The Congress of the United States O Congressional Budget Office

CBO

An Analysis of the President’s Budgetary 

Proposals for Fiscal Year 2006

March 2005
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 on mandatory spending are available from within the electronic version of 

this report on the Congressional Budget Office’s Web site (www.cbo.gov).
Preface

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

for fiscal year 2006—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. The baseline revenue estimates and the estimates of certain revenue 

proposals were prepared by CBO; most of the estimates of the President’s revenue proposals 

were prepared by the Joint Committee on Taxation (JCT). This report expands on CBO’s 

preliminary analysis, which was released on March 4, 2005. In some instances, JCT has 

slightly revised the estimates incorporated there; those updated revenue estimates are not 

reflected in this report.

Barry Blom and Ann Futrell of CBO’s Projections Unit wrote Chapter 1 under the supervision of Jeff Holland, with assistance from Mark Booth and Pamela Greene. Ben Page of the 

Macroeconomic Analysis Division wrote Chapter 2 and Appendixes C and D with assistance 

from Bob Arnold, Paul Burnham, Ufuk Demiroglu, Eva de Francisco, Mark Lasky, Shinichi 

Nishiyama, Larry Ozanne, Frank Russek, and Sven Sinclair. Thomas Bradley of the Health 

Cost Estimates Unit wrote Appendix A, and Noah Meyerson of the Health and Human 

Resources Division wrote Appendix B. The contributors to the revenue and spending projections underlying this report are listed in Appendix E.

Leah Mazade and Christian Spoor edited the report, and Christine Bogusz and John Skeen 

proofread it. Maureen Costantino took the photograph for the cover and prepared the report 

for publication. Lenny Skutnik printed the initial copies, and Annette Kalicki produced the 

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

Douglas Holtz-Eakin

Director

March 2005

1 CBO’s Estimates of the President’s Budget for 2006 1

Overview of CBO’s Estimates 1

Policy Proposals That Affect Mandatory Spending 7

Policy Proposals That Affect Discretionary Spending 10

Policy Proposals That Affect Revenues 13

CBO’s and the Administration’s Economic Assumptions 16

Differences Between CBO’s and the Administration’s Budget

Estimates 17

Changes to CBO’s Baseline Since January 2005 22

2 The Economy Under the President’s Budget and Under

CBO’s Baseline Policy Assumptions 27

How Fiscal Policy Affects the Economy 27

A Description of CBO’s Models and Their Results 34

A Changes in CBO’s Projections of Medicare Spending for

2005 to 2015 41

Medicare’s Prescription Drug Benefit 41

Regional Preferred Provider Organizations Under Medicare

Advantage 46

B The Administration’s Proposal for Individual Social Security

Accounts 47

Overview of the Account Proposal 47

Factors Affecting Participation 47

C The Potential Economic Effects of Selected Tax Proposals in the

President’s 2006 Budget 51

Extend JGTRRA’s Dividend and Capital Gains Tax Rates 51

Expand Tax-Free Savings Accounts 53

Extend the Repeal of the Estate Tax 53

CONTENTS
vi AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

D The Models Used to Analyze the Macroeconomic Effects of the

President’s Budget 55

E Contributors to the Revenue and Spending Projections 59

Revenue Projections 59

Spending Projections 59
CONTENTS vii

Tables

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

Estimate of the President’s Budget and in CBO’s March Baseline 2

1-2. CBO’s Estimate of the President’s Budget for 2006 3

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

Deficits or Surpluses 4

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

Estimates of the President’s Budget 6

1-5. CBO’s Estimate of the President’s Proposed Changes in Discretionary 

Budget Authority, 2004 to 2006 11

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

March Baseline 12

1-7. Comparison of Discretionary Budget Authority Enacted for 2005 and

Requested by the President for 2006, by Budget Function 14

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

Economic Projections for Calendar Years 2005 to 2010 18

1-9. Comparison of CBO’s March 2005 Baseline and the Administration’s 

February 2005 Current-Services Baseline 20

1-10. CBO’s Baseline Budget Projections 23

1-11. Changes in CBO’s Baseline Projections of the Deficit or Surplus

Since January 2005 24

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

Deficit After Accounting for Economic Effects 29

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

Labor Income 31

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

Capital Income 33

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

2005 Through 2015 36

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

Real Gross Domestic Product 38

2-6. The Budgetary Implications of the Macroeconomic Effects 39

A-1. Comparison of CBO’s March 2005 and January 2005 Baseline

Projections of Medicare Mandatory Spending 42

B-1. The Budgetary Impact of Individual Social Security Accounts 48
viii AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Figures

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

Would Affect the Deficit After Accounting for Economic Effects 28

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

Tax Rates on Capital Income and Labor Income 34

Box

A-1. Comparing CBO’s March 2005 Projection of Medicare Part D

Spending with Its Original Estimate of the Program’s Cost 44
1

CBO’s Estimates of the

President’s Budget for 2006

At the request of the Senate Committee on Appropriations, the Congressional Budget Office (CBO) 

has analyzed the President’s budget request for fiscal year 

2006 using its own economic assumptions and estimating techniques, with contributions from the Joint Committee on Taxation (JCT). This report presents CBO’s 

analysis of that budget, which provides more details than 

the preliminary report released on March 4, 2005.

Overview of CBO’s Estimates

According to CBO’s estimates, carrying out the proposals 

in the President’s budget would result in a deficit of $394 

billion in 2005, equal to 3.2 percent of the nation’s gross 

domestic product (GDP). That deficit would be smaller 

than the one recorded in 2004, which totaled $412 billion, or 3.6 percent of GDP (see Table 1-1). The estimate 

for 2005 includes outlays of $32 billion resulting from 

the President’s recent request for supplemental appropriations, mainly for military activities in Iraq.

In 2006, the deficit under the President’s budgetary proposals would shrink to $332 billion, CBO estimates—

but the President’s request for that year omits additional 

funds to continue U.S. operations in Iraq and Afghanistan. Consequently, CBO’s estimate of the budget’s effects in 2006 reflects only outlays for those operations 

that would result from the 2005 supplemental request (a 

total of $82 billion in budget authority) and from appropriations enacted for previous years. Additional funding 

to keep the operations at roughly the same level as expected for 2005 would add about $40 billion to the 2006 

deficit, bringing it to between $370 billion and $375 billion, or 2.9 percent of GDP.1

Beyond 2006, the deficit would decline further as a percentage of GDP under the President’s proposals—to 2.0 

percent of GDP in 2007 and then to 1.3 percent of GDP 

by 2015 (the end of CBO’s 10-year projection period). 

Over the 2006-2015 period, deficits under the President’s 

budget would total $2.6 trillion, or 1.6 percent of GDP, 

CBO estimates. Federal debt held by the public would 

grow to 39 percent of GDP in the next few years, up 

from 37 percent of GDP at the end of 2004; it would 

then gradually fall back to that level by 2015. However, 

such figures reflect neither significant spending for military operations in Iraq and Afghanistan nor the potential 

budgetary impact of the President’s proposal to provide 

individual investment accounts as part of an overhaul of 

the Social Security program. The President’s budget offers 

no details about other possible changes to Social Security, 

which makes estimating the impact of individual accounts difficult because such changes would affect participation in the accounts. 

The President’s budget does not provide year-by-year estimates of spending and revenues after 2010. Rather, for 

each proposed change to laws that govern revenues or 

mandatory spending, the budget specifies a total effect 

through 2015. For discretionary spending, the budget 

provides details just for 2005 and 2006; for 2007 through 

2010, such funding is shown only in the aggregate, by 

budget function.2

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

the 2011-2015 period by projecting the amount of disCHAPTER

1. That assumption is consistent with the first policy alternative presented in Congressional Budget Office, The Budget and Economic 

Outlook: Fiscal Years 2006 to 2015 (January 2005), Table 1-3.

2. Budget functions are the 20 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 2006

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: n.a. = not applicable.

cretionary budget authority recommended by the President for 2010 and adjusting that amount for inflation. 

Total outlays under the President’s budget would peak at 

20 percent of GDP this year, CBO estimates, before declining to around 19 percent of GDP for most of the next 

10 years (see Table 1-2). Spending for entitlements and 

other mandatory programs would grow at an average rate 

of 5.9 percent a year—faster than nominal GDP, which is 

projected to grow by 4.9 percent annually—whereas discretionary outlays would increase at an average rate of 1.2 

percent a year. Revenues would remain relatively low by 

historical standards, rising from 16.8 percent of GDP this 

year to 17.1 percent in 2006 and to 18.0 percent by 

2015.

The proposals in the President’s budget would add $30 

billion to the deficit that CBO now projects for 2005, 

mainly as a result of the proposed supplemental appropriations. Over the 2006-2010 period, those proposals 

would increase the cumulative deficit by $104 billion 

relative to CBO’s baseline projections. Lower nondefense 

spending would largely offset higher defense spending. 

But proposed changes in tax laws—such as extending the 

reduced tax rates on dividends and capital gains that were 

enacted in 2003 and extending the research and experiTotal, Total,

Actual 2006- 2006-

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015

On-Budget Deficit -567 -569 -517 -484 -474 -487 -486 -539 -512 -535 -544 -557 -2,449 -5,135

Off-Budget Surplus 155 175 186 206 224 241 257 271 282 290 297 301 1,113 2,554 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ _____ _____

Total Deficit -412 -394 -332 -278 -250 -246 -229 -268 -230 -244 -247 -256 -1,336 -2,581

On-Budget Deficit -567 -539 -487 -477 -473 -463 -461 -370 -229 -226 -203 -183 -2,361 -3,571

Off-Budget Surplus 155 175 189 209 227 244 260 275 286 295 302 305 1,129 2,591 ____ ____ ____ ____ ____ ____ ____ ___ __ __ __ ___ _____ ____

Total Deficit (-) or Surplus -412 -365 -298 -268 -246 -219 -201 -95 57 69 99 122 -1,232 -980

On-Budget Deficit 0 -30 -31 -7 -1 -24 -25 -169 -283 -309 -341 -374 -88 -1,564

Off-Budget Surplus 0 0 -3 -3 -3 -3 -3 -4 -4 -4 -5 -5 -16 -37 _ ___ ___ ___ __ ___ ___ ____ ____ ____ ____ ____ ____ _____

Total Deficit 0 -30 -34 -10 -4 -28 -28 -173 -287 -313 -346 -378 -104 -1,601

Memorandum:

Total Deficit as a

Percentage of GDP

CBO's estimate of the

President's budget -3.6 -3.2 -2.6 -2.0 -1.8 -1.6 -1.5 -1.6 -1.3 -1.4 -1.3 -1.3 -1.9 -1.6

CBO's baseline -3.6 -3.0 -2.3 -2.0 -1.7 -1.5 -1.3 -0.6 0.3 0.4 0.5 0.6 -1.7 -0.6

Debt Held by the Public

as a Percentage of GDP

CBO's estimate of the

President's budget 37.2 38.3 39.0 39.1 39.0 38.8 38.5 38.5 38.2 37.9 37.6 37.3 n.a. n.a.

CBO's baseline 37.2 38.1 38.5 38.6 38.5 38.2 37.8 36.7 34.8 33.0 31.1 29.1 n.a. n.a.

CBO's Estimate of the President's Budget

CBO's March 2005 Baseline

Difference (President's budget minus baseline)
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 3

Table 1-2.

CBO’s Estimate of the President’s Budget for 2006

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Total, Total,

Actual 2006- 2006-

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015

On-budget 1,345 1,484 1,605 1,713 1,820 1,919 2,029 2,110 2,226 2,351 2,482 2,621 9,086 20,876

Off-budget 535 573 605 638 672 706 740 774 809 845 882 919 3,361 7,591 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

1,880 2,057 2,210 2,350 2,492 2,625 2,770 2,884 3,036 3,196 3,364 3,540 12,447 28,467

894 962 947 926 931 949 968 993 1,006 1,033 1,057 1,083 4,721 9,893

1,237 1,313 1,382 1,451 1,532 1,626 1,718 1,832 1,918 2,053 2,185 2,330 7,709 18,028

160 177 213 252 278 297 312 327 342 354 369 383 1,352 3,127 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,292 2,451 2,542 2,629 2,742 2,872 2,999 3,152 3,266 3,441 3,611 3,796 13,783 31,047

On-budget 1,913 2,053 2,122 2,197 2,294 2,407 2,515 2,649 2,738 2,886 3,026 3,177 11,535 26,011

Off-budget 380 399 419 432 448 465 484 503 527 555 585 618 2,248 5,037

-412 -394 -332 -278 -250 -246 -229 -268 -230 -244 -247 -256 -1,336 -2,581

-567 -569 -517 -484 -474 -487 -486 -539 -512 -535 -544 -557 -2,449 -5,135

155 175 186 206 224 241 257 271 282 290 297 301 1,113 2,554

4,296 4,681 5,021 5,310 5,573 5,831 6,070 6,346 6,582 6,831 7,081 7,338 n.a. n.a.

11,553 12,233 12,888 13,586 14,307 15,029 15,757 16,494 17,245 18,023 18,826 19,652 71,566 161,806

On-budget 11.6 12.1 12.5 12.6 12.7 12.8 12.9 12.8 12.9 13.0 13.2 13.3 12.7 12.9

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

16.3 16.8 17.1 17.3 17.4 17.5 17.6 17.5 17.6 17.7 17.9 18.0 17.4 17.6

7.7 7.9 7.3 6.8 6.5 6.3 6.1 6.0 5.8 5.7 5.6 5.5 6.6 6.1

10.7 10.7 10.7 10.7 10.7 10.8 10.9 11.1 11.1 11.4 11.6 11.9 10.8 11.1

1.4 1.4 1.7 1.9 1.9 2.0 2.0 2.0 2.0 2.0 2.0 1.9 1.9 1.9 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

19.8 20.0 19.7 19.3 19.2 19.1 19.0 19.1 18.9 19.1 19.2 19.3 19.3 19.2

On-budget 16.6 16.8 16.5 16.2 16.0 16.0 16.0 16.1 15.9 16.0 16.1 16.2 16.1 16.1

Off-budget 3.3 3.3 3.3 3.2 3.1 3.1 3.1 3.0 3.1 3.1 3.1 3.1 3.1 3.1

-3.6 -3.2 -2.6 -2.0 -1.8 -1.6 -1.5 -1.6 -1.3 -1.4 -1.3 -1.3 -1.9 -1.6

-4.9 -4.7 -4.0 -3.6 -3.3 -3.2 -3.1 -3.3 -3.0 -3.0 -2.9 -2.8 -3.4 -3.2

1.3 1.4 1.4 1.5 1.6 1.6 1.6 1.6 1.6 1.6 1.6 1.5 1.6 1.6

37.2 38.3 39.0 39.1 39.0 38.8 38.5 38.5 38.2 37.9 37.6 37.3 n.a. n.a.

In Billions of Dollars

Outlays

Revenues

Discretionary spending

Total

As a Percentage of GDP

Mandatory spending

Net interest

Total

Deficit (-) or Surplus

Gross Domestic Product

On-budget 

Off-budget

Debt Held by the Public

Memorandum:

Revenues

Deficit (-) or Surplus

Outlays

Discretionary spending

Mandatory spending

Off-budget

Debt Held by the Public

Total

Net interest

Total

On-budget 
4 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

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; SCHIP = State Children’s Health Insurance Program.

a. These numbers represent estimates from the Joint Committee on Taxation (JCT) as of March 4, 2005. JCT later made relatively minor 

revisions to a few of the estimates, but CBO did not receive those revisions in time to incorporate them into this analysis. 

Total, Total,

2006- 2006,

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015 00 0

in CBO's March 2005 Baseline -365 -298 -268 -246 -219 -201 -95 57 69 99 122 -1,232 -980

General tax rates, child tax credit, and brackets 0 0 0 0 0 0 -96 -154 -158 -161 -166 0 -736

Estate and gift taxes 0 -1 -2 -2 -2 -3 -28 -55 -59 -67 -72 -9 -290

Tax rates on dividends and capital gains 0 0 0 -2 -13 -8 -22 -23 -25 -27 -28 -23 -148

Expensing for small businesses 0 0 0 -3 -4 -3 -2 -2 -2 -1 -1 -10 -19

Education, retirement, and other provisions 0 0 0 0 0 0 -4 -7 -8 -9 -9 0 -36 _ __ __ __ __ __ ___ ___ ___ ___ ___ ___ ____

0 -1 -2 -7 -19 -13 -152 -241 -251 -265 -277 -42 -1,228

0 -2 -5 -6 -7 -8 -9 -9 -10 -10 -11 -29 -78

0 * -2 -2 -3 -3 -3 -4 -4 -5 -5 -10 -33

0 * -1 -1 -1 -1 -1 -2 -2 -2 -1 -5 -12

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

0 * * * -1 -1 -2 -3 -3 -3 -3 -3 -17

* -2 -2 -4 -9 -10 -9 -7 -5 -4 -4 -26 -55

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

* -3 -7 -16 -37 -37 -178 -268 -278 -293 -307 -100 -1,425

31 34 22 20 28 34 37 38 39 40 42 139 336

1 -2 -17 -30 -39 -46 -51 -54 -56 -58 -60 -134 -412 __ __ __ __ __ __ __ __ __ __ __ ___ ___

32 32 5 -10 -11 -12 -14 -16 -17 -17 -18 5 -77

* * * * * * * 16 16 16 15 -1 62

Refundable health credits 0 * 6 6 6 7 7 6 6 6 6 26 57

Pension Benefit Guaranty Corporation 0 * -5 -5 -4 -4 -4 -4 -3 * * -18 -29

Medicaid and SCHIP * -1 -1 -2 -2 -2 -3 -3 -4 -4 -5 -9 -27

0 * -2 -2 -2 -2 -2 -2 -2 -2 -2 -7 -16

-3 -2 -1 * * * 1 1 1 2 2 -3 4

* * -3 -4 -3 -4 -4 -4 -4 -4 -4 -14 -34 __ __ __ __ __ __ __ __ __ __ __ ___ __

-3 -3 -5 -7 -5 -5 -5 10 11 13 13 -26 16

* 2 4 5 6 8 13 25 41 57 76 25 237 __ __ _ ___ __ __ __ __ __ __ __ __ ___

29 31 3 -12 -9 -9 -5 19 35 52 71 4 176

-30 -34 -10 -4 -28 -28 -173 -287 -313 -346 -378 -104 -1,601

-394 -332 -278 -250 -246 -229 -268 -230 -244 -247 -256 -1,336 -2,581

Total Impact on the Deficit or Surplus

Tax credit for developers of affordable housing

Other proposalsa

 Net interest

Education programs

Total Effect on Outlays

Total Deficit Under the President's Proposals

Extension of expiring EGTRRA and JGTRRA provisions

Effect of the President's Proposals

Subtotal, proposed extensions

Subtotal, mandatory

Subtotal, discretionary

Total Effect on Revenues

Defense

Discretionary

Total Deficit (-) or Surplus as Projected 

Research and experimentation tax credit

Refundable health insurance tax credit

Expansion of tax-free savings accounts

Deduction for high-deductible health insurance

Revenues

Other proposals

Earned income and child tax credits

Commodity Credit Corporation

Mandatory

Outlays

Nondefense
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 5

mentation tax credit—would reduce revenues by $100 

billion through 2010 (see Table 1-3).3

The impact of the President’s proposals on the cumulative deficit would be far greater over 10 years ($1.6 trillion) than over five years ($104 billion). Under the 

assumption in CBO’s baseline that current laws and policies do not change, deficits turn into small surpluses by 

2012, whereas under the President’s policies, deficits 

would continue through 2015, CBO projects. Total revenues during the 2006-2015 period would be $1.4 trillion 

lower under the President’s policies than in CBO’s baseline, primarily because of the proposal to extend certain 

expiring tax provisions enacted in 2001 and 2003. Total 

discretionary spending would be $77 billion lower than 

the baseline level, but mandatory spending would be $16 

billion higher. (Additional spending in the President’s 

budget for refundable tax credits would be mostly offset 

by higher premiums paid to the Pension Benefit Guaranty Corporation, by reductions in Medicaid spending, 

and by other savings in mandatory programs.) Net interest costs on additional borrowing would add another 

$237 billion to the 10-year deficit.

