CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

An Analysis of the President’s Budgetary

Proposals for Fiscal Year 2008

MARCH 2007
Pub. No. 2908
CBO

An Analysis of the President’s Budgetary 

Proposals for Fiscal Year 2008

March 2007
Notes

Unless otherwise indicated, the years referred to in this report are fiscal years.

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

Supplemental data for this analysis are available on the home page of the Congressional 

Budget Office’s Web site (www.cbo.gov), under “Current Budget Projections.”

This version (updated on June 11, 2007) includes three footnotes in Appendix D that were 

inadvertently omitted from the original report.
Preface

This Congressional Budget Office (CBO) analysis of the President’s budgetary proposals 

for fiscal year 2008—prepared at the request of the Senate Committee on Appropriations—

was produced by the staffs of CBO’s Budget Analysis, Macroeconomic Analysis, and Tax 

Analysis Divisions under the supervision of Robert Sunshine, Robert Dennis, and Thomas 

Woodward, respectively. CBO prepared the baseline revenue estimates and the estimates of 

selected revenue proposals; the Joint Committee on Taxation (JCT) prepared most of the 

estimates of the President’s revenue proposals. The report expands on CBO’s preliminary 

analysis, which was released on March 2, 2007, and incorporates updated estimates from JCT 

for the President’s health insurance proposal.

Barry Blom of CBO’s Projections Unit was the lead author for Chapter 1; Pamela Greene and 

John Peterson wrote major portions of the chapter. Robert Shackleton of the Macroeconomic 

Analysis Division wrote Chapter 2, Appendix B, and Appendix D. Benjamin Page coordinated the economic analysis in Chapter 2 under the supervision of Douglas Hamilton. 

Robert Arnold, Paul Burnham, Ufuk Demiroglu, Mark Lasky, Larry Ozanne, Frank Russek, 

Marika Santoro, Kurt Seibert, and Sven Sinclair carried out the modeling described in that 

chapter and in Appendix C. 

Ann Futrell of the Projections Unit wrote Appendix A. David Weiner of the Tax Analysis 

Division wrote Appendix C, with contributions from David Auerbach, James Baumgardner, 

Stuart Hagen, and Kevin Perese. The contributors to the revenue and spending projections 

underlying this report are listed in Appendix E.

Christine Bogusz, Christian Howlett, and Loretta Lettner edited the report, with assistance 

from Kate Kelly. Maureen Costantino took the photograph for the cover and prepared the 

report for publication. Lenny Skutnik printed the initial copies, Linda Schimmel coordinated 

the print distribution, and Annette Kalicki and Simone Thomas prepared the electronic 

version for CBO’s Web site (www.cbo.gov).

Peter R. Orszag

Director

March 2007

Contents

1 CBO’s Estimates of the President’s Budget for Fiscal Year 2008 1

Overview of CBO’s Estimates 1

Policy Proposals That Affect Revenues 9

Policy Proposals That Affect Mandatory Spending 11

Policy Proposals That Affect Discretionary Spending 16

Differences Between CBO’s and the Administration’s

Budget Estimates 22

2 The Economy Under the President’s Budget and

Under CBO’s Baseline Policy Assumptions 31

How Federal Budget Policies Affect the Economy 31

The Models and Their Results 38

A Changes in CBO’s Baseline Since January 2007 45

B The Potential Economic Effects of Selected Proposals in the

President’s 2008 Budget 51

C The President’s Proposal for a Standard Tax Deduction for

Health Insurance 57
VI AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

D The Models Used to Analyze the Supply-Side Macroeconomic

Effects of the President’s Budgetary Proposals 63

E Contributors to the Revenue and Spending Projections 67
CONTENTS VII

Tables

1-1. Comparison of Projected Deficits and Surpluses in CBO’s Estimate of the

President’s Budget and in CBO’s March 2007 Baseline 2

1-2. CBO’s Estimate of the President’s Budget for 2008 4

1-3. CBO’s Estimate of the Effect of the President’s Budget on Baseline Deficits or

Surpluses 6

1-4. Differences Between CBO’s Estimate of the President’s Budget and the

Administration’s Estimate, by Source 7

1-5. Proposed Changes in Discretionary Budget Authority in the President’s Budget, 

2006 to 2008 18

1-6. Discretionary Budget Authority Requested by the President for 2008

Compared with Funding for 2007, by Budget Function 20

1-7. Comparison of CBO’s March 2007 Baseline and OMB’s February 2007 

Current-Services Baseline 24

1-8. Comparisons of CBO’s, the Administration’s, and Private-Sector Economic 

Projections for Calendar Years 2007 to 2012 26

1-9. CBO’s and the Administration’s Projections of Tax Bases for Selected 

Calendar Years 28

2-1. CBO’s Estimates of How the President’s Budget Would Affect the Deficit

After Accounting for Economic Effects 33

2-2. CBO’s Estimates of Effective Federal Marginal Tax Rates on Labor Income 35

2-3. CBO’s Estimates of Effective Federal Marginal Tax Rates on Capital Income 37

2-4. CBO’s Estimates of How the President’s Budget Would Affect Real Gross

National Product 41

2-5. The Budgetary Implications of the Macroeconomic Effects 42

A-1. CBO’s Baseline Budget Projections 46

A-2. Changes in CBO’s Baseline Projections of the Deficit or Surplus

Since January 2007 47

C-1. Budgetary Effects of the President’s Health Proposal 59

C-2. CBO’s Estimates of Effective Federal Marginal Tax Rates on Labor Income 

Under the President’s Proposals 60
VIII AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Figures

1-1. Total Deficit or Surplus, 1965 to 2017 3

1-2. Discretionary Budget Authority in Recent Decades and Under Policies 

Proposed in the President’s 2008 Budget 19

1-3. CBO’s and the Administration’s Forecasts of Wages and Salaries 23

2-1. CBO’s Estimates, Using Various Models, of How the President’s Budget 

Would Affect the Deficit After Accounting for Economic Effects 32

2-2. Effects of the President’s Budget on the Deficit and on the Effective 

Tax Rates on Capital Income and Labor Income 39

Box

1-1. The Effect of the President’s Proposals for Medicare on the Long-Term Outlook 14
CHAPTER

1

CBO’s Estimates of the

President’s Budget for Fiscal Year 2008

At the request of the Senate Committee on 

Appropriations, the Congressional Budget Office (CBO) 

has analyzed the President’s budget request for fiscal year 

2008. The analysis is based on CBO’s own economic 

assumptions and estimating techniques, and incorporates 

the Joint Committee on Taxation’s (JCT’s) estimates for 

provisions that affect the tax code. In addition, it incorporates updated estimates from JCT for the President’s 

health insurance proposal. This report provides more 

detail and analysis about the President’s budgetary 

proposals—and about CBO’s updated baseline budget 

projections—than did the preliminary report that CBO 

released on March 2. 

Overview of CBO’s Estimates

If enacted, the proposals in the President’s budget would 

add $37 billion to the deficit this year, reducing revenues 

by $9 billion and boosting outlays by $28 billion (mostly 

for military operations in Iraq and Afghanistan). As a 

result, the deficit in 2007 would total $214 billion, or 

1.6 percent of gross domestic product (GDP), according 

to CBO’s estimates (see Table 1-1). By comparison, the 

deficit in 2006 was $248 billion, or 1.9 percent of GDP.

Estimates for the 2008–2017 Period

In 2008, CBO estimates, the deficit under the President’s 

budget would again total 1.6 percent of GDP (amounting to $226 billion in nominal dollars)—about twice the 

shortfall that CBO projects under current laws and policies. That difference is attributable largely to proposals 

from the Administration that affect defense spending and 

revenues. The President is requesting additional appropriations of nearly $100 billion in 2007 for military operations in Iraq and Afghanistan and for other activities 

related to the war on terrorism; much of that funding 

would be spent in 2008. The President also is seeking 

$145 billion for such activities next year. (CBO’s baseline 

projection for 2008 includes an extrapolation of the 

$70 billion provided this year for those same purposes.) 

In addition, the President’s budget proposes a one-year 

extension of the higher exemption levels that mitigate 

some of the effects of the alternative minimum tax 

(AMT).

The President’s budget does not contain year-by-year 

estimates of spending and revenues after 2012. Instead, 

it provides a cumulative estimate through 2017 for each 

proposed change to laws that govern revenues and mandatory spending. For discretionary spending, the budget 

contains details only for 2007 and 2008; for 2009 

through 2012, the Administration has provided aggregate 

funding totals for two categories of spending: that designated for the Department of Defense (DoD) and that 

designated for all other agencies. CBO incorporated 

those aggregate levels in its estimates and calculated 

discretionary outlays for the 2013–2017 period by 

projecting the amount of discretionary budget authority 

that the President recommended for 2012 and adjusting 

it for inflation. 

From 2008 to 2012, the deficit as a percentage of GDP 

would decline steadily under the President’s proposals, 

dropping from 1.4 percent in 2009 to a level approaching 

balance in 2012; the budget would remain close to balance through 2017, CBO estimates (see Figure 1-1). The 

cumulative deficit between 2008 and 2017 (the current 

10-year projection period) would total $1.1 trillion, or 

0.6 percent of GDP. Federal debt held by the public 

would decrease from 37 percent of GDP in 2009 to 

29 percent of GDP in 2017. (Those results reflect the 

$50 billion budgeted by the President for military operations in Iraq and Afghanistan in 2009 but no further 
2 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-1.

Comparison of Projected Deficits and Surpluses in CBO’s Estimate of the

President’s Budget and in CBO’s March 2007 Baseline

(Billions of dollars)

Source: Congressional Budget Office.

Note: * = between zero and $500 million; ** = between -0.05 percent and zero; GDP = gross domestic product; n.a. = not applicable.

a. Off-budget surpluses comprise surpluses in the Social Security trust funds as well as the net cash flow of the Postal Service.

b. Negative numbers indicate an increase relative to the baseline deficit or a decrease relative to the baseline surplus. 

Total, Total,

Actual 2008- 2008-

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017

On-Budget Deficit -434 -400 -428 -424 -392 -390 -286 -319 -295 -270 -284 -219 -1,920 -3,309

Off-Budget Surplusa 186 186 202 209 223 241 255 245 231 218 215 210 1,130 2,248 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

-248 -214 -226 -215 -169 -149 -31 -74 -64 -53 -70 -10 -790 -1,060

On-Budget Deficit -434 -363 -315 -351 -388 -281 -102 -123 -104 -82 -104 -46 -1,438 -1,897

Off-Budget Surplusa 186 186 202 217 232 247 257 263 266 268 267 263 1,155 2,482 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

-248 -177 -113 -134 -157 -35 155 139 163 186 163 217 -283 586

On-Budget Deficit 0 -37 -113 -73 -3 -109 -184 -196 -191 -188 -181 -173 -482 -1,412

Off-Budget Surplusa 0 0 * -8 -9 -6 -2 -17 -36 -51 -52 -54 -24 -234 __ ___ ____ ___ ___ ___ ____ ____ ____ ____ ____ ____ ____ _____

0 -37 -113 -81 -12 -114 -186 -213 -227 -239 -233 -227 -507 -1,646

Memorandum:

Total Deficit (-) or Surplus

as a Percentage of GDP

CBO's estimate of the

President's budget -1.9 -1.6 -1.6 -1.4 -1.1 -0.9 -0.2 -0.4 -0.3 -0.3 -0.3 ** -1.0 -0.6

CBO's baseline -1.9 -1.3 -0.8 -0.9 -1.0 -0.2 0.9 0.8 0.9 1.0 0.8 1.0 -0.4 0.3

Debt Held by the Public

as a Percentage of GDP

CBO's estimate of the

President's budget 37.0 37.0 37.0 36.8 36.2 35.6 34.3 33.3 32.3 31.3 30.4 29.2 n.a. n.a.

CBO's baseline 37.0 36.7 35.9 35.2 34.7 33.4 31.1 29.1 27.0 25.0 23.2 21.2 n.a. n.a.

Probability of a Budget

Deficit (Percent)

CBO's estimate of the

President's budget n.a. 97 87 77 69 64 52 n.a. n.a. n.a. n.a. n.a. n.a. n.a.

CBO's baseline n.a. 94 72 68 68 53 38 n.a. n.a. n.a. n.a. n.a. n.a. n.a.

CBO's Baseline

Total Deficit (-) or Surplus

Difference (President's budget minus baseline)b

Total Deficit (-) or Surplus

CBO's Estimate of the President's Budget for 2008

Total Deficit (-) or Surplus
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 3

Figure 1-1.

Total Deficit or Surplus, 1965 to 2017

(Percentage of gross domestic product)

Source: Congressional Budget Office.

funding for such operations thereafter. The results also 

reflect the fact that the Administration is not proposing 

any changes to the AMT beyond the one-year extension 

of the higher exemption levels.)

CBO has estimated a set of probabilities that the budget 

will be balanced under both its baseline projections 

(which assume the continuation of current laws and policies) and its evaluation of the President’s proposals. On 

the basis of historical estimating experience, CBO calculates that, under baseline assumptions, there is roughly a 

40 percent chance that the budget will be in deficit and a 

60 percent chance that the budget will be balanced (or in 

surplus) in 2012. Assuming that the President’s policies 

are enacted in their entirety and that no other legislation 

affecting spending or revenues is enacted in the next five 

years, the likelihood that the budget will be in deficit in 

2012 is about equal to the likelihood that it will be in 

surplus.

According to CBO’s estimates, if the President’s proposals 

were enacted, total outlays as a share of GDP would 

measure 20.1 percent this year and 20.3 percent in 2008, 

slightly lower than their average of 20.6 percent over the 

last 40 years. Thereafter, total outlays would decline to 

about 19 percent of GDP for most of the next 10 years, 

CBO projects (see Table 1-2). Spending for mandatory 

programs would grow faster than nominal GDP through 

2017—by an average of 6.2 percent annually, versus 

4.5 percent for nominal GDP. By contrast, discretionary 

outlays would decline by $82 billion over the 2008–2012 

period; as a percentage of GDP, they would fall from 

7.9 percent to 6.1 percent.

Revenues as a percentage of GDP would total 18.6 percent this year and 18.7 percent in 2008 under the 

President’s policies. That share would fall slightly—to 

18.3 percent of GDP—in 2010 and 2011 but would 

gradually increase thereafter, reaching 19.2 percent of 

GDP by 2017. At that level, revenues would be about 

1 percentage point above their average share of GDP 

over the past 40 years. Future growth in revenues as a 

percentage of GDP reflects a combination of factors: an 

increase in effective tax rates resulting from the progressive structure of the tax code combined with increases in 

real (inflation-adjusted) income; the withdrawal of taxdeferred retirement savings as workers with 401(k) plans 

and traditional individual retirement accounts begin to 

retire in increasing numbers; and the fact that the AMT 

is not indexed for inflation. According to estimates by 

JCT, the President’s proposal on the taxation of health 

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

-7

-6

-5

-4

-3

-2

-1

0

1

2

3

4

CBO's

Baseline

Projection

CBO's

Estimate

of the

President's

Budget

Actual Projected
4 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-2.

CBO’s Estimate of the President’s Budget for 2008

Source: Congressional Budget Office.

Note: n.a. = not applicable; * = between -0.05 percent and zero. 

Total, Total,

Actual 2008- 2008-

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017

On-budget 1,799 1,895 2,010 2,093 2,148 2,239 2,367 2,463 2,598 2,743 2,897 3,062 10,858 24,621

Off-budget 608 638 669 695 729 767 807 847 889 932 976 1,022 3,666 8,333 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,407 2,533 2,679 2,787 2,877 3,007 3,174 3,310 3,487 3,675 3,873 4,084 14,524 32,954

1,413 1,454 1,527 1,613 1,706 1,823 1,873 2,029 2,168 2,315 2,496 2,623 8,543 20,173

1,016 1,056 1,123 1,124 1,064 1,047 1,041 1,061 1,083 1,109 1,139 1,161 5,399 10,952

227 236 256 265 276 285 291 295 300 305 308 310 1,372 2,890 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,655 2,747 2,905 3,002 3,046 3,156 3,205 3,384 3,552 3,728 3,943 4,094 15,314 34,014

On-budget 2,233 2,296 2,439 2,517 2,540 2,629 2,654 2,782 2,893 3,013 3,181 3,281 12,778 27,929

Off-budget 422 451 467 485 506 526 552 602 658 714 762 813 2,536 6,085

-248 -214 -226 -215 -169 -149 -31 -74 -64 -53 -70 -10 -790 -1,060

-434 -400 -428 -424 -392 -390 -286 -319 -295 -270 -284 -219 -1,920 -3,309

186 186 202 209 223 241 255 245 231 218 215 210 1,130 2,248

4,829 5,048 5,286 5,518 5,703 5,866 5,909 5,994 6,067 6,126 6,201 6,214 n.a. n.a.

13,065 13,645 14,300 15,014 15,742 16,465 17,205 17,973 18,764 19,582 20,425 21,295 78,726 176,766

On-budget 13.8 13.9 14.1 13.9 13.6 13.6 13.8 13.7 13.8 14.0 14.2 14.4 13.8 13.9

Off-budget 4.7 4.7 4.7 4.6 4.6 4.7 4.7 4.7 4.7 4.8 4.8 4.8 4.7 4.7 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

18.4 18.6 18.7 18.6 18.3 18.3 18.4 18.4 18.6 18.8 19.0 19.2 18.4 18.6

10.8 10.7 10.7 10.7 10.8 11.1 10.9 11.3 11.6 11.8 12.2 12.3 10.9 11.4

7.8 7.7 7.9 7.5 6.8 6.4 6.1 5.9 5.8 5.7 5.6 5.5 6.9 6.2

1.7 1.7 1.8 1.8 1.8 1.7 1.7 1.6 1.6 1.6 1.5 1.5 1.7 1.6 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

20.3 20.1 20.3 20.0 19.3 19.2 18.6 18.8 18.9 19.0 19.3 19.2 19.5 19.2

On-budget 17.1 16.8 17.1 16.8 16.1 16.0 15.4 15.5 15.4 15.4 15.6 15.4 16.2 15.8

Off-budget 3.2 3.3 3.3 3.2 3.2 3.2 3.2 3.4 3.5 3.6 3.7 3.8 3.2 3.4

-1.9 -1.6 -1.6 -1.4 -1.1 -0.9 -0.2 -0.4 -0.3 -0.3 -0.3 * -1.0 -0.6

-3.3 -2.9 -3.0 -2.8 -2.5 -2.4 -1.7 -1.8 -1.6 -1.4 -1.4 -1.0 -2.4 -1.9

1.4 1.4 1.4 1.4 1.4 1.5 1.5 1.4 1.2 1.1 1.1 1.0 1.4 1.3

37.0 37.0 37.0 36.8 36.2 35.6 34.3 33.3 32.3 31.3 30.4 29.2 n.a. n.a.

Off-budget

Debt Held by the Public

Total

Net interest

Total

On-budget 

Revenues

Deficit (-) or Surplus

Outlays

Mandatory spending

Discretionary spending

Gross Domestic Product

On-budget 

Off-budget

Debt Held by the Public

Memorandum:

In Billions of Dollars

As a Percentage of Gross Domestic Product

Outlays

Revenues

Discretionary spending

Total

Mandatory spending

Net interest

Total

Deficit (-) or Surplus
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 5

insurance would also contribute to the growth in revenues as a share of GDP.

The Impact of the President’s Proposals on the 

Current Budget Outlook

CBO measures the potential budgetary effects of proposed policy changes relative to its baseline projections, 

which—in keeping with long-standing procedures—are 

constructed under the assumption that present laws and 

policies remain unchanged. Specifically, the baseline 

reflects the assumption that various tax provisions 

(including those affecting the AMT) will expire as scheduled, that most mandatory programs will continue to 

operate as they do under current law, and that all discretionary funding for the current year (including any supplemental appropriations) will grow at the rate of inflation in future years.

Relative to those baseline projections, the President’s policies would increase the cumulative deficit by $507 billion over the 2008–2012 period, in CBO’s estimation 

(see Table 1-3). Proposed changes to tax laws—such as 

extending the expiring provisions originally enacted in 

the Economic Growth and Tax Relief Reconciliation Act 

of 2001 (EGTRRA) and the Jobs and Growth Tax Relief 

Reconciliation Act of 2003 (JGTRRA)—would reduce 

revenues by an estimated $479 billion through 2012 

compared with the baseline.1 At the same time, outlays 

would be $28 billion higher under the President’s proposals than they would be under current policies, CBO 

estimates. The proposed policy changes would increase 

discretionary outlays of the Department of Defense by 

$132 billion and net interest outlays by $61 billion, relative to the amounts in the baseline. They would reduce 

mandatory spending by $34 billion and other discretionary spending by $131 billion. 

Over the 10-year budget window, the President’s proposals would increase the cumulative deficit by $1.6 trillion. 

Under baseline assumptions, near-term deficits would be 

followed by surpluses in the vicinity of 1 percent of GDP 

starting in 2012, CBO projects. By contrast, under the 

President’s policies, the budget would show a slight deficit (0.4 percent of GDP or less) beyond 2011. Between 

2008 and 2017, the President’s proposals would reduce 

revenues by almost $1.6 trillion (4.6 percent) from baseline levels, mainly by extending tax provisions that are 

scheduled to expire by 2011. Over that same period, 

proposals in the President’s budget would increase mandatory spending by a total of $164 billion (0.8 percent) 

from baseline levels and decrease discretionary spending 

by $424 billion (3.7 percent), mostly for nondefense 

activities. The deficits that would result under the President’s budget would require additional federal borrowing; 

debt-service costs on that borrowing would add another 

$323 billion to the cumulative deficit between 2008 and 

2017. Overall, the President’s policies would increase outlays over the 10-year period by $63 billion relative to 

CBO’s baseline projection.

The Impact on the Economy

The estimates presented in this chapter are the result of 

an analysis that does not account for the potential impact 

of the President’s budgetary proposals on the economy. 

Such an economic impact, however, could influence how 

the policy changes would affect spending and revenues. 

Therefore, CBO has also prepared a macroeconomic 

analysis of the President’s budget, which is described in 

Chapter 2. That assessment uses various models to indicate the range of possible economic and budgetary effects 

of the President’s proposals. On the basis of that analysis, 

CBO has concluded that if the President’s proposals were 

enacted, the macroeconomic effects—and their resulting 

budgetary impact—would most likely be minor relative 

to the size of both the budget and the U.S. economy over 

the next 10 years.

Comparison with the Administration’s Estimates

CBO’s estimate of how the President’s budget would 

affect the deficit in 2007 differs from the Administration’s 

estimate by $30 billion (see Table 1-4). Whereas CBO 

anticipates a deficit of $214 billion, the Administration 

predicts a shortfall of $244 billion. CBO estimates that 

outlays would be $37 billion below the Administration’s 

projection and that revenues would be $7 billion lower. 

Estimated outlays for the Defense Department and the 

Department of Homeland Security represent the largest 

differences in the two projections: CBO’s estimates for 

those agencies are lower than the Administration’s by 

$12 billion and $7 billion, respectively. 

For 2008, the deficit estimates calculated by CBO and 

the Administration are only $13 billion apart. CBO 

calculates a deficit of $226 billion under the President’s 

budget, whereas the Administration expects a deficit of

1. For proposals that would amend the Internal Revenue Code, 

CBO is generally required by law to use estimates provided by the 

Joint Committee on Taxation. 
6 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-3.

CBO’s Estimate of the Effect of the President’s Budget on Baseline

Deficits or Surpluses

(Billions of dollars)

Sources: Congressional Budget Office; Joint Committee on Taxation.

Note: * = between -$500 million and $500 million; EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; 

JGTRRA = Jobs and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax; SCHIP = State Children’s Health 

Insurance Program.

a. The estimates shown include the effect on revenues only; however, outlays for the refundable earned income and child tax credits are also 

affected. Estimates of those effects are included in the entry for earned income and child tax credits.

b. Negative numbers indicate an increase in the deficit or a decrease in the surplus.

Total, Total,

2008- 2008-

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017

CBO's March 2007 Baseline -177 -113 -134 -157 -35 155 139 163 186 163 217 -283 586

0 0 0 0 -93 -150 -152 -154 -157 -160 -164 -243 -1,030

0 -2 -1 -3 -36 -60 -67 -74 -79 -85 -91 -102 -499

0 * 1 -2 -17 -15 -33 -35 -37 -38 -41 -33 -216

0 0 0 -3 -5 -4 -3 -2 -1 -1 -1 -12 -19

0 0 0 0 -1 -2 -2 -2 -3 -3 -3 -3 -15

_ __ __ __ ___ ___ ___ ___ ___ ___ ___ ___ _____

0 -2 * -8 -152 -231 -257 -266 -277 -287 -299 -392 -1,779

0 0 -14 -6 7 22 39 57 78 101 127 8 411

0 -3 -5 -7 -8 -10 -11 -12 -13 -14 -15 -33 -99

0 0 -7 -7 -7 -7 -8 -8 -9 -9 -9 -28 -71

-9 -37 0 0 0 0 0 0 0 0 0 -37 -37

0 * 1 1 2 2 2 3 3 3 3 5 19

0 -1 -2 -1 -1 -1 -1 * * * * -6 -8

0 3 5 4 * -5 -3 -1 -1 -2 -2 6 -3

* -1 -1 * * -1 -2 -2 -3 -3 -3 -2 -15 __ ___ ___ ___ ____ ____ ____ ____ ____ ____ ____ ____ _____

-9 -41 -22 -24 -160 -231 -241 -231 -222 -211 -200 -479 -1,583

0 0 0 0 1 1 21 44 62 68 73 2 270

0 -4 -8 -11 -16 -20 -24 -28 -33 -40 -48 -58 -232

0 * * 10 10 24 24 24 24 24 24 44 164

* -1 -2 -4 -4 -4 -4 -4 -5 -5 -5 -14 -37

0 -5 * 1 1 3 4 4 4 4 4 * 19

0 1 1 1 2 2 2 1 1 * -1 7 9

* * -3 -5 -3 -3 -3 -3 -3 -3 -3 -14 -30 __ __ ___ ___ ___ __ __ __ __ __ __ ___ ___

* -9 -11 -8 -8 3 20 37 50 47 43 -34 164

26 77 80 16 -15 -25 -32 -35 -36 -37 -37 132 -44

1 * -18 -30 -38 -46 -47 -48 -49 -51 -53 -131 -380 __ __ __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

27 77 62 -14 -53 -71 -79 -83 -85 -88 -90 1 -424

* 5 8 10 15 23 32 42 53 63 73 61 323 __ __ __ ___ ___ ___ ___ ___ __ __ __ __ ___

28 72 59 -12 -46 -45 -28 -4 17 22 27 28 63

-37 -113 -81 -12 -114 -186 -213 -227 -239 -233 -227 -507 -1,646

-214 -226 -215 -169 -149 -31 -74 -64 -53 -70 -10 -790 -1,060

Department of Defense

Expansion of tax-free savings accounts

Other proposalsa

Subtotal, discretionary

Other proposals

Medicare

Mandatory

Social Security individual accounts

Other

Air transportation taxes

Extension of expiring EGTRRA and JGTRRA provisions

 Net interest

Total Effect on Outlays

Farm bill

Expansion of expensing for small businesses

Total Effect on Revenues

Outlays

Discretionary

Total Impact on the Deficit or Surplusb

Total Deficit Under the President's Proposals

Effect of the President's Proposals

Research and experimentation tax credit

Revenues

General tax rates, child tax credit, and tax bracketsa

Estate and gift taxes

Tax rates on dividends and capital gains

Expensing for small businesses

Education, retirement, and other provisions

Subtotal, mandatory

AMT extension

Earned income and child tax credits

Medicaid and SCHIP

Higher education

Expansion of information reporting

Total Deficit (-) or Surplus as Projected in

Health insurance taxation and standard deductiona

Subtotal, proposed extensions
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 7

Table 1-4.

