CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

An Analysis of

the President's Budgetary Proposals

for Fiscal ^ear 1996

Prepared at the Request of the Senate Committee on Appropriations

AN ANALYSIS OF THE PRESIDENT'S

BUDGETARY PROPOSALS FOR FISCAL YEAR 1996

The Congress of the United States

Congressional Budget Office
NOTES

Unless otherwise indicated, all years referred to in Chapter 2 are calendar years, and all

years in other chapters and Appendixes A and B are fiscal years.

Unemployment rates throughout the report are calculated on the basis of the civilian labor

force.

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

For sale by the U.S. Government Printing Office

Superintendent of Documents, Mail Stop: SSOP, Washington, DC 20402-9328

ISBN 0-16-048013-2
Preface

T

his analysis of the President's budget for fiscal year 1996 was prepared at the

request of the Senate Committee on Appropriations. The report discusses the

President's policies in terms of changes from the Congressional Budget Office's

(CBO's) baseline budget projections for 1996 through 2000. It provides estimates of the

budgetary impact of the Administration's proposals using CBO's economic assumptions

and technical estimating methods.

The report was prepared by the staffs of the Budget Analysis, Macroeconomic Analysis, and Tax Analysis divisions under the supervision of Paul Van de Water, Robert Dennis, and Rosemary D. Marcuss. James Horney wrote Chapters 1 and 3, John Peterson

wrote Chapter 2, and Frank Sammartino wrote Chapter 4. Appendix A was written by

Jeffrey Holland, and Appendix B was written by Robert Dennis. The baseline revenue

estimates were prepared under the direction of Richard A. Kasten. The estimates of the

President's revenue proposals were prepared by the Joint Committee on Taxation. The

principal contributors to the revenue and spending estimates and analyses are listed in

Appendix C.

Paul L. Houts supervised the editing and production of the report. Major portions

were edited by Paul L. Houts, Sherwood D. Kohn, Leah Mazade, Sherry Snyder, and Chris

Spoor. Chris Spoor also provided editorial assistance during production. The authors owe

thanks to Marion Curry, Dorothy Kornegay, Linda Lewis, L. Rae Roy, and Simone

Thomas, who assisted in the preparation of the report. Kathryn Quattrone prepared it for

final publication.

June E. O'Neill

Director

April 1995

Contents

ONE

TWO

THREE

FOUR

APPENDIXES

A

B

SUMMARY AND INTRODUCTION

CBO's Reestimate of the President's

Budgetary Proposals 7

CBO's Estimate of the Effects of the

President's Budgetary Proposals 5

COMPARISON OF ECONOMIC FORECASTS

The Short-Term Outlook, 1995-1996 9

The Outlook for the Projection Period, 1997-2000 9

THE ADMINISTRATION'S SPENDING PROPOSALS

Mandatory Spending 75

Discretionary Spending 20

THE ADMINISTRATION'S REVENUE PROPOSALS

Tax Relief for Middle-Income Families 25

Modifying the Earned Income Tax

Credit Eligibility Rules 33

Other Revenue Proposals 33

CBO's Baseline Budget Projections 39

Economic and Budgetary Implications

of Balancing the Budget 57

Major Contributors to the Revenue and

Spending Projections 59

15

25
vi AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS April 1995

TABLES

1.

2.

3.

4.

5.

6.

7.

8.

CBO's Budgetary Estimates Under the President's Policies

CBO's Reestimates of the President's Budgetary Proposals

CBO's Estimates of the President's Budgetary Proposals

Comparison of Congressional Budget Office,

Administration, and Blue Chip Economic Projections,

Calendar Years 1994-2000

CBO's Estimates of the President's Spending Proposals

Estimates of the President's Pay-As-You-Go

Spending Proposals

Estimates of the President's Asset Sale Proposals

Pay Raises Under CBO's Current-Law Assumptions

2

4

6

10

16

17

18

and the President's Budget 19

9. The Administration's Proposals for Discretionary

Spending in Fiscal Year 1996 21

10. CBO's Estimates of Revenues Under the President's Proposals 26

11. Comparison of Revenue Estimates of the President's

1996 Budgetary Proposals 27

12. Comparison of Revenue Estimates of the President's

1996 Budgetary Proposals to Provide Tax Relief to

Middle-Income Families 28

13. Comparison of Revenue Estimates of the President's

1996 Budgetary Proposals to Modify Eligibility Rules

for the Earned Income Tax Credit 32

14. Comparison of Revenue Estimates of Other Tax

Provisions in the President's 1996 Budget 34

A-1. Changes in CBO's Baseline Deficit Projections 40

A-2. CBO's Deficit Projections 41

A-3. CBO's Baseline Budget Projections with Discretionary

Inflation After 1998 42
CONTENTS

A-4.

A-5.

A-6.

CBO's Baseline Projections for Mandatory Spending

How Tight Are the Discretionary Caps?

CBO's Baseline Projections for Interest Costs

vii

45

47

and Federal Debt 48

A-7. The Budget Outlook Through 2005 with Discretionary

Inflation After 1998 49

A-8. The Budget Outlook Through 2005 Without Discretionary

Inflation After 1998 50

B-1. Illustrative Deficit Reduction Path 52

B-2. Potential Economic Impacts of Balancing the Budget by

2002 Compared with CBO's January Economic Forecast 53

B-3. CBO's January Economic Forecast After Adjusting for

the Economic Impacts of Balancing the Budget 54

B-4. Change in the Federal Deficit Resulting from the

Economic Impacts of Balancing the Budget by 2002 57

Chapter One

Summary and Introduction

T

he Congressional Budget Office (CBO) estimates that under the policies proposed in the

President's budget for fiscal year 1996, deficits would increase from $177 billion in 1995 to $276

billion in 2000. Except for the current year, the estimates of deficits under the President's policies based

on CBO's economic and technical assumptions are

higher than those stated in the President's budget.

CBO estimates that the deficit in 2000 would be $82

billion higher than the Administration projects.

The President's policies would not substantially

change the deficits from the levels that would result

under current laws and policies. An exact estimate of

the change, however, depends on what assumption is

made about the level of discretionary spending under

current policy after the statutory limits on discretionary spending expire at the end of 1998. (CBO assumes that baseline discretionary spending will equal

the limits in 1996 through 1998.) Compared with

CBO's baseline projections that assume discretionary

spending in 1999 and 2000 will equal the 1998 limit

adjusted for inflation, the President's policies would

reduce the cumulative deficits in 1995 through 2000

by almost $30 billion. Compared with CBO's baseline projections that assume discretionary spending in

1999 and 2000 will be at the same level as in 1998,

the President's policies would increase the deficits

over the next six years by about $31 billion.

In addition to reestimating the President's budget,

CBO has revised the baseline projections published

in its January report The Economic and Budget Outlook: Fiscal Years 1996-2000 to take account of new

information. Those revisions slightly reduce the projected baseline deficit for 1995 but increase the deficits after that by amounts growing from $3 billion in

1996 to $15 billion in 2000 (see Appendix A).

CBO has also revised the illustrative path to a

balanced budget published in the January report and

expanded its analysis of the economic benefits of

moving toward a balanced budget in 2002 (see Appendix B). That analysis includes estimates of the

revenue increases and net interest savings that would

result over the next seven years from the economic

improvements.

CBOfs Reestimate of the

President^ Budgetary

Proposals

CBO estimates that under the President's policies the

deficit would increase from $177 billion in 1995 to

$276 billion in 2000, or from 2.5 percent of gross

domestic product (GDP) to 3.1 percent (see Table 1).

CBO estimates that total outlays under the President's

policies would grow at an average annual rate of almost 5 percent over the next five years-from $1,532

billion in 1995 to $1,954 billion in 2000. Revenues

would grow a little more slowly, about 4.4 percent a

year on average, and would increase from $1,355

billion in 1995 to $1,678 billion in 2000.

CBO's estimates of the deficits for 1996 through

2000 under the President's policies are higher than

those projected by the Administration, which anticipates that the deficit will be essentially the same in
2 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table 1.

CBO's Budgetary Estimates Under the President's Policies (By fiscal year)

Debt Held by the Public

Memorandum:

Gross Domestic Product

Actual

1994 1995 1996 1997 1998

3,432

6,632

3,622

7,036

3,851

7,370

4,109

7,747

4,372

1999

8,152 8,572

2000

Revenues

On-budget

Off-budget

Outlays

On-budget

Off-budget

Deficit

On-budget deficit

Off-budget surplus

In

1,258

923

335

1,461

1,182

279

203

259

56

Billions of Dollars

1,355

998

357

1,532

1,244

289

177

246

69

1,416

1,041

375

1,626

1,324

303

211

283

72

1,464

1,072

392

1,696

1,383

313

232

311

79

1,534

1,122

411

1,765

1,439

326

231

316

85

1,604

1,173

431

1,860

1,517

342

256

344

89

1,678

1,226

452

1,954

1,598

356

276

372

96

4,658 4,965

9,013

As a Percentage of GDP

Revenues

On-budget

Off-budget

Outlays

On-budget

Off-budget

Deficit

On-budget deficit

Off-budget surplus

Debt Held by the Public

19.0

13.9

5.1

22.0

17.8

4.2

3.1

3.9

0.8

51.7

19.3

14.2

5.1

21.8

17.7

4.1

2.5

3.5

1.0

51.5

19.2

14.1

5.1

22.1

18.0

4.1

2.9

3.8

1.0

52.3

18.9

13.8

5.1

21.9

17.9

4.0

3.0

4.0

1.0

53.0

18.8

13.8

5.0

21.7

17.6

4.0

2.8

3.9

1.0

53.6

18.7

13.7

5.0

21.7

17.7

4.0

3.0

4.0

1.0

54.3

18.6

13.6

5.0

21.7

17.7

4.0

3.1

4.1

1.1

55.1

SOURCE: Congressional Budget Office.
CHAPTER ONE SUMMARY AND INTRODUCTION 3

2000 as in 1995 (see Table 2). For 1995, however,

CBO expects that the deficit will be lower than anticipated by the Administration. Most of CBO's reestimate of the deficits reflects differences between

its and the Administration's projections of the revenues and outlays that would occur under current laws

and policies. CBO separates its reestimates of the

Administration's budget into two categories: those

that result from differences in economic assumptions

and those that result from technical estimating differences. For 2000, economic and technical reestimates

are almost equally responsible for the $82 billion difference between CBO's estimate of the deficit under

the President's policies and the Administration's estimate.

Economic Reestimates

The economic assumptions of CBO and the Administration appear quite similar. Yet the differences are

sufficient to produce noticeable differences in budget

projections. CBO's economic assumptions lower the

projected deficits for 1995 and 1996 compared with

the Administration's assumptions but raise the deficits thereafter. Although it assumes lower growth for

the current year, the Administration foresees faster

economic growth on average between now and 2000.

It projects roughly the same rate of inflation as CBO

and a marginally lower rate of unemployment after

1997.

In addition, the Administration forecasts somewhat higher interest rates than does CBO. The Administration and CBO (as well as the consensus of

private-sector economists reflected in the Blue Chip

survey) assume that the tightening of monetary policy over the past year will cause economic growth to

slow from its pace of 1994. The forecasts differ

somewhat, however, in the timing and degree of the

slowdown. CBO (and the Blue Chip survey) anticipate significantly faster growth this year than next.

The Administration assumes a smoother path with

real (inflation-adjusted) growth of about 2!/2 percent

in both 1995 and 1996.

Differences between CBO's economic forecast

and that of the Administration push down CBO's projected revenues by more than $40 billion in 2000

compared with the Administration's estimates.

CBO's lower projections of corporate profits reduce

revenues in every year compared with the Administration's projections. CBO also projects lower imports than does the Administration, and the resulting

lower estimate of customs duties holds CBO's estimate of other revenues below the Administration's in

every year but 1995. CBO projects higher individual

income than the Administration does through 1998

but lower income in 1999 and 2000. In 1995 and

1996, the higher individual income tax and social

insurance receipts resulting from CBO's forecast for

individual income more than offset the revenue effects of the other aspects of CBO's economic forecast. From 1997 on, however, CBO's economic forecast reduces revenues compared with the Administration's forecast.

CBO's economic assumptions also reduce its projection of spending compared with that of the Administration but by far less than the reduction in revenues. CBO's lower unemployment forecast pushes

down its estimate of unemployment benefit payments

by $1 billion in 1995 and 1996. But after that, less

than $500 million of the difference between CBO's

and the Administration's projections of unemployment costs in any year is the result of differences in

economic assumptions. Because it projects a more

rapid increase in the consumer price index, CBO estimates that the costs of other benefit programs (Social

Security and other programs with automatic cost-ofliving adjustments) will be higher. CBO's projection

of interest payments is below the Administration's,

since CBO assumes lower interest rates.

Technical Reestimates

Estimating differences unrelated to economic assumptions add to CBO's estimates of the deficits under the President's budgetary policies compared with

the Administration's estimates over the 1996-2000

period. Excluding economic differences, CBO's projection of revenues in 2000 is about $8 billion higher

than the Administration's, but CBO's projection of

spending is $50 billion higher. Nearly half of the

difference in projected spending can be found in the

Medicare and Medicaid programs. Although CBO

believes that the growth of those programs has
4 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table 2.

CBO's Reestimates of the President's Budgetary Proposals (By fiscal year, in billions of dollars)

Deficit Under the President's Budgetary

Proposals as Estimated by the Administration

Economic Reestimates

Revenues3

Individual income and social insurance taxes

Corporate profits taxes

Other

Subtotal

Outlays

Unemployment compensation

Other benefit programs

Net interest

Other

Subtotal

Total, economic reestimates

Technical Reestimates

Revenues3

Individual income and social insurance taxes

Corporate profits taxes

Other

Subtotal

Outlays

Medicaid

Medicare

FCC spectrum auctions

Unemployment compensation

Housing assistance

Deposit insurance

Net interest

Other

Subtotal

Total, technical reestimates

Total Reestimates

Deficit Under the President's Budgetary

Proposals as Estimated by CBO

1995

193

-15

3

_b

-13

-1

b

b

_b

-1

-13

b

-1

4

4

1

4

-5

1

b

-3

1

-3

-6

-2

-16

177

1996

197

-13

8

1

-4

-1

b

1

b

b

-4

3

-2

_2

4

3

4

3

1

1

-1

2

_L

15

18

14

211

1997

213

-9

13

4

8

b

1

-3

b

-2

5

1

-2

2

b

5

6

1

1

2

-3

4

j£

14

14

19

232

1998

196

-4

14

_z

17

b

2

-7

_b

-5

12

-1

-3

_2

-2

7

7

2

2

5

-6

5

_3

25

23

35

231

1999

197

4

17

9

29

b

3

-7

_b

-4

25

-6

-5

_2

-8

10

9

b

2

9

-2

6

J

41

33

58

256

2000

194

7

22

11

41

b

5

-6

b

-1

40

-7

-5

4

-8

12

11

-1

3

10

1

8

_7

50

42

82

276

SOURCES: Congressional Budget Office; Joint Committee on Taxation.

NOTE: FCC = Federal Communications Commission.

a. Revenue reductions are shown as positive because they increase the deficit.

b. Less than $500 million.
CHAPTER ONE SUMMARY AND INTRODUCTION 5

slowed from the extremely high rates of recent years,

it is not quite as optimistic as the Administration

about the slowdown. Given the size of those two

programs and the uncertainty about their future costs,

the projections of CBO and the Administration are

not very far apart.

CBO and the Administration differ in their assumptions about the timing of proceeds from auctioning portions of the electromagnetic spectrum by

the Federal Communications Commission. In estimating spending for unemployment compensation,

CBO assumes that average benefits will be higher

than the Administration projects. CBO's reestimate

of net outlays by deposit insurance agencies reflects

both its more optimistic outlook about future failures

of banks and thrift institutions and its higher estimate

of proceeds from the sale of assets acquired by the

government as a result of previous thrift failures.