The estimates described above—and presented in detail 

later in this chapter—come from an analysis of the President’s budgetary proposals that does not account for the 

proposals’ potential impact on the economy. Because any 

such impact could in turn influence how the proposals 

would affect the deficit, CBO has prepared a macroeconomic analysis of the President’s budget, which is discussed in Chapter 2. That assessment uses a variety of 

models to indicate the range of potential economic and 

budgetary effects of the President’s proposed policies. 

CBO has concluded that the macroeconomic effects and 

their resulting budgetary impact would most likely be 

modest.

Overall, CBO’s estimates of the President’s budget are 

similar to the Administration’s estimates (see Table 1-4). 

Both CBO and the Administration expect the deficit to 

peak in 2005: CBO projects a deficit of $394 billion 

under the President’s budget; the Administration expects 

a shortfall of $427 billion. For 2006, CBO estimates that 

the deficit would total $332 billion under the President’s 

proposals, $58 billion less than the Administration’s estimate of $390 billion. (Neither figure includes additional 

funding after 2005 for operations in Iraq and Afghanistan.) For the 2006-2010 period, CBO’s total deficit projection of $1.34 trillion is only $57 billion less than the 

Administration’s projection. (As noted above, the Administration did not provide estimates beyond 2010.)

CBO’s estimates of outlays under the President’s budget 

are smaller than those of the Administration—by $28 billion for 2005 and by a total of $110 billion (or 0.8 percent) for the 2006-2010 period. Those differences result 

mainly from differing estimates of Medicare spending 

under current law. CBO’s projections of revenues under 

the President’s budgetary proposals are also similar to the 

Administration’s. CBO’s revenue estimate is $4 billion 

higher than the Administration’s for 2005 but $53 billion 

(or 0.4 percent) lower than the Administration’s for the 

2006-2010 period, mostly because of differing estimates 

of revenues under current law.

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

CBO has updated its baseline projections to take into 

account new information from the budget and other 

sources. Nearly all of the changes to the updated baseline 

are technical, in that they do not result from new legislation or from changes to CBO’s economic forecast. (Legislative changes have been minimal since January, when 

CBO published its previous baseline, and CBO has not 

updated its economic assumptions.) 

CBO now projects that if current tax and spending policies remained the same, the cumulative deficit for the 

2006-2015 period would total $980 billion—an increase 

of $125 billion from the January baseline projection. 

Much of that change stems from a rise of $70 billion in 

CBO’s estimate of Medicare spending over the 2006-

2015 period. The rise is primarily attributable to revised 

estimates of the cost of the prescription drug program 

(Part D of Medicare), which CBO has increased by $54 

billion for the 2006-2015 period. (About $36 billion of 

that amount is expected through 2013, the period covered by CBO’s original estimate of the cost of the Medi3. 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 preliminary JCT estimates that were available as of March 4, 2005. JCT subsequently 

made minor revisions to a few estimates, as reflected in Joint 

Committee on Taxation, Estimated Budget Effects of the Revenue 

Provisions Contained in the President’s Fiscal Year 2006 Budget Proposal, JCX-10-05 (March 9, 2005). Those revisions were made too 

late to be incorporated into this analysis. In total, they reduce projected revenues by an additional $0.8 billion for the 2006-2010 

period and about $5 billion for the 2006-2015 period. (Projected 

outlays are not affected.)
6 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-4.

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

of the President’s Budget

(Billions of dollars)

Continued

Total,

2006-

2005 2006 2007 2008 2009 2010 2010

-427 -390 -312 -251 -233 -207 -1,393

5 35 10 -20 -37 -46 -59

* -2 -3 5 12 -5 6

_ __ __ __ __ __ __

Total Revenue Differences 4 32 6 -15 -25 -51 -53

-3 1 -10 -3 -4 -3 -19

Medicare -1 -14 -14 -16 -18 -17 -79

Veterans' benefits -1 -1 -2 -4 -6 -8 -22

Food Stamps -1 -4 -5 -4 -3 -4 -20

Other -17 -11 -8 6 13 * * ___ ___ ___ ___ ___ ___ ___

 Subtotal, baseline -20 -31 -29 -19 -14 -28 -121

Medicaid and SCHIP * -2 * 2 2 2 4

Commodity Credit Corporation 0 1 -1 -1 -1 -1 -4

Student aid -4 -1 1 1 1 1 4

Continued Dumping and Subsidy Offset Act 0 2 * 1 1 1 4

Power marketing administrations 0 * * * 1 1 3

Pension Benefit Guaranty Corporation 0 2 -1 -1 -1 -1 -3

Refundable health credits 0 * 3 1 -1 -1 2

Other * * 1 -2 2 2 4 _ _ _ _ _ _ __

 Subtotal, policy -4 2 4 * 4 4 14

-24 -29 -25 -19 -10 -24 -106

-1 2 7 6 2 -2 16

__ __ __ __ __ __ ___

Total Outlay Differences -28 -26 -28 -16 -11 -29 -110

32 58 34 * -14 -22 57

Total Deficit Under the President's Proposals -394 -332 -278 -250 -246 -229 -1,336

Baseline

Policy

Outlay Differences

Discretionary

Total Deficit Under the President's Proposals

Revenue Differencesa

Administration's Estimate

Sources of Differences Between the Administration and CBO

CBO's Estimate

Mandatory

Baseline

Net interest

 Subtotal, mandatory

 Policy

All Differencesb
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 7

Table 1-4.

Continued

(Billions of dollars)

Sources: Congressional Budget Office; Joint Committee on Taxation.

Note: * = between -$500 million and $500 million; SCHIP = State Children’s Health Insurance Program.

a. The Administration’s current-services estimates, contrary to the rules for constructing baselines, include certain proposals that would 

affect revenues between 2005 and 2010. CBO has classified differences in its estimates of those proposals as policy differences in this 

table; baseline differences for revenues reflect only differences in economic or technical assumptions about tax policy under current law.

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

care Modernization Act.)4 Changes in the estimated net 

cost of the basic Part D benefit account for more than 

half of the total revision, and changes in the cost of the 

low-income subsidy account for the rest. Those changes 

reflect both a refinement of CBO’s estimating methods 

and provisions in the final rules governing formulary requirements and eligibility for the low-income subsidy 

that differ from what CBO had anticipated on the basis 

of legislative language.

Policy Proposals That Affect 

Mandatory Spending

Overall, CBO estimates that the policies proposed in the 

President’s budget would generate net savings of $26 billion in mandatory spending over the 2006-2010 period 

(see Table 1-3 on page 4). Savings totaling $73 billion 

from various mandatory proposals would be partly offset 

by $25 billion in increased outlays for refundable tax 

credits and $22 billion in added spending for certain 

mandatory programs.

Over the entire 2006-2015 period, however, the Administration’s proposals would produce a net increase of $16 

billion in mandatory spending, CBO estimates. Higher 

spending for refundable tax credits would be largely offset 

by higher premium payments to the Pension Benefit 

Guaranty Corporation (PBGC) and by savings in Medicaid and other mandatory programs. 

After issuing its budget request, the Administration released a general description of a plan to create personal 

investment accounts as part of an overhaul of the Social 

Security system (which did not appear in the President’s 

budget). However, that plan is not sufficiently detailed or 

complete for CBO to estimate its budgetary impact at 

this time. (For a discussion of the proposal to create individual accounts, see Appendix B.)

Refundable Tax Credits 

CBO and JCT estimate that the Administration’s tax proposals—primarily those involving refundable tax credits—would add roughly $120 billion to mandatory outlays over the 2006-2015 period. The largest such change 

involves making permanent the recent expansion of the 

child tax credit. Before the Economic Growth and Tax 

Relief Reconciliation Act of 2001 (EGTRRA) was enTotal,

2006-

2005 2006 2007 2008 2009 2010 2010

6 -2 -7 -13 -21 -36 -80

* 2 5 1 -9 -23 -24

_ __ ___ ___ ___ ___ ___

6 -4 -13 -14 -12 -13 -55

-1 34 14 -3 -4 -15 27

-28 -28 -33 -17 -2 -6 -86

__ __ __ __ __ __ ___

27 62 47 14 -2 -8 112

Revenues

Outlays

Outlays

Technical Differences

Revenues

Totalb

Totalb

Memorandum:

Economic Differences

4. For more details, see Appendix A of this report and Congressional 

Budget Office, Updated Estimates of Spending for the Medicare Prescription Drug Program (March 4, 2005).
8 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

acted, 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. If EGTRRA expires as currently scheduled at the 

end of calendar year 2010, the child credit will revert to 

its previous form in 2011. Instead, the President’s budget 

proposes to permanently extend the tax credit in its current form—at $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). That 

proposal, combined with proposed changes to tax brackets and tax rates that also affect refundable tax credits, 

would increase outlays by $62 billion over the 2006-2015 

period, CBO and JCT estimate.5

 The President also suggests creating a refundable tax credit for the cost of health 

insurance and for certain contributions to health savings 

accounts. Together, those credits would add $57 billion 

to outlays over the 10-year period, according to CBO’s 

and JCT’s estimates. (The proposal for a refundable 

health insurance credit is described in more detail on 

page 15 in the section about revenue proposals.)

Pension Benefit Guaranty Corporation 

The President’s budget proposes changing the way in 

which liabilities for defined-benefit pension plans are 

measured—and consequently the extent to which plans 

are considered underfunded—and altering the premiums 

charged to underfunded plans. One change would be to 

discount pension obligations using interest rates that were 

based on the rates on corporate bonds instead of the rates 

on 30-year Treasury bonds. (That part of the proposal 

would also affect federal tax receipts.) In addition, the 

PBGC’s board of directors would be given the authority 

to alter the premium rate charged to underfunded plans, 

which is currently set by statute at $9 per $1,000 of underfunding. 

The Administration’s proposal for the PBGC would also 

increase the flat-rate premiums charged to all sponsors of 

defined-benefit pension plans. The current premiums, 

which are based on the number of participants in each 

plan, would rise from $19 to $30 per participant in 2006 

and be indexed to the growth of wages thereafter. Those 

flat-rate premiums were last increased in 1991, although 

the PBGC’s insured liabilities have generally risen with 

wages. 

In all, the proposal for the PBGC would increase the 

agency’s premium collections by a total of $18 billion 

over the 2006-2010 period and $29 billion over the 

2006-2015 period, CBO estimates.

Medicaid and SCHIP

The budget includes a series of proposals that, according 

to the Administration, would reduce federal spending for 

Medicaid by a total of $60 billion between 2006 and 

2015. However, the Administration has not provided 

enough details for CBO to prepare its own estimates for 

some of the proposals that deal with restrictions on certain types of above-cost payments by states to health care 

providers and on payments for various social and rehabilitative services. (By the Administration’s estimate, those 

proposals would save $23 billion over 10 years.)

CBO estimates that the rest of the proposals would lower 

federal Medicaid spending by a total of $37 billion over 

the 2006-2015 period—$16 billion from restricting the 

taxes that states impose on health care providers, $14 billion from reducing payments to pharmacies, $4 billion 

from cutting the federal matching rate for certain social 

services, and $3 billion from restricting eligibility for coverage of nursing home care. CBO estimates that the proposal to set a limit on the federal matching payments that 

could be available for administrative costs would generate 

no savings, because the proposed limits are higher than 

CBO’s baseline projection for administrative costs.

The Medicaid savings proposed in the President’s budget 

would be offset by an estimated $10 billion increase in 

spending over the 2006-2015 period—including additional outlays for efforts to enroll more children in Medicaid and in the State Children’s Health Insurance Program (SCHIP). Overall, CBO estimates that the 

proposals that are detailed enough to analyze would reduce federal spending for Medicaid and SCHIP by a total 

of $27 billion through 2015.

Commodity Credit Corporation

The President’s budget includes several proposals that, on 

net, would lower spending for the Department of Agriculture’s Commodity Credit Corporation by a total of 

$16 billion over the 2006-2015 period. Most of those 

savings come from a proposal to limit the benefits that 

are available to producers through commodity loan pro5. The Administration’s February 2005 baseline assumes that certain 

individual income tax provisions enacted in 2001 and 2003 will 

be extended. By contrast, CBO’s baseline, following rules specified 

in law, assumes that those tax provisions—which raise outlays for 

the earned income and child tax credits—will expire as scheduled.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 9

grams. The Administration also proposes lowering crop 

and dairy payments to farmers for all commodity programs by 5 percent, requiring the dairy price-support 

program to minimize expenditures, and imposing marketing assessments to be paid by sugar processors on all 

domestically produced sugar. In addition, the budget includes a proposal that would increase spending by extending the Milk Income Loss Compensation program 

for two years.

Education Programs 

The President’s 2006 budget contains a number of proposals that together would reduce spending for federal 

education programs by $3 billion over five years but increase spending by roughly $4 billion over 10 years, CBO 

estimates. The effects of those proposals on outstanding 

student loans would save an additional $3.4 billion in 

2005, CBO estimates.6

The Administration’s proposals would affect most of the 

parties to the student loan programs: borrowers, lenders, 

guaranty agencies, and the federal government. Proposals 

affecting borrowers—which would change eligibility criteria for loans as well as the terms, amounts, fees, and 

interest rates on those loans—would increase federal costs 

by $8.7 billion over the 2006-2015 period. However, 

proposals that would affect the returns to lenders would 

save $10.1 billion over that period. Those policies include 

imposing a fee of 25 basis points on nonconsolidated 

loans, increasing the fee on consolidated loans by 50 basis 

points, reducing the insured percentage for guaranteed 

loans, and permanently extending restrictions on special 

payments to lenders for loans based on the proceeds of 

certain tax-exempt bonds. The remaining proposals, 

which would affect guaranty agencies, would have small 

federal savings (about $1.4 billion) through 2015. The 

interactions between the provisions that would increase 

loan volumes and those that would reduce subsidies to 

lenders and guaranty agencies would boost savings by 

$5.3 billion over the 2006-2015 period—for total savings 

of more than $8 billion from the changes to student loan 

programs, CBO estimates. 

In addition, the President’s budget proposes recalling a 

portion of the Perkins loan revolving funds held by postsecondary institutions beginning in 2006. Under that 

proposal, as Perkins loans were repaid each year, schools 

would give the federal government a share of the repayments. CBO’s baseline projects that under current law, 

the recall would begin to appear in the budget in 2012. 

As a result, the net effect on federal collections of the proposed recall would be diminished beginning in 2012 and 

turn negative beginning in 2013. CBO estimates that the 

proposal would save a total of $3.3 billion over the 2006-

2010 period and $3.5 billion through 2015.

The Administration proposes using a portion of the savings from student loans and the Perkins loan recall to pay 

for raising the maximum Pell grant by $100 (to $4,150) 

for the 2006-2007 academic year and by another $100 

annually for each of the following four years. That additional funding would be available only if the $4,050 maximum was funded through appropriations for 2006 and 

subsequent years. In addition to the increased maximum, 

the minimum grant would be raised each year, beginning 

with the 2007-2008 academic year, and would reach 

$600 by the 2010-2011 academic year. The proposal 

for Pell grants would increase outlays by $4.6 billion 

through 2010 and by $14.8 billion through 2015, CBO 

estimates.

Other Mandatory Spending Proposals 

The President’s budget also includes proposals that would 

affect receipts from the Federal Communications Commission’s (FCC’s) auctions of licenses to use parts of the 

electromagnetic spectrum. Those proposals include imposing new fees on licenses used for analog television 

broadcasts and on licenses awarded by methods other 

than auctions as well as extending the FCC’s authority to 

conduct auctions beyond 2007. Overall, CBO estimates, 

implementing those proposals would increase offsetting 

receipts from fees and auctions (which are recorded in the 

budget as negative mandatory spending) by $12.7 billion 

over the 10-year projection period.

The President’s budget request for veterans’ health care 

includes proposals that would increase offsetting receipts 

and decrease mandatory spending by a total of $2.5 billion over five years and $5.3 billion over 10 years, CBO 

estimates. The Administration seeks to charge veterans 

with income above certain thresholds an annual enrollment fee of $250 and raise their copayment for a 30-day 

prescription from $7 to $15. Under current law, similar 

receipts—such as those from third-party insurance payments and the current $7 copayment for prescriptions—

6. That figure represents the estimated change in the present value of 

outstanding federal loans and loan guarantees. Under the Federal 

Credit Reform Act, such changes, known as loan modifications, 

are recorded in the year that legislation is enacted.
10 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

are classified as discretionary offsetting collections. (The 

President’s budget proposes increasing discretionary appropriations for veterans’ health care by the amount of 

the new mandatory receipts.)

The President’s budget also includes a proposal to repeal 

the Continued Dumping and Subsidy Offset Act 

(CDSOA), which requires the federal government to 

disburse collections of antidumping and countervailing 

duties to the U.S. industries whose petitions for relief 

resulted in the imposition of the duties. In the past, those 

collections have averaged about $300 million per year. 

However, the United States and Canada are in the midst 

of a dispute about duties collected from exporters of 

Canadian softwood lumber. The assessments in question 

are much larger—approaching $4 billion—than previous 

duties and outlays under the CDSOA. Because CBO 

cannot predict the outcome of that dispute, its baseline 

assumes an equal probability that Canada or the United 

States will prevail. If the CDSOA was repealed at the 

beginning of fiscal year 2006, the savings relative to 

CBO’s baseline would total $4.2 billion through 2015. 

The President also proposes leasing the coastal plain of 

the Arctic National Wildlife Refuge for oil and gas development. Under that proposal, the state of Alaska would 

receive half of the proceeds from bonus bids, rents, and 

royalties. 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 2008 and the 

second in 2010. Proceeds to the federal government from 

the bonuses, rents, and royalties would total $5.2 billion 

over the 2006-2015 period, CBO estimates, and half of 

that sum would be paid to the state of Alaska.