Differences Between CBO’s Estimate of the President’s Budget and the

Administration’s Estimate, by Source 

(Billions of dollars)

Sources: Congressional Budget Office; Joint Committee on Taxation.

Notes: Technical differences occur when CBO updates its annual baseline to reflect new information derived from the President’s budget

submission and from other sources. The Administration did not provide budget estimates beyond 2012.

* = between -$500 million and $500 million.

a. Positive numbers denote that such differences cause CBO’s estimate of the deficit to be lower than the Administration’s estimate.

Total,

2008-

2007 2008 2009 2010 2011 2012 2012

-244 -239 -187 -94 -54 61 -514

-32 -64 -93 -118 -155 -189 -619

25 69 71 -2 24 35 196

* 12 11 42 34 21 120 ___ ___ ___ ___ ___ ___ ____

25 81 82 40 58 56 317

Total Revenue Differences -7 17 -11 -78 -97 -133 -302

* 1 * -3 -9 -10 -21

Social Security individual accounts -1 * * -1 * -28 -29

Other -10 -1 1 -2 3 -11 -10 ___ ___ ___ ___ ___ ___ ___

-11 -1 1 -3 3 -40 -39

-11 * 1 -6 -6 -50 -61

-23 9 26 8 3 2 48

* -1 -1 5 15 23 42

-3 -5 -9 -11 -13 -17 -54 ___ ___ __ ___ ___ ___ ___

-3 -6 -10 -5 1 7 -13

Total Outlay Differences -37 4 17 -3 -2 -41 -26

30 13 -28 -74 -95 -92 -276

-214 -226 -215 -169 -149 -31 -790

-32 -64 -92 -120 -160 -203 -640

62 77 64 46 65 110 363

CBO's Estimate

Deficit Under the President's Proposals

Memorandum:

Baseline

Policy

Technical

Subtotal, net interest

Administration's Estimate

Sources of Differences Between CBO and the Administration

Economic

Net interest

Economic

Technical

Discretionary (Technical)

Deficit Under the President's Proposals

Revenue Differences

Outlay Differences

Subtotal, technical

Total Technical Differencesa

Mandatory

Economic

Technical

Subtotal, technical

Subtotal, mandatory

Total Economic Differencesa

All Differencesa
8 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

$239 billion. Thereafter, both CBO and the Administration estimate that the deficit will decline each year 

through 2012, but the Administration estimates larger 

declines in the deficit than CBO does and anticipates a 

surplus in 2012. As a result, for the 2008–2012 period, 

CBO’s cumulative deficit projection of $790 billion is 

$276 billion higher than the Administration’s. (The 

Administration did not provide budget estimates beyond 

2012.)

Overall, CBO’s estimates of outlays under the President’s 

budget are smaller than those of the Administration—by 

a total of $26 billion for the 2008–2012 period. CBO 

projects that outlays will be $29 billion lower under the 

President’s Social Security proposals over the five-year 

period, primarily because of differing expectations about 

when the first substantial outlays would be recorded in 

the budget if the President’s proposal to add individual 

accounts to the Social Security program were to be implemented. (CBO shows those outlays beginning in 2013; 

the Administration expects them to begin in 2012.) 

Lower projected inflation and wages cause CBO’s baseline projections of mandatory outlays between 2008 and 

2012 to be lower than the Administration’s by another 

$21 billion. 

In total, CBO’s projection of mandatory spending over 

the five years is $61 billion below that of the Administration. In addition, CBO estimates that net interest payments over that period will be about $13 billion lower 

than the Administration’s estimate. (Most of that gap 

comes from differing assumptions about future interest 

rates and rates of inflation.) Partially offsetting those 

lower estimates, CBO’s calculation of discretionary outlays under the President’s budget during the 2008–2012 

period exceeds the Administration’s by $48 billion, 

primarily because CBO’s estimate of outlays for DoD is 

$52 billion higher.2

CBO’s and the Administration’s projections of revenues 

under the President’s budget are also very close through 

2009 but then diverge by larger amounts thereafter. As a 

result, the Administration’s estimate of revenues for the 

2008–2012 period is $302 billion, or 2.1 percent, higher 

than CBO’s projection. The difference mainly results 

because the Administration projects higher nominal 

GDP than CBO does. (Most of the difference in nominal 

GDP projections, in turn, reflects differences in inflation 

projections: CBO projects lower inflation than the 

Administration does.) Also contributing to the difference 

in revenue estimates is CBO’s expectation that wages and 

salaries will make up a smaller share of GDP than the 

Administration anticipates. 

CBO’s Most Recent Baseline Budget Projections

In conjunction with its annual analysis of the President’s 

budget, CBO typically updates its baseline projections to 

account for new information from that budget submission and other sources. (CBO refers to such changes as 

technical revisions.) The update also incorporates the 

effects of legislation enacted in the two months since the 

previous baseline was completed.3

All of the revisions to CBO’s previous baseline that are 

attributable to legislation result from enactment of the 

Revised Continuing Appropriations Resolution, 2007 

(Public Law 110-5). As of mid-February, funding for 

2007 for departments other than Defense and Homeland 

Security had been provided through a series of short-term 

continuing resolutions; the appropriations that were 

provided for the rest of the year boosted discretionary 

appropriations by $7 billion relative to the amounts 

in the previous resolution. In addition, budgetary 

resources provided in the form of obligation limitations 

for certain transportation programs were raised by nearly 

$4 billion.4 Extrapolating those amounts through 2017 

increases projected discretionary outlays by $12 billion to 

$14 billion annually over the 2008–2017 period. In their 

entirety, the effects of that law have increased total outlay 

projections by $172 billion over those 10 years. 

Technical changes to CBO’s baseline have increased 

mandatory outlays by $72 billion and projected revenues 

by $6 billion over 10 years. The two largest technical 

changes are attributable to Medicare and Medicaid. CBO 

2. CBO cannot identify reasons for the disparity because the Administration did not include detailed information for discretionary 

programs beyond 2008.

3. For the previous baseline, see Congressional Budget Office,

The Budget and Economic Outlook: Fiscal Years 2008 to 2017 

(January 2007).

4. An obligation limitation is a provision of a law or legislation 

that restricts or reduces the availability of budget authority that 

would have become available under another law. Generally, when 

appropriation acts routinely place an obligation limitation on 

mandatory (or direct) spending, the limitation is treated as 

a discretionary resource, and the associated outlays are treated 

as discretionary. 
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 9

has raised its estimate of outlays over the 2008–2017 

period by $38 billion for Medicare and by $29 billion 

for Medicaid. The increase in Medicare outlays derives 

primarily from faster-than-anticipated growth in enrollment for the Medicare Advantage program, which is 

more expensive than traditional fee-for-service programs. 

The increase in projected Medicaid outlays is also primarily due to faster enrollment growth, specifically of children and low-income adults. 

As a result of the various changes to its baseline, CBO 

now projects that if current tax and spending policies 

remained the same, the cumulative surplus for the 2008–

2017 period would total $586 billion. That figure is 

$214 billion lower than CBO estimated in January. 

(For more information about recent revisions to CBO’s 

baseline, see Appendix A.)

Policy Proposals That Affect Revenues

The President’s budget proposes a number of changes to 

tax law that, in aggregate, would reduce revenues over the 

next decade relative to the amounts that would be collected under current law. Those proposals include the 

extension of a number of expiring tax provisions and a 

variety of new tax incentives. The most significant 

changes involve provisions originally enacted in 

EGTRRA and JGTRRA; other significant changes 

involve the AMT, the research and experimentation tax 

credit, the tax treatment of health insurance premiums 

and medical expenses, and the financing of the Airport 

and Airway Trust Fund.

Using the Joint Committee on Taxation’s estimates of 

revenue provisions that affect the tax code, CBO estimates that, if they were enacted, the President’s proposals 

as a whole would reduce revenues by $9 billion this year, 

by $41 billion in 2008, and by $1.6 trillion over the 

2008–2017 period (see Table 1-3 on page 6). Those proposals would also increase mandatory outlays for refundable tax credits by $164 billion through 2017.5

Permanent Extension of Provisions in 

EGTRRA and JGTRRA

The Administration proposes to make permanent various 

provisions originally enacted in EGTRRA and JGTRRA 

that currently are set to expire at the end of 2010. Those 

provisions include changes in tax rates on income, capital 

gains, and dividends; relief from the so-called marriage 

penalty; an increase in the child tax credit; provisions 

related to education; and repeal of the estate tax. In total, 

this proposal would reduce revenues by $1.8 trillion and 

increase outlays by $91 billion through 2017, according 

to JCT=s estimates.

Another provision originally enacted in JGTRRA altered 

the rules governing depreciation for small businesses. 

Specifically, it increased from $25,000 to $100,000 the 

amount of investment that such businesses could expense 

(that is, deduct from their taxable income immediately 

rather than over time). That change is currently scheduled to expire at the end of 2009. Extending this provision of JGTRRA would make the $100,000 limit permanent and index it for inflation, which would decrease 

revenues by about $19 billion over the 2008–2017 

period. (The President is also proposing to raise the limit 

to $200,000 and index it for inflation. That change is 

discussed below.)

Changes to the Alternative Minimum Tax

The AMT exists alongside the regular income tax but 

includes a more limited set of exemptions, deductions, 

and tax credits than normally applies under the regular 

income tax. The taxpayer must calculate the amount 

owed under the AMT and the regular income tax and pay 

the higher of the two. The exemption amounts that 

taxpayers can use for the AMT calculation are set by law 

and are not indexed for inflation. EGTRRA and 

JGTRRA reduced income tax liabilities under the regular 

income tax through the end of 2010 but made adjustments to the AMT for a shorter period. As a result, unless 

the law is changed, a growing number of taxpayers will be 

subject to the AMT over time.

Since 2001, the law has been amended several times to 

temporarily raise the amount of income that is exempt 

from the alternative minimum tax. The AMT exemption 

reverted to pre-EGTRRA levels at the beginning of calendar year 2007, which will cause many more people to be 

liable for tax under the AMT. In addition, under current 

law, the AMT will restrict the use this year of some nonrefundable personal tax credits, such as the higher education credits and the child and dependent care credit.

The President=s budget proposes to continue for one year 

(through the end of 2007) both the unrestricted use of 

5. An income tax credit is refundable if the taxpayer receives a refund 

when the allowable credit exceeds the amount of income tax 

owed. Such refunds are recorded in the budget as outlays.
10 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

those personal tax credits under the AMT and the higher 

AMT exemption levels. JCT expects that most of the 

reduction in revenues from this provision will occur in 

fiscal year 2008 when taxpayers file their returns for 

tax year 2007. The proposal would decrease revenues by 

$37 billion in 2008.

Extension of the Research and Experimentation

Tax Credit

Under current law, corporations can obtain a tax credit 

of 20 percent on certain research expenditures above a 

base amount. That credit is scheduled to expire on 

December 31, 2007, but the President proposes to make 

it permanent. According to JCT, the proposal would 

reduce revenues by a total of $99 billion over the next 

10 years.

Expansion of Expensing for Small Businesses

The President proposes not only to make permanent the 

increased limit on the amount of investment that small 

businesses can expense, but also to further raise that limit 

to $200,000 (and index it for inflation). Those changes 

would decrease revenues by $8 billion over 10 years.

Provision of a Standard Income Tax Deduction for 

Taxpayers Who Purchase Health Insurance 

Among the Administration’s proposals is a plan to replace 

most current tax exclusions and deductions for health 

insurance premiums and out-of-pocket costs with a new 

standard deduction from income of $15,000 for married 

taxpayers and $7,500 for single taxpayers. All taxpayers 

not enrolled in Medicare who purchase qualifying insurance would be eligible for the deduction.

If the proposal took effect on January 1, 2009, it would 

increase revenues by $411 billion through 2017, JCT 

estimates. Of that amount, $57 billion would be counted 

as off-budget because of the proposal’s effect on income 

subject to payroll taxes. In addition, through its impact 

on the earned income tax credit, the policy change would 

raise outlays by $77 billion over the 2008–2017 period. 

(See Appendix C for a more detailed discussion of the 

President’s health insurance tax proposal.)

Expansion of Information Reporting

Under the Administration’s proposals, additional information about potentially taxable transactions would need 

to be reported. Provisions of the proposal include the

following:

B Businesses would be required to file an information 

return on certain payments to corporations.

B Brokers would be required to report the adjusted basis 

for certain types of securities sales; and the amount of 

information that brokers report about sales of tangible 

personal property, such as business equipment and 

vehicles, would be expanded.

B Certain banks would be required to report gross reimbursement payments to merchants from credit and 

debit card transactions. 

B Penalties would be increased for those who did not 

comply with information-reporting requirements.

JCT estimates that the proposals to expand information 

reporting would increase revenues by almost $19 billion 

between 2008 and 2017.

Expansion of Tax-Free Savings Accounts

The tax code provides for a variety of tax-favored savings 

plans, which are used primarily for retirement savings but 

also for other purposes, such as education. The President 

proposes to unify many of those plans into two taxfavored vehicles for saving—retirement savings accounts 

(RSAs) and lifetime savings accounts (LSAs)—and to 

expand their scope.

Individuals would be allowed to contribute up to $5,000 

a year to an RSA, with no income limits on participation. 

Those contributions would not be tax-deductible, but all 

earnings on the account would accumulate tax-free. 

Account holders could withdraw funds without facing 

taxes or penalties after they turned 58 years old or became 

disabled. (Upon an account holder’s death, his or her 

heirs could also make tax- and penalty-free withdrawals.)

Accounts that are now held as Roth individual retirement 

accounts (IRAs) would automatically become RSAs 

under the President=s plan. In addition, traditional IRAs 

could be converted into RSAs in the same way that they 

can now be converted into Roth IRAs. No further contributions to traditional IRAs would be allowed.

The same tax treatment and lack of income restrictions 

that applied to RSAs would apply to lifetime savings 

accounts as well, but annual contributions to LSAs would 

be limited to $2,000. (Individuals could contribute to 

both types of accounts in the same year.) Holders of 
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 11

LSAs, unlike holders of RSAs, could make withdrawals at 

any age and for any purpose. Balances now held in 

Coverdell education savings accounts and qualified state 

tuition plans could be moved into LSAs.

On net, those proposals would reduce revenues by $3 billion over the 2008–2017 period. JCT projects a net 

increase in revenues during the first few years of that 

period as new contributions were directed away from current savings plans, which receive an immediate tax deduction, and toward the new plans, which would not. In 

addition, some taxpayers would convert their traditional 

IRAs to RSAs, generating more revenue in the early years. 

These temporary revenue gains, however, mask the 

underlying fiscal effect of the proposal: By expanding taxpreferred savings opportunities, the proposal would 

reduce revenue over time. Indeed, by the second half of 

the projection period, the proposals would result in a net 

reduction in revenues as the effect of untaxed withdrawals 

began to outweigh the effect of new contributions.

Modification of Financing of the Airport and Airway 

Trust Fund

Currently, excise taxes on airline tickets, domestic 

air freight transportation, and aviation fuel fund the 

Airport and Airway Trust Fund. Starting in 2009, the 

Administration proposes to stop collecting most taxes on 

air transportation. A tax on international arrivals and 

departures would continue, along with the aviation fuel 

tax, although the tax rates might change. Eliminating or 

changing these taxes would reduce revenues by $71 billion over the 2009–2017 period.

The Administration proposes replacing those taxes with 

various fees on commercial aviation that would help pay 

for the use of air traffic control services by that industry. 

Under the Administration’s proposal, those fees would 

be recorded as offsets to discretionary spending by the 

Federal Aviation Administration, starting in 2009. 

(CBO assumes that the impact of those fees on discretionary spending is reflected in the aggregate funding 

levels specified in the President’s budget for discretionary 

spending over the 2009–2012 period.) 

Other Revenue Proposals

The President’s budget also includes a number of other 

tax proposals, such as changing the treatment of incentives related to charitable giving, health care, education, 

the environment, and tax compliance. Together, those 

other proposals would reduce revenues by over $15 billion between 2008 and 2017 and decrease outlays for 

refundable tax credits by $4 billion over the same period.

Policy Proposals That Affect Mandatory 

Spending

If the proposals in the President’s budget were enacted, 

they would reduce mandatory spending by $34 billion 

(0.4 percent) over the next five years, CBO estimates, but 

increase it by $164 billion over the 2008–2017 period 

(see Table 1-3 on page 6). Outlays would rise mostly for 

the Social Security program (for the proposed individual 

accounts), for refundable tax credits (primarily the earned 

income and child tax credits), for the Pell Grant program, 

and for the reauthorization of the farm bill. Those 

increases would be partly offset by lower spending for student loan programs, Medicare, and Medicaid, and by 

higher premium payments from Medicare beneficiaries. 

Social Security

The President proposes to establish voluntary individual 

accounts for workers, which would replace some of the 

Social Security benefits provided under current law. For 

people who chose to participate, the government would 

deposit an amount equivalent to up to 4 percentage 

points of the current 12.4 percent tax on covered earnings 

into an individual account. The account holder would 

direct how the money should be invested within a limited 

number of investment options similar to those available 

under the Thrift Savings Plan for federal employees. 

When account holders eventually began to draw Social 

Security benefits, their defined benefit would be reduced 

according to a formula based on the amount deposited in 

their individual account. 

Net outlays from establishing individual accounts would 

total $270 billion between 2011 and 2017, in CBO’s estimation. The Administration projects much higher outlays—$637 billion over that period—chiefly because it 

estimates that two-thirds of eligible workers will participate, whereas CBO estimates that about one-third will 

sign up. In addition, CBO assumes that, initially, there 

will be a lag between the point at which the contributions 

are set aside and the point at which they are transferred to 

the individual accounts and recorded as outlays; therefore, CBO estimates that most outlays resulting from

the establishment of individual accounts will first be 

recorded in 2013 (rather than in 2012, as estimated by 

the Administration).
12 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

The President’s budget also includes three proposals that 

would modestly reduce outlays for Social Security benefits: 

B Suspending benefits for 16- and 17-year-old children 

of retired, deceased, or disabled workers unless the 

children are in school (under current law, such 

benefits essentially continue through age 18 or for 

a slightly longer period if the recipients are still in 

secondary school);

B Requiring state and local governments to provide 

information about their annuitants in order to 

strengthen enforcement of two current provisions (the 

windfall elimination provision and the government 

pension offset) that reduce Social Security benefits for 

people who have pensions from employment that was 

not covered by Social Security; and

B Altering the way disability benefits are reduced when 

beneficiaries also receive workers’ compensation for a 

work-related illness or injury.

In all, those three proposals would save more than $5 billion over the 2008–2017 period, CBO estimates. (Those 

savings are included under “other” mandatory outlay proposals in Table 1-3.) 

Medicare

The President’s budget contains various proposals to alter 

the Medicare program. The major components of the 

plan would reduce payment rates for a broad range of services covered by Hospital Insurance (Part A) and Supplementary Medical Insurance (Part B), shift some spending 

to private insurers, and increase premiums paid by certain 

beneficiaries. In CBO’s estimation, those provisions 

would reduce net Medicare spending by $232 billion (or 

4.3 percent) over the 2008–2017 period. (See Box 1-1 for 

a discussion of the long-term effects of the President’s 

Medicare proposals.)

The proposal that would yield the largest estimated savings calls for a reduction in the annual updates to payment rates for most nonphysician services. Under current 

law, payment rates for most services increase each year 

with inflation. The proposal would permanently reduce 

those automatic annual updates for most nonphysician 

services by half of the expected gain in productivity, or 

0.65 percentage points. (As a result, those payment rates 

would be about 6 percent lower in 2017 than is the case 

under current law.) In addition, the proposal would 

freeze payment rates in 2008 for services furnished by 

skilled nursing facilities and through 2012 for home 

health services. CBO estimates those provisions will 

reduce net Medicare spending by $133 billion over the 

2008–2017 period.

Refundable Tax Credits

The Administration’s tax proposals would add about 

$164 billion to mandatory outlays for the refundable 

portion of the earned income and child tax credits over 

the 2008–2017 period, JCT estimates. The change with 

the largest impact would make the 2001 expansion of the 

child tax credit permanent.6 Continuation of that credit 

in its current form, combined with changes to tax brackets and tax rates that affect the earned income tax credit, 

would increase outlays by $91 billion through 2017. In 

addition, the Administration’s proposals to change the 

way that health insurance premiums and health care 

expenses are taxed would raise outlays by about $77 billion over the next 10 years. Other proposals would reduce 

refundable tax credits by $4 billion.

Medicaid and SCHIP

Implementing the President’s proposals for the State 

Children’s Health Insurance Program (SCHIP) and Medicaid would increase spending for the former by $12 billion, CBO estimates, and lower spending for the latter 

by a total of $49 billion over the 2008–2017 period. 

Under the President’s proposals, SCHIP would be reauthorized for five years but several changes would be made 

to the program. The changes would include the following: Funding would be increased by $277 million in 

2009 and by $1.5 billion for each year from 2010 to 

2012; the time that states could use SCHIP funds would 

be shortened from three years to one year before those 

funds were reallocated to other states; and the Medicaid 

match rate would be applied to spending on all adults 

other than pregnant women and to spending on children 

and pregnant women with family income greater than 

200 percent of the federal poverty level. Consistent with 

6. Before enactment of EGTRRA, the maximum child tax credit per 

qualifying child was $500. The credit was refundable only for 

families with three or more qualifying children and had other 

limitations. EGTRRA increased the credit to $1,000 per child, 

with refundability not contingent on the number of qualifying 

children but limited to 15 percent of the amount of earned 

income in excess of $10,000 (indexed for inflation after 2001).
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 13

longstanding practice, CBO assumes in its estimate that 

funding for the program after 2012 would continue at 

the proposed 2012 level of $6.5 billion. (Under current 

law, the program has been funded at $5 billion per year.) 

CBO estimates that the proposal would increase SCHIP 

spending by $1 billion in 2007 and by $12 billion over 

the 2008–2017 period. By reducing the extent to which 

states could use Medicaid funds after exhausting their 

SCHIP funds, the proposal also would decrease Medicaid 

spending by $8 billion over the 2008–2017 period. 

A total of 7.4 million people were enrolled in SCHIP at 

some point during 2006. Under the baseline funding 

level of $5 billion per year, CBO estimates that the program’s enrollment would remain at 7.4 million in 2007 

and then decline to 5.6 million by 2012. CBO estimates 

that, under the President’s proposal, enrollment would 

reach 8.3 million people in 2007 and then fall to 6.7 million by 2012.

Further Medicaid savings would be realized by lowering 

the federal matching rate for certain services ($24 billion), by reducing spending on prescription drugs 

($7 billion), and by reducing payments to states for 

administrative services ($4 billion). Additional savings of 

$4 billion would result from tightening eligibility for 

long-term-care services and increasing recoveries from 

estates of deceased beneficiaries. And, a policy to increase 

funding for the Supplemental Security Income program’s 

disability reviews would lower Medicaid spending by an 

estimated $2 billion over the 10-year period. 

Student Aid

The Administration proposes raising the maximum 

award under the Pell Grant program from the current 

level of $4,310 for academic year 2007–2008 to $4,600 

for 2008–2009 and then by an additional $200 each succeeding year until the award reaches $5,400 in 2012–

2013. CBO estimates that this proposal will increase 

mandatory outlays by nearly $47 billion between 2008 

and 2017. 7

The President also proposes numerous changes to the student loan programs. For the most part, those changes are 

designed to reduce the government’s subsidy costs for 

guaranteed student loans by reducing federal payments to 

private lenders, increasing lender origination fees, and 

lowering the amount of the federal guarantee. In addition, the President proposes reducing the payments made 

to cover administrative costs of the guaranty agencies that 

oversee the guaranteed loan program on behalf of the federal government and accelerating the recall of the federal 

share of Perkins loan repayments. Changes that would 

raise the government’s costs include a plan to increase 

borrowing levels for certain undergraduate students and 

to make the interest rates on parent and gradPLUS loans 

comparable across all programs. On net, those changes 

would reduce mandatory outlays by over $27 billion 

from 2008 to 2017, CBO estimates. 

