An Ana lysis of the

President's Budgetary Proposals

for Fiscal Year 1985

FEBRUARY 1984

Prepared at the Request of the Senate Committee on Appropriations

CONGRESS OF THE UNITED STATES CONGRESSIONAL BUDGET OFFICE
AN ANALYSIS OF

THE PRESIDENTS BUDGETARY PROPOSALS

FOR FISCAL YEAR 1985

The United States Congress

Congressional Budget Office
NOTES

Unless otherwise noted, all years referred to in

this report are fiscal years.

Details in the text, tables, and figures of this

report may not add to the totals because of rounding.
ANALYSIS OF THE PRESIDENT'S

BUDGETARY PROPOSAL FOR FISCAL YEAR 1985

Errata

On page 32, the last paragraph should begin as follows:

As part of its "women's initiative," the Administration proposes to

raise to $4,000 the current annual $2,250 limit on the tax-deferred

contributions to individual retirement accounts (IRA) for one-earner

couples. Under current law, an individual taxpayer may contribute to an

IRA the lesser of $2,000 or his or her yearly income. For a one-earner

couple the $2,000 limit rises to $2,250. By comparison, a two-earner couple,

each with an IRA, can contribute up to $4,000. The Administration would

raise the one earner-couple's limit to $4,000. Justifying ....

On page 33, the first sentence in the second paragraph should read:

The Administration proposes that up to 75 small, economically

distressed geographic areas be designated "enterprise zones."

PREFACE

This analysis of the President's budget for fiscal year 1985 was

prepared at the request of the Senate Committee on Appropriations. The

report discusses the President's policy proposals in terms of changes from

the Congressional Budget Office (CBO) baseline budget projections for 1985- 1989. It includes estimates of the budgetary impact of the Administration's

proposals using CBO's economic assumptions and technical estimating

methods.

This report was prepared by the staff of the Budget Analysis, Fiscal

Analysis, and Tax Analysis Divisions under the supervision of James L. Blum, William J. Beeman, and Rosemary D. Marcuss, respectively. Paul Van de

Water was responsible for Chapter I; Stephen H. Zeller for Chapter II;

Rosemary Marcuss for Chapter III; Edward A. Swoboda for Chapter IV; and

Charles E. Seagrave and Robert A. Sunshine for Chapter V. Principal

contributors are listed in Appendix B.

Robert L. Faherty supervised the editing and production of the

report, assisted by Nancy H. Brooks. Major portions were edited by Patricia

H. Johnston, Francis Pierce, and Johanna Zacharias. Thelma L. Jones

coordinated the production of the report. The final manuscript was

prepared for publication by Barbara Bakari, Linda Brockman, Cindy

Cleveland, Gwen Coleman, Mechita O. Crawford, Shirley Hornbuckle, Betty

Jarrells, Theresa D. Kirkland, and Nina Tuaau-glaude.

Rudolph G. Penner

Director

February 1984

111

CONTENTS

PREFACE iii

CHAPTER I. SUMMARY AND INTRODUCTION 1

CBO Baseline Budget Projections 3

The Administration's Budget Program 4

CBO Budget Estimates 7

CHAPTER II. THE ADMINISTRATION'S

ECONOMIC ASSUMPTIONS 13

The Short-Term Outlook 13

The Long-Run Economic

Assumptions for 1986-1989 15

Consequences of Large Deficits 19

CHAPTER III. THE ADMINISTRATION'S REVENUE

PROPOSALS AND ESTIMATES 23

The President's Revenue Proposals 2^

Tax Employer-Provided Health

Insurance Premiums 25

Increase Federal Employees' Contributions Toward

Retirement 28

Cover Railroad Employees Under

Unemployment Insurance 28

Restrict Leasing by Tax- Exempt Entities 28

Limit Use of Private-Purpose

Tax-Exempt Bonds 29

Restrict Tax Shelter, Accounting

and Corporate Tax Abuse 29

Establish Petroleum Overcharge

Restitution Fund 30

Revise Life Insurance

Company Taxes 30

Establish Education

Savings Accounts 31
CONTENTS (continued)

Institute a Tuition Tax Credit ............ 32

Increase Individual Retirement Account

Limit for One-Earner Couples .......... 32

Revise the Dependent-Care

Tax Credit ........................ 33

Establish Enterprise Zones .............. 33

Extend the Targeted Jobs Tax Credit ....... 33

Modify Research and Development

Tax Provisions ..... ................ 34

Institute Trusts for

Investment in Mortgages .............. 34

Differences in Administration and

CBO Revenue Estimates .................. 35

Economic Assumptions ................. 36

Technical Reestimates ................. 39

CHAPTER IV. THE ADMINISTRATION'S

DEFENSE BUDGET ....................... 41

Defense Funding Levels .................... 41

Comparison with CBO

Defense Baseline Projections ........... 45

Composition of the Administration's Defense Plan .................. 46

Possible Underpricing for Inflation ......... 48

Potential Reductions .................. 52

Growth in Defense Appropriation

Request for 1985 ....................... 56

Procurement Plans .................... 56

Research and Development (R&D) ......... 64

Operations and Maintenance ............. 65

Military Personnel .................... 66

Other Accounts ...................... 66

Changes from the 1984-1988 Defense

Plan for Fiscal Year 1985 ................. 67

Program Decreases .................... 67

Program Increases .................... 76

VI
CONTENTS (continued)

CHAPTER V. THE ADMINISTRATION'S NONDEFENSE

SPENDING PROPOSALS 77

Entitlements and Other

Mandatory Spending SI

Federal Retirement

and Disability 82

Medicare and Medicaid 84

Major Means-Tested

Transfer Programs 85

Farm Price Supports 86

Other Proposed Changes 87

Nondefense Discretionary Spending 90

Aid to Foreign Governments and

International Organizations 91

Benefits and Services to Individuals 95

Transportation, Natural Resources,

and Other Infrastructure 98

Assistance to Business

and Commerce 100

Other Discretionary Spending 102

Offsetting Receipts 104

Off-Budget Spending 105

APPENDIX A. CBO OUTLAY REESTIMATES Ill

APPENDIX B. MA3OR CONTRIBUTORS TO THE

PREPARATION OF THIS REPORT 121

VII

FIGURES

FIGURE I- 1.

FIGURE 1-2.

FIGURE 1-3.

FIGURE 1-4.

FIGURE II- 1.

FIGURE II-2.

FIGURE IV- i.

FIGURE IV-2.

FIGURE IV-3.

FEDERAL BUDGET DEFICIT

FEDERAL DEFICIT AS A

PERCENTAGE OF GNP

THE ADMINISTRATION'S

SPENDING PROGRAMS

FEDERAL BUDGET OUTLAYS UNDER

THE ADMINISTRATION'S PROGRAM

PROJECTIONS OF THREE-MONTH

TREASURY BILL RATES

FEDERAL DEBT HELD BY THE PUBLIC

AS A PERCENTAGE OF GNP

BUDGET AUTHORITY FOR

NATIONAL DEFENSE

NATIONAL DEFENSE OUTLAYS

AS A PERCENTAGE OF GNP

COMPOSITION OF NATIONAL

DEFENSE OUTLAYS

... 1

... 3

8

. . . 11

... 18

20

42

43

54

CHAPTER I. SUMMARY AND INTRODUCTION

The Congressional Budget Office (CBO) estimates that the budget def- icit under Administration policies would grow from $186 billion in 1984 to

$192 billion in 1985 and $248 billion by 1989 (see Figure 1-1). These esti- mates are higher than those of the Administration primarily because CBO

assumes no decline in inflation-adjusted (real) interest rates. Administra- tion spokesman have stated that the drop in interest rates assumed in the

budget is not likely to be achieved without the enactment of deficit reduc- tions above and beyond those the Administration has proposed. Chapter II

discusses the economic assumptions of both the Administration and CBO.

CBO projects that, under current spending and taxing policies, the

federal budget deficit would grow from $189 billion in 1984 to $197 billion in

1985 and $308 billion by 1989. As a percent of gross national product (GNP), the baseline deficit would decline from 5.3 percent in 1984 to 5.0 percent in

Figure 1-1.

Federal Budget Deficit

350

300

250

I 200

150

100

50

Vtfft CBO Baseline Projections

l'-:'-:'-:'-:'^ Administration Estimates

308

i ^

L J CBO Reestimates 272

245

197 192

180

I1!

Ji3

233

180

241

152

248

123

1985 1986 1987

Fiscal Years

1988 1989
TABLE 1-1. THE BUDGET OUTLOOK (By fiscal year)

CBO Baseline a/

Revenues

Outlays

Deficit

Administration's Program

as Estimated by CBO

Revenues

Outlays

Deficit

CBO Baseline a/

Revenues

Outlays

Deficit

Administration's Program

as Estimated by CBO

Revenues

Outlays

Deficit

Memorandum:

Gross National Product

(In billions of dollars)

SOURCE: Congressional

1984 1985 1986

In Billions of Dollars

663 733 795

852 930 1,012

189 197 217

665 741 807

851 933 1,018

186 192 211

As a Percent of GNP

18.6 18.7 18.7

23.9 23.8 23.8

5.3 5.0 5.1

18.7 19.0 19.0

23.9 23.9 24.0

5.2 4.9 5.0

3,563 3,910 4,251

Budget Office.

1987

863

1,109

245

878

1,111

233

18.7

24.0

5.3

19.0

24.1

5.1

4,612

1988

945

1,217

272

964

1,204

241

19.0

24.4

5.5

19.3

24.1

4.8

4,987

1989

1,016

1,323

308

1,039

1,287

248

18.9

24.6

5.7

19.3

23.9

4.6

5,379

a. The CBO baseline figures are preliminary revisions of those appearing in

Congressional Budget Office, Baseline Budget Projections for Fiscal

Years 1985-1989 (February 1984).
Figure 1-2.

Federal Deficit as a Percentage of GNP

Actual j Projected

I

I I I I

1965 1970 1975

Fiscal Years 1980

I

CBO Baseline -

CBO Estimate of

Administration

Program

1985 1989

1985 but rise thereafter, reaching 5.7 percent by 1989. The Administration's

budgetary policies would hold the deficit-GNP ratio at about 5 percent of

GNP in the 1985-1987 period and reduce it to 4.6 percent of GNP by 1989

(see Table 1-1 and Figure 1-2).

CBO BASELINE BUDGET PROJECTIONS

CBO's baseline budget projections, which are preliminary revisions of

those published earlier this month, assume no changes in current laws gov- erning taxes or entitlement spending. For nondefense spending that is dis- cretionary and subject to annual appropriation, the CBO baseline projections

generally assume that the 1984 appropriations level will be maintained, with

future increases to keep pace with inflation. The projections for defense

spending are calculated on a different basis than nondefense programs. The

baseline projections for defense not only allow for increases to keep pace

with inflation but also provide for roughly 5 percent annual real increases in

defense budget authority, as assumed in the Congressional budget resolution

adopted in June 1983.
The revisions to the CBO baseline involve only spending and affect

primarily the last three years of the projections. The current baseline defi- cit estimates of $245 billion in 1987, $272 billion in 1988, and $308 billion in

1989 are $3 billion, $10 billion, and $18 billion lower, respectively, than the

figures published in CBO's baseline budget projections report. l_/The changes

reflect additional technical information gleaned from the Administration

budget, which was not available when the previous projections were pre- pared, as well as a reduction in the estimated rate of inflation in the de- fense sector of the economy. The revision in the defense inflators, along

with its effect on debt-service costs, accounts for the bulk of the changes— $2 billion in 1987, $5 billion in 1988, and $12 billion in 1989.

THE ADMINISTRATION'S BUDGET PROGRAM

The Administration's 1985 budget reflects the same priorities as its

1984 budget request, although the size of the proposed policy changes has

been scaled back. Substantially smaller tax increases are requested than

last year, primarily because the Administration is no longer proposing a

contingent tax increase in 1986 and thereafter. The Administration's de- fense program is somewhat smaller than that proposed a year ago, although

the requested funding levels are still much greater than approved in the

latest Congressional budget resolution, which CBO uses as its defense base- line. No new proposals are made for the Social Security and railroad retire- ment programs, which were subject to major changes last year. Finally, the

Administration is no longer requesting or has reduced in size a number of

cuts in entitlements and nondefense discretionary spending that it has

sought unsuccessfully in the past.

The major elements of the Administration's budget program are listed

in Table 1-2. CBO estimates that, over the next five years, the Administra- tion's program would reduce the cumulative deficit by $115 billion. Most of

this reduction occurs in 1988 and 1989 under CBO's projections. For the

next three years, which will be the period covered by the next Congressional

budget resolution, the Administration's proposals would reduce projected

deficits by only $24 billion compared with the CBO baseline. Also note- worthy is the extent to which the Administration's deficit-reduction mea- sures focus on health expenditures. About $60 billion of the cumulative

five-year savings would be achieved through the taxation of certain private

health insurance premiums, increased premium charges for Supplementary

Medical Insurance, and reduced spending for Medicare and Medicaid.

1. Congressional Budget Office, Baseline Budget Projections for Fiscal

Years 1985-1989 (February 1984).
TABLE 1-2. THE ADMINISTRATION'S DEFICIT-REDUCTION

PROGRAM AS ESTIMATED BY CBO

(By fiscal year, in billions of dollars)

1985

CBO Baseline Deficit

Proposed Changes

Revenues a/

Taxation of health

insurance premiums

Other tax increases

Tax reductions

Subtotal

Outlays

National defense

Entitlements and other

mandatory spending

Nondefense discretionary

spending

Offsetting receipts

Net interest

Subtotal

Total Policy Changes

President's Budget

as Estimated by CBO

197

-4

-6

2

-8

10

-4

-2

*

-1

3

-5

192

1986

217

-6

-10

4

-12

21

-6

-5

_ i

-2

7

-5

211

1987

245

-8

-12

5

-15

23

-9

-7

-2

-3

2

-13

233

1988

272

-10

-14

5

-18

20

-12

-12

-4

-5

-13

-32

241

Cumulative

Five- Year

1989 Total

308

-12

-17

5

-24

11

-15

-17

-6

-10

-36

-60

248

1,239

-40

-59

22

-77

85

-46

-44

-13

-20

-38

-115

1,124

SOURCE: Congressional Budget Office.

a. Revenue increases are shown with minus signs because they reduce the

deficit; revenue decreases, which are displayed with no sign, increase

the deficit.
Tax changes proposed by the Administration would increase revenues

by $77 billion over the 1985-1989 period. The Administration's revenue pro- posals contain both tax increases and tax deductions. The largest revenue- raising item—a proposal to impose income and Social Security taxes on em- ployer-paid health insurance premiums in excess of certain thresholds — is a

repeat from last year's budget. Further tax increase proposals include re- strictions on tax-exempt leasing and industrial development bonds, curtail- ment of certain tax shelters, higher federal employee contributions for civil

service retirement, and establishment of a petroleum overcharge restitution

fund. New to the Administration budget is a women's initiative, which

would expand individual retirement accounts for one-earner couples and re- structure the dependent care tax credit. In addition, the Administration has

resubmitted proposals for private-school tuition tax credits and enterprise

zone tax incentives. Revenue proposals and estimates are detailed in

Chapter III.

Proposed outlay changes would reduce spending by $38 billion over the

1985-1989 period. This reduction is the net effect of $85 billion in defense

spending increases, $103 billion in cuts in nondefense spending programs, and a $20 billion reduction in net interest costs resulting from the tax in- creases and other spending changes. The proposed reductions in nonde- fense spending consist of:

o $46 billion in reductions in entitlement programs. The largest re- duction is a proposal to freeze target prices in the farm price- support program. Cost-of-living increases for federal retirees

would be delayed. Medicare proposals include freezing physicians' fees for one year and indexing the deductible. Reductions are also

proposed for various means-tested programs, including Medicaid, Aid to Families with Dependent Children (AFDC), and Food

Stamps.

billion in lower nondefense discretionary spending. While in- creases are provided for a few programs, such as assistance to

Central American countries, a manned space station, and some law

enforcement activities, all major elements of this category are

held below baseline levels.

o $13 billion in increased offsetting receipts. This reflects higher

premium charges for Supplementary Medical Insurance (Part B of

Medicare) and a number of new user fees.

In 1985, 1986, and 1987 the proposed defense spending increases exceed the

proposed cuts in nondefense programs. Only by 1988 and 1989 would the

Administration's program reduce spending below the CBO baseline. The
Administration's spending program thus represents more a reordering of

spending priorities than it does a major reduction in spending, as illustrated

in Figure 1-3. The Administration's defense and nondefense spending pro- posals are considered in more detail in Chapters IV and V.

The composition of spending under the Administration's budgetary pro- gram is set out in Table 1-3 and Figure 1-4. Total outlays would increase

from $851 billion in 1984 to $1,287 billion by 1989. Of the $436 billion

increase, $185 billion would be devoted to national defense programs, which

would grow from 6.6 percent to 7.8 percent of GNP. Because of continuing

large deficits, net interest costs would take an additional $98 billion and

would rise from 3.0 percent to 3.8 percent of GNP. Nondefense spending

programs—the remainder of the budget—would grow by $153 billion but

would shrink from 14.3 percent of GNP in 1984 to 12.3 percent of GNP by

1989. Of the increase in nondefense spending, $114 billion—or 75 percent- is in just two programs, Social Security and Medicare.

CBO BUDGET ESTIMATES

CBO's estimates of the budgetary picture under the Administration's

program are much less optimistic than the Administration's own estimates. While the Administration projects that the deficit will fall from $184 billion

in 1984 to $123 billion in 1989, CBO estimates that it will grow to $248

billion. The bulk of this difference results from different long-run economic

assumptions, primarily with respect to interest rates. The remainder is the

result of technical estimating factors.

Differences in economic assumptions cause the CBO estimate of the

budget deficit to exceed the Administration estimate by $3 billion in 1984, $8 billion in 1985, and $95 billion by 1989 (see Table 1-4). Higher CBO

interest-rate assumptions and the effect of economic differences on debt- service costs account for $1 billion of the difference in deficit estimates in

1984, $7 billion in 1985, and $75 billion in 1989. The remaining economic

differences in outlay estimates amount to $1 billion or less in 1984, 1985, and 1986. In later years higher CBO inflation and unemployment assump- tions also raise CBO's outlay and deficit estimates. Economic reestimates

of Administration revenues add to the deficit by amounts ranging from

$1 billion in 1984 to $7 billion in 1989. These differences result from lower

CBO assumptions for corporate profits and corporate income taxes, offset

only partly by higher estimates of other revenues.

Technical differences between CBO and the Administration affect the

deficit estimates by only $1 billion in 1984 and $3 billion in 1985. After

1985, however, CBO's technical assumptions add substantially to the deficit

30-778 0-84- 2
Figure 1-3.

The Administration's Spending Programs

National Defense Programs

440

400

:360

1320

280

240

CBO Estimate of

Administration Program ^«

\ ^~~~

CBO Baseline

No Real Growth

1986

7201—

1985 1987 1988 1989

Nondefense Spending Programs1

680

c640

leoo

560

CBO Baseline

CBO Estimate of

Administration Program

520-

1985 1986 1987

Fiscal Years

1988 1989

Excludes net interest.
TABLE 1-3. CBO ESTIMATES OF ADMINISTRATION SPENDING

PROGRAM BY MA3OR CATEGORIES (By fiscal year)

1984 1985

In Billions of

National Defense

Entitlements and Other

Mandatory Spending

Nondefense Discretionary

Spending

Net Interest

Offsetting Receipts

Total Budget Outlays

Off-Budget Spending

Total Outlays

National Defense

Entitlements and Other

Mandatory Spending

Nondefense Discretionary

Spending

Net Interest

Offsetting Receipts

Total Budget Outlays

Off -Budget Spending

Total Outlays

235

396

157

109

-46

851

15

866

As a

6.6

11.1

4.4

3.0

-1.3

23.9

0.4

24.3

273

423

162

125

-49

933

14

947

Percent

7.0

10.8

4.1

3.2

-1.3

23.9

0.4

24.2

1986

Dollars

315

449

166

143

-54

1,018

9

1,028

of GNP

7.4

10.6

3.9

3.4

-1.3

24.0

0.2

24.2

1987

352

479

174

164

-58

1,111

8

1,119

7.6

10.4

3.8

3.6

-1.3

24.1

0.2

24.3

1988

387

514

179

188

-64

1,204

8

1,212

7.8

10.3

3.6

3.8

-1.3

24.1

0.2

24.3

1989

419

549

183

207

-71

1,287

6

1,293

7.8

10.2

3.4

3.8

-1.3

23.9

0.1

24.0

SOURCE: Congressional Budget Office.
TABLE 1-1. CBO AND ADIV

THE ADMINIST

(By fiscal year,

1

Revenues

Administration Estimate

CBO Estimate

Outlays

Administration Estimate

CBO Estimate

Deficit

Administration Estimate

CBO Estimate

Dif

Revenues

Economic

Technical

Total

Outlays

Economic

Technical

Total

Deficit

Economic

Technical

Total

SOURCES: Congressional

Budget.

INISTRATION ESTIMATES OF

RATION'S BUDGET PROGRAM

in billions of dollars)

>84 1985 1986

J70

i65

554

551

184

186

745 815

741 807

925 992 1

933 1,012 1

180 177

192 211

1987

888

878

,068

,111

180

233

1988

978 1

964 1

1,130 1

1,204 1

152

241

1989

,060

,039

,184

,287

123

248

Eerences in Projections

-1

-4

-5

2

-5

-3

3

-1

2

Budget

-1 -2 -3 -6 -4 -8

8 17

* 9

8 26

8 19

3 15

12 34

Office; Office

10

-3

-6

-10

32

11

43

35

17

53

-6

-9

-15

59

15

74

65

24

89

of Management

-7

-13

-21

87

16

103

95

30

124

and
Figure 1-4.

Federal Budget Outlays Under the Administration's Program

National Defense

Nondefense N>oc

£ £ ? I

1970 1975 1980 1985 1989

Fiscal Years

estimates—$15 billion in 1986 and $30 billion by 1989. On the outlay side, the largest technical differences relate to defense spending and to receipts

from oil and gas production activities on the Outer Continental Shelf (OCS). CBO believes that the Administration has underestimated the rate at which

requested increases in defense budget authority will show up in outlays. Higher CBO defense spending rates, particularly for procurement, increase

estimated outlays by $5 billion in 1986 and $10 billion in 1989. CBO also

concludes that the Administration has overestimated OCS receipts by an

average of $* billion per year in the 1986-1989 period. On the revenue side, most of the technical differences are in the individual income tax esti- mates—$3 billion in 1986 and $13 billion by 1989. Differences between CBO

and Administration revenue estimates are detailed in Chapter III; Appendix

A analyzes the outlay differences.

11

CHAPTER n. THE ADMINISTRATION'S ECONOMIC ASSUMPTIONS

By most measures, the performance of the economy improved marked- ly in 1983. Growth was stronger than expected, although it was still

somewhat less than that of an average postwar recovery. The unemploy- ment rate, on the other hand, fell more rapidly than is typical in recover- ies, and the continued slowing of inflation in 1983 was good news, indeed. Interest rates remained very high, however, apparently because of large

current and prospective federal deficits and the Federal Reserve's anti- inflationary monetary policy. High interest rates in turn pushed up the

value of the dollar in foreign exchange markets, with the result that the

export and import-competing sectors of the economy did not participate in

the recovery last year.

Most forecasters expect economic growth in the 4-5 percent range this

year, with inflation continuing to be moderate. This is subject to some

uncertainty, however, largely because of economic policy. Nothing was

done in 1983 to remove the potential for a conflict between fiscal and

monetary policies in the future. Efforts by the Congress and the Adminis- tration to reduce federal budget deficits accomplished very little. CBO's

projected baseline deficits for coming years remain extraordinarily high and

have changed little from those published last year.

THE SHORT-TERM OUTLOOK

The Administration's proposed changes in budget policy are incorpo- rated in its short-run forecast. CBO's reestimates of these policies, discussed in Chapter I, suggest that the changes are quite small: in 1985, outlays are $3 billion above the CBO baseline and receipts rise by $8 billion. The CBO forecast, by contrast, is based on budget policies currently in place

and assumes a lower path of real defense spending than the Administration's. The CBO forecast also assumes growth in the money aggregate, Ml, averaging 6.0 percent during 1984 and 5.5 percent during 1985. I/

In part because the differences in policy assumptions are small, the

Administration and CBO forecasts, shown in Table 1-1, are in close agree1. The Administration does not publish its assumptions of growth in the

money aggregates.

