CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

An Analysis of the President’s Budgetary

Proposals for Fiscal Year 2007

MARCH 2006

CBO

An Analysis of the President’s Budgetary 

Proposals for Fiscal Year 2007

March 2006
Notes

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

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

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

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

along with the report Preliminary Analysis of the President’s Budget Request for 2007 (March 3, 

2006).
Preface

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

for fiscal year 2007—prepared at the request of the Senate Committee on Appropriations—

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

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

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

selected revenue proposals; the Joint Committee on Taxation prepared most of the estimates 

of the President’s revenue proposals. This report expands on CBO’s preliminary analysis, 

which was released on March 3, 2006.

Barry Blom of CBO’s Projections Unit was the lead author for Chapter 1; Mark Booth, 

Pamela Greene, and Christina Hawley Sadoti wrote major portions of the chapter. Ben Page 

of the Macroeconomic Analysis Division wrote Chapter 2 and Appendixes B and C, with 

assistance from Robert Arnold, Paul Burnham, Ufuk Demiroglu, Eva de Francisco, Mark 

Lasky, Larry Ozanne, Frank Russek, and Marika Santoro. Ann Futrell of the Projections Unit 

wrote Appendix A. The contributors to the revenue and spending projections underlying this 

report are listed in Appendix D.

Leah Mazade and Christian Spoor edited the report, with assistance from Christine Bogusz 

and Loretta Lettner. Maureen Costantino took the photograph for the cover and prepared the 

report for publication. Lenny Skutnik produced the printed copies.

Donald B. Marron

Acting Director

March 2006

Contents

1 CBO’s Estimates of the President’s Budget for Fiscal Year 2007 1

Overview of CBO’s Estimates 1

Policy Proposals That Affect Revenues 8

Policy Proposals That Affect Mandatory Spending 10

Policy Proposals That Affect Discretionary Spending 15

Differences Between CBO’s and the Administration’s

Budget Estimates 22

2 The Economy Under the President’s Budget and Under CBO’s

Baseline Policy Assumptions 29

How Fiscal Policy Affects the Economy 29

A Description of the Models Used by CBO and Their Results 36

A Changes to CBO’s Baseline Since January 2006 45

B The Potential Economic Effects of Selected Proposals in the

President’s 2007 Budget 51

C The Models Used to Analyze the Supply-Side Macroeconomic

Effects of the President’s Budget 55

D Contributors to the Revenue and Spending Projections 59
VI AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Tables

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

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

1-2. CBO’s Estimate of the President’s Budget for 2007 4

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

Surpluses 5

1-4. Sources of Differences Between CBO’s and the Administration’s Estimates of the

President’s Budget 7

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

2005 to 2007 16

1-6. Discretionary Spending Under the President’s Budget and in CBO’s

March Baseline 18

1-7. Comparison of Discretionary Budget Authority Enacted or Requested for

2006 and Requested by the President for 2007, by Budget Function 20

1-8. Comparison of CBO’s March Baseline and the Administration’s February 

Current-Services Baseline 24

1-9. Comparison of CBO’s, the Administration’s, and Private-Sector Economic

Projections for Calendar Years 2006 to 2011 26

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

After Accounting for Economic Effects 31

2-2. CBO’s Estimates of Effective Federal Marginal Tax Rates on Labor Income 33

2-3. CBO’s Estimates of Effective Federal Marginal Tax Rates on Capital Income 35

2-4. CBO’s Year-by-Year Forecast and Projections for Calendar Years

2006 Through 2016 38

2-5. CBO’s Estimates of How the President’s Budget Would Affect Real Gross

National Product 40

2-6. The Budgetary Implications of the Macroeconomic Effects 42

A-1. CBO’s Baseline Budget Projections 46

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

January 2006 47
CONTENTS VII

Figures

1-1. The Total Deficit or Surplus, 1965 to 2016 3

1-2. Discretionary Budget Authority Under the President’s Budget, 1985 to 2011 17

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

Would Affect the Deficit After Accounting for Economic Effects 30

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

Tax Rates on Capital Income and Labor Income 37

Box

1-1. The President’s Proposal for Individual Social Security Accounts 12
 
CHAPTER

1

CBO’s Estimates of the President’s Budget

for Fiscal Year 2007 Chapter 1: CBO’s Estimates of the President’s Budget for Fiscal Year 2007

At the request of the Senate Committee on 

Appropriations, the Congressional Budget Office (CBO) 

has analyzed the President’s budget request for fiscal year 

2007 using its own economic assumptions and estimating techniques.1 The analysis also incorporates the Joint 

Committee on Taxation’s (JCT’s) estimates for provisions 

that affect the tax code. This report provides more detail 

and analysis about the President’s budgetary proposals—

and about CBO’s updated baseline budget projections—

than did the preliminary report that CBO released on 

March 3.

Overview of CBO’s Estimates

The President’s proposals would add $35 billion to the 

deficit that CBO currently projects for 2006, reducing 

revenues by nearly $9 billion and boosting outlays by $27 

billion (mostly for military operations in Iraq and Afghanistan). If those proposals were enacted, the deficit 

would total $371 billion this year, CBO estimates (see 

Table 1-1). Relative to the size of the economy, this year’s 

deficit would equal 2.8 percent of gross domestic product 

(GDP). By comparison, the deficit in 2005 was $318 billion, or 2.6 percent of GDP.

Estimates for the 2007-2016 Period

In 2007, the deficit would total $335 billion under the 

President’s budgetary proposals, CBO estimates. However, the amount that the President has requested to fund 

ongoing U.S. operations in Iraq and Afghanistan for that 

year ($50 billion) may not be sufficient. If the pace of 

those operations remained at about this year’s level, the 

deficit in 2007 would be around $355 billion, or 2.6 percent of GDP.

After 2007, the deficit would continue to decline as a percentage of GDP under the President’s proposals—to 1.6 

percent in 2008 and 1.3 percent in 2009, CBO estimates, 

before stabilizing at around 1.0 percent through 2016 

(see Figure 1-1). Those deficits would total $2.1 trillion, 

or 1.2 percent of GDP, between 2007 and 2016 (the current 10-year projection period). Federal debt held by the 

public would grow from 37.4 percent of GDP at the end 

of 2005 to 38.5 percent at the end of 2007. It would then 

gradually fall to 34.5 percent of GDP by 2016. However, 

those figures do not reflect any additional funding for 

military activities in Iraq and Afghanistan beyond 2007.

The President’s budget does not contain year-by-year estimates of spending and revenues after 2011. Instead, it 

provides a cumulative estimate through 2016 for each 

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

provides details only for 2006 and 2007; for 2008 

through 2011, such funding is shown in the aggregate, by 

budget function.2

 CBO incorporated those aggregate levels in its estimates and calculated discretionary outlays for 

the 2012-2016 period by projecting the amount of discretionary budget authority that the President recommended for 2011 and adjusting it for inflation. 

Total outlays would remain at more than 20 percent of 

GDP this year and next year under the President’s budget, close to their average of 20.5 percent since 1965. 

Thereafter, total outlays would decline to around 

1. The analysis covers the budget that the President submitted on 

February 6 as well as the detailed requests for supplemental funding that were transmitted on February 16, primarily for military 

operations in Iraq and Afghanistan and hurricane recovery.

2. Budget functions are the broad categories into which the federal 

budget is divided so that all budget authority and outlays can be 

presented according to the national interests they address (such as 

defense, agriculture, transportation, and so forth).
2 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-1.

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

President’s Budget and in CBO’s March Baseline

(Billions of dollars)

Source: Congressional Budget Office.

Note: GDP = gross domestic product; n.a. = not applicable.

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

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

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

estimates (see Table 1-2). Mandatory spending programs 

would grow faster than nominal GDP through 2016: at 

an average rate of 6.1 percent a year, versus 4.8 percent 

for nominal GDP. By contrast, discretionary outlays 

would be lower in 2011 than estimated for 2007 in dollar 

terms; as a percentage of GDP, they would fall from 7.5 

percent in 2007 to 5.9 percent in 2011.

Revenues would rise under the President’s budget from 

17.6 percent of GDP this year and next year to 18.2 percent by 2016. At that point, revenues would equal their 

average share of GDP since 1965.

Total, Total,

Actual 2007- 2007-

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 2016

On-Budget Deficit -493 -551 -527 -448 -422 -410 -447 -389 -414 -412 -412 -450 -2,255 -4,332

Off-Budget Surplusa 175 180 192 213 228 245 244 231 218 214 208 200 1,123 2,195 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

-318 -371 -335 -236 -194 -165 -204 -158 -195 -197 -204 -250 -1,133 -2,137

On-Budget Deficit -493 -516 -460 -466 -456 -465 -382 -216 -227 -211 -198 -220 -2,228 -3,300

Off-Budget Surplusa 175 180 195 215 232 249 265 274 280 286 288 290 1,156 2,574 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

-318 -336 -265 -250 -224 -216 -117 58 53 74 91 70 -1,072 -726

On-Budget Deficit 0 -35 -67 17 34 54 -66 -174 -186 -201 -214 -230 -27 -1,031

Off-Budget Surplusa 0 0 -3 -3 -3 -4 -21 -42 -62 -71 -80 -90 -33 -380 __ ___ ___ ___ ___ ___ ___ ____ ____ ____ ____ ____ ___ _____

0 -35 -70 15 31 50 -86 -216 -249 -272 -294 -320 -61 -1,411

Memorandum:

Total Deficit as a

Percentage of GDP

CBO's estimate of the

President's budget -2.6 -2.8 -2.4 -1.6 -1.3 -1.0 -1.2 -0.9 -1.1 -1.0 -1.0 -1.2 -1.5 -1.2

CBO's baseline -2.6 -2.6 -1.9 -1.7 -1.5 -1.3 -0.7 0.3 0.3 0.4 0.5 0.3 -1.4 -0.4

Debt Held by the Public

as a Percentage of GDP

CBO's estimate of the

President's budget 37.4 38.0 38.5 38.3 37.8 37.1 36.7 36.1 35.7 35.2 34.8 34.5 n.a. n.a.

CBO's baseline 37.4 37.7 37.8 37.7 37.4 37.0 36.2 34.3 32.6 30.9 29.1 27.6 n.a. n.a.

CBO's Estimate of the President's Budget for 2007

CBO's Baseline

Difference (President's budget minus baseline)b

Total Deficit

Total Deficit (-) or Surplus

Total Deficit or Surplus
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 3

Figure 1-1.

The Total Deficit or Surplus, 1965 to 2016

(Percentage of gross domestic product)

Source: Congressional Budget Office.

The Impact of the President’s Proposals on the

Current Budget Outlook

The President’s policies would increase the cumulative 

deficit over the next five years by $61 billion relative to 

current laws and policies, as projected in CBO’s latest 

baseline. CBO’s baseline projections are required by law 

to incorporate the assumption that present laws and policies remain unchanged. Specifically, the baseline assumes 

that various tax provisions expire as scheduled and that all 

discretionary funding for the current year (including supplemental appropriations) grows at the rate of inflation in 

future years.

Over the 2007-2011 period, outlays would be $221 billion lower under the President’s proposals than under 

current law, CBO estimates (see Table 1-3). Those proposals would reduce mandatory spending by $28 billion, 

defense outlays by $33 billion, and nondefense discretionary outlays by $170 billion, and increase net interest 

spending by $10 billion, from the amounts in the baseline. At the same time, proposed changes to tax laws—

such as extending the expiring provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 

(EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA)—would reduce revenues by an estimated $282 billion through 2011 compared with the baseline.3

The impact of the President’s proposals on the cumulative deficit would be far greater over 10 years ($1.4 trillion) than over five years ($61 billion). Under the assumptions of the baseline, deficits would be followed by 

small surpluses beginning in 2012, CBO projects; under 

the President’s policies, by contrast, deficits would continue throughout the 2007-2016 period. Mainly because 

of proposals to extend tax provisions that are scheduled to 

expire by 2011, total revenues during the 2007-2016 

period would be $1.7 trillion lower under the President’s 

budget than in the baseline. Over those 10 years, the 

President’s proposals would increase mandatory spending 

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

-6

-5

-4

-3

-2

-1

0

1

2

3

Actual Projected

CBO's

Estimate

of the

President's

Budget

CBO's

Baseline

Projection

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

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

Committee on Taxation. This analysis uses JCT’s preliminary projections; JCT may revise some of those projections when it publishes final estimates. (At the time this report was written, the 

release date of those final estimates was not known.)
4 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-2.

CBO’s Estimate of the President’s Budget for 2007

(Billions of dollars)

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Total, Total,

Actual 2007- 2007-

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 2016

On-budget 1,576 1,696 1,789 1,908 2,000 2,104 2,182 2,294 2,415 2,544 2,680 2,826 9,984 22,744

Off-budget 577 608 642 676 712 747 782 817 853 890 928 968 3,559 8,014 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,154 2,304 2,431 2,585 2,712 2,852 2,964 3,111 3,268 3,434 3,608 3,794 13,543 30,758

1,320 1,431 1,485 1,561 1,643 1,742 1,877 1,961 2,119 2,253 2,396 2,587 8,308 19,624

968 1,025 1,034 995 987 988 993 1,001 1,027 1,050 1,074 1,104 4,998 10,253

184 219 246 265 276 287 297 307 317 329 341 353 1,370 3,017 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,472 2,675 2,766 2,820 2,906 3,017 3,167 3,270 3,463 3,631 3,812 4,044 14,676 32,895

On-budget 2,070 2,247 2,316 2,357 2,422 2,515 2,629 2,684 2,829 2,956 3,092 3,276 12,239 27,076

Off-budget 402 428 450 464 483 502 538 586 634 675 720 768 2,437 5,819

-318 -371 -335 -236 -194 -165 -204 -158 -195 -197 -204 -250 -1,133 -2,137

-493 -551 -527 -448 -422 -410 -447 -389 -414 -412 -412 -450 -2,255 -4,332

175 180 192 213 228 245 244 231 218 214 208 200 1,123 2,195

4,592 4,966 5,311 5,560 5,766 5,943 6,158 6,326 6,528 6,733 6,942 7,195 n.a. n.a.

12,293 13,082 13,781 14,508 15,264 16,021 16,768 17,524 18,311 19,121 19,963 20,839 76,343 172,101

On-budget 12.8 13.0 13.0 13.2 13.1 13.1 13.0 13.1 13.2 13.3 13.4 13.6 13.1 13.2

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

17.5 17.6 17.6 17.8 17.8 17.8 17.7 17.8 17.8 18.0 18.1 18.2 17.7 17.9

10.7 10.9 10.8 10.8 10.8 10.9 11.2 11.2 11.6 11.8 12.0 12.4 10.9 11.4

7.9 7.8 7.5 6.9 6.5 6.2 5.9 5.7 5.6 5.5 5.4 5.3 6.5 6.0

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

20.1 20.4 20.1 19.4 19.0 18.8 18.9 18.7 18.9 19.0 19.1 19.4 19.2 19.1

On-budget 16.8 17.2 16.8 16.2 15.9 15.7 15.7 15.3 15.4 15.5 15.5 15.7 16.0 15.7

Off-budget 3.3 3.3 3.3 3.2 3.2 3.1 3.2 3.3 3.5 3.5 3.6 3.7 3.2 3.4

-2.6 -2.8 -2.4 -1.6 -1.3 -1.0 -1.2 -0.9 -1.1 -1.0 -1.0 -1.2 -1.5 -1.2

-4.0 -4.2 -3.8 -3.1 -2.8 -2.6 -2.7 -2.2 -2.3 -2.2 -2.1 -2.2 -3.0 -2.5

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

37.4 38.0 38.5 38.3 37.8 37.1 36.7 36.1 35.7 35.2 34.8 34.5 n.a. n.a.

Off-budget

Debt Held by the Public

Total

Net interest

Total

On-budget 

Revenues

Deficit (-) or Surplus

Outlays

Mandatory spending

Discretionary spending

Gross Domestic Product

On-budget 

Off-budget

Debt Held by the Public

Memorandum:

In Billions of Dollars

As a Percentage of Gross Domestic Product

Outlays

Revenues

Discretionary spending

Total

Mandatory spending

Net interest

Total

Deficit (-) or Surplus
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 5

Table 1-3.

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

Surpluses

(Billions of dollars)

Sources: Congressional Budget Office; Joint Committee on Taxation.

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

and Growth Tax Relief Reconciliation Act of 2003; AMT = alternative minimum tax.

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

Total, Total,

2007- 2007-

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

in CBO's March 2006 Baseline -336 -265 -250 -224 -216 -117 58 53 74 91 70 -1,072 -726

0 0 0 0 0 -94 -154 -159 -162 -166 -172 -94 -906

* -1 -2 -1 -2 -30 -56 -60 -67 -73 -79 -35 -369

0 0 -2 -12 -9 -24 -26 -28 -30 -31 -33 -48 -197

0 0 -3 -6 -4 -3 -2 -1 -1 -1 -1 -16 -23

0 0 0 0 0 -4 -7 -8 -9 -10 -11 -4 -50

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

* -1 -7 -19 -14 -155 -245 -257 -269 -282 -296 -197 -1,545

-6 -26 0 0 0 0 0 0 0 0 0 -26 -26

-2 -4 -6 -7 -8 -8 -9 -9 -10 -10 -10 -32 -80

0 -1 -3 -2 -1 -1 -1 -1 -1 -1 -1 -9 -12

0 * -1 -1 -2 -2 -2 -2 -2 -2 -3 -5 -16

0 * -1 -3 -4 -4 -4 -3 -3 -2 -1 -11 -24

0 * * -1 -1 -1 -1 -1 -1 -1 -1 -4 -10

0 3 5 4 3 * -1 -2 -3 -4 -5 15 *

* * -1 -3 -4 -5 -4 -4 -3 -4 -4 -12 -30 __ ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ____ _____

-9 -30 -14 -31 -32 -175 -267 -279 -291 -305 -320 -282 -1,744

0 0 0 1 1 18 38 55 61 66 72 19 312

0 -3 -5 -8 -9 -12 -12 -15 -19 -24 -31 -37 -138

0 * * * * * 15 16 16 16 16 -1 77

0 0 -4 -4 -4 -4 -4 -4 -4 -4 -4 -14 -35

0 * 1 1 2 2 2 3 3 3 4 6 21

0 -1 -1 -1 -1 -1 -1 -1 -1 -2 -2 -5 -11

3 5 1 -2 * * * * 1 -2 -3 4 1 __ __ __ ___ ___ __ __ __ __ __ __ ___ ___

3 1 -8 -12 -11 2 40 54 56 53 52 -28 226

22 35 -6 -16 -21 -25 -26 -27 -28 -28 -29 -33 -171

1 * -17 -35 -50 -68 -74 -77 -80 -82 -84 -170 -567 __ __ ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ____

23 35 -23 -52 -71 -93 -100 -104 -107 -110 -113 -203 -738

1 3 3 2 * 1 9 20 33 46 61 10 179 __ __ ___ ___ ___ ___ ___ ___ ___ ___ __ ___ ____

27 40 -28 -62 -82 -89 -51 -30 -19 -11 * -221 -333

-35 -70 15 31 50 -86 -216 -249 -272 -294 -320 -61 -1,411

-371 -335 -236 -194 -165 -204 -158 -195 -197 -204 -250 -1,133 -2,137

Total Deficit (-) or Surplus as Projected 

AMT extension

Subtotal, proposed extensions

Discretionary

Tax rates on dividends and capital gains

Expensing for small businesses

Education, retirement, and other provisions

Subtotal, mandatory

Expansion of health savings accounts

Earned income and child tax credits

Pension insurance

Refundable tax credits from health care proposals

Deduction for high-deductible health insurance

Medicaid

Refundable health insurance tax credit

Total Effect on Revenues

Outlays

Effect of the President's Proposals

Research and experimentation tax credit

Revenues

General tax rates, child tax credit, and tax brackets

Estate and gift taxes

Expansion of expensing for small businesses

Extension of expiring EGTRRA and JGTRRA provisions

 Net interest

Total Effect on Outlays

Total Impact on the Deficit or Surplusa

Total Deficit Under the President's Proposals

Defense

Expansion of tax-free savings accounts

Other proposals

Subtotal, discretionary

Other proposals

Medicare

Mandatory

Social Security individual accounts

Nondefense
6 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

by a total of $226 billion from baseline levels but would 

decrease discretionary spending by $738 billion. The 

higher deficits that would result under the President’s 

budget would require additional federal borrowing; debtservice costs on that borrowing would add another $179 

billion to the cumulative deficit between 2007 and 2016.

The Impact on the Economy

The estimates in this chapter result from an analysis of 

the President’s budgetary proposals that does not account 

for the proposals’ potential impact on the economy. Such 

an economic impact, however, could influence how the 

policy changes would affect spending and revenues. 

Therefore, CBO has also prepared a macroeconomic 

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

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

of the President’s proposals. 

CBO has concluded that the macroeconomic effects—

and their resulting budgetary impact—would most likely 

be modest over the next five years. During the following 

five years, the effects would be somewhat larger and 

would generally increase economic output.

Comparison with the Administration’s Estimates

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

affect the deficit differs noticeably from the Administration’s estimate for 2006. However, the two sets of estimates are similar for each year of the 2007-2011 period. 