Policy Proposals That Affect

Discretionary Spending

Discretionary budget authority for the current year totals 

$840 billion, including $11.5 billion in supplemental appropriations for disaster relief enacted in October 2004. 

That total will rise to $922 billion if the supplemental 

budget authority of $82 billion that was recently requested, chiefly for military operations in Iraq, is enacted.

The President’s budget proposes $843 billion in discretionary budget authority for 2006, CBO estimates—

$439 billion for national defense and $404 billion for

nondefense programs (see Table 1-5).7 However, those 

totals include no additional appropriations in 2006 for 

operations in Iraq or Afghanistan.

With proposed and enacted supplemental appropriations 

for 2005 excluded, discretionary budget authority would 

grow by 1.7 percent, or roughly $14 billion, between 

2005 and 2006 under the President’s budget, CBO estimates. Defense funding would increase by about 4.4 percent, but nondefense funding would fall by 1.0 percent.

Discretionary outlays would total $962 billion in 2005 

and shrink to $947 billion in 2006, CBO estimates—assuming that no additional funding was provided for operations in Iraq and Afghanistan beyond the amount proposed for 2005 in the President’s budget (see Table 1-6).

Additional funding to maintain those operations in 2006 

at about the level expected for 2005 would add some $40 

billion to 2006 outlays, raising them to about $990 billion, CBO projects.

Proposals for Defense Spending 

CBO estimates that the President’s proposals for defense 

would increase outlays by $31 billion in 2005, $139 billion over the 2006-2010 period, and $336 billion over 

the 2006-2015 period relative to CBO’s baseline projections. Those increases would result both from supplemental funding requested for 2005 and from increases in 

regular funding (relative to the baseline) requested for 

2006 and later years.

Defense outlays would rise in 2005 because the Administration has requested $75 billion in supplemental budget 

authority for that year (most of the $82 billion supplemental appropriation mentioned above), primarily for 

costs associated with military activities in Iraq. If that 

supplemental funding is enacted, it will also add about 

$28 billion to defense outlays in 2006 and smaller 

amounts in subsequent years.

The Administration’s proposals for defense spending for 

2006 through 2010 exceed the amounts in CBO’s baseline, even though they do not include any further fund7. For a number of reasons (including different projections of offsetting collections and of the effect of changes to mandatory programs proposed in appropriation bills), the Administration 

estimates that total budget authority for 2006 will be about 

$2.7 billion lower than CBO’s figure.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 11

Table 1-5.

CBO’s Estimate of the President’s Proposed Changes in Discretionary 

Budget Authority, 2004 to 2006

(Billions of dollars)

Source: Congressional Budget Office.

a. The numbers in the top half of this column include the Administration’s request for supplemental appropriations to fund activities in Iraq 

and Afghanistan and for other purposes. CBO assumed that none of that funding was classified as being for homeland security.

b. The amounts shown here reflect net spending for homeland security activities. (About $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 definition, whereas nondepartmental activities (such as some defense-related programs 

and some funding for the National Institutes of Health) fall within the Administration’s definition of homeland security. About half of all 

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

c. Supplemental appropriations in 2004, mainly for activities in Iraq and Afghanistan, totaled $117 billion. Supplemental funding of $11.5 

billion has been provided thus far in 2005 for hurricane disaster assistance. The President has requested $82 billion in additional supplemental funding—mostly for activities in Iraq—but those appropriations have not yet been enacted.

ing for operations in Iraq and Afghanistan.8 The amount 

of budget authority requested for 2006, $439 billion, is 

$7 billion higher than CBO’s baseline level. That difference grows in subsequent years, reaching $36 billion, or 

7.0 percent, by 2010. Consequently, outlays from the 

President’s proposals would exceed baseline levels by a 

total of $139 billion through 2010. With the Administration’s request for 2010 funding extrapolated through 

2015, outlays from those proposals would total $336 billion more than the baseline over the 2006-2015 period.

Proposals for Nondefense Discretionary Spending 

The President’s budget proposes cutting budget authority 

for nondefense discretionary activities by 1.0 percent in 

2006 from this year’s level (not counting supplemental 

appropriations). For 2007 through 2010, the President’s 

budget would essentially freeze nondefense discretionary 

spending other than that for homeland security.

Although most homeland security activities would receive 

increases in budget authority, total homeland security 

Actual

2004

Budget Authority

Defense 486 497 439 2.3 -11.7

Nondefense

Homeland securityb 27 31 29 11.9 -4.9

Other 394 394 375 0.1 -4.9 ___ ___ ___

421 425 404 0.9 -4.9

Total 907 922 843 1.6 -8.6

Budget Authority Excluding Supplementalsc

Defense 394 421 439 6.8 4.4

Nondefense

Homeland securityb 27 31 29 12.3 -4.9

Other 368 377 375 2.4 -0.7 ___ ___ ___

396 408 404 3.1 -1.0

Total Excluding Supplementals 789 829 843 4.9 1.7

Subtotal, nondefense

Subtotal, nondefense

2005 2004-2005 2005-2006 a 2006

Administration's Request Percentage Change

8. Pursuant to the rules that govern baseline projections, the baseline 

excludes funding for operations in Iraq and Afghanistan because 

no funds have yet been appropriated for those activities for the 

current year.
12 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-6.

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

March Baseline

(Billions of dollars)

Continued

funding would drop by $1.5 billion (4.9 percent) from 

the 2005 level because of two changes. First, Project BioShield, which received appropriations of $2.5 billion for 

2005, would not receive additional funding in 2006 under the President’s budget. Second, a proposed increase in 

fees charged by the Transportation Security Administration would boost offsetting collections by about $1.7 billion in 2006.

In all, nondefense discretionary budget authority would 

decline by roughly $4 billion in 2006 from the 2005 level 

(excluding supplemental appropriations) under the President’s budget, with reductions occurring in several budget functions (see Table 1-7). For example, appropriations for natural resource and environmental programs 

would drop by $2.5 billion, reflecting cuts in aid to states 

and Native American tribes and cuts in programs to preTotal, Total,

Actual 2006- 2006-

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015

486 497 439 463 481 501 511 524 538 551 566 580 2,395 5,154

Homeland securityb 27 31 29 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 394 394 375 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 421 425 404 403 406 410 409 418 428 438 448 458 2,032 4,222

Total 907 922 843 866 887 911 920 943 966 989 1,013 1,038 4,427 9,376

454 495 472 457 468 486 503 522 526 544 558 572 2,387 5,108

Homeland securityb 23 26 28 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a.

Other 417 441 446 n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ___

Subtotal, nondefense 440 467 474 468 463 463 465 471 480 490 500 510 2,334 4,785

Total 894 962 947 926 931 949 968 993 1,006 1,033 1,057 1,083 4,721 9,893

486 422 432 442 453 464 475 487 499 511 524 537 2,266 4,826

Homeland securityb 27 31 29 29 30 33 31 32 33 34 34 35 152 320

Other 394 388 398 407 417 427 436 447 457 468 479 490 2,085 4,424 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 421 418 427 437 447 459 468 479 490 501 513 525 2,237 4,744

Total 907 840 859 879 900 923 943 966 989 1,013 1,037 1,062 4,503 9,570

454 464 438 435 448 458 469 484 489 505 517 530 2,248 4,773

Homeland securityb 23 26 29 30 31 31 31 32 33 33 34 35 152 319

Other 417 440 448 455 463 471 480 490 500 512 524 535 2,316 4,878 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ____

Subtotal, nondefense 440 466 477 485 493 502 511 522 533 545 558 570 2,468 5,197

Total 894 930 915 921 941 960 980 1,006 1,022 1,050 1,075 1,100 4,716 9,970

Budget Authority

CBO's Estimate of Discretionary Spending Under the President's Budgeta

Defense

Nondefense

Outlays

Defense

Nondefense

Budget Authority

Defense

CBO's March 2005 Baseline for Discretionary Spending

Nondefense

Outlays

Defense

Nondefense
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 13

Table 1-6.

Continued

(Billions of dollars)

Source: Congressional Budget Office.

Notes: n.a. = not applicable; * = 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 2010. Discretionary spending after 2010 under the President’s 

budget is projected by CBO using its baseline rates of inflation.

b. The amounts shown here reflect net spending for homeland security activities. (About $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 definition, whereas nondepartmental activities (such as some defense-related programs 

and some funding for the National Institutes of Health) fall within the Administration’s definition of homeland security. About half of all 

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

vent or fight fires on public and private lands. Discretionary health programs would have their funding reduced by 

about $3.4 billion in 2006. Much of that decline results 

from the absence of funding for Project BioShield in 

2006, although reductions for the Health Resources and 

Services Administration (a $767 million cut) and the 

Centers for Disease Control and Prevention (a $556 

million cut) have also been requested.

Some areas of the budget would receive funding increases 

in 2006 under the President’s proposals. International affairs would see the largest rise—$3.8 billion (12.8 percent), with roughly $1.5 billion of that increase allocated 

to the Millennium Challenge Corporation. Medicare 

would receive an increase of $1.1 billion in discretionary 

funding in 2006, mainly for the costs of administering 

the new Part D prescription drug program.

Policy Proposals That Affect Revenues

The President’s budget proposes several changes to tax 

law that would reduce revenues significantly over the next 

decade relative to the amounts that CBO and JCT estimate would be collected under current law. Such proposals include the extension of a number of expiring tax provisions and a variety of new tax incentives. The most

Total, Total,

Actual 2006- 2006-

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015

0 75 7 21 28 37 36 37 38 40 41 43 128 328

Homeland securityb 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 7 -23 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 7 -23 -33 -41 -50 -58 -60 -62 -64 -65 -67 -204 -522

Total 0 82 -16 -13 -13 -13 -22 -23 -23 -24 -24 -24 -76 -194

0 31 34 22 20 28 34 37 38 39 40 42 139 336

Homeland securityb 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 1 -2 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 -2 -17 -30 -39 -46 -51 -54 -56 -58 -60 -134 -412

Total 0 32 32 5 -10 -11 -12 -14 -16 -17 -17 -18 5 -77

Budget Authority

Defense

Nondefense

Difference (President's budget minus baseline)

Outlays

Defense

Nondefense
14 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-7.

Comparison of Discretionary Budget Authority Enacted for 2005 and Requested 

by the President for 2006, by Budget Function

(Billions of dollars)

Source: Congressional Budget Office.

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

a. Excludes $82 billion in supplemental appropriations, mostly for activities in Iraq, that have been proposed but not yet enacted.

b. Excludes supplemental appropriations for disaster relief enacted in 2005.

c. Includes certain receipts (such as those from loan guarantees made by the Federal Housing Administration’s Mutual Mortgage Insurance 

program) and other collections (such as those from the Securities and Exchange Commission) that are recorded as negative budget

authority and outlays.

d. 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.

421.6 1.1 420.6 439.0 18.4 4.4

30.0 0.1 29.9 33.8 3.8 12.8

24.3 0.1 24.2 24.6 0.4 1.8

3.8 0 3.8 4.5 0.7 19.1

31.3 0.9 30.4 28.0 -2.5 -8.1

5.7 0 5.7 5.4 -0.4 -6.3

1.8 * 1.8 0.9 -1.0 -53.1

25.3 1.3 24.0 21.6 -2.4 -10.1

22.7 7.7 14.9 12.6 -2.4 -15.9

79.6 0 79.6 78.1 -1.5 -1.8

54.4 0.1 54.3 50.9 -3.4 -6.3

4.0 0 4.0 5.1 1.1 26.5

46.1 * 46.0 47.3 1.2 2.6

4.4 0 4.4 4.7 0.3 7.0

30.9 0.1 30.7 31.4 0.7 2.3

38.7 * 38.7 38.8 0.1 0.4

15.4 0.1 15.3 16.4 1.1 7.2

0 0 0 * * n.a. ____ ___ ____ ____ ___

418.4 10.4 408.0 404.0 -4.0 -1.0

Total 840.0 11.5 828.6 843.0 14.4 1.7

45.3 0 45.3 45.7 0.4 0.8

2005 Enacteda

Change, 

Defense Discretionary

Nondefense Discretionary

International affairs

General science, space, and technology

Energy

Natural resources and environment

Agriculture

Commerce and housing creditc

Transportation

Community and regional development

Education, training, employment, and

Subtotal, nondefense discretionary

social services

Health

Medicare (Administrative costs)

Income security

Transportation Obligation Limitationsd

Total

Disaster Relief

Supplemental

Memorandum:

Allowances for emergencies and

other needs

Social Security (Administrative costs)

Veterans' benefits and services

Administration of justice

General government

Supplemental

Total Excluding 2006

Request

Billions of

Dollars Percent

2005-2006b
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 15

significant changes include those involving provisions of 

EGTRRA and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), the research and experimentation tax credit, deductions for certain premiums 

paid for health care plans with high deductibles, tax-free 

savings accounts, and tax credits for developers of 

affordable housing. CBO and JCT estimate that, as a 

whole, the Administration’s proposals would reduce revenues by $3 billion in 2006 and by $1.4 trillion over the 

2006-2015 period (see Table 1-3 on page 4). As discussed 

above, the proposals’ effects on refundable tax credits 

would also increase outlays by roughly $120 billion over 

those 10 years.

Permanent Extensions of 

EGTRRA and JGTRRA Provisions 

The Administration proposes to permanently extend various provisions of EGTRRA and JGTRRA that are 

scheduled to expire in coming years. Those provisions 

include changes in income tax rates, relief from the socalled marriage penalty, an increase in the child tax credit, 

provisions related to education and retirement, and repeal 

of the estate tax. The implementation of those provisions 

was accelerated by JGTRRA, which directed that they 

take effect earlier than they would have done under 

EGTRRA. Extending those provisions rather than letting 

them expire as scheduled would reduce revenues by just 

over $1 trillion through 2015. 

The President’s budget also proposes extending the lower 

rates on capital gains and dividends that are scheduled 

under JGTRRA to rise at the end of 2008. Making those 

rates permanent would reduce revenues by an additional 

$148 billion between 2006 and 2015, CBO and JCT 

project. 

Another provision of JGTRRA and the American Jobs 

Creation Act of 2004 liberalized the rules governing depreciation for small businesses from 2003 through 2007, 

mainly by increasing 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. The President’s budget would 

make those expensing changes permanent, at a cost of 

about $19 billion between 2006 and 2015. 

In total, the proposals in the 2006 budget to make permanent various extensions and accelerations of tax provisions would reduce revenues by an estimated $1.2 trillion 

(and increase outlays by $62 billion) through 2015.

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. The credit is scheduled to expire on December 

31, 2005, but the President’s budget proposes to make it 

permanent. That proposal would reduce projected revenues by a total of $78 billion over the next 10 years, 

according to CBO and JCT.

“Above-the-Line” Deduction for 

High-Deductible Health Insurance 

Currently, people who buy individual (not employmentbased) health insurance plans with a high deductible that 

must be met before reimbursement will occur can contribute to health savings accounts, which can be used to 

pay their and their dependents’ health care costs. The Administration proposes allowing people who contribute to 

health savings accounts to deduct from their taxable income the premiums they pay for individually purchased, 

high-deductible plans.9

 The deduction would be used in 

calculating adjusted gross income (AGI) and would be 

allowed even if taxpayers did not itemize deductions. 

(Taxpayers who itemize deductions can deduct medical 

expenses exceeding 7.5 percent of AGI from their taxable 

income.) If that proposal took effect on January 1, 2006, 

as envisioned, it would cost an estimated $33 billion over 

the 2006-2015 period.

Refundable Tax Credit for Health Insurance 

Another of the President’s proposed policies for 2006 is 

the creation of a refundable income tax credit for the cost 

of health insurance. The credit, which would also take 

effect on January 1, 2006, would be worth as much as 

$1,000 per adult and $500 per child (for up to two children). It could cover a maximum of 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.) That 

credit would reduce revenues by a total of $12 billion and 

raise outlays by $52 billion over the 2006-2015 period.

Expansion of Tax-Free Savings Accounts 

The tax code contains a variety of tax-favored savings 

plans, which are used primarily for retirement but also for 

9. The Administration did not provide specific information about 

what kinds of plans would qualify as high-deductible health

insurance.
16 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

other purposes, such as education. The President proposes to unify many of those accounts into two taxfavored savings vehicles—retirement savings accounts 

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

expand their scope. For RSAs, individuals could contribute up to $5,000 annually, and no income limits would 

apply. Contributions would not be deductible, but all 

earnings on the accounts would accumulate tax-free. Taxand penalty-free withdrawals could occur after age 58 or 

because of death or disability. Accounts currently held as 

Roth individual retirement accounts (IRAs) would become RSAs. No further contributions to traditional IRAs 

would be allowed, but such accounts could be converted 

into RSAs in the same way that they can now be converted into Roth IRAs. 

In addition, individuals could contribute up to $5,000 

annually to lifetime savings accounts, which would face 

the same tax treatment as RSAs and, like them, have no 

income restrictions on participation. In contrast to the 

treatment that applies to IRA withdrawals, however, 

withdrawals from LSAs could be made for any purpose 

and at any age. Balances currently held in Coverdell education savings accounts and qualified state tuition plans 

could be converted into balances in LSAs.

On net, those proposals would reduce revenues by $2 billion over the 2006-2015 period, CBO and JCT estimate. 

Revenues would increase from 2006 to 2010 as new contributions were directed away from current savings plans 

that receive an immediate tax deduction and toward the 

new vehicles, which would not. In addition, some taxpayers would convert their existing traditional IRAs to RSAs, 

generating more revenue in the first four years. As a result, the proposals would increase federal revenues when 

the contributions were made and the balances converted 

but would reduce revenues later (from 2011 to 2015) 

when withdrawals went untaxed.

Tax Credit for Developers of Affordable Housing 

Another proposal in the President’s budget would provide 

a tax credit to developers of affordable single-family housing sold to buyers with income below a certain level. 

Starting in 2006, state and local housing credit agencies 

would be given authority to award credits to developers 

of some single-family housing in places with median income that was no more than 80 percent of the area’s median income or in places with chronic economic problems. Developers would receive the credit only if a home’s 

buyer had an income no higher than 80 percent of median family income. The credit would lower revenues by 

an estimated $17 billion over 10 years.

Other Revenue Proposals 

The President’s budget contains a number of other tax 

changes, such as incentives related to charitable giving, 

health care, education, and the environment. It also includes various changes in tax law related to pensions and 

other retirement saving, incentives to increase energy production or encourage energy conservation, and extensions of a number of provisions scheduled to expire at the 

end of 2005. Together, those other proposed changes 

would reduce revenues by $55 billion and increase outlays by $7 billion over the 2006-2015 period.

CBO’s and the Administration’s

Economic Assumptions

CBO and the Administration are forecasting similar values for the underlying economic variables used to estimate revenues and outlays. On the whole, however, the 

Administration’s economic forecast implies higher projections of revenues, slightly higher projections of outlays, 

and a more favorable outlook for the budget. Those differences in economic assumptions add about $55 billion 

to CBO’s estimate of the cumulative deficit for the 2006-

2010 period under the President’s budget.