13
TABLE II-1. COMPARISON OF ADMINISTRATION AND CBO

FORECASTS

Actual Forecast

Economic Variable 1983 1984 1985

Fourth Quarter to Fourth Quarter (percent change)

Real GNP

Adminstration 6.1 4.5 4.0

CBO 6.1 4.7 3.7

GNP Implicit Price Deflator

Administration 4.1 5.0 4.7

CBO 4.1 5.3 5.1

Calendar Year Average (percent)

Civilian Unemployment Rate

Administration a/ 9.6 7.9 7.7

CBO 9.6 7.8 7.3

3-Month Treasury Bill Rate

Administration

CBO

8.6

8.6

8.5

8.9

7.7

8.6

a. CBO has adjusted the Administration's total unemployment rate to

obtain the civilian rate.

ment. Both the Administration and CBO show real growth slowing to the 4

to 454 percent range over the next two years, as is typical in the second

stage of an expansion, and a gradual further improvement in the unemploy- ment rate. Both forecasts also show a slight pickup in inflation this year, to

the range of 5.0 to 5.3 percent, as special factors holding inflation down in

1983 begin to unwind. No further rise in inflation is expected during 1985.

Finally, interest rates are projected to move down slowly from current

levels. Short-term interest rates, as measured by the three-month Treasury

bill rate, are forecast to average 7.7 percent in 1985 by the Administration,

nearly one percentage point lower than projected by CBO.

14
Despite the similarity of these forecasts, an unusual amount of

uncertainty surrounds them, particularly with respect to interest rates:

o Many private forecasters expect the competition between private

and public demands for credit to intensify as early as 1985, resulting in higher interest rates and lower real growth than in the

CBO and Administration forecasts.

o Foreign inflows of savings helped finance domestic budget deficits

last year, but there is a risk that these inflows will slow, or

reverse themselves, putting upward pressure on interest rates.

In addition, the outlook for monetary policy suggests continued high

interest rates. In his testimony before the House Committee on Banking, Finance and Urban Affairs on February 7, 1984, Federal Reserve Chairman

Volcker emphasized the importance of maintaining a strong inflation- fighting posture. He indicated that interest rates are much too high for the

long-run health of the economy. But he also indicated that, given the recent

strength of the economy, the continued stimulative impact of the federal

deficit, and the inflationary expectations of some participants in financial

markets, high interest rates are currently "appropriate." Thus interest rates

may be expected to continue high in the short run barring some unexpected

development such as a sag in the economy, a change in budget policy, or a

shift in inflationary expectations.

THE LONG-RUN ECONOMIC ASSUMPTIONS FOR 1986-1989

The Administration and CBO have prepared longer-run economic

assumptions, shown in Table II-2, for use in calculating the profile of federal

government receipts and spending in the second half of the decade. The

Administration's projection shows real growth averaging 4.0 percent for the

1986-1989 period. Inflation averages 4.1 percent over the period and the

civilian unemployment rate moves down to 5.8 percent in 1989. The

Administration takes the position, however, that the outyear projections

would not be realized with policies proposed in the budget; Martin Feldstein, Chairman of the Council of Economic Advisers (CEA) testified before the

House Budget Committee on February 6, 1984, that the Administration's

outyear economic projection assumes "that legislative action will reduce

budget deficits sharply in the years ahead." The size and composition of

these policy changes have not been defined.

The CBO long-run projections for the 1986-1989 period assume moder- ate noncyclical real GNP growth averaging 3.4 percent. Such a growth

pattern lowers the unemployment rate to about 6& percent in 1989~a level

15
TABLE II-2. COMPARISON OF CBO AND ADMINISTRATION ECONOMIC ASSUMPTIONS

(By calendar year)

1984 1985 1986 1987 1988 1989

GNP (billions of current dollars)

CBO 3651.2 3994.8 4339.0 4703.7 5083.5 5480.5

Administration 3642.4 3973.8 4319.2 4681.2 5059.0 5444.9

Difference 8.8 21.0 19.8 22.5 24.5 35.6

Real GNP (1972 dollars, percent

change, year over year)

CBO 5.4 4.1 3.5 3.5 3.4 3.3

Administration 5.3 4.1 4.0 4.0 4.0 3.9

Difference 0.1 0.0 -0.5 -0.5 -0.6 -0.6

GNP Deflator (percent change, year over year)

CBO 4.7 5.1 4.9 4.7 4.5 4.3

Administration 4.5 4.8 4.5 4.2 3.9 3.6

Difference 0.2 0.3 0.4 0.5 0.6 0.7

Consumer Price Index (percent

change, year over year) a/

CBO 4.5 5.0 4.9 4.7 4.5 4.3

Administration 4.4 4.6 4.5 4.2 3.9 3.6

Difference 0.1 0.4 0.4 0.5 0.6 0.7

Civilian Unemployment Rate

(percent, annual average)

CBO 7.8 7.3 7.0 6.8 6.6 6.5

Administration b/ 7.9 7.7 7.5 6.9 6.2 5.8

Difference -0.1 -0.4 -0.5 -0.1 0.4 0.7

3-Month Treasury Bills (percent, annual average)

CBO 8.9 8.6 8.4 8.2 8.0 7.8

Administration 8.5 7.7 7.1 6.2 5.5 5.0

Difference 0.4 0.9 1.3 2.0 2.5 2.8

Inflation-Adjusted Interest Rates c/

CBO 4.2 3.5 3.5 3.5 3.5 3.5

Administration 4.0 2.9 2.6 2.0 1.6 1.4

Difference 0.2 0.6 0.9 1.5 1.9 2.1

a. Consumer Price Index for urban wage earners and clerical workers.

b. The Administration publishes only the overall unemployment rate. The civilian adjustment

is made by CBO.

c. Defined here as the Treasury bill rate minus growth in the GNP deflator.

16
thought by many economists to be near the lowest rate that can be attained

without provoking additional inflation. This rate of growth is not a forecast

or a CBO judgment concerning appropriate growth rates. Instead, it is based

on historical growth trends—the average economic growth rate during the

seven-year period following postwar recessions—and is intended to serve

only as a benchmark for evaluating budget policy. 2/

Although the short-run forecasts are quite similar, the Administration

and CBO longer-run projections differ significantly. Both show some

gradual decrease in inflation and nominal GNP growth, in contrast to the

projections of many private forecasters. In this regard they are broadly

consistent with statements by both the Administration and the monetary

authorities calling for moderate growth and gradually declining inflation. But the tradeoff between real growth and inflation is more optimistic in the

Administration's assumptions: annual real growth rates average 0.5 percent

higher and inflation 0.6 percent lower in the 1986-1989 period. Consequent- ly, the unemployment rate drops more rapidly in the Administration's

projection.

The interest-rate assumptions, as reflected in the three-month

Treasury bill rate, are very different (see Figure II-1). Both real and

nominal rates in the Adminstration's projection fall well below those in

2. The projected growth rate from the recession trough in the fourth

quarter of 1982 to 1989 is precisely equal to the average growth rate

for seven-year periods following the trough quarter of six previous

postwar recessions (4.0 percent):

Average Annual Real GNP

Trough Quarter Growth During Seven Years

of Recession Following Trough (percent)

4.7

1954:2 3.0

1958:2 4.6

1961:1 5.0

1970:4 3.6

1975:1 3.0

Average 4 . 0

The averages for different periods do, however, vary substantially, ranging from 5 percent for the recovery beginning in 1961 to about 3

percent for the 1954 and 1975 recoveries.

17
Figure 11-1.

Projections of Three-Month Treasury Bill Rates

Nominal Rate

10

I ^

I

CBO

Administration

I I I

1983 1984 1985 1986 1987

Inflation Adjusted Rate

1988 1989

CBO

Administration

1 -

1983 1984 1985 1986

Calendar Years

1987 1988 1989

SOURCES: Congressional Budget Office, The Economic Outlook (February 1984); Budget of the

United States Government, Fiscal Year 1985.

18
CBO's. The Administration's real interest rates, defined as the short-term

Treasury bill rate less growth in the GNP deflator, average 2.0 percent

below the CBO projections in 1988 and 1989. Apparently, the difference in

interest rate projections stems partially from budget assumptions. In his

February 7 testimony before the House Banking Committee, CEA Chairman

Feldstein pointed outs "If sharp deficit reductions are not enacted, the

interest rates are not likely to fall over the next five years as we have

projected and growth of real GNP is likely to be slower than we have

assumed."

Thus both the Administration and CBO agree that without substantial

changes in fiscal policy, interest rates are likely to remain very high in the

outyears. In the face of an expansive fiscal policy, the Federal Reserve's

inflation-fighting posture may also necessitate continued upward pressure on

interest rates during the next several years.

CONSEQUENCES OF LARGE DEFICITS

Federal deficits of the magnitude shown in the Administration's budget

and in the CBO baseline projections would have major consequences both for

the economy and for future budgetary choices. Most economists agree that

federal deficits of the size projected will keep interest rates higher than

they would be otherwise. The effect would be particularly strong as the

economy approached full employment (or the limits to growth set by

monetary policy), where public and private borrowing would compete for a

relatively fixed level of saving. Even in the present situation of less than

full employment, deficits are likely to raise interest rates. A few analysts

contend that there is no historical evidence for a link between deficits and

interest rates. But one should not expect to find in historical data a simple

association between deficits and interest rates. Previous deficits experi- enced during peacetime have been much smaller than those now projected, and their impact on interest rates has often been overwhelmed by reces- sions, Federal Reserve policies, or international capital flows.

The current and prospective deficits are extremely large relative to

past history. In fiscal year 1983, the federal deficit was about 107 percent

of domestic net private saving and 34 percent of gross private saving. CBO's forecast implies that the deficits projected by the Administration, as

reestimated by CBO, would be 79 percent of net private savings and 29

percent of gross private savings during the 1984-1985 period. Fortunately, very large capital inflows from abroad have so far limited the rise in

interest rates. It should be emphasized that these capital inflows are not a

costless remedy for deficits. If the capital inflow continued for a long time, foreign claims on U.S. output (interest and dividend payments to foreigners)

could rise to such a level that they would reduce the U.S. standard of living

19
Figure 11-2.

Federal Debt Held by the Public as a Percentage of GNP

60

50

40

30

Actual

CBO Baseline -

i I I I I I I I I I I I I I I I I I I I I I

Projected

CBO Estimate of

Administration

Program

I I I I I I 1 I I

1955 1960 1965

SOURCE: Congressional Budget Office.

1970 1975

Fiscal Years

1980 1985 1989

significantly below what it would be with less government borrowing and

lower capital inflows.

High interest rates, if they persist, are likely to reduce capital

accumulation. Although the cyclical rise in demands and increased capacity

utilization rates are now providing a strong stimulus to investment, this may

eventually be offset by the retarding effect of high interest rates on

investment in structures. Over time a reduction in the capital-output ratio

will retard growth in productivity, the major source of rising living

standards.

Another aspect of high deficits is the growing cost of financing them. The most striking feature of both sets of budget projections is the extremely

rapid growth in outlays for interest on the debt (see Chapter I). Net interest

costs, which were between 1 and 2 percent of GNP for decades, are

projected to rise from 2.8 percent of GNP in fiscal year 1983 to 3.8 percent

in 1989. As a consequence, the stock of federal debt outstanding rises

dramatically in the outyears (see Figure II-2 and Table II-3). The CBO

20
TABLE 11-3. FEDERAL DEBT HELD BY THE PUBLIC

1985 1986 1987 1988 1989

In Billions of Dollars

CBO Baseline a/ 1,329 1,538 1,768 2,028

CBO Estimate of

Administration

Program 1,326 1,529 1,749 1,990

As a Percent of GNP

CBO Baseline a/ 37.3 39.3 41.6 44.0

CBO Estimate of

Administration

Program 37.2 39.1 41.1 43.1

2,315 2,636

2,237 2,490

46.4

44.9

49.0

46.3

a. The CBO baseline figures are preliminary revisions of those appearing

in Congressional Budget Office, Baseline Budget Projections for Fiscal

Years 1985-1989 (February 1984).

baseline and Administration estimates show federal debt rising to between

46 and 49 percent of GNP in 1989. This ratio has only risen above

30 percent of GNP four times in the history of the republic. 3/ In these

circumstances, major spending cuts or tax increases are necessary just to

avoid the possibility of explosive growth in interest outlays.

The rapid rise in the debt-to-GNP ratio also makes the future deficit

outlook highly sensitive to interest rates, one of the hardest economic

variables to forecast. A one-percentage-point error in the forecast, if

continued through the projection period, implies a $30 billion error in the

projection of the 1989 deficit.

3. For a discussion of deficits, debt, and their long-run effects on the

economy, see Congressional Budget Office, The Economic Outlook

(February 1984), Chapter III.

21

CHAPTER ffl. THE ADMINISTRATION'S REVENUE PROPOSALS

AND ESTIMATES

The Administration's fiscal year 1985 budget proposes a more modest

revenue increase than did its 1984 budget. Most of this year's revenue

proposals were contained in last year's budget and have been considered by

the Congress. In the first year of implementation, these proposals would

increase revenues by $8 billion; by the fifth year, they would increase reve- nues by $24 billion (see Table III-l). Using economic and technical estimat- ing assumptions somewhat different from the Administration's, CBO pro- jects slightly lower total revenue growth than does the Administration for

the 1985-1989 period. For 1987, the CBO estimate of the President's budget

is $10 billion below the Administration estimate; by 1989, it is $21 billion

lower.

TABLE III-l. PROJECTED REVENUES UNDER THE

ADMINISTRATION'S 1985 BUDGET PROPOSALS

(By fiscal year, in billions of dollars)

1984 1985 1986 1987 1988 1989

CBO Baseline

Revenue Projection a/ 663 733 795 863 945 1,016

Administration Proposals

Revenue increases 3 10 16 20 24 29

Revenue reductions -1 -2 -4 -5 -5 -5

Subtotal, revenue proposals 2 8 12 15 18 24

President's 1985 Budget

as Estimated by CBO 665 741 807 878 964 1,039

SOURCES: Budget of the Unitd States Government for Fiscal Year 1985 and

Congressional Budget Office.

a. Revenues generated under existing tax law with two exceptions: taxes

for the aviation trust fund are assumed extended beyond 1987 at cur- rent rates, and likewise, highway trust fund taxes beyond 1988.

23

30-778 0-84- 3
THE PRESIDENT'S REVENUE PROPOSALS

The President's 1985 budget proposes net tax increases growing from

$8 billion in 1985 to $24 billion, or 0.4 percent of GNP, in 1989 (see Table

III-l). J7 The only new proposals with significant revenue effects are the

establishment of a petroleum overcharge restitution fund and the un- employment insurance coverage of railroad employees; together, these

measures raise about $3 billion over the five-year period (see Table IH-2). Other proposals are similar to previous Administrations' or to other legisla- tive plans considered by the Congress.

The budget describes the President's revenue proposals as "... measures

to strengthen the revenue base and adjust certain unwarranted or no longer

justifiable features of the Internal Revenue Code." 2) Though some

proposals, such as the taxation of employer-provided health insurance

premiums (also proposed last year), would significantly expand the personal

income tax base, the main features of the Administration's revenue

proposals are the adjustment or extension of tax incentives, the completion

of structural tax code changes recently considered by the Congress, such as

revision in life insurance company taxation and restriction of leasing by tax- exempt entities, and the limitation of tax shelters and abuses.

The President has suggested that further changes in the tax code

might be supported by the Administration. The Economic Report of the

President mentions that "... further improvement and simplification of our

tax system are sorely needed," and that the Secretary of Treasury has been

asked to develop a plan to make the tax system "... fairer, simpler, and less

of a burden on our Nation's economy." 3/

Proposals of three types account for most of the revenue increases the

Administration envisions:

o Taxation of health insurance premiums, which accounts for more

than half of the increases;

1. The revenue effects of the extension of and the removal of the cap

from the hazardous substance trust fund (superfund) taxes after Sep- tember 30, 1985, and of the federal pay increases proposed by the

Administration (neither of which are not included in CBO baseline

revenues) are treated here as Administration proposals.

2. See Budget of the United States Government, Fiscal Year 1985 (Febru- ary 1984), page 3-54.

3. See Economic Report of the President (February 1984), p. 7.

24
o "Structural reform" proposals, limitations on tax-exempt leasing

and on private-purpose tax-exempt bonds; and

o Restrictions on tax shelters and on accounting and corporate tax

abuses.

At the same time, however, several Administration proposals would

reduce revenues (see Tables III-l and III-2). The most significant revenue- losing proposal is the revision in life insurance taxation rules; this accounts

for about one-quarter of the proposed reduction in revenues. Other

proposals that adjust or extend current tax incentives, or create new ones, result in relatively minor revenue losses. Brief discussions of some of the

significant proposals follow. Unless stated otherwise, these proposals are

assumed to become effective at the beginning of 1985.

Tax Employer-Provided Health Insurance Premiums

Taxation of premiums for employment-related health insurance would

increase revenues by $18 billion over the 1985-1987 period and by $40 billion

through 1989. About 70 percent of the revenue increase would be in income

taxes, the remainder, in payroll taxes. Under this proposal, employees

would be taxed on employer-paid health insurance premiums in excess of

monthly thresholds of $175 for family plans and $70 for single-person plans. The thresholds would be indexed to the annual increase in the Consumer

Price Index. Revenues in years after 1985 would grow rapidly because

premiums are likely to increase at about 10.5 percent a year, while the

maximum tax-exempt employer contributions would rise by only about 5

percent a year.

The Administration estimates that the tax on employer-paid premiums

in excess of the ceilings would initially affect about 38 percent of all

workers with job-related health benefits. This proportion would rise to

about 55 percent by 1989. On an individual taxpayer basis, the increase in

taxes would be higher for persons in higher income brackets, both because of

the higher employer-paid premiums they receive and because of the higher

tax rates they pay on additions to income ("marginal tax rates"). Overall, though, more than 60 percent of the increased tax liability would be borne

by persons with annual incomes between $20,000 and $60,000.

Compared to a similar proposal made by the Administration last year, this proposal would affect more employees and raise more revenue, because

the proposed ceilings on tax-exempt employer-paid health insurance premi- ums have not been adjusted to reflect inflation in the intervening year.

25
TABLE IH-2. REVENUE LEGISLATION AND ADMINISTRATIVE ACTION

PROPOSED BY THE ADMINISTRATION (By fiscal year,

in billions of dollars)

Revenue Increase Proposals

Extend and remove cap

from superfund taxes a/

Tax health insurance premium;

198* 1985

0 0

i 0 3.9

1986

0.2

6.5

1987

0.2

8.0

1988

0.2

9.7

1989

0.2

12.1

Increase federal

employees' contributions

to retirement

Cover of railroad

employees under

unemployment insurance

Restrict leasing by

tax-exempt entities

Limit use of private- purpose tax-exempt bonds

Restrict tax shelters, accounting and corporate

tax abuses

Establish petroleum

overcharge restitu1.2

0.8

0.7

0.1

1.7

0.2

3.2

0.1

2.7

1.5

0.1

0.8

1.7

1.6

0.2

1.0

5.7

1.7

0.2

7.0

1.3

6.6

tion fund

Other

Subtotal, revenue

increase proposals

0.5

*

2.5

0.5

0.1

10.3

0.5

*

16.1

0.5

0.1

19.8

0

0.1

23.9

0

-0.1

28.9

(Continued)

a. Included in Administration current services receipts, but not included in CBO

baseline receipts.

* Less than $50 million.

SOURCE: Budget of the United States Government for Fiscal Year 1985 and

Congressional Budget Office.

26
TABLE IH-2. (Continued)

1985 1986 1987 1988 1989

Revenue Reduction Proposals

Administration's federal

pay proposal b/ 0 -0.1 -0.1 -0.1 -0.1 -0.1

Revise life insurance

company taxation -0.5 -0.8 -0.9 -1.0 -1.1 -1.2

Establish education

savings accounts 0 * -0.1 -0.3 -0.5 -0.7

Institute tuition tax credit 0 -0.3 -0.6 -0.9 -0.9 -0.9

"Women's initiative" c/ 0 -0.3 -0.9 -0.9 -1.0 -1.0

Establish enterprise zones 0 -0.1 -0.4 -0.8 -1.0 -1.1

Extend targeted jobs

tax credit one year 0 -0.2 -0.4 -0.4 -0.2 -0.1

Extend incremental R&D

tax credit three years 0 0 -0.4 -0.7 -0.8 -0.4

Extend moratorium on

research and experimental

rce allocation

ler

ubtotal, revenue

eduction proposals

-0.1

*

-0.5

-0.1 -0.1

* *

-2.0 -3.9

0 0 0

* # *

-5.0 -5.5 -5.3

Total Proposed Legis- lation and Administra- tive Revenue Action 2.0 8.3 12.3 14.8 18.* 23.6

b. Effect of proposed federal pay increases on payroll taxes and retirement

contributions; included in Administration "receipts under existing legislation," but not included in Administration current services receipts.

c. Includes a proposed increase in the limit on annual IRA contributions for one- earner couples and changes in the dependent-care credit.

27
Increase Federal Employees' Contributions Toward Retirement

The Administration's proposed increase in contribution rates to the

federal employee retirement plan would raise $4 billion over the 1985-1987

period and $7 billion through 1989. Federal employees now contribute 7

percent of their wages and salaries to the Civil Service Retirement system. The Administration would increase the contribution rate to 8 percent as of

October 1985 and to 9 percent as of October 1986. (This proposal includes

employees of the District of Columbia who are under CSR.) The President's

1984 budget included a similar proposal, calling for higher contribution rates

of 9 percent and 11 percent, effective October 1983 and 1984, respectively.

Cover Railroad Employees Under Unemployment Insurance

The Administration proposes that railroad employees be covered under

the regular unemployment insurance program, while current railroad unem- ployment insurance taxes be retained to pay back the substantial loans that

the Railroad Retirement Account has made to the Railroad Unemployment

Insurance (RRUI) program. The Railroad Retirement Solvency Act of 1983

(Public Law 98-76) prohibits further such lending, effective September 30, 1985, but without further action, RRUI will become insolvent. A committee

established under Public Law 98-76 is to submit a report on the program to

the Congress no later than April 1, 1984; to date, however, the committee

has made no specific proposals.

The Administration estimates that the proposal would increase reve- nues by upwards of $1 billion over the five-year period. CBO has not

reestirnated the revenue effects of the proposal because of the lack of

specific detail. CBO's estimate of such a proposal is unlikely to be very

different, however.

Restrict Leasing by Tax-Exempt Entities

The President's budget would reduce depreciation allowances under the

Accelerated Cost Recovery System and investment tax credits for sale- leasebacks of property currently used by tax-exempt institutions, including

federal agencies. The proposal also covers leases of property financed by

tax-exempt bonds. Similar proposals have been approved by committees in

both Houses during the last session of the Congress.

The Administration estimates that these measures would raise reve- nues by $8 billion over the 1985-1987 period and by $21 billion through 1989. Comparable Congressional proposals showed smaller revenue gains, attribu28
table for the most part to a number of transitional rules in the legislation

that exempted certain projects from their provisions. The Administration's

proposal assumes that all transactions entered into after May 23, 1983, would be affected, without exception.

Limit Use of Private-Purpose Tax-Exempt Bonds

The Administration has proposed several limitations on the use of tax- exempt bonds providing loans for private businesses and for students. These

restrictions are substantially the same as those proposed in the still-pending

Tax Reform Act of 1983, as amended and approved by the Committee on

Ways and Means in November 1983 under H.R. 4170. These proposals call

for limits, based on state population, on the volume of tax-exempt industrial

revenue bonds (IRBs) and on student loan bonds. The annual volume limits

for each state would amount to $150 per capita from 1984 through 1986, rising to $100 per capita beginning in 1987, when use of small issue IRBs is

scheduled to end. Additional restrictions include requiring that IRBs be

available to acquire existing facilities only if some rehabilitation takes

place, prohibiting the use of more than 25 percent of the proceeds of an IRB

issue to acquire land, and limiting the availability of new IRB financing to

firms with outstanding tax-exempt debt of less than $40 million.

The Administration estimates that these changes would raise revenues

by $1 billion over the 1985-1987 period and by $4 billion through 1989. These estimates assume continuation of the "sunset" on mortgage revenue

bonds, which effectively ruled out new issues of these bonds as of January 1, 1984. Enactment of IRB and student loan bond restrictions might be

accompanied by a five-year extension of mortgage revenue bonds (as in H.R. 4170). Such an extension is estimated to reduce revenues by about $1 billion

in the 1985-1987 period, cancelling out much of the potential short-term

revenue gains from the restrictions on other bonds. For the 1985-1989

period, the net revenue gain, including extension, is estimated at less than

$0.5 billion.