(The Administration did not provide budget estimates 

beyond 2011.)

CBO projects a deficit of $371 billion in 2006 under the 

President’s budget, whereas the Administration expects a 

shortfall of $423 billion (see Table 1-4). For 2007, CBO 

estimates that the deficit would total $335 billion under 

the President’s proposals, $20 billion less than the Administration’s estimate of $354 billion. Both CBO and 

the Administration expect the deficit to shrink each year 

through 2010. For the 2007-2011 period, CBO’s cumulative deficit projection of $1.1 trillion is only $40 billion 

less than the Administration’s projection. 

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

budget are smaller than those of the Administration—by 

$34 billion for 2006 and by a total of $130 billion (or 0.9 

percent) for the 2007-2011 period. Almost half of the 

difference over five years (about $63 billion) stems from 

different estimates of the President’s proposal to add voluntary individual accounts to the Social Security program 

starting in 2010. Differing economic assumptions cause 

CBO’s baseline projections of mandatory outlays between 

2007 and 2011 to be lower than the Administration’s by 

another $31 billion. In addition, CBO projects that net 

interest payments over that period would be about $69 

billion lower than the Administration’s estimate. (Most of 

that gap comes from differing assumptions about future 

interest rates and lower projected deficits.) Partially offsetting those lower estimates, CBO’s calculation of discretionary outlays under the President’s budget during the 

2007-2011 period exceeds the Administration’s by $37 

billion, mostly because of differing estimates of defense 

outlays.

CBO’s and the Administration’s projections of revenues 

under the President’s budget are generally similar. CBO’s 

revenue estimates are $19 billion higher than the Administration’s for 2006 but $90 billion (or 0.7 percent) lower 

than the Administration’s for the 2007-2011 period. 

Those differences mainly result from differing estimates 

of revenues under current law.

CBO’s Most Recent Baseline Budget Projections

In conjunction with its analysis of the President’s budget, 

CBO typically updates its baseline projections to account 

for new information from the budget submission and 

other sources. (CBO refers to such changes as technical 

revisions.) The update also incorporates the effects of legislation enacted in the two months since the previous 

baseline was completed.4 (CBO typically updates its 

economic assumptions during the summer.)

In this case, most of the changes to CBO’s baseline since 

January result from enactment of the Deficit Reduction 

Act of 2005 (Public Law 109-171). As a whole, new laws 

have lowered total outlay projections for the 2007-2016 

period by $124 billion. Reductions in mandatory spending stemming from the Deficit Reduction Act account 

for $106 billion of that total.5

4. For the previous baseline, see Congressional Budget Office, The 

Budget and Economic Outlook: Fiscal Years 2007 to 2016 (January 

2006).

5. CBO estimates that the Deficit Reduction Act will reduce mandatory spending by $39 billion between 2006 and 2010, the period 

covered by the budget resolution for 2006. For more details, see 

Congressional Budget Office, Cost Estimate for S. 1932, the Deficit 

Reduction Act of 2005 (January 27, 2006).
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 7

Table 1-4.

Sources of Differences Between CBO’s and the Administration’s Estimates of the 

President’s Budget

(Billions of dollars)

Sources: Congressional Budget Office; Joint Committee on Taxation.

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

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

Total,

2007-

2006 2007 2008 2009 2010 2011 2011

-423 -354 -223 -208 -183 -205 -1,173

-15 -26 -35 -41 -47 -65 -213

34 41 29 39 21 -7 123 ___ ___ ___ ___ ___ ___ ___

Total Revenue Differences 19 15 -6 -2 -26 -71 -90

* -2 -4 -7 -8 -11 -31

Social Security individual accounts 0 * * * -23 -40 -63

Other -25 -7 4 -6 2 4 -4 ___ __ __ __ ___ ___ ___

-25 -7 3 -6 -21 -36 -67

-25 -9 -1 -12 -29 -47 -98

-7 6 15 12 5 -1 37

-1 3 * -4 -6 -8 -15

-1 -4 -8 -11 -14 -17 -54

__ __ __ ___ ___ ___ ___

-1 -1 -8 -15 -20 -25 -69

Total Outlay Differences -34 -4 7 -16 -44 -73 -130

52 20 -12 14 18 1 40

-371 -335 -236 -194 -165 -204 -1,133

-15 -26 -31 -30 -33 -46 -166

67 46 18 44 51 47 206

Subtotal, technical

Subtotal, mandatory

All Differencesa

Technical

Deficit Under the President's Proposals

Memorandum:

CBO's Estimate

Subtotal, net interest

Total Economic Differencesa

Deficit Under the President's Proposals

Revenue Differences

Administration's Estimate

Sources of Differences Between CBO and the Administration

Total Technical Differencesa

Economic

Technical

Outlay Differences

Discretionary (Technical)

Economic

Net interest

Mandatory

Economic

Technical
8 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Technical changes to CBO’s baseline have increased projected outlays and revenues slightly—by $24 billion and 

$6 billion, respectively—over 10 years. The largest technical change involves the Medicare program. CBO has 

raised its estimate of Medicare outlays over the 2007-

2016 period by $102 billion because of recent rapid 

growth in spending for that program. In the other direction, CBO has trimmed its estimate of spending for the 

Medicaid program by $63 billion over that period, primarily because of slower-than-expected growth in per 

capita spending in several areas, such as long-term care 

services and prescription drugs. 

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

now projects that if current tax and spending policies 

remained the same, the cumulative deficit for the 2007-

2016 period would total $726 billion. That figure is 

$106 billion smaller than CBO estimated in January. 

(For more information about recent revisions to CBO’s 

baseline, see Appendix A.) 

Policy Proposals That Affect Revenues

The President’s budget proposes several changes to tax 

law that would reduce revenues significantly over the next 

decade from the amounts that CBO estimates would be 

collected under current law. Those proposals include the 

extension of a number of expiring tax provisions and a 

variety of new tax incentives. The most significant 

changes involve provisions of EGTRRA and JGTRRA, 

the alternative minimum tax (AMT), the research and 

experimentation tax credit, tax deductions for certain 

premiums paid for health care plans with high deductibles, and various types of savings accounts.

CBO and JCT estimate that as a whole, the President’s 

proposals would reduce revenues by $9 billion this year, 

$30 billion in 2007, and $1.7 trillion over the 2007-2016 

period (see Table 1-3 on page 5).6

 The effect of those 

proposals on refundable tax credits would also increase 

mandatory outlays by $98 billion through 2016.7

Permanent Extensions of Provisions in

EGTRRA and JGTRRA

The Administration proposes to make permanent various 

provisions of EGTRRA and JGTRRA that are set to expire at the end of 2010. Those provisions include changes 

in income tax rates, relief from the so-called marriage 

penalty, an increase in the child tax credit, provisions 

related to education, and repeal of the estate tax. (The 

provisions were enacted in EGTRRA; implementation of 

some of them was accelerated by JGTRRA.) Extending 

those provisions rather than letting them expire as scheduled would reduce revenues by $1.3 trillion and increase 

outlays by $81 billion through 2016, according to CBO’s 

and JCT’s projections.

The President also proposes to make permanent the current tax rates on capital gains and dividends, which are 

scheduled under JGTRRA to rise at the end of 2008. 

That policy change would reduce revenues by an additional $197 billion between 2009 and 2016.

Another provision of JGTRRA and the American Jobs 

Creation Act of 2004 altered the rules governing depreciation for small businesses from 2003 through 2007. It 

increased the amount of investment that such businesses 

could expense (that is, deduct from their taxable income 

immediately rather than over time) from $25,000 to 

$100,000. One proposal in the President’s budget would 

make the $100,000 limit permanent and index it for inflation, which would decrease revenues by about $23 billion over the 2007-2016 period.

In all, the proposals in the 2007 budget to permanently 

extend various tax provisions of EGTRRA and JGTRRA 

would reduce revenues by an estimated $1.5 trillion 

through 2016. They would also increase outlays for 

refundable tax credits by $81 billion over that period.

Changes to the Alternative Minimum Tax

EGTRRA, JGTRRA, and the Working Families Tax 

Relief Act of 2005 expanded the amount of income that 

is exempt from the alternative minimum tax through

6. As noted above, CBO is required by law to use estimates from the 

Joint Committee on Taxation for proposals that would amend the 

Internal Revenue Code.

7. A tax credit is refundable if, when the allowable credit exceeds the 

amount of tax owed, the difference is paid to the taxpayer as a 

refund. Such refunds are recorded in the budget as outlays.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 9

2005.8 Those exemption amounts reverted to preEGTRRA levels at the beginning of calendar year 2006, 

which will cause many more people to be liable for tax 

under the AMT. In addition, under current law, the 

AMT will restrict the use of some nonrefundable personal tax credits—such as the higher education credits 

and the child and dependent care credit—this year.

The President’s budget proposes to continue both the 

AMT’s unrestricted use of those personal tax credits and 

the higher AMT exemption levels for one year (through 

2006). CBO and JCT assume that the provision would 

be enacted early enough to allow taxpayers to reduce their 

payments of estimated taxes in 2006, in which case it 

would lower federal revenues by $6 billion this year. That 

proposal would also decrease revenues by $26 billion and 

increase outlays for refundable tax credits by about $0.2 

billion in 2007.

Extension of the Research and Experimentation

Tax Credit

Under current law, corporations can obtain a tax credit of 

20 percent on certain research expenditures above a base 

amount. That credit expired on December 31, 2005, but 

the President’s budget proposes to make it permanent. 

That proposal would reduce projected revenues by a total 

of $80 billion over the next 10 years, according to CBO 

and JCT. 

Expansion of Expensing for Small Businesses

The President’s budget proposes not only to make permanent the current $100,000 limit on the amount of investment that small businesses can expense but also to raise 

that limit to $200,000 and include off-the-shelf computer equipment as qualified investments. Those additional changes would decrease revenues by $12 billion 

over 10 years.

Health-Related Tax Changes

The President’s budget contains several proposals 

designed to encourage the use of health insurance plans 

with high deductibles. Those proposals include expanding health savings accounts (HSAs) and adding new tax 

deductions and credits for the cost of HSA-eligible insurance plans.

Expansion of Health Savings Accounts. Currently, people 

can use health savings accounts to accumulate funds on a 

tax-preferred basis to pay for medical expenses if those 

expenses are covered only by an HSA-qualified highdeductible health plan. Under the President’s proposal, 

people who made after-tax contributions to an HSA 

would be able to take an income tax credit of up to 15.3 

percent of their HSA contributions so as to offset any 

payroll taxes they paid. However, most nonmedical withdrawals from an HSA would be subject to an additional 

tax of 30 percent (designed in part to recapture the tax 

credit for payroll taxes) in order to discourage the use of 

HSAs for anything other than medical expenses. The 

President’s HSA proposal would make other changes as 

well: 

B Increasing the maximum amount that people are 

allowed to contribute to HSAs from the amount of 

their health plan’s deductible to their maximum outof-pocket expenses;

B Allowing HSA funds to be used tax-free to pay premiums for nongroup high-deductible health insurance; 

and

B Allowing taxpayers to make higher contributions to 

HSAs in certain other cases.

If those changes took effect on January 1, 2007, as proposed, they would reduce revenues by an estimated $16 

billion and increase outlays by $0.4 billion over the 2007-

2016 period.

“Above-the-Line” Tax Deduction for High-Deductible 

Health Insurance. In most cases, income used to pay premiums for employment-based health insurance is not 

taxed, whereas income that individuals use to pay premiums for non-employment-based health insurance is 

taxed, whether the policy has a low or a high deductible. 

As noted above, people who buy certain individual health 

plans with a high deductible can contribute to HSAs, 

which can be used to pay their and their dependents’ outof-pocket health care costs. 

The President’s budget proposes allowing people who 

contribute to HSAs to deduct the premiums they pay for 

8. The AMT is a tax that limits the extent to which higher-income 

taxpayers can reduce the amount they owe by using preferences in 

the tax code. People subject to the AMT are required to recalculate their tax liability on the basis of a more limited set of exemptions, deductions, and tax credits than would normally apply. The 

amount by which a taxpayer’s AMT calculation exceeds his or her 

regular tax calculation is that taxpayer’s AMT liability.
10 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

individual high-deductible health plans from their taxable income. The deduction would occur “above the 

line”—in other words, it would be subtracted from 

income to calculate adjusted gross income (AGI) on tax 

returns. As a result, it would be allowed even if taxpayers 

did not itemize deductions. (Currently, taxpayers who 

itemize can deduct medical expenses that exceed 7.5 percent of AGI from their taxable income.) 

If that proposal took effect on January 1, 2007, it would 

lower revenues by an estimated $24 billion through 

2016. In addition, by increasing eligibility for the proposed income tax credit for HSA contributions, it would 

increase the amount of refundable HSA credits paid and 

thus raise outlays by $9 billion over the 2007-2016 

period.

Refundable Tax Credit for High-Deductible Health

Insurance. The President also proposes to establish a 

refundable income tax credit for lower-income people for 

the cost of high-deductible health insurance. The credit 

would be worth as much as $1,000 per adult and $500 

per child (for up to two children). It could cover up to 90 

percent of the cost of insurance for single taxpayers with a 

maximum modified AGI of $15,000; those with higher 

income would receive less, and the credit would phase 

out completely for single taxpayers with a modified AGI 

of $30,000. (The maximum AGI would be higher for 

families.) If that credit took effect on January 1, 2007, it 

would reduce revenues by $10 billion and raise outlays by 

$11 billion over the 2007-2016 period, CBO and JCT 

estimate. 

Expansion of Tax-Free Savings Accounts

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

plans. Those plans are used primarily for retirement but 

also for other purposes, such as education. The President 

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

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

expand their scope. 

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

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

Those contributions would not be tax-deductible, but all 

earnings on the account would accumulate tax-free. 

Account holders could withdraw funds without facing 

taxes or penalties after they turned 58 years old or became 

disabled. (When an account holder died, his or her heirs 

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

Accounts that are now held as Roth individual retirement 

accounts (IRAs) would automatically become RSAs 

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

could be converted into RSAs in the same way that they 

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

Lifetime savings accounts would have the same contribution limits, tax treatment, and lack of income restrictions 

as RSAs. (Individuals could contribute to both types of 

accounts in the same year.) Unlike with RSAs, however, 

holders of LSAs could make withdrawals at any age and 

for any purpose. Balances now held in Coverdell education savings accounts and qualified state tuition plans 

could be moved into LSAs. 

On net, those proposals would reduce revenues by $0.3 

billion over the 2007-2016 period. CBO and JCT project a net increase in revenues during the first half of that 

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

addition, some taxpayers would convert their traditional 

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

By the second half of the projection period, however, the 

proposals would result in a net reduction in revenues as 

the effect of untaxed withdrawals began to outweigh the 

effect of new contributions. 

Other Revenue Proposals

The President’s budget proposes a number of other tax 

changes, such as incentives related to charitable giving, 

health care, and education. It would also make various 

changes in tax law related to pensions and other retirement saving and extend some provisions that expired at 

the end of 2005. Together, those proposals would reduce 

revenues by $30 billion between 2007 and 2016 and 

decrease outlays for refundable tax credits by $3 billion 

over the same period.

Policy Proposals That Affect 

Mandatory Spending

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

they would produce a net reduction in mandatory spending of $28 billion over the next five years, CBO estimates, but a net increase of $226 billion over the full 

2007-2016 period (see Table 1-3 on page 5). Outlays 

would rise for the Social Security program (for the proposed individual accounts) and for refundable tax credits 
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 11

(including the earned income and child tax credits as well 

as refundable credits for health care expenses). Those 

increases would be partly offset by lower spending for 

Medicare and Medicaid and by higher premium payments from individuals for Medicare and from corporations for pension insurance.

Social Security

The President’s budget proposes establishing voluntary 

individual accounts for workers that would partially 

replace their future defined Social Security benefits. For 

people who chose to participate, the government would 

deposit an amount equivalent to up to 4 percentage 

points of the current 12.4 percent tax on covered earnings 

into an individual account. The money in the account 

would be invested at the direction of the account holder, 

with a limited number of investment options similar to 

those available under the Thrift Savings Plan for federal 

employees. When account holders eventually began to 

draw Social Security benefits, their defined benefit would 

be reduced according to a formula based on the amount 

deposited in their account. 

CBO estimates that net outlays from establishing individual accounts would total $312 billion over the 2009-

2016 period. (For more details, see Box 1-1.) The Administration projects much higher outlays—$712 billion 

over that period—chiefly because it estimates that twothirds of eligible workers would participate, whereas 

CBO estimates that about one-third would sign up.

The President’s budget also includes four proposals

that would modestly reduce outlays for Social Security 

benefits: 

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

of retired, deceased, or disabled workers unless the 

children are in school (under current law, such benefits essentially continue through age 18, or for a 

slightly longer period if the recipients are still in 

secondary school);

B Requiring state and local governments to provide 

information about their annuitants in order to 

strengthen enforcement of two current provisions (the 

windfall elimination provision and the government 

pension offset) that reduce Social Security benefits for 

people who have pensions from employment that was 

not covered by Social Security;

B Altering the way disability benefits are reduced when 

beneficiaries also receive workers’ compensation for a 

work-related illness or injury; and 

B Ending the lump-sum death benefit, a one-time payment of $255 that goes to about 800,000 people per 

year.

In all, those four proposals would save $6 billion over the 

2007-2016 period, CBO estimates. (Those savings are 

included under other mandatory outlay proposals in 

Table 1-3 on page 5.) 

Medicare

The budget contains various proposals to alter the Medicare program; together, they would reduce spending by 

$138 billion through 2016, CBO estimates. About onethird of those savings would result from holding increases 

in payment rates for many services below the rate of inflation from 2007 through 2009. Those payment-rate provisions would affect Medicare services furnished by hospitals, skilled nursing facilities, home health agencies, 

hospices, and ambulance providers, among others.

Another one-third of the estimated savings come from 

two proposals that would have relatively little impact on 

Medicare spending over the next five years but a sharply 

rising effect thereafter. One provision involves the income 

thresholds that determine income-related premiums for 

Part B of Medicare (supplementary medical insurance). 

The President proposes to eliminate the scheduled indexing of those thresholds for inflation, which would increase receipts from premium payments and thus reduce 

net outlays. That provision would affect a growing number of people over time as nominal incomes rose. The 

other provision would impose across-the-board cuts in 

payment rates when more than 45 percent of Medicare 

spending was funded from general revenues—which 

CBO estimates will occur beginning in 2011.

Most of the remaining estimated savings stems from two 

other proposals. One would shorten the period of time 

that Medicare would pay to rent oxygen equipment for 

beneficiaries before transferring ownership of the equipment to the beneficiary. The other would eliminate payments to health care providers for bad debt (for deductibles and cost sharing owed by Medicare beneficiaries).
12 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Box 1-1.

The President’s Proposal for Individual Social Security Accounts

The Old-Age, Survivors, and Disability Insurance 

programs—popularly known as Social Security—are 

financed through a tax of 12.4 percent on earnings 

(up to a statutory limit) from jobs covered by Social 

Security. The President’s budget proposes giving 

workers the option to transfer up to 4 percentage 

points of that tax into individual investment accounts, beginning in 2010.1 The amount that could 

be transferred into an account would be capped at 

$1,100 in 2010. In subsequent years, the cap would 

increase through two mechanisms: $100 would be 

added to it each year (through 2016), and the sum 

would be adjusted upward at the same rate as average 

wages (see the table at right). The dollar cap would 

keep contributions below the full 4 percentage points 

for most workers.

In the first year of the individual-account program, 

only workers born between 1950 and 1965 (ages 45 

through 60) would be eligible to participate. Eligibility would expand in 2011 to include workers born 

between 1950 and 1978 (ages 33 through 61). After 

2011, any worker born in 1950 or later could take 

part. As in the federal employees’ Thrift Savings Plan, 

participants could pick from a limited selection of 

investments for their account balances. 

When account holders eventually began to draw Social Security benefits, their benefits would be reduced 

according to a formula based on the sums deposited 

in their account. The reduction (or offset) would 

equal the amount of annuity payments that would 

result if the deposited sums earned an annual return 

of 3.0 percent after inflation, minus 30 basis points 

(0.3 percentage points) for administrative expenses, 

for a total real return of 2.7 percent per year. Exact 

distribution rules—notably, whether some or all of 

an account would have to be converted into an annuity—are unclear. If a married account holder died 

before retirement, the balance would go into his or 

her spouse’s account; balances of unmarried account 

holders would go to their heirs.

Participation in the accounts would be optional, so 

a key factor in estimating their budgetary impact is 

determining how many workers would be likely to 

participate. The Congressional Budget Office (CBO) 

estimates that one-third of eligible workers would 

sign up—lower than the two-thirds estimated in the 

President’s budget. CBO bases that judgment on several key features of the proposal: 

B The proposed offset rules and the initially modest 

size of the accounts limit the potential advantages 

of participation. 

B Workers would have to opt in (elect to participate). Recent research on 401(k) and similar plans 

has shown that opt-in plans tend to have significantly lower participation rates than opt-out plans 

(in which workers are automatically enrolled and 

then have the opportunity to cease participating). 

