to reach theirlong-term historical averages gradually, with an ad-justment for any special factors present (or absent)that would make the 1990s different from the post-war period as a whole. Increased federal deficits andgreater demand for capital among newly industrial-ized and newly liberalized economies are two exam-ples of factors that tend to boost real interest ratesrelative to historical averages. CBO assumes that therate on three-month Treasury bills will remain steadyat 5.1 percent during the 1997-2005 period and thatthe rate on 10-year Treasury notes will hold at 6.7percent. Neither assumption has changed sinceCBO's winter report.


3. This rebenchmarking was not included in CBO's projectionsfrom last winter but was incorporated into the economic as-sumptions used for the budget resolution.

Chapter Two

The Baseline Budget Outlook

The Congressional Budget Office estimates thatthe deficit in the fiscal year ending September30, 1995, will total $161 billion-the smallest

posted deficit since 1989 and almost $100 billionlower than the deficit recorded just two years ago.Under current taxing and spending policies, though,the deficit is expected to resume an upward trend in1996. CBO projects a deficit of $189 billion nextyear, rising to $462 billion in 2005 if there is nochange in the laws and policies underlying the bud-get. As a percentage of gross domestic product, thedeficit rises from 2.3 percent in 1995 to 4.0 percentin 2005. Concerned over the prospect of persistentlarge deficits, the Congress is attempting to bring thebudget into balance by 2002. Chapter 3 describes thedeficit path proposed in the budget resolution.

In terms of baseline projections, little haschanged since CBO's last report to the Congress.The near-term outlook is somewhat brighter: com-pared with the estimates CBO published in its Aprilreport, An Analysis of the President's Budgetary Pro-posals for Fiscal Year 1996, the deficit is likely to beabout $13 billion lower in 1995 and $21 billion lowerin 1996. Those changes are almost entirely attribut-able to new economic information and other develop-ments; legislation adopted so far this year hasscarcely affected the budget totals. The near-termrevisions, however, do not alter CBO's view of long-run budget trends. By 2005, projected deficits arebasically the same as those CBO published in April.

The Deficit Outlook

Much of the concern about the budget stems from thesheer size of the federal deficit; Table 6 displays sev-eral measures of that gap. The most commonly usedmeasure of the deficit is simply the difference be-tween total revenues and total spending. Since thestatutory caps on discretionary spending are currentlyset to expire in 1998, CBO produces two projectionsof that difference-one assuming that discretionaryspending grows at the rate of inflation after 1998 andthe other assuming that it is frozen at the 1998 dollarlevel.

Participants in the budget debate often cite othermeasures of the deficit, such as the standardized-em-ployment, or structural, deficit. That figure showswhat is left after removing the cyclical deficit (thereduction in revenues and the extra spending on ben-efits that result when the economy operates below itsfull potential). With output around its full employ-ment level, the distinction between the structural def-icit and the conventionally measured deficit is farless relevant now than during a period of recession,such as was experienced in the early 1990s.

Spending and receipts for Social Security and thePostal Service, which are designated as off-budget bystatute, are often displayed separately. The surplusesor deficits of those programs are depicted in Table 6.Despite their special status, those off-budget transac-


Table 6.CBO Deficit Projections (By fiscal year)

Actual1994 1995 1996 1997 1998 1999 2000


Baseline Total DeficitWith discretionary inflation after 1998Without discretionary inflation after 1998

Standardized-Employment Deficit3

With discretionary inflation after 1998Without discretionary inflation after 1998

On-Budget Deficit (ExcludingSocial Security and Postal Service)


Memorandum:Deposit Insurance

Cyclical Deficit

Off-Budget SurplusSocial SecurityPostal Service

Total, Off-Budget Surplus

Baseline Total DeficitWith discretionary inflation after 1998Without discretionary inflation after 1998

Standardized-Employment Deficit3'0


203203

194194

259259

-8

16

57_d

56

As a Percentage

3.13.1

2.92.9

161161

189189

224224

-16

-11

621

63

of GDP

2.32.3

2.72.7

189189

188188

253253

-8

9

63_b

63

2.62.6

2.62.6

218218

211211

286286

-4

12

671

68

2.82.8

2.72.7

229229

221221

301301

-5

13

701

71

2.82.8

2.72.7

261243

251233

338319

-3

13

76-Jb

77

3.12.9

2.92.7

288250

277239

373335

-2

14

841

85

3.22.8

3.12.7


NOTE: Caps on discretionary spending are set by law through 1998. Measures of the deficit "with discretionary inflation" assume thatdiscretionary spending grows at the rate of inflation after 1998. Measures of the deficit "without discretionary inflation" assume thatdiscretionary spending remains frozen in dollar terms at the level of the 1998 caps.

a. Excludes the cyclical deficit and deposit insurance.

b. Less than $500 million.

c. Expressed as a percentage of potential gross domestic product.

CHAPTER TWO THE BASELINE BUDGET OUTLOOK 21

tions loom so large in the revenue and spending totalsthat any measure of the budget that omits them yieldsa distorted picture of the government's drain on creditmarkets and its role in the economy.

Changes in the BudgetOutlook Since April

Although the outlook for this year's and next year'sdeficit has noticeably improved, the longer-term pic-

ture remains close to what CBO had projected at thebeginning of the year. Deficits are down in eachyear, chiefly because of lower projected interestrates. New information on revenues and mandatoryprograms also contributes to lower deficit estimates;however, revenue losses due to economic changespartially offset those improvements in the deficit out-look (see Table 7).

Only three bills enacted so far this year have con-tributed significantly to changes in the baseline.Supplemental emergency spending-primarily fordefense readiness and disaster assistance—increases

Table 7.Changes in CBO Baseline Deficit

April Baseline Deficit withDiscretionary Inflation After 1998a

Legislative Changes

Economic ChangesRevenuesOutlays

Net interestOther outlays

Subtotal

Deficit

Technical ChangesRevenuesOutlays

DiscretionaryMandatoryDeposit insuranceNet interest

Subtotal

Deficit

Total Changes

August Baseline Deficit withDiscretionary Inflation After 1998a

Projections Since

1995

175

b

2

-2_b-2

b

-4

-2-7-1b

-9

-13

-13

161

April 1995

1996

210

-2

9

-171

-16

-6

-5

b-70

jj.-8

-13

-21

189

(By fiscal year,

1997

230

-1

12

-151

-13

-1

-5

b-30

^2-5

-10

-12

218

in billions

1998

232

b

12

-8J.-7

6

-3

0-20

^2-5

-8

-3

229

of dollars)

1999

266

b

11

-5_b-6

6

-5

0-30

J3-5

-11

-5

261

2000

299

b

9

-5^3-7

2

-6

0-20

^4-6

-13

-11

288


NOTE: Revenue increases are shown as negative because they reduce the deficit.

a. Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and grows at the rate ofinflation after that.



the deficit by $2 billion to $3 billion a year from1996 onward. That supplemental spending, however,is authorized in two rescission bills that also providefor cuts in outlays by similar amounts each year. Inaddition, to fund the extension of the deduction forhealth insurance costs incurred by self-employed in-dividuals, the Congress imposed an interest and divi-dend test on recipients of the earned income taxcredit (EITC) and repealed the preferential tax treat-

ment of income from sales of broadcast facilities tobuyers certified as minority businesses. In total, leg-islative action so far this year has reduced the deficitby $2 billion in 1996 and $1 billion in 1997, withnegligible effects in other years.

A more important source of revision is changesin the economic outlook. As noted in Chapter 1, pro-jected interest rates over the next year are expected to

Table 8.CBO Baseline Budget Projections with Discretionary Inflation After 1998 (By fiscal year)

Actual1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

RevenuesIndividual incomeCorporate incomeSocial insuranceOther

TotalOn-budgetOff-budget

OutlaysDiscretionary3

DefenseInternationalDomesticUnspecified reductions

Subtotal

MandatoryDeposit insuranceNet interestOffsetting receipts


DeficitOn-budget deficitOff-budget surplus

Debt Held by the Public

Memorandum:Gross Domestic Product

in Billions of Dollars

543 595 625140 156 159461 484 507113 122 122

652 687 725 767 812 859164 171 177 183 189 196527 551 579 609 638 670124 128 131 135 140 146

960 1,016212 221737 775157 163

1,258 1,357 1,413 1,468 1,537 1,612 1,694 1,779 1,870 1,966 2,066 2,175923 1,007 1,046 1,085 1,136 1,190 1,249 1,313 1,381 1,452 1,528 1,608335 350 367 383 401 422 445 466 489 513 538 566

282 26921 21243 256_Q _Q546 546

27022264

27822274

28522285

29523296-39

30424307-42

31424317-44

32425327-45

33426338-47

550 553 556 574 593 612 631 651

345 35627 28349 360-48 -50672 694

791 835 893 958 1,023 1,095 1,172 1,246 1,333 1,425 1,523 1,635-8 -16 -8 -4 -5 -3 -2 -2 -2 -2 -1 -1

203 233 242 255 271 288 305 321 342 364 388 415-71 -79 -75 -75 -79 -81 -85 -89 -93 -97 -102 -106

1,461 1,518 1,602 1,686 1,766 1,873 1,982 2,087 2,211 2,341 2,480 2,6371,182 1,231 1,299 1,371 1,437 1,527 1,622 1,710 1,817 1,930 2,052 2,190279 287 304 315 329 346 360 377 393 410 428 447

203 161259 22456 63

18925363

21828668

22930171

26133877

28837385

30839789

34043696

375478103

414 462523 582110 119

3,432 3,605 3,809 4,044 4,289 4,568 4,873 5,199 5,557 5,949 6,380 6,860

6,634 6,992 7,295 7,667 8,062 8,479 8,918 9,379 9,862 10,370 10,904 11,465

^Continued)


be about a full percentage point lower than CBO hadpreviously forecast. With federal debt held by thepublic standing near $3.6 trillion, those lower ratestranslate into significant interest savings--$17 billionin 1996 and $15 billion in 1997. Smaller savingsaccrue through the end of the decade as interest ratesadjust to projected long-term levels.

Decreased revenues stemming from downwardrevisions in CBO's income projections, though, willmore than offset interest rate savings by 1998. Inthat year, revenues are projected to be $12 billionless, leading to an overall increase of $6 billion inCBO's baseline deficit due to economic changes.

Table 8.Continued

Actual1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

As a Percentage of GDPRevenues

Individual incomeCorporate incomeSocial insuranceOther


OutlaysDiscretionary3

DefenseInternationalDomesticUnspecified reductions

Subtotal

MandatoryDeposit insuranceNet interestOffsetting receipts


DeficitOn-budget deficitOff-budget surplus


8.22.17.0

AJ.

19.013.95.1

4.30.33.7

08.2

22.017.84.2

3.13.90.8

8.52.26.9

_LZ

19.414.45.0

8.62.27.0

19.414.35.0

8.52.16.9

JL§

19.114.15.0

8.52.16.8

8.52.16.8

3.80.33.7_o7.8

11.9-0.23.3

-1.1

21.717.64.1

2.33.20.9

3.70.33.6

^QJ.7.5

12.2-0.13.3

-1.0

22.017.84.2

2.63.50.9

3.60.33.6

JL27.2

12.5-0.13.3

-1.0

22.017.94.1

2.83.70.9

19.114.15.0

3.50.33.5

19.014.05.0

3.50.33.5

8.62.06.81.5

19.014.05.0

3.40.33.4

8.72.06.81.5

19.014.05.0

3.30.33.4

8.72.06.8

19.014.05.0

3.30.33.3

8.82.06.8

19.014.05.0

3.20.23.3

8.81.96.81.4

19.014.04.9

3.20.23.2

21.917.84.1

2.83.70.9

22.118.04.1

3.14.00.9

22.218.24.0

3.24.21.0

22.318.24.0

3.34.20.9

22.418.44.0

3.54.41.0

22.618.64.0

3.64.61.0

22.718.83.9

3.84.81.0

8.91.96.81.4

19.014.04.9

3.10.23.1

6.9 6.8 6.6 6.5 6.4 6.3 6.2 6.0

11.9-0.13.1

-1.1

11.9-0.23.3

-1.1

12.2-0.13.3

-1.0

12.5-0.13.3

jiQ

12.7-0.13.4

^LQ

12.9b

3.410

13.1b

3.4^LQ

13.3b

3.4^LQ

13.5b

3.5^09

13.7b

3.5^09

14.0b

3.6^9

14.3b

3.6^9

23.019.13.9

4.05.11.0

51.7 51.6 52.2 52.7 53.2 53.9 54.6 55.4 56.3 57.4 58.5 59.8


a. Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and grows at the rate ofinflation after that. Discretionary outlays would be $18 billion lower in 1999 and $39 billion lower in 2000 if no adjustment for inflation wasassumed.

b. Less than 0.05 percent.


Revisions that do not result from economic de-velopments or new legislation are classified as tech-nical and can occur for a variety of reasons. Incometax projections, for example, have been revised up-ward because of higher-than-expected receipts thisyear and other factors.

Other, relatively small revisions to CBO's out-look have occurred since April. In addition to thereduction in outlays for the earned income tax creditachieved through legislation, CBO has reduced itsestimates of EITC outlays by $2 billion to $3 billiona year throughout the projection period. EITC spend-ing has been lower than expected this year, possiblyas a result of a recent crackdown by the Internal Rev-enue Service on fraudulent claims. Current spendingpatterns also indicate that the Commodity CreditCorporation, the Postal Service, and various othermandatory programs will spend less this year thanoriginally thought.

CBO Baseline Projections

In 1995, federal revenues are expected to equal$1,357 billion and outlays $1,518 billion. The majorcomponents of those totals and their projected growthover the next five years are depicted in Table 8 (seepages 22 and 23).

Although persistent deficits have spurred a num-ber of recent proposals to balance the budget over thenext several years, none of the proposals have yetbeen enacted (see Chapter 3). CBO's baseline projec-tions therefore do not reflect the savings those pro-posals might achieve. Instead, the projections indi-cate the path that federal spending will take if gov-ernment programs continue on the course implied bycurrent law. Although spending and revenues areunderstandably more difficult to estimate beyond theusual five-year budget window, long-term projec-tions often figure heavily in policymakers' decisions.Thus, CBO makes reasonable assumptions about fu-ture budget levels based on its analysis of broadtrends in federal programs.

The Outlook for Revenues

Federal revenues are expected to equal 19.4 percentof GDP in 1995, up from 19.0 percent in 1994. Indi-vidual income taxes are the main source of thatgrowth; they increase from 8.2 percent of GDP in1994 to 8.5 percent in 1995, reflecting in part the taxincreases legislated in the Omnibus Budget Reconcil-iation Act of 1993. The government's other majorsources of revenue—corporate income taxes, socialinsurance taxes, excise taxes, estate and gift taxes,customs duties, and profits returned by the FederalReserve System—remain more or less constant overthe next decade as a percentage of GDP.

The Outlook for Spending

The Budget Enforcement Act of 1990 formalized theuse of several categories that had long been used todescribe federal spending. Discretionary spending isfunded anew each year through the appropriationprocess. Such spending encompasses nearly the en-tire budgets for defense and international affairs anda wide variety of domestic programs-space and sci-ence, environmental protection, transportation, manyeducation and social service programs, veterans'medical care, law enforcement activities, and the op-eration of the Internal Revenue Service, to name afew.

In its baseline projections, CBO assumes thatpolicymakers will continue to abide by the discre-tionary spending limits set in law through 1998. Sep-arate caps apply to budget authority (the authority tocommit funds, the basic currency of the appropriationprocess) and outlays (actual spending); the stricterconstraint governs. Within those limits, policy-makers must make trade-offs among competingneeds—defense, international, and domestic. Becausethe caps hold discretionary spending relatively fiateven as output grows, such outlays shrink steadily inrelation to the economy. From 7.8 percent of GDPtoday-already far below the levels of 10 percent to12 percent that were typical of the 1960-1989 period—total discretionary spending drifts down to 6.0 per-cent in 2005 if it grows with inflation after 1998.


The drop in discretionary spending as a percent-age of GDP is even more precipitous if appropria-tions are frozen at the 1998 level. As shown in Table9, discretionary outlays would fall to 4.9 percent ofGDP in 2005—less than one-fourth of total federalspending—if frozen at their 1998 level.

Outlays for entitlements and other mandatoryprograms, by far the largest spending category, willamount to $835 billion this year and are growing fast.Fueling that growth are expenditures for Social Secu-

rity, Medicare, and Medicaid, which together accountfor about three-quarters of all mandatory outlays.Lawmakers control mandatory spending indirectly-not by voting annual dollar amounts but by settingstandards for eligibility, benefit formulas, and soforth. Table 10 displays more information about thishuge cluster of programs.

The big health entitlements essentially explainwhy mandatory spending, and eventually the deficit,are projected to grow in relation to GDP. Health-

Table 9.The Budget Outlook Through 2005 Without Discretionary Inflation After 1998 (By fiscal year)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Revenues

OutlaysDiscretionaryNet interestAll other3


1,357 1,413 1,468 1,537 1,612 1,694 1,779 1,870 1,966 2,066 2,175

546 550 553 556 556 556 556 556 556 556 556233 242 255 271 287 302 316 332 348 365 382739 810 879 939 1.011 1.085 1.155 1.238 1.326 1.420 1.528

Total 1,518 1,602 1,686 1,766 1,854 1,944 2,027 2,126 2,230 2,341 2,467

Deficit 161 189 218 229 243 250 247 256 264 275 292

Debt Held by the Public 3,605 3,809 4,044 4,289 4,549 4,816 5,081 5,355 5,636 5,929 6,239

As a Percentage of GDP

19.1 19.1 19.0 19.0Revenues 19.4 19.4 19.0 19.0 19.0 19.0 19.0

OutlaysDiscretionaryNet interestAll other3

Total

Deficit


7.83.3

10.6

21.7

2.3

51.6

7.53.3

11.1

22.0

2.6

52.2

7.23.3

JLLS

22.0

2.8

52.7

6.93.4

11.7

21.9

2.8

53.2

6.63.4

11.9

21.9

2.9

53.7

6.23.4

12.2

21.8

2.8

54.0

5.93.4

12.3

21.6

2.6

54.2

5.63.4

12.6

21.6

2.6

54.3

5.43.4

12.8

21.5

2.5

54.4

5.13.3

13.0

21.5

2.5

54.4

4.93.3

13.3

21.5

2.5

54.4


NOTE: Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998. Discretionary spendingis held constant at the 1998 level from 1999 through 2005.

a. Spending for all other categories-mandatory outlays, deposit insurance, and offsetting receipts-would be the same as in Table 8.


Table 10.CBO Baseline Projections for Mandatory Spending (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

MedicaidFood Stamps3

Supplemental Security IncomeFamily SupportVeterans' PensionsChild NutritionEarned Income Tax CreditStudent Loansb

Other

Total, Means-TestedPrograms

Social SecurityMedicare

Subtotal

Other Retirement and DisabilityFederal civilian0

MilitaryOther

Subtotal

Unemployment Compensation

Other ProgramsVeterans' benefitsd

Social servicesCredit reform liquidating accountsOther

Subtotal

Total, Non-Means-TestedPrograms

Total Mandatory Spending

Means-Tested Programs

8926241838154

_3

99272419381834

110293019392034

12230332039

2135

1353236203102235

1483343213

112336

1633539213

112436

1783747223122537

1953950233132647

2124054243132748

2324263243142848

191 205 226 245 266 291 306 333 359 386 420

Non-Means-Tested Programs

333 352 371 391 412 434 456 480 505 532 560178 199 219 240 263 288 315 345 379 416 458511 551 590 631 675 722 771 825 884 948 1,018

4328_575

4428_476

4630480

4931584

5133_589

54 57 59 6234 36 38 39

_S _5 _5 _593 97 102 106

65 6941 43

_5 _5111 116

21 24 25 26 27 28 30 31 33 34 35

176-11537

176-41837

196-61837

196-71937

206-71938

226-71739

236-71941

236-71942

246-71943

256-71944

276-71946

644 687 732 778 829 882 940 1,000 1,066 1,137 1,215

Total

835 893 958 1,023 1,095 1,172 1,246 1,333 1,425 1,523 1,635


NOTE: Spending for major benefit programs shown in this table includes benefits only. Outlays for administrative costs of most benefitprograms are classified as domestic discretionary spending; Medicare premium collections are classified as offsetting receipts.

a. Includes nutrition assistance to Puerto Rico.

b. Formerly known as guaranteed student loans.

c. Includes Civil Service, Foreign Service, Coast Guard, and other retirement programs, and annuitants' health benefits.

d. Includes veterans' compensation, readjustment benefits, life insurance, and housing programs.


related mandatory spending is growing considerablyfaster than the rest of the economy. Rising at a rateof about 10 percent a year, total Medicaid and Medi-care outlays are projected to more than double by2005. That rapid growth helps explain why the Hos-pital Insurance Trust Fund is expected to begin run-ning a deficit in the current fiscal year and will be outof money in 2001. Combined, Medicaid and Medi-care will expand dramatically in relation to GDP,from 3.8 percent in 1995 to 6.0 percent in 2005.CBO projects that those two programs alone willnearly equal total discretionary spending at the end of10 years or easily surpass it if discretionary spendingis not allowed to grow with inflation after 1998. (SeeAppendix D for a discussion of national expenditureson health care.)