Another difference between CBO and the Administration is in the estimates of discretionary spending

for housing assistance programs. However, the Department of Housing and Urban Development is in

the process of revising and updating the Administration's assisted housing proposals, which may significantly reduce the difference between CBO's and the

Administration's estimates in this area. The difference in projected net interest costs primarily reflects

the debt service on the increase in the projected deficits that result from other technical reestimates.

CBOfs Estimate of the Effects

of the President^ Budgetary

Proposals

CBO estimates that enacting the President's budgetary proposals would not significantly change the deficits from the levels it projects under current laws

and policies (see Table 3). The President's proposed

changes in nondiscretionary spending and revenues

would increase the deficit by almost $40 billion over

the 1995-2000 period, but the discretionary appropriations proposed in the budget are below CBO's projections of discretionary spending under current policies. How much of a reduction the discretionary proposals represent—as well as CBO's estimate of the net

effect on the deficits of all of the President's policies-depends on assumptions about discretionary

spending in 1999 and 2000.

The President has proposed tax measures that

would shrink revenues by almost $60 billion over the

1995-2000 period and by $20 billion in 2000. Proposed savings in Medicare (stemming primarily from

extending provisions of the Omnibus Budget Reconciliation Act of 1993 that expire at the end of 1998)

and other mandatory programs offset only about $17

billion of the revenue loss over the six-year period

and $8 billion of the loss in 2000. The President has

also proposed to sell assets that CBO estimates

would produce almost $8 billion in income. Other

proposals would increase nondiscretionary spending

(other than net interest) by almost $4 billion.

Assessing the change in the deficit that can be

attributed to the President's discretionary spending

proposals is not so straightforward because proposed

discretionary spending can be measured against two

different baselines. The two baselines are the same

through 1998: both include CBO's estimate of discretionary spending in 1995 from already enacted appropriations, and both assume that discretionary spending for 1996 through 1998 will equal the statutory

limits on such spending contained in the Balanced

Budget and Emergency Deficit Control Act of 1985

(the Balanced Budget Act). After 1998-the last year

that the statutory limits are in effect-one baseline

assumes that discretionary spending equals the 1998

limit adjusted for inflation. The other assumes that

there is no adjustment for inflation after 1998-in

other words, that discretionary spending in 1999 and

2000 will be the same in nominal terms as in 1998.

According to CBO's estimates, the President's

proposals would result in discretionary spending that

ranges from $550 billion in 1995 to $561 billion in

2000. Compared with CBO's baseline with discretionary inflation after 1998, the President's proposals

would reduce discretionary spending by $67 billion

in 1995 through 2000, with most of the reductions in

the last two years. Those savings more than offset

the deficit increases that result from the President's

revenue and mandatory spending proposals and produce net deficit reduction of almost $30 billion in the

1995-2000 period. Compared with CBO's baseline

without discretionary inflation, the President's pro-
6 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table 3.

CBO's Estimates of the President's

Changes from

CBO's Baseline Deficit With

Discretionary Inflation After 1998a

President's Budgetary Proposals

Pay-as-you-go

Revenues6

Outlays

Subtotal

Asset salesd

Discretionary appropriations

Other outlays

Debt service

Total Changes

Deficit Under the President's Budgetary

Proposals as Estimated by CBO

Budgetary Proposals (By fiscal

1995

CBO's Baseline With

175

c

_Q

c

0

2

c

_c

2

177

1996

Discretionary

210

2

c

2

-1

-1

c

_c

1

211

year, in billions of dollars)

1997 1998 1999 2000

Inflation After 1998

230

11

^1

10

-4

-5

c

_c

2

232

Changes from CBO's Baseline Without Discretionary Inflation

CBO's Baseline Deficit Without

Discretionary Inflation After 1998e

President's Budgetary Proposals

Pay-as-you-go

Revenues'3

Outlays

Subtotal

Asset salesd

Discretionary appropriations

Other outlays

Debt service

Total Changes

Deficit Under the President's Budgetary

Proposals as Estimated by CBO

175

c

_Q

c

0

2

c

_c

2

177

210

2

_c

2

-1

-1

c

_c

1

211

230

11

-1

10

-4

-5

c

_c

2

232

232

13

^2

11

-3

-9

1

_c

-1

231

After 1998

232

13

-2

11

-3

-9

1

_c

-1

231

266

15

-5

9

0

-21

1

_c

-11

256

247

15

-5

9

0

-2

1

J.

9

256

299

20

-8

11

0

-34

1

^2

-23

276

258

20

-8

11

0

4

1

2

18

276

SOURCES: Congressional Budget Office; Joint Committee on Taxation.

a. Projections assume discretionary spending is equal to the spending limits that are in effect through 1998 and is equal to the 1998 limit

adjusted for inflation after that.

b. Revenue reductions are shown as positive because they increase the deficit.

c. Less than $500 million.

d. Under current law, proceeds from asset sales are not counted for purposes of the Congressional Budget Act or the Balanced Budget and

Emergency Deficit Control Act enforcement procedures. The President has proposed that the proceeds from the sales in his budget should

be counted for those purposes.

e. Projections assume discretionary spending is equal to the spending limits that are in effect through 1998 and is equal to the 1998 limit after

that.
CHAPTER ONE SUMMARY AND INTRODUCTION 7

posals would reduce discretionary spending over

those six years by only about $10 billion. Because

those cuts are not enough to offset the increases in

the deficit resulting from other proposals, the deficits

under the President's policies represent an increase of

about $31 billion in 1995 through 2000 compared

with the deficits projected in this baseline.

CBO estimates that the President's mandatory

spending and revenue proposals would add more than

$22 billion in deficit increases to the pay-as-you-go

scorecard in 1995 through 1998 (the pay-as-you-go

procedures of the Balanced Budget Act are scheduled

to expire after 1998). The President has recommended disposing of assets that CBO estimates

would sell for nearly $8 billion. Under current law,

those proceeds would not count for pay-as-you-go

purposes, but the President has proposed that the law

be changed to allow the asset sales to be counted.

In addition, the Administration asserts that a proposed reduction in the discretionary spending limits

(to the levels of discretionary spending in the President's budget) should be counted as pay-as-you-go

savings. Based on CBO's estimates, total nonemergency discretionary spending proposed by the President is $20 billion below the current limits for 1996

through 1998. CBO believes, however, that the current budget enforcement process reflects a clear decision by lawmakers that discretionary spending should

be subject to different budgetary control mechanisms

than would be applied to mandatory spending and

receipts. Therefore, in CBO's view, reductions in the

discretionary spending limits cannot be included in

the pay-as-you-go scorecard without a change in law.

Most of the supposed savings in discretionary

spending result from an increase in the discretionary

appropriation limits made by the Office of Management and Budget (OMB) in the sequestration preview

report included in the President's budget. OMB interpreted a provision of the Omnibus Budget Reconciliation Act of 1993 as allowing a new method of

calculating the required adjustment to the limits for

changes in inflation. Instead of continuing to adjust

the limits for the difference between actual inflation

experienced in the most recently completed fiscal

year (1994 in this instance) and the inflation anticipated for that year when the limits were set, OMB

adjusted for the differences between its current forecast of inflation for 1996, 1997, and 1998 and the

inflation forecast for those years when the limits

were set.

CBO estimates that the change in method increased the limits by almost $16 billion in 1996

through 1998. Although CBO believes that OMB's

interpretation of the law is incorrect, CBO will continue to use OMB's limits in its baseline budget projections. Therefore, CBO's estimates of the President's budget show savings in discretionary spending

compared with OMB's official estimate of the limits

through 1998. CBO's estimated savings in discretionary spending after 1998 also reflect the higher

OMB limits because CBO's baseline projections of

discretionary spending in those years take the 1998

limit as their starting point. If CBO had not adjusted

its baseline estimates of discretionary spending to

conform to OMB's official limits, CBO's estimate of

discretionary savings proposed in the President's budget would have been significantly smaller. Moreover, CBO's estimate of the overall effect of the President's policies would have shown an increase in total

deficits over the 1995-2000 period, even when compared with CBO's baseline that includes discretionary

inflation after 1998.

Chapter Two

Comparison of Economic Forecasts

T

he economic assumptions of the Clinton

Administration and the Congressional Budget

Office are similar. The differences, however,

are sufficient to raise the Administration's projections

of the deficit for 1995 and 1996 slightly above CBO's

and to lower them for 1997 through 2000. The Administration foresees slower growth for 1995 but

faster growth on average between 1996 and 2000. It

also projects roughly the same rate of inflation overall, a marginally lower rate of unemployment, and

higher interest rates. In addition, the Administration's forecast for the share of gross domestic product

subject to taxation is slightly lower than CBO's for

the near term but is higher for 1997 through 2000.

The Administration's economic assumptions incorporate the effects of its 1996 budget proposal,

whereas CBO's forecast and projections are based on

current law. The Administration's budget does not

differ greatly from current law, however, as far as its

effect on the overall economy is concerned, so the

difference in assumptions about fiscal policy is not a

cause of differences in the economic assumptions.

The Short-Term Outlook,

1995-1996

The differences between the Administration's and

CBO's forecasts do not affect the short-term deficit

outlook significantly. The Administration assumes,

as do CBO and economists generally, that the economy is at a high rate of resource use and that inflationary pressures are building. Furthermore, CBO,

the Administration, and a consensus of private-sector

economists reflected in the Blue Chip Economic Indicators all expect that the tightening of monetary policy over the past year will ultimately cause the economy to cool. The three forecasts differ, however, in

the timing and degree of the slowdown. CBO and

the Blue Chip anticipate about 3 percent growth in

1995 and significant slowing next year, although

CBO is more pessimistic than the Blue Chip for

1996. In contrast, the Administration assumes less

growth this year and little further slowing in 1996

(see Table 4).

Other differences among the three short-term

forecasts are also slight. The Blue Chip foresees

higher inflation in 1996 than do the other two and,

consequently, higher interest rates as well. The Administration's forecast for inflation and interest rates

is similar to CBO's.

The Outlook for the Projection

Period, 1997-2000

The Administration expects faster growth on average,

a different pattern of price change, and higher interest rates than does CBO for 1997 through 2000. The

average growth of real GDP is 0.2 percentage points

per year greater than CBO's. Both the Administration and CBO assume an average unemployment

rate of just below 6 percent for the period. The implicit GDP deflator grows faster in the Administration's outlook than in CBO's by about 0.2 percentage

points, but CBO's projections for inflation as measured by the consumer price index (CPI) are higher
10 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

by about 0.2 percentage points. Finally, the Administration projects higher nominal interest rates.

The Administration is generally closer than CBO

to the Blue Chip's long-range projections. The Blue

Chip indicates the same average growth over the

1997-2000 period as the Administration and has similar projections for interest rates and the GDP deflator. Only in its projections for the CPI is the Blue

Chip significantly closer to CBO's projection than to

the Administration's.

Real Growth

Real growth over the 1997-2000 period averages 2.5

percent in the Administration's projection, compared

with 2.3 percent in CBO's. A useful way to compare

Table 4.

Comparison of Congressional Budget Office, Administration, and Blue Chip Economic Projections,

Calendar Years 1994-2000

Actual

1994

Forecast

1995 1996 1997

Projected

1998 1999 2000

Nominal GDP (Billions of dollars)

CBO 6,735 7,127 7,456 7,847 8,256 8,680 9,128

Administration 6,735 7,117 7,507 7,921 8,361 8,832 9,310

Real GDPa

(Percentage change, year over year)

CBO 4.0 3.1 1.8 2.4 2.3 2.3 2.3

Administration 4.0 2.8 2.5 2.5 2.5 2.5 2.5

Blue Chip 4.0 3.2 2.2 2.0 2.3 2.9 2.8

GDP Deflator (Percentage change)

CBO 2.1 2.6 2.8 2.8 2.8 2.8 2.8

Administration 2.1 2.8 3.0 3.0 3.0 3.0 3.0

Blue Chip 2.1 2.6 3.2 3.3 3.1 3.0 3.0

Consumer Price lndexb

(Percentage change, year over year)

CBO 2.6 3.1 3.4 3.4 3.4 3.4 3.4

Administration 2.6 3.1 3.2 3.2 3.2 3.1 3.1

Blue Chip 2.6 3.2 3.6 3.4 3.4 3.4 3.4

Civilian Unemployment Rate (Percent)

CBO 6.1 5.5 5.7 5.8 5.9 6.0 6.0

Administration 6.1 5.8 5.9 5.8 5.8 5.8 5.8

Blue Chip 6.1 5.5 5.7 6.0 6.2 6.0 5.8

——————————————————————______— _ ____________________————————————————————————————————————————_——___„_________.„ _

(Continued)

SOURCES: Congressional Budget Office; Office of Management and Budget; Eggert Economic Enterprises, Inc., Blue Chip Economic

Indicators (March 10, 1995).

NOTE: GDP = gross domestic product.
CHAPTER TWO COMPARISON OF ECONOMIC FORECASTS 11

projections is to look at the growth of nonfarm business GDP, which excludes the output of farms, government workers, and housing services. That measure of output, which is projected to grow slightly

faster than total GDP, can be broken down into two

categories: the growth in total hours worked and the

growth in labor productivity. The Administration's

projection of nonfarm business GDP is slightly

greater than CBO's because the Administration has a

slightly more optimistic view of both the future

growth in hours worked (1.4 percent a year compared

with CBO's 1.3 percent) and the growth in labor productivity (also 1.4 percent versus 1.3 percent).

Given the large changes in the growth of hours

worked and labor productivity since the late 1950s,

the differences between the Administration's and

CBO's projections are small. Hours worked rose at

Table 4.

Continued

Three-Month Treasury Bill Rate (Percent)0

CBO

Administration

Blue Chip

Ten-Year Treasury Note Rate (Percent)

CBO

Administration

Blue Chip"

Nominal Income (Percentage of GDP)

Wage and salary disbursements

CBO

Administration

Other personal income8

CBO

Administration

Corporate profits'

CBO

Administration

Actual

1994

4.2

4.2

4.2

7.1

7.1

7.1

48.7

48.7

36.0

36.0

7.8

7.8

Forecast

1995

6.2

5.9

6.1

7.7

7.9

7.6

48.8

48.2

36.4

36.4

7.5

7.6

1996

5.7

5.5

6.1

7.0

7.2

7.4

48.9

48.1

36.9

36.7

7.2

7.6

1997

5.3

5.5

5.5

6.7

7.0

7.2

48.8

48.0

37.2

37.0

7.1

7.6

Projected

1998

5.1

5.5

5.3

6.7

7.0

7.1

48.7

47.9

37.6

37.4

7.0

7.5

1999

5.1

5.5

5.2

6.7

7.0

7.0

48.6

47.8

38.0

37.7

6.9

7.5

2000

5.1

5.5

5.4

6.7

7.0

7.2

48.5

47.7

38.4

38.0

6.8

7.7

a. Based on 1987 dollars.

b. Consumer price index for all urban consumers (CPI-U).

c. The Blue Chip projects the secondary market rate for three-month Treasury bills; CBO and the Administration project the auction average

rate.

d. The Blue Chip does not project a 10-year note rate. The values shown here are based on the Blue Chip projection of the Aaa bond rate,

adjusted by CBO to reflect the estimated spread between Aaa bonds and 10-year Treasury notes.

e. Personal income less wage and salary disbursements.

f. Corporate profits reported are book, not economic, profits.
12 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

an annual rate of 2.3 percent between 1959 and 1969,

1.9 percent between 1969 and 1979, and 1.7 percent

between 1979 and 1988. The decline continued in

the 1988-1994 period-hours worked rose just 1.1

percent. The slowing of growth since the mid-1970s

stems largely from the smaller increase in the size of

the working-age population (down from 2.1 percent a

year during the 1970s to about 1.0 percent in recent

years). Growth in hours worked also eased because

of a slowdown in the growth of labor force participation rates (that is, the percentage of the working-age

population that is working or seeking work). The

causes of that slowdown, particularly in recent years,

are not well understood, raising the level of uncertainty about projections of growth in hours worked.

