CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE FEBRUARY 1985

An Analysis of the President's

Budgetary Proposals for Fiscal Year 1986

Prepared at the Request of the

Senate Committee on Appropriations

NOTICE

This Document is Not Available

for Public Release Until

2 p.m. (EST)

Wednesday, February 27, 1985
AN ANALYSIS OF THE PRESIDENT'S

BUDGETARY PROPOSALS

FOR FISCAL YEAR 1986

The Congress of the United States

Congressional Budget Office
._J_tJL__

Unless otherwise noted, all years referred to in this

report are fiscal years.

Details in the text, tables, and figures of this report

may not add to the totals because of rounding.
PREFACE

This analysis of the President's budget for fiscal year 1986 was prepared at

the request of the Senate Committee on Appropriations. The report discusses the President's policy proposals in terms of changes from the Congressional Budget Office (CBO) baseline budget projections for 1986-1990.

It provides estimates of the budgetary impact of the Administration's proposals using CBO's economic assumptions and technical estimating methods.

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

Analysis, and Tax Analysis Divisions under the supervision of James L.

Blum, William J. Beeman, and Rosemary D. Marcuss, respectively. Paul Van

de Water was responsible for the Summary; Frederick C. Ribe for Chapter I;

Rosemary D. Marcuss for Chapter II; Michael A. Miller for Chapter HI;

Charles E. Seagrave for Chapter IV; Robert A. Sunshine for Chapter V;

Kathy A. Ruffing for Chapter VI; and Richard P. Emery for Chapter VII.

Principal contributors are listed in Appendix C.

Paul L. Houts supervised the editing and production of the report,

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

Johnston, Francis S. Pierce, and Sherry Snyder. Thelma L. Jones coordinated the preparation of the report. The final manuscript was prepared for

publication by Barbara Bakari, Debra M. Blagburn, Linda Brockman, Cindy

Cleveland, Mechita O. Crawford, Judith Freeman, Paula Gatens, Theresa D.

Kirkland, Dorothy J. Kornegay, and Sheri McLain.

Rudolph G. Penner

Director

February 1985

ni

TTT

CONTENTS

CHAPTER I

CHAPTER II

CHAPTER III

CHAPTER IV

SUMMARY xv

THE ADMINISTRATION'S

ECONOMIC ASSUMPTIONS 1

The Short-Run Outlook 1

Medium-Term Projections 2

Using the Economic Projections 5

THE ADMINISTRATION'S

REVENUE PROPOSALS 7

Legislative Proposals 12

Administrative Actions 20

THE ADMINISTRATION'S

DEFENSE BUDGET 21

Defense Funding Levels 23

Major Defense Proposals 28

Sources of Outlay Growth and

Potential Reductions 46

ENTITLEMENTS AND OTHER

MANDATORY SPENDING 53

Overview of Administration Proposals 53

Major Program Proposals 56
__LJL

Contents (continued)

CHAPTER V

CHAPTER VI

CHAPTER VII

APPENDIX A

APPENDIX B

APPENDIX C

NONDEFENSE DISCRETIONARY SPENDING 69

Major Spending Reductions 71

Other Spending Reductions 81

Programs Maintained or Increased 85

Impact on State and

Local Governments 88

OFFSETTING RECEIPTS AND

NET INTEREST 91

Offsetting Receipts 91

Net Interest 96

THE FEDERAL CREDIT BUDGET 101

The President's Credit Proposals in Aggregate 102

Major Program Changes Proposed

by the Administration 107

Closing Comment 119

CBO REVENUE REESTIMATES 123

CBO OUTLAY REESTIMATES 129

MAJOR CONTRIBUTORS TO THE PREPARATION OF THIS REPORT 139

VI
TABLES

SUMMARY

TABLE 1.

SUMMARY

TABLE 2.

SUMMARY

TABLE 3.

SUMMARY

TABLE 4.

TABLE 1-1.

TABLE 1-2.

TABLE II-l.

TABLE II-2.

TABLE II-3.

TABLE III-l.

TABLE III-2.

CBO BASELINE BUDGET

PROJECTIONS xvi

THE ADMINISTRATION'S

DEFICIT REDUCTION PROGRAM

AS ESTIMATED BY CBO xviii

CBO ESTIMATES OF THE

ADMINISTRATION'S SPENDING

PROGRAM BY MAJOR CATEGORY xxi

CBO AND ADMINISTRATION

ESTIMATES OF THE ADMINISTRATION'S

BUDGET PROGRAM xxiii

COMPARISON OF ADMINISTRATION

AND CBO SHORT-RUN ECONOMIC

FORECASTS 3

COMPARISON OF ADMINISTRATION AND

CBO ECONOMIC ASSUMPTIONS,

1985-1990 4

PROJECTED REVENUES UNDER THE ADMINISTRATION'S 1986 BUDGET PROPOSALS 8

ADMINISTRATION AND CBO ESTIMATES

OF ADMINISTRATION'S BUDGET

REVENUES, BY SOURCE 9

ADMINISTRATION'S REVENUE

PROPOSALS 10

CBO ESTIMATE OF THE

ADMINISTRATION'S NATIONAL

DEFENSE PROPOSALS 24

ADMINISTRATION'S DEFENSE BUDGET AS

ESTIMATED BY CBO, BY COMPONENTS 25

vn

"T II ~T
. J-J1JL

Tables (continued)

TABLE III-3.

TABLE III-4.

TABLE III-5.

TABLE III-6.

TABLE III-7.

TABLE III-8.

TABLE III-9.

TABLE 111-10.

TABLE HI-11.

TABLE 111-12.

TABLE 111-13.

REAL GROWTH IN DEFENSE

BUDGET AUTHORITY BY APPROPRIATION CATEGORIES 27

SUMMARY OF MAJOR U.S. FORCES

AND MANPOWER FOR FISCAL

YEARS 1980, 1985, AND 1986 29

REQUESTED MILITARY

STRENGTH LEVELS 30

ADMINISTRATION'S REQUEST FOR

OPERATION AND MAINTENANCE 32

REAL GROWTH IN PROCUREMENT

BUDGET AUTHORITY, BY BUDGET

ACTIVITIES 34

AIRCRAFT ACQUISITION PLANS, BY

TYPE AND SERVICE 36

STRATEGIC AND THEATER NUCLEAR

MISSILE ACQUISITION PLANS,

BY TYPE AND SERVICE 37

TACTICAL MISSILE ACQUISITION PLANS,

BY TYPE AND SERVICE 38

ARMORED COMBAT VEHICLE ACQUISITION

PLANS, BY TYPE AND SERVICE 39

ADMINISTRATION'S NAVY SHIPBUILDING

PROGRAM FOR 1986-1990 40

ADMINISTRATION'S CHANGES IN COSTS OF

MAJOR WEAPONS SYSTEMS BETWEEN FEBRUARY 1984 AND FEBRUARY 1985 ESTIMATED AND ON 1986 BUDGET EFFECT 42

vin
Tables (continued)

TABLE 111-14.

TABLE 111-15.

TABLE 111-16.

TABLE IV-1.

TABLE IV-2.

TABLE IV-3.

TABLE V-l.

TABLE V-2.

PERCENT CHANGE BETWEEN FEBRUARY 1984

AND FEBRUARY 1985 IN QUANTITY AND PROCUREMENT UNIT COST OF SELECTED

WEAPONS IN THE ADMINISTRATION'S

1986 ACQUISITION PLAN

REAL GROWTH IN BUDGET AUTHORITY

FOR RESEARCH, DEVELOPMENT, TEST,

AND EVALUATION, BY BUDGET

ACTIVITIES

COMPARISON OF THE CBO

REESTIMATE OF THE ADMINISTRATION'S 1986 DEFENSE BUDGET

WITH ALTERNATIVE BUDGET

ASSUMPTIONS

43

44

50

CBO BASELINE AND CBO ESTIMATES

OF THE ADMINISTRATION'S PROPOSED REDUCTIONS IN ENTITLEMENTS

AND OTHER MANDATORY SPENDING . 55

CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSED REDUCTIONS IN

ENTITLEMENTS AND OTHER

MANDATORY SPENDING

CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSED REDUCTIONS IN MEDICARE

57

58

CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED INCREASE OR

DECREASE IN OUTLAYS OF DISCRETIONARY PROGRAMS 72

CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED REDUCTIONS IN

NONDEFENSE DISCRETIONARY

SPENDING 73

IX
Tables (continued)

TABLE V-3.

TABLE V-4.

TABLE V-5.

TABLE VI-1.

TABLE VI-2.

TABLE VI-3.

TABLE VI-4.

TABLE VII-1.

TABLE VII-2.

TABLE VII-3.

CBO ESTIMATE OF OTHER

LARGE DISCRETIONARY SPENDING

REDUCTIONS PROPOSED BY

THE ADMINISTRATION 81

CBO ESTIMATE OF SPENDING

INCREASES OR SMALL SPENDING

REDUCTIONS PROPOSED BY THE

ADMINISTRATION 85

CBO ESTIMATE OF THE ADMINISTRATION'S OUTLAYS FOR MAJOR DISCRETIONARY GRANT PROGRAMS,

1985-1990

CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSALS FOR

OFFSETTING RECEIPTS

CBO ESTIMATES OF PROPOSED

USER FEES IN THE

ADMINISTRATION'S BUDGET ..

CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSALS FOR

NET INTEREST

CBO ESTIMATES OF FEDERAL

DEBT HELD BY THE PUBLIC .

CBO ESTIMATE OF ADMINISTRATION'S CREDIT BUDGET

PROPOSALS

89

92

93

97

99

104

IMPACT ON THE UNIFIED

BUDGET OF THE PRESIDENT'S

PROPOSED CHANGES IN

THE CREDIT BUDGET

MAJOR CHANGES IN SUBSIDIES

ESTIMATED FOR FEDERAL

CREDIT PROGRAMS

105

107
Tables (continued)

TABLE VII-4.

TABLE VII-5.

TABLE VII-6.

TABLE A-l.

TABLE A-2.

TABLE A-3.

TABLE A-4.

TABLE B-l.

TABLE B-2.

TABLE B-3.

MAJOR CHANGES IN THE

BASELINE CREDIT PROGRAM

LEVELS PROPOSED IN THE

PRESIDENT'S BUDGET 110

MAJOR CHANGES IN BASELINE

OUTLAYS FOR CREDIT PROGRAMS RESULTING FROM THE

PRESIDENT'S BUDGET 112

MAJOR CHANGES IN SUBSIDIES

ESTIMATED FOR CREDIT

PROGRAMS RESULTING FROM

THE PRESIDENT'S BUDGET 114

CBO'S REESTIMATES OF

THE ADMINISTRATION'S

BUDGET REVENUES 123

BUDGET REVENUES AS

PERCENTS OF GNP 124

CBO REVENUE REESTIMATES

REFLECTING DIFFERENT

ECONOMIC ASSUMPTIONS 125

CBO REVENUE REESTIMATES

REFLECTING TECHNICAL

ESTIMATING DIFFERENCES 127

CBO'S REESTIMATES OF THE

ADMINISTRATION'S SPENDING

PROPOSALS 129

CBO OUTLAY REESTIMATES

RESULTING FROM DIFFERENT

ECONOMIC ASSUMPTIONS 130

CBO OUTLAY REESTIMATES

RESULTING FROM TECHNICAL

ESTIMATING DIFFERENCES 132

XI

1F~T
-IllTables (continued)

TABLE B-4. CBO OUTLAY ESTIMATES FOR

DEFENSE RESEARCH, DEVELOPMENT, TEST, AND EVALUATION

BASED ON THE PRESIDENT'S

FEBRUARY BUDGET AUTHORITY

REQUEST 133

TABLE B-5. REVISIONS TO CBO BASELINE

OUTLAY PROJECTIONS 137

xn
FIGURES

SUMMARY

FIGURE 1.

SUMMARY

FIGURE 2.

FIGURE III-l.

FIGURE III-2.

FIGURE HI-3.

FIGURE V-l.

FIGURE VI-1.

THE COMPOSITION OF

FEDERAL SPENDING xxii

FEDERAL DEFICIT

PROJECTIONS xxv

COMPOSITION OF ADMINISTRATION'S REQUEST FOR

NATIONAL DEFENSE 26

SOURCES OF GROWTH IN

DEFENSE OUTLAYS,

FISCAL YEARS 1986-1990 48

SOURCES OF GROWTH IN

DEFENSE OUTLAYS,

FISCAL YEARS 1981-1985 48

NONDEFENSE DISCRETIONARY

SPENDING, 1980-1990 70

FEDERAL DEBT HELD BY

THE PUBLIC AS A PERCENTAGE OF GNP 100

xni

TTT

SUMMARY

The Administration's budget proposal for fiscal year 1986 would reduce projected deficits solely by cutting government spending. The Congressional

Budget Office (CBO) estimates that these spending reductions would total

$364 billion over the next five years. Defense spending would be increased

relative to CBO's baseline projections by $43 billion, but nondefense spending would be cut by $406 billion. The Administration proposes only minor

changes in revenues.

According to CBO's revised baseline projections, the federal budget

deficit would rise from $215 billion in 1985 to $220 billion in 1986 and $302

billion by 1990 if current spending and taxing policies were continued. Under the same economic and technical estimating assumptions, the Administration's proposals would stabilize the deficit at just under $190 billion in

the 1986-1990 period. If interest rates decline as the Administration assumes, the deficit under Presidential policies would drop to $122 billion by

1990.

THE BUDGET UNDER CURRENT POLICIES

CBO's baseline budget projections assume, for the most part, no changes in

current laws governing taxes or entitlement spending. For nondefense

spending that is discretionary and subject to annual appropriations, the baseline projections generally assume that the 1985 appropriation levels will be

increased to keep pace with inflation. For defense spending, an extrapolation of the 1985 Congressional budget resolution is used as the best approximation of current policy. Thus, the baseline projections are not forecasts of

future federal budgets, since those budgets will doubtless include numerous

policy changes. The projections are, however, a benchmark against which

proposed policy changes may be measured.

Summary Table 1 shows the latest CBO baseline budget projections.

The outlay and deficit projections are slight upward revisions of those pubXV

~n~ir~r
.__LJJJ

lished earlier this month and reflect additional information about spending

patterns gleaned from the President's budget. Most of the changes in the

projections are for public enterprise funds—such as the Agricultural Credit

Insurance Fund, Rural Housing Insurance Fund, Postal Service Fund, LowRent Public Housing Loan Fund, and Loan Guaranty Revolving Fund—where

the Executive Branch has considerable freedom of action in administering

the programs.

In relation to gross national product, baseline deficits are roughly

stable—at about 5.4 percent of GNP. In dollar terms, however, the baseline

deficit rises from $220 billion in 1986 to $302 billion by 1990. With deficits

of this magnitude, federal debt held by the public would more than double

over the next six years. At the end of 1984, debt held by the public equaled

$1.3 trillion, or 37 percent of GNP. By the end of 1990, it would reach

$2.8 trillion, or 50 percent of GNP—far above its average of 28 percent of

GNP during the 1970s.

SUMMARY TABLE 1. CBO BASELINE BUDGET PROJECTIONS

(By fiscal year) a/

1985 1986 1987 1988 1989 1990

Revenues

Outlays b/

Deficit b/

Debt Held by the Public

In Billions of Dollars

735 788 855 934 1,005 1,088

950 1,008 1,095 1,191 1,284 1,390

215 220 240 257 280 302

1,526 1,745 1,984 2,240 2,519 2,820

As a Percent of GNP

Revenues

Outlays b/

Deficit b/

Debt Held by the Public

19.1

24.6

5.6

39.6

19.0

24.2

5.3

42.0

19.1

24.4

5.4

44.3

19.3

24.7

5.3

46.4

19.3

24.7

5.4

48.4

19.4

24.8

5.4

50.3

a. The baseline figures are revisions of those appearing in Congressional

Budget Office, The Economic and Budget Outlook; Fiscal Years 1986-

1990 (February 1985).

b. Includes programs that are off-budget under current law.

xvi
For comparability with Administration estimates, the baseline projections of outlays and the deficit include spending that is off-budget under

current law. The Administration is proposing that programs currently excluded from the unified budget be included in the budget totals. Like the

unified budget deficit, the outlays of these off-budget entities must be

financed by borrowing from the public. The Congressional Budget Office

has long supported a comprehensive federal budget because it portrays most

accurately the economic importance of government activities and gives

policymakers the greatest control over spending and tax policies.

THE ADMINISTRATION'S BUDGET PROGRAM

The Administration's 1986 budget continues the current trends toward higher

defense and lower nondefense spending. The proposed reductions in nondefense outlays are similar in size to those requested by President Reagan in

1981, and are greater than those requested in any year since. Moreover, the

reductions generally consist of specific proposals and do not include, as in

past years, unspecified future reductions or management savings targets.

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

in Summary Table 2. Over the 1986-1990 period, revenues would be within

$4 billion of the CBO baseline. The proposed outlay changes, however,

would reduce spending by $364 billion. This reduction is the net effect of

$43 billion in defense spending increases, $363 billion in cuts in nondefense

spending programs, and a $43 billion reduction in net interest costs resulting

from the other spending changes. The proposed reductions in nondefense

programs consist of:

o $144 billion in reductions in entitlement programs. The largest

reductions—$44 billion—would be targeted on Medicare and Medicaid. Farm price supports would be cut by $32 billion, general

revenue sharing by $24 billion, and federal employee retirement

by $12 billion. No reductions are proposed in Social Security, unemployment insurance, or veterans' benefits. Only small cuts

would be made in means-tested, income-transfer programs.

o $187 billion in lower nondefense discretionary spending. Fifty

percent of these cuts can be found in only six areas—$39 billion

from eliminating most direct loans by the Farmers Home Administration, $19 billion from lower civilian agency pay, $14 billion

from reduced housing subsidies, $9 billion from halving urban mass

transit assistance, $8 billion from ceasing to add oil to the

Strategic Petroleum Reserve, and $7 billion from eliminating

xvn

"TTT"
SUMMARY TABLE 2. THE ADMINISTRATION'S DEFICIT REDUCTION

PROGRAM AS ESTIMATED BY CBO

(By fiscal year, in billions of dollars)

1986 1987 1988 1989

Cumulative

1990 Five-Year

Total

CBO Baseline Deficit a/ 220 240 257 280 302 1,299

Policy Changes

Revenues b/ -1 1 c/ -2 -2 -4

Outlays

National defense 2 6 11 12

Entitlements and other

mandatory spending -14 -23 -31 -36

Nondefense discretionary

10 43

-40 -144

spending a/

Offsetting receipts

Net interest

Subtotal, outlays

Total Policy Changes

President's Budget as

Estimated by CBO a/

a.

b.

Includes programs that

Revenue increases are

-17

-4

£/

-33

-33

186

-32

-5

-3

-56

-55

185

are off-budget

shown

-39

-6

-7

-71

-71

186

-46

-8

-13

-91

-93

187

-53

-9

-21

-113

-116

187

-187

-32

-43

-364

-368

930

under current law.

with minus signsi because tlhey reduce the

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

the deficit.

c. Less than $500 million.

xvni
Export-Import Bank direct lending. Another 20 percent of the

savings would be achieved in student financial aid, training and

employment assistance, highway grants, small business and rural

electric loans, health research, and subsidies to Amtrak and the

Postal Service.

o $32 billion in increased offsetting receipts. One-third of this

increase would come from fees charged to users of government

services such as inland waterways, deep-draft ports, customs inspections, nonemergency boating assistance, and meat inspection.

Another third of the increased receipts comes from increasing the

premiums charged to participants in Supplementary Medical Insurance (Part B of Medicare). Other proposals include increases in

Postal Service payments for employee retirement and the sale of

Small Business Administration loan assets and the Conrail system.

The Administration's proposed revenue and spending changes are described

in detail and analyzed in Chapters II through VI of this report.

The Administration proposes particularly deep cuts in federal credit

programs and in grants to state and local governments. Over the 1986-1990

period, subsidized lending by the Farmers Home Administration, Rural

Electrification Administration, Export-Import Bank, Small Business Administration, and other agencies would be cut by $80 billion. The savings in

credit subsidy costs would be $48 billion. The Administration contends that

borrowers under these programs can find alternative sources of credit and

that credit subsidies drive up the interest costs of nonsubsidized borrowers.

Chapter VII reviews the credit budget in detail.

Grants to state and local governments would be cut by roughly $105

billion. Programs targeted for cuts are revenue sharing and other general

purpose fiscal assistance, Medicaid and public assistance, highways and mass

transit, education and social services, community development, and sewage

treatment plant construction. The Administration argues that many of the

programs provide only local benefits and should not be subsidized by the

national taxpayer. It also points to the relatively favorable fiscal position

of states and localities vis-a-vis the federal government. Under the Administration's proposals, federal grants would represent 1.9 percent of GNP in

1990, as compared with 2.7 percent of GNP in 1985, and 3.6 percent of GNP

as recently as 1980.

Altogether, nondefense discretionary spending over the 1986-1990

period would be cut 19 percent from CBO baseline levels, while the entitlement reductions represent only 6 percent of that category. Excluding Social

Security and Medicare benefits, however, entitlements would be cut by

xix

~TTT
LJJJ

12 percent. The proposed increase in defense spending and the cuts in nondefense spending would change the composition of federal spending as set

out in Summary Table 3 and Summary Figure 1. Defense spending would

grow from $253 billion in 1985 to $435 billion in 1990 and would reach 7.8

percent of GNP, about the same level as in 1965. Nondefense discretionary

spending, which is already slightly below its 1965 level, would shrink from

its current 4.6 percent of GNP to 2.9 percent of GNP in 1990. Social Security and Medicare benefits would remain a roughly constant share of GNP,

but the projected decline in other entitlements and mandatory spending

would be accelerated.

CBO's spending reduction estimates are substantially lower than those

of the Administration—$33 billion instead of $51 billion in 1986 and $364

billion instead of $507 billion over the 1986-1990 period. Of the $143 billion

cumulative difference, $113 billion is definitional and results from using alternative baseline concepts for national defense. As noted earlier, CBO

uses the appropriation targets in the most recent Congressional budget resolution (extrapolated from 1988 to 1990) as its defense baseline; defense outlays are estimated consistently with the assumed budget authority using

CBO technical estimating methods. In contrast, the Administration measures its defense policy changes from the outlays in the Administration's

August 1984 mid-session budget review. The remaining discrepancy of $30

billion in cumulative savings represents different estimates of the budgetary

effects of the Administration's proposal.

CBO BUDGET ESTIMATES

For purposes of comparability with the CBO baseline projections and with

other deficit-reduction plans, the foregoing estimates of the Administration's budget use CBO baseline economic and technical estimating assumptions. Such projections provide a basis for evaluating the initial, static

budgetary impact of the Administration's proposals, prior to considering any

changes in the economy that might result from changes in the budget. Under these assumptions, the Administration's policies would hold the deficit

virtually constant at about $186 billion each year during the 1986-1990

period. The Administration's own estimates of the deficit, however, are

substantially lower, as shown in Summary Table 4.

Almost all of the differences in budget estimates between CBO and

the Administration derive from their differing economic assumptions, which

are described in detail in Chapter I. Most of the economic differences

result, in turn, from differences in assumed interest rates, which become

quite substantial in 1989 and 1990. CBO holds real interest rates constant

xx
SUMMARY TABLE 3. CBO ESTIMATES OF THE ADMINISTRATION'S

SPENDING PROGRAM BY MAJOR CATEGORY

(By fiscal year)

1985 1986

In Billions of

National Defense

Entitlements and Other

Mandatory Spending

Social Security and

Medicare benefits

Other entitlements

Subtotal

Nondefense Discretionary a/

Net Interest

Offsetting Receipts

Total outlays a/

253

255

182

437

179

130

-48

950

284

269

162

431

167

146

-54

975

As a Percent

National Defense

Entitlements and Other

Mandatory Spending

Social Security and

Medicare benefits

Other entitlements

Subtotal

Nondefense Discretionary a/

Net Interest

Offsetting Receipts

Total outlays a/

6.6

6.6

4.7

11.3

4.6

3.4

-1.2

24.7

6.8

6.5

3.9

10.4

4.0

3.5

-1.3

23.5

1987

Dollars

319

290

166

456

162

161

-59

1,039

of GNP

7.1

6.5

3.7

10.2

3.6

3.6

-1.3

23.2

1988

358

313

167

481

164

180

-64

1,120

7.4

6.5

3.5

10.0

3.4

3.7

-1.3

23.2

1989

396

338

169

507

164

195

-68

1,193

7.6

6.5

3.2

9.7

3.2

3.7

-1.3

22.9

1990

435

365

173

538

165

212

-73

1,276

7.8

6.5

3.1

9.6

2.9

3.8

-1.3

22.8

a. Includes programs that are off-budget under current law.

xxi
Summary Figure 1.

The Composition of Federal Spending

National Defense

z

a

i 4

7.7 7.6

7.8

6.5

5.8

1965 1975 1985

-Actual Estimate

1990

CBO AdminBase- istration

line Program

Social Security and

Medicare Benefits

6.6 6.7

5.2

2.6

6.5

1965 1975 1985

' Actual

1990

Estimate CBO AdminBase- istration

line Program

Fiscal Years

Including programs that are off-budget under current law.

SOURCE: Congressional Budget Office.

Nondefense Discretionary'

5.7

4.8 4.6

3.9

2.9

1965 1975 1985 1990

_Actua| 1 Estimate <JBO AdminBase- istration

line Program

Other Entitlements and

Mandatory Spending

5.4

4.7

3.6

3.1

1965 1975 1985 1990

' Actual

J

 Estimate CBO AdminBase- istration

line Program

Fiscal Years

XX11
SUMMARY TABLE 4. CBO AND ADMINISTRATION ESTIMATES OF

THE ADMINISTRATION'S BUDGET PROGRAM

(By fiscal year, in billions of dollars)

Using CBO Technical

and Economic

Assumptions

Revenues

Outlays

Deficit

Using CBO Technical

Assumptions, Administration Interest Rates,

and Other CBO Economic Assumptions

Revenues

Outlays

Deficit

Using CBO Technical

Assumptions and

Administration

Economic Assumptions

Revenues

Outlays

Deficit

Using Administration

Technical and Economic Assumptions

Revenues

Outlays

Deficit

1985

735

950

215

735

950

215

736

950

214

737

959

222

1986

789

975

186

789

972

183

793

972

179

794

974

180

1987

855

1,039

185

855

1,034

179

864

1,033

169

862

1,027

165

1988

934

1,120

186

934

1,102

168

953

1,100

147

950

1,095

144

1989

1,007

1,193

187

1,005

1,152

147

1,029

1,148

119

1,030

1,137

107

1990

1,090

1,276

187

1,086

1,208

122

1,108

1,202

94

1,108

1,190

82

XXlll

~7~T
L L.

by convention after 1986; the three-month Treasury bill rate is a flat 8.2

percent from 1987 through 1990. In contrast, the Administration assumes

that real interest rates decline steadily after 1987; the Treasury bill rate

falls to 5.0 percent by 1990. The different patterns stem in part from the

fact that CBO assumes current budgetary policy, while the Administration

assumes deficit reductions of $368 billion from 1986 through 1990. The

difference in interest rates also reflects the Administration's lower inflation

assumptions in 1986 and later years. If the effect of Administration policies

were estimated using Administration interest rates, the projected deficit in

1990 would be $65 billion lower than the estimate assuming CBO rates.

The remaining economic differences result from the Administration's

assumption of more rapid growth in the gross national product throughout

the 1985-1990 period. The Administration's projection of nominal GNP exceeds CBO's by $21 billion in 1985, $47 billion in 1986, and an average of

$84 billion in the 1987-1990 period. These GNP differences affect revenues,

debt service costs, and, to a minor extent, non-interest outlays by a total of

$4 billion in 1986 and $28 billion in 1990.

In contrast to recent years, technical differences between CBO and

Administration budget estimates are relatively small. CBO would shave the

Administration's 1985 deficit estimate by $9 billion for technical reasons—

primarily as a result of lower spending estimates for defense, foreign military sales, nuclear waste fees, Medicare, and Social Security. By 1989 and

1990, however, technical estimating differences cause CBO's deficit projections to exceed the Administration's by $11 billion. CBO's reestimates of

the Administration's revenue and outlay figures are analyzed in Appendixes

A and B.

Summary Figure 2 illustrates the effects of the Administration's proposals and of different economic and technical assumptions on the deficit

projections. Under current budgetary policies, CBO projects that the deficit

would rise from $220 billion in 1986 to $302 billion in 1990. Under the

President's program, and using CBO technical and economic assumptions,

the deficit would be stabilized at about $186 billion. Using Administration

interest rates but other CBO assumptions, the deficit under Administration

policies would decline from $183 billion in 1986 to $122 billion by 1990.

Using Administration economic and technical assumptions, the decline in the

deficit would be even greater—from $180 billion in 1986 to $82 billion in

1990.

XXIV
Summary Figure 2.

Federal Deficit Projections

320

280

240

e 200

"5

o 160

C

O

3 120

80

40

0

CBO Baseline

Estimate of Administration

Program Using CBO Technical

and Economic Assumptions

t

Estimate of Administration

Program Using Administration

Technical and Economic

Assumptions

Administration

Policy Proposals

Interest Rate

Differences

Other Economic

and Technical

Differences

1986 1987

SOURCE: Congressional Budget Office.

1988

Fiscal Years

1989 1990

XXV

CHAPTER I

THE ADMINISTRATION'S ECONOMIC ASSUMPTIONS

Economic projections play an important role in budget estimates. Assumptions as to the rate of economic growth affect forecasts of the tax base and

of spending for certain entitlement programs. Interest-rate projections help

determine the expected levels of outlays for interest on the debt and of tax

revenues (since they affect individual and corporate incomes from financial

assets). Inflation projections are important to the estimates of federal purchases and spending on indexed programs.

This chapter briefly compares the Administration's economic projections with those of the Congressional Budget Office (CBO). The CBO

figures are used in the reestimates of the Administration's 1986 budget proposals that are presented in this volume, and also in CBO's current baseline

budget projections.

THE SHORT-RUN OUTLOOK

CBO's short-run economic forecast for 1985 and 1986 is conditional on several specific assumptions regarding policy and external developments. It

assumes that current federal spending and tax policies remain in effect. It

also assumes that the growth of the Ml monetary aggregate will be held to

5.5 percent in 1985 (the midpoint of the tentative target range announced

last July by the Federal Reserve) and to 5.0 percent in 1986. Other assumptions relate to the behavior of such factors as commodity prices and exchange rates. I/

The Administration's forecast is based on different policy assumptions

in that it assumes the implementation of proposed deficit reductions of $160

1. For a detailed discussion of CBO's forecast, see Congressional Budget

Office, The Economic and Budget Outlook; Fiscal Years 1986-1990

(February 1985).

~T~T
billion over three years. This difference in assumptions makes a noticeable

difference in the medium-term economic projections discussed elsewhere in

this chapter. The reductions would occur too late, however—both in terms

of when the legislation would be passed and when its economic effects would

be felt—to affect the short-term economic outlook significantly.

Largely for this reason, the near-term economic forecasts by the Administration and by CBO are quite similar (see Table 1-1). Both imply that

the economic expansion should continue at a healthy rate at least through

the end of 1986, without a major acceleration of inflation. The Administration projects growth in real GNP of about 4.0 percent during this period,

while CBO's forecast is below 3.5 percent. Both forecasts have the unemployment rate declining to around 7.0 percent by 1986, while inflation remains in the 4.0 percent to 4.5 percent range. The two inflation and realgrowth forecasts are close enough that the projections of nominal GNP in

1986, which include both real growth and inflation, are only 1 percent or

about $45 billion apart (CBO's is the lower of the two).

Significant short-run differences begin to appear only in the two interest-rate forecasts. Both the Administration and the CBO expect short-term

rates to remain between 8.0 percent and 8.5 percent during calendar year

1985. After that, however, the interest-rate paths in the two projections

begin to diverge. Rates rise slightly in the CBO projection, but they start to

decline in the Administration's projection. The different patterns stem in

part from the fact that CBO assumes current budget policy while the Administration assumes deficit reductions of $33 billion in fiscal year 1986.

The difference also reflects the Administration's lower forecasts of inflation

in 1986 and later years.