Deposit insurance spending spurted from 1988 to1991 but then subsided, turning negative in 1993 and1994 (see Table 8). CBO expects that net outlayswill continue to be negative but in shrinking amountsafter 1995, as proceeds from liquidations begin to dryup and as the government cuts the assessment thatinstitutions must pay to the Bank Insurance Fund oninsured deposits.

Net interest payments for the past few years havebeen remarkably flat (around $200 billion a year),largely because of low interest rates. However, thecombination of higher interest rates early in 1995 anda persistently large deficit will boost net interest to$233 billion in 1995 and over $400 billion in 2005.Correspondingly, federal debt will continue to in-crease, with debt held by the public rising to almost60 percent of GDP in 2005. Another measure of debtthat will be receiving a lot of attention as the Trea-sury nears the ceiling on federal borrowing authoritythis fall is the debt subject to limit. Chapter 4 dis-cusses that measure and projects its future growth.

The last category of outlays, offsetting receipts,is composed of various receipts and collections thatare recorded as negative outlays rather than as reve-nues. Those receipts come either from the public(such as voluntary Medicare premiums or paymentsfor licenses to use portions of the electromagneticspectrum) or from within the government (such asagencies' contributions to retirement funds). Offset-ting receipts amount to a steady 1 percent of GDP inCBO's projections.

Ten-year projections inherently carry with them agreat deal of uncertainty. Unexpected changes ineconomic growth or interest rates can have profoundeffects on revenues and outlays. Also, unanticipatedoccurrences will certainly affect federal finances 10years down the road. Nevertheless, despite the un-certainties surrounding the economic and budget pro-jections, attempts to eliminate the deficit within thenext 10 years will clearly require significant changesin current fiscal policy.

A Comparison with theAdministration's Projections

At the end of July, the Administration's Office ofManagement and Budget (OMB) issued its midses-sion review of the budget. In that publication, theAdministration outlined a budgetary plan for fiscalyears 1996 through 2005 that included reductions incorporate subsidies and outlay savings designed tomake large reductions in the federal deficit. ThePresident's plan, though, starts from a baseline thatdiffers from CBO's baseline by growing amountsthrough 2005 (see Table 11).

CBO and OMB agree about the current year'sdeficit; by 2005, however, CBO's estimate of the def-icit under current policies is $214 billion aboveOMB's projection. Small differences in economicassumptions along with other, technical estimatingdifferences add up to large discrepancies by the endof the projection period.

On average, the Administration foresees slightlyfaster economic growth and lower inflation (as mea-sured by the consumer price index) than does CBO.Because the CPI affects indexed benefit programsand tax brackets, and the GDP deflator affects esti-mates of taxable income, CBO's assumption of alarger gap between the two growth rates adds to itsprojection of the deficit. Projections of economicgrowth and inflation diverge by just 0.1 percentagepoint a year; but combined with offsetting technicaldifferences, that translates into a $76 billion gap inrevenues in 2005.


Estimating differences unrelated to economicassumptions also contribute to the difference betweenCBO's estimate of the baseline deficit and the Ad-ministration's. In 2005, about $52 billion of the dif-ference in projected spending stems from differencesin Medicare and Medicaid. Although CBO believesthat the growth of those programs will slow from theextremely high rates of recent years, it is not quite asoptimistic as the Administration about the extent towhich such a slowdown would occur without achange in policy.

The Federal Sector of theNational Income and ProductAccounts

The projections summarized so far in this chapterdraw on the usual labels—revenues by source, outlaysby category—that are familiar to policymakers.Economists, though, often use another approach for

Table 11.Comparison of CBO Baseline with OMB Midsession Review Baseline (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

OMB Midsession ReviewBaseline Deficit 160 185 197

DifferencesOutlays

Discretionary -5 -1 -1Mandatory

194 202 208 206 216 222 235 248

Social SecurityMedicareMedicaidOther

Subtotal

Net interest

Total

Revenues

Deficit

CBO Baseline Deficit

-131

_15

JL

a

1

1

161

223

^15

j£

-1

5

4

189

335

_i11

.16

4

17

22

218

448

^114

Ji

10

24

35

229

48

10_628

_;3

27

32

59

261

51012_835

a

37

43

80

288

612141446

_2

50

51

101

308

71515J654

Jl

68

57

125

340

820172Q.65

21

91

62

153

375

925182275

^2

112

66

178

414

932202688

44

138

76

214

462

SOURCES: Congressional Budget Office; Office of Management and Budget.

NOTES: Both baselines assume that discretionary spending is equal to the spending limits that are in effect through 1998 and grows at therate of inflation after that.

Reductions in revenues are shown as positive because they increase the deficit,

a. Less than $500 million.


Table 12.Relationship of the Budget to the Federal Sector of the National Income and Product(By fiscal year, in billions of dollars)

Actual1994a

Revenue (Budget basis)b

DifferencesNetting and grossing

Government contributionsfor employee retirement

Medicare premiumsDeposit insurance premiumsOther

Geographic exclusionsOther

Total

Receipts (NIPA basis)

1,258

571873

-2JO

92

1,349

1995 1996

Receipts1,357 1

582079

-3^3

89

1 ,445 1

,413

602023

-3_Q

83

,496

1997

1,468

63222c

-3

.2

88

1,555

1998

1,537

67242c

-3.2

92

1,629

Accounts

1999

1,612

7026

2-2-3_2

96

1,708

2000

1,694

7427

2-2-3_c

98

1,792

ExpendituresOutlays (Budget basis)b

DifferencesNetting and grossing

Government contributionsfor employee retirement

Medicare premiumsDeposit insurance premiumsOther

Lending and financial transactionsDeposit insuranceOther

Defense timing adjustmentGeographic exclusionsOther

Total

Expenditures (NIPA basis)

Deficit (Budget basis)b

DifferencesLending and financial transactionsDefense timing adjustmentGeographic exclusionsOther

Total

Deficit (NIPA basis)


1,461

571873

1-11

-9-8

68

1,529

203

c1

-6ilfi

-24

180

NOTE: Projections assume that discretionary spendinginflation after that.

1,518 1

5820

79

11-31

-9-4

90

1 ,608 1

Deficit161

81

-7~ *

2

163

,602

602023

5-15

-10-4

82

,684

189

55

-7-3

-1

189

is equal to the spending limits

a. Differences estimated by CBO. Actual NIPA receipts, expenditures, and deficit

1,686

6322

2c

111

-10-8

73

1,759

218

21

-7-11

-15

203

that are in

1,766

6724

2c

121

-11-8

78

1,845

229

31

-8-10

-14

215

effect through

1,873

70262

-2

c11

-11-8

79

1,951

261

c1

-8-10

-17

244

1,982

74272

-2

-1c1

-12-14

75

2,057

288

-21

-9-14

-24

265

1998 and grows at the rate of

for 1994 are subject to revision by the Department ofCommerce, Bureau of Economic Analysis.

b. Includes Social Security and the Postalc. Less than $500 million.

Service.


Table 13.Projections of Baseline Receipts and Expenditures Measured by the National Income and Product Accounts(By fiscal year, in billions of dollars)

Actual1994a 1995 1996 1997 1998 1999 2000

Receipts

Personal Tax and Nontax Receipts

Corporate Profits Tax Accruals

Indirect Business Tax and Nontax Accruals

Contributions for Social Insurance

Total

Purchases of Goods and ServicesDefenseNondefense

Subtotal

Transfer PaymentsDomesticForeign

Subtotal

552

161

93

543

1,349

599

177

97

572

1,445

Expenditures

296 288144 148439 436

66016

676

70015

715

636

173

94

592

1,496

293154446

75215

766

664

180

92

619

1,555

299161460

80115

816

700

186

94

649

1,629

307168475

852

868

738

194

95

681

1,708

319174493

907JL6923

780

201

97

714

1,792

330181511

96416

980

Grants-in-Aid to Stateand Local Governments

Net Interest

Subsidies Less Current Surplusof Government Enterprises

Required Reductions inDiscretionary Spending

Total

Deficit

195 213 225 239 256 274 292

186 213 221 231 246 263 278

32 31 31

-6

34

-22

35

-36

38

-39

1,529 1,608

Deficit

180 163

38

-43

1,684 1,759 1,845 1,951 2,057

189 203 215 244 265


NOTES: Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and grows at the rateof inflation after that.

* = not applicable.

a. Differences estimated by CBO. Actual NIPA receipts, expenditures, and deficit for 1994 are subject to revision by the Department ofCommerce, Bureau of Economic Analysis.


measuring the government's activities. The federalsector of the national income and product accounts(NIPAs) divides the government's spending and re-ceipts into categories that are conventionally used toanalyze domestic production and income. That cate-gorization allows economists to track the relationshipbetween the government and other sectors of theeconomy.

Just a few major differences distinguish theNIPA versions of federal receipts and expendituresfrom their budget analogues. Netting and grossingadjustments move some collections, mainly thoselabeled offsetting receipts in the budget, from thespending to the receipts side of the NIPAs (see Table12 on page 29). Most are recorded in the budget asnegative outlays because they do not result from thegovernment's taxing power. Shifting them to the re-ceipts side of the NIPA ledger gives the users a fullerpicture of government receipts regardless of sourceand does not affect the total deficit.

Macroeconomic analysis typically disregardstransactions that merely reflect the transfer of exist-ing assets and liabilities and do not contribute to cur-rent production. The NIPAs therefore exclude lend-ing and financial transactions that appear in the bud-get. Prominent among such adjustments are those fordeposit insurance outlays and for direct loans andguarantees made before 1992 (when credit reformwas enacted). Other, relatively minor factors thatcause the NIPA and budget totals to diverge are geo-graphic adjustments (the exclusion of Puerto Rico,the Virgin Islands, and a few other areas from do-mestic economic statistics) and timing adjustments(such as the recording of corporate taxes when ac-crued rather than paid, adjustments for irregular num-bers of benefit checks or paychecks because of calen-dar quirks, and so forth).

Tracing the relationship between the NIPA andthe budget data is complicated by the fact that theBureau of Economic Analysis regularly revises theNIPA data-sometimes by large amounts. Budgettotals, in contrast, seldom receive more than negligi-ble revisions. Nevertheless, when the dust finallysettles, the NIPA deficit generally resembles the bud-get deficit excluding deposit insurance—echoingCBO's frequent emphasis on that measure in its regu-lar budget reports.

The NIPA federal sector generally portrays re-ceipts according to their sources and expendituresaccording to their purpose and destination (see Table13). Receipts are split into four large categories-personal tax and nontax receipts, corporate profits taxaccruals, indirect business tax and nontax accruals,and social insurance contributions—whose labelssummarize the nature of the collection and the iden-tity of the payer. The term "nontax" indicates thatNIPA receipts include some charges, such as fees andpremiums, that are not generally treated as revenuesin the budget.

Federal spending can take the form of defenseand nondefense purchases (which enter directly intoGDP), transfers (most of which find their way intopersonal income and from there into consumption orsaving), grants to state and local governments (whichmay end up as state and local purchases or transfers),net interest, and the subsidies less the current surplusof government enterprises such as the Postal Serviceand public housing authorities. A final category-required reductions in discretionary spending-ap-pears in Table 13 as a consequence of the discretion-ary spending caps that are mandated by law. Thosecaps will limit future spending for programs fundedthrough the appropriation process. Although no onecan predict how particular programs will fare, thedeepest effects of the required reductions will almostcertainly be felt in the NIPA categories of defenseand nondefense purchases and grants.

Chapter Three

The Congressional Budget Resolutionand the Economic Effects of

Balancing the Budget

T he budget resolution adopted by the Congressearlier this summer proposes a dramaticchange in fiscal policy that would lead to a

balanced budget in 2002. It calls for reducing defi-cits over the 1996-2002 period by about $1.25 trillioncompared with the Congressional Budget Office'sprojections under current policy. This change in pol-icy is not reflected in the baseline economic and bud-get projections detailed in Chapters 1 and 2. Al-though the Congress has adopted the budget resolu-tion, it has not completed action on the legislationneeded to implement the plan-to provide appropria-tions for 1996, set new statutory caps to limit futureappropriations to the levels assumed by the resolu-tion, and make the changes in the laws governingmandatory programs to reduce spending for thoseprograms.

If the implementing legislation is enacted this fallas the budget resolution assumes, CBO's winter 1996baseline budget projections will be dramatically dif-ferent from those presented in Chapter 2. CBO be-lieves that enacting legislation that puts the govern-ment on a credible path to a balanced budget by 2002will also affect the economy. The economic effectsof balancing the budget are likely to be similar to thereduction in interest rates and the slight increase inreal growth that CBO detailed in Appendix B of itsApril 1995 report An Analysis of the President's Bud-getary Proposals for Fiscal Year 1996. They wouldlower federal interest costs and increase revenues byan estimated $50 billion in 2002 and a total of $170billion in 1996 through 2002. Those savings havebeen referred to as a fiscal dividend.

The budget resolution also assumes a significanttax cut, although the effects of the tax cut are not re-flected in the revenue totals stated in the resolution.The resolution establishes a procedure that will allowa tax cut totaling $50 billion in 2002 and $245 billionover the 1996-2002 period if CBO certifies that rec-onciliation legislation, which is intended to imple-ment the changes in mandatory spending and reve-nues assumed in the budget plan, produces the sav-ings required to balance the budget in 2002.

The Budget Resolution

CBO projects that the deficit will grow to nearly$350 billion in 2002 under current policies, assumingthat discretionary spending after 1998 equals thelevel of the statutory cap for 1998 adjusted for infla-tion. In contrast, the budget resolution represents aseven-year plan to balance the budget (see Figure12). Since the budget resolution is based on eco-nomic and technical assumptions that are largely thesame as those CBO used in its baseline projections inApril 1995, the budget resolution assumes that signif-icant changes in policy are required to achieve a bal-anced budget by 2002. (Because the budget resolu-tion is based on the April projections and becausethere is little difference for most years betweenCBO's April projections and the projections de-scribed in Chapter 2 of this report, this chapter usesthe April baseline as the starting point for describingthe budget resolution and its effects.)


Figure 12.Comparison of Projected Deficits (By fiscal year)

Billions of Dollars500

450

400

350

300

250

200

150

100

50

0

-50

CBO's April Baseline

CBO's August Baseline

Budget ResolutionWithout Tax Cut or

Fiscal Dividend President's JulyBudget as

Estimated by CBO

1995 1997 2003 2005


The resolution proposes to balance the budget in2002 by reducing discretionary spending in that yearabout $30 billion below the 1995 nominal level($121 billion below CBO's baseline level) and bymaking changes in mandatory programs (particularlyMedicare and Medicaid) that would reduce spending$161 billion below the level projected for 2002 undercurrent policy. Those savings, along with proposedsavings in the preceding years, would reduce the gov-ernment's costs of servicing the debt by $66 billion in2002.

The resolution also allows the Congress to con-sider a large tax cut if CBO certifies that the legisla-tion implementing the budget resolution wouldachieve a balanced budget in 2002. Because the ef-fects of the tax cut are not reflected in the revenuelevels of the resolution, the tax cut would increasethe deficits stated in the resolution. However, thefiscal dividend from balancing the budget also is notreflected in the resolution totals. The effects of thatdividend would fully offset the planned tax cut in2002 and would partially offset it in the earlier yearscovered by the budget resolution.

Baseline Assumptions of the BudgetResolution

As is the case with almost any budget plan, the start-ing point for developing the budget resolution is a

projection of the spending, revenues, and deficit un-der current policies. Such a starting point allows par-ticipants in the budget process to consider the appro-priate changes in policy. If a particular outcome-such as a balanced budget—is desired, the baselineprojections indicate how much of a change is neededto reach that goal.

Baseline projections of discretionary spendingare both more ambiguous and less important thanbaseline projections of mandatory spending and reve-nues. Discretionary spending is determined by theamount appropriated in legislation enacted each year.With minor exceptions, current laws do not providediscretionary appropriations for 1996 or any subse-quent year. Thus, it is not clear what current policyis regarding spending in those years.

This ambiguity allows different interpretations ofcurrent-policy baselines for discretionary spending.For example, the baseline used by the Senate Com-mittee on the Budget assumed that appropriations fornondefense accounts in 1996 through 2002 would bethe same as in 1995 but that appropriations for de-fense accounts would equal President Clinton's Feb-ruary 1994 budget request (adjusted to reflect actualappropriations for 1995). In describing the discre-tionary spending in the budget resolution, the HouseCommittee on the Budget compared the levels rec-ommended for 1996 through 2002 with estimatedspending in 1995. In contrast, the CBO baseline dis-cussed in this chapter assumes that discretionaryspending will equal the statutory limits that applythrough 1998 and will increase at the rate of inflationafter 1998.

Because setting the policy for discretionaryspending in future years simply requires determiningthe amount to be appropriated in those years, agree-ing on a discretionary baseline is not crucial to reach-ing agreement on the policy or defining it. In theend, the specified level of discretionary spending rep-resents the same policy whether it is described as acut from an inflated baseline or an increase abovezero funding. The difference between CBO's base-line with discretionary inflation after 1998 and thebaseline for discretionary spending used by the bud-get committees does not reflect any difference in eco-nomic or technical assumptions, and the difference istherefore not included in the baseline adjustments in

CHAPTER THREE THE BUDGET RESOLUTION AND THE ECONOMY 35

Table 14. However, the difference between CBO'sbaseline and the discretionary spending proposed inthe resolution is separated into the effects from freez-ing discretionary spending at the 1995 appropriatedlevel and the additional cuts required to reach thelevels specified in the resolution.

In contrast to the process that determines discre-tionary spending, laws currently in place will deter-mine mandatory spending and revenues in futureyears if no new legislation is enacted. Laws govern-ing mandatory programs usually define who is eligi-ble for benefits and set rules that determine theamount to be paid to beneficiaries based on theircharacteristics such as age, income, or contributionspaid into the program fund. Revenues are governedby laws defining the taxes to be paid on certain typesof income or on certain transactions. Current policyfor mandatory programs and revenues simply meansthe eligibility rules, benefit levels, and tax rules spec-ified in current laws. Most analysts agree on whatthose laws provide. But the level of mandatoryspending and revenues projected under those lawsdepends on assumptions about the number of peoplewho will be eligible, their characteristics, the level oftaxable income that will be reached, and a host ofother factors referred to as economic and technicalassumptions.

Economic and technical assumptions can have amajor impact on the baseline projections of manda-tory spending and revenues, and in turn, those projec-tions can have a major impact on policy proposalsand decisions. For instance, the President has pre-sented proposals in his July 31 Mid-Session Reviewof the 1996 Budget that are intended to lead to a bal-anced budget by 2004. The economic and technicalassumptions in the Administration's baseline areslightly more optimistic than CBO's, as discussed inChapter 2. Because the cumulative effect of thosedifferences reduces the baseline deficits estimated bythe Administration (spending is lower and revenuesare higher) compared with CBO's projections, thedeficit reduction proposed by the President is signifi-cantly smaller than the budget resolution calls for.Using CBO's economic and technical assumptions,the President's proposals would result in deficits thathover around $200 billion from 2002 through 2005(see Figure 12 and testimony by the Director of CBO

before the House Committee on the Budget on Au-gust 3, 1995).

The budget resolution, however, is essentiallybased on CBO's economic and technical assump-tions; the mandatory spending and revenue baselineused in developing the budget resolution is largelythe same as CBO's April 1995 baseline. The mostsignificant adjustment to that baseline results fromassuming that annual increases in the consumer priceindex will be 0.2 percentage points lower starting incalendar year 1998 than CBO's baseline had as-sumed. That adjustment reflects CBO's estimate thatits baseline economic projections, which were com-pleted in December 1994, understated the reductionin the reported CPI that is likely to result when theBureau of Labor Statistics rebenchmarks the CPI in1998. As shown in Table 14, the CPI adjustment,which lowers mandatory spending and raises reve-nues, reduces the baseline projection of the deficit in2002 by $9 billion.

The budget resolution's baseline was also ad-justed to account for a change in the method of calcu-lating the subsidy costs of direct student loans. Theresolution requires that estimates made for purposesof the Congressional Budget Act include the costs ofadministering the direct student loan program in thesubsidy costs of the loans. Recalculating the subsi-dies of direct loans increased the projected baselinecost of the student loan program by almost $1 billionin 2002.

The only other significant adjustment dealt withexcise taxes on oil and chemical feedstock that arededicated to Superfund and are scheduled to expire inDecember 1995. CBO's baseline follows the baselinerules for revenues set forth in section 257(b) of theBalanced Budget and Emergency Deficit Control Actof 1985, as amended, and assumes that expiring ex-cise taxes that are dedicated to a trust fund will beextended at current rates. The budget resolution'sbaseline assumes that the Superfund taxes will expireas provided under current law, reducing baseline rev-enues by less than $1 billion in 2002.