Many forecasters anticipate a gentle rebound in participation rates during the last half of the 1990s that

will result in a slight increase in the growth of hours

worked. CBO's assumption that hours worked will

rise to 1.3 percent and the Administration's assumption of 1.4 percent are both close to the consensus

opinion.

The growth of labor productivity has also fallen--

from 2.4 percent during the 1960s, to 1.3 percent during the 1970s, to 1.0 percent between 1979 and 1987.

Growth between 1987 and 1994 is currently reported

as 1.2 percent, although recent data on labor productivity are subject to revision. Both the Administration and CBO anticipate a slight pickup in productivity growth, largely because of the high rates of investment in recent years. With the rapid growth in

the available stock of equipment and technology, the

productivity of labor is likely to accelerate moderately. As with growth in hours worked, projections

of increases in productivity are subject to great uncertainty. Given that uncertainty, the differences between CBO's and the Administration's assumptions

are not large.

Inflation

The Administration projects somewhat lower inflation than CBO, as measured by the growth of the

consumer price index, although the difference is only

0.2 or 0.3 percentage points. Such a small difference

in inflation would not normally create any significant

difference in projections of the deficit, since it would

affect items on the revenue and outlay sides of the

budget in a roughly offsetting way.

The comparison is clouded, however, because

CBO and the Administration differ in their projections of the growth of the CPI, which affects indexed

programs and tax brackets, relative to that of the

GDP deflator, which affects estimates of taxable income. CBO assumes that the CPI will grow significantly faster than the deflator from 1997 through

2000, whereas the Administration assumes only

slightly faster growth. Projections of federal outlays

are heavily affected by changes in the CPI because it

is the index for programs such as Social Security,

Supplemental Security Income, and Military and

Civil Service Retirement. Projections of federal revenues, however, are affected by changes in the deflator, since the growth in taxable income overall is

closely related to the growth in nominal GDP. The

Administration's projections indicate that the CPI

will grow only about 0.2 percentage points faster

than the deflator, whereas CBO anticipates a difference of 0.6 percentage points.

The historical evidence implies that the difference in the growth rates of the CPI and the GDP deflator will be larger than that projected by the Administration. Between 1987 and 1994, the CPI increased an average of 0.5 percentage points a year

faster than the GDP deflator. The two measures of

price changes differ over the long run primarily because of the way computer prices affect them. Computers constitute a much bigger share of GDP than of

the basket of goods used to calculate the CPI, and the

continued decline in their prices will dampen the

growth of the GDP measure of price far more than

that of the CPI. Furthermore, computer expenditures

are projected to grow as a share of GDP. The weight

of computers in the GDP deflator increases with their

share of GDP, whereas the weight of computers in

the CPI will continue to be small.

Although computers are the primary cause of the

difference in the growth rates of inflation, the measures differ for other reasons as well. One major offset to the effect of computer prices on the relative

growth of the CPI and the deflator is medical care.

The price of medical care, which is weighted more

heavily in the deflator than in the CPI, has risen
CHAPTER TWO COMPARISON OF ECONOMIC FORECASTS 13

faster than the CPI on average over the past 10 years,

a trend that is expected to continue. Other sectors,

however, reinforce the effect that computers have on

the spread between the growth of the CPI and the

deflator. Prices of business equipment excluding

computers and residential and business structures,

which are not included in the CPI, have been increasing much more slowly than the CPI. On balance, the

recent trends in those sectors also indicate that the

CPI will grow about 0.6 percentage points faster than

the GDP deflator over the next several years.

Several revisions in the CPI that the Bureau of

Labor Statistics has recently completed or intends to

carry out in the next few years would probably slow

the growth of that measure. Most of those revisions,

however, would also apply to the GDP deflator and

thus would not significantly affect the difference between the indexes. In 1998, the Bureau of Labor Statistics will update the weights in the CPI, and that

will probably slow the growth of the CPI relative to

that of the GDP deflator. But the slowing is unlikely

to be large enough to offset the other factors, such as

the decline in computer prices, that drive a wedge

between those indexes.

Interest Rates

The projections of CBO and the Administration differ only a little on interest rates in the short term, but

more noticeable differences emerge in later years.

After 1996, both short-term and long-term nominal

interest rates are higher in the Administration's projections than in CBO's. Judged against the projections of the CPI, the Administration's rates are also

significantly higher than CBO's. Using CBO's projections of inflation-adjusted interest rates rather than

the Administration's would reduce projected deficits

for the 1997-2000 period.

The Administration projects that the inflationadjusted interest rate on three-month Treasury bills

will average about 2.3 percent after 1996, compared

with 1.7 percent for CBO. The Blue Chip's longrange projection of 2.0 percent lies between those

two forecasts. All three sets of projections of real

short-term interest rates are substantially higher than

the rates that prevailed during the most recent recession and the early years of the expansion. The projected rates reflect the small amount of capacity currently available for further economic expansion; they

fall within the range of the real rates that prevailed in

the late 1980s. The Administration's projections of

real long-term rates are higher than CBO's by about

the same margin as the short-term rates (roughly 0.6

percentage points).

Share of National Income

Subject to Taxation

Estimates of future deficits are affected by the projected distribution of total gross domestic product

among various income categories, as well as by the

overall size of GDP. Some of those categories-such

as corporate profits, wages and salaries, and dividends-are taxable income. A projection that assumes a larger share of GDP for income categories

that are taxed at relatively high rates would generate

a larger revenue estimate than a projection that assumed a smaller share for such categories. Corporate

profits and wages and salaries are taxed at the highest

effective marginal rates. (The effective marginal tax

rate on a given component of income represents the

amount of additional tax collected from each additional dollar of income.) Dividends and interest are

taxed at a lower effective rate because they are not

subject to payroll taxes and some of them are received by tax-exempt entities. Compliance problems

reduce the effective tax rate on the income of proprietors.

The Administration's projections of these various

income shares reduces estimates of future deficits in

the longer term but result in forecasts of deficits for

1995 and 1996 that are higher than CBO's. The Administration's projection of the wage and salary share

of GDP is lower than CBO's throughout the 1995-

2000 period and the corporate profits share is higher

(see Table 4). The Administration's projections of

these income shares, together with its projections of

the shares of other categories of taxable income (not

shown separately in Table 4), result in lower revenues over the next two years in comparison with

CBO's projections but higher revenues thereafter.
14 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

The Administration's assumption of the share of

total taxable income for 2000 is close to the average

of the past 20 years, whereas CBO assumes the taxable share will gradually fall. The decline in the

CBO projection stems in part from the assumed increase in the share of labor compensation that is not

subject to tax, specifically medical care benefits (the

employer's share of medical care insurance premiums is a significant part of the compensation to

workers, but it is not taxable income). CBO also assumes that dividend income will account for a

smaller share of gross domestic product in 2000 than

it has recently. This projection is tied to that of the

corporate profit share, which has been abnormally

high for over two years and is likely to decline over

the projection period.
Chapter Three

The Administration's Spending Proposals

T

he Congressional Budget Office estimates

that total federal spending under the policies

proposed in the President's budget would

grow from $1,532 billion in 1995 to $1,954 billion in

2000 (see Table 5). As a percentage of gross domestic product, total annual spending would hardly

change at all. It would hover just under 22 percent of

GDP throughout the 1995-2000 period. The President's proposals for discretionary spending are responsible for the restrained growth in total spending.

Total nondiscretionary outlays other than net interest

would grow from 10.6 percent of GDP in 1995 to 12

percent in 2000, and spending for net interest would

increase slightly as a percentage of GDP over that

period. Under the President's policies, however, total

discretionary spending would increase by only $11

billion from 1995 to 2000 and shrink from 7.8 percent of GDP in 1995 to 6.2 percent in 2000.

under the Balanced Budget Act total $8 billion in

2000 and almost $17 billion over the 1996-2000 period (see Table 6). The Administration assumes the

savings from those policies would be almost $3 billion higher over the five years. (Because the pay-asyou-go procedures are scheduled to expire at the end

of 1998, only the savings for 1996 through 1998-

which total about $3.5 billion--would actually be recorded on the scorecard under current law.) Savings

in the Medicare program account for more than $6

billion of the savings in 2000 and $11 billion of the

five-year total. Those savings are achieved by extending provisions of law enacted in the Omnibus

Budget Reconciliation Act of 1993 (OBRA-93) that

are scheduled to expire at the end of 1998. Almost

$4 billion of the savings in 2000 comes from extending the requirement that Medicare Part B premiums

paid by beneficiaries cover 25 percent of the total

costs of Part B.

Mandatory Spending

The President's policies would have little effect on

the growth of mandatory spending. CBO projects

that total nondiscretionary spending (excluding net

interest) under current laws and policies will grow at

an average annual rate of almost 8 percent over the

1995-2000 period-from $747 billion in 1995 to

$1,088 billion in 2000. Under the President's policies, the growth would be only slightly slower, and

outlays in 2000 would be only about $7 billion lower

than CBO's baseline projections.

CBO estimates that savings from mandatory

spending policies proposed by the President that

would be recorded on the pay-as-you-go scorecard

Extending provisions of OBRA-93 that are

scheduled to expire in 1998 also accounts for almost

all of the proposed $2.5 billion reduction in spending

for veterans' programs in 1996 through 2000. About

half of the $1 billion in savings in 2000 comes from

extending the limit on pensions paid to veterans receiving nursing home care paid for by Medicaid

(about half of those savings are offset by higher Medicaid costs). Extending current authority to collect

payments from commercial insurers for medical services provided by the Department of Veterans Affairs

to privately insured individuals produces an additional quarter of the total reduction in spending in

2000.

Proposed limitations on the earned income tax

credit would reduce spending for the refundable por-
16 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table 5.

CBO's Estimates of the President's Spending Proposals (By fiscal year)

Memorandum:

Gross Domestic Product

Actual

1994 1995 1996 1997 1998

6,632 7,036 7,370 7,747 8,152

1999

8,572

2000

Outlays in billions of dollars

Discretionary

Defense

International

Domestic

Subtotal

Mandatory

Deposit Insurance

Net Interest

Offsetting Receipts

Asset Sales

Total

On-budget

Off-budget

282

21

243

546

791

-8

203

-71

_Q

1,461

1,182

279

271

22

257

550

843

-16

235

-80

0

1,532

1,244

289

264

21

266

551

897

-8

261

-74

-1

1,626

1,324

303

258

21

269

548

961

-4

271

-76

-4

1,696

1,383

313

255

20

272

548

1,025

-5

281

-80

-3

1,765

1,439

326

260

20

275

555

1,096

-3

296

-84

0

1,860

1,517

342

268

19

273

561

1,174

-2

312

-91

0

1,954

1,598

356

9,013

Outlays as a Percentage of GDP

Discretionary

Defense

International

Domestic

Subtotal

Mandatory

Deposit Insurance

Net Interest

Offsetting Receipts

Asset Sales

Total

On-budget

Off-budget

4.3

0.3

_3J

8.2

11.9

-0.1

3.1

-1.1

_Q

22.0

17.8

4.2

3.9

0.3

_3,6

7.8

12.0

-0.2

3.3

-1.1

0

21.8

17.7

4.1

3.6

0.3

_3,6

7.5

12.2

-0.1

3.5

-1.0

a

22.1

18.0

4.1

3.3

0.3

_15

7.1

12.4

-0.1

3.5

-1.0

a

21.9

17.9

4.0

3.1

0.2

3.3

6.7

12.6

-0.1

3.4

-1.0

a

21.7

17.6

4.0

3.0

0.2

3.2

6.5

12.8

a

3.4

-1.0

Q

21.7

17.7

4.0

3.0

0.2

_10

6.2

13.0

a

3.5

-1.0

Q

21.7

17.7

4.0

SOURCE: Congressional Budget Office,

a. Less than 0.05 percent.
CHAPTER THREE THE ADMINISTRATION'S SPENDING PROPOSALS 17

tion of the credit (which is counted as outlays) by $2

billion in 1996 through 2000. (The proposals would

also increase revenues by more than $300 million

over that period.) The proposals would deny the

credit to families with more than $2,500 in interest

and dividend income during a year and would

tighten compliance procedures to ensure that illegal

and nonresident aliens did not receive the credit.

More than $3 billion in savings in 1996 through

2000 is attributed to the President's proposals to

speed up and complete the shift in the student loan

Table 6.

Estimates of the President's Pay-As-You-Go Spending Proposals (By fiscal year, in billions of dollars)

Medicare

Administration estimate

CBO estimate

CBO minus Administration

Accelerate Shift to Direct Student Loans

Administration estimate

CBO estimate

CBO minus Administration

Earned Income Tax Credit

Administration estimate

CBO estimate

CBO minus Administration

Veterans' Programs

Administration estimate

CBO estimate

CBO minus Administration

Other

Administration estimate

CBO estimate

CBO minus Administration

Total

Administration estimate

CBO estimate

CBO minus Administration

1995

0

_Q

0

0

0

0

0

_Q

0

0

0

0

0

0

0

0

0

0

1996

-0.1

JLL

a

-0.3

^02

0.1

a

_a

a

-0.1

-0.1

a

0.4

0.1

-0.3

-0.2

-0.3

-0.1

1997

-0.5

^5

a

-0.7

-0.7

a

-0.6

^5

0.1

-0.1

^Q/L

a

0.2

_04

0.2

-1.7

-1.3

0.4

1998

-0.7

^Q7

-0.1

-1.0

-0.9

0.1

-0.6

^0,5

0.1

-0.2

^Q/L

0.1

-0.4

0.4

0.8

-2.8

-1.8

1.0

1999

-3.1

^4

-0.3

-0.9

^Q7

0.3

-0.6

^5

0.1

-1.3

^10

0.3

-0.1

_0£

0.6

-6.1

-5.1

1.0

2000

-5.4

^2

-0.8

-1.1

-0.7

0.4

-0.7

^0,5

0.1

-1.4

_iLl

0.3

-0.1

0.3

0.4

-8.7

_£2

0.5

SOURCES: Congressional Budget Office; Joint Committee on Taxation.

NOTE: This table includes only those proposals that CBO would count for purposes of the pay-as-you-go procedures of the Balanced Budget

and Emergency Deficit Control Act of 1985. The President's budget included proceeds from proposed asset sales in its calculation of

pay-as-you-go effects. Under current law, proceeds from asset sales are not counted for purposes of the pay-as-you-go enforcement

procedures. The President has proposed that the proceeds from the sales in his budget should be counted for those purposes. The

President's budget also assumes that reductions in the statutory limits on discretionary spending can be counted as pay-as-you-go

savings. CBO believes that changes in the discretionary limits cannot be counted under current law.

a. Less than $50 million.
18 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

program from the government guaranteeing loans

made to students by private lenders to the government making the loans directly to the students. Under current law, direct student loans are required to

account for 60 percent of the total loan volume in

1998 and subsequent years. Under the President's

proposals, direct loans would fully replace guaranteed loans by 1998. Most of the estimated savings

resulting from the shift from guaranteed to direct

loans stems from the different treatment of administrative costs in the projections of the loan subsidy

costs of the two programs. Under the Credit Reform

Act of 1990, administrative costs that are paid directly by the federal government (as are most of the

costs associated with direct loan programs) are not

included in the estimated subsidy cost of a loan.

However, administrative costs that are paid by another entity (as are most of the costs associated with

guaranteed loans) are implicitly included in the calculation of the subsidy costs. Therefore, in any esti

Table 7.