B Once enrolled, workers would not be able to 

change their minds; as a result, many people 

might adopt a “wait and see” attitude to the 

accounts. 

B More people might sign up if traditional Social 

Security benefits were reduced significantly, which 

could make the accounts more attractive, but no 

specific changes of that type are proposed in the 

President’s budget.

1. The details of the President’s proposal described here come 

mainly from a memorandum from Stephen C. Goss, Chief 

Actuary of the Social Security Administration, to Charles P. 

Blahous, Special Assistant to the President for Economic Policy, February 6, 2006.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 13

Box 1-1.

Continued

Estimated Budgetary Effect of the Administration’s Proposal for Individual Social Security Accounts

Source: Congressional Budget Office.

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

a. Includes startup costs in 2009 and 2010 and then payments as necessary to supplement the amounts raised by charging 

accounts 30 basis points annually.

b. Indexed after 2010 to growth in Social Security’s average wage index, with a two-year lag.

Besides a lower rate of participation, CBO’s estimate 

of the proposal reflects two other differences from the 

Administration’s calculations. First, the portion of 

Social Security taxes allocated to individual accounts 

each year would probably not be credited to account 

holders immediately. Under the current system of 

annual wage-reporting, the Social Security Administration does not have enough information to post 

earnings and credit payments of Social Security taxes 

to individual workers until the year after those taxes 

are paid. CBO assumes that the government would 

temporarily record the total estimated contributions 

in an interim fund and eventually transfer the money 

to specific accounts with about one year’s interest. 

(Budgetary outlays would occur only when funds 

were transferred to those accounts.) 

Second, CBO concludes that the government would 

incur administrative costs for the program—initially 

for startup tasks and then to supplement the 30-

basis-point charge, which is unlikely to suffice in the 

first few years after the accounts are created.2

(Billions of dollars) Total,

2009-

2009 2010 2011 2012 2013 2014 2015 2016 2016

0 0 17 36 52 57 63 69 293

0 0 1 2 3 3 3 4 15

0 0 0 * * * * -1 -1

11*1111* 4 __ __ ___ ___ ___ ___ ___ ___ ____

1 1 18 38 55 61 66 72 312

0 24 57 96 115 127 140 153 712

0 12 31 48 56 62 67 73 349

0 1,100 1,200 1,300 1,400 1,500 1,600 1,700 9,800

0 1,100 1,253 1,412 1,581 1,759 1,947 2,148 11,200

CBO's Estimate of Payments to Interim Fund

Maximum Contribution (In dollars, by calendar year)

2010 dollars

Current dollarsb

Administrative Costsa

Transfers to Individual Accounts

Contributions

Interest

Savings from Social Security Benefit Reductions

Net Outlays

Memorandum:

Administration's Estimate of Net Outlays

2. For a fuller discussion of some of those implementation 

issues, see Congressional Budget Office, Analysis of 

H.R. 3304, Growing Real Ownership for Workers Act of 2005, 

letter to the Honorable Max Baucus (September 13, 2005). 
14 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Refundable Tax Credits

The tax proposals involving refundable credits that were 

discussed above would add about $98 billion to mandatory outlays over the 2007-2016 period, CBO and JCT 

estimate. The largest of those changes would be making 

the 2001 expansion of the child tax credit permanent.9

Continuation of that credit in its current form, combined 

with changes to tax brackets and tax rates that affect the 

earned income tax credit, would increase outlays by $77 

billion through 2016. In addition, the tax proposals to 

expand the use of HSAs and add new tax deductions and 

credits for the cost of HSA-eligible insurance plans would 

raise outlays by $21 billion over the next 10 years.

Pension Insurance

The President proposes raising the variable-rate insurance 

premiums that some companies pay to the federal Pension Benefit Guaranty Corporation (PBGC) under its 

single-employer program if their plans are underfunded. 

PBGC’s board of directors would be given the authority 

to alter the premium rate, which currently is set by statute at $9 per $1,000 of underfunding. The higher premiums would be used to offset PBGC’s existing deficit as 

well as its anticipated deficits over the next 10 years. 

(Unlike the policies enacted as part of the Deficit Reduction Act, which increased flat-rate premiums and implemented a termination premium, this proposal would 

affect only variable-rate premiums.)

That change, and related pension-reform initiatives, 

would increase collections of variable-rate premiums 

nearly fivefold—by $35 billion—over the 2008-2016 

period from the amount that would be collected under 

current law, CBO estimates.10 Such an increase would 

almost triple PBGC’s total premium receipts (including 

other types of premiums it collects) over that period. 

Those premium payments are recorded in the budget as 

offsets to outlays.

Medicaid

On net, the President’s proposals for the Medicaid program would reduce federal spending by more than $11 

billion over the 2007-2016 period, CBO estimates. Proposals to cut spending on prescription drugs by reducing 

payment rates for multisource drugs and by allowing 

states to use closed formularies would save about $7 billion during that period. Lowering the federal matching 

rate for some social services would save about $4 billion, 

and cutting payments to states for administration would 

save another $4 billion. Those savings would be partly 

offset by additional outlays of about $4 billion for children’s vaccines and for efforts to enroll more children in 

Medicaid and in the State Children’s Health Insurance 

Program. 

Other Mandatory Spending Proposals

The costs and savings of other proposals that involve 

mandatory spending programs would largely offset one 

another, resulting in about $1 billion in additional outlays over the 2007-2016 period, CBO estimates. The 

effects of some of those proposals—notably, increasing 

funding for the flood insurance program—would be 

reflected in the federal budget almost immediately. Other 

proposals—such as extending customs user fees, which 

are recorded as offsets to mandatory spending—would 

not affect outlays until the last years of the projection

period.

Flood Insurance. The President proposes to raise the borrowing limit for the National Flood Insurance Program 

by nearly $6 billion to pay outstanding claims from Hurricanes Katrina, Rita, and Wilma. In recent months, the 

Congress and the President have raised that limit twice 

(by a cumulative $17 billion), bringing the program’s 

total available borrowing authority to $18.5 billion.11

The provision in the President’s budget would increase 

the limit to $24.1 billion, resulting in additional outlays 

of roughly $3 billion in both 2006 and 2007, CBO 

estimates. 

Agricultural Commodity Programs. The President’s budget includes several proposals that would reduce spending 

for the Department of Agriculture’s Commodity Credit 

Corporation by a total of $6 billion over the next 10 

years, CBO estimates. Those proposals include lowering 

9. Before EGTRRA was enacted, the maximum child tax credit per 

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

families with three or more qualifying children and had other limitations. EGTRRA increased the credit to $1,000 per child, with 

refundability not contingent on the number of qualifying children 

but limited to 15 percent of the amount of earned income in 

excess of $10,000 (indexed for inflation after 2001).

10. PBGC would also earn additional interest income as a result.

11. At the time this report was written, the Senate had passed legislation increasing the borrowing limit to $21.2 billion; the House 

had passed a bill raising it to $20.8 billion. 
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 15

crop and dairy payments to farmers under all commodity 

programs by 5 percent, adjusting the price-support rates 

for dairy products to reduce the cost of purchases by the 

federal government, and tightening the limits on the 

maximum commodity payments that producers can

receive.12

Customs User Fees. Under current law, customs user fees 

are scheduled to expire on September 30, 2014. The President has proposed extending those fees, which CBO estimates would increase offsetting receipts by $6 billion 

through 2016.

Leasing in ANWR. The President also proposes leasing a 

portion of the coastal plain of the Arctic National Wildlife Refuge (ANWR) for oil and gas development. CBO 

anticipates that those leases would be offered in two 

phases (as specified in recent legislative proposals), with 

the first sale likely to occur in 2009 and the second in 

2011. Proceeds to the federal government from bonuses 

and rents would total $6 billion between 2009 and 2016, 

CBO estimates. (Although the federal government would 

later receive income from royalties on production, those 

payments would most likely begin after 2016.) Under the 

President’s proposal, half of the receipts from leasing 

would be paid to Alaska, resulting in net federal receipts 

of $3 billion over the projection period.

CBO’s estimate of bonus bids is based on the U.S. Geological Survey’s projections of the mean value of economically recoverable oil that could be produced from federal 

land in ANWR. It also relies on information from other 

federal agencies, the state of Alaska, and private sources 

about oil and gas companies’ perceptions of key factors 

that affect the expected profitability of ANWR leases—in 

particular, companies’ probable assumptions about longterm oil prices and required rates of return on such 

investments.

Other. Other policies proposed in the President’s budget 

would affect mandatory spending in a number of areas. 

For example, over the next 10 years, the Administration 

would add about $4 billion in spending for state grants 

and demonstration projects aimed at ensuring health coverage for children and for people with chronic illnesses. 

Proposed spending for the Temporary Assistance for 

Needy Families (TANF) program would also rise by 

about $4 billion over the 2007-2016 period, CBO estimates, through a combination of continuing an existing 

supplemental grant, adding a new one, and making 

TANF’s contingency fund easier for states to access. In 

addition, the President’s proposal to restructure existing 

tax benefits for New York City would effectively provide 

$2 billion in grants to the city and state for improvements 

in transportation infrastructure.

Policy Proposals That Affect 

Discretionary Spending

So far, lawmakers have enacted $901 billion in discretionary budget authority for 2006, including $50 billion for 

military operations in Iraq and Afghanistan and a net $9 

billion in various supplemental appropriations. The Administration has requested another $92 billion in supplemental funding for 2006 ($72 billion for military operations in Iraq and Afghanistan and other purposes and $20 

billion for relief from hurricane damage). If that supplemental funding was enacted, total budget authority for 

2006 would rise to $993 billion.

The President’s budget proposes $925 billion in discretionary budget authority for 2007, CBO estimates—

$510 billion for defense and $415 billion for nondefense 

programs (see Table 1-5). The defense request includes 

$50 billion for operations in Iraq and Afghanistan.

With proposed and enacted supplemental appropriations 

and funding for Iraq and Afghanistan excluded, discretionary budget authority would grow by 3.6 percent, or 

$30 billion, between 2006 and 2007 under the President’s budget, CBO estimates. Defense funding would 

increase by about 6.4 percent, and appropriations for 

homeland security activities would rise by 6.6 percent. 

Funding for other nondefense activities would grow by 

0.2 percent.

For 2008 through 2011, the President proposes increasing defense funding by an average of 2.8 percent per year 

(excluding possible appropriations for operations in Iraq 

and Afghanistan) and essentially holding nondefense 

funding constant, other than spending for homeland

security.

12. The President also proposes to charge sugar processors and milk 

producers marketing assessments on all domestically produced 

sugar and milk. CBO considers the receipts from those assessments, which would total about $900 million over the next 10 

years, to be additional federal revenues rather than offsets to 

spending.
16 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-5.

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

2005 to 2007

(Billions of dollars)

Source: Congressional Budget Office.

Note: Does not include obligation limitations for certain transportation programs.

a. This amount does not include $23 billion in balances that were still available in 2005 from $26.8 billion in emergency funding that was 

provided at the end of 2004. That funding, which was largely for 2005 costs associated with military operations in Iraq and Afghanistan, 

was counted as budget authority in 2004 because it was made available in that year.

b. Includes the Administration’s request for supplemental appropriations to fund operations in Iraq and Afghanistan and for further hurricane relief and recovery. CBO assumes that very little of that funding will be classified as related to homeland security.

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

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

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

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

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

d. In 2005, the Congress and the President provided $82 billion in supplemental funding primarily for military operations in Iraq and 

Afghanistan, $62 billion in supplemental appropriations in response to Hurricanes Katrina and Rita, and $13 billion in other supplemental 

funding (mostly for disaster relief from hurricanes in 2004 and veterans' benefits). Thus far in 2006, about $59 billion has been provided 

for operations in Iraq and Afghanistan and for supplemental appropriations, net of rescissions. For this year, the President's budget 

requests another $72 billion in supplemental funding, mostly for military activities in Iraq and Afghanistan, as well as $20 billion for hurricane relief and recovery. For 2007, the President is requesting $50 billion in additional appropriations for activities in Iraq and Afghanistan. In addition, the budget requests $2.3 billion for 2007 to prepare for a possible flu pandemic; since funding for such activities in 2006 

($3.8 billion) was provided through supplemental appropriations, for consistency the 2007 request has been excluded here.

Actual

2005

Budget Authority

Defense 500 a 558 b 510 11.7 -8.6

31 28 b 29 -9.3 6.2

456 407 b 386 -10.8 -5.3 ____ ____ ____

487 435 b 415 -10.7 -4.6

Total 987 993 b 925 0.7 -6.8

Budget Authority Excluding Funding for Activities in

Iraq and Afghanistan and Supplemental Appropriationsd

Defense 420 432 460 2.8 6.4

30 28 29 -8.2 6.6

379 382 383 1.0 0.2 ____ ____ ____

409 410 413 0.3 0.7

Total 829 842 873 1.6 3.6

Subtotal, nondefense

Percentage Change

Subtotal, nondefense

Administration's Request

Other

2006 2007 2005-2006 2006-2007

Nondefense

Nondefense

Homeland securityc

Other

Homeland securityc
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 17

Figure 1-2.

Discretionary Budget Authority Under 

the President’s Budget, 1985 to 2011

(Percentage of gross domestic product)

Source: Congressional Budget Office.

Defense Programs

CBO estimates that the President’s proposals would add 

$22 billion to defense outlays in 2006 and $35 billion in 

2007 relative to the baseline (see Table 1-6). Most of 

those outlays stem from the request for another $68 billion in budget authority in 2006 for military activities 

in Iraq and Afghanistan (in addition to the $50 billion 

already appropriated for this year).13 If that $68 billion 

and other requested emergency supplemental funding 

was appropriated, budget authority for defense would 

total $558 billion this year—7 percent more than the 

$523 billion provided for 2005.14 Defense outlays would 

reach 4.0 percent of GDP in 2006, up from 3.0 percent 

of GDP just six years ago.

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

on terrorism would total $118 billion in 2006, compared 

with $100 billion in 2005. Most of that growth would 

come from an increase of more than $15 billion (or 27 

percent) in funding for operations and maintenance. 

Emergency appropriations for procurement would also 

rise—by almost $7 billion, or 36 percent. Those increases 

would be slightly offset by declines of $3 billion in emergency appropriations for military personnel and $1 billion for other military accounts. In total, emergency 

appropriations for Iraq, Afghanistan, and the war on terrorism would constitute 21 percent of budget authority 

for defense in 2006.

The President’s budget includes a much smaller amount 

for those activities in 2007 ($50 billion) and no appropriations thereafter. As a result, budget authority for defense 

would decline to 3.1 percent of GDP in 2011 under the 

President’s budget, CBO estimates (see Figure 1-2). Outlays for defense would be a total of $68 billion less than 

the amounts in CBO’s baseline between 2008 and 2011. 

(In keeping with the rules that govern baseline projections, the baseline assumes that the $50 billion already 

appropriated this year will continue in each subsequent 

year through 2016, with adjustments for inflation.)

With funding for Iraq and Afghanistan and other supplemental appropriations excluded, budget authority for 

defense grew by 2.8 percent, or $12 billion, from 2005 

to 2006. Under the President’s budget, it would rise by 

6.4 percent, or $28 billion, in 2007.

All major categories of funding for the Department of 

Defense would receive increases in 2007. The largest 

percentage rise (57 percent, or $5 billion) would be for 

military construction, to implement a new round of base 

closures. Other categories that would receive significant 

increases in 2007 would be operation and maintenance 

activities (7 percent, or $9.7 billion) and procurement 

(10 percent, or $8 billion). Appropriations for military 

personnel and for research and development would both 

grow by between 3 percent and 4 percent (by $4 billion 

for personnel and by $2 billion for research and development).

Nondefense Discretionary Programs

The President’s budget includes an additional $22 billion 

in supplemental nondefense appropriations for 2006, 

mostly for hurricane relief and recovery. For 2007 

13. The supplemental request for operations in Iraq and Afghanistan 

in 2006 includes $4 billion in funding for nondefense programs. 

In addition, the supplemental request for hurricane relief includes 

nearly $2 billion in funding for the Department of Defense.

14. The 2005 amount includes $23 billion in budget authority provided for war-related activities in the Department of Defense 

Appropriations Act, 2005 (Public Law 108-287) that was made 

available upon enactment in August 2004 but was not obligated 

by the beginning of fiscal year 2005.

1985 1988 1991 1994 1997 2000 2003 2006 2009

0

1

2

3

4

5

6

7

8

Defense

Nondefense

Actual Projected
18 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-6.

Discretionary Spending Under the President’s Budget and in CBO’s

March Baseline

(Billions of dollars)

Continued

through 2011, the budget proposes to keep nondefense 

discretionary budget authority at about the amount provided so far for 2006. Under the President’s proposals, 

that budget authority would decline from 3.3 percent of 

GDP this year to 2.5 percent in 2011, CBO estimates. In 

2007, total nondefense discretionary budget authority 

would grow by $2.8 billion, or 0.7 percent, under the 

President’s budget (excluding supplemental appropriations as well as funding for research and preparedness 

related to avian flu). Within that total, budget authority 

would rise for some activities and fall for others (see 

Table 1-7).

Total, Total,

Actual 2007- 2007-

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 2016

500 558 510 482 502 512 523 536 549 563 577 591 2,530 5,345

Homeland securityb 31 28 29 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 456 407 386 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ _____ _____

Subtotal, nondefense 487 435 415 414 417 417 418 428 437 447 457 468 2,080 4,317

Total 987 993 925 896 919 929 941 964 986 1,010 1,034 1,058 4,610 9,662

494 523 533 503 503 510 522 525 542 555 569 588 2,571 5,350

Homeland securityb 27 28 30 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 447 474 471 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 474 502 501 492 484 478 471 476 485 495 506 516 2,427 4,904

Total 968 1,025 1,034 995 987 988 993 1,001 1,027 1,050 1,074 1,104 4,998 10,253

500 488 501 512 525 537 550 563 577 591 605 620 2,625 5,580

Homeland securityb 31 28 28 29 32 30 31 32 33 34 35 36 151 319

Other 456 385 421 431 441 451 461 472 483 494 506 518 2,205 4,679 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 487 413 449 459 472 481 492 504 516 528 541 553 2,355 4,998

Total 987 901 950 972 997 1,019 1,042 1,068 1,093 1,119 1,146 1,173 4,980 10,578

494 501 498 508 519 531 547 551 569 583 597 617 2,604 5,521

Homeland securityb 27 28 30 30 30 31 31 32 33 34 34 35 152 320

Other 447 472 471 479 489 498 507 518 529 541 553 565 2,445 5,150 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 474 501 501 509 519 529 539 550 562 574 587 601 2,597 5,471

Total 968 1,002 999 1,018 1,038 1,060 1,086 1,101 1,131 1,157 1,184 1,217 5,201 10,991

Nondefense

Outlays

Defense

Nondefense

Nondefense

Budget Authority

Defense

CBO's March 2006 Baseline for Discretionary Spending

Defense

Nondefense

Outlays

Defense

Budget Authority

CBO's Estimate of Discretionary Spending Under the President's Budgeta
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 19

Table 1-6.

Continued

(Billions of dollars)

Source: Congressional Budget Office.

Notes: n.a. = not applicable (no details have been provided for discretionary spending after 2007); * = between -$500 million and $500 

million.

Discretionary outlays derive from both budget authority and obligation limitations. Spending from the Highway Trust Fund and the Airport and Airway Trust Fund is subject to such limitations. Budget authority for those programs is provided in authorizing legislation 

and is not considered discretionary.

a. The President’s budget specifies total discretionary spending only through 2011. CBO projected discretionary spending after 2011 under 

the President’s budget using its baseline rates of inflation.

b. The amounts shown here reflect net spending for homeland security activities ($3 billion to $4 billion in spending per year is offset by 

fees and other receipts). CBO’s classification of homeland security funding is based on designations established by the Administration. 

Those designations are not limited to the activities of the Department of Homeland Security. In fact, some of the department’s activities 

(such as disaster relief) are not included in the Administration’s definition of homeland security, whereas nondepartmental activities 

(such as some defense-related programs and some funding for the National Institutes of Health) fall within that definition. About 60 percent of all spending considered to be for homeland security is for activities outside the Department of Homeland Security.

The largest funding increase in dollar terms would be for 

international affairs programs. That category of spending 

would receive an additional $3.7 billion, or 11.9 percent, 

in 2007, mainly for the Millennium Challenge Corporation, the global HIV/AIDS Initiative, and economic support for other countries. Funding for veterans’ benefits 

and services would increase by $2.9 billion, or 8.7 percent, primarily to provide medical care to veterans and 

other beneficiaries.