The budget resolution also assumes that balanc-ing the budget will produce lower interest rates and aslightly higher rate of economic growth than the


Table 14.Changes in the Budget Resolution from CBO's April Baseline (By fiscal year, in billions of dollars)

Total,1996 1997 1998 1999 2000 2001 2002 1996-2002

CBO April Baseline Deficit3

Baseline Adjustments'1

CPI rebenchmarking0

Other adjustments

210

0_L

230

0_1

232

0_[

266

-1_2

299

-3_2

316

-6_L

349

-9_L

*

-18JIO

Total0 1 1 1 1 - 1 - 4 - 8 - 9

Policy ChangesOutlays

DiscretionaryFreezed

Additional savingsSubtotal

MandatoryMedicareMedicaidOther

Subtotal

Net interest

Total Outlays

Revenues0

Total PolicyChanges

Total Adjustments andPolicy Changes

Budget Resolution Deficit

-8-10-18

-8-4

-10-22

-1

-41

_e

-41

-40

170

-9-21-29

-18-8

-19-45

-5

-79

e

-79

-78

152

-12-21-39

-27-16^25-67

11

-117

e

-117

-116

116

-35-24-59

-37-24^26-87

_^2Q

-167

e

-167

-166

100

-55-20-75

-49-33-29

-111

-217

e

-218

-219

81

-75i24-99

-60-43-30

-133

-47

-278

-278

-283

33

-96_^25-121

-71-54

_^36-161

-66

-348

-348

-356

-6

-289

^440

-270-182115-626

-181

-1,247

-1,248

-1,257

*

SOURCE: Congressional Budget Office based on U.S. House of Representatives, Concurrent Resolution on the Budget for Fiscal Year 1996,Conference Report 104-159, to accompany H. Con. Res. 67 (June 26, 1995).

NOTE: * = not applicable; CPI = consumer price index.

a. Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and grows at the rate ofinflation after that.

b. Adjustments are to projections of mandatory spending and revenues only.

c. Revenue increases are shown as negative because they reduce the deficit.

d. Savings from freezing 1996-2002 appropriations at the nominal level appropriated for 1995.

e. Less than $500 million.


CBO baseline assumes. The resulting fiscal divi-dend, however, is not reflected in the resolution'sbaseline or in the outlay, revenue, and deficit totalsstated in the resolution (see Table 15).

Policy Proposals

The budget resolution assumes that very substantialchanges in policy are required to balance the budgetin 2002. It sets stringent limits on appropriations forfiscal years 1996 through 2002. Under those limits,defense outlays will be almost the same in 2002 asthe $269 billion that CBO estimates will be paid outin 1995 and only slightly higher than the outlays thatwould result from freezing appropriations at the 1995level (see Table 16). Outlays for defense in 2002under the budget resolution are about $54 billion, or17 percent, below the spending needed to keep pacewith inflation. Planned nondefense spending in 2002

is about $30 billion lower than projected outlays in1995. That represents more than a 30 percent reduc-tion in real (inflation-adjusted) terms. By 2002, thereal buying power of total (defense and nondefense)discretionary spending will be almost one-quarterlower than it is today.

While drafting the budget resolution, the budgetcommittees discussed various ways to keep appropri-ations within the strict limits assumed by the resolu-tion, but the final decisions about funding for particu-lar programs will be made by the appropriationscommittees and the full House and Senate duringconsideration of appropriation bills over the 1996-2002 period. Because deeper cuts in real terms arerequired in each succeeding year, hard choices willhave to be made every year through 2002 in order tocomply with the plan set out in this year's budget res-olution.

Table 15.Budget Resolution Outlays, Revenues, and Deficits (By fiscal year, in billions of dollars)

OutlaysDiscretionary

MandatorySocial SecurityMedicareMedicaidOther

Subtotal

Net interest

Total Outlays

Revenues

Deficit

1996

534

35217196

177795

259

1,588

1,417

170

1997

524

371180102184837

266

1,627

1,475

152

1998

518

391189106188874

270

1,661

1,546

116

SOURCE: Congressional Budget Office based on U.S. House of Representatives,Conference Report 104-159, to accompany H. Con. Res. 67 (June 26,

NOTE: Neither the effects of the contingent tax cut anticipated bybalancing the budget are reflected in these figures.

the budget

1999

516

411200110203925

276

1,718

1,618

100

2000

520

433212115216976

282

1,778

1,697

81

Concurrent Resolution on the1995).

resolution nor

2001

516

456227119221

1,023

283

1,822

1,789

33

Budget for Fiscal

the fiscal dividend expected to

2002

515

480244124230

1,078

284

1,876

1,883

-6

Year 1996,

result from


Table 16.Discretionary Outlay Savings in the Budget Resolution (By fiscal year,

1995 1996 1997 1998

in billions

1999

of dollars)

2000 2001 2002

Savings from CBO Baseline with Inflation

Appropriations at the 1995Level Adjusted for Inflation

DefenseNondefense

Total

Budget ResolutionDefenseNondefense

Total

Budget Resolution MinusBaseline with Inflation

DefenseNondefense

Total

269 270 278 285277 286 296 307

546 556 574 592

264 266 265270 258 253

534 524 518

-6 -12 -20-16 -38 -54

-22 -50 -74

295319

613

268248

516

-27-70

-97

304331

635

272249

520

-33-82

-115

315342

657

271246

516

-44^6

-140

325354

679

271244

515

-54-109

-164

Savings from CBO Baseline Without Inflation

Appropriations Frozen at the1995 Dollar Level

DefenseNondefense

Total

Budget ResolutionDefenseNondefense

Total

Budget Resolution MinusBaseline Without Inflation

DefenseNondefense

Total

269 264 264 264277 280 281 281

546 544 545 545

264 266 265270 258 253

534 524 518

0 2 1-10 -23 -28

-10 -21 -27

264277

540

268248

516

4^29

-24

264276

540

272249

520

8-28

-20

264276

540

271246

516

7

.31

-24

264276

540

271244

515

7^32

-25


NOTES: Nondefense amounts include Violent Crime Reduction Trust Fund spending.

* = not applicable.


The planned level of discretionary spending in2002 represents savings of $121 billion comparedwith CBO's baseline projection that assumes compli-ance with the discretionary caps and an inflation ad-justment for discretionary spending after 1998 (seeTable 14).1 To reach a balanced budget in 2002, thebudget resolution also calls for changes in mandatoryprograms that would save a total of $161 billion inthat year. The budget resolution divides responsibil-ity for achieving those savings among 11 Senate and12 House committees. The committees are instructedto submit legislation to achieve the required savingsto the budget committees of their respective Housesno later than September 22. The budget committeeswill then package the legislation submitted by all ofthe committees into an omnibus reconciliation bill.

The conferees on the budget resolution made cer-tain assumptions about which programs would be cutin order to determine the level of savings to assign toeach committee. However, the committees are notbound by those assumptions; they may achieve therequired savings through any combination of cuts inprograms within their jurisdiction. Nevertheless, theassumptions behind the budget resolution indicate thelikely cuts in various programs. The budget commit-tees have not provided a full description of their as-sumptions, but they have indicated that savings in theMedicare and Medicaid programs represent $125billion (more than three-quarters) of the assumed to-tal reduction in mandatory spending in 2002 (seeTable 14). Medicare would be reduced below thecurrent-policy projections by $71 billion in 2002 andby $270 billion over the 1996-2002 period. Medicaidsavings would equal $54 billion in 2002 and $182billion over seven years. These savings were as-signed to the Ways and Means Committee and theCommerce Committee in the House and to the Fi-nance Committee in the Senate.

Other significant reductions in mandatory spend-ing over the 1996-2002 period that were specified inthe conference report on the resolution include sav-ings from agricultural programs ($13 billion), studentloan programs ($10 billion), federal retiree health

1. The savings are smaller than the $164 billion in total savingsshown in Table 16 because savings from complying with the statu-tory caps through 1998 are already included in the baseline used asthe starting point in Table 14.

benefits ($5 billion), veterans' benefits ( $6 billion),increased retirement contributions by federal em-ployees or their employing agency ( $4 billion), andadditional proceeds from auctions by the FederalCommunications Commission of portions of the elec-tromagnetic spectrum ($14 billion). In addition, thebudget resolution assumes substantial savings fromvarious programs as a result of welfare reform legis-lation, but those savings were not clearly specified bythe conference report. The resolution also assumessavings from the sale of assets such as naval petro-leum reserves, the United States Enrichment Corpo-ration, and the right to explore for oil and gas on aportion of the Arctic National Wildlife Refuge. Pre-vious budget resolutions have not allowed proceedsfrom asset sales to count for purposes of deficit re-duction, but this year's resolution includes a provi-sion that requires them to be treated as savings for allpurposes of the Congressional Budget Act.

The net policy change in revenues included in thebudget resolution is very small—just $1 billion overthe 1996-2002 period (see Table 14). As mentionedabove, however, the budget resolution provides for acontingent tax cut that is not reflected in the budgetresolution's totals. A special procedure establishedin the resolution, which is discussed in more detail inBox 1, will allow the Congress to consider tax cutprovisions as part of the reconciliation bill if the defi-cit reduction legislation produced in response to thereconciliation directives achieves the level of savingsrequired to balance the budget in 2002. The tax cutis not to exceed $50 billion in 2002 or $245 billion in1996 through 2002. The resolution does not specifyany particular changes in tax law, but the conferencereport indicated that taxes should be reduced on fam-ilies with children, on two-earner married couples,and on savings and investment.

Because the outlay and revenue levels stated inthe budget resolution show a surplus of only about $6billion in 2002, simply adding a $50 billion revenuereduction that is not included in the resolution totalswould clearly throw the budget out of balance. How-ever, the resolution assumes that the budget will bebalanced in 2002 because the $50 billion fiscal divi-dend in that year-which, like the tax cut, was notincluded in the stated resolution totals—will offset thelost revenues. Since the tax cut may be as large as$245 billion over the 1996-2002 period and the fiscal


Boxl.Certification of a Balanced Budget and Consideration of the Proposed Tax Cut

The budget resolution contains special procedures that areintended to allow the Congress to consider a $245 billiontax cut if the reconciliation legislation is consistent with theresolution and therefore provides enough savings to ensurea balanced budget in 2002. (Reconciliation is the legislativevehicle for achieving the changes in mandatory spendingand revenues assumed by the budget resolution.) The pro-cedures are slightly different for the Senate and the House(the Senate provisions are in section 205 of the budget reso-lution, and the House provisions are in section 210).1 Bothprocedures, however, require CBO's certification that enact-ing the proposed reconciliation legislation would lead to abalanced budget in 2002 (assuming compliance with thediscretionary spending levels assumed in the resolution)before the Senate or the House can consider proposals to cuttaxes as part of the reconciliation bill.

Procedure in the Senate

Reconciliation instructions included in the budget resolutionrequire Senate committees to submit all of their recom-mended reconciliation legislation to the Senate BudgetCommittee by September 22, except that the Finance Com-mittee is not to include the tax cut provisions in the legisla-tion it submits at that time. The Budget Committee thensubmits the reconciliation package—still excluding the taxcut provisions-to CBO. CBO must estimate whether thesavings from the reconciliation legislation would balancethe budget in 2002. In making that estimate, CBO is to as-sume compliance with the discretionary spending limits inthe budget resolution unless legislation that supersedesthose limits has been enacted. CBO must also use the eco-nomic and technical assumptions underlying the resolutionin making its estimate. Those assumptions are largely thesame as the ones CBO used in developing its April baselineand do not include the effects of the fiscal dividend de-scribed in this chapter.

If CBO estimates that the reconciliation savings are atleast as great as the budget resolution assumed, it must cer-tify that finding to the Chairman of the Senate Budget Com-mittee, who will then submit the certification to the Senate.The Finance Committee will then submit legislation to im-plement the tax cut, and the Chairman of the Budget Com-mittee will adjust the budget resolution to reflect the tax cut.The tax cut legislation can then be folded into the reconcili-ation bill and considered by the Senate.

Section 205 also provides for a similar estimate andcertification by CBO when the House/Senate conference

1. As included in the budget resolution, section 205 mistakenlyapplied to the House as well as the Senate. Under the rule(H.Res. 175) adopted by the House to govern consideration ofthe budget resolution, section 205 does not apply to the House.

committee has reached agreement on the reconciliation bill.Since the tax cut will presumably be included in the confer-ence report, CBO at that time will have to take the fiscaldividend into account in estimating whether enacting thereconciliation bill would lead to a balanced budget.

In addition to the contingencies included in the proce-dure described above, section 205 specifies that the entireprocedure does not apply unless the reconciliation legisla-tion complies with the sum of the reconciliation directivesfor the 1996-2002 period and the budget would be in bal-ance in 2002 through 2005.

Procedure in the House

The procedure in the House is slightly different in that thetax cut is to be included in the reconciliation legislation sub-mitted to the Budget Committee on September 22 and sub-sequently submitted to CBO. As in the Senate's procedure,CBO is to make its estimate assuming compliance with thediscretionary spending limits of the budget resolution (un-less superseded by law) and using the economic and techni-cal assumptions underlying the budget resolution. Since thereconciliation package that the House submits to CBO issupposed to include the tax cut, however, section 210 speci-fies that CBO's estimate should reflect the fiscal dividend itpublished in Table B-4 of the Analysis of the President'sBudgetary Proposals for Fiscal Year 1996. If CBO deter-mines that the budget would be balanced in 2002 if the leg-islation was enacted, the Chairman of the House BudgetCommittee will certify that and will adjust the budget reso-lution to reflect the tax cut.

If CBO determines that the budget would not be bal-anced in 2002, the Chairman of the Budget Committee is tonotify the Chairman of the Rules Committee. Under section210, the Rules Committee may recommend a substitute rec-onciliation bill that would provide the additional savingsneeded to achieve a balanced budget in 2002. That substi-tute bill would be submitted to CBO for an estimate to bemade on the same basis as the earlier estimate. If CBO de-termines that the substitute bill would balance the budget in2002, the Chairman of the Budget Committee would certifythat and make appropriate adjustments to the budget resolu-tion.

Section 210 specifies that an objection (point of order)by any Representative can block the initial consideration ofthe reconciliation bill if the Chairman of the Budget Com-mittee has not certified a balanced budget in 2002, but nosuch certification is required for House consideration of aconference report. The Rules Committee could, however,recommend a rule waiving the point of order and allowingthe House to consider the bill even if a balanced budget hasnot been certified.


dividend totals only $170 billion for the seven years,cumulative deficits over the period can be $75 billionhigher than those stated in the resolution. The reso-lution does not specify how the tax cut should be dis-tributed year by year, however, making it impossibleto calculate the yearly deficits that will be projectedwhen both the tax cut and the fiscal dividend aretaken into account.

The reductions in spending for discretionary andmandatory programs assumed in the budget resolu-tion will reduce the amount of money the federalgovernment will have to borrow in 1996 through2002 below the levels assumed in the CBO baseline.That reduction will lower the interest that the federalgovernment must pay on the debt held by the publicby $66 billion in 2002 and by $181 billion over the1996-2002 period. Those savings, shown in Table14, do not include the savings resulting from lowerinterest rates that are part of the fiscal dividend CBOestimates could result from balancing the budget.Additional interest costs that are not reflected in thebudget resolution would be incurred, however, be-

cause of increases in the deficit resulting from taxcuts that exceed the fiscal dividend in 1996 through2001. Calculating those costs precisely is impossiblewithout knowing the size of the tax cut in each year,but the cumulative deficit increases could push inter-est costs in 2002 up by several billion dollars. Theincrease is likely, however, to be less than the $6 bil-lion budget surplus shown for that year in the budgetresolution.

The budget resolution also directs the HouseWays and Means Committee and the Senate FinanceCommittee to include in their reconciliation submis-sions an increase in the statutory limit on federaldebt. The current limit is $4.9 trillion. As discussedin Chapter 4, debt subject to the limit is likely toreach that level in October or November. The budgetresolution calls for an increase in the debt limit to$5.5 trillion, which will probably be high enough tofacilitate necessary borrowing until the end of 1997 ifthe policies proposed in the budget resolution areenacted.

Table 17.Change in the Deficit Resulting from the Economic Impacts of Balancing the Budget by 2002(By fiscal year, in billions of dollars)

1996 1997 1998 1999 2000 2001Total,

2002 1996-2000

Change Resulting from LowerInterest Rates

Outlays (Net interest)Revenues (Federal Reserve earnings)3

Subtotal

Change Resulting from Higher

-2Ja-2

-6_L-5

-12_2-10

-20_3-17

-28_4-24

-36_5-31

-42_5-37

-146_^0-126

Gross Domestic Product (Revenues)3

Total Effect on Deficit

-1

-3

-2

-7

-4

-14

-6

-23

-8

-32

-10

-41

-13

-50

^44

-170


NOTE: These estimates assume that the budget is balanced by 2002. Outstanding debt depends only on the budget deficit and is unaffectedby the changes reflected in this table. Consequently, no further savings in servicing the debt accrue from these changes.

a. Revenue reductions are shown as positive because they increase the deficit.



Economic and BudgetaryImplications of Balancingthe BudgetEnacting the Congress's plan to balance the budgetby 2002 would provide a fiscal dividend by reducingfederal interest costs and increasing federal revenues.CBO's April report, An Analysis of the President'sBudgetary Proposals for Fiscal Year 1996, describedthose economic implications. The progressive elimi-nation of the federal government's competition forfunds in private capital markets would lower interestrates and slightly increase the potential growth of theeconomy over the next decade.

The path of deficit reduction in the Congressionalplan roughly approximates the illustrative path ofdeficit reduction that CBO assumed in the April re-port (see Figure 12). At that time, CBO estimatedthat balancing the budget would yield a fiscal divi-dend of about $170 billion over seven years andabout $50 billion in 2002 (see Table 17). Those sav-ings would result from lower interest rates, whichwould cut the cost of federal payments for interest onthe debt, and from greater economic growth, whichwould boost the tax base and tax revenues. The defi-cit reductions envisaged by the budget resolutionseem likely to yield a similar fiscal dividend.

Balancing the budget over the next seven yearswill require many hard decisions about taxing andspending policies, and many of those choices willhave important implications for the nation's eco-nomic outlook. Although the Congress is still work-ing out the details of those decisions, some likelymacroeconomic benefits that flow simply from bal-ancing the budget are evident. Growth is likely to bemodestly higher, on average, from now until 2002,provided that the policy changes necessary to balancethe budget do not fall especially hard on private sav-ing or on productive public investments. Inflationcould increase or decrease slightly but should not bemuch affected. Although the road could be bumpy inthe short term, the fiscal restraint implied by the ef-fort to balance the budget need not weaken the econ-omy substantially as long as the Federal Reserve acts

to offset that restraint. Interest rates are likely to besignificantly lower, falling to the range that they in-habited in the 1950s and 1960s, when budget deficitswere typically modest by today's standards.

The estimates in this chapter reflect only themacroeconomic effects on national saving and in-vestment in an environment in which monetary pol-icy offsets fiscal restraint. The actual outcomes willdepend on the fiscal and monetary policy choices thatare made. Closing the deficit by means that lead toparticularly strong disincentives for private saving orinvestment, or by reducing productive governmentinvestments in infrastructure or education, could un-dermine the benefits of eliminating the deficit.Moreover, monetary policy that does not accommo-date the fiscal restraint inherent in a balanced budgetcould lead to short-run losses in output-and in in-comes as well. Of course, policy choices could alsowork the other way, by increasing private and publicinvestment. In that case, the nation's economic out-look under a balanced budget would be enhanced.

Although the Congressional plan specifies whatwill happen only for the next seven years, the courseof fiscal policy in subsequent years is also important.(The resolution requires that the budget be balancedin the years 2002 through 2005 in order for the Sen-ate to consider the tax cut anticipated by the resolu-tion.) The growth of health spending and the need tofinance the retirement of the baby boomers will putupward pressure on deficits in the years just beyondthe current 10-year projection window. Unless thatpressure is resisted, the economic benefits of thisyear's efforts could be reversed.

The Effects of Balancing the Budget

The budget resolution described above lays out tar-gets for fiscal policy-levels of overall revenues, out-lays, deficits, and public debt, and more specific tar-gets for broad categories of spending-but legislationis still necessary to implement them. The appropria-tion bills for 1996, already under way, will begin theprocess of implementation, but many decisions re-main to be made, particularly for the years beyond1996. The resolution's deficit targets, moreover, give


Table 18.Potential Economic Impacts of Balancing the Budget by 2002 Compared withCBO's January Economic Forecast (By calendar year)

1996 1997 1998 1999 2000 2001 2002

Real Gross National ProductPercentage change in level from base 0.1 0.2 0.3 0.4 0.6 0.7 0.8Change in growth rate (Percentage points) 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Real Gross Domestic ProductPercentage change in level from base 0 0.1 0.2 0.3 0.3 0.4 0.5Change in growth rate (Percentage points) 0 0.1 0.1 0.1 0.1 0.1 0.1

Interest Rates (Percentage points)Three-month Treasury bills -0.2 -0.4 -0.7 -0.9 -1.1 -1.1 -1.1Ten-year Treasury notes -0.2 -0.5 -0.8 -1.1 -1.4 -1.7 -1.7


only a rough guide to what deficits will be if the reso-lution's legislative targets are met, because they re-flect neither the fiscal dividend nor any tax cut.