MEDIUM-TERM PROJECTIONS

Neither CBO nor the Administration attempts to forecast economic activity

beyond the end of 1986. Economic forecasting is highly uncertain even in

the short term, and is especially difficult over extended periods such as

those covered by longer-term budget projections. Various alternative procedures have been tried, including the use of goals or targets for the economy's performance instead of longer-term forecasts. Their results have

consistently turned out to be too optimistic. Partly for this reason, both

CBO and the Administration now generate their longer-term projections

(shown in Table 1-2) using simple rules of thumb based on historical

experience.
TABLE 1-1. COMPARISON OF ADMINISTRATION AND CBO SHORTRUN ECONOMIC FORECASTS (By calendar year)

Actual Forecast

Economic Variable 1984 1985 1986

Fourth Quarter to Fourth Quarter (percent change)

Real GNP 5.6 4.0 4.0

Administration 3.4 3.1

CBO

Nominal GNP 9.3

Administration 8.5 8.5

CBO 7.7 7.8

Consumer Price Index a/ 3.5

Administration 4.2 4.3

CBO 3.9 4.5

Calendar-Year Average (percent)

3-Month Treasury Bill Rate 9.5

Administration 8.1 7.9

CBO 8.3 8.7

Civilian Unemployment Rate 7.5

Administration b/ 7.0 6.9

CBO 7.1 6.9

SOURCE: Congressional Budget Office.

a. Urban wage and clerical workers.

b. The Administration's projection is for the total labor force including

armed forces residing in the United States, while CBO's is for the

civilian labor force excluding armed forces. In recent years, the

former has tended to be 0.1 to 0.2 percentage points below the rate

for the civilian labor force.
TABLE 1-2. COMPARISON OF ADMINISTRATION AND CBO ECONOMIC

ASSUMPTIONS, 1985-1990 (By calendar year)

Actual

1984 1985 1986 1987 1988 1989 1990

Nominal GNP

(in billions of

dollars) 3661

Administration

CBO

Real GNP (percent

change, year over

year) 6 . 8

Administration

CBO

Consumer Price

Index (percent

change, year over

year) a/ 3.4

Administration

CBO

91-Day Treasury

Bill Rate (percent) 9.5

Administration

CBO

Civilian Unemployment

Rate (percent) 7.5

Administration b/

CBO

3948

3927

3.

3.

4.

3.

8.

8.

7.

7.

9

5

1

8

1

3

0

1

4285

4238

4

3

4

4

7

8

6

6

.0

.2

.3

.5

.9

.7

.9

.9

4642

4567

4.

3.

4.

4.

7.

8.

6.

6.

0

3

2

2

2

2

6

7

5017

4921

4.

3.

3.

4.

5.

8.

6.

6.

0

4

9

2

9

2

3

6

5399

5301

3

3

3

4

5

8

6

6

.9

.4

.6

.2

.1

.2

.1

.4

5780

5711

3.6

3.4

3.3

4.2

5.0

8.2

5.8

6.2

SOURCE: Congressional Budget Office.

a. Urban wage and clerical workers.

b. The Administration's projection is for the total labor force including

armed forces residing in the United States, while CBO's is for the

civilian labor force excluding armed forces. In recent years, the

former has tended to be O.,l to 0.2 percentage points below the rate

for the civilian labor force.
The CBO projections assume that labor productivity and real GNP

grow over the entire period from the trough of the recent recession (in late

1982) through 1990 at the average rates achieved over comparable periods

during past postwar recovery-expansions. Thus, real GNP growth is in the

range of 3.3 percent to 3.4 percent during the later years of the projection

period, a pattern consistent with the projection of a gradual decline in the

unemployment rate to 6.2 percent in 1990 and with the projected inflation

rate of 4.2 percent. Because CBO assumes no change in budget policy, real

interest rates are kept constant by convention over the longer-term projection, a procedure that is reflected in the 8.2: percent Treasury bill rate.

The rules governing the Administration's longer-term projections are

somewhat different: the assumed growth rate of real output exceeds the

postwar average assumed by CBO but falls short of that achieved during the

strongest postwar expansion in 1961 through 1969. As a result, longer-term

real growth in the Administration's projection averages nearly 4.0 percent.

The Administration assumes a larger decline in unemployment than does

CBO (to 5.8 percent by 1990), a slowing in inflation to 3.3 percent, and

gradually declining real and nominal interest rates—the Treasury bill rate

falling to 5.0 percent by 1990.

USING THE ECONOMIC PROJECTIONS

Economic projections play an important role in estimating the budgetary

impacts of changes in spending and tax provisions, as this discussion has

already suggested. The projections provide a basis for evaluating the

"static" or "direct" budgetary impacts of such changes—that is, the impacts

measured before any consideration is given to changes in the economy that

might be caused by the policy changes, and to the impacts such changes in

the economy might in turn have on the budget.

Economists disagree sharply over how the economy might react to

different deficit-reducing measures. -Indeed, the ultimate effects will depend on the composition as well as the size of the policy changes. CBO's

longer-term projections therefore make no attempt to analyze the economic

impacts of budget policy changes. Instead, they provide the basis for consistent estimates of the static quantitative impacts of different proposals.

A variety of deficit-reducing proposals are expected to be put before

the Congress during the next several months, including the Administration's

proposals discussed in this volume. Since all of these proposals will have

current budget policy as their starting point, CBO's economic projection,

with its assumption of a continuation of current policy, provides a good basis

for measuring and comparing the static impacts of all the proposals.

CHAPTER

THE ADMINISTRATION'S REVENUE PROPOSALS

The Administration's fiscal year 1986 budget includes some revenue proposals that were contained in earlier budgets; and some new proposals that

would have relatively minor revenue effects. Together, the Administration's

proposals would reduce revenues slightly in 1986, 1987, and 1988 and increase them slightly in 1989 and 1990 (see Table II-l).

The CBO estimates of revenues under the Administration's budget are

lower than those of the Administration, by amounts growing from $2 billion

in 1985 to $23 billion in 1989 and $18 billion in 1990. This is because CBO

uses somewhat different assumptions in its estimates, which are described in

detail in Appendix A. A breakdown of estimated receipts by major tax

source is given in Table II-2.

The Administration describes its proposals as "primarily user fees and

trust fund reforms." Proposed reductions in income taxes slightly outweigh

proposed increases in payroll taxes, excise taxes, and fees in 1986-1988. By

1989, the tax increases dominate, adding $1 billion to receipts in that year

and $0.5 billion in 1990.

Earlier budgets proposed a higher education tax incentive, a tuition

tax credit, a revised dependent care credit, enterprise zones, and a threeyear extension of the research and experimentation (R&E) credit, which is

scheduled to expire at the end of this year. These proposals are repeated in

the current budget. Proposed increases in taxes for the Hazardous Substance Response and Black Lung Disability trust funds and additional collections from increased IRS auditing partially offset the proposed tax reductions. (For a list of all proposals, see Table II-3.)

42-72 6 O - 85 - 2 QL 3
TABLE II-l. PROJECTED REVENUES UNDER THE

ADMINISTRATION'S 1986 BUDGET PROPOSALS

(By fiscal year, in billions of dollars)

1985 1986 1987 1988 1989 1990

CBO Baseline a/ 735 788 855 934 1,005 1,088

Adjustments to CBO baseline to reflect Administration definition

of current services a/ b/ 1 1 1 1 2

Administration current

services as estimated

by CBO 735 789 856 935 1,006 1,089

Administration Proposals

Legislative proposals c/ — b/ -2 -3 -2 -2

Administrative actions b/ b/ b/ 2 3 3

Subtotal, revenue

proposals b/ b/ -1 -1 1 b/

President's Budget as

Estimated by CBO 735 789 855 934 1,007 1,090

SOURCES: Budget of the United States Government for Fiscal Year 1986

and Congressional Budget Office.

a. The CBO baseline assumes the extension of the 1.3 percent contributions to the Civil Service Retirement program paid by newly hired federal workers and the extension of the Hazardous Substance Response

Trust Fund (Superfund) taxes at current rates. The Administration current services estimates do not assume the extension of the Civil Service

Retirement adjustment. They assume extension of Superfund taxes at

higher than current rates.

b. Less than $500 million.

c. Includes net effects of proposed Superfund tax increases above current

services levels.
TABLE II-2. ADMINISTRATION AND CBO ESTIMATES OF

ADMINISTRATION'S BUDGET REVENUES, BY SOURCE

(By fiscal year, in billions of dollars)

1985 1986 1987 1988 1989 1990

Administration Estimates

Individual Income Taxes a/

Corporate Income Taxes

Social Insurance Taxes

and Contributions a/

Excise Taxes

Windfall profit taxes

Other

Other

Total

Percent of

Administration GNP

Individual Income Taxes a/

Corporate Income Taxes

Social Insurance Taxes

and Contributions a/

Excise Taxes

Windfall profit taxes

Other

Other

Total

Percent of CBO

GNP

SOURCES: Budget of the

333

66

265

7

30

35

737

19.0

CBO

333

63

266

7

31

36

735

19.1

United States

363

74

285

5

30

36

794

18.9

Estimates

361

70

285

5

30

37

789

19.0

Government

397

87

305

4

31

37

862

18.9

392

87

302

4

32

38

855

19.1

for Fiscal

439

99

341

4

30

38

950

19.3

431

95

335

4

31

39

934

19.3

Year

482

107

370

3

30

38

1,030

19.4

470

102

360

4

31

40

1,007

19.3

1986 and

520

113

401

3

31

40

1,108

19.5

513

108

391

3

32

43

1,090

19.4

Congressional Budget Office.

a. The Administration's own budget estimates include a reduction in individual income

taxes and an increase in social insurance taxes to reflect the general revenue transfer to the Social Security trust funds for the (partial) taxation of Social Security

benefits. Both the CBO and Administration estimates shown here exclude this

transfer; that is, the revenues are included in individual income taxes.
TABLE II-3. ADMINISTRATION'S REVENUE PROPOSALS

(By fiscal year, in billions of dollars)

1985 1986 1987 1988 1989 1990

Legislative Proposals

New, Revised or Extended

Tax Incentives

Education savings

accounts -- a/ -0.1 -0.3 -0.5 -0.7

Tuition tax credit ~ ~0.4 -0.6 -0.9 -0.9 -0.9

Revision in dependent care credit — a/ -0.2 -0.2 -0.2 -0.1

Enterprise zones — ~0.1 -0.5 -0.9 -1.1 -1.1

Extension of research

and experimentation credit — -0.7 -1.3 -1.5 -1.0 -0.5

Subtotal,

tax incentives — -1.2 -2.8 -3.8 -3.7 -3.3

User Fees and Other b/ ~ 0.1 0.1 0.1 0.1 0.1

Trust Fund Tax Increases

Extension and increase

in Hazardous Substance

Response Trust Fund

(Superfund) taxes c/ — 0.3 0.3 0.3 0.3 0.4

Increase in Black Lung

Disability Trust

Fund fees — 0.2 0.2 0.2 0.2 0.3

Increase in D.C. government retirement

contributions — a/ a/ a/ 0.1 0.1

SOURCE: Budget of the United States Government for Fiscal Year 1986

and the Congressional Budget Office.

a. Less than $50 million.

b. IRS user charges, Iranian claim fees, and increases in migratory birdhunting stamp fees and Department of Housing and Urban Development

mobile home inspection fees.

c. Includes net effects of proposed increases above current services levels.

(Continued)

10
TABLE II-3. (Continued)

1985 1986 1987 1988 1989 1990

Extension of unemployment insurance coverage to railroad

employees — 0.2 0.2 0.2 0.2 0.1

Subtotal,

trust funds — 0.7 0.7 0.8 0.8 0.8

Other

Taxation of Railroad

Retirement benefits

as pensions — a/ 0.1 0.1 0.1 0.1

Acceleration of

deposits of Social

Security taxes by

state and local

governments

Subtotal, other

Subtotal, Legislative

Proposals

Increase in IRS Examination Staff

Other d/

Subtotal, Administrative Actions

Total Legislative

Proposals and Administrative Actions

0.4

0.4

a/

Administrative

a/ a/

a/ a/

a/ a/

a/

0.1

-1.9

Actions

0.5

§/

0.5

-1.4

0.3

0.4

-2.6

1.5

a/

1.5

-1.1

1.2

1.2

-1.6

2.6

a/

2.6

1.0

0.2

0.2

-2.3

2.8

a/

2.8

0.5

d. Increases in fishermen's contingency fund fees and Department of

Housing and Urban Development fees on interstate land sales.

11
LEGISLATIVE PROPOSALS

Education Savings Accounts

For the third year, the Administration is proposing to exclude from taxation

the interest earnings of savings accounts earmarked for higher education.

Under this proposal, a separate account could be set up for each dependent

child under 18 years of age, with contributions permitted up to $1,000 per

child per year. The $1,000 contribution limit would decline for contributors

with adjusted gross incomes (AGIs) above $40,000 and would reach zero for

those with AGIs above $60,000. These thresholds would not be indexed for

inflation. Interest earnings would become taxable to the contributor and a

penalty would be assessed if the savings were not used for higher education

expenses before the child reached 26 years of age. Certain unspecified

exceptions would be allowed.

The revenue loss from these accounts would be small initially, but

would grow rapidly for 10 years or more as amounts deposited grew. The

Administration projects a revenue loss of about $30 million in 1986, increasing to about $700 million in 1990. By the mid-1990s revenue reductions

from such accounts could equal $2 billion per year.

Several bills permitting education savings accounts (S. 1489, H.R. 919,

H.R. 4147, and H.R. 4794) were introduced in the 98th Congress, although

none was voted out of committee. These bills differed structurally from the

Administration's proposal in that contributions would be deductible from the

parents' AGI and the accumulated value of an account would be included in

the child's AGI after college. Initial-year revenue losses are much higher

when deposits are deductible, but the difference narrows over time because

the entire account would ultimately be included in the AGI of the child.

Other Administration 1986 budget proposals would reduce federal outlays and loan guarantees for higher education. Total federal aid per student

would be capped at $4,000 per year; students from families with AGIs above

$25,000 would not qualify for grants, direct loans, or subsidized jobs; and

students from families with incomes above $32,500 would not qualify for

subsidized guaranteed loans. All children under the age of 22 would have

their parents' AGI used in determining eligibility and benefit levels. Currently, some children are assessed on the basis of their own income. The

subsidy in guaranteed student loans would also be decreased.

Some of the reduction in federal support for higher education via loans

and grants could be offset over time through the tax preference for educa12
tion savings accounts. This would be true mainly for families with AGIs

above the proposed limits for grants and subsidized loans—$25,000 and

$32,500--but below the proposed $60,000 maximum limit for the savings

accounts. Even for these families, however, there would be several years of

reduced federal government support because the grant and loan cutbacks

would begin in 1986, while significant benefit from the savings accounts

would require at least five years of cumulated contributions.

Tuition Tax Credits

The Administration is also proposing a nonrefundable tax credit for families

sending their children to private elementary and secondary schools. This is

the third year the credit has been proposed. It would be equal to a maximum of 50 percent of tuition costs. Following a two-year phase-in period,

the credit would be capped at $300 per dependent and gradually reduced

below this level for taxpayers with AGIs above $40,000. Taxpayers with

AGIs of $60,000 or more would receive no credit. The revenue loss from the

credit is estimated to start at $360 million in 1986 and level off around $900

million per year when fully phased in two years later. The revenue loss

could be greater if the recently observed growth in private school enrollments continues.

Many bills providing for tuition tax credits were introduced in the 98th

Congress. One, S. 528, was reported out of the Senate Committee on

Finance but was not voted on by the Senate. This bill was similar to the

Administration's proposal except that the credit would have been completely

phased out at $50,000 of AGI instead of $60,000. An amendment authorizing

similar tuition credits, offered to House Joint Resolution 290, was tabled by

the Senate.

If enacted, the tuition credits would constitute a relatively large share

of total general-purpose federal aid for elementary and secondary education. Currently, the major source of untargeted federal aid is the Chapter II

block grant, with proposed budget authority of $500 million for 1986. Most

of the remaining $6.1 billion in federal aid for elementary and secondary

education is targeted on children or local districts with special needs, on

districts adversely affected by federal installations, or on particular services such as science education.

Revision in the Dependent Care Credit

The Administration is proposing a restructuring of the child and dependent

care credit that would focus the tax preference more on lower-income taxpayers. Under current law, the credit is available for up to 30 percent of

13
qualifying expenses for taxpayers with AGIs below $10,000. It phases down

to 20 percent for those with AGIs over $28,000. The Administration's proposal would raise the credit to 40 percent for those with AGIs under $11,000,

and phase it down to zero for those with AGIs over $60,000. As a result, the

credit would be raised for taxpayers with AGIs under $35,000 (about 70

percent of taxpayers claiming the credit in 1982) and lowered for the

remaining taxpayers with higher AGIs. For example, for a family with

$16,500 of AGI, the credit would be 36 percent of expenses under the proposal, instead of 26 percent under current law. The Administration estimates

that this would reduce revenues by about $20 million in 1986, $200 million in

1987 and in 1988, and by diminishing amounts thereafter. This is the second

year the proposal has been made.

Qualifying expenses are those that enable a person to be gainfully

employed and that are spent for the care of children under 15 years of age

or other people unable to care for themselves. Up to $2,400 in annual

expenses may be claimed for one dependent; $4,800 for two or more. A

family with $16,500 in AGI and one dependent could claim a maximum of

$864 under the proposal, instead of $624 under current law. In contrast, a

taxpayer with $60,000 or more in AGI and two dependents would receive

nothing under the proposal, compared with a credit of $960 under current

law. Thus, the restructuring of the credit would shift its benefits more to

those less able to afford child care and more in need of assistance to make a

job financially practical. Many single-parent families would benefit. One

out of five families with dependent children is female-headed, and the

median 1982 income of such families, as reported in a Bureau of the Census

survey, was $9,000, compared with $27,000 for two-parent families with

dependent children. \l Similar revisions in the credit were included in two

bills introduced last year, H.R. 4500 and S. 888, neither of which was reported out of committee.

The federal government also finances child care through another provision of the tax code and several direct expenditure programs. Employers

are allowed to provide child care for ejnployees as a tax-free fringe benefit.

Such care is not yet widespread nor is it targeted toward lower-paid

employees. Most federal outlays for child care, however, go to those in

financial need. Programs providing some child care support include Head

Start (budgeted for $1 billion in 1986), Social Services Block Grants (budgeted for $2.7 billion, but not restricted to child care), the Child Care Food

1. U.S. Bureau of the Census, Current Population Reports, Series P-60,

No. 142, Money Income of Households, Families, and Persons in the

United States: 1982, p. 93.

14
program (budgeted for $0.3 billion), and the exclusion of $160 per month of

child care expenses from the benefit calculation for Aid to Families with

Dependent Children. As a whole, funding for these programs was reduced in

1982, but has grown slowly since then.

Enterprise Zones

The Administration is proposing enterprise zone legislation that would provide for the designation of up to 75 small, economically distressed geographic areas as enterprise zones, at a rate not to exceed 25 zones per year.

Within these zones, federal tax and other incentives would be available in

order to stimulate private-sector economic activity and employment.

Employers operating within the zones would receive a wide range of tax

preferences, including a tax credit based on the wages of economically disadvantaged employees. Employees of zone firms would be allowed a tax

credit equal to 5 percent of the first $10,500 earned in the zone. The

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

equipment used within the zones; a 10 percent investment credit would be

allowed for new construction and reconstruction of buildings within the

zones; capital gains on zone business interests and property would be exempt

from taxation; and small issue industrial development bonds could be used to

finance investment in the zones after the 1986 sunset date for these bonds.

The proposal, made for the fourth year, is estimated by the Administration to reduce revenues by about $1.4 billion over the 1986-1988 period

and by $3.7 billion through 1990. These losses are very difficult to estimate

because they would depend on the size and characteristics of the zones as

designated by the Secretary of the Department of Housing and Urban Development. The proposal gives the Secretary such wide latitude in his choice

that specific cost estimates are impossible to make. The Treasury's estimates are based on assumptions that might or might not apply to enterprise

zones. For example, if average employment in the zones was lower than the

Treasury assumptions, revenue losses could be lower; conversely, if employment was higher or the average size of zones was larger, revenue losses

could be greater.

At the same time, the Administration is proposing to cut the amount

of direct assistance provided to distressed urban areas. The programs earmarked for cuts are different in their effects from the tax incentives that

would be provided through enterprise zones. The Community Development

Block Grant (CDBG) program provides community and economic development support to cities, counties, Indian tribes, and territories. This support

takes many forms and is available for use in industrial, commercial, and

residential areas. In an effort to funnel a larger share of total assistance to

15
rural areas, the Administration proposes to change the statutory urban-rural

distribution from a 70/30 percent split to a 60/40 percent split. It also

proposes to reduce total budget authority for the overall CDBG program by

10 percent in 1986 (to $3.1 billion from a 1985 level of nearly $3.5 billion).

The Administration also proposes to terminate the Urban Development

Action Grant program, which has budget authority of $440 million in 1985.

A final element in the proposals for urban areas is the termination of all of

the Department of Commerce's Economic Development Administration

(EDA) activities. EDA provides public works grants to states, localities, and

Indian tribes. Its budget authority has been reduced from $300 million in

1984 to about $50 million for 1985. No new budget authority is requested

for 1986, with the exception of small amounts to cover expenses associated

with the expenditure of obligations made in earlier years.

Extension of Research and Experimentation Credit

The Administration is proposing a three-year extension of the research and

experimentation (R&E) tax credit. The credit, which is for 25 percent of

the incremental research and experimentation expenditures by an ongoing

business over an established base level, is scheduled to expire at the end of

1985. Extension would reduce income tax revenues by about $660 million in

1986 and about $5 billion over the 1986-1990 period. This is the second year

the proposal has been made.

The budget does not present a rationale for extending the R&E credit,

but testimony by a Treasury Department official in August 1984 presented

the Administration's position at that time. The credit is favored in order to

encourage technological innovation that is "necessary for the long-run vitality of the American economy." 2/ The Treasury does not currently support

permanent extension of the credit, however, because not enough data are

available to measure its effectiveness in promoting research activities. The

Treasury would like to see the definition of qualifying expenditures

tightened up so that only activities that result in a significant advancement

of scientific knowledge or produce a significant technological improvement

of a business component are eligible for the credit.

In addition to the credit, the tax code currently provides additional

favorable treatment for R&E expenditures. R&E costs, such as wages and

2. Statement of Ronald A. Pearlman, Acting Assistant Secretary (Tax

Policy), Department of the Treasury, before the Subcommittee on

Oversight of the Committee on Ways and Means (August 2, 1984).

16
supplies, can be expensed. Also, the current effective tax treatment of

depreciable property used in R&E is similar to expensing. The federal government also provides significant support (about $40 billion in 1984) for research and development through direct expenditures.

The Senate included a permanent extension of the credit in its version

of the Deficit Reduction Act of 1984, but the provision was dropped in

conference. If no legislative action is taken this year, the credit will expire.

Internal Revenue Service User Fees

The Administration proposes a $100 fee for each IRS letter of determination

requested by a pension fund or a tax-exempt organization. The letters,

which provide approval of tax-exempt status, are now free. The $100 fee

would also apply to private letter rulings, which are clarifications of the IRS

position regarding unusual circumstances, such as changes in accounting periods or methods. The fees would generate about $40 million in receipts per

year.

Increase in Superfund Taxes

The Administration proposes to increase the taxes used to finance the Hazardous Substance Response Trust Fund, or Superfund, which supports cleanup

of hazardous waste sites. The specifications of the proposal have not yet

been announced. The proposed increase is intended to cover outlays for

cleanup proposed by the Administration for the 1986-1988 period.

Under current law, Superfund taxes would expire at the end of 1985.

In its current services receipts projections, the Administration includes an

extension of these taxes at rates sufficient to match projected trust fund

budget authority for 1986-1990. The assumed tax rates would require the

removal of the cap on trust fund revenues, originally imposed in 1980 to

ensure the termination of taxes when cumulative collections reached $1.38

billion. The proposed extension and increase in taxes would raise unified

budget receipts by a net amount of about $650 million in 1986, growing to

$750 million in 1990, when measured relative to receipts generated under

current law. When measured relative to the Administration's current services receipts estimates, the proposed tax increases would add about $315

million to net receipts in 1986, growing to about $360 million in 1990.

In 1984, the House passed H.R. 5640 which would have increased

Superfund tax rates on an expanded set of feedstock chemicals but would

not have imposed a tax on hazardous wastes, an option debated in the Con17
..1

gress. The bill addressed this issue by including two sets of tax rates on

chemicals, the higher set to become effective on October 1, 1986, if a

hazardous waste tax was not enacted before July 1, 1986. The bill was not

acted on by the Senate. It would have increased net unified budget receipts

by about $6 billion over the 1986-1990 period.

Increase Black Lung Disability Trust Fund Taxes

The Administration proposes to increase the tax on coal production from

$1.00 to $1.50 per ton for underground mining and from $.50 to $.75 per ton

for surface mining. This is a new proposal. The taxes were last adjusted by

the Black Lung Revenue Act of 1981 (Public Law 97-119), which raised the

taxes from $.50 to $1.00 per ton for underground mining and from $.25 to

$.50 per ton for surface mining.

The proposed fee increases are considered necessary because Black

Lung Disability receipts have not kept pace with expenditures, leading to a

rapidly growing trust fund deficit. This proposal is designed to put the fund

on a path that would freeze the cumulative deficit over the 1986-1990

period by raising receipts to cover expected outlays. It would raise net

unified budget receipts by about $210 million in 1986 and $260 million in

1990.

Extension of Unemployment Insurance to Railroad Employees

The Administration proposes to extend federal and state unemployment insurance coverage to railroad employees beginning in October 1985. This is

the last major sector to be covered. The Railroad Unemployment Insurance

program has been in debt to the Railroad Retirement program for 19 of the

last 24 years. The Railroad Retirement Solvency Act of 1983 (Public Law

98-76) mandated that there be no borrowing after September 1985, after

which the program must repay its loans from the Railroad Retirement System. This proposal complies with Public Law 98-76. A similar proposal was

included in last year's budget.

The Administration estimates that unemployment insurance receipts

would increase by about $150 million each year. The CBO estimates are

slightly higher than those of the Administration. These differences are explained by CBO's assumption of higher unemployment, which necessitates

higher benefit payments.

18
Increase in B.C. Employer Contribution to Civil Service Retirement

The District of Columbia currently contributes 7 percent of employees'

wages and salaries to the Civil Service Retirement system on behalf of its

employees. Employees also contribute 7 percent of their wages and salaries.

These amounts do not cover the full cost of D.C. employee benefits. The

Administration proposes that the D.C. government increase its contribution

by 2 percent a year until the employer contribution reaches 29 percent of

payroll, the level (in addition to the 7 percent employee contribution) necessary to cover the full cost of these benefits.

The Administration estimates that this proposal will increase Civil

Service Retirement system revenues by about $10 million in 1986, and close

to $70 million in 1990.

Taxation of Railroad Industry Pensions

The Administration proposes to make tax treatment of a portion of Tier I

Railroad Retirement benefits consistent with that of ordinary pensions.

This is proposed as a technical correction to the Social Security Amendments of 1983 (Public Law 98-21), which taxed all of Tier I benefits like

Social Security benefits. The Administration estimates that this would

increase individual income tax revenues by about $30 million in 1986, growing to about $60 million in 1990.

Acceleration of Deposits of Social Security Taxes by

State and Local Governments

The Administration proposes that state and local governments make deposits

of Federal Insurance Contributions Act (FICA) taxes at the same frequency

as private employers. This proposal would mean that state and large local

governments would make deposits about every four days. Under current

law, state and local governments are required to make their deposits only

twice a month. Their deposit schedule was last changed by the Social Security Amendments of 1983, and this provision took effect in January 1984.

The proposal would also make state and local governments subject to the

same penalty rate on late deposits (the prime interest rate) charged private

employers.

The Administration estimates that the speedup of deposits would increase Social Security revenues by aboitt $2.0 billion over the 1986-1990

period.

19
ADMINISTRATIVE ACTIONS

Increase in Internal Revenue Service (IRS) Examination Staff

This proposal would increase the IRS examination staff by 2,500 examiners

each year over the 1987 to 1989 period (for a total increase of 7,500 examiners). The added revenues attributable to this increase are estimated to be

$0.5 billion, $1.5 billion, and $2.6 billion in 1987, 1988, and 1989, with concurrent costs of $100 million, $200 million, and $300 million.

The Administration's assumptions for 1990 are unclear. The estimated

revenue gain of $2.8 billion in 1990 assumes continued employment of the

7,500 examiners. The Administration's 1990 outlay estimates, however, do

not include any amount to cover the cost of continued employment during

that year, about $300 million. If that cost was included, the 1990 deficit

reduction attributable to this initiative would be about $2.5 billion instead

of the $2.8 billion included in the Administration's budget.

Other

The Administration also proposes to increase Department of Housing and

Urban Development fees on interstate land sales and fishermen's contingency fund fees. Together, these fees generate about $2 million in receipts

per year.

20
CHAPTER HI

THE ADMINISTRATION'S DEFENSE BUDGET

The Administration's fiscal year 1986 budget proposes substantial real

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

for national defense programs rise from $323 billion in budget authority in

1986 to $488 billion in 1990, for a five-year total of about $2 trillion. Under

CBO's assumptions about future inflation, the Administration's dollar requests represent an average annual real growth of 5.7 percent in defense

appropriations. Under the Administration's slightly lower inflation assumptions, the real growth in budget authority is an average of 6.4 percent for

the period.

The program increases in the President's budget are concentrated in

research and development, which would grow by 18 percent in real terms

from 1986 through 1990, based on CBO economic assumptions. All other

major accounts would also grow in real terms over the five-year period,

though most at slower annual rates than those achieved since 1980. Military

end strengths would increase by 73,000, or 2.3 percent, with most of the

increase in the reserve components. Funding for both operation and maintenance and procurement would grow about 4 percent in real terms. The

portion of total defense budget authority for research, development, testing,

and evaluation would increase from 10.8 percent in 1985 to 13.5 percent by

1990, while most other categories would retain their relative shares, except

military personnel whose percentage would decline.

Defense outlays would grow by $32 billion from 1985 to 1986 under the

Administration's request. The largest part of that growth—$18 billion--

comes from past appropriations. Price growth would contribute $6 billion

and real program growth would add nearly $9 billion. In 1990 outlays would

be $182 billion higher than 1985, with real program growth accounting for

the largest share of the increase—$92 billion; inflation would account for

$61 billion and outlays from prior appropriations would add the remaining

$30 billion.

21
DEFENSE BUDGET ESTIMATES

The CBO and the Administration estimates for the defense budget differ in two

basic ways. First, CBO and the Administration use different concepts for defining the

defense baseline. The CBO defense baseline is derived from the budget authority

targets for 1986 and 1987 specified in the Congressional budget resolution for 1985

adopted last September. CBO extrapolated these targets for 1988-1990 with guidance from the two Budget Committees and applied its technical estimating methods

to produce corresponding outlay projections. The Administration defense baseline,

or current services projections, for 1986-1990 represent administration policy proposals as contained in the OMB Mid-Session Review of the 1985 budget made last

August. The two different defense baselines are as follows:

(In billions of dollars)

1986 1987 1988 1989 1990

CBO Baseline

Budget Authority 325 360 398 439 485

Outlays 282 313 347 384 425

Administration Current

Services

Budget Authority 334 372 421 461 501

Outlays 295 330 368 404 442

The second major difference in defense budget estimates results from the use

of different inflation assumptions and technical estimating methods. Different inflation

assumptions produce different estimates of real growth in defense budget authority.

Different technical estimating methods produce different estimates of outlays that

will occur each fiscal year from given levels of budget authority provided in appropriation bills. The different real growth and outlay estimates for the Administration's

1986-1990 defense budget authority proposals are shown below. Further details on

these differences are provided in Appendix B.