In addition, budget authority for activities designated as 

relating to homeland security would rise by about $2 billion, or 6.6 percent, in 2007 under the President’s budget. About half of that increase would go to the Coast 

Guard, whose funding would grow from $1.5 billion to 

$2.5 billion. Other agencies that would receive additional 

funding in 2007 include the Centers for Disease Control 

and Prevention, the National Institutes of Health, and 

the Federal Bureau of Investigation. Obligation limitaTotal, Total,

Actual 2007- 2007-

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 2016

0 70 10 -30 -22 -25 -27 -27 -28 -28 -29 -29 -95 -236

0 * 1 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 0 22 -35 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. _ __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 0 22 -34 -46 -56 -65 -75 -77 -79 -81 -83 -86 -275 -681

Total 0 92 -25 -76 -78 -90 -101 -104 -107 -109 -112 -115 -370 -916

0 22 35 -6 -16 -21 -25 -26 -27 -28 -28 -29 -33 -171

0 * * n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 0 1 * n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. _ _ __ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 0 1 * -17 -35 -50 -68 -74 -77 -80 -82 -84 -170 -567

Total 0 23 35 -23 -52 -71 -93 -100 -104 -107 -110 -113 -203 -738

Outlays

Defense

Nondefense

Budget Authority

Defense

Nondefense

Difference (President's budget minus baseline)

Homeland securityb

Homeland securityb
20 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-7.

Comparison of Discretionary Budget Authority Enacted or Requested for 2006 

and Requested by the President for 2007, by Budget Function

(Billions of dollars)

Source: Congressional Budget Office.

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

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

b. Spending from the Highway Trust Fund and the Airport and Airway Trust Fund is provided through obligation limitations. Budget authority 

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

432.4 55.9 69.9 558.2

31.4 0.2 4.2 35.8

24.5 0.4 0 24.8

3.8 * 0 3.8

30.2 3.4 1.7 35.3

5.9 0.1 * 6.1

1.9 0.1 0 2.0

24.7 3.0 0.1 27.8

13.2 -11.2 15.2 17.2

78.2 1.8 0 80.0

50.8 3.4 0 54.2

4.9 0 0 4.9

47.1 0.5 0 47.6

4.4 0 0.2 4.6

33.2 0.6 0.6 34.4

39.5 0.3 0.2 39.9

16.4 0.1 0.1 16.5

0 0 00 _____ ____ ____ _____

Subtotal, nondefense discretionary 410.0 2.6 22.3 435.0

 Total Discretionary 842.4 58.5 92.2 993.1

47.3 0 0 47.3

Allowances for emergencies and

other needs

Social Security (Administrative costs)

Veterans' benefits and services

Memorandum:

Transportation Obligation Limitationsb

Community and regional development

Education, training, employment, and

Administration of justice

General government

social services

Health

Medicare (Administrative costs)

Income security

Natural resources and environment

Agriculture

Commerce and housing credit

Transportation

International affairs

2006

General science, space, and technology

Energy

Regular Total

Funding Enacted

Supplemental Funding 

Already Enacteda

Supplemental 

Defense Discretionary

Nondefense Discretionary

Funding Requesteda Funding
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 21

460.1 50.1 510.2 27.6 6.4

35.2 0 35.2 3.7 11.9

26.1 0 26.1 1.7 6.8

3.8 0 3.8 * -0.2

28.2 0 28.2 -2.0 -6.7

5.7 0 5.7 -0.2 -3.0

3.1 0 3.1 1.2 61.2

22.9 0 22.9 -1.8 -7.2

11.7 0 11.7 -1.5 -11.0

74.7 0 74.7 -3.5 -4.4

50.7 2.3 53.0 -0.1 -0.1

5.0 0 5.0 0.1 1.1

47.8 0 47.8 0.7 1.4

4.8 0 4.8 0.4 9.9

36.1 0.1 36.2 2.9 8.7

39.8 0 39.8 0.3 0.8

17.2 0 17.2 0.8 5.0

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

412.7 2.4 415.1 2.8 0.7

872.8 52.6 925.3 30.4 3.6

50.4 0 50.4 3.2 6.7

Percent

Change in Regular Funding, 2006-2007

Supplemental Billions

Funding of Dollars

Total

2007

Requested

Regular Funding

Funding Requested
22 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

tions that govern spending from the Highway and Airport and Airways Trust Funds would rise by $3.2 billion, 

or 6.7 percent. 

Other areas of the budget would see their funding decline 

in 2007 under the President’s proposals. The category of 

education, training, employment, and social services 

would face the largest cut: $3.5 billion, or 4.4 percent. 

The biggest reductions in that category would apply to 

grants for social services, vocational education, higher 

education, and employment and training programs. 

Reductions in funding for natural resources and the environment would total $2.0 billion, or 6.7 percent, mainly 

relating to activities of the Army Corps of Engineers and 

the Natural Resources Conservation Service.

Grants to state and local governments (other than for 

disaster relief programs) make up about one-third of the 

nondefense discretionary funding for 2007 in the President’s budget—a total of $165 billion.15 That amount is 

about $3 billion, or 2 percent, less than the corresponding figure for 2006. The budget proposes to reduce grant 

funding for criminal justice programs by 56 percent, for 

economic development by 30 percent, for homeland 

security by 10 percent, and for social services programs by 

7 percent. At the same time, grants for transportation 

programs (including obligation ceilings for highway and 

transit trust fund programs) would increase by 6 percent.

Differences Between CBO’s and the 

Administration’s Budget Estimates

As noted above, CBO’s estimate of the deficit in 2006 

under the President’s budget ($371 billion) is $52 billion 

less than the Administration’s estimate ($423 billion). 

That difference narrows over the 2007-2011 period (see 

Table 1-4 on page 7). The cumulative five-year deficits 

projected by CBO and the Administration differ by only 

$40 billion—equivalent to less than 0.3 percent of projected outlays during that period. CBO’s estimate of outlays over those five years is $130 billion lower than the 

Administration’s, and its estimate of revenues is $90 billion lower. 

Baseline Differences

In conjunction with the President’s budget request, the 

Administration published a current-services baseline 

extending through 2011. In that baseline, as in CBO’s, 

the deficit declines each year through 2011. But the 

Administration’s baseline shows a cumulative shortfall of 

$948 billion over the 2007-2011 period, whereas CBO 

projects a $1.1 trillion deficit for those five years (see 

Table 1-8 on page 24). 

Conceptual differences account for most of the gap between the two baselines. CBO constructs its baseline as 

specified in the Balanced Budget and Emergency Deficit 

Control Act of 1985. The Administration, however, has 

deviated from prior practices in three ways. First, its 

current-services baseline assumes that the major tax-law 

changes enacted in EGTRRA and JGTRRA will be 

extended rather than expire as scheduled. That conceptual difference primarily affects revenues. Second, the 

Administration has not extrapolated into future years the 

$33 billion in supplemental appropriations (mostly for 

hurricane relief) or the $50 billion in funding for operations in Iraq and Afghanistan provided so far this year.16

Third, the Administration has adjusted the way it 

accounts for increases in pay when projecting discretionary spending. 

With such conceptual differences excluded, the cumulative baseline deficits that CBO and the Administration 

project for the 2007-2011 period would differ by roughly 

$80 billion (or 0.5 percent of projected outlays) rather 

than by $124 billion.

Differences in Economic Assumptions

CBO and the Administration are forecasting generally 

similar values for the economic variables used to estimate 

revenues and outlays (see Table 1-9 on page 26). On the 

whole, however, the Administration’s economic forecast 

implies higher revenues, slightly higher outlays, and a 

moderately more favorable outcome for the budget. The 

Administration’s economic outlook decreases the cumula15. That amount includes obligation ceilings for highway and transit 

trust fund programs.

16. The supplemental appropriation act for hurricane relief also 

rescinded $23 billion in funds previously provided to the Federal 

Emergency Management Agency (FEMA), but those rescissions 

are not extended into the future in CBO’s baseline. Similarly, the 

transfer of nearly $1 billion from FEMA’s disaster relief account to 

the Small Business Administration (SBA) is not extended into the 

future (although SBA’s disaster loan payments are assumed to

continue).
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 23

tive deficit for the 2007-2011 period by about $166 billion compared with CBO’s economic outlook.

Most of that difference appears in revenue estimates. The 

Administration’s forecast leads to higher revenue projections for two main reasons. First, its forecast for the 

growth of nominal GDP is higher than CBO’s over the 

2008-2011 period, which tends to raise its projections of 

all types of income. Second, it estimates that wages and 

salaries—a category of income that is extremely important for projecting revenues—will constitute a larger 

share of GDP than CBO projects. Both of those differences occur primarily because the Administration anticipates higher inflation from 2007 through 2011 than 

CBO does, which more than offsets CBO’s higher projection for the growth of real (inflation-adjusted) GDP in 

2006 and 2007.

In terms of outlays, the Administration’s economic outlook leads to slightly higher estimates mainly because it 

forecasts greater growth in the consumer price index for 

wage earners and clerical workers—the measure of inflation used for cost-of-living adjustments in Social Security 

and other programs. The fact that the Administration 

projects higher long-term interest rates over the 2007-

2011 period than CBO does also tends to raise its outlay 

projections by increasing debt-service costs. However, 

that effect is partially offset because the Administration’s 

forecast of short-term interest rates is lower than CBO’s.

Total Outlay Differences

For 2006, CBO’s estimate of outlays under the President’s budget is $34 billion below the Administration’s 

(see Table 1-4 on page 7). CBO anticipates $25 billion 

less in outlays for mandatory programs than the Administration projects, largely because of baseline differences. 

Medicare accounts for about $11 billion of that gap. 

Contributing to the gap is CBO’s lower projection of 

spending for the Part D prescription drug program in 

2006, which incorporates data made available in midFebruary that show lower enrollment than expected. 

CBO’s projections of 2006 outlays are also $4 billion less 

than the Administration’s for unemployment compensation, $3 billion less for Medicaid, and $2 billion less for 

student loans.

CBO also expects lower discretionary outlays this year 

under the President’s budget than the Administration 

does. That difference, $7 billion, largely results from different expectations about how quickly funds requested 

for operations in Iraq and Afghanistan would be spent. 

For the 2007-2011 period, CBO’s and the Administration’s projections of total outlays under the President’s 

budget differ by $130 billion (or 0.9 percent of total outlays). CBO estimates that mandatory outlays will be $98 

billion lower than the Administration does. Much of that 

gap—$63 billion—stems from differing estimates of 

spending for the President’s plan to allow workers to 

establish individual investment accounts under Social 

Security (see Box 1-1 on page 12).

Another $31 billion of the difference in projected mandatory outlays over five years results from differing economic assumptions (and their impact on the baseline). In 

particular, CBO’s estimate of Social Security outlays between 2007 and 2011 is $30 billion less than the Administration’s because it assumes lower cost-of-living adjustments and lower wages than the Administration does. (In 

all, CBO’s projection of Social Security spending—other 

than for individual accounts—is 1.1 percent lower than 

the Administration’s over the 2007-2011 period.)

Other differences in projections of mandatory outlays are 

relatively small and largely offset each other. CBO anticipates higher spending than the Administration does for 

Medicare and Medicaid after 2007 but lower spending 

for veterans’ programs and unemployment benefits. 

Estimates of discretionary spending under the President’s 

budget partially offset those differences, with CBO’s projection for the 2007-2011 period exceeding the Administration’s by $37 billion. Part of that difference reflects 

estimates of outlays from proposed supplemental appropriations for 2006. CBO estimates that less will be spent 

this year and more in 2007 than the Administration does. 

Most of the remaining difference stems from projections 

of the rate at which the budget authority requested for 

2008 to 2011 will be spent. 

Finally, CBO’s projection of net interest outlays over the 

2007-2011 period is $69 billion below the Administration’s estimate. That difference occurs mainly because 

CBO projects lower deficits under the President’s budget 

as well as lower long-term interest rates than the Administration does.
24 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-8.

Comparison of CBO’s March Baseline and the Administration’s February 

Current-Services Baseline

(Billions of dollars)

Continued

Total Revenue Differences

If the President’s proposals were enacted, revenues would 

total $2.3 trillion this year, CBO estimates—$19 billion 

more than the Administration projects. For the 2007-

2011 period, however, CBO’s projection of $13.5 trillion 

in total revenues is lower than the Administration’s by 

$90 billion, or 0.7 percent.17

As discussed above, differences in economic assumptions 

cause CBO’s estimates of revenues under the President’s 

Total,

2007-

2006 2007 2008 2009 2010 2011 2011

2,313 2,461 2,598 2,743 2,883 3,139 13,825

1,704 1,820 1,922 2,032 2,136 2,357 10,266

608 642 676 712 747 782 3,559

1,429 1,484 1,569 1,655 1,753 1,875 8,336

1,002 999 1,018 1,038 1,060 1,086 5,201

218 243 262 274 286 295 1,361 _____ _____ _____ _____ _____ _____ ______

2,648 2,726 2,849 2,968 3,099 3,256 14,898

On-budget 2,220 2,280 2,388 2,488 2,601 2,739 12,494

Off-budget 428 447 461 480 498 517 2,403

-336 -265 -250 -224 -216 -117 -1,072

-516 -460 -466 -456 -465 -382 -2,228

180 195 215 232 249 265 1,156

2,301 2,444 2,597 2,729 2,901 3,064 13,735

1,691 1,802 1,918 2,013 2,142 2,262 10,137

610 642 679 716 758 802 3,598

1,451 1,495 1,575 1,668 1,762 1,883 8,382

998 962 957 973 990 1,017 4,900

219 244 266 284 298 310 1,402 _____ _____ _____ _____ _____ _____ ______

2,669 2,701 2,798 2,925 3,050 3,210 14,683

On-budget 2,240 2,251 2,335 2,441 2,544 2,682 12,252

Off-budget 428 450 463 484 506 528 2,431

-367 -257 -201 -196 -149 -146 -948

-549 -449 -416 -428 -402 -420 -2,115

182 192 216 233 252 274 1,167

Administration’s February 2006 Current-Services Baseline

Revenues

On-budget

Off-budget

Outlays

Mandatory

Discretionary

Revenues

On-budget

Off-budget

CBO's March 2006 Baseline

Outlays

Discretionary

Mandatory

Net interest

Total

Deficit (-) or Surplus

On-budget

Off-budget

Net interest

Total

Deficit (-) or Surplus

On-budget

Off-budget

17. Revenue projections in CBO’s baseline exceed those in the 

Administration’s current-services baseline by $11 billion in 2006 

and $91 billion over the 2007-2011 period (see Table 1-8). Conceptual differences between the two baselines explain why CBO 

projects higher baseline revenues, but lower revenues under the 

President’s budget, than the Administration does.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 25

Table 1-8.

Continued

(Billions of dollars)

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

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

The Administration’s baseline deviates from the concepts delineated in the Balanced Budget and Emergency Deficit Control Act of

1985 in two significant ways: it assumes that most tax provisions enacted in 2001 and 2003 will be extended rather than expire as 

scheduled, and it does not extrapolate supplemental appropriations provided for 2006 into future years.

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

budget to be smaller than the Administration’s. CBO’s 

projections for wages and salaries, the most highly taxed 

category of income, are below the Administration’s for all 

years of the 2007-2011 period, and CBO’s projections 

for corporate profits are lower than the Administration’s 

for each year through 2009. For those and other economic reasons, CBO projects $15 billion less in receipts 

than the Administration does for 2006 and $213 billion 

less for the 2007-2011 period.

Some of the difference related to economic projections is 

offset by other factors (classified as technical differences). 

In particular, CBO estimates a higher revenue yield from 

any given economic projection because it estimates a 

higher average tax rate on corporate profits as measured 

in the national income and product accounts. Such technical differences cause CBO’s revenue projections to 

exceed the Administration’s by $34 billion for 2006 and 

$123 billion for the 2007-2011 period.

Little of that overall technical difference reflects discrepancies between CBO’s and the Administration’s estimates 

of the effects of the President’s revenue proposals. CBO 

and JCT estimate that the President’s proposals would 

reduce revenues by a total of about $282 billion between 

2007 and 2011—just $2 billion more than the Administration estimates. Differences do exist, however, in estimates of specific proposals. 

In a number of cases, CBO’s and JCT’s estimates of revenue proposals point to larger deficits under the President’s budget than the Administration’s estimates do. For 

example, extending the EGTRRA and JGTRRA provisions that affect tax rates, the child tax credit, and income 

Total,

2007-

2006 2007 2008 2009 2010 2011 2011

11 17 1 14 -17 75 91

13 18 3 19 -6 95 129

-2 -1 -3 -4 -11 -20 -38

-23 -11 -6 -12 -9 -8 -46

4 37 61 65 70 69 301

-1 * -4 -10 -12 -15 -41

__ __ __ __ ___ ___ ___

-20 26 51 43 49 46 214

On-budget -20 29 53 47 57 57 242

Off-budget * -3 -2 -4 -8 -10 -28

31 -8 -50 -29 -66 29 -124

33 -11 -49 -28 -63 38 -113

-2 3 * -1 -3 -9 -11

Difference (CBO minus Administration)

Revenues

Deficit or Surplusa

On-budget

Off-budget

Outlays

Mandatory

Discretionary

Net interest

Total

On-budget

Off-budget
26 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 1-9.

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

Projections for Calendar Years 2006 to 2011

Continued

tax brackets would reduce revenues by more than $94 billion in 2011, according to CBO’s and JCT’s calculations. 

That figure is almost $17 billion more than the Administration’s estimate. Likewise, CBO’s and JCT’s estimate of 

the cost in 2007 of continuing expired AMT provisions 

through this year ($26 billion) is $6 billion more than the 

Administration’s estimate. (CBO’s and JCT’s projection 

for 2006, however, is $7 billion less than the Administration’s.) In addition, CBO and JCT estimate that expanding tax-free savings accounts would boost revenues by 

about $15 billion through 2011, which is $12 billion less 

than the Administration’s estimate. (Their projection that 

the proposal would reduce revenues by $0.3 billion over 

the full 2007-2016 period is very close to the Administration’s estimate, however.)

Differences in estimates for those revenue proposals are 

largely offset by several cases in which CBO and JCT 

project smaller revenue reductions than the Administration does. For instance, CBO and JCT estimate that the 

proposal to expand HSAs would lower revenues by about 

$5 billion over the 2007-2011 period, whereas the Administration estimates a $29 billion decrease. Similarly, 

CBO and JCT estimate smaller revenue reductions from 

extending and expanding expensing for small businesses 

(a difference of $8 billion for those two proposals) and 

from allowing a tax deduction for the cost of highdeductible health insurance (a difference of $6 billion).

2006 2007

CBO 12,494 13,262 13,959 16,954 a

Administration 12,482 13,210 13,949 17,177 a

March Blue Chip 12,486 13,253 13,954 17,107 b

CBO 6.5 6.1 5.3 5.0

Administration 6.4 5.8 5.6 5.3

March Blue Chip 6.4 6.0 5.3 5.2

CBO 3.6 3.6 3.4 3.1

Administration 3.6 3.4 3.3 3.2

March Blue Chip 3.5 3.4 3.0 3.1

CBO 2.7 2.4 1.8 1.8

Administration 2.7 2.4 2.2 2.1

March Blue Chip 2.8 2.6 2.2 2.1

CBO 3.4 2.8 2.2 2.2

Administration 3.4 3.0 2.4 2.4

March Blue Chip 3.4 2.9 2.4 2.3

CBO 5.1 5.0 5.0 5.2

Administration 5.1 5.0 5.0 5.0

March Blue Chip 5.1 4.8 4.9 4.9

Forecast Projected Annual Average,

Nominal GDP (Billions of dollars)

Estimated

2005 2008-2011

Nominal GDP (Percentage change)

Real GDP (Percentage change)

GDP Price Index (Percentage change)

Consumer Price Indexc

 (Percentage change)

Unemployment Rate (Percent)
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR FISCAL YEAR 2007 27

Table 1-9.

Continued

Sources: Congressional Budget Office; Office of Management and Budget; Aspen Publishers, Inc., Blue Chip Economic Indicators (March 10, 

2006); Department of Commerce, Bureau of Economic Analysis; Federal Reserve Board; Department of Labor, Bureau of Labor

Statistics.

Notes: GDP = gross domestic product.

Percentage changes are year over year.

a. Level in 2011.

b. Estimated by CBO.

c. The consumer price index for all urban consumers.

d. The Blue Chip survey does not include projections of tax bases.

2006 2007

CBO 3.2 4.5 4.5 4.4

Administration 3.2 4.2 4.2 4.3

March Blue Chip 3.2 4.7 4.7 4.7

CBO 4.3 5.1 5.2 5.2

Administration 4.3 5.0 5.4 5.6

March Blue Chip 4.3 4.8 5.0 5.5

 

CBO 1,434 1,451 1,438 1,555

Administration 1,425 1,505 1,497 1,500

CBO 5,723 6,050 6,383 7,785

Administration 5,745 6,095 6,459 8,028 

CBO 11.5 10.9 10.3 9.4

Administration 11.4 11.4 10.7 9.5

CBO 45.8 45.6 45.7 45.9

Administration 46.0 46.1 46.3 46.6

Estimated Forecast Projected Annual Average,

2005 2008-2011

Three-Month Treasury Bill Rate (Percent)

Ten-Year Treasury Note Rate (Percent)

Tax Basesd

 (Billions of dollars)

Wages and salaries

Corporate book profits

Wages and salaries

Tax Basesd

 (Percentage of GDP)

Corporate book profits

CHAPTER

2

The Economy Under the President’s Budget and

Under CBO’s Baseline Policy Assumptions Chapter 2: The Economy Under the President’s Budget and Under CBO’s Baseline Policy Assumptions

In addition to providing estimates of the cost of the 

President’s budgetary proposals (see Chapter 1), the Congressional Budget Office analyzed how those policies—in 

comparison with the policies incorporated in its baseline—would affect the economy. CBO concluded that 

under the tax and spending policies in the President’s 

budget, economic output during the first five years of the 

current baseline projection period—2007 to 2011—

might be either slightly lower or slightly higher, on average, than it would be under the policies in the baseline. 