Estimates of the President's Asset Sale Proposals (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000

Naval Petroleum Reserve Elk

Hills Crude Oil

Administration estimate

CBO estimate

CBO minus Administration

Federal Housing Administration

Nonperforming Notes

Administration estimate

CBO estimate

CBO minus Administration

U.S. Enrichment Corporation

Administration estimate

CBO estimate

CBO minus Administration

Power Marketing Administrations

Administration estimate

CBO estimate

CBO minus Administration

Total

Administration estimate

CBO estimate

CBO minus Administration

0

_0

0

0

_Q

0

0

_0

0

0

_Q

0

0

_Q

0

-0.1

-0.2

Q

0.2

-0.8

-0.5

0.3

-0.1

-0.1

-1.2

-0.7

0.5

-2.6

-1.5

1.1

0

J)

0

-1.1

-1.1

-0.9

-0.9

0

0

_0

0

0

_Q

0

0

J)

0

-3.5

-3.5

0

-4.6 -3.5

1.1

0

_0

0

0

J)

0

0

_Q

0

0

_Q

0

0

_Q

0

0

_Q

0

0

J)

0

0

J)

0

0

_o

0

0

_Q

0

SOURCE: Congressional Budget Office.

NOTE: The President's budget included proceeds from proposed asset sales in its calculation of pay-as-you-go effects. Under current law,

proceeds from asset sales are not counted for purposes of the pay-as-you-go enforcement procedures. The President has proposed

that the proceeds from the sales in his budget should be counted for those purposes.
CHAPTER THREE THE ADMINISTRATION'S SPENDING PROPOSALS 19

mate of savings from shifting from guaranteed loans

to direct loans, at least some administrative costs will

drop out of the calculation of the subsidies.

The President's proposals also include some

changes in mandatory spending that would not appear on the pay-as-you-go scorecard. For instance,

the President has proposed selling naval petroleum

reserves, three power marketing administrations, and

the United States Enrichment Corporation (along

with the highly enriched uranium owned by the corporation). CBO estimates that proceeds from those

proposed sales would total almost $8 billion in 1996

through 1998 (see Table 7). However, under current

law, those proceeds are not counted as deficit reduction for purposes of the pay-as-you-go procedures.

The President has proposed changing the law to allow those proceeds to be counted for those purposes.

In addition, some changes in mandatory spending

are not included on the pay-as-you-go scorecard because they do not directly result from a change in

laws governing mandatory programs. Virtually all of

the increase in spending in that category-nearly $4

billion over the 1995-2000 period-is the result of the

President's proposed pay raises for federal civilian

employees and military personnel, which are lower

than those provided in current law (see Table 8). Because almost all expenditures for pay are categorized

as discretionary, little of the direct effects of the

lower pay shows up in mandatory programs. However, the budget category of offsetting receiptswhich is considered mandatory-is affected. Federal

agencies and the armed services are required to make

payments, which are equal to a specified percentage

of pay, to the civil service and military retirement

trust funds on behalf of civilian employees and

Table 8.

Pay Raises Under CBO's Current-Law Assumptions and the President's Budget (By fiscal year, in percent)

1996 1997 1998 1999 2000

Civilian Raises3

Across-the-board raises

Locality raises5

Total

Military Raises

CBO's Estimate Under Current Law

2.4

M

5.6

3.2

-2A

5.7

3.1

TI

2.4 3.2 3.1

President's Budget Proposal

3.0

4

5.4

3.0

3.0

JLA

5.5

3.0

Civilian Raises0

Military Raises

2.4

2.4

3.1

3.1

2.1

3.1

2.1

3.1

2.1

2.1

SOURCE: Congressional Budget Office.

a. Civilian raises shown apply to General Schedule employees. That group makes up the largest portion of the federal civilian workforce.

b. CBO adjusts locality raises to account for employees who do not receive the full amount of those raises because they are already receiving

supplements to their pay.

c. The President's budget does not make any assumptions about how the total annual pay increases it proposes should be distributed between

across-the-board raises and locality raises.
20 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

military personnel. The payments received by the

trust funds are recorded as offsetting receipts, or negative outlays. The President's proposal to reduce future pay increases compared with the raises that

would occur under current law would also reduce the

amounts received by the retirement trust funds on

behalf of the employees-lowering offsetting receipts

and increasing net outlays.

Discretionary Spending

CBO has estimated that the total discretionary appropriations proposed by the President would result in

outlays that increase by only $11 billion over the next

five years-from $550 billion in 1995 to $561 billion

in 2000. That total includes both proposed anticrime

spending from the Violent Crime Reduction Trust

Fund (VCRTF) and all other, or general purpose, appropriations. Total discretionary appropriations in

2000 under the President's proposals are almost 16

percent (about $100 billion) below the level that

would be needed to keep pace with inflation, assuming enacted funding for 1995 as the starting point.

CBO estimates that the general purpose discretionary spending proposed by the President is less

than the statutory limits in 1996 through 1998 (the

limits are scheduled to expire after 1998). If one excludes spending resulting from emergency appropriations proposed in the President's budget (which

would result in an adjustment to the limits if enacted), discretionary outlays would be about $2 billion below the limit in 1996, $7 billion below the

limit in 1997, and $11 billion below the limit in

1998. The President has proposed reducing the discretionary limits for those years to the levels of discretionary spending in the budget as estimated by the

Administration. The budget also recommends extending the limits through 2000 at the levels of

spending proposed for those years.

The President's budget proposes specific appropriations from the VCRTF for 1996. The budget authority requested is only $15 million below the

$4,287 million available for appropriation from the

fund. CBO estimates that outlays will be $204 million below the $2,334 million limit on VCRTF outlays established in the Violent Crime Control and

Law Enforcement Act of 1994. The budget does not

identify specific VCRTF appropriations for 1997 and

later years but instead simply assumes that budget

authority and outlays will equal the full amount identified in the crime bill (the budget authority increases

to $6,500 million in 2000, and outlays grow to

$6,225 million).

The President has also proposed almost $11 billion in 1995 appropriations for emergency purposes.

CBO estimates that outlays from those appropriations

would equal nearly $2 billion in 1995, more than $1

billion in 1996, and $2 billion a year in 1997 through

1999. Nearly $3 billion of the requested funding

would go to the Department of Defense to offset the

costs of peacekeeping and humanitarian assistance

operations in and around Iraq, Bosnia, Haiti, Cuba,

and Korea. Somewhat less than $1 billion would be

appropriated for the U.S. share of additional costs of

United Nations peacekeeping operations. Almost all

of the remaining $7 billion of the requested emergency appropriations would go to the Federal Emergency Management Agency to meet additional costs

of the 1994 Northridge earthquake in Southern California and various other disasters in over 40 states.

The President has requested total discretionary

budget authority of $538.3 billion for 1996. Excluding the outlay effect of proposed 1995 supplemental

appropriations and rescissions (including proposed

emergency appropriations), CBO estimates that 1996

outlays resulting from the President's proposals

would total $549.4 billion. The President's proposals

do not represent a dramatic shift in priorities, but certain areas of the budget fare better than others. The

winners and losers can be determined by comparing

CBO's estimate of the discretionary appropriations

requested by the President for 1996 with its estimate

of the level of spending if 1996 appropriations for

each account were frozen (with some minor technical

adjustments in a few accounts) at the amount appropriated in 1995 (see Table 9).

In order to facilitate the comparison, CBO's

freeze has been adjusted to account for a proposed

change in the way budget authority is provided for

some transportation trust fund programs dealing with

highway, mass transit, and air transportation. Under
CHAPTER THREE THE ADMINISTRATION'S SPENDING PROPOSALS 21

the current system, the budget authority for those

programs is provided in authorizing legislation and is

considered mandatory spending. When appropriation

bills subsequently impose obligation limits that restrict the use of that budget authority, the outlays for

the programs are charged to those bills as discretionary spending. Under the President's proposals, the

budget authority would be provided in appropriation

bills instead of in the authorizing legislation. To

compare its freeze estimate accurately with the President's request for transportation appropriations,

which includes budget authority for those programs,

Table 9.

The Administration's Proposals for Discretionary Spending in Fiscal Year 1996 (In billions of dollars)

Funding at the 1995

Enacted Level as

Estimated by CBO

Budget

Authority Outlays

President's Budget

as Estimated

bv CBOa

Budget

Authority Outlays

President's Budget

Minus 1995

Enacted Level

Budget

Authority Outlays

Defense 262.9 263.6

International 20.4 21.1

Domestic

General science, space,

and technology 17.1 16.9

Energy 6.6 6.7

Natural resources and environment 21.6 21.3

Agriculture 4.0 4.0

Commerce and housing credit 3.4 3.2

Transportation0 38.4 39.1

Community and

regional development 8.8 10.4

Education, training, employment,

258.3

21.3

17.2

5.9

22.4

4.0

3.5

36.5

9.7

262.0

21.2

17.0

6.4

21.7

4.1

3.2

39.0

10.9

-4.6

0.9

0.1

-0.6

0.8

b

0.2

-1.9

0.9

-1.7

b

0.2

-0.3

0.5

b

b

-0.1

0.5

and social services

Health

Medicare

Income security

Social Security

Veterans' benefits

Administration of justice

General government

Subtotal, domestic0

Total, discretionary spending0

42.0

22.8

3.0

33.6

0

18.3

18.1

12.3

250.1

533.4

41.2

22.3

3.0

39.2

2.6

19.0

17.9

12.5

259.3

544.0

44.5

23.7

3.2

33.6

0

19.3

21.5

13.7

258.7

538.3

42.6

22.6

3.2

40.4

3.2

19.1

19.7

13.2

266.3

549.4

2.5

0.9

0.2

-0.1

0

1.0

3.4

1.4

8.6

4.9

1.4

0.3

0.2

1.2

0.6

0.2

1.8

0.7

7.0

5.4

SOURCE: Congressional Budget Office.

a. These figures exclude the effects of proposed 1995 rescissions or supplemental appropriations.

b. Less than $50 million.

c. CBO's projection of budget authority for transportation has been adjusted to reflect a proposed change in the method of providing budget

authority from the transportation trust funds for a number of programs.
22 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

CBO has increased the freeze estimate by an amount

of budget authority equivalent to the 1995 obligational authority for those transportation programs.

In total, the discretionary budget authority requested by the President for 1996 is about $5 billion,

or 1 percent, above the level of appropriations enacted for 1995. Proposed defense appropriations,

however, are nearly $5 billion (2 percent) below the

1995 level, whereas nondefense appropriations are

more than $9 billion (3 percent) higher than in 1995.

Nondefense Discretionary

The largest increase in percentage terms is in the area

of administration of justice. Under the terms of the

Violent Crime Control Act, nearly $2 billion more

can be appropriated from the Violent Crime Reduction Trust Fund for 1996 than is available in 1995.

The President's budget proposes using virtually all of

the funds available, significantly increasing spending

in the administration of justice category. Other

categories with relatively large proposed increases

over 1995 funding levels include general government

and community and regional development. About

half of the proposed $1.4 billion increase for general

government activities is for the Internal Revenue Service. The growth in community and regional development funding primarily reflects a proposed increase in appropriations for rural development programs.

The largest reduction below the 1995 appropriated level in percentage terms is in the energy area.

However, more than half of the proposed $600 million cut comes from eliminating discretionary appropriations from the Nuclear Waste Fund, which is part

of the Administration's proposal to begin funding

nuclear waste activities through a mandatory account.

The next largest reduction is in the funding requested

for transportation programs. As noted above, the

President has proposed a significant change in the

way funds from the transportation trust funds are

made available. In addition to having the spending

authority provided directly in appropriation bills, the

President has proposed a restructuring of the accounts through which the funds flow. When that restructuring is taken into account, and the 1995 appropriations are adjusted to conform to the approach of

the 1996 proposal, the President's proposal for 1996

transportation funding is $2 billion below the funding

provided in 1995.

Defense Discretionary

The President has requested $258 billion in funding

for defense programs in 1996 and about $1.3 trillion

over the 1996-2000 period. Defense appropriations

would continue to fall through 1997; the proposed

increases after that would about keep pace with inflation. The proposed defense budget would support a

force of about 1.4 million people in uniform on a

full-time basis and an additional 0.9 million part-time

or reserve personnel. Those forces would serve in 13

active Army and Marine Corps divisions, 42 reserve

brigades, 358 Navy ships (including 12 aircraft carriers), and 13 active and 7 reserve Air Force air wings.

The budget provides sufficient funding to maintain

training rates and keep equipment in good repairboth of which are necessary to ensure that the forces

are ready to fight on short notice. In order to modernize weaponry, the budget would boost procurement funding beginning in 1997, with an especially

large increase in 1998.

Last year there was concern that the President's

fiscal year 1995 budget request for defense spending

in 1996 through 1999 was not sufficient to fund the

plan put forward by the Department of Defense.

CBO attributed that potential underfunding to the

failure of the budget request to provide fully for the

general inflation assumed by the Administration, pay

raises for military and civilian personnel, growth in

the cost of weapons, base closing costs, quality-oflife improvements, and contingency operations.

The President's 1996 budget has substantially reduced the potential funding gap. The Administration

has lowered its forecast of inflation since last yearreducing the difference between the assumptions supporting the budget and those used in preparing the

Department of Defense plan. In addition, the new

budget added $10 billion in 1996-1999 funding ($25

billion through 2002) for the out-year costs of 1995
CHAPTER THREE THE ADMINISTRATION'S SPENDING PROPOSALS 23

pay raises and for other expenses such as child care,

maintenance of facilities, and purchases of munitions.

In total, however, the request for defense funding

for the 1996-1999 period is only $7 billion higher

than it was a year ago. Therefore, the reduction in

the potential underfunding has been achieved primarily by assuming lower spending in other areas of the

defense budget. For instance, plans for closing bases

have been scaled back, reducing the one-time costs

associated with those closings. More important, the

fiscal year 1996 budget includes about $28 billion

less for procurement than was requested last year.

Proposed funding for procurement in 1996 alone is

$9 billion lower than previously planned: Navy

funding for weapons has plunged by nearly $5 billion

(25 percent), Air Force funding is down by $4 billion

(18 percent), and Army funding has fallen by $1 billion (10 percent).

The Department of Defense would save about $6

billion in 1996 through 1999 by cancellations or delays in several major programs:

o The Tri-Service Standoff Attack Missile was

cancelled.

o No Comanche helicopters will be bought after

two prototypes are produced.

o Purchases of a new attack submarine, new destroyers (DDG-51s), the V-22 Osprey aircraft, an

advanced amphibious assault vehicle, and the

F-22 fighter aircraft will be stretched out over a

longer period of time than planned earlier.

Some of those changes are the result of problems

with the weapons (for instance, the failure of the TriService Standoff Attack Missile to meet specifications and stay within planned costs) or revised estimates of needs. Other changes, however, are clearly

the result of attempts to make defense plans conform

to budgetary constraints.

Chapter Four

The Administration's Revenue Proposals

T

he Congressional Budget Office estimates

that revenue would grow from $1.355 trillion

this year to $1.678 trillion in 2000 under the

policies included in the President's budget (see Table

10). As a percentage of gross domestic product, revenue is projected to fall from 19.3 percent this year to

18.6 percent in 2000. Enacting the President's proposals would reduce revenues by $2 billion in 1996

and by $20 billion, or 0.2 percent of GDP, in 2000,

but would add $0.1 billion to revenues in 1995 (see

Table 11).

The two largest proposed tax cuts~a tax credit

for dependent children and a new deduction for education and training expenses-would not be fully effective until tax returns are filed in 2000. Revenue

losses would also be limited in the early years because the proposal to expand individual retirement

accounts (IRAs) would bring in revenues if, as expected, taxpayers transfer their existing IRA funds to

the new IRAs proposed by the Administration. After

2000, revenue losses would no longer increase faster

than incomes, except for losses from the proposed

IRA, which can be expected to accelerate over time.

Under the current pay-as-you-go limits, the $60

billion of net tax reduction proposed by the Administration would have to be offset by cuts in mandatory

spending or increases in other taxes. If the Administration's revenue proposals became law without legislation offsetting the tax reduction or modifying the

pay-as-you-go rules, automatic cuts in mandatory

spending would be triggered.