1986 1987 1988 1989 1990

Real Growth in Budget

Authority (percent change,

year-to-year)

CBO 5.5 7.4 7.9 3.9 3.9

Administration 6.0 7.9 8.7 4.8 4.7

Outlays Resulting from

Administration Budget

Authority Proposals

(Sbillions)

CBO 284 319 358 396 435

Administration 286 321 358 392 429

22
DEFENSE FUNDING LEVELS

The Administration's budget proposes $323 billion in budget authority for

the national defense function in 1986, an increase of $30 billion from the

level provided for 1985. After adjusting for projected inflation, the increase in budget authority would represent real growth of 5.5 percent under

CBO's assumptions and 6.0 percent under the Administration's (see box on

facing page). The real growth in budget authority for 1986 would be about

half as large as the increases provided in 1981 and 1982, and roughly equal

to the average annual real increases since 1982.

Defense appropriations would continue to increase during each of the

four succeeding years under the Administration's plan. Total budget authority would rise to $363 billion in 1987 and to $488 billion by 1990. The projected annual real growth in defense budget authority under CBO inflation

assumptions would increase to about 7.4 percent in 1987 and 7.9 percent in

1988, before falling to about 3.9 percent annually in 1989 and 1990. CBO

estimates that defense outlays also would grow substantially during the next

five years under the Administration's proposals, rising from an estimated

$253 billion in 1985 to $284 billion in 1986 and $435 billion in 1990.

As shown in Table III-l, the Administration's defense proposals are

very close to the CBO baseline projection for 1986. The proposals exceed

the CBO baseline projections over the five-year period, however, by about

$28 billion in budget authority and $43 billion in outlays. Estimated outlays

under the Administration's proposals exceed the CBO baseline by more than

budget authority because of proposed changes in the composition of the

defense budget. The Administration's budget allocates somewhat more

funds to relatively fast-spending program areas than was assumed for the

CBO baseline, which was based on 1985 appropriation action and last year's

budget resolution targets for 1986-1987.

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

budget, with outlays as estimated by CBO. Over the five-year period 1986-

1990, procurement accounts for the largest portion of the national defense

budget, amounting to $693 billion, or 34 percent of total budget authority.

Procurement funds are spent out relatively slowly because of the long lead

times involved in completing major weapons systems. Therefore, procurement outlays for the five-year period are $151 billion less than proposed

budget authority. The next largest component is operation and maintenance, which receives $531 billion, or 26 percent of total defense budget

authority. These are relatively fast-spending budget items so that outlays

nearly match the budget authority during the next five years. Military

personnel takes another $425 billion, or 21 percent. Again, these are fast23
spending accounts so that outlays almost equal budget authority. Military

research and development (R&D) programs add $253 billion over the 1986-

1990 period; and military construction, family housing, and other national

defense activities account for $85 billion. Five-year outlays for these budget accounts are somewhat lower—$224 billion for R&D programs and

$54 billion for the other activities.

TABLE III-l. CBO ESTIMATE OF THE ADMINISTRATION'S

NATIONAL DEFENSE PROPOSALS

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Change

Budget Authority

CBO Baseline Projections a/ 325 360 398 439 485

Proposed Changes -2 4 14 9 3 28

Administration's Budget as

Estimated by CBO 323 363 412 449 488

Outlays

CBO Baseline Projections a/ 282 313 347 384 425

Proposed Changes 2 6 11 12 10 43

Administration's Budget as

Estimated by CBO 284 319 358 396 435

SOURCE: Congressional Budget Office.

a. Defense budget authority for 1986 and 1987 are the amounts specified

in the most recent Congressional budget resolution. Defense budget

authority for 1988-1990 is a CBO extrapolation of the budget resolution. CBO baseline outlay projections are based on CBO technical

estimating methods.

b. CBO reestimates of the budget authority proposals in the President's

budget are limited to the treatment of reappropriations or extension

of expiring authority.

24
TABLE III-2. ADMINISTRATION'S DEFENSE BUDGET AS ESTIMATED BY CBO,

BY COMPONENTS (By fiscal year, in billions of dollars)

Component 1985 1986 1987 1988 1989

Total

1990 1986-1990

Military Personnel

Operation and

Maintenance

Procurement

Research, Development,

Test, and Evaluation

Other

Subtotal, DoD

Other National Defense

Total

Military Personnel

Operation and

Maintenance

Procurement

Research, Development,

Test, and Evaluation

Other

Subtotal, DoD

Other National Defense

Total

Budget Authority

68.9 73.4 79.6 85.5 90.7 95.4 424.6

78.2 82.5 95.1 108.9 117.7 127.1 531.2

97.3 107.4 122.5 141.4 155.0 166.9 693.2

31

9

285

7

.5

.3

.1

.8

39.

11.

314.

8.

3

8

4

5

42

14

354

9

.6

.4

.1

.3

49.

16.

401.

9.

3

8

8

9

55.9

19.5

438.8

10.1

66

22

477

10

.0

.3

.7

.4

253.1

84.7

1,986.8

48.1

293.0 322.9 363.4 411.7 448.9 488.1 2,034.9

Outlays

67.9 72.6 78.7 84.5 89.8 94.5 420.1

73.1 80.0 89.4 102.4 112.4 121.7 505.9

70.8 83.2 94.5 107.3 121.7 135.6 542.3

27.3 33.2 38.8 43.!

5.9 7.1 9.0 10.7

50.1 58.1 224.0

12.5 14.5 53.8

245.1 276.2 310.4 348.7 386.5 424.5 1,746.2

7.5 8.2 8.9 9.8 10.0 10.2 47.0

252.6 284.4 319.2 358.5 396.5 434.7 1,793.2

SOURCE: Congressional Budget Office.

25
L.

Figure III-l shows that from 1980 through 1985 an increasing share of

defense budget authority went to investment, primarily procurement, with

the shares of military personnel and operation and maintenance declining.

From 1985 through 1990, this pattern continues, with research and development having a greater share of the investment portion and military personnel declining as a share of the operating accounts. These shifts in the

relative composition of the defense budget affect slightly the overall rate of

spending of budget authority during the next five years. The Administration's proposals call for a faster-spending mix of programs than the CBO

baseline assumes.

Focusing more on 1986, Table III-3 compares the 1986 request with

1985 and with average annual rates for 1980-1985 in terms of real growth in

dollars and percents, using CBO inflation assumptions. The largest real

increase in 1986 over 1985 occurs in research, development, test, and

evaluation (RDT&E) which grows by $6.1 billion, or 18 percent, which are

both larger than 1980-1985 annual averages. The procurement account

grows by 4.3 percent ($4.4 billion) over 1985 in real terms, much slower

annual growth than has been the case since 1980. Operation and mainteFigure 111-1.

Composition of Administration's Request for National Defense

(Budget authority in percent of total request)

5.2%

1980

Military Personnel

|f'k.-'j Operations and Maintenance

SOURCE: Congressional Budget Office.

1985

6.7%

1990

Procurement

Research, Development,

Test and Evaluation

All Other

26
TABLE III-3. REAL GROWTH IN DEFENSE BUDGET AUTHORITY BY

APPROPRIATION CATEGORIES (By fiscal year)

Category

Department of Defense

Military

Military personnel

Operation <5t

maintenance

Procurement

Research, development,

test, and evaluation

Military construction

Family housing

Revolving funds & other

Total, DoDb/

Other National Defense

Total b/

1986

Request

(Billions

of Dollars)

73.4

82.5

107.4

39.3

7.1

3.3

1.4

314.4

8.5

322.9

Average Annual Real

Growth 1980-1985 a/

Billions

of Dollars

1.9

4.5

10.3

2.9

0.6

0.2

c/

20.5

0.8

21.3

Percents

2.9

6.9

14.9

12.3

14.3

8.3

3.0

8.8

13.8

9.0

Real Growth

1985 to 1986 a/

Billions

of Dollars

0.9

3.0

4.4

6.1

1.3

0.3

0.6

16.6

0.3

16.8

Percents

1.2

3.8

4.3

18.3

23.6

9.9

66.2

5.6

2.5

5.5

SOURCE: Compiled by Congressional Budget Office from data supplied by the Department of Defense.

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

assumptions.

b. Individual percentage calculations are not weighted and therefore are not additive.

c. Less than $50 million.

27
nance is 3.8 percent higher ($3 billion) than the real 1985 program, another

decrease in the rate of real growth. Military personnel and "Other National

Defense" similarly grow, but at lower rates. Military construction, family

housing, and the revolving funds show large real increases from 1985 to

1986; these are larger than the 1980-1985 averages, but relatively small in

dollar terms.

The next section of this chapter centers on the four largest appropriation categories of the defense budget: military personnel, operations and

maintenance, procurement, and RDT&E.

MAJOR DEFENSE PROPOSALS

The defense budget serves the national security objectives of the United

States by supporting a variety of land, air, and naval forces. Table III-4

shows that most major force categories would increase from 1985 to 1986

and that improvements have already occurred since 1980. The table might

understate force improvements because, in addition to the greater quantities it displays, force levels have a higher quality now than in the past; for

example, many Army units now are equipped with M-l tanks instead of

M-60 tanks.

The following section discusses the proposed funding for the defense

force structure in terms of appropriation categories used by Congress. The

appropriation categories of military personnel and operation and maintenance (O&M) fund the operations and readiness of currently deployed

forces. Military personnel pays for those people on active and reserve duty

and O&M finances a wide range of logistical and personnel support functions. The procurement accounts contribute to force operations and readiness with funding for spare parts.

The force growth in terms of weapons projected for 1986 results from

past decisions to procure ships, aircraft, and vehicles. The improvements

in quality of weapons result from past decisions to pursue technological

initiatives with RDT&E funding. These two categories have grown signficantly in real terms since 1980. On average, procurement appropriations

have grown 15 percent in real terms from 1980 to 1985 while research and

development has risen by 12 percent. Operation and maintenance on the

other hand has risen by a smaller amount—7 percent annually in real terms—

and military personnel funding has risen by only 3 percent.

28
Military Personnel

For the military personnel appropriation in 1986, the Administration is requesting $4.5 billion more than in 1985, for a total of $73.4 billion. The

request calls for increasing both active and reserve (including National

TABLE III-4. SUMMARY OF MAJOR U.S. FORCES AND MANPOWER

FOR FISCAL YEARS 1980, 1985, and 1986

Actual Estimated

Forces 1980 1985 1986

Active Forces (in units)

Strategic bomber aircraft 376 298 315

Strategic defense squadrons 7 5 4

Land-based intercontinental ballistic

missiles 1,052 1,023 1,009

Sea-based intercontinental ballistic

missiles 576 640 688

Army and Marine Corps divisions 19 20 21

Naval battle forces 473 528 537

Tactical air squadrons 164 166 169

Airlift and tactical support aircraft 567 583 609

Active Manpower (personnel in thousands)

Active duty end strength 2,050 2,152 2,178

Civilian end strength 990 1,088 1,107

Reserve and Guard Forces (in units)

Strategic defense squadrons 10 11 11

Army and Marine Corps divisions 9 10 11

Naval battle forces 6 14 18

Tactical air squadrons 56 60 60

Airlift and tactical support aircraft 410 336 336

Reserve Manpower (personnel in thousands) 851 1,077 1,124

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

29
Guard) end strengths by 73,000 people by the end of 1986, representing a 2.3

percent increase, the same rate of increase as the 1980-1985 average. Also,

the request would raise certain components of military pay and allowances.

Table III-5 shows the average percent growth in strength levels from

1980 through 1985 and from 1985 to 1986. Since 1980 active end strength

has increased by an average of 20,000 people (or 1.0 percent) per year; the

growth in 1986 would be slightly greater—26,000 people, or 1.2 percent. Of

the four services, the Army has had the smallest amount of growth over the

1980-1985 period. The Army is modernizing and redefining its active force

structure without requiring many additional people, but as discussed below,

the Army's reserve components are growing, with much of the growth in

TABLE III-5. REQUESTED MILITARY STRENGTH LEVELS (By fiscal year,

in thousands of people at year end)

Percent Increase

Service Branch

Army

Navy

Marine Corps

Air Force

Subtotal

Reserves

Total

1980

777

527

188

558

2,050

851

2,901

1985

781

571

198

602

2,152

1,077

3,229

1980-1985

1986 Average

781

586

200

612

2,178

1,124

3,302

a/

1.6

1.1

1.5

1.0

4.8

2.3

1985-

1986

—

2.6

0.6

1.6

1.2

4.4

2.3

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

a. Less than 0.5 percent.

30
full-time personnel. The largest active force growth occurs in the Navy,

with the goal of manning a 600-ship force. The Marine Corps' increase is

relatively small, and additional manpower has been targeted towards fleet

Marine improvements. The Air Force accounts for the second largest

active-duty increase, 1.5 percent per year over the 1980-1985 period and 1.6

percent from 1985 to 1986. Through 1985 extra manpower was targeted for

26 tactical fighter wings; in 1986 the additional people are intended to support strategic programs as well.

The 1986 request would raise end strengths in the reserve components

by 47,000, or 4.4 percent over 1985; this is a slightly slower increase than

has been averaged since 1980. Army Reserve and National Guard strengths

would increase by a combined 27,000 (3.7 percent), continuing progress to

fill 90 percent of planned unit strength. Of the 27,000 people, 14,000 would

be full-time personnel. The Navy Reserve would grow by 13,000 people to

support additional force structure. The Marine Corps Reserve would add

1,000 people to assume additional duties and missions. The Air Force

Reserve and National Guard would increase by 6,000 as units are either

expanded or formed.

CBO estimates the cost of the strength increases at $290 million for

active-duty forces and $630 million for the reserves. Pay raises account for

most of the remaining increase in the appropriation request. The proposed

July 1985 pay raise of 3 percent would cost $1.8 billion in 1986, and the fullyear effect of the January 1985 pay raise would cost about $550 million.

Other significant increases are $412 million for permanent change of

station allowances, $130 million for variable housing allowances, $168 million for an increase in basic allowances for quarters rates, $86 million for

subsistence-in-kind, $43 million for enlistment and reenlistment bonuses,

and $167 million for a new educational assistance program.

Operation and Maintenance

The 1986 operation and maintenance budget includes an increase of $4.2 billion, or 4 percent in real terms, over 1985 budget authority. This represents

the continuation of a trend of increases in the O&M accounts, though at a

slower rate. Over the 1980-1985 period, O&M budgets have increased by

almost 40 percent after adjusting for inflation, an average of almost 7

percent per year. Of the eight major programs, only one, reserve forces,

would grow at a faster rate than it has from 1980 to 1985 (see Table III-6).

Reserve forces would have the largest source of growth in the 1986

O&M budget, an inflation-adjusted rate of 9 percent. These additional funds

31

42-72 6 O - 85 - 3 QL 3
would allow reserve forces to operate the additional C-5, C-141, KC-10, and

F/A-18 aircraft available to reserve forces. Intelligence and communication

funds would increase by over 5 percent, with a portion going to modernize

the Defense Communication System. Increases in flying hours and operating

funds for new weapons for the Army and Marines account for much of the

TABLE III-6. ADMINISTRATION'S REQUEST FOR OPERATION AND

MAINTENANCE (By fiscal year, in budget authority)

Program

1986

Request

(Billions

Average Annual Real

Growth 1980-1985 a/

Billions

of Dollars) of Dollars Percents

Real Growth

1985 to 1986 a/

Billions

of Dollars Percents

Strategic Forces 5.5 0.2

General Purpose

Forces 24.7 1.6

Intelligence and

Communications 7.6 0.6

Airlift and Sealift 2.0 0.2

Reserve Forces 6.1 0.3

Central Supply and

Maintenance 21.4 0.7

Training, Medical,

5

9

11

14

5

0.1

0.9

0.4

0.1

0.5

0.4

3

4

6

5

9

and Other

Administration

Support to Other

Nations

Total

11.6

3.4

0.2

82.5

0.7

0.2

b/

4.5

7

8

12

7

0.4

0.2

b/

3.0

3

7

—

4

SOURCE: Congressional Budget Office based on Budget of the United States

Government 1986 Appendix.

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

b. Less than $50 million.

32
increase in the strategic forces, general purpose forces, and airlift and sealift categories.

Over the 1980-1985 period, the largest percentage increases in the

O&M budget have been in the intelligence and communications, airlift and

sealift, and support to other nations categories, each of which has grown by

over 10 percent annually. In 1986 this rate would be slowed to no more than

6 percent per year for each category. Central supply and maintenance,

which has had the lowest real growth in the preceding five-year period,

would increase two percent in 1986. Operation and maintenance for strategic forces, which has increased by 5 percent per year since 1980, would grow

by only 3 percent in 1986.

Procurement

The 1986 request for procurement represents a 4 percent real increase over

the 1985 level (see Table III-7). This growth rate is down from an average of

15 percent annual real growth over the 1980-1985 period. This growth rate

would be 3 percent, however, if $1.5 billion of 1985 procurement funds for

21 MX missiles were included in 1985. Similarly, real funds for ballistic

missiles would be more than double the 1985 level. The average annual

growth rate for the 1980-1985 period would be 15 percent rather than -2

percent, and the growth between 1985 and 1986 would be 33 percent. The

programs primarily responsible for this growth include the MX, Trident II,

and Tomahawk missiles.

The second largest real growth in procurement from 1985 to 1986

would be for purchases of communications and electronic equipment. Many

individual programs would contribute to this real increase. The same is true

in other missiles, torpedoes, and weapons. The remaining seven budget activities would experience real rates of growth lower than their preceding fiveyear averages. Five of these seven would experience real decline over the

1985 level.

About half of the 1986 request would pay for defense hardware like

ships, missile, aircraft, tanks, and other weapons. The rest would fund support equipment, communications and electronic equipment modifications of

existing equipment, spares, and ammunition. The next section of this report

discusses the Administration's procurement plans in more detail and in terms

of quantities of weapons. In general, a greater number of weapons are

planned than have been funded for 1985. These purchases contribute to

lower estimated unit costs through, for example, learning curve effects—the

tendency for unit costs to fall as the cumulative number of units purchased

gets larger.

33
TABLE III-7. REAL GROWTH IN PROCUREMENT BUDGET AUTHORITY,

BY BUDGET ACTIVITIES (By fiscal year))

Real Growth

1985 to 1986 a/

Activity

1986 Average Annual Real

Request Growth 1980-1985 a/

(Billions Billions Billions

of Dollars) of Dollars Percents of Dollars Percents

Aircraft

Modifications

Spares and Repair

Parts b/

Vehicles c/

Support and Other

Equipment

Ballistic Missiles d/

Other Missiles,

Torpedoes, and

Weapons

Shipbuilding and

Conversion

Communications and

Electronic Equipment

Ammunition, Munitions

and Related

Equipment

24.

6.

8.

7.

20.

3.

10.

11.

8.

4.

Total 107.

7

0

8

6

8

8

9

5

6

7

4

2.

0.

1.

1.

2.

e

1.

0.

0.

0.

10

9

4

1

0

1

:/

0

7

7

5

.3

18

8

22

21

16

-2

17

7

14

18

15

-1.

-o.

-o.

-o.

1.

2.

1.

-o.

1.

0.

4.

1

5

2

4

0

5

9

7

6

2

4

-4

-8

-2

-5

5

199

21

-6

23

5

4

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

a. Real growth computed using CBO's economic assumptions and the

President's pay-raise assumptions.

b. Spares and repair parts for Navy weapon procurement, Navy "other"

procurement, and Marine Corps procurement were not broken-out in

the DoD justification materials until 1986.

c. Includes Army weapons and tracked combat vehicles and purchases of

National Guard and Reserve equipment, but excludes all Navy vehicles

which are included in Support and Other Equipment.

d. Fiscal year 1985 does not include $1.5 billion of prior-year funds for

the purchase of 21 MX missiles; if these funds were included in the

analysis, the five-year average for ballistic missiles would be 15 percent and the real growth between 1985 and 1986 would be 33 percent.

e. Less than $50 million.

34
Aircraft. The Administration wants $25 billion in 1986 for 919 new aircraft

(see Table III-8). This includes almost $10 billion for Navy and Air Force

fighters, including the large F-14s and F-15s and the smaller F-16s and

F~18s. The Administration also plans to spend about $6 billion for 48 B-l

bombers to complete the Administration's plan to buy 100 B-ls. Nearly

$3 billion is targeted for 16 C-5 cargo planes and 12 KC-10 advanced tanker

cargo aircraft, which are used primarily for mid-air refueling of strategic

and tactical aircraft. The Army would like $2 billion for helicopters, and

the Navy hopes for $1 billion in 1986 for antisubmarine aircraft. The remainder would pay for a variety of other aircraft. The Administration proposes to buy 54 more aircraft in 1986 than in 1985. Only the Army would

purchase fewer (40) aircraft—eight fewer UH-60 assault/support helicopters

and 32 fewer other aircraft, such as trainers and transports. Requests for

AV-8B close air support aircraft, EA-6B aircraft that help hide U.S. planes

from the enemy radars by jamming them, and CH/MH-53 heavy transport

helicopters, in addition to aircraft such as trainers and transports, account

for the increase of 23 aircraft in the Navy and Marine Corps. The Air Force

program shows increased requests for all major aircraft. The Air Force plan

for 1986 projects buying 71 more aircraft than in 1985. This proposed increase is primarily in purchases of major combat aircraft such as F-15s,

F~16s, and B-ls, and cargo aircraft like C-5s and KC-lOs; the Air Force plan

also shows an increase in the purchase of trainer and transport aircraft.

Missiles. Of the $4 billion the Administration requests for buying more ballistic missiles, $3 billion is allocated for 48 MX missiles. If this request and

the 1985 request were approved, about 133 more missiles would have to be

purchased to meet the President's goal of deploying 100 MXs. The request

for all strategic and theater nuclear missiles, except for Pershing II missiles,

for 1986 is 71 missiles higher than in 1985 (Pershing II missile quantities are

classified in 1986). While the Navy plans to buy 69 more Tomahawk cruise

missiles, the Air Force plans to buy 25 fewer ground-launched cruise missiles and 27 more MX missiles (see Table III-9).

Table 111-10 shows that the number of tactical missiles would increase

by 38,975 from 1985 to 1986. About 55 percent of the proposed increase is

in relatively inexpensive rockets for the Army's surface-to-surface multiple

launch rocket system.

In 1987 the Administration plans to request more air-to-air, air-tosurface, and surface-to-air missiles than in 1986, but it would buy fewer

surface-to-surface missiles.

Armored Vehicles. Real funding of all vehicles would decline by $400 million in 1986. Procurement of armored combat vehicles, such as tanks, fighting vehicles, light armored personnel carriers, and ancillary armored recov35
TABLE III-8. AIRCRAFT ACQUISITION PLANS, BY TYPE AND SERVICE

(By fiscal year, in units procured)

Aircraft Type 1984 1985 1986 1987

Army

AH-64 helicopter 112

UH-60 helicopter 84

EH-60 helicopter 12

Other aircraft 6

Subtotal 214

Navy/Marine Corps

F/A-18 aircraft 84

F-14 aircraft 24

AV-8B aircraft 27

A-6E aircraft 6

EA-6B aircraft 8

CH/MH-53E helicopter 11

SH-60B helicopter 21

Other aircraft 51

Subtotal 232

Air Force

F-16 aircraft 144

F-15 aircraft 36

B-1B aircraft 10

KC-10 aircraft 8

C-5B aircraft 4

TR-1 aircraft 6

Other aircraft 34

Subtotal 242

Total 688

144

86

18

32

280

84

24

32

6

6

10

24

113

299

150

42

34

8

8

4

40

286

865

144

78

18

240

84

18

46

6

12

14

18

124

322

180

48

48

12

16

8

45

357

919

144

78

18

240

102

18

47

6

12

14

18

112

329

180

48

8

21

2

128

387

956

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

36
ery vehicles, would increase, as shown in Table III-ll. The Administration's

program for armored combat vehicles emphasizes acquisition of two "families" of vehicles (see Table III-ll):

o Heavy combat vehicles for use by Army forces in Europe committed to NATO; and

TABLE III-9. STRATEGIC AND THEATER NUCLEAR MISSILE ACQUISITION PLANS, BY TYPE AND SERVICE (By fiscal year, in

units procured)

Missile Type

Funded

1984 1985

Requested

1986 1987

Army

Pershing II

Navy

Trident I

72

52

70 a/

Trident II

Tomahawk

Subtotal

Air Force

MX

Air-launched cruise

missile

Ground-launched cruise

missile

Subtotal

Total

—

124

176

21

240

120

381

629

180

180

21

b/

120

141

391

—

249

.249

48

b/

95

143

392

27

330

357

48

b/

76

124

481

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

a. Quantity classified.

b. Program terminated in favor of a classified radar-evading version that

is not included in this table.

37

T
o Light armored vehicles for both the Army and the Marine Corps

to support the heavy combat vehicles committed to NATO and to

strengthen the Rapid Deployment Force, primarily for potential

operations in the Middle East.

The major 1986 change for heavy combat vehicles is an increase of 61

fighting vehicles over the 1985 funded level. For light armored vehicles, the

TABLE 111-10. TACTICAL MISSILE ACQUISITION PLANS, BY TYPE AND

SERVICE (By fiscal year, in units procured)

Funded

Missile Type

Requested

1984 1985 1986 1987

Air-to-Air Missiles

Navy

Air Force

Subtotal

Air-to-Surface Missiles

Army

Navy

Air Force

Subtotal

Surface-to-Air Missiles

Army

Navy/Marine Corps

Air Force

Subtotal

Surface-to-Surface Missiles

Army

Navy/Marine Corps

Subtotal

Total

1,310

2,705

4,015

4,651

785

2,297

7,733

1,645

1,091

60

2,796

54,000

3,705

57,705

72,249

2,936

404

3,340

5,342

1,851

3,556

10,749

2,800

1,230

156

4,186

62,472

5,293

67,765

86,040

3,525

1,315

4,840

6,576

3,903

5,312

15,791

4,324

1,467

—

5,791

92,100

6,493

98,593

125,015

3,703

1,555

5,258

6,576

4,780

8,329

19,685

8,925

3,030

—

11,955

89,000

6,693

95,693

132,591

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

38
budget proposes large increases in quantities of M-113 armored personnel

carriers, as well as increases in quantities of field artillery ammunition

support vehicles and M-88A1 recovery vehicles, or tow trucks for wrecked

tanks. There is a planned decrease in the request for M-577 light command

post carriers. The Marine Corps does not plan to purchase any additional

light armored vehicles in 1986.

TABLE III-ll. ARMORED COMBAT VEHICLE ACQUISITION PLANS, BY

TYPE AND SERVICE (By fiscal year, in units procured)

Funded Requested

Vehicle Type 1984 1985 1986 1987

Heavy Combat Vehicles

Army

M-l tanks 840 840 840 840

Fighting vehicles 600 655 716 870

Subtotal 1,440 1,495 1,556 1,710

Light Armored Vehicles

Army

M-113 armored personnel

carriers 125 35 325

M-577 light command post

carriers 250 167 115

Field artillery ammunition

support vehicles 120 170 197 190

M-88A1 medium recovery

vehicles 180 180 240 180

Subtotal 675 ' 552 877 370

Marine Corps

Light armored vehicles

Total

236

2,351

292

2,339

— —

2,433 2,080

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

39
Ships. Having won the funds for a 600-ship Navy, the Administration requests about $12 billion for ships in 1986, the bulk of which is for 28 new

ships and conversions of older vessels. The request includes about $3 billion

for three cruisers equipped with the Aegis antimissile control system. The

Administration would also like $3 billion for four hunter-killer submarines of

the Los Angeles class. Nearly $2 billion would be allocated for a new helicopter carrying ship, about the size of a WWII aircraft carrier. The remainder would pay for various other ships and would cover modernization of

older ships, including the aircraft carrier Kitty Hawk and advance funding

for the reactivation of the battleship Wisconsin which is planned for 1987.

As Table 111-12 shows, its plan calls for 131 ships to be constructed, converted, or modified from 1986 through 1990. The 1986 request for 28 ships reTABLE 111-12. ADMINISTRATION'S NAVY SHIPBUILDING PROGRAM

FOR 1986-1990 (By fiscal year, in units procured)

Funded Requested 1986-1990

Ship Type 1985 1986 1987 1988 1989 1990 Total

Trident Submarines 1 1111 1 5

Other Major

Warships a/ 9 7 11 12 10 10 50

Amphibious Ships 2 3—46 6 1 9

Mine Warfare

a n d Patrol Ships b/ 4 8544 — 2 1

Auxiliaries 9 9 7 7 6 7 36

Total c/ 25 28 24 28 27 24 131

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

a. Includes service life extension program (SLEP) for one conventional

carrier in 1985, 1987, and 1990, but no nuclear carriers.

b. Includes frigates.

c. Includes 27 planned reactivations, SLEPs, and conversions.

40
fleets a net increase of three ships over those funded in 1985. In the major

warships category, however, the Administration has requested one less

destroyer and one less complete overhaul of an aircraft carrier in 1986 than

in 1985. The 1986 request also reflects procurement of four more mine

sweeper-hunter ships and one more amphibious assault ship than in 1985.

Nevertheless the proposed budget for shipbuilding and conversion would

decrease from $11.6 billion in 1985 to $11.5 billion in 1986 in nominal terms,

which represents a real decline of $700 million,,

Unit Costs. In recent years, much of the defense budget debate has centered on the unit costs of major weapons systems; in fact, legislation has

been enacted that brings unit cost increases to the attention of the relevant

committees. Too little budget justification material is available to evaluate

fully the most recent changes in unit costs, but what is available suggests

that, on balance, unit prices are slightly lower than the Administration estimated a year ago. Table 111-13 provides cost-growth data for 74 major

weapons systems by comparing unit costs for 1986 as initially projected by

the Administration in February 1984 against estimates contained in the current budget. The table shows a net projected cost decrease of $795 million,

or 1.4 percent, since last year (lower inflation estimates account for roughly

$175 million of the decline). The table shows that, based on Department of

Defense (DoD) estimates, the costs for 45 systems experiencing savings

would be about $3.1 billion lower in 1986 than previously projected for the

same year. The table also shows that 29 systems would experience cost

increases totaling about $2.3 billion above the 1984 estimates.

Generally, unit costs vary inversely with quantities purchased for two

reasons. First, fixed costs need to be distributed regardless of the ultimate

quantity purchased—lower quantities increase fixed costs per unit. Second,

production becomes more efficient as experience increases with quantities

purchased—the learning curve effect (see Table 111-14). In 14 cases, quantities have been revised upward and unit costs decline, as expected, and in

another 20 cases, the opposite occurs. Quantity changes, however, might

not be the only reason for the changes in projected unit costs for these 34

systems. Reduced or increased prices could result from any or all of the

following: contract negotiations on prior-year purchases, engineering

changes, schedule changes, contractor cost performance, support changes,

or estimating changes. Indeed, for 40 other procurement items, changes in

unit costs appear not to be related to changes in planned new quantities.

With no change in planned quantity, 24 systems would experience unit price

decreases and 10 systems would experience unit price increases. Five

systems would experience unit price decreases with decreases in the planned

quantity, and one system would experience a unit price increase with an

increase in the planned quantity. The budget justification material already

41
JL_ _ .

TABLE 111-13. ADMINISTRATION'S CHANGES IN COSTS OF MAJOR WEAPONS

SYSTEMS BETWEEN FEBRUARY 1984 AND FEBRUARY 1985

ESTIMATED AND ON 1986 BUDGET EFFECT

(In millions of dollars, in budget authority and percents)

Weapons System

Procurement Unit Cost

February 1984 February 1985

Percent

Change a/

Cost Effect

on 1986

Budget a/

Programs with Decreases

TR-1 aircraft 96.60

HH-60D helicopter 57.70

AGM-130 powered

GBU-15 bomb 0.77

Chaparral missile 0.51

TOW missile,

Marine Corps 0.01

EA-6B aircraft 52.23

MSH-1 mine sweeper

hunter ship 58.58

UC-12B aircraft 2.79

44.05

33.-33

0.50

0.37

0.01

38.96

46.13

2.24

-54

-42

-35

-28

-26

-25

-21

-20

37 Other Systems

Subtotal, decreases

for 45 systems

AMRAAM missile, Air

Force

MC-130H aircraft

IIR Maverick missile,

Air Force

Phoenix missile

RAM missile

DIVAD gun

Sidearm missile

E-6A aircraft

21 Other Systems

Subtotal, increases

for 29 systems

Programs with Increases

0.78

35.23

0.09

0.89

0.26

3.00

0.09

141.40

4.40

83.90

0.14

1.39

0.38

4.33

0.12

197.50

466

138

61

55

49

44

41

40

326

49

191

131

15

155

6

112

1,360

2,345

Total Effect of

74 Systems -795

SOURCE: Compiled by Congressional Budget Office from data supplied by the

Department of Defense.

a. Percent change and cost effect were calculated before rounding procurement

unit costs.