The President’s Farm Bill Proposal

The President’s budget includes an allowance of $5 billion over 10 years for legislation that would revise and 

extend expiring provisions of the Farm Security and Rural 

Investment Act of 2002. The Department of Agriculture 

subsequently announced details of the Administration’s 

proposals (and estimated their total cost at $3 billion 

from 2008 to 2017). CBO estimates that the proposals, 

which would affect commodity, conservation, trade, rural 

development, nutrition and other programs, would 

increase spending by nearly $9 billion over the next 

10 years, relative to CBO’s baseline projections (which 

assume continuation of most current farm programs). 

The proposals are intended to shift spending to programs 

that are not tied to current farm production. Under the 

proposals, lower loan rates would reduce spending for the 

commodity loan program (which compensates farmers 

for their current production if prices fall below a specified 

level) whereas higher payment rates would increase 

spending for the direct payment program (which provides fixed prices to farmers for a portion of their historical production). The countercyclical payment program, 

under which farmers receive payments on a portion of 

past production if national average prices fall below target 

prices, would be replaced by a countercyclical program 

under which farmers would receive payments if national 

average revenues were to fall below target revenues. (Producers could receive direct and countercyclical payments 

even if they did not produce a crop in the current year.) 

In addition, the President proposes to tighten payment 

limits, reduce spending for the sugar program, and 

extend dairy payments (under current law, those payments end in 2007). 

7. The proposal would classify amounts necessary to fund a maximum grant of $4,050 as discretionary but funding for amounts 

above $4,050 as mandatory.
14 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Box 1-1.

The Effect of the President’s Proposals for Medicare on the

Long-Term Outlook

The major components of the President’s proposals 

for Medicare would reduce payment rates to health 

care providers for services covered by the Hospital 

Insurance (Part A) and Supplementary Medical 

Insurance (Part B) programs, shift some spending 

to private insurers, and increase premiums paid by 

certain beneficiaries. The Congressional Budget 

Office (CBO) estimates that those provisions would 

reduce net Medicare spending by $232 billion, or 

0.1 percent of gross domestic product (GDP), over 

the 2008–2017 period.

Because the growing costs of the government’s health 

care programs will apply considerable pressure to the 

budget in the coming decades, it is useful to examine 

the long-term impact of proposed changes to those 

programs. In assessing the long-term budget outlook 

for Medicare, CBO projects the future path of such 

spending and the effect of the President’s proposals 

using multiple scenarios.1 In the high-cost scenario, 

spending per Medicare enrollee would grow 2.5 percentage points faster than per capita GDP between 

2007 and 2050, approximately the average growth 

rate for overall U.S. health costs over the past few 

decades. In the intermediate scenario, such spending 

would grow 1 percentage point faster than per capita 

GDP, consistent with the assumptions used by the 

Medicare trustees.

Assessing the long-term impact of any proposed 

changes in payment rates is particularly difficult 

because the degree to which such proposals could be 

sustained for an extended time is unclear. Over the 

course of several decades, it would not be feasible for 

Medicare payment rates to differ substantially from 

private sector payment rates without limiting access 

or creating other problems. As a result, other changes 

in the health sector that slowed overall cost growth 

would be necessary in order to continue the proposed 

changes in payment policies for several decades while 

maintaining current levels of access to services among 

Medicare beneficiaries.

Nevertheless, to provide insight into the potential 

magnitude of the President’s proposed changes in the 

event that they could be sustained for a long period, 

CBO has calculated their impact on net Medicare 

spending through 2050. In particular, the calculations assume that the proposed constraint on 

increases in payment rates for specified Medicare services would continue through 2050 without significant changes in providers’ practices or their level of 

participation in the program and that increased premiums would not cause substantial reductions in 

beneficiaries’ level of participation in Part B or the 

prescription drug program.

Those hypothetical calculations show that, under the 

high-cost scenario, the President’s proposals to slow 

growth in Medicare spending and to increase Medicare premiums would reduce federal outlays for 

Medicare, net of premiums paid by beneficiaries, 

from about 9 percent of GDP to about 7 percent by 

2050. Under the intermediate scenario, the potential 

effect of the proposals would be somewhat smaller—

they would reduce the growth in net federal outlays 

by about 1.4 percent of GDP in 2050, relative to 

current law.

1. See Congressional Budget Office, The Long-Term Budget 

Outlook (December 2005). That report also includes a third 

scenario, which illustrates the level of spending that would 

occur if Medicare outlays grew only because of the aging of 

the population.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 15

Box 1-1.

Continued

The Effect of the President’s Proposals for Medicare on the Long-Term Outlook

Source: Congressional Budget Office.

Notes: GDP = gross domestic product.

Medicare outlays include receipts from premiums.

CBO estimates that net Medicare outlays in 2007 will equal 2.7 percent of GDP.

Those effects are much larger than would occur in 

earlier years because the proposed reductions in 

growth rates would compound over time. One way

to summarize the effects over the entire period from 

2007 to 2050 is to compare the present value of 

Medicare outlays with the present value of GDP.2

The President’s proposals would reduce that present 

value calculation from 7.4 percent of GDP to 

6.7 percent of GDP under the high-cost scenario. 

Under the intermediate scenario, the present value

of Medicare outlays as a percentage of GDP would 

drop from 5.3 percent to 4.7 percent. The effect of 

the proposals (amounting to about 0.5 percent of 

GDP) is generally consistent with the Administration’s estimate.3

Those rough calculations are provided to indicate the 

potential long-run impact on Medicare’s costs from 

proposed changes in the program’s parameters. However, historical experience and the fact that Medicare 

has significant interactions with the rest of the health 

system suggest that, ultimately, slowing cost growth 

in the health sector as a whole will also be necessary 

to constrain the growth of costs for Medicare over a 

long period if broad access to medical services is to be 

maintained.

Medicare Outlays in 2050 (Percentage of GDP)

6.9 4.8

8.9 6.3

___ ___

Change -2.0 -1.4

Medicare Outlays from 2007 to 2050 (Present value as a 

6.7 4.7

7.4 5.3

___ ___

Change -0.6 -0.5

Intermediate-Cost 

Scenario Scenario 

Under the President's proposals

Under the President's proposals

Under current law

percentage of the present value of GDP)

High-Cost 

Under current law

2. Present value is a single number that expresses a flow of current and future income (or payments) in terms of an equivalent lump sum received (or paid) today.

3. The Administration has published present-value figures 

through 2080 that are significantly higher than CBO’s 

calculations primarily because of the effect of compounding 

over the additional 30 years.
16 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Other provisions of the proposal would extend benefits 

to producers of specialty crops, livestock and forestry 

enterprises, and other agricultural and rural interests. The 

proposals also would reduce subsidies for crop insurance, 

expand access to Food Stamps among the elderly and 

working poor, and increase purchases of fruits and vegetables for nutrition assistance programs. 

Other Mandatory Spending Proposals

If all other proposals that involve mandatory spending 

programs were enacted, they would, on net, decrease outlays by $30 billion over the 2008–2017 period, CBO 

estimates. Those proposals affect the following spending 

categories:

Pension Insurance. The President proposes raising the 

variable-rate insurance premiums that some companies 

pay to the federal Pension Benefit Guaranty Corporation 

(PBGC) on behalf of underfunded plans. Currently, the 

premium rate is set by statute at $9 per $1,000 of underfunding. Under the President’s proposal, PBGC’s board 

of directors would be given the authority to alter the premium rate; both CBO and the Administration assumed 

that the board would raise the rate to $14 per $1,000 of 

underfunding. The higher premiums would be used to 

offset some of PBGC’s existing deficit and a portion of its 

anticipated deficits over the next 10 years. That change 

would increase collections and thus reduce outlays by 

$9 billion over the 2008–2017 period.8

ANWR Leasing. The President proposes leasing a portion 

of the coastal plain of the Arctic National Wildlife Refuge 

(ANWR) for the development of oil and natural gas. 

CBO anticipates that those leases would be offered in two 

phases (as specified in recent legislative proposals), with 

the first sale likely to occur in 2010 and the second in 

2012. Proceeds to the federal government from bonuses 

and rents would total $6 billion between 2008 and 2017, 

CBO estimates. (Although the federal government would 

later receive income from royalties on production, nearly 

all of those payments would occur after 2017.) Under the 

President’s proposal, half of the receipts from leasing 

would be paid to Alaska, resulting in net federal receipts 

of $3 billion over the projection period.9

Veterans’ Benefits. The President has proposed several 

changes in the health care program of the Department of 

Veterans Affairs. First, the President proposes eliminating 

the practice of waiving copayments for doctors’ visits 

from veterans with third-party insurance, beginning in 

2008. The second proposal, which would also take effect 

in 2008, would increase pharmacy copayments from $8 

to $15 for veterans without service-connected disabilities 

and incomes above a certain threshold. Third, the President proposes charging an enrollment fee for that same 

group of veterans, beginning in 2009; the annual fee 

would be $250, $500, or $750, depending on the level of 

family income. CBO estimates that, together, those proposals would generate additional receipts totaling nearly 

$5 billion over the 2008–2017 period. Those sums 

would be considered offsets to mandatory spending.

Other. Other policy changes proposed in the President’s 

budget would affect mandatory spending in a number of 

areas. For example, the Administration has proposed 

reducing annual funding for the Social Services Block 

Grant program by $500 million starting in 2009, which 

would decrease outlays over the 10-year period by over 

$4 billion.10 Proposed spending for Temporary Assistance for Needy Families would rise by nearly $3 billion 

over the 2008–2017 period, CBO estimates. That 

increase results mostly from proposals to continue an 

existing supplemental grant, to implement a change in 

work penalties, and to make the contingency fund available to states that opt into a new foster care block grant 

program and then experience an increase in their foster 

care caseload.

Policy Proposals That Affect 

Discretionary Spending

As of early March, lawmakers had enacted $951 billion

in discretionary budget authority for 2007, including 

$70 billion for military operations in Iraq and Afghanistan. The Administration has requested another $103 billion in supplemental funding for 2007 (nearly $100 bil8. PBGC would also earn additional interest income as a result.

9. CBO’s estimate of bonus bids is based on the U.S. Geological Survey’s projections of the mean value of economically recoverable oil 

that could be produced from federal land in the refuge. It also 

relies on information from other federal agencies, the state of 

Alaska, and industry experts about how oil and gas companies 

perceive several key factors that affect the expected profitability of 

ANWR leases—in particular, companies’ probable assumptions 

about long-term oil prices and required rates of return on such 

investments.

10. The reduction in 2008 would be classified as discretionary.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 17

lion for military operations in Iraq and Afghanistan and 

for other activities related to the war on terrorism and 

over $3 billion for relief from hurricane damage). If that 

supplemental funding was enacted, total budget authority for 2007 would rise to $1,054 billion (see Table 1-5 

and Table 1-6).

For 2008, the President proposes $1,078 billion in discretionary budget authority, CBO estimates—$646 billion 

for national defense and $432 billion for nondefense programs.11 The defense request includes $142 billion for 

operations in Iraq and Afghanistan and other operations 

related to the war on terrorism.

If funding for activities in Iraq and Afghanistan and 

for relief from hurricane damage was excluded from 

the comparison, discretionary budget authority under 

the President’s proposals would grow by 5.8 percent, or 

$51 billion, from 2007 to 2008. Appropriations for 

defense would increase by about 11.4 percent, and 

funding for homeland security activities would rise by 

3.2 percent. Other appropriations would decrease overall 

by 0.3 percent.

As previously mentioned, the budget does not specify 

detailed appropriation amounts beyond 2008 but instead 

includes aggregate funding totals through 2012 for two 

categories of spending: that designated for the Department of Defense and that provided for all other agencies.12 With funding for military operations in Iraq and 

Afghanistan and other activities related to the war on terrorism excluded, proposed funding for DoD would grow 

by $53 billion from 2008 to 2012—an average annual 

rate of growth of 2.6 percent (somewhat faster than the 

2.2 percent rate of inflation that CBO projects for the 

period).

Discretionary funding provided for all other agencies 

would grow slightly from the level proposed for 2008—

rising from $453 billion next year to $463 billion in 

2012. Such a level in 2012 would represent a reduction of 

6 percent in inflation-adjusted terms.

Defense Programs

CBO estimates that, relative to its baseline, the President’s proposals will add $26 billion to defense outlays in 

2007 and $77 billion in 2008. Most of those outlays stem 

from the request for another $94 billion in budget 

authority in 2007 and $142 billion in 2008 for military 

operations in Iraq and Afghanistan (in addition to the 

$70 billion already appropriated for this year).13 If that 

$94 billion were appropriated, budget authority for 

defense would total $616 billion this year—10.7 percent 

more than the $557 billion provided for 2006. Defense 

outlays would reach 4.1 percent of GDP in 2007, up 

from 3.0 percent of GDP just six years ago.

Budget authority provided through emergency appropriations for DoD operations in Iraq and Afghanistan and 

the war on terrorism would total $164 billion in 2007, 

compared with $116 billion in 2006. Most of that 

growth would come from increases of more than $19 billion (26 percent) in funding for operations and maintenance and $26 billion (114 percent) for procurement. In 

total, emergency appropriations for Iraq, Afghanistan, 

and for the war on terrorism would constitute over 

26 percent of budget authority for defense in 2007.

Operations and maintenance ($79 billion), procurement 

($40 billion), and personnel ($17 billion) would receive 

the bulk of the $142 billion that the President has 

requested for military operations in Iraq and Afghanistan 

in 2008. The President’s budget includes a much smaller 

amount of such funding in 2009 and no appropriations 

thereafter. As a result, budget authority for the Defense 

Department would fall from $561 billion in 2009 to 

$536 billion in 2012 under the President’s policies (see 

Figure 1-2). Outlays for DoD would be a total of 

$132 billion above the amounts in CBO’s baseline 

between 2008 and 2012. (In keeping with the rules that 

govern baseline projections, the baseline assumes that the 

$70 billion already appropriated this year will continue in 

each subsequent year through 2017, with adjustments for 

inflation.)

11. For a number of reasons—including differences in projections of 

offsetting collections, estimates for the defense health program, 

and other technical factors—the Administration’s estimate of budget authority for 2008 is $2.7 billion lower than CBO’s estimate.

12. The defense discretionary category in Table 1-5 and Table 1-6 also 

includes spending for atomic energy and other defense-related 

programs that are not administered by the Department of 

Defense. The Administration included its request for such funding for 2009 to 2012 in its “all other” category.

13. The President’s request includes $10 billion in funding for 2007 

and $4 billion for 2008 for programs outside of the Defense 

Department.
18 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-5.

Proposed Changes in Discretionary Budget Authority in the President’s Budget, 

2006 to 2008

(Billions of dollars)

Source: Congressional Budget Office.

Notes: These numbers do not include obligation limitations for certain transportation programs. 

 * = between -0.05 percent and zero.

a. Includes the effects of the full-year continuing resolution (which had not been enacted at the time the President released his budget).

b. Includes the Administration’s request for supplemental appropriations to fund military operations in Iraq and Afghanistan and for further 

hurricane relief and recovery.

c. CBO’s classification of homeland security funding is based on designations established by the Administration. Those designations are not 

limited to the activities of the Department of Homeland Security. In fact, some of the department’s activities (such as disaster relief) are 

not included in the Administration’s definition of homeland security, whereas nondepartmental activities (such as some defense-related 

programs and some funding for the National Institutes of Health) fall within that definition. About 60 percent of all spending considered 

to be for homeland security is for activities outside the Department of Homeland Security.

d. In 2006, the Congress and the President provided $120 billion in funding for activities in Iraq and Afghanistan and for the war on 

terrorism and nearly $25 billion in supplemental appropriations in response to Hurricanes Katrina and Rita. Thus far in 2007, $70 billion in 

funding has been provided for operations in Iraq and Afghanistan. For 2007, the President’s budget requests another $100 billion in supplemental funding for activities in Iraq and Afghanistan and for the war on terrorism, as well as $3 billion for hurricane relief and recovery. 

In addition, the President’s budget requests $145 billion for 2008 for activities in Iraq and Afghanistan and for the war on terrorism.

With funding for Iraq and Afghanistan and disaster relief 

excluded from the comparison, budget authority for 

defense grew by 4.4 percent, or $19 billion, from 2006 

to 2007. Under the President’s budget, it would rise by 

11.4 percent, or $51 billion, in 2008.

Most major categories of nonemergency funding for 

DoD would receive increases in 2008. The largest percentage rise (100 percent, or $9.1 billion) would be for 

military construction, primarily to implement a new 

round of base closures. Procurement funding would 

increase by $20.4 billion (25.1 percent), in part for new 

equipment sought for the Administration’s plan to permanently increase the number of personnel in the Army 

and Marine Corps. 

Actual

2006

Budget Authority

Defense 557 616 b 646 10.7 4.8

29 31 b 32 6.0 3.1

410 407 b 400 -0.7 -1.8 ____ ____ ____

439 438 b 432 -0.3 -1.4

Total 996 1,054 b 1,078 5.8 2.2

Budget Authority, Excluding Funding for Activities in

Iraq and Afghanistan and Disaster Reliefd

Defense 433 452 504 4.4 11.4

29 31 32 6.5 3.2

389 398 397 2.4 -0.3 ____ ____ ____

418 429 429 2.6 *

Total 851 881 932 3.6 5.8

Nondefense

Nondefense

Homeland securityc

Homeland securityc

Subtotal, nondefense

Administration's Request Percentage Change

Other

2007a 2008 2006-2007 2007-2008

Subtotal, nondefense

Other
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 19

Figure 1-2.

Discretionary Budget Authority in Recent Decades and Under Policies 

Proposed in the President’s 2008 Budget

(Percentage of gross domestic product)

Source: Congressional Budget Office.

That increase, which must be approved by the Congress, 

would add 65,000 active-duty personnel to the Army and 

27,000 to the Marine Corps, relative to the number of 

personnel serving prior to September 2001. The procurement increase would be used to purchase additional combat, tactical, and support vehicles for personnel already 

serving in the Army as well as for combat and other aircraft, including the Joint Strike Fighter. 

Operation and maintenance activities would also receive 

a large boost (11.8 percent, or $17.6 billion), funding a 

wide variety of areas, such as depot maintenance, training, recruiting, transportation, and logistics and other 

support. The requested funds also would cover certain 

other costs associated with the planned increase in the 

number of Army and Marine Corps personnel.

Nondefense Discretionary Programs

Under the President’s budget, funding for nondefense 

discretionary programs would reach $438 billion in 

2007, an amount that includes a request for an additional 

$3.4 billion in supplemental appropriations for hurricane 

relief and recovery. For 2008, the Administration seeks to 

reduce budget authority for nondefense discretionary 

programs to $432 billion.

Excluding funding for activities in Iraq and Afghanistan 

and other activities related to the war on terrorism and 

funding for hurricane relief, total nondefense discretionary budget authority in 2008 under the President’s budget would be about the same as that appropriated in 

2007. Budget authority would rise for some activities and 

fall for others.

The largest funding decreases in dollar terms would be 

for education, training, employment and social services 

programs. That category of spending would face a reduction of $3.8 billion (4.8 percent), primarily for grants for 

social services, vocational education, higher education, 

employment, and training programs. Budget authority 

for community and regional development would decrease 

by $1.9 billion (14.7 percent); about half of that drop 

would occur in the community development fund.

Other areas of the budget would see their funding 

increase in 2008 under the President’s proposals. Budget 

authority for international affairs programs would grow 

by $3.8 billion (11.5 percent), largely for the Millennium 

Challenge Corporation, economic support for other 

countries, and the global HIV/AIDS initiative. Veterans’ 

benefits would receive an additional $3.1 billion (8.5 percent) in 2008, mainly to provide medical care to veterans 

1985 1988 1991 1994 1997 2000 2003 2006 2009 2012

0

1

2

3

4

5

6

7

8

Actual Projected

Defense

Nondefense
20 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-6.

Discretionary Budget Authority Requested by the President for 2008

Compared with Funding for 2007, by Budget Function

(Billions of dollars)

Source: Congressional Budget Office.

Note: n.a. = not applicable; * = between -$50 million and $50 million.

a. Mostly for military operations in Iraq and Afghanistan and for hurricane relief.

b. Spending from the Highway Trust Fund and the Airport and Airway Trust Fund is controlled by obligation limitations. Budget authority for 

those programs is provided in authorizing legislation and is not considered discretionary.

452.4 70.0 93.6 616.0

32.7 * 6.0 38.7

25.0 0 0 25.0

4.2 0 0 4.2

30.4 0 0 30.4

5.8 0 0 5.8

2.7 0 0 2.7

25.9 0.2 0 26.1

13.0 0 3.4 16.4

80.3 0 0 80.3

52.1 0 0 52.1

4.8 0 0 4.8

49.5 0 0 49.5

4.7 0 0 4.7

36.5 0 0 36.5

42.6 1.7 0.1 44.3

16.1 0 * 16.1

0.8 0 0 0.8 _____ ___ ____ _____

Subtotal, nondefense discretionary 426.9 1.8 9.5 438.2

 Total 879.3 71.8 103.0 1,054.2

51.1 0 0 51.1

Allowances for emergencies and

other needs

Social Security (Administrative costs)

Veterans' benefits and services

Memorandum:

Transportation Obligation Limitationsb

Community and regional development

Education, training, employment, and

Administration of justice

General government

social services

Health

Medicare (Administrative costs)

Income security

Natural resources and environment

Agriculture

Commerce and housing credit

Transportation

International affairs

Funding for 2007

General science, space, and technology

Energy

Regular

Enacted

Emergency 

Enacteda

Supplemental 

Nondefense Discretionary

Requesteda Total

Defense Discretionary
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 21

503.8 141.8 645.7 51.4 11.4

36.5 3.3 39.8 3.8 11.5

27.3 0 27.3 2.4 9.5

4.3 0 4.3 0.2 3.7

28.8 0 28.8 -1.6 -5.3

5.8 0 5.8 * 0.4

3.4 0 3.4 0.7 26.5

23.3 * 23.3 -2.6 -10.2

11.0 -0.4 10.7 -1.9 -14.7

76.5 * 76.5 -3.8 -4.8

52.0 0 52.0 -0.1 -0.2

5.2 0 5.2 0.4 8.4

49.2 * 49.2 -0.3 -0.6

4.9 0 4.9 0.2 3.7

39.5 0 39.5 3.1 8.5

43.7 * 43.7 1.1 2.5

17.6 0 17.6 1.6 9.8

* 0 * * n.a. _____ ____ _____ ____

429.0 3.0 432.0 2.9 0.5

932.8 144.8 1,077.6 54.3 6.1

51.6 0 51.6 0.5 1.0

Percent

Change in Regular Funding, 2007-2008

Supplemental Billions

Requested Total of Dollars

Regular 

Requested

Funding for 2008
22 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

and other beneficiaries. Funding for general science, 

space and technology would increase by $2.4 billion 

(9.5 percent), primarily for the National Aeronautics and 

Space Administration and energy programs.

Differences Between CBO’s and the 

Administration’s Budget Estimates

CBO’s estimate of the deficit in 2007 under the President’s budget ($214 billion) is $30 billion less than the 

Administration’s estimate ($244 billion). The differences 

are smaller for 2008 and 2009 but larger for subsequent 

years. The cumulative five-year deficits and surpluses projected by CBO and the Administration differ by 

$276 billion—equivalent to 1.8 percent of projected outlays during that period. CBO’s estimate of outlays over 

those five years is lower than the Administration’s by 

$26 billion (0.2 percent), and its estimate of revenues is 

lower by $302 billion (2.1 percent).

Baseline Differences

In conjunction with the President’s budget request, the 

Administration published a current-services baseline 

extending through 2012. In that baseline, the deficit 

declines each year through 2009; thereafter, the Administration projects an increasing surplus through 2012 

(when it reaches $147 billion). CBO’s baseline, by contrast, shows a growing deficit through 2010, followed by 

a sharp decline in the deficit in 2011 and a surplus in 

2012 ($155 billion). The Administration’s baseline shows 

a cumulative surplus of $143 billion over the 2008–2012 

period, whereas CBO projects a $283 billion cumulative 

deficit for those five years (see Table 1-7).

There are significant conceptual differences between the 

two baselines, but because those differences largely offset 

one another, they do not significantly affect the gap 

between the baselines. CBO constructs its baseline as 

specified in the Balanced Budget and Emergency Deficit 

Control Act of 1985. (Although the provisions of the act 

that pertain to the baseline expired at the end of September 2006, CBO continues to follow that law’s specifications in preparing its projections.) The Administration, 

however, has deviated from prior practices in three main 

ways. First, its current-services baseline assumes that the 

major tax-law changes enacted in EGTRRA and 

JGTRRA will be extended rather than allowed to expire 

as scheduled. From 2008 to 2012, that conceptual difference reduces the Administration’s estimate of revenues by 

$374 billion. Second, the Administration has not extrapolated into future years the $72 billion in 2007 emergency funding that was appropriated in 2007 for operations in Iraq and Afghanistan ($70 billion) and for the 

Department of Homeland Security ($2 billion). Third, 

the Administration has adjusted the way it accounts for 

increases in pay when projecting discretionary spending.

With such conceptual differences excluded, the difference 

between the cumulative baseline deficits that CBO and 

the Administration project for the 2008–2012 period 

increases from $427 billion to $447 billion (or 2.9 percent of projected outlays). When presented on a comparable basis, the Administration’s revenue estimates are 

$422 billion higher than CBO’s, and its projection of 

outlays is $25 billion lower over the five-year period.

Most of the underlying discrepancy in baseline revenues 

results from differing economic assumptions, which are 

discussed in the next section. The Administration’s 

assumptions result in higher projections of taxable 

income, thus leading to higher revenue estimates. 

Excluding conceptual differences, CBO’s projection of 

discretionary spending is still higher than the Administration’s over the 2008–2012 period. About $20 billion of 

that difference is from defense spending projections; 

CBO also projects higher outlays than the Administration does for highway programs, veterans’ medical services, and border security. In contrast, CBO projects 

lower total outlays for mandatory programs. Its estimates 

are lower than those outlined in the President’s currentservices baseline for Medicare (by $56 billion), veterans’ 

benefits (by $32 billion), and Social Security (by $23 billion); they are higher for a few programs, including Medicaid (by $39 billion) and unemployment compensation 

(by $15 billion).