The Joint Committee on Taxation (JCT) prepared

the estimates for the Administration's revenue proposals, except for those involving fees. CBO provided the estimates for fees. As a whole, the JCT and

CBO estimates are similar to the Administration's.

Tax Relief for MiddleIncome Families

The major tax initiative in the President's budget

aims to reduce taxes for middle-income families.

The Administration proposes to provide tax relief for

middle-income families through a nonrefundable tax

credit for families with young children, a deduction

for postsecondary education and training expenses,

and expanded benefits for saving through IRAs. The

JCT estimates that the three proposals together would

cost $66 billion over the next five years.

Tax Credit for Families with

Young Children

The Administration proposes a nonrefundable tax

credit for each dependent child under the age of 13.

The credit would be phased in at $300 per child for

1996, 1997, and 1998, and $500 per child in 1999

and thereafter. The credit would be applied to any

remaining tax liability after the earned income tax

credit and would be reduced for families with adjusted gross income (AGI) between $60,000 and

$75,000. Families with AGI of $75,000 or more

would not be eligible for the credit. The amount of

the credit and the phaseout range would be indexed

for inflation beginning in 2000.
26 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Few families with adjusted gross income below

$20,000 would receive the credit. Because it is nonrefundable, the credit would not be available to families that owe no federal income taxes. Few families

with income below $20,000 owe income tax once the

earned income tax credit is applied.

The JCT estimates that the Administration's proposed credit would cost $1.4 billion in 1996 and

$33.4 billion over five years (see Table 12). The annual cost of the credit would rise to $10.6 billion in

2000, by which time the full $500 credit would apply. The JCT assumes that fewer families would take

immediate advantage of the credit by adjusting their

withholding rather than realizing the benefits when

their taxes come due in the following year. That factor reduces the cost of the credit initially and when

the credit amount increases from $300 to $500 but

has little impact in later years.

Title VI of the Tax Fairness and Deficit Reduction Act of 1995 (H.R. 1215) also proposes a family

Table 10.

CBO's Estimates of Revenues Under the President's Proposals (By fiscal year)

Source 1995 1996 1997 1998 1999 2000

In Billions of Dollars

Individual Income

Corporate Income

Social Insurance

Excise

Other

Total

On-budget

Off-budget

Memorandum:

Gross Domestic Product

1,355

998

357

7,036

625

151

517

56

_6Z

1,416

1,041

375

7,370

644

156

539

57

_68

1,464

1,072

392

7,747

679

162

565

58

1,534

1,122

411

8,152

1,604

1,173

431

8,572

752

173

618

59

_75

1,678

1,226

452

9,013

As a Percentage of GDP

Individual Income

Corporate Income

Social Insurance

Excise

Other

Total

On-budget

Off-budget

8.4

2.1

7.0

0.8

-0,9

19.3

14.2

5.1

8.5

2.1

7.0

0.8

_09

19.2

14.1

5.1

8.3

2.0

7.0

0.7

-09

18.9

13.8

5.1

8.3

2.0

6.9

0.7

_QJ

18.8

13.8

5.0

8.3

2.0

6.9

0.7

_08

18.7

13.7

5.0

8.3

1.9

6.9

0.7

_08

18.6

13.6

5.0

SOURCE: Congressional Budget Office.
CHAPTER FOUR THE ADMINISTRATION'S REVENUE PROPOSALS 27

tax credit. Although the Administration's proposal

and H.R. 1215 would both provide a $500 credit for

each dependent, the two specify eligibility for the

credit in significantly different ways. The Administration's proposal would limit eligibility for the full

credit to families with AGI under $60,000; H.R. 1215

would limit it to families with AGI under $200,000

(the tax credit would phase out over a $50,000 income range for families with AGI in excess of

$200,000). The Administration's proposal would

allow a credit for each dependent child under the age

of 13; H.R. 1215 would allow a credit for each dependent child under age 18. The Administration's

proposal would not allow families to receive the

credit if the earned income tax credit (EITC) eliminated their tax liability; H.R. 1215 would allow families to claim the credit if tax liability was positive

before applying the EITC.

The family tax credit in H.R. 1215 would cost

more than the Administration's proposal (about two

and one-half times as much on an annual basis by

2000) because more families would be eligible and

the average amount received per family would be

higher. Those differences would occur because of

the higher income limit, because families with children 13 to 17 years old would qualify, and because

the credit would apply to tax liability before the

EITC.

The Administration's proposal would raise the

after-tax income of families with children by a small

amount-an average of between 1 percent and 2 percent for eligible families with income between

$20,000 and $75,000. Although additional after-tax

income could cause some parents to reduce the number of hours they worked, such small changes in

after-tax income would not lead to a significant labor

market response. Phasing out the credit for higherincome families would raise their marginal tax rates.

The approximately 3 million families who have income between $60,000 and $75,000 and who are eligible for the credit would see an increase in their

marginal tax rate of about 3 percentage points for

each eligible child once the $500 per child credit was

payable. Higher marginal tax rates are a consequence of any phaseout of benefits that is conditional

on income.

Tax Deduction for Education

and Job Training

The Administration proposes a deduction for qualified expenses for postsecondary education. TaxpayTable11.

Comparison of Revenue Estimates of the President's 1996 Budgetary Proposals

(By fiscal year, in billions of dollars)

CBO/JCT

Administration

1995

0.1

a

1996

-2.1

-3.0

1997

-11.3

-10.4

1998

-12.6

-10.9

1999

-14.5

-13.6

2000

-19.5

-18.1

1995-

2000

-59.9

-56.0

Difference 0.1 0.9 -0.9 -1.6 -0.9 -1.4 -3.9

SOURCES: Congressional Budget Office; Joint Committee on Taxation; Office of Management and Budget.

NOTE: JCT = Joint Committee on Taxation,

a. Less than $50 million.
28 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

ers would be allowed to deduct the expenses of education and training for themselves, their spouses, or

their dependents. The maximum deduction would be

$5,000 in 1996, 1997, and 1998, and $10,000 in 1999

and thereafter. The deduction would be phased out

for couples with income between $100,000 and

$120,000 and for single taxpayers with income between $70,000 and $90,000. The income phaseout

range would be indexed for inflation beginning in

2000.

The deduction would apply to adjusted gross income. Thus, in order to qualify for the new deduction, taxpayers would not need to itemize deductions

or meet the current floor of 2 percent of AGI that applies to certain deductible education and other

business-related expenses under current law.

The deduction would apply to qualified education

expenses, defined as tuition and fees directly related

to a course of studies for which an eligible student is

Table 12.

Comparison of Revenue Estimates of the President's 1996 Budgetary Proposals to Provide

Tax Relief to Middle-Income Families (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000

1995-

2000

CBO/JCT

Administration

0

0

Tax Credit for Families with Young Children

-1.4

-3.5

-7.0

-6.8

-6.9

-6.6

-7.5

-8.3

-10.6

-10.1

-33.4

-35.4

CBO/JCT

Administration3

0

0

Education and Training Tax Deduction

-1.7

-0.7

-5.0

-4.7

-6.0

-4.9

-6.7

-5.7

-7.0

-7.5

-26.4

-23.5

CBO/JCT

Administration

0

0

Expanded Individual Retirement Accounts

0.2

0.4

-0.4

-0.3

-1.0

-0.8

-1.7

-1.0

-3.4

-2.0

-6.3

-3.8

Total Tax Relief for Middle-Income Families

CBO/JCT

Administration

0

0

-2.9

-3.8

-12.5

-11.8

-13.8

-12.4

-15.9

-15.1

-21.0

-19.6

-66.1

-62.7

SOURCES: Congressional Budget Office; Joint Committee on Taxation; Office of Management and Budget.

NOTE: JCT = Joint Committee on Taxation.

a. After the budget was published, the Treasury Department issued slightly revised estimates of this provision. The revised estimates are

-$5.0 billion in 1998, -$5.8 billion in 1999, and -$7.6 billion in 2000.
CHAPTER FOUR THE ADMINISTRATION'S REVENUE PROPOSALS 29

enrolled on at least a half-time basis. The deduction

would not be allowed for expenses associated with

meals, lodging, student activities, health care, transportation, books, and other living expenses. The

amount of qualified expenses would be reduced by

any nontaxable education assistance, such as certain

scholarships and fellowships.

The Joint Committee on Taxation estimates that

the deduction would cost $26 billion over five years

and $7 billion in 2000 (see Table 12).

At current levels of enrollment, about 60 percent

of the students eligible to claim the deduction would

come from families with income of $50,000 or less.

Because students from higher-income families tend

to have higher tuition expenses on average, the 40

percent of students from families with income of

$50,000 or more would claim about 50 percent of the

total deductions.

As with all deductible expenditures, the education deduction would provide greater tax relief for

families in higher tax brackets than for those in lower

tax brackets. A $10,000 deduction would save

$2,800 in taxes for a family in the 28 percent bracket,

but $1,500 for a family in the 15 percent bracket.

The deduction would not benefit families with income too low to owe taxes, although most such families already qualify for existing federal education

assistance.

Some of the benefits from the deduction would

go to schools if they took advantage of the deduction

to raise tuition without increasing the after-tax cost to

students. Research on previous increases in federal

educational assistance has shown only a weak link

between increased aid and higher tuition levels. Because the proposed deduction would be available to

most students, however, schools could raise tuition

without making many students worse off. A significant number of schools might choose to adopt that

course.

Because the deduction would have to be taken in

the year in which educational expenses are paid, students who finance their own education with loans

would receive no tax benefits. The deduction would

do them little good while they are in school and have

little income and hence little or no tax liability, and

would not be available later when they are working

and paying back a loan. Allowing students to deduct

repayment of principal and interest later on student

loans would provide them with equal treatment but

would also add to the cost of the proposal.

Because the $10,000 deduction would be phased

out over a relatively narrow range of income, the proposal would significantly increase marginal tax rates

for eligible families who have income in that range;

for example, by 14 percentage points for a family in

the 28 percent bracket. Only families that choose to

take the deduction and have income in the phaseout

range would be affected.

Expanded Individual

Retirement Accounts

The Administration proposes to expand eligibility for

deductible individual retirement accounts, establish

new "special IRAs," and allow penalty-free withdrawals from regular IRAs for certain qualified purposes.

Extend Eligibility for Deductible IRAs. Under current law, a taxpayer may make a tax-deductible contribution to an IRA of up to a $2,000 a year. The

amount contributed cannot exceed the taxpayer's

earnings. If the taxpayer or the taxpayer's spouse is

an active participant in an employer-sponsored retirement plan, the $2,000 limit is reduced by $1 for every $5 of income in excess of $40,000 for a couple

and $25,000 for a single taxpayer. Thus, couples

with an income of $50,000 or more and singles with

an income of $35,000 or more cannot make deductible contributions. If taxpayers cannot make fully

deductible contributions because their income exceeds those limits, they can nevertheless contribute to

a nondeductible IRA.

Investment income in an IRA is tax-exempt

while it accrues. A taxpayer must include in taxable

income the full amount of withdrawals from an account (withdrawals from a nondeductible IRA are

only included in taxable income insofar as they exceed the original contributions). An additional 10

percent penalty generally applies to withdrawals

made before age 59!/2.
30 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

The Administration proposes to double the income limits for deductible contributions to $80,000

for a couple and $50,000 for a single taxpayer. The

proposal would also double the phaseout range from

$10,000 to $20,000. The income limits, the phaseout

range, and the current annual contribution limit of

$2,000 would be indexed for inflation.

Establish Special IRAs. The Administration also

proposes to establish new special IRAs. Taxpayers

who are eligible for regular deductible IRAs could

choose to contribute an amount up to the contribution

limit to either a deductible or a special IRA. Contributions to a special IRA would not be tax-deductible,

but taxpayers could withdraw contributions and earnings that remained in the account for a least five

years tax-free and with no penalties. Earnings taken

out before they had been in the account for five years

would be subject to income taxes. An additional 10

percent penalty would apply to those early withdrawals of earnings unless the money withdrawn was used

for certain purposes. Taxpayers eligible for special

IRAs could transfer balances in deductible IRAs to

special IRAs penalty-free, but those transfers would

be subject to tax. Transfers made before January 1,

1997, could be included in taxable income spread

evenly over four years.

Allow Penalty-Free Withdrawals for Certain Expenditures. The Administration proposes to allow

penalty-free withdrawals of funds from a regular IRA

as well as funds held in a special IRA less than five

years if the money is used for postsecondary education, to buy a first home, to cover living costs if unemployed, or to pay for catastrophic medical expenses (including some nursing home costs).

The Joint Committee on Taxation estimates that

the proposal to expand IRAs would cost $6.3 billion

over five years. The proposal would raise revenues

in the first year as holders of regular IRAs transfer

funds to special IRAs (and pay taxes on those transfers), and those additional revenues would offset

some of the costs through 1999. The proposal would

cost $3.4 billion by 2000 and increase in cost thereafter. Although the Administration projects that the

proposal to expand IRAs would cost somewhat less--

about $4 billion over five years-the differences in

the estimates are quite small in view of the range of

uncertainty. The projections depend on estimates of

the amount of contributions by newly eligible taxpayers, whether taxpayers will choose to contribute to

regular or special IRAs, the amount of funds that will

be transferred from existing IRAs to special IRAs,

and when people will withdraw funds from special

IRAs.

The Administration's proposal differs from the

proposal to expand IRAs in title VI of the Tax Fairness and Deficit Reduction Act. That bill would not

change existing IRAs but would create new American Dream Savings Accounts (ADSAs). As with

special IRAs, contributions (up to $2,000 per taxpayer) to an ADSA would not be tax-deductible, but

withdrawals would not be included in taxable income. If withdrawals were made before age 591/2, the

portion attributable to investment earnings would be

subject to income tax and a 10 percent penalty unless

the ADSA had been in existence for at least five

years and the withdrawals were used for higher education expenses, a first-time home purchase, or medical expenses. There would be no income limits for

eligibility to contribute to an ADSA. A taxpayer

could contribute up to $2,000 to both an ADSA and

an IRA, a total of $4,000. Taxpayers could transfer

funds from an existing deductible IRA to an ADSA.

Transfers would be penalty-free but taxable.

The new special IRAs proposed by the Administration and the American Dream Savings Accounts

are examples of back-loaded tax-favored savings accounts. They are back-loaded because contributions

are not tax-deductible when they are made but, together with accumulated earnings, are not taxable

when withdrawn from the account. By contrast, regular IRAs are front-loaded because contributions are

initially tax-deductible but, together with accumulated earnings, are taxable when withdrawn.

As long as taxpayers are in the same marginal tax

bracket when they make contributions to an IRA and

when they withdraw funds at retirement, the economic benefits of a front-loaded and a back-loaded

account are the same. For example, 40-year-old

workers in the 15 percent tax bracket who make a

$1,000 contribution to a deductible (front-loaded)

IRA will have $3,870 in their accounts at age 60 if

they earn a 7 percent annual return on their investment. After paying taxes—assuming they are still in

the 15 percent bracket-they will have $3,289 to
CHAPTER FOUR THE ADMINISTRATION'S REVENUE PROPOSALS 31

spend. If those workers chose instead to open a nondeductible (back-loaded) IRA with their $1,000, they

would have $850 to deposit in the account after paying taxes. When the workers reached the age of 60,

that investment would have grown to $3,289 and,

owing no additional taxes, they would have that

amount to spend.

Back-loaded IRAs can be more advantageous

than front-loaded IRAs when both have the same annual contribution limit. For back-loaded and frontloaded IRAs with the same contribution limit, investors can place the equivalent of more before-tax income in the back-loaded IRA. Thus, back-loaded

IRAs have higher effective limits, as taxpayers can

accumulate more retirement savings tax-free with the

back-loaded IRA.