Restrict Tax Shelter, Accounting and Corporate Tax Abuse

Some 25 proposed changes to the tax code would limit transactions

that have no economic substance other than tax avoidance ("tax arbitrage" transactions). Most of the proposals have been discussed in the tax-writing

committees during the past year. Several were included in H.R. 4170 (see

above), and many of them are expected to be considered by the Congress

early this year. One proposal would tax the accrued gain on appreciated

property that is distributed as a corporate dividend, such as the units in an

29
oil royalty trust. This provision would make such trusts tess attractive by

increasing the cost of establishing them. These proposals are estinaat«d to

increase revenues by $12 billion over the 19S5-19S7 period and by $25 billion

over five years.

Establish Petroleum Overcharge Restitution Fund

The Administration proposes to create a special fund to handle monies

recovered from oil companies found to have been in violation of price

controls in the 1970s. These monies are currently held in escrow accounts. Although attempts are made to identify the victims of overcharges and to

compensate them, doing so is not always possible. In those cases in which

the overcharges could be measured but not allocated to particular victims, the balance would be remitted by the oil companies to the government and

put in this fund.

The Administration's estimate of a revenue increase of $2 billion from

the creation of the fund is reasonable, according to CBO's calculation. But

because of the likely large numbers of claims and the slow administrative

process of dealing with them—at times, including court litigation—CBO has

spread the increase evenly over the 1984-1987 period, attributing $0.5

billion in revenue gains to each year.

Revise Life Insurance Company Taxes

Before 1982, the tax treatment of life insurance companies and their

products was based on a system adopted in 1959, despite major changes in

the industry and the economy in the decades between. The life insurance

provisions of the Tax Equity and Fiscal Responsibility Act of 1982 began the

process of reforming and simplifying life insurance company taxation by

repealing the modified coinsurance provisions that had become a major

source of unintended tax reduction, and by changing the tax treatment of

some life insurance company products. In addition, several stopgap provi- sions were enacted to stabilize the industry's tax burden for a two-year

period while permanent legislation was developed. At the end of 1983, the

rules under which life insurance companies are taxed reverted to 1959 law.

The Administration's proposals—estimated to reduce revenues by $3

billion over the 1985-1987 period and by $5 billion by 1989—are similar to

ones contained in H.R. 4170 and S. 1992 introduced in the Senate Finance

Committee during the 98th Congress. These bills included a special

deduction for life insurance companies that would allow all companies to

reduce their taxable life insurance income by 25 percent. The Administra30
tion proposal would scale this deduction back to 20 percent. It would also

eliminate a provision of the avovementioned bills that would treat as

taxable income to the holder the deferred income of an annuity's contract if

the holder dies before the annuity's starting date. In addition, it would

include limits on the deduction of interest on policyholder loans more

stringent than the limits included in the bills.

Establish Education Savings Accounts

The earnings of proposed educational savings accounts—also proposed

by the Administration in its 1984 budget—would be tax exempt so long as

the proceeds were used for post-secondary education. This year's proposal

broadens acceptable expenditures to include graduate school and possibly

trade school tuition, and tuition for part-time as well as full-time students. The main revenue loss from education saving accounts would be in later

years. The Administration estimates a revenue loss of $0.5 billion over the

1985-1987 period; however, by 1989, the estimated loss would have risen to

$0.7 billion a year. Revenue losses could be expected to continue growing

rapidly for 10 to 20 years, as savings in the account balances accumulate.

The Administration envisions a separate account set up for each

dependent child with contributions permitted up to $1,000 per child per year

for children under 18 years of age. The $1,000 contribution limit would

decline for contributors with adjusted gross incomes above $40,000 and

would reach zero for those with incomes of $60,000 and above. Education

savings accounts would encourage families to save for college and would

reduce the burden of doing so for families who would save in any event. A

middle-income family saving regularly for 18 years would reduce its college

costs by 18 percent compared to saving the same money in a taxable

account.

In fact, however, parents do not need to wait for educational savings

accounts to start tax-exempt saving for their children. Under existing law, parents can use trusts or gifts to minors to set up savings accounts in their

children's names. With an 8 percent interest rate, a child could hold $12,500

before earning enough to pay tax. With four-year costs for many colleges

already well in excess of $12,500, however, families with the resources to

save more than that amount per child could benefit from education savings

accounts. Gifts to minors come under the child's control at age 18, and they

can be used for whatever purpose the child chooses, though parents might

prefer to restrict use of their savings to education. Though trusts can be

restrictive in their use, they tend to be more complicated and costly to set

up than education savings accounts would be.

31
A number of bills have been proposed in past sessions of the Congress

that would provide tax-favored accounts for education. Unlike the Adminis- tration's proposal, most plans would make contributions tax deductible, and

would subsequently recapture contributions and interest by requiring the

child to add these to his post-secondary-school income. Such proposals

usually entail larger revenue losses than would the Administration's current

plan.

Institute a Tuition Tax Credit

The Administration proposes a nonrefundable tax credit that would be

available to families sending their children to nonpublic elementary and

secondary schools. The credit would equal up to 50 percent of tuition costs. Following a phase-in period, the credit would be capped at $300 per

dependent and phased down for taxpayers with more than $40,000 in annual

adjusted gross incomes, with a zero credit for taxpayers with annual

incomes above $60,000.

The Congress has considered such credits before. Tuition tax credit

legislation was defeated in the Senate in 1982 and 1983, and the Administra- tion proposed a similar tuition tax credit in its 1984 budget. The current

proposal would reduce revenues by $2 billion over the 1985-1987 period and

by $4 billion over the five-year period.

Increase Individual Retirement Account Limit for One-Earner Couples

As part of its "women's initiative," the Administration proposes to

raise the annual limit on tax-deferred contributions to individual retirement

accounts (IRAs) for one-earner couples. Under current law, taxpayers may

contribute to IRAs the lesser of $2,000 or the taxpayer's yearly income. The

Administration's plan would raise that limit either to $4,000 or to the

employed spouses' qualified earned income, whichever is less. Thus, couples

with two employed spouses can deduct up to $4,000 per year, while couples

with only one spouse working outside the home and filing a joint return can

deduct up to $2,250. Justifying the raised limit for tax-deferred IRA

contributions, one can argue that couples with one earner will need as much

retirement income as two-earner couples. The lower spousal limit currently

in force bears most heavily on couples with dependent children. This

proposal would reduce revenues by $2 billion over the 1985-1987 period and

by $4 billion over five years.

32
Revise the Dependent-Care Tax Credit

Under current tax law, taxpayers may claim a tax credit for depen- dent-care expenses up to $2,400 for one child and $4,800 for two or more

children. For families with incomes below $10,000, the credit is 30 percent

of employment-related expenses up to a maximum credit of $1,440 a year

for two or more dependents; it phases down to 20 percent for those with

incomes over $28,000. The Administration proposes to raise the credit to 40

percent for taxpayers with incomes below $10,000 and then phase out the

credit entirely at incomes above $60,000. By reducing the credit at higher

incomes while expanding it at lower incomes, the proposal keeps the

additional revenue loss small relative to the nearly $2 billion annual loss for

the credit under current law. The Administration estimates the additional

revenue loss to equal $0.4 billion over the 1985-1989 period.

Establish Enterprise Zones

The Administration proposes that up to 75 small, economically dis- tressed geographic areas each year be designated "enterprise zones." Within

these zones, federal tax and other incentives would be provided to stimulate

private-sector economic activity, to help redevelop deteriorated areas, and

to stimulate employment. Within the zones, employers would receive tax

credits based on the number of economically disadvantaged persons they

hire. Employees of zone firms would be allowed a tax credit equal to 5

percent of the first $10,500 of wages earned in the zone. The regular

investment tax credit now in effect would be increased by 50 percent for

machinery and equipment used in zones; a 10 percent investment tax credit

would be allowed for new construction and reconstruction of buildings within

zones; capital gains on business property and interests in businesses would be

exempt from taxation; and small issue tax-exempt bonds could be used to

finance investment in the zones after the 1986 sunset date applicable for

these bonds elsewhere. This proposal is estimated to decrease revenues by $1 billion over the 1985-1987 period and by $3 billion over five years. These

and similar proposals are contained in bills that have been drafted in both

Houses of Congress.

Extend the Targeted Jobs Tax Credit

The Administration proposes a one-year extension of the Targeted

3obs Tax Credit (T3TC), which provides corporate income tax reductions to

hire certain jobless and generally low-skilled persons. Employers who hire a

member of any one of nine targeted groups may claim credits of up to

$3,000 in the first year and $1,500 in the second. (Deductions for wage and

33
salary expenses must be reduced by the amount of the credit, however.) The

legislation authorizing TJTCs is scheduled to expire at the end of 1984. The

proposal would reduce revenues by slightly more than $1 billion over the

five-year period.

The credit is designed in part to offset the effect on the employment

of unskilled workers of minimum wage laws. Evidence suggests that the

current TJTC has not been very effective in stimulating employment, however, owing in part to problems with its implementation. Changes in

implementation or larger tax reductions might be necessary to encourage its

use by large numbers of employers.

Modify Research and Development Tax Provisions

A 25 percent credit for corporations' research and development (R&D)

expenditures enacted as part of the Economic Recovery Tax Act of 1981 is

scheduled to expire at the end of 1985. (The credit is only for incremental

expenditures over some base level, as defined by the law.) The Administra- tion proposes to extend the credit through 1988. Because of the difficulties

in defining R&D expenditures, the Administration also proposes to modify

the definition of eligible expenditures so that only those costs incurred in

the development of new or significantly improved products or processes

would qualify. The extension would reduce revenues by $2 billion over the

1986-1989 period.

In addition, the Administration proposes to extend for two years the

Congressionally imposed suspension of regulations regarding the allocation

of research and experimental expenditures between domestic- and foreign- source corporate income. At present, firms are allowed to charge all

domestic research and experimental expenditures against U.S. income—no

apportionment is required. The regulations would require some allocation, generally reducing foreign-source corporate income and increasing U.S. income, thereby increasing corporate income taxes. The Administration

would like to study the regulations further. A five-year extension was

suggested last year by the Subcommittee on Oversight of the House Ways

and Means Committee, but it was not acted on by the full Committee. The

proposed two-year extension of the moratorium would reduce revenues by $0.2 billion over the 1984-1986 period.

Institute Trusts for Investment in Mortgages

The Administration proposes to create a new tax classification for

entities investing in mortgages. Called Trusts for Investments in Mortgages
(TIMs), these entities would function like mutual funds for mortgages. Investors would buy shares in a TIM, which would actively manage a

mortgage portfolio, and the trust would be exempt from tax on income

distributed to its shareholders (as is the case for mutual funds). Under

current law, entities actively buying and selling mortgages are taxable. Those that passively hold mortgages are tax exempt but must be dissolved as

homeowners prepay their mortgages.

The Administration proposes to deny TIM benefits to the three

federally related institutions that currently dominate the buying and selling

of mortgages: the Government National Mortgage Association, the Federal

National Mortgage Association, and the Federal Home Loan Mortgage

Corporation. These institutions could not manage TIMs, and their own

securities or securities backed by them would not be qualified assets for

TIMs. Furthermore, existing TIM-like entities would be penalized for future

purchases of securities issued or backed by the federally related institutions. To curtail federal influence in credit markets, the Administration proposes

to exclude the federally related institutions from TIM benefits. Others

would like to extend the federal influence in combination with TIMs to

attract more funds to housing at lower rates.

In 1983, a TIMs bill was introduced in the Senate. That bill, however, would have allowed the three federally related entities to benefit indirectly

from TIMs. TIMs were also proposed by the President's Commission on

Housing in its 1982 report. Because most mortgages are already held in tax- exempt or lightly taxed entities, the proposal is expected to entail only a

negligible revenue loss.

DIFFERENCES IN ADMINISTRATION AND CBO REVENUE ESTIMATES

About one-third of the difference between the CBO and Administration

revenue estimates is attributable to differences in economic assumptions

(see Table III-3). Most of the remaining two-thirds arises from technical

assumptions that include differences about administrative actions, about

taxpayers' or general business behavior, and about effective tax rates.

The CBO analysis corroborates the Administration's estimates of the

revenue effects of most of its tax proposals. Two estimates differ, however. The revenue effect of increasing federal employees' contributions

to the Civil Service Retirement system (also treated in Chapter V) has been

reestimated on the basis of CBO's economic assumptions; and the revenue

increase from a proposed petroleum overcharge restitution fund has been

assumed to spread over four years instead of accruing entirely in 1985.

35
TABLE III-3. CBO REESTIMATES OF THE ADMINISTRATION'S

REVENUE PROJECTIONS (By fiscal year, in billions of dollars)

1984 1985 1986 1987 1988 1989

President's 1985 Budget, Administration Estimate

CBO Reestimates

Different economic

assumptions

Individual income taxes

Corporate income taxes

Social insurance taxes

Other taxes

Subtotal

Technical reestimates

Individual income taxes

Corporate income taxes

Social insurance taxes

Other taxes

Subtotal

Total Reestimates

President's 1985 Budget

as Estimated by CBO

670 745 815 888 978 1,060

-3

1

*

-l

-l

-l

^j_

-4

-5

3

-9

4

_2

-1

-1

-2

*

-4

3

-12

5

3

-2

-3

-3

*

2

-12

3

4

-3

-5

-1

1

jj.

-6

2

-15

1

6

-6

-8

1

1

-2

-9

-8 -10 -15

-17

-2

7

-7

-13

1

2

-3

-13

-21

665 741 807 878 964 1,039

* Less than $500 million.

SOURCES: Budget of the United States Government for Fiscal Year 1985

and Congressional Budget Office.

Economic Assumptions

Revenue estimates are directly related to projected tax bases—wages

and salaries, personal property income, corporate profits, and sales. Inter- est rates affect revenue through Federal Reserve payments (mostly return

of earnings from federal government securities) and through income taxes

36
by way of interest income. The rate of inflation also directly affects

revenues through the indexation of the taxable wage base for Social Security

taxes and, beginning in 1985, of the individual income tax brackets, zero

bracket amount, and personal exemptions, and through the valuation of

corporate inventories and capital consumption. Investment directly affects

corporate income taxes through deductions and credits for newly acquired

depreciable assets.

CBO's economic projections differ somewhat from the Administra- tion's. CBO projects slightly higher gross national product (GNP), with

slightly higher prices and generally lower real output than the Administra- tion projects. (CBO's projected oil prices, however, are slightly lower.)

CBO's projection of taxable personal income is higher than the Administra- tion's, although CBO's wage and salary component falls below the Adminis- tration's by 1988. CBO's projection of corporate profits is generally lower

than the Administration's, while its interest rate projections are consider- ably higher throughout the five-year period. The differences in the CBO

revenue reestimates attributable to economic assumptions are calculated by

using Administration economic projections in CBO's estimating procedures. The differences between these revenue estimates and CBO's estimates, using common procedures, arise from differences in economic projections. (The remaining differences between CBO and Administration revenue esti- mates are attributed to technical factors.)

CBO's economic assumptions cause revenue projections to be lower in

each year, by amounts ranging from $1 billion in 1985 to $7 billion in 1989

(see Table III-3). CBO's projection of lower corporate income tax revenues

attributable to a lower projection of corporate profits (before tax and

before adjusting for Accelerated Cost Recovery System deductions) more

than account for the difference. The lower profits level explains most of

the total difference between CBO and Administration corporate income tax

estimates through 1987, and it accounts for more than the total difference

for 1988 and 1989.

CBO's projection of taxable personal income is above the Administra- tion's projections throughout the 1985-1989 period. Considered alone, this

factor would raise the CBO estimates of individual income tax revenues

above the Administration estimates by amounts ranging from $2 billion to $4

billion a year. After 1986, however, technical differences in estimation

procedures more than offset the differences caused by economic assump- tions. As a result, CBO's projected individual income tax revenues are lower

than the Administration's projections (see Table Hl-'f).

CBO's projection of higher wages and salaries and employment through

1987 also raises its estimates of social insurance tax receipts (about 90

37
TABLE IM-4. ADMINISTRATION AND CBO ESTIMATES OF

ADMINISTRATION &UOG£T REVENUES, BY SOURCE

(By fiscal year, in billions of dollars)

1984 1985 1986 1987 1988 1989

Administration Estimates

Individual Income Taxes a/

Corporate Income Taxes

Social Insurance Taxes

and Contributions a/

Excise Taxes

Windfall profit taxes

Other taxes a/

Other

Total

Percent of

Administration GNP

Individual Income Taxes

Corporate Income Taxes

Social Insurance Taxes

and Contributions

Excise Taxes

Windfall profit taxes

Other taxes a/

Other

Total

Percent of CBO GNP

SOURCES: Budget of the

295

67

237

9

29

33

670

18.8

CBO

294

63

237

8

29

33

665

18.7

332

77

267

8

30

31

745

19.2

Estimates

334

66

270

7

31

34

741

19.0

368

§8

294

7

27

31

815

19.3

368

73

299

5

28

34

807

19.0

United States Government

406

98

319

6

27

31

888

19.3

403

84

323

4

28

35

878

19.0

for Fiscal

453

104

356

6

28

31

978

19.7

447

90

359

4

29

36

964

19.3

Year

498

108

388

6

29

32

1,060

19.8

489

92

388

4

30

37

1,039

19.3

1985 and

Congressional Budget Office.

NOTE: Details may not total because of rounding.

a. The Administration's budget estimates, as shown in the proposed budget, include

a reduction in individual income taxes and an increase in social insurance taxes

to reflect the general revenue transfer to the Social Security trust funds for the

(partial) taxation of Social Security benefits. The estimates shown here exclude

this transfer.
percent of which awe Social Security taxes) above the Administration's

throufh 1988, By 1939, the effects of CBO's lower projected wages an<f

salaries and employment for 1988 and 19S9 cause the CBO estimates of

social insurance taxes to fall betow the Administration's projections.

By itself, the lower CBO oil price projections reduce CBO's estimates

of windfall profit tax receipts below the Administration's estimates through- out the five-year period. The largest remaining economic reestimate is

attributable to CBO's projection of higher interest rates. Higher rates raise

CBO's estimates of Federal Reserve payments to the Treasury above the

Administration's by amounts that grow to $6 billion by 1989.

Technical Reestimates

Technical reestimates also lower CBO's revenue estimates relative to

the Administration's in each year. Altogether, the effects of these factors

are about twice as large as those ascribed to economic reestimates. Some

technical differences are attributable in part to factors that might be

properly considered to be economic, such as oil production or the growth of

personal income across the income tax brackets.

The largest technical reestimates are those for the predominant single

revenue source—individual income taxes. These reestimates, which account

for roughly two-thirds of total technical reestimates, reduce the CBO

revenue estimates relative to the Administration's in each year. On the

basis of the Administration's assumed rates of real growth and inflation, CBO estimates that the overall tax rate applied to taxable personal income

should be several tenths of a percent lower than the Administration's—a

minor difference that accounts for most of the technical reestimate.

Technical reestimates of corporate income taxes, which place the

CBO revenue projections below the Administration's in some years and raise

them above in others, can be attributed in part to two differing assumptions:

those concerning state business taxes, and those reflecting the amount of

total profits accruing from the foreign operations of U.S. corporations. Almost all of the technical reestimates of social insurance taxes, which

raise CBO revenue projections relative to the Administration's beyond 1985, are found in unemployment insurance (UI) tax estimates. The tapering-off

in the growth of Administration UI tax projections is difficult to explain on

the basis of economic projections and past program experience.

39

30-778 0-84- 4

CHAPTER IV. THE ADMINISTRATION'S DEFENSE BUDGET

The Administration's fiscal year 1985 budget proposes substantial real

growth in defense spending over the next five years. Appropriation requests

for national defense programs rise from $314 billion in 1985 to $456 billion in

1989, for a five-year total of over $1.9 trillion. Combining the Administration's dollar requests with CBO's assumptions about future inflation implies

average annual real growth of 5.1 percent. As a consequence, defense spending would grow relative to the size of the economy, regaining the levels of

the early 1970s.

The Administration's current defense budget plan is similar to the one

proposed last year, although funding levels are somewhat lower. Budget

authority is $16 billion less for 1985 than for 1984 and $42 billion less over

the 1985-1988 period, mainly because the Administration's plan cuts previously planned purchases of ships, missiles, and aircraft.

The Administration's 1985 defense budget is higher, however, than the

targets set by the Congress in its First Concurrent Resolution on the Budget

for Fiscal Year 1984. The President's latest defense budget exceeds the

budget resolution targets for 1985 by $17 billion in budget authority and

$10 billion in outlays. Compared to CBO's national defense baseline projections for 1985-1989, which are based on the 1984 Congressional budget resolution, the Administration's latest defense budget is higher by over

$80 billion in both budget authority and outlays. If inflation grows at the

levels projected by CBO, which are higher than those assumed by the

Administration, the President's latest defense budget could be underpriced

by nearly $100 billion over the 1985-1989 period.

In contrast with recent experience, the real costs of defense weapons

purchases in the 1985 budget are projected to decline significantly from the

previous year. CBO analysis shows that expected declines in unit costs for

weapon systems has lowered the 1985 budget by about $2.4 billion from the

level projected a year ago. This anticipated decline in real costs may be the

result of recent revisions in defense procurement policies.

DEFENSE FUNDING LEVELS

The President's budget proposes $314 billion in budget authority and

$273 billion in outlays for the national defense function in 1985. This is an

increase of $50 billion in budget authority and $38 billion in outlays from

41
Figure IV-1.

Budget Authority for National Defense (In Constant 1985 Dollars)

1955 I960 1965 1970 1975 1980 Fiscal Years

SOURCE: CBO calculations based on data from the Department of Defense.

1985 1989

currently estimated levels for 1984. After adjusting for projected inflation,

these increases would represent real growth of 12 percent in budget authority and 10.0 percent in outlays. The 12 percent real growth in budget auth- ority would be as large as the increases provided in 1981 and 1982, and

substantially larger than the 3.1 percent real increase provided in 1984.

Defense appropriations would continue to increase during each of the

next four years, although at a decreasing rate. Total budget authority for

national defense under the Administration's plan would rise to $359 billion in

1986 and to $456 billion by 1989. As shown in Table IV-1, the projected

annual growth in defense spending authority slows from about 19 percent in

1985 and 14 percent in 1986 to a little over 8 percent annually in 1987-1989

in current dollar terms. In real terms, after adjusting for inflation, total

budget authority is projected to grow by an average of 5.1 percent annually

over the entire 1985-1989 period, but by only 2 percent annually over 1987- 1989, according to Administration estimates.

Figure IV-1 portrays the real growth in national defense budget auth- ority (in constant 1985 dollars) for 1985-1989. The projected levels of bud- get authority in real terms for 1985-1989 would be 39 percent above the

42
Figure IV-2.

National Defense Outlays as a Percent of GNP

1950 1955 1960 1965 1970 1975 1980 1985 1989

Fiscal Year

SOURCES: For historical data, Department of Defense; for projections,Congressional Budget Office,

amount appropriated by the Congress for the previous five years (1980-

1984), and 37 percent above the levels provided during the Vietnam War

(1966-1970).

Defense outlays also would grow substantially during the next fiveyears, rising from an estimated $235 billion in 198* to $419 billion in 1989,

an increase of 78 percent. The average annual nominal growth for the five- year period would be 12 percent, but the year-to-year growth would decline

steadily from 17 percent in 1985 to 8 percent by 1989. In real terms, annual

growth in defense outlays would average 5.8 percent for the five-year per- iod. Like budget authority, however, the annual real growth rate in outlays

would decline steadily from 10.0 percent in 1985 to only 2.1 percent in 1989

under the Administration's latest defense plan (see Table IV-1).