Because of this uncertainty, CBO has not revisedits estimates of the fiscal dividend resulting from abalanced budget. The estimates published in Aprilshould, however, provide a good approximation ofthe fiscal dividend that will occur if the budget reso-lution's plan is implemented. Without consideringeither tax reductions or the fiscal dividend, the reso-lution's deficit path is quite close to the illustrativepath that CBO used for its April calculations (seeFigure 12). Allowing for both a fiscal dividend and atax cut would probably mean larger deficits in someyears, but the differences may not be significant.

Increased Growth

Balancing the budget by 2002 could allow the econ-omy to grow modestly faster—by about 0.1 percent-age point a year on average. The annual level ofgross national product might be about 0.8 percenthigher in 2002 than it would be if fiscal policy con-tinued on its current path (see Table 18).2 Moving

to a balanced budget would add to growth by redi-recting resources away from public and private con-sumption and toward investment and an improvednational balance sheet-especially by slowing the cur-rent pace of borrowing from foreigners and eliminat-ing the need to service that debt.

The increase in national saving that results di-rectly from reducing the deficit is likely to be par-tially offset by a decrease in private saving. Theextent of that decrease is highly uncertain, dependingcritically on how the deficit is reduced and whetherpolicy changes alter any of the tax factors that enterinto decisions to save. Without such changes intaxes, private saving might fall by between 20 per-cent and 40 percent of the reduction in the deficit,according to the models that CBO has analyzed.Over time, therefore, national wealth would increaseby between 60 percent and 80 percent of the cumula-tive reduction in the deficit.

Some of the rise in national wealth would appearas a higher level of capital stock, thereby increasingproductive capacity in the United States, and somewould show up as lower levels of borrowing fromforeigners. No consensus exists on how much eachof those elements would change, but the range of

The more familiar concept of gross domestic product measuresonly production in the United States and does not reflect the de-cline in debt-service costs paid to foreign lenders. Thus, GNP

could increase by some 0.8 percent in 2002, but GDP might in-crease by only 0.5 percent.


possible increases in productive capacity over thenext seven years is limited. The existing capitalstock is large and takes years to change by a notice-able proportion. Moreover, the models that CBO hasexamined predict that private investment will in-crease by only about 20 percent of the amount of re-duction in the deficit. Such an increase would raisethe capital stock by about 2.2 percent in 2002, ex-panding productive capacity by about 0.5 percent.

The shift of resources to investment and net ex-ports may not go smoothly, however. Balancing thebudget implies a substantial amount of restraint over-all, averaging some 0.4 percent of GDP each year forseven years. (Fiscal restraint usually lasts for twoyears or less.) If the Federal Reserve failed to offsetthat restraint, consumption could fall more quicklythan investment and net exports could rise, possiblyweakening the economy in the short run. Moreover,even if the Federal Reserve sought to offset fiscalrestraint with a more expansionary monetary policy,both the size and timing of the effects of monetarypolicy on the economy are uncertain. Because a per-fect offset would be too much to expect, balancingthe budget risks some temporary reduction in realoutput.

Nevertheless, the danger that balancing the bud-get as envisaged by the budget resolution would onits own precipitate a substantial downturn seemssmall, provided that changes in spending and taxesfollow a relatively smooth path and are credible toboth financial markets and the Federal Reserve.Given such credibility, long-term interest rates arelikely to fall and help boost domestic investment, andthe Federal Reserve could act early to reduce short-term rates. The annual amount of restraint, more-over, seems manageable if deficit reduction follows areasonably smooth course. Any short-term problemsthat might occur should not interfere with the invest-ment and gains in productivity that would bring in-creased growth between now and 2002.

Lower Interest Rates

Economists disagree widely over the effect of fiscalpolicy on interest rates. Some believe that the open-ness of U.S. capital markets ensures that real ratescannot stray far from those in other countries, and

thus they would give little credence to any fiscallyinduced change in real rates. Others, using models ofthe U.S. economy alone, cite much larger impacts:according to one of those models, balancing the bud-get could reduce long-term interest rates by as muchas 400 basis points (4 percentage points).

Good arguments exist for a smaller reduction inlong-term rates-between 100 and 200 basis points.That narrower range encompasses the uncertaintyabout the likely effects of balancing the budget. Adrop of that magnitude from CBO's baseline forecastwould leave real long-term rates at between 1 percentand 2 percent—lower than they have been since the1950s-and real short-term rates close to zero. Dur-ing the 1970s, short-term rates fell below the rate ofinflation largely because of unanticipated increases ininflation and inappropriately expansionary monetarypolicy. But in periods without such policy mistakes,real short-term interest rates have rarely been as lowas zero.

How quickly rates would fall depends on manypoorly understood factors, but the drop in rates wouldprobably anticipate actual deficit reduction by a yearor so. Long-term interest rates, for example, mightrespond to announced future reductions in the deficitif those reductions seemed credible, and credibilitywould be likely to increase as the Congress pro-ceeded along the path of deficit reduction. The tim-ing of a drop in short-term rates would depend onwhen the Federal Reserve acted, which—given thelong lags in the effect of monetary policy on theeconomy—could also anticipate the actual decline inthe deficit. CBO has assumed, relatively conserva-tively, that the decline in both long- and short-termrates might occur over a five- to six-year period.Some analysts might argue that long-term rates couldrespond even faster, as they did after enactment ofthe Omnibus Budget Reconciliation Act of 1993.But the evidence on the cause of that drop is mixed:the sharp decline in long-term rates in 1993 couldalso be attributed to falling expectations about infla-tion, and in any case the decline was partly reversedwithin a year. Moreover, long-term rates did not fallquickly following enactment of a similar fiscal pack-age in 1990. With such conflicting evidence, somecaution about the likely speed of reductions in inter-est rates seems warranted.


Narrowing the range any further than 100 to 200basis points proves difficult.3 CBO's estimates inTable 18 split that range, since they imply that aweighted average of interest rates would drop by 150basis points over six years. (The weights are 25 per-cent on short-term rates and 75 percent on long-termrates and roughly reflect the shares of short- andlong-term securities in current federal borrowingfrom the public.) Long-term rates drop more thanshort-term ones, on the assumption that the policiesundertaken to balance the budget will put the long-term fiscal outlook on a more sustainable path than ispossible under current policies.

The Uncertainty of the EconomicEstimates

The economic estimates are subject to several risks.First, there is substantial uncertainty about how bal-ancing the budget directly affects capital markets and

3. See Appendix B in Congressional Budget Office, An Analysis ofthe President's Budgetary Proposals for Fiscal Year 1996 (April1995).

growth. Second, the policy changes needed to imple-ment the budget resolution will themselves affect theworkings of the economy, sometimes in hard-to-pre-dict ways. A third uncertainty arises because manythings will happen-not just in the area of fiscal pol-icy but in the rest of the economy—that may not beanticipated in the budget resolution's economic as-sumptions. CBO's current economic assumptions,described in Chapter 1, reflect economic data as ofearly July and already differ from those of the budgetresolution, which are based on a forecast that CBOmade at the end of 1994. Although the differenceshave little effect on the budget in 2002, they illustratethe imperfection of forecasts (see Appendix A).

Changes in the economy that are unrelated tofiscal policy could easily obscure the effects ongrowth and interest rates that balancing the budgetwould set in motion. For example, if inflation threat-ens to rise, the Federal Reserve might be unwilling tolower short-term interest rates as quickly as thebudget-balancing scenario assumes. The estimates inTable 18 should therefore be viewed with appropriatecaution: a few years down the road, it may be impos-sible to disentangle the effects of balancing the bud-get from other forces operating at the same time inthe U.S. economy.

Chapter Four

Debt Subject to Limit

The Congress has long placed a cap on theTreasury's issuance of debt, covering both se-curities sold to the public for cash and the spe-

cial securities issued to federal trust funds. Lawmak-ers have had to hike that limit 19 times over the pastdecade, and with the current ceiling likely to bereached within the next couple of months, they willsoon have to take action again.

Before World War I, the Congress generally hadto approve each separate issuance of federal debt.Since the Second Liberty Bond Act was passed in1917, however, the Congress, by statute, has simplyset an overall dollar ceiling on the amount of debtthat the Treasury can issue. The debt ceiling typi-cally gives the Treasury unfettered authority to issuedebt for a year or two before seeking an increase, butvery short term ceilings (which grant the Treasurypermission to issue debt only for a few months oreven days) are hardly rare.

The Treasury is now operating under a debt ceil-ing of $4,900 billion, enacted in August 1993. Withdebt subject to limit standing at $4,870 billion at theend of July and the government continuing to rundeficits, the Treasury is likely to bump against theceiling in October or November.

What the Debt Limit Covers

The debt limit applies to nearly all debt of the federalgovernment. Thus, it covers the special securities(government account series) issued to trust funds

and other government accounts as well as to debtheld by the public (securities such as bills, notes, andbonds that are sold in the market to raise cash andpurchased by a variety of investors, including privatedomestic investors, state and local governments, for-eign investors, and the Federal Reserve system). Be-cause of large deficits, debt held by the public hasclimbed steeply—reaching $3.6 trillion in 1995 com-pared with $710 billion in 1980. Internally held debthas also grown quite rapidly in recent years as SocialSecurity and other trust funds have run large sur-pluses. At the end of fiscal year 1995, CBO esti-mates, government-held debt will amount to $1.3trillion compared with only $200 billion in 1980.

With rare exceptions, the limit on debt does notapply to debt issued by other federal agencies, suchas the Tennessee Valley Authority, which the Trea-sury does not control. However, few federal agencieshave authority to conduct their own borrowing. Thestatutory limit also does not apply to debt issued bythe Federal Financing Bank, which used its full au-thority during an interruption in the debt ceiling in1985.

Debt subject to limit generally counts the facevalue of federal debt. Special rules, however, applyto securities that are sold at a discount. Savingsbonds, Treasury bills, and zero-coupon bonds are alldiscount securities, meaning that holders of thosesecurities collect no income at all from them untilmaturity, when they receive the face amount that re-flects the initial purchase price plus accrued interest.If maturity is far in the future, the face amount ofthose securities greatly exaggerates their current


worth. Hence, such securities are included in thedebt subject to limit at their purchase price when theyare first sold and then at gradually greater amountsuntil they mature.

Together, the deficit and the trust fund surpluseasily explain most of the growth in debt subject tolimit (see Table 19). The deficit largely determineswhat the Treasury must borrow in credit markets.The trust fund surplus drives the issuance of debt tofederal government accounts. Because the income—mostly earmarked revenues (such as Social Securitytaxes) and interest~of trust funds is likely to continueto exceed their outlays, debt subject to limit will con-tinue growing even if the budget is brought into bal-ance. Under the budget resolution adopted by theCongress this past June, the debt subject to limitwould rise from its current ceiling of $4.9 trillion tonearly $6.7 trillion at the end of 2002.

At one time, the debt ceiling may have been aneffective control on the budget when most spendingwas subject to annual appropriations. But discretion-ary spending is now a much lower proportion of totalspending, amounting to only 36 percent in 1995. Un-der the recently adopted budget resolution, discre-tionary outlays will continue to fall further to 27.5percent by 2002. The rise in mandatory spending andgrowth of the trust fund surplus has turned the statu-tory limit on federal debt into an anachronism.Through its regular budget process, the Congress al-ready has ample opportunity to vote on overall reve-nues, outlays, and deficits. Voting separately on thedebt is ineffective as a means of controlling deficitsbecause the decisions that necessitate borrowing aremade elsewhere. By the time the debt ceiling comesup for a vote, it is too late to balk at paying the gov-ernment's bills without incurring drastic conse-quences.

Table 19.Projections of Debt Subject to Limit Under the Budget Resolution(By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000 2001 2002

Debt Subject to Limit, Start of Year 4,605 4,887 5,195 5,494 5,764 6,023 6,273 6,487

ChangesDeficitTrust fund surplusOther changes3

Total

Debt Subject to Limit, End of Year

161103

17

282

4,887

170121

17

308

5,195

15212720

299

5,494

11613420

270

5,764

10013920

259

6,023

81151

18

250

6,273

33162

19

215

6,487

-6173

19

185

6,672


NOTES: The current statutory ceiling is $4,900 billion.

The figures shown here are based on the outlay and revenue levels reported in the budget resolution. Those reported levels do notinclude the effects of a contingent tax cut that the resolution provides for or the effect of the so-called fiscal dividend that CBOestimates would result from balancing the budget. Also, the figures reflect changes to CBO's estimates for 1995 that were com-pleted after the resolution was passed.

a. Mostly investments by government accounts that are not trust funds and net outlays of credit financing accounts.

CHAPTER FOUR DEBT SUBJECT TO LIMIT 49

As a result, because raising the debt ceiling isconsidered to be "must pass" legislation, the debtlimit is frequently used as a device to force action toobtain some other legislative goal. For example, in1990, the Congress voted seven times on the debtlimit between August 9 and November 5 as the bud-get summit meetings progressed and the Congressconsidered the resulting budget resolution and recon-ciliation bill.

What Are the Consequences ofNot Raising the Debt Limit?

Financial markets find the debt limit a periodicsource of anxiety. The government has never de-faulted on its principal and interest payments, nor hasit failed to honor its other checks. However, even atemporary default-that is, a few days' delay in thegovernment's ability to meet its obligations-couldhave serious repercussions in the financial markets.Those repercussions include a permanent increase infederal borrowing costs relative to yields on othersecurities as investors realize that Treasury instru-ments are not immune to default.

Failing to raise the debt ceiling would not bringthe government to a screeching halt the way that notpassing appropriation bills would. Employees wouldnot be sent home, and checks would continue to beissued. If the Treasury was low on cash, however,there could be delays in honoring checks and disrup-tions in the normal flow of government services.Carried to its ultimate conclusion, defaulting on pay-ments would have much graver economic conse-quences—such as loss of confidence in governmentand a higher risk premium on Treasury borrowing-than failing to enact discretionary appropriations bythe start of a fiscal year.

Important Upcoming Dates

The date on which the debt ceiling is reached de-pends on the Treasury's borrowing schedule, whichin turn is based on the government's cash outflows

and cash inflows. The Treasury tries to maintain apredictable borrowing calendar to minimize uncer-tainty in the market and help reduce costs. Manyreceipts and outlays also follow a predictable pattern,which helps in projecting the Treasury's cash needs.

Borrowing

Treasury securities are generally issued according toa regular schedule, except cash management bills,which are issued when needed to temporarily covershortfalls in cash balances (see Table 20 for expectedissue dates from September through November).Three-month and six-month bills are auctioned on aweekly basis, with 52-week bills offered every fourweeks. As for longer-term securities, two-year andfive-year notes are sold at the end of each month,with three-year and 10-year notes auctioned quarterlyand 30-year bonds sold twice a year.

The sizes of note and bond auctions are generallystable from one issuance to the next, usually varyingby no more than $0.5 billion, if they change at all.Fluctuations in financing requirements are thereforemade up through bill auctions. The predictability ofTreasury issues, as well as the market's liquidity, mayhelp the Treasury keep down the cost of borrowing.

Debt issued to trust funds plays an important rolein calculating the debt limit. As shown in Table 21,debt held by government accounts represents overone-quarter of all outstanding debt subject to limit.Social Security, Medicare, and federal retirementtrust funds account for the bulk of those holdings.

Purchases and sales of debt by trust funds arehandled within the Treasury and do not flow throughcredit markets. Similarly, interest on those securitiesis simply an intragovernmental transfer: it is paid byone part of the government to another part and addsnothing to the deficit. Thus, participants in the finan-cial markets view those investments accuratelyenough as a bookkeeping entry, an intragovernmentalI.O.U. Nevertheless, transactions in government ac-count series debt accrue against the debt ceiling.Moreover, continued investment of trust fund sur-pluses may cause the Treasury to bump against thedebt limit even without a major payment to the pub-


Table 20.Calendar of Treasury Borrowing, September to November 1995

Auction Date

September 5September 5September 1 1September 1 1September 14September 18September 18September 25September 25September 26September 27

October 2October 2October 10October 10October 12October 16October 16October 23October 23October 24October 25October 30October 30

November 6November 6November 7November 8November 9November 13November 13November 20November 20November 21November 22November 27November 27

SOURCE: Congressional Budget Office based on

NOTE: Does not include cash management bills.

Type of Issue

3-month bills6-month bills3-month bills6-month bills52-week bills3-month bills6-month bills3-month bills6-month bills2-year notes5-year notes

3-month bills6-month bills3-month bills6-month bills52-week bills3-month bills6-month bills3-month bills6-month bills2-year notes5-year notes3-month bills6-month bills

3-month bills6-month bills3-year notes1 0-year notes52-week bills3-month bills6-month bills3-month bills6-month bills2-year notes5-year notes3-month bills6-month bills

the regularly announced schedule

Settlement Date3

September 7September 7September 14September 14September 21September 21September 21September 28September 28October 2October 2

October 5October 5October 12October 12October 19October 19October 1 9October 26October 26October 31October 31November 2November 2

November 9November 9November 15November 15November 16November 16November 16November 23November 23November 30November 30November 30November 30

of the Department of the Treasury.

a. Date when debt is actually issued and the Treasury collects money.


Table 21.Relationship Between Debt Held by the Public and Debt Subject to Limit(End of fiscal year, in billions of dollars)

1980Actual1985 1990

Projected1995

Debt Held by the Public 710 1,500 2,411 3,605

Debt Held by Government AccountsTrust funds

Social Security3

Medicare13

Civil Service RetirementMilitary RetirementUnemployment InsuranceHighwayAirport and AirwaysRailroad RetirementFederal Deposit Insurance Corporation0

OtherSubtotal

Other government accountsDeposit insurance agencies0

Otherd

Subtotal

Total

Gross Federal Debt

Exclusions from Debt Limit6

Debt Subject to Limit

3119740

131153

10JL4180

51419

199

909

f

909

SOURCE: Congressional Budget Office based on information fromBudget.

a. Old-Age and Survivors Insurance and Disability Insurance.

b. Hospital Insurance (Medicare Part A) and Supplementary Medical

3732

12712171274

16^3287

7_24

31

318

1,818

6

1,824

the Department of the

Insurance (Part B).

c. Until August 1989, the Federal Deposit Insurance Corporation Fund was classified as a

215110236

655117149c

^2755

11_29

41

796

3,207

-45

3,161

Treasury and

trust fund. Its

48114737511048171213

c_511,255

29^8

67

1,322

4,927

-40

4,887

the Office of Management and

successor, the Bank InsuranceFund, is not a trust fund and is thus included in "other government accounts." Other deposit insurance funds include the Federal Savingsand Loan Insurance Corporation (FSLIC) Fund and its successor, the FSLIC Resolution Fund; the Savings Association Insurance Fund;and the Credit Union Share Insurance Fund.

d. Beginning in 1989, includes Treasury securities purchased in the open market by the Tennessee Valley Authority.

e. Mostly debt issued by the Federal Financing Bank and debt issued by federal agencies other than the Treasury.

f. Less than $500 million.


lie or auction scheduled on that day. Indeed, a lumpsum credit to the Civil Service Retirement trust fundof around $20 billion on September 30 and a similarpayment of around $11 billion to the Military Retire-ment trust fund on October 1 will involve large issu-ances of government account series debt.

Cash Inflows

If the Treasury is barred from borrowing, it can countonly on taxes and other current receipts to replenishits cash balances. Withheld income and employmenttaxes are the backbone of the Treasury's deposits,accounting for the majority of all non-debt-relateddeposits. Withheld taxes flow in fairly smoothly atabout $3 billion to $4 billion per day. By contrast,corporate income taxes are concentrated around fourmajor payments dates: April 15, June 15, September15, and December 15. Given today's large budgetdeficits, though, the Treasury cannot count on suchinflows to cover its cash drains for very long.

Cash Outflows

Two large drains on the Treasury—cash benefit pay-ments and cash interest payments—are particularlynoteworthy. Nearly all cash benefit payments forSocial Security and other retirement and disabilityprograms go out between the first and third of themonth. Currently, those programs drain the Trea-sury's cash by about $37 billion in the first week ofthe month.

Cash interest payments to owners of Treasurynotes and bonds take place on fixed dates. The big-gest spikes occur on midquarter refunding settlementdates: February 15, May 15, August 15, and Novem-ber 15. Interest payments on those dates total around$25 billion. Smaller spikes (of $4 billion to $5 bil-lion or so) occur on other semiannual cycles, mostlyat the end of each month.