Under most sets of assumptions, output over the second 

five years—2012 to 2016—would be higher under the 

President’s policies, according to CBO’s estimates. The 

proposals’ effects tend to be more positive in the second 

period primarily because that span includes a greater 

number of years in which the largest reductions in marginal tax rates on labor would be effective (those stemming from proposals to extend certain tax cuts set to expire after 2010) and a greater number of years in which 

proposed government spending for goods and services 

would fall well below the levels in CBO’s baseline. However, CBO’s analysis suggests that the proposals’ overall 

impact on output is likely to be modest, affecting its average over the full 10-year projection period (2007 to 

2016) by 0.4 percent or less, depending on the assumptions used.

The limited extent of the proposed policies’ effects on 

output stems in part from the small magnitude—relative 

to the overall economy—of the proposals’ budgetary impact. For example, in CBO’s estimation, revenues from 

2007 to 2011 under the President’s proposals (excluding 

economic effects) would be lower by 0.4 percent of cumulative gross domestic product than they would be under the policies reflected in CBO’s baseline. Spending, including interest on government debt, would be lower by 

0.3 percent of cumulative GDP. Moreover, various proposals in the budget have offsetting effects: some tend to 

imply greater output, and some tend to imply less. 

The macroeconomic effects of the proposals could in 

turn alter their budgetary cost. CBO estimates that under 

its baseline economic assumptions, the President’s budgetary proposals will increase the cumulative deficit for 

the five years from 2007 to 2011—relative to the deficit 

under the baseline’s policy assumptions—by $61 billion 

(0.1 percent of cumulative GDP). If the budgetary effects 

of the supply-side economic changes resulting from those 

proposals were included in the estimate, the increase in 

the cumulative deficit would range from $50 billion to 

$70 billion (see Figure 2-1 and Table 2-1).

For the years 2012 to 2016, the President’s proposals, as 

assessed using the baseline’s economic assumptions, 

would increase the cumulative deficit by $1,351 billion 

(1.4 percent of cumulative GDP). If the budgetary effects 

of the economic changes resulting from the proposals 

were also considered, the projected increase in the cumulative deficit over that period would range from as much 

as $1,357 billion (1.4 percent of cumulative GDP) to as 

little as $1,181 billion (1.2 percent of cumulative GDP), 

with most estimates lower than the baseline projection of 

$1,351 billion. 

How Fiscal Policy Affects the Economy

Budgetary policies may affect the economy in a variety of 

ways. Changes in the tax rates that people face on their 

income may affect incentives to work and save; government spending for goods and services may reduce the resources available for investment; and spending and tax 

policies may influence the overall level of demand in the 

economy. Those factors and other possible economic influences may be broadly divided into long-run effects, 

which apply largely to the supply side of the economy, 
30 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Figure 2-1.

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

Affect the Deficit After Accounting for Economic Effects

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

Source: Congressional Budget Office.

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

baseline.

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

(C) closed-economy life-cycle model with lower government spending after 2016, (D) closed-economy life-cycle model with higher 

taxes after 2016, (E) open-economy life-cycle model with lower government spending after 2016, (F) open-economy life-cycle model 

with higher taxes after 2016, (G) infinite-horizon model with lower government consumption after 2016, (H) infinite-horizon model 

with higher taxes after 2016, (I) Macroeconomic Advisers’ model, and (J) Global Insight’s model.

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

not compute an estimate for the 2012-2016 period.

-100

-80

-60

-40

-20

0

-1,800

-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

A BCDE FGH

2007 to 2011

2012 to 2016

Budget's Impact on the 2007-2011 Deficit

Assuming No Macroeconomic Feedbacks (-$61 billion)

Budget's Impact on the 2012-2016 Deficit

Assuming No Macroeconomic Feedbacks (-$1,351 billion)

a

ABCDEFGH I J

a I J
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 31

Table 2-1.

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

After Accounting for Economic Effects

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

Source: Congressional Budget Office.

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

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

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

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

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

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

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

include a full consideration of effects on descendants.

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

2016. CBO chose two alternatives—cutting government purchases of goods and services and transfer payments or raising marginal 

tax rates.

n.a. = not applicable.

High (Hours worked respond strongly to tax-rate changes) -54 -1,298

Low (Hours worked respond weakly to tax-rate changes) -61 -1,357

Lower government spending after 2016 -65 -1,227

Higher taxes after 2016 -70 -1,234

Lower government spending after 2016 -50 -1,181

Higher taxes after 2016 -56 -1,187

Lower government spending after 2016 -63 -1,231

Higher taxes after 2016 -56 -1,203

-57 n.a.

-50 n.a.

-59 n.a.

-88 n.a.

Memorandum:

-61 -1,351

2007 to 2011 2012 to 2016

Macroeconomic Advisers' Model

Textbook Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Infinite-Horizon Model

Macroeconometric Models

Supply-Side Contribution

President's Proposals Under Baseline Economic Assumptions

Global Insight's Model

CBO's Estimate of the Budgetary Effects of the

Growth Models

With Forward-Looking Behavior

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers' Model

Global Insight's Model

Without Forward-Looking Behavior
32 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

and short-run effects, which largely affect the demand 

side.

The economy’s underlying potential to produce goods 

and services depends on the size and quality of both the 

labor force and the stock of productive capital (such as 

factories and information systems) as well as on the level 

of technological know-how. Analysts refer to long-term 

changes in those three determinants of potential output 

as supply-side changes because they alter the quantity of 

goods and services that the economy is capable of supplying on a sustainable basis. Such supply-side changes have 

a lasting effect on the economy. 

In the short run, however, economic output may deviate 

from its potential level, as the total demand for goods and 

services moves above and below that level, causing employment to rise and fall and the stock of capital to be 

used more or less intensively. Those movements are referred to as demand-side, or cyclical, variations.1

 Unlike 

movements on the supply side of the economy, cyclical 

changes are temporary: built-in corrective forces usually 

tend to move the economy back toward the sustainable 

potential level determined by the supply side. 

Both supply-side and demand-side economic developments depend on the choices that millions of individuals 

make about what and how much to buy, how much to 

save and what assets to hold, and where and how much to 

work. Such developments also depend on the choices that 

firms make about how much to invest, how many workers to hire, and how many goods or services to produce. 

The government plays a crucial role in establishing the legal and institutional framework within which the economy operates as well as an overall level of government 

spending and taxation. Within that general structure, 

however, modest changes in government spending and 

taxation policies influence economic performance only to 

a limited degree.

Supply-Side Effects

The supply-side effects of the President’s taxation and 

spending proposals might include influences on the 

quantity and quality of labor, the size and composition of 

the capital stock, and technological progress. Changes in 

any or all of those factors can alter potential output. 

The Quantity and Quality of Labor. Potential output is 

strongly influenced by the overall quantity and quality of 

labor in the economy. Put simply, a long-term increase in 

the overall number of hours worked raises the economy’s 

potential to generate output. Moreover, increases in 

workers’ educational attainment, level of training, and experience or degree of effort on the job raise the quality of 

each hour worked, which will also increase potential output. Some analysts argue that certain policies in the President’s budget—for example, making current tax rates 

permanent—will ultimately affect the quality of labor. 

However, the channels through which budgetary policies 

influence that supply-side variable and the pace at which 

such effects occur are not well understood. For that reason, CBO’s analysis concentrated on the hours of labor 

supplied, which the President’s proposals would affect in 

two main ways. 

First, several provisions, such as the extension of the child 

tax credit, would increase people’s after-tax income but 

would not significantly change the marginal tax rates on 

income resulting from labor. (In general, the marginal 

rate is the rate on the next dollar of income.) A rise in 

after-tax income without a change in marginal rates tends 

to reduce the number of hours that people want to work 

because they can maintain the same standard of living 

with less work. 

Second, some of the President’s proposed policies, such as 

the extension of the marginal tax rates enacted in the 

Economic Growth and Tax Relief Reconciliation Act of 

2001, would increase both after-tax compensation for 

each additional hour of work and overall after-tax income. Evaluating how that kind of change would affect 

the number of hours people work is complicated by the 

fact that the policy would have opposing effects: people 

would earn more for each extra hour they worked, which 

would tend to encourage them to supply more labor, but 

they could also work fewer hours and earn the same aftertax income, which would tend to discourage work. Studies generally have found that, on balance, reductions in 

marginal tax rates such as those the President has proposed will increase the hours of labor that workers supply, 

primarily because those reduced tax rates will draw secondary earners (for example, the spouse of a household’s 

primary breadwinner) into the labor force. 

To summarize as a single number the changes proposed 

by the President in the schedule of marginal tax rates, 

CBO estimated the impact those changes would have on 

1. Supply-side factors such as energy prices may also trigger cyclical 

movements in the economy.
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 33

Table 2-2.

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

(Percent)

Source: Congressional Budget Office.

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

specifically, federal individual income and payroll taxes.

the effective marginal tax rate on labor income—the rate 

at which the average additional dollar of a worker’s compensation for labor is taxed (see Table 2-2). Under the 

President’s policies, that rate would fall—relative to 

CBO’s baseline—by about 2 percent in 2006, largely as a 

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

the exemptions allowed under the alternative minimum 

tax. However, the rates would be little changed over the 

2007-2010 period; instead, the biggest rate changes 

would occur for the years 2011 to 2016—because the 

President proposes to make permanent various reductions 

in taxes that are scheduled to expire after 2010. For the 

2011-2016 period, the average effective marginal tax rate 

on labor income would be between 3 percent and 5 percent lower under the President’s proposals than under the 

current-law policies incorporated in CBO’s baseline. 

The President’s proposals might also influence the level of 

the capital stock (discussed in the next section), which 

could change people’s productivity and wages and thus 

affect the hours of labor they supplied. That is, if the proposals reduced investment, the stock of productive capital 

would be smaller and wages would be lower, which would 

discourage work. Conversely, increasing investment 

would lift wages and encourage work. 

Another way in which the President’s proposals might

affect the hours worked in the economy would be by 

changing people’s expectations about future government 

policies. Under the President’s proposals, the cumulative 

federal budget deficit over the 10-year projection period 

would be larger than it would be under the policies in 

CBO’s baseline. That higher deficit could lead people to 

expect that at some time after that period, fiscal policy 

would have to change to finance the increase in the federal government’s interest payments on the money that 

the government had borrowed to cover the bigger deficit. 

Either taxes would have to be raised or spending cut.2 If 

people expected to pay more in taxes or to receive fewer 

services or smaller transfer payments (such as Social Security benefits), they might try to work and save more now 

so they would have more resources to compensate for the 

increased burden in the future. In addition, if people expected to face higher tax rates on their income from labor 

in the future, they might try to work more before the 

Calendar

Year

2006 27.6 27.1 -0.5 -1.9

2007 27.8 27.8 0 0

2008 28.1 28.1 0 0

2009 28.4 28.4 0 0

2010 28.6 28.6 0 0

2011 30.4 28.9 -1.5 -4.9

2012 30.5 29.1 -1.4 -4.7

2013 30.7 29.3 -1.3 -4.4

2014 30.8 29.6 -1.2 -3.9

2015 31.0 29.8 -1.2 -3.9

2016 31.2 30.0 -1.1 -3.6

Tax Rate Under

Current Law Percentage Points

Difference

Percent

Tax Rate Under the

President's Budget

2. For some time, the shortfall could be made up by running larger 

deficits. However, the government could not follow such an 

approach indefinitely because interest costs would compound relative to output over time (under the assumption, which CBO’s 

findings incorporate, that the rate of interest on government debt 

is higher than the rate of economic growth).
34 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

rates went up and then work less when the rates were 

higher. 

It is difficult, however, to gauge the degree to which such 

foresight influences people’s economic decisions. Also unclear is the time horizon that people consider in making 

plans and the future changes in policy that they actually 

expect. To illustrate the importance of those factors, 

CBO used various assumptions in its analysis to account 

for the extent of people’s foresight and the expectations 

they might have about future policies and then assessed 

the differences in results. 

In sum, CBO estimates, the President’s budgetary proposals would probably raise the number of hours people 

worked in 2006 but have relatively small effects (which 

could be positive or negative) during the 2007-2010 period. Over the 2011-2016 period—when the reductions 

in marginal tax rates would be largest relative to CBO’s 

baseline policy assumptions—the proposals would probably increase the hours of labor supplied. 

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

capital stock primarily by affecting both public and private consumption of goods and services and therefore

investment. The President’s proposals would directly alter 

government purchases of goods and services relative to 

their level in CBO’s baseline. For 2006 and 2007, the 

proposals imply that the level of such purchases will be 

higher than their level in the baseline—which would, in 

the absence of cyclical effects, tend to lessen investment 

in private capital by reducing the resources available for 

that purpose. However, from 2008 to 2016, the proposals 

imply that government purchases will be lower than in 

the baseline, which would tend to boost private investment.

The President’s budgetary policies would also produce 

offsetting influences on private consumption of goods 

and services. The reductions in taxes that the budget proposes would increase after-tax income, which would tend 

to increase consumption, and other things being equal, a 

higher level of consumption might crowd out investment 

in capital goods. But some of the President’s tax proposals—for example, extending EGTRRA’s marginal income 

tax rates, extending the tax rates on dividends and capital 

gains enacted in the Jobs and Growth Tax Relief Reconciliation Act of 2003, and expanding tax-free savings accounts—could tend to reduce consumption during the 

years that they were in effect. The reason is that the proposals would provide an incentive to save by lowering

the effective marginal tax rates on capital income and 

thus increasing the after-tax rate of return on savings. 

(Appendix B analyzes in more detail the potential economic effects of the President’s proposals for dividend 

and capital gains taxation, tax-free savings accounts, the 

estate tax, and individual accounts in Social Security.) 

To summarize in one number the effects of the President’s 

proposals on the rate of return on savings, CBO calculated the average effective marginal tax rate on capital 

income under the current-law policies in CBO’s baseline and under the President’s proposed policies (see 

Table 2-3). In both sets of calculations, the estimated effective tax rates were lower than they would otherwise 

have been because some capital income (for example, the 

interest that flows into tax-free savings accounts or pension funds) is not taxed. According to CBO’s estimates, 

the effective marginal tax rate on capital income during 

the 2011-2016 period would average about 18 percent 

less under the President’s proposals than under the policies in CBO’s baseline. That difference is greater than the 

difference estimated last year for the period because for 

this analysis, CBO used an updated method to calculate 

effective tax rates that incorporates the assumption that a 

larger share of capital income is subject to individual income taxation.3

The reductions in taxes on capital income that the President’s budget proposes would raise the rate of return on 

savings and affect private consumption in two opposing 

ways (just as lowering the marginal tax rate on labor income would have opposing effects on the supply of labor). The higher return on savings that the reductions 

imply would tend to increase saving and reduce current 

consumption. But the higher return would also increase 

savers’ wealth by boosting their after-tax income both 

now and in the future—which would tend to push up 

their current consumption. On balance, the implications 

that higher returns would have for consumption might be 

either positive or negative. The general conclusion that 

researchers have drawn from empirical data is that the return on savings has a relatively small effect on how much 

3. For a description of the updated method, see Congressional Budget Office, Taxing Capital Income: Effective Rates and Approaches to 

Reform (October 2005), Appendix A. CBO moved to the new 

method because it is the approach used by most other researchers. 
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 35

Table 2-3.

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

(Percent)

Source: Congressional Budget Office.

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

specifically, federal individual income and corporate income taxes.

a. The effective tax rate would increase slightly under the President’s proposals in 2006 because the proposed change in the alternative minimum tax would lower the value of mortgage interest deductions in that year by more than it would lower the effective marginal tax rate 

on other capital income.

people spend. Nevertheless, to cover other possibilities, 

CBO included a range of assumptions in its analysis. For 

some of its estimates, CBO assumed that the rate of return on savings would have little or no effect on how 

much people spend; for others, CBO assumed that increasing the rate of return on savings would reduce consumption—and increase saving—significantly.

Finally, as described earlier, the larger (relative to CBO’s 

baseline estimate) cumulative 10-year deficit under the 

President’s budgetary proposals might lead some people 

to anticipate changes in policy in the future. If people expected higher taxes, smaller transfer payments, or fewer 

government services in the years to come, they might reduce their spending and build up their savings to compensate for those anticipated policies. CBO used a range 

of assumptions about those expectations—and about 

other factors—in its analysis, and the estimated effects 

varied depending on the assumptions used: under some 

assumptions, the domestically owned capital stock was 

projected to be smaller when the policies in the President’s budget were in place than when those in CBO’s 

baseline were in effect; under other assumptions, the capital stock was projected to be larger. In general, however, 

the differences were modest. 

In addition to changes in the level of the capital stock, 

changes in the mix of different types of capital within 

that stock may affect potential output. Among the policies in the President’s budget, the proposal to extend the 

lower tax rates on corporate dividends and capital gains 

would probably have the biggest effect on the composition of the capital stock because the proposal would 

lessen taxes on personal income received from the corporate sector and thus encourage some investors to shift 

capital from the noncorporate to the corporate sector. 

Currently, some corporate income is taxed once at the 

level of the firm, through the corporate income tax, and 

again at the personal level, through the individual income 

tax on dividends and capital gains. That tax treatment 

distorts the way that capital is allocated in the economy 

because it discourages investment in the corporate sector 

relative to investment in the housing and noncorporate 

business sectors. As a result, less capital is held in the corporate sector than is optimal for the economy’s efficient 

operation. Extending lower tax rates on dividends and 

capital gains would reduce that distortion, which could 

increase economic output.

The taxation of dividends and capital gains also encourages firms to finance investment by borrowing rather 

Calendar

Year

2006a 13.6 13.7 0.1 1.0

2007 13.6 13.6 0 0

2008 13.7 13.7 0 0

2009 14.4 13.3 -1.0 -7.2

2010 14.3 13.3 -1.0 -7.1

2011 16.3 13.3 -3.0 -18.4

2012 16.2 13.3 -2.9 -18.0

2013 16.2 13.3 -2.9 -17.8

2014 16.2 13.3 -2.8 -17.6

2015 16.1 13.4 -2.8 -17.2

2016 16.1 13.3 -2.8 -17.2

Percent

Tax Rate Under the

President's Budget

Tax Rate Under

Current Law Percentage Points

Difference
36 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

than by issuing stock. Because firms may deduct their interest payments on debt (for example, bonds they have issued) from their taxable income, they can lessen the tax 

they pay. (The interest payments will then be taxed only 

once, at the individual level.) The tax treatment of interest payments on debt may influence firms’ decisions 

about financing and lead to inefficient allocation of the 

economy’s resources. Extending the current tax rates on 

dividends and capital gains would lessen such inefficiency 

relative to that under the baseline’s assumption that the 

tax rates on those categories of income will rise after 

2008.

Technological Progress. New and improved technical 

processes and products are the source of most long-term 

growth in productivity, and the President’s budgetary 

proposals could affect the economy by influencing the 

rate of such progress. Researchers, however, lack a basis 

for estimating how taxation and spending policies affect 

technological innovation. Because so little is understood 

about the genesis of such innovation, CBO for the most 

part has not incorporated in its analysis effects on technological progress arising from the President’s proposals.4

Demand-Side (Cyclical) Effects

The federal government’s policies for taxation and spending also affect the economy by adding to or subtracting 

from the total demand for goods and services. Increases 

in demand may cause firms to temporarily gear up production and hire more workers; decreases in demand may 

have the opposite effects. From a demand-side perspective, budgetary policies that reduce private and public 

consumption might slow the pace of the economy’s current cyclical expansion. 

Demand-side effects, however, are relatively fleeting: they 

can only temporarily raise or lower output beyond what it 

would otherwise have been because built-in economic 

forces tend to move output toward its sustainable potential level. Moreover, policies that increase demand by raising government purchases or private consumption are 

likely to lower output in the long run because such policies tend eventually to decrease investment and the size of 

the capital stock. 

A Description of the Models Used by 

CBO and Their Results

In estimating the economic effects of the President’s budgetary proposals relative to those arising from the policy 

assumptions in the baseline, CBO used several different 

economic models that in some respects are similar but 

that capture different features of the economy and reflect 

different ways of thinking about it. The models fall into 

two broad categories. Three estimate only supply-side effects. The other two are commercial macroeconometric 

models that emphasize the business-cycle aspects of the 

economy and are designed primarily to analyze demandside effects—although they incorporate some supply-side 

influences as well. (Figure 2-2 presents, year by year, the 

impact of the President’s proposals on some of the key inputs for CBO’s various models—effective tax rates on labor and capital and the size of the deficit. Table 2-4 presents details of CBO’s baseline projections of GDP and 

other economic variables.) 