Relative to the total economy, defense outlays under the Administra- tion's proposals would increase from 6.6 percent in 1984 to 7.8 percent in

1989. Figure IV-2 shows the post-World War II trend for defense outlays as a

percentage of gross national product (GNP). Over the 1985-1989 period, de- fense outlays would average 7.5 percent of GNP, compared to 6.1 percent
TABLE IV-1. NATIONAL DEFENSE FUNDING LEVELS AS ESTIMATED BY CBO

(By fiscal year)

Funding Levels 1984 1985 1986 1987 1988 1989

Administration 1984 Budget Proposals

(in billions of dollars) c/ 275

Budget Authority

Administration 1985

Budget Proposals

(in billions of dollars) 264 314

Nominal growth (percent

change, year-to-year) 7.6 18.6

Real Growth (percent

change, year-to-year) 3.1 12.0

CBO Baseline Projections a/ b/

(in billions of dollars)

With 5% real annual growth in

defense budget authority

With no real growth in

defense budget authority

359

14.5

7.7

389

8.4

2.0

422 456

8.4 8.3

2.1 2.1

264 297 329 367 409 455

264 280 297 316 335 355

330 365 397 433

Administration 1985

Budget Proposals

(in billions of dollars)

Nominal growth (percent

change, year-to-year)

Real Growth (percent

change, year-to-year)

Outlays

235 273 315 352 387 419

11.5 16.6 15.3 11.8 9.9 8.3

7.5 10.0 8.2 5.2 3.7 2.1

CBO Baseline Projections a/ b/

(in billions of dollars)

With 5% real annual growth in

defense budget authority

With no real growth in

defense budget authority

Administration 1984 Budget Proposals

(in billions of dollars) c/

235 263 295 329

235 262 283 301

242 285 323 354

367 408

321 338

386

SOURCE: Office of Management and Budget, with real growth based on CBO economic

assumptions.

a. Includes revisions to previously published CBO baseline projections for 1985-1989. The CBO baseline is an extrapolation of the 1984 budget resolution. b. The CBO baseline projections shown in this table have been revised from those

published in the recent CBO annual report to Congress to reflect the mix of

purchases in the Administration's latest budget plan, and to reflect the historical

relationship between inflation for defense purchases and general inflation projected

by CBO for the 1986-1989 period. c. Administration's budget proposals contained in the Mid-Session Review of the 1984

Budget which OMB uses as the base for their current services estimates.
for the preceding five years. This amount is substantially lower, however, than the 8.5 percent average during the Vietnam War and the 10 percent

average for the several years following the Korean War.

Comparison with CBO Defense Baseline Projections

The Administration's defense proposals are significantly above the

CBO baseline projections for 1985-1989. Because the Administration re- quests such large increases in 1985 and 1986, their budget contains

$90 billion more budget authority over the five-year period than if a con- stant 5 percent real increase occurred each year. In contrast, the CBO

defense baseline is an extrapolation of the 1984 budget resolution, and shows

annual real increases of about 5 percent in budget authority. J7 For 1985

and 1986, baseline budget authority for national defense programs is the

actual dollar amounts specified in the 1984 budget resolution. For 1987- 1989, it is CBO's estimates of the amounts required to achieve real in- creases of 5 percent per year.

The Administration's budget and the CBO baseline show one way of

achieving 5 percent annual real growth—with various growth rates in each

year which produce a 5 percent average over the projection period. In the

Administration's budget, the rapid increases in 1985 and 1986 yield much

more budget authority over five years. A second approach would apply a

constant 5 percent growth rate in each year and result in cumulatively less

budget authority over the five-year period than either the Administration

budget or the CBO baseline.

CBO has also calculated an alternative baseline for defense programs

that is comparable to the baseline projections for nondefense discretionary

spending. Under this alternative baseline, defense budget authority would

be increased just enough to keep pace with inflation in the defense sector;

there would be no real growth.

The Administration's latest defense budget plan exceeds the CBO

baseline projection with 5 percent real annual growth by $17 billion in de- fense budget authority in 1985, and by $83 billion for the five-year period. Compared to a baseline with no real growth in defense budget authority, the

1. The CBO baseline projections shown in Table IV-1 have been revised

from those published in other recent CBO reports to reflect the mix of

purchases in the Administration's latest budget plan, and to reflect the

historical relationship between inflation for defense purchases and

general inflation projected by CBO for the 1986-1989 period.
Administration's latest budget plan is $34 billion larger in 1985 and

$356 billion more over the 1985-1989 period (see Table IV-1).

The differences between the CBO defense baseline outlay projections

and CBO's estimates of outlays that would result from the Administration's

budget authority proposals parallel those for budget authority. Compared to

the CBO baseline projections with 5 percent real growth in defense budget

authority, the Administrations defense outlays would be $10 billion, higher

in 1985 and $84 billion higher over the entire five-year projection period. Relative to a zero growth baseline, outlays under the Administration's pro- posals would be $11 billion larger in 1985 and $241 billion higher over the

1985-1989 period.

Compared to last year's budget proposals, which OMB uses as its cur- rent services baseline for national defense, the Administration's latest de- fense plan shows somewhat lower budget authority and outlays for 1985- 1988. Budget authority is $16 billion less for 1985 and $42 billion lower for

the four-year period. The decreases primarily stem from reductions in the

quantities of ships, missiles, and aircraft to be purchased. While inflation

for defense purchases, including fuel purchases, is now projected at lower

levels for 1984 and 1985 than was estimated a year ago, the Administration's

defense inflation projections for 1985-1989 may prove to be overly opti- mistic. If this should be the case—a possibility that is examined in more

detail later in this chapter—the Administration's latest defense plan would

be underpriced.

Composition of the Administration's Defense Plan

Table IV-2 displays the composition of the Administration's defense

budget as estimated by CBO. Over the five-year period, procurement

accounts for the largest portion of the national defense budget, amounting

to $679 billion, or 35 percent of total budget authority. The next largest

component is defense operations, which receives $513 billion, or 26 percent

of total defense spending authority. Military personnel, including accrued

costs for retirement pay, takes another $412 billion, or 21 percent of total

defense authority. Military research and development programs add

$202 billion over 1985-1989, and military construction, family housing, and

other national defense activities accounts for $133 billion.

Short-term changes planned for U.S. strategic nuclear forces, tactical

air forces, and general purpose army and naval forces in 1985 are shown in

Table IV-3. The major strategic force change is the retirement of eight

Titan II intercontinental ballistic missile (ICBM) launchers, which is offset

by the delivery of one Trident submarine. Tactical air forces are scheduled

46
TABLE IV-2. THE ADMfNSTRATtON DEFENSE BUDGET

AS ESTIMATED BY CBO (By fiscal year, in billion of dollars)

Component 1984 19S5 1986 1987 1988 1989

Military Personnel

Operations and

Maintenance

Procurement

Research, Development, Test and Evaluation

Other

Subtotal, DoD

Other National Defense

Total

Military Personnel

Operations and

Maintenance

Procurement

Research, Development, Test and Evaluation

Other

Subtotal, DoD

Other National Defense

Total

65.1

70.9

85.2

26.9

9.2

257.3

7.2

Budget Authority

70.3 77.0 82.8

81.5 92.7 103.8

107.9 126.0 137.0

37.9

16.1

38.6

17.0

34.0

11.6

305.3 349.7 379.2

8.4 9.3 9.9

88.4 93.5

113.1 122.3

147.1 161.5

44.0 47.5

18.9 21.3

411.5 446.1

10.1 10.4

264.5 313.7 359.0 389.1 421.6 456.4

Outlays

64.6 69.5 76.3 82.1

68.6

64.1

24.0

6.6

227.9

6.7

89.2 99.9

94.7 109.7

78.1

79.8

29.7

8.6

265.7 306.5 343.1

7.7 8.8 9.4

87.7 92.8

109.5 118.7

123.1 134.4

34.9

11.3

37.4

13.9

45.1

18.1

41.1

16.0

377.5 409.1

9.9 10.3

234.6 273.5 315.3 352.5 387.4 419.3

SOURCE: Congressional Budget Office.

47
TABLE IV-3. SUMMARY OF MAJOR U.S. FORCES AND

MANPOWER FOR FISCAL YEARS 1983-1985

1983 1984 1985

Active Forces (in units)

Strategic bomber aircraft 297 297 297

Land-based intercontinental ballistic

missiles 1,042 1,031 1,023

Sea-based intercontinental ballistic

missiles 568 616 640

Army and Marine Corps divisions 19 19 20

Naval battle forces 504 513 532

Tactical air squadrons 162 165 168

Manpower (personnel in thousands)

Active duty end strength 2,123 2,136 2,166

Civilian end strength 1,064 1,078 1,085

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

to increase by three squadrons—two for the Navy and one for the Air Force. The Army plans to activate a new light division. For naval forces, a net

increase of nineteen battle force ships is planned for the active fleet in

1985.

In the longer term, major planned increases in force structure are

designed to meet the Administration's goal of expanding Navy resources to

over 600 ships by the early 1990s. The Air Force is also projected to expand

from its present level of about 37 tactical wing equivalents to about 40 wing

equivalents by 1989. The Administration's five-year plan for land forces

includes continued force modernization through the acquisition of heavy and

light armored vehicles as well as attack and assault-support helicopters, plus

the addition of a seventeenth Army division.

Possible Underpricing for Inflation

In addition to the fact that the President has requested significant

increases in national defense funding, there is some risk that the Adminis- tration may have underestimated the future costs of inflation in its projec48
tions. The defense budget is uniquely sensitive to inflation because so many

of the items funded each year in annual appropriations take many years to

produce. For example, a ship ordered in 1985 will result in outlays over the

next five years or more. Thus, the 1985 budget must anticipate future

prices at least through 1989, when the last funds for many currently ordered

weapons systems will be spent. Higher than anticipated inflation could

either necessitate a reduction in planned defense purchases to stay within

appropriated funding, or require additional Congressional funding to

complete the Administration's plans for weapons procurement and other pur- chases.

CBO predicts higher inflation for defense purchases than the Adminis- tration does for two reasons. First, CBO expects higher economy-wide in- flation as measured by the GNP deflator. Second, CBO expects a greater

difference between general price escalation rates and more specific rates

relevant to defense purchases. Table IV-4 shows a comparison of CBO and

Administration assumptions for price growth in the general economy, de- fense fuel purchases, and nonpay defense purchases in general.

In addition to the difference in general economic inflation trends, CBO

anticipates faster weapons price growth than does the Administration over

the next five years. 2/ The average percentage difference between Admin- istration inflation rates for defense purchases and for the GNP deflator is

one-sixth of the average difference over the past five years. In the CBO

baseline projections for fiscal years 1985 to 1989, the spread between the

GNP and the defense purchases deflators is about equal to the average dif- ferential (excluding fuel) during the past five years.

CBO anticipates price growth in DoD procurement to continue to out- pace GNP price growth, especially after 1985. As orders for the major

weapons systems enter their production stages, capacity in defense indus- tries may be strained, and bottlenecks for isolated parts and raw materials

could not only delay completion of the weapons but also drive up their prices

as well. V The impact of increasing procurement outlays will not affect all

defense industries equally, however. The shipbuilding industry, for example, appears to have ample resources and capacity to handle the new defense

2. For a comparison of the general economic forecasts of the CBO and

the Administration, see Chapter II of this report.

3. See Congressional Budget Office, Defense Spending and the Economy

(February 1983); and U.S. Department of Commerce, Bureau of Indus- trial Economics, Sectoral Implications of Defense Expenditures

(August 1982).
TABLE IV-4. COMPARISON OF CBO AND ADMINISTRATION

INFLATION PROJECTIONS (By fiscal year, in percents)

Deflator 1984 1985 1986 1987 1988 1989

GNP Deflator

CBO

Administration

4.4

4.3

5.2

4.9

5.0

4.6

4.8

4.3

4.5

4.0

4.4

3.7

DoD Fuel Purchases

Outlay Deflator

CBO -1.1 1.5 1.5 2.7 4.6 4.3

Administration -2.5 0.5 0.5 3.2 4.2 3.7

Total Defense Purchases

Outlay Deflator

CBO 3.8 6.8 6.7 6.5 6.2 6.1

Administration 4.2 5.2 4.9 4.7 4.4 4.0

SOURCES: Congressional Budget Office, Department of Defense, and

Office of Management and Budget, January 1984.

orders. There is more uncertainty about the existence of sufficient capacity

in the aerospace, instruments and controls, and forgings and castings indus- tries. Although no problems are anticipated in the next year, the projected

increase in DoD outlays might strain the future ability of these producers to

meet the increased demand without price growth.

Unlike procurement, price growth for operations and maintenance

(O&M) purchases historically has not strayed too much above or below

growth in the GNP deflator, an index often used to measure the general

level of inflation in the economy. So any differences between CBO and the

Administration for projected costs in O&M are probably attributable more

to the difference in general economic forecasts, which include energy costs, than to conditions in defense-intensive industries.

Because there is often a long lag between the obligation of defense

funds and the actual production of the defense goods, with attendant out- lays, CBO computes different inflation rates for budget authority and out- lays. For those procurement accounts whose budget authority will result

50
TABLE IV-5. CBO INFLATION PROJECTIONS FOR NATIONAL

DEFENSE (By fiscal year, in percents) a/

1985 1986 1987 1988 1989

Budget Authority

Pay and benefits 3.5-5.5 5.8 5.6 5.5 5.3

Purchases 6.7 6.5 6.5 6.2 6.1

Composite 5.9 6.3 6.3 6.1 6.0

Outlays

Pay and benefits

Purchases

Composite

3.5-5.5

6.8

6.0

5.8

6.7

6.5

5.6

6.5

6.3

5.5

6.2

6.0

5.3

6.1

6.0

SOURCE: Compiled by CBO from data supplied by the Department of Defense, and CBO.

a. The deflators used in this table differ from those in the CBO report

Baseline Budget Projections for Fiscal Years 1985-1989 (February

1984), based on the pay raises and the mix of purchases in the Admin- istration's 1985 budget submission and reestimates of the underlying

indexes.

in outlays over many years, the inflation rate for budget authority reflects

projected changes in prices over the period during which the budget authority will be spent. The outlay inflation rate, on the other hand, reflects only

price changes for spending in the current year. Table IV-5 shows CBO's

budget authority and outlay inflation rates for the two main components of

the defense budget—pay and purchases.

Using CBO's inflation estimates for defense, the total amount of bud- get authority needed in 1985 would be $5 billion more than the President

requested to fund the Administration's defense program (see Table IV-6).

Over the 1985-1989 period, a total of $9*.* billion would need to be added to

the President's February budget projections in order to carry out the Administration's program. For procurement accounts, this would result in a need

for additional budget authority of $4.7 billion in 1985 and a total of

$72.4 billion over the five-year period. For 1985, the required addition

would be partially offset by decreases resulting from lower inflation estimates than those used by the Administration in certain other accounts.

51
TABLE IV-6. AMOUNT BY WHICH ADMINISTRATION'S DEFENSE

PROGRAM MAY BE UNDERPRICED BECAUSE OF TOO

LOW INFLATION ESTIMATES (By fiscal year,

in billions of dollars)

Five-Year

1985 1986 1987 1988 1989 Total

O&M

Budget Authority 0.6 1.5 2.8 4.0 5.6 14.5

Outlays 0.4 1.2 2.4 3.6 5.1 12.7

Procurement Budget

Budget Authority 4.7 8.8 13.6 19.1 26.1 72.4

Outlays 1.2 3.2 6.2 10.2 15.0 35.8

All Other Budget

Budget Authority -0.3 0.4 1.2 2.4 3.7 7.4

Outlays -0.4 0.1 0.8 1.7 2.9 5.1

Total

Budget Authority 5.0 10.7 17.6 25.5 35.4 94.4

Outlays 1.2 4.5 9.4 15.5 23.0 53.5

SOURCE: Compiled by CBO from data supplied by the Department of

Defense, and CBO.

Potential Reductions

Much of the current debate about the Administration's defense budget

is motivated by efforts to reduce projected deficits. It is important to

understand that funds for some defense programs are appropriated in one

year, but are spent over a number of years. Thus, a decision to cancel some

investment programs in the 1985 budget would produce only small outlay

savings in 1985 compared with the changes in the total amount of funds

requested. The following breakdown of the source of defense outlays in the

1985 budget helps to illustrate this problem.

o 36 percent ($97 billion) of national defense outlays for 1985

result from budget authority provided in 1984 (including proposed

supplemental) and earlier years.

52
o 33 percent ($90 billion) of 1985 outlays relate to proposed 1985

budget authority for pay and benefits for military and civilian

defense personnel.

o 17 percent ($48 billion) of 1985 outlays are for operating and

support costs, including training, logistics, and various personnel

support activities that sustain current force readiness.

o 14 percent ($39 billion) of 1985 outlays stem from 1985 budget

authority for modernization through new weapons procurement, research and development, and military construction.

Reducing the $97 billion of 1985 outlays from prior-year budget auth- ority would require cancellation, delay, or termination of programs already

approved, often already under contract, and, in some cases, partially manu- factured. Substantial financial penalties could result if the government can- celed orders for partially built weapons or if the rate of production was

substantially slowed. The preponderance of programs in this category repre- sent fully funded orders for major weapons systems and construction that

expend appropriations over several years. These characteristics mean that

1985 outlay savings would be only a small portion of the ultimate outlay

reductions from cutting such programs.

Similar problems affect other categories. For example, if none of the

$107.9 billion in budget authority requested for weapons systems procure- ment was appropriated in 1985, outlays in that year would decline by less

than $16 billion, because so much of the budget authority would be spent

after 1985 when most production would occur. Thus, to achieve a high

proportion of 1985 outlay savings from the Administration's 1985 request

would require cuts in readiness items rather than investments to improve

future modernization. Immediate outlay effects could be obtained by trim- ming purchases with relatively short order-to-delivery times, such as fuel, spare parts, and depot maintenance—all of which would affect current read- iness—or by cutting personnel levels, which would reduce current force

levels.

Figure IV-3 shows that the basic structure of defense outlays does not

change much between 1984 and 1989 except that the share of outlays from

prior years' funding increases each year. The growing share of outlays from

prior years means that the Congress has less and less control over outlays in

each budget year under consideration. Given this unfavorable trend and the

difficulty in achieving immediate outlay savings, clearly reducing the deficit

by reducing defense spending would require a multiyear approach. For 1985, the Administration has requested $223 billion in budget authority for nonpay

purchases; the outlays from this budget authority would total $86 billion in

53
Figure IV-3.

Composition of National Defense Outlays

400

300

* 200

100

$419.3

$387.4

$325.5

$315.3

$273.5

$234.6

Current

Investments

Current

Operations

Pay and

Retired Pay

Prior

Years3 *"

i 3%

17%

34%

§14%

W//////M

:

:S 17%;:;

36%

'•:•••: 17% '••:•:

38%

18%

40%

18%

41%

18%

41%

1984 1985 1986 1987

Fiscal Years

1988 1989

SOURCE: Congressional Budget Office.

'Outlays from prior years' budget authority.

1985, $74 billion in 1986, $35 billion in 1987, and lesser amounts each year

thereafter. So, in making decisions on these programs for 1985, Congress

affects 1986 outlays almost as much as it affects 1985 outlays.

In order to illustrate some of the choices that the Congress has if it

wishes to reduce the 1985 defense budget, Table IV-7 shows some options

assuming fixed growth rates. While these options illustrate the outlay impact of various approaches to reducing the defense budget, they do not

address a more difficult question that the Congress would face: which spec- ific programs and systems should be cut to obtain reduced funding? One set

of options can be found in Chapter II of the CBO report, Reducing the

Deficit; Spending and Revenue Options (February 1984).

The next section of this chapter indicates which major accounts receive the real growth requested in the 1985 budget and serves as an intro- duction to subsequent sections describing the Administration's budget in

more detail and comparing it to previous plans.

54
TABLE IV-7. COMPARISON OF THE CBO REESTIMATE OF THE

ADMINISTRATION'S 1985 DEFENSE BUDGET WITH

ALTERNATIVE BUDGET ASSUMPTIONS (By fiscal year, in

billions of dollars)

Cumulative

Spending Level

Administration's Request

Budget Authority

Outlays

Savings

0 Percent Real Growth

Budget Authority

Outlays

1 Percent Real Growth

Budget Authority

Outlays

2 Percent Real Growth

Budget Authority

Outlays

3 Percent Real Growth

Budget Authority

Outlays

4 Percent Real Growth

Budget Authority

Outlays

5 Percent Real Growth

Budget Authority

Outlays

1985

314

273

1986

359

315

1987

389

352

1988 1989

422

387

456

419

Five- Year

Savings

Under Alternative Assumptions

34

11

31

10

28

9

26

8

23

7

20

7

62

32

56

29

50

26

44

23

38

20

31

17

73

51

64

45

54

40

44

34

34

28

23

22

86

66

73

57

59

48

44

39

29

29

14

19

101

81

83

68

64

55

44

41

24

27

3

13

356

241

306

210

255

178

202

145

148

112

92

78

SOURCE: CBO and data supplied by the Department of Defense.

55

30-778 O - 84 - 5
GROWTH IN DEFENSE APPROPRIATION REQUEST FOR 1985

The Administration's request for defense appropriations for 1985 totals

$313.7 billion, which is $49.2 billion more than its 1984 request. After ad- justing for the costs of projected inflation, estimated to be $15.5 billion by

CBO, this increase would provide real growth of $33.7 billion or 12 percent

above 1984 levels. Although this increase is large by historical standards, it

is roughly $16 billion less than the levels for defense appropriations for 1985

projected by the Administration a year ago.

One way to analyze the Administration's defense budget is to examine

the sources of real growth in the budget. As shown in Table IV-8, the bulk

of requested real growth in defense falls in the categories of procurement

and of research, development, testing, and evaluation (RDT&E). This re- flects a continuation of the Administration's emphasis on modernization of

military equipment and expansion of forces. This section discusses the

nature of requested real growth in defense more fully. Defense real growth

from 1984 to 1985 is summarized by appropriation categories in Table IV-9.

Procurement Plans

Under the Administration's 1985 defense budget, procurement approp- riations would increase by about $16 billion in real terms from 1984 to 1985.

TABLE IV-8. SOURCES OF GROWTH IN DEFENSE APPROPRIATIONS

REQUEST FOR 1985 (In billions of dollars)

Amount of

Category Increase

Real Growth

Procurement 16.0

Operations and Maintenance 7.3

Research, Development, Test and Evaluation 5.7

Other 4.7

Subtotal 33.7

Cost of Projected Inflation 15.5

Total 49.2

SOURCE: Compiled by CBO from data supplied by the Department of

Defense and using CBO inflation assumptions.

56
TABLE IV-9. REAL GROWTH IN DEFENSE BUDGET AUTHORITY AND OUTLAYS, BY

APPROPRIATION CATEGORIES (By fiscal year, in billions of dollars)

1985

Real Growth in

Budget Authority a/

Category

Department of Defense

Military

Military personnel

Budget authority

Outlays

Operations &

maintenance

Budget authority

Outlays

Procurement

Budget authority

Outlays

RDT&E

Budget authority

Outlays

Military construction

Budget authority

Outlays

Family housing

Budget authority

Outlays

Revolving funds

Budget authority

Outlays

Other DoD

Budget authority

Outlays

Total, DoD

Budget authority

Outlays

Atomic Energy Defense

Activities

Budget authority

Outlays

Defense-Related Activities

Budget authority

Outlays

Total

Budget authority

Outlays

1984

Request

63.9 c/

63. 4

70. 4

68.1

85.2

64.1

26.9

24.0

4.5

4.0

2.7

2.3

2.5

0.8

1.2

1.2

257.3

227.9

6.7

6.1

0.5

0.5

264.5

234.6

President's

Budget

Request

67.8

67.1

80.9

77.5

107.9

79.8

34.0

29.7

7.2

4.7

3.2

2.7

1.8

1.8

2.5

2.4

305.3

265.7

7.8

7.2

0.6

0.5

313.7

273.5

Billions

of

Dollars

2.1

—

7.3

16.0

5.7

—

2.4

—

0.3

-0.9

—

d/

—

32.9

—

0.7

—

0.1

—

33.7

~~" •"

Percents b/

4.2

—

10.0

17.4

20.1

50.8

—

12.2

-33.7

—

d/

12.0

—

10. i

—

19.6

12.0

"~ — "*

SOURCE: Compiled by CBO from data supplied by the Department of Defense and CBO.

a. Real growth computed using CBO's economic assumptions and the President's pay-raise

assumptions. b. Individual percentage calculations are not weighted and therefore are not additive. c. These amounts include 1984 retirement accruals for comparability with 1985. d. Since the amounts in this category include offsetting receipts and the allowance for

1985 pay raises, real growth computations are not meaningful.
Increases are proposed in the following areas: aircraft and missiles, includ- ing strategic systems such as the MX missile, B-l bomber and tactical air- to-surface, surface-to-air, and surface-to-surface missiles; fighting

vehicles; light armored vehicles; readiness and sustainability items, such as

spare and repair parts and ammunition; modifications of existing equipment;

and investment in communications, electronics, vehicles, and other support

equipment.

Aircraft. Table IV-10 shows that aircraft purchases planned through

1986 would steadily increase above 1983 levels. The Administration pro- poses buying 147 more aircraft in 1985 than in 1984. Requests for AH-64

attack helicopters and other Army aircraft, such as transport helicopters

and reconnaissance aircraft, increase by 46 aircraft, although 6 fewer UH- 60 assault-support helicopters would be purchased. Except for increases in

AV-8B attack aircraft and aircraft such as trainers and transports, requests

for Navy and Marine Corps aircraft in 1985 are relatively unchanged from

the levels funded for 1984. The most significant changes in the Air Force

program are the projected increases for purchases of F-16, F-15, B-1B, and

C-5 aircraft.