CBO’s and the Administration’s Economic 

Assumptions

The Administration’s economic projections lead to more 

favorable budget projections than CBO’s forecast does. 

The Administration’s forecast indicates higher inflation, 

higher taxable incomes as a share of GDP, and slightly 

higher real GDP growth (see Table 1-8 and Table 1-9); as 

a result, its projections of revenues are also higher. Compared with CBO’s economic outlook, the Administration’s forecast decreases the projection of the cumulative 

deficit for the 2008–2012 period by $640 billion (including debt service).
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 23

Figure 1-3.

CBO’s and the Administration’s 

Forecasts of Wages and Salaries

(Percentage of gross domestic product)

Sources: Congressional Budget Office; Department of Commerce, 

Bureau of Economic Analysis.

According to CBO’s estimates, revenue projections based 

on the Administration’s economic forecast of wages and 

salaries, corporate profits, and other taxable incomes 

would be $619 billion greater over the 2008–2012 period 

than those that would result from CBO’s economic outlook. The Administration’s forecast for nominal GDP 

growth over that period is higher (largely because of 

higher inflation forecasts for this year and next), and its 

estimate of the share of wages and salaries in GDP is 

greater than CBO projects (see Figure 1-3). The difference in projections during the initial years of the projection period for the share of wages and salaries—a category of income that is extremely important for projecting 

revenues—stems in part from the timing of the forecasts. 

The Administration had completed its forecast before the 

November 30, 2006, revision in the national income and 

product accounts, a revision that lowered the wage share 

for early 2006. CBO’s forecast, which was completed 

later than the Administration’s, incorporated that revision. The revision, however, was not a major factor in the 

difference in the latter years of the projection period 

because CBO and the Administration use different procedures to project the longer-run income shares.14 The 

higher level of nominal GDP projected by the Administration coupled with the higher share of wages relative to 

GDP resulted in a projection of a much higher level of 

wages and salaries. That discrepancy accounts for most 

of the difference in the revenues implied by the two economic forecasts. 

The forecasts also have different implications for outlays, 

but they are much smaller than for revenues. Because the 

Administration’s inflation forecast is higher than CBO’s, 

its economic outlook leads to slightly higher estimates of 

outlays.15 The faster growth in the consumer price index 

results in projections of larger cost-of-living adjustments 

for Social Security and other indexed programs, and the 

faster growth in the GDP price index increases projections of discretionary spending. 

Other differences between the two forecasts are smaller 

and have little effect on the respective budget projections. 

For example, the Administration’s forecast for the unemployment rate is only slightly below that of CBO, and the 

two forecasts have similar outlooks for interest rates. 

Total Outlay Differences

For 2007, CBO’s estimate of outlays under the President’s budget is $37 billion below the Administration’s 

(see Table 1-4 on page 7). CBO’s estimates of discretionary spending and mandatory outlays are less than the 

Administration’s by $23 billion (2 percent of such outlays) and $11 billion (1 percent of outlays), respectively. 

CBO’s estimate of net interest, which is $3 billion below 

the Administration’s, mainly results from technical 

factors.

About $12 billion of the gap in discretionary outlays 

stems from different estimates for defense spending. 

Half of that amount is attributable to proposed supplemental appropriations for this year for operations in Iraq 

and Afghanistan—CBO expects that such spending will 

occur more slowly than does the Administration. The 

other half stems from a timing difference. CBO’s estimates incorporate the effects of the recently enacted 

Revised Continuing Appropriations Resolution, 2007. 

1975 1980 1985 1990 1995 2000 2005 2010

51

50

49

48

47

46

45

0

Administration

CBO

14. See Congressional Budget Office, How CBO Forecasts Income

(August 2006).

15. The CBO forecast of inflation assumes that over the 2009–2012 

period, the growth of the personal consumption price index will 

average about 2.0 percent—the upper end of the range in inflation that has been identified as acceptable by leading members of 

the Federal Reserve’s Open Market Committee.
24 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-7.

Comparison of CBO’s March 2007 Baseline and OMB’s February 2007 

Current-Services Baseline

(Billions of dollars)

Continued

That act provided less funding for certain defense programs outside of the Department of Defense than was 

assumed for 2007 in the President’s budget.16

In the nondefense discretionary category, outlays for 

disaster relief and community development in 2007 are 

expected to be $4 billion less than the Administration’s 

estimate, largely because CBO expects spending on relief 

and recovery from Hurricane Katrina to occur more 

slowly than the Administration does. Furthermore, CBO 

anticipates lower outlays for a number of other programs 

and activities, including diplomatic and consular programs administered by the State Department, flood 

Total,

2008-

2007 2008 2009 2010 2011 2012 2012

2,542 2,720 2,810 2,901 3,167 3,405 15,003

1,905 2,051 2,107 2,164 2,395 2,597 11,313

638 669 703 738 773 808 3,690

1,454 1,536 1,625 1,714 1,832 1,870 8,576

1,029 1,046 1,062 1,078 1,100 1,112 5,398

236 251 256 266 270 268 1,312 ____ ____ ____ ____ ____ ____ _____

2,719 2,833 2,944 3,058 3,202 3,250 15,286

On-budget 2,268 2,366 2,458 2,552 2,676 2,699 12,751

Off-budget 451 467 486 506 526 551 2,535

-177 -113 -134 -157 -35 155 -283

-363 -315 -351 -388 -281 -102 -1,438

186 202 217 232 247 257 1,155

2,550 2,714 2,831 3,008 3,151 3,348 15,051

1,916 2,040 2,119 2,254 2,356 2,513 11,282

634 674 711 753 796 835 3,770

1,465 1,537 1,631 1,727 1,850 1,918 8,664

1,032 961 976 987 1,008 1,028 4,960

238 254 258 259 258 255 1,284 ____ ____ ____ ____ ____ ____ _____

2,735 2,752 2,866 2,973 3,116 3,201 14,908

On-budget 2,284 2,290 2,380 2,464 2,583 2,642 12,359

Off-budget 451 462 486 509 533 559 2,549

-185 -38 -35 34 35 147 143

-368 -250 -261 -210 -228 -130 -1,077

183 212 225 244 263 277 1,221

Administration’s February 2007 Current-Services Baseline

Revenues

On-budget

Off-budget

Outlays

Mandatory

Discretionary

Revenues

On-budget

Off-budget

CBO's March 2007 Baseline

Outlays

Discretionary

Mandatory

Net interest

Total

Deficit (-) or Surplus

On-budget

Off-budget

Net interest

Total

Deficit (-) or Surplus

On-budget

Off-budget

16. The President submitted his budget request to the Congress on 

February 5, 2007, prior to the enactment of Public Law 110-5. 

Therefore, the Administration could not include the effects of that 

legislation in its estimates.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 25

Table 1-7.

Continued

(Billions of dollars)

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

Notes: OMB’s baseline deviates from the concepts delineated in the Balanced Budget and Emergency Deficit Control Act of 1985 in two significant ways: It assumes that most tax provisions enacted in 2001 and 2003 will be extended rather than allowed to expire as scheduled, 

and it does not extrapolate supplemental appropriations provided for 2007 into future years.

* = between -$500 million and $500 million.

a. Positive numbers denote that the Administration’s deficit estimate is higher than CBO’s, and negative numbers denote that the Administration’s deficit estimate is lower than CBO’s.

control and coastal emergencies activities of the Corps 

of Engineers, Project Bioshield, and several education 

programs.

Among mandatory programs, CBO’s estimates of spending for Medicare, veterans’ benefits, and certain programs 

for the administration of justice—such as customs and 

border protection, and assistance to crime victims—are 

each $2 billion less than those of the Administration. In 

addition, CBO estimates about $1 billion less in outlays 

for the Disability Insurance and Food Stamp programs.

For the 2008–2012 period, CBO estimates that total outlays under the President’s budget would be $26 billion 

less than the Administration projects, a difference of 

about 0.2 percent of total outlays. The biggest difference 

occurs in 2012; the variance for the preceding four years 

is smaller. Over the five-year period, CBO estimates that 

mandatory outlays and net interest on the public debt 

will be lower than the Administration anticipates—by 

$61 billion and $13 billion, respectively. In contrast, 

CBO’s estimate of discretionary outlays exceeds the 

Administration’s forecast by $48 billion.

On the mandatory side, about $28 billion of the difference occurs because CBO anticipates that the first substantial outlays for the President’s proposal to establish 

individual retirement accounts would begin in 2013, 

rather than in 2012 as shown in the Administration’s 

budget. Another difference in the two estimates, $21 billion, results from differing economic assumptions, especially those that affect Social Security benefits. CBO’s 

estimate of Social Security outlays between 2008 and 

2012 is $20 billion less than the Administration’s 

Total,

2008-

2007 2008 2009 2010 2011 2012 2012

-7 6 -21 -106 16 57 -48

-11 11 -12 -91 39 85 31

3 -5 -9 -16 -23 -27 -80

-12 -1 -6 -13 -19 -48 -88

-2 85 86 91 92 84 438

-2 -3 -2 7 13 13 28

__ __ __ __ ___ ___ ___

-16 81 78 84 86 49 378

On-budget -16 77 78 88 93 57 392

Off-budget * 4 * -3 -7 -7 -14

8 -75 -99 -191 -70 8 -427

5 -66 -90 -179 -54 28 -360

4 -9 -8 -12 -16 -20 -66

Difference (CBO minus Administration)

Revenues

Deficit or Surplusa

On-budget

Off-budget

Outlays

Mandatory

Discretionary

Net interest

Total

On-budget

Off-budget
26 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-8.

Comparisons of CBO’s, the Administration’s, and Private-Sector Economic 

Projections for Calendar Years 2007 to 2012

Continued

13,245 13,805 14,472 17,395 a

13,245 13,946 14,711 18,003 a

Top 10 average 13,245 13,933 14,741 18,366 b

Consensus 13,245 13,867 14,580 17,790 b

Bottom 10 average 13,245 13,801 14,436 17,281 b

6.3 4.3 4.8 4.7

6.3 5.3 5.5 5.2

Top 10 average 6.3 5.2 5.8 5.6

Consensus 6.3 4.7 5.1 5.1

Bottom 10 average 6.3 4.2 4.6 4.6

3.3 2.3 3.0 2.9

3.3 2.7 3.0 3.0

Top 10 average 3.3 2.8 3.4 3.3

Consensus 3.3 2.5 3.0 3.0

Bottom 10 average 3.3 2.2 2.6 2.6

2.9 1.9 1.8 1.8

2.9 2.5 2.4 2.1

Top 10 average 2.9 2.5 2.5 2.5

Consensus 2.9 2.2 2.1 2.1

Bottom 10 average 2.9 1.8 1.7 1.8

3.2 1.9 2.3 2.2

3.2 2.1 2.6 2.4

Top 10 average 3.2 2.4 2.8 2.6

Consensus 3.2 2.0 2.4 2.3

Bottom 10 average 3.2 1.6 2.0 1.9

4.6 4.7 4.9 5.0

4.6 4.6 4.8 4.8

Top 10 average 4.6 4.9 5.1 5.3

Consensus 4.6 4.7 4.8 4.8

Bottom 10 average 4.6 4.5 4.5 4.4

March Blue Chip

CBO

Administration

March Blue Chip

Unemployment Rate (Percent)

Administration

March Blue Chip

CBO

Administration

CBO

Administration

March Blue Chip

CBO

Nominal GDP (Percentage change)

Real GDP (Percentage change)

GDP Price Index (Percentage change)

Consumer Price Index (Percentage change)c 

Administration

March Blue Chip

CBO

Administration

March Blue Chip

CBO

Projected Annual Average,

Nominal GDP (Billions of dollars)

Actual

2006 2009-2012 2008

Forecast

2007
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 27

Table 1-8.

Continued

Sources: Congressional Budget Office; Office of Management and Budget; Randell E. Moore, ed., Blue Chip Economic Indicators (New York: 

Aspen Publishers, March 10, 2007); Department of Commerce, Bureau of Economic Analysis; Federal Reserve Board; Department of 

Labor, Bureau of Labor Statistics.

Notes: Percentage changes are year over year. 

GDP = gross domestic product.

a. Level in 2012.

b. Calculated by CBO from growth rates published in the Blue Chip survey.

c. The consumer price index for all urban consumers.

projection, mostly because CBO assumes lower cost-ofliving adjustments and lower wages.

CBO’s estimate of Medicare outlays is also lower than the 

Administration’s—by $48 billion (0.5 percent) over five 

years ($26 billion for Parts A and B and $22 billion for 

Part D, the new prescription drug program). Those differences result almost entirely from differing projections 

of spending under current law. CBO also anticipates less 

spending for veterans’ disability compensation—a difference of $31 billion (or 15 percent) over the 2008–2012 

period because of projected lower caseloads and smaller 

benefit payments. In contrast, CBO estimates higher 

spending for Medicaid—by about $33 billion (or 3 percent) over that period. CBO projects more savings from 

the President’s proposals but higher baseline outlays than 

the Administration anticipates. In addition, CBO also 

projects $25 billion more in outlays for the earned 

income and child tax credits.

On the discretionary side, CBO’s estimates of outlays are 

slightly higher—by less than 1 percent—in four of the 

five years and about 2 percent higher in 2009. That difference is partially explained by CBO’s estimates of 

spending from both regular and supplemental appropriations, which will be less in 2007 and more in subsequent 

years than the Administration anticipates.

CBO’s estimate of net interest payments over the 

2008–2012 period is $13 billion lower than that of the 

Administration. Economic differences increase CBO’s 

estimate of net interest by $42 billion over the Administration’s estimate. CBO’s projection of lower inflation 

and interest rates reduces its net interest estimate by 

$23 billion compared with that of the Administration 

over the five-year period; however, the effect on debt 

service of other economic differences in outlays and 

revenues raises the cumulative estimate by $65 billion. 

Technical differences in estimates of net interest by CBO 

4.7 4.8 4.5 4.4

4.7 4.7 4.6 4.2

Top 10 average 4.7 5.2 5.4 5.2

Consensus 4.7 5.0 4.9 4.7

Bottom 10 average 4.7 4.6 4.4 4.2

4.8 4.8 5.0 5.2

4.8 5.0 5.1 5.3

Top 10 average 4.8 5.0 5.4 5.5

Consensus 4.8 4.8 5.0 5.2

Bottom 10 average 4.8 4.5 4.6 4.7

Three-Month Treasury Bill Rate (Percent)

Ten-Year Treasury Note Rate (Percent)

CBO

Administration

March Blue Chip

CBO

Administration

March Blue Chip

Actual Projected Annual Average,

2006 2009-2012 2007 2008

Forecast
28 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 1-9.

CBO’s and the Administration’s 

Projections of Tax Bases for Selected 

Calendar Years

Sources: Congressional Budget Office; Office of Management and 

Budget.

Note: The Blue Chip survey does not include projections of tax 

bases.

and the Administration total $54 billion between 2008 

and 2012, largely as a result of debt service and other 

technical variations.

Total Revenue Differences

If the President’s proposals were enacted, revenues would 

total $2.5 trillion this year, CBO estimates—$7 billion 

less than the Administration projects. For the 2008–2012 

period, however, CBO’s projection of $14.5 trillion 

in total revenues is lower than the Administration’s by 

$302 billion, or 2.1 percent.17

As discussed above, differences in economic assumptions—CBO’s lower projections for GDP, the share of 

GDP that comes from wages and salaries, and the 

amount of corporate profits—cause CBO’s estimates of 

revenues under the President’s budget to be $32 billion 

lower than the Administration’s for 2007 and $619 billion less for the 2008–2012 period.

Some of the difference related to economic projections is 

offset by technical differences. In particular, CBO estimates a higher revenue yield from any given economic 

scenario mainly because it estimates a higher average tax 

rate on corporate profits. Such technical differences raise 

CBO’s revenue projections, relative to those of the 

Administration, by $25 billion for 2007 and by $196 billion for the 2008–2012 period.

Additional technical differences result from varying estimates of the effects of the President’s revenue proposals. 

CBO, using JCT’s estimates for most revenue provisions, 

projects that if the President’s proposals were enacted, 

they would reduce revenues by a total of about $479 billion between 2008 and 2012, which is $120 billion less 

than the Administration estimates. 

That difference can largely be attributed to variations in 

the estimate of the proposed change in the treatment of 

health insurance premiums and medical expenses (for 

further details, see Appendix C). JCT estimates that the 

proposal would raise revenues by $8 billion between 

2008 and 2012, whereas the Administration estimates 

that the proposal would reduce revenues by $121 billion. 

JCT also projects smaller revenue reductions for several 

other proposals as well. For instance, JCT estimates that 

the proposal to permanently extend lower tax rates for 

dividends and capital gains would reduce revenues by 

about $33 billion over the five-year period, $10 billion 

less than the Administration projects. Similarly, JCT 

estimates smaller revenue reductions from permanently 

extending the research and experimentation tax credit (a 

difference of $9 billion).

Corporate Book Profits

CBO 1,795 1,775 1,787 1,763

Administration 1,779 1,785 1,815 1,879

Wages and Salaries

CBO 6,032 6,330 6,642 8,019

Administration 6,115 6,478 6,862 8,454

Corporate Book Profits

CBO 13.6 12.9 12.3 10.1

Administration 13.4 12.8 12.3 10.4

Wages and Salaries

CBO 45.6 45.9 45.9 46.1

Administration 46.2 46.5 46.6 47.0

Estimated Forecast Projected

2006 2007 2008 2012

In Billions of Dollars

As a Percentage of

Gross Domestic Product

17. Revenue projections in CBO’s baseline are below those in the 

Administration’s current-services baseline by $7 billion in 2007 

and $48 billion over the 2008–2012 period (see Table 1-7). 

Conceptual differences between the two baselines cause CBO’s 

baseline revenues to be $374 billion higher than the Administration’s current-services baseline revenues between 2008 and 2012. 

Almost all of that occurs in 2011 and 2012 as a result of the expiration of tax provisions originally enacted in 2001 and 2003 

under EGTRRA and JGTRRA.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2008 29

In a number of other cases, JCT’s estimates of the President’s revenue proposals indicate larger reductions in revenue than the Administration’s estimates do. For example, extending those provisions of EGTRRA and 

JGTRRA that affect tax rates, the child tax credit, and 

income tax brackets would reduce revenues by almost 

$243 billion over the 2008–2012 period, according to 

JCT’s calculations. That figure is almost $18 billion more 

than the Administration’s estimate. Likewise, JCT estimates that permanently extending the EGTRRA estate 

and gift provisions would reduce revenues by more than 

$102 billion over the five-year period, $11 billion more 

than the Administration estimates.

CHAPTER

2

The Economy Under the President’s Budget and

Under CBO’s Baseline Policy Assumptions

In addition to estimating the direct budgetary impact 

of the President’s proposals (see Chapter 1), the Congressional Budget Office has analyzed how those policies 

would affect the economy as a whole. Several important 

provisions of his proposals would tend to have mutually 

offsetting effects on the economy: Those that would tend 

to reduce output would offset others that would tend to 

expand it, resulting in quite modest effects overall. In 

terms of direct budgetary effects—that is, excluding economic feedbacks—CBO estimates that the President’s 

budgetary proposals would increase the cumulative deficit relative to its level under the current-law baseline by 

$507 billion, or about 0.6 percent of cumulative gross 

domestic product, from 2008 to 2012 and by $1,139 billion, or 1.2 percent of cumulative GDP, from 2013 to 

2017.

CBO’s estimates of the economic feedbacks associated 

with the President’s proposals depend on a variety of specific assumptions. However, under any of the assumptions incorporated into this analysis, economic feedbacks 

would modify the budgetary impact of the proposals to 

only a minor extent: They could raise the proposals’ 

impact on the cumulative deficit by $26 billion or reduce 

it by $11 billion from 2008 to 2012, and they could raise 

the proposals’ impact on the cumulative deficit by $46 

billion or reduce it by $68 billion from 2013 to 2017 (see 

Figure 2-1, Table 2-1, and Table 2-5). 

How Federal Budget Policies 

Affect the Economy

Over the long run, the nation’s potential to produce 

goods and services depends on the size and quality of 

both the labor force and the stock of productive capital 

(such as factories, vehicles, and computers) as well as on 

the level of technological know-how. Changes in those 

determinants of potential output—referred to by economists as “supply-side” changes—can have a lasting, sustainable impact on the economy’s ability to supply goods 

and services.

In the short run, however, economic activity may deviate 

from its potential level in response to changes in aggregate demand, which can rise above or fall below the economy’s sustainable ability to supply it. Such “demand-side” 

variations can push the employment of labor and the utilization of capital away from their long-term potential 

levels.1 Unlike movements on the supply side of the economy, however, those changes generally balance out over 

time: Over the longer term, corrective forces usually tend 

to move the economy back toward the sustainable potential level determined by the supply side.

Economic developments on both the supply side and the 

demand side depend on the choices that millions of individuals make about what and how much to buy, how 

much to save and what assets to hold, and whether and 

how much to work. Such developments also depend on 

the choices that firms make about investment, employment, and production. The government plays important 

roles in establishing the legal, institutional, and regulatory framework within which the economy operates, 

including monetary policy, and in setting overall levels of 

government spending and taxation. 

Budgetary policies can influence the economy through 

various channels, some of them affecting the supply side 

of the economy, some affecting the demand side, and 

some affecting both. Changes in the tax rates that people 

1. Changes in supply-side factors such as energy prices, as well as 

other types of shocks, may also trigger temporary movements in 

the economy.
32 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Figure 2-1.

CBO’s Estimates, Using Various Models, of How the President’s Budget Would 

Affect the Deficit After Accounting for Economic Effects

(Cumulative change from CBO’s baseline, in billions of dollars)

Source: Congressional Budget Office.

Notes: The estimates in the panels above reflect the supply-side effects of the President’s proposals on the economy but exclude demandside economic impacts, as explained in the text. A negative change indicates an increase in the cumulative deficit relative to CBO’s 

baseline.

CBO’s analysis used the following models (which are described in the text): (A) “textbook” high model, (B) “textbook” low model, 

(C) closed-economy life-cycle model with lower government spending after 2017, (D) closed-economy life-cycle model with higher 

taxes after 2017, (E) open-economy life-cycle model with lower government spending after 2017, (F) open-economy life-cycle model 

with higher taxes after 2017, (G) infinite-horizon model with lower government consumption after 2017, (H) infinite-horizon model 

with higher taxes after 2017, (I) Macroeconomic Advisers’ model, and (J) Global Insight’s model.

a. Because this model is designed primarily to capture business-cycle developments, which are hard to predict beyond a few years, CBO did 

not compute an estimate for the 2013–2017 period.

-600

-500

-400

-300

-200

-100

0

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

A BCDE FGH

2008 to 2012

2013 to 2017

Budget's Impact on the 2008-2012 Deficit

Assuming No Macroeconomic Feedbacks (-$507 billion)

Budget's Impact on the 2013-2017 Deficit

Assuming No Macroeconomic Feedbacks (-$1,139 billion)

a

ABCDEFGH I J

a

I J
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 33

Table 2-1.

CBO’s Estimates of How the President’s Budget Would Affect the Deficit

After Accounting for Economic Effects

(Cumulative change from CBO’s baseline, in billions of dollars)

Source: Congressional Budget Office.

Notes: A negative number indicates an increase in the cumulative deficit relative to CBO’s baseline.

The “textbook” growth model is an enhanced version of a model developed by Robert Solow. The life-cycle growth model, developed

by CBO, is an overlapping-generations general-equilibrium model. The infinite-horizon growth model is an enhanced version of a 

model first developed by Frank Ramsey. The models by Macroeconomic Advisers and Global Insight, which are available commercially, 

are designed to forecast short-term economic developments. The various models reflect a wide range of assumptions about the 

extent to which people are forward-looking in their behavior: In the textbook model and those by Macroeconomic Advisers and Global 

Insight, people have the least foresight, whereas in the infinite-horizon model, people’s foresight is perfect and extends infinitely to 

include a full consideration of effects on descendants.

In models with forward-looking behavior, CBO had to make assumptions about how the President’s budget would be financed after 

2017. CBO chose two alternatives—adjusting government purchases of goods and services and transfer payments or adjusting 

marginal tax rates.

n.a. = not applicable. 

High (Hours worked respond strongly to tax-rate changes) -503 -1,168

Low (Hours worked respond weakly to tax-rate changes) -515 -1,185

Government spending adjusted after 2017 -520 -1,110

Taxes adjusted after 2017 -521 -1,115

Government spending adjusted after 2017 -496 -1,071

Taxes adjusted after 2017 -498 -1,077

Government spending adjusted after 2017 -508 -1,101

Taxes adjusted after 2017 -508 -1,100

-528 n.a.

-533 n.a.

-519 n.a.

-497 n.a.

Memorandum:

President's Proposals Under Baseline Economic Assumptions -507 -1,139

Global Insight's Model

CBO's Estimate of the Budgetary Effects of the

Growth Models

With Forward-Looking Behavior

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers' Model

Global Insight's Model

Without Forward-Looking Behavior

2008 to 2012 2013 to 2017

Macroeconomic Advisers' Model

Textbook Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Infinite-Horizon Model

Macroeconometric Models

Supply-Side Contribution
34 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

face can affect their willingness to work and save, potentially influencing the short-run level of demand but also 

changing the sustainable long-run levels of labor supply 

and capital. Similarly, changes both in government 

spending for goods and services and in government transfers can affect the overall level of demand in the short run 

and may also increase or reduce the resources available for 

private investment, affecting the long-term level of the 

capital stock. (CBO’s macroeconomic analysis distinguishes between government transfers to persons and 

government purchases of goods and services, but most of 

CBO’s models do not differentiate more finely among 

various types of government spending in terms of their 

impact on long-term economic performance. In reality, 

however, the economic effects of different types of government spending vary.) The economic effects of changes 

in both revenue and spending policies depend on how 

those changes are financed. In the short run, reductions 

in tax rates or increases in spending can be financed by 

larger budget deficits. Over the long term, however, the 

fiscal impact of changes in spending or revenues must 

ultimately be offset through other policy changes; those 

offsetting policy changes can significantly influence the 

long-term economic impact of the initial change in 

spending or revenues.