42
TABLE 111-14. PERCENT CHANGE BETWEEN FEBRUARY 1984 AND

FEBRUARY 1985 IN QUANTITY AND PROCUREMENT

UNIT COST OF SELECTED WEAPONS IN THE

ADMINISTRATION'S 1986 ACQUISITION PLAN

Change in

Change in Procurement

Weapons System Quantity Unit Cost

Increasing Quantity and Decreasing Cost

TR-1 Aircraft 700 -54

AGM-130 Powered GBU-15 Bomb 49 -35

TOW Missile, Marine Corps 19 -26

EA-6B Aircraft 100 -25

Harpoon Missile 10 -15

HARM Missile, Navy 16 -14

HARM Missile, Air Force 2 -10

M-l Tank 17 -8

Tomahawk Missile 38 -7

C-20A Aircraft 167 -6

Sparrow Missile 11 ~5

M88A1 Medium Recovery Vehicle 33 ~4

Hawk Missile, Marine Corps 14 -3

TOW 2 Missile, Army 12 -1

Decreasing Quantity and Increasing Cost

AMRAAM Missile, Air Force

MC-130 Aircraft

IIR Maverick Missile, Air Force

Phoenix Missile

RAM Missile

DIVAD Gun

E-6A Aircraft

Standard Missile

T-34C Aircraft

F/A-18 Aircraft

Patriot Missile

Stinger Missile, Marine Corps

IIR Maverick Missile, Navy

F-15 Aircraft

F-14 Aircraft

Stinger Missile, Army

GLCM Missile

Bushmaster 25mm Gun

MK-46 Torpedo

Fighting Vehicle

-91

-75

-56

-53

-13

-19

-33

-46

-67

-18

-28

-61

-3

-20

-25

-47

-21

-24

-67

-20

466

138

61

55

49

44

40

29

18

16

14

12

10

8

6

5

5

4

2

2

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.
provided by DoD does not provide an explanation for any of these unit price

changes.

Research, Development, Test, and Evaluation

The 1986 RDT&E budget of $39 billion represents an increase in budget

authority of $6.1 billion, or 18 percent (both in real terms), over 1985 levels

(see Table 111-15). This continues the trend set in the 1980-1985 period, at

an increased rate. Over the previous five-year period, RDT&E budgets increased an average of 12 percent a year after adjusting for inflation.

TABLE 111-15. REAL GROWTH IN BUDGET AUTHORITY FOR RESEARCH,

DEVELOPMENT, TEST, AND EVALUATION, BY BUDGET

ACTIVITIES

1986

Request

(Billions

Program of Dollars)

Technology Base 3 . 5

Advanced Technology

Development 5.5

Strategic Programs 8.6

Tactical Programs 12.4

Intelligence and

Communications 5.0

Defense-wide Mission

Support 4.3

Total 39.3

Average Annual Real

Growth 1980-1985 a/

Billions

of Dollars

b/

0.4

1.2

0.5

0.5

0.2

2.9

Percents

1

28

24

6

22

8

12

Real Growth

1985 to

Billions

of Dollars

0.2

2.5

-0.3

2.4

0.9

0.4

6.1

1986 a/

Percents

7

87

-3

24

21

9

18

SOURCE: Compiled by Congressional Budget Office from data supplied by

the Department of Defense.

a. Real growth computed using CBO's economic assumptions and the

President's pay-raise assumptions.

b. Less than $50 million.

44
The largest increase in the 1986 budget is for advanced technology

development, 87 percent after adjusting for inflation, which is significantly

higher than the past five-year average of 28 percent. Advanced technology

programs explore alternative designs before development of specific

hardware/software systems. The request of about $4 billion for the strategic defense initiative accounts for $2.2 billion of the $2.5 billion real increase. The balance of the increase is scattered among many programs.

Tactical programs would grow by nearly 24 percent in 1986, compared with

an average annual growth rate of 6 percent over the 1980-1985 period.

Many programs contribute to this growth, including all types of weapons

from new designs through modifications of existing systems. The third largest increase, 21 percent in real terms, would occur in intelligence and

communications programs, in which classified programs account for most of

the increase. Defense-wide mission support programs would grow at a rate

of 9 percent in 1986, a slightly higher rate than the past five-year average

of 8 percent. On the other hand, technology base programs—those dealing

with more theoretical research—would grow 7 percent in 1986, compared

with the past five-year average of only 1 percent. Many programs would

account for these planned increases.

Over the 1980-1985 period, the largest average real growth in the

RDT&E budget—28 percent—appeared in the advanced technology development activity. Some of the programs contributing to this growth were the

strategic defense initiative, very high-speed integrated circuits, and several

other programs. Programs such as the B-1B aircraft, Trident II long-range

ballistic missile, strategic communications, and classified programs contributed to the 24 percent average annual increase in strategic programs.

Classified programs were the primary cause of the 22 percent average real

growth in intelligence and communications activity. Defense-wide mission

support grew by about 8 percent annually, primarily because of increases in

such programs as satellite launch support.

Tactical programs, for example, missiles, radars, and advanced fighter

aircraft, increased by an average of 6 percent over the 1980-1985 period.

Programs such as ballistics technology, defense against chemical agents, and

laser weapons would be the primary reasons for the 1 percent average real

growth in the technology base activity.

Other Accounts

The military construction account funds programs directed at improving the

quality of life on military installations and at supporting the introduction of

new weapons systems. Quality of life programs are aimed at improving

living and working conditions on military bases. Weapons-related projects in

45

r
this budget category would support the ground-launched cruise missile, the

multiple launch rocket system, the Trident II missile, and the B-l bomber.

The Administration requests $3.3 billion for construction, operations,

and leasing of housing for military families. The request calls for 9.8 percent real growth ($300 million) and includes initiatives to renovate and replace units that are energy inefficient.

The Department of Energy (DOE) conducts research and production

programs for nuclear weapons and materials; DOE also has programs related

to storing nuclear waste and to the design of reactors for nuclear-powered

naval vessels. A real increase over 1985 of about $266 million, or 3.4 percent, would support increases in missile warhead production and production

of special nuclear materials.

SOURCES OF OUTLAY GROWTH AND POTENTIAL REDUCTIONS

In the previous section, the defense budget was discussed in terms of budget

authority, that is, the authority to spend approved by the Congress in appropriation bills. Budget authority levels can be raised or lowered more easily

than cash outlays although it is outlays that are calculated in the budget

deficit, not budget authority. Defense outlays would grow over the next

five years even if budget authority were held absolutely constant over the

entire period. The growth stems from the large funding increases for defense since 1980, and from the fact that a time lag exists between appropriations and corresponding expenditures. I/ With constant budget authority, defense outlays would increase until they eventually equaled budget

authority. Increasing the budget authority each year to cover the costs of

expected inflation means that outlays will also grow because they vary in

somewhat direct proportion to budget authority. Similarly, providing real

growth in budget authority means still further growth in outlays.

The major sources of outlay growth in the Administration's defense

budget from 1986 through 1990 are shown in Figure III-2. The largest component of the $32 billion growth in defense outlays proposed for 1986 is the

result of past increases in budget authority. If defense budget authority

were frozen in 1986 at the 1985 level, outlays would still grow by $18 billion

1. This time lag varies from one to eight years, depending on the program. An appropriation that would fully fund an aircraft carrier in

one fiscal year, for example, would result in outlays for five or more

years because of the time required for contracts to be negotiated fully, the work to be performed, and the expenditures (outlays) to be

made.

46
as funds are paid out from prior-year appropriations. Another $5.9 billion of

the increase can be attributed to keeping pace with inflation. The real

growth component of the 1986 increase in defense outlays is $8.5 billion, or

26 percent of the total outlay increase. By 1988, the real growth component

is substantially larger than the inflation component or the outlay catch-up

for past budget authority increases, and by 1990 it represents 51 percent

($92 billion) of the $183 billion increase over the 1985 outlay level. Keeping

pace with assumed inflation over the next five years will make up $61 billion

(33 percent) of the 1990 outlay increase. The remaining $30 billion increase

can be attributed to outlays catching up with the budget authority increases

provided prior to 1986.

The future pattern of outlay growth in the Administration's budget

proposals is similar to that of the last five years. Figure III-3 shows a

similar pattern for the growth in defense outlays from 1981 through 1985.

Of the $119 billion increase in defense outlays during this five-year period,

$70 billion (59 percent) can be attributed to real growth in budget authority,

$40 billion (34 percent) to keeping pace with inflation, and $9 billion (7 percent) to increases in budget authority in prior years. In both periods, it is

the increases in budget authority to cover inflation and to provide real

growth that eventually dominate outlay growth.

The sources of future growth in defense outlays will be directly related to alternative defense budgets that the Congress will consider. In recent

years, the debate about appropriate levels of defense appropriations has

been couched in terms of different real growth rates—for example, 3

percent, 5 percent, 7 percent, and the like. This year, the notion of a freeze

in defense appropriations is also being considered. A freeze in defense

spending authority can be applied in real terms, allowing increases for

expected inflation, or in nominal terms with no increases for inflation. A

nominal freeze in defense appropriations would mean a real decline in

funding levels since the costs of inflation still would have to be met.

Table 111-16 shows various levels of funding under different rates of

defense growth, including a one-year freeze in 1986 in both real and nominal

terms. The most stringent level of funding shown is a defense budget that

only keeps pace with expected inflation during 1986-1990—a zero real

growth budget. A zero real growth budget would save $81 billion in outlays

by 1988 and $243 billion by 1990. In contrast, a nominal freeze in 1986

followed by baseline budget authority lagged one year for 1987-1990 would

save slightly more through 1988, $85 billion, but less through 1990,

$183 billion. 2/

2. This alternative effectively slips the budget resolution one year in that

1986 budget authority equals the budget resolution amount for 1985;

1987 budget authority equals the baseline amount for 1986 and so on.

47
Figure 111-2.

Sources of Growth in Defense Outlays, Fiscal Years 1986-1990

200

160

=5 120 O

£ 80

40

Real Growth

Other

25

48

^^$$s V0> 2800<\

E^S^

69

92

1986 1987 1988

Fiscal Years

1989 1990

SOURCE: Congressional Budget Office.

Figure 111-3.

Sources of Growth in Defense Outlays, Fiscal Years 1981 -1985

120

100

I 80

a

a

I eo

40

20

0

I I Real Growth

Inflation

Other

22

40

70

m 40 m

1981 1982 1983

Fiscal Years

1984 1985

SOURCE: Congressional Budget Office.

48
The second pair of alternatives shows the importance of the 1986 base

in achieving savings. A zero real growth budget in 1986, followed by 3

percent real growth, would save $68 billion through 1988 and $179 billion

through 1990. In contrast, 3 percent real growth in all years would save

$50 billion and $141 billion through 1988 and 1990. respectively. The difference between providing 3 percent real growth in the 1986 base is $18 billion

through 1988 and $38 billion through 1990.

The programmatic consequences of these alternatives are hard to predict for there are many options available. An alternative calling for lower

real growth in budget authority might be implemented by trimming or postponing marginal programs and levels of effort from the Administration's

request. Such possible program reductions are outlined in the CBO report,

Reducing the Deficit: Spending and Revenue Options (February 1985). The

options outlined in the CBO report are certainly not exhaustive. They are

enough, however, to assemble packages that significantly reduce defense

spending by slowing investment force growth or operating costs—or by some

combination of these options. The choice affects the speed of modernization versus improvements in force and readiness. It also determines when

the effects on deficits take place. Emphasis on slowing investment means

smaller outlay reductions in the budget year. For example, providing no real

growth in defense budget authority in 1986—which reduces 1986 budget

authority by $17 billion—would reduce outlays from the Administration's request by $9 billion in 1986 if total budget authority were allocated according

to CBO baseline assumptions. Alternatively, outlays would be cut by

$5 billion if total budget authority were allocated with a faster spending mix

of programs such as the Administration does with its increases in RDT&E.

The alternatives shown in Table 111-16 incorporate two important sets

of assumptions. First, CBO economic assumptions for defense purchases and

the Administration's pay- raise proposals are used to determine budget

authority. Second, when an option calls for real growth, CBO assumes that

the real growth is used much more to buy hardware than to increase

numbers of military and civilian employees. The second assumption means

that, for a given amount of defense budget authority, associated outlays

would be lower than if budget authority were allocated to faster-spending

accounts as the Administration does when it allocates a sharply increasing

share to RDT&E.

CBO estimates for price growth in defense purchases are related to

CBO's overall economic forecast calling for generally higher inflation than

the Administration. Consequently, CBO expects more price growth in defense purchases than the Administration does, as shown in box on page 52.

(Outlay deflators measure current price change much as the GNP deflator

49
TABLE 111-16. COMPARISON OF THE CBO REESTIMATE OF THE

ADMINISTRATION'S 1986 DEFENSE BUDGET WITH

ALTERNATIVE BUDGET ASSUMPTIONS

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

Spending Level 1986 1987 1988 1989 1990 Totals

Administration's Request

Budget Authority 323 363 412 449 488 2,035

Outlays 284 319 358 396 435 1,793

Alternative Funding Levels

3 Percent Real Growth in

All Years, 1986-1990

Budget Authority 315 341 368 398 429 1,851

Outlays 279 304 329 356 384 1,653

Zero Real Growth 1986-1990

Budget Authority 306 321 337 354 370 1,688

Outlays 276 294 311 327 343 1,551

Real Freeze in 1986,

3 Percent Real

Growth 1987-1990

Budget Authority 306 331 358 386 417 1,798

Outlays 276 297 321 347 373 1,614

Nominal Freeze in 1986,

Lagged Baseline

Levels in 1987-1990

Budget Authority 293 324 360 398 439 1,814

Outlays 270 290 317 349 385 1,609

(Continued)

50
TABLE 111-16. (Continued)

Spending Level 1986

Administration's Request

Budget Authority

Outlays

323

284

1987

363

319

1988

412

358

1989

449

396

Cumulative

Five-Year

1990 Totals

488

435

2,035

1,793

Savings Under Alternative Funding Levels

3 Percent Real Growth in

All Years, 1986-1990

Budget Authority

Outlays

Zero Real Growth 1986-1990

Budget Authority

Outlays

Real Freeze in 1986,

3 Percent Real

Growth 1987-1990

Budget Authority

Outlays

Nominal Freeze in 1986,

Lagged Baseline

Levels in 1987-1990

Budget Authority

Outlays

8

6

17

9

17

9

30

15

23

15

42

25

33

22

39

29

43

29

75

48

54

38

52

42

51

40

95

69

62

50

51

48

59

50

118

92

71

61

49

50

183

141

347

243

237

179

220

183

SOURCE: Congressional Budget Office.

51
does and in contrast to budget authority deflators that are a weighted average of future inflation). 3/

Through 1985, most real increases in budget authority have been allocated to purchasing hardware—especially major weapons systems. CBO

bases its projections of alternative funding levels on the assumption that

such allocations will continue. The Administration's request would change

the pattern by increasing RDT&E, a relatively fast-spending account, more

than other areas. As a result, the differences between the alternatives in

Table 111-16 and the request reflect both a difference in budget authority

and a difference in program mix. Greater outlay savings or lesser outlay

savings are possible, depending on how one proposes to allocate a given

amount of budget authority.

COMPARISON OF CBO AND ADMINISTRATION INFLATION

ASSUMPTIONS FOR DEFENSE PURCHASES

(Percent change, purchase deflator for outlays)

1985 1986 1987 1988 1989

CBO 4.0 4.7 5.4 5.3 5.1

Administration 3.6 4.6 4.5 4.4 4.1

1990

4.8

3.7

3. Pay raises pose a unique problem in that they are treated as administered price changes. Real growth in military personnel is determined

by increases in strengths; in the short term, pay raises do not affect

strength and quality appreciably and are a suitable proxy for price

changes. In the long run, differences in pay between federal and private employees can make a difference in measuring real growth because quantity and quality have time to change.

52
CHAPTER IV

ENTITLEMENTS AND OTHER MANDATORY SPENDING

The Administration's fiscal year 1986 budget proposes reductions that would

lower entitlement spending relative to CBO's baseline by $14 billion in 1986

and by $144 billion from 1986 to 1990. These program changes amount to 3

percent of baseline spending in 1986 and rise to almost 7 percent by 1990.

Since half of entitlement spending, including that in Social Security, is excluded from the proposals, reductions in the remaining programs are relatively large, and one program—general revenue sharing—is proposed for

elimination.

Entitlement programs provide benefits to persons, businesses, or units

of government that meet eligibility requirements established in law. Social

Security is the largest entitlement program, with outlays constituting about

20 percent of the entire federal budget. Other major entitlement programs

include Railroad Retirement, civil service and military retirement and disability, Unemployment Insurance, Medicare and Medicaid, Aid to Families

with Dependent Children (AFDC), Supplemental Security Income (SSI), Food

Stamps, farm price supports, Guaranteed Student Loans (GSLs), and veterans' compensation, pensions, and readjustment benefits.

OVERVIEW OF ADMINISTRATION PROPOSALS

Directly setting levels of budgetary outlays in entitlement programs is virtually impossible. To reduce spending below baseline levels, laws must be

changed to modify eligibility rules or benefit levels. A complete freeze on

entitlement spending, for example, would require complicated programmatic

changes to offset the often unpredictable growth in caseloads or benefit

levels.

The Administration proposals fall into two categories: (1) freezing

benefit levels in selected programs where benefit rates or other explicit

program parameters are increased for inflation; or (2) more fundamental

programmatic changes in areas not susceptible to freezes.

53
Freeze Variants

The 1986 budget proposes to: (1) eliminate the COLAs for one year in all

federal employee retirement and disability programs, (2) eliminate the July

1986 inflation adjustment in reimbursement rates for child nutrition programs, (3) freeze the reimbursement rates to hospitals and physicians in the

Medicare program, and (4) freeze the benefit levels in the Black Lung and

Special Benefits for Disabled Coal Miners programs. Together these actions

are estimated to save $30 billion from 1986 through 1990.

The Administration's request does not, however, propose eliminating

the 1986 COLA in other indexed programs. Social Security and veterans'

compensation beneficiaries would receive a full inflation adjustment on January 1, 1986, under the President's request. If, as some Congressional plans

have suggested, these COLAs were also eliminated for one year, savings

would increase by $36 billion from 1986 through 1990. Finally, the Administration's request would give full COLAs to recipients of SSI, veterans' pensions, and food stamps. If the 1986 inflation adjustment were eliminated in

these means-tested programs, savings would increase by $6 billion in the

period 1986-1990.

For several programs, reductions are proposed in addition to a oneyear freeze. The Administration proposes a number of additional reductions

in Medicare and in civil service and foreign service retirement and disability, many of which have been included in previous budgets but have not been

enacted by the Congress. Together these additional proposals would save

$15 billion from 1986 through 1990.

Programs Not Susceptible to a Freeze

The Administration's request also suggests large reductions in a number of

other programs not susceptible to a freeze, including farm price supports,

Guaranteed Student Loans, and other entitlement programs. Finally, general revenue sharing would be eliminated under the Administration's request.

These additional proposals would save another $99 billion over the next five

years.

As shown in Table IV-1, the distribution of reductions across entitlement programs is highly uneven. The Administration has proposed no reductions for Social Security, Unemployment Insurance, SSI, and veterans' compensation and pensions. Yet Social Security alone is responsible for almost

45 percent of total baseline spending for entitlements from 1986-1990, and

when other programs exempted from reductions are considered, over half of

all entitlement spending is held harmless.

54
While the Administration's request would reduce total entitlement

spending by almost 6 percent, programs targeted for reductions would be

reduced by 12 percent on average. A number of programs would be reduced

even more. General revenue sharing would be eliminated. Farm price supports would be reduced by 50 percent. Guaranteed Student Loans and child

nutrition would each be reduced by 20 percent or more as would

TABLE IV-1. CBO BASELINE AND CBO ESTIMATES OF THE

ADMINISTRATION'S PROPOSED REDUCTIONS

IN ENTITLEMENTS AND OTHER MANDATORY

SPENDING (In billions of dollars)

Program

CBO

Baseline

1986-1990

Administration

Reductions

1986-1990

Percent

Reduction

Social Security and

Railroad Retirement

Federal Retirement

and Disability

Medicare and Medicaid

Unemployment Insurance

AFDC, Food Stamps, SSI

Veterans' Programs c/

Farm Price Supports

General Revenue Sharing

Child Nutrition

Guaranteed Student Loans

Other

Total

1,144

247

624

88

170

85

64

25

23

18

72

2,557

a/

-12

-44

a/

-1

-2

-32

-24

-5

-5

-21

-144

5

7

b/

1

2

50

96

22

30

29

a. Less than $500 million.

b. Less than 0.5 percent.

c. Includes veterans' compensation, pensions, readjustment benefits, and

home loan guarantees.

55

T
certain other, smaller entitlement programs. On the other hand, the reductions proposed for the major means-tested programs are small relative to

the reductions proposed in other entitlement programs and relative to

reductions proposed in these programs in previous years.

The annual savings in proposed entitlement reductions are estimated

by CBO to grow rapidly from $14 billion in 1986 to $40 billion in 1990 (see

Table IV-2). The largest savings are proposed for the major health entitlements, Medicare and Medicaid, followed by farm price supports. Estimated

savings from the four largest program categories—health, farm price supports, general revenue sharing, and federal retirement and disability—equal

$112 billion over the five-year period and constitute over 75 percent of the

total savings requested.

MAJOR PROGRAM PROPOSALS

Medicare and Medicaid

Medicare and Medicaid, the major entitlement programs providing federal

funding for health services, are the fastest-growing programs in the nondefense budget (aside from interest costs). Medicare, which includes the

Hospital Insurance (HI) and the Supplementary Medical Insurance (SMI) programs, covers hospital, physician, and other medical costs for people aged

65 and over and for most disabled people entitled to Social Security cash

benefits. Medicaid, through federal and state financing, pays for health

services for some low-income people. Medicare and Medicaid together provide benefits to about 50 million people, at an estimated federal cost of $93

billion in 1985.

The President's proposed cuts from the CBO baseline in Medicare and

Medicaid total $4.4 billion in 1986 and $43.9 billion in 1986-1990. They

account for 30 percent of proposed savings in entitlement programs.

Medicare. The Administration's 1986 budget proposals would curb the

growth in the Medicare program both by limiting the growth in reimbursements to health care providers and by shifting costs to beneficiaries. The

Administration's proposals—both regulatory and legislative—would save an

estimated $24.1 billion in HI and $6.2 billion in SMI between 1986 and 1990.

Savings of another $10.8 billion from increases in SMI premiums are also

proposed. Further discussion of premiums can be found in Chapter VI. Even

with these proposed reductions, Medicare spending is projected to rise by 51

percent between 1986 and 1990,, and rise relative to GNP from 1.8 percent

to 2.0 percent. The major components of the proposed Medicare cuts are

shown in Table IV-3 and discussed below.

56
TABLE IV-2. CBO ESTIMATES OF THE ADMINISTRATION'S

PROPOSED REDUCTIONS IN ENTITLEMENTS

AND OTHER MANDATORY SPENDING

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Change

CBO Baseline Outlays

Proposed Changes

Medicare and Medicaid

Farm price supports

General revenue

sharing

Federal retirement

and disability

Housing loans

and expenses a/

Guaranteed Student

Loans

Child nutrition

Mortgage guaranty

fees

AFDC, Food Stamps,

and SSI

Other

Total

President's 1986 Budget

as Estimated by CBO

446 478 512 543 578

-4

-1

O

-1

-1

-1

-1

-1

b/

-1

-7

-4

-5

-2

-2

-1

-1

-1

b/

_ 1

-9

-8

-5

-3

-2

-1

-1

-1

b/

-1

-11

-10

-5

-3

-2

-1

-1 .

-1

b/

-2

-13

-10

-5

-4

-2

-2

-1

-1

b/

-2

-14 -23 -31 -36 -40

431 456 481 507 538

-44

-32

-24

-12

-10

-5

-5

-4

-1

-7

-144

The President's budget proposes that the Department of Housing and

Urban Development be forgiven the interest payments on certain

Treasury borrowing made in 1985 and earlier years. The reduced

interest payments shown above are offset elsewhere in the unified

budget. This change is discussed in Chapter VI.

Less than $500 million.

57
TABLE IV-3. CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSED REDUCTIONS

IN MEDICARE (By fiscal year, in billions of dollars)

Proposal 1986 1987 1988 1989

Cumulative

Five-Year

1990 Change

CBO Baseline Outlays

Change Hospital DRG Rate:

1986 Freeze

1987-1990 Policy- -

Market Basket Only

Freeze Physician Fees

Freeze Other Payments- -

Skilled Nursing Facilities,

Labs, PPS-Exempt

Hospitals, Direct Medical

Education, Medical Supplies

Total Freeze Changes

Phase SMI Premium to

35 Percent, Offsets

from Other Proposals a/

Reduce Indirect Medical

Education Add-on

to 5.79 Percent

Require Home Health

Copayment, Increase SMI

Deductible, Delay

Eligibility One Month

Extend Medicare Second

Payer to Over-Age 69,

and Other

Total Program Changes

Total Changes

President's 1986 Budget

as Estimated by CBO

77.5 86.3 96.5 107.9 120.7

freeze Provider Payments

-1.5

-0.5

-2.1

-0.1

-0.5

-2.4

-0.3

-0.5

-2.6

-0.5

-0.5

-2.9

-0.8

-0.5

-11.5

-1.7

-2.3

-0.3 -0.5 -0.9 -1.3 -1.7

-0.6 -0.8 -1.1 -1.2 -1.4

-0.3 -0.5 -0.6 -0.7 -0.9

-0.2 -0.4 -0.4 -0.5 -0.5

-1.1 -1.6 -2.1 -2.4 -2.7

-3.4 -4.8 -6.1 -7.3 -8.6

74.0 81.4 90.3 100.5 112.0

-4.8

-2.3 -3.2 -4.0 -4.9 -5.9 -20.3

Mandate Program Changes

(-0.2) (-0.7) (-1.7) (-3.2) (-4.9) (-10.8)

-5.1

-3.0

-2.0

-10.1

-30.3

a. SMI premiums are included in the offsetting receipts category discussed in Chapter VI

and are not counted in the totals for entitlements.

58
Under current law, hospitals are reimbursed by Medicare through a

prospective payment system (PPS) under which rates are set in advance for

each of 468 diagnostic categories, known as diagnosis related groups (DRGs).

In the HI program, the Administration proposes to achieve major savings by

freezing the DRG rates of reimbursement in 1986 for hospitals subject to

PPS. In addition, the Administration's current services projections assume

that in 1987 through 1990 the rate of increase in DRGs would be limited to

the rate of increase in the cost of a market basket of goods and services

typically purchased by hospitals. This policy differs from that enacted in

the Deficit Reduction Act of 1984, which capped the growth in the DRG

rates at market basket plus one-quarter (0.25 percentage point) for 1986 and

left future increases to the discretion of the Secretary of Health and Human

Services with the advice of a special commission. The CBO baseline

assumes a rate of increase equal to the market basket plus one-quarter. The

Administration's policy changes would lower DRG growth one-quarter of a

percentage point each year from 1987 through 1990 relative to CBO baseline. Estimated savings from these initiatives would total $13.2 billion from

1986 through 1990 and would account for a 4 percent decrease in HI outlays.

The Administration is also proposing to freeze physician fees for one

additional year, which would reduce SMI outlays. The Deficit Reduction Act

of 1984 froze physician fees for 15 months beginning in July 1984, and this

new legislative proposal would extend the freeze through fiscal year 1986,

for a total of 27 months. The Administration's proposed freeze would save

$2.3 billion over the 1986-1990 period, and total savings from the 27-month

freeze would be $5.8 billion over the same period.

A freeze is also proposed on certain other payments: to skilled nursing

facilities, to laboratories, to certain hospitals not included in the prospective payment system, and for direct medical education and medical supplies.

All of the freeze proposals account for about two-thirds of the total $30.3

billion estimated to be saved in Medicare during 1986-1990.

In addition to freezing certain provider payments, the Administration

is proposing a number of program changes. One of these changes—reducing

reimbursement for indirect medical education by 50 percent (to 5.79 percent)—would also affect providers in teaching hospitals and save an estimated $5.1 billion during 1986-1990.

A number of the proposed changes would affect beneficiaries directly.

Similar proposals have been suggested by the Administration in previous

budgets. The SMI deductible would be indexed and increased each year. The

deductible would increase from the current rate of $75 to $90 by 1990. A

copayment equal to 1 percent of the hospital deductible (about $4.80 in

59
1986) would be established for each home health visit after 20 visits. Also,

Medicare eligibility for the aged would be delayed one month, to the first

day of the month following a person's sixty-fifth birthday. Together these

proposals would save an estimated $3 billion during 1986-1990.

Finally, coverage of elderly people who work would be modified by

making Medicare the secondary payer for workers over 69 who chose to be

covered under employment-related insurance. This and several other proposals would save an estimated $2 billion during 1986-1990.

Medicaid. The President's budget proposes to change the nature of the

Medicaid program from an open-ended entitlement to one that is capped.

Estimated savings would total $13.6 billion between 1986 and 1990.

Specifically, the President's budget proposes to limit 1986 payments to

the states for medical care services to a level $1.3 billion below current

services. During 1986 only, a total of $0.3 billion would be returned to the

states in the form of payments to states facing special problems. From

1987 through 1990, the limits on Medicaid payments would be adjusted for

changes in the medical care component of the CPI. The Administration

intends to offer additional legislative and regulatory changes to increase

state flexibility in limiting eligibility, coverage, or reimbursements. Otherwise, states might find it impossible to meet federal requirements without

substantial increases in their spending on Medicaid.

In addition to a cap on spending for medical services, the President

proposes to limit the federal payment for administrative expenses in 1986 to

the 1985 level. After 1986, the federal share for administrative expenses

would be allowed to grow at a rate equivalent to the GNP deflator.

Farm Price Supports

Farm price- and income-support programs provide benefits to farmers by

stabilizing and enhancing farm prices and incomes (see accompanying box).

Outlays for price-support programs peaked at $18.9 billion in 1983, nearly

six times their average in the 1970s. Outlays fell to $7.3 billion in fiscal

year 1984 as a result of a sharp decline in crop production caused by the

payment-in-kind (PIK) program and a severe drought. Outlays in 1985 are

expected to rise to $14.2 billion as crop production rebounds and exports

remain sluggish in the face of a strong dollar. In addition, advance deficiency payments on 1985 crops will help push outlays above last year's level.

With a continuation of current policy, outlays are forecast to average $12.8

billion over the 1986-1990 period.

60
HOW FARM PRICE SUPPORTS WORK

Price-support expenditures are designed to stabilize crop prices

and increase farm income. The commodities covered by these programs are wheat, corn and other feed grains, soybeans, rice, upland

cotton, tobacco, peanuts, milk, and wool. The main price stabilization tools are nonrecourse loans and the farmer-owned grain reserve.

Nonrecourse loans are made to crop farmers at a specified loan

rate, or price support, per unit of production. Farmers may store

crops and use them as collateral for 9- to 12-month loans at the loan

rate. If a farmer elects not to repay the loan plus interest, the

government agrees to accept the commodity as full reimbursement.

Thus, nonrecourse loans place a floor under market prices, provide a

source of interim financing for farmers, and help farmers spread

their sales throughout the marketing year.

A wheat or feed grain grower may place grain in the farmerowned reserve when a nonrecourse loan becomes due. Under the

reserve program, a farmer contracts with the government to store

grain for a three-year period, while the farmer receives an extended

nonrecourse loan. Grain in the reserve cannot be sold, except with a

financial penalty, until the market price reaches a trigger release

price, at which time storage payments cease and the farmer can repay his loan without financial penalty. Interest is charged only for

the first year. Both nonrecourse loans and the farmer-owned reserve

tend to withhold products from the market when prices are low.