The Administration's plan for 1986 projects buying 208 more aircraft

than in 1985. This proposed increase is about equally divided between the

Navy and the Air Force. The plan would fund increased purchases of F/A- 18, AV-8B and other aircraft such as trainers and transports for the Navy

and Marine Corps. In 1986, the Air Force plans to increase the level of

orders for F-16, F-15, B-1B, KC-10, C-5B and trainer aircraft. Army orders

for CH-47 helicopters and RC-12 aircraft would decrease from the amount

requested in 1985.

Missiles. The request for all strategic and theater nuclear missiles for

1985 is 194 missiles less than the number funded for 1984. As shown in

Table IV-11, the Air Force requests fewer strategic and theater nuclear

missiles overall than in 1984, but the Army and Navy plans to buy more of

these missiles. The Army's request reflects increased procurement of

Pershing II missiles. The Navy plans to buy more Tomahawk missiles in 1985

compared to 1984 but proposes to make no further new purchases of Trident

I missiles in 1985. Projected changes include no further purchases of air- launched cruise missiles and increased purchases of MX missiles.

The Defense Department's procurement plan for unclassified purchases

in 1986 is relatively unchanged from the plan for 1985, except for planned

purchases of MX missiles.

The Administration's request for purchases of tactical missiles in 1985

includes the acquisition of four groups of missiles:

58
TABLE IV-10. AIRCRAFT ACQUISITION PLANS, BY SERVICE (By fiscal

year, in units procured)

Aircraft Type 1983 1984 1985 1986

Army

AH-64 helicopter 48 112 144 144

UH-60 helicopter 96 84 78 78

EH-60 helicopter — 12 18 a/

Other aircraft 31 6 20 —

Subtotal 175 214 260 222

Navy/Marine Corps

F/A-18 aircraft 84 84 84 102

F-14 aircraft 24 24 24 24

AV-8B aircraft 21 27 32 46

A-6E aircraft 8 6 6

EA-6B aircraft 686 6

CH-53E helicopter 11 11 10 14

SH-60B helicopter 27 21 18 18

Other aircraft 93 51 107 b/ 198

Subtotal 274 232 287 408

Air Force

F-16 aircraft 120 144 150 216

F-15 aircraft 39 36 48 60

B-1B aircraft 7 10 34 48

KC-10 aircraft 8 8 8 12

E-3A aircraft 2

C-5B aircraft 1 4 10 16

TR-1 aircraft 554 1

Other aircraft 15 18 17 43

Subtotal 197 225 271 396

Total 646 671 818 1,026

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

a. Excludes purchases that are classified.

b. Excludes tentative purchases of from 2 to 6 used C-9 aircraft.

59

30-778 0-84- 6
Air-to-air missiles, which include Air Force and Navy versions of

Sparrow and Sidewinder, the Navy Phoenix and Sidearm, and the

Air Force advanced medium range air-to-air missile (AMRAAM).

Air-to-surface missiles, which include Army and Navy purchases

of Hellfire, and Air Force and Navy versions of Maverick and

high-speed anti-radiation missiles (HARM), as well as purchases of

Harpoon missiles for the Air Force.

TABLE IV-11. STRATEGIC AND THEATER NUCLEAR MISSILE ACQUISITION PLANS, BY SERVICE (By fiscal year, in units

procured)

Missile Type 1983 1984 1985 1986

Army

Pershing II

Navy

Trident I

Tomahawk

Subtotal

91

62

_5J.

113

70

52

124

176

93

180

180

a/

180

180

Air Force

MX

Air-launched cruise missile 330

Ground-launched cruise

missle 84

Subtotal 414

Total 618

21

240

120

381

627

40

120

160

433

48

120

168

348

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

a. Quantity classified.

b. Program terminated in favor of a classified radar evading version

which is not included in this table.

60
o Surface-to-air missiles, which include the Army Patriot and Chap- parral, Navy Rolling Airframe missile (RAM), and Marine Hawk, as well as purchases of Stinger for the Army, Marines, and Air

Force.

o Surface-to-surface missiles, which include Army and Marine pur- chases of TOW anti-tank missiles (which can also be used as air- to-surface missiles), Navy purchases of Harpoon ^/ and Standard

missiles, and Army purchases of rockets for the Multiple Launch

Rocket System.

Table IV-12 shows that the number of tactical missiles would increase

steadily from 1983 to 1986. The Administration requests 22,500 more tact- ical missiles in 1985 than were funded for 1984. About 64 percent of the

proposed increase is in relatively inexpensive rockets for the Multiple

Launch Rocket System. The Administration also requests more air-to- surface missiles, surface-to-air missiles, and surface-to-surface missiles in

1985, than in 1984, but would buy fewer air-to-air missiles.

Defense Department plans for 1986 propose a 39 percent increase, or

about 37,000 more tactical missiles than the total plan for 1985. Again, about 60 percent of the proposed increase would be for purchases of rockets

for the Multiple Launch Rocket System. DoD proposes to buy more of all

missile types in 1986 than were requested for 1985.

Armored Vehicles. Armored combat vehicles include tanks, fighting

vehicles, light armored personnel carriers, and ancillary armored recovery

vehicles. The Administration's armored combat vehicle program emphasizes

acquisition of two "families" of vehicles (see Table IV-13):

o Heavy combat vehicles dedicated for use by Army forces in Europe

committed to NATO; and

o Light armored vehicles for both the Army and the Marine Corps to

support the heavy combat vehicles committed to NATO and to

strengthen the Rapid Deployment Force, primarily for deployment

in the Middle East.

The major 1985 change for heavy combat vehicles is a reduction of 120

M-l tanks from the level funded for 1984. Proposed quantities for the tank's

companion fighting vehicles would increase in 1985 by 110, however. The

budget proposes increased quantities of field artillery ammunition support

4. Harpoon missiles can be air-launched as well as sub-surface launched.

61
TABLE IV-12. TACTICAL MISSILE ACQUISITION PLANS, BY TYPE AND

SERVICE (By fiscal year, in units procured)

Missile Type 1983 1985 1986

Air-to-Air Missiles

Navy

Air Force

Subtotal

Air-to-Surface Missiles

Army

Navy

Air Force

Subtotal

Surface-to-Air Missiles

Army

Navy/ Marine Corps

Air Force

Subtotal

Surface-to-Surface Missiles

Army

Navy/Marine Corps

Subtotal

Total

1,228

3,107

*,335

3,971

250

1,029

5,250

1,293

1,771

3,06—*

35,6*0

2,373

38,013

50,662

1,310

2,705

*,015

*,651

785

2,321

7,757

1,6*5

1,091

60

2,796

5*, 000

3,703

57,703

72,271

2,650

17*

2,82*

6,026

2,031

5,*56

13,513

2,9*5

1,330

156

*,*31

68,*72

5,556

7*, 028

9*, 796

3,630

1,0*2

*,672

6,576

3,783

9,682

20,0*1

7,582

2,672

10,25—*

90,000

6,80*

96,80*

131,771

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

vehicles for the Army and "off-the-shelf" light armored vehicles for the

Marine Corps. Reduced purchases of light command post carriers and

armored personnel carriers are also planned.

The plan for 1986 includes about 260 fewer armored vehicles than the

total requested for 1985. It does include increases in fighting vehicles and

medium recovery vehicles, but no planned purchases of light command post

carriers, armored personnel carriers, or light armored vehicles.

62
TABLE IV-13. ARMORED COMBAT VEHICLE ACQUISITION PLANS, BY

TYPE AND SERVICE (By fiscal year, in units procured)

Vehicle Type 1983 1984 1985 1986

Heavy Combat Vehicles

Army

M-l tanks 855 840 720

Fighting vehicles 600 600 710

Subtotal 1,455 1,440 1,430

Light Armored Vehicles

Army

M-l 13 armored personnel

carriers 520 125 50

Light command post carriers « 250 167

Field artillery ammunition

support vehicles 54 120 170 230

M-88A1 medium recovery

vehicles 180 180 180 180

LAV-25 light armored

vehicles 36 -^ ^ ^

Subtotal 790 675 567 410

Marines

Light armored vehicles

Total

134

2,379

236

2,351

292

2,289

„

2,030

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

Procurement of Readiness Related Items. Procurement programs devoted to readiness of military forces include spare and repair parts, support

equipment, facilities, and munitions necessary to keep military forces ready

for combat in peacetime and to sustain their operations once combat begins.

In past years, funding for readiness has often been reduced to pay for pro- curement of aircraft, tanks, and ships. Both the Reagan and Carter Admin- istrations, however, have been committed to raise funding for readiness.

63
As shown in Table IV-14, the proposed funding for readiness items in

1985 would increase by about $4.3 billion over the level funded for 1984. Similarly, the planned level for 1986 expenditures is about $2.7 billion higher

than the 1985 total. In each year, proposed funding for spare parts, support

equipment, and facilities would receive the larger share of the increase.

Ships. The Administration continues its ambitious shipbuilding and

conversion program. As Table IV-15 shows, its plan calls for 142 ships to be

constructed, converted, modified, or leased between 1985 and 1989. The

proposed budget for shipbuilding and conversion increases from $11.4 billion

in 1984 to $13.1 billion in 1985. The 1985 request for 29 ships reflects a net

increase of seven ships over those funded in 1984. The Administration's

funding request for major warships reflects the following increases above

1984 levels: one additional destroyer, reactivation of a battleship, one

complete overhaul of an aircraft carrier, and one attack submarine. The

1985 request also reflects procurement of one less frigate and four fewer

support ships than in 1984.

Research and Development (R&D)

The Administration's 1985 appropriations request for R&D is

spread across nearly all defense elements, but is concentrated in advanced

TABLE IV-14. PROPOSED FUNDING FOR READINESS ITEMS (By fiscal

year, in billions of 1985 dollars)

Readiness Category 1983 1984 1985 1986

Spare Parts, Support Equipment, and Facilities

Munitions a/

Total

13.7

3.8

17.5

15.4

3.5

18.9

18.6

4.6

23.2

20.1

5.8

25.9

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

a. Navy ammunition was included in ordinance support equipment and

aviation support equipment in the budget documentation.

64
TABLE IV-15. ADMINISTRATION'S NAVY SHIPBUILDING PROGRAM

FOR 1985-1989 (By fiscal year, in units procured)

Funded 1985-1989

Ship Type 1984 1985 1986 1987 1988 1989 Total

Trident Submarines 11111 1 5

Other Major

Warships a/ 6 10 7 12 11 12 52

Amphibious Ships b/ 22336 6 2 0

Mine Warfare

a n d Patrol Ships c/ 54854 4 2 5

Auxiliaries _8 12 10 _5 _6 _7 40

Total b/ d/ 22 29 29 26 28 30 142

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

a. Includes service life extension program for one conventional carrier in

1985 and 1987, but no nuclear carriers.

b. Total excludes Landing Craft Air Cushion (LCAC) ships—57 over the

1985-1989 period.

c. Includes frigates.

d. Includes planned reactivations and conversions.

technology and tactical programs. Advanced technology programs explore

alternative designs before development of specific hardware or software

systems. Major programs include Strategic Defense Initiatives—the so- called "star wars" program—very high speed integrated circuits, aircraft

propulsion, ship propulsion, and aircraft avionics. Major levels of peacetime

tactical research programs include a derivative of the F-15 or F-16 aircraft,

a modernized version of the F-14, an advanced tactical fighter, as well as

joint Army/Air Force programs for target acquisition and use of new missiles to strike targets behind enemy lines.

Operations and Maintenance

The proposed real increase of $7.3 billion in 1985 over 1984 for operations and maintenance (O<5cM) appropriations would support higher levels of

65
peacetime activity for aircraft flying time, naval operations at sea, and

other activities. Among the military services, the Navy shows the largest

gain in proposed funding. Much of this increase would be applied to depot

maintenance and the support necessary to sustain a planned increase to

annual ship operations of about fifty thousand hours at sea, or 3.5 percent

more than proposed for 1984. The Air Force program would fund increases

to space support programs, logistics programs, and operations support for

over 200 thousand added aircraft flying hours—an increase of about 3.6

percent over the number funded in 1984. The increase in Army O&M

appropriations primarily reflects the costs of continuing the Army

modernization program and increases in battalion and individual training.

Military Personnel

The military personnel account contains $2.1 billion, or 4.2 percent, real growth in 1985. Most of this increase comes from the request for an

additional 29,900 active and 52,200 selected reserve personnel. Included in

this amount is $200 million for grade enrichment. _5/

Other Accounts

The $2.4 billion proposed real increase in military construction from

1984 to 1985, shown in Table IV-9, results partly from the continuation of

the facilities modernization program begun in 1981. The 1985 program

includes some support facilities for Pershing II and the ground-launched

cruise missile that were deleted by Congress from the 1984 request. Military construction for other weapons systems, notably the Trident

submarine, MX, B-1B and KC-10, also explains part of the increase.

Requests for atomic energy defense accounts are increased in 1985

over the levels funded for 1984 by $0.7 billion in real terms, or 10.1 percent

using CBO's deflator. Other 1985 requests for DoD spending for military

family housing, revolving funds, and defense related activities decline in

real terms by about $0.5 billion from the 1984 plan.

Another way to analyze the current defense budget is to study the

changes relative to the defense projections for 1985 that the Administration

made last year. This analysis shows that the Administration has scaled

5. Grade enrichment represents an increase in the average grade level

from one year to the next. Grade enrichment builds upon itself year

after year. This year's increased grade structure comes on top of a

$122 million grade enrichment from last year.

66
down its defense program somewhat, primarily by reducing its plans for

procurement and RDT&E. The next section examines these changes in the

scope of the Administration's defense plans.

CHANGES FROM THE 1984-1988 DEFENSE PLAN FOR FISCAL YEAR 1985

The Administration's defense request for 1985 is significantly larger

than its current estimates for 1984. Yet, it also is somewhat scaled down

from the Administration's projection of defense appropriations for 1985- 1988 that was submitted last year. For example, defense budget authority

now is $16.6 billion less in 1985 and $41.6 billion less over the period. As

shown in Table IV-16, the 1985 budget request reflects a reduction of

$19.0 billion from previously proposed funding for procurement, military

construction, operations and maintenance, pay, military personnel, family

housing, and atomic energy defense activities. These reductions would be

partially offset by proposed increases in research and development and other

activities for a net decrease of $16.6 billion.

Undoubtedly the Administration's reduction in defense plans was partly

a response to the reductions made by the Congress in the fiscal year 1984

budget. A portion of the reduction, however, reflects the fact that the

Defense Department now projects lower pay-raise costs and lower unit costs

for purchases of major weapons. These two considerations permit a

reduction in projected costs of defense programs without reducing tangible

goods or services devoted to defense. The vast majority of reductions, however, are achieved by slowing the growth of investment in new weapons

and equipment.

This section provides a detailed discussion of the changes in the

defense program as a result of the Administration's scaled-down plan. The

section also examines the Defense Department's projections of reductions in

unit costs of major weapons purchases.

Program Decreases

In the aggregate, requested budget authority for purchases of

individual weapons systems in 1985 is $12.1 billion less than corresponding

projections a year ago. Of this reduction, $2.4 billion reflects anticipated

savings from lower unit procurement costs projected by DoD for major

weapons purchases. The remainder reflects actual reductions in

procurement plans. Unfortunately, the exact amount of these reductions

cannot be identified by individual programs because the total appropriations

projected for defense procurement by the Administration last year was

$3.1 billion less than the sum of its projections of costs for individual

67
TABLE IV-16. ADMINISTRATION CHANGES TO 1985 DEFENSE BUDGET

BETWEEN JANUARY 1983 AND FEBRUARY 198* (Budget

authority in billions of dollars)

Administration Proposals

1985 budget (February 198*) 313.*

1984 budget (January 1983) 330.0

Total net change -16.6

Net Decreases

Procurement -12.1

Construction of facilities -2.7

Operations and maintenance -2.2

Pay raises -1.1

Military personnel -0.*

Family housing -0.3

Atomic energy defense activities -0.2

Subtotal, decreases -19.0

Net Increases

Research and development 1.8

Other increases 0.6

Subtotal, increases 2.*

Total net change -16.6

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

programs. Because of this anomaly, the following subsections identify only

the gross amount of reductions without benefit of the allocation of the

undistributed reduction of $3.1 billion. Oddly, the opposite of this anomaly

has surfaced in the current defense budget, because the aggregate

procurement costs now projected by the Administration for 1986 is roughly $2 billion more than the sum of the individual procurement programs

detailed in the budget.

Aircraft. As shown in Table IV-17, the Administration requests 82

fewer aircraft purchases than previously planned for 1985, thereby saving

68
TABLE IV-17. ADMINISTRATION CHANGES FOR AIRCRAFT

PROCUREMENT PLANS BETWEEN 3ANUARY 1983 AND

FEBRUARY 1984 (By fiscal year, in units procured)

Aircraft Type 1985 1986

Combat Aircraft

Navy/Marine Corps

F/A-18 -8 -4

F-14 — -6

A-6E — -6

AV-8B -16 -14

Air Force

F-15 -24 -36

F-16 30 36

Other Aircraft -64 -19

Total -82 -49

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

about $4.6 billion in budget authority for 1985. This reduction includes 24

fewer combat aircraft for the Navy.

The Navy plans to purchase 287 aircraft in 1985, some of which are for

the Marine Corps. Navy procurement planning data, however, indicate that

at least 324 aircraft should be procured annually to maintain both the

strength and the present average age of current carrier air wings. 6/ Thus, if procurement quantities continued at this rate, there would not be enough

aircraft to sustain the current 13 carrier air wings or to begin the proposed

increase to 14 carrier air wings by 1987.

In 1985, the Air Force plans to procure 198 fighter aircraft, which is

six more than the 1984 plan. Air Force procurement planning data indicate

6. Each carrier air wing typically contains about 86 aircraft.

69
that 265 aircraft should be purchased annually to sustain both the size and

the average age of the 40.5 tactical and air defense wing equivalents now

planned for 1985. 7/ If the procurement quantities continued at the 19S5

requested rate, there would not be enough aircraft to sustain the existing air

wings or to begin the Air Force's proposed increase to 40 air wings by 1989. The Air Force objective of 40 air wings by 1989 has slipped from its previous

goal of 41 wings by 1988.

Missiles. The Administration has reduced its planned procurement of

missiles thereby saving roughly $3 billion in budget authority for 1985

relative to last year's plan. As shown in Table IV-18, this year's defense plan

reduces planned purchases of the Tomahawk strategic missiles for 1985 and

1986. The 1985 plan proposes buying nearly 1,700 fewer tactical missiles in

1985 compared with last year. Procurement of many individual systems

would be reduced, but the largest planned decreases are for the IIR

Maverick, missile-launched laser-guided bombs, Stinger, Standard missiles, and Patriot systems. The Administration's new plan for the Air Force

proposes over 1,000 fewer missile purchases for 1986 compared with the

previous projection for the same year. Reductions in IIR Mavericks and

missile-launched laser-guided bombs would be partially offset by proposed

increases in purchases of Navy tactical missiles, such as Sparrow, Laser

Maverick, TOW, HARM, and Hellfire missiles.

Ships. The current shipbuilding plan for 1985 proposes two more newly

constructed ships than were proposed in last year's plan. Both are support

ships costing less than $300 million. Despite this increase, the Administra- tion projects the shipbuilding account to be $1.6 billion lower than last

year's plan for 1985, primarly as a result of estimated lower costs per ships. For 1985-1988, the latest shipbuilding plan cuts 11 from the number of new

construction ships to be built, including four major warships. Table IV-19

shows this reduction by category of ship.

Last year's shipbuilding plan was presented as the level of construction

needed to meet the goal of a modern navy of 600-plus ships with 15 carrier

battle groups by 1990. This goal could still be achieved with the revised

shipbuilding plan. The pace of modernization would be much slower, however, particularly for major warships.

Armored Vehicles. The Administration's proposed 1985 reduction in

procurement of weapons and tracked combat vehicles would save about

$500 million from last year's plan. Proposed purchases of the M-l tank's

companion fighting vehicle have been reduced by 120 and 180 vehicles in

7. Each wing typically contains three squadrons of 24 aircraft each.

70
TABLE IV-18. ADMINISTRATION CHANGES FOR MISSILE PRO- CUREMENT PLANS BETWEEN JANUARY 1983 AND

FEBRUARY 1984 (By fiscal year, in units procured)

Missile Type 1985 1986

Strategic a/

Navy

Tomahawk -173 -248

Air Force

MX 3 --

Subtotal, Strategic -170 -248

Tactical

Army -480 -943

Navy/Marine Corps -12 1,864

Air Force -1,197 -1,018

Subtotal, Tactical -1,689 -97

Total -1,859 -345

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

a. Excludes purchases of Pershing II missiles because quantities are

classified in 1986.

1985 and 1986, respectively. In addition, previous plans to purchase 281

light armored vehicles in 1985 and 256 in 1986 were cancelled in this year's

budget.

Decrease in Projected Unit Costs of Weapons. A significant change in

the 1985 budget is DoD's projection of decreases in the unit costs of major

weapons systems. CBO's preliminary analysis of 74 major systems in the

Administration's budget indicates that unit prices have decreased

$2.4 billion from previous projected costs for 1985.

Defense purchases have experienced significant cost growth in recent

years. Actual inflation frequently has been higher than expected. In

addition, unbudgeted program changes (such as new specifications or revised

production schedules) and underestimation of required resources, such as

71
TABLE IV-19. ADMINISTRATION CHANGES BETWEEN JANUARY 1983

AND FEBRUARY 1984 FOR NEW CONSTRUCTION IN

NAVY SHIPBUILDING PLAN FOR FISCAL YEARS 1985- 1988 (In units procured)

Ship Type 1985 1985-1988

Nuclear Carriers — -1

Destroyers — -1

Attack Submarines — -2

Amphibious Assault — -1

Mine Warfare — 1

Support _2 -7

Total 2 -11

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

manufacturing hours, material, and labor costs, has resulted in unit cost

growth. DoD has dubbed these latter phenomena collectively "real cost

growth"—that is, the portion of growth not related to general price

increases.

After recognizing the cost growth problem in major weapons systems, the Administration instituted a number of acquisition initiatives to restrain

real cost growth. Sufficient information does not yet exist to evaluate fully

the success of these initiatives. The data presented below, however, suggest

that real cost growth declined for many major weapons systems during 1983, if DoD's unit cost projections prove to be accurate. As explained earlier, the sum of the DoD estimates of costs for individual systems last year was

$3.1 billion more than the total procurement budget for 1985. Because of

this anomaly, the $2.4 billion reduction from lower unit costs can only be a

very crude calculation without the benefit of the allocation of the

$3.1 billion to specific programs. Justification material included with the

1985 budget does not provide any explanation. CBO will further examine

this cost-growth issue when it receives the latest Selected Acquisition

Reports, which are due in March.

Table IV-20 provides cost-growth data for 74 major weapons systems

by comparing 1985 unit costs as initially projected by the Administration in

January 1983 against estimates contained in the current 1985 budget. The

72
TABLE IV-20. ADMINISTRATION CHANGES IN 1985 MA3OR WEAPONS SYSTEMS

COSTS BETWEEN JANUARY 1983 AND FEBRUARY 1984 (in millions of

dollars and percents)

Procurement

Unit Cost

Weapon System January 1983

Programs with Decreases

Laser Maverick missile,

Navy

Harpoon missile, Air Force

HARM missile, Navy

Stinger missile, Army

MX missile

LSD-41 ship dock

SH-2F helicopter

P-3C aircraft

35 Other Systems

Showing Unit

Price Decreases

Subtotal, decreases

for 43 systems

Programs with Increases

Tomahawk missile

TR-1 aircraft

T-46 aircraft

Light armored vehicle, Navy

Patriot missile

AMRAAM missile, Air

Force

Fighting vehicle

F-15 aircraft

23 Other Systems

Showing Unit

Price Increases

Subtotal, increase

for 31 systems

Total Impact of 74

0.36

0.81

0.58

0.13

106.96

347.65

15.55

66.78

—

1.95

36.56

7.43

0.70

1.44

1.77

1.19

34.70

Systems

Procurement

Unit Cost Percent

February 1984 Change a/

0.18

0.47

0.39

0.09

73.47

243.00

11.73

51.48

—

3.04

55.65

11.02

0.94

1.87

2.17

1.45

41.15

-49

-41

-34

-33

-31

-30

-25

-23

—

—

56

52

48

34

30

23

21

19

—

—

Cost Impact

on

1985 Budget a/

-107

-28

-159

-103

-1,339

-209

-23

-138

-1,946

-4,053

196

76

36

70

252

70

182

310

445

1.637

-2,416

SOURCE: Compiled by CBO from data supplied by the Department of Defense.

a. Percent change and cost impact were calculated before rounding procurement

unit costs.
table shows a net projected cost decrease of $2.4 billion since last year, compared with projected increases of $2.6 billion for 60 systems in CBC^s

analysis of the 1984 budget and $2.7 billion for 48 systems in CBO*s analysis

of the 1983 budget.