Supply-Side Effects

The supply-side effects of the President’s budgetary proposals can include influences on the quantity and quality 

of the labor force, the size and composition of the capital 

stock, and technological progress. Changes in any or all 

of those factors can alter potential output. 

The Quantity and Quality of the Labor Force. Potential 

output is strongly influenced by the overall quantity and 

quality of labor in the economy. A sustained, long-term 

increase in the total number of hours worked raises the 

economy’s potential to generate output. CBO’s analysis 

focused on channels through which the President’s proposals could affect the quantity of labor—that is, the 

number of hours of labor supplied. Potential output 

could also be affected by improvements in workers’ levels 

of education, training, experience, and on-the-job effort, 

which raise the quality of each hour worked. However, 

because any such effects would not be very large over the 

2008-2017 budget period, CBO did not incorporate 

them in this analysis.

The President’s proposals could affect the quantity of 

labor through two channels. First, several of the President’s proposed policies would change people’s after-tax 

income but would not significantly alter the marginal tax 

rates on income resulting from labor.2 (For some people, 

for example, the extension of the child tax credit would 

raise their after-tax income but would not affect their 

marginal tax rates.) In the absence of a change in marginal rates, a rise in after-tax income tends to reduce the 

number of hours of labor supplied because people can 

maintain their standard of living with less work; conversely, a decline in income tends to increase hours

supplied.

Second, some provisions would change after-tax income 

and also would change after-tax compensation for each additional hour of work. (For example, the extension of the 

marginal tax rates on income enacted in the Economic 

Growth and Tax Relief Reconciliation Act of 2001 would 

increase both. In contrast, other provisions, such as the 

President’s health proposal, would reduce them for many 

people in most years.) Provisions that raise both after-tax 

income and incremental after-tax compensation (as well 

as provisions that reduce both) have opposing effects on 

people’s incentives. In the case of the extension of 

EGTRRA, for example, workers would earn more for 

each extra hour of labor they supplied, which would tend 

to encourage them to work longer hours, but they could 

also maintain their current levels of after-tax income by 

working fewer hours, which would tend to discourage 

work. Studies generally have found that, on balance, 

those opposing incentives largely offset each other, but 

that the former (the substitution effect) slightly outweighs the latter (the income effect). As a consequence, 

reductions in marginal tax rates will tend to increase 

modestly the hours of labor that workers supply, primarily because those reductions will draw secondary earners 

(for example, the spouse of a household’s primary breadwinner) into the labor force.3 Conversely, increases in 

marginal tax rates will modestly decrease hours worked. 

2. The marginal tax rate is the rate on an additional dollar of 

income.

3. See Congressional Budget Office, Labor Supply and Taxes (January 

1996). Since that report was published, CBO has slightly reduced 

its estimated total wage elasticity and substitution elasticity for 

secondary earners, on the basis of evidence that their responsiveness has declined over time as their participation in the labor force 

has grown. See Francine D. Blau and Lawrence M. Kahn, 

“Changes in the Labor Supply Behavior of Married Women: 

1980-2000,” Discussion Paper No. 2180 (Bonn, Germany: Institute for the Study of Labor, June 2006), forthcoming in the Journal of Labor Economics.
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 35

Table 2-2.

CBO’s Estimates of Effective Federal Marginal Tax Rates on Labor Income

(Percent)

Source: Congressional Budget Office.

Notes: The effective federal marginal tax rate on labor income is the share of the last dollar of earnings in the economy that is taken by 

federal individual income taxes and payroll taxes.

* = between zero and 0.05 percentage points.

CBO estimates that the President’s policies would lower 

the marginal tax rate on labor by about 3 percent in 

2007, compared with its baseline level, largely as a result 

of the proposal to extend for one year an increase in the 

exemptions allowed under the alternative minimum tax 

(see Table 2-2).4 The President’s policies would leave the 

marginal rate nearly unchanged in 2008; but after 2008, 

two sets of proposals would have large, opposing effects 

on marginal tax rates. The proposed changes in the taxation of health insurance would raise the marginal rate on 

labor by 4 percent in 2009 and by even more in succeeding years (see Appendix C). However, proposals that 

would make a number of provisions associated with the 

2001 and 2003 tax legislation permanent would reduce 

the marginal rate by 4.5 percent in 2011 and by somewhat less in the following years (because the AMT would 

offset an increasing share of the marginal rate reductions 

over time). Together, those sets of proposals would raise 

effective marginal federal tax rates on labor income 

by 4 percent in 2009 and 2010, reduce it by about 

0.4 percent in 2011, and gradually raise it thereafter, by 

about 0.1 percent in 2012, to stand at nearly 2 percent 

by 2017.

Taking into account the effects described above, CBO 

estimates that the President’s budgetary proposals would 

probably raise the number of hours people worked in 

2007 but have a negligible effect on that measure in 

2008. In 2009 and 2010, higher marginal tax rates from 

the health proposal would tend to discourage people 

from working. After 2010, however, changes in marginal 

tax rates might lead workers either to increase or decrease 

their work effort modestly and would tend to have a fairly 

minor impact, on average, on the number of hours supplied over the entire 2011–2017 period, compared with 

the rates in CBO’s baseline policy assumptions.

The Size and Composition of the Capital Stock. The President’s budgetary policies would influence the size of the 

capital stock owned by Americans primarily by affecting 

national saving. National saving comprises private saving 

minus the budget deficit; an increase in private saving 

raises national saving, whereas an increase in the budget 

Calendar

Year

2007 30.3 29.4 -0.9 -2.9

2008 30.6 30.6 0 0

2009 30.9 32.1 1.2 4.0

2010 31.1 32.4 1.3 4.0

2011 32.9 32.7 -0.1 -0.4

2012 33.0 33.1 * 0.1

2013 33.3 33.4 0.1 0.4

2014 33.4 33.7 0.2 0.7

2015 33.6 34.0 0.4 1.2

2016 33.8 34.3 0.4 1.3

2017 34.0 34.6 0.6 1.8

Tax Rate Under

Current Law Percentage Points

Difference

Percent

Tax Rate Under the

President's Budget

4. CBO’s estimates of current-law effective marginal tax rates on 

labor income are about 2.5 percentage points higher than they 

were last year, primarily because CBO has lowered its estimate of 

the portion of any increment in labor compensation that workers 

would choose to receive in tax-exempt health insurance payments. 

That change, which is not related to the President’s budgetary proposals, increases the portion of incremental labor compensation 

subject to tax, raising effective marginal tax rates under 

current law.
36 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

deficit reduces it. An overall decline in national saving 

reduces the capital stock owned by Americans over time, 

either through a decrease in domestic investment or an 

increase in borrowing from abroad, or both.

According to CBO’s estimates, the President’s proposals 

would increase the federal deficit relative to its level in the 

agency’s baseline in every year from 2007 to 2017. However, almost half of the increase in the deficit would result 

from two proposals that, in CBO’s judgment, would have 

little effect on national saving. First, the establishment of 

individual accounts in Social Security would raise private 

saving while increasing the budget deficit; the net effect 

on national saving would thus be much smaller than the 

increase in the deficit itself. (The net effect of that proposal on national saving depends on the reaction of 

households to the funds deposited into individual 

accounts as well as the impact of the deposits on federal 

budget policy.) Second, the increase in incomes resulting 

from the extension of the repeal of the estate tax would 

nearly all be saved, almost entirely offsetting the resulting 

decline in government revenues. Taking into account all 

of the President’s proposals, the higher deficits, by themselves, would have a modest negative effect on national 

saving.

In addition to their effect on the deficit, several of the 

President’s tax proposals might encourage greater private 

saving by lowering the effective marginal tax rates on capital income and thus raising the after-tax rate of return on 

savings. Through that channel, the tax proposals would 

influence private saving in two opposing ways, just as 

lowering marginal tax rates on labor income would have 

opposing effects on the supply of labor: Higher after-tax 

returns would tend to increase saving and thus reduce 

current consumer spending; but they would also increase 

the value of existing assets, making households wealthier 

and thus tending to encourage spending. On balance, the 

combined effect on spending of higher after-tax returns 

can be either positive or negative. CBO included in its 

analysis a range of plausible assumptions about how 

households might respond to changes in the after-tax rate 

of return on savings. At one end of the range, some of 

CBO’s models assumed that the rate would have little or 

no effect on how households allocate their income 

between consumer spending and saving; at the other end, 

other models assumed that increasing the rate of return 

would boost saving and reduce spending significantly.

The provisions of the President’s budget that could affect 

the after-tax rate of return on capital include extending 

EGTRRA’s marginal income tax rates, extending the cuts 

in tax rates on dividends and capital gains enacted in the 

Jobs and Growth Tax Relief Reconciliation Act of 2003, 

and expanding tax-free savings accounts. (Appendix B 

provides greater detail on the potential economic effects 

of the President’s proposals for dividend and capital gains 

taxation, tax-free savings accounts, the estate tax, and 

individual accounts in Social Security. Appendix C provides greater detail about the proposal to change the tax 

treatment of health benefits.) CBO summarized the 

effects of those provisions on the rate of return on savings 

by estimating the aggregate impact they would have on 

effective marginal tax rates on capital income, compared 

with its baseline estimates of those rates under 

current-law policies (see Table 2-3).5 According to CBO’s 

estimates, effective marginal federal tax rates on capital 

income during the 2011–2017 period would be about 

15 percent lower under the President’s proposals than 

under the policies assumed in CBO’s baseline.6

Taking into account the effects discussed above, CBO 

estimates that the policies in the President’s proposed 

budget would lead to modest declines, on average, in the 

capital stock over the 2008–2017 period, compared with 

the policies in its baseline.

Some policies proposed in the President’s budget would 

not only affect the level of the capital stock but would 

change the mix of different types of capital within that 

stock—a shift that could also affect potential output. 

Among the relevant policies in the President’s budget, the 

proposal to extend the lower tax rates on corporate dividends and capital gains would probably have the biggest 

effect on the composition of the capital stock because the 

proposal would reduce taxes on personal income received 

from the corporate sector, thus encouraging some capital 

to shift from the noncorporate to the corporate sector. 

Currently, some corporate income is taxed once at the 

level of the firm (through the corporate income tax) and

5. Both sets of estimates yield effective tax rates that are below all but 

the lowest statutory marginal rates, because some capital income 

(for example, the interest that flows into tax-free savings accounts 

or pension funds, as well as rental income from owner-occupied 

housing) is not taxed.

6. For a description of CBO’s method for estimating effective tax 

rates, see Congressional Budget Office, Computing Effective Tax 

Rates on Capital Income (December 2006).
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 37

Table 2-3.

CBO’s Estimates of Effective Federal Marginal Tax Rates on Capital Income

(Percent)

Source: Congressional Budget Office.

Note: The effective federal marginal tax rate on income from capital is the share of the last dollar of such income that is taken by taxes—

specifically, federal individual income and corporate income taxes.

again at the personal level (through the individual income 

tax on dividends and capital gains). (Not all corporate 

income is taxed in this fashion—some corporate income 

is effectively not taxed at the firm level, and some corporate income is not taxed at the personal level.) That tax 

treatment distorts the way that capital is allocated in 

the economy because it discourages investment in the 

corporate sector relative to investment in the housing and 

noncorporate business sectors. As a result, less capital may 

be held in the corporate sector than is optimal for the 

economy’s efficient operation. Extending lower tax rates 

on dividends and capital gains would reduce that distortion, tending to enhance economic output.

Extending the current tax rates on dividends and capital 

gains would also diminish a distortion that would come 

into effect under the baseline’s assumption that the tax 

rates will rise again after 2010. The taxation of dividends 

and capital gains may encourage greater corporate reliance on debt to finance investment than would otherwise 

be the case. Because firms may deduct interest payments 

on debt they owe (such as the bonds they have issued) 

from any taxable income, they can lower their tax payments by borrowing rather than issuing stock to finance 

their investments. The net result is that the interest payments are taxed only once, at the personal level. If the 

current tax rates expire as projected in the baseline, the 

tax treatment of interest payments on debt may influence 

firms’ decisions about financing and lead to a less efficient allocation of resources. 

Technological Progress. New and improved technical 

processes and products are the source of most long-term 

growth in productivity, and the President’s budgetary 

proposals could affect the economy by influencing the 

rate of technological progress. Researchers, however, 

understand little about how taxation and spending policies affect technological innovation. Therefore, CBO for 

the most part has not incorporated in its analysis effects 

on technological progress arising from the President’s 

proposals.7

Demand-Side Effects

By increasing the deficit, the President’s budgetary proposals would also increase after-tax income, thus tending 

to encourage higher consumer spending and enhance the 

total demand for goods and services. Increases in demand 

may cause firms to temporarily gear up production and 

Calendar

Year

2007 14.2 14.4 0.2 1.6

2008 14.1 14.1 0 0

2009 14.0 14.1 0.1 0.4

2010 13.9 13.9 0.1 0.4

2011 16.2 13.8 -2.4 -14.9

2012 16.1 13.7 -2.4 -14.9

2013 16.1 13.7 -2.4 -15.0

2014 16.0 13.6 -2.4 -15.1

2015 16.0 13.6 -2.4 -15.0

2016 16.0 13.6 -2.4 -15.0

2017 15.9 13.5 -2.3 -14.8

Percent

Tax Rate Under the

President's Budget

Tax Rate Under

Current Law Percentage Points

Difference

7. CBO used two commercial macroeconometric models to estimate 

the demand-related effects of the President’s proposals. In one of 

those models, created by Global Insight, potential GDP responds 

positively to spending for research and development—which in 

turn would be stimulated by the proposal to extend tax credits for 

such activities.
38 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

hire more workers; decreases in demand may have the 

opposite effects. From a demand-side perspective, budgetary policies that raise private and public consumption 

might increase the pace of the economy’s current expansion. Nevertheless, demand-side effects are relatively fleeting: They can only temporarily raise or lower output 

beyond what it would otherwise be because stabilizing 

economic forces tend to move output back toward its sustainable potential level. Moreover, policies that increase 

demand by raising government consumption or private 

consumer spending are likely to lower national income in 

the long run because such policies may tend eventually to 

reduce the size of the capital stock owned by Americans 

and therefore reduce aggregate income.

The Models and Their Results

CBO used five different economic models to estimate the 

economic effects of the President’s budgetary proposals 

relative to the policy assumptions in CBO’s baseline. The 

models, which fall into two broad categories, focus on 

somewhat different aspects of the economy and reflect 

distinct ways of thinking about it. Three models provide 

estimates of supply-side effects only; the other two are 

commercial macroeconometric models that emphasize 

the business-cycle aspects of the economy and are 

designed primarily to analyze demand-side effects, 

although they incorporate some supply-side influences as 

well. Each type of model represents individuals’ economic 

decisions—in particular, the degree to which individuals 

anticipate future developments—in an idealized way that 

does not capture all aspects of actual behavior. Even so, 

results from such models are likely to provide a reasonable range of estimates of individuals’ responses to 

changes in policy. (Figure 2-2 presents, year by year, the 

impact of the President’s proposals on some of the key 

inputs for CBO’s various models—effective tax rates on 

labor and capital and the size of the deficit.)

Supply-Side Effects

CBO used three growth models to analyze the supplyside effects of the President’s proposals from 2007 

through 2017.8 The models—a “textbook” growth 

model, a life-cycle growth model, and an infinite-horizon 

growth model—differ mainly in their assumptions about 

how far into the future people look in making plans (see 

Appendix D). The textbook growth model assumes, in 

effect, that people do not explicitly take into account 

expected future policies when making their current 

plans—that is, the model incorporates no forwardlooking behavior. Moreover, the model does not account 

for the influence on investment of changes in marginal 

tax rates on capital income.

In contrast, the life-cycle model incorporates the assumption that people make lifelong plans for working and saving but do not consider events that might occur after they 

die. The infinite-horizon model differs yet again, assuming, in effect, that people behave as if they will live forever—or, equivalently, that they care about the well-being 

of their descendants as well as their own. Moreover, the 

latter two models assume that people know with certainty 

how the government will resolve its long-term budget 

imbalance, whether it be through higher tax rates, lower 

spending and transfer payments, or some combination of 

the two.

CBO used the textbook growth model to estimate effects 

under two different assumptions about how much people 

will adjust their work hours in response to changes in 

marginal tax rates: a “low” assumption, under which 

workers respond very little, and a “high” assumption, 

under which their response is on the high side of the consensus range of empirical estimates.9

 CBO found that 

under both assumptions, the President’s proposals would 

reduce gross national product (GNP) by 0.1 percent, on

8. Growth models are often referred to as supply-side models. They 

assume that the labor market is always in equilibrium—that is, 

that fiscal policy does not shift unemployment from its natural 

rate. CBO presents effects for the 2008–2012 and 2013–2017 

periods because the main purpose of this discussion is to illustrate 

how economic feedbacks could affect the budget numbers presented in Chapter 1 for those periods. Its models showed positive 

supply-side effects on output in 2007. The positive effects 

stemmed mainly from reduced tax rates on labor income as a 

result of the proposal to extend for one year the increase in the 

exemptions allowed under the alternative minimum tax. The positive effects in 2007 are reflected in calculations of revenues, government debt, and interest costs for 2008 and beyond.

9. Based on data from a large sample of taxpayers, CBO’s estimates 

account for the effects on labor supply of changes in both marginal tax rates and after-tax income under the President’s proposals 

and incorporate a larger response to changes in marginal tax rates 

among secondary earners than among primary earners. 
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 39

Figure 2-2.

Effects of the President’s Budget on the Deficit and on the Effective Tax Rates on 

Capital Income and Labor Income

Source: Congressional Budget Office.

Note: Effects on the deficit are by fiscal year; impacts on effective tax rates are by calendar year.

a. The bars represent the effects of the President’s proposals on the budget balance under CBO’s baseline economic assumptions. A 

negative change indicates an increase in the annual deficit relative to CBO’s baseline.

b. Changes in the effective federal marginal tax rate on income from labor (the share of the last dollar of such income taken by federal 

individual income and payroll taxes).

c. Changes in the effective federal marginal tax rate on income from capital (the share of the last dollar of such income taken by federal 

individual income and corporate income taxes).

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-20

-15

-10

-5

0

5

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

-1.5

-1.0

-0.5

0.0

0.5

Budget's Impact on the Deficit

Changes in the Effective Tax Rate

Capital income

Labor income

0

(Percentage of gross domestic product)

(Percent)

a

b

c
40 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

average, over the 2008–2012 period.10 Over the 2013–

2017 period, the proposals would reduce GNP by about 

0.3 percent under the high assumption and by about 

0.4 percent under the low assumption (see Table 2-4).

The results of the life-cycle and infinite-horizon growth 

models differ from those of the textbook growth model, 

for several reasons. Unlike the textbook growth model, 

the other two models are built on the assumption that 

individuals adjust their decisions about work, consumer 

spending, and saving both in response to changes in marginal tax rates and after-tax rates of return and in anticipation of expected future changes in policy.

The forward-looking characteristics of the life-cycle and 

infinite-horizon growth models require CBO to make 

assumptions about what people believe will happen in the 

future, both in CBO’s baseline and under the President’s 

proposed policies, not only during the 10-year projection 

period but into the indefinite future as well. For its analysis, CBO assumed that people believe that the budgetary 

policies being assessed—those of the President or of 

CBO’s baseline—will be maintained over the entire 10-

year projection period. (In reality, people may well believe 

that the policies might change at some point during that 

time.)

For the years beyond 2017, however, matters are complicated by the fact that the policies reflected in both CBO’s 

baseline and the President’s proposals are unsustainable in 

the long run, owing to projected increases in spending for 

health and retirement programs.11 For the purposes of its 

analysis, CBO assumed that people expect the fiscal 

imbalances projected under current-law policies to be 

resolved over the long run. It then made explicit assumptions about the manner in which changes in deficits or 

surpluses under the President’s budgetary policies, relative 

to those in the baseline, would eventually be financed in 

the future.

The life-cycle and infinite-horizon models each generated 

two sets of estimates based on different assumptions 

about that financing. Under one assumption, people 

believe that the proposals will be financed by gradually 

adjusting government spending for goods and services 

and for transfer payments (as shares of GNP) over the 

2018–2027 period. Under the other assumption, people 

believe that the proposals will be financed by gradually 

adjusting marginal tax rates on income over the same 

period. 

Depending on which assumption about financing is used 

and whether the economy is considered to be open or 

closed to flows of foreign capital, both models project 

that the President’s proposals will have little impact on 

GNP over the 2008–2012 period—roughly a decline 

between 0.1 percent and 0.2 percent. Over the 2013–

2017 period, the two models project that the President’s 

proposals will raise GNP by between zero and 0.2 percent, depending on assumptions.

The supply-side effects of the President’s proposed policy 

changes would feed back to the budget but would tend to 

have very modest effects (see Tables 2-1 and 2-5). Under 

the assumptions incorporated into its baseline, CBO 

projects that the President’s proposals will expand the 

cumulative deficit over the 2008–2012 period by $507 

billion, ignoring economic feedbacks, but those feedbacks could add as much as $26 billion to that total or 

subtract as much as $11 billion from it, depending on 

which set of assumptions is incorporated into the analysis. (That range includes supply-side effects from all five 

models.) For the 2013–2017 period, the President’s budgetary policies are projected to boost the cumulative deficit by $1,139 billion, ignoring economic feedbacks, but 

those feedbacks could add up to $46 billion to that 

increase or subtract as much as $68 billion from it. No 

single number is likely to provide an accurate measure of 

the feedback, but the numbers presented here illustrate 

the range of its likely magnitude.

Demand-Side Effects

Because demand-side economic developments become 

increasingly hard to estimate the farther projections 

extend into the future, CBO analyzed demand-side 

effects of the President’s budgetary proposals only for the

10. In presenting the economic effects of the President’s budgetary 

proposals, CBO uses gross national product as its measure of output rather than the more commonly cited gross domestic product. 

Changes in GNP exclude foreigners’ earnings on investments in 

the domestic economy but include domestic residents’ earnings 

overseas and are therefore a better measure of the proposals’ effects 

on domestic residents’ income than changes in GDP in an open 

economy like that of the United States. The budget calculations 

presented in Table 2-5 reflect the fact that tax treaties and other 

factors result in some foreign income being effectively untaxed.

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

(December 2005).
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 41

Table 2-4.

CBO’s Estimates of How the President’s Budget Would Affect Real Gross

National Product

(Average percentage difference from CBO’s baseline, by calendar year)

Source: Congressional Budget Office.

Notes: The “textbook” growth model is an enhanced version of a model developed by Robert Solow. The life-cycle growth model, developed 

by CBO, is an overlapping-generations general-equilibrium model. The infinite-horizon growth model is an enhanced version of a 

model first developed by Frank Ramsey. The models by Macroeconomic Advisers and Global Insight, which are available commercially, 

are designed to forecast short-term economic developments. The various models reflect a wide range of assumptions about the 

extent to which people are forward-looking in their behavior: In the textbook model and those by Macroeconomic Advisers and Global 

Insight, people have the least foresight, whereas in the infinite-horizon model, people’s foresight is perfect and extends infinitely to 

include a full consideration of effects on descendants.

In models with forward-looking behavior, CBO had to make assumptions about how the President’s budget would be financed after 

2017. CBO chose two alternatives—adjusting government purchases of goods and services and transfer payments or adjusting 

marginal tax rates.

* = between -0.05 and 0.05 percent; n.a. = not applicable

-0.1 -0.3

-0.1 -0.4

-0.2 *

-0.2 *

-0.1 0.2

-0.1 0.2

-0.1 0.1

-0.1 0.1

-0.2 n.a.

-0.2 n.a.

0.1 n.a.

* n.a.

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers' Model

Global Insight's Model

Growth Models

With Forward-Looking Behavior

Macroeconometric Models

Without Forward-Looking Behavior

Supply-Side Contribution

High (Hours worked respond strongly to tax-rate changes)

Low (Hours worked respond weakly to tax-rate changes)

2013 to 2017

Macroeconomic Advisers' Model

Global Insight's Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Taxes adjusted after 2017

Government spending adjusted after 2017

Taxes adjusted after 2017

Infinite-Horizon Model

2008 to 2012

Government spending adjusted after 2017

Taxes adjusted after 2017

Government spending adjusted after 2017
42 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table 2-5.

The Budgetary Implications of the Macroeconomic Effects

(Cumulative change from CBO’s estimate of the President’s budget, in billions of dollars)

Source: Congressional Budget Office.

Notes: Numbers in this table reflect the effects on the cumulative deficit (relative to CBO’s baseline) of the economic impacts shown in 

Table 2-4. (Negative numbers indicate an increase in the deficit; positive numbers, a reduction.) They do not include the estimated 

cost of the President’s budgetary proposals under CBO’s baseline economic assumptions. The total impact of the proposals on the

cumulative deficit, including both those direct costs and the secondary effects shown above, appear in Table 2-1.

The “textbook” growth model is an enhanced version of a model developed by Robert Solow. The life-cycle growth model, developed

by CBO, is an overlapping-generations general-equilibrium model. The infinite-horizon growth model is an enhanced version of a 

model first developed by Frank Ramsey. The models by Macroeconomic Advisers and Global Insight, which are available commercially, 

are designed to forecast short-term economic developments. The various models reflect a wide range of assumptions about the 

extent to which people are forward-looking in their behavior: In the textbook model and those by Macroeconomic Advisers and Global 

Insight, people have the least foresight, whereas in the infinite-horizon model, people’s foresight is perfect and extends infinitely to 

include a full consideration of effects on descendants.

In models with forward-looking behavior, CBO had to make assumptions about how the President’s budget would be financed after 

2017. CBO chose two alternatives—adjusting government purchases of goods and services and transfer payments or adjusting 

marginal tax rates.

n.a. = not applicable.