Estimates of the cost of special IRAs and ADS As

anticipate a pickup in revenue initially as taxpayers

transfer funds from regular IRAs, pay tax on those

transfers, and deposit the after-tax proceeds in the

new accounts. Some taxpayers would be willing to

make the transfer, trading a front-loaded account for

a back-loaded account, because both special IRAs

and ADSAs offer the advantage of penalty-free withdrawals much sooner then regular IRAs. The revenue increase represents an acceleration of taxes that

would have been paid in the future and thus a corresponding revenue loss outside the five-year projection period in the budget.

In addition to the effect from accelerating future

revenues into the five-year budget period, the longterm revenue loss from special IRAs will grow over

time. Special IRAs differ from ordinary taxable accounts because earnings on contributions are not

taxed. Since it would take some time for funds to

build up in special IRAs, the revenue loss would be

small initially but would grow as funds accumulated

in those accounts. By contrast, the government loses

more revenue initially from deductible IRAs, when

taxpayers make tax-deductible contributions.

The government loses revenues from special

IRAs or regular deductible IRAs because it would

have collected taxes on annual investment earnings if

those funds were saved in ordinary taxable accounts.

If the funds contributed to IRAs come from money

that would have been spent and not saved in ordinary

taxable accounts, there is no revenue loss from IRAs.

The Administration's proposal would increase the

amount saved in IRAs, but how much of that would

be an increase in total personal saving and not a shift

of funds from taxable saving is unclear. People may

respond initially by transferring assets from other

savings to IRAs and receive the full tax benefit.

Eventually, many people will exhaust existing savings to transfer, and contributions to IRAs will come

from new saving. Whether this new saving would be

greater than the amount that people would have

saved without the additional tax incentives is also

unclear. People who had planned to save at least as

much as the contribution limit to IRAs would not

receive a tax advantage for additional saving and thus

should not be expected to increase saving. Higherincome families, the group made eligible for IRAs

under the Administration's proposals as well as for

ADSAs, are more likely to have planned to save at

least as much as the contribution limit.

For people with little other savings to transfer to

IRAs and who would have saved less than the

amount of the contribution limit, the tax advantages

of IRAs would raise the after-tax rate of return from

saving, which would encourage them to save more

than they would have otherwise, because each dollar

of saving could buy more in the future. Since the

after-tax rate of return would be higher, however,

people would have to save less in order to reach

some savings goal. The net effect could be an increase in saving, but it could also be no change or

even a decrease. The evidence on how people respond to changes in after-tax rates of return is mixed,

but most studies suggest a small increase in saving in

response to an increase in the after-tax rate of return.

IRAs are thought to promote saving in other

ways, aside from the way in which people respond to

a change in the after-tax return from saving. The penalty for early withdrawals encourages the use of

IRAs to save for retirement, making those accounts

less like other forms of saving and making it less

likely that people will use them as substitutes for

nonretirement saving. Tax deductible contributions

(front-loading) of regular deductible IRAs are

thought to encourage contributions at the expense of
32 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

current consumption because it is easier for people to

perceive the immediate benefit of the deduction~for

example, when faced with the choice between making a tax payment on April 15th or depositing their

money in an IRA and reducing their tax bill.

Special IRAs (and ADSAs) do not have those

possible added inducements for saving. They

broaden the purposes for which taxpayers can make

withdrawals free of penalties, making the accounts

more like other forms of saving and increasing the

likelihood that more contributions to the new accounts will come from transfers from other saving

instead of reduced consumption. Special IRAs (and

ADSAs) do not allow tax-deductible contributions,

but if certain conditions are met, all withdrawals will

be tax-free. Although back-loaded benefits such as

those offered by special IRAs and ADSAs are economically equivalent to those offered by regular deductible IRAs, they do not provide the psychological

inducement of an immediate reduction in taxes.

Although research and experience have produced

mixed messages about the effect of IRAs on saving,

the conclusion that IRAs increase private savings by

only a small amount cannot be ruled out. The Administration's proposals (and ADSAs) contain features that make them less likely to increase private

savings than existing IRAs. Because the revenue loss

from the proposal grows over time, if the private savings response is small the net effect may be to reduce

national savings (the sum of public and private savings) in the long run.

Table 13.

Comparison of Revenue Estimates of the President's 1996 Budgetary Proposals to Modify

Eligibility Rules for the Earned Income Tax Credit (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000

1995-

2000

CBO/JCT

Administration

Earned Income Tax Credit Compliance Proposals3

0

0

b

b

b

0.1

b

0.1

b

0.1

b

0.1

0.1

0.4

Interest and Dividend Test for Earned Income Tax Credit0

CBO/JCT

Administration

0

0

b

b

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.1

0.3

0.3

SOURCES: Congressional Budget Office; Joint Committee on Taxation; Office of Management and Budget.

NOTE: JCT = Joint Committee on Taxation.

a. Changes in outlays are included in Chapter 3. Earned income tax credit outlays would decrease by $10 million in 1996 and by $0.2 billion

per year in 1997 through 2000.

b. Less than $50 million.

c. Changes in outlays are included in Chapter 3. Earned income tax credit outlays would decrease by $13 million in 1996 and by $0.3 billion

per year in 1997 through 2000.
CHAPTER FOUR THE ADMINISTRATION'S REVENUE PROPOSALS 33

Modifying the Earned Income

Tax Credit Eligibility Rules

The Administration proposes two changes in the eligibility rules for the EITC. The first is intended to

focus the credit more sharply on families with low

earnings and little other economic resources by denying it to families with income from interest and dividends of $2,500 or more. The second proposal

would prevent individuals who are not authorized to

work in the United States from receiving the credit.

The proposals would have a small effect on revenues

(see Table 13). The main effect would be to reduce

outlays by reducing earned income tax credit refunds.

Interest and Dividend Test for

the Earned Income Tax Credit

The EITC is payable to taxpayers who have modest

amounts of income from wages or self-employment.

The amount of the credit depends on the level of

earnings and whether the taxpayer has one, two or

more, or no qualifying children. Earnings (or if

greater, adjusted gross income) above certain thresholds reduce the amount of the credit. The EITC is a

refundable credit, payable to taxpayers even if it exceeds the amount of their tax liability.

Under current law, taxpayers can receive the

earned income tax credit even though they have significant amounts of income from interest and dividends. A family with one qualifying child, for example, could receive the maximum credit even though it

had more than $5,000 in income from interest and

dividends.

The Administration proposes to deny the EITC to

taxpayers who receive more than $2,500 in annual

interest and dividend income beginning in 1996. The

$2,500 threshold would be indexed for inflation in

subsequent years.

The Administration's proposal does not allow for

a phaseout of the credit if interest and dividend income exceed the $2,500 threshold by a small amount.

Because families with interest and dividend income

just over the threshold would lose the entire credit,

they would have a strong incentive to rearrange their

assets so as to reduce their interest and dividend income below $2,500.

The Congress has already passed H.R. 831, the

Self-Employed Health Insurance Act of 1995. That

act includes a provision similar to the Administration's proposal, but would deny the EITC to taxpayers who receive interest and dividend income in excess of $2,350. The $2,350 threshold would not be

indexed for inflation.

Earned Income Tax Credit

Compliance Proposal

Under current rules, a taxpayer must live in the

United States for more than six months to be eligible

for the EITC. Beginning in 1995, nonresident aliens

are not entitled to the credit. The Administration

proposes to tighten compliance procedures so that

illegal aliens or those who do not have the proper

documentation for employment purposes would be

denied the earned income tax credit.

Other Revenue Proposals

The Administration's budget includes other revenue

proposals (see Table 14). Two proposals, aimed at

increasing the number of empowerment zones and

reducing the vaccine excise tax, would reduce revenues by a small amount. The remaining proposals

would raise revenues by tightening the rules for taxing income from foreign trusts, limiting opportunities

for tax avoidance by U.S. citizens who renounce their

citizenship, increasing bank examination fees and

fees charged under the securities laws, and reauthorizing the corporate environmental income tax

used to finance the cleanup of hazardous waste sites.

CBO estimates that those proposals together would

increase revenues by about $6 billion over the next

five years, or about $1 billion less than the amount

projected by the Administration.
34 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table 14.

Comparison of

(By fiscal year,

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT

Administration

CBO/JCT3

Administration

Memorandum:

After the budget

earlier estimates

Revenue Estimates of Other Tax Provisions in the President's 1996 Budget

in billions

1995

-0.1

-0.1

0

0

Tax

0.1

0

0.1

0

0

0

0.1

0.1

0

0

0

0

of dollars)

1996 1997 1998 1999

Increase Number of Empowerment Zones

-0.1 -0.1 -0.1

-0.1 -0.1 -0.1

Reduce Excise Tax on Certain Vaccines

-0.1 -0.1 -0.1

-0.1 -0.1 -0.1

Unrealized Capital Gains of Americans Who Renounce

0.2 0.2 0.3

0.1 0.2 0.3

Revise Taxation of Foreign Trusts

0.2 0.2 0.2

0.3 0.4 0.4

Extend Corporate Environmental Income Tax

0.3 0.5 0.5

0.3 0.5 0.5

Increase or Expand Fees Collected Under Securities

0.2 0.2 0.3

0.3 0.3 0.3

Impose Fees on State Chartered Banks

0.1 0.1 0.1

0.1 0.1 0.1

Limit Pay Raises for Federal Employees

0 0 0

-0.1 -0.2 -0.3

was published, the Treasury Department issued corrected estimates

were based

Tax

0.1

0.1

-0.1

-0.1

-0.1

-0.1

Citizenship

0.4

0.4

0.2

0.5

0.6

0.5

Laws

0.3

0.4

0.1

0.1

0

-0.4

2000

-0.2

-0.1

-0.1

-0.1

0.5

0.5

0.2

0.5

0.6

0.5

0.3

0.4

0.1

0.1

0

-0.5

of the following two

1995-

2000

-0.7

-0.7

-0.4

-0.3

1.7

1.5

1.1

2.0

2.5

2.4

1.3

1.8

0.3

0.4

0

-1.3

provisions. The

on a later effective date than the final proposal. The revised estimates are:

Unrealized Capital Gains of Americans Who Renounce Citizenship

0.2 0.3 0.4

Revise Taxation of Foreign Trusts

0.3 0.5 0.5

0.5

0.5

0.7

0.6

2.2

2.4

SOURCES: Congressional Budget Office; Joint Committee on Taxation; Office of Management and Budget.

NOTE: JCT= Joint Committee on Taxation.

a. As a result of proposals to limit future increases in federal pay, the Administration assumes a decrease in federal employee contributions to

the Civil Service Retirement System and the Federal Employees' Retirement System. Under Congressional scorekeeping rules, revenue

estimates are not adjusted for changes in discretionary appropriations.
CHAPTER FOUR THE ADMINISTRATION'S REVENUE PROPOSALS 35

Increase the Number of

Empowerment Zones

The Administration would authorize the designation

of two additional urban empowerment zones. The

Omnibus Budget Reconciliation Act of 1993 provided tax incentives for nine empowerment zones

and 95 enterprise communities. Businesses located

in an empowerment zone receive such tax advantages

as tax credits, more liberal write-off of investment

expenses, and access to subsidized borrowing.

Reduce Vaccine Excise Taxes

The Administration proposes a reduction in manufacturers1

 excise taxes on certain vaccines. Net revenues

from vaccine excise taxes are deposited in the Vaccine Injury Compensation Trust Fund and used to

compensate individuals who are injured by those vaccines. The trust fund has accumulated a large balance, and at current rates, transfers to the fund will

continue to exceed outlays. A decrease in taxes will

still allow the fund to provide compensation.

Tax Unrealized Capital Gains of

Americans Who Renounce Citizenship

By relinquishing U.S. citizenship, a U.S. taxpayer

can avoid tax on unrealized capital gains that were

earned while he or she was a citizen. The Administration proposes that when a U.S. citizen renounces

citizenship, that individual's assets will be treated as

if a transaction occurred in which all gains and losses

were realized and subject to tax. The provision

would exempt the first $600,000 in gains.

Revise Taxation of Income

from Foreign Trusts

The Administration proposes to tighten the rules for

taxing foreign trust income of U.S. taxpayers. The

proposals would strengthen reporting requirements

for U.S. taxpayers who transfer property to foreign

trusts and limit opportunities to defer or completely

avoid tax on income from such trusts. The proposals

would reduce the tax incentives to establish and

maintain foreign trusts by treating domestic and foreign trusts in a more even-handed way.

Extend Corporate Environmental

Income Tax

The Administration proposes to extend the environmental tax on corporate taxable income that is scheduled to expire on December 31, 1995. Under current

law, a tax of 0.12 percent of alternative minimum

taxable income in excess of $2 million is levied on

all corporations and deposited in the Hazardous Substance Superfund. Monies from the fund are used to

clean up hazardous waste sites.

Increase or Expand Fees Collected

Under Securities Laws

The Administration proposes a multitiered structure

of increases in fees collected under the securities

laws to fund the continuing operations of the Securities and Exchange Commission and reduce the deficit. Some of the increases would be classified as

governmental revenues and some would be offsetting

collections.

Impose Fees for Examination

of State-Chartered Banks

Depository institutions such as thrifts, credit unions,

and nationally chartered banks all pay a bank examination fee to the federal agency that supervises them.

The Administration proposes to require state-chartered banks that are not members of the Federal Reserve System to pay examination fees to the Federal

Deposit Insurance Corporation. Under the proposal,

state-chartered member banks of the Federal Reserve

System would pay examination fees to it.

Because the Federal Reserve would no longer be

required to fund the cost of bank examinations from

earnings, earnings of the Federal Reserve, which are

classified as government revenues, would increase.

Fees collected by the Federal Deposit Insurance Corporation are classified as offsetting receipts and are

not counted as part of revenues.

Appendixes

Appendix A

CBO's Baseline Budget Projections

T

hroughout this report, the Administration's

proposals are contrasted with the Congressional Budget Office's (CBO's) baseline estimates of the budget. Those estimates show the path

of revenues and spending if current laws and policies

remain unchanged. They are not forecasts of budget

outcomes, since policymakers will certainly seek to

alter current priorities. But these current-policy estimates serve as handy yardsticks for gauging the potential impact of proposed changes—those advocated

in the President's budget as well as in competing

packages.

The Baseline Concept

Baseline projections follow some general rules. Revenues and entitlement programs (like Social Security

and Medicare) continue on their course until the Congress changes the laws that underpin them-laws that

define taxable income and set tax rates, benefit formulas, eligibility, and so forth. For those categories,

therefore, the baseline represents CBO's best estimate

of what will happen in the absence of any changes to

current laws.

Discretionary programs, unlike entitlement programs, are funded anew each year through the appropriation process. Discretionary programs encompass

nearly all spending for defense and international affairs plus many domestic programs-for space, energy, highway and airport grants, environmental protection, and health research, to name just a few-as

well as the salaries and expenses of civilian agencies.

The Budget Enforcement Act of 1990 set caps on

total discretionary spending for the 1991-1995 period, and the Omnibus Budget Reconciliation Act of

1993 (OBRA-93) extended them through 1998.

CBO's baseline assumes compliance with the caps,

which, as explained below, will force trade-offs

among many competing programs. No law specifies

caps after 1998. Thus, for 1999 and 2000, CBO produces two alternative projections of discretionary

spending. One set of baseline projections preserves

discretionary spending at the same real level as in

1998, increasing it by around 3 percent a year to account for inflation. The other set of projections assumes that discretionary spending is frozen at the

1998 dollar level.

Three categories of spending remain. The federal government has pledged to protect depositors in

banks and savings and loan institutions, and the baseline for deposit insurance shows the net cost of meeting those promises. The category labeled offsetting

receipts, which encompasses Medicare insurance premiums and similar fees and collections, represents

CBO's best estimate of the amounts that the government will collect under current laws and policies.

The last category is net interest, which is driven by

market interest rates and future deficits rather than

being directly controlled by policymakers; CBO estimates such spending consistent with its projections

of those two fundamental determinants.