CBO projects slightly higher growth of real (inflationadjusted) GDP than the Administration does for most of 

those five years (see Table 1-8 on page 18). However, 

CBO’s projection of the nominal level of GDP between 

2006 and 2010 is lower than the Administration’s by 

roughly $325 billion, or 0.5 percent. That lower projection for nominal GDP is reflected in lower projections for 

wages and salaries, which reduce projected receipts from 

individual income and social insurance taxes.

In addition, the Administration projects that wages and 

salaries—the category of income with the largest effect on 

revenue projections—will make up a larger share of GDP 

during the 2006-2010 period than CBO does. For later 

years in that projection period, Administration’s slightly 

higher level of nominal GDP also tends to keep the projected level of wages and salaries above that in CBO’s projection.

Compared with CBO, the Administration projects higher 

inflation through 2010 (as measured by the consumer 

price index for all urban consumers) and generally lower 
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 17

interest rates (although its projection of rates on 10-year 

Treasury notes is higher beginning in 2009). The slightly 

higher inflation projection coupled with the higher projection of 10-year interest rates causes the Administration 

to estimate greater outlays under the President’s budget 

after 2008 than CBO does. The inflation measures that 

CBO uses to estimate cost-of-living adjustments for Social Security and other programs are the same as the Administration’s in 2006 but slightly lower thereafter. However, CBO projects a higher percentage increase in the 

consumer price index for food consumed at home—

which is used to estimate the maximum Food Stamp benefit—in 2006 (differences are minimal thereafter). The 

Administration’s projections of short- and long-term interest rates are generally lower than CBO’s, resulting in 

lower projected costs for servicing federal debt held by 

the public.

Differences Between CBO’s and the 

Administration’s Budget Estimates

Overall, the cumulative deficits projected by CBO and 

the Administration for the 2006-2010 period under the 

President’s budget differ by only $57 billion—equivalent 

to 0.4 percent of projected outlays in that period. That 

difference results because CBO estimates lower outlays 

from the President’s proposals than the Administration 

does, largely for technical reasons. To a lesser extent, 

CBO and JCT also estimate lower revenues under the 

President’s budget, mainly because of differences in economic assumptions. Most of the differences between the 

two projections relate to the baseline estimates. 

CBO’s Baseline Versus the Administration’s 

Current-Services Baseline

In the current-services baseline published with the President’s budget, the Administration projects a deficit of 

$390 billion for 2005, whereas CBO’s baseline projects a 

deficit of $365 billion (neither of those estimates includes 

any additional funding for military operations in Iraq and 

Afghanistan). Thereafter, the Administration projects 

that the deficit will decline each year from 2006 through 

2010, with the cumulative shortfall totaling about $1.35 

trillion. CBO’s baseline anticipates the same trend and 

projects a deficit of $1.23 trillion for that five-year period 

(see Table 1-9 on page 20).

As was the case last year, the two baselines reflect some 

conceptual differences. CBO constructs its baseline as 

specified by the Balanced Budget and Emergency Deficit 

Control Act of 1985. The Administration, however, has 

deviated from prior practices in three ways. First, its baseline assumes that the major tax-law changes enacted in 

EGTRRA and JGTRRA will be extended. Second, it has 

not extrapolated into future years the $11.5 billion in 

supplemental appropriations provided for disaster relief 

for 2005. And third, it has adjusted the way in which it 

accounts for increases in pay when projecting discretionary spending. As a result, some differences between the 

two baselines can be attributed to conceptual differences 

as well as to economic and technical factors.

On the spending side of the budget, CBO’s estimate of 

outlays for 2005 is $21 billion below the Administration’s. Almost all of that difference ($20 billion) results 

from differences in estimates of mandatory spending—

the largest being a $5 billion difference for Medicaid. In 

terms of discretionary spending, CBO’s and the Administration’s estimates for 2005 are within about $0.5 billion 

of each other.

For the 2006-2010 period, CBO’s baseline estimate of total outlays is $125 billion lower than that of the Administration. Virtually all of that difference ($121 billion) involves mandatory outlays (excluding debt service). CBO’s 

estimate of Medicare spending over that period is lower 

than the Administration’s by $79 billion, or 3.9 percent, 

mostly because the Administration projects higher enrollment in and higher costs for Medicare’s new prescription 

drug benefit. In addition, CBO estimates lower spending 

on veterans’ programs over that period than the Administration does (by about $22 billion, or 11.2 percent), 

mostly because CBO expects lower participation in the 

veterans’ disability compensation program and a smaller 

average benefit per enrollee. Similarly, CBO’s estimate of 

2006-2010 outlays for the Food Stamp program falls 

short of the Administration’s by about $20 billion, or 

10.6 percent, because of lower projections of participation. Discretionary outlays in CBO’s baseline are $11 billion below the Administration’s projection for the 2006-

2010 period, with almost all of that difference stemming 

from differing projections of defense spending. 

Overall, revenue projections in CBO’s latest baseline are 

very similar to the Administration’s current-services projections. CBO expects $5 billion more in revenues than 

the Administration does in 2005 but a total of $6 billion 

less in the 2006-2010 period. 
18 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-8.

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

Projections for Calendar Years 2005 to 2010

Continued

As noted above, the Administration’s baseline assumes 

that EGTRRA and JGTRRA will be permanently extended beyond their scheduled expirations. In contrast, 

CBO’s baseline does not assume that any of the expiring 

provisions of those laws will be extended, which increases 

its revenue projections relative to the Administration’s by 

roughly $53 billion over the five-year period. The expiring provisions whose extension would have the greatest 

effect on revenues during those years include the amount 

of expensing allowed for certain small-business investments (which expires at the end of 2007) and the reduced 

tax rates on capital gains and dividends (which expire at 

the end of 2008). The revenue effects of extending the 

provisions in those two laws that are scheduled to expire 

at the end of 2010 would be quite small over the 2006-

2010 period.

That conceptual difference is offset by technical and economic differences between the two baselines—mostly 

related to assumptions about GDP, inflation, and the 

amount of tax revenue generated by a given level of income. Those differences lower CBO’s revenue projections 

by $59 billion over the five-year period compared with 

the Administration’s.

Differences Between CBO’s and 

the Administration’s Policy Estimates 

Overall, CBO’s estimates of the impact of the President’s 

proposals on mandatory spending and revenues do not 

differ much from those of the Administration ($14 billion and $6 billion higher, respectively, for the 2006-

2010 period). However, some notable differences exist in 

estimates of specific proposals.

2005 2006

CBO 11,730 12,396 13,059 15,940 a

Administration 11,731 12,392 13,083 16,112 a

March Blue Chip 11,741 12,417 13,089 n.a. 

CBO 6.6 5.7 5.3 5.1

Administration 6.6 5.6 5.6 5.3

March Blue Chip 6.6 5.8 5.4 5.3

 

CBO 4.4 3.8 3.7 3.3

Administration 4.4 3.6 3.5 3.2

March Blue Chip 4.4 3.7 3.4 3.2

 

CBO 2.1 1.8 1.5 1.8

Administration 2.1 1.9 2.0 2.1

March Blue Chip 2.1 2.0 2.0 2.1

 

CBO 2.7 2.4 1.9 2.2

Administration 2.7 2.4 2.3 2.4

March Blue Chip 2.7 2.5 2.3 2.4

CBO 5.5 5.2 5.2 5.2

Administration 5.5 5.3 5.2 5.1

March Blue Chip 5.5 5.2 5.1 5.0

Unemployment Rate (Percent)

Nominal GDP (Percentage change)

Real GDP (Percentage change)

GDP Price Index (Percentage change)

Consumer Price Indexb

 (Percentage change)

Forecast Projected Annual Average,

Nominal GDP (Billions of dollars)

Estimated

2004 2007-2010
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 19

Table 1-8.

Continued

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

2005); Department of Commerce, Bureau of Economic Analysis; Federal Reserve Board; Department of Labor, Bureau of Labor

Statistics.

Note: Percentage changes are year over year. n.a. = not available.

a. Level in 2010.

b. The consumer price index for all urban consumers.

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

Differences in Outlays. CBO projects that the President’s 

proposals would decrease mandatory outlays by $26 billion over the 2006-2010 period—roughly $14 billion less 

than the Administration estimates. Nearly one-third of 

that difference is attributable to proposals involving Medicaid and the State Children’s Health Insurance Program.

The President’s budget reports savings of $45 billion 

through 2015 from legislation that would alter Medicaid 

and SCHIP. However, CBO estimates that the proposal 

to enroll more children in Medicaid and SCHIP would 

be less effective over the 2006-2015 period than the Administration anticipates. In addition, CBO could not estimate savings from several other proposals (dealing with 

restrictions on certain types of above-cost payments to 

providers and on payments for various social and rehabilitative services) because the Administration did not provide sufficient details about how the savings would be 

achieved. (The Administration estimated that those proposals would save $23 billion over the 2006-2015 period). As a result, CBO estimates that the Medicaid and 

SCHIP proposals in the President’s budget would generate only $9 billion in savings between 2006 and 2010—

about $4 billion less than the Administration estimates 

(see Table 1-4 on page 6). Over 10 years, those proposals 

would save $27 billion, CBO estimates.

2005 2006

CBO 1.4 2.8 4.0 4.6

Administration 1.4 2.7 3.5 4.1

March Blue Chip 1.4 3.1 3.9 4.2

 

CBO 4.3 4.8 5.4 5.5

Administration 4.3 4.6 5.2 5.5

March Blue Chip 4.3 4.6 5.2 5.5

 

CBO 8.4 10.7 9.4 8.7

Administration 8.5 10.5 9.8 8.5

CBO 45.6 45.7 45.8 45.9

Administration 45.6 45.6 45.8 46.3 

CBO 984 1,331 1,222 1,349 a

Administration 998 1,307 1,276 1,292 a

CBO 5,346 5,665 5,979 7,317 a

Administration 5,345 5,649 5,988 7,502 a

Wages and salaries

Corporate book profits

Wages and salaries

Tax Basesc

 (Billions of dollars)

Corporate book profits

Three-Month Treasury Bill Rate (Percent)

Ten-Year Treasury Note Rate (Percent)

Tax Basesc

 (Percentage of GDP)

Estimated Forecast Projected Annual Average,

2004 2007-2010
20 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-9.

Comparison of CBO’s March 2005 Baseline and the Administration’s 

February 2005 Current-Services Baseline

(Billions of dollars)

Continued

Another difference between the Administration’s and 

CBO’s outlay estimates involves the refundable portion 

of the tax credits for certain health expenditures. JCT and 

CBO project that those proposals would increase outlays 

by $2 billion more over the 2006-2010 period and by 

$12 billion more over the 2006-2015 period than the

Administration projects.

CBO’s estimates of the effects of the President’s proposals 

for student aid are similar in total to the Administration’s 

estimates for the 2005-2010 period but significantly different for the following five years. CBO estimates that the 

proposals would produce net savings of $0.2 billion between 2005 and 2015; the Administration concludes that 

they would save $10.1 billion. Estimating differences for 

specific proposals result from differences in the baselines 

or from conceptual differences (in the case of the Perkins 

loan recall and reinsurance payments to guaranty agencies 

for defaulted loans), from different modeling techniques 

(which affect the proposed impact of a cap on borTotal,

2006-

2005 2006 2007 2008 2009 2010 2010

2,057 2,213 2,357 2,508 2,662 2,807 12,547

1,484 1,608 1,719 1,836 1,956 2,066 9,186

573 605 638 672 706 740 3,361

930 915 921 941 960 980 4,716

1,316 1,385 1,456 1,539 1,631 1,724 7,735

177 211 248 274 290 304 1,328 ____ ____ ____ ____ ____ ____ _____

2,422 2,511 2,625 2,754 2,881 3,008 13,779

On-budget 2,023 2,095 2,196 2,309 2,419 2,527 11,547

Off-budget 399 416 429 445 462 481 2,232

-365 -298 -268 -246 -219 -201 -1,232

-539 -487 -477 -473 -463 -461 -2,361

175 189 209 227 244 260 1,129

2,053 2,178 2,347 2,518 2,668 2,841 12,552

1,492 1,585 1,718 1,854 1,967 2,098 9,222

561 593 629 665 701 743 3,331

930 914 923 942 961 986 4,727

1,336 1,416 1,485 1,558 1,645 1,752 7,856

177 209 242 269 291 310 1,321 ____ ____ ____ ____ ____ ____ _____

2,443 2,539 2,650 2,770 2,897 3,048 13,903

On-budget 2,044 2,119 2,218 2,323 2,429 2,560 11,650

Off-budget 399 420 432 446 467 488 2,253

-390 -361 -303 -251 -229 -207 -1,351

-552 -534 -500 -469 -462 -462 -2,429

162 173 197 218 233 256 1,078

Deficit (-) or Surplus

On-budget

Off-budget

Discretionary

Mandatory

Net interest

Total

Revenues

On-budget

Off-budget

Outlays

CBO's March 2005 Baseline

Outlays

Discretionary

Mandatory

Administration's February 2005 Current-Services Baseline

Revenues

On-budget

Off-budget

Net interest

Total

Deficit (-) or Surplus

On-budget

Off-budget
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 21

Table 1-9.

Continued

(Billions of dollars)

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

Note: * = between -$500 million and zero; BEA = Budget Enforcement Act of 1990.

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.

rowers’ interest rates), and from other estimating assumptions.

Another proposal for which CBO’s estimate differs markedly from the Administration’s is a proposal to increase 

the rates that federal power marketing administrations 

charge for electricity to reflect “market” prices for the sale 

of power. CBO’s estimate of the net additional receipts 

from that change is about $2.6 billion less over the 2006-

2010 period and $10.5 billion less over the 2006-2015 

period than the Administration’s estimate. That difference has three sources. First, CBO assumes that the proceeds from any increase in rates collected by the Bonneville Power Administration (BPA) would be spent by 

that agency, in accordance with current law. BPA’s operations are financed by a revolving fund, using the proceeds 

from the sale of electricity and transmission services. 

CBO assumes that the agency would continue to operate 

in that manner. Second, CBO assumes that under current 

law, the other three power marketing administrations (the 

Southwestern, Southeastern, and Western) would sell 

power at a weighted average rate of around $30 per 

megawatt hour. The Administration assumes a much 

lower rate under current law. Third, CBO estimates a 

lower “market” rate than the Administration does.

CBO’s estimate of savings to the Commodity Credit Corporation over the 2006-2015 period from the President’s 

agriculture proposals is $10 billion lower than the Administration’s estimate. Among the reasons, CBO’s forecasts of crop and milk prices tend to be lower than the 

Administration’s, especially for the later years of the projection period. Also, CBO incorporates into its estimates 

the probability of a range of commodity-price forecasts 

and the possible cost to the government if prices fall below the projected levels. In addition, CBO assumes that 

the President’s proposals for commodity programs (except 

those affecting dairy programs) would take effect in 2006 

Total,

2006-

2005 2006 2007 2008 2009 2010 2010

5 35 10 -10 -6 -34 -6

-8 23 1 -18 -11 -31 -36

12 12 9 7 5 -3 30

-1 1 -2 -2 -2 -6 -11

-20 -31 -29 -19 -14 -28 -121

-1 2 6 5 * -6 7 ___ ___ ___ ___ ___ ___ ___

-21 -28 -25 -16 -16 -40 -125

On-budget -21 -24 -22 -14 -10 -33 -103

Off-budget -1 -4 -3 -2 -6 -7 -21

26 63 35 5 10 6 119

13 47 23 -4 -1 2 67

13 16 11 9 11 4 52

-391 -369 -315 -256 -213 -212 -1,364

On-budget

Off-budget

Memorandum:

Deficit Under the 

Deficit or Surplusa

On-budget

Off-budget

Outlays

Discretionary

Mandatory

Net interest

Total

Administration's BEA Baseline

Revenues

Difference (CBO minus Administration)
22 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

because of contractual commitments that are likely to be 

entered into this year, whereas the Administration assumes that they would take effect in 2005.

In addition, over the 2006-2010 period, CBO assumes 

roughly $4 billion less in savings than the Administration 

does from the proposed repeal of the Continued Dumping and Subsidy Offset Act. That difference results from 

two sources. First, as noted above, CBO assumes a 50 

percent probability that the United States will prevail in 

its current dispute with Canada about duties on Canadian softwood lumber. Second, CBO does not assume 

that the United States will continue to collect duties on 

Canadian lumber following the resolution of the dispute. 

The Administration, by contrast, assumes that the United 

States will prevail in the case and continue to collect duties on Canadian lumber thereafter and that all of the 

duties collected will be distributed to the affected domestic industries.

Finally, CBO’s estimate of savings from the President’s 

proposal to change funding rules for pensions and alter 

the PBGC’s premium structure exceeds the Administration’s estimate by $2.6 billion over five years and $2.4 billion over 10 years. The reason is that CBO interprets the 

proposal as being intended to achieve a specific level of 

total premiums. CBO’s baseline estimate of premium 

income is lower than the Administration’s, which means 

that CBO assumes that in reaching the Administration’s 

target, the proposal would generate a larger increase in 

premium receipts relative to CBO’s baseline.

Differences in Revenues. CBO and JCT estimate that the 

President’s budgetary proposals would reduce revenues by 

a total of about $100 billion over the 2006-2010 period—$6 billion less than the Administration estimates. 

Compared with the Administration, CBO and JCT 

project smaller revenue losses in 2008 and 2009 and 

larger revenue losses in 2006, 2007, and 2010.

The overall revenue difference for the 2006-2010 period 

stems in large part from the proposals to extend the current tax rates on capital gains and dividends beyond their 

scheduled expiration (on December 31, 2008). CBO’s 

and JCT’s estimate of the degree to which those extensions would reduce revenues is $11 billion less than the 

Administration’s—about $9 billion for the capital gains 

provision and $2 billion for the dividend provision—and 

is concentrated in the 2008-2010 period, around the 

time of expiration. CBO and JCT also estimate $3 billion 

less in revenue losses than the Administration does from 

extending the expensing of certain capital investments by 

small businesses.

Those differences are partially offset by several cases in 

which CBO and JCT estimate greater revenue losses than 

the Administration does: adjusting the funding for singleemployer pension plans (a $2 billion greater revenue loss 

through 2010), extending the repeal of the estate tax and 

modifying gift taxes (a $2 billion greater revenue loss), 

and extending the research and experimentation tax 

credit (a $1 billion greater revenue loss). CBO and JCT 

also estimate a smaller revenue gain through 2010 (by $2 

billion) from the proposals to expand tax-free savings accounts.

Changes to CBO’s Baseline 

Since January 2005

In conjunction with its annual analysis of the President’s 

budget, CBO updates the 10-year baseline projections it 

published in the previous January.10 Those projections, 

which are constructed according to rules specified in law, 

estimate the future path of spending and revenues under 

the assumption that current laws do not change. As such, 

the projections are intended to serve as a neutral benchmark against which to measure the budgetary effects of 

proposed policy changes.