Table IV-20 shows that DoD estimates that the costs for 43 systems

would be about $4 billion lower in 1985 than previously projected for the

same year. The table also shows that 31 systems would experience cost

increases totaling about $1.6 billion.

If the production level of a system has been changed, the change in

unit costs is about what would be expected (see Table 21). In 10 cases

quantities are revised upward and unit costs decline as expected. In 16

cases the production quantity is decreased and unit costs rise as expected. These 16 cases are signficant in that the DoD action in changing the level of

production downward is contrary to the announced DoD policy of

maintaining efficient production rates. The budget justification material

already provided by DoD does not provide an explanation for the unit price

changes.

Other Purchases. The Administration's current plan proposes reduced

appropriations of about $5.6 billion from last year for planned equipment

purchases, including ammunition, support vehicles, communications and

electronics equipment, and Marine Corps and defense agency procurement.

Construction. Military construction programs for 1985 have been re- duced by about $2.7 billion from the $9.9 billion projected by the Adminis- tration in 3anuary 1983. This decrease represents a scaling down of plans

for modernization of troop facilities.

Operations and Maintenance. The proposed funding for operations and

maintenance is $2.2 billion less than the Administration's previous estimates

of $82.4 billion for 1985.

Pay Reductions. The Administration's 1984 defense plan proposed pay

increases for 1985 of about 6.1 percent for civilians and 10.9 percent for

military personnel. The Administration now proposes pay increases of 3.5

percent for civilians and 5.5 percent for military personnel.

Other Decreases. Proposed funding for military personnel, family

housing, and atomic energy defense activities would decline by about

$0.9 billion from last year's plan for 1985.

74
TABLE IV-21. CHANGE BETWEEN JANUARY 1983 AND FEBRUARY

1984 IN QUANTITY AND PROCUREMENT UNIT COST

OF SELECTED WEAPONS IN THE ADMINISTRATION'S

1985 ACQUISITION PLAN (In percents)

Quantity

Weapon System Change

Increasing Quantity and Decreasing Cost

P-3C aircraft

Harpoon missile, Navy

HARM missile, Navy

Tow missile, Navy

Laser maverick missile, Navy

TAGOS Surtass ship

Hellfire missile, Navy

Hawk missile, Marine Corps

F-16 aircraft

Harpoon missile, Air Force

Decreasing Quantity and Increasing Cost

Patriot missile

Pershing II missile

Fighting vehicle

Bushmaster gun

M88A1 recovery vehicle

AV-8B aircraft

Tomahawk missile

Phoenix missile

Stinger missile, Navy

LCAC landing craft

Captor torpedo system

F-15 aircraft

TR-1 aircraft

T-46A aircraft

IIR Maverick missile, Air Force

AMRAAM missile, Air Force

50

4

49

26

224

50

39

14

25

70

-28

-11

-14

-13

-10

-33

-49

-14

-16

-25

-37

-33

-20

-52

-21

-22

Procurement

Unit

Cost

Change

-23

-3

-34

-7

-49

-5

-12

-16

-5

-41

30

18

21

10

6

11

56

6

19

12

29

19

52

48

1

23

SOURCE: Compiled by CBO from data supplied by the Department of

Defense.

75

30-778 0-84- 7
Program Increases

Research and Development. In the aggregate, budget authority for re- search and development (R&D) programs for 1985 increased by about

$1.8 billion over last year's plan. Unfortunately, the exact amount of this

increase cannot be identified by individual program, because the Adminis- tration's previous projections of the total appropriation for RDT&E for 1985

was $2 billion more than the sum of the DoD projections of costs for individ- ual programs.

Other Increases. The Administration's current plan proposes increased

appropriations of $0.6 billion from last year for revolving funds, offsetting

receipts, and other miscellaneous defense activities.

76
CHAPTER V. THE ADMINISTRATION'S NONDEFENSE SPENDING

PROPOSALS

The Administration's fiscal year 1985 budget for nondefense spending

programs—both on- and off-budget—proposes reductions that would lower

outlays relative to CBO baseline projections by an estimated $7 billion in

1985 and by $131 billion from 1985 to 1989 (see Table V-l). This amounts to

a reduction of 4 percent in projected nondefense outlays for the next five

years under current laws and policies, and continues the scaling back of

these programs. Over the past three years, legislative actions to date have

reduced nondefense spending by an average of $70 billion a year over the

1985-1989 period.

Under the Administration's proposals, total nondefense spending

(excluding interest costs) would rise from an estimated $522 billion in 1984

to $549 billion in 1985 and $667 billion in 1989. This represents an average

increase of 5 percent per year, which is less than the projected growth for

the economy. As a result, nondefense spending under the Administration's

proposals would fall from 14.7 percent of GNP in 1984 to 12.4 percent in

1989 (see Table V-2).

The President's proposals for the nondefense programs are summarized

in Table V-l. All proposed changes are shown relative to the CBO baseline. Baseline spending projections are designed to show what outlays would be in

future years if current policies were continued without change. I/

The President's budget proposes total reductions in entitlements and

mandatory programs of $46 billion from 1985 to 1989. The largest proposed

reduction is in farm price supports, where the President's budget proposes

1. For entitlements and other mandatory spending programs and offsetting

receipts, the baseline spending projections assume that current laws

will remain unchanged and that program spending will respond to

assumed economic and demographic changes as in the past. For

discretionary programs, federal spending depends on annual

appropriations actions. The 1985-1989 projections for these

appropriated accounts represent a continuation of the policies and

program levels embodied in the 1984 appropriation. Generally, the

projections assume that budget authority is kept constant in real

terms—that is, to keep pace with a measure of inflation appropriate to

the particular program.

77
TABLE V-l. CBO ESTIMATE OF NONDEFENSE SPENDING REDUCTIONS

IN THE ADMINISTRATION'S 1985 BUDGET PLAN (By fiscal

year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays

Nondefense Programs

Proposed Changes

Entitlements and

Other Mandatory Spending

Nondefense Discretionary

Spending

Offsetting Receipts

Total Changes

President's Budget as

Estimated by CBO

Unified Budget

541 573 613 657 699

-12 -15

-6 -13

535 560

-7

-2

-19

595

-12

-4

-28

629

-17

-6

-38

661

-44

-13

-103

CBO Baseline Outlays

Nondefense Programs

Proposed Changes

President's Budget as

Estimated by CBO

Off-Budget

14 14 15 16 15

* -4 -7 -8 -9

14 8 8

-28

* Less than $500 million.

SOURCE: Congressional Budget Office

78
TABLE V-2. THE ADMINISTRATION'S NONDEFENSE BUDGET AS

ESTIMATED BY CBO (By fiscal year)

Outlays

Entitlement and Other

Mandatory Spending

Social Security and

Railroad Retirement

Medicare and Medicaid

Other Entitlements and

Mandatory Spending

Nondefense Discretionary

Offsetting Receipts

Subtotal, Unified Budget

Off -budget

Total, Unified Budget

and Off -budget

Outlays

Entitlement and Other

Mandatory Spending

Social Security and

Railroad Retirement

Medicare and Medicaid

Other Entitlements and

Mandatory Spending

Nondefense Discretionary

Offsetting Receipts

Subtotal, Unified Budget

Off -budget

1984

in Billions

179

8*

133

157

-46

507

15

522

1985 1986 1987 1988 1989

of Dollars

190

95

138

162

-49

535

14

549

203

105

141

166

-54

560

9

570

217

118

144

174

-58

595

8

603

234

132

148

179

-64

629

8

637

250

147

152

183

-71

661

6

667

as a Percent of GNP

5.0

2.4

3.7

4.4

-1.3

14.2

0.4

4.9

2.4

3.5

4.1

-1.3

13.7

0.4

4.8

2.5

3.3

3.9

-1.3

13.2

0.2

4.7

2.6

3.1

3.8

-1.3

12.9

0.2

4.7

2.6

3.0

3.6

-1.3

12.6

0.2

4.6

2.7

2.8

3.4

-1.3

12.3

0.1

Total, Unified Budget

and Off-budget 14.7 14.0 13.4 13.1 12.8 12.4
freezing target prices at the 1984 crop-year levels mandated in the 1981

Agriculture Act. It is estimated that this proposal would save $15 billion

over the 1985-1989 period compared to CBO's baseline projections. The

President's budget also proposes reducing federal Medicaid and Medicare

spending by $9 billion. In addition, the President is proposing reductions in

spending for federal retirement and disability programs, means-tested

benefits, and other entitlement or mandatory spending. As a result, outlays

in this area would grow at an average rate of 6.7 percent annually from 198*

to 1989, compared to 7.2 percent per year under baseline assumptions.

Outlays under the Administration's request for nondefense

discretionary programs included in the unified budget would grow much

more slowly—at an annual rate of 3.1 percent from 1984 to 1989. As a

result, nondefense discretionary spending would fall $44 billion, or about 5

percent, below the CBO baseline from 1985 to 1989. While a number of

individual programs would have funding reduced or be eliminated entirely, funding for most discretionary programs would be held at about 1984 levels

or increased slowly over the 1985-1989 period. This would result in on- budget nondefense discretionary spending falling from 4.4 percent of GNP in

1984 to 3.4 percent in 1989. Part of the on-budget spending increase, however, reflects a proposed shift in the financing of foreign military

assistance, from off-budget to the unified budget. When adjusted to include

the off-budget effects of this change, nondefense discretionary spending is

projected to grow at an annual rate of 2.6 percent from 1984 to 1989, and

total outlays over this period would fall $62 billion below the baseline.

The President's budget proposes increases in offsetting receipts of $13

billion. Most of this increase^ $11 billion, would come from a proposed

increase in the Supplemental Medical Insurance premiums.

In addition to the savings proposed for activities on the unified budget, the Administration is proposing significant reductions in off-budget

spending. Such spending includes major federal credit activities financed by

the Federal Financing Bank, as well as oil purchases for the Strategic

Petroleum Reserve and Postal Service operations. Under the President's

proposals, outlays for off-budget activities are projected to decline from

$15 billion in 1984 to $6 billion in 1989. Most of this savings reflects

proposed changes in foreign military sales financing, but significant

reductions are proposed for credit programs of the Rural Electrification

Administration and the Farmers Home Administration. As a result, total

off-budget outlay savings would be about $28 billion in 1985-1989.

Each of these major spending categories will be discussed in more

detail in the remainder of the chapter.

80
ENTITLEMENTS AND OTHER MANDATORY SPENDING

Entitlement programs provide benefits to persons, businesses, or units

of government that meet eligibility requirements established in law. Social

Security is the largest single entitlement program with outlays constituting

about 20 percent of the entire federal budget. Other major entitlement

programs include Unemployment Insurance and Railroad Retirement, Civil

Service and Military Retirement and Disability; Medicare and Medicaid; Aid

to Families with Dependent Children (AFDC), Supplemental Security Income

(SSI), and Food Stamps; farm price supports; Veterans' Pensions, Compensation, and Readjustment Benefits; and Guaranteed Student Loans

(GSLs).

Growth in entitlements in the President's budget continues at the

slower rate of the past three years, following very rapid growth in the 1960s

and 1970s. By 1980, entitlements were 10.9 percent of GNP—an increase

from 5.4 percent in 1965. They increased further to 12.4 percent of GNP in

1983, but are projected to decline to 10.2 percent by 1989 under the

President's budget proposals. Legislative cuts, reduced inflation, and lower

unemployment are the main causes of the projected decline in entitlement

outlays relative to GNP.

The Administration's budget shows outlays for entitlements and other

mandatory spending programs increasing by $153 billion over the next five

years, from $396 billion in 1984 to $549 billion in 1989 (see Table V-3). Social Security and Railroad Retirement, Medicare and Medicaid, and

federal employee retirement and disability account for almost all of this

projected increase.

The President's budget proposes legislative reforms to entitlement

programs that would reduce spending by an estimated $4 billion in fiscal

year 1985 and by $46 billion from 1985 to 1989 (see Table V-4). Many of the

legislative proposals contained in this year's budget were also proposed in

previous budgets. The range of entitlement programs targeted for

reductions, however, is smaller than last year. Little or no legislation is

proposed for the major social insurance programs including Social Security, Railroad Retirement, and Unemployment Insurance. The Congress enacted

major reforms to both the Social Security and Railroad Retirement

programs last year. In Unemployment Insurance, the Federal Supplemental

Compensation program was extended through March 31, 1985. The

President's budget does not propose extending the program beyond this date.

Relatively large reductions are proposed in health, federal retirement

and disability, AFDC, Food Stamps, and farm price supports. These and

other legislative proposals are discussed in the following section.

81
TABLE V-3. PROPOSED OUTLAYS FOR ENTITLEMENTS AND OTHER

MANDATORY SPENDING PROGRAMS AS ESTIMATED BY

CBO (By fiscal year, in billions of dollars)

1984 1985 1986 1987 1988 1989

Social Security and

Railroad Retirement 179 190 203 217 234 250

Federal Retirement and

Disability 39 40 43 46 49 52

Medicare and Medicaid 84 95 105 118 132 147

Unemployment Trust Fund 24 22 22 22 20 20

SSI, AFDC, Child Support,

and Food Stamps

Veterans' Programs

Farm Price Supports

General Revenue Sharing

Other a/

Total

29

16

6

5

15

396

29

17

11

5

14

423

31

17

10

5

13

449

32

18

10

5

12

479

34

18

9

5

14

514

35

18

8

5

13

549

a. Includes a variety of programs providing educational assistance,

nutrition assistance, social and rehabilitation services, and aid to

certain businesses.

Federal Retirement and Disability

The President's 1985 budget proposes delaying scheduled cost-of-living

adjustments (COLAs) in all federal employee retirement programs. In

addition, structural changes are proposed for civil service, military, and

foreign service retirement.

82
TABLE V-4. CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED

REDUCTIONS IN ENTITLEMENTS AND OTHER

MANDATORY SPENDING (By fiscal year, in billions

of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline OutlaysEntitlements and Other

Mandatory Spending 427 455 488 526 564

Proposed Changes

Federal retirement

and disability -1 -1 -2 -2 -2 -8

Medicare and Medicaid -1 -2 -2 -2 -2 -9

Food Stamps, SSI, AFDC,

and Child Support -1 -1 -1 -1 -1 -3

Farm price supports * -1 -3 -5 -6 -15

Other a/ ^i -1 ^2 ^3 -3 -10

Total Changes -4 -6 -9 -12 -15 -46

President's 1985 Budget

as Estimated by CBO 423 449 479 514 549

* Less than $500 million.

a. Includes reductions in Guaranteed Student Loans, Federal Employees

Health Benefits, Pension Benefit Guaranty Corporation, Child

Nutrition, Veterans' Compensation, and Rehabilitation Services.

Includes a benefit increase for Veterans' Readjustment benefits.

Civil Service Retirement and Disability. The Administration

recommends the adoption of pending reconciliation legislation, delaying the

COLAs until January of each year. Retirees under age 62 would receive

half of the actual COLA in 1985. The budget also proposes limiting the

COLA to 55 percent for benefits above $10,000 starting in 1985. The

83
$10,000 limit would increase with subsequent COL As. Finally, beginning in

1986, the budget proposes limiting the COLA to the lesser of the change in

federal pay or in the Consumer Price Index (CPI). CBO has estimated

savings of $0.4 billion in 1985 reflecting delay of the 1984 and 1985 COLAs;

1989 savings of $1.6 billion result about equally from the COLA delay and

the COLA reduction for benefits above $10,000 (in 1985 dollars).

In addition, the budget again proposes increasing employee and

matching employer contributions from the current 7 percent to 8 percent in

1985 and to 9 percent thereafter. CBO estimates increased revenues of $0.7

billion in 1985 and $7 billion from 1985 to 1989 as a result. The proposals to

increase revenues and reduce COLAs attempt to close the gap between

contributions to Civil Service Retirement and benefit payments from the

Civil Service Trust Fund. Current projections show 2.0 million annuitants in

1985 but only 2.7 million active employees, and payments of $23.5 billion

but contributions of only $9.2 billion.

Military Retirement. In addition to the COLA delay, the President's

budget proposes changing the calculation of retirement benefits. The

calculation is now based on years of service and final basic pay, which would

be changed to the average of the highest three years of basic pay. This

change would become effective for personnel entering the service after

September 1980 and thus would have almost no budget effect during the

1985-1989 period.

Other Retirement and Disability Programs. The proposed COLA delay

would also affect Foreign Service Retirement, the Retired Commissioned

Health Officers Fund, the Federal Employee Compensation program, and the

Foreign Service Retirement and Disability Fund. In addition to delaying the

COLA, the budget also proposes changes in Foreign Service Retirement

similar to the changes in Civil Service Retirement described above.

Medicare and Medicaid

Medicare and Medicaid are major entitlement programs that provide

federal funding for health services and are the fastest growing programs in

the nondefense budget. Medicare, which includes the Hospital Insurance (HI)

program and the Supplementary Medical Insurance (SMI) program, covers

hospital, physician, and other medical costs for persons aged 65 and over and

for most disabled persons entitled to Social Security cash benefits. Medicaid, through federal and state financing, pays for health services for

low-income persons. In total, Medicare and Medicaid provide benefits to

about 49 million people, at an estimated cost of $84 billion in 1984.

84
The Administration's 1985 budget proposals would curb the growth in

federally funded medical care programs, both by shifting costs to

beneficiaries and by freezing physicians' fees. The Administration's

Medicare and Medicaid proposals would add $20 billion to more than $40

billion in savings for the 1985-1989 period already enacted in the Omnibus

Budget Reconciliation Act of 1981, the Tax Equity and Fiscal Responsibility

Act of 1982, and the Social Security Act of 1983. These reductions included

transfers of Medicare costs to both beneficiaries and providers. Even with

the Administration's latest proposals, federal Medicare and Medicaid

spending is projected to increase by 75 percent between 1984 and 1989, and

rise relative to GNP from 2.4 percent to 2.7 percent.

The Administration's proposed Medicare legislation is targeted mainly

toward decreasing spending in SMI rather than in HI. CBO estimates these

proposals would save $6 billion in SMI, $1 billion in HI, and $11 billion in

premiums over the 1985-1989 period. The SMI proposals include freezing

physicians' fees for one year, indexing the deductible, and delaying

eligibility for one month. The HI proposals include delaying eligibility for

one month, and requiring a copayment for durable medical equipment used

in conjunction with home health care.

Although the Administration's Medicare proposals have been suggested

in previous budgets and have not yet been enacted, Congressional

committees have reported legislation incorporating some of these savings. Last year the House Ways and Means Committee reported a bill (H.R. 4170)

that included a freeze on physicians' fees and an increase in premiums. The

reconciliation bill reported by the Senate Budget Committee (S. 2062)

contained provisions for a freeze on physicians' fees, a premium increase, and an increase in the SMI deductible.

In Medicaid, the President's proposed legislation is estimated to save

$2 billion between 1985 and 1989 relative to CBO's baseline projections. This saving would be achieved largely by extending the current state

Medicaid penalties on excessive cost growth and by requiring nominal

copayments from beneficiaries for many services. These proposals also

were included in last year's budget but have been neither enacted nor

included in House or Senate 1983 reconciliation bills.

Major Means-Tested Transfer Programs

Means-tested transfer programs—Aid to Families with Dependent

Children, Food Stamps, and Supplemental Security Income—provide the

major governmental support to low-income families. Significant reductions

are again proposed for these programs in the President's budget, although

these reductions are well below those in last year's budget. CBO's estimated

85
savings for the President's proposals are $0.6 billion in 1985 and $2.8 billion

over the 1985-1989 period.

In AFDC, Food Stamps, and SSI, the President's proposals were in

general also incorporated in last year's budget. The major proposals

affecting AFDC would require job search and workfare for employable

recipients, reduce benefits to recipient families who share shelter with

nonrecipients, and require all family members with income to be part of the

AFDC unit. In the Food Stamp program, mandatory workfare is proposed, as

are increased error-rate sanctions on the states for overpayments. In SSI, the Administration proposes recapturing overpayments and certain other

duplicate payments from OASDI benefits received by SSI recipients.

CBO's estimated savings for these proposals are about 40 percent less

than the Administration's. The greatest difference is in estimates of

potential savings from the workfare proposals, particularly in AFDC. Workfare requires employable adult recipients to work in exchange for their

benefits. Current CBO estimates show small costs in AFDC from workfare

instead of savings. Whether workfare costs or saves money in AFDC will

not be known until reliable findings of workfare's cost effectiveness become

available.

The Child Support Enforcement (CSE) program serves AFDC and non- AFDC families by enforcing support obligations owed by absent parents to

their children. While not means-tested, it is closely related to AFDC

because collections of support for AFDC children offset AFDC

expenditures. The President's budget includes proposed changes that are

almost identical to the child support provisions in H.R. 4325, which was

passed by the House late in 1983. This bill would require states to use

certain enforcement techniques such as wage withholding. It would also

alter incentive payments to states from 12 percent of AFDC collections to a

range of 4-10 percent of AFDC and non-AFDC collections, the precise

percentage would depend on state ratios of collections to expenditures. In

addition, the Administration proposes to reduce the federal share of CSE

expenditures from 70 percent to 65 percent and to require states to impose

fees for applications and delinquent payments. CBO's estimated savings are

somewhat higher than the Administration's after 1985.

Farm Price Supports

Agricultural price supports provide price and income protection to

farmers. Expenditures are made through a number of agricultural

commodity programs designed to support and stabilize farm prices and

incomes. The programs use several tools, including commodity loans and

purchases, direct payments, and supply controls. The principal commodities

86
covered by these programs are wheat, corn and other feed grains, rice,

upland cotton, tobacco, peanuts, milk, and wool.

The President's primary legislative initiative is to freeze target prices

at the 1984 crop-year levels mandated in the 1981 Agriculture Act. It is the

difference between target prices and market prices that determines the rate

at which deficiency payments will be made on each eligible farmer's crop

production. Freezing these levels is estimated to save $1.4 billion in 1985, and $14.8 billion during the 1985-1989 period. In addition, the President

proposes to make the honey price support program discretionary.

The price support proposal comes at a time of rising farm support

payments. Outlays for agricultural price support programs rose sharply in

1982 and again in 1983 to a record $18.8 billion, nearly five times the 1981

level. This dramatic rise in spending reflected a sharp decline in farm

prices resulting from large U.S. crops and weak export demand.

Outlays are expected to decline in 1984 to $6.1 billion, because of the

sharply reduced production of drought-stricken crops and the payment-in- kind (PIK) program. Higher prices in feed grains, rice, and cotton are

projected to reduce deficiency payments and commodity loans, particularly

in the case of feed grains where liquidation of grain under loan in the

farmer-owned-reserve is expected to result in net repayments of $2.5

billion. Dairy outlays are also expected to decline from a record $2.5 billion

in 1983 to an estimated $1.5 billion as a result of lower support prices and a

paid diversion program required by the Dairy and Tobacco Act of 1983. Outlays would be projected even lower but for an estimated $1.4 billion to

cover export credit defaults that the President has included in 1984

estimated outlays.

Outlays in 1985 are projected to increase to $11.0 billion because

rising crop production is expected to reduce prices. Crop production is

expected to rebound from last year's drought and to increase further as a

result of less restrictive acreage reductions (the PIK program is continued

only for the 1984 wheat crop). Deficiency payments are estimated to

increase from $0.9 billion in 1984 to $2.6 billion in 1985, though total direct

payments will rise only $1 billion. Net commodity lending is estimated to

increase by $2.4 billion. Dairy costs are projected to be $0.5 billion above

1984 levels as the diversion program ends March 31, 1985, and lower grain

prices encourage greater feeding.