Under certain conditions, farmers can also qualify for deficiency payments and reductions in planted acreage. Deficiency payments

support the incomes of feed grain, wheat, rice, and cotton farmers

when national average prices for a specified period fall below target

prices. The maximum payment per unit of production is the difference between the target price and the nonrecourse loan rate.

Reductions in planted acreage from predetermined base levels

may also be required of grain and cotton farmers to qualify them for

the above program benefits. Further, these farmers may be offered

land diversion payments in cash or in kind for additional acreage reduction. The total amount of deficiency and cash diversion payments

that an individual can receive is $50,000 a year.

Milk prices are supported by government purchases of surplus

manufactured dairy products. The support price for milk determines

the government purchases of these products.

T
The President proposes to reduce spending from projected baseline

levels for price supports by 50 percent over the five-year period. The proposed changes are estimated by CBO to save $1.4 billion in 1986 and $32.2

billion from 1986-1990. The major components of the proposal are:

o Setting nonrecourse loan rates at 75 percent of the average of

market prices during the past three years.

o Phasing out deficiency payments by the 1991 crop. For the 1986

crop, target prices would be set at 100 percent of the average of

market prices experienced during the preceding three years.

o Reducing the $50,000 limitation on direct payments to individuals

to $20,000 for the 1986 crop, $15,000 for the 1987 crop, and

$10,000 for the 1988 and later crops.

o Phasing out acreage control programs. During the first three years

of the program a transitional acreage control program would be

retained for wheat, corn and other feed grains, cotton, and rice.

o Phasing out the dairy price-support purchase program and replacing

it with a direct payment program in 1988.

The effects of these changes on the farm sector are difficult to forecast. In recent years, price-support programs and the high value of the

dollar have caused U.S. crops to become less competitive in world markets.

Reducing market prices through lower price supports should result in increased exports of our agricultural products. In addition, some analysts

argue that current agricultural policies encourage excessive investment in

agriculture. The proposed changes would cause investment and production

decisions to be determined more by market forces than by federal agricultural policy. Consumers would benefit directly from lower prices for sugar

and dairy products. Meat prices might also decline as grain prices drop.

Lower prices and reductions in income support, however, would have

significant effects on farmers. These changes would aggravate current

credit problems brought on by high interest rates and already relatively low

commodity prices. Transitional costs could be high for people in certain

sectors of the agricultural economy as the value of land and other assets

adjust to the new lower commodity prices.

General Revenue Sharing

The general revenue sharing (GRS) program provides unrestricted grants

totaling $4.6 billion annually to all local governments--counties, municipal62
ities, townships, and Indian tribes. Revenue sharing funds are divided among

local governments according to formulas based on population, income, and

tax factors. The formulas are designed to target assistance toward governments with low per capita incomes or high tax efforts. The program generally has accounted for less than 2 percent of local government revenues,

although for some rural and suburban governments the percentage has been

higher. States participated in the program until 1981 when their shares

were eliminated.

The President proposes eliminating the program in 1986, a year before

the current authorization expires. Savings from this proposal would be

$3.4 billion in 1986 and $23.7 billion over the 1986-1990 period. The estimated savings are from the CBO baseline, which assumes that the program

is reauthorized in 1987 at levels that would keep pace with inflation. Previous Presidential budgets have not proposed eliminating general revenue

sharing funds.

Federal Retirement and Disability

Federal retirement and disability programs provide benefits to all federal

employees—both civilian and military—when they retire or become disabled.

The President's 1986 budget proposes eliminating the scheduled 1986 COLAs

in all federal retirement programs. Based on projections of consumer

prices, CBO projects a 3.7 percent COLA under current law. Eliminating

this COLA would reduce projected benefit payments beginning in January

1986, saving $1.2 billion in 1986 and $7.7 billion in 1986-1990.

Civil Service and Foreign Service Retirement and Disability. The President's budget proposes almost identical changes to the civil service and

foreign service retirement and disability programs. Elimination of the 1986

COLA would save an estimated $0.7 billion in 1986 and $4.3 billion in

1986-1990. In addition, the President's budget suggests structural changes

in these programs that would save another $4.8 billion over the five-year

period ending in 1990. Most structural changes have been requested in previous budgets, but they have never been acted on by Congress.

Beginning in 1987, the COLA would be changed to equal the lower of

the proposed General Schedule (GS) pay increase for civil servants or the

change in the Consumer Price Index. The Administration's proposed GS pay

increase of 3 percent each year in 1987 through 1990 is estimated to be

lower than the CPI change, resulting in a lower COLA than under current

law. Also, those whose benefits exceed $10,000 a year would receive only

55 percent of the COLA on benefit amounts in excess of $10,000.

63

42-72 6 O - 85 - 4 QL 3
In addition to COLA changes, the budget proposes to reduce civil service benefits for those retiring before age 65 (before age 60 for foreign

service retirees). This reduction would be phased in over 10 years and would

not affect people currently 55 years or older. When fully implemented,

those people retiring at age 55 with 30 years of service would receive 50

percent less in benefits than under current law. Other proposals in civil

service and foreign service retirement include reducing survivor benefits,

eliminating student benefits, phasing out the use of unused sick leave in

calculating retirement benefits, and changing the annuity calculation from

using the highest three years of pay to the highest five years of pay.

The magnitude of the proposed reductions is far larger than the fiveyear savings would indicate. Savings from the changes would grow considerably after the end of the projection period. The President's proposals this

year to change federal retirement benefits, and to reduce federal civilian

pay and federal employee health insurance benefits, would focus a significant portion of the proposed budget reductions on federal civilian employees.

Other Retirement and Disability Programs. The proposed freeze of the

1986 COLA would also lower benefits in the retirement programs of the

military, Public Health Service Commissioned Officers, Coast Guard, and in

federal employee workers' compensation. Savings are estimated to be $0.5

billion in 1986 and $3.5 billion in 1986-1990.

The Administration's treatment of military retirement is in sharp contrast to the proposed reductions in civil service retirement and disability.

While COLAs are proposed for elimination in both programs, civil service is

also targeted for additional major changes in the calculation of benefits for

future retirees. No additional reductions are proposed for current or future

military retirees.

Guaranteed Student Loans

The Guaranteed Student Loans (GSL) program provides guaranteed loans at

below-market interest rates to eligible college students. The President has

proposed comprehensive changes for students attending postsecondary institutions, covering both grants—such as Pell grants discussed in Chapter V—

and guaranteed loans. The President's proposal for the GSL program would

further target assistance toward the lowest-income students and would reduce subsidies and loan levels generally. All parties—students, lenders, and

state guarantee agencies—would be affected, resulting in estimated savings

of $0.5 billion in 1986 and $5.2 billion in 1986-1990. By 1990, projected

program costs would be cut by 50 percent.

64
Some 35 percent fewer students would be eligible for guaranteed loans

in 1986 under the proposed tightening of eligibility rules. Any student from

a family with income greater than $32,500 would be ineligible for a subsidized loan. Financial need assessments would be required for all students.

With few exceptions, no students under age 22 could be classified as financially independent from their parents, thus implying that parental income

would be considered in determining eligibility,. Finally, a "mega cap" of

$4,000 a year would be imposed on all federal student aid. Interest rates

paid by the student after leaving school would be set at the market rate

rather than at the current 8 percent rate, but the government would continue to pay interest while students are in school.

Lenders who now receive a variable return of 350 basis points above a

fluctuating 91-day Treasury bill rate would receive 150 basis points above

the bill rate at the loan's initiation while the student is in school and 300

basis points above that rate when the student is repaying the loan. This

would increase lenders' risk to rising interest rates. Lenders would also be

required to disburse funds in multiple increments over the school year. In

addition, state guarantee agencies would no longer receive an administrative

allowance, would be required to share more of the cost of defaults, and

would have to return all federal advance funds.

CBO estimates that the combined effect of these proposals would be

to cut in half annual new loan volume, reducing it to an estimated $4.8 billion in 1987. The estimated number of GSL borrowers in 1987 would drop

from 3.6 million to 2.3 million. Some 1.0 million students from families

with incomes in excess of $30,000—almost 30 percent of current borrowers—would be eliminated from the program as would another 0.3 million

borrowers with incomes below $30,000. The effect would be even larger

than estimated here if private lenders dropped out of the program because

of either a reduced demand for loans or reduced subsidies.

Child Nutrition

The child nutrition programs provide subsidized meals to children, with

larger subsidies going to those in families with low or moderate incomes.

The President's budget proposes to eliminate all subsidies to children from

families with incomes above 185 percent of the poverty level. These subsidies currently account for 16 percent of total outlays. In addition, the July

1986 inflation adjustment in reimbursement rates for meals would be eliminated. Total savings from these changes are estimated to be $0.7 billion in

1986 and $5.2 billion from 1986-1990. CBO estimates that program spending

would be cut by almost one-quarter as a result of these proposed changes.

Eliminating subsidies to children from families with incomes above 185 per65
cent of poverty would affect the school lunch, school breakfast, and child

care programs and would save an estimated $1.0 billion in 1990. The Administration proposed a similar change in its 1982 budget, but since then has

sought to limit growth primarily by consolidating certain child nutrition programs into a block grant to states.

This proposal would eliminate subsidies for approximately one-half of

the children now in the school lunch program. As a result, some schools,

though probably a small number, might discontinue the school lunch program, thereby further decreasing the number of subsidized meals.

Mortgage Guaranty Fees

The Federal Housing Administration (FHA) and the Veterans Administration

(VA) insure home loans made to veterans and other qualified buyers by private lenders against the risk of default. The Government National Mortgage

Association (GNMA), an agency of the Department of Housing and Urban

Development, sells government securities that are backed by pools of the

mortgages insured by FHA or VA. GNMA further guarantees the prompt

payment of principal and interest to the purchasers of these securities.

A major strategy underlying many of the President's deficit reduction

proposals is to shift more of the costs of providing federal services to the

specific users of the services. As part of this approach, the 1986 budget

proposes to increase the fees charged by these agencies to guaranty or insure home mortgages and mortgage-backed securities.

Federal Housing Administration. Under current law, the FHA charges a

mortgage insurance premium set at a level sufficient to cover the risk incurred by the government on these loans. The current premium is 3.8 percent of the mortgage principal. The President's proposal would raise the

premium to 5.0 percent, an increase of 1.2 percentage points. This small an

increase is not expected to have a significant impact on either new loans

insured or on default rates, The measure would, however, expand FHA

collections by $0.3 billion in 1986 and $2.2 billion over the full five-year

period.

Veterans' Home Loan Guaranty Program. The President is also proposing to

increase the loan origination fee charged by the VA to guaranty veterans'

home loans to 5 percent of the mortgage principal. The current VA fee is

only 1 percent. Thus this proposal represents a major increase, the results

of which are expected to have more of an effect on program activity than

would be expected from the relatively small increase in the FHA premium.

CBO anticipates that the VA measure would raise both the default rate and

66
the default cost for loans in which the fee is financed as part of the mortgage principal. Further, the discounts paid by the agency to sell vendee

loans incorporating the 5 percent fee would also be expected to rise. The

net result of these effects could be program outlays in 1990 that are actually higher than 1990 baseline outlays. The $1.6 billion in added collections estimated to accrue from 1986 to 1989 would, thus, be more than

offset by higher costs in 1990 and beyond.

Mortgage-Backed Securities. Higher fees are also proposed in the 1986 budget for the guaranties provided by the Government National Mortgage Association (GNMA) in connection with the sale of mortgage-backed securities. Beginning in 1986, the annual guaranty fee would be raised 9 basis

points (0.09 percentage points) from 6 points to 15 points. This change

would increase federal collections by an estimated $0.6 billion over the

1986-1990 period.

Major Means-Tested Transfer Programs

Means-tested transfer programs—Aid to Families with Dependent Children,

Food Stamps, and Supplemental Security Income—provide the major governmental support to low-income families. The Administration's 1986 budget

proposes no changes in SSI and only small reductions in AFDC and Food

Stamps. The proposed reductions are smaller than in any of the President's

previous budgets. CBO's estimated savings for the Administration's proposals are $0.1 billion in 1986 and $0.6 billion over the 1986-1990 period.

The proposed reductions are repeats of previous Administration requests. First, the Administration proposes to convert the financing of

administrative costs in both AFDC and Food Stamps from an open-ended

entitlement to a grant in the same manner as in the Medicaid program.

Based on CBO's estimates, this proposal would account for over 60 percent

of total AFDC and Food Stamp savings from 1986-1990. A similar proposal

—combined welfare administration—was in the President's 1983 budget, but

the grant would have been fixed rather than increased over time by the GNP

deflator.

The concept of workfare—requiring employable AFDC and Food Stamp

recipients to work off their welfare grants—is proposed again. States would

be required to include only 25 percent of employable recipients in workfare

or in similar work-related activities in 1986 and 75 percent in 1988 and later

years. Administrative costs associated with workfare would be financed in

full under current matching rates despite the limitation on administrative

costs discussed above. CBO estimates small savings over the five-year

period beginning in 1986, but evidence is not available to assess the costeffectiveness of workfare with any reliability.

67
In other AFDC changes proposed by the Administration, an employable

caretaker would no longer receive benefits after the youngest child turned

16 years of age, and an unmarried minor mother would have to live with her

parents to receive benefits.

All Other Entitlements and Mandatory Spending

This residual category contains a diverse collection of smaller programs

including the Forest Service, the Pension Benefit Guaranty Corporation, the

Bonneville Power Administration, and Federal Employees Health Benefits.

Cuts proposed in these programs would reduce federal expenditures by $1

billion in 1986 and $7 billion over the five-year period from 1986-1990.

The Administration is proposing to deduct certain operating costs from

the timber and mineral receipts collected by the Forest and Minerals Management Services before calculating the share of those receipts to be returned to the states. This measure would save an estimated $1.7 billion over

the next five years. An increase in the single-employer premium charged by

the Pension Benefit Guaranty Corporation is proposed by the President for

the third consecutive year. This year's proposed increase, from $2.60 to

$7.50 per employee, is estimated to raise collections by $1.2 billion from

1986-1990. A new method of calculating the employers' contribution to

Federal Employees Health Benefits, proposed for the second time by this

Administration, would decrease outlays for this program by $0.3 billion between now and 1990.

The President's 1986 budget also proposes measures to ensure the recovery of the federal investment in the Bonneville Power Administration

and other power-marketing administrations that sell the hydroelectric power

generated at federal dams. This proposal, which would increase Bonneville's

collections by $1.3 billion from 1986 to 1990, would impose a fixed schedule

for repayment of principal and would increase the interest charged on outstanding balances to the current cost of Treasury borrowing. While the

changes would increase the cost of electricity for Bonneville's customers,

the higher rates would still be only about half the national average.

68
CHAPTER V

NONDEFENSE DISCRETIONARY SPENDING

A major share of the President's deficit reduction effort is concentrated in

nondefense discretionary programs. More than half of the five-year savings

relative to the CBO baseline fall in this category, even though only about 17

percent of projected federal outlays in 1986 through 1990 fall in this category under current policies.

WHAT IS NONDEFENSE DISCRETIONARY SPENDING?

Many nondefense programs are considered "discretionary" in that

the law establishes no entitlement to benefits from them. The Congress controls spending for these programs through the appropriations

process— either by providing budget authority or by establishing loan

limits, expenditure limits, or obligation ceilings.

The nondefense discretionary category encompasses a wide array

of programs—including foreign aid, environmental regulation, housing

assistance, education and community development grants, and law

enforcement activities, among many others. Of the $163 billion in

this category spent in 1984, slightly more than half went either to

states and localities (about $48 billion) or for pay and benefits of the

federal work force (about $36 billion). The remainder went directly

to individuals, businesses, or foreign governments in the form of loans,

grants, or purchases of goods and services.

While most of such spending appears in the unified budget, a

portion is defined in law as "off-budget" and is not counted in the

budget totals. The President is proposing to eliminate this distinction,

and in order to provide useful comparisons, this chapter will not

differentiate between on- and off-budget programs, a/

a. Virtually all off-budget spending falls in the nondefense discretionary category.

69
The President's proposals would reduce nondefense discretionary outlays from an estimated $179 billion in 1985 to $167 billion in 1986 and to

$162 billion in 1987, a drop of 9.4 percent over the two years. The budget

would maintain spending at close to that level for the rest of the decade,

with outlays reaching $165 billion in 1990. This amount contrasts with

CBO's baseline projections, which assume that spending under current policies would keep pace with inflation, growing by about 4 percent per year

over the next five years to $218 billion in 1990. The difference between the

Administration's outlays as reestimated by CBO and the CBO baseline is $17

billion in 1986, rising to $32 billion in 1987 and $53 billion in 1990 (see

Figure V~l). Total spending reductions over the five-year period would be

$187 billion, and spending in 1990 would be 24 percent below the baseline

level. As a proportion of all budget outlays, nondefense discretionary

Figure V-1.

Nondefense Discretionary Spending, 1980-1990

230

220

210

i 200

"o

I 190

l/>

C

a

I 180

170

160

Actual Projected

CBO Estimate of

Administration Program

1980 1982 1984 1986 1988 1990

SOURCE: Congressional Budget Office.

70
spending would fall from an estimated 19 percent in 1985 to 13 percent in

1990. IJ

Spending cuts are proposed for almost all types of nondefense discretionary spending, but the treatment of individual programs varies widely. A

number of programs would be eliminated, many would have sharply reduced

funding, but some would be maintained at current levels or even increased.

The Administration's spending priorities for discretionary programs are

concentrated on basic operations of the federal government, foreign aid,

space, and veterans' programs. Expenditures for space and science programs

would be 19 percent above the baseline, and relatively small reductions

would be made in veterans' programs, international affairs, justice, and general government. On the other hand, significant reductions are proposed for

assistance to business and commerce, human resources programs, transportation, natural resources, and community development activities. Discretionary outlays in the agriculture and mortgage credit areas would be

reduced by two-thirds or more over the 1986-1990 period relative to the

CBO baseline, while spending for commerce, energy, community and regional development, training, employment, and social services would be reduced

by 25 percent to 40 percent. Table V-l summarizes the percentage changes

proposed by the President for the various program areas, which are ranked

by the percentage reduction in outlays over the 1986-1990 period.

MAJOR SPENDING REDUCTIONS

Over 70 percent of the proposed savings would be obtained in 15 major

programs or program areas, while the remainder would be spread over hundreds of programs or accounts (see Table V-2). The largest dollar savings

are proposed in farm and rural housing loans made by the Farmers Home

Administration (FmHA), in federal employees' pay, and in housing programs

of the Department of Housing and Urban Development (HUD); these four

areas alone account for almost 40 percent of the recommended savings in

this category.

Farm Loans

The Administration is proposing to eliminate most direct loan programs of

the Agricultural Credit Insurance Fund and replace them with increased loan

guarantee activity. It would eliminate direct ownership loans—used to improve or acquire farms, refinance debts, finance nonfarm enterprises, or

1. In 1980, outlays for this category totaled $155 billion, or 6.0 percent

of GNP.

71
TABLE V-l. CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED INCREASE OR

DECREASE IN OUTLAYS OF DISCRETIONARY PROGRAMS (By fiscal

year, in percent differences from the CBO baseline)

Percentage Increase or Decrease (-)

for Program Area

Program Area

ALL DISCRETIONARY

NONDEFENSE PROGRAMS

Agriculture

Mortgage Credit

Commerce

Energy

Community and Regional

Development

Training, Employment

and Social Services

Education

Transportation

Income Security

1986

-9

-71

-39

-2

-15

-7

-11

-6

-6

-10

1990

-24

-74

-84

-54

-51

-39

-32

-23

-23

-20

Total

1986-1990

-19

-70

-66

-39

-38

-27

-25

-18

-15

-15

Program with

Largest Proposed

Outlay Reduction

FmHA Farm Loans

FmHA Housing Loans

Postal Subsidies

Strategic Petroleum

Reserve

SBA Disaster Loans

Training and Employment Services

Postsecondary

Student Aid

Mass Transit

Grants

HUD Housing

Subsidies

Natural Resources and

Environment -8

Health -6

International Affairs 1

Justice, General Government and Fiscal Assistance -4

Veterans' Benefits and

Services -1

General Science, Space

and Technology 2

-20

-18

-13

-6

-5

EPA Construction

-14 Grants

-14 NIH Research

-7 Export-Import Bank

Legal Services

-4 Corporation

-3 VA Medical Care

4 NASA Space Shuttle

NOTE: This table reflects only the discretionary spending in each program area. The

budgetary effects of the President's proposals on entitlement or mandatory

programs and offsetting receipts are discussed in Chapters IV and VI, respectively.
TABLE V-2. CBO ESTIMATE OF THE ADMINISTRATION'S PROPOSED

REDUCTIONS IN NONDEFENSE DISCRETIONARY SPENDING

(By fiscal year, in billions of dollars)

CBO Baseline Outlays

Proposed Changes

Farm Loans (ACIF)

Civilian Agency Pay

Rural Housing (RHIF)

HUD Housing Subsidies

Mass Transit

Strategic Petroleum

Reserve

Export-Import Bank

Student Financial Aid

Training and Employment

Services

Highway Grants

Small Business Loans

Rural Electrification

Administration

Health Research (NIH)

Grants to Amtrak

Postal Subsidies

Subtotal

Other

Total

1986

184.5

-4.4

-2.0

-2.0

-1.8

-0.8

-0.9

-0.3

-0.5

-0.2

-0.2

-0.2

0.0

-0.3

-0.6

0.2

-14.0

-3.4

-17.4

1987

193.9

-4.4

-3.1

-3.1

-2.5

-1.3

-1.9

-1.1

-1.3

-1.0

-0.8

-0.8

-0.5

-0.8

-0.7

-1.4

-24.5

-7.7

-32.2

1988

203.0

-4.0

-3.7

-3.6

-2.8

-1.9

-1.8

-1.7

-1.4

-1.3

-1.3

-1.2

-1.2

-0.9

-0.8

-0.7

-28.3

-10.4

-38.7

1989

209.9

-3.9

-4.6

-4.0

-3.2

-2.3

-1.8

-1.9

-1.5

-1.4

-1.5

-1.5

-1.6

-1.0

-0.8

-0.7

-31.9

-13.9

-45.8

1990

217.9

-3.8

-5.7

-4.4

-3.9

-2.8

-1.4

-2.0

-1.7

-1.7

-2.0

-1.4

-2.0

-1.2

-0.8

-0.5

-35.2

-17.7

-52.9

Cumulative

Five-Year

Total

1,009.3

-20.5

-19.1

-17.1

-14.2

-9.2

-7.8

-7.1

-6.4

-5.6

-5.6

-5.2

-5.2

-4.3

-3.7

-3.2

-134.0

-53.0

-187.0

President's Budget as

Estimated by CBO 167.1 161.7 164.4 164.1 165.0 822.3

73
make additions to farms—for which $650 million was authorized in 1985. It

would also reduce direct loans for farm operations from $1.9 billion in 1985

to $0.4 billion in 1986, and eliminate them by 1990. Interest rates on the

direct operating loans remaining would be raised to one and one-eighth percentage points above Treasury costs, and the limited resource loan program

would be eliminated. The limitation on guaranteed operating loans would be

increased from $650 million in 1985 to $3 billion in 1986, but the origination

fee would be raised from 1 percent to 5 percent.

Legislation will also be proposed to exclude disaster loans in counties

where federal crop insurance is available, which the Administration expects

would eliminate most eligibility for such loans. In total, the Administration

proposes to reduce direct loans authorized from $4.5 billion in 1985 to $0.4

billion in 1986. No direct loans would be made after 1989, though the

authority would be retained to make disaster loans when crop insurance

assistance is not sufficient to meet emergency needs resulting from natural

disasters. Outlay savings would average $4 billion per year.

Civilian Agency Pay

The Administration proposes cuts in federal civilian employee pay and retirement benefits. (The retirement proposals are discussed in Chapter IV.)

The pay of most federal civilian employees would be cut by 5 percent in

January 1986. In 1987 through 1990, pay would be increased 3 percent each

January. On the other hand, the CBO baseline assumes that all federal

employees will receive pay rate adjustments equal to the annual rate of

growth in private-sector pay, ranging from 3.0 percent in October 1985 to

5.6 percent in October 1989.

CBO estimates that the proposed 5 percent pay reduction, by itself,

would reduce outlays by about $1.1 billion in 1986 and by more than $1.6

billion annually in subsequent years, compared with current pay rates. The

Administration's overall pay adjustment plans, including reduced future pay

raises, would save about $2.0 billion in 1986, increasing to $5.7 billion in

1990, compared with the CBO baseline. 2/

Rural Housing Programs

The President's budget proposes the complete elimination (except for minor

housekeeping activities) of the Farmers Home Administration's rural housing

2. Excluding offsets for federal agencies' share of employee retirement.

74
programs beginning in 1986, Most of this assistance is provided by the Rural

Housing Insurance Fund (RHIF) in the form of reduced interest-rate mortgage loans to low-income households or to developers of low-income rental

housing. Over $3.2 billion was authorized for this purpose in 1985. The

Administration expects that after the two-year moratorium on HUD commitments, a portion of HDD's rental assistance will be allocated to rural

areas.

This proposal would result in significant budgetary savings. In 1984,

interest subsidies and losses associated with the loan programs cost over

$2.1 billion. Outlay savings from terminating the programs are projected at

$2.0 billion in 1986, increasing to $4.4 billion in 1990.

HUD Housing Subsidies

The Administration is proposing a two-year moratorium on additional housing assistance commitments and a large reduction in funding for modernizing public housing. The CBO baseline (based on fiscal year 1985 appropriations) contains authority in each year estimated to be sufficient to support

100,000 incremental housing units and increases modernization funding to

account for inflation. The Administration plans to resume commitments in

1988 at the annual rate of 100,000 units, but with assistance heavily weighted toward five-year vouchers rather than the more traditional 15- to 20-

year rental assistance contracts. In addition to the moratorium, the President has proposed a one-year freeze on rent increases for much of the

assisted housing inventory. Annual rent adjustments to allow for cost increases would resume in 1987. The CBO baseline assumes rent adjustments

for each year. The net reduction for HUD's housing subsidy programs would

be $1.8 billion below the baseline level in 1986, and $3.9 billion below in

1990.

Mass Transit

The President proposes to eliminate two-thirds of the funding for mass transit programs of the Urban Mass Transportation Administration. The Administration's budget includes funds for the Washington Metro (expected to

cover the remaining costs of building 89.5 miles of the planned 101-mile

system), a small amount to cover reduced administrative and research costs,

and $1.1 billion annually for capital grants from the Highway Trust Fund.

As a result, the $875 million operating assistance to local governments

would be eliminated, and the amount of capital assistance apportioned by

formula would be reduced by 30 percent. (The latter is used primarily for

purchasing buses and improving existing rail systems.) No funding would be

75

"I
provided after fiscal year 1985 for major capital programs, such as new

subway systems, and no discretionary funds would be available for modernization and extensions to existing rail systems. Total transit funding would

drop from $4.1 billion in 1985 to $1.4 billion in 1986, with total outlay

savings of $9.2 billion over the 1986-1990 period.

Strategic Petroleum Reserve

The President is proposing an indefinite moratorium on the future development of the Strategic Petroleum Reserve (SPR). Under this proposal, no

additional capacity would be built and no oil purchased after fiscal year

1985, unless either market or fiscal conditions warranted a resumption of

SPR development. The Department of Energy estimates that the SPR will

contain approximately 489 million barrels of oil by the end of 1985, which is

equivalent to about 98 days of current U.S. oil imports. Under existing

Congressional policy, the SPR's ultimate capacity would total 750 million

barrels, and would be completed by about 1990.

To implement this plan, the President requests no funding for either

oil acquisition or construction over the 1986-1990 period, and has deferred

$1.1 billion appropriated for 1985 for these purposes. Assuming the moratorium continues through 1990, it would reduce federal outlays over the

1986-1990 period by about $7.8 billion relative to the CBO baseline. 3/

Export-Import Bank

The Export-Import Bank lends money at subsidized interest rates to foreign

purchasers of U.S. products. The President is proposing to replace the

bank's direct loan program with a $1.8 billion program of guaranteed loans,

coupled with direct subsidy payments for exports facing competition from

official export credits offered by other nations. Outlays from the direct

loan program arise when loan disbursements in any period are in excess of

repayments. Under the interest subsidy program, these cash flows are between the private financial institution and the borrower, and thus not in the

federal budget. Government outlays are limited to collections of loan application and commitment fees and interest subsidy payments to the lender as

the loans are repaid. The elimination of the direct loan program is projected to reduce outlays by $0.3 billion in 1986, with savings increasing to

$2.0 billion by 1990.

3. The CBO baseline includes the 1985 deferrals; thus, the savings estimate does not include the outlay effect of the deferrals.

76
Student Financial Assistance

The Administration is seeking major changes in all postsecondary student aid

programs, including Pell grants, state student incentive grants, and the

campus-based loan, grant, and work-study programs. (The Guaranteed Student Loan program is discussed in Chapter IV.) The Administration plans to

reduce total federal aid, target the remaining assistance toward the more

needy, and lower interest subsidies. Under its proposals, students could not

receive more than $4,000 in federal aid per year; students under the age of

22 would be considered financially dependent on their parents; and students

from families with adjusted gross incomes of more than $25,000 would not

qualify for grants, direct loans, or work-study jobs. The Administration

would reduce Pell grant funding, eliminate state student incentive grants

and federal capital contributions to the National Direct Student Loan

(NDSL) program, and combine the campus-based grant and work-study programs. Students would repay NDSLs at Treasury bill rates instead of the

current rate of 5 percent.

The budget projects total funding about 29 percent below CBO baseline levels over the 1986-1990 period, with outlay savings of $0.5 billion in

1986, increasing to $1.7 billion in 1990. These proposals would eliminate

Pell grants for about 800,000 students and campus-based assistance for

about 500,000 students, some of whom have low family incomes.

Training and Employment Services

Under the Job Training Partnership Act, the Department of Labor provides

grants to states for job training programs for the economically disadvantaged, for summer jobs programs for youth, and for assistance to displaced

workers. It also finances federal training assistance programs for special

segments of the population, including the Job Corps for disadvantaged youth

ages 14 to 21. The President's budget proposes to eliminate the Job Corps in

1986, and to continue funding the remaining programs at or below the 1985

level. The recommended appropriation for training and employment services totals $2.8 billion for 1986 and $2.9 billion annually thereafter, compared with the $3.8 billion provided for 1985. Total outlay savings relative

to the CBO baseline would reach $1.7 billion in 1990.

Highway Grants

The federal-aid highways program provides grants to states for construction

and improvements on the Interstate system and on urban and rural roads.

The President proposes to reduce spending by limiting the total funds that

77
can be obligated by states in 1986 to the 1985 level of $13.25 billion, and by

including additional programs under the ceiling. The budget assumes that

the obligation limit would remain at $13.25 billion in 1987, and increase to

$14.2 billion for each of the years from 1988 through 1990. (The CBO

baseline reflects the 1986 obligation cap of $14.45 billion enacted in the

Surface Transportation Assistance Act of 1982, with adjustments for inflation in subsequent years.)

Outlay savings from the budget proposals would reach $2.0 billion in

1990, and would total $5.6 billion over the 1986-1990 period. Since states

are able to choose the projects for which they wish to use their portion of

the available funds, those projects deemed less important by the states

would be postponed until a later date, or perhaps canceled.

This program is totally financed from gasoline and other excise taxes

paid to the Highway Trust Fund. Previous analyses by CBO have shown that,

although the trust fund has a cash balance of almost $10 billion, baseline

levels of spending would exceed projected revenues and the balance would

disappear, perhaps as early as 1989 or 1990. The President's proposal would

slow the erosion of the fund's cash balance, but expenditures would continue

to exceed revenues.

Small Business Loans

The President proposes to abolish the Small Business Administration (SBA),

which provides financial, management, procurement and advocacy assistance to small businesses. The President would terminate the programs

providing direct and guaranteed loans and equity investments to small businesses, much of which are targeted to the socially and economically disadvantaged, the handicapped, veterans, and disaster victims. These programs are authorized to make $0.9 billion in direct loans and $3.4 billion in

loan guarantees in 1985, and their elimination would reduce outlays relative

to the baseline by $5.2 billion from 1986 through 1990.