Revisions to CBO’s baseline since January have added 

$125 billion to the cumulative deficit projected for the 

2006-2015 period, which now stands at $980 billion (see 

Table 1-10). The projection of total outlays over that period has increased by $128 billion, offset slightly by an 

increase of $3 billion in projected revenues (see Table 1-

11). Those revisions are almost exclusively technical; legislative changes since January have been minimal, and 

CBO has not updated its economic assumptions.

Outlays

Much of the change to CBO’s outlay projections comes 

from an increase of $70 billion (or 1.5 percent) in projected spending for Medicare over the 2006-2015 period, 

partially offset by a decrease of $26 billion (less than 1 

percent) in projected spending for Medicaid over that 

10. See Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2006 to 2015.
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 23

Table 1-10.

CBO’s Baseline Budget Projections

Source: Congressional Budget Office.

Note: n.a. = not applicable.

Total, Total,

Actual 2006- 2006-

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2010 2015

809 899 986 1,082 1,172 1,265 1,362 1,561 1,718 1,822 1,932 2,048 5,867 14,947

189 216 226 226 237 246 249 254 261 270 281 292 1,184 2,542

733 790 833 876 918 962 1,009 1,054 1,102 1,151 1,202 1,253 4,598 10,360

148 153 167 173 181 188 188 193 222 231 243 255 897 2,041 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

1,880 2,057 2,213 2,357 2,508 2,662 2,807 3,062 3,304 3,475 3,657 3,847 12,547 29,891

On-budget 1,345 1,484 1,608 1,719 1,836 1,956 2,066 2,288 2,494 2,629 2,775 2,928 9,186 22,301

Off-budget 535 573 605 638 672 706 740 774 809 845 882 919 3,361 7,591

894 930 915 921 941 960 980 1,006 1,022 1,050 1,075 1,100 4,716 9,970

1,237 1,316 1,385 1,456 1,539 1,631 1,724 1,838 1,908 2,042 2,172 2,317 7,735 18,012

160 177 211 248 274 290 304 313 316 314 312 307 1,328 2,890 _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ _____ ______ ______

2,292 2,422 2,511 2,625 2,754 2,881 3,008 3,157 3,246 3,406 3,559 3,725 13,779 30,871

On-budget 1,913 2,023 2,095 2,196 2,309 2,419 2,527 2,658 2,723 2,855 2,978 3,111 11,547 25,871

Off-budget 380 399 416 429 445 462 481 499 524 551 580 614 2,232 5,000

-412 -365 -298 -268 -246 -219 -201 -95 57 69 99 122 -1,232 -980

-567 -539 -487 -477 -473 -463 -461 -370 -229 -226 -203 -183 -2,361 -3,571

155 175 189 209 227 244 260 275 286 295 302 305 1,129 2,591

4,296 4,656 4,965 5,246 5,506 5,737 5,949 6,054 6,004 5,941 5,847 5,726 n.a. n.a.

11,553 12,233 12,888 13,586 14,307 15,029 15,757 16,494 17,245 18,023 18,826 19,652 71,566 161,806

7.0 7.3 7.7 8.0 8.2 8.4 8.6 9.5 10.0 10.1 10.3 10.4 8.2 9.2

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

6.3 6.5 6.5 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4 6.4

1.3 1.3 1.3 1.3 1.3 1.3 1.2 1.2 1.3 1.3 1.3 1.3 1.3 1.3

___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

16.3 16.8 17.2 17.3 17.5 17.7 17.8 18.6 19.2 19.3 19.4 19.6 17.5 18.5

On-budget 11.6 12.1 12.5 12.7 12.8 13.0 13.1 13.9 14.5 14.6 14.7 14.9 12.8 13.8

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

7.7 7.6 7.1 6.8 6.6 6.4 6.2 6.1 5.9 5.8 5.7 5.6 6.6 6.2

10.7 10.8 10.7 10.7 10.8 10.9 10.9 11.1 11.1 11.3 11.5 11.8 10.8 11.1

1.4 1.4 1.6 1.8 1.9 1.9 1.9 1.9 1.8 1.7 1.7 1.6 1.9 1.8 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___

19.8 19.8 19.5 19.3 19.3 19.2 19.1 19.1 18.8 18.9 18.9 19.0 19.3 19.1

On-budget 16.6 16.5 16.3 16.2 16.1 16.1 16.0 16.1 15.8 15.8 15.8 15.8 16.1 16.0

Off-budget 3.3 3.3 3.2 3.2 3.1 3.1 3.0 3.0 3.0 3.1 3.1 3.1 3.1 3.1

-3.6 -3.0 -2.3 -2.0 -1.7 -1.5 -1.3 -0.6 0.3 0.4 0.5 0.6 -1.7 -0.6

-4.9 -4.4 -3.8 -3.5 -3.3 -3.1 -2.9 -2.2 -1.3 -1.3 -1.1 -0.9 -3.3 -2.2

1.3 1.4 1.5 1.5 1.6 1.6 1.6 1.7 1.7 1.6 1.6 1.6 1.6 1.6

Debt Held by the Public 37.2 38.1 38.5 38.6 38.5 38.2 37.8 36.7 34.8 33.0 31.1 29.1 n.a. n.a.

Total

Deficit (-) or Surplus

On-budget 

Off-budget

Outlays

Discretionary spending

Mandatory spending

Revenues

Individual income taxes

Net interest

Corporate income taxes

Social insurance taxes

Other

Total

Off-budget

Debt Held by the Public

Memorandum:

Gross Domestic Product

Deficit (-) or Surplus

On-budget 

Revenues

Individual income taxes

Corporate income taxes

Social insurance taxes

In Billions of Dollars

As a Percentage of GDP

Other

Total

Outlays

Discretionary spending

Mandatory spending

Net interest

Total
24 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 1-11.

Changes in CBO’s Baseline Projections of the Deficit or Surplus Since

January 2005

(Billions of dollars)

Source: Congressional Budget Office.

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

period. CBO has made technical changes to its baseline 

for Medicare to reflect revised estimates of the cost of the 

prescription drug program. Those revisions result from 

changes in CBO’s estimating methods and from the fact 

that various final rules issued for the program differ from 

what CBO had anticipated on the basis of legislative language. (For more details, see Appendix A.) For those reasons, CBO now expects the prescription drug program to 

cost $54 billion more through 2015 than it projected in 

January (with about $36 billion of that increase expected 

through 2013, the time frame covered by CBO’s original 

estimate of the cost of the Medicare Modernization Act). 

A little more than half of the increase involves estimates 

of the net cost of basic benefits; the rest involves estimates 

of the cost of the program’s subsidy for low-income beneficiaries.

For the Medicaid program, revisions to CBO’s baseline 

projections were fueled by a number of factors, such as 

the continuing efforts of states to control spending for 

the program, updated data from the Centers for Medicare 

and Medicaid Services, and slower growth in the number 

of people receiving Supplemental Security Income benefits (who are automatically eligible for Medicaid). CBO 

now projects that Medicaid spending will grow at an 

Total, Total,

2006- 2006-

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

-368 -295 -261 -235 -207 -189 -80 71 85 115 141 -1,188 -855

Changes to Revenue Projections

**000000000 * *

*********** 1 3

_ _ _ _ _ _ _ _ _ _ _ _ _

Total Revenue Changes * * * * * * * * * * * 1 3

Changes to Outlay Projections

-1 1 1 1 1 * * * * * * 3 3

2 2 5 7 6 5 7 6 8 11 13 25 70

-2 -3 -3 -2 -2 -2 -2 -2 -3 -4 -4 -11 -26

* 1 1 1 2 2 2 2 3 3 3 6 19

* * 1 1 1 1 2 2 2 2 3 4 14

0 1 1 1 1 1 1 1 1 1 1 5 10

-1 4 2 3 2 3 3 4 3 * -1 14 23 __ _ _ __ __ __ __ __ __ __ __ __ ___

-1 5 7 11 10 11 13 12 14 13 14 43 110

-1 -2 -1 * 1 1 2 2 3 3 5 * 15

_ _ _ __ __ __ __ __ __ __ __ __ ___

Total Outlay Changes -3 4 7 11 12 12 15 14 17 16 19 46 128

3 -3 -7 -11 -12 -12 -15 -14 -16 -16 -19 -44 -125

-365 -298 -268 -246 -219 -201 -95 57 69 99 122 -1,232 -980

Other

Deficit or Surplus

Legislative

Total Deficit (-) or Surplus 

as Projected in March 2005

Total Impact on the

Total Deficit (-) or Surplus

as Projected in January 2005

Discretionary

Mandatory

Technical

Technical

Medicare

Net interest

Medicaid

Veterans' compensation

Social Security

Student loans

Subtotal, mandatory
CHAPTER ONE CBO’S ESTIMATES OF THE PRESIDENT’S BUDGET FOR 2006 25

average annual rate of 7.8 percent from 2006 to 2015, 

compared with 8.2 percent in the January baseline.

CBO has also increased its estimate of Social Security 

outlays over the 10-year projection period by $19 billion, 

chiefly to reflect a change in its projections of retroactive 

benefits in the Old-Age and Survivors Insurance program. Retroactive benefits, which go primarily to new 

beneficiaries, reflect a recomputation of benefits to incorporate final earnings or lump-sum payments to compensate for processing time.

CBO has raised its projection of spending for veterans’ 

disability compensation over the 2006-2015 period by 

$14 billion because of new information from the Department of Veterans Affairs about the average disability rating of veterans who join the disability-compensation 

rolls. CBO has changed the average disability rating 

assumed for those new recipients to 40 percent from 

roughly 30 percent in the previous baseline.

Finally, CBO has added about $1 billion per year to its 

projection of outlays for student loans, for a total increase 

of $10 billion over the 2006-2015 period. New data indicate higher loan volumes than CBO anticipated in the 

January baseline. In addition, CBO now expects lower 

premiums to be charged to borrowers because it assumes 

that fewer guaranty agencies will change their premiums 

to meet minimum reserve requirements.

Revenues

CBO’s revenue projections have not changed significantly 

since January. CBO has raised its baseline projection of 

revenues for each year of the 2006-2015 period by less 

than $500 million, for a total increase of about $3 billion 

over that period. The rise mainly reflects slightly higher 

projections of receipts from miscellaneous fees and fines, 

especially the fees that finance the Universal Service Fund 

(which supports certain telephone and telecommunications services). 

In addition to such technical changes, a small legislative 

change enacted since CBO completed its previous baseline has affected revenue projections. Public Law 109-1 

allows taxpayers to deduct from their income in 2004 any 

charitable cash contributions they made in January 2005 

for the relief of victims of the Indian Ocean tsunami. 

That law will reduce revenues by $11 million in 2005 

and raise them by $9 million in 2006, JCT estimates.

Net Interest

As a result of revisions to the baseline that increase projected revenues and outlays, CBO now estimates that the 

Treasury would need to borrow more if current laws did 

not change than it would have had to under the January 

baseline. By CBO’s estimate, such additional borrowing 

and other technical adjustments would raise net interest 

payments on federal debt by a total of $15 billion over 

the 2006-2015 period.

2

The Economy Under the President’s Budget and Under 

CBO’s Baseline Policy Assumptions

In analyzing the President’s budgetary proposals for 

2006, the Congressional Budget Office considered how 

those policies—in comparison with the policies incorporated in CBO’s baseline—would affect the economy. 

CBO concluded that under the policies in the President’s 

budget, economic output would probably be slightly 

lower, on average, over the 2006-2010 period but somewhat higher over the 2011-2015 period than it would be 

under the policies in CBO’s baseline. However, CBO’s 

analysis suggests that the differences are likely to be small, 

affecting output by an average of less than one-half of 

1 percent over the full 10-year period. 

The small size of the 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 2006 to 2010 under 

the President’s proposals—excluding economic effects—

would be lower by 0.14 percent of cumulative gross domestic product than they would be under CBO’s baseline. Spending, including interest on government debt, 

would be higher by 0.01 percent of 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. Under CBO’s economic 

assumptions, the President’s budgetary proposals would 

increase the cumulative deficit for the 2006-2010 period, 

CBO estimates, by $104 billion (0.1 percent of cumulative GDP), compared with the deficit under the baseline’s 

policy assumptions. If the budgetary effects of the economic changes resulting from those proposals were included in the estimate, the projected increase in the cumulative deficit over that period would range from as 

much as $165 billion to as little as $105 billion (see 

Figure 2-1 and Table 2-1).

For the years 2011 to 2015, the President’s proposals, as 

assessed using the baseline’s economic assumptions, 

would increase the cumulative deficit by $1,497 billion 

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

of the economic changes resulting from those proposals 

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

as $1,523 billion to as little as $1,366 billion.

How Fiscal Policy Affects the Economy

Budgetary policies can affect the economy in a variety of 

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

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

policies can influence the overall level of demand in the 

economy.1

 Those factors and other possible economic influences can be broadly divided into long-run supply-side 

effects and short-run demand-side effects. 

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 

CHAPTER

1. Analysts refer to government outlays for current goods and services (as opposed to outlays for transfer payments, interest on government debt, or long-lasting investments, such as highways or 

military equipment) as government “consumption,” because it 

reduces the resources available for investment in much the same 

way that private consumption does.
28 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

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 figure reflect the proposals’ supply-side effects on the economy but exclude demand-side 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 2015, (D) closed-economy life-cycle model with higher taxes 

after 2015, (E) open-economy life-cycle model with lower government spending after 2015, (F) open-economy life-cycle model with

higher taxes after 2015, (G) infinite-horizon model with lower government consumption after 2015, (H) infinite-horizon model with 

higher taxes after 2015, (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 2011-2015 period.

-200

-160

-120

-80

-40

0

-1,800

-1,600

-1,400

-1,200

-1,000

-800

-600

-400

-200

0

A BCDE F GH

2006 to 2010

2011 to 2015

Budget's Impact on the 2006-2010 Deficit

Assuming No Macroeconomic Feedbacks (-$104 billion)

Budget's Impact on the 2011-2015 Deficit

Assuming No Macroeconomic Feedbacks (-$1,497 billion)

a

AB CDE FGH I J

a I J
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 29

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 

2015. CBO chose two alternatives—cutting government consumption and transfer payments or raising marginal tax rates.

n.a. = not applicable.

High (Hours worked respond strongly to tax-rate changes) -114 -1,472

Low (Hours worked respond weakly to tax-rate changes) -115 -1,523

Lower government spending after 2015 -133 -1,430

Higher taxes after 2015 -141 -1,443

Lower government spending after 2015 -154 -1,399

Higher taxes after 2015 -165 -1,408

Lower government spending after 2015 -121 -1,405

Higher taxes after 2015 -109 -1,366

-132 n.a.

-105 n.a.

-109 n.a.

-105 n.a.

Memorandum:

-104 -1,497

2006 to 2010 2011 to 2015

Macroeconomic Advisers

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

CBO's Estimate of the Budgetary Effects of the

Growth Models

With Forward-Looking Behavior

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers

Global Insight

Without Forward-Looking Behavior
30 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

as supply-side changes because they alter the quantity of 

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

lasting effect on the economy.

In the short run, however, economic output can 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. Unlike 

movements on the supply side of the economy, cyclical 

changes are temporary—built-in corrective forces that 

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 of millions of individuals 

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

what assets to hold, and where and how much to work. 

The government plays a crucial role in establishing the legal and institutional framework within which the economy operates and an overall level of government spending and taxes. Once that general structure is in place, 

however, changes in government spending and tax policies influence individuals’ choices only to a limited degree. Decisions by businesses, personal circumstances, 

and preferences play a much larger role in economic performance than do modest changes in the federal government’s fiscal policies. 

Supply-Side Effects

The supply-side effects of the President’s budgetary proposals could 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 are capable of altering potential output. 

The Quantity and Quality of Labor. The overall quantity 

and quality of labor in the economy is an important determinant of potential output. 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 and the exemption from taxation of some dividend and capital gains income, would increase people’s 

after-tax income but 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 of labor that people supply 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 both increase the compensation after taxes 

for each additional hour of work and boost after-tax income overall. Evaluating how that kind of change affects 

the number of hours people work is complicated by the 

fact that the policy has opposing effects: people earn 

more for each extra hour they work, which tends to encourage them to supply more labor, but they can also 

work fewer hours and earn the same after-tax income, 

which tends to discourage work. Most studies find that, 

on balance, reductions in marginal tax rates such as those 

that the President is proposing will increase the hours of 

labor supplied, primarily because they 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 that those changes would 

have on the effective marginal tax rate on labor income—

the rate at which the average additional dollar of compensation for labor is taxed (see Table 2-2). The largest 

changes in rates occur for the years 2011 to 2015, because the President proposes to make permanent various 

reductions in taxes that are scheduled to expire after 

2010. For those years, the average effective marginal tax 

rate on labor income would be between 4 percent and 5 

percent lower under the President’s proposals than under 

the current-law policies incorporated in CBO’s baseline. 
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 31

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 taken by taxes—

specifically, federal individual income and payroll taxes.

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 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. (Increasing investment would imply the 

opposite results.) 

Another way in which the President’s proposals could affect the hours worked in the economy would be by 

changing people’s expectations about future policies. Under the President’s proposals, the cumulative federal budget deficit over the 2006-2015 period would grow. That 

rise 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 

larger 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 

rates went up and then work less when the rates were 

higher. 

But it is difficult to gauge the degree to which such foresight influences people’s 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 about the extent of people’s foresight and the expectations they might have about 

future policies and assessed the differences in results. 

In sum, the President's budgetary proposals would have 

relatively small effects, on average, on the number of 

hours worked over the 2006-2010 period, CBO estimates, and those effects could be positive or negative. 

Over the 2011-2015 period, however—when the reductions in marginal tax rates were 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 

Calendar

Year

2005 26.7 26.7 0 0

2006 27.2 27.2 0 0

2007 27.5 27.5 0 0

2008 27.7 27.7 0 0

2009 28.0 28.0 0 0

2010 28.3 28.3 0 0

2011 30.0 28.6 -1.5 -5.0

2012 30.2 28.8 -1.4 -4.7

2013 30.3 29.0 -1.3 -4.4

2014 30.5 29.2 -1.3 -4.2

2015 30.7 29.4 -1.3 -4.1

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. But the federal government could not follow such an 

approach indefinitely because the interest costs would compound 

over time.
32 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

capital stock primarily by affecting consumption and 

therefore investment. The President’s proposals would directly alter government consumption of goods and services relative to the level in CBO’s baseline. In 2006 and 

2007, the proposals imply an increase in consumption 

relative to the baseline level, which would tend to lessen 

investment in private capital by reducing the resources 

available for that purpose. However, from 2008 through 

2015, the proposals imply a reduction in government 

consumption, which would tend to boost private investment.3

The President’s budgetary policies would also produce 

offsetting influences on private consumption. The reductions in taxes that the budget proposes would increase 

after-tax income, which would tend to increase consumption. Other things being equal, a higher level of consumption could 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—would 

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 C analyzes in more detail the potential economic effects of the President’s proposals for dividend 

and capital gains taxation, savings accounts, and the estate tax.)