Other Proposed Changes

This residual category includes a variety of programs providing

educational assistance, nutrition assistance, social and rehabilitation

87
TABLE V-5. CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSED

REDUCTIONS IN THE "OTHER" CATEGORY OF

ENTITLEMENTS AND MANDATORY SPENDING

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays- Other Entitlements and

Mandatory Spending 35 35 35 37 36

Proposed Changes

-0.3 -0.3 -0.4 -0.5 -0.5

— -0.2 -0.3 -0.4 -0.5

Guaranteed Student Loans

Federal Employees' Health

Benefits

Pension Benefit Guaranty

Corporation -0.2 -0.2 -0.2

Child Nutrition — -0.1 -0.1

General Revenue Sharing — — -0.3

Rehabilitation Services -0.1 -0.2 -0.2

Veterans'Programs -0.3 0.3 0.2

Other -0.2 -0.2 -0.4

-0

-0

-0

-0

-0.0

-0.4

-0.3

-0.3

-0.7

-0.3

-0.1

-0.4

Total Changes -1.1 -0.8 -1.8 -2.5 -3.1

-2.0

-1.5

-1.0

-0.7

-1.5

-1.0

-0.1

-1.6

-9.3

President's Budget as

Estimated by CBO 34 34 33 34 33

services, aid to state and local governments, and aid to certain businesses

(see Table V-5).

Guaranteed Student Loans. The Administration again proposes

eliminating the $30,000 income cap and making all students subject to a

need analysis for GSLs. Under this proposal 800,000 of the 2.8 million

borrowers would either be ineligible for a loan or have their loan amount

reduced. The vast majority are independent students, part-time students,

88
and students who attend low-cost two-year schools. New loan volume would

decrease by an estimated $1.1 billion in 1985 with similar reductions in the

outyears. By 1989, this change would save an estimated $450 million. The

Administration also proposes making state guarantee agencies share more of

the cost of the GSL program.

Government Contributions to Employer Health Insurance. The

President's budget proposals for federal employees' health benefits (FEHB)

would reduce outlays by $0.2 billion beginning in 1986. The federal

government's contribution would be based on a broader measure of cost

changes, and a wider range of plans would be allowed to participate in the

program. Also, the Administration proposes changing contributions for

annuitants' health benefits in the Postal Service and other off-budget

entities.

Pension Benefit Guaranty Corporation. To increase revenues, the

Administration is proposing an increase in the single-employer premium rate

from $2.60 to $6.00 per participant, effective January 1, 1984.

Child Nutrition. The President's budget proposes several changes in

the child nutrition programs. For child care and summer food service

programs, a block grant would be fixed at the projected 1985 level. For the

school lunch program, the Administration proposes tying the reimbursement

rate for all lunches to a food price index and slightly lowering

reimbursement rates for reduced-price lunches.

General Revenue Sharing. The President's budget proposes funding

general revenue sharing at its 1984 level throughout the 1985-1989 period. The CBO baseline is held at the constant authorization ceiling through 1986, but is inflated thereafter. By 1989, the President's spending request is 13

percent below CBO's baseline.

Rehabilitation Services. The President's budget request for basic

grants is below the levels stated in recently passed legislation for 1984- 1987. In 1988 and 1989, the President's request grows more slowly than the

CBO baseline, which is increased by the CPI. By 1989, the difference is

over $300 million.

Veterans' Programs. The President's budget proposes that in Veterans' Compensation cost-of-living adjustments be given every April, saving about

$150 million each year. In Readjustment Benefits, the Administration

proposes a 15 percent increase in benefit levels effective January 1, 1985,

costing about $200 million a year.

89
The budget also includes major changes in the operation of the home- loan guarantee program that would be effected without legislation: halting

the acquisition of property at foreclosure sales involving loans guaranteed

by the Veterans Administration (VA); eliminating VA financing of the sale of

real property owned by the agency; barring repurchase agreements on all

future sales of loan assets; and terminating the loan refunding program. As

a result, costs attributable to property acquisitions would be eliminated, followed about a year later by the elimination of collections that would have

resulted from the sale of the ensuing vendor loan. Thus outlays in 1984 and

1985 would be more than $600 million below baseline outlays, partially

offset in 1986 and 1987 by $226 million more in outlays from the drop in

collections. In later years, there should be a small net savings.

NONDEFENSE DISCRETIONARY SPENDING

Many nondefense programs are considered "discretionary," in that the

law establishes no entitlement to benefits from them. The Congress

exercises its discretion in setting spending levels for these programs through

the appropriations process, either by appropriating budget authority or by

establishing loan limits, expenditure limits, or obligation ceilings. While

most of such spending appears in the unified budget, a portion is defined in

law as "off-budget" and is not counted in the budget totals. \J

Outlays for on-budget discretionary programs grew more slowly than

entitlements during the 1970s, but still increased from 4.5 percent of GNP

in 1970 to 5.5 percent by 1980. Over the next three years, there was little

growth in this category; 1983 outlays were about $144 billion, down to 4.4

percent of GNP and less than $3 billion above the 1980 level. Some growth

is expected for 1984, in part attributable to spending increases enacted

under the Surface Transportation Assistance Act of 1982 (Public Law

97-424), the Tax Equity and Fiscal Responsibility Act of 1982 (Public Law

97-248), and the Emergency Jobs Appropriations Act of 1983 (Public Law

98-8). As a result, on-budget 1984 outlays are expected to be $157 billion, an increase of 9 percent over the 1983 level.

Under CBO's baseline projections for discretionary programs, which

allow spending to keep pace with inflation, on-budget outlays would grow by

about 5 percent per year over the next five years, rising from $157 billion in

1984 to $200 billion in 1989. The Administration's 1985 budget proposes to

1. A separate discussion of the President's proposals for off-budget

spending appears later in this chapter.

90
hold the growth of programs in this category to about 3 percent per year

over the next five years, with outlays reaching $183 billion by 1989 (see

Table V-6). If fully implemented, the budget would result in outlay savings

of $2 billion in 1985, and a total on-budget deficit reduction of $44 billion

over the 1985-1989 period, relative to the CBO baseline projections for

discretionary programs. As a consequence, spending for nondefense discre- tionary programs in 1985 would be 1.2 percent below the baseline and 4.1

percent of GNP. By 1989, it would fall 9 percent below the baseline and

represent only 3.4 percent of GNP.

This overall pattern does not apply uniformly to all types of discre- tionary spending. The President's budget includes proposed increases in

certain areas and decreases in others. As shown in Table V-7, the largest

on-budget increases are for foreign aid, amounting to $17 billion over five

years. This increase, however, is more than offset by a $19 billion decrease

in off-budget spending in the same area. Significant reductions below the

baseline are proposed for benefits and services to individuals, infrastructure, assistance to business and commerce, and various off-budget activities. Federal government operations and research and development would be

maintained at close to baseline levels over the five-year period.

Aid to Foreign Governments and International Organizations

This category includes programs for development and security assist- ance, contributions to international organizations, and international

monetary programs. The substantial on-budget outlay increase projected for

these activities largely reflects the President's proposal that beginning in

1985 all foreign military sales be provided as direct loans or grants, instead

of the current mix of grants and guaranteed loans provided off-budget

through the Federal Financing Bank (FFB). For 1985, grants and forgiven

direct loans would increase by a total of $1.6 billion over the 1984 level;

concessional direct loans would increase by $0.5 billion, while loans at

Treasury rates would be reduced by $2.4 billion. 2] The amount of

concessionality in the financing package would increase from 30 percent in

1984 to 60 percent, increasing the ultimate cost to the federal government

of the 1985 assistance by $1.8 billion, on a present-value basis. (This cost

would be reflected in lower interest receipts and principal repayments in

future years.) On-budget outlays for foreign military sales assistance would

be $1.3 billion above the baseline in 1985 (see Table V-8), but off-budget

outlays of the FFB would be reduced by $1.2 billion. Over the 1985-1989

2. Excluding funds for the Central American assistance program.

91

30-778 0-84- 8
TABLE V-6. PROPOSED OUTLAYS FOR NONDEFENSE DISCRETION- ARY SPENDING PROGRAMS AS ESTIMATED BY CBO a/

(By fiscal year, in billions of dollars)

198* 1985 1986 1987 1988 1989

Aid to Foreign

Governments and

International

Organizations

Federal Government

Operations

Benefits and Services

to Individuals

Transportation, Natural

Resources, and Other

Infrastructure

Assistance to Business

and Commerce

11

24

50

45

9

14 14

25 25

50 51

47 47

7 6

16

25

52

48

6

17

26

53

47

6

17

27

54

47

6

Research and

Development

Civilian Agency Pay

Raises

Total

18

1

157

19

*

162

20

3

166

21

5

174

21

7

179

22

10

183

* Less than $500 million.

SOURCE: Congressional Budget Office.

a. Does not include off-budget spending, which is shown in Table V-13.

92
TABLE V-7. CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED

REDUCTIONS IN NONDEFENSE DISCRETIONARY SPEND- ING a/ (By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays-- Nondefense Discretionary

Programs

Proposed Changes

Aid to foreign

governments and

international

organizations

Benefits and services

to individuals

Transportation, natural

resources, and other

infrastructure

Assistance to business

and commerce

Other

Total Changes

President's Budget as

Estimated by CBO

16* 171 181 191 200

17

-3 -5 -7 -8 -10 -33

-1 -2 -6

-1 -2 -2 -3 -3

-2 -5 -7 -12 -17

162 166 17* 179 183

-12

-2

* Less than $500 million.

SOURCE: Congressional Budget Office.

a. Does not include off-budget spending, which is shown in Table V-13.

93
TABLE V-8. PROPOSED FUNDING CHANGES FOR AID TO FOREIGN

GOVERNMENTS AND INTERNATIONAL ORGANIZATIONS

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays a/ 11.2 11.5 11.9 12.4 12.8

Proposed Changes

Foreign military

sales financing a/ 1.3 2.2 3.3 3.9 4.0 14.7

Assistance to

Central America 0.8 0.7 0.8 0.8 0.8 3.7

Other 0.3 -0.1 -0.2 -0.3 -0.8 -1.3

Total Changes 2.4 2.8 3.9 4.1 4.0 17.2

President's Budget as

Estimated by CBO a/ 13.6 14.3 15.8 16.5 16.7

SOURCE: Congressional Budget Office.

a. Excludes off-budget outlays of the FFB, which would be reduced $18.8

billion over the 1985-1989 period under the President's proposal (see

Table V-13.

period, total outlays (on-budget and off-budget) for these programs would be

$4.1 billion below the baseline, resulting from reductions in the total

amounts of assistance provided. (The on-budget outlay increase would be

$14.7 billion, compared to an off-budget decrease of $18.8 billion over the

five years.)

The President is also requesting funds for assistance to Central

America—a $500 million supplemental for 1984, and appropriations of $750

million a year through 1989. The six-year package, with outlays totaling

$3.7 billion over the period, encompasses both economic and military

94
assistance intended to implement the recommendations of the Commission

on Central America. Other major budget proposals include funding for

payments to the Marshall Islands and the Federated States of Micronesia

($0.9 billion in the 1985-1989 period) and reductions in multilateral assist- ance (a total of $0.7 billion below the baseline in 1985-1989). The

President's request for other programs is close to baseline levels for 1985, but below the baseline by a total of $1.5 billion from 1986 to 1989.

Benefits and Services to Individuals

The largest portion of nondefense discretionary spending is for bene- fits and services to individuals—including housing, education, employment

and job training, veterans' hospitals, health and legal services, and assist- ance in paying energy costs. Such spending was the fastest-growing area of

discretionary spending during the 1970s, growing at an annual rate of more

than 14 percent. Since then outlays have increased only slightly, from $47

billion in 1980 to $48 billion in 1983.

Under the President's budgetary proposals, discretionary spending for

benefits and services to individuals would increase by an average of 1.7

percent annually from 1985 to 1989, reaching $54 billion in 1989. Outlays in

1985 would be $2.5 billion, or 5 percent, below the baseline level. By 1989, outlays would be $10.3 billion, or 16 percent, below the baseline. Total

savings from 1985 through 1989, relative to the baseline, would be $33

billion (see Table V-9).

Housing Programs. The President's 1985 budget request proposes a

significant change in the means by which the Department of Housing and

Urban Development (HUD) would provide low-income rental assistance. Beginning in 1985, most new section 8 subsidy agreements would be in the

form of five-year certificates (vouchers) rather than the 15- to 30-year

contracts currently typical of the program. In addition, HUD plans to

convert units currently under payment to voucher assistance when contracts

are due for renewal.

The President has requested about $6.2 billion in new budget authority

for section 8 and public housing commitments in 1985. With shortened

contract terms, this amount plus about $2.9 billion in authority carried over

or recaptured in 1985 is estimated by HUD to be sufficient to subsidize

100,000 additional units, about the same number currently estimated for

1984. The budget authority contained in the CBO baseline is based on 1984

new authority of $9.3 billion (the amount appropriated in 1984 less $615

million that is to be used for rental rehabilitation and construction). The

baseline, however, does not include the assumption that most assistance will

be in the form of vouchers.

95
TABLE V-9. PROPOSED FUNDING CHANGES FOR BENEFITS AND

SERVICES TO INDIVIDUALS (By fiscal year, in billions of

dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays 52.9 55.8 58.7 61.6 64.7

Proposed Changes

Housing programs -0.7 -1.3 -2.1 -2.8 -3.5 -10.4

Education programs -0.3 -1.2 -1.9 -2.5 -3.3 -9.2

Training, employment and

social services

programs -0.8 -1.4 -1.8 -2.1 -2.5 -8.5

Veterans'programs 0.2 0.3 0.7 1.0 1.2 3.4

Other -1.0 -1.5 -1.7 -1.9 -2.3 -8.4

Total Changes -2.5 -5.1 -6.7 -8.4 -10.3 -33.0

President's Budget as

Estimated by CBO 50.4 50.7 52.0 53.2 54.4

SOURCE: Congressional Budget Office.

In addition to the shift to voucher assistance and the associated

reduction in budget authority, the Administration has proposed reduced

funding levels relative to the baseline for two other housing assistance

programs. Commitments to make direct federal loans for the construction

of housing for the elderly and the handicapped under HUD's section 202

program are limited to 10,000 units in the President's budget. Loan

authority estimated to be sufficient for 14,000 units was provided in 1984

appropriations and is included in the baseline. Restricted funding levels are

also proposed for housing assistance to low-income rural residents. The

96
Farmers Home Administration's reduced interest-rate direct loan and rental

assistance programs will obligate almost $3.4 billion in 1984. The President

has requested about $2.4 billion for 1985.

Education Programs. Nearly one-third of the five-year outlay savings

in benefits and services to individuals is projected in education programs. The President is proposing 1985 budget authority $0.4 billion below the 1984

funding levels. These savings would be obtained by reducing funding by $0.7

billion for student assistance, aid to postsecondary institutions, and impact

aid payments, and increasing funding by $0.3 billion for quality education

and math and science education programs. Additional savings are projected

in 1985 and subsequent years because funding for most of the other

education programs is held to the 1984 funding levels through 1989. As a

result, the President's 1989 outlays are $3.3 billion or 21 percent below the

baseline projection for that year.

Employment, Training, and Social Service Programs. These programs

are also targeted for significant reductions, with outlays in 1985 estimated

to be $0.8 billion, or 11 percent, below the baseline. Reductions in 1989 are

$2.5 billion, which is 27 percent of baseline levels. Major funding reductions

include the elimination of the work incentive program and the community

service block grant program. Funding for these programs totaled $0.7

billion in 1984.

Veterans' Programs. The President's 1985 budget authority request of

$10.5 billion for veterans' programs exceeds the 1984 funding level by $0.9

billion and the 1985 CBO baseline by $0.3 billion. The President's funding

levels continue to grow through 1989 when they exceed the baseline level by

$1.4 billion. As a result, outlays for veterans' programs would exceed the

baseline by $0.2 billion in 1985 and by a total of $3.4 billion over the 1985- 1989 period. The increases are primarily in funds for major construction

projects and to operate the Veterans Administration health care system. Real increases in construction funding are planned to meet the rise in

demand for VA health care—particularly nursing home care—that is

expected over the next decade. Increased funding for medical care is

requested to staff and operate the new facilities scheduled to open during

the period and to upgrade existing programs.

Other Programs. The President's request is significantly below base- line levels in other programs in this category, including the Legal Services

Corporation, for which no 1985 request is made, low-income energy assist- ance, refugee and entrant assistance, and the Special Supplemental Feeding

Programs for Women, Infants, and Children (WIC).

97
Transportation, Natural Resources, and Other Infrastructure

Close to 30 percent of nondefense discretionary spending is devoted to

the construction, operation, management, and maintenance of the nation's

physical resources—including the major transportation systems, pollution

control facilities, forests, parks, and other public lands, water, mineral, and

other natural resources, and community development projects. Spending for

these programs dropped from $44 billion in 1980 to $40 billion in 1983. Outlays in 1984, however, primarily reflecting increas

are estimated to rise sharply, to $45 billion, ed highway, airport, and airways funding, as well

as spending from the 1983 jobs bill and a one-time payment to the FFB for

defaulted Amtrak loans, above the 1980 level. Even then, 1984 spending will be only slightly

Under the President's

next few years, averaging

reduction of $14 billion, or

over the 1985-1989 period, percent, below the baseline

proposals, spending would grow little over the

about $47 billion a year. This represents a

6 percent, below the baseline outlay projections

Outlays in 1985 would be $0.4 billion, or about 1

level (see Table V-10).

The major increases ir

are for programs of the

1985 funding for FAA fac

double the $750 million

continuing program to

annual outlays are projecte^l

in 1989.

below the CBO baseline 1

$3.7 billion lower over the

tion ceilings are more re

Transportation Assistance

the President's budget, relative to the baseline, Federal Aviation Administration (FAA). Proposed

lities and equipment is $1.7 billion, more than

appropriated for 1984. This increase is part of the

modernize the air traffic control system. As a result, to grow from $0.7 billion in 1985 to $1.4 billion

The Administration's Ixudget for most other transportation programs is

ivel. Federal-aid highways outlays, under the

President's proposals, would be $0.1 billion below the baseline in 1985 and

1985-1989 period, because the proposed obliga- itrictive than those established in the Surface

\ct of 1982. (The President also assumes that

1987-1989 ceilings would remain at the proposed 1986 level of $14.8 billion.)

The budget also provides for reductions in transit funding, with 1985 budget

authority $0.2 billion below the 1984 level. Appropriations for formula

grants would be held at the 1984 level of $2.4 billion through 1989, but the

use of such grants for operating assistance would be gradually phased out. Since capital grants are spent much more slowly than operating funds, and

because funding would be held below the baseline level, mass transit outlays

over the 1985-1989 period would be $7.2 billion below the baseline. Funding

for Amtrak subsidies would be held almost constant, at $680-690 million per

year, below the $716 million appropriated for 1984. Resulting outlay savings

over the five-year period would be $0.7 billion.

98
TABLE V-10. PROPOSED FUNDING CHANGES FOR TRANSPORTATION, NATURAL RESOURCES, AND OTHER INFRASTRUCTURE

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays 47.0 48.3 49.9 51.7 53.5

Proposed Changes

Airports and airways 0.4 0.5 0.7 0.6 0.4 2.6

Other transportation -0.6 -0.8 -1.3 -2.7 -3.7 -9.1

Natural resources, environment and

energy -0.1 -0.4 -0.8 -1.2 -1.5 -4.0

Community and

regional development -0.2 -0.5 -0.7 -1.0 -1.4 -3.8

Total Changes -0.4 -1.1 -2.2 -4.3 -6.2 -14.2

President's Budget as

Estimated by CBO 46.5 47.2 47.7 47.4 47.2

SOURCE: Congressional Budget Office.

Under the President's budget, spending for infrastructure activities

other than transportation would be $23 billion in 1985, about 1 percent

above the 1984 level, then decline slightly each year to $22 billion in 1989. Budget authority in 1985 would be $0.9 billion, or 4 percent, below the

baseline, while outlays would be $0.2 billion below. Over the 1985-1989

period, outlays would be $7.8 billion below the baseline. The spending

reductions span many areas of activity—energy conservation programs ($0.4

billion below the baseline over five years), water and land conservation

programs (funding reduced by almost one-third in 1985), land acquisition for

national parks (funded at half the 1984 level), and operations of the National

Oceanic and Atmospheric Administration (reduced by 10 percent). Funding

99
for wastewater treatment plant construction grants and abatement, control, and compliance activities of the Environmental Protection Agency (EPA)

would be held at about the 198* level of $2.8 billion in all years, resulting in

outlays $0.8 billion below the baseline over the 1985-1989 period. Programs

of the Economic Development Administration and the Appalachian Regional

Commission would be terminated, while community development block

grants, urban development action grants, major Farmers Home Administra- tion programs, and Indian programs would be held at or near the 198*

funding level. Funding for the Corps of Engineers would be slightly below

the baseline, while increases above the baseline are requested for the

Bureau of Reclamation and EPA's hazardous substance response trust fund.

Assistance to Business and Commerce

The major on-budget activities in this area include subsidy payments

to the Postal Service and programs of the departments of Agriculture, Commerce, and Energy, the Small Business Administration (SBA), the

Government National Mortgage Association (GNMA), and the Export-Import

Bank. Outlays for these activities in 1983 were $8.5 billion, representing

little change from the $7.6 billion spent in 1975 and slightly below the 1980

level of $8.8 billion. The Administration is proposing to reduce outlays

relative to the baseline by approximately $1.* billion in 1985 and $11.8

billion in total by 1989, with outlays in all years below the estimated 198*

level (see Table V-ll). The President's budget represents an outlay

reduction of 27 percent below the baseline for the 1985-1989 period, the

largest percentage reduction in discretionary spending.

The largest savings are projected for the uranium enrichment program

of the Department of Energy. The President is proposing that program

obligations be funded entirely with revenues from the sale of enriched

uranium, thus requiring no new budget authority beginning in 1985. Because

of a weakened market for enriched uranium, CBO estimates that revenues

will decline by $500 million in 1985 and and remain at approximately that

level through 1989. As a result, the Administration's proposal would

effectively reduce operating levels and slow research and development in

new technologies, resulting in outlay savings of $0.3 billion in 1985 and a

total of $3.8 billion through 1989.

The President is also proposing to reduce the revenue forgone payment

to the Postal Service to $*00 million per year, beginning in 1985—which

would result in outlay savings relative to the baseline of $0.5 million in 1985

and $2.9 billion over the 1985-1989 period. This proposal assumes enact- ment of legislation proposed last year by the Administration to reduce

revenue forgone subsidies for nonprofit mailers. Furthermore, the Adminis100
TABLE V-ll. PROPOSED FUNDING CHANGES FOR ASSISTANCE TO

BUSINESS AND COMMERCE (By fiscal year, in billions of

dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays 8.0 7.4 8.8 9.3 9.7

Proposed Changes

Uranium enrichment

activities -0.3 -0.6 -0.9 -1.0 -1.1 -3.8

Postal subsidies -0.5 -0.6 -0.6 -0.6 -0.7 -2.9

Small business loans -0.4 -0.5 -0.5 -0.6 -0.7 -2.7

Agriculture and

other programs -0.2 -0.2 -0.4 -0.7 -0.8 -2.4

Total Changes -1.4 -1.9 -2.4 -2.9 -3.3 -11.8

President's Budget as

Estimated by CBO 6.6 5.5 6.5 6.4 6.4

SOURCE: Congressional Budget Office.

tration is proposing appropriation language that would bar payments in

subsequent years to adjust for unanticipated changes in mail volumes and/or

rates.

Program cuts are also proposed for 5BA, including the elimination of

most direct loans and a reduction in guarantee loan levels from $3.3 billion

in 1985 to $0.9 billion in 1989. These are estimated to result in outlay

savings of $0.2 billion in 1985 and $1.6 billion in total by 1989. In addition, net outlays for disaster assistance total $1.1 billion below the baseline

between 1985 and 1989 because baseline levels reflect recent historical

experience, while the Administration assumes no major disasters through

1989.

101
The President would also reduce funding below the baseline for

activities of the Agriculture Department. The largest reductions are for the

Extension Service and the Animal and Plant Health Inspection Service

(APHIS), resulting in savings in each of the programs of approximately $0.4

billion between 1985 and 1989. Parts of this savings reflect proposed

increases in user fees collected in connection with APHIS disease and pest

control activities.

Other Discretionary Spending

The major other areas of discretionary spending include research and

development, federal government operations, and allowances for civilian

agency pay raises. In aggregate, outlays in these areas under the President's

budget are slightly above the baseline in 1985-1987, and slightly below

thereafter.

Research and Development. Spending on civilian research and

development (R&D) is estimated to total $18.1 billion in 1984, up from $15.3

billion in 1980. Estimated outlays for these activities in 1984 include $7.0

billion for space and aeronautic research of the National Aeronautics and

Space Administration (NASA), $4.4 billion for health research undertaken by

the various National Institutes of Health, and $3.4 billion for energy

research activities of the Department of Energy. The remaining amounts

are primarily for programs in the National Science Foundation and the

departments of Agriculture and Education.