High (Hours worked respond strongly to tax-rate changes) 4 -29

Low (Hours worked respond weakly to tax-rate changes) -9 -46

Government spending adjusted after 2017 -14 28

Taxes adjusted after 2017 -15 24

Government spending adjusted after 2017 11 68

Taxes adjusted after 2017 9 62

Government spending adjusted after 2017 -1 37

Taxes adjusted after 2017 -1 39

-22 n.a.

-26 n.a.

-12 n.a.

10 n.a.

2008 to 2012 2013 to 2017

Macroeconomic Advisers' Model

Global Insight's Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Infinite-Horizon Model

Macroeconomic Advisers' Model

Global Insight's Model

Growth Models

With Forward-Looking Behavior

Macroeconometric Models

Supply-Side and Demand-Side Contributions

Without Forward-Looking Behavior

Supply-Side Contribution
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 43

first five years of the 2008–2017 period. To do so, it used 

macroeconometric forecasting models created by two private forecasting firms—Macroeconomic Advisers and 

Global Insight. The design of each of those models 

includes an embedded growth model, but each concentrates primarily on demand-side economic effects.

As with the textbook growth model, CBO adjusted 

Macroeconomic Advisers’ and Global Insight’s models to 

incorporate its own estimates of how workers would 

adjust their hours worked in response to the changes in 

marginal tax rates on labor income implied by the President’s proposals.

Like the textbook growth model, Macroeconomic 

Advisers’ and Global Insight’s models are not forwardlooking—people, as the models represent them, do not 

behave as though they have specific expectations about 

future policies or economic developments. However, the 

models do represent individuals as responding to some 

economic changes in the same way that they have 

responded in the past, regardless of the source of those 

changes. For example, people are assumed to react to the 

tax proposals in the President’s budget that would change 

marginal income tax rates and after-tax labor income in 

roughly the same way as they did, on average, when aftertax wages and income changed in the past.

The lack of forward-looking behavior in the macroeconometric models implies that specific policy changes that 

are scheduled to occur in the future will not affect current 

behavior unless special adjustments are made to mimic 

such behavior.12 For example, the President’s proposals 

would reduce taxes throughout the projection period, 

compared with the levels in CBO’s baseline. Those lower 

taxes would increase the amount of after-tax income that 

people expected in the future, which might cause them to 

boost their spending today (as the forward-looking models imply). In the macroeconometric models, however, 

those changes in taxes affect consumer spending only 

when they occur. 

CBO explored the relative magnitude of demand- and 

supply-side effects of the proposed policies by manipulating monetary policy responses in the models. For one set 

of scenarios, CBO assumed that the Federal Reserve 

would respond to economic developments as it has in the 

past. For a second set, CBO assumed that the Federal 

Reserve would respond in such a way as to hold the 

unemployment rate at the level projected in CBO’s baseline. The second approach produced an estimate of the 

implications of the proposals for potential (noncyclical) 

GNP—in other words, the supply-side effects. Subtracting the second set of results from the first provides an 

estimate of the demand-side effects of the proposed 

policies.

Incorporating CBO’s estimate of effects on labor supply, 

Macroeconomic Advisers’ model predicted that the 

demand- and supply-side effects of the President’s proposed policies would increase GNP by 0.1 percent, on 

average, between 2008 and 2012 (see Table 2-4 on 

page 41). Global Insight’s model forecast virtually no 

effect. The models also projected similar, small negative 

supply-side effects under the President’s budgetary policies, with output estimated as 0.2 percent lower over the 

2008–2012 period using either model. The similarity of 

those results reflects in part the common assumption 

about effects on labor supply.

Both models indicate that the proposals’ projected economic impacts would feed back to the budget and affect 

the size of the projected deficit. According to the projections from Macroeconomic Advisers’ model, feedback 

effects on the supply side could add $22 billion to the 

$507 billion increase in the cumulative deficit projected 

for the 2008–2012 period under the CBO baseline’s economic assumptions (see Table 2-5). By the estimates of 

Global Insight’s model, the supply-side feedbacks of the 

President’s proposals over the same period could add 

$26 billion to the deficit.

Including both demand- and supply-side effects, the two 

models estimate different feedbacks on the budget. In 

Global Insight’s model, the proposals would decrease the 

cumulative deficit by $10 billion over the 2008–2012 

period. In contrast, Macroeconomic Advisers’ model predicts that the deficit will increase by $12 billion from 

2008 to 2012. In that model, positive demand-side stimulus would raise the inflation rate by much more than in 

Global Insight’s model. Monetary authorities would 

respond by raising interest rates, thus increasing federal 

outlays for net interest. Those higher outlays would offset 

a greater portion of the positive impacts of higher GNP 

on the budget than in Global Insight’s model.

12. One such adjustment is that stock prices are assumed to incorporate the effects of extending lower rates on income earned from 

capital gains and dividends immediately, even though the extension would not affect tax rates until after 2010.

APPENDIX

A

Changes in CBO’s Baseline

Since January 2007

In conjunction with its annual analysis of the President’s budgetary proposals, the Congressional Budget 

Office (CBO) typically updates its baseline budget projections, which show the paths of federal spending and 

revenues over the next 10 years under current laws and 

policies (see Table A-1). The updated baseline reflects 

new information gleaned from various sources—including the President’s budget—and legislation enacted since 

January, when CBO completed its previous baseline projections.1 (Because CBO has not updated its overall economic assumptions since January, none of the revisions to 

the baseline reflect changes to those assumptions.)

CBO constructs its baseline in accordance with the provisions set forth in the Balanced Budget and Emergency 

Deficit Control Act of 1985 and the Congressional Budget and Impoundment Control Act of 1974. (Although 

the provisions of the Deficit Control Act that pertain to 

the baseline expired at the end of September 2006, CBO 

continues to follow that law’s specifications in preparing 

its baseline.) To project revenues and mandatory spending, CBO assumes that current laws continue unchanged 

in the future, with only a few exceptions.2 That approach 

includes the assumption that various tax-law changes 

enacted since 2001 will expire as scheduled by 2011, 

causing a rise in revenues thereafter. To project discretionary spending, CBO adjusts the current year’s budget 

authority for inflation and certain other factors specified 

in law. The resulting baseline projections are not 

intended to be a prediction of future budgetary outcomes. Rather, they serve as a benchmark that lawmakers 

can use to measure the effects of spending or revenue proposals, such as those in the President’s budget.

Since January, CBO has increased its estimate of the deficit that would result in 2007 under current law by $5 billion, to $177 billion. Likewise, it has lowered its projection of the cumulative surplus for the 2008–2017 period 

by $214 billion—from $800 billion to $586 billion (see 

Table A-2). Most of those changes affect the outlay side 

of the budget; they stem from extrapolating the appropriations enacted in the Revised Continuing Appropriations 

Resolution, 2007 (Public Law 110-5), and from so-called 

technical changes (revisions attributable to factors other 

than new laws or changes in CBO’s economic forecast). 

CBO has made only negligible revisions to its revenue 

estimates for the 10-year projection period, increasing 

them by 0.02 percent, or a total of $6 billion.

Changes to Outlay Projections

CBO has added $5 billion to its outlay projection for 

2007 and a total of $220 billion (0.7 percent) to the outlay projections for the 2008–2017 period. More than 

three-quarters of that increase—$172 billion over the 

10-year period (including debt-service costs)—results 

from the enactment of appropriations for the remainder 

of this year. Technical changes to the baseline have 

increased projected outlays between 2008 and 2017 by 

another $48 billion. 

1. Those projections were published in Congressional Budget Office, 

The Budget and Economic Outlook: Fiscal Years 2008 to 2017

(January 2007).

2. For example, the Deficit Control Act directed that spending programs whose authorizations are set to expire be assumed to continue if they have outlays of more than $50 million in the current 

year and were established on or before the enactment of the Balanced Budget Act of 1997. Expiring programs established after 

that law was enacted are not automatically assumed to continue. 

The Deficit Control Act also required CBO to assume that expiring excise taxes that are dedicated to trust funds will be extended 

at their current rates. The law did not provide for the extension of 

other expiring tax provisions, even if they have routinely been 

extended in the past.
46 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table A-1.

CBO’s Baseline Budget Projections

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Total, Total,

Actual 2008- 2008-

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017

1,044 1,144 1,259 1,311 1,380 1,584 1,730 1,830 1,928 2,036 2,149 2,269 7,263 17,473

354 368 374 360 336 339 349 333 340 349 360 373 1,758 3,513

838 875 914 958 1,004 1,052 1,100 1,149 1,198 1,249 1,301 1,354 5,029 11,281

172 155 173 181 181 192 226 239 251 263 275 289 954 2,270 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,407 2,542 2,720 2,810 2,901 3,167 3,405 3,551 3,718 3,896 4,085 4,284 15,003 34,537

On-budget 1,799 1,905 2,051 2,107 2,164 2,395 2,597 2,707 2,838 2,979 3,130 3,290 11,313 26,258

Off-budget 608 638 669 703 738 773 808 844 880 917 955 994 3,690 8,279

1,413 1,454 1,536 1,625 1,714 1,832 1,870 2,009 2,131 2,264 2,449 2,580 8,576 20,009

1,016 1,029 1,046 1,062 1,078 1,100 1,112 1,140 1,166 1,194 1,227 1,250 5,398 11,376

227 236 251 256 266 270 268 263 258 252 246 237 1,312 2,567 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,655 2,719 2,833 2,944 3,058 3,202 3,250 3,411 3,555 3,710 3,921 4,067 15,286 33,951

On-budget 2,233 2,268 2,366 2,458 2,552 2,676 2,699 2,830 2,942 3,062 3,233 3,336 12,751 28,154

Off-budget 422 451 467 486 506 526 551 581 613 649 688 731 2,535 5,797

-248 -177 -113 -134 -157 -35 155 139 163 186 163 217 -283 586

-434 -363 -315 -351 -388 -281 -102 -123 -104 -82 -104 -46 -1,438 -1,897

186 186 202 217 232 247 257 263 266 268 267 263 1,155 2,482

4,829 5,010 5,137 5,285 5,455 5,502 5,358 5,229 5,075 4,895 4,737 4,525 n.a. n.a.

13,065 13,645 14,300 15,014 15,742 16,465 17,205 17,973 18,764 19,582 20,425 21,295 78,726 176,766

8.0 8.4 8.8 8.7 8.8 9.6 10.1 10.2 10.3 10.4 10.5 10.7 9.2 9.9

2.7 2.7 2.6 2.4 2.1 2.1 2.0 1.9 1.8 1.8 1.8 1.8 2.2 2.0

6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4

1.3 1.1 1.2 1.2 1.2 1.2 1.3 1.3 1.3 1.3 1.3 1.4 1.2 1.3 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

18.4 18.6 19.0 18.7 18.4 19.2 19.8 19.8 19.8 19.9 20.0 20.1 19.1 19.5

On-budget 13.8 14.0 14.3 14.0 13.7 14.5 15.1 15.1 15.1 15.2 15.3 15.5 14.4 14.9

Off-budget 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7

10.8 10.7 10.7 10.8 10.9 11.1 10.9 11.2 11.4 11.6 12.0 12.1 10.9 11.3

7.8 7.5 7.3 7.1 6.8 6.7 6.5 6.3 6.2 6.1 6.0 5.9 6.9 6.4

1.7 1.7 1.8 1.7 1.7 1.6 1.6 1.5 1.4 1.3 1.2 1.1 1.7 1.5 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

20.3 19.9 19.8 19.6 19.4 19.4 18.9 19.0 18.9 18.9 19.2 19.1 19.4 19.2

On-budget 17.1 16.6 16.5 16.4 16.2 16.3 15.7 15.7 15.7 15.6 15.8 15.7 16.2 15.9

Off-budget 3.2 3.3 3.3 3.2 3.2 3.2 3.2 3.2 3.3 3.3 3.4 3.4 3.2 3.3

-1.9 -1.3 -0.8 -0.9 -1.0 -0.2 0.9 0.8 0.9 1.0 0.8 1.0 -0.4 0.3

-3.3 -2.7 -2.2 -2.3 -2.5 -1.7 -0.6 -0.7 -0.6 -0.4 -0.5 -0.2 -1.8 -1.1

1.4 1.4 1.4 1.4 1.5 1.5 1.5 1.5 1.4 1.4 1.3 1.2 1.5 1.4

Debt Held by the Public 37.0 36.7 35.9 35.2 34.7 33.4 31.1 29.1 27.0 25.0 23.2 21.2 n.a. n.a.

Total

Deficit (-) or Surplus

On-budget 

Off-budget

Outlays

Discretionary spending

Mandatory spending

Revenues

Individual income taxes

Net interest

Corporate income taxes

Social insurance taxes

Other

Total

Off-budget

Debt Held by the Public

Memorandum:

Gross Domestic Product

On-budget 

Revenues

Individual income taxes

Corporate income taxes

Social insurance taxes

In Billions of Dollars

As a Percentage of Gross Domestic Product

Other

Total

Outlays

Discretionary spending

Mandatory spending

Net interest

Total

Deficit (-) or Surplus
APPENDIX A CHANGES IN CBO’S BASELINE SINCE JANUARY 2007 47

Table A-2.

Changes in CBO’s Baseline Projections of the Deficit or Surplus

Since January 2007

(Billions of dollars)

Source: Congressional Budget Office.

Note: * = between -$500 million and $500 million.

a. Includes offsetting receipts.

b. Negative numbers indicate an increase in the deficit or decrease in the surplus.

Total, Total,

2008- 2008-

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2012 2017

-172 -98 -116 -137 -12 170 159 185 208 192 249 -194 800

***11111111 2 6

Changes to Outlay Projections

Mandatory **********0 * *

Discretionary

Defense 1 2 2 2 3 3 3 3 3 3 3 11 26

Nondefense 7 11 11 10 10 10 10 11 11 11 11 52 106 __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____

Subtotal, discretionary 8 13 13 13 12 13 13 13 14 14 14 63 132

Net interest (Debt service) * 1 1 2 3 3 4 5 6 7 8 10 40 __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____

8 13 14 15 15 16 17 18 20 21 22 74 172

Mandatory

Medicarea -2 1 4 5 7 2 4 4 3 5 3 19 38

Medicaid * * 1 1 1 2 3 4 5 6 7 5 29

Social Security -1 -1 -1 -1 -1 -1 -2 -2 -2 -3 -3 -6 -17

Veterans' compensation 1 1 1 1 1 1 2 2 2 3 3 5 17

Other 1 2 * 1 2 * 1 * -1 -1 2 5 6 __ __ __ __ ___ __ __ __ __ ___ ___ ___ ___

Subtotal, mandatory -2 3 5 6 11 4 7 8 7 10 12 29 72

Discretionary -3 -1 -1 -2 -2 -1 -2 -2 -2 -2 -2 -7 -17

Net interest

Debt service * * 1 1 1 1 2 2 2 2 3 5 15

Other 1 * -1 1 -3 -5 -4 -3 -3 -2 -2 -8 -22 __ __ __ __ __ __ __ __ __ __ __ __ ___

Subtotal, net interest 1 * * 2 -1 -3 -2 -2 -1 * 1 -3 -7

-4 2 3 6 8 * 3 4 3 8 11 19 48 __ __ __ __ __ ___ __ __ __ __ ___ ___ ____

Total Outlay Changes 5 15 18 20 23 16 21 23 23 29 33 92 220

-5 -15 -17 -20 -22 -15 -20 -22 -22 -28 -32 -90 -214

-177 -113 -134 -157 -35 155 139 163 186 163 217 -283 586

-8 -13 -14 -15 -15 -16 -17 -18 -20 -21 -22 -74 -172

4 -2 -3 -5 -7 1 -3 -3 -3 -7 -10 -16 -42

Memorandum:

Total Legislative Changesb

Total Technical Changesb

Projected in March 2007

Legislative

Technical

Total Impact on the Deficit

Subtotal, legislative

Subtotal, technical

Total Deficit (-) or Surplus as

Total Deficit (-) or Surplus as

Projected in January 2007

or Surplusb

Changes to Revenue Projections

(Technical)
48 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Legislative Changes

Through mid-February, funding for 2007 for departments other than the Departments of Defense (DoD) 

and Homeland Security had been provided through a 

series of short-term continuing resolutions. Appropriations for the rest of the year, which were enacted on 

February 15, boosted discretionary budget authority for 

2007 by $7 billion over the amount in the previous resolution. In addition, budgetary resources provided in the 

form of obligation limitations for certain transportation 

programs were increased by nearly $4 billion. Extrapolating those amounts through 2017—in accordance with 

the rules used to construct CBO’s baseline—raises projected discretionary outlays by $12 billion to $14 billion 

per year over the 2008–2017 period.

That higher projected spending raises CBO’s projections 

of the federal government’s borrowing needs, thereby 

boosting projected debt-service costs over 10 years by 

$40 billion.

Technical Changes

CBO has made relatively small technical changes to its 

outlay projections, reducing them by $4 billion for 2007 

and increasing them by $48 billion for the 2008–2017 

period. The largest changes involve higher spending 

projections for Medicare, Medicaid, and veterans’ compensation, partly offset by lower spending projections for 

Social Security and discretionary programs (mostly for 

DoD). 

Medicare. Since publishing the January baseline, CBO 

has reduced its estimate of Medicare spending in 2007 

by $2 billion. However, it has raised its Medicare projections for the following 10 years by a total of $38 billion, 

or 0.7 percent.

The change for 2007 is the net result of a $2.6 billion 

reduction in projected net spending for Hospital Insurance (Part A of Medicare) and Supplementary Medical 

Insurance (Part B) and a $0.6 billion increase in projected 

net spending for the prescription drug benefit (Part D). 

Information on spending for Parts A and B through midFebruary suggests that the slower rate of growth in spending that occurred in 2006 appears to be continuing and 

that receipts from Medicare beneficiaries’ premium payments for Part B have been unexpectedly high. In the 

other direction, the program’s payments to prescription 

drug plans under Part D grew slightly more in January 

(the first month of the new benefit year) than CBO had 

anticipated.

The change for the 2008–2017 period is concentrated in 

Parts A and B and results largely from rapid growth in 

enrollment in the private fee-for-service (PFFS) component of the Medicare Advantage program.3 Medicare 

generally pays much more for enrollees in PFFS plans 

than it would if those beneficiaries remained in the traditional fee-for-service program. (The additional cost varies 

by area but can be 40 percent or more.) During 2006, 

enrollment in PFFS plans soared from about 200,000 to 

almost 900,000. Another 500,000 people enrolled in 

those plans in January 2007. CBO now projects that 

enrollment in PFFS plans will total about 5 million by 

2017 and that those plans will account for roughly onethird of enrollment in the Medicare Advantage program. 

(Currently, about 18 percent of Medicare beneficiaries are 

enrolled in Medicare Advantage plans; CBO expects that 

share to grow to 26 percent by 2017.)

Medicaid. Revisions to CBO’s outlook for the Medicaid 

program have increased projected federal spending for 

Medicaid by $29 billion (or less than 1 percent) over the 

2008–2017 period. Because the percentage of the population with private-sector health insurance is expected to 

keep declining, CBO has raised its projection of the 

number of children and low-income adults who will 

enroll in Medicaid, boosting projected spending by 

$40 billion over 10 years. Partially offsetting that change 

is a decrease of $15 billion through 2017 in the estimated 

growth of Medicaid spending for prescription drugs. 

Other, smaller adjustments have increased projected 

Medicaid spending over that period by $4 billion.

Social Security. The most recent information about 

Social Security recipients has led CBO to lower its spending projections slightly. The changes include reducing 

the average monthly and initial (retroactive) retirementbenefit payments expected in Social Security’s Old-Age 

and Survivors Insurance program. For the Disability 

Insurance program, reduced projections of retroactive 

benefit payments are offset by increased projections of 

3. A private fee-for-service plan is a Medicare Advantage health plan 

that—unlike other Medicare Advantage plans—generally neither 

establishes a network of providers nor requires that enrollees use 

such a network. Beneficiaries can see any provider who is eligible 

to receive payment from Medicare and who agrees to accept payment from the PFFS plan.
APPENDIX A CHANGES IN CBO’S BASELINE SINCE JANUARY 2007 49

caseloads. The net effect of those changes is to decrease 

spending by an average of roughly $2 billion per year over 

the 2008–2017 period, for a total drop of $17 billion, or 

0.2 percent.

Veterans’ Compensation. CBO now projects that spending for veterans’ disability compensation will be about 

$17 billion higher between 2008 and 2017 than it anticipated in January. Recent data from the Department of 

Veterans Affairs about average monthly benefit payments 

for veterans suggest that monthly benefits for new recipients of disability compensation will be higher than previously projected. 

Other Mandatory Programs. Technical changes to the 

spending projections for other mandatory programs have 

been relatively small; on net, they increase mandatory 

outlays by $6 billion over the 2008–2017 period. In the 

largest such change, CBO has added $7 billion to its 

10-year projection of outlays for the Pension Benefit 

Guaranty Corporation because it anticipates lower 

income from premiums and interest and smaller transfers 

from nonbudgetary funds (all of which are recorded in 

the budget as negative outlays), partly offset by lower 

payments to pension recipients. In the other direction, 

CBO has reduced its estimate of outlays for international 

affairs programs by a total of $4 billion over 10 years (primarily because of adjustments in the estimated earnings 

of the Exchange Stabilization Fund). Other, smaller 

changes have added a net $3 billion to total projected 

mandatory spending over the 2008–2017 period.

Discretionary Programs. Technical changes since January 

have had a smaller effect on CBO’s baseline projections of 

discretionary spending than on its projections of mandatory spending. Those adjustments decrease discretionary 

outlays by $3 billion in 2007 and by $17 billion over the 

2008–2017 period. The biggest change for 2007 was a 

reduction of $4 billion to reflect slower-than-expected 

growth in spending by DoD—especially in the category 

of operations and maintenance, which funds many of the 

department’s day-to-day activities. 

The $17 billion reduction for the 2008–2017 period 

reflects a $21 billion decrease in projected outlays for 

defense programs and a $4 billion increase in projected 

spending for nondefense discretionary programs. The 

revisions to projections of defense spending are mostly 

attributable to new actuarial information from DoD that 

shows lower contribution rates for 2008 for the military’s 

TRICARE For Life Trust Fund. That change has led 

CBO to pare $14 billion from its projection of spending 

for future health care benefits from the TRICARE For 

Life program.

Net Interest. In all, technical changes to projections of 

net interest spending have reduced projected outlays over 

the next 10 years by $7 billion. That reduction is the net 

result of two countervailing changes. On one hand, CBO 

has lowered its projections of net interest costs for the 

2008–2017 period by $22 billion, in large part because of 

revisions to certain intragovernmental interest payments 

and adjustments in the estimated balances of financing 

accounts for federal credit programs (which affect federal 

borrowing needs). On the other hand, increases in projected deficits (or decreases in projected surpluses) resulting from other technical changes to the baseline have 

added $15 billion to projected debt-service costs between 

2008 and 2017. 

Changes to Revenue Projections

The revisions to CBO’s revenue projections since January 

are all considered technical and reflect higher projections 

of revenues from miscellaneous fees and fines (such as 

receipts of the Department of Justice’s Assets Forfeiture 

Fund). The changes have little effect on projected 

revenues in 2007 and 2008 but add $500 million to 

$700 million each year thereafter.

APPENDIX

B

The Potential Economic Effects of

Selected Proposals in the President’s 2008 Budget

Considerable uncertainty surrounds the potential 

economic impact of five of the President’s budgetary proposals for 2008—those that would extend beyond 2010 

the lower tax rates on dividends and capital gains, expand 

the availability of tax-free savings accounts, extend the 

repeal of the estate tax, establish individual accounts as 

part of Social Security, and change the tax treatment of 

health insurance. This appendix discusses the factors that 

the Congressional Budget Office (CBO) considered and 

methods it used in assessing the impact of the first four of 

those proposals. Appendix C discusses the health proposal, and Chapter 2 presents the analysis of the overall 

economic effects of all of the proposals.

Extend the Lower Tax Rates on 

Dividends and Capital Gains

Enactment of the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) reduced tax rates applicable 

to dividends and capital gains through 2008. Those rates 

comprise a bottom bracket of 5 percent and a top bracket 

of 15 percent; in 2008, the bottom bracket is slated to 

drop to zero. The Tax Increase Prevention and Reconciliation Act of 2006 extended the zero and 15 percent rates 

through 2010. Before JGTRRA was enacted, dividends 

were subject to the same tax rates as ordinary income—

ranging from 10 percent to 35 percent—and most capital 

gains were subject to rates of 8 percent, 10 percent, or 

20 percent (depending on a filer’s income tax bracket and 

on how long the asset was held). 

The President, in his 2008 budget, has proposed making 

the rates of zero and 15 percent permanent. Many types 

of productive capital are sufficiently long-lived that 

investments in them today will continue to earn returns 

long after JGTRRA’s rate changes are scheduled to expire. 

Permanently extending those rates would enhance firms’ 

incentive to invest in long-lived capital stock by increasing the expected returns.

Reduced rates on capital gains and dividends lower the 

overall taxation of corporate profits, some of which are 

taxed twice: once under the corporate income tax and 

again when people receive dividends and realize capital 

gains—brought about by a firm’s reinvestment of its profits—on sales of stock. Lowering the tax rates that individuals face on the two types of income would reduce the 

total rate of taxation. 

In addition to decreasing tax rates on corporate income, 

JGTRRA reduced taxes on some income that is currently 

taxed only once. A substantial portion of taxable capital 

gains arises from investments whose earnings are not subject to the corporate income tax, such as gains on real 

estate held by individuals. The lower capital gains tax rate 

reduced the level of taxation on those investments as well. 

One effect of extending the tax rates on dividends and 

capital gains involves the cost of financing for businesses. 