Other cash withdrawals for purposes as varied asfederal employees' pay, defense contracts, grants tostates and localities, and Medicare are less lumpy andaverage about $4 billion to $6 billion per day.

So when will the Treasury hit the ceiling? It isstill too early to determine the particular week thatthe debt ceiling will be reached, much less a specificday. With the 1995 deficit expected to total $161billion, the federal government should be able tosqueak through September with a small amount ofborrowing authority remaining.

After that point, when exactly the Treasury usesup its available authority will depend on the size andtiming of upcoming cash drains and on the Treasury'scash balance at the beginning of the fiscal year. Nor-mally, the Treasury enters a new fiscal year with acash balance of $30 billion to $40 billion. Drawingon those cash reserves and using any remaining bor-rowing authority, the Treasury should be able to holdout until mid-October. Note, however, that thoseprojections do not presuppose any unusual action bythe Treasury. By departing from some of its normalpractices, the Treasury might even be able to hold outinto early November.

The November 15 interest payment date willpresent a very high hurdle for the Treasury to jumpand may turn out to be the actual day of reckoning.October and November are both low-revenue-andtherefore high-deficit—months. The Treasury bor-rowed more than $27 billion in the market last Octo-ber and almost $37 billion in November to meet cashneeds. Even if the Treasury manages to avoid cashflow problems into early November, it is unlikely tobe able to raise enough money to pay note and bondholders their interest without an increase in the debtlimit before November 15.

Treasury Options to Copewith Interruptions inBorrowing Authority

During an interruption in borrowing authority, theTreasury's main objectives are to avoid default, honorgovernment obligations, and keep operations run-ning. To do so, in the past the Treasury has adoptedvarious tactics to cope with interruptions in the debtceiling (see Table 22). The Treasury's options are


Table 22.Recent Increases in the Debt Limit

Enactment Amount of Limit ExpirationDate3 (Billions of dollars) Date

Sept. 30, 1982

May 26, 1983Nov. 21, 1983May 25, 1984July 6, 1984

Oct. 13, 1984

Nov. 14, 1985Dec. 12, 1985

Aug. 21, 1986

Oct. 21, 1986May 15, 1987July 30, 1987

Aug. 10, 1987

Sept. 29, 1987Aug. 7, 1989

Nov. 8, 1989Aug. 9, 1990Sept. 30, 1990

Oct. 9, 1990Oct. 19, 1990

Oct. 25, 1990

Oct. 28, 1990

Nov. 5, 1990

April 6, 1993

Aug. 10, 1993

1,290.2

1,389.01,490.01,520.01,573.0

1,823.8

1,903.82,078.7

2,111.0

2,300.02,320.02,320.0

2,352.0

2,800.02,870.0

3,122.73,195.03,195.0

3,195.03,195.0

3,195.0

3,230.0

4,145.0

4,370.0

4,900.0

Sept. 30, 1983

PermanentPermanentPermanentPermanent

Permanent

Dec. 6, 1985Permanent

Permanent

May 15, 1987July 17, 1987Aug. 6, 1987

Sept. 23, 1987

PermanentOct. 31, 1989

PermanentOct. 2, 1990Oct. 6, 1990

Oct. 19, 1990Oct. 24, 1990

Oct. 27, 1990

Nov. 5, 1990

Permanent

Sept. 30, 1993

Permanent

Treasury Actions at Closeb

Deteriorated budget outlook necessitated action well before expiration. In-crease enacted in May 1983 as a consequence of Social Security rescuepackage.

Beginning late October 1983, delayed auctions; underinvested trust funds.Beginning late April 1984, trimmed auctions; underinvested Social Security.Beginning late June 1984, trimmed auctions; underinvested Social Security.Delayed auctions (beginning late September 1984); underinvested trust funds

(beginning early September); cash situation not critical.Prolonged interruption associated with debate over Balanced Budget and

Emergency Deficit Control Act of 1985 (commonly known as Gramm-Rudman). Underinvested trust funds beginning early September 1985; cutlate-September auctions, worsening cash situation; issued debt through FFBin October; actively disinvested trust funds in order to pay benefits in earlyNovember.

More or less timely increase.Used FFB temporarily to credit Social Security and preserve regular auctions

August 1-15, 1986; otherwise timely.Used FFB authority; underinvested trust funds beginning September 30, 1986;

delayed or cut auctions beginning late September; cash situation not critical.Timely increase at expiration.Postponed some auctions beginning July 20, 1987; cash situation not critical.Postponed auctions normally held in early August but settling on August 15,

1987 (midquarter refunding).Part of Balanced Budget and Emergency Deficit Control Reaffirmation Act of

1987 (commonly known as Gramm-Rudman II) package. Rescheduledauctions normally held September 21-24, 1987; otherwise timely.

More or less timely increase associated with savings and loan bill.Boosted auction sizes and accelerated settlements to build up cash balances

in late October.More or less timely increase before Congressional recess.Very short term increase associated with 1990 budget summit's conclusion.Very short term increase as 1990 budget summit agreement underwent modifi-

cations.Borrowed up to limit on October 19 while awaiting next increase.Delayed several auctions normally held October 18-22, 1990, but settling after

scheduled expiration of ceiling.Compressed auctions and settlements into the period between October 25

and 27, 1990.Temporary limit until reconciliation bill (including the Budget Enforcement Act

of 1990) was signed.Postponed several auctions pending last-minute increase before Congres-

sional recess.Next increase enacted August 1993, comfortably before expiration, as part of

OBRA-93.Not yet expired.

SOURCE: Congressional Budget Office based on information from the Department of the Treasury and various news items.

NOTE: FFB = Federal Financing Bank; OBRA-93 = Omnibus Budget Reconciliation Act of 1993.

a. Date signed into law, typically one to seven days after passage by the Congress.

b. Actions listed do not include suspension of sales of savings bonds and state and local government series, which are more or less routineresponses to an interruption in the debt ceiling (especially after expiration of a temporary ceiling). From 1983 through 1990, the SocialSecurity trust funds enjoyed a special arrangement under which they were credited on the first of the month with all revenues expectedduring that month. If fully invested, that credit caused the debt subject to limit to spike between $15 billion and $20 billion. On occasion,when constrained by the debt limit, the Treasury credited the trust funds as required but was unable to invest the resulting balances fully.


influenced by whether it is operating under a perma-nent or temporary debt ceiling. Permanent ceilings(such as the current one) do not expire, but the dollaramount eventually becomes inadequate. Under apermanent ceiling, the Treasury can issue debt solong as it does not violate the dollar limit; even if it isright at the ceiling, it can refinance maturing securi-ties or take other actions that do not, on balance, raisethe debt.

In stark contrast, a temporary ceiling expires on agiven date. The Treasury's authority to issue debtabruptly ceases, unless it can somehow get the debtdown beneath its permanent ceiling. Debt that wasissued before the expiration date need not be paid offimmediately because it was perfectly legal when itwas issued. But the Treasury can issue no new debt,not even to refinance maturing securities; instead, itmust pay them off with cash. That requirement--combined with other drains on the Treasury's funds-brings matters to a head quickly.

Among the most common responses by the Trea-sury to interruptions in the debt limit in the past havebeen:

o Suspending Sales of Nonmarketable Debt. Sus-pending the sales of savings bonds, state and lo-cal government series, and other nonmarketabledebt for the duration of the interruption is a moreor less routine response.

o Trimming or Delaying Auctions of MarketableSecurities. If the Treasury is unsure whether itcan legally issue bills, notes, and bonds on thesettlement date, it will not auction them.

o Underinvestment of Government Trust Funds.This practice has frequently proved unavoidable.

In many cases, the Treasury could not invest trustfund receipts fully when it was up against thedebt limit. The trust funds were properly cred-ited, but they simply held large amounts of so-called uninvested balances. Upon the passage ofa new debt ceiling, the Congress has routinelyvoted to invest those balances and replenish anytrust funds that lost interest income as a result ofthe interruption.

Only once did the underinvestment of trustfunds go a step further: in November 1985, theTreasury redeemed trust fund securities a fewdays early to create room under the debt ceilingto auction regular, marketable securities. Themoney raised in those auctions permitted thepayment of benefits to Social Security recipients,otherwise imperiled by the Treasury's razor-thincash balances. During a period when issuingdebt has been suspended, the Treasury retains theoption to disinvest particular trust funds.

The Debt Limit andDeficit Reduction

Limiting the Treasury's borrowing authority is not aproductive method of achieving deficit reduction.Significant deficit reduction can best be accom-plished by legislative decisions that reduce outlays orincrease revenues. Failing to raise the debt limit in atimely manner, though perhaps bringing a difficultvote on legislation to a head, only serves to make theTreasury's job of paying the government's bills moredifficult. An extended delay could have a significanteffect on the government's credibility and the interestrates that it must pay on future borrowing.

Appendixes

Appendix A

Evaluating CBO's Record ofEconomic Forecasts

S ince issuing its first forecast in 1976, the Con-gressional Budget Office (CBO) has compileda record of economic predictions that com-

pares favorably with the track records of five Admin-istrations and the consensus forecasts of a sizablesample of private-sector economists. Although themargin is slight, CBO's forecasts have generally beencloser than the Administration's to the actual valuesof several economic indicators that are important forprojecting the budget. Moreover, during the 12 yearsfor which comparisons are possible, CBO's forecastshave been about as accurate as the average of the 50or so forecasts that make up the Blue Chip consensussurvey. Comparing CBO's forecasts with that surveysuggests that when CBO's economic predictionsmissed the mark by a wide enough margin to contrib-ute to sizable misestimates of the deficit, those errorsprobably reflected limitations that confronted allforecasters.

These conclusions echo the findings of previousstudies published by the Congressional Budget Of-fice and other government and academic reviewers.They emerge from an evaluation of the accuracy ofshort-term forecasts for four economic indicators:growth in real (inflation-adjusted) output, inflation inthe consumer price index (CPI), interest rates onthree-month Treasury bills in both nominal and realterms, and interest rates on 10-year Treasury notesand Aaa corporate bonds. In carrying out this evalu-ation, CBO compiled two-year averages of its fore-casts for the four indicators and compared them withhistorical values as well as with the correspondingforecasts of the Administration and the Blue Chipconsensus.

Both CBO and the Administration have tended toerr toward optimism in their forecasts over a two-year horizon. In other words, the average forecasterror for real growth was an overestimate, and theaverage error for inflation was an underestimate. TheAdministration has been more optimistic than CBOin forecasting interest rates, with the average errorbeing an underestimate. Overall, the average errorsin the Administration's two-year forecasts wereslightly larger than in CBO's. Finally, CBO's fore-casts appear to be about as accurate as those of theBlue Chip consensus over the period for which com-parable Blue Chip forecasts are available (1982-1993).

CBO's and the Administration's longer-term(five-year) projections of average growth in real out-put were generally optimistic, but CBO's errors weremuch smaller than the Administration's. For thelonger-term projections of real gross national prod-uct, CBO's errors were only slightly larger on aver-age than those in its short-term forecasts of real out-put. Again, CBO's projections were about as accu-rate as those of the Blue Chip consensus over thecomparable period (1979-1990).

The differences among the three forecasts, how-ever, are not large enough to be statistically signifi-cant. The small number of forecasts available for theanalysis makes it difficult to distinguish meaningfuldifferences in their performance from differences thatmight arise randomly. Thus, the statistics presentedhere are not reliable indicators of the future perfor-mance of any of the forecasters.


Sources of Data forthe Evaluation

Evaluating CBO's forecasting record requires com-piling the basic historical and forecast data forgrowth in real output, CPI inflation, and interestrates. Although each of those series has an importantinfluence on budget projections, an accurate forecastof the two-year average growth in real output is themost critical economic factor in accurately estimat-ing the deficit for the upcoming budget year. Two-year average forecasts published in early 1994 and1995 could not be included in this evaluation becausehistorical values for 1995 and 1996 are, of course,not yet available.1 The data were therefore compiledusing forecasts published early in the years 1976through 1993.

Selection of Historical Data

Which historical data to use for the evaluation wasdictated by the availability of actual data and the na-ture of the individual forecasts examined. AlthoughCBO, the Administration, and Blue Chip all pub-lished the same measure for real output growth, se-lecting a historical series was difficult because ofperiodic benchmark revisions to the actual data.2 Bycomparison, not all of the forecasters published thesame measures for CPI inflation and interest rates,but the selection of historical data for those serieswas clear-cut.

Real Output Growth. Historical two-year averagesof growth in real output were developed from calen-dar year averages of the quarterly chain-type annual-weighted indexes of real gross national product(GNP) and real gross domestic product (GDP) pub-

1. The Clinton Administration adopted CBO's economic assumptionsas the basis for its budget in early 1993. As a result, the errors forthe early 1993 forecast are virtually the same for CBO and theAdministration.

2. Before 1992, CBO, the Office of Management and Budget, andBlue Chip used gross national product to measure output. How-ever, beginning in early 1992, all three forecasters began to pub-lish forecasts and projections of gross domestic product instead.

lished by the Bureau of Economic Analysis (BEA).The fact that several real GNP and GDP series werediscontinued because of periodic benchmark revi-sions meant that they were unsuitable historicalseries.

For example, during the 1976-1985 period, thethree forecasters published estimates for a measure ofgrowth in real GNP that was based on 1972 prices,the measure published by BEA at the time. In late1985, however, BEA discontinued this 1972-dollarseries and began to publish GNP on a 1982-dollarbasis. As a result, an official series of values forGNP growth in 1972 dollars is not available for yearsafter 1984; thus, actual two-year average growthrates are not available to compare with the forecastsmade in early 1984 and 1985. From 1986 to 1991,forecasters published estimates of growth in realGNP based on 1982 prices. BEA revised the bench-mark again in the second half of 1991; it discontin-ued the 1982-dollar GNP and began to publish GNPon a 1987-dollar basis.3 Consequently, the historicalannual series for 1982-dollar GNP is available onlythrough 1990, and actual two-year average growthrates are not available for the forecasts made in early1990 and 1991.

By periodically updating the series to reflectmore recent prices, BEA's benchmark revisions yielda measure of real output that is more relevant foranalyzing contemporary movements in real growth.But the process makes it difficult to evaluate fore-casts of real growth produced over a period of yearsfor series that are subsequently discontinued. Thedifficulties presented by periodic revisions of thedata are avoided here by using one of BEA's alterna-tive measures of real GNP and GDP, the chain-typeannual-weighted index. This index is discussed inAppendix B.

CPI Inflation. Two-year averages of inflation in theconsumer price index were calculated from calendaryear averages of monthly data published by the Bu-reau of Labor Statistics. Before 1978, the bureaupublished only one consumer price index series,known today as the CPI-W (the price index for urban

3. With the 1992 benchmark revision, GDP replaced GNP as thecentral measure of national output.

APPENDIX A EVALUATING CBO'S RECORD OF ECONOMIC FORECASTS 59

wage earners and clerical workers). In January 1978,however, it began to publish a second, broader con-sumer price index series, the CPI-U (the price indexfor all urban consumers). CBO's comparison of fore-casts used both series.

Until 1992, the Administration published its fore-casts for the CPI-W, the measure used to index mostof the federal government's expenditures for entitle-ment programs. By contrast, for all but four of itsforecasts since 1979 (1986 through 1989), CBObased its inflation forecast on the CPI-U, a morewidely cited measure of inflation and the one nowused to index federal income tax brackets. The BlueChip consensus has always published its forecast ofthe CPI-U. Although both the CPI-U and CPI-Wmay be forecast with the same relative ease, and an-nual fluctuations in the two series are virtually indis-tinguishable, they differ in some years; for that rea-son, CBO used historical data for both series to eval-uate the alternative forecast records.

Interest Rates. Two-year averages of nominalshort- and long-term interest rates were developedfrom calendar year averages of monthly data pub-lished by the Board of Governors of the FederalReserve System.

The forecasts of short-term interest rates werecompared using historical values for two measures ofthe interest rate on three-month Treasury bills: thenew-issue rate and the secondary-market rate. TheAdministration forecasts the new-issue rate, whichcorresponds to the price of three-month bills auc-tioned by the Treasury Department—that is, it reflectsthe interest actually paid on that debt. CBO forecaststhe secondary-market rate, which corresponds to theprice of the three-month bills traded outside the Trea-sury auctions. Because such transactions occur con-tinually in markets that involve many more tradersthan do Treasury auctions, the secondary-market rateprovides an updated evaluation by the wider financialcommunity of the short-term federal debt. Blue Chiphas alternated between these two rates: it publishedthe new-issue rate from 1982 to 1985, switched to thesecondary-market rate during the 1986-1991 period,and then returned to the new-issue rate in 1992.Clearly, there is no reason to expect the two rates todiffer persistently; indeed, the differences betweentheir calendar year averages are minuscule.

The various forecasts of long-term interest rateswere likewise compared using historical values fortwo measures of long-term rates: the 10-year Trea-sury note rate and Moody's Aaa corporate bond rate.A comparison of forecasts is only possible beginningin 1984 because not all of the forecasters publishedprojections of long-term interest rates before thatyear. For forecasts made in early 1984 and 1985,CBO projected the Aaa corporate bond rate. Begin-ning with its early 1986 forecast, however, CBOswitched to the 10-year Treasury note rate. The Ad-ministration has always published its projection forthe 10-year Treasury note rate, but Blue Chip haspublished the Aaa corporate bond rate.

Separate historical values for real short-term in-terest rates were calculated using the nominal short-term interest rate and inflation rate appropriate foreach forecaster. In each case, the two-year averagenominal interest rate was discounted by the two-yearaverage rate of inflation. The resulting real short-term interest rates were very similar. Since there isno agreed-upon method for calculating real long-terminterest rates, they were not included in the evalua-tion.

Sources of Forecast Data

The evaluation used calendar year forecasts and pro-jections, which CBO has published early each yearsince 1976, timed to coincide with the publication ofthe Administration's budget proposals. The Adminis-tration's forecasts were taken from the Administra-tion's budget in all but one case: the forecast made inearly 1981 came from the Reagan Administration'srevisions to President Carter's last budget. The corre-sponding CBO forecast was taken from CBO's pub-lished analysis of President Reagan's budget propos-als. That forecast did not include the economic ef-fects of the new Administration's fiscal policy pro-posals.

The average two-year forecasts of the Blue Chipconsensus survey were taken from those published inthe same month as CBO's forecasts. Because theBlue Chip consensus did not begin publishing itstwo-year forecasts until the middle of 1981, the firstconsensus forecast available for use in this compari-son was published in early 1982. Average five-year


projections, however, are published by Blue Chiponly two or three times a year. All but one of itsfive-year projections used in this evaluation werepublished in March; the 1980-1984 projection waspublished in May.

Measuring ForecastPerformance

Following earlier studies of economic forecasts, thisevaluation of CBO's forecasts focused on two aspectsof their performance: statistical bias and accuracy.

Bias

The statistical bias of a forecast is the extent to whichthe forecast can be expected to differ from what actu-ally occurs. CBO's evaluation used the mean error tomeasure statistical bias. That statistic~the arithmeticaverage of all the forecast errors—is the simplest andmost widely used measure of forecast bias. Becausethe mean error is a simple average, however, under-estimates and overestimates offset each other in cal-culating it. As a result, the mean error imperfectlymeasures the quality of a forecast—a small mean er-ror would result either if all the errors were small orif all the errors were large but the overestimates andunderestimates happened to balance out.

Accuracy

The accuracy of a forecast is the degree to whichforecast values are narrowly dispersed around actualoutcomes. Measures of accuracy more clearly reflectthe usual meaning of forecast performance than doesthe mean error. This evaluation used two measuresof accuracy. The mean absolute error--the averageof the forecast errors without regard to arithmeticsign—indicates the average distance between fore-casts and actual values without regard to whetherindividual forecasts are overestimates or underesti-mates. The root mean square error--calculated byfirst squaring all the errors, then taking the squareroot of the arithmetic average of the squared

errors-also shows the size of the error without regardto sign, but it gives greater weight to larger errors.

Measurement Issues

These three statistics do not exhaust the availablesupply of measures of forecast performance. For ex-ample, to test for statistical bias in CBO's forecasts,previous studies have used measures that are slightlymore elaborate than the mean error. Those studieshave generally concluded, as does this evaluation,that CBO's short-term economic forecasts do notcontain a statistically significant bias.4

In addition, a number of methods have been de-veloped to evaluate a forecast's efficiency. Effi-ciency indicates the extent to which a particular fore-cast could have been improved by using additionalinformation that was at the forecaster's disposal whenthe forecast was made.5 The Blue Chip consensusforecasts represent a wide variety of economic fore-casters and thus reflect a broader blend of sourcesand methods than can be expected from any singleforecaster. The use of the Blue Chip forecasts in thisevaluation can therefore be interpreted as a proxy foran efficient forecast. The fact that CBO's forecastsare about as accurate as Blue Chip's is a rough indica-tion of their efficiency.