Ten-Year Analysis of Supply-Side Effects

CBO used three growth models—a “textbook” growth 

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

growth model—to analyze the supply-side effects of the 

President’s proposals from 2007 through 2016 (the same 

period that CBO’s baseline projections cover).5 The 

models differ in their assumptions about how far ahead 

people look in making their plans (see Appendix C). The 

textbook growth model is not forward-looking—it assumes that people do not explicitly take into account expected future policies in making current decisions. The 

life-cycle model incorporates the assumption that people 

make lifelong plans for working and saving but do not 

consider events that might occur after their death. By 

contrast, the infinite-horizon model incorporates the

4. CBO used two commercial macroeconometric models to estimate 

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

them, created by Global Insight, potential GDP responded positively to spending for research and development—which in turn 

would be stimulated by the proposal for extending tax credits for 

such activities.

5. CBO chose to analyze effects during the 2007-2011 and 2012-

2016 periods for consistency with the periods presented in many 

of the tables in Chapter 1—despite the resulting exclusion of 

2006, during which the President’s proposals are estimated to have 

budgetary and economic effects. CBO’s models showed positive 

supply-side effects on output in 2006 ranging from about 0.1 percent to 0.2 percent. The positive effects stemmed mainly from 

reduced tax rates on labor income as a result of the proposal to 

extend for one year the increase in the exemptions allowed under 

the alternative minimum tax.
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 37

Figure 2-2.

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

Capital Income and Labor Income

(Percentage of gross domestic product) (Percent)

Source: Congressional Budget Office.

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

a. The bars represent the effects of the President’s proposals on the budget balance under CBO’s baseline economic assumptions. A negative change indicates an increase in the annual deficit relative to CBO’s baseline.

b. Changes in the effective federal marginal tax rate on income from capital (the share of the last dollar of such income taken by federal individual income and corporate income taxes).

c. Changes in the effective federal marginal tax rate on income from labor (the share of the last dollar of such income taken by federal individual income and payroll taxes).

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

-2.0

-1.6

-1.2

-0.8

-0.4

0.0

0.4

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

2

4

Left Scale

Budget's Impact on the Deficit a

Right Scale

Changes in the Effective Tax Rate on:

Capital income b

Labor income c
38 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 2-4.

CBO’s Year-by-Year Forecast and Projections for Calendar Years

2006 Through 2016

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor

Statistics; Federal Reserve Board.

Note: Percentage changes are year over year; GDP = gross domestic product.

a. The consumer price index for all urban consumers.

b. The consumer price index for all urban consumers excluding food and energy prices.

c. The employment cost index for wages and salaries of workers in private industry.

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

12,494 13,262 13,959 14,696 15,455 16,208 16,954 17,718 18,512 19,329 20,178 21,064

6.5 6.1 5.3 5.3 5.2 4.9 4.6 4.5 4.5 4.4 4.4 4.4

3.6 3.6 3.4 3.4 3.3 3.0 2.8 2.7 2.6 2.6 2.6 2.5

2.7 2.4 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8

3.4 2.8 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2

2.2 2.2 2.3 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2

2.4 3.0 3.2 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3

5.1 5.0 5.0 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2

3.2 4.5 4.5 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4 4.4

4.3 5.1 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2

Corporate book profits 1,434 1,451 1,438 1,439 1,468 1,511 1,555 1,611 1,675 1,742 1,818 1,901

Wages and salaries 5,723 6,050 6,383 6,745 7,103 7,447 7,785 8,132 8,491 8,861 9,246 9,647

Corporate book profits 11.5 10.9 10.3 9.8 9.5 9.3 9.2 9.1 9.0 9.0 9.0 9.0

Wages and salaries 45.8 45.6 45.7 45.9 46.0 45.9 45.9 45.9 45.9 45.8 45.8 45.8

Tax Bases

(Percentage of GDP)

Ten-Year Treasury

Note Rate (Percent)

Tax Bases

(Billions of dollars)

Unemployment Rate

(Percent)

Three-Month Treasury 

Bill Rate (Percent)

(Percentage change)

(Percentage change)

Employment Cost Indexc

(Percentage change)

Core Consumer Price Indexb

(Percentage change)

Nominal GDP 

(Billions of dollars)

Nominal GDP 

(Percentage change)

Consumer Price Indexa

2005

Estimated Forecast Projected

Real GDP

(Percentage change)

GDP Price Index
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 39

assumption that people care as much about the welfare of 

their descendants as they do about their own welfare. 

That assumption means that people behave as if they will 

live forever.6

CBO used the textbook growth model to estimate effects 

under two assumptions about the degree to which people 

will alter their hours of labor in response to changes in 

marginal tax rates: a “low” assumption, in which there is 

little response, and a “high” assumption, in which the response is at the upper end of the consensus of empirical 

estimates.7 Over the 2007-2011 period, on average, the 

President’s proposals under either assumption would have 

little effect on gross national product (GNP), in CBO’s 

estimation.8 Over the 2012-2016 period, the proposals 

would reduce GNP by 0.1 percent under the low assumption and raise GNP by 0.2 percent under the high 

assumption (see Table 2-5). Those estimates illustrate the 

budgetary proposals’ opposing effects, as estimated by the 

textbook growth model: higher deficits crowd out investment and thus reduce the capital stock, but lower marginal tax rates increase the labor supplied (especially in 

the last six years of the 2007-2016 period). Which effect 

dominates depends on the assumption made about how 

sensitive the supply of labor is to changes in marginal tax 

rates. 

The results of the textbook growth model differ from 

those of the other two growth models in large part because the textbook model does not incorporate forwardlooking behavior: people, as the model represents them, 

do not shift hours of labor from the earlier to the later period and do not work and save more in anticipation of 

changes in policy after 2016. In addition, unlike the lifecycle and infinite-horizon models, the textbook growth 

model does not incorporate any direct effects on private 

consumption as a result of lower marginal (as opposed to 

lower average) tax rates and higher pretax interest rates. 

The estimates that CBO produced using the life-cycle 

and infinite-horizon growth models are based on the assumption that people behave as if they believe that the 

budgetary policies being assessed—those of the President 

or of CBO’s baseline—will be maintained over the entire 

10-year modeling period. That assumption is an important characteristic of CBO’s estimates. In reality, people 

would probably think that the policies might change at 

some point during that time. 

Another characteristic of the estimates produced by the 

life-cycle and infinite-horizon models is that they depend 

in part on how the President’s budgetary proposals affect 

people’s expectations about fiscal policy beyond 2016. 

Assumptions about those expectations are complicated by 

the fact that the policies reflected in CBO’s baseline are 

likely to be unsustainable in the long run, owing to projected increases in spending for health and retirement 

programs.9 However, CBO assumed that people would 

expect the fiscal imbalances under current-law policies to 

be resolved—although the way in which that would happen is not specified. In projections that use its forwardlooking models, CBO made explicit assumptions only 

about the manner in which increases in deficits under 

the President’s budgetary policies, relative to those in 

the baseline, would eventually be financed—not about 

the way that deficits projected in the baseline would be 

addressed. 

The life-cycle and infinite-horizon models each generated 

two sets of estimates based on different assumptions 

about that financing (the models require such an assump6. Although the infinite-horizon model that CBO used in this year’s 

analysis of the economic effects of the President’s budgetary proposals is similar in spirit to the one it used last year, the model differs in a number of ways. Most important, the current model 

incorporates the assumption that income may vary unpredictably 

(in contrast to the former model’s assumption that future income 

is known with certainty) and that insurance against such fluctuations is unavailable. That assumption implies that people, as represented in the model, will hold some savings for “precautionary” 

reasons—as a buffer against drops in income. That practice in 

turn may imply that changes in the after-tax rate of return on savings will have less effect on consumption.

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

1996).

8. In presenting the economic effects of the President’s budgetary 

proposals, CBO uses as its measure of output gross national product rather than the more commonly cited gross domestic product 

to better illustrate the proposals’ effects on the resources available 

to U.S. residents. In those circumstances in which capital can flow 

across borders, GDP may be a misleading guide to domestic 

incomes because foreigners may invest and earn returns from 

domestic production—which means that a portion of GDP is not 

included in U.S. income. GNP—the amount produced by U.S. 

residents and the capital they own anywhere in the world—provides a better measure of the United States’ resources in an openeconomy context.

9. See Congressional Budget Office, The Long-Term Budget Outlook

(December 2005).
40 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 2-5.

CBO’s Estimates of How the President’s Budget Would Affect Real Gross

National Product

(Average percentage difference from CBO’s baseline, by calendar year)

Source: Congressional Budget Office.

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

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

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

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

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

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

include a full consideration of effects on descendants.

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

2016. CBO chose two alternatives—cutting government purchases of goods and services and transfer payments or raising marginal 

tax rates.

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

* 0.2

* -0.1

* 0.6

-0.1 0.5

* 0.7

* 0.6

* 0.5

* 0.7

* n.a.

0.1 n.a.

0.2 n.a.

-0.3 n.a.

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers' Model

Global Insight's Model

Growth Models

With Forward-Looking Behavior

Macroeconometric Models

Without Forward-Looking Behavior

Supply-Side Contribution

High (Hours worked respond strongly to tax-rate changes)

Low (Hours worked respond weakly to tax-rate changes)

2012 to 2016

Macroeconomic Advisers' Model

Global Insight's Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Higher taxes after 2016

Lower government spending after 2016

Higher taxes after 2016

Infinite-Horizon Model

2007 to 2011

Lower government spending after 2016

Higher taxes after 2016

Lower government spending after 2016
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 41

tion because they are forward-looking). Under one assumption, people believe that the proposals will be financed by gradually reducing government spending for 

goods and services and for transfer payments (as shares of 

GNP) over the 2017-2026 period. Under the other assumption, people believe that the proposals will be financed by gradually increasing marginal tax rates over the 

same period. 

Depending on which assumption about financing is used 

and whether the economy is considered to be open or 

closed to flows of foreign capital, the life-cycle model 

projects that the President’s proposals will subtract (relative to CBO’s baseline) up to 0.1 percent from GNP over 

the 2007-2011 period but then add between 0.5 percent 

and 0.7 percent over the 2012-2016 period. The difference between the projected effects over the two periods 

stems partly from the model’s estimate that people will 

shift some hours of work from the earlier to the later period, when tax rates will be lower (relative to the assumptions of CBO’s baseline). 

The infinite-horizon model projects that the President’s 

proposals will have little effect on GNP on average (relative to CBO’s baseline) from 2007 to 2011. Depending 

on which assumption about financing is used, the model 

estimates that during the second five years of the modeling period, the President’s proposals will add an average 

of between 0.5 percent and 0.7 percent to GNP. Once 

again, the difference in projected effects arises in part because the model estimates that people will shift some of 

their hours of work from the first five-year span to the 

second to take advantage of lower (relative to the baseline’s assumptions) tax rates on labor income.

The effects on the economy from the President’s proposed changes in fiscal policy would in turn affect the 

budget (see Table 2-1 on page 31 and Table 2-6). CBO 

projects that under the economic assumptions incorporated in its baseline, the President’s proposals will expand 

the cumulative deficit over the 2007-2011 period by $61 

billion. Under the various assumptions used in the 

growth models that CBO employed in its analysis, the 

economic effects of the President’s proposals over that period could add as much as $9 billion to that total or subtract as much as $10 billion from it.

For the 2012-2016 period, the President’s budgetary policies under the baseline’s economic assumptions are projected to boost the cumulative deficit by $1,351 billion. 

The economic effects of the President’s proposals over 

that period, according to the models, could add as much 

as $6 billion to that increase or subtract as much as $170 

billion from it. Most of the estimates indicate a reduction 

in the deficit as a result of those effects. 

Five-Year Analysis Including Demand-Side Effects

To analyze how the President’s budgetary proposals might 

affect both the demand side and the supply side of the 

economy over the next five years, CBO turned to macroeconometric forecasting models created by two private 

forecasting firms—Macroeconomic Advisers and Global 

Insight. Although the models include embedded growth 

models, their design concentrates on demand-side (cyclical) economic effects. Such effects become increasingly 

harder to estimate the further projections extend. Therefore, CBO used those models to produce estimates only 

for the first five years of the 2007-2016 period. 

Like the textbook growth model, Macroeconomic 

Advisers’ and Global Insight’s models are not forwardlooking—people, as the models represent them, do not 

behave as though they have specific expectations about 

future policies or economic developments. Instead, people respond to economic changes the same way they responded in the past, regardless of the source of the 

changes. For example, they react to those tax proposals in 

the budget that would boost after-tax labor income by increasing their purchases to about the same degree as they 

have, on average, in the past when after-tax labor income 

rose. However, people might increase their spending by a 

smaller amount in response to a change in taxes than they 

would in response to some other change that boosted 

their labor income (such as an increase in productivity) if 

they thought that tax legislation was more likely to be reversed in the future. 

The lack of forward-looking behavior in the macroeconometric models implies that specific policy changes 

that are scheduled to occur in the future will not affect 

the current actions of people represented in the models 

unless special adjustments are made to mimic forwardlooking behavior.10 For example, the President’s proposal 

to extend many of the provisions in EGTRRA would reduce taxes (compared with the levels in CBO’s baseline) 

10. One such adjustment is that stock prices are assumed to incorporate the effects of extending lower rates on capital gains and dividend income immediately, even though the extension would not 

affect tax rates until after 2008. 
42 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table 2-6.

The Budgetary Implications of the Macroeconomic Effects

(Cumulative change from CBO’s estimate of the President’s budget, in billions of dollars)

Source: Congressional Budget Office.

Notes: Numbers in this table reflect the effects on the cumulative deficit (relative to CBO’s baseline) of the economic impacts shown in 

Table 2-4. (Negative numbers indicate an increase in the deficit; positive numbers, a reduction.) They do not include the estimated 

cost of the President’s budgetary proposals under CBO’s baseline economic assumptions. The total impact of the proposals on the

cumulative deficit, including both those direct costs and the secondary effects shown above, appear in Table 2-1.

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

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

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

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

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

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

include a full consideration of effects on descendants.

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

2016. CBO chose two alternatives—cutting government purchases of goods and services and transfer payments or raising marginal 

tax rates.

n.a. = not applicable.

High (Hours worked respond strongly to tax-rate changes) 7 52

Low (Hours worked respond weakly to tax-rate changes) -1 -6

Lower government spending after 2016 -5 123

Higher taxes after 2016 -9 117

Lower government spending after 2016 10 170

Higher taxes after 2016 5 164

Lower government spending after 2016 -2 120

Higher taxes after 2016 5 147

4 n.a.

11 n.a.

2 n.a.

-27 n.a.

2007 to 2011 2012 to 2016

Macroeconomic Advisers' Model

Global Insight's Model

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Infinite-Horizon Model

Macroeconomic Advisers' Model

Global Insight's Model

Growth Models

With Forward-Looking Behavior

Macroeconometric Models

Supply-Side and Demand-Side Contributions

Without Forward-Looking Behavior

Supply-Side Contribution
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 43

in the years 2011 to 2016. Those lower taxes would increase the amount of after-tax income that people expected in the future, which might cause them to boost 

their spending today (as the forward-looking models imply). In the macroeconometric models, however, those 

changes in taxes affect people’s consumption only when 

they occur. 

The projections by Macroeconomic Advisers’ and Global 

Insight’s models also required an adjustment to the supply of labor. Like the textbook growth model, those models do not incorporate the effects of taxes on the number 

of hours worked. Therefore, CBO adjusted the models to 

incorporate its own estimates of those effects.11

Two sets of estimates were produced to illustrate the magnitude of both demand- and supply-side effects in the 

models. For one set, CBO used the standard assumption 

that monetary policy would allow both demand- and 

supply-side effects. For the second set, CBO adjusted the 

model in such a way as to hold the unemployment rate at 

the level projected in its baseline. That approach produced an estimate of the implications of the proposals for 

potential (noncyclical) GNP—in other words, the 

supply-side effects.

Macroeconomic Advisers’ model predicted that the 

demand- and supply-side effects of the President’s proposed policies would raise GNP by 0.2 percent, on average, between 2007 and 2011 (see Table 2-5 on page 40). 

Global Insight’s model, by comparison, estimated that 

the proposed policies would subtract an average of 0.3 

percent from GNP over the same period. The difference 

arises largely from two factors: 

B The effect of government purchases on output. Cumulative government purchases would be reduced under 

the President’s proposals over the 2007-2011 period 

relative to the levels in CBO’s baseline. Global Insight’s model assumes that a given decline in purchases 

has a larger negative effect on GNP (through reduced 

demand) than does Macroeconomic Advisers’ model.

B The effect of stock prices on consumption. CBO’s analysis 

estimated that under the President’s proposal to extend the lower dividend and capital gains taxes now 

set to expire in 2008, stock prices would rise. Macroeconomic Advisers’ model assumes that such an increase will boost consumption by a greater amount 

than Global Insight’s model assumes and therefore 

that it will have a more positive effect on GNP 

(through increased demand).

The models’ estimates of the supply-side impacts of the 

President’s proposals were more similar. Both macroeconometric models projected small supply-side effects 

under the President’s budgetary policies: Macroeconomic 

Advisers’ model estimated that output would be little 

changed, and Global Insight’s model estimated that it 

would be 0.1 percent higher.

The projected economic impacts of the proposals would 

in turn affect the budget. According to the projections 

from Macroeconomic Advisers’ model, the proposals’ impact on the economy could subtract $2 billion from the 

$61 billion increase in the deficit projected for the 2007-

2011 period under the baseline’s economic assumptions 

(see Table 2-6). By the estimates of Global Insight’s 

model, the supply-side and cyclical effects of the President’s proposals over the same period could add $27 billion to the deficit.

11. Using data from a large sample of taxpayers, CBO's estimates 

accounted for the effects of changes in both marginal tax rates and 

after-tax income under the President's proposals by incorporating 

a larger response to changes in marginal tax rates among secondary earners than among primary earners.

APPENDIX

A

Changes to CBO’s Baseline Since January 2006

In conjunction with its annual analysis of the President’s budget, the Congressional Budget Office (CBO) 

typically updates the baseline projections that it published in its January report on the budget and economic 

outlook. Those projections—which are constructed 

according to rules set forth in law (primarily the Balanced 

Budget and Emergency Deficit Control Act of 1985)— 

project what spending and revenue levels would look like 

over the next 10 years if current laws and policies did not 

change (see Table A-1). 

For revenues and mandatory spending, CBO is required 

to prepare baseline projections under the assumption that 

current laws continue unaltered in the future, with relatively few exceptions.1

 CBO projects discretionary spending by adjusting the current year’s budget authority to 

reflect inflation and certain other factors specified in law. 

The resulting baseline estimates are not intended to predict future budgetary outcomes. Rather, they serve as 

neutral benchmarks that lawmakers can use to measure 

the effects of spending or revenue proposals, such as those 

in the President’s budget.

Since January, CBO has reduced its projection of the 

cumulative deficit for the 2007-2016 period by $106 billion, to $726 billion (see Table A-2). Nearly all of that 

change stems from a decline of $100 billion, or 0.3 percent, in projected outlays over that period—mainly 

because of the enactment of the Deficit Reduction Act of 

2005 (Public Law 109-171). Revenue projections for the 

10-year period are virtually unchanged since January, rising by a total of just $6 billion.

Changes to Outlay Projections

Most of the revisions to CBO’s spending projections in 

the past two months result from new laws, which have 

reduced the total outlays projected for the 2007-2016 

period by $124 billion. Technical changes (those attributable to factors other than legislation or economic variables) offset part of that reduction, increasing projected 

outlays by $24 billion between 2007 and 2016.

Legislative Changes 

The Deficit Reduction Act of 2005—also known as the 

spending reconciliation act—is responsible for almost all 

of the legislation-related changes to CBO’s baseline since 

January.2 CBO estimates that the law will reduce mandatory spending by $106 billion over the 2007-2016 period.3 The largest savings are expected to occur in Medicaid, student loan programs, Medicare, and receipts from 

auctioning licenses to use the electromagnetic spectrum.

The reconciliation act will decrease net federal spending 

for Medicaid by a total of more than $40 billion through 

2016, CBO estimates. The bulk of those savings come 

from three changes: allowing state Medicaid programs to 

require beneficiaries to pay higher premiums and a 

1. Among those exceptions, mandatory spending programs that are 

set to expire must be assumed to continue if they have outlays of 

more than $50 million in the current year and were established on 

or before the enactment of the Balanced Budget Act of 1997. Programs established after that are not automatically assumed to continue. Similarly, the Deficit Control Act requires CBO to assume 

that expiring excise taxes that are dedicated to trust funds will be 

extended at their current rates. The law does not provide for the 

extension of other expiring tax provisions, even if they have routinely been extended in the past.

2. The budget resolution for 2006 instructed certain Congressional 

committees to recommend legislation that would reduce mandatory spending and revenues by specified amounts. That process is 

known as reconciliation.

3. For information about the effects of that law between 2006 and 

2010—the period covered by the budget resolution for 2006— 

see Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 to 2016 (January 2006), Box 1-2. Also see 

Congressional Budget Office, Cost Estimate for S. 1932, the Deficit 

Reduction Act of 2005 (January 27, 2006).
46 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Table A-1.