Baseline Projections

In January, CBO published its baseline projections in

The Economic and Budget Outlook: Fiscal Years

1996-2000 and described the key factors that drive

the federal government's revenues, spending, and
40 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

deficit. Since then, CBO has revised its baseline projections modestly in the face of new information.

Those revisions raise projected deficits in every year

after 1995 (see Table A-1).

Because CBO has not updated its economic forecast and no new legislation has affected outlay projections since January, all changes to the baseline fall

into the technical category. Technical revisions stem

from new information that has come to light through

late February, much of it contained in the President's

budget and supporting documents.

The largest technical revision reflects adjustments made by the Office of Management and Budget (OMB) to the discretionary spending caps specified in OBRA-93. CBO conforms its baseline for

total discretionary spending to the most recent official limits published by OMB. Ordinarily, there are

only small differences between CBO's previous estimate of the limits and OMB's official limits. In this

instance, however, different interpretations of a provision in OBRA-93 led to OMB limits that are significantly higher than CBO's estimates. Instead of continuing to adjust the caps for the difference between

Table A-1.

Changes in CBO's Baseline Deficit Projections (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000

January Baseline Deficit with

Discretionary Inflation After 1998a

Technical Revisions

Discretionary spending13

Mandatory spending

Medicaid

Medicare

FHA mutual mortgage insurance

FCC spectrum auctions

Other

Subtotal

Deposit insurance

Interest

Total Revisions

March Baseline Deficit with

Discretionary Inflation After 1998a

176

-1

2

-3

-3

-1

175

207

-1

3

-4

0

_c

-2

210

224

-1

3

-3

c

_c

-1

1

230

222

-1

3

-3

c

_c

-1

10

232

253

-1

13

266

284

10

-1

2 2

-1 c

0 -1

_1 _3

1 2

c c

2 3

15

299

SOURCE: Congressional Budget Office.

NOTE: FHA = Federal Housing Administration; FCC = Federal Communications Commission.

a. Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and equal to the 1998 limit

adjusted for inflation after that.

b. The changes in 1996 through 2000 are the result of differences between CBO's January estimate of the discretionary spending limits for

1996 through 1998 and the official limits presented in the President's budget.

c. Less than $500 million.
APPENDIX A CBO'S BASELINE BUDGET PROJECTIONS 41

Table A-2.

CBO's Deficit Projections (By fiscal year)

Actual

1994 1995 1996 1997 1998 1999 2000

In Billions of Dollars

Baseline Total Deficit

With discretionary inflation after 1998

Without discretionary inflation after 1998

Standardized-Employment Deficit3

With discretionary inflation after 1998

Without discretionary inflation after 1998

On-Budget Deficit (Excluding Social Security

and Postal Service)

With discretionary inflation after 1998

Without discretionary inflation after 1998

Memorandum:

Deposit Insurance

Cyclical Deficit

Off-Budget Surplus

Social Security

Postal Service

Total

Baseline Total Deficit

With discretionary inflation after 1998

Without discretionary inflation after 1998

Standardized-Employment Deficit3 c

With discretionary inflation after 1998

Without discretionary inflation after 1998

203

203

187

187

259

259

-8

23

57

-1

56

As a Percentage

3.1

3.1

2.8

2.8

175

175

199

199

243

243

-16

-8

69

_b

69

of GDP

2.5

2.5

2.8

2.8

210

210

218

218

283

283

-8

b

73

_b

73

2.9

2.9

2.9

2.9

230

230

229

229

309

309

-4

5

78

_L

79

3.0

3.0

2.9

2.9

232

232

230

230

317

317

-5

6

84

1

85

2.8

2.8

2.8

2.8

266

247

260

241

355

336

-3

10

89

b

89

3.1

2.9

3.0

2.8

299

258

289

248

395

354

-2

13

95

1

96

3.3

2.9

3.2

2.7

SOURCE: Congressional Budget Office.

NOTE: Caps on discretionary spending are set by law through 1998. Measures of the deficit "with discretionary inflation" assume that

discretionary spending grows at the rate of inflation after 1998. Measures of the deficit "without discretionary inflation" assume that

discretionary spending remains frozen in dollar terms at the level of the 1998 caps.

a. Excludes the cyclical deficit and deposit insurance.

b. Less than $500 million.

c. Expressed as a percentage of potential gross domestic product.
42 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table A-3.

CBO's Baseline Budget Projections with Discretionary Inflation After 1998 (By fiscal year)

Debt Held by the Public

Memorandum:

Gross Domestic Product

Actual

1994 1995 1996 1997 1998 1999 2000

Revenues

Individual income

Corporate income

Social insurance

Other

Total

On-budget

Off-budget

Outlays

Discretionary3

Defense

International

Domestic

Unspecified reductions

Subtotal

Mandatory

Deposit insurance

Net interest

Offsetting receipts

Total

On-budget

Off-budget

Deficit

On-budget deficit

Off-budget surplus

In

543

140

461

113

1,258

923

335

282

21

243

_Q

546

791

-8

203

-71

1,461

1,182

279

203

259

56

Billions of Dollars

594

149

494

_M9

1,355

998

357

270

21

256

_Q

548

843

-16

235

^80

1,530

1,241

289

175

243

69

628

151

517

122

1,418

1,043

375

270

22

264

_i4

552

897

-8

260

.33.

1,628

1,326

302

210

283

73

656

155

539

_125

1,475

1,084

392

278

22

274

"553

961

-4

271

_iZ§

1,706

1,393

313

230

309

79

693

161

565

127

1,546

1,135

411

285

22

285

^35

557

1,025

-5

281

^79

1,778

1,452

326

232

317

85

731

167

590

130

1,618

1,187

431

295

23

296

^38

575

1,098

-3

296

_^2

1,885

1,543

342

266

355

89

772

173

618

134

1,697

1,245

452

304

24

307

_^40

595

1,176

-2

313

^86

1,997

1,641

356

299

395

96

3,432

6,632

3,618 3,843 4,090 4,338

7,036 7,370 7,747 8,152

4,621 4,938

8,572 9,013

^Continued)

SOURCE: Congressional Budget Office.
APPENDIX A CBO'S BASELINE BUDGET PROJECTIONS 43

Table A-3.

Continued

Revenues

Individual income

Corporate income

Social insurance

Other

Total

On-budget

Off-budget

Outlays

Discretionary3

Defense

International

Domestic

Unspecified reductions

Subtotal

Mandatory

Deposit insurance

Net interest

Offsetting receipts

Total

On-budget

Off-budget

Deficit

On-budget deficit

Off-budget surplus

Debt Held by the Public

Actual

1994

As a

8.2

2.1

7.0

AJ.

19.0

13.9

5.1

4.3

0.3

3.7

0

8.2

11.9

-0.1

3.1

-1.1

22.0

17.8

4.2

3.1

3.9

0.8

51.7

1995

Percentage

8.4

2.1

7.0

AJ.

19.3

14.2

5.1

3.8

0.3

3.6

_Q

7.8

12.0

-0.2

3.3

-1.1

21.7

17.6

4.1

2.5

3.5

1.0

51.4

1996

of GDP

8.5

2.1

7.0

AJ.

19.2

14.2

5.1

3.7

0.3

3.6

T5

12.2

-0.1

3.5

.iLO

22.1

18.0

4.1

2.9

3.8

1.0

52.1

1997

8.5

2.0

7.0

JL6

19.0

14.0

5.1

3.6

0.3

3.5

~7~T

12.4

-0.1

3.5

22.0

18.0

4.0

3.0

4.0

1.0

52.8

1998

8.5

2.0

6.9

_L6

19.0

13.9

5.0

3.5

0.3

3.5

~6~8

12.6

-0.1

3.4

21.8

17.8

4.0

2.8

3.9

1.0

53.2

1999

8.5

2.0

6.9

_L5

18.9

13.9

5.0

3.4

0.3

3.4

~6J

12.8

b

3.5

A&

22.0

18.0

4.0

3.1

4.1

1.0

53.9

2000

8.6

1.9

6.9

_L5

18.8

13.8

5.0

3.4

0.3

3.4

^04

6.6

13.1

b

3.5

22.2

18.2

4.0

3.3

4.4

1.1

54.8

a. Projections assume that discretionary spending is equal to the spending limits that are in effect through 1998 and equal to the 1998 limit

adjusted for inflation after that. Discretionary outlays would be $19 billion lower in 1999 and $38 billion lower in 2000 if no adjustment for

inflation was assumed.

b. Less than 0.05 percent.
44 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

actual inflation experienced in the most recently

completed year (1994 in this instance) and the inflation anticipated for that year when the limits were

set, OMB adjusted for the differences between its

current forecast of inflation in 1996, 1997, and 1998

and the inflation forecast for those years when the

limits were set. The resulting limits are as much as

$9 billion higher by 1998 than CBO estimated in January. Although CBO believes that OMB's interpretation of the law is incorrect, CBO will continue to use

OMB's limits in its baseline budget projections.

Other, relatively small revisions to CBO's outlook have occurred since January. Projected Medicaid outlays are expected to grow slightly more slowly

than previously assumed, whereas expenditures for

Medicare should grow slightly faster. In particular,

new data about payments on behalf of Medicare beneficiaries who enroll in health maintenance organizations show those payments rising more rapidly than

had been thought earlier. Also, fewer claims are expected in the Federal Housing Administration's mutual mortgage insurance program from properties

insured before 1992, thereby generating fewer default

payments.

When CBO released its January baseline, the

Federal Communications Commission (FCC) had

just begun its most recent auction of rights to use

portions of the electromagnetic spectrum. Since

then, the FCC has received $7 billion in bids in the

ongoing auction (in addition to $1 billion from the

previous auction). With another $1 billion in receipts

expected before the end of the year, CBO has raised

its estimate of 1995 auction receipts by $3 billion.

CBO has also increased its projection of net spending

by deposit insurance agencies by $2 billion in 1996

and $1 billion in 1997 to reflect a further reduction in

premiums that banks pay to the Bank Insurance Fund

to maintain a balance of $1.25 per $100 of insured

deposits.

The remaining tables in this appendix update

some of the most widely used information in CBO's

January report. Because the revisions are relatively

minor, readers seeking a fuller explanation of underlying trends in the budget can rely on that earlier

publication.

Much of the concern about the budget stems

from the sheer size of the federal deficit; Table A-2

displays several measures of that gap. The most

commonly used measure of the deficit is simply the

difference between total revenues and spending. As

explained above, CBO produces two projections of

that difference-one assuming that discretionary

spending grows at the rate of inflation after 1998 and

the other assuming that it is frozen at the 1998 dollar

level.

Participants in the budget debate often cite other

measures of the deficit as well-most usefully, the

standardized-employment or structural deficit. That

figure shows what is left after removing the cyclical

deficit—in other words, the weakened revenues and

extra benefit spending that result when the economy

operates below its potential. With the current economic recovery on a solid footing, the distinction

between the structural deficit and the conventionally

measured deficit is less relevant now than during periods of slower growth.

Spending and receipts for a number of large programs are generally tracked separately; chief among

them are Social Security and the Postal Service (both

of which are off-budget under different statutory provisions). The surpluses or deficits of those programs

are depicted in Table A-2. Despite their special status, those programs loom so large in the revenue and

spending totals that any measure of the budget that

omits them yields a distorted picture of the government's drain on credit markets and its role in the

economy.

Federal government revenues by source and outlays by broad category, both in dollar terms and in

relation to the country's gross domestic product

(GDP), are presented in Table A-3. Spending for

entitlements and other mandatory programs, by far

the largest spending category, will reach almost $850

billion this year and is growing fast. Fueling that

growth are expenditures for Social Security, Medicare, and Medicaid, which together account for

around three-quarters of all mandatory outlays.

Table A-4 displays more information about this huge

cluster of programs. In response to increased interest

in the projected growth of individual mandatory programs, CBO has for the first time extended that table

through 2005.
APPENDIX A CBO'S BASELINE BUDGET PROJECTIONS 45

Table A-4.

CBO's Baseline Projections for Mandatory Spending (By fiscal year, in billions of dollars)

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Medicaid

Food Stamps3

Supplemental Security Income

Family Support

Veterans' Pensions

Child Nutrition

Earned Income Tax Credit

Student Loansb

Other

Total, Means-Tested

Programs

Social Security

Medicare

Subtotal

Other Retirement and Disability

Federal civilian0

Military

Other

Subtotal

Unemployment Compensation

Other Programs

Veterans' benefitsd

Social services

Credit reform liquidating accounts

Other

Subtotal

Total, Non-MeansTested Programs

Total Mandatory Spending

Means-Tested Programs

89

26

24

18

3

8

17

4

__3

99

27

24

19

3

8

20

3

__4

110

29

30

19

3

9

23

3

_4

122

30

33

20

3

9

24

3

_5

135

32

36

20

3

10

25

3

_5

148

33

43

21

3

11

26

3

_6

163

35

39

21

3

11

27

3

_6

178

37

47

22

3

12

28

3

7

195

38

51

23

3

13

29

4

7

212

40

55

24

3

13

30

4

_8

232

42

64

24

3

14

31

4

_8

193 207 229 248 268 293 309 336 362 389 423

Non-Means-Tested Programs

42

28

_5

74

44

28

4

76

46

30

4

80

49

31

4

84

51

33

4

89

54

35

5

93

57

36

5

98

60

38

5

102

63

39

5

107

66

41

5

112

69

43

5

117

334

JI78

512

42

28

5

74

21

17

6

-1

20

42

352

199

551

44

28

4

76

23

17

6

-4

20

39

371

219

590 631

391

240

412 435 458 483 509 537 566

263 288 315 345 379 416 458

675 723 773 828 888 953 1,024

24

19

6

-6

26 27 28 30 31 33 34

38

35

19 20 22 23 24 24 25 26

6666666 6

-7 -7 -7 -7 -7 -7 -7 -7

19 19 18 18 18 18 18 18

36 38 39 40 41 41 42 43

649 689 732 777 829 883 941 1,002 1,069 1,142 1,220

Total

843 897 961 1,025 1,098 1,176 1,250 1,339 1,431 1,531 1,643

SOURCE: Congressional Budget Office.

NOTE: Spending for major benefit programs shown in this table includes benefits only. Outlays for administrative costs of most benefit

programs are classified as domestic discretionary spending; Medicare premium collections are classified as offsetting receipts.

a. Includes nutrition assistance to Puerto Rico.

b. Formerly known as guaranteed student loans.

c. Includes Civil Service, Foreign Service, Coast Guard, and other retirement programs, and annuitants' health benefits.

d. Includes veterans' compensation, readjustment benefits, life insurance, and housing programs.
46 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

In its baseline projections, CBO assumes that

policymakers will continue to abide by the discretionary spending limits set in law through 1998. Separate caps apply to both budget authority (the authority to commit funds, the basic currency of the appropriation process) and outlays (actual spending); the

stricter constraint governs. The caps have no unique

implications for particular programs but rather force

a bruising competition for resources. In a reversal

from previous years, in 1996 the limit on budget authority may be more constraining than the limit on

outlays. Table A-5 shows that preserving resources

next year at the 1995 level adjusted for inflation

would cause budget authority to exceed the discretionary cap by $13 billion and outlays to exceed the

cap by $4 billion. Future cuts are likely to be painful

—even a freeze of total discretionary spending at the

current level would result in outlays just $12 billion

below the caps in 1998.

Net interest payments for the past few years have

been remarkably flat (around $200 billion a year),

thanks to low interest rates. However, as Table A-6

shows, the combination of higher interest rates and a

persistently large deficit will boost net interest to

$235 billion in 1995 and over $300 billion in 2000.

Correspondingly, federal debt will continue to increase, with debt held by the public rising to almost

55 percent of GDP in 2000.