The President is requesting an appropriation of $2.0 billion in 1986 for

the Treasury Department to purchase the SBA direct loan portfolio from the

Federal Financing Bank. The formerly off-budget loans, together with SBA's

on-budget portfolio, would be sold to the private sector over a four-year

period, resulting in receipts of approximately $3.8 billion. Over the 1986-

1990 period, the proceeds would be partially offset by an estimated $0.9

million in lost interest to the Treasury relative to the baseline. The budgetary effects of the sale of assets and the interest to the Treasury fall

within the offsetting receipts category and are discussed in Chapter VI.

78
Some existing SBA activities supporting advocacy, management, and

procurement assistance would be transferred to the Department of Commerce and combined with the Minority Business Development Administration to form the Administration for Enterprise Development and Opportunity. Beginning in 1987, these programs would receive funding of approximately $100 million annually, or about one-quarter of the baseline program

level.

Rural Electrification

The President is proposing to phase out federal loans and loan guarantees for

rural electric and telephone cooperatives, and to increase the interest rate

on subsidized loans. Existing policy requires the Rural Electrification Administration (REA) to make $1.1 billion a year in direct loans bearing interest at 5 percent, and to guarantee another $1.2 billion in loans. Cooperatives with REA guarantees currently are entitled to borrow funds from

the Federal Financing Bank (FFB) at the Treasury interest rate plus 0.125

percent. Under the President's proposal, direct loans would be phased out by

1990, starting with a 50 percent reduction in 1986, while the remaining loans

would bear interest at the Treasury rate plus 1,125 percent. Likewise, REA

would stop guaranteeing loans by 1990, starting with a 75 percent reduction

in 1986. Thus, after 1989, REA would make no new loan or guarantee

commitments. The President also would limit cooperatives' access to the

FFB, by requiring borrowers to obtain an increasing proportion of their financing from private sources. These changes in REA loan programs would

reduce federal outlays by about $5.2 billion relative to the CBO baseline

projections for the 1986-1990 period. Most of the estimated savings would

result from the reduction in federal lending activity and would appear offbudget under current law.

Health Research (NIH)

Outlays in the President's budget for health research of the National Institutes of Health (NIH) are $0.3 billion below the CBO baseline in 1986, the

difference increasing to $1.2 billion in 1990. This results from a 6 percent

reduction in funding from 1985 to 1986, and increases in funding thereafter

at less than the baseline rate. The President proposes to reduce the number

of new and competing research grants funded each year to 5,000, compared

with the more than 6,500 provided by the 1985 appropriation.

79
Grants to Amtrak

The President proposes to eliminate completely the annual subsidy to

Amtrak for operating and capital expenses, and for labor protection payments. This would result in outlay savings of $0.6 billion in 1986, and $3.7

billion over the 1986-1990 period, relative to the CBO baseline.

Although Amtrak was established in 1970 as a government-sponsored,

for-profit corporation, it has never operated without federal assistance.

Without the federal subsidy, Amtrak claims that it would be unable to operate any routes, even the Northeast Corridor. While the President also

assumes that any labor protection costs resulting from discontinued service

would be solely Amtrak's responsibility, it is unclear whether the government would have a legal obligation to bear these costs, and, if not, whether

the Congress would choose to assume the liability, as it has previously done

for Amtrak, Conrail, the Rock Island Railroad, and the Milwaukee Railroad.

Under current contract provisions that call for up to six years of severance

pay, Amtrak estimates its potential liability at more than $2 billion over six

years, with a first-year payout of $600 million to $800 million.

Postal Subsidies

The President proposes eliminating the revenue forgone appropriation to the

U.S. Postal Service. This payment compensates the Postal Service for revenues lost because the Congress has specified reduced postage rates for

certain classes of mailers, primarily religious and other nonprofit organizations, blind and otherwise handicapped people, small-circulation newspapers,

and libraries. Rather than continue taxpayer support for these subsidies, the

President is proposing to eliminate in 1986 that portion of the subsidy that is

currently scheduled to expire in 1987, and to allow, but not require, the

Postal Service to cover the difference by increasing rates for other classes

of mail. These changes would result in outlay savings of approximately $0.8

billion in 1986, increasing to $1.0 billion in 1990.

The Administration is also proposing to increase by 2 percent annually

the Postal Service payments to the Civil Service Retirement fund. As a

result, the Postal Service's annual share of the actuarial costs of employee

pensions would grow from the current level of 7 percent to 17 percent by

1990. (This would increase certain offsetting receipts, which are discussed

in Chapter VI.)

The Postal Service would recover the cost of these two proposals by

increasing postal rates. Because of the length and complexity of rate

filings, and the effect of rate increases on volume and workload, increases

80
in Postal Service obligations in each year would not always be directly offset by increased revenues, although over time the Postal Service would be

required to break even. Estimated savings relative to the CBO baseline are

expected to total $3.2 billion from 1986 through 1990.

OTHER SPENDING REDUCTIONS

About 30 percent of the proposed savings in the Administration's budget for

discretionary programs would be derived from terminating or reducing

funding for many other programs spread throughout the budget. A large

proportion of these reductions is concentrated in community and regional

development, natural resources, and education programs (see Table V~3).

TABLE V-3. CBO ESTIMATE OF OTHER LARGE DISCRETIONARY

SPENDING REDUCTIONS PROPOSED BY THE ADMINISTRATION (By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Changes

Community and Regional

Development

Natural Resources and

Environment

Education

Training, Employment

and Social Services

Energy

-0.4 -1.4 -2.3 -2.8 -3.2 -10.1

-1.1 -1.6 -1.9 -2.3 -3.0/ -9.9

-0.4 -1.2 -1.7 -2.0 -2.4 -7.7

-0.6 -0.9 -1.0 -1.1 -1.3 -4.9

-0.4 -0.7 -CI.8 -1.1 -1.5 -4.5

NOTE: Excludes small business disaster loans, student financial assistance,

training and employment services, Strategic Petroleum Reserve,

and rural electrification programs, which are included in Table

V~2. Also excludes the estimated effects of the President's pay

reduction and pay-raise proposals.

81

T
Community and Regional Development

The President's budget projects large reductions in spending in this category,

in addition to the elimination of small business disaster loans discussed earlier. In 1986, the Administration would eliminate Urban Development

Action Grants (UDAGs), Rental Housing Development Grants (HODAGs),

Economic Development Assistance programs, and Appalachian regional development programs. The Rural Development Insurance Fund (RDIF) and

rural water and waste disposal grant programs of the Farmers Home Administration would be limited to new loan and grant obligations totaling $75

million in 1986, a reduction of almost $500 million from the direct loan

levels authorized for 1985. After 1986, no new obligations would be permitted for these programs, and potential recipients would be required to

compete for Community Development Block Grants (CDBGs). The overall

CDBG program level would be reduced 10 percent below the 1985 appropriation, and the percentage of CDBG funds going to rural areas would be increased. The President would eliminate both RDIF and CDBG loan guarantee programs, and would impose a two-year moratorium on rental rehabilitation grants.

These proposals would reduce annual outlays by $3 billion from 1985 to

1990, and would result in total savings relative to the CBO baseline of $10.1

billion over the five-year period. By 1990, outlays in this area would be 39

percent below the baseline level.

Natural Resources and Environment

The Administration has proposed reductions for most discretionary natural

resources and environment programs, which would result in outlay savings

from the baseline of about $1.3 billion in 1986, rising to $3.3 billion in 1990.

About 11 percent of these savings would result from the proposed 5 percent

pay cut, but most represent programmatic decreases.

Funding for many land and water resource programs would be reduced

in 1986 from 1985 levels—including a 27 percent reduction for the Soil

Conservation Service and a 28 percent decrease for construction activities

of the Bureau of Reclamation. Forest Service obligations would drop 9

percent in 1986, and several land conservation programs of the Agricultural

Stabilization and Conservation Service would be terminated. National Park

Service funding in 1986 would be 26 percent below the 1985 level, and reductions are also requested for the Fish and Wildlife Service and the Bureau

of Land Management, primarily because of a proposed three-year moratorium on discretionary land acquisition and major cuts in recreational construction. The $2.4 billion sewage treatment plant construction grant pro82
gram of the Environmental Protection Agency (EPA) would be funded at the

1985 level in 1986, and then phased out completely over the next four years.

In addition, funding for the operations and programs of the National Oceanic

and Atmospheric Administration would be reduced by about 20 percent in

1986, largely because of terminations or reductions of a number of ocean,

coastal, and marine fishery programs.

These decreases would be partially offset by substantial increases in

spending for EPA's Hazardous Substance Response Fund (Superfund), with

outlays projected to grow from $0.4 billion in 1985 to $1.2 billion in 1990.

Funding increases are also requested for EPA's research, enforcement, and

regulatory activities, which would grow at close to baseline levels over the

1986-1990 period.

Education

The President proposes a one-year freeze for the two largest grants to local

school districts—one for disadvantaged children and the other for educating

the handicapped. In addition, impact aid would be eliminated for construction of school facilities and for compensating school districts for so-called

"B" children (whose parents either work or live on federal property). Compensation would be frozen at the 1985 level for type "A" children, whose

parents both work and live on federal property.

The budget would also freeze all other grants to states and school

districts and would drastically reduce or eliminate many of the remaining

categorical education grant programs. Compared with the CBO baseline,

these proposals would save $0.4 billion in 1986, growing to $2.4 billion by

1990.

Training, Employment, and Social Services

In addition to reducing funding for training and employment services, as

discussed earlier, the President's budget would reduce outlays for other

training and social service programs by $0.6 billion in 1986, growing to $1.3

billion by 1990. Two programs would be eliminated—the Work Incentive

Program (WIN), which provides job training to recipients of Aid to Families

with Dependent Children (AFDC), and the Community Services Block Grant

to states. In addition, 1986 funding would be held at 1985 levels for the

Older Americans program, Head Start, and other grant programs.

83
Aside from rural electrification and the Strategic Petroleum Reserve, which

are discussed earlier, outlays for discretionary energy programs in the President's budget would be approximately $5 billion, or 17 percent, below

the CBO baseline projections for the 1986-1990 period. Approximately $1.5

billion of the total reduction would result from limiting spending on uranium

enrichment activities to the amount of revenues collected each year, and

requiring the program to earmark certain revenues for the repayment of

past appropriations. The Administration also proposes to phase out major

conservation grants and reduce conservation research and development.

These proposals would reduce outlays by $1.2 billion over the 1986-1990

period relative to the CBO baseline. Although the budget provides for continued funding for nuclear and fusion research at about 90 percent of the

1985 levels, funding for fossil, solar, and other renewable energy research

and development programs would be reduced by about one-third.

Other Savings

The President's budget also projects significant savings in a number of other

areas. An estimated $4 billion would be saved over the 1986-1990 period by

reductions in health care delivery, education, and training programs of the

Department of Health and Human Services. The elimination of federally

subsidized crop insurance is projected to save $1.4 billion from 1986 through

1990, while reductions in various research and services performed by the

Department of Agriculture would save another $1.5 billion during that

period.

The budget includes funding for Federal Aviation Administration

(FAA) operations at about the 1985 level in all years, and projects reduced

funding for FAA grants to airports, facilities and equipment, research and

other activities. Total FAA outlays would be slightly below the baseline in

1986, and $2.3 billion below over the 1986-1990 period (excluding the effects

of the proposed 5 percent pay cut). The Administration also proposes to

reduce spending for low-income home energy assistance grants by using recoveries from petroleum price overcharges to fund part of the program.

Although the budget reflects savings of $4.5 billion from this source, CBO

projects that only $1.2 billion of the overcharges will be available for this

purpose.

84
PROGRAMS MAINTAINED OR INCREASED

For a number of broad categories in the budget, the President's budget

would be above or only slightly below the CBO baseline. Spending for such

programs would therefore be maintained at approximately the same real

level as in 1985, or above. The largest growth relative to the baseline is

projected for the space programs of the National Aeronautics and Space

Administration (NASA), and funding for international affairs (excluding the

Export-Import Bank) is also above baseline levels. Veterans' programs,

justice, and general government activities show relatively small decreases

(see Table V~4).

TABLE V-4. CBO ESTIMATE OF SPENDING INCREASES OR

SMALL SPENDING REDUCTIONS (-) PROPOSED

BY THE ADMINISTRATION

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Changes

Space

International Affairs

Veterans

Justice, General

Government, and

Fiscal Assistance

0.2 0.2 0.3 0.7 0.9 2.4

0.5 0.4 0.4 -0.1 -0.7 0.5

0.1 a/ a/ -0.1-0. 2 -0.2

-0.3 -0.2 -0.1 -0.2 -0.5 -1.2

NOTE: Excludes Export-Import Bank, which is included in Table V~2. Also

excludes the estimated effects of the President's pay reduction and

pay-raise proposals.

a. Less than $50 million.

85
The President's budget includes funding above the baseline level in all years

for the space programs of the National Aeronautics and Space Administration (NASA). Outlays are projected to rise from $6.7 billion in 1985 to $8.6

billion in 1990—largely because of funding increases for space station construction and for other research and development. 4/ The budget shows

declining spending for space shuttle construction and operations, reflecting

completion of the last shuttle and the Administration's expectations of increased reimbursements from more frequent shuttle flights. Under the

Administration's proposals, total NASA outlays for space programs would

exceed the baseline by $0.2 billion in 1986 and $0.8 billion in 1990, with a

total increase in spending of $2.2 billion over the five-year period.

International Affairs

The President is proposing increases for security assistance totaling $0.9

billion over the baseline for the 1986-1990 period. Most of the increase is

for military assistance, primarily to Israel and Egypt. The budget does not

include a request for aid to Israel from the economic support fund (ESF),

pending further negotiations with Israel. Because the Administration has

indicated that it will be seeking funds for this purpose, the CBO estimate of

the President's budget request includes the CBO baseline level of ESF assistance.

Funding for the State Department's conduct of foreign affairs is also

above the baseline level, reflecting both a $0.2 billion 1985 supplemental

request for security enhancement and a projected increase in personnel

levels. In addition, the budget projects spending increases for the United

States Information Agency, including a major upgrading of the Voice of

America and increased personnel levels.

These increases are partially offset by proposed reductions in development assistance, totaling $2 billion from 1986 through 1990. Voluntary contributions to international organizations and bilateral aid are both to be

reduced below the 1985 level, and sharp reductions are planned in future

4. The baseline does not include major spending for the space station,

because no clear Congressional decision—for example, selection of a

specific option or appropriation of construction funds—has yet been

made to build a manned space station. Moreover, the uncertainty over

the configuration of a possible station precludes accurate estimation

of future funding requirements.

86
replenishments for international development banks. Proposed funding for

Public Law 480 food assistance is below the current 1985 level throughout

the five-year period; however, the President has requested a 1985 supplemental for appropriation of $185 million for African drought relief.

Veterans

The President's budget maintains discretionary veterans' programs close to

but slightly below the CBO baseline level over the 1986-1990 period. Total

outlays over the period would be about 3 percent below the baseline, for a

total spending reduction of $1.7 billion over the five years. About $1.5

billion of that savings would result from the proposed 5 percent federal pay

cut in 1986. As a result, overall programmatic activity would be at just

about the CBO baseline level during this period,, Total outlays for the 1986-

1990 period under the Administration's proposals, however, would be only 88

percent of OMB's current services outlays. In contrast to the CBO baseline,

which increases to reflect inflation, OMB's current services projections

would accommodate the continued rapid expansion of the Veterans Administration hospital system.

The budget includes an increase in funding for medical care of $0.3

billion (or 3 percent) in 1986, with increases in subsequent years at close to

the baseline rate. The President is proposing, however, to institute a means

test for eligibility to VA hospital care for most veterans without serviceconnected disabilities. The Administration estimates that this would save

almost $1 billion annually by 1990; CBO expects that at least 20 percent of

currently eligible veterans would be excluded by this proposal, and that savings would be even greater.

Justice and General Government

The Administration is proposing funding for justice and general government

activities that would result in outlays $3.1 billion below the baseline over

the 1986-1990 period. About $1.9 billion of that amount is attributable to

the proposed 5 percent pay cut—leaving other reductions totaling $1.2 billion, or less than 2 percent below baseline levels. These savings are primarily attributable to the proposed termination of the Legal Services Corporation, which would save about $1.7 billion over five years, as well as to a

proposed 10 percent reduction in Legislative Branch spending.

Most other activities in these areas are projected at or slightly below

the baseline level, reflecting the proposed pay cut; these include the Federal

Bureau of Investigation, the Drug Enforcement Administration, and the

87

42-72 6 O - 85 - 5 QL
Immigration and Naturalization Service. Large increases are proposed for

the Judiciary, primarily to provide staff and facilities for the 85 new judgeships provided by law. The budget also includes increased resources, after

adjusting for the pay cut, for the Internal Revenue Service, which is seeking

to hire 7,500 additional examiners beginning in 1987.

IMPACT ON STATE AND LOCAL GOVERNMENTS

Approximately 30 percent of nondefense discretionary spending is for

grants to states and localities. Grant outlays in this category were about

$48 billion in 1984, and are estimated at $53 billion in 1985. The President's

budget would reduce discretionary grant outlays to about $52 billion in 1986

and to about $50 billion annually through 1990 (see Table V-5). Highway

funding would increase over this period, as a result of the spending authorized in the Surface Transportation Assistance Act of 1982. At the same

time, other grants would drop from $41 billion in 1985 to about $35 billion

per year from 1987 through 1990. In real terms, this would represent a

decline in purchasing power of about 30 percent by 1990.

The largest reductions below the 1985 level would occur in two areas.

Appropriations for wastewater treatment construction grants would drop

from $2.4 billion in 1985 to zero in 1990, and funding for mass transit grants

would decline from $4.1 billion in 1985 to $1.2 billion in 1990. In addition,

the President is proposing to eliminate or reduce a variety of other discretionary grant programs, particularly in the area of community and regional

development. The budget also includes reductions in certain entitlement

grant programs, including the elimination of General Revenue Sharing,

which are discussed in Chapter IV.

88
TABLE V-5. CBO ESTIMATE OF THE ADMINISTRATION'S OUTLAYS

FOR MAJOR DISCRETIONARY GRANT PROGRAMS

1990 (By fiscal year, in billions of dollars)

Highways

Education

Housing Assistance

Other Income Security

Training, Employment

and Social Services

Community Development

Block Grants

Mass Transit

Wastewater Treatment

Construction Grants

Other Community and

Regional Development

All Other

Total

1985

12.5

7.0

6.1

4.3

5.5

3.9

3.7

2.7

1.6

5.9

53.2

1986

13.7

7.1

5.4

4.1

5.1

3.6

3.2

2.6

1.6

5.6

52.0

1987

13.9

7.1

5.3

4.2

4.5

3.4

3.2

2.3

1.3

5.6

50.8

1988

14.1

7.2

5.4

4.4

4.4

3.2

2.4

2.2

0.8

5.6

49.7

1989

14.6

7.4

5.7

4.5

4.5

3.3

2.1

2.0

0.5

5.2

49.8

, 1985-

1990

14.8

7.6

6.0

4.7

4.5

3.5

1.7

1.6

0.4

5.0

49.8

89

CHAPTER VI

OFFSETTING RECEIPTS AND NET INTEREST

The Administration's fiscal year 1986 budget proposes substantially larger

offsetting receipts and lower net interest outlays than under current policy.

Offsetting receipts—receipts that are treated as offsets to outlays rather

than as revenues—are projected to account for an increasing portion of the

budget under current policies. The Administration's proposals would hasten

this trend, primarily by requiring people and businesses that use government

services to bear a larger portion of their cost. Net interest—the cost of

servicing the government's debt—is currently the fastest growing major

component of federal spending. The Administration's proposals, by reducing

the growth of the debt, would restrain some of the increase in this category.

OFFSETTING RECEIPTS

Offsetting receipts comprise federal government proprietary receipts from

the public as well as certain intragovernmental payments. Under current

policies, offsetting receipts are projected by CBO to total $50 billion in

1986, growing to $64 billion in 1990. The largest component—$29 billion in

1986—is the employer share of federal employee retirement, which offsets

the contributions made by government agencies toward their employees'

retirement (counted as spending elsewhere in the budgetary totals). The

government also collects premiums from participants in the Medicare

program, mostly for Part B (Supplemental Medical Insurance) coverage;

these premiums are projected to total $6 billion in 1986. Offsetting receipts

from rents and royalties on the Outer Continental Shelf are expected to be

about $6 billion in 1986. Other offsetting receipts include proceeds from

the sale or lease of minerals, timber, and electric power, as well as other

miscellaneous sources.

Offsetting receipts collected by the federal government would

increase greatly under the Administration's budget, rising by $4 billion in

1986 and totaling an additional $32 billion over the 1986-1990 period (see

Table VI-1). About one-third of the increase in receipts would come from

91
TABLE VI-1. CBO ESTIMATES OF THE ADMINISTRATION'S

PROPOSALS FOR OFFSETTING RECEIPTS (By fiscal year,

in billions of dollars) a/

1986 1987 1988 1989

Cumulative

Five-Year

1990 Changes

CBO Baseline

Proposed Changes

User fees

Medicare premiums

Employer contributions to employee

retirement:

Postal Service

Military

Other

Subtotal

Third-party reimbursements to

Veterans Administration

Small business

49.9 53.8 57.7 60.3 64.2

1.4 2.1 2.4 2.5

0.2 0.7 1.7 3.2

2.7

4.9

0.3

b/

0.4

0.6

0.4

-0.6

0.8

0.6

-0.8

1.2

0.7

1.6

0.5

1.2

-0.2

0.1

0.4 0.5

0.2 0.2

1.0

0.2

0.9

0.2

11.1

10.8

4.4

2.2

-4.0

2.6

0.8

loan asset sales

Sale of Conrail

Other

Total Changes

President's Budget as

Estimated by CBO

1.0

1.2

0.1

3.8

53.6

1.0

—

0.4

4.7

58.6

0.9

—

0.4

6.1

63.9

0.9

—

0.4

8.1

68.5

b/

—

0.4

9.2

73.5

3.8

1.2

1.6

32.0

For purposes of arriving at total budget outlays, offsetting receipts

are treated as negative outlays and are subtracted from other spending

figures.

Less than $50 million.

92
fees charged to users of government services. Another third would come

from higher premiums paid by Medicare participants. Other Administration

proposals include the sale of Small Business Administration loan assets and

the Conrail system, and changes in the federal government's contributions

for employee retirement. Virtually all of the Administration's proposals

would require Congressional approval.

User Fees

The federal government recoups part of the cost of providing special facilities or services by charging user fees. Since these fees arise from voluntary, business-type transactions—rather than the government's sovereign

taxing power—they are counted as offsets to outlays rather than as revenues. The Administration proposes to charge a number of new or expanded

user fees as shown in Table VI-2.

Substantially higher fees would be levied on users of the nation's

waterways and ports under the Administration's proposed budget. Commercial users currently pay about 3 percent of the Army Corps of Engineers'

TABLE VI-2. CBO ESTIMATES OF PROPOSED USER FEES IN THE

ADMINISTRATION'S BUDGET (By fiscal year,

in billions of dollars)

User Fee

Waterways and harbors

Customs

Boat and yacht

Meat inspection

Recreation

Government-sponsored

enterprise

Other

Total

1986

0.4

0.5

0.2

0.1

0.1

a/

a/

1.4

1987

0.6

0.5

0.5

0.3

0.1

0.1

a/

2.1

1988

0.6

0.5

0.5

0.4

0.1

0.2

0.1

2.4

1989

0.7

0.5

0.5

0.4

0.1

0.3

0.1

2.5

1990

0.8

0.5

0.5

0.4

0.1

0.3

0.1

2.7

Cumulative

Five-Year

Changes

3.2

2.6

2.1

1.5

0.4

1.0

0.3

11.1

a. Less than $50 million.

93
cost of operating, maintaining, and constructing the nation's waterways and

harbors. The proposed budget would increase this share to 40 percent in

1986 and about 65 percent by 1990. The Corps would continue to pay most

of the operating, maintenance, and construction costs for inland waterways,

but would substantially reduce its share of expenditures for harbor construction and improvements, shifting the remaining costs to local port

authorities. Offsetting receipts would increase by an estimated $0.4 billion

in 1986 and $3.2 billion from 1986 through 1990.

The Administration intends to propose new customs fees for processing

passengers and commercial carriers entering the United States. This proposal, which has not been spelled out in detail, is projected by the Administration to yield about $0.5 billion annually in the 1986-1990 period.

New fees also are proposed for nonemergency services provided by the

Coast Guard to commercial and recreational boaters. These services include inspection and licensing of vessels and facilities, maintenance of navigational aids, towing, and others. Coast Guard services that benefit the

general public (such as law enforcement) and emergency operations would

continue to be funded by the taxpayer. These proposed user fees are estimated to total about $0.2 billion in 1986 and $2.1 billion in 1986-1990.

The Administration proposes that meat and poultry processors be required to pay the full costs of inspection by the Food Safety Inspection

Service. The amount of costs recovered would increase gradually over three

years, totaling $0.1 billion in 1986 and $1.5 billion for the 1986-1990 period.

A proposal to increase fees paid by recreational users of national parks and

other facilities would raise an estimated $0.4 billion through 1990.

The Administration proposes to levy an annual fee on debt and other

securities issued by government-sponsored enterprises beginning in 1986.

The affected enterprises include the Federal National Mortgage Association

(Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac),

the Student Loan Marketing Association (Sallie Mae), the Farm Credit System, and the Federal Home Loan Bank System. These enterprises have a

quasi-government status and receive certain benefits (such as standby lines

of credit with the Treasury and exemption from certain securities regulations) unavailable to private issuers. As a result, their securities—like Treasury debt—are perceived as high-quality, low-risk instruments. Net borrowing by these enterprises totaled about $55 billion in 1984. After a short

phase-in, the proposed fees would amount to 0.083 percent annually for debt

issued in 1987 and beyond. The user fees are estimated to raise $40 million

in 1986 and $1.0 billion over the 1986-1990 period, as larger and larger

amounts of debt become subject to the fees.

94
Several of the Administration's user fee proposals were included in

budgets of previous years and in recommendations by the President's Private

Sector Survey on Cost Control (Grace Commission), the General Accounting

Office, and others. Increased waterway and harbor fees, for example, have

been proposed in each of the current Administration's annual budget submissions, while boat and yacht fees and recreational fees have also been

proposed repeatedly. The Congress so far has only partially agreed to the

Administration's proposals to recoup the costs of certain federal government

services from those directly benefiting.

Medicare Premiums

Under the proposed 1986 budget, premiums paid by Supplemental Medical

Insurance (SMI) participants would increase gradually until they reach 35

percent of program costs in 1990. Premiums now cover about 25 percent of

those costs. As part of its entitlement proposals, the Administration also

advocates reducing SMI program costs; these changes are discussed in

Chapter IV. CBO estimates that the proposals would increase Medicare

premiums by $0.2 billion in 1986 and $10.8 billion over the 1986-1990 period.

CBO projects that the monthly SMI premium—currently $15.50—would increase by 1990 to $34.90 under this proposal, compared with $21.10 under

current policy.

Other Proposals

The Administration proposes to increase the Postal Service's contributions

to the Civil Service Retirement Trust Fund to equal, over time, the full

actuarial cost of employee pensions. CBO estimates that offsetting receipts

to the trust fund would be $0.3 billion greater in 1986 and $4.4 billion

greater in the 1986-1990 period.

Employer contributions for federal government employee retirement

would also be affected by the Administration's proposals either to raise or

cut salaries of government workers. Higher pay raises for members of the

military, as sought by the Administration, would lead to larger offsetting

receipts for military retirement accruals. In contrast, the Administration's

proposal to cut civilian salaries by 5 percent in 1986 and limit the annual

increases thereafter, as well as delaying pay raises until January in each

year, would lead to smaller offsetting receipts. Table VI-1 shows the change

in employer contributions attributable to the Administration's military and

civilian pay proposals.

95
1.

Included in the President's budget is a proposal to have private health

insurers reimburse the Veterans Administration for care provided to their

policyholders, except in the case of veterans with service-connected disabilities. At present, exclusionary clauses in private insurance contracts bar

payment for services rendered in VA facilities. Requiring such third-party

reimbursement would save the government an estimated $0.1 billion in 1986,

and $0.8 billion over the 1986-1990 period.

In addition to terminating new credit extensions by the Small Business

Administration, the Administration proposes the sale of the SBA's existing

loan portfolio to the public. Proceeds from these sales are projected to be

$1.0 billion in 1986 and $3.8 billion over the 1986-1990 period.

The Administration also plans to sell Conrail, the government-owned

freight railroad, to the private sector in 1986. Receipts from the sale are

projected at $1.2 billion.

NET INTEREST

Net interest outlays reflect the cost of financing the government's burgeoning debt. As offsets, net interest also includes interest income received by

the government—such as interest on loans extended by the government, interest on the Treasury's cash balances, and so forth. As shown in Table VI-3,

net interest outlays under current policy are projected by CBO to rise rapidly from $146 billion in 1986 to $234 billion in 1990. The President's budget

proposes to restrain the projected growth of the federal debt, thereby reducing net interest costs. A small part of this savings would be offset by

lower interest income to the government as a result of reduced lending.

Even with the President's proposed changes, however, net interest would run

a close second to defense as the fastest-growing major component of federal

spending—growing from $146 billion in 1986 to $212 billion in 1990.

The Administration's own projections of interest costs differ sharply

from CBO's. The Office of Management and Budget (OMB) projects that net

interest outlays will rise from $143 billion in 1986 to $148 billion in 1989,

and will actually fall to $138 billion in 1990. These differences result almost entirely from the use of different interest rate assumptions by CBO

and the Administration. OMB assumes that short-term Treasury bill rates

will fall to 5.0 percent by 1990, while CBO assumes that they will level off

at 8.2 percent—only slightly below their current levels. Because of the uncertain economic consequences of possible fiscal policy changes, CBO compares alternative budget programs by using a consistent set of economic

assumptions—in this case, assumptions that posit only modest declines from

96
current interest rates. By using the same interest rate assumptions for the

baseline and the Administration's budget proposals, CBO's projections provide a basis for evaluating the direct budgetary effects of the Administration's policies, abstracting from the changes in the economy that might

result from changes in government spending.

TABLE VI-3. CBO ESTIMATES OF THE ADMINISTRATION'S PROPOSALS

FOR NET INTEREST (By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Changes

CBO Baseline Outlays 145.7 163.6 187.3 207.6 233.6

Proposed Changes

Interest from

FFB and SBA

Other intragovernmental interest

Interest on

foreign military

sales

Interest savings

due to lower

deficits

Total Changes

a/ 1.0 2.2 3.4 4.6 11.2

1.9 2.3 2.9 3.4 3.8 14.3

a/ a/ a/ a/ -0.1 -0.1

-1.5 -5.8 -11.9 -19.6 -29.6 -68.5

0.3 -2.5 -6.9 -12.9 -21.2 -43.1

President's Budget as

Estimated by CBO 146.0 161.1 180.4 194.7 212.4

a. Less than $50 million.

97
Changes in net interest in the President's budget result exclusively

from proposed policy changes in other spending programs and in revenues.

As a result of the proposed curtailment of the Federal Financing Bank's

(FFB's) lending activity and the sale of SBA's loan assets, interest receipts

from the FFB and the SBA are projected to decrease—only slightly in 1986

but by $11.2 billion over the 1986-1990 period (see Table VI-3). By the end

of 1990, total FFB loans outstanding are projected to be $137 billion under

the President's proposals, compared with $189 billion under the continuation

of current policies. The SBA loan portfolio is expected to be fully sold by

1990.

A number of other federal agencies are permitted to borrow from the

Treasury to finance parts of their program costs. Interest on this borrowing

is an outlay of the agency, and an intragovernmental interest receipt to the

Treasury. The President's budget proposes that the Department of Housing

and Urban Development's obligation to pay interest on certain Treasury

borrowing in 1985 and earlier years be forgiven, leading to smaller intragovernmental interest receipts. The Administration also proposes to curtail

the need for borrowing from the Treasury by other federal agencies, especially the Commodity Credit Corporation. If all of these proposals are

enacted, intragovernmental interest receipts are projected to be $1.9 billion

smaller in 1986 and $14.3 billion smaller over the 1986-1990 period. Since

these interest payments are intragovernmental, they do not affect total

outlays or the deficit.