Again, 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. That calculation was performed 

under two sets of policy assumptions: one comprising the 

current-law policies in CBO’s baseline and the other, the 

President’s policies (see Table 2-3). In both instances, the 

estimated effective tax rates were below all but the lowest 

statutory marginal rate 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, during the 2011-2015 period, the effective marginal tax rate on capital income would be about 

81⁄2 percent lower under the President’s proposals than 

under the policies in CBO’s baseline.

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

savings and affect 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 for consumption 

that higher returns would have could 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 people spend. 

Nevertheless, to cover other possibilities, CBO included 

in its analysis a range of assumptions about how the rate 

of return on savings might affect consumption. Some of 

CBO’s estimates incorporate the assumption that the rate 

has little or no effect on how much people spend; for 

other estimates, CBO assumed that increasing the rate of 

return on savings would reduce consumption—and increase saving—significantly. 

Finally, as described earlier, the larger cumulative 10-year 

deficit under the President’s budgetary proposals (larger 

relative to CBO’s baseline estimate) 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 in its analysis. 

Most of its estimates indicated that, on average, the domestically owned capital stock would be smaller under 

the policies in the President’s budget than under those in 

CBO’s baseline—but the differences were modest. Positive effects on the capital stock were projected only under 

the most dramatic assumption about foresight—that people care just as much for future generations as they do for 

3. Some of the supportive effect on investment of lower government 

consumption would probably be offset by a decline in the amount 

of capital flowing into the United States from other countries. 

However, because most of the returns on those investments accrue 

to foreigners, a decline in capital inflows would not commensurately reduce the resources available to U.S. firms and consumers 

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

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 taken by taxes—specifically, federal individual income and corporate income taxes.

themselves. In effect, if people had a sufficiently long 

time horizon, they might recognize and counter the deleterious effects of fiscal policy on the formation of capital 

and thus on future standards of living. 

In addition to changes in the level of the capital stock, 

changes in the mix of different types of capital within 

that stock can affect potential output. Among the policies 

in the President’s budget, the proposal to extend the tax 

rates on corporate dividends and capital gains would 

probably have the biggest effect on the stock’s composition because it would lessen the taxation of corporate income and thus encourage a shift of capital from the noncorporate to the corporate sector. 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. 

The taxation of dividends and capital gains also encourages firms to finance investment by borrowing rather 

than by issuing stock. Because firms can 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.) That tax policy may influence firms’ decisions about financing and lead to economic inefficiencies. Extending the tax rates on dividends 

and capital gains would lessen those inefficiencies. 

Technological Progress. New and improved technical 

processes and products are the source of most long-term 

growth in productivity, and the President’s budgetary policies could affect the economy by influencing the rate of 

such progress. Researchers, however, lack a basis for estimating how fiscal policy influences technological innovation. Because so little is understood about the genesis of 

that innovation, CBO for the most part has not incorporated in its analysis effects on technological progress arising from the President’s proposals.4

Calendar

Year

2005 13.8 13.6 -0.3 -1.8

2006 13.8 13.5 -0.3 -2.1

2007 13.8 13.5 -0.3 -2.4

2008 13.7 13.4 -0.4 -2.7

2009 14.1 13.6 -0.5 -3.7

2010 14.2 13.6 -0.6 -4.2

2011 14.9 13.6 -1.3 -8.5

2012 14.9 13.6 -1.3 -8.6

2013 14.9 13.6 -1.3 -8.5

2014 14.9 13.6 -1.3 -8.5

2015 14.9 13.6 -1.3 -8.6

Percent

Tax Rate Under the

President's Budget

Tax Rate Under

Current Law Percentage Points

Difference

4. In Global Insight’s model, one of two commercial macroeconometric models that CBO used to estimate the demand-related 

effects of the President’s proposals, potential GDP responds positively to spending on research and development—which in turn 

would be stimulated by the proposal to extend tax credits for 

research and development. However, the estimated effect on output in the model was very small.
34 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

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 GDP Percent

Source: Congressional Budget Office.

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).

Demand-Side (Cyclical) Effects

The federal government’s fiscal policies also affect the 

economy by adding to or subtracting from the total demand for goods and services. Increases in demand can 

cause firms to temporarily gear up production and hire 

more workers; decreases in demand can have the opposite 

effects. From a demand-side perspective, budgetary policies that reduce consumption (and other purchases) 

might slow the pace of the economy’s current cyclical 

expansion. 

Demand-side effects, however, 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 or private consumption are likely to lower output in the long 

run because they tend eventually to decrease investment 

and the size of the capital stock. 

A Description of CBO’s Models and 

Their Results

In estimating the economic effects of the President’s budgetary proposals relative to its baseline assumptions, CBO 

used several different economic models that—although 

similar in some respects—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 businesscycle aspects of the economy and are designed primarily 

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

-2.0

-1.6

-1.2

-0.8

-0.4

0.0

0.4

-10

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

Left Scale

Budget's Impact on the Deficit a

Right Scale

Changes in the Effective Tax Rate on:

Capital Income b

Labor Income c
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 35

to analyze demand-side 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 effective tax rates on labor and capital and on the deficit—some of the key inputs for CBO’s various models. 

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 2006 through 2015 (the same 

period that CBO’s baseline projections cover). The models differ in part in their assumptions about how far ahead 

people look in making their plans (see Appendix D). The 

textbook growth model is not forward-looking—it assumes that people do not explicitly take into account expected future policies in making their current plans. The 

life-cycle model incorporates the assumption that people 

make lifelong plans for working and saving but do not 

take into consideration events that might occur after their 

death. By contrast, the infinite-horizon model incorporates the 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.

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.5 Under either response assumption, the President’s budgetary proposals would have little effect on 

GDP in the 2006-2010 period. Over the 2011-2015 period, the proposals would reduce GDP by 0.2 percent under the low assumption, in CBO’s estimation, and raise 

GDP by 0.1 percent under the high assumption. Those 

estimates illustrate the budgetary proposals’ opposing effects, as estimated by the textbook growth model: higher 

deficits crowd out investment, reducing the capital stock, 

but lower marginal tax rates increase the labor supplied 

(especially in the last five years of the projection period). 

Which effect dominates depends on the assumption 

made about how sensitive the supply of labor is to 

changes in marginal tax rates.

The textbook growth model’s results differ from those of 

the other two growth models largely because the textbook 

model does not incorporate forward-looking behavior: 

people, as it 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 policy changes after 2015. In 

addition, unlike the life-cycle and infinite-horizon models, the textbook growth model does not incorporate any 

direct effects on private consumption from lower marginal (as opposed to 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 are certain that the 

assumed budgetary policies—those of the President or of 

CBO’s baseline—will be maintained over the 10-year 

modeling period. That assumption is an important characteristic of CBO’s estimates. In reality, people would 

probably think it possible that the policies could 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 would 

affect people’s expectations about fiscal policy beyond 

2015. Assumptions about those expectations are complicated by the fact that the policies reflected in the baseline 

are likely to be unsustainable, owing to the extent of both 

current deficits and projected increases in spending for 

health and retirement programs.6

 However, CBO assumed that people already expect that the fiscal imbalances under current-law policies will be resolved, though 

in some unspecified way. In projections using its forwardlooking models, CBO made explicit assumptions only 

about the way in which increases in deficits under the 

President’s budgetary proposals, relative to 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 assumption about financing because they are forward-looking). 

5. See Congressional Budget Office, Labor Supply and Taxes

(January 1996). 

6. See Congressional Budget Office, The Long-Term Budget Outlook

(December 2003).
36 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 2-4.

CBO’s Year-by-Year Forecast and Projections for Fiscal Years

2005 Through 2015

Sources: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor 

Statistics; Federal Reserve Board.

Note: Percentage change is year over year.

a. The consumer price index for all urban consumers.

b. The employment cost index for wages and salaries only, private-industry workers.

Estimated

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Nominal GDP 

(Billions of dollars) 11,553 12,233 12,888 13,586 14,307 15,029 15,757 16,494 17,245 18,023 18,826 19,652

Nominal GDP 

(Percentage change) 6.6 5.9 5.4 5.4 5.3 5.0 4.8 4.7 4.6 4.5 4.5 4.4

 

Real GDP 

(Percentage change) 4.6 3.8 3.7 3.8 3.5 3.2 3.0 2.8 2.7 2.7 2.6 2.6

GDP Price Index 

(Percentage change) 1.9 2.0 1.6 1.6 1.8 1.8 1.8 1.8 1.8 1.8 1.8 1.8

Consumer Price Indexa 

(Percentage change) 2.3 2.8 1.9 2.1 2.2 2.2 2.2 2.2 2.2 2.2 2.2 2.2

Employment Cost Indexb

(Percentage change) 2.7 3.1 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3

Unemployment Rate 

(Percent) 5.6 5.3 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2 5.2

Three-Month Treasury 

Bill Rate (Percent) 1.1 2.4 3.8 4.5 4.6 4.6 4.6 4.6 4.6 4.6 4.6 4.6

Ten-Year Treasury 

Note Rate (Percent) 4.3 4.6 5.3 5.5 5.5 5.5 5.5 5.5 5.5 5.5 5.5 5.5

Tax Bases

(Billions of dollars)

Corporate book profits 970 1,257 1,247 1,223 1,264 1,311 1,342 1,378 1,426 1,483 1,549 1,614

Wages and salaries 5,279 5,584 5,900 6,225 6,562 6,898 7,233 7,570 7,912 8,265 8,629 9,002

Tax Bases

(Percentage of GDP)

Corporate book profits 8.4 10.3 9.7 9.0 8.8 8.7 8.5 8.4 8.3 8.2 8.2 8.2

Wages and salaries 45.7 45.7 45.8 45.8 45.9 45.9 45.9 45.9 45.9 45.9 45.8 45.8

 Forecast Projected
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 37

Under one assumption, people believe that the proposals 

will be financed by gradually reducing government 

spending on goods and services and on transfer payments 

(as shares of GDP) over the 2016-2025 period. (The reductions in the two categories would be proportional to 

their shares of government spending in CBO’s baseline.) 

Under the other assumption, people believe that the proposals will be financed by gradually increasing marginal 

tax rates over the same period.

The life-cycle model projects that under the President’s 

proposals, GDP will fall by between 0.2 percent and 0.4 

percent over the 2006-2010 period relative to CBO’s 

baseline and will rise by between 0.3 percent and 0.8 percent over the 2011-2015 period. Again, the difference

between the projected effects over the two periods stems 

partly from the assumption that people will shift some 

hours of work from the earlier to the later period,

when tax rates will be lower (relative to those assumed in 

CBO’s baseline). 

However, in the projections that incorporate the assumption of an open economy, the higher deficits under the 

President’s proposals would attract net inflows of capital 

from the rest of the world. That means that people in 

other countries would have increasing claims on the output produced in the United States—that is, on GDP. An 

alternative measure of output, gross national product 

(GNP), measures the output produced by labor and capital supplied by U.S. residents, regardless of where those 

factors of production are located. That measure by definition nets out those increased foreign claims—that is, the 

capital income that nonresidents earn from their investments in the United States. CBO estimates that under 

the President’s proposals, GNP will fall by about 0.4 percent over the 2006-2010 period relative to CBO’s baseline and will rise by between 0.1 percent and 0.2 percent 

over the 2011-2015 period.

Depending on which of the assumptions is used and on 

whether the economy is assumed to be open or closed to 

flows of foreign capital, the infinite-horizon model 

projects that the President's proposals will subtract (relative to CBO’s baseline) between zero and 0.1 percent 

from GDP during the first five years of the period but 

then add between 0.5 percent and 0.7 percent during the 

second five years (see Table 2-5). The difference in projected effects arises partly because people are estimated to 

shift some of their hours of work from the first five-year 

span to the second.

The effects on the economy from the President’s proposed changes in fiscal policy would in turn affect the 

federal budget (see Tables 2-1 and 2-6). Using the economic assumptions incorporated in its baseline, CBO 

projects that the President’s proposals will expand the cumulative deficit over the 2006-2010 period by $104 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 

further increase the deficit by $6 billion to $61 billion. 

For the 2011-2015 period, the President’s budgetary policies are projected to boost the cumulative deficit by 

$1,497 billion under the baseline’s economic assumptions. The economic effects of the President’s proposals 

over that period, according to the models, could add as 

much as $26 billion to that increase or subtract as much 

as $131 billion from it. 

Five-Year Analysis Including Demand-Side Effects

CBO turned to macroeconometric forecasting models 

created by two private forecasting firms—Macroeconomic Advisers and Global Insight—to analyze both the 

demand-side and supply-side effects of the President’s 

budgetary proposals on the economy over the next five 

years. Although the models include embedded growth 

models, their design concentrates on demand-side (cyclical) economic effects. Such effects are increasingly harder 

to estimate as the projections extend further. Therefore, 

CBO used those models to produce estimates only for the 

first five years of the 2006-2015 projection period. 

Like the textbook growth model, Macroeconomic Advisers’ and Global Insight’s models are not forward-looking—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 in the same way as they 

have in the past, regardless of the source of those changes. 

For example, they react to the tax proposals in the President’s budget (which would boost disposable income) by 

increasing their purchases to about the same degree as 

they have, on average, in the past when disposable income rose. However, in reality, 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 expanded their income (such as an increase in productivity), because they might feel that tax 

legislation was more likely to be reversed in the future. 
38 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table 2-5.

CBO’s Estimates of How the President’s Budget Would Affect Real Gross

Domestic Product

(Average percentage change from CBO’s baseline)

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 

2015. CBO chose two alternatives—cutting government consumption and transfer payments or raising marginal tax rates.

* = -0.05 and 0.05 percent; n.a. = not applicable

* 0.1

* -0.2

-0.2 0.4

-0.2 0.3

-0.3 0.8

-0.4 0.8

Lower government spending after 2015 -0.4 0.2

Higher taxes after 2015 -0.4 0.1

-0.1 0.5

* 0.7

-0.2 n.a.

-0.1 n.a.

* n.a.

* n.a.

Lower government spending after 2015

Higher taxes after 2015

Infinite-Horizon Model

2006 to 2010

Lower government spending after 2015

Higher taxes after 2015

Lower government spending after 2015

2011 to 2015

Macroeconomic Advisers

Global Insight

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Memorandum:

Gross National Product

Open-Economy Life-Cycle Model

Higher taxes after 2015

Supply-Side and Demand-Side Contributions

Macroeconomic Advisers

Global Insight

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)
CHAPTER TWO THE ECONOMY UNDER THE PRESIDENT’S BUDGET AND UNDER CBO’S BASELINE POLICY ASSUMPTIONS 39

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 

2015. CBO chose two alternatives—cutting government consumption and transfers or raising marginal tax rates.

n.a. = not applicable.

High (Hours worked respond strongly to tax-rate changes) -11 25

Low (Hours worked respond weakly to tax-rate changes) -11 -26

Lower government spending after 2015 -29 68

Higher taxes after 2015 -37 55

Lower government spending after 2015 -51 99

Higher taxes after 2015 -61 89

Lower government spending after 2015 -17 92

Higher taxes after 2015 -6 131

-28 n.a.

-1 n.a.

-5 n.a.

-1 n.a.

2006 to 2010 2011 to 2015

Macroeconomic Advisers

Global Insight

Closed-Economy Life-Cycle Model

Open-Economy Life-Cycle Model

Textbook Model

Infinite-Horizon Model

Macroeconomic Advisers

Global Insight

Growth Models

With Forward-Looking Behavior

Macroeconometric Models

Supply-Side and Demand-Side Contributions

Without Forward-Looking Behavior

Supply-Side Contribution
40 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

The lack of forward-looking behavior in the macroeconometric models implies that specific policy changes that 

are scheduled to occur in the future do not affect the current behavior of people represented in the models unless 

special adjustments are made to mimic such behavior. For 

example, the President’s proposal to extend many of the 

provisions in EGTRRA would reduce taxes from 2011 to 

2015 compared with the levels in CBO’s baseline. Those 

lower taxes would increase the amount of after-tax income that people expected in the future, which might 

cause them to boost their spending today (as the forwardlooking models imply). In the macroeconometric models, 

however, those changes in taxes affect 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’ 

equations to incorporate its own estimates of those effects.7

Two sets of estimates were produced to illustrate the magnitude of demand-side effects in the models. For one set, 

CBO ran the models using the standard assumption that 

monetary policy would allow both demand- and supplyside effects. For the second set, CBO attempted to isolate 

the supply-side effects by altering interest rates in such a 

way as to hold the unemployment rate at the level projected in CBO’s baseline. That approach produced an estimate of the implications of the proposals for potential 

(noncyclical) GDP.8

Macroeconomic Advisers’ model and Global Insight’s 

model differed in their estimates of the effects of the policies in the President’s budget relative to the policies in 

CBO's baseline (see Table 2-5). However, both models 

predicted that together, the demand- and supply-side effects of those changes would have little effect on GDP, on 

average, between 2006 and 2010. Also similar were the 

models’ estimates of the supply-side impacts of the President’s proposals. Both macroeconometric models projected that the supply-side effects of the President’s budgetary policies would decrease output by between 0.1 

percent and 0.2 percent. 

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 add $5 billion to the $104 

billion increase in the deficit projected for the 2006-2010 

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 could add $1 billion to the deficit over the same 

period.

7. 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.

8. Because the resulting changes in interest rates stem mostly from 

demand-side effects and the Federal Reserve’s efforts to offset 

them, using those changes in interest rates to calculate budgetary 

effects ascribed to the supply side makes little sense. Instead, in its 

estimates of those effects in Tables 2-1 and 2-6, CBO used 

changes in interest rates that reflected only the predicted changes 

in the marginal product of capital (the amount produced by one 

additional unit of capital)—which is the true supply-side effect.
A

Changes in CBO’s Projections of

Medicare Spending for 2005 to 2015

As part of the process of updating its projections 

of Medicare spending for the March 2005 baseline, the 

Congressional Budget Office (CBO) reviewed the final 

rules recently published for the prescription drug (Part 

D) and Medicare Advantage programs, analyzed new data 

relevant to those activities, and refined its estimating 

methods. On the basis of those analyses, CBO now 

projects that net mandatory spending for Medicare will 

grow from $290 billion in 2005 to $649 billion in 2015 

and will total just over $5 trillion for the 2005-2015

period. In January 2005, CBO projected that net

mandatory spending for Medicare would grow from 

$287 billion in 2005 to $636 billion in 2015, totaling 

just under $5 trillion for the same period. The new projection for net mandatory spending over the period is $72 

billion (1.5 percent) higher than CBO’s January projection (see Table A-1).1

That increase of $72 billion in projected Medicare spending comprises a $2.4 billion rise in 2005 and a boost of 

$70 billion over the 2006-2015 period. The increase of 

$2.4 billion projected for 2005 is attributable to spending 

in the first five months of the fiscal year that has grown 

more rapidly than CBO anticipated in January 2005. Information on which components of the program are responsible for that unexpectedly rapid growth is not yet 

available.