4. Another approach to testing a forecast for bias is based on linearregression analysis of actual and forecast values. For details ofthat method, see J. Mincer and V. Zarnowitz, "The Evaluation ofEconomic Forecasts," in Mincer, ed., Economic Forecasts andExpectations (New York: National Bureau of Economic Research,1969). That approach is not used here because of the small samplesize. However, previous studies that have used it to evaluate theshort-term forecasts of CBO and the Administration have not beenable to reject the hypothesis that those forecasts are unbiased. See,for example, M.T. Belongia, "Are Economic Forecasts by Gov-ernment Agencies Biased? Accurate?" Review, Federal ReserveBank of St. Louis, vol. 70, no. 6 (November/December 1988), pp.15-23.

5. For studies that have examined the relative efficiency of CBO'sforecasts, see Belongia, "Are Economic Forecasts by GovernmentAgencies Biased?"; and S.M. Miller, "Forecasting Federal BudgetDeficits: How Reliable Are U.S. Congressional Budget OfficeProjections?" Applied Economics, vol. 23 (December 1991), pp.1789-1799. Although both of the studies identify series that mighthave been used to make CBO's forecasts more accurate, they relyon statistics that assume a larger sample than is available. More-over, although statistical tests can identify sources of inefficiencyin a forecast after the fact, they generally do not indicate how suchinformation can be used to improve forecasts when they are made.


More elaborate measures, however, are not nec-essarily reliable indicators when the sample of obser-vations is small, such as the 18 observations thatmake up the sample of CBO's two-year forecasts.Small samples present three main types of problemsfor evaluating forecasts, including forecasts based onthe simple measures presented here. First, smallsamples reduce the reliability of statistical tests thatare based on the assumption that the underlying pop-ulation of forecast errors follows a normal distribu-tion. The more elaborate tests of forecast perfor-mance all make such an assumption about the hypo-thetical ideal forecast with which the actual forecastsare compared. Second, in small samples, individualforecast errors have a relatively large weight in thecalculation of summary measures. The mean error,for example, can fluctuate in arithmetic sign when asingle observation is added to a small sample. Third,the small sample means that CBO's forecast historycannot be used in a statistically reliable way to indi-cate either the direction or the size of future forecast-ing errors.

Apart from the general caution that should attendstatistical conclusions based on small samples, thereare several other reasons to view this evaluation ofCBO's forecasts with particular caution. First, theprocedures and purposes of CBO's and the Adminis-tration's forecasts have changed over the past 19years and may change again in the future. For exam-ple, in the late 1970s, CBO characterized its long-term projections as a goal for the economy, whereasit now considers its projections to be what will pre-vail on average if the economy continues to reflecthistorical trends. Second, an institution's forecastingtrack record may not foretell its future abilities be-cause of changes in personnel or methods. Finally,forecast errors increase when the economy is morevolatile. All three forecasters made exceptionallylarge errors when forecasting for periods that in-cluded turning points in the business cycle.

CBOfs Forecasting Record

This analysis evaluated the Congressional BudgetOffice's forecasts over two-year and five-year peri-ods. The period of most interest for forecasters of

the budget is two years. Because the Administra-tion's and CBO's winter budget publications focus onthe budget projection for the fiscal year beginning inthe following October, an economic forecast that isaccurate not only for the months leading up to thebudget year but also for the budget year itself willprovide the basis for a more accurate forecast of thedeficit. A five-year horizon is used to examine theaccuracy of longer-term projections of growth in realoutput.

Short-Term Forecasts

Historically, CBO's two-year forecasts are slightlymore accurate than the Administration's and sufferfrom slightly less statistical bias. In most cases,however, the differences are slim. Furthermore,CBO's forecasts are about as accurate as Blue Chip'saverage forecasts.

An accurate forecast of two-year growth in realoutput is the most important factor in minimizingerrors in forecasting the deficit for the budget year.Accurate forecasts of nominal output, inflation, andnominal interest rates are less important for forecast-ing deficits now than they were in the late 1970s andearly 1980s. The reason is that given current law andthe level of the national debt, inflation increases bothrevenues and outlays by similar amounts. Revenuesincrease with inflation because taxes are levied onnominal incomes. Outlays increase because variousentitlement programs are indexed to inflation andbecause nominal interest rates tend to increase withinflation, which in turn raises the cost of servicingthe federal debt.6

Real Output Growth. For the two-year forecastsmade between 1976 and 1993, CBO had a slightlybetter record than the Administration in forecastinggrowth in real output (see Table A-l). On average,both CBO's and the Administration's forecasts tendedto be overestimates. CBO was closer to the truevalue in eight of the 18 forecasts made between 1976

Rules of thumb for estimating the effect on the deficit of changesin various macroeconomic variables are given in CongressionalBudget Office, The Economic and Budget Outlook: Fiscal Years1996-2000 (January 1995), pp. 77-81.


and 1993, the Administration was closer in six peri-ods, and the two forecasters had identical errors infour periods. CBO's forecasts of real growth duringthe 1982-1993 period were, on average, about as ac-curate as those of the Blue Chip consensus.

Forecast errors tend to be larger when the econ-omy is more unstable. That tendency can be clearlyseen in the forecasts of real GNP growth by compar-ing the large errors for 1979 through 1983-when theeconomy went through its most turbulent recession-ary period of the postwar era—with the smaller errorsrecorded for later years. Similarly, the recent busi-ness cycle accounts for the large errors in the fore-casts made in 1989 through 1991; during that period,CBO's errors were only slightly larger than those ofthe Blue Chip consensus.

CPI Inflation. The records for forecasting the aver-age annual growth in the consumer price index over atwo-year horizon were very similar (see Table A-2).Both CBO and the Administration underestimatedfuture inflation in their forecasts for 1977 through1980, and both tended to overestimate it in their fore-casts for 1981 through 1986. The average measuresof bias and accuracy were virtually the same for CBOand the Administration. CBO was closer to the truevalue in six of the 18 periods, the Administration wascloser in eight periods, and the two forecasters hadidentical errors in four periods. For the 1982-1993period, CBO's forecasts of inflation were about asaccurate as those of both the Administration and BlueChip.

Nominal Interest Rates. For the 1976-1993 fore-casts, CBO's record was about as accurate as the Ad-ministration's for nominal short-term interest ratesover a two-year horizon (see Table A-3). On aver-age, the Administration tended to underestimatenominal short-term interest rates; CBO's mean errorwas zero over this period. CBO was closer to thetrue value in eight of the 18 periods, the Administra-tion was closer in nine periods, and the two forecast-ers had identical errors in one period. However, forthe 1982-1993 period, the mean absolute error ofCBO's forecasts was slightly above those of the Ad-ministration and Blue Chip.

For the 1984-1993 forecasts of long-term interestrates, CBO did significantly better than the Adminis-

tration (see Table A-4). The Administration tendedto underestimate rates, and its mean error was largerthan CBO's. In addition, the Administration's fore-casts had a larger mean absolute error and root meansquare error. CBO was closer to the true value in sixof the 10 periods, the Administration was closer inthree periods, and the two forecasters had identicalerrors in one period.

CBO's forecasts of long-term interest rates wereabout as accurate as those of the Blue Chip consen-sus. Both CBO and Blue Chip tended to overestimatelong-term rates. CBO had a mean error of 0.3 per-centage points compared with 0.4 percentage pointsfor Blue Chip.

Real Short-Term Interest Rates. For the forecastsmade in 1976 through 1993, CBO had a slight edgeover the Administration in estimating real short-terminterest rates (see Table A-5). Again, the Adminis-tration was more likely than CBO to underestimateinterest rates, and its mean error was greater. CBOand the Administration recorded similar mean abso-lute and root mean square errors. CBO's forecastswere closer to the actual value in 10 of the 18 peri-ods, the Administration's were closer in seven, andthe two had identical errors in one period. For fore-casts made between 1982 and 1993, CBO's errorswere generally similar in both direction and magni-tude to those of the Blue Chip consensus.

Longer-Term Projections

In projecting real GNP growth for the more distantfuture, measured here as five years ahead, the Ad-ministration's errors were larger than CBO's (seeTable A-6). Although this comparative advantagefor CBO does not directly affect the estimates of thedeficit for the budget year, accuracy in the longerterm is obviously important for budgetary planningover several years. Neither the Administration norCBO, however, considers its projections to be its bestguess about the year-to-year course of the economy.The Administration's projections each year are basedon the adoption of the President's budget as sub-mitted, and for most years CBO has considered itsprojections an indication of the average future perfor-mance of the economy if major historical trends con-


tinue. Neither institution attempts to anticipate cycli-cal fluctuations in the projection period.

CBO's projections of longer-term growth in realGNP were closer than the Administration's to the ac-tual value in 12 of the 15 periods. The Administra-tion's projections showed an upward bias of 1.4 per-centage points compared with an upward bias of 1.0percentage point for CBO. Those biases occurredlargely because the projections made in early 1976through 1979, which CBO and the Administrationpresented as target rates of growth, did not incorpo-rate the recessions of 1980 and 1982. Through the

subsequent years of expansion until the most recentrecession, the upward bias was much smaller for theAdministration's projections and smaller yet forCBO's.

The size of the root mean square errors for theentire period for CBO and, to a lesser extent, the Ad-ministration also resulted largely from errors in pro-jections made during the first four years. CBO had adefinite edge in the projections made in January 1980through 1982 and a lesser edge in later years. Again,CBO's projections were about as accurate as those ofthe Blue Chip consensus over the comparable period.


Table A-1.Comparison of CBO, Administration, and Blue Chip Forecasts of Two-Year AverageGrowth Rates for Real Output (By calendar year, errors in percentage points)

Actual

GNP1976-19771977-19781978-19791979-19801980-19811981-19821982-19831983-19841984-19851985-19861986-19871987-19881988-19891989-19901990-19911991-1992

GDPd

1992-19931993-1994

Statistics for1976-1993

Mean errorMean absolute

errorRoot mean

square error



errorRoot mean

square error

1972Dollars

6.75.23.91.31.10.20.75.2

bbbbbbbb

bb

*

*

*

*

*

*SOURCES: Congressional

1982Dollars

4.85.03.91.10.9

-0.30.55.25.13.03.13.93.51.7

cc

cc

*

*

*

*

*

*Budget Office;

1987Dollars

4.84.73.81.10.5

-0.40.74.94.42.82.93.53.32.00.30.7

2.73.6

*

*

*

*

*

*

Office of

Chain-typeAnnual-

WeightedIndex

5.25.14.21.41.0

00.65.24.82.82.93.53.32.00.30.6

2.33.0

*

*

*

*

*

it

Management

CBOForecast

6.25.54.72.70.52.12.13.44.73.33.12.92.42.52.01.6

2.62.9

*

*

*

*

*

*and Budget;

Error

0.90.40.61.3

-0.52.21.5

-1.8-0.10.50.3

-0.6-0.90.51.81.1

0.3-0.1

0.4

0.9

1.1

0.2

0.8

1.0

AdministrationForecast

5.95.14.72.90.52.62.72.64.73.93.73.33.03.22.81.4

2.22.9

*

*

*

*

*

*

Error

0.70.10.61.5

-0.52.72.0

-2.6-0.11.10.8

-0.2-0.31.22.50.8

-0.1-0.1

0.6

1.0

1.3

0.4

1.0

1.3

Eggert Economic Enterprises, Inc.

Blue OhioForecast

aaaaaa

2.03.54.33.23.02.82.12.21.91.2

2.33.0

*

*

*

*

*

*

, Blue Chip

Error

aaaaaa

1.4-1.7-0.50.40.1

-0.6-1.20.21.70.6

00

*

*

*

0

0.7

0.9

EconomicIndicators', Department of Commerce, Bureau of Economic Analysis.

NOTES: Actual values are the two-year growth rates for real gross national product (GNP) and gross domestic product (GDP) last reported bythe Bureau of Economic Analysis, not the first reported values. Forecast values are for the average annual growth of real GNP orGDP over the two-year period. The forecasts were issued in the first quarter of the initial year of the period or in December of thepreceding year. Errors are forecast values minus actual values; thus, a positive error is an overestimate. The chain-type annual-weighted index of actual GNP or GDP was used in calculating the errors.

* = not applicable.

a. Two-year forecasts for the Blue Chip consensus were not available until 1982.

b. Data for 1972-dollar GNP and GDP are available only through the third quarter of 1985.

c. Data for 1982-dollar GNP and GDP are available only through the third quarter of 1991.

d. With the 1992 benchmark revision, GDP replaced GNP as the central measure of national output.


Table A-2.Comparison of CBO, Administration, and Blue Chip Forecasts of Two-Year AverageInflation Rates in the Consumer Price Index (By calendar year, errors in percentage points)

Actual CBO AdministrationCPI-U CPI-W Forecast Error Forecast Error

Blue ChipForecast Error

1976-19771977-19781978-19791979-19801980-19811981-19821982-19831983-19841984-19851985-19861986-19871987-19881988-19891989-19901990-19911991-19921992-19931993-1994



errorRoot mean

square error



errorRoot mean

square error

6.17.09.4

12.411.98.24.63.83.92.72.83.94.45.14.83.63.02.8

*

*

*

*

*

*

6.17.09.5

12.511.98.14.53.33.52.52.63.84.45.04.63.52.92.7

*

*

it

*

*

*

7.14.95.88.1

10.110.47.24.74.94.13.83.94.74.94.14.23.42.8

*

*

*

*

*

*

1.0-2.1-3.7-4.3-1.82.12.61.01.01.41.20.10.3

-0.1-0.70.60.50.1

-0.1

1.4

1.8

0.7

0.8

1.0

6.15.26.07.4

10.59.76.64.74.54.23.83.34.23.73.94.63.12.8

*

*

*

*

*

0-1.8-3.5-5.0-1.41.62.11.51.01.71.2

-0.5-0.2-1.3-0.71.10.20.1

-0.2

1.4

1.8

0.5

1.0

1.2

aaaaaa

7.24.95.24.33.83.64.34.74.14.43.53.3

*

*

*

*

*

aaaaaa

2.61.11.31.61.0

-0.2-0.1-0.4-0.70.80.50.6

*

*

*

0.7

0.9

1.1

SOURCES: Congressional Budget Office; Office of Management and Budget; Eggert Economic Enterprises, Inc., Blue Chip EconomicIndicators; Department of Labor, Bureau of Labor Statistics.

NOTES: Values are for the average annual growth of the consumer price index (CPI) over the two-year period. Before 1978, the Bureau ofLabor Statistics published only one consumer price index series, known today as the CPI-W (the price index for urban wage earnersand clerical workers). In January 1978, however, the bureau began to publish a second, broader consumer price index series, theCPI-U (the price index for all urban consumers). For most years since 1979, CBO forecast the CPI-U; from 1986 through 1989, CBOforecast the CPI-W. The Administration forecast the CPI-W until 1992, when it switched to the CPI-U. Blue Chip forecast the CPI-Ufor the entire period. The forecasts were issued in the first quarter of the initial year of the period or in December of the precedingyear. Errors are forecast values minus actual values; thus, a positive error is an overestimate.

* = not applicable,



Table A-3.Comparison of CBO, Administration, and Blue Chip Forecasts of Two-Year AverageInterest Rates on Three-Month Treasury Bills (By calendar year, errors in percentage points)

ActualNewIssue

1976-1977 5.11977-1978 6.21978-1979 8.61979-1980 10.81980-1981 12.81981-1982 12.41982-1983 9.71983-1984 9.11984-1985 8.51985-1986 6.71986-1987 5.91987-1988 6.21988-1989 7.41989-1990 7.81990-1991 6.51991-1992 4.41992-1993 3.21993-1994 3.6


Mean error *Mean absolute

error *Root mean

square error *


Mean error *Mean absolute

errorRoot mean

square error *

SOURCES: Congressional Budget

Secondary CBOMarket Forecast

5.16.28.6

10.712.712.39.69.18.56.75.96.27.47.86.44.43.23.6

*

*

*

*

*

Office; Office of

6.26.46.08.39.5

13.212.67.18.78.56.75.66.47.57.06.84.73.4

*

*

*

*

*

*

Management

AdministrationError

1.10.2

-2.6-2.4-3.20.93.0

-2.00.31.80.9

-0.6-0.9-0.30.62.41.5

-0.2

0

1.4

1.7

0.5

1.2

1.5

and Budget;

Forecast

5.54.46.18.29.7

10.011.17.98.18.06.95.55.25.96.06.24.53.4

*

*

*

*

*

*

Eggert Economic

Error

0.4-1.8-2.5-2.6-3.1-2.41.4

-1.1-0.41.31.0

-0.7-2.1-1.9-0.41.81.3

-0.2

-0.7

1.5

1.7

0

1.1

1.3

Enterprises,

Blue ChipForecast

aaaaaa

11.37.99.18.57.15.76.17.57.16.44.63.8

*

*

*

*

*

*

Inc., Blue

Error

aaaaaa

1.6-1.20.51.81.2

-0.5-1.2-0.30.72.01.40.2

*

*

*

0.5

1.1

1.2

Chip EconomicIndicators; Federal Reserve Board.

NOTES: Values are for the geometric averages of the three-month Treasury bill rates for the two-year period. The actual values are publishedby the Federal Reserve Board as the rate on new issues (reported on a bank-discount basis) and the secondary-market rate. CBOforecast the secondary-market rate; the Administration forecast the new-issue rate. Blue Chip alternated between the two rates,forecasting the new-issue rate from 1982 to 1985, the secondary-market rate from 1986 to 1991, and the new-issue rate againbeginning in 1992. The forecasts were issued in the first quarter of the initial year of the period or in December of the preceding year.Errors are forecast values minus actual values; thus, a positive error is an overestimate.

* = not applicable,



Table A-4.Comparison of CBO, Administration, and Blue Chip Forecasts of Two-Year AverageLong-Term Interest Rates (By calendar year, errors in percentage points)

Actual10-Year

NoteCorporateAaa Bond

CBOForecast Error

AdministrationForecast Error

Blue ChipForecast Error

1984-19851985-19861986-19871987-19881988-19891989-19901990-19911991-19921992-19931993-1994

Statistics for1984-1993Mean errorMean absolute

errorRoot mean

square error

11.59.18.08.68.78.58.27.46.46.5

12.010.29.29.59.59.39.08.57.77.6

11.911.58.97.29.49.17.77.87.16.6

-0.11.30.9

-1.40.70.6

-0.50.40.70.2

0.3

0.7

0.8

9.710.68.76.67.77.77.27.36.96.6

-1.81.50.7

-2.0-1.0-0.8-1.0-0.10.50.2

-0.4

0.9

1.1

12.211.89.98.79.89.58.78.78.48.2

0.21.70.8

-0.80.30.3

-0.30.30.70.6

0.4

0.6

0.7

SOURCES: Congressional Budget Office; Office of Management and Budget; Eggert Economic Enterprises, Inc., Blue Chip EconomicIndicators; Federal Reserve Board.

NOTES: Actual values are for the geometric averages of the 10-year Treasury note rates or Moody's corporate Aaa bond rates for the two-year period as reported by the Federal Reserve Board. CBO forecast the 10-year Treasury note rate in all years except 1984 and1985. The Administration forecast the 10-year note rate, but Blue Chip forecast the corporate Aaa bond rate. Data are only availablebeginning in 1984 since not all of the forecasters published long-term rate projections before then. The forecasts were issued in thefirst quarter of the initial year of the period or in December of the preceding year. Errors are forecast values minus actual values;thus, a positive error is an overestimate.

* = not applicable.


Table A-5.Comparison of CBO, Administration, and Blue Chip Forecasts of Two-Year Average Real InterestRates on Three-Month Treasury Bills (By calendar year, errors in percentage points)

ActualNewIssue

1976-19771977-19781978-19791979-19801980-19811981-19821982-19831983-19841984-19851985-19861986-19871987-19881988-19891989-19901990-19911991-19921992-19931993-1994



errorRoot mean

square error



errorRoot mean

square error

CPI-U

-0.9-0.8-0.7-1.40.83.84.85.14.43.93.02.32.82.61.60.80.20.8

*

*

*

*

*

CPI-W

-0.9-0.7-0.8-1.50.94.04.95.74.94.13.22.42.92.61.70.90.41.0

*

*

*

*

*

SecondaryMarket

CPI-U

-0.9-0.8-0.7-1.40.73.74.75.14.43.93.02.32.82.61.50.70.20.8

*

*

*

*

*

CPI-W

-0.9-0.7-0.8-1.50.83.94.95.64.84.13.22.32.92.61.70.90.30.9

*

*

*

*

*

CBOForecast

-0.81.50.20.2

-0.52.65.02.23.64.22.81.71.72.52.82.51.30.5

*

*

*

*

*

*

Error

0.12.21.01.7

-1.2-1.20.3

-2.9-0.80.3

-0.4-0.6-1.2-0.21.21.81.0

-0.3

0.1

1.1

1.3

-0.1

0.9

1.2

AdministrationForecast

-0.6-0.80.10.7

-0.70.34.23.13.43.63.02.11.02.12.01.51.30.6

*

*

*

*

*

*

Error

0.3-0.10.92.2

-1.6-3.7-0.8-2.6-1.4-0.4-0.3-0.2-1.9-0.60.30.61.1

-0.3

-0.5

1.1

1.4

-0.5

0.9

1.1

Blue OhioForecast

aaaaaa

3.82.93.64.03.22.01.82.72.91.91.10.5

*

*

*

*

*

Error

aaaaaa

-1.0-2.3-0.80.10.2

-0.3-1.10.21.31.20.8

-0.4

*

*

*

-0.2

0.8

1.0

SOURCES: Congressional Budget Office; Office of Management and Budget; Eggert Economic Enterprises, Inc., Blue Chip EconomicIndicators] Department of Labor, Bureau of Labor Statistics; Federal Reserve Board.