By far the largest change in net interest spending in the proposed

budget would result from lower deficits. The President's proposed nondefense spending cuts—offset somewhat by defense spending increases and

small revenue reductions—would reduce the federal government's borrowing

needs. The interest savings compound dramatically over time. If all of the

Administration's proposed changes were enacted, interest savings would

grow from $1.5 billion in 1986 to $29.6 billion in 1990 (see Table VI~3).

These interest savings would reflect a marked slowdown in the growth

of the federal debt. As Table VI-4 shows, federal debt held by the public at

the end of 1990 is projected to reach $2,452 billion under the Administration's proposed policies, compared with $2,820 billion in CBO's baseline. The

growth in the debt-to-GNP ratio would be slowed—but not stopped—by the

Administration's program. By 1990, the debt-to-GNP ratio is projected to

reach 43.7 percent under the budget's proposed policies, substantially lower

than the 50.3 percent projected assuming no changes in policy.

Such high ratios of debt to GNP have not been seen since the late

1950s and early 1960s, when the bulk of the government's debt was traceable

98
TABLE VI-4. CBO ESTIMATES OF FEDERAL DEBT HELD

BY THE PUBLIC (By fiscal year)

1985 1986 1987 1988 1989 1990

CBO Baseline

CBO Estimate of

Administration Program

CBO Baseline

CBO Estimate of

Administration Program

In Billions of Dollars

1.526 1,745 1,984 2,240 2,519 2,820

1.527 1,712 1,896 2,081 2,266 2,452

As a Percent of GNP

39.6 42.0 44.3 46.4 48.4 50.3

39.6 41.2 42.3 43.1 43.6 43.7

to the World War II effort (see Figure VI-1 on next page). A sustained rise

in the debt-to-GNP ratio during peacetime had never occurred before the

1C Os. A rising debt-to-GNP ratio spurs concern about the effects on

private capital investment, foreign capital flows, and other economic

variables, while substantially complicating the conduct of monetary

policy. !_/ While the Administration's proposed policies, if fully enacted, are

projected to reduce deficits, they would not stop the growth in the debt-toGNP ratio—a necessary first step in stemming the rising cost of interest

payments.

1. The consequences of a rising debt-to-GNP ratio are discussed in Congressional Budget Office, The Economic and Budget Outlook: Fiscal

Years 1986-1990 (February 1985).

99
Figure VI-1.

Federal Debt Held by the Public as a Percentage of GNP

Actual Projected

60

50

40

30

>l I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I

CBO

Estimate of _

Administration

Program

i I i K

1955 1960 1965 1970 1975

Fiscal Years

1980 1985 1990

SOURCE: Congressional Budget Office.

100
CHAPTER VII

THE FEDERAL CREDIT BUDGET

The federal government provides assistance to individuals, firms, and political subdivisions by extending loans on favorable terms directly to borrowers

and by guaranteeing repayment of loans made by others. In both cases, the

borrower benefits from lower interest rates, longer repayment periods,

higher loan-to-value ratios, and relaxed borrower qualification standards

than would otherwise be available.

In providing these benefits, the government incurs two types of costs:

cash-flow and subsidy costs. Cash-flow costs for a budget year are the

funds the government pays out during that year in excess of current-period

receipts: for example, loan disbursements in excess of current-period repayments; and guaranteed loan-claim outlays in excess of current-period

fees and recoveries. The cash-flow costs of credit programs are the outlay

effects in a particular year. Subsidy costs, in contrast, are calculated for

the life of the credit agreement and consist of costs incurred in excess of

repayments, fees, and all other eventual recoveries.

Cash-flow needs are of great importance in managing the government's cash position and are the primary focus of the unified budget.

Knowledge of subsidy costs is necessary for budgeting scarce fiscal resources. Although both subsidy costs and cash-flow costs tend to increase

and decrease with direct loan and guarantee activity, credit policy changes

can have markedly different effects on these two measures.

In the past, the cash-flow costs of federal credit were recognized as

not directly comparable to the cash cost of other forms of assistance. The

recognition of these differences contributed to the off-budget status of

some credit programs. The concern that credit activity was not adequately

controlled by the budget process led to the establishment of a separate

credit budget in 1981. Neither the cash-based unified budget nor the activity-based credit budget permits cost comparisons between spending and

credit programs. Recently, the Office of Management and Budget and CBO

have developed means of identifying the spending-equivalent, subsidy costs

101
of federal credit. !_/ These developments could permit credit activity to be

reintegrated into the unified budget.

Preceding chapters of this report have examined the President's spending proposals in relation to the CBO baseline projections. This chapter

analyzes the President's proposals for federal credit, first by assessing their

consequences for aggregate measures of credit activity, outlays, and subsidy

costs. The principal finding is that the outlay or cash-flow savings from

proposed reductions in credit activity are about double the savings in resource or subsidy costs. The chapter then provides details of the effects on

individual programs for which major policy changes are requested.

THE PRESIDENT'S CREDIT PROPOSALS IN AGGREGATE

The Administration proposes to reduce future direct lending relative to

amounts expected if current policies are not changed. Primary loan guarantees would be increased slightly compared with current policy while

secondary guarantees would stay at current policy levels. 2/ If the

President's proposals are adopted, 1986 direct lending, relative to the

baseline projection, would be reduced by 38 percent or $15.8 billion, and

primary guarantees would increase by 3 percent or $2.4 billion. Total

assisted credit—the sum of the direct and guaranteed lending—would

decrease by $13.4 billion.

Over the next five years, 1986-1990, the cumulative projected effects

of the Administration's credit proposals are:

o Direct loan obligations: $-108.9 billion.

o Primary loan guarantee commitments: $10.3 billion.

1. See Office of Management and Budget, Executive Office of the President, Circular A-70 (August 1984); and Congressional Budget Office,

New Approaches to the Budgetary Treatment of Federal Credit Assistance (March 1984).

2. Secondary guarantees in which government provides a second guarantee on top of an earlier, primary one, arise principally from Government National Mortgage Association guarantees of securities already

backed by FHA and VA guaranteed mortgages. Secondary guarantees

have no significant cash-flow or subsidy cost, and thus are not treated

further here.

102
o Outlays attributed to credit assistance: $-79.8 billion,

o Credit subsidies:: $-48.4 billion.

Subsidized government lending would be cut back most in agriculture, export

financing, housing, electricity production and distribution, and general business. Increases in loan guarantees are offered as a substitute for some

direct loan programs slated for reduction. Growth in guarantees is projected for agriculture, export financing, and housing. Reductions in guarantee activity are requested for business and student loans.

Credit Budget Activity Levels

Assuming the continuation of current policy, CBO projects that direct loan

obligations by the federal government would reach $43.6 billion while federal primary guarantee commitments would climb to $89.7 billion in 1990

(see Table VII-1). These projections and the President's credit proposals are

stated in terms of loan obligations and guarantee commitments rather than

in some other measure—disbursements, for example—to focus on the point

at which government makes an irrevocable offer to provide assistance and

to bear the associated subsidy costs. Obligations and commitments are the

last points of control for credit activity and costs. Table VII-1 also shows

the Administration's request for loans and guarantees. The Administration's

proposed reduction from current policy in direct loans is $15.8 billion in the

first year, reaching $25.9 billion in the fifth year, a cumulative reduction of

more than 50 percent over the five-year period. Primary guarantees would

be higher than in the baseline projection by approximately $2 billion per

year through 1990. Total assisted credit is reduced by more than $98 billion

over the five years.

Outlay Savings arid Deficit Reductions

Changes in obligations and commitments do not translate immediately into

dollar-for-dollar changes in cash outlays. Direct loan obligations may be

paid out over several years in accord with the cash needs of the borrower

who may be, for example, constructing an electric power plant. As loans

mature into the repayment stage, they yield a positive cash inflow that

reduces outflow financing requirements. Similarly, years may pass before a

commitment to guarantee loans leads to claims for payment (default); only a

fraction of guaranteed loans end in default and foreclosure. Changes in

direct loans and guarantees, therefore, are unlikely to produce equal

changes in cash disbursements and the deficit. A comparison of Tables VII-1

and VII-2 confirms year-to-year differences between changes in the volume

103
TABLE VII-1. CBO ESTIMATE OF ADMINISTRATION'S CREDIT BUDGET

PROPOSALS (By fiscal year, in billions of dollars)

Major Program 1986 1987 1988 1989

Cumulative

Five-Year

1990 Changes

CBO Baseline

Direct loan

obligations

Primary guarantee

commitments

Total, new

lending

Secondary guarantees

41

75

117

43

.6

.7

.3

.1

42.2

75.2

117.4

45.0

Proposed

Direct loan

obligations

Primary guarantee

commitments

Total, new

lending

Secondary guarantees

-15

2

-13

0

.8

.4

.4

.0

-20.0

1.7

-18.3

0.0

42.

79.

122.

46.

4

9

3

9

42.

85.

128.

48.

8

7

5

8

43.

89.

133.

50.

6

7

3

9

212.

406.

618.

234.

6

2

9

7

Changes

-22.

1.

-20.

0.

7

8

9

0

-24.

2.

-22.

0.

5

0

5

0

-25.

2.

-23.

0.

9

5

4

0

-108.

10.

-98.

0.

9

3

5

0

President's Budget as

Estimated by CBO

Direct loan

obligations

Primary guarantee

commitments

Total new

lending

Secondary guarantees

25

78

103

43

.8

.1

.9

.1

22.2

76.9

99.1

45.0

19.

81.

101.

46.

7

7

3

9

18.

87.

106.

48.

3

7

1

8

17.

92.

109.

50.

8

2

9

9

103.

416.

520.

234.

8

6

3

7

SOURCE: Congressional Budget Office.

104
of assisted credit and outlays. In 1986, for example, total assisted lending is

projected to decline by $13.4 billion under the President's proposal, whereas

cash outlays fall by $9.7 billion (see Table VII-2).

Subsidy Cost Savings

Neither obligations and commitments nor outlays for a particular year

measure the value of resources consumed by federal credit assistance. Nor

do changes in obligations, commitments, and outlays measure changes in

subsidy costs. In 1984, for instance, total federal direct loan obligations and

guarantee commitments amounted to $39.1 billion and $70.8 billion, respectively. Cash disbursements less repayments of principal and interest, however, totaled only $6.3 billion. Neither the total of $109 billion in assisted

credit nor the contemporaneous cash outlay indicates the amount that the

government will eventually lose, over and beyond recoveries, in administrative expenses, defaults, and negative interest spreads.

To obtain a useful measure of these subsidy costs, the value of assets

exchanged in credit transactions must be compared. In a loan transaction,

the government gives up cash and receives a promissory note for the same

amount. In every case, the note signed by the borrower would be worth less

in private markets than the cash disbursed. The government gives up cash

now for a promise of repayment of principal and some interest in the

future. But the value of the promissory note is reduced by the government's

cost (in excess of fees) of processing the loan and monitoring collections, by

TABLE VII-2. IMPACT ON THE UNIFIED BUDGET OF THE PRESIDENT'S

PROPOSED CHANGES IN THE CREDIT BUDGET

(By fiscal year, in billions of dollars)

Cumulative

Five-Year

1986 1987 1988 1989 1990 Changes

Outlay Impact

of Changes -9.7 -13.7 -17.8 -19.4 -19.2 -79.8

SOURCE: Congressional Budget Office.

105
the certainty of some defaults and late payments, and by the lower interest

on some government loans than on government borrowings. The value of the

loan note is less than the value of the principal by virtue of present and

future subsidy costs, expressed in terms of their present value. If the government lends $100 under such terms that the loan note received is worth

$90, the subsidy cost of the loan is $10. For loan guarantees, subsidy cost is

the difference between the present value of future costs to be incurred by

government under the guarantee agreement and the present value of fees to

be received by government.

A reasonable measure of subsidy cost is the difference between the

amount paid by a borrower without government assistance—to a private

lender—and the amount paid with assistance, adjusted for differences in the

time of payments. This difference is revealing because the private lender

must recover all expected costs—defaults, administrative expenses, interest—from the borrower. The difference between payments to the private

lender and to the government reflects expected, unrecovered costs or subsidy costs. Subsidy costs for both direct loans and guarantees are conveniently expressed as a percent of principal. For 1984, the Office of Management and Budget (OMB) estimates that the average subsidy value for

federal direct loans was approximately 21 percent of principal and for guarantees approximately 10 percent of principal. OMB estimated subsidy costs

of federal credit in 1984, amounted to $8.3 billion for direct loans and $7.4

billion for guarantees.

These subsidy costs are estimates rather than observed market values

and are therefore subject to substantial error. One proposal for obtaining

market valuations of subsidy cost is the Credit Accounting Reform Act of

1984 introduced by Congressman Gradison and Senator Trible. Under this

plan, the government would sell its direct loans to private investors at competitive auction and reinsure its guarantee liabilities with private insurance

specialists.

Until such market value subsidies are available, estimates must be

used. For the purposes of this analysis, CBO has in general applied the OMB

subsidy estimates for 1984 to the proposed credit reductions to obtain projected subsidy cost savings. The OMB subsidy estimates have been adjusted,

as noted, to account for changes in the portfolio mix. These estimates are

shown in Table VII-3. Adoption of the President's request would save an

average of over $9.7 billion in resources per year. This number is 61 percent

of the projected reductions in cash outlays. It Indicates the value of resources that would be freed for other uses by adoption of the proposed

program changes.

106
TABLE VII-3. MAJOR CHANGES IN SUBSIDIES ESTIMATED

FOR FEDERAL CREDIT PROGRAMS

(By fiscal year, in billions of dollars)

1986

Cumulative

Five~Year

1987 1988 1989 1990 Changes

Proposed Changes

Direct loans

Guaranteed loans

Total

-4.7

-2.8

-7.5

-5.2

-3.9

-9.1

-5.5

-4.4

-9.9

-5.9

-4.7

-10.6

-6.4

-4.9

-11.3

-27.7

-20.7

-48.4

SOURCE: Subsidy estimates are calculated using OMB's estimated subsidies

from Special Analysis Tables F-ll, F-12, and F-13 in the Budget,

CBO's credit budget baseline, and CBO's reestimate of the President's credit budget proposals.

MAJOR PROGRAM CHANGES PROPOSED BY THE ADMINISTRATION

The aggregate savings projected from adoption of the President's request

result from a mix of cutbacks and increases spread across a number of

programs. This section describes these changes for programs in which the

projected effects are especially large.

Tables VII-4, VII-5, and VII-6 show the effects of the Administration's

credit proposals on loan and guarantee activity, outlays, and subsidies, respectively. The assumptions used by CBO in compiling these tables are

summarized below:

o Table VII-4. Major Changes in Credit Program Levels Proposed in

the President's Budget. The CBO baseline estimate maintains

1985 credit program levels through 1990. Discretionary programs—those limited by annual appropriation action—have been

increased to adjust for inflation. Open-ended credit programs,

such as guaranteed student loans and VA mortgage assistance, are

projected on the basis of policies in place in 1985 and CBO economic and technical assumptions.

107
o Table VII-5. Major Changes in Baseline Outlays for Credit Programs Resulting from the President's Budget. CBO outlay estimates for the President's proposals include all identifiable credit

program outlays: loan disbursements, interest subsidies, administrative costs, repayments and prepayments, and loan guarantee

defaults and fees.

o Table VII-6. Major Changes in Subsidies for Credit Programs

Resulting from the President's Budget.. Subsidy estimates are

based on OMB subsidy ratios shown in Special Analysis F of the

Budget—Tables 11, 12, and 13. The OMB subsidy estimates are

calculated from a comparison of the terms on government loans

with the terms on hypothetical private loans to the same borrower

or class of borrowers. The baseline subsidy estimates apply the

OMB subsidy ratios assuming continuation of the 1985 mix of loan

programs and average depth of subsidy. Subsidy estimates for the

President's proposals for 1986 through 1990 show reductions in the

subsidies provided by many programs as a result of proposed

changes in loan terms.

The remainder of this section examines individual loan programs. The

terms of the government loan and the extent of the subsidy under current

policy are described. Then the President's proposal is assessed in terms of

loan volume, impact on outlays, and the resource costs or subsidy effects.

Export-Import Bank

Under current policies, the Export-Import Bank (Eximbank) provides direct

loans to foreign countries and firms to purchase U.S. exports at an estimated subsidy of 16.1 percent of loan principal. Guaranteed loan subsidies

are estimated to be 4.1 percent. The Administration is proposing to eliminate direct lending by Eximbank, which otherwise would be expected to

obligate $3.8 billion in 1986. As a partial offset, loan guarantees are to be

increased by $1.6 billion in 1986. These changes are reflected in Table

VII-4. Eximbank would also be authorized to spend up to $100 million (plus

$36 million for application fees) per year to "buy down" the interest rates on

$1.8 billion of federally guaranteed private loans to foreign importers of

U.S. goods. Table VII-5 shows the projected $7.1 billion reduction in Eximbank outlays for direct loans. The subsidy cost savings from implementing

the President's proposal is $2.3 billion over five years (see Table VII-6). This

total consists of a $3.5 billion reduction in subsidy savings for direct loans

offset by $1.2 billion in increased subsidies for the $3.1 billion in increased

guarantees over the period.

108
Foreign Military Sales Credit

The FMSC program provides a mix of forgiven loans—effectively grants—

and concessional and Treasury rate loans to foreign countries and organizations to purchase U.S. defense articles and services. In 1985 the mix of

forgiven and less deeply subsidized loans resulted in an average subsidy of 64

percent of loan volume. The Administration's budget proposes both to increase the volume of FMSC loans over the baseline assumptions and to

increase the proportion of forgiven loans. Direct loan volume would exceed

the baseline by $1.4 billion, and subsidies would increase by $1.3 billion.

Outlays would increase by $0.8 billion.

AID Housing Loan Guarantee Program

The housing guarantee program extends guarantees to assist developing

countries in providing housing for lower-income groups. Under current

policy all guarantees are coguaranteed by the receiving countries. The loans

bear interest of approximately 11 percent for 30 years. OMB estimates that

completely private financing would cost 14.7 percent interest for 20-year

loans. Given these rates, the baseline subsidy is 19.6 percent of principal.

The Administration is proposing to eliminate the program after 1986. Its

proposal would reduce the loan volume by $865 million over the next five

years, but save $170 million in subsidies for the period. The resource

savings are therefore much smaller than the reduced loan volume might

suggest.

Rural Electrification and Telephone Revolving Fund

REA direct loans are made at 5 percent and guaranteed loans at the Treasury rate plus 1/8 of 1 percent for 35 years under current policy. Comparable private loans are estimated by OMB to bear 14.6 percent interest for 15

years in the case of direct loans and 3 years for guaranteed loans. The

Administration proposes to phase down government lending to rural electric

and telephone cooperatives to zero by 1990. The Administration also proposes to increase the interest rate on REA direct loans to the Treasury rate

plus 1 and 1/8 percent. REA direct loan obligations and Federal Financing

Bank-originated direct loans are projected to be reduced by $11 billion over

the five-year period. Subsidies would decline because of both the lower loan

volume and the proposed increase in rates for the REA direct loans. Baseline subsidies would be reduced by $4.1 billion. Outlays are estimated to be

cut by $5.2 billion.

109
TABLE VII-4. MAJOR CHANGES IN THE BASELINE CREDIT PROGRAM

LEVELS PROPOSED IN THE PRESIDENT'S BUDGET

(By fiscal year, in billions of dollars)

Major Program

Cumulative

Five-Year

1985 1986 1987 1988 1989 1990 Changes

Direct Loan Obligations

CBO Baseline

President's Proposals

Foreign Military Sales

Credit

Export-Import Bank

Rural Electrification and

Telephone Revolving Fund

Agriculture Credit

Insurance Fund

Commodity Credit

Corporation

Rural Housing

Insurance Fund

Small Business

Administration

Community development

grant guarantee

Rural Development

Insurance Fund

Low-rent public housing

Other

Direct Loan Change

President's Request

51.9 41.6 42.2 42.4 42.8 43.6

0.5 0.4 0.3 0.2 0.0

1.1 -4.0 -4.3 -4.4 -4.6 -4.8

0.0 -1.6 -1.9 -2.2 -2.5 -2.8

0.0 -4.3 -4.6 -4.6 -4.9 -5.2

0.0 0.0 -1.8 -3.6 -4.1 -4.2

0.0 -3.4 -3.5 -3.7 -3.8 -4.0

0.0 -1.3 -1.6 -2..2 -2.5 -2.7

0.1 -0.1 -0.1 -0.1 -0.1 -0.1

0.0 -0.4 -0.5 -0.5 -0.5 -0.6

0.0 0.0 -0.9 -1.1 -1.1 -1.2

0.0 -1.1 -1.2 -0.6 -0.4 -0.3

212.6

1.4

-22.1

-11.0

-23.6

-13.7

-18.4

-10.3

-0.7

-2.5

-4.3

-3.6

_K_3 -15.8 -20.0 -22.7 ^24.5 ~25.9 -108.9

53.2 25.8 22.2 19.7 18.3 17.8 103.8

(Continued)

110
Table VII-4. (Continued)

Major Program

Cumulative

Five-Year

1985 1986 1987 1988 1989 1990 Changes

Guaranteed Loan

Commitments

CBO Baseline

President's Proposals

AID housing guarantees

Export-Import Bank

Agriculture Credit

Insurance Fund

Commodity Credit

Corporation

Federal Housing

Administration

Small Business

Administration

Rural Development

Insurance Fund

Guaranteed student

loans

VA loan guaranty

revolving fund

Other

Guaranteed Loan Change

President's Request

68.8 75.7 75.2 79.9 85.7 89.7 406.2

-0.1 -0.2 -0.2 -0.2 -0.2 -0.9

1.6 1.1 0.6 0.2 -0.3 3.1

0.0 2.3 2.2 2.2 2.2 2.1 11.0

0.0 -1.5 -1.5 -1.5 -1.5 -1.5 -7.5

7.0 7.9 8.4 8.5 8.6 8.6 42.0

0.5 -2.4 -2.5 -2.6 -2.7 -2.8 -13.1

-0.2 -0.2 -0.2 -0.2 -0.2

0.0 -1.5 -3.3 -3.4 -3.6 -3.7

0.0 -3.5 -2.1 -1.4 -0.4 0.9

0.0 -0.2 -0.3 -0.3 -0.3 -Q.4

7.6 2.4 1.7 1.8 2.0 2.5

76.4 78.1 76.9 81.7 87.7 92.2

-0.9

-15.4

-6.5

-1.5

10.3

416.6

SOURCE: Congressional Budget Office.

Ill
TABLE VII-5. MAJOR CHANGES IN BASELINE OUTLAYS FOR CREDIT

PROGRAMS RESULTING FROM THE PRESIDENT'S

BUDGET (By fiscal year, in billions of dollars)

Major Program

Foreign Military

Sales Credits

Export-Import Bank

Rural Electrification and

Telephone Revolving Fund

Agriculture Credit

Insurance Fund

Commodity Credit

Corporation

Rural Housing

Insurance Fund

Small Business

Administration

Community Development

Grant Guarantee

Rural Development

Insurance Fund

Low-rent public housing

Federal Housing

Administration

Guaranteed student loans

VA loan guaranty

revolving fund

Outlay Changes for

Loan Programs

1986

0.0

-0.3

0.0

-4.4

0.2

-2.0

-1.2

0.0

0.0

-0.7

-0.3

-0.5

-0.5

-9.7

1987

0.1

-1.2

-0.5

-4.4

0.0

-3.1

-1.5

0.0

-0.1

-1.7

-0.4

-0.5

-0.5

-13.7

1988

0.3

-1.7

-1.2

-4.0

-1.7

-3.6

-1.7

-0.1

-0.2

-2.0

-0.4

-1.0

-0.4

-17.8

1989

0.2

-1.9

-1.6

-3.9

-1.7

-4.0

-1.9

-0.2

-0.4

-2.0

-0.5

-1.3

-0.2

-19.4

1990

0.2

-2.0

-2.0

-3.8

-1.4

-4.4

-0.7

-0.2

-0.5

-2.1

-0.5

-1.8

0.0

-19.2

Cumulative

Five-Year

Changes

0.8

-7.1

-5.2

-20.5

-4.6

-17.2

-7.0

-0.5

-2.2

-8.6

-2.2

-5.2

-1.6

-79.8

SOURCE: Congressional Budget Office.

112
Agriculture Credit Insurance Fund (ACIF)

The Farmers Home Administration finances direct loans and guarantees for

purchasing, operating, and improving farms. Emergency disaster loans are

also provided to assist recovery from natural disasters, including to compensate for loss of income from reduced crop yields. Most borrowers are not

acceptable credit risks for commercial or Farm Credit banks. Although the

average ACIF loan conveys a subsidy of about 27 percent of principal, this

average is significantly raised by the 53 percent subsidy on emergency disaster loans, which may bear interest as low as 5 percent for terms of up to 40

years. Under the CBO baseline, ACIF lending would average $5 billion annually and new guarantees would average $800 million. The subsidy on guarantees is estimated to be 4 percent of principal.

The President proposes to limit direct loans to $400 million in 1986

and to reduce the ceiling $100 million per year until 1990 when direct lending would be halted. Guarantees for farm operating loans would be increased to $3 billion but the guarantee would be limited to 70 percent of

principal—rather than the current 100 percent figure—and borrowers would

be charged a 5 percent loan guarantee/origination fee. Emergency disaster

loans would be available only where federal crop insurance is not available.

Because federal all-risk crop insurance is currently available in virtually all

counties of the United States, emergency lending would fall to insignificant

levels—a five-year reduction of $9.7 billion.

If adopted, the President's proposal would significantly reduce ACIF

activity and shift it away from deep-subsidy direct lending. Total assisted

credit would decline by more than $2 billion per year. Outlay reductions

would also exceed $4 billion per year and subsidy costs would drop to about

$50 million annually from the current rate of $1.3 billion.

Commodity Credit Corporation (CCC)

The two major credit activities of the CCC are price support, nonrecourse

direct loans to producers, and guarantees of loans made to finance U.S.

agricultural exports. CCC price support "loans" are more closely related to

purchase agreements than to pure credit transactions but are treated here

as loans, for consistency with Administration practice. The CCC makes

direct loans to producers with the crop serving as collateral. On the maturity date of a loan, the borrower can either pay off the loan or forfeit the

commodity collateral to the CCC. If the market price is near or below the

loan support price, the farmer has an incentive to default. If the market

price is above the loan support price, the farmer typically then sells the

crop, pays off the loan, and pockets the difference. These loans are called

113

T
TABLE VII-6. MAJOR CHANGES IN SUBSIDIES ESTIMATED FOR CREDIT

PROGRAMS RESULTING FROM THE PRESIDENT'S BUDGET

(By fiscal year, in billions of dollars)

Major Program

Cumulative

Five-Year

1985 1986 1987 1988 1989 1990 Changes

Direct Loans

President's Proposals

Foreign Military Sales

Credit

Export-Import Bank

Rural electrification and

telephone revolving fund

Agriculture Credit

Insurance Fund

Commodity Credit

Corporation

Rural Housing

Insurance Fund

Small Business

Administration

Community development

grant guarantee

Rural Development

Insurance Fund

Low-rent public housing

Direct Loan Change

0.4 0.3 0.3 0.2 0.1 1.3

-0.6 -0.7 -0.7 -0.7 -0.8 -3.5

-0.7 -0.8 -0.8 -0.9 -1.0 -4.1

-1.2 -1.3 -1.2 -1.3 -1.4 -6.4

0.0 0.0 -0.1 -0.1 -0.1 -0.2

-2.3 -2.4 -2.5 2.6 2.7 -12.3

-0.2 -0.3 -0.4 -0.4 -0.5

0.0 0.0 0.0 0.0 0.0

-0.1 -0.1 -0.1 -0.1 -0.1

0.0 0.0 0.0 0.0 0.0

-1.8

0.0

-0.5

-0.1

0.0 -4.7 -5.2 -5.5 -5.9 -6.4 -27.7

(Continued)

114
Table VII-6. (Continued)

Major Program

Cumulative

Five-Year

1985 1986 1987 1988 1989 1990 Changes

Guaranteed Loans

President's Proposals

AID housing guarantees

Export-Import Bank

Agriculture Credit

Insurance Fund

Commodity Credit

Corporation

Federal Housing

Administration

Small Business

Administration

Rural Development

Insurance Fund

Guaranteed student loans

VA loan guaranty

revolving fund

Guaranteed Loan Change

0.0 0.0 0.0 0.0 0.0 -0.2

0.3 0.3 0.2 0.2 0.2 1.2

0.0 0.0 0.0 0.0 0.0 0.0

-0.1 -0.1 -0.1 -0.1 -0.1 -0.4

-0.1 -0.1 -0.1 -0.1 -0.1 -0.5

-0.6 -0.6 -0.6 -0.6 -0.7 -3.0

0.0 0.0 0.0 0.0 0.0 -0.1

-0.8 -1.8 -1.9 -1.9 -2.0 -8.4

-1.6 -1.7 -1.8 -2.1 -2.2 -9.4

0.0 -2.8 -3.9 -4.4 -4.7 -4.9 -20.7

SOURCE: Congressional Budget Office.

115
nonrecourse because the government has no further claim on the farmer

other than the commodity collateral. The CCC's loss, therefore, depends on

crop prices. OMB estimates that CCC commodity loans entail a subsidy of

only 1.3 percent of principal. This small subsidy does not consider the nonrecourse provision, which would not be included in a private loan. The

existence of the nonrecourse provision potentially converts the loan subsidy

to a price support equal to the difference between the crop price and the

level specified in the nonrecourse agreement. Export loan guarantees

against defaults are also assigned a shallow subsidy of 2.9 percent.

The President proposes to set loan support prices at 75 percent of the

three-year average price of the commodity and to limit nonrecourse crop

loans to $200,000 per farmer. An origination fee of 5 percent of the principal is proposed to be levied on export guarantees and a small direct loan

program for exports is to be terminated.

If the President's proposal is adopted, direct commodity loans would

decline by $3.4 billion annually over 1987-1990. Lending would decline because price support loan rates would fall relative to market prices, thus

reducing farmers' incentives to use nonrecourse loans. Fiscal year 1986

lending would not be affected since the proposed changes begin with the

1986 crop year. New loan guarantees are projected to be $1.5 billion per

year lower over 1986-1990 because of the origination fee.

Federal Housing Administration (FHA)

The FHA revolving fund finances about 40 separate credit programs including the basic Section 203(b) home mortgage insurance plan. The only significant proposed change affecting these programs is to raise the mortgage

insurance fee from 3.8 percent of principal to 5 percent. This increase is

expected to eliminate the $105 million annual subsidy on single-family

mortgage guarantees and to increase revenue by $400 million per year over

the next five years.

Rural Housing Insurance Fund (RHIF)

The Rural Housing Insurance Fund finances some of the government's deepest subsidy loan programs. Zero~downpayment homeownership loans are

made at 3 percent interest for 33 years, for example. The next largest

category, after homeownership loans, consists of rental housing loans which

can carry effective rates of 1 percent for 50-year terms. The average

subsidy on RHIF loans is 67 percent of principal. Current lending is about

$3.2 billion per year, projected to reach $4.0 billion in 1990 under current

policy.

116
The President proposes to terminate Farmers Home housing loans (except for those to finance essential repairs to existing, occupied dwellings),

to shift rural housing assistance to the Department of Housing and Urban

Development, and to adopt a two-year moratorium on new assistance. If

adopted, this would reduce subsidies by about $2.5 billion per year for 1986

through 1990 and outlays by $3.4 billion.