Lower tax rates on capital gains and dividends could 

lower the cost of financing, because businesses could pay 

investors less before taxes to yield the same after-tax 

return. But how much the cost of capital might fall is 

unclear. Some analysts argue that only the decrease in 

taxes on capital gains will act to reduce that cost. Others 

hold that both the decrease in taxes on dividends and the
52 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

decrease in taxes on capital gains will reduce the cost of 

capital.1

A related difference of views among analysts involves how 

much the value of firms’ stock might rise if the lower rates 

of taxation were extended permanently. (Share values rise 

because the decrease in taxes increases the after-tax return 

to shareholders, making the investments more valuable to 

them.) The view of corporate finance that predicts a relatively large increase in those values predicts a relatively 

small decrease in the cost of capital, and vice versa.

In the absence of a clear consensus about which view is 

correct, CBO has adopted middle-ground estimates of 

the effects of the President’s proposal on the cost of capital for firms and on share values. 

Higher values for shares of stock raise the net wealth of 

shareholders, encouraging more spending on goods and 

services—the so-called wealth effect. Through that channel, the President’s proposal would boost overall demand 

in the short run. But to the extent that it enhanced 

demand by raising consumer spending in the short run, it 

would tend to reduce national saving and national 

income in the long run. 

The enactment of JGTRRA has provided an opportunity 

to examine how changes in dividend taxes affect a firm’s 

value. Some researchers have found evidence that reductions in dividend taxes raised stock prices, although it is 

uncertain whether those changes will be permanent or 

temporary.2 Other researchers have found no measurable 

effects on the value of the total U.S. stock market, but 

their work does not rule out the possibility of a modest 

positive effect. 3

Extending the lower rates on capital gains and dividends 

is also likely to lessen the disadvantage that the corporate 

sector now faces in the competition for capital. For example, although some income from the corporate sector is 

taxed twice under current law, income from unincorporated businesses is taxed only once (at the personal level), 

and income from owner-occupied housing—that is, the 

value of the housing “services” consumed by the owner—

is not taxed at all at the federal level. That disparity in tax 

treatment may lead to lower investment in the corporate 

sector than is optimal for economic output. Lowering the 

taxes that firms face would allow them to attract additional capital from the housing and small-business sectors 

and may thus improve the economy’s efficiency. Such a 

shift in investment might, however, conflict with other 

policy goals, such as support for owners’ occupancy of 

homes or for unincorporated businesses. 

The proposal to extend the lower rates on dividends and 

capital gains might affect firms’ financial behavior in two 

ways: They might choose to finance more investment by 

issuing stock (equity financing) rather than debt, and 

they might decide to pay out more in dividends and 

retain fewer earnings. Currently, firms may deduct the 

interest they pay on debt from their taxable income, so 

those payments are taxed only once, at the personal level. 

(That is, the individual who receives the payment pays 

the tax.) But if a firm finances a project by issuing stock, 

some of the returns on the investment that the project 

generates are taxed at both the corporate and personal 

levels. The President’s proposal would narrow that disparity in tax treatment. 

1. Although economists do not agree on how the taxation of dividends affects the economy, two competing views prevail. Under 

the first (or “traditional”) view, reducing the tax on dividends lowers the cost of capital and increases investment. In the short run, 

stock prices rise under this view because expected after-tax returns 

to investors increase. But the additional investment drives the pretax return to capital back down over time, so the impact on stock 

prices is temporary. Under the second (or “new” view), reducing 

the tax on dividends permanently raises the value of a firm and 

therefore its stock price but leaves unaffected both the cost of capital and investment by the firm. For an overview of those issues, 

see Alan Auerbach, “Taxation and Corporate Financial Policy,” in 

Alan Auerbach and Martin Feldstein, eds., Handbook of Public 

Economics, vol. 3 (Amsterdam: North-Holland, 2003); and 

George R. Zodrow, “On the ‘Traditional’ and ‘New’ Views of 

Dividend Taxation,” National Tax Journal, vol. 44, no. 4, part 2 

(December 1991), pp. 497–509; and Roger Gordon and Martin 

Dietz, “Dividends and Taxes,” Working Paper No. 12292 

(Cambridge, Mass.: National Bureau of Economic Research, June 

2006).

2. Alan J. Auerbach and Kevin A. Hassett, “The 2003 Dividend Tax 

Cuts and the Value of the Firm: An Event Study,” in A. Auerbach, 

J. Hines, and J. Slemrod, eds., Taxing Corporate Income in the 21st 

Century (Cambridge: England, Cambridge University Press, 

2007), pp. 93–126; Alan J. Auerbach and Kevin A. Hassett, “Dividend Taxes and Firm Valuation: New Evidence,” American Economic Review, vol. 96, no. 2 (May 2006), pp. 119–123.

3. Gene Amromin, Paul Harrison, and Steven Sharpe, How Did

the 2003 Dividend Tax Cut Affect Stock Prices? Working Paper 

2006–17 (Chicago: Federal Reserve Bank of Chicago, October 

2006).
APPENDIX B THE POTENTIAL ECONOMIC EFFECTS OF SELECTED PROPOSALS IN THE PRESIDENT’S 2008 BUDGET 53

The evidence amassed so far is consistent with the view 

that dividend taxation affects firms’ payout policies, at 

least in the short run. The reduction in dividend taxation 

in 2003, for instance, has been followed by a significant 

increase in dividends issued by firms, although it is uncertain whether that increase will be permanent and whether 

the tax cut caused firms to increase their total payout to 

shareholders or simply to substitute dividends for share 

repurchases.4

 In addition, the factors explaining why 

some firms increased dividend payouts more than others 

are still being explored; the evidence to date suggests that 

the response to the tax reduction appeared to be greater 

among firms whose top executives held relatively large 

amounts of company stock (and relatively small amounts 

of unexercised stock options) and among firms whose 

ownership was dominated by taxable institutions. 

The proposed reduction in the future taxation of dividends and capital gains would also interact with some of 

the President’s other proposals and with current law. For 

instance, the President’s proposal to boost the amount 

that people may deposit in tax-free savings accounts (discussed below) would increase the share of personal assets 

held in such accounts—duplicating some of the effect 

that the proposal to extend the tax rates on dividends and 

capital gains would have on the cost of capital and its 

allocation among sectors of the economy. However, the 

expanded accounts would partly mitigate the impact that 

the dividend/capital gains proposal would have in bolstering equity financing because the interest earned on 

assets in the accounts would not be taxed at either the 

personal or the corporate level. Also contributing to that 

lessening of the proposal’s impact on equity financing 

would be the combined effect of the two policies in 

increasing the proportion of interest-bearing assets in taxfree accounts: Investors’ incentive to hold stocks in such 

accounts would be weakened if their returns already faced 

lower tax rates.

CBO incorporated the effects of the dividend/capital 

gains proposal in its analysis in two ways. For the 

two macroeconometric forecasting models (from 

Macroeconomic Advisers and Global Insight), CBO 

estimated the proposal’s effect on the cost of capital in 

different sectors of the economy and on the value of stock 

shares under the assumption that both investors and businesses are forward-looking. It then incorporated those 

estimates in the models and projected the ultimate effect 

on the economy. 

For the growth models (the “textbook” growth model, 

life-cycle growth model, and infinite-horizon growth 

model), CBO incorporated an estimate of the proposal’s 

overall effect on the cost of capital. Those models, however, have no mechanism to account for the effect of reallocating capital. CBO therefore reviewed research on how 

reallocation might influence output, determined a 

midrange estimate, and added that amount to the models’ underlying estimates of the effect on output. The procedure phased in an increase in gross national product 

over the 2008–2017 period that reached 0.07 percent in 

2017. 

Expand Tax-Free Savings Accounts

The President’s 2008 budget includes a proposal that is 

designed to both consolidate and expand the current system of tax-free savings accounts for retirement and other 

purposes, such as education. Two new kinds of accounts 

would be created: retirement savings accounts (RSAs) and 

lifetime savings accounts (LSAs). The RSA would function in some ways like a Roth individual retirement 

account (IRA)—that is, taxes would not be deferred on 

contributions, as they are for contributions to traditional 

IRAs, but the interest that the accounts earned would 

accrue tax-free. In contrast to Roth IRAs, however,

RSAs would be available to all workers (and their 

spouses) regardless of income. In addition, the President’s 

proposal would eliminate further tax deferrals for IRA 

contributions. 

Like the RSAs, the proposed lifetime savings accounts 

would face tax treatment similar to that governing Roth 

IRAs. However, unlike Roth IRAs or RSAs, LSAs would 

be open to everyone, regardless of age, income, or 

employment status, and participants could withdraw 

4. Raj Chetty and Emmanuel Saez, “The Effects of the 2003 Dividend Tax Cut on Corporate Behavior: Interpreting the Evidence,” 

American Economic Review, vol. 96, no. 2 (May 2006), pp. 124–

129; Raj Chetty and Emmanuel Saez, “Dividend Taxes and Corporate Behavior: Evidence from the 2003 Dividend Tax Cut,” 

Quarterly Journal of Economics, vol. 120, no. 3 (2005), pp. 791–

833; Jeffrey Brown, Nellie Liang, and Scott Weisbenner, “Executive Financial Incentives and Payout Policy: Firm Responses to the 

2003 Dividend Tax Cut,” Working Paper No. 11002 (Cambridge, 

Mass.: National Bureau of Economic Research, 2004); and 

Jennifer Blouin, Jana Raedy, and Douglas Shackelford, “Did Dividends Increase Immediately After the 2003 Reduction in Tax 

Rates?” Working Paper No. 10301 (Cambridge, Mass.: National 

Bureau of Economic Research, February 2004). 
54 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

funds at any time for any reason. Taxpayers could also use 

LSAs to consolidate other savings plans, including Coverdell education savings accounts and qualified state tuition 

plans. 

In CBO’s estimation, the new savings accounts that the 

President has proposed would have little effect on the 

economy, on average, over the 2008–2017 period. Most 

taxpayers would save similar amounts in one of the new 

accounts as they would have saved in one of their present 

tax-free accounts. Furthermore, a possible outcome of 

implementing the new accounts is that people who currently have assets in taxable accounts will reduce their tax 

liability by selling those assets and putting the proceeds 

into the new accounts; similarly, over time some people 

may contribute less to taxable savings accounts because 

they contributed to the tax-preferred ones instead. To the 

extent that such shifting of assets occurred, total private 

saving would be unaffected but the budget deficit would 

be larger, so the net effect on national saving would be 

negative (because the change in private saving would fail 

to offset the increase in the budget deficit). Most new private saving would involve small amounts set aside by 

taxpayers with few taxable assets to shift. 

Beyond 2017, the effects of the proposal might be greater 

than those just described (because increasing numbers of 

taxpayers would run out of assets that could be shifted). 

For those later years, CBO estimates, the proposal would 

have a modestly positive impact on private saving.

Extend the Estate Tax’s Repeal

The President’s proposal to extend the repeal of the estate 

tax beyond the end of calendar year 2010 (the repeal’s 

scheduled expiration date) could have varying effects on 

consumer spending and saving, depending on people’s 

motives for leaving bequests. Consensus is lacking, however, about which motives predominate and how estate 

taxes affect consumer spending. A lower estate tax makes 

it cheaper for people to leave money to their heirs, which 

could encourage people to reduce their spending to leave 

larger bequests. But a lower estate tax also means that 

people can make the same after-tax bequest and spend 

more at the same time. Furthermore, to the extent that a 

lower estate tax increased the size of bequests after taxes, 

potential recipients might increase their spending as well. 

Some opponents of the estate tax argue that it has a particularly negative effect on the creation of new small businesses, but CBO has found little evidence to support that 

contention.5

CBO’s estimates of the effects of the President’s proposal 

incorporated the assumption that extending the repeal of 

the estate tax would increase consumer spending slightly, 

on balance—by about 5 cents for each dollar of tax savings. That assumption implies that the extension of the 

repeal will reduce the capital stock, but by an amount too 

small to affect the estimates presented in Chapter 2 of 

this report. Alternative assumptions that CBO considered—for example, that the positive effect on consumer 

spending from increasing after-tax income would be balanced by the incentive effects of lower tax rates, resulting 

in no net impact on that spending—would have yielded 

similar results.

Establish Individual Accounts in 

Social Security

The President’s budget includes a proposal that would 

allow workers to redirect a portion of their payroll tax 

payments from the Social Security trust funds to individual accounts and invest the contributions to such 

accounts in various financial assets. In CBO’s estimation, 

the proposal would result in budgetary outlays of $270 

billion from 2011 to 2017; however, it would have no 

appreciable effect on the economy during that period 

because it would not change people’s expected lifetime 

income (once the expected returns of the assets in the 

accounts were adjusted for the risk they carry) and would 

not alter people’s take-home pay. In addition, the 

accounts would not significantly affect the investment 

capital available in the economy, because the additional 

government borrowing to finance the accounts would be 

roughly offset by the increase in investable funds in the 

accounts.

Under the proposal, workers could redirect payroll taxes 

to individual accounts, but their contributions to the 

accounts would ultimately be offset by reductions in their 

traditional Social Security benefits, which would be calculated using hypothetical accounts. In addition to tracking the actual balances in an individual account, the 

Social Security Administration would follow a hypothetical account that held the same amount of contributions 

5. See Congressional Budget Office, Effects of the Federal Estate Tax 

on Farms and Small Businesses (July 2005).
APPENDIX B THE POTENTIAL ECONOMIC EFFECTS OF SELECTED PROPOSALS IN THE PRESIDENT’S 2008 BUDGET 55

and that grew at a specified real (inflation-adjusted) 

rate of 2.6 percent per year. When a person claimed 

traditional Social Security benefits, those benefits 

would be reduced in such a way that the actuarial value 

of the reduction over the person’s remaining lifetime 

would equal the amount in the hypothetical account—

regardless of how much was actually in the person’s 

individual account.

CBO derived the rate of growth for the notional account 

from projections by the trustees of the Social Security system. In their estimation, Treasury bonds over the long 

run will earn an average real return of 2.9 percent, and 

the individual accounts, if enacted, will incur annual 

administrative expenses equal to 0.3 percent of assets—

for a net real return of 2.6 percent. Because that rate 

equals the rate of return on the notional account that 

would be used to calculate the reduction in benefits, 

diverting payroll taxes to an individual account and 

investing entirely in government bonds is projected to 

leave a person’s total benefits (including the account 

assets) unchanged. If, however, the average rate of return 

on government bonds turns out to be higher or lower 

than that projected 2.9 percent, the total benefits of a 

person who chose to divert some payroll taxes to an individual account and invest in Treasury bonds will also be 

correspondingly higher or lower.

On average, greater returns would be expected from 

investing the contributions to an individual account in 

other assets, such as corporate bonds or equities. However, those investments would also be riskier than government bonds. The prices of various assets and their 

expected returns are determined by the preferences and 

judgments of financial market participants, who attempt 

to balance the risks of various assets against their extra 

expected returns. Therefore, despite the fact that an individual account holding assets such as stocks (with an 

expected return higher than 2.6 percent) would yield 

expected lifetime Social Security benefits whose value was 

greater than it would be under the traditional system, 

that higher anticipated income would not be expected to 

change the account holder’s behavior (by, for example, 

inducing him or her to increase spending now) because 

the higher expected return would be balanced by additional risk. Shifting some payroll taxes to an individual 

account would also be unlikely to affect the consumption 

patterns of people who spend all of their income because 

it would not alter their take-home pay.6

6. See Congressional Budget Office, Evaluating Benefit Guarantees in 

Social Security (March 2006).

APPENDIX

C

The President’s Proposal for a Standard

Tax Deduction for Health Insurance

In his 2008 budget request, the President proposes 

to replace virtually all of the current tax preferences for 

health insurance with a new standard deduction for any 

taxpayer who buys a qualifying health insurance plan. 

The Joint Committee on Taxation (JCT) estimates that 

the proposal would increase federal revenues by a net 

$411 billion over the next 10 years (as well as raising 

outlays for refundable tax credits by $77 billion over 

that period). The reason for the significant net revenue 

increase in JCT’s estimates is that the large revenue gain 

from eliminating current tax advantages for health spending would outweigh the large revenue loss from the new 

standard health deduction. The proposal would also raise 

effective marginal tax rates on labor income (the rate that 

applies to the last dollar of earnings) and would lead to a 

slight reduction in economic output between 2008 and 

2017, according to economic modeling by the Congressional Budget Office (CBO). In addition, the plan would 

reduce the number of uninsured people by about 6.8 million, CBO estimates. 

The current tax exclusion for the costs of employmentbased health insurance tends to cause more health spending to occur through that type of insurance—and more 

spending on health in general—than would otherwise be 

the case. The President’s proposal would eliminate the 

distortion toward employment-based insurance by replacing the exclusion with a standard tax deduction for the 

purchase of a qualifying health plan regardless of its cost 

or source (that is, whether the policy was obtained 

through an employer, union, or professional association 

or in the individual “nongroup market.”)1 Thus, the 

proposal would set employment-based health insurance 

on a par with individually purchased insurance. Moreover, once taxpayers had purchased a plan qualifying for 

the standard health deduction, they would no longer have 

a tax incentive to spend additional income on health 

insurance rather than on other goods. The change in 

incentives for purchasing insurance would be likely to 

have a variety of important effects, especially over time. 

This analysis focuses on the proposal’s impact on the 

budget, marginal tax rates on labor, economic output, 

and the number of people with health insurance. It does 

not examine other potential effects, such as on economic 

efficiency or health outcomes.

Description of the Proposal

Under current law, employers’ payments for 

employment-based health insurance (and most payments 

by employees) are excluded from taxable income for calculating income and payroll taxes, whereas the income 

that individuals use to buy non-employment-based 

health insurance is generally subject to taxation. Current 

law offers employees another tax advantage as well: Their 

spending from employer-sponsored flexible spending 

accounts and health savings accounts is exempt from 

both individual income and payroll taxes. Self-employed 

individuals are allowed to take an income tax deduction 

for health insurance payments. Finally, people who itemize deductions on their tax returns can deduct medical 

expenses that exceed 7.5 percent of their adjusted gross 

income.

The Administration’s proposal would replace most of 

those tax exclusions and deductions with a standard 

health deduction for taxpayers not enrolled in Medicare 

who purchased qualifying insurance. The standard 

deduction would be allowed for calculating federal 

income and payroll taxes. 

1. For simplicity, this appendix uses the term “nongroup market” to 

mean people who purchase health insurance through the traditional nongroup market as well as those who buy insurance as part 

of a group not associated with employment.
58 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

To qualify for the deduction, a health insurance plan 

would have to meet certain minimum requirements, 

including a specific limit on out-of-pocket expenses, reasonable caps on annual or lifetime benefits, rules about 

the types of care covered, and guaranteed renewability.2

Nearly all current health plans would be expected to qualify, although some policies sold in the individual insurance market might not meet those standards. 

The President’s proposal contains the following

provisions:

B All contributions by employers and employees for 

health insurance would be included in employees’ 

taxable income.

B Employees would no longer be able to use flexible 

spending accounts to pay for the costs of health insurance and health care. However, health savings 

accounts would continue to exist.

B Self-employed people would not be allowed to deduct 

health insurance payments for income tax purposes.

B Taxpayers who bought qualifying health plans—

whether through their employer or on their own—

would receive a deduction against their earnings (for 

income and payroll tax purposes) of $15,000 for family coverage and $7,500 for single coverage. Those 

amounts would be indexed to rise with inflation each 

year, as measured by the change in the consumer price 

index (CPI). Taxpayers enrolled in Medicare would 

not be eligible for the standard health deduction.

B The itemized deduction for medical expenses that 

exceed 7.5 percent of adjusted gross income would be 

eliminated, except for taxpayers enrolled in Medicare.

B For taxpayers with qualifying children, the rate at 

which the earned income tax credit (EITC) phases out 

as earnings rise would be lowered to 15 percent from 

the current range of 15.98 percent to 21.06 percent. 

That change would reduce the potential loss in the 

EITC that some low-income workers would experience when health insurance premiums were counted 

as taxable earnings.

Effects on the Federal Budget

If the President’s proposal took effect in 2009, it would 

reduce revenues by almost $14 billion in that fiscal year 

and by $6 billion the following year but would raise revenues by growing amounts thereafter, according to JCT 

(see Table C-1). Over the current 10-year budget window 

(2008–2017), the proposal would increase revenues by a 

total of about $411 billion. Some of that increase would 

come from higher Social Security payroll taxes. With the 

additional revenues to the Social Security trust funds 

excluded, on-budget revenues would rise by $354 billion. 

JCT estimates that the proposal would also boost outlays 

for refundable tax credits by $77 billion over the 2008–

2017 period. Therefore, the proposal would have a net 

budgetary effect of $334 billion over 10 years.3

Repealing the current tax preferences for employmentbased health insurance and other health benefits would 

have a net positive budgetary effect of $3.6 trillion over 

the 10-year budget window, while creating the standard 

health deduction would have a negative effect of $3.2 trillion over that period. Thus, eliminating the current tax 

preferences would produce more revenues than would be 

lost by creating the new deduction. The additional revenues collected under the proposal would rise over time 

because the revenue gain from the repeal would grow at a 

faster rate than the revenue loss from the deduction. That 

pattern results from the fact that the deduction would be 

indexed to increases in the CPI, whereas under current 

law, health insurance premiums (which influence the size 

of the current tax exclusions) are assumed to grow more 

quickly than the CPI.

Beyond 2017, the revenues collected under the proposal 

would continue to rise, but they would be partly offset by 

growing outlays for Social Security benefits. The proposal 

would affect spending for Social Security to the extent 

that changes in taxable wages altered the covered wages 

used to calculate Social Security benefits. Through 2017, 

any effect on Social Security outlays would be quite 

small, and the cumulative impact on those outlays could 

2. The limits on out-of-pocket costs would be based on the standards that apply to health savings account plans; currently, those 

limits cannot exceed $5,500 for individuals and $11,000 for family policies (amounts that are indexed to increase with overall 

inflation). Other requirements for the new deduction would be 

established by the Treasury Department through regulation. 

Those rules would not preempt states’ minimum standards for 

health insurance coverage.

3. That “net budgetary effect”—as is generally the case when CBO 

analyzes specific proposals—excludes any associated changes in 

debt-service costs.
APPENDIX C THE PRESIDENT’S PROPOSAL FOR A STANDARD TAX DEDUCTION FOR HEALTH INSURANCE 59

Table C-1.

Budgetary Effects of the President’s Health Proposal

(Billions of dollars)

Sources: Joint Committee on Taxation; Department of the Treasury.

a. Negative numbers indicate an increase in the deficit or a decrease in the surplus, whereas positive numbers indicate a decline in the 

deficit or a rise in the surplus.

be either positive or negative. Over a longer period, however, the proposal would have the effect of raising taxable 

wages—and hence outlays for Social Security benefits—

by increasingly significant amounts.

Compared with JCT’s estimates, which envision a significant revenue increase from the President’s proposal over 

the next decade, the Treasury Department’s estimates 

suggest more modest effects. In particular, the Treasury 

estimates that the proposal would have a net budgetary 

cost of $33 billion over the 2008–2017 period (see 

Table C-1). JCT estimates negative net budgetary effects 

in the proposal’s first three years, after which its estimates 

turn positive, whereas the Treasury predicts negative 

effects for the first five years. For 2017, the Treasury 

estimates that the proposal would reduce the deficit or 

increase the surplus by $54 billion, compared with JCT’s 

estimate of $118 billion.

Effects on Marginal Tax Rates on Labor

The rate at which someone’s last dollar of income from 

labor is taxed influences the amount of labor supplied to 

the economy. Increases in marginal tax rates reduce the 

return from working and therefore tend to reduce the 

amount of labor supplied to the economy, at least to 

some degree. CBO estimates that the President’s proposed changes in the tax deductibility of health insurance 

would increase effective marginal tax rates on labor. That 

effect arises from the fact that when people consider the 

benefits of working additional hours, they think about 

what they can buy with the additional income earned. 

To the extent that they wanted to purchase more health 

insurance with their higher income, the President’s proposal would raise marginal tax rates because it would 

increase the cost of buying additional insurance from the 

additional income earned.

In the near term, workers have little flexibility to alter the 

amount they spend on health insurance: In most cases, 

insurance is offered in a fixed amount by their employer. 

Over time, however, as their income rises, employees can 

demand more-expensive health insurance plans. That 

longer-run connection between changes in income and 

desired increases in health insurance spending underlies 

CBO’s conclusion that the President’s health proposal 

would raise effective marginal tax rates on labor.

That rise can be illustrated by considering how workers 

would spend the money earned from another hour of 

work. To understand how taxes interact with health 

spending, assume that workers can instantaneously 

adjust the amount spent on employment-based health 

insurance. If the workers would devote some of their 

additional earnings to health insurance premiums, they 

would enjoy a tax savings under the current tax treatment 

of such spending. However, the same workers considering 

an additional hour of work under the President’s health

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

 0 -6 3 12 22 34 48 63 80 98 354

 0 -8 -9 -5 -1 4 10 15 22 29 57 __ ___ __ __ __ __ __ __ ___ ___ ___

Total 0 -14 -6 7 22 39 57 78 101 127 411

Outlays 0 0 10 10 10 10 10 9 9 9 77

0 -14 -17 -4 12 29 48 69 93 118 334

0 -32 -44 -36 -25 -11 4 20 36 54 -33

Total,

2008-2017

Revenues

On-budget

Off-budget 

Net Budgetary Effecta

Memorandum:

The Treasury's Estimate of the

Proposal's Net Budgetary Effecta
60 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Table C-2.

CBO’s Estimates of Effective Federal 

Marginal Tax Rates on Labor Income 

Under the President’s Proposals

Source: Congressional Budget Office.

Note: The effective federal marginal tax rate on labor income is the 

share of the last dollar of earnings in the economy that is 

taken by federal individual income taxes and payroll taxes.

proposal would no longer enjoy the tax savings from 

their extra spending on health insurance. As long as they 

would spend some of their additional earnings from 

increased work on employment-based health insurance, 

the after-tax benefit from working an extra hour would 

be lower under the President’s proposal. That reduction 

in the after-tax benefit from working an extra hour is 

similar to an increase in tax rates; therefore, CBO incorporated an increase in rates into its estimates of effective marginal tax rates on labor under the President’s 

proposal. 