Revised projections for two programs account for most of 

the estimated $70 billion change over the 2006-2015 period. CBO’s projection of net mandatory Medicare 

spending for the prescription drug benefit under Part D 

is $54 billion higher than its January estimate. A revision 

in projected spending for the regional preferred provider 

organization (PPO) component of the Medicare Advantage program accounts for $6 billion of the 10-year

increase.

Medicare’s Prescription Drug Benefit 

CBO projects that net mandatory Medicare spending for 

Part D will total $851 billion over the 2005-2015 period, 

or $54 billion more than CBO’s projection in January 

2005. (Box A-1 on page 44 compares CBO’s current projection of Part D spending with its original estimate of 

the program’s cost covering the 2004-2013 period.) The 

changes in CBO’s new projection of Part D spending 

through 2015 fall into three broad categories:

B An increase of $12 billion in the net cost of the basic 

benefit, which reflects provisions in the final rule that 

differ from those CBO had anticipated in its original 

estimate;2

B An increase of $19 billion in the net cost of the basic 

benefit resulting from the use of new data and other 

refinements of CBO’s estimating methodology; and

B An increase of $23 billion in the cost of the lowincome subsidy and transitional drug assistance.

APPENDIX

1. All of the revisions in CBO’s projections of Medicare spending are 

“technical” changes—that is, there has been no change in CBO’s 

economic projections since the completion of the January 2005 

baseline, nor has legislation been enacted that would affect CBO’s 

projections of Medicare spending.

2. The Part D program, as discussed here, has two main parts: the 

basic benefit and the low-income subsidy. The basic benefit portion comprises payments to participating prescription drug plans 

(including employer- or union-sponsored plans and Medicare 

Advantage plans) for the federal share of spending below the initial benefit limit or above the catastrophic threshold. Net spending for the basic benefit also includes receipts from premiums. 

Spending for the low-income subsidy represents payments for 

transitional assistance and the cost-sharing obligations of participants in the low-income subsidy program (as well as the mandatory administrative costs of that program).
42 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table A-1.

Comparison of CBO’s March 2005 and January 2005 Baseline Projections of 

Medicare Mandatory Spending

(By fiscal year, in billions of dollars)

Continued

Total, Total,

2005- 2005-

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

177.8 182.4 194.2 203.8 215.5 228.4 246.0 253.8 274.6 292.4 312.2 1,202 2,581

145.9 149.5 159.4 166.6 175.9 187.7 205.9 215.9 238.7 258.9 280.6 985 2,185

0 35.7 57.7 66.5 72.7 81.0 89.0 99.5 110.6 124.8 140.1 314 878

1.1 9.0 15.2 17.7 19.9 22.1 24.4 27.3 30.5 34.3 38.5 85 240

__ ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ___ ____

1.1 44.7 72.9 84.2 92.6 103.1 113.4 126.8 141.1 159.1 178.7 399 1,118 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

324.7 376.6 426.4 454.6 483.9 519.2 565.3 596.5 654.4 710.4 771.5 2,586 5,884

2.7 1.9 1.6 1.6 1.6 1.6 1.7 1.7 1.7 1.7 1.7 11 20 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

327.5 378.6 428.0 456.2 485.5 520.9 566.9 598.1 656.1 712.2 773.2 2,597 5,903

-37.9 -40.4 -42.9 -45.5 -48.4 -52.6 -57.8 -61.9 -67.9 -74.6 -81.9 -268 -612

0 -6.0 -9.0 -10.5 -11.5 -12.9 -14.3 -16.3 -18.3 -21.0 -23.8 -50 -144

0 -6.0 -9.0 -9.9 -10.8 -11.8 -12.7 -13.9 -15.2 -16.6 -18.0 -48 -124 ___ ___ ___ ___ ___ ___ ___ ___ ____ ____ ____ ____ ____

-37.9 -52.5 -60.8 -65.9 -70.7 -77.3 -84.8 -92.0 -101.4 -112.2 -123.8 -365 -879

____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

289.6 326.1 367.2 390.4 414.9 443.5 482.1 506.1 554.7 599.9 649.4 2,232 5,024

176.9 182.4 192.6 202.7 214.5 227.2 243.8 252.7 272.5 290.0 308.5 1,196 2,564

144.7 148.7 157.1 163.9 175.2 189.3 207.9 219.5 241.1 260.7 282.0 979 2,190

0 38.0 56.9 63.8 69.4 76.3 83.3 92.7 103.2 115.5 129.3 304 829

0.8 6.6 14.3 16.6 18.6 20.6 22.7 25.1 28.1 31.6 35.4 77 220

__ ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ___ ____

0.8 44.6 71.3 80.4 88.0 97.0 106.0 117.8 131.3 147.1 164.7 382 1,049 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

322.3 375.7 420.9 446.9 477.6 513.5 557.8 590.1 644.9 697.8 755.3 2,557 5,803

2.7 1.6 1.6 1.6 1.6 1.6 1.7 1.7 1.7 1.7 1.8 11 19 ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

325.0 377.3 422.5 448.5 479.2 515.1 559.4 591.7 646.6 699.5 757.0 2,568 5,822

-37.9 -40.4 -42.4 -44.8 -48.5 -53.3 -58.5 -63.5 -69.1 -75.7 -83.1 -267 -617

0 -6.8 -9.0 -10.0 -10.8 -11.9 -12.9 -14.4 -16.0 -17.9 -20.0 -48 -130

0 -5.7 -9.1 -10.1 -10.9 -11.8 -12.7 -13.8 -15.1 -16.5 -17.8 -48 -124 ___ ___ ___ ___ ___ ____ ____ ____ ____ ____ ____ ___ ____

-37.9 -52.9 -60.5 -64.9 -70.2 -76.9 -84.1 -91.7 -100.2 -110.1 -120.9 -363 -870

____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ ____

287.2 324.4 362.0 383.7 409.0 438.2 475.3 500.1 546.4 589.4 636.2 2,204 4,952

March 2005 Baseline Projections of Medicare Mandatory Spending

Benefits

Part A

Part B

Part D

Basic benefits

Low-income subsidy and transitional assistance

Subtotal, Part D

Subtotal, benefits

Other Mandatory

Subtotal, gross mandatory

Offsetting Receipts

Premiums for Parts A and B 

Premiums for Part D

Payments by states for Part D

Subtotal, offsetting receipts

Total, Net Mandatory

January 2005 Baseline Projections of Medicare Mandatory Spending

Part B

Benefits

Part A

Part D

Basic benefits

Low-income subsidy and transitional assistancea

Subtotal, Part D

Subtotal, benefits

Other Mandatory

Subtotal, gross mandatory

Offsetting Receipts

Premiums for Parts A and B 

Premiums for Part Da

Payments by states for Part D

Subtotal, offsetting receipts

Total, Net Mandatory
APPENDIX A CHANGES IN CBO’S PROJECTIONS OF MEDICARE SPENDING FOR 2005 TO 2015 43

Table A-1.

Continued

(By fiscal year, in billions of dollars)

Source: Congressional Budget Office.

Notes: Medicare Part A is the Hospital Insurance component of the program, Part B is Supplementary Medical Insurance, and Part D is the 

prescription drug benefit.

More details on CBO’s March 2005 baseline projections for Medicare are available at www.cbo.gov/factsheets/2005/Medicare.pdf.

* = between -$500 million and $500 million; ** = between -$50 million and $50 million.

a. Prior to the March 2005 baseline, CBO presented premiums paid by the low-income subsidy program both as outlays by that program and 

as receipts (in the Part D premium line). The Administration presents outlays for the low-income subsidy net of the premium payments. 

To conform to how spending will be reported in the future, CBO has adopted that presentation for the March 2005 baseline. The amounts 

in this table for the January 2005 baseline have also been adjusted to show spending for the low-income subsidy net of premium payments. That change in presentation has no effect on the estimate of net Medicare spending in the January 2005 baseline or on the differences between the two baselines in projections of net Medicare spending.

Changes Deriving from the Final Rule for the 

Basic Benefit

In preparing its estimate of the Medicare Prescription 

Drug, Improvement, and Modernization Act of 2003 

(Medicare Modernization Act), CBO made numerous assumptions about how the legislative language would be 

implemented and how decisions about implementation 

would affect federal spending. Most of those assumptions 

were either confirmed by the final rule for the Medicare 

prescription drug program that was issued on January 28, 

2005, or, if an assumption differed from the rule, the 

change was judged not to have a substantial effect on 

CBO’s projections of spending.

One of CBO’s original assumptions, however—regarding 

the formulary requirements that plans must satisfy to be 

approved for participation in the Part D program—differs from the guidance in the final rule, resulting in an increase of $12 billion in CBO’s projection of net federal 

spending for the basic benefit over the 2006-2015 period. 

CBO had assumed that, in general, plans would be permitted to establish restrictive formularies to manage 

Total, Total, 

2005- 2005-

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

1.0 ** 1.6 1.1 1.0 1.2 2.2 1.0 2.1 2.5 3.7 6 17

1.2 0.8 2.3 2.7 0.7 -1.5 -2.1 -3.6 -2.4 -1.9 -1.4 6 -5

0 -2.3 0.8 2.7 3.3 4.7 5.6 6.8 7.3 9.3 10.8 9 49

0.3 2.5 0.8 1.1 1.3 1.5 1.7 2.2 2.4 2.8 3.1 7 20 ___ ___ ___ ___ ___ ___ ___ ___ ___ ____ ___ __ __

0.3 0.1 1.6 3.8 4.6 6.1 7.4 9.0 9.8 12.1 14.0 17 69 ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ ___ __ __

2.4 0.9 5.5 7.7 6.3 5.8 7.5 6.4 9.5 12.7 16.2 29 81

0 0.4 0 0 0 0 0 0 0 0 0 * * __ __ __ __ __ __ __ __ __ ___ ___ __ __

2.4 1.3 5.5 7.7 6.3 5.8 7.5 6.4 9.5 12.7 16.1 29 81

0 0 -0.5 -0.7 0.1 0.6 0.7 1.6 1.2 1.1 1.2 0 5

0 0.8 0.1 -0.4 -0.7 -1.1 -1.4 -1.9 -2.3 -3.1 -3.8 -1 -14

0 -0.4 0.2 0.1 0.1 ** ** -0.1 -0.1 -0.1 -0.3 0 0

_ __ __ __ __ __ __ __ __ __ __ _ __

0 0.4 -0.3 -1.0 -0.5 -0.4 -0.7 -0.3 -1.1 -2.1 -2.9 -2 -9 __ __ __ __ __ __ __ __ __ ___ ___ __ __

2.4 1.7 5.2 6.7 5.8 5.4 6.8 6.0 8.3 10.5 13.2 27 72

Difference (March minus January)

Benefits

Part A

Part B

Part D

Basic benefits

Low-income subsidy and transitional assistancea

Subtotal, Part D

Subtotal, benefits

Other Mandatory

Subtotal, gross mandatory

Subtotal, offsetting receipts

Total, Net Mandatory

Offsetting Receipts

Premiums for Parts A and B 

Premiums for Part Da

Payments by states for Part D
44 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Box A-1.

Comparing CBO’s March 2005 Projection of Medicare Part D

Spending with Its Original Estimate of the Program’s Cost

In November 2003, the Congressional Budget Office (CBO) estimated that the Medicare Prescription 

Drug, Improvement, and Modernization Act of 

2003 (Medicare Modernization Act) would result in 

additional direct spending of about $395 billion over 

the 2004-2013 period. That figure, the net outcome 

of a number of different types of expenditures and 

receipts stemming from the legislation, included an 

estimated $552 billion in mandatory spending for 

Medicare Part D—$771 billion in payments for benefits and mandatory administrative costs offset by 

$219 billion in premiums paid by beneficiaries and 

payments by states. (The states’ payments represent 

part of their share of the savings from shifting some 

Medicaid spending for prescription drugs to Medicare.) Those costs were further offset by net savings 

of almost $13 billion from changes to Parts A and B 

of Medicare (Hospital Insurance and Supplementary 

Medical Insurance, respectively) and estimated savings of almost $145 billion from lower spending by 

Medicaid and other federal programs (largely from 

shifting some of their spending for prescription 

drugs to Medicare).

Since enactment of the Medicare Modernization Act, 

CBO’s baselines have included explicit projections of 

Medicare spending for the Part D program (the 

$552 billion component of the original estimate). 

CBO’s baseline projections for Parts A and B of 

Medicare and for Medicaid and other federal health 

programs incorporate the law’s effects on those programs’ spending. However, those effects—the $157 

billion of offsetting savings in the original estimate—

are not readily identifiable, and CBO does not 

project them separately. 

Net Medicare spending for the Part D program over 

the 2004-2013 period, CBO now projects, will total 

$593 billion—$41 billion more than its original estimate of $552 billion.1 That increase results from:

B Slightly higher inflation in CBO’s current economic projections, a change incorporated in its 

January 2005 baseline ($5 billion);

B Provisions in the final rule for the basic Part D 

benefit that differ from those CBO had anticipated in the original estimate ($8 billion);

B The use of new data as well as other refinements 

in CBO’s method for estimating the net cost of 

the basic benefit ($11 billion); and 

B More-current data on the characteristics of Medicare beneficiaries, the final rule governing eligibility for the low-income subsidy, and other 

revisions in the cost of the low-income subsidy 

and transitional drug assistance ($17 billion).

CBO does not separately project the offsetting savings that Medicaid and other federal programs accrue from shifting some prescription drug spending 

to Medicare. Those savings, however, are likely to be 

larger than CBO’s original estimate of $145 billion—both because of CBO’s projection of higher 

inflation and because its current estimate of the 

number of Medicare beneficiaries who are enrolled 

in Medicaid is larger than its previous projection. 

Thus, CBO projects that over the 2004-2013 period, the increase (relative to CBO’s original estimate) in the cost of establishing the Part D program 

will probably be less than $41 billion.

1. See the Congressional Budget Office’s letter to the Honorable Joe Barton regarding updated estimates of spending for 

the Medicare prescription drug program (March 4, 2005), 

available at www.cbo.gov/ftpdocs/61xx/doc6139/03-04-

BartonMedicare.pdf.
APPENDIX A CHANGES IN CBO’S PROJECTIONS OF MEDICARE SPENDING FOR 2005 TO 2015 45

spending. However, the guidance regarding the formulary 

makes it clear that the Secretary of Health and Human 

Services will rely heavily on a comparison of a plan’s proposed formulary with “industry best practices” in deciding whether to approve the plan’s application. As a result, 

CBO now expects that prescription drug plans will be 

slightly less effective in controlling drug spending than it 

had previously assumed.

Changes from Methodological Refinements

In the two years that have passed since its original estimate of the Part D benefit, CBO has reviewed and refined the methods it used in that analysis and incorporated survey and program data that have become 

available. As a result, CBO has revised its estimate of how 

much plans will incur in administrative costs. That 

change increased the projection of net federal spending 

for the basic benefit by $20 billion over the 2006-2015 

period.

CBO has also made several other revisions to its projections of spending for the basic benefit. On the basis of information furnished by sponsors of retiree health benefits, it has reduced its projection of the number of 

beneficiaries who will be covered by plans in the alternative subsidy program and correspondingly increased its 

projection of the number who will receive Part D benefits 

through qualified prescription drug or Medicare Advantage plans. Overall, the budgetary effects of those other 

revisions are largely offsetting. 

Changes Related to the Low-Income Subsidy 

CBO has also reviewed and refined the methods it used 

to prepare the original estimate of the low-income subsidy component of the Part D benefit, incorporating new 

data and modifying its estimate to reflect the final rule. 

The combined effect of those revisions to CBO’s estimate 

of federal spending for the subsidy over the 2006-2015 

period is an increase of $23 billion, resulting from:

B A reduction in the lag between when costs are incurred and outlays are made ($6.5 billion);

B Provisions in the final rule regarding how family size 

will be determined for individuals who apply for the 

low-income subsidy, in combination with refinements 

in estimating methods ($6.5 billion); and

B The incorporation of new income and population 

data in conjunction with changes in CBO’s estimates 

of the costs of the basic benefit ($10 billion).

Payment Lag. CBO’s original estimate of the cost of the 

low-income subsidy incorporated the assumption that the 

average lag between when services were furnished and 

when payment was made would be similar to the threemonth delay that is typical for many Medicaid services. 

CBO now expects that lag to be one month or less. As a 

result, about $6.5 billion in spending that CBO had previously assumed would occur in 2016 will be brought inside the 2006-2015 period, and some spending from each 

year will be moved into the preceding year.

Rules for Determining Family Size and Counting Income. 

To qualify for the low-income subsidy, a Medicare beneficiary’s income must fall below a certain percentage of the 

federal poverty level, which in turn varies by family size. 

In counting income, the Medicare Modernization Act requires that the low-income subsidy program use the same 

method as that used in the Supplemental Security Income (SSI) program. CBO had assumed, in estimating 

the cost of the low-income subsidy, that all applicants 

would be classified as individuals or couples—as they are 

in the SSI program. However, the final rule includes dependents in the determination of family size. At the same 

time, the rule excludes any income from those dependents from the calculation of family income. The rule’s 

treatment of dependents will raise the relevant federal 

poverty level for some applicants and allow more people 

to qualify for the low-income subsidy. That provision, in 

combination with other refinements in estimating the 

number of individuals who qualify for the low-income 

subsidy, resulted in a $6.5 billion increase in CBO’s projection of that subsidy’s costs.

Other Changes. CBO has updated its projections of participation in Medicaid and in the low-income subsidy 

program to take account of new data. Those changes, in 

conjunction with the effects on estimated spending for 

the subsidy program resulting from revised projections of 

the cost of the basic benefit, raised CBO’s estimate of the 

subsidy’s costs by $10 billion. Two revisions based on new 

data account for most of that increase. 

The available information now indicates that more Medicare beneficiaries have enrolled in Medicaid in recent 

years than CBO had expected. As a result, in projecting 

both Medicaid and Medicare spending, CBO has in-
46 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

creased the number of Medicare beneficiaries who are estimated to have some form of Medicaid coverage. (Those 

individuals will be automatically enrolled in the low-income subsidy program.) Also contributing to the hike in 

CBO’s projection of the number of individuals eligible 

for the subsidy are new data indicating that low-income 

Medicare beneficiaries have fewer liquid assets than CBO 

had assumed. Accordingly, CBO has increased its projection of the proportion of beneficiaries in the Part D program who will participate in the low-income subsidy program by 2015 from 26 percent to 27.5 percent.

Regional Preferred Provider

Organizations Under Medicare

Advantage

CBO has raised its projection of Medicare spending by 

$6 billion over the 2006-2015 period as a result of its reassessment of the regional PPO component of the Medicare Advantage program, which is due to be implemented 

in 2006. Previously, CBO had assumed that PPOs would 

not be financially viable in most areas of the country.3

However, on the basis of the final rule for the Medicare 

Advantage program (published on January 28, 2005), 

CBO has revised its assessment of the likelihood that 

PPOs will participate in that program on a regional basis. 

The final rule establishes formulas for geographic adjustment of the amounts paid to PPOs that will result in payment rates in many regions that are substantially higher 

than CBO had anticipated. 