Small Business Administration (SBA)

The SBA provides direct and guaranteed loans to small businesses and to

victims of physical disasters who are otherwise unable to obtain such loans

on reasonable terms. Under current policy, the terms of SBA's major loan

programs and comparable private loans are as follows:

Government Loan Private Loan

Rate Term Rate Term

(years) (years)

Direct Loans

Disaster loans 8.00 3.0 17.8 1

General business loans 13.50 7.0 17.8 2

Small Business Investment Corporation 13.50 0.5 14.0 15

General business

guarantees 13.05 9.0 17.8 2

OMB estimates that the average subsidy for SBA direct loans was 17.1 percent and for SBA guaranteed loans, 22.9 percent in 1984. The Administration has proposed to eliminate the SBA loan programs. This would reduce

baseline direct loans by $10.3 billion and baseline primary guarantees by

$13.1 billion over five years. CBO estimates the outlay savings from 1986

to 1990 to be $7.0 billion. Assuming a constant subsidy level and mix of SBA

programs in the baseline, the subsidy costs would be reduced by $4.8 billion.

Rural Development Insurance Fund (RDIF)

This revolving fund is the smallest of the three major Farmers Home funds

and finances three credit programs: direct loans for water and waste disposal; direct loans for community facilities such as fire stations, town halls,

and social centers; and loan guarantees to facilitate commercial and industrial development. Loan obligations are currently running at almost $500

117
million annually; new commitments to guarantee are less than $200 million

per year. Direct loans are made at rates as low as 5 percent for 40 years.

The average RDIF loan subsidy is 20 percent of principal. For guarantees,

the subsidy is 8 percent of the principal amount.

The President's proposal is to terminate RDIF credit programs, except

for $50 million in water and waste disposal loans in 1986, and to transfer

responsibility for these activities to the Community Development Block

Grant program. If adopted, this proposal would reduce total assisted lending

by $3.4 billion and Farmers Home Administration credit subsidies by $577

million.

Community Development Block Grant (CDBG) Guarantees

The Secretary of Housing and Urban Development guarantees the debt securities of Community Development Block Grant recipients to finance the acquisition of property and preparation of sites in anticipation of CDBG development. The guarantees are financed by and converted to direct federal

loans by the Federal Financing Bank at a rate of 1/8 of a percent above the

Treasury rate. The loans are largely repaid from the CDBG grants. Because

the loan is made at approximately the Treasury rate and repaid with government funds, the subsidy is minimal. OMB estimated the subsidy to be 1.6

percent of principal for funds committed in 1984. The Administration has

proposed the elimination of the program. Baseline direct loans would be

reduced by $0.7 billion, outlays by $500 million, and subsidy cost by $10

million.

Guaranteed Student Loans (GSL)

Loans to students and parents are guaranteed and the interest on the loans

subsidized. During 1984, OMB estimated that while GSLs were made at 8

percent for a term of 14 years, comparable private loans would cost 15

percent for a term of 10 years. The subsidy was estimated to be 52 percent

of the face value of the loans. In its budget the Administration has proposed

a number of restrictions on the GSL program: a $4,000 per year cap on all

subsidized grant and loan aid per student; a $32,500 cap on income eligibility; and reductions in the GSL allowances to lenders. CBO estimates that

GSL loan volume would fall by $15.4 billion from the baseline between 1986

and 1990 and that outlays would be reduced by $5.2 billion between 1986 and

1990. Applying the OMB subsidy estimates yields a reduction in subsidy

costs of $8.7 billion.

118
Low-Rent Public Housing

In 1984, federal guarantees of the tax-exempt borrowing of public housing

authorities were converted to direct federal loans. These loans financed

outstanding obligations for the construction of low-rent public housing and

will be repaid from federal rental assistance payments. OMB estimated the

subsidy to be 3 percent of loan principal for 1984. The Administration's

budget assumes the continuation of approximately $1.4 billion in new loans

in 1986 and 1987, a significant decrease in 1988 through 1990. In total, from

1986 to 1990, the Administration proposes reductions of $4.3 billion from

baseline estimates for direct loan obligations. Subsidies would be reduced

by $129 million and outlays by $8.6 billion.

VA Loan Guaranty Revolving Fund

The Veterans Administration insures or guarantees the purchase or construction of new homes for veterans. OMB estimated that the subsidy cost was

equal to 9 percent of loan volume in 1984. The Administration has proposed

a 5 percent upfront fee on the full principal of VA guaranteed mortgages.

While the fee can be financed, CBO projects that the increased fee will

decrease loan volume by 6 percent below baseline estimates. Guarantee

volume would be reduced by $6.5 billion, and outlays by $3.8 billion between

1986 and 1990. The subsidy cost of individual loans would be reduced by

$9.2 billion because of the higher fees.

CLOSING COMMENT

When the Congress considers the possible savings from adopting the President's budget proposals for federal credit, these savings—all in relation to

baseline projections—should be viewed in terms of reductions in assisted

credit, outlay savings, and resources freed for other uses. Each of the proposed changes would affect the volume of credit, outlays, and subsidies and,

in fact, most would reduce these three measures. The concept of savings

that is relevant will depend on the motivation for Congressional action.

Where the objective is to reduce the credit market presence of federally

assisted borrowers, the credit budget measure of activity will provide the

appropriate gauge for savings. Where the current budget deficit is the object of concern, the outlay savings indicate the potential gain. Where the

goal is to reduce the consumption of economic resources by federal credit

programs, subsidy cost savings should be the guide. It should be noted that

where federal credit is being traded off against spending, the appropriate

cost saving from credit cutbacks is subsidy cost rather than outlay savings,

which tend to overstate most credit program reductions.

119

42-72 6 O - 85 - 6 QL 3

APPENDIXES

APPENDIX A

CBO REVENUE REESTIMATES

This appendix explains CBO's reestimates of the Administration's budget

revenues. It is a companion to Appendix B, which explains CBO's reestimates of the Administration's spending program.

Almost all of the differences between the CBO and Administration

revenue estimates are attributable to CBO's use of different economic

assumptions, primarily lower taxable incomes (see Table A-1). The differTABLE A-1. CBO'S REESTIMATES OF THE ADMINISTRATION'S

BUDGET REVENUES (By fiscal year, in billions

of dollars)

1985 1986 1987 1988 1989 1990

President's Budget 737 794 862 950 1,030 1,108

CBO Reestimates

Different economic

assumptions -1 -4 -9 -18 -22 -18

Technical reestimates a/ 2! ._£ 2 -1 a/

Subtotal -2 -5 -7 -16 -23 -18

President's Budget as

Estimated by CBO 735 789 855 934 1,007 1,090

SOURCES: Budget of the United States Government for Fiscal Year 1986

and Congressional Budget Office.

a. Less than $500 million.

123

T
ences attributable to technical assumptions are very small in the aggregate.

The net result of CBO's reestimates is to reduce revenues below the Administration's budget estimates by amounts ranging from $2 billion in 1985 to

$23 billion in 1989 and $18 billion in 1990.

Estimated revenues can be measured as percents of GNP, allowing a

comparison that abstracts from differences in GNP assumptions. CBO's

estimates of revenues as a share of GNP are higher than the Administration's by 0.1 percent in 1986 and 0.2 percent in 1987, and lower by 0.1

percent in 1989 and 1990 (see Table A-2).

DIFFERENCES IN ECONOMIC ASSUMPTIONS

CBO's economic assumptions are distinguished from the Administration's

primarily by their slightly lower economic growth and higher interest rates.

The lower GNP path projected by CBO is reflected in lower taxable personal

income through 1989. CBO taxable personal income is $28 billion below the

Administration's projection in 1987 and $19 billion below in 1989. By 1990,

CBO's projection of taxable personal income rises above that of the Administration because of the assumption that property income (nonwage personal

income) will claim a higher share of GNP. This assumption partially explains why CBO's estimate of total revenues is closer to that of the Administration in 1990 than in 1989 even though the GNP paths continue to diverge.

TABLE A-2. BUDGET REVENUES AS PERCENTS OF GNP

(By fiscal year)

1985 1986 1987 1988 1989 1990

President's Budget 19.0 18.9 18.9 19.3 19.4 19.5

President's Budget as

Estimated by CBO 19.1 19.0 19.1 19.3 19.3 19.4

SOURCES: Budget of the United States Government for Fiscal Year 1986

and Congressional Budget Office.

124
In every year except 1986, CBO's projection of corporate profits

before tax and before adjustment for the Accelerated Cost Recovery System (ACRS) is lower than the Administration's, with the difference increasing to $25 billion by 1990. About two-thirds of this difference stems from

differences in the profits share of GNP; the rest is the result of the

Administration's higher GNP projection.

The effect of CBO's different economic assumptions is to reduce revenues in each year by amounts ranging from $1 billion in 1985 to $22 billion in

1989 and $18 billion in 1990 (see Table A-3). Revenues from personal

income and social insurance taxes are lower in each year after 1985. The

TABLE A-3. CBO REVENUE REESTIMATES REFLECTING DIFFERENT

ECONOMIC ASSUMPTIONS (By fiscal year, in

billions of dollars)

1985 1986 1987 1988 1989 1990

Individual Income Taxes

Corporate Income Taxes

Social Insurance Taxes

Windfall Profit Taxes

Federal Reserve Payments

Other b/

-1

-1

1

§/

§/

a/

-3

-1

a/

a/

§./

a/

-5

-1

-3

a/

a/

a/

-5

-6

-8

1

§/

a/

-4

-8

-12

1

2

a/

_§/

-8

-15

1

4

a/

Total Reestimates -1 -4 -9 -18 -22 -18

SOURCE: Congressional Budget Office.

a. Less than $500 million.

b. Estate and gift taxes, customs duties, excise taxes other than windfall

profit taxes, and miscellaneous receipts other than Federal Reserve

payments.

125
relatively smaller income tax reestimates result from the partially offsetting effects of lower CBO wage and salary income projections and higher

CBO property income projections after 1986. The social insurance reestimates reflect the full effects of the lower wage and salary projections.

CBO's corporate income tax estimates reduce revenues about $1 billion in 1985, $0.5 billion in 1987, and afterward by larger amounts, reaching

$8 billion in 1990—because of CBO's assumption of generally lower taxable

profits. The slightly higher windfall profit tax estimates result from CBO's

assumption of higher oil prices. The higher Federal Reserve payments result

from CBO's higher interest rates.

TECHNICAL ESTIMATING DIFFERENCES

Technical differences between CBO and the Administration are largely offsetting and consequently small in the aggregate, not exceeding $2 billion in

any year (see Table A-4).

Most of the individual income tax technical reestimates, positive in

1985 and 1986 and negative in 1987-1990, result from differences between

CBO and Administration statistical estimation techniques. These differences are small relative to income tax collections (about 1.5 percent in 1989

and 1990). The Administration continues to estimate somewhat higher outyear receipts when starting from common economic assumptions. Since it

does not detail its estimation techniques, this differential cannot be fully

explained.

The negative corporate income tax reestimates in 1985 and 1986 reflect different assumptions about refunds. The Administration assumes that

the fall-off in corporate tax refunds in recent months will be sustained

through the year, implying fiscal year 1985 refunds as much as 24 percent

below their 1984 level. CBO assumes a higher level of refunds. The positive

technical corporate reestimates in 1988-1990 are primarily due to different

methods of estimating the revenue effects of ACRS. For any given level of

investment, Administration estimation methods produce greater corporate

revenue losses from ACRS.

The positive social insurance tax technical reestimates for the 1988-

1990 period reflect, for the most part, different assumptions about state

unemployment insurance tax rates. The Administration projects lower rates

than does CBO, on the assumption that lower rates generate smaller, more

realistic trust fund balances. CBO's higher tax rates and higher projected

benefit levels also produce realistic fund balances for 1988-1990.

126
CBO's estimate of the proposed federal civilian pay-cut proposal also

contributes to the positive technical reestimate for social insurance.

Although this proposal is an outlay proposal, the Administration includes in

its budget estimates the effects of associated reductions in Social Security

TABLE A-4. CBO REVENUE REESTIMATES REFLECTING TECHNICAL

ESTIMATING DIFFERENCES (By fiscal year, in

billions of dollars)

Individual Income Taxes

Corporate Income Taxes

Social Insurance Taxes

Windfall Profit Taxes

Other Excise Taxes

Customs Duties

Federal Reserve Payments

Other b/

Total Reestimates

1985

1

-3

§/

§/

1

1

a/

§/

a/

1986

1

-3

a/

a/

a/

1

a/

a/

-1

1987

a/

a/

1

a/

1

1

a/

a/

2

1988

-3

2

1

a/

1

1

a/

a/

2

1989

-8

3

3

a/

1

1

-1

a/

-1

1990

-7

4

4

a/

1

1

-2

a/

a/

SOURCE: Congressional Budget Office.

a. Less than $500 million.

b. Estate and gift taxes and miscellaneous receipts other than Federal

Reserve payments.

127
and Civil Service Retirement contributions. I/ CBO treats this proposal like

others in the budget and includes only first-round effects of the initiative.

Therefore, the CBO reestimate of the proposal does not include any revenue

effects.

The excise tax technical reestimates primarily reflect CBO's assumptions of higher levels of smoking and of liquor consumption. The reason for

the positive reestimate of customs duties is unclear because of a lack of

specific import data for comparison.

1. Budget of the United States Government for Fiscal Year 1986, Special

Analyses, p. A-14.

128
APPENDIX B

CBO OUTLAY REESTIMATES

As part of its analysis of the Administration's budget, CBO has reestimated

the Administration's spending program to reflect CBO baseline economic

assumptions and technical estimating methods. The effect of these reestimates on outlays is summarized in Table B-l and explained in the next two

sections of this appendix. Most of the CBO reestimates result from the use

of different economic assumptions—primarily higher interest rates. These

different economic assumptions increase outlays by only small amounts in

the first few years, but they add $21 billion in 1988, $46 billion in 1989, and

$75 billion in 1990. Technical estimating differences reduce CBO's 1985 and

1986 outlay estimates by $9 billion and $1 billion, respectively, but increase

estimated outlays thereafter. By 1990 technical estimating differences

TABLE B-l. CBO'S REESTIMATES OF THE ADMINISTRATION'S SPENDING PROPOSALS (By fiscal year, outlays in billions of dollars)

1985 1986 1987 1988 1989 1990

President's Budget 959 974 1,027 1,095 1,137 1,190

Preliminary CBO

Reestimates

Different economic

assumptions a/ 3 7 21 46 75

Technical reestimates ^9 ^i 6 !> LP. LI

Subtotal -9 2 " 13 26 56 86

President's Budget as

Estimated by CBO 950 975 1,039 1,120 1,193 1,276

a. Less than $500 million.

129
reach $11 billion, of which $6 billion is in the national defense function. The

appendix concludes with a description of the revisions that have been made

to CBO's baseline budget projections.

DIFFERENCES IN ECONOMIC ASSUMPTIONS

Differences in interest costs account for almost all of the economic

differences between CBO and Administration outlay estimates, as shown in

Table B-2. As the federal government's debt swells, budget estimates are

becoming increasingly sensitive to interest rates. CBO assumes that the

three-month Treasury bill rate will average 8.3 percent in calendar year

1985, 8.7 percent in 1986, and 8.2 percent in 1987 through 1990. In contrast,

the Administration assumes that the bill rate will decline to 7.9 percent in

1986 and to 5.0 percent by 1990. Differences in assumed longer-term rates

are even greater—CBO assumes a 10.0 percent three- to five-year note rate

for 1987 through 1990, while the Administration rate falls to 5.5 percent by

the end of the period. (These differences in assumptions are assessed in

Chapter I.) CBO estimates that these higher interest rates will directly

TABLE B-2. CBO OUTLAY REESTIMATES RESULTING FROM DIFFERENT ECONOMIC ASSUMPTIONS (By fiscal year, in billions of

dollars)

1985 1986 1987 1988 1989 1990

Interest Costs

Due to different interest rates a/ 3 5 16 36 56

Due to different deficits a/ _1 _2 _4 __9 IT_

Subtotal a/ 3 " 7 21 45 73

Social Security and Other

Indexed Benefits a/ a/ a/ a/ 1 2

Medicare and Medicaid a/ a/ a/ -1 -1 -1

Unemployment Compensation,

Food Stamps, and AFDC

Total

a/

a/

a/

3

a/

7

a/

21

-I

46

_1

75

a. Less than $500 million.

130
increase interest costs and other interest-sensitive outlays by $3 billion in

1986 and $56 billion in 1990. In addition, economic reestimates of outlays

and revenues indirectly increase interest costs by increasing the amount of

debt to be financed. In total, differences in interest outlays total $3 billion

in 1986, $7 billion in 1987, and $73 billion by 1990.

CBO's projected inflation rates are slightly below those of the

Administration in the early years but a little higher later on. As a result,

CBO estimates that outlays for Social Security and other indexed benefits

will be within $500 million of the Administration's estimates in 1985 through

1988, $1 billion higher in 1989, and $2 billion higher in 1990. Outlays for

Medicare and Medicaid are sensitive to medical care costs, of which

employee compensation rates are the most important component. Because

CBO projects slower wage growth than does the Administration, CBO's

outlay estimates for Medicare and Medicaid are $1 billion lower than the

Administration's figures in 1988 through 1990.

CBO's unemployment rate assumptions are generally higher than the

Administration's. CBO therefore estimates higher outlays for unemployment compensation and other unemployment-sensitive programs. These

differences are negligible in 1985 through 1988, but grow to $1 billion in

1989 and 1990.

TECHNICAL ESTIMATING DIFFERENCES

Table B-3 lists the major technical estimating differences between CBO and

the Administration. The next section of this appendix discusses the differences in defense estimates. The concluding; section discusses the remainder of the budget.

National Defense

CBO estimates that defense outlays under the Administration's request will

be $6 billion higher over the 1985-1990 period than the Administration

estimates. This figure is relatively small, given the inherent error in such

estimates, but results in large part from differences in the research,

development, test, and evaluation (RDT&E) account estimates. Other

differences may be found in the operations and procurement accounts.

RDT&E. As noted above, most of the difference between CBO and

Administration estimates is concentrated in the RDT&E account. The

estimates differ by small amounts in the 1985-1986 period, and by increasingly larger amounts thereafter, reaching $9.3 billion in 1990. Table B-4

shows how CBO arrived at its estimate. The outlay rates used are

consistent with recent experience and differ only slightly from those

published by the Administration. While it is possible that the difference

represents a change in the mix of goods and services purchased through this

account, the difference remains unexplained.

131
TABLE B-3. CBO OUTLAY REESTIMATES RESULTING FROM

TECHNICAL ESTIMATING DIFFERENCES

(By fiscal year, in billions of dollars)

National Defense

Procurement

RDT&E

Operations and other

Subtotal

International Affairs

Energy

Agriculture

Commerce and

Housing Credit

Transportation

Medicare

Social Security

Net Interest

Estimating differences

Differences in deficits

Subtotal

OCS Receipts

Other, Net

Total

1985

1

-1

-2

-1

-2

-2

1

a/

-1

-1

-2

a/

a/

-1

a/

a/

-9

1986

a/

-1

-1

-1

a/

a/

-1

a/

a/

1

-2

1

-1

a/

1

a/

-1

1987

-2

a/

1

;

-2

1

-1

3

1

1

2

-2

3

-1

"2

a/

JL

6

1988

-3

2

1

a/

2

-1

a/

3

1

3

-2

1

a/

1

-2

_1

5

1989

-2

5

1

4

2

-1

1

1

1

3

-3

2

a/

2

-1

a/

10

1990

rt

9

a/

6

2

-1

1

1

1

4

-3

1

1

2

-2

a/

11

a. Less than $500 million.

132
Procurement. CBO's outlay estimates for the procurement accounts differ

from the Administration's by small amounts given the size of the budget.

The differences are spread over several accounts, with the largest in Army

ammunition and weapons and tracked combat vehicles.

Operations and Other. As defined by CBO, operations consists of the

sum of the operations and maintenance (O&M) and the revolving and

management accounts. They are grouped together because an outlay change

in one is often balanced by a change in the other; the O&M accounts are the

main customers of the revolving funds, and receipts in the latter are

TABLE B-4. CBO OUTLAY ESTIMATES FOR DEFENSE RESEARCH,

DEVELOPMENT, TEST, AND EVALUATION BASED ON THE

PRESIDENT'S FEBRUARY BUDGET AUTHORITY REQUEST

(By fiscal year)

1985 1986 1987 1988 1989 1990

Billions of Dollars

Budget Authority 31.2 39.3 42.6 49.3 55.9 65.9

Outlays from

1984 and prior BA 11.3 2.2 0.7 0.0 0.0 0.0

1985 BA 16.0 11.0 2.3 0.8 0.0 0.0

1986 BA 20.0 14.0 2.7 1.1 0.0

1987 BA 21.8 15.0 2.9 1.2

1988 BA 25.2 17.4 3.4

1989 BA 28.6 19.7

1990 BA 33.7

Total Outlays 27.3 33.2 38.8 43.8 50.0 58.0

Percent

Implicit Outlay Rates

from New BA for

1985 51.2 28.0 5.4 1.7 0.0 0.0

1986 50.8 32.8 5.5 1.9 0.0

1987 51.2 30.5 5.3 1.7

1988 51.2 31.1 5.2

1989 51.2 29.9

1990 51.2

133
often disbursements from the former. Because of this relationship, they are

difficult to estimate separately. For operations and the remaining categories of defense spending, the estimating differences between CBO and the

Administration are attributable to different interpretations of historical

spending patterns.

Nondefense Spending

For a number of reasons, CBO estimates of international affairs outlays are

below the Administration's in 1985 and 1986 and higher thereafter. ExportImport Bank outlays are lower initially because of lower estimated loan

levels in 1985; the resulting reduction in estimated loan repayments causes

outlays to be higher in later years. For foreign military sales loans, CBO

estimates lower rates of disbursement in the early years and lower repayments later in the budget projections period. The CBO estimate of the

President's program also adds over $1 billion in outlays in each year for

nonmilitary economic assistance for Israel. Although the Administration

states in the budget document that a request for appropriations will be

forthcoming, no money for Israel is included in the budget totals.

CBO estimates lower energy outlays in all years except 1986. Estimated outlays for loans by the Rural Electrification Administration and for

production of synthetic fuels are consistently lower, reflecting recent

spending patterns. Outlays in 1985 are also lower because recent data

indicate higher payments of nuclear waste disposal fees by private utilities.

Finally, CBO projects that the proposal to increase loan repayments by

power-marketing administrations will achieve smaller savings in 1986

because of delays in implementation.

The major reestimates in agriculture programs involve the Agricultural Credit Insurance Fund (ACIF) and the price support programs of the

Commodity Credit Corporation (CCC). CBO's estimate of ACIF outlays is

$2 billion above the Administration's in each year except 1986. While details behind the Administration's ACIF estimate are not available, the estimating difference is probably related to less optimistic CBO assumptions

about loan repayments. For CCC, CBO's estimate of the export credit contingency is lower than the Administration's by about $1 billion each year.

CBO also projects that the Administration's proposed changes in farm price

supports will not achieve their full savings as rapidly as assumed.

In the commerce and housing credit function, CBO estimates that net

outlays of the Federal Depo-sit Insurance Corporation will exceed the Administration's estimate by $1 billion in 1987 through 1990. CBO projects

that the need for assistance to troubled banks will decline less rapidly than

the Administration assumes, Based on the latest data from the Postal

Service, CBO also estimates that the Postal Service Fund will run a deficit

134
of $2 billion in 1988 and $1 billion in 1989; because of the variability of the

fund, the Administration assumes no net outlays in all years from 1987

through 1990.

Recent data on transportation spending suggest that appropriations for

discretionary mass transit grants and Federal Aviation Administration

facilities and equipment will initially result in outlays at a slower rate than

the Administration assumes. This results in lower CBO spending estimates

for these programs in 1985 and 1986 and higher spending thereafter. In

addition, CBO has upped the Administration's estimate of spending for

federal-aid highways and mass transit formula grants in 1986 through 1990

that will result from obligations made before 1985. On balance, CBO's

transportation estimates are below the Administration's in 1985, about the

same in 1986, and higher in 1987-1990.

Projections of Medicare outlays are especially uncertain because of

recent major legislative changes. The prospective payment system for

hospital admissions will be fully implemented by 1986. Under this approach,

hospitals are reimbursed according to a fixed payment schedule for each of

468 diagnosis related groups (DRGs). The 1984 Deficit Reduction Act also

froze physician fees for 15 months. The CBO and Administration differ in

their estimates of the future impact of these recent changes. CBO also

assumes higher levels of utilization of medical services by beneficiaries than

does OMB. The 1985 reestimates are attributable primarily to actual yearto-date spending patterns.

Technical reestimates in the Old-Age and Survivors Insurance portion

of Social Security in 1985 reflect recent spending patterns. CBO's downward reestimate in 1985 lowers the base for future-year increases, resulting

in lower outlays in 1986 through 1990. CBO projects lower outlays for

Disability Insurance in 1985 than the Administration, based on a smaller

number of beneficiaries, but the differences are relatively small in later

years.

Estimating differences in net interest total from $1 billion to $3

billion in fiscal years 1986 through 1990. CBO assumes that the Treasury

will continue its strategy of lengthening the average maturity of the federal

debt, raising most of its new money in notes and bonds. OMB assumes a

larger proportion of short-term financing, which carries lower interest rates

but must be refinanced frequently. CBO projects different interest on

Outer Continental Shelf escrow releases consistent with its assumptions

about the timing and amount of settlements, as discussed below. Interest

receipts from foreign military sales credits are projected by CBO to be

lower, primarily because loan disbursements are expected to occur more

slowly. CBO projects smaller intragovernmental interest receipts consistent

with its outlay projections for agencies that borrow from the Treasury.

Partially offsetting these upward reestimates, CBO projects lower interest

135
costs on Internal Revenue Service refunds and larger interest receipts from

Treasury tax and loan accounts and the International Monetary Fund.

Technical reestimates in other spending categories and in revenues lower

the amounts of deficits to be financed in 1985 but increase estimated

borrowing requirements in 1987 through 1990.

The major difference in CBO and OMB projections of Outer Continental Shelf (OCS) receipts lies in differing assumptions about escrow releases.

The federal government is currently embroiled in a dispute with seven states

concerning the equitable distribution of receipts from tracts near the

boundary between federal and state waters. The funds are invested in

interest-bearing escrow accounts pending resolution of the controversy. The

Administration assumes that the states will accept settlements giving them

17 percent of the disputed funds, and that the remaining 83 percent will be

disbursed to the federal government mostly in fiscal years 1986 and 1987.

Because of the uncertain outcome of these disputes, and because some of

the states have recently been prevailing in court, CBO assumes that the

federal government will receive only 50 percent of the disputed funds,

spread over fiscal years 1986 through 1988. The remaining technical

reestimates stem from different assumptions about royalties and bonus

receipts. Because a long-term auction schedule is unavailable, CBO and the

Administration both assume roughly constant bonus receipts after 1986.

Both CBO and OMB have lowered their estimates since last summer because

of the oil price situation, but CBO assumes annual bonuses of $2.5 billion

after 1986 in contrast to the Administration's $1 billion.

REVISIONS TO CBO BASELINE PROJECTIONS

Since the release of the President's budget on February 4, CBO has updated

its baseline outlay projections. These new projections are slightly higher

than those published earlier this month in The Economic and Budget

Outlook; Fiscal Years 1986-1990. The major revisions to the baseline are

listed in Table B-5.

Most of the changes in the projections are for public enterprise funds--

such as the Agricultural Credit Insurance Fund, Commodity Credit Corporation Fund, Rural Housing Insurance Fund, Postal Service Fund, and LowIncome Public Housing Fund—where the Executive Branch has considerable

administrative flexibility. Most of these funds receive large offsetting

collections from the public, which are netted against gross spending. As a

result, a change in gross spending or collections causes a far more than

proportional change in net outlays. The changes in the projections reflect

additional information that CBO has obtained regarding lending plans,

repayment schedules, rate increases, and other aspects of the businesslike

activities of these funds.

136
Many offsetting receipts estimates—notably for mineral and timber

leases, royalties on Outer Continental Shelf lands, and military retirement

contributions—have been revised to correspond more closely to the figures

in the budget. In the case of foreign military credit sales, the changes in

the projections are based on updated information on the expected borrowing

requirements of Egypt and Israel. Finally, by increasing outlays, the

foregoing changes cause an increase in net outlays. Changes not discussed

above are small and largely offsetting.

TABLE B-5. REVISIONS TO CBO BASELINE OUTLAY PROJECTIONS

(By fiscal year, in billions of dollars)

1985 1986 1987 1988 1989 1990

Foreign Military Credit Sales -1 1 1 1 a/ a/

Agricultural Credit Insurance

Fund 1 1 1 1 1 a/

Commodity Credit Corporation

Fund -2 -1 -1 a/ a/ 1

Rural Housing Insurance Fund a/ 1 1 1 1 1

Postal Service Fund a/ a/ a/ 1 1 -1

Housing Assistance 31211 1

Offsetting Receipts a/ 2 2 2 1 1

Net Interest a/ a/ 1 1 2 3

Other li §/ _! JL §/ l!

Total Revisions a/ 5 7 8 8 6

a. Less than $500 million.

137
.... 1
APPENDIX C

MAJOR CONTRIBUTORS TO THE PREPARATION OF THIS REPORT

Members of the Budget Analysis, Fiscal Analysis, and Tax Analysis Divisions

were major contributors to this report. The individuals who helped prepare

the analyses for each chapter are listed below:

Chapter

Summary

Chapter I

Chapter II

Chapter III

Analyst

Paul Van de Water

Frederick C. Ribe

Jeffrey Steger

Rosemary D. Marcuss

Kathleen M. O'Connell

Valerie Amerkhail

Neil Fisher

Robert Lucke

Nancy O'Hara

Larry Ozanne

Stephen Porter

Linda Radey

Pearl Richardson

Michael A. Miller

Eugene Bryton

Regina Carpel

Julia Doherty

Barbara Hollinshead

Michael J. McCord

William Myers

Jonathan Tyson

Telephone

Number

226-2880

226-2769

226-2762

226-2687

226-2685

226-2692

226-2720

226-2683

226-2688

226-2684

226-2678

226-2693

226-2691

226-2840

226-2840

226-2840

226-2840

226-2840

226-2840

226-2840

226-2840

139
Appendix C (Continued)

Chapter

Chapters IV and V

Chapter VI

Chapter VII

Analyst

Charles E. Seagrave

Robert A. Sunshine

David Bashpre

Lisa Brown

Diane M. Burnside

Carol Camp

Hinda R. Chaikind

Paul R. Cullinan

Marianne S. Deignan

Paul DiNardo

Peter H. Fontaine

Debra F. Goldberg

Kathleen Gramp

Theresa A. Gullo

James Hearn

Richard J. Hendrix

Roger E. Hitchner

Deborah A. Kalcevic

Kathleen Kelly

Kelly Lukins

Mary B. Maginniss

Anne R. Manley

Maureen McLaughlin

Andrew Morton

Carmela S. Pena

Janice Peskin

Deborah Reis

Stacey R. Sheffrin

Kathleen W. Shepherd

Brent G. Shipp

Joseph C. Whitehill

Heidi E. Zukoski

Kathy A. Ruffing

Charles J. Richardson

Richard P. Emery

Marvin M. Phaup

Mark Weatherly

Telephone

Number

226-2820

226-2860

226-2880

226-2840

226-2820

226-2860

226-2820

226-2820

226-2820

226-2860

226-2860

226-2860

226-2860

226-2860

226-2860

226-2820

226-2860

226-2820

226-2860

226-2820

226-2860

226-2820

226-2672

226-2860

226-2820

226-2820

226-2860

226-2820

226-2820

226-2860

226-2840

226-2860

226-2880

226-2880

226-2835

226-2835

226-2835

140
Appendix C (Continued)

Appendix A

Appendix B

Rosemary D. M

Kathleen M. O

ircuss

onnell

Paul Van de Wa

Kathy A. Ruffi

Computer support for the spending an

by David Bashore, Timothy Buck, Jerry

Farris, Vernon Hammett, Vera Powell, and

support was provided by Janet Airis,

Edward Balu, Betty Embrey, Glen Goodno

Sempsey. C.G. Nuckols, Jr. also gave valuable

many drafts of the spending chapters.

:er

226-2687

226-2685

226-2880

226-2880

lysis in this report was provided

Cumberland, Marion Curry, Kenneth

David Sanders. Other technical

Arnold, Priscilla Aycock,

Patricia Kinslow, and Robert

assistance in reviewing the

George

141