NOTES: Values are for the appropriate three-month Treasury bill rate discounted by the respective forecast for inflation as measured by thechange in the consumer price index. The forecasts were issued in the first quarter of the initial year of the period or in December ofthe preceding year. Errors are forecast values minus actual values; thus, a positive error is an overestimate.

CPI-U = consumer price index for all urban consumers; CPI-W = consumer price index for urban wage earners and clerical workers;* = not applicable.



Table A-6.Comparison of CBO and Administration Projections of Five-Year Average GrowthRates for Real GNP (By calendar year, errors in percentage points)

Actual

1976-19801977-19811978-19821979-19831980-19841981-19851982-19861983-19871984-19881985-19891986-19901987-19911988-19921989-19931990-1994



errorRoot mean

square error



errorRoot mean

square error

1972Dollars

4.23.11.61.32.1

bbbbbbbbbb

*

*

*

*

*

*SOURCES: Congressional

1982Dollars

3.42.81.41.01.92.62.74.04.13.32.8

cccc

*

*

*

*

*

*

Budget Office;

1987Dollars

3.32.61.21.11.72.42.63.73.73.12.72.01.91.71.9

*

*

*

*

*

*Office of

Chain-typeAnnual-

WeightedIndex

3.73.11.61.32.02.62.73.83.93.12.82.01.81.51.6

*

*

*

*

*

*Management

CBOForecast

5.75.34.83.82.42.83.03.64.03.43.32.92.62.32.3

*

*

*

*

*

*

and Budget;

Error

2.02.23.22.50.40.10.2

-0.20.10.30.60.90.70.80.7

1.0

1.0

1.4

0.6

0.6

0.9

AdministrationForecast Error

6.25.14.83.83.03.83.93.54.34.03.83.53.23.23.0

*

*

*

*

*

*

2.52.13.22.51.01.11.2

-0.40.40.91.01.41.41.71.3

1.4

1.5

1.7

1.1

1.2

1.3

Eggert Economic Enterprises, Inc.

Blue OhioForecast

aaa

3.12.53.02.73.53.53.43.12.72.52.62.4

*

*

*

*

*

*

, Blue Chip

Error

aaa

1.80.50.4

0-0.4-0.40.30.40.60.71.00.8

*

*

*

0.5

0.6

0.7

EconomicIndicators; Department of Commerce, Bureau of Economic Analysis.

NOTES: Actual values are for the five-year growth rates for real gross national product (GNP) last reported by the Bureau of EconomicAnalysis, not the first reported values. Projected values are for the average growth of real GNP over the five-year period. Themajority of the projections were issued in the first quarter of the initial year of the period or in December of the preceding year. Errorsare projected values minus actual values; thus, a positive error is an overestimate. The chain-type annual-weighted index of actualGNP was used in calculating the errors.

* = not applicable.

a. Five-year forecasts for the Blue Chip consensus were not available until 1979.

b. Data for 1972-dollar GNP are available only through the third quarter of 1985.

c. Data for 1982-dollar GNP are available only through the third quarter of 1991.

Appendix B

A More Accurate Measureof Real Economic Growth

F ixed-weighted measures of output—grossdomestic product (GDP) or gross nationalproduct—have been the primary measure of

inflation-adjusted, or real, economic activity through-out the postwar period. As part of its quinquennialbenchmark revision scheduled for this December,however, the Bureau of Economic Analysis (BEA)will switch to a chain-type annual-weighted measureof real GDP and its components. The revision willalter analysts' view of the trend in real economicgrowth and price changes, but it should not, in princi-ple, affect perceptions of trends in nominal GDP.BEA will also change the base year used in reportingthe traditional fixed-weighted measure of real GDP.1

Calculating nominal, or current-dollar, GDP isfairly straightforward, but the best method for calcu-lating real economic activity is less clear. NominalGDP is calculated by simply adding up the dollarvalues of the various components of final demand-that is, the value of all the goods and services thatpeople, businesses, and governments produce. RealGDP, however, can be calculated in several ways,each of which has advantages and disadvantages.

1. For details of the revision and the chain-type annual-weighted in-dex, see J. Steven Landefeld and Robert P. Parker, "Preview of theComprehensive Revision of the National Income and Product Ac-counts: BEA's New Featured Measures of Output and Prices," Sur-vey of Current Business (July 1995), pp. 31-38; and Allan H.Young, "Alternative Measures of Change in Real Output andPrices," Survey of Current Business (April 1992), pp. 32-48.

Fixed-Weighted GDP

The fixed-weighted measure calculates real GDP us-ing the prices of a specific year, called the base year.The current year's dollar value of each component offinal demand is expressed in terms of its price in thebase year, and the sum of the value of the compo-nents equals real GDP. The base year, which is cur-rently 1987, is updated periodically—in recent de-cades, about every five years—and all of the historicaldata are revised at that time. Such a revision willoccur in December when BEA shifts the base year to1992.

The fixed-weighted measure has several advan-tages: it is easy to calculate; its interpretation isstraightforward in that it uses the prices of one spe-cific year (so it can be called "1987-dollar GDP," forexample); and it permits analysts to calculate thecontribution of each component of final demand togrowth in GDP. The drawback of the fixed-weightedmeasure is that it does not accurately describe realeconomic activity when prices change a lot relativeto those in the base year. For example, computersnow cost only about 35 percent of what they cost in1987 (after adjusting for changes in quality), but theprice of food has increased 30 percent. Valuing cur-rently produced computers at their high 1987 priceswhile valuing food at much lower 1987 prices greatlyoverstates the current importance of computer outputrelative to food output.


The problem of inappropriate weights becomesserious when the base year is too distant. Changes inrelative prices therefore require periodic rebasing ofthe GDP data. During the postwar years, the baseyear has been changed a number of times. The years1947, 1954, 1958, 1972, 1982, and 1987 have beenused as base years.

The periodic rebasing of the fixed-weighted mea-sure of real GDP causes significant revisions of realgrowth for previous decades. Each time a new baseyear is instituted and the data are revised back to1929, the real growth rate of previous decades is re-duced. For example, the average annual growth ratefrom 1972 to 1984 was reported to be 2.7 percent in1982 dollars, but switching to 1987 dollars reducedmeasured average growth by 0.4 percentage points ayear. Rebasing tends to reduce measured growth forthe years before the new base year because it puts asmaller weight on the components of demand thathave increased the least in price, and those sectorstend to be the fastest growing.

The repeated revisions also make most recessionsappear milder than first reported. The decline in out-put during 1974, for example, was reported to be 1.4percent using the 1972-dollar measure but only 0.6percent using the 1987-dollar measure.

Chain-type Annual-Weighted GDP

Starting with its December revisions, the Bureau ofEconomic Analysis intends to feature the chain-typeannual-weighted measure of GDP. The chain-typemeasure of the growth of real economic activity iscalculated as the geometric average (the square rootof the product) of two output indexes. One of theseindexes values the change in output from the preced-ing year at that year's prices and the other does thereverse, valuing the change in output at the currentyear's prices. When the two output measures areaveraged, therefore, both sets of prices play a role.The growth rates so calculated are then linked to-gether in a composite chain index. For presentation

purposes, BEA will set the composite index equal tothe nominal value of GDP in 1992.

The pros and cons of the chain-type measure arejust the oppsoite of those of the fixed-weighted mea-sure. The chain-type index yields a more accuratemeasure of real economic activity because it usesprices relevant to the period being considered, and italso reduces the need to revise historical data. Itsdrawbacks are that it is more difficult to calculate,and the components of real final demand do not sumto real GDP (the mathematics of geometric averagesresults in a residual component of total GDP growththat cannot be allocated to any category of final de-mand). BEA, however, will publish estimates of thecontributions to growth made by each component ofGDP.

An Altered View of PastEconomic Growth

The chain-type method of calculating real GDP sig-nificantly alters the historical picture of real eco-nomic growth. The fixed-weighted procedure, using1987 prices, is biased downward for the years before1987 and upward for subsequent years. For example,that measure indicates that real growth averaged 3.1percent a year between 1959 and 1987, whereas thenew measure shows higher annual growth of 3.4 per-cent. Conversely, real growth between 1990 and1994 averaged 2.2 percent a year using the currentmeasure but 1.8 percent using the new measure. Theoverstatement of growth for recent years is particu-larly large for the last half of 1994 and the first halfof this year (see Table B-l).

Growth rates for specific components of GDPcan differ even more. Real business fixed invest-ment, for example, grew an average of 5.3 percent ayear between 1990 and 1994 using the fixed-weighted measure, compared with 3.3 percent usingthe chain-type measure.

Although BEA has provided the chain-type mea-sure for a few years, detailed data have not been

APPENDIX B A MORE ACCURATE MEASURE OF REAL ECONOMIC GROWTH 73

readily available and BEA has not highlighted thatmeasure. Consequently, few analysts have investi-gated the implications of the new measure for fore-casting or policy analysis. Forecasts are affected in anumber of ways by the interpretation of past events,

so the new data, by encouraging reinterpretation ofthe past, may influence future forecasts. However,the way in which forecasts may be affected, if at all,is not yet clear.

Table B-1.Comparison of Growth Rates of Real GDP for Recent Quarters

Quarter

1994:11994:111994:1111994: IV1995:11995:11

Fixed1987-Weighted

Measure

3.34.14.05.12.70.5

Chain-typeAnnual-Weighted

Measure

3.24.23.64.01.7-0.2

Difference

0.1-0.10.41.11.00.7

SOURCE: Congressional Budget Office using data from the Department of Commerce, Bureau of Economic Analysis.

Appendix C

Sequestration Update Reportfor Fiscal Year 1996

T he Budget Enforcement Act of 1990amended the Balanced Budget and Emer-gency Deficit Control Act of 1985 and the

Congressional Budget Act of 1974 to add new en-forcement procedures for direct (mandatory) spend-ing, receipts, and discretionary spending for fiscalyears 1991 through 1995. The Omnibus Budget Rec-onciliation Act of 1993 extended the application ofthe new procedures through 1998. The law requiresthe Congressional Budget Office (CBO) to issue asequestration preview report five days before thePresident's budget submission in January or Febru-ary, a sequestration update report on August 15, anda final sequestration report 10 days after the end of asession of Congress. Those reports must contain esti-mates of the following items:

o The discretionary spending limits and any adjust-ments to them;

o The amount by which direct spending or receiptlegislation enacted after the Budget EnforcementAct has increased or decreased the deficit; and

o The amount of any required pay-as-you-go se-questration.

This report to the Congress and the Office ofManagement and Budget (OMB) provides the infor-mation required for the August 15 update of CBO'sSequestration Preview Report for Fiscal Year 1996.In addition to updating the information required inthis report, the final report that CBO will issue10 days after the current session of Congress endsmust also assess whether a sequestration is required.

A sequestration will be triggered if enacted appropri-ations have exceeded the spending limits for 1996 ordirect spending or receipt legislation has increasedthe total deficit for 1995 and 1996. Based on the lev-els of spending allowed under the budget resolutionadopted earlier this year and on legislative action todate, CBO does not anticipate that any discretionaryspending or pay-as-you-go sequestration will be re-quired in 1996.

Discretionary SequestrationReport

The Omnibus Budget Reconciliation Act of 1993(OBRA-93) established new limits on total discre-tionary budget authority and outlays for fiscal years1996 through 1998. But it left in place the existingdiscretionary spending limits for 1993 through 1995and the existing enforcement procedures, includingspecific instructions for adjusting the discretionarylimits. The Violent Crime Control and Law Enforce-ment Act of 1994, enacted in September 1994, ex-cluded spending from the Violent Crime ReductionTrust Fund (VCRTF) from the constraints of the ex-isting caps. It also lowered those caps by the as-sumed amount of trust fund spending for each yearthat the caps would be in effect and established sepa-rate limits through 1998 on outlays resulting fromVCRTF appropriations.

The estimates of the limits on total general-pur-pose (non-VCRTF) discretionary spending for 1995


through 1998 shown in Table C-l differ from thosein CBO's January 1995 preview report for three rea-sons. First, the estimates have been revised to reflectdifferences between the spending limits in CBO'spreview report and those specified in OMB's previewreport, which was included in the President's budgetsubmission. Second, the limits have been increasedto reflect emergency funds made available sinceOMB issued its preview report. Third, as required bythe package of supplemental appropriations and re-scissions enacted on July 27 (Public Law 104-19),the limits have been decreased to reflect the effect of

that legislation on nonemergency discretionaryspending. The limits on the VCRTF are not subjectto any adjustment, so they remain as presented in theJanuary report.

Differences Between the Limits inCBO's and OMBfs Preview Reports

Amendments made by the Budget Enforcement Act(BEA) require both CBO and OMB to calculate

Table C-1.CBO Estimates of Discretionary Spending Limits for Fiscal Years 1995 Through 1998 (In millions of dollars)

1995 1996 1997 1998Budget Budget Budget

Authority Outlays Authority Outlays Authority OutlaysBudget

Authority Outlays

General-Purpose SpendingLimits in CBO's January1995 Preview Report

AdjustmentsTechnical differencesfrom OMB's February1995 preview report

Emergency 1995appropriations enacted sinceOMB's preview report

Contingent emergencyappropriations designatedsince OMB's preview report

Reduction required by

517,067 546,438 512,891 546,714 521,234 543,276 523,098 541,128

4,492 2,670 8,682 6,213

5,930 1,401 3,275 1,387 0 2,131

542 197 0 168 0 98

12,989 10,474

0 2,032

54

P.L 104-19

Total

General-Purpose SpendingLimits as of August 15, 1995

Violent Crime ReductionTrust Fund Spending Limits

Total DiscretionarySpending Limits

-15.295

-8,823

508,244

2,423

510,667

-599

1,000

547,438

703

548,141

0

7,767

520,658

4,287

524,945

-3.149

1,076

547,790

2,334

550,124

-55

8,627

529,861

5,000

534,861

-2.659

5,783

549,059

3,936

552,995

0

12,989

536,087

5,500

541,587

-2.168

10,392

551,520

4,904

556,424


NOTE: OMB = Office of Management and Budget; P.L. = Public Law.

APPENDIX C SEQUESTRATION UPDATE REPORT FOR FISCAL YEAR 1996 77

changes to the discretionary spending limits specifiedin the act. OMB's estimates of the limits are control-ling, however, in determining whether enacted appro-priations are within the limits or a sequestration isrequired to eliminate a breach of the limits. CBO'sestimates are advisory. In acknowledgement ofOMB's statutory role, when CBO calculates changesin the limits for a report, it first adjusts for the differ-ences between the limits in its most recent report andthe limits in OMB's most recent report—in effect, us-ing OMB's official estimates as the starting point forthe adjustments that CBO is required to make in thenew report.

The spending limits for 1995 in CBO's January1995 preview report were essentially the same asthose in OMB's February 1995 preview report:CBO's estimate of the budget authority limit was thesame as OMB's, and CBO's estimate of the outlaylimit was only $1 million lower than OMB's. Thatdifference merely reflects different assumptionsabout the rate at which $44 million in emergency ap-propriations will be spent (the spendout rate); thoseappropriations were released by the President to fundeconomic development programs and assistance tovictims of natural disasters.

CBO's estimates for the years after 1995, how-ever, were dramatically lower than OMB's. In 1998,CBO's spending caps were lower than OMB's by $13billion in budget authority and $10.5 billion in out-lays.

The principal source of the dramatic differencebetween CBO's and OMB's projections of the discre-tionary spending caps is the agencies' different inter-pretation of the rules governing inflation adjust-ments. The BEA amendments required that both pre-view reports include adjustments to the limits to ac-count for differences between actual inflation andinflation estimated at the time the BEA was enacted.For the years before 1995, CBO and OMB agreedthat an adjustment equal to the ratio of actual infla-tion in the previous fiscal year to inflation projectedfor that year should be applied to the spending limitsfor all years in which they are in effect.

OMB changed its method of adjusting for infla-tion in its February 1995 preview report. It basedthat change on provisions in OBRA-93 that extended

the discretionary spending limits through 1998.OMB's adjustments in that report were based on theratio of OMB's forecast of inflation in 1996, 1997,and 1998 (as reflected in the President's budget sub-mission) to inflation projected for those years whenOBRA-93 was enacted. Although CBO believes thatOMB's change in method is not warranted by the pro-visions of OBRA-93 (the conference report onOBRA-93 stated that the legislation "retains, withminor technical and conforming changes, the currentlaw's procedures for periodically adjusting the discre-tionary spending limits"), CBO will continue to usethe OMB-adjusted limits as the starting point for itsreports.

In comparison with CBO's adjustments, whichreflect only changes that result from the differencebetween projected and actual inflation for the previ-ous fiscal year (1994), OMB's prospective adjust-ments steadily increase the maximum budget author-ity and outlays allowed under the caps. For 1996,OMB's inflation adjustment increases the limits onoutlays by $1.8 billion relative to its estimate of thecap in its December 1994 final report, a figure thatclimbs to $5.1 billion in 1997 and $8.9 billion in1998. CBO's adjustment, which results from an ac-tual 1994 inflation rate that was lower than expectedwhen the discretionary limits were established, de-creases the limits by $571 million in 1996. Thesereductions reach $1 billion in 1997 and $1.3 billionin 1998. The total effect of the opposite inflationadjustments on the limits in 1998 is approximately$13 billion in budget authority and $10.2 billion inoutlays.

The second largest source of variance betweenthe discretionary spending limits contained in CBO'sand OMB's preview reports is also a difference ininterpretation of the law. OMB's caps reflect outlayincreases of $171 million in 1996, $62 million in1997, and $259 million in 1998 as a result of rees-timates of enacted emergency legislation. CBO,however, believes that the Budget Enforcement Actdoes not allow adjustments for reestimates of thecosts of legislation and so does not include any.

Other sources of difference between CBO's andOMB's estimates of the caps include changes in con-cepts and definitions and differing estimates for thespendout rate of emergency appropriations released


by the President. Approximately $80 million of the$152 million in cumulative changes in outlays cate-gorized as changes in concepts and definitions is theresult of different estimates of various provisions of1995 appropriation acts; the remainder is attributableto a change in the calculation of the subsidy cost ofloan guarantees from the Community OpportunityFunds program to conform with the provisions of theCredit Reform Act of 1990. Annual changes thatresult from differing estimates of spendout rates foremergency appropriations put CBO's estimates be-tween $2 million below and $4 million above OMB'sannual estimates, but they sum to zero over the 1995-1998 period.

Emergency Funding Made AvailableSince OMBfs Preview Report

The discretionary spending limits are also adjusted toreflect emergency appropriations made availablesince OMB's preview report. The largest adjustmentis for the $3.5 billion in 1995 emergency budget au-thority provided in the recently enacted supplementalappropriations and rescissions act (P.L. 104-19) fordisaster assistance and antiterrorism activities (in-cluding recovery from the Oklahoma City bombing).Additional 1995 budget authority of $2.5 billion wasprovided in the Emergency Supplemental Appropria-tions and Rescissions for the Department of Defenseto Preserve and Enhance Military Readiness Act of1995 (P.L. 104-6). The President's release of contin-gent emergency appropriations—largely relating torecovery from natural disasters—adds another $542million in 1995 budget authority to the totals inOMB's preview report. Those appropriations raisethe outlay limits by $1.6 billion in 1995 and 1996,$2.2 billion in 1997, and $2.1 billion in 1998.

Required Revision to Reflect Reductionin Nonemergency Spending

Section 2003 of the supplemental appropriations andrescissions package (P.L. 104-19) required down-ward adjustments to the discretionary spending limitsequal to the total effect of the legislation on non-emergency budget authority and outlays. CBO esti-mates that the discretionary nonemergency provi-

sions reduced 1995 budget authority by $15.3 billion,with minor effects on budget authority in futureyears. The resulting outlay reductions are $599 mil-lion in 1995, $3.2 billion in 1996, $2.7 billion in1997, and $2.2 billion in 1998. As required, CBOhas adjusted the caps by those amounts.

Pay-As-You-Go SequestrationReport

If legislated changes in direct spending programs orgovernmental receipts enacted since the Budget En-forcement Act increase the combined current andbudget year deficits, a pay-as-you-go sequestration istriggered at the end of the Congressional session, andnonexempt mandatory programs are cut enough toeliminate the increase. The pay-as-you-go provisionsof the BEA applied through fiscal year 1995, andOBRA-93 extended them through 1998.