CBO’s Baseline Budget Projections

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Total, Total,

Actual 2007- 2007-

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 2016

927 1,003 1,108 1,190 1,281 1,374 1,572 1,724 1,824 1,930 2,043 2,164 6,525 16,210

278 302 296 300 303 305 309 317 326 335 346 360 1,513 3,197

794 838 882 925 970 1,017 1,064 1,112 1,161 1,212 1,264 1,319 4,857 10,926

154 169 176 184 189 188 194 225 235 247 259 271 930 2,169 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

2,154 2,313 2,461 2,598 2,743 2,883 3,139 3,378 3,546 3,725 3,913 4,114 13,825 32,502

On-budget 1,576 1,704 1,820 1,922 2,032 2,136 2,357 2,562 2,694 2,835 2,985 3,146 10,266 24,488

Off-budget 577 608 642 676 712 747 782 817 853 890 928 968 3,559 8,014

1,320 1,429 1,484 1,569 1,655 1,753 1,875 1,921 2,065 2,198 2,343 2,535 8,336 19,399

968 1,002 999 1,018 1,038 1,060 1,086 1,101 1,131 1,157 1,184 1,217 5,201 10,991

184 218 243 262 274 286 295 298 297 296 294 291 1,361 2,838 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

2,472 2,648 2,726 2,849 2,968 3,099 3,256 3,321 3,493 3,650 3,822 4,044 14,898 33,228

On-budget 2,070 2,220 2,280 2,388 2,488 2,601 2,739 2,777 2,921 3,046 3,183 3,366 12,494 27,788

Off-budget 402 428 447 461 480 498 517 543 572 604 639 678 2,403 5,440

-318 -336 -265 -250 -224 -216 -117 58 53 74 91 70 -1,072 -726

-493 -516 -460 -466 -456 -465 -382 -216 -227 -211 -198 -220 -2,228 -3,300

175 180 195 215 232 249 265 274 280 286 288 290 1,156 2,574

4,592 4,931 5,206 5,470 5,706 5,934 6,062 6,014 5,968 5,901 5,816 5,749 n.a. n.a.

12,293 13,082 13,781 14,508 15,264 16,021 16,768 17,524 18,311 19,121 19,963 20,839 76,343 172,101

7.5 7.7 8.0 8.2 8.4 8.6 9.4 9.8 10.0 10.1 10.2 10.4 8.5 9.4

2.3 2.3 2.1 2.1 2.0 1.9 1.8 1.8 1.8 1.8 1.7 1.7 2.0 1.9

6.5 6.4 6.4 6.4 6.4 6.3 6.3 6.3 6.3 6.3 6.3 6.3 6.4 6.3

1.3 1.3 1.3 1.3 1.2 1.2 1.2 1.3 1.3 1.3 1.3 1.3 1.2 1.3 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

17.5 17.7 17.9 17.9 18.0 18.0 18.7 19.3 19.4 19.5 19.6 19.7 18.1 18.9

On-budget 12.8 13.0 13.2 13.2 13.3 13.3 14.1 14.6 14.7 14.8 15.0 15.1 13.4 14.2

Off-budget 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.7 4.6 4.6 4.7 4.7

10.7 10.9 10.8 10.8 10.8 10.9 11.2 11.0 11.3 11.5 11.7 12.2 10.9 11.3

7.9 7.7 7.3 7.0 6.8 6.6 6.5 6.3 6.2 6.1 5.9 5.8 6.8 6.4

1.5 1.7 1.8 1.8 1.8 1.8 1.8 1.7 1.6 1.5 1.5 1.4 1.8 1.6 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

20.1 20.2 19.8 19.6 19.4 19.3 19.4 19.0 19.1 19.1 19.1 19.4 19.5 19.3

On-budget 16.8 17.0 16.5 16.5 16.3 16.2 16.3 15.8 16.0 15.9 15.9 16.2 16.4 16.1

Off-budget 3.3 3.3 3.2 3.2 3.1 3.1 3.1 3.1 3.1 3.2 3.2 3.3 3.1 3.2

-2.6 -2.6 -1.9 -1.7 -1.5 -1.3 -0.7 0.3 0.3 0.4 0.5 0.3 -1.4 -0.4

-4.0 -3.9 -3.3 -3.2 -3.0 -2.9 -2.3 -1.2 -1.2 -1.1 -1.0 -1.1 -2.9 -1.9

1.4 1.4 1.4 1.5 1.5 1.6 1.6 1.6 1.5 1.5 1.4 1.4 1.5 1.5

37.4 37.7 37.8 37.7 37.4 37.0 36.2 34.3 32.6 30.9 29.1 27.6 n.a. n.a.

In Billions of Dollars

As a Percentage of Gross Domestic Product

Other

Total

Outlays

Discretionary spending

Mandatory spending

Net interest

Total

Deficit (-) or Surplus

On-budget 

Revenues

Individual income taxes

Corporate income taxes

Social insurance taxes

Off-budget

Debt Held by the Public

Memorandum:

Gross Domestic Product

Individual income taxes

Net interest

Corporate income taxes

Social insurance taxes

Other

Total

Debt Held by the Public

Total

Deficit (-) or Surplus

On-budget 

Off-budget

Outlays

Discretionary spending

Mandatory spending

Revenues
APPENDIX A CHANGES TO CBO’S BASELINE SINCE JANUARY 2006 47

Table A-2.

Changes in CBO’s Baseline Projections of the Deficit or Surplus Since 

January 2006

(Billions of dollars)

Source: Congressional Budget Office.

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

a. Includes offsetting receipts.

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

Total, Total,

2007- 2007-

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

-337 -270 -259 -241 -222 -114 38 40 57 73 67 -1,107 -832

***11111111 3 6

Changes to Outlay Projections

Mandatory -5 4 -4 -21 -12 -12 -14 -13 -11 -11 -12 -46 -106

Discretionary 0 1 1 1 1 1 1 1 1 1 1 3 7

Net interest (Debt service) * * * -1 -1 -2 -3 -3 -4 -5 -6 -5 -25 __ _ __ ___ ___ ___ ___ ___ ___ ___ ___ ___ _____

-5 4 -4 -21 -13 -13 -16 -15 -14 -15 -16 -47 -124

Mandatory

Medicarea -5 -4 1 6 11 22 2 11 11 12 28 36 102

Medicaid -1 -1 -1 -2 -3 -5 -6 -8 -10 -12 -15 -12 -63

Social Security * * 1 1 1 1 2 2 2 2 2 4 13

Other 7 -3 2 4 1 2 2 2 * 3 4 6 16 __ __ __ __ ___ ___ __ ___ ___ ___ ___ ___ ___

Subtotal, mandatory 1 -8 2 9 10 20 * 7 3 5 20 34 68

Discretionary 3 -1 -5 -3 -1 -2 -2 -2 -3 -3 -3 -12 -25

Net interest

Debt service * * * * * 1 1 1 1 1 1 2 7

Other * -1 -2 -2 -2 -2 -3 -3 -4 -4 -4 -9 -26 _ __ __ __ __ __ __ __ __ __ __ __ ___

Subtotal, net interest * * -2 -2 -2 -1 -2 -2 -2 -3 -3 -7 -19

4 -9 -5 5 7 17 -4 2 -2 -1 14 15 24 __ __ __ __ __ ___ __ __ __ __ ___ ___ ___

Total Outlay Changes -1 -5 -8 -16 -6 4 -20 -13 -16 -17 -2 -32 -100

1 6 9 17 7 -3 20 13 17 17 3 35 106

-336 -265 -250 -224 -216 -117 58 53 74 91 70 -1,072 -726

5 -4 4 21 13 13 16 15 14 15 16 47 124

-4 10 5 -4 -6 -16 5 -2 3 2 -13 -12 -18

or Surplusb

Changes to Revenue Projections

(Technical)

Total Deficit (-) or Surplus

as Projected in January 2006

as Projected in March 2006

Legislative

Technical

Total Impact on the Deficit

Subtotal, legislative

Subtotal, technical

Total Deficit (-) or Surplus

Memorandum:

Total Legislative Changesb

Total Technical Changesb
48 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

greater share of their health care costs, letting states 

reduce coverage for some beneficiaries, and lowering 

Medicaid’s payments for outpatient prescription drugs.

Provisions of the Deficit Reduction Act that affect student loan programs are estimated to produce net savings 

of $4 billion in 2006 and $30 billion over the next 10 

years. Changes that reduce spending include lowering 

payments to lenders, raising the interest rate charged on 

loans to students’ parents, mandating that guaranty agencies pay certain fees, reducing lenders’ insurance reimbursements, and eliminating mandatory funding for 

administrative costs. Those changes are partly offset by 

provisions that increase federal spending for student 

loans, such as raising annual borrowing limits, reducing 

the loan-origination fees that the government collects 

from borrowers, and creating two new grant programs.

The reconciliation act decreases spending for Medicare by 

an estimated $21 billion over the 2007-2016 period. Part 

of the savings result from lowering payments for certain 

imaging services (such as magnetic resonance imaging, or 

MRI) and for home health services. Savings also come 

from improving the accuracy of the process by which 

Medicare adjusts payments to managed care plans for differences in expected costs that stem from differences in 

patients’ health status.

The Deficit Reduction Act also includes provisions that 

will increase collections from the Federal Communications Commission’s auctions of spectrum licenses, raise 

the premiums that companies pay to the Pension Benefit 

Guaranty Corporation for pension insurance, and modify 

other mandatory programs. Those provisions reduce 

projected spending by $15 billion over the 2007-2016 

period.

Besides enacting the Deficit Reduction Act, the Congress 

and the President recently transferred $712 million from 

balances in the Federal Emergency Management Agency’s 

Disaster Relief Fund to the Small Business Administration for disaster loans to aid victims of Hurricanes Katrina, Rita, and Wilma. Extrapolating that funding 

through 2016 adds $7 billion to CBO’s baseline projection of discretionary spending over the 10 years.

In all, changes directly related to recent legislation have 

reduced CBO’s projection of the cumulative deficit for 

the 2007-2016 period by $99 billion. In turn, that 

reduction means less borrowing by the federal government, which decreases projected debt-service costs over 

the 10-year period by $25 billion.

Technical Changes 

Technical revisions to the baseline since January have 

raised projected outlays between 2007 and 2016 by a 

total of $24 billion. Much of that rise comes from an 

increase in estimated spending for Medicare, partly offset 

by reductions in projected spending for Medicaid and for 

discretionary programs. 

Medicare. Although CBO lowered its projection of 

Medicare spending over 10 years because of provisions in 

the Deficit Reduction Act, it added $102 billion to that 

projection because of new information about recent 

spending. That increase is the result of a $148 billion 

(3 percent) rise in projected net spending for Parts A and 

B of Medicare and a $46 billion (5 percent) reduction in 

projected net spending for the prescription drug benefit 

under Part D. (Those amounts reflect changes in both 

gross outlays and receipts from premium payments.) 

In 2005, Medicare spending grew at its fastest rate in a 

decade—by 10 percent (taking into account the effect of 

shifts in the timing of payments to managed care plans). 

Rapid growth has continued through February of this 

year. As a result, CBO has raised its estimate of the rate at 

which spending for Part A and B benefits will increase in 

the future. It now expects that growth rate to be 9 percent 

in 2006 and to average 6.9 percent annually between 

2006 and 2016 (compared with a 6.6 percent average in 

CBO’s January baseline). 

Nearly all of the reduction in projected spending for 

Part D over 10 years reflects updated information about 

national spending for prescription drugs in 2004 and 

2005. On the basis of actual spending in 2004—which 

was about 4 percent lower than expected—and estimated 

spending in 2005, CBO now anticipates that spending 

for prescription drugs throughout the coming decade will 

be about 6 percent lower than projected in January. For 

that reason and because of current enrollment figures, 

CBO has also reduced its estimate of net spending for 

Part D in 2006 by $4.4 billion. 

Medicaid. Technical changes have lowered CBO’s projection of federal Medicaid spending over the 2007-2016 

period by $63 billion. Those changes are based on CBO’s 

analyses of data on Medicaid spending and enrollment 

from the Centers for Medicare & Medicaid Services. 
APPENDIX A CHANGES TO CBO’S BASELINE SINCE JANUARY 2006 49

Those data indicate slower-than-expected growth in per 

capita spending in several areas—particularly long-term 

care services and prescription drugs. Some of the decrease 

from slower growth in per capita spending is offset by 

increases in expected enrollment of people with disabilities. Overall, CBO now projects that Medicaid spending 

will grow at an average annual rate of 7.5 percent from 

2007 to 2016, compared with 8.0 percent in the January 

baseline. 

Social Security. Additional information about Social 

Security recipients has led CBO to revise its projections 

slightly. Those changes—chiefly, boosting the average 

initial retirement benefit expected in the Old-Age and 

Survivors Insurance program and shaving the number of 

recipients and the average payment expected in the Disability Insurance program—have opposite effects on the 

two programs’ benefits. On balance, they increase estimates of Social Security outlays by roughly $1 billion per 

year for 2008 through 2011 and by $2 billion per year 

(approximately 0.2 percent of total benefits) thereafter, 

for a total increase over the projection period of $13 

billion.

Other Mandatory Programs. The remaining technical 

changes to CBO’s baseline projections of mandatory 

spending involve a number of programs. For example, 

projected outlays for the Universal Service Fund over 10 

years have risen by $8 billion because of anticipated 

growth in spending for telecommunications services in 

high-cost areas. That increase in outlays is roughly offset 

by an equal increase in estimated revenues. Projected outlays from the Military Retirement Fund have risen by $7 

billion because of revised estimates by Defense Department actuaries of the future population of military retirees and their survivors. 

Discretionary Programs. Whereas technical changes to 

CBO’s baseline since January have increased projections 

of mandatory spending, they have decreased estimates of 

discretionary outlays. Those decreases reduce the cumulative deficit projected for the 2007-2016 period by $25 

billion. 

The biggest change reflects new information from the 

Department of Defense about the allocation of budget 

authority for pay and nonpay purposes, which affects the 

overall inflation rate used to project defense spending. 

On the basis of that information, CBO has reduced its 

baseline projection of budget authority for national 

defense, which reduces projected defense outlays over the 

2007-2016 period by roughly $14 billion. Other, smaller 

adjustments have lowered projected outlays by $11 billion over that 10-year period.

Net Interest. CBO has also trimmed $26 billion from its 

estimate of net interest costs over the 2007-2016 period 

because of changes to certain intragovernmental interest 

payments, changes in the estimated balances of financing 

accounts for federal loan programs, and updated information about the stock of debt held by the public. (Twothirds of that reduction occurs in the last five years of the 

projection period.) In the other direction, increases in 

deficits—and thus in debt-service costs—because of technical changes to spending and revenue projections add $7 

billion to net interest outlays over the 10-year projection 

period.

Changes to Revenue Projections

Revisions to CBO’s revenue projections since January 

have been far smaller than the changes to outlay projections. Those revisions are entirely technical, reflecting 

higher projections of miscellaneous fees and fines (mainly 

the ones that finance the Universal Service Fund). The 

changes add less than $500 million to projected revenues 

in 2006 and growing amounts thereafter, for a total 

increase over the 2007-2016 period of $6 billion.

APPENDIX

B

The Potential Economic Effects of

Selected Proposals in the President’s 2007 Budget

Considerable uncertainty surrounds the potential 

economic effects of four of the President’s budgetary proposals for 2007—those that would extend beyond 2008 

the dividend and capital gains tax rates enacted in the 

Jobs and Growth Tax Relief Reconciliation Act of 2003 

(JGTRRA), expand the availability of tax-free savings 

accounts, extend the repeal of the estate tax, and establish 

individual accounts as part of Social Security. Discussed 

below are the factors that the Congressional Budget Office (CBO) considered and the methods it used in assessing those effects. (CBO’s analysis of the overall economic 

impact of the President’s budgetary proposals is described 

in Chapter 2.) 

Extend JGTRRA’s Dividend and Capital 

Gains Tax Rates

The enactment of JGTRRA in 2003 reduced tax rates applicable to both dividends and capital gains for the years 

2003 through 2008. Those rates comprise a bottom 

bracket of 5 percent and a top bracket of 15 percent; in 

2008, the bottom bracket is slated to drop to zero. Before 

JGTRRA was enacted, dividends were subject to the 

same tax rates as those on ordinary income—ranging 

from 10 percent to 38.6 percent—and most capital gains 

were subject to rates of 8 percent, 10 percent, or 20 percent. The President, in his 2007 budget, has proposed 

making the zero and 15 percent rates permanent. 

Such reduced rates would lower the overall taxation of 

corporate profits, some of which are taxed once under the 

corporate income tax and then again, when people receive dividends and realize capital gains—brought about 

by the firm’s reinvestment of its profits—on sales of stock. 

Lowering the tax rates that individuals face on the two 

types of income would reduce the total rate of taxation. 

In lowering tax rates, JGTRRA not only reduced the taxation of corporate income but also lowered taxes on some 

income that is currently taxed only once. A substantial 

portion of taxable capital gains arises from investments 

whose earnings are not subject to the corporate income 

tax, such as gains on real estate held by individuals. The 

lower capital gains tax rate cut the level of taxation on 

those investments as well. 

To some extent, the economy is already feeling the effects 

of JGTRRA’s reductions in rates on dividends and gains. 

However, the short duration of those lower rates—they 

are scheduled to expire after 2008—lessens their effect on 

investment and the capital stock. Much productive capital is long-lived, and firms will not fully adjust their investment plans for changes in tax policy that are due to 

expire before that investment is taken out of service. 

Thus, some of the potential effects of the current rates 

can be expected to occur only if the proposed extension 

of those rates becomes law. 

One such effect involves the cost of financing for businesses. By reducing the overall taxation of capital income, 

a drop in taxes on dividends and capital gains might be 

expected to lower that cost, because businesses could pay 

investors less before taxes to yield the same after-tax return. But how much the cost of capital might fall is unclear. Some analysts argue that only the decrease in taxes 

on capital gains will act to reduce that cost. Others hold 

that both the decrease in taxes on dividends and the

decrease in taxes on capital gains will reduce the cost of 

capital.1

1. See George R. Zodrow, “On the ‘Traditional’ and ‘New’ Views of 

Dividend Taxation,” National Tax Journal, vol. 44, no. 4 (December 1991), pp. 497-509.
52 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

A related difference of opinion among analysts involves 

how much the value of firms’ stock might rise if the lower 

rates were extended. (Share values rise because the decrease in taxes increases the after-tax return to shareholders.)2 The view of corporate finance that predicts a 

relatively large increase in those values predicts a relatively 

small decrease in the cost of capital, and vice versa. 

In the absence of a consensus about which view is correct, 

CBO has adopted middle-ground estimates of the effects 

of the President’s proposal on the cost of capital for firms 

and on share values. 

High values for shares of stock lead to more spending by 

shareholders on goods and services (the so-called wealth 

effect). Therefore, the President’s proposal will help

boost overall demand in the short run. But the more it 

helps demand by raising consumption, the more it will 

hurt supply in the long run, by reducing saving and 

investment. 

Extending the rates on capital gains and dividends is also 

likely to lessen the disadvantage that the corporate sector 

now faces in the competition for capital. For example, although some income from the corporate sector is taxed 

twice under current law, income from unincorporated 

businesses is taxed only once (at the personal level), and 

the value of the housing “services” provided by owneroccupied housing is not taxed at all. That disparity in tax 

treatment leads to less investment in the corporate sector 

than may be optimal for economic output. Lowering the 

taxes that firms face would allow them to attract additional capital from the housing and small-business sectors 

and in general improve the economy’s efficiency. Such a 

shift in investment might, however, conflict with other 

policy goals, such as support for owners’ occupancy of 

homes or for unincorporated businesses. 

The proposal might affect firms’ financial behavior in two 

ways: firms might choose to finance investment by issuing stock (equity financing) rather than debt, and they 

might decide to pay dividends rather than retain earnings. Currently, firms may deduct the interest they pay on 

debt from their taxable income, so those payments are 

taxed only once, at the personal level. (That is, the individual who receives the payment pays the tax.) But if a 

firm finances a project by issuing stock, some of the returns on the investment that the project generates are 

taxed at both the corporate and personal levels. The 

President’s proposal would narrow that disparity in tax 

treatment. 

The proposed reduction in the future taxation of dividends and capital gains would also interact with some of 

the President’s other proposals and with current law. For 

instance, the President’s proposal to boost the amount 

that people may deposit in tax-free savings accounts (discussed below) would increase the share of personal assets 

held in such accounts—duplicating some of the effect 

that the proposal to extend the tax rates on dividends and 

capital gains would have on the cost of capital and its allocation among sectors of the economy. However, the expanded accounts would partly undo the impact that the 

dividend/capital gains proposal would have in bolstering 

equity financing because the interest earned on assets in 

the accounts would not be taxed at either the personal or 

the corporate level. Also contributing to that smaller impact on equity financing would be the combined effect of 

the two policies in increasing the proportion of interestbearing assets in tax-free accounts: the incentive to hold 

stocks in such accounts would be weakened if their returns already faced lower tax rates. 