The President proposes to increase budget authority for civilian R&D

by about $0.5 billion in 1985, and by nearly $3.4 billion above 1984 levels by

1989. These funding levels, however, fall below the baseline by about 2

percent in 1985 and by 3.5 percent over the 1985-1989 period, reflecting a

real decline in civilian R&D spending. As a result, outlays would be below

the baseline by $0.1 billion in 1985 and by $2.2 billion over the 1985-1989

period (see Table V-12).

Though the President proposes this overall increase in civilian R&D

spending, a significant shift occurs among research areas. Spending on most

nonspace R&D declines in real terms through 1989. Under the President's

budget, outlays would be below the baseline by $0.3 billion in 1986 and by

$1.7 billion in 1989. Most of the reductions occur in energy and health

research. These reductions primarily result from rates of growth lower than

that assumed in the baseline. Proposed budget authority for health research

in 1985 is about 2 percent above the 1984 level, and the Administration

projects a similar rate of growth for 1986-1989. (The baseline reflects an

average annual increase of about 6 percent.) In energy research, major cuts

are proposed in nuclear and fossil research programs.

102
TABLE V-12. PROPOSED FUNDING CHANGES FOR OTHER ON-BUDGET

NONDEFENSE DISCRETIONARY SPENDING (By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays

Proposed Changes

Research and development

Space

Health

Energy and other

Federal government

operations and

civilian agency

pay raises

Total Changes

President's Budget as

Estimated by CBO

44.6 48.1 51.7 55.7 59.8

* 0.2 0.5 0.6 0.7

-0.1 -0.2 -0.4 -0.6 -0.9

* -0.1 -0.4 -0.6 -0.8

0.2 0.4 0.4 * -0.4

0.1 0.3 0.1 -0.6 -1.4

44.7 48.4 51.8 55.1 58.4

2.0

-2.1

-2.1

0.6

-1.5

* Less than $500 million.

SOURCE: Congressional Budget Office.

In contrast, proposed spending on space research by NASA is $2 billion

over the baseline between 1985 and 1989. This increase reflects the

Administration's commitment of $5.4 billion for design and development of a

space station and the commitment to funding a larger space science

program. As a result, projected NASA space spending rises from $6.4 billion

in 1984 to $8.3 billion in 1989.

103
Federal Government Operations and Pay. Federal government opera- tions is the only major category of nondefense discretionary spending for

which the Administration's budget would maintain baseline spending levels

over the 1985-1989 period. (It has also grown faster than any category other

than foreign aid from 1980 through 1984.) It includes various basic activities

of the federal government, encompassing the conduct of foreign affairs, the

Coast Guard, the administration of the Social Security and Medicare

programs, law enforcement, judicial, and regulatory activities, the opera- tions of the Legislative Branch, and the Internal Revenue Service. The 1985

budget authority request for these activities is $0.2 billion above the

baseline and almost 5 percent above the 1984 level.

Significant increases are requested for State Department operations

and the United States Information Agency, resulting in outlays above the

baseline by $0.3 billion in 1985 and by $2.3 billion over the 1985-1989 period. Funding for justice programs is generally maintained at 2-3 percent above

the baseline level over the five years, including increases for the Judiciary, the Federal Bureau of Investigation, the Drug Enforcement Administration, the Immigration and Naturalization Service, and the federal prison system. The 1985 budget authority request for the Internal Revenue Service is 8

percent above the 1984 level, with outlays projected to be above the

baseline by $0.1 billion in 1985 and by $0.6 billion over the 1985-1989 period. Coast Guard operations are maintained at the baseline level, while reduc- tions are proposed in Coast Guard acquisition and construction activities, energy regulatory and administrative activities, and the juvenile justice

grant program. The budget assumes pay raises for civilian agency

employees of 3.5 percent in January 1985, and 5-6 percent per year

thereafter.

OFFSETTING RECEIPTS

This category consists of various federal government receipts that are

treated as deductions from outlays rather than as revenues. It includes

proprietary receipts from the public, largely for lease, sale, or royalty

payments for timber, power, or minerals. It also encompasses the receipts

from federal agencies' payments (as an employer) for employee retirement

and health benefits. Finally, health insurance premiums paid by Supple- mental Medical Insurance recipients are treated as offsetting receipts.

The President's budget proposals in offsetting receipts are dominated

by the proposed change in the SMI premium. Under current law, SMI

premiums are set at 25 percent of program costs through 1985, and are

increased by the growth in the CPI thereafter. The President's budget

proposes increasing the premiums by 1.67 percent of program costs until

January 1, 1990, when premiums would equal 35 percent of program costs.

104
Under current law, CBO estimates monthly premiums of $20.40 by

1989. Under the Administration's proposal, monthly premiums would

increase to $35.60 in 1989, a 75 percent increase. This proposal would add

$11 billion to offsetting receipts from 1985 to 1989.

Other Administration proposals for offsetting receipts would have the

Postal Service make additional payments to the Civil Service Retirement

trust fund and would impose navigation user fees in anticipation of legisla- tion to recover capital and operating expenses of deep draft and inland

waterway projects.

OFF-BUDGET SPENDING

The spending of certain federal entities has, by law, been excluded

from the unified budget total. These include oil purchases for the Strategic

Petroleum Reserve and operations of the Postal Service. The Federal

Financing Bank (FFB) accounts for most off-budget outlays through its

purchases of direct or guaranteed loans made under other government

programs. Purchases of loans from other, on-budget federal agencies reduce

on-budget outlays and transfer off-budget most of the impact of agencies' lending activities. Purchases of guaranteed loans convert such guarantees

into direct federal loans, with outlays appearing off-budget.

Under the Administration's proposals, off-budget outlays are projected

to decline from $15 billion in 1984 to $6 billion in 1989, a reduction of $28

billion below the baseline over the 1985-1989 period (see Table V-13). Almost $19 billion of that reduction is the result of proposed changes in the

financing of foreign military assistance, which were discussed earlier in this

chapter. The remainder is chiefly attributable to reductions in credit

activity of the Rural Electrification Administration (REA) and the Farmers

Home Administration (FmHA), offset in part by additional expenditures for

public housing bonds.

For REA, the President's budget includes a substantial reduction in

both direct loans and loan guarantees. Commitments for direct loans would

be cut from $1.1 billion in 1984 to $575 million in each of the years 1985

through 1989. Loan guarantee commitments would be cut from $3.4 billion

in 1984 to $1.3 billion a year, beginning in 1985. In addition, the President is

proposing that higher interest rates be charged for REA direct loans. REA

credit activity is off-budget. In addition, a portion of REA's direct loans is

sold to the FFB, and REA's guaranteed loans become direct loans made by

the FFB. As a result, the Administration's proposals would reduce off- budget outlays, relative to the baseline, by $0.8 billion in 1986 and by $6.6

billion over the 1985-1989 period.

105
TABLE V-13. PROPOSED FUNDING CHANGES FOR OFF-BUDGET

SPENDING (By fiscal year, in billions of dollars)

Cumulative

Five-Year

1985 1986 1987 1988 1989 Changes

CBO Baseline Outlays 14.1 13.9 15.2 16.0 14.7

Proposed Changes

Foreign military

sales credit -1.2 -3.3 -4.3 -4.9 -5.1 -18.8

Rural Electrification

Administration * -0.8 -1.5 -2.0 -2.3 -6.6

Farmers Home

Administration -0.3 -1.5 -1.7 -1.9 -2.0 -7.4

Low-rent public

housing 1.2 1.2 1.2 1.2 1.2 6.0

Other -0.2 *_ -0.7 -0.2 -0.3 -1.5

Total Changes -0.5 -4.4 -7.0 -7.8 -8.5 -28.2

President's Budget as

Estimated by CBO 13.6 9.5 8.2 8.3 6.2

* Less than $500 million.

SOURCE: Congressional Budget Office.

A large portion of the financing needed by the FmHA's agricultural

credit, rural development, and rural housing direct loan programs comes

from the sale of loan assets to the FFB. To the extent these FFB sales

occur, program costs are reflected off-budget, rather than in the unified

budget. Under the President's budget proposals, CBO estimates a 1985 loan

level of about $7.5 billion, $1.3 billion less than the level assumed for the

CBO baseline and $1.1 billion below the 1984 level. (The 1985 total includes

106
$2.3 billion for emergency disaster loans, a CBO reestimate. These loans

are not subject to limitation.) For the five years 1985 through 1989, the

Administration budget includes loan levels about $9.8 billion less than

assumed in the CBO baseline, resulting in a reduction in off-budget outlays

for the five-year period of an estimated $7.4 billion. Most of this reduction

would occur in FmHA's rural housing programs.

These off-budget savings would be offset, in part, by increased outlays

of $1.2 billion per year for the sale of public housing bonds to the FFB.

These sales would result in off-budget outlays totaling an estimated $6

billion over the 1985-1989 period.

107

30-778 0-84- 9

APPENDIXES

APPENDIX A. CBO OUTLAY REESTIMATES

As part of its analysis of the Administration's budget, CBO has

reestimated the Administration's spending program to reflect CBO baseline

economic assumptions and technical estimating methods. The effect of

these reestimates on outlays is summarized in Table A-l and explained in

this appendix. Most of the CBO reestimates result from the use of different

economic assumptions—primarily higher interest rates. These different

economic assumptions increase estimated outlays by an amount growing

from $2 billion in 1984 to $87 billion by 1989. Technical estimating

differences reduce CBO's 1984 outlay estimate by $5 billion but increase

estimated outlays thereafter. By 1989 technical estimating differences

reach $16 billion, of which $10 billion is in the national defense function.

TABLE A-l. CBO'S REESTIMATES OF THE ADMINISTRATION'S SPEND- ING PROPOSALS (By fiscal year, in billions of dollars)

1984 1985 1986 1987 1988 1989

President's Budget 854 925 992 1,068 1,130 1,184

Preliminary CBO

Reestimates

Different economic

assumptions 2 8 17 32 59 87

Technical reestimates -5 * 9 U 15 16

Subtotal -3 8 26 43 74 103

President's Budget as

Estimated by CBO 851 933 1,018 1,011 1,204 1,287

* Less than $500 million.

SOURCE: Congressional Budget Office.

Ill
DIFFERENCES IN ECONOMIC ASSUMPTIONS

The major difference between CBO and Administration economic

assumptions, as discussed in Chapter II, regards interest rates. Budget

estimates are becoming increasingly sensitive to interest rates as past and

projected deficits add to the amount of federal debt that must be financed.

CBO assumes that the three-month Treasury bill rate will average 8.9

percent in calendar year 1984 and will decline to 7.8 percent in 1989. In

contrast, the Administration assumes that the bill rate will drop to 5.0

percent by 1989. Differences in assumed longer term rates are even

greater--CBO assumes a 10.2 percent three- to five-year note rate for

1989, while the Administration assumes 5.5 percent. CBO estimates that

TABLE A-2. CBO OUTLAY RESTIMATES DUE TO DIFFERENT

ECONOMIC ASSUMPTIONS (By fiscal year, in

billions of dollars)

1984 1985 1986 1987 1988 1989

Interest Costs

Due to different

interest rates 1 7 14 24 41 58

Due to different

deficits _* _1 _2 _5 9 17

Subtotal 1 7 16 29 51 75

Other InterestSensitive Programs * * * 1 1 1

Social Security and

Other Indexed Benefits * 1 1 3 4 6

Medicare and Medicaid * 1 1 1 2 3

Unemployment Compensation,

Food Stamps, and AFDC 'J, J, -1. --1 J. _3

Total 2 8 17 32 59 87

* Less than $500 million.

SOURCE: Congressional Budget Office.

112
these higher interest rates will increase interest costs by $1 billion in

$7 billion in 1985, and $58 billion by 1989. Economic reestimates of outlays

and revenues further increase interest costs by increasing the amount of

debt to be financed. In total, differences in interest outlays account for $7

billion out of $8 billion in economic reestimates in 1985 and $75 billion out

of $87 billion by 1989 (see Table A-2). Higher interest rates also increase

outlays for certain other federal programs, notably guaranteed student

loans.

The inflation rates projected by CBO exceed the Administration's by

increasing amounts in successive years. As a result, CBO estimates higher

outlays for Social Security, federal employee retirement, and other benefits

indexed to the Consumer Price Index. Differences in indexed programs are

$1 billion or less in 1984, 1985, and 1986 but grow to $6 billion by 1989. Medicare and Medicaid outlays are also higher in CBO's estimates because

higher inflation pushes up the cost of providing services to eligible families

and individuals.

CBO's projected civilian unemployment rate is lower than that of the

Administration in 1985-1987, but the Administration's rate drops below

CBO's in the final two years of the budget estimates. CBO therefore

estimates lower outlays for unemployment compensation and other

unemployment-sensitive programs in the 1985-1987 period but higher outlays

in 1988 and 1989.

TECHNICAL ESTIMATING DIFFERENCES

Table A-3 lists the major technical estimating differences between

CBO and the Administration. The next section of this appendix discusses

the differences in defense estimates. The concluding section covers the

remainder of the budget.

National Defense

CBO estimates that defense outlays under the Administration's request

will be $25 billion higher over the 1984-1989 period than the Administration

estimates. The reason for this large estimating difference—most of which

is in defense procurement—is not clear. In making its estimate CBO

assumes the same total program as the Administration assumes in all years

and the same program composition in 1984 and 1985. Because the

Administration does not detail its program mix beyond 1985, CBO assumes a

mix within each appropriation category consistent with the mixes in the

113
TABLE A-3. CBO OUTLAY RESTIMATES DUE TO TECHNICAL

ESTIMATING DIFFERENCES (By fiscal year, in

billions of dollars)

National Defense

Procurement

Operations

Other

Subtotal

International Affairs

Mineral and Timber

Receipts

Farm Price Supports

Medicare

Social Security

Net Interest

Estimating Differences

Different Deficits

Subtotal

OCS Receipts

Other, Net

Total

1984

*

-1

-1

-3

-1

*

#

-1

*

*

*

^T

2

_2

_5

1985

2

1

-1

1

-2

*

#

-2

-1

1

*

~T

2

*

*

1986

3

2

*

~5

-2

1

3

-2

-3

2

1

3

4

*

9

1987

3

1

*

~£

-1

1

3

-2

-4

2

2

4

5

_1

11

1988

6

1

*

~8

*

1

2

-1

-4

2

4

6

4

*

15

1989

8

2

1

10

*

1

2

*

-4

-1

7

6

3

-2

16

* Less than $500 million.

SOURCE: Congressional Budget Office.
earlier years. CBO and the Administration both expect that some appro- priations will never be spent; CBO assumes that about one percent of

defense budget authority will not translate into outlays. Questions of

program mix and appropriation lapses, however, cannot explain much of the

estimating differences.

Procurement. CBO's outlay estimates for procurement are shown in

Table A-4; the budget authority is the Administration's request and total

outlays are decomposed into the amounts due to each year's appropriations. The implicit outlay rates shown in the bottom panel of the table indicate

that the program mix contained in the estimates tends toward slower

spending programs, but is basically stable.

The Administration has not provided a similar decomposition of its

procurement estimates, but when CBO attempted to reconstruct the

Administration estimate using published DoD outlay rates for 1984 and 1985, it was unable to do so. In fact, using published Administration outlay rates, CBO computed outlays that exceeded Administration estimates by $3.0

billion in 1986, $3.9 billion in 1987, $7.5 billion in 1988, and $10.6 billion in

1989. This inconsistency in Administration estimates could explain much of

the difference with CBO for procurement outlays.

Operations. As defined here, operations combines the operation and

maintenance (O&M) accounts and the revolving funds. CBO groups these

categories because an outlay change in one is often balanced by an

offsetting change in the other; the O&M accounts are the main customers of

the revolving funds and receipts in the latter are often disbursements from

the former. This year, however, the Administration is requesting $3-4

billion per year between 1986 and 1989 to enhance revolving fund

inventories—an action that would increase total budget outlays because

there would be no offsetting receipt from the O&M accounts.

The difficult estimating question is what outlay rate to use for the

revolving funds' budget authority. CBO assumes that the first year spending

will be about 76 percent of the appropriation, with the balance of spending

in the second and third years. The Administration apparently assumes that

all 1984 and 1985 budget authority will be spent in the first year.

Assuming a 100 percent outlay rate for the revolving funds and DoD's

published outlay rates for the O&M accounts, a discrepancy emerges

between Administration outlay rates and Administration outlay estimates. Like procurement, the outlay estimates appear too low. In operations the

underestimate averages $1 billion per year and explains 75 percent of the

estimating difference between CBO and the Administration. (Relaxing the

115
TABLE A-4. CBO OUTLAY ESTIMATES FOR DEFENSE PROCUREMENT

BASED ON THE PRESIDENT'S FEBRUARY BUDGET

AUTHORITY REQUEST (By fiscal year)

1984 1985 1986 1987 1988 1989

Budget Authority (BA)

Outlays from

1983 and prior BA

1984 BA

1985 BA

1986 BA

1987 BA

1988 BA

1989 BA

Total Outlays a/

Billions of Dollars

85.2 107.9 126.0 137.0 147.1

52.0 33.5

12.1 30.6

15.6

16.1

22.9

38.7

17.0

8.6

9.3

28.8

44.8

18.2

4.8

5.6

11.6

33.8

48.1

19.2

64.1 79.6 94.7 109.7 123.1

161.5

1.3

3.2

7.0

13.9

36.6

51.1

21.4

134.4

Percent

Implicit Outlay Rates

from New BA for

1984

1985

1986

1987

1988

1989

14.2 35.9

14.5

26.9

35.9

13.5

10.9

26.8

35.6

13.3

6.6

10.8

26.8

35.1

13.1

3.8

6.5

11.0

26.

34,

.7

.7

13.3

SOURCE: Compiled by CBO from data supplied by the Department of De- fense, and the CBO.

116
TABLE A-5. CBO TECHNICAL REESTIMATES FOR OTHER DEFENSE

PROGRAMS (By fiscal year, in millions of dollars)

1984 1985 1986 1987 1988 1989

Military Personnel

RDT&E

Military Construction

Family Housing

Other

Total

41

-1,157

-68

-237

-26

-1,448

-243

-753

-216

-215

-50

-1,477

-222

130

55

-244

-1

-282

-265

240

141

-244

—-128

-281

403

371

-244

—

249

-285

608

570

-244

--

649

SOURCE: Compiled by CBO from data supplied by the Department of

Defense, and the CBO.

100 percent outlay rate assumption to the CBO rates reduces the discrep- ancy to $0.9 billion per year.)

All Other. For the remaining categories of defense spending, CBO

estimates lower outlays in 1984 to 1987 and higher outlays in 1988 and 1989,

as shown in Table A-5. CBO would estimate lower net outlays throughout

the six-year period were it not for inconsistencies between Administration

outlay rates and outlay estimates similar to those discussed above for

procurement and operations. Between 1986 and 1989, CBO's reconstruction

of the Administration's estimate points to outlays averaging $550 million per

year more than Administration estimates or $450 per year more than CBO

estimates.

Nondefense Spending

Technical estimating differences between CBO and the Administration

are small for nondefense spending in the aggregate, although there are a

number of offsetting pluses and minuses. CBO projects lower outlays for

international affairs, primarily the Export-Import Bank and foreign military

sales financing. CBO expects smaller increases in Export-Import Bank

direct loan obligations because of relatively slow growth in exports to the

less developed countries, the largest customers for Export-Import Bank

financing. CBO is also estimating slower disbursements for foreign military

117
sales direct loans, consistent with the experience of the off-budget foreign

military sales loan program.

CBO estimates that receipts from onshore mineral leases will be less

than the Administration projects because of smaller oil and coal production

and lower energy prices. Projected timber receipts are also lower because

of fewer housing starts and lower demand for lumber.

CBO has substantially higher farm price support outlays than the

Administration in 1986 and later years, mostly because of lower wheat and

dairy prices. For wheat, CBO assumes higher yields per acre than the

Administration and lower participation in acreage reduction programs. For

dairy, CBO projects a less rapid decline in herds and a slower growth in

consumption.

Medicare and Social Security outlays are lower in CBO's projections

than in the Administration's for technical reasons. CBO has lowered its

estimate of Hospital Insurance outlays for fiscal year 198* to reflect recent

experience in the program; CBO assumes a more rapid growth rate in later

years, however, so that the technical differences are less than $500 million

by 1989. The technical differences in Social Security result from generally

lower CBO projections of the beneficiary population.

The technical differences in net interest outlays result primarily from

the effect of other technical differences on deficits. In addition, however, there are some technical estimating differences in the net interest function

itself. Based on traditional Treasury debt management practices, CBO

estimates that 33 percent of each year's financing will be accomplished

through Treasury bill sales. In contrast, the Office of Management and

Budget generally assumes that 35 to 36 percent of borrowing will be

accomplished with bills, which generally have lower interest rates than

longer term instruments. OMB also assumes net purchases of savings bonds

in all periods, even though the introduction of the new market-based savings

bonds has not stanched the flow of net redemptions. Consistent with its

estimates of Outer Continental Shelf receipts (discussed in the next

paragraph), CBO also assumes that interest receipts from OCS esrow

releases will be less than the Administration projects in 1985-1987 but

greater in 1989. As a result, the total estimating differences in net interest

become negative in 1989.

The largest technical estimating difference between CBO and the

Administration, aside from national defense, is in receipts from oil and gas

leasing and production on Outer Continental Shelf tracts. The differences

are smallest in 198* and 1985 but grow thereafter. For fiscal years 1986

through 1989, CBO assumes that bonus receipts will remain at about the

118
1985 level, while the Administration assumes that bonuses will increase by

about 10 percent per year. Because of lower energy price and production

levels, CBO also has lower royalty estimates each year. Finally, CBO

estimates that litigation over funds now in escrow will not be resolved as

early as the Administration assumes. This will result in smaller escrow

releases through 1988 and greater releases in 1989.

119

APPENDIX B. MAJOR CONTRIBUTORS TO THE PREPARATION OF

THIS REPORT

Members of the Budget Analysis, Fiscal Analysis, and Tax Analysis

Divisions were major contributors to this report. The individuals who helped

prepare the analyses for each chapter are listed below:

Chapter and Section

Chapter I.

Chapter II.

Chapter HI.

Chapter IV.

Chapter V.

Telephone

Analyst Number

Paul N. Van de Water 226-2880

Kathy A. Ruffing 226-2880

Charles J. Richardson 226-2880

Stephen H. Zeller 226-2753

Kathy A. Ruffing 226-2880

Rosemary Marcuss 226-2687

Kathleen O'Connell 226-2685

Valerie Amerkhail 226-2692

Robert Lucke 226-2720

Carl Moor 226-2686

Steve Porter 226-2678

Larry Ozanne 226-268*

Linda Radey 226-2693

Pearl Richardson 226-2691

Hy Sanders 226-2690

Edward A. Swoboda 226-28*0

Eugene Bryton 226-28*0

Julia Doherty 226-28*0

Pat Haar 226-2880

Barbara Hollinshead 226-28*0

Michael A. Miller 226-28*0

William Myers 226-28*0

Jonathan Tyson 226-28*0

W. Ritchie Smith 226-28*0

Charles E. Seagrave 226-2820

Robert A. Sunshine 226-2860

Lloyd Bernard 226-2860

121
Chapter and Section

Chapter V.

Analyst

Diane Burnside

Hinda Chaikind

Stephen Chaikind

Howard Conley

Mary Ann Curtin

Marianne Deignan

Debra Goldberg

Kathleen Gramp

Richard Hendrix

Roger Hitchner

Anne Hoffman

Deborah Kalcevic

Kathleen Kelly

Car la Kruytbosch

Linwood Lloyd

Kelly Lukins

Mary Maginniss

Anne Manley

Jeffrey Nitta

Carmela Pena

Janice Peskin

Deborah Reis

Stacey Sheffrin

Kathleen Shepherd

Brent Shipp

Jack Rodgers

Joseph Whitehall

Telephone

Number

226-2860

226-2820

226-2820

226-2860

226-2860

226-2820

226-2860

226-2860

226-2820

226-2860

226-2860

226-2820

226-2860

226-2840

226-2860

226-2820

226-2860

226-2820

226-2860

226-2820

226-2835

226-2860

226-2820

226-2820

226-2860

226-2820

226-2840

Computer support for the spending analysis in this report was provided

by Cindy Andre, Timothy Buck, Marion Curry, Kenneth Farris, Vernon

Hammett, Daniel Hill, Vera Powell, and David Sanders. Other technical

support was provided by Janet Airis, George Arnold, Priscilla Aycock, Edward Blau, Shirley Edwards, Betty Embrey, Glen Goodnow, Patricia

Kinslow, and Robert Sempsey. C.G. Nuckols, Jr. also gave valuable

assistance in reviewing the many drafts of the spending chapters.

122