The Budget Enforcement Act requires both CBOand OMB to estimate the net change in the deficitresulting from direct spending or receipt legislation.As is the case with the discretionary spending limits,however, OMB's estimates are controlling in deter-mining whether a sequestration is required. CBOtherefore adopts OMB's estimates of changes in thedeficit at the end of the previous session of Congressas the starting point for this report.

CBO's estimates of changes in the deficit for1995 through 1998 resulting from direct spending orreceipt legislation enacted since the Budget Enforce-ment Act are shown in Table C-2. Those estimatesinclude OMB's estimates of changes in the deficitresulting from legislation enacted through the end ofthe 103rd Congress but exclude changes in the deficitfor 1996 through 1998 resulting from legislation en-acted before OBRA-93 (the pay-as-you-go proce-dures did not apply to those years until OBRA-93was enacted). Deficit reduction contained in OBRA-93 is also excluded, as required by law.

The only significant change to the pay-as-you-gototals thus far in the 104th Congress results from theSelf-Employed Health Insurance Act of 1995 (P.L.104-7). That legislation, which affects receipts and

APPENDIX C SEQUESTRATION UPDATE REPORT FOR FISCAL YEAR 1996 79

outlays, both extends and enriches a deduction avail-able to self-employed individuals for the cost ofhealth insurance and denies the earned income taxcredit to otherwise-eligible individuals whose annualinvestment income exceeds $2,350. The changes indirect spending and revenues attributable to the act,added to the combined net deficit reduction of $2.2

billion for 1995 and 1996 that OMB estimated in itspreview report, yield a net decrease in the combined1995 and 1996 deficits of $1.8 billion. The onlyother legislation enacted in 1995 tallied under thepay-as-you-go procedures-the District of ColumbiaEmergency Highway Relief Act (P.L. 104-21)~re-duces outlays in 1997 and 1998.

Table C-2.Budgetary Effects of Direct Spending or Receipt LegislationEnacted Since the Budget Enforcement Act (By fiscal year, in millions of dollars)

Legislation 1995 1996 1997 1998

Total for OMB's February 1995 Preview Report3

Legislation Enacted Since OMB's Preview Report

-2,009 -148 -357

Self-Employed Health Insurance Act (P.L. 104-7)b

District of Columbia Emergency Highway Relief Act(P.L. 104-21)

Change in the Deficit Since the Budget Enforcement Act

248

0

-1,761

83

0

-65

-67

-2

-426

-68

-2

-79


NOTES: OMB = Office of Management and Budget; P.L. = Public Law.

The following bills affected direct spending but did not increase or decrease the deficit by as much as $500,000 in any year through1998: Congressional Accountability Act (P.L. 104-1); District of Columbia Financial Responsibility and Management Assistance Act(P.L. 104-8); Paperwork Reduction Act (P.L. 104-13); An Act to Permit Medicare Select Policies in All States (P.L. 104-18).

a. Section 254 of the Balanced Budget and Emergency Deficit Control Act of 1985, as amended by the Budget Enforcement Act of 1990, callsfor a list of all bills enacted since the Budget Enforcement Act that are included in the pay-as-you-go calculation. Because the data in thistable assume OMB's estimate of the total change in the deficit resulting from bills enacted through the end of the 103rd Congress, readersare referred to the list of those bills included in Table 6 of the OMB Final Sequestration Report to the President and Congress for Fiscal Year1995 (December 16, 1994) and in previous sequestration reports issued by OMB.

b. Includes reductions in receipts and outlays.

Appendix D

CBO Projections of National HealthExpenditures Through 2005

T he projected growth of the federal deficit un-der current law stems largely from the contin-ued double-digit growth rates of Medicare

(the large federal health insurance plan for the agedand disabled) and Medicaid (the joint federal/stateinsurance system for the poor). Until recently, Medi-care and Medicaid mirrored private health insurance,and the rapid growth of those programs was symp-tomatic of the rapid growth of health spending ingeneral. Recent changes in the structure of privatehealth insurance, however, have led to a surge ofcompetitive pricing and have significantly slowed thegrowth of private health spending. This appendixsummarizes the Congressional Budget Office's(CBO's) latest projections of national health expendi-tures, highlighting the dramatic changes taking placein the health economy.

To some extent, changes spearheaded by the pri-vate sector will spill over to the Medicare and Medic-aid programs. But there are some limitations on howeffectively the public programs can replicate the costsavings in the private sector. Under current law, theopen-ended nature of fee-for-service Medicare andthe formulas that Medicare uses to pay health mainte-nance organizations (HMOs) prevent the programfrom taking full advantage of the changes takingplace in the private sector. The trend in Medicaidoutlays is also extremely uncertain. Medicaid's pay-ment rates are generally below the rates paid byMedicare and private insurers; many states are shift-ing to managed care for poor families; and managedcare for the disabled and those in nursing homes islargely untried. Moreover, some of the states' recentefforts also include expansions of coverage.

Budget plans the Congress is considering wouldreduce the growth of Medicare and federal contribu-tions to Medicaid. If implemented, they would alsoreduce national health spending. The amount woulddepend on the methods that the Congress chose toachieve its budget targets.

Changes in the HealthEconomyIn recent decades, U.S. health spending has grownvery rapidly, mainly because consumers of healthcare have had little incentive to economize on healthspending and because providers of health serviceshave focused on diagnosis and treatment, not on cost.People often delegate decisions about health treat-ments to health providers, primarily their doctors andthe hospitals in which their doctors practice. Untilrecently, private insurance companies paid the rea-sonable and customary charges of those providers,and government insurance programs generally paidproviders based on their costs. Those insurance ar-rangements gave providers an incentive to developnew, high-cost procedures—which had no customarycharge and for which high charges seemed reason-able—and allowed the health sector to expand withlittle restraint. The ultimate costs of those expensivenew services were reflected in government budgetsand, for workers with employment-based health in-surance, in employees' noncash compensation.

Although the rapid growth of health spendingcontributed to rising taxes or government deficits,


slow growth of cash pay, and rising numbers of peo-ple without health insurance, the connection was notalways direct or apparent. People did not benefit in-dividually by taking actions to slow the growth oftheir health spending.

All of that is beginning to change. After severalyears of extremely rapid growth, spending for healthcare—especially by private payers—has slowed. Un-like traditional insurers, managed care plans activelypurchase health care instead of passively paying thebills. These new plans, led by HMOs, have the po-tential to control the growth of health spending onbehalf of their enrollees. Since the mid-1980s, themarket share of managed care plans has increaseddramatically. Since about 1990, the market domi-nance of traditional fee-for-service health insurancehas shrunk, and the emergent managed care plans-taking advantage of the excess capacity that fee-for-service insurance had encouraged—have helped touchoff a hotly competitive response to the problems ofthe health economy.

The development of price competition amonghealth plans and providers in the 1990s probably re-flects the confluence of many interrelated factors.The recession of 1990-1991, like the previous reces-sion of 1981-1982, highlighted the need for efforts tocontrol health payments. During both downturns, thegrowth in health spending remained strong whilegovernment tax revenues and private incomes-thefunding resources for health care-were under eco-nomic pressure.

By the early 1990s, enrollment in managed careplans had grown to levels that providers of healthcare services found increasingly difficult to ignore,improving the ability of plans to contract with hospi-tals and doctors at favorable terms. Those price dis-counts, combined with the potential that managedcare plans have to reduce the use of health servicesbelow what would be expected under fee-for-servicereimbursement, have allowed managed care plans toachieve significant cost advantages over traditionalinsurance plans.

As some businesses have used managed care tohelp slow the premium increases faced by their work-ers, other businesses have felt pressure to keep up. Ifa company finds that its employees are amenable to

managed care, it can use the savings to pay its work-ers more, leaving businesses that do not find ways toslow premium growth at a competitive disadvantagein attracting and retaining a skilled workforce.

Finally, plans found that they could establish andexpand the looser independent practice association(IPA) form of health maintenance organization muchmore rapidly than group- or staff-model HMOs.Many traditional insurers formed preferred providerorganizations (PPOs), which offer HMO-style bene-fits (low fixed copayments) if the enrollee uses thePPO network. These new plans found a climate fer-tile for cost control, and their market share expandedrapidly.

Managed care plans and the price competitionthey have spawned are helping to offset (rather thaneliminate) some of the root problems that have weak-ened incentives for cost containment in the healthsector. Enrollees of managed care plans still delegatemuch decisionmaking to the plans' health providersand still have no financial incentive, as patients, toeconomize on services they request. But the incen-tives for providers under managed care plans can bedramatically different from the incentives they facedunder traditional insurance. Fee-for-service provid-ers had an economic incentive to maximize the num-ber of billable services they performed. Many man-aged care providers, however, receive capitated pay-ments, a fixed amount per patient regardless of thenumber of services provided. Providers receivingcapitation payments have an incentive to maximizethe number of patients in their practice. As morepayments are made through capitation, the incentivefor excessive volume of services switches to an in-centive to provide less care. Managed care providerscan increase their income by keeping their patientshealthy and avoiding unnecessary services (a desir-able social outcome) or by withholding appropriatecare (an undesirable result).

CBO Projections of HealthSpending

In 1965, national health spending constituted lessthan 6 percent of U.S. gross domestic product (GDP).

APPENDIX D CBO PROJECTIONS OF NATIONAL HEALTH EXPENDITURES THROUGH 2005 83

In 1995, health spending will total an estimated$1 trillion, or 14 percent of GDP. Assuming that fed-eral laws do not change, CBO projects that nationalhealth expenditures will grow to 16 percent of GDPin 2000 and to 18 percent in 2005 (see Table D-l).

CBO estimates that spending for health care grewabout 6 percent in 1994, the slowest rate in 30 years,and will grow about 7 percent in 1995. Private healthinsurance premiums show correspondingly slow ratesof growth: 5 percent in 1994 and almost 6 percent in

Table D-1.National Health Expenditures for Selected Calendar Years, by Source of

Source of Funds 1965 1980Actual1985 1990

Funds

1993 1995Projected

2000 2005


Private 31

PublicFederal 5State and local _5

Total 42

As a

Private 75.3

PublicFederal 11.6State and local 13.2

Total 100.0

146

7233

251

Percentage

58.1

28.713.3

100.0

259

12352

434

410

19691

697

496

281107

884

552

334121

1,008

770

528174

1,472

1,051

821247

2,119

of Total Expenditures

59.7

28.4_LL2

100.0

58.9

28.113.0

100.0

56.1

31.7

100.0

54.8

33.212.0

100.0

52.3

35.8

100.0

49.6

38.8

100.0

Average Annual Growth Rate from Previous Year Shown (Percent)

Private *

PublicFederal *State and local *

National Health Expenditures *

Memorandum:Gross Domestic Product(Billions of dollars)3 703

Average Annual Growth of GrossDomestic Product from PreviousYear Shown (Percent)

National Health Expendituresas a Percentage ofGross Domestic Product 5.9

10.8

19.712.8

12.7

2,708

9.4

9.3

12.2

11.49.2

11.6

4,039

8.3

10.8

9.6

9.711.9

9.9

5,546

6.5

12.6

6.6

12.75.7

8.3

6,343

4.6

13.9

5.5

9.16.3

6.8

7,127

6.0

14.1

6.9

9.67.5

7.9

9,128

5.1

16.1

6.4

9.37.2

7.6

11,772

5.2

18.0


NOTE: * = not applicable.

a. Economic assumptions reflect the Congressional Budget Office's forecast of January 1995.


1995. The growth of private health insurance premi-ums will average about 7 percent a year between1995 and 2005. Federal spending for Medicare andMedicaid is projected to increase by 10 percent ayear under current law.

Government spending on health care has risenfrom 40 percent of total health spending in 1985 toan estimated 45 percent in 1995 and will account forover 50 percent of total health spending by 2005.Increases in federal outlays account for all of the pro-jected growth in the public share of health spendingunder current law. Although state government initia-tives—especially for Medicaid—are inherently unpre-dictable, CBO assumes that the share of healthspending paid by state and local governments willremain steady at about 12 percent of the total.

Alternative Scenarios forGrowth of Private HealthSpendingWhether the recent trends toward price competitionwill continue to moderate the growth of health spend-ing is highly uncertain. Previous slowdowns in thegrowth of health spending-in the late 1970s andmid-1980s, for example-proved temporary. Healtheconomists and policy experts are divided aboutwhether the current moderate growth of health premi-ums will persist. To illustrate some possibilities,CBO has computed the path of health spending undertwo alternative scenarios: one in which growth inhealth spending accelerates and one in which theslowdown continues.

Scenario 1: Rapid Growth Returns

The possibility that the current slowdown in privatehealth spending could turn out to be more of a short-term aberration than a long-term trend has beenraised by several analysts.1 To illustrate this possi-

1. See, for example, Henry Aaron, "Thinking Straight about MedicalCosts," and Katharine Levit and others, "National Health SpendingTrends, 1960-1993," both in Health Affairs (Winter 1994).

bility, Scenario 1 assumes that the current slowdownin private-sector health spending is temporary andthat the growth of private insurance premiums andout-of-pocket payments reverts to historical trends.Specifically, the growth of private health spendinggradually rises to 2 percentage points a year abovethe baseline. National health expenditures under this

Figure D-1.National Health Expenditures UnderAlternative Scenarios for Growth inPrivate Health Spending (By calendar year)

National Health Spendingas a Percentage of GDP

Percent25

20 -

15 -

10 -

CBO Baseline

Scenario 1

Scenario 2

20

1965 1970 1975 1980 1985 1990 1995 2000 2005

Growth of National Health Spending

Percentage Change

15 -

10

CBO Baseline

Scenario 1

Scenario 2

1965 1970 1975 1980 1985 1990 1995 2000 2005


NOTE: Scenario 1 assumes that growth in private health spend-ing is 2 percentage points higher than in the baseline.Scenario 2 assumes that growth is 2 percentage pointslower.

APPENDIX D CBO PROJECTIONS OF NATIONAL HEALTH EXPENDITURES THROUGH 2005 85

scenario would account for 19.5 percent of the econ-omy in 2005, closer to CBO's previous projections.2

Health spending would grow by about 8.5 percent ayear in the projection period compared with about7.7 percent a year in the baseline (see Figure D-l).

Scenario 2: The Slowdown Continues

Although some health economists doubt that theslowdown in private spending will continue, manyobservers from private health plans believe that it cango on indefinitely. For example, when CBO con-vened a panel of outside experts to discuss these pro-jections in December 1994, representatives fromlarge health plans generally believed that continuedrestraint was likely. Under Scenario 2, the currentmoderate growth of private insurance premiums andout-of-pocket spending persists throughout the pro-jection period. Specifically, their growth graduallyfalls to 2 percentage points a year below the baselineprojection. Under Scenario 2, health spending wouldaccount for 16.7 percent of the economy in 2005compared with CBO's baseline projection of 18.0percent. Total spending under this alternative wouldgrow by about 6.9 percent each year compared withaverage annual growth of 7.7 percent in the baseline.

Impact of the BudgetResolutionThe Congress has resolved to reduce the average rateof growth of Medicare spending to 6.3 percent a yearbetween fiscal years 1995 and 2002, down from the10.3 percent annual rate expected under current law.The growth of federal contributions for Medicaidwould slow from 10.4 percent a year under currentlaw to about 4.8 percent annually under the budgetresolution. Slower growth of Medicare and Medicaidwould in turn reduce the growth of national healthspending. Depending on exactly how the growth ofthose programs is slowed, the outlook for nationalhealth spending could be substantially changed.

2. CBO's health projections were introduced in Projections of Na-tional Health Expenditures, CBO Study (October 1992) and up-dated in Projections of National Health Expenditures: 1993 Up-date, CBO Paper (October 1993).

The budget resolution calls for Medicare outlays(net of premiums collected from beneficiaries) togrow by 6.3 percent. Raising premiums for Supple-mentary Medical Insurance (SMI, or Part B of Medi-care) would have no effect on national health spend-ing if everyone continued to participate. Increasingbeneficiaries' cost sharing by raising deductibles orcoinsurance would slightly reduce national healthspending. The 15 percent of beneficiaries withoutsupplementary coverage that pays for cost sharing(either through Medicaid or a private medigap plan)would use fewer health services if they had to bear agreater share of coinsurance. Their out-of-pocketpayments would increase, but not by as much as gov-ernment payments would decline. Beneficiaries withsupplemental insurance coverage would pay highermedigap premiums if cost sharing was increased, andsome might therefore drop their medigap coverage.But for most beneficiaries, increased private medi-gap payments would simply offset the decreased fed-eral payments.

Cutting Medicare reimbursement rates to provid-ers would tend to reduce national health spending,although health care providers would be likely topartly offset a reduction in rates by increasing thevolume of services performed. Also, some research-ers have theorized that past cuts in Medicare reim-bursement have spurred health providers to increasetheir charges to private patients and their insurers,further offsetting the government's cuts. Becausemost private health insurers now purchase care di-rectly from providers, however, often under capita-tion arrangements, there may be less room for suchcost shifting today. Capitated providers could notsimply bill more and extract additional payments tooffset the Medicare cuts. Rate reductions in Medi-care might even make private payers seek lower ratesas well.

The Congress has proposed to reduce the growthof Medicaid spending to 4.8 percent a year in the1996-2002 period. The impact of that reduction onnational health spending would depend on how statesreacted and on whether the states were subject tomaintenance-of-effort or other matching require-ments. If the growth in states' spending continued atcurrently projected levels, then national spendingwould fall roughly in line with the federal reductions.


If states cut the growth of their Medicaid spending in would imply. If states instead increased their Medic-line with the federal outlays, then national health aid outlays, then the impact on national health spend-spending would fall by more than the federal cuts ing would be less than the federal cuts alone.

Appendix E

Major Contributors to theRevenue and Spending Projections

The following Congressional Budget Office analysts prepared the revenue and spending projections in thisreport:

Revenue Projections

Mark Booth Corporate income taxes, Federal Reserve System earnings, excise taxesDrew McMorrow Excise taxesPeter Ricoy Social insurance contributions, estate and gift taxesMelissa Sampson Customs duties, miscellaneous receiptsDavid Weiner Individual income taxesStephanie Weiner Customs duties, miscellaneous receipts

Spending Projections

Defense, International Affairs, and Veterans' Affairs

Elizabeth Chambers Military retirement, atomic energy defense, military health careKent Christensen DefenseSunita D'Monte International affairsVictoria Fraider Veterans' education and housing, defense (weapons)Michael Groarke Veterans' housing and medical careRaymond Hall Defense (weapons)Mary Helen Petrus Veterans' compensation, pensions, and medical careAmy Plapp Defense (personnel)Jeannette Van Winkle Defense (weapons)JoAnn Vines Defense (weapons)Joseph Whitehill International affairs

THE ECONOMIC AND BUDGET OUTLOOK: AN UPDATE August 1995

Human Resources

Wayne Boyington

Sheila DaceyScott HarrisonChristie HawleyJean HearneAnne HuntDeborah KalcevicJustin LatusLisa LaymanJeffrey LemieuxDorothy RosenbaumRobin RudowitzKathy Ruffing

Natural and Physical Resources

Gary BrownKim CawleyRachel ForwardMark GrabowiczKathleen GrampVictoria HeidDavid HullCraig JaggerMary MaginnissEileen ManfrediSusanne MehlmanDavid MooreJohn PattersonDeborah ReisJohn RighterRachel RobertsonJudith RuudJohn Webb

Other

Janet AirisEdward BlauJodi CappsKarin CarrBetty EmbreyKenneth FarrisVernon HammettSandra HoffmanJeffrey HollandDeborah Keefe

Civil Service Retirement, Social Security, Pension Benefit GuaranteeCorporation

Aid to Families with Dependent Children, child support enforcementMedicareUnemployment insurance, training programsMedicaidPublic Health ServiceEducationEducation, foster care, child careMedicareFederal employee health benefits, national health expendituresSocial services, food stamps, child nutritionMedicaidSupplemental Security Income, Social Security

Water resources, other natural resourcesEnergy, pollution control and abatementCommerceJustice, Postal ServiceEnergy, science and spaceConservation and land management, Outer Continental Shelf receiptsAgricultureAgricultureDeposit insurance, legislative branchAgricultureJustice, Federal Housing AdministrationSpectrum auction receiptsTransportationRecreation, water transportationGeneral governmentCommunity and regional development, disaster assistanceDeposit insuranceCommerce

Appropriation billsAuthorization billsAppropriation billsBudget projections, historical budget dataAppropriation billsComputer supportComputer supportComputer supportNet interest on the public debtComputer support

APPENDIX E MAJOR CONTRIBUTORS TO THE REVENUE AND SPENDING PROJECTIONS 89

Daniel Kowalski Credit programs, other interestCatherine Mallison Appropriation billsRobert Sempsey Appropriation billsMichael Simpson National income and product accountsSusan Strandberg Budget projections, civilian agency pay

£• U.S. GOVERNMENT PRINTING OFFICE: 1995 - 386-526 - 814/47252

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