As a result, CBO now expects that regional PPOs will be 

financially viable in much of the country and has increased its projection of the number of Medicare beneficiaries who will be enrolled in Medicare Advantage plans. 

In 2004, 4.7 million beneficiaries (11.5 percent of Part A 

enrollees) were enrolled in such plans; CBO now projects 

that the share of beneficiaries enrolled in them will grow 

to 16 percent by 2011 and then stabilize. (Previously, 

CBO had projected that enrollment in Medicare Advantage plans would remain relatively stable at about 12 percent of Part A enrollees.) That additional enrollment in 

regional PPOs results in higher projected Medicare 

spending because Medicare’s payments for beneficiaries 

who enroll in regional PPOs will be larger than its payments for those same beneficiaries if they remain in the 

fee-for-service sector.

3. See Congressional Budget Office, CBO’s Analysis of Regional Preferred Provider Organizations Under the Medicare Modernization 

Act (October 2004).
B

The Administration’s Proposal for

Individual Social Security Accounts

In February, the Administration proposed introducing 

voluntary individual accounts into the Social Security 

system.1

 Under that proposal, workers would be able to 

redirect part of their payroll taxes into an account, and 

their retirement benefits would be reduced proportionally. The Administration suggested that the proposal 

would be part of a more comprehensive Social Security 

plan, but it has not yet identified other specific changes. 

Thus, the budgetary and economic impact of the overall 

plan cannot be estimated. In isolation, the provision for 

individual accounts could increase federal outlays by a 

total of almost $1 trillion from 2009 through 2015 if all 

workers chose to participate, but actual outlays would

depend on the extent of participation.

Overview of the Account Proposal

Beginning in 2009, workers born in 1950 or later would 

be allowed to redirect 4 percentage points of the overall 

12.4 percent Social Security payroll tax to an individual 

account, up to a maximum dollar limit.2 That contribution limit would be $1,000 in 2009 and then increase by 

$100 per year plus the growth in average annual wages. 

Investment options and program management for the 

accounts would be similar to those used in the federal 

employees’ Thrift Savings Plan, which offers a limited 

number of broad stock and bond index funds.

Investments in the accounts would be recorded in the 

federal budget as outlays, because the receipts from the 

designated payroll taxes would be paid into people’s investment accounts instead of remaining in the Treasury. 

If everyone eligible for an account took part in the program, those additional outlays would total $969 billion 

(not including any administrative costs) over the 2009-

2015 period, the Congressional Budget Office (CBO) 

estimates. If two-thirds of eligible workers participated, 

the impact over that period would fall to $646 billion 

(see Table B-1).3

 Should only one-third of eligible workers choose to participate, the impact would fall to $323 

billion. 

Factors Affecting Participation

The actual level of participation in an individual-account 

program would depend on the provisions of the complete 

proposal, including details about implementation of the 

accounts, the resulting value that workers would place on 

the accounts, and any changes to the traditional Social 

Security system. 

Workers would base their decisions on a comparison of 

the benefits of having or not having an individual account. Under the Administration’s proposal, the benefits 

from participating in the account program would be uncertain. Participants would forgo part of their traditional 

retirement benefits, so total benefits would be dependent 

on the returns earned by their account. Thus, participaAPPENDIX

1. Although the President’s budget did not formally include a proposal for individual Social Security accounts, the Administration 

released a general description of such a proposal (Strengthening 

Social Security for the 21st Century, February 2005). Further details 

were included in a February 3 memo from Stephen Goss, Chief 

Actuary of the Social Security Administration, to Charles Blahous, 

Special Assistant to the President for Economic Policy.

2. In 2009, only people born between 1950 and 1965 would be eligible to participate. In 2010, eligibility would be expanded to people born through 1978; and beginning in 2011, anyone born in 

1950 or later could participate.

3. The Social Security actuaries estimate that total costs would be 

$671 billion through calendar year 2015 if two-thirds of eligible 

workers participated.
48 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Table B-1.

The Budgetary Impact of Individual Social Security Accounts

(Billions of dollars)

Source: Congressional Budget Office.

tion would be affected by the size of the reduction (or 

“offset”) in traditional benefits. The larger that offset, the 

less likely workers would be to take part. The offset envisioned in the President’s proposal is based on a real (afterinflation) return of 3 percent. If account holders realized 

a higher rate of return, their total retirement benefits 

would be larger; if they realized a lower return, their total 

benefits would generally be smaller.

A central issue is the role of investment returns in such 

accounts. On the basis of historical patterns and likely 

future economic conditions, CBO assumes that the real 

return on Treasury securities will average 3.3 percent in 

the future, whereas the comparable return on stocks will 

average 6.8 percent. But stocks also carry higher risk. 

When choosing investments, investors evaluate the opportunities for low returns (and low risk) versus higher 

returns (and higher risk) and select a balance of stocks 

and bonds that suits their individual tolerance for risk. 

Investors who have a very high tolerance for risk purchase 

mostly stocks; others are willing to accept a lower expected return in exchange for the relative safety of bonds. 

In the process, investors’ purchases reveal their current 

valuation of potential future returns and risks. The market prices of stocks and bonds indicate how those securities are valued by investors, including individuals and 

pension funds.

The fact that the market value of $100 worth of bonds 

and $100 worth of stocks is identical means that investors 

value the net effect of the higher risk and return of stocks 

as equal to the lower risk and return of bonds. For that 

reason, one can use the expected return on government 

bonds as a guide to the current value of an account that 

would influence a typical worker’s decision about

participation.

Many other factors, however, would also affect participation decisions:

B Interactions with the traditional benefit structure. The 

offset included in the Administration’s proposal would 

reduce traditional retirement benefits on the basis of 

contributions to an account. If all else was equal, that 

provision would make the accounts less attractive and 

reduce participation. However, if changes to the Social 

Security system significantly lowered traditional benefits, the maximum benefit offset might be smaller, encouraging participation.

B Rules for inheritance. Allowing workers to include part 

or all of an individual account in their estate would 

encourage participation, especially if they could 

choose to leave their balance to their heirs without 

having their traditional Social Security benefits offset, 

as would occur if they drew from the account directly.

B Guaranteed returns. If the government guaranteed that 

the accounts would earn a certain return, more workers would participate.

B Tax treatment. If the returns in the accounts were taxed 

at a lower rate than other investments, participation 

would rise.

B Timing of withdrawals. Allowing participants to have 

flexibility in when they could make withdrawals from 

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Total, 

2006- 

2015

Share of Eligible 

Workers Participating

All 0 0 0 36 88 132 155 171 186 201 969

Two-thirds 0 0 0 24 59 88 103 114 124 134 646

One-third 0 0 0 12 29 44 52 57 62 67 323

None 0 0 0 0 0 0 0 0 0 0 0
APPENDIX B THE ADMINISTRATION’S PROPOSAL FOR INDIVIDUAL SOCIAL SECURITY ACCOUNTS 49

their account would encourage participation, especially if it gave people the opportunity to leave larger 

estates.

B Automatic enrollment. Participation rates would be 

sensitive to the administrative structure of the accounts. If workers were automatically enrolled, participation would be higher than if enrollment required 

some action on their part.

C

The Potential Economic Effects of Selected

Tax Proposals in the President’s 2006 Budget

Three provisions of the President’s 2006 budget—

the proposals to extend dividend and capital gains tax 

rates under the Jobs and Growth Tax Relief Reconciliation Act (JGTRRA) beyond 2008, to expand the availability of tax-free savings accounts, and to extend the repeal of the estate tax—have especially complex economic 

effects. Discussed below are the factors that the Congressional Budget Office (CBO) considered and the methods 

it used in assessing those impacts. (CBO’s analysis of the 

overall economic effects of the President’s budgetary proposals is described in Chapter 2.) 

Extend JGTRRA’s Dividend and 

Capital Gains Tax Rates

In 2003, JGTRRA reduced the tax rates applicable to 

both dividends and capital gains for 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 ordinary income—ranging from 10 percent to 35 percent—and 

most capital gains were subject to rates of 8 percent, 10 

percent, or 20 percent. The President, in his 2006 budget, is proposing to make the zero and 15 percent rates 

permanent.

Such reduced rates lower the overall taxation of corporate 

profits. Some corporate profits 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 reinvesting of its profits—on sales of stock. 

Lowering the tax rates that individuals face on the two 

types of income reduces the total rate of taxation. 

JGTRRA’s tax rates not only reduced the taxation of corporate income but also decreased 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 the tax rates on dividends and capital gains under 

JGTRRA. However, the currently short duration of those 

rates lessens their effect on investment and the capital 

stock. Investments in productive capital take time to implement, and firms are unlikely to adjust their long-term 

investment plans fully in response to temporary changes 

in dividend and capital gains taxation. Thus, some portion of the impact of the current rates can be expected to 

occur only if the proposed extension of those rates takes 

effect. 

One such impact 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 the reduction in the cost 

of capital will reflect only the decrease in taxes on capital 

gains. Others hold that the reduction will reflect the fall 

in taxes on both gains and dividends.1

Corresponding to the disagreement among analysts about 

the size of the drop in the cost of capital is a difference of 

opinion about how much the values of firms’ stock might 

APPENDIX

1. See George R. Zodrow, “On the ‘Traditional’ and ‘New’ Views of 

Dividend Taxation,” National Tax Journal, vol. 44, no. 4, part 2 

(December 1991), pp. 497-509.
52 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

rise. (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 a middle-ground estimate 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 consumption 

among shareholders (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 lowering saving and investment. 

Another impact of extending the rates on capital gains 

and dividends is that it is 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 housing “services” provided by owner-occupied 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 smallbusiness 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. 

Yet another impact of the proposal is that it would affect 

firms’ financial behavior in two ways: it would make equity financing more attractive relative to debt financing, 

and it would make the payment of dividends more attractive relative to the retention of earnings. Currently, firms 

can 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 (equity financing), 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 could 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 on 

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. That lessening of the proposal’s impact on equity financing would be intensified 

by the combined effect of the two policies in increasing 

the proportion of interest-bearing assets in tax-free accounts: the incentive to hold equities 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, CBO estimated the proposal’s 

effect on the cost of capital in different sectors of the 

economy and on the values of stock shares under the assumption that both investors and businesses would be 

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 take account of the effect of the reallocation of 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 added an average of 0.07 percent over the 2006-

2015 period to the proposal’s projected effect on gross 

domestic product in the models.

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 C THE POTENTIAL ECONOMIC EFFECTS OF SELECTED TAX PROPOSALS IN THE PRESIDENT’S 2006 BUDGET 53

Expand Tax-Free Savings Accounts

The President’s 2006 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 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, through 2015. Most taxpayers 

would simply save the same amount 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 cash from the sale 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 2015, the effects of the proposal could be greater 

than those just described (because more and more taxpayers would run out of assets that could be shifted). In those 

years, CBO estimates, the proposal would have a modestly positive impact on saving. 

Extend the Repeal of the Estate Tax

The President’s proposal to extend the repeal of the estate 

tax beyond the end of 2010 (its scheduled expiration 

date) could have varying effects on consumption and saving, depending on people’s motives for leaving bequests. 

There is little consensus about which motives predominate or even about whether bequests are typically the result of a deliberate saving plan. If they are not, the repeal 

of the estate tax will not encourage saving. Moreover, analysts who believe that estate taxes affect consumption 

and saving disagree about the direction of that 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 leave the same after-tax bequest with a smaller amount of savings, which might induce them to save less. Furthermore, to the extent that a 

lower estate tax increased the size of bequests after taxes, 

potential recipients might 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 there is little evidence to support that

contention.

The models CBO used to estimate the effect 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 That assumption implies that the extension of the repeal will reduce the capital stock but by an 

amount too small to affect the estimates presented in 

Chapter 2 of this report. Alternative assumptions that 

CBO considered—for example, that the positive effect 

on 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 consumption would increase by only a small 

amount because recipients of larger 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.

D

The Models Used to Analyze the 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 2006 to 2015: 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.) 

The textbook growth model, which CBO uses to project 

the economy’s potential output for the agency’s 10-year 

economic baseline, is an enhanced version of a model developed by Robert Solow, a pioneer in the theory of 

growth accounting.1 The textbook growth model assumes 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; people 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 demandside, 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 of the changes in 

marginal tax rates specified in the President’s budget on 

the number of hours worked. (CBO estimated the taxrate effects in a separate calculation.) Those effects are 

greatest from 2011 through 2015, when lower marginal 

tax rates would increase the supply of labor relative to the 

level in CBO’s baseline. 

The President’s budgetary proposals are estimated to have 

a negative effect on the capital stock in the textbook 

growth model. The proposals would increase after-tax income relative to that in the baseline, which would lead to 

increased private consumption that crowded 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, for which the model includes 

assumptions based on past relationships. First, the increase in private consumption is moderated by the assumption that people increase their private saving by 40 

cents for every dollar that the deficit increases. Second, 

for every dollar that national saving falls (national saving 

equals private plus government saving), the amount of 

foreign capital invested in the United States is assumed to 

increase by 40 cents. 

The life-cycle and infinite-horizon growth models that 

CBO also used in its supply-side analysis differ in fundamental ways from the textbook growth model.2

 The lifecycle and infinite-horizon models incorporate simulated 

people who make decisions about how much to work and 

save in order to make themselves as well off as possible 

over their lifetime. Their behavior is calibrated so that 

macroeconomic variables such as the total amount of labor supplied and the size of the capital stock match the 

APPENDIX

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).

2. For a detailed description of the life-cycle model, see Shinichi 

Nishiyama, Analyzing Tax Policy Changes Using a Stochastic OLG 

Model with Heterogeneous Households, Technical Paper 2003-12 

(December 2003). For a detailed description of the infinitehorizon model, see Tracy Foertsch, Macroeconomic Impacts of Stylized Tax Cuts in an Intertemporal Computable General Equilibrium 

Model, Technical Paper 2004-11 (August 2004).
56 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

levels that occur in the U.S. economy. In the life-cycle 

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 saving. 

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 possible assumptions 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 

2015 (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 the higher deficits. 

Assumptions about how and when to offset the bill that 

comes due can influence the estimated economic effects 

of the President’s proposed policies over the 2006-2015 

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 2015: either marginal tax rates would be increased, 

or government consumption of goods and services 

(which the models assume does not enhance people’s 

well-being) and transfer payments would be cut. The size 

of the cuts in those two categories that the models incorporate is proportional to the relative size of transfer payments and government consumption in CBO’s baseline 

for 2015, an assumption that implies that the cuts would 

be roughly equal. Both the increase in marginal tax rates 

and the cuts in government consumption and transfers 

are assumed to 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 on themselves and not on 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. That 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 expectation implies that a belief that taxes will increase in 

the future has a greater effect on their current work and 

saving than it does on the corresponding variables for 

people in the life-cycle model. For that reason, the most 

positive estimates of the effect of the President’s budget 

on the economy within the current budget window 

(2006 through 2015) are produced by the infinitehorizon model using the assumption of future tax increases. 

CBO used two different assumptions in the life-cycle 

model about how open the economy is to flows of capital 

3. See Joseph G. Altonji, Fumio Hayashi, and Laurence Kotlikoff, 

“Risk Sharing Between and Within Families,” Econometrica, 

vol. 64, no. 2 (March 1996), pp. 261-294; Paul Evans, “Consumers Are Not Ricardian: Evidence from Nineteen Countries,” Economic Inquiry, vol. 31, no. 4 (October 1993), pp. 534-548; 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 D THE MODELS USED TO ANALYZE THE MACROECONOMIC EFFECTS OF THE PRESIDENT’S BUDGET 57

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 although it is relatively open to investment, it is so large 

that it can influence world interest rates.

E

Contributors to the Revenue

and Spending Projections

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

Revenue Projections

Annabelle Bartsch Customs duties, miscellaneous receipts

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 Corporate income taxes

Rob McClelland Estate and gift taxes

Larry Ozanne Capital gains realizations

Monisha Primlani Individual income taxes

Kurt Seibert Earned income tax credit

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 (Navy weapons, missile defenses, stockpile sales, atomic energy 

defense)

Sarah Jennings Military retirement, veterans’ education

APPENDIX
60 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

David Newman Defense (infrastructure and procurement, military activities in Iraq and 

Afghanistan and for the war on terrorism)

Sam Papenfuss Veterans’ health care, military health care

Michelle Patterson Defense (military personnel)

Jason Wheelock Defense (military activities in Iraq and Afghanistan and for the war on 

terrorism, other programs), intelligence programs, radiation exposure compensation, Department of Energy employees’ occupational 

illness compensation

Joseph Whitehill International affairs (development, security, international financial 

institutions)

Dwayne Wright Veterans’ compensation and pensions

Health

Tom Bradley Unit Chief

Niall Brennan Medicare

Julia Christensen Federal Employees Health Benefits program, Public Health Service

Jeanne De Sa Medicaid, State Children’s Health Insurance Program

Phil Ellis Medicare

Tim Gronniger Medicare

Lyle Nelson Medicare

Eric Rollins Medicaid, State Children’s Health Insurance Program

Shinobu Suzuki Medicare

Christopher Topoleski 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

Kathleen FitzGerald Food Stamps and nutrition programs, child and family services

Geoffrey Gerhardt Federal civilian retirement, Pension Benefit Guaranty Corporation, 

Supplemental Security Income, Railroad Retirement

Justin Humphrey Elementary and secondary education, Pell grants

Deborah Kalcevic Education

Matthew Kapuscinski Low Income Home Energy Assistance Program, refugee assistance

Chad Newcomb Social Security

Kathy Ruffing Social Security

Christina Hawley Sadoti Unemployment insurance, training programs, Administration on 

Aging, foster care, Smithsonian, arts and humanities
APPENDIX E 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

Rachel Milberg Highways, Amtrak, mass transit

Matthew Pickford General government

Deborah Reis Recreation, water transportation, community development, other 

natural resources, legislative branch, conservation and land 

management

Lanette Walker Justice, regional development

Gregory Waring Air transportation, justice, regional development

Michael Waters Science and space exploration, Bureau of Indian Affairs

Melissa Zimmerman Commerce, Small Business Administration, Universal Service Fund

Other

Janet Airis Unit Chief, Scorekeeping

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, Agriculture)

Kenneth Farris Computer support

Mary Froehlich Computer support

Ann Futrell Other interest, report coordinator

Ellen Hays Federal pay, report coordinator

Catherine Little Appropriation bills (Transportation-Treasury-HUD, military quality of 

life and veterans’ affairs)

Virginia Myers Appropriation bills (Commerce-State-Justice, energy and water)

Jennifer Reynolds Appropriation bills (Defense, foreign relations)

Eric Schatten Interest on the public debt, report coordinator

Robert Sempsey Appropriation bills (Labor-HHS, Homeland Security)
62 AN ANALYSIS OF THE PRESIDENT’S BUDGETARY PROPOSALS FOR FISCAL YEAR 2006

Gerard Trimarco Other interest, report coordinator

Patrice Watson Database system administrator