CBO incorporated the effects of the dividend/capital 

gains proposal in its analysis in two ways. For the two 

macroeconometric models (the models CBO used in its 

analysis are discussed in Appendix C), CBO estimated 

the proposal’s effect on the cost of capital in different 

sectors of the economy and on the value of stock shares 

under the assumption that both investors and businesses 

are forward-looking. It then incorporated those estimates 

in the models and projected the ultimate effect on the 

economy. 

For the growth models, CBO estimated the proposal’s 

overall effect on the average cost of capital and incorporated that calculation. Those models, however, have no 

mechanism to account for the effect of reallocating capital. CBO therefore reviewed research on how reallocation 

might influence output, determined a midrange estimate, 

and added that amount to the models’ underlying estimates of the effect on output. The procedure phased in 

an increase in gross national product over the 2006-2016 

period that reached 0.07 percent in 2016. 

2. Over time, however, increased investment will enlarge the capital 

stock, in turn reducing the pretax rate of return and offsetting at 

least some of the impact of the reduction in taxes.
APPENDIX B THE POTENTIAL ECONOMIC EFFECTS OF SELECTED PROPOSALS IN THE PRESIDENT’S 2007 BUDGET 53

Expand Tax-Free Savings Accounts

The President’s 2007 budget includes a proposal that is 

designed to both consolidate and expand the current system of tax-free savings accounts for retirement and other 

purposes, such as education. Two new kinds of accounts 

would be created: retirement savings accounts (RSAs) and 

lifetime savings accounts (LSAs). The RSA would function in some ways like a Roth individual retirement account (IRA)—that is, taxes would not be deferred on 

contributions, as they are for contributions to traditional 

IRAs, but the interest that the accounts earned would accrue tax-free. In contrast to Roth IRAs, however, RSAs 

would be available to all workers (and their spouses) regardless of income; they would also have higher limits on 

contributions and allow penalty-free withdrawals at a 

slightly earlier age. In addition, the President’s proposal 

would eliminate further tax deferrals for IRA contributions. 

Like the RSAs, the proposed lifetime savings accounts 

would face tax treatment similar to that governing Roth 

IRAs. However, unlike Roth IRAs or RSAs, LSAs would 

be open to everyone, regardless of age, income, or employment status, and participants could withdraw funds 

at any time for any reason. Taxpayers could also use LSAs 

to consolidate other savings plans, including Coverdell 

education savings accounts and qualified state tuition 

plans. 

In CBO’s estimation, the new savings accounts that the 

President has proposed would have little effect on the 

economy, on average, over the 2007-2016 period. Most 

taxpayers would save similar amounts in one of the new 

accounts as they would have saved in one of their present 

tax-free accounts. One possible outcome of implementing the new accounts is that people who currently have 

assets in taxable accounts will reduce their tax liability by 

selling those assets and putting the proceeds into the new 

accounts. However, that action would create no new saving and thus would have no effect on the total amount of 

private saving. Most new saving would involve small 

amounts set aside by taxpayers with few taxable assets to 

shift. 

Beyond 2016, the effects of the proposal might be greater 

than those just described (because increasing numbers of 

taxpayers would run out of assets that could be shifted). 

In later years, the proposal would have a modestly positive impact on saving, CBO estimates. 

Extend the Estate Tax’s Repeal

The President’s proposal to extend the repeal of the estate 

tax beyond the end of 2010 (the repeal’s scheduled expiration date) could have varying effects on consumption 

and saving, depending on people’s motives for leaving bequests. Yet consensus is lacking about which motives predominate or even about whether people intentionally 

save in order to make bequests. On the one hand, people 

might save additional amounts for bequests to enhance 

their children’s welfare, to enjoy the feeling of being generous, or to influence the behavior of their heirs. On the 

other hand, the desire to make bequests might have little 

influence on saving; some people might acquire wealth 

largely for other purposes and leave it as a bequest if they 

die before they expect to. In that case, extending the repeal of the estate tax would have little effect on saving. 

Also in dispute, even among analysts who believe that estate taxes affect consumption and saving, is the direction 

of the effect. A lower estate tax makes it cheaper for people to leave money to their heirs, which could encourage 

people to save more to leave larger bequests. But a lower 

estate tax also means that people can make the same aftertax bequest with a smaller amount of savings, which 

might induce them to save less. Furthermore, to the extent that a lower estate tax increases the size of bequests 

after taxes, potential recipients may increase their consumption. Some opponents of the estate tax argue that it 

has a particularly negative effect on the creation of new 

small businesses, but CBO found little evidence to support that contention. 

CBO’s estimates of the effects of the President’s proposal 

incorporated the assumption that extending the repeal of 

the estate tax would increase consumption slightly, on 

balance, by about 5 cents for each dollar of tax savings.3

Alternative assumptions that CBO considered—for example, that the positive effect on consumption from increasing after-tax income is exactly balanced by the incentive effects of lower tax rates, yielding no net impact on 

consumption—would have yielded similar results. 

3. CBO assumed that consumer spending would increase by a small 

amount because recipients of after-tax bequests would be unlikely 

in any given year to raise their spending by a significant amount 

and because the effect on recipients might be offset to some degree 

by increased saving among those planning to leave bequests.
54 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

Establish Individual Accounts in

Social Security

The President’s budget includes a proposal that would allow workers to redirect a portion of their payroll tax payments from the Social Security trust funds to individual 

accounts and invest the contributions to such accounts in 

various financial assets. In CBO’s estimation, the proposal would result in budgetary outlays of $312 billion 

from 2009 to 2016; however, it would have no appreciable effect on the economy during that period because it 

would not change people’s projected lifetime income 

(once the expected returns of the assets in the accounts 

were adjusted for the risk they carry) and would not alter 

people’s take-home pay. In addition, the accounts would 

not have a direct effect on the investment capital available 

in the economy because the additional government borrowing needed to finance the accounts would be offset by 

the increase in investable funds in the accounts.

Under the proposal, workers could redirect payroll taxes 

to individual accounts, but the contributions to the accounts would ultimately be offset by reductions in traditional benefits that would be calculated by using hypothetical accounts. In addition to tracking the actual 

balances in an individual account, the Social Security

Administration would follow a hypothetical account that 

held the same amount of contributions and that grew at a 

specified real (inflation-adjusted) rate of 2.7 percent per 

year. When the person claimed traditional Social Security 

benefits, those benefits would be cut back in such a way 

that the actuarial value of the reduction over the person’s 

remaining lifetime would equal the amount in the hypothetical account—regardless of how much was actually in 

the person’s individual account.

The rate of growth for the hypothetical account is derived 

from projections by the trustees of the Social Security system. In their estimation, Treasury bonds over the long 

run will earn an average real return of 3 percent, and the 

individual accounts, if enacted, will incur annual administrative expenses equal to 0.3 percent of assets—for a net 

real return of 2.7 percent. Because that rate equals the 

rate of return on the hypothetical account that would be 

used to calculate the reduction in benefits, diverting payroll taxes to an individual account and investing entirely 

in government bonds is projected to leave a person’s total 

benefits (including the account assets) unchanged. If, 

however, the average rate of return on government bonds 

turns out to be higher or lower than that projected 3.0 

percent, the total benefits of a person who chose to divert 

some payroll taxes to an individual account and invest in 

Treasury bonds will also be higher or lower.

On average, higher returns would be expected from investing the contributions to an individual account in 

other assets, such as corporate bonds or equities. However, those investments would also be riskier than government bonds. Market trading establishes the prices of various assets and their expected returns, both of which are 

determined by the preferences and judgments of market 

participants who attempt to balance the risks of various 

assets against their extra expected returns. Therefore, despite the fact that an individual account holding assets 

such as stocks (with an expected return higher than 2.7 

percent) would yield expected lifetime Social Security 

benefits whose value was greater than it would be under 

the traditional system, that higher anticipated income 

would not be expected to change the account holder’s

behavior (by, for example, inducing him or her to increase consumption) because the higher expected return 

would be balanced by additional risk. Shifting some payroll taxes to an individual account would also be unlikely 

to affect the consumption of people who spend all of 

their income because it would not alter their take-home 

pay.
APPENDIX

C

The Models Used to Analyze the Supply-Side 

Macroeconomic Effects of the President’s Budget

The Congressional Budget Office (CBO) used three 

models to estimate the supply-side effects of the President’s budget from 2007 to 2016: a “textbook” growth 

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

growth model. (The estimates that those models generated are presented in Chapter 2.) 

Textbook Growth Model

The textbook growth model is an enhanced version of a 

model developed by Robert Solow, a pioneer in the 

theory of growth accounting.1

 The textbook growth 

model incorporates the assumption that output is determined by the number of hours of labor supplied by workers, the size and composition of the capital stock (for example, factories and information systems), and total 

factor productivity—which represents the state of technological know-how. The model is not forward-looking; 

the people that it represents base their decisions entirely 

on current economic conditions. In particular, they do 

not respond to expected future changes in government 

policy. Nor does the model incorporate effects from demand-side, or cyclical, variations in the economy. Rather, 

it assumes that output is always at its potential level. 

The estimates that CBO developed using the textbook 

growth model incorporate the effects that changes in 

marginal tax rates specified in the President’s budget 

would have on the number of hours worked. (CBO estimated the tax-rate effects in a separate calculation.) 

Those effects would be greatest between 2011 and 2016, 

when lower marginal tax rates would increase the supply 

of labor relative to its estimated level in CBO’s baseline. 

Because they would increase federal deficits over the 10-

year budget window, the President’s budgetary proposals 

are projected to have a negative effect on the capital stock 

in the textbook growth model. The proposals would increase after-tax income relative to its level in the baseline, 

which would lead to greater private consumption that in 

turn would crowd out investment. In the textbook 

growth model, changes in marginal tax rates on capital 

have no direct effect on spending by the private sector. 

The negative effects on the capital stock would be partially offset by two factors, which the model accounts for 

by including assumptions based on past relationships. 

First, the increase in private consumption would be moderated by the assumption that people increase their private saving by 40 cents for every dollar that the deficit increases. That assumption implies that every dollar of 

deficit reduces national saving—government plus private 

saving—by 60 cents. Second, for every dollar that the 

level of national saving falls, the amount of foreign capital 

invested in the United States is assumed to increase by 

40 cents. Together, those figures imply that a one-dollar 

increase in the deficit results in a 40 cent increase in private saving, a 24 cent increase in capital inflows (24 cents 

equals 60 cents times 0.4), and a 36 cent decline in domestic investment. 

The Life-Cycle and Infinite-Horizon 

Growth Models

The other models that CBO used in its supply-side analysis—the life-cycle and infinite-horizon growth models—

differ in fundamental ways from the textbook growth 

1. For a detailed description of the textbook growth model, see Congressional Budget Office, CBO’s Method for Estimating Potential 

Output: An Update (August 2001).
56 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

model.2 The life-cycle and infinite-horizon models incorporate simulated people who make decisions about how 

much to work and save to make themselves as well off as 

possible over their lifetime. Their behavior is calibrated so 

that such macroeconomic variables as the total amount of 

labor supplied and the size of the capital stock match the 

levels of those variables in the U.S. economy. In the lifecycle and infinite-horizon growth models, people’s consumption changes by a relatively large amount in response to changes in the after-tax rate of return on their 

savings. Like the textbook growth model, those models 

do not allow for any demand-side effects. 

The people in the life-cycle and infinite-horizon models 

are assumed to be forward-looking—that is, they know 

how economic conditions and policy will change in the 

future and alter their behavior accordingly. In terms of 

the degree to which people incorporate future events into 

their current behavior, that “perfect foresight” is at the 

other end of the range of possibilities from the assumption used in the textbook growth model. Most people’s 

foresight actually falls somewhere between those two extremes. However, in using those two somewhat dramatic 

assumptions, CBO has tried to encompass as broad a 

range of possible responses to the President’s budgetary 

proposals as is feasible. 

Because people’s behavior as represented in the life-cycle 

and infinite-horizon growth models depends in part on 

future policies, the use of those models requires analysts 

to make assumptions about budgetary policies beyond 

2016 (the end of the period covered by CBO’s current 

10-year baseline projections). Policies that increase deficits must be offset at some point in the future by taxes 

that are higher or spending that is lower than it would 

have been in the absence of those higher deficits. 

Assumptions about how and when to finance the increased deficits can influence the estimated economic effects of the President’s proposed policies over the 2007-

2016 period. That impact stems from the fact that in the 

models, people anticipate the offsetting policies and plan 

accordingly. In its analysis, CBO used two different assumptions about how the budget would be stabilized after 2016: either marginal tax rates would be increased, or 

government spending would be reduced (spending reductions are assumed to be spread roughly equally among 

government purchases of goods and services—which the 

models assume do not substitute for private consumption—and transfer payments). Both the increase in marginal tax rates and the reductions in government spending would be phased in over 10 years, beginning in 2016. 

The life-cycle and infinite-horizon growth models differ 

in what they assume about how far ahead people look in 

making their plans. The life-cycle model is calibrated so 

that the probability of death at a given age matches current U.S. mortality rates and people are assumed to take 

account of the impact of future economic or policy 

changes only for themselves and not for their children. In 

the infinite-horizon model, people behave as though the 

well-being of their descendants is as important to them as 

their own well-being—which leads them to behave as if 

they expected to live forever. Although the possibility that 

such an assumption reflects actual behavior cannot be 

ruled out, there is some evidence against it.3

The difference in the models’ time horizons has an important effect on the resulting estimates. The people in 

both models expect the increase in deficits under the 

President’s budgetary proposals to be offset at some point 

in the future. However, people as represented in the lifecycle model, especially older individuals, know that they 

may die before an offsetting policy change occurs. Consequently, they may be less willing to work or save more 

during the 10-year projection period to compensate for 

any future tax increases or cuts in transfer payments. 

By contrast, people in the infinite-horizon model act as 

though they (or, equivalently, their descendants, whom 

they care about as much as they do themselves) will be 

alive when the offsetting policy change is made. That ex2. For a detailed description of the life-cycle model, see Shinichi 

Nishiyama, “Analyzing Tax Policy Changes Using a Stochastic 

OLG Model with Heterogeneous Households,” Technical 

Paper 2003-12 (December 2003), available at www.cbo.gov/

publications/bydoctype.cfm?dtype=8. For a description of a 

model very similar to the infinite-horizon model, see S. Rao 

Aiyagari, “Uninsured Idiosyncratic Risk and Aggregate Saving,” 

Quarterly Journal of Economics, vol. 109, no. 3 (August 1994).

3. See Paul Evans, “Consumers Are Not Ricardian: Evidence from 

Nineteen Countries,” Economic Inquiry, vol. 31, no. 4 (October 

1993), pp. 534-548; Fumio Hayashi, Joseph Altonji, and Laurence Kotlikoff, “Risk Sharing Between and Within Families,” 

Econometrica, vol. 64, no. 2 (March 1996), pp. 261-294; and T.D. 

Stanley, “New Wine in Old Bottles: A Meta-Analysis of Ricardian 

Equivalence,” Southern Economic Journal, vol. 64, no. 3 (January 

1998), pp. 713-727.
APPENDIX C THE MODELS USED TO ANALYZE THE SUPPLY-SIDE MACROECONOMIC EFFECTS OF THE PRESIDENT’S BUDGET 57

pectation implies that people’s belief about taxes increasing in the future may have a greater effect on their current 

work and saving than it may have for people in the lifecycle model.

CBO used a different infinite-horizon model for this 

year’s analysis than it had used in the past, and the new 

model yielded estimates closer to those of the life-cycle 

model. The current infinite-horizon model incorporates 

unforeseeable fluctuations in income. That feature, together with an assumption that insurance against changes 

in income is not available, implies that people, as represented in the model, will hold some savings for “precautionary” reasons—as a buffer against drops in income. 

That practice in turn may imply that anticipated changes 

in policy will have less effect on current behavior.

The degree to which an economy is open to the flow of 

foreign capital is important because it determines both 

how easily domestic investment can be financed by 

sources other than domestic saving and the degree to 

which budgetary policies can affect wage and interest 

rates. CBO used two different assumptions in the lifecycle model about how open the economy is to flows of 

capital to and from other countries. One assumption was 

that the economy is completely closed—no capital can 

flow into or out of the United States. The other assumption was that the economy is completely open and cannot 

affect world interest rates—capital flows freely into and 

out of the country to keep the domestic interest rate 

equal to a constant world rate. The U.S. economy effectively operates somewhere between those two extremes 

because even though it is relatively open to investment, it 

is so large that it can influence world interest rates.

APPENDIX

D

Contributors to the Revenue

and Spending Projections

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

Revenue Projections

Mark Booth Individual income taxes

Paul Burnham Retirement income

Barbara Edwards Social insurance taxes, Federal Reserve System earnings

Seth Giertz Health and education taxation

Pamela Greene Corporate income taxes, estate and gift taxes

Laura Hanlon Excise taxes

Ed Harris Individual income taxes

Larry Ozanne Capital gains realizations

Kevin Perese Tax modeling

Monisha Primlani Individual income taxes

William Randolph International and corporate income taxes

Emily Schlect Customs duties, miscellaneous receipts

Kurt Seibert Earned income tax credit and depreciation

David Weiner Individual income taxes

Dennis Zimmerman Tax-exempt activities

Spending Projections

Defense, International Affairs, and Veterans’ Affairs

Jo Ann Vines Unit Chief

Kent Christensen Defense

Sunita D’Monte International affairs (conduct of foreign affairs and informationexchange activities), veterans’ housing

Raymond Hall Defense (stockpile sales, atomic energy defense)

Sarah Jennings Military retirement, veterans’ education
60 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2007

David Newman Defense (military construction and family housing, military activities in 

Iraq and Afghanistan and for the war on terrorism)

Sam Papenfuss International affairs (development, security, international financial 

institutions)

Michelle Patterson Veterans’ health care, military health care

Matthew Schmit Defense (military personnel, military activities in Iraq and Afghanistan 

and for the war on terrorism)

Jason Wheelock Defense (other programs), radiation exposure compensation, 

Department of Energy employees’ occupational illness 

compensation

Dwayne Wright Veterans’ compensation and pensions

Health

Tom Bradley Unit Chief

Julia Christensen Federal Employees Health Benefits program, Public Health Service

Jeanne De Sa Medicaid, State Children’s Health Insurance Program

Sarah Evans Medicare, Public Health Service

Geoffrey Gerhardt Medicare

Tim Gronniger Medicare, Public Health Service

Eric Rollins Medicaid, State Children’s Health Insurance Program

Shinobu Suzuki Medicare

Camile Williams Medicare, Public Health Service

Human Resources

Paul Cullinan Unit Chief

Chad Chirico Housing assistance, education

Sheila Dacey Child Support Enforcement, Temporary Assistance for Needy 

Families, Social Services Block Grant program, child care programs, 

Social Security

Kathleen FitzGerald Food Stamps and nutrition programs, child and family services

Justin Humphrey Elementary and secondary education, Pell grants

Deborah Kalcevic Education

Matthew Kapuscinski Low Income Home Energy Assistance Program, refugee assistance

Craig Meklir Federal civilian retirement, Pension Benefit Guaranty Corporation, 

Railroad Retirement

Kathy Ruffing Social Security, Supplemental Security Income

Christina Hawley Sadoti Unemployment insurance, training programs, Administration on 

Aging, foster care, Smithsonian, arts and humanities, report 

coordinator
APPENDIX D CONTRIBUTORS TO THE REVENUE AND SPENDING PROJECTIONS 61

Natural and Physical Resources

Kim Cawley Unit Chief

Megan Carroll Conservation and land management, air transportation

Lisa Cash Driskill Energy, Outer Continental Shelf receipts

Mark Grabowicz Justice, Postal Service

Kathleen Gramp Spectrum-auction receipts, energy, deposit insurance

Greg Hitz Agriculture

David Hull Agriculture

James Langley Agriculture

Susanne Mehlman Pollution control and abatement, Federal Housing Administration 

and other housing credit programs

Julie Middleton Water resources, Federal Emergency Management Agency

Melissa Z. Petersen Commerce, Small Business Administration, Universal Service Fund, 

mass transit

Matthew Pickford General government

Deborah Reis Recreation, water transportation, other natural resources, legislative 

branch, conservation and land management

Gregory Waring Justice, community and regional development, highways, Amtrak

Michael Waters Science and space exploration, Bureau of Indian Affairs

Other

Janet Airis Unit Chief, Scorekeeping (legislative branch)

Jeffrey Holland Unit Chief, Projections

Edward Blau Authorization bills

Barry Blom National income and product accounts, monthly Treasury data, 

report coordinator

Joanna Capps Appropriation bills (Interior and the environment, Labor-HHS)

Kenneth Farris Computer support

Mary Froehlich Computer support

Ann Futrell Other interest, report coordinator

Ellen Hays Federal pay, report coordinator

Virginia Myers Appropriation bills (Commerce-State-Justice, energy and water)

Jennifer Reynolds Appropriation bills (Agriculture, foreign relations)

Mark Sanford Appropriation bills (Defense, Homeland Security)

Eric Schatten Interest on the public debt, report coordinator

Phan Siris Computer support

Esther Steinbock Appropriation bills (Transportation-Treasury-HUD, military quality of 

life and veterans’ affairs, District of Columbia)

Patrice Watson Database system administrator