CBO analyzed the impact of that proposal on marginal 

tax rates not only for people considering changing how 

many hours they work but also for individuals entering or 

leaving the labor force. For those individuals, marginal 

tax rates could either rise or fall under the proposal. The 

outcome would depend on several factors, including the 

number of people who had tax-deductible insurance 

through another family member, the availability of jobs 

that provided insurance, and the value of the new standard health deduction relative to the value of insurance. 

Another factor could also affect marginal tax rates: To the 

extent that the new deduction exceeded the amount that 

would be included in taxable income from the removal of 

current tax preferences, a taxpayer’s taxable income might 

be reduced and the taxpayer might fall into a lower marginal tax bracket. Conversely, to the extent that the 

deduction was smaller than the rise in taxable income 

from the elimination of current preferences, a taxpayer 

might move into a higher marginal tax bracket. 

The impact of the President’s health proposal on marginal tax rates on earnings can be seen by comparing 

effective marginal rates under the full set of proposals in 

the President’s budget with rates calculated excluding the 

health proposal (see Table C-2). Beginning in 2009, 

when the health proposal would take effect, economywide marginal tax rates on labor under the President’s 

budget would be 1.2 percentage points higher as a result 

of the health proposal. That difference would grow to 

1.8 percentage points by 2017. Those increases represent 

a rise of 4 percent to 5 percent from the rates under the 

rest of the President’s budgetary proposals. 

CBO’s estimates depend on assumptions about the 

amount that would be spent on additional health insurance from additional income earned. CBO assumed that 

for the average person, health spending grows at half the 

rate at which income grows (an elasticity of 0.5).4

Deductible health spending is projected to make up 

roughly 10 percent of total compensation during the 

2008–2017 period. Given those assumptions, under current law, 5 cents of each additional dollar earned would 

be spent on health insurance and would not be subject to 

income and payroll taxes. The current tax exclusion thus 

makes marginal tax rates on labor about 5 percent lower 

than they would be otherwise, which amounts to a reduction of about 1.5 percentage points, given that rates 

without the health proposal average roughly 30 percent. 

Eliminating that exclusion as part of the health proposal 

would therefore raise marginal tax rates on labor by about 

1.5 percentage points. The increase would be less than 

that initially, CBO estimates, because many workers 

Calendar

Year

2007 29.4 29.4 0

2008 30.6 30.6 0

2009 30.9 32.1 1.2

2010 31.1 32.4 1.3

2011 31.4 32.7 1.4

2012 31.6 33.1 1.5

2013 31.9 33.4 1.5

2014 32.1 33.7 1.6

2015 32.3 34.0 1.7

2016 32.6 34.3 1.7

2017 32.8 34.6 1.8

Health Health Proposal

Proposal Proposal (Percentage points)

 (Percent) Attributable

Without With to the Health

Tax Rates Under the

President's Budget Change

4. The amount of additional health insurance that people desire 

when their income rises is uncertain. CBO’s assumed elasticity 

of 0.5 falls in the middle of estimates by other researchers (which 

range from near zero to almost 1). To the extent that the actual 

response was lower than CBO assumed, the increase in marginal 

rates from the President’s health proposal would be lower than 

estimated here. To the extent that the actual response was higher, 

the increase in marginal tax rates would be greater. 
APPENDIX C THE PRESIDENT’S PROPOSAL FOR A STANDARD TAX DEDUCTION FOR HEALTH INSURANCE 61

would be shifted to lower marginal tax brackets in the 

first years of the proposal, when the value of the standard 

health deduction would exceed the value of insurance. 

The reverse would be true in later years, when the value 

of insurance would tend to be greater than the value of 

the deduction.5

A rise in marginal tax rates is normally associated with 

an increase in the total taxes paid by workers. The 

increase in taxes—and accompanying reduction in aftertax income—by itself causes people to work more in an 

attempt to maintain the same standard of living. That 

“income effect” usually offsets, to some extent, people’s 

tendency to work less when marginal tax rates rise 

because the prospect of lower after-tax compensation 

from another hour of labor makes work less attractive 

relative to other uses of a person’s time. 

Except for the first two years, JCT estimates that the total 

taxes paid would increase under the President’s health 

proposal. The income effect from the reduced after-tax 

income would cause people to work more, thus offsetting 

some of the effect of higher marginal tax rates on labor. 

However, the total taxes paid would not rise as much as 

marginal rates would, because the total revenues gained 

from repealing the current tax exclusion would largely be 

reduced by the new standard health deduction. The 

income effect, which is linked to the change in the total 

taxes paid, would therefore be smaller as well.

Effects on Gross National Product

The proposal to change the tax treatment of health insurance premiums would reduce economic output slightly 

from what it would be under the President’s budget without that proposal. By raising effective marginal tax rates 

on labor income, the health proposal would decrease the 

supply of labor somewhat. At the same time, however, the 

additional tax revenues collected under the proposal 

would reduce the government’s need to borrow funds. 

Less federal borrowing would raise national saving, which 

in turn would increase future economic output. (The 

proposal might also affect private saving by changing 

effective marginal tax rates on capital. Those rates would 

be largely unaffected, however, because the change in the 

effective price of additional health insurance spending 

would occur in all years and therefore would not alter 

the trade-off between current and future consumption, 

which matters for calculating effective marginal tax rates 

on capital.)6

To illustrate how the health proposal fits into CBO’s estimates of the effects of the President’s budget on economic 

output, CBO used some of its growth models to estimate 

the macroeconomic impact from adding that proposal to 

the other policy changes in the President’s budget. (For 

more information about CBO’s models and the impact of 

all of the President’s proposals, see Chapter 2 and Appendix D.) Depending on assumptions about workers’ 

responsiveness to tax changes, how the government 

ultimately finances deficits, and whether the economy is 

open or closed to flows of foreign capital, CBO estimates 

that the health proposal would reduce real (inflationadjusted) gross national product (GNP) by a total of zero 

to 0.3 percent in the five years from 2008 to 2012 and 

by zero to 0.5 percent over the following five years.

Although the health proposal is projected to reduce GNP 

modestly, it would also have the beneficial effect of lessening the overall tax incentive to shift additional spending to health insurance from other goods and services 

(beyond the spending on a qualifying health plan). To the 

extent that the existing incentive distorts households’ 

spending patterns, the proposal might reallocate total 

spending in the economy in a way that could tend to 

improve overall well-being or economic efficiency but 

that GNP would not reflect.

Effects on the Number of People with 

Health Insurance

In addition to its budgetary and economic effects, the 

President’s health proposal would reduce the number of 

5. In estimating the economic impact of the President's health proposal using various models (as described later in this appendix), 

CBO phased in the increase in marginal tax rates on labor for the 

models that do not assume forward-looking behavior (the textbook growth model, Global Insight’s model, and Macroeconomic 

Advisers’ model). In those models, taxpayers might not recognize 

the policy change right away, and even when they did recognize it, 

they might not be able to alter their purchase of health insurance 

quickly. As a result, they would not experience an immediate 

increase in marginal tax rates under the President’s proposal. (In 

the forward-looking models, there would be no lags in recognizing 

or adjusting to the policy change.)

6. Although taxing additional health spending under the proposal 

would have no effect on effective marginal tax rates on capital, the 

proposal would move some people into different tax brackets. 

That movement would have a small net effect on the overall marginal tax rate on capital, changing it by less than 0.1 percentage 

point in any year through 2017.
62 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

uninsured people in the United States, CBO estimates. 

Under current law, an average of about 51 million people 

are expected to lack health insurance on any given day in 

2010.7

 Assuming that individuals and firms had fully 

adjusted to the new policy by then, CBO estimates that 

under the President’s proposal, the number of people 

without health insurance would be about 6.8 million 

smaller. (Because the proposal represents a significant 

departure from the current tax treatment of health insurance, its estimated effects on coverage are highly uncertain. The numbers described here represent CBO’s best 

estimates of the effects, but significant uncertainty surrounds them.)

The overall reduction in the number of uninsured individuals reflects many channels of change in the health 

insurance market. Of people who would otherwise be 

uninsured in 2010, for example, approximately 7 million 

would become insured in the nongroup market under the 

proposal, CBO estimates, and about 1.3 million would 

obtain employment-based coverage. At the same time, 

about 1.5 million people who would have employmentbased coverage under current law would become uninsured under the proposal, and about 6.3 million would 

switch from employment-based to nongroup coverage. 

The amount of the proposed tax deduction would represent a subsidy of about 70 percent of the health insurance 

premiums for the average person who became newly 

insured through the nongroup market. That subsidy rate 

would vary among individuals and households depending 

on their taxable income, the type and comprehensiveness 

of the insurance they bought, such factors as their age and 

health status (which could affect their quoted premiums), 

the number of individuals covered under their policy, and 

the cost of health care in their region. 

Compared with people who would be uninsured in 2010 

under current law, those gaining insurance coverage 

under the President’s proposal would have higher income, 

on average. The reason is that the value of the new deduction would be greater at higher marginal tax rates, which 

are associated with higher income. Nonetheless, the 

majority of newly insured people would come from 

lower-middle- and middle-income households, mostly 

because the uninsured population as a group has relatively low income compared with the population as a 

whole. The uninsured people who would acquire insurance coverage under the proposal would also have better 

health status, on average, than the uninsured population 

at large. The reason is that premiums in the nongroup 

market are generally lower for people with lower expected 

health costs, so the proposed deduction would represent a 

larger percentage subsidy of premiums for people with 

lower expected costs.

Replacing the tax exclusion for employment-based health 

plans with a deduction that could be used in either the 

employment-based or nongroup market would make 

employment-based plans less attractive relative to nongroup plans than they are now.8

 As a result, the number 

of people insured through employment-based plans 

would decline by more than 6 million, CBO estimates. 

Although some of the people losing coverage in the 

employment-based market would become uninsured, the 

bulk of them would be insured through the nongroup 

market instead. 

Despite the change in tax treatment, the vast majority of 

privately insured individuals would remain in the 

employment-based market rather than the nongroup 

market, CBO estimates, because the former has significantly lower administrative costs and advantages in forming insurance pools with more predictable costs. Nevertheless, the number of people obtaining coverage through 

the nongroup market would increase significantly, mainly 

as a result of newly insured individuals and those who 

would switch from employment-based coverage to nongroup coverage.

Moving from the current system—in which the tax exclusion creates a bigger tax subsidy for larger health insurance expenditures—to a fixed deduction independent of 

the comprehensiveness of a health plan would cause people to buy plans with less generous benefits, on average. 

CBO estimates that the extent of that benefit reduction—combining both the effects of people purchasing 

employment-based plans with less generous benefits and 

a shift in coverage toward the nongroup market (where 

coverage is typically less generous)—would amount to 

roughly 15 percent in 2010.

7. For a discussion of different ways to measure the uninsured, see 

Congressional Budget Office, How Many People Lack Health 

Insurance and for How Long? (May 2003).

8. Under current law, self-employed people can take an income tax 

deduction for health insurance premiums even though they often 

purchase insurance through the traditional nongroup market.
APPENDIX

D

The Models Used to Analyze the 

Supply-Side Macroeconomic Effects of the 

President’s Budgetary Proposals

The Congressional Budget Office (CBO) used three 

models to estimate the supply-side effects of the President’s budgetary proposals from 2008 to 2017: a “textbook” growth model, a life-cycle growth model, and an 

infinite-horizon growth model. (Estimates generated by 

those models are presented in Chapter 2.) 

The Textbook Growth Model

The textbook growth model is an enhanced version of 

a model developed by Robert Solow, a pioneer in the 

theory of growth accounting.1

 The textbook growth 

model incorporates the assumption that economic output 

is determined by the number of hours of labor supplied 

by workers, the size and composition of the capital stock 

(for example, factories and information systems), and 

total factor productivity—which represents the state of 

technological know-how. The model is not forwardlooking; the people that it represents base their decisions 

about working and saving entirely on current economic 

conditions. In particular, they do not respond to expected 

future changes in government policy. Nor does the model 

incorporate effects from demand-side variations in the 

economy. Rather, it assumes that output is always at its 

potential (or sustainable) level. 

The estimates that CBO developed using the textbook 

growth model incorporate the effects that changes in 

marginal tax rates on labor income specified in the 

President’s proposals would have on the number of 

hours worked. (CBO calculated those tax-rate effects 

separately.) Changes in marginal tax rates on capital, 

however, have no direct effect on private-sector saving in 

the model.

The President’s budgetary proposals would increase 

federal deficits over the 10-year budget window, but as 

described in Chapter 2, almost half of the increase in the 

deficit would result from two proposals that, in CBO’s 

judgment, would have little effect on national saving 

(that is, private saving minus the government deficit). 

Nevertheless, under the assumptions of the textbook 

growth model, all of the President’s proposals, taken 

together, would modestly reduce national saving relative 

to its level in CBO’s baseline and would thus tend to 

crowd out investment. 

In deriving those effects on saving and investment, the 

textbook growth model makes specific assumptions about 

how changes in deficits affect national saving and about 

how changes in national saving affect investment. In the 

model, the negative effects of deficits are partially offset 

by an increase in private saving. That increase could 

result from a number of possible responses by households, including a response to higher interest rates or 

anticipation of potential future tax increases associated 

with the larger budget deficits under the President’s 

proposals. In addition, the effect of a decline in national 

saving on the capital stock could be offset by increased 

borrowing from abroad. However, those capital inflows 

would require payments of interest and profits to foreigners. As a result, the net effect on the total income of U.S. 

residents of the increase in the capital stock and the 

increase in borrowing from abroad would be small.

The textbook growth model accounts for those tendencies by including two assumptions, each based on past 

1. For a detailed description of the textbook growth model, see 

Congressional Budget Office, CBO’s Method for Estimating Potential Output: An Update (August 2001).
64 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

relationships. First, the model assumes that every dollar 

of deficit leads people to increase their private saving by 

40 cents and thus reduces national saving by only 

60 cents. Second, the model assumes that every decline of 

$1 in the level of national saving leads to a 40 cent 

increase in the amount of foreign capital invested in the 

United States. Together, those assumptions imply that a 

$1 increase in the budget deficit results in a 40 cent 

increase in private saving, a 24 cent increase in capital 

inflows (24 cents equals 60 cents times 0.4), and a 

36 cent decline in domestic investment.

The Life-Cycle and Infinite-Horizon 

Growth Models

The other models that CBO used in its supply-side 

analysis—the life-cycle and infinite-horizon growth 

models—are similar to the textbook growth model in 

ignoring demand-side effects but differ from it in several 

other fundamental ways.2 The life-cycle and infinitehorizon models assume that people decide how much to 

work and save in order to make themselves as well off as 

possible over their lifetime. Their behavior is calibrated so 

that such macroeconomic variables as the total amount of 

labor supplied and the size of the capital stock (relative to 

output) match the levels of those variables in the U.S. 

economy. In the life-cycle and infinite-horizon models, 

people’s spending changes by a relatively large amount in 

response to changes in the after-tax rate of return on their 

saving.

The life-cycle and infinite-horizon models are designed to 

take into account the fact that people make decisions on 

the basis not only of information about the present but 

also of their expectations about future developments. In 

any given year, the President’s proposals can affect government spending and revenues over the 10-year projection period, and any deficits or surpluses that accumulate 

over that period can affect budgetary decisions in later 

years. People’s expectations about those future developments—correct or not—can affect their behavior long 

before the developments materialize. Analysts disagree, 

however, on the extent to which expectations influence 

people’s economic decisions, the time horizon over which 

people plan, or the future policy shifts they actually 

expect. CBO therefore analyzed the President’s proposals 

using a wide range of assumptions about the extent of 

people’s foresight and the expectations they might have 

about future policies. That approach yields a range of 

plausible estimates about how those proposals could 

affect economic growth.

The households in the life-cycle and infinite-horizon 

models are assumed to have “rational” or “modelconsistent” expectations—that is, they are forwardlooking, have information about future developments, 

and alter their behavior accordingly. They are assumed to 

have foresight about future developments of the economy 

as a whole and about future policies—the other end of 

the range of possibilities from the assumption of no foresight used in the textbook growth model. Most people’s 

foresight actually falls somewhere between those two 

extremes, but in using those two somewhat dramatic 

assumptions, CBO has tried to encompass as broad a 

range of possible responses to the President’s budgetary 

proposals as is feasible. 

Although households in the life-cycle and infinitehorizon models are fully knowledgeable about broad 

future developments, they face unforeseeable fluctuations 

in income against which they cannot buy insurance. 

Faced with those income uncertainties, households hold 

some additional, “precautionary” savings to buffer against 

potential drops in income. Because that saving motive is 

not affected as strongly by changes in tax rates as some 

other motives are, simulated households’ saving behavior 

may not respond as strongly to policy changes as it would 

in models that do not include the precautionary motive. 

That, in turn, may make the model’s simulations somewhat more realistic than simulations from models whose 

households are assumed to have perfect information 

about their future income.

Because people’s behavior as represented in the life-cycle 

and infinite-horizon models depends in part on future 

policies, the use of those models requires analysts to make 

assumptions about budgetary policies beyond 2017 (the 

end of the period covered by CBO’s current 10-year baseline projections). Policies that increase deficits during the 

projection period would yield greater debt payments, 

2. For a detailed description of the life-cycle model, see Shinichi 

Nishiyama, Analyzing Tax Policy Changes Using a Stochastic OLG 

Model with Heterogeneous Households, Congressional Budget 

Office Technical Paper 2003-12 (December 2003), available at 

www.cbo.gov/publications/bydoctype.cfm?dtype=8. For a description of a model very similar to the infinite-horizon model, see 

S. Rao Aiyagari, “Uninsured Idiosyncratic Risk and Aggregate 

Saving,” Quarterly Journal of Economics, vol. 109, no. 3 (August 

1994).
APPENDIX D THE MODELS USED TO ANALYZE THE SUPPLY-SIDE MACROECONOMIC EFFECTS OF THE PRESIDENT’S BUDGETARY PROPOSALS 65

requiring higher taxes or lower spending than would have 

been the case under CBO’s baseline assumptions. Policies 

that reduce deficits would require the opposite.

Assumptions about how and when to finance the 

increased deficits can influence the estimated economic 

effects of the President’s proposed policies over the 2008–

2017 period. That impact stems from the fact that in the 

models, people anticipate the offsetting policies and plan 

accordingly. In its analysis, CBO used two different 

assumptions about how the budget would be stabilized 

after 2017: Either marginal tax rates would be adjusted, 

or government spending would be adjusted. (Spending 

adjustments are assumed to be spread roughly equally 

across government purchases of goods and services—

which the models assume do not substitute for private 

spending—and transfer payments.) In either case, those 

adjustments are assumed to be phased in over 10 years, 

from 2017 to 2026.

The life-cycle and infinite-horizon models differ in what 

they assume about how far ahead people look in making 

their plans. The life-cycle model is calibrated so that the 

probability of death at a given age matches current U.S. 

mortality rates, and people are assumed to take account 

of the impact of future economic or policy changes only 

for themselves and not for their children. In the infinitehorizon model, people behave as though they expect to 

live forever—behavior that is effectively equivalent to acting as though the well-being of their descendants is also 

important to them. Although the possibility that such an 

assumption reflects actual behavior cannot be ruled out, 

there is some evidence against it.3

The difference in the models’ time horizons has an 

important effect on the resulting estimates. Although 

people in both models anticipate future changes in policy 

under the President’s budgetary proposals, older generations in the life-cycle model know that they may retire or 

die before policy changes occur. Consequently, anticipation of future policy changes tends to have a smaller effect 

on people’s current behavior in the life-cycle model than 

in the infinite-horizon model. 

Another characteristic that affects the models’ estimates is 

the degree to which the domestic economy is open to the 

flow of foreign capital. That characteristic is important 

because it determines both how easily domestic investment can be financed by sources other than domestic saving and the degree to which budgetary policies can affect 

wage and interest rates. CBO used two different assumptions in the life-cycle model about how open the economy is to flows of capital to and from other countries. 

One assumption is that the economy is completely 

closed—no capital can flow into or out of the United 

States. The other assumption is that the economy is completely open and cannot affect world interest rates—in 

the models, capital flows freely into and out of the country to keep the domestic interest rate equal to a constant 

world rate. The U.S. economy effectively operates somewhere between those two extremes because even though 

it is relatively open to investment, it is so large that it can 

influence world interest rates. By using two different 

assumptions, CBO obtained a range of results that 

bounds the likely effect of the modeled policy changes. 

3. See Paul Evans, “Consumers Are Not Ricardian: Evidence from 

Nineteen Countries,” Economic Inquiry, vol. 31, no. 4 (October 

1993), pp. 534-548; Fumio Hayashi, Joseph Altonji, and Laurence Kotlikoff, “Risk Sharing Between and Within Families,” 

Econometrica, vol. 64, no. 2 (March 1996), pp. 261–294; and 

T.D. Stanley, “New Wine in Old Bottles: A Meta-Analysis of 

Ricardian Equivalence,” Southern Economic Journal, vol. 64, no. 3 

(January 1998), pp. 713–727.

APPENDIX

E

Contributors to the Revenue Revenue

and Spending Projections

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

Revenue Projections

Mark Booth Individual income taxes

Paul Burnham Retirement income

Barbara Edwards Social insurance taxes, Federal Reserve System earnings

Seth Giertz Health and education taxation

Pamela Greene Corporate income taxes, estate and gift taxes, excise taxes

Ed Harris Individual income taxes

Andrew Langan Excise taxes

Larry Ozanne Capital gains realizations

Kevin Perese Tax modeling, health insurance

Kristy Piccinini State and local taxes, tax-exempt bonds

William Randolph International and corporate income taxes

Emily Schlect Customs duties, miscellaneous receipts

Kurt Seibert Earned income tax credit, depreciation

David Weiner Individual income taxes

Spending Projections

Defense, International Affairs, and Veterans’ Affairs

Sarah Jennings Unit Chief

Kent Christensen Defense

Sunita D’Monte International affairs (conduct of foreign affairs and informationexchange activities), veterans’ housing

Raymond Hall Defense (research and development, stockpile sales, atomic energy)

David Newman Defense (military construction and family housing, military activities in 

Iraq and Afghanistan and the war on terrorism)
68 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2008

Sam Papenfuss International affairs (development, security, international financial 

institutions)

Michelle Patterson Veterans’ health care, military health care

Matthew Schmit Defense (military personnel, military activities in Iraq and Afghanistan 

and the war on terrorism)

Mike Waters Military retirement, veterans’ education

Jason Wheelock Defense (other programs, operations and maintenance, radiation 

exposure compensation, energy employees’ occupational illness 

compensation)

Dwayne Wright Veterans’ compensation and pensions

Health

Tom Bradley Unit Chief

Julia Christensen Federal Employees Health Benefits program, Public Health Service

Jeanne De Sa Medicaid, State Children’s Health Insurance Program

Sarah Evans Medicare, Public Health Service

Geoffrey Gerhardt Medicare

Tim Gronniger Medicare, Public Health Service

Eric Rollins Medicaid, State Children’s Health Insurance Program, Medicare

Shinobu Suzuki Medicare

Camile Williams Medicare, Public Health Service

Human Resources

Paul Cullinan Unit Chief

Christina Hawley Anthony Unemployment insurance, training programs, Administration on Aging, 

Smithsonian, arts and humanities, report coordinator

Chad Chirico Housing assistance, education

Sheila Dacey Old-Age and Survivors Insurance, Social Security trust funds

Kathleen FitzGerald Food Stamps and nutrition programs

Justin Humphrey Elementary and secondary education, Pell grants, student loans

Deborah Kalcevic Student loans, higher education

Matthew Kapuscinski Low Income Home Energy Assistance Program, refugee assistance

Craig Meklir Federal civilian retirement, Pension Benefit Guaranty Corporation, 

Railroad Retirement

Jonathan Morancy Child Support Enforcement, Temporary Assistance for Needy 

Families, foster care, Social Services Block Grant program, child 

care programs, child and family services

David Rafferty Disability Insurance, Supplemental Security Income

Defense, International Affairs, and Veterans’ Affairs (Continued)
APPENDIX E CONTRIBUTORS TO THE REVENUE AND SPENDING PROJECTIONS 69

Natural and Physical Resources

Kim Cawley Unit Chief

Megan Carroll Energy, conservation and land management, air transportation

Mark Grabowicz Justice, Postal Service

Kathleen Gramp Spectrum auction receipts, energy, deposit insurance, Outer Continental 

Shelf receipts

Greg Hitz Agriculture

Daniel Hoople Science and space exploration, Bureau of Indian Affairs, justice, 

community and regional development

David Hull Agriculture

James Langley Agriculture

Susanne Mehlman Pollution control and abatement, Federal Housing Administration 

and other housing credit programs

Julie Middleton Water resources, Federal Emergency Management Agency, other natural 

resources

Matthew Pickford General government, highways, Amtrak, mass transit

Deborah Reis Recreation, water transportation, legislative branch, conservation and 

land management

Susan Willie Commerce, Small Business Administration, Universal Service Fund

Other

Janet Airis Unit Chief, Scorekeeping; legislative branch appropriation bill

Jeffrey Holland Unit Chief, Projections

Edward Blau Authorization bills

Barry Blom Federal pay, monthly Treasury data, report coordinator

Joanna Capps Appropriation bills (Interior and the environment, 

Labor–Health and Human Services)

Kenneth Farris Computer support

Mary Froehlich Computer support

Ann Futrell Other interest, report coordinator

Virginia Myers Appropriation bills (Commerce–Justice, financial services, 

general government)

Jennifer Reynolds Appropriation bills (Agriculture, foreign relations)

Mark Sanford Appropriation bills (Defense, Homeland Security)

Eric Schatten Interest on the public debt, report coordinator

Luis Serna National income and product accounts, report coordinator

Phan Siris Computer support

Esther Steinbock Appropriation bills (Transportation–Housing and Urban Development, 

military construction and veterans’ affairs, energy and water)

Patrice Watson Database system administrator