Long-range budget projections are highly uncertain because no one can foresee the path of the economy or such important trends as growth in health

care spending. CBO's long-run extrapolations thus

contain less detail than its five-year projections,

which are required under the Congressional budget

process. Nevertheless, CBO's broad-brush overview

suggests that after 1998--in the absence of concerted

action by policymakers—the deficit is likely to continue climbing both in dollar terms and, more worrisomely, as a percentage of GDP (see Table A-7).

Sustained growth in the two big health care programs, Medicare and Medicaid, is the major reason,

as they mount steadily from 3.8 percent of GDP today to 5.9 percent of GDP in 2005.

Most other spending programs, along with federal revenues, are expected to be roughly flat as a

percentage of GDP over the next 10 years. Discretionary spending, the exception, will drop sharply

(relative to GDP) through 1998. After the caps expire in 1999, the programs governed by them may

resume growing, but even if discretionary spending

increases at the rate of inflation, it will continue to

decline as a proportion of GDP. If discretionary

spending is held to the 1998 dollar level, it will decline even more rapidly—to 4.8 percent of GDP by

2005—and the deficit will stabilize at approximately

2.5 percent of GDP (see Table A-8).
APPENDIX A CBO'S BASELINE BUDGET PROJECTIONS 47

Table A-5.

How Tight Are the Discretionary Caps? (By fiscal year, in billions of dollars)

1996 1997 1998

Budget Authority

Discretionary Caps3 522 535 542

Amount Needed to Preserve 1995 Real Resources

Defense

International

Domestic

Total

Amount over or under (-) caps

Amount Needed to Freeze 1995 Dollar Resources

Defense

International

Domestic

Total

Amount over or under (-) caps

Outlays

Discretionary Caps3

Amount Needed to Preserve 1995 Real Resources

Defense

International

Domestic

Total

Amount over or under (-) caps

Amount Needed to Freeze 1995 Dollar Resources

Defense

International

Domestic

Total

Amount over or under (-) caps

272

21

.241

534

13

263

20

227

511

-11

552

270

22

264

556

4

264

21

259

544

-8

282

22

.251

555

20

263

20

227

511

-24

553

278

22

274

574

21

264

21

260

545

-9

291

23

269

583

42

263

20

227

511

-31

557

285

22

285

592

35

262

21

262

545

-12

SOURCE: Congressional Budget Office.

NOTE: Amounts needed to preserve 1995 real resources include adjustments for inflation of about 3 percent a year. Amounts needed to

freeze 1995 dollar resources include no adjustments for inflation. Both paths include the budget authority necessary to renew expiring

contracts for subsidized housing. There are no discretionary caps after 1998.

a. The caps reflect discretionary spending limits as specified by the Office of Management and Budget in the sequestration preview report

included in the President's budget.
48 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table A-6.

CBO's Baseline Projections for Interest Costs and Federal Debt (By fiscal year, in billions of dollars)

Actual

1994 1995 1996 1997 1998 1999 2000

Net Interest Outlays (Billions of dollars)

Interest on Public Debt

(Gross interest)3 296 340 371 386 401 422 445

Interest Received by Trust Funds

Social Security

Other trust fundsb

Subtotal

Other Interest0

Total

Federal Debt, End of Year (Billions of dollars)

Gross Federal Debt 4,644 4,943 5,285 5,648 6,013 6,407 6,834

Debt Held by Government Accounts

-29

^56

-86

j£

203

-35

^62

-96

^8

235

-39

j£3

-102

^8

260

-45

_£3

-107

^8

271

-50

^63

-112

-7

281

-55

^63

-118

^8

296

-61

^62

-123

^8

313

Social Security

Other government accounts"

Total

Debt Held by the Public

Debt Subject to Limit"

Debt Held by the Public

420

792

1,212

3,432

4,605

Federal Debt

51.7

489

836

1,325

3,618

4,903

561

881

1,442

3,843

5,244

as a Percentage of

51.4 52.1

640

919

1,559

4,090

5,607

GDP

52.8

724

952

1,675

4,338

5,971

53.2

812

973

1,786

4,621

6,365

53.9

907

989

1,896

4,938

6,792

54.8

SOURCE: Congressional Budget Office.

NOTE: Projections of interest and debt assume compliance with the discretionary spending caps in the Budget Enforcement Act. Discretionary spending is assumed to rise with inflation after the caps expire in 1998.

a. Excludes interest costs of debt issued by agencies other than the Treasury (primarily the Tennessee Valley Authority).

b. Principally Civil Service Retirement, Military Retirement, Medicare, unemployment insurance, and the Highway and the Airport and Airway

trust funds.

c. Primarily interest on loans to the public and to the Resolution Trust Corporation and the Bank Insurance Fund.

d. Differs from the gross federal debt primarily because most debt issued by agencies other than the Treasury is excluded from the debt limit.
APPENDIX A CBO'S BASELINE BUDGET PROJECTIONS 49

Table A-7.

The Budget Outlook Through 2005 with Discretionary

Revenues

Outlays

Discretionary

Mandatory

Deposit insurance

Net interest

Offsetting receipts

Total

Deficit

Social Security Surplus

Hospital Insurance

Surplus

Debt Held by

the Public

Revenues

Outlays

Discretionary

Mandatory

Deposit insurance

Net interest

Offsetting receipts

Total

Deficit

Social Security Surplus

Hospital Insurance

Surplus

Debt Held by

the Public

1995

1,355

548

843

-16

235

_£Q.

1,530

175

69

3

3,618

19.3

7.8

12.0

-0.2

3.3

-1.1

21.7

2.5

1.0

a

51.4

1996

1,418

552

897

-8

260

^Z3

1,628

210

73

-2

3,843

19.2

7.5

12.2

-0.1

3.5

-1.0

22.1

2.9

1.0

a

52.1

1997

In

1,475

553

961

-4

271

^ZS

1,706

230

78

-9

4,090

As

19.0

7.1

12.4

-0.1

3.5

-1.0

22.0

3.0

1.0

-0.1

52.8

1998

Billions

1,546

557

1,025

-5

281

-79

1,778

232

84

-15

4,338

Inflation After 1998 (By fiscal year)

1999 2000 2001 2002 2003 2004 2005

of Dollars

1,618

575

1,098

-3

296

-82

1,885

266

89

-22

4,621

1,697

595

1,176

-2

313

-86

1,997

299

95

-29

4,938

1,787

615

1,250

-2

329

_^9Q

2,103

316

102

-37

5,271

1,880

636

1,339

-2

350

-94

2,229

349

109

-46

5,638

1,978

658

1,431

-2

372

_^8

2,361

384

116

-56

6,040

2,082

680

1,531

-1

397

-102

2,504

422

124

-67

6,479

2,191

703

1,643

-1

424

^IQZ

2,663

472

133

-80

6,969

a Percentage of GDP

19.0

6.8

12.6

-0.1

3.4

-1.0

21.8

2.8

1.0

-0.2

53.2

18.9

6.7

12.8

a

3.5

-1.0

22.0

3.1

1.0

-0.3

53.9

18.8

6.6

13.1

a

3.5

-1.0

22.2

3.3

1.0

-0.3

54.8

18.8

6.5

13.2

a

3.5

-0.9

22.2

3.3

1.1

-0.4

55.6

18.8

6.4

13.4

a

3.5

-0.9

22.3

3.5

1.1

-0.5

56.5

18.8

6.3

13.6

a

3.5

-0.9

22.5

3.7

1.1

-0.5

57.5

18.8

6.2

13.9

a

3.6

-0.9

22.7

3.8

1.1

-0.6

58.7

18.8

6.1

14.1

a

3.6

-0.9

22.9

4.1

1.1

-0.7

60.0

SOURCE: Congressional Budget Office,

a. Less than 0.05 percent of GDP.
50 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table A-8.

The Budget Outlook Through

Revenues

Outlays

Discretionary

Net interest

All other3

Total

Deficit

Debt Held by

the Public

1995

1,355

548

235

_74Z

1,530

175

3,618

2005 Without Discretionary Inflation After 1998

1996

1,418

552

260

816

1,628

210

3,843

1997

In

1,475

553

271

881

1,706

230

4,090

1998

Billions

1,546

557

281

941

1,778

232

4,338

1999 2000 2001

(By fiscal year)

2002 2003 2004 2005

of Dollars

1,618

557

295

1.013

1,865

247

4,602

1,697

557

311

1.088

1,956

258

4,877

1,787

557

324

1.158

2,038

252

5,146

1,880

557

339

1.243

2,139

259

5,423

1,978

557

355

1.331

2,243

266

5,707

2,082

557

372

1.427

2,355

273

5,998

2,191

557

389

1.535

2,481

290

6,306

As a Percentage of GDP

Revenues

Outlays

Discretionary

Net interest

All other3

Total

Deficit

Debt Held by

the Public

19.3

7.8

3.3

10.6

21.7

2.5

51.4

19.2

7.5

3.5

11.1

22.1

2.9

52.1

19.0

7.1

3.5

JLL4

22.0

3.0

52.8

19.0

6.8

3.4

21.8

2.8

53.2

18.9

6.5

3.4

_LL8

21.8

2.9

53.7

18.8

6.2

3.4

J2J.

21.7

2.9

54.1

18.8

5.9

3.4

12.2

21.5

2.7

54.3

18.8

5.6

3.4

J2.5

21.4

2.6

54.4

18.8

5.3

3.4

J27

21.4

2.5

54.4

18.8

5.0

3.4

12.9

21.3

2.5

54.3

18.8

4.8

3.3

13.2

21.3

2.5

54.2

SOURCE: Congressional Budget Office.

a. Spending for all other categories-mandatory outlays, deposit insurance, and offsetting receipts-would be the same as in Table A-7.
Appendix B

Economic and Budgetary Implications

of Balancing the Budget

T

he Congressional Budget Office's (CBO's)

January report, The Economic and Budget

Outlook: Fiscal Years 1996-2000, laid out

one of many possible paths of deficit reduction that

would lead to a balanced budget by 2002. CBO has

updated that illustrative path to reflect the revisions

to the baseline projections of the budget in this report

(see Table B-l). The January report also briefly discussed the possibility that reducing the budget deficit

would positively affect the overall economy, which

in turn would yield further reductions in the deficit.

This appendix expands on that discussion and provides estimates of those impacts.

Balancing the budget over the next seven years

will require many hard decisions about taxing and

spending policies, and many of those choices will

have important implications for the nation's economic outlook. Although the details of those decisions have yet to be worked out, some likely macroeconomic effects that flow simply from balancing the

budget can be anticipated, based on available empirical research. CBO's analysis indicates that growth is

likely to be modestly higher, on average, from now

until 2002, provided that the policy changes necessary to balance the budget do not fall especially hard

on private saving or on productive public investments

(see Tables B-2 and B-3). Inflation could increase or

decrease slightly but should not be much affected. In

the short term, although some bumps could appear in

the road, the fiscal restraint implied by the effort to

balance the budget need not weaken the economy

substantially as long as the Federal Reserve acts to

offset that restraint. Interest rates are likely to be

significantly lower, falling to the range that they inhabited in the 1950s and 1960s, when budget deficits

were typically modest by today's standards.

Most of the benefits of balancing the budget

would accrue over time, becoming more pronounced

after the next seven years. Thus, the major beneficiaries of a balanced budget may be future generations,

who would gain from both the nation's increased productive capacity and a lower burden of debt. Indeed,

current fiscal policies literally cannot remain unchanged indefinitely: at some time, action will have

to be taken to bring government borrowing under

control, or servicing the federal debt will require

unsustainable tax rates in future years. Prompt action

would limit the damage that occurs when federal debt

crowds out capital investment, putting upward pressures on interest rates. It would also limit the size of

the needed changes in fiscal policy.

The estimates in this appendix of the economic

implications of balancing the budget over the next

seven years reflect only the macroeconomic component of effects on national saving and investment in

an environment with a favorable monetary policy.

The actual outcomes will depend on the fiscal and

monetary policy choices that are made. If the deficit

is closed by means that lead to particularly strong

disincentives for private saving or investment, or by

reducing productive government investments, the

benefits of eliminating the deficit could be reduced.

Moreover, monetary policy that does not accommodate the fiscal restraint inherent in a balanced budget
52 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

could lead to short-run losses in output-and in incomes as well. Of course, policy changes could also

work the other way—by increasing private and public

investment. In that case, the nation's economic outlook under a balanced budget would be enhanced.

Because those policy decisions have not been made,

their effects are not included in this analysis.

An Illustrative Path to

a Balanced Budget

For illustrative purposes, CBO has laid out one of

many possible paths to a balanced budget in 2002

Table B-1.

Illustrative Deficit Reduction Path (By fiscal year, in billions of dollars)

CBO March Baseline Deficit with

Discretionary Inflation After 1998a

Freeze Discretionary Outlays After 1998

Discretionary reduction

Debt service

Deficit Reduction

CBO March Baseline Deficit Without

Discretionary Inflation After 1998b

Additional Deficit Reduction

Policy changes0

Debt service

Deficit Reduction

Resulting Deficit

Total Change from Baseline Deficit

with Discretionary Inflation After 1998

Policy changes

Debt service

Total Deficit Reduction

1995

175

0

_ Q

0

175

0

-0

0

175

0

-Q

0

1996

210

0

— Q

0

210

-36

-1

-37

173

-36

-1

-37

1997

230

0

__Q

0

230

-72

-5

-76

154

-72

-£

-76

1998

232

0

_0

0

232

-107

-11

-118

114

-107

-11

-118

1999

266

-19

-1

-20

247

-161

^20

-181

66

-180

-21

-200

2000

299

-38

^3

-41

258

-173

^32

-204

54

-211

_i34

-245

2001

316

-59

_J3

-64

252

-186

^45

-231

21

-245

^50

-295

2002

349

-80

jdO

-90

259

-200

j£Q

-259

d

-279

^70

-349

1996-

2002

n.a.

-196

.ili

-215

n.a.

-934

-173

-1,107

n.a.

-1,130

-192

-1,322

SOURCE: Congressional Budget Office.

NOTE: n.a. = not applicable.

a. Assumes compliance with discretionary spending limits of the Balanced Budget and Emergency Deficit Control Act through 1998.

Discretionary spending is assumed to increase at the rate of inflation after 1998.

b. Assumes compliance with discretionary spending limits of the Balanced Budget and Emergency Deficit Control Act through 1998.

Discretionary spending is frozen at the 1998 level after that year.

c. These changes represent only one of a large number of possible paths that would lead to a balanced budget. The exact path depends on

when deficit reduction begins and the specific policies adopted by the Congress and the President. This path is not based on any specific

policy assumptions but does assume that policies are fully phased in by 1999.

d. Surplus of less than $500 million.
APPENDIX B ECONOMIC AND BUDGETARY IMPLICATIONS OF BALANCING THE BUDGET 53

(see Table B-l). Starting from a baseline that assumes that discretionary spending is adjusted for inflation after 1998, that path first shows the savings

that would be achieved by freezing discretionary

spending through 2002 at the dollar level of the 1998

cap. The freeze, along with the resulting debtservice effects, would produce $90 billion of the required savings of $349 billion in 2002. Such a freeze

would reduce the buying power of total discretionary

appropriations nearly 20 percent below the 1995

level.

CBO also built into its illustrative path a possible

course of savings from further policy changes. The

amounts of those savings are not based on any particular set of policies. The pattern of savings between

1996 and 1999, however, is similar to the phasing in

of changes in mandatory spending enacted in the last

two major efforts at reducing the deficit, in 1990 and

1993. After 1999, the assumed savings increase at

the baseline rate of growth for entitlement and other

mandatory spending, excluding Social Security-implying that the cuts made in earlier years are permanent but no additional policy changes are made. If

those savings were achieved entirely out of entitlement or other mandatory programs (excluding Social

Security), they would represent about a 20 percent

reduction from current-policy levels for those programs.

Over the entire period from 1996 to 2002, the

policy changes in CBO's illustrative path would save

more than $1.1 trillion from a baseline that adjusts

discretionary spending for inflation after 1998. The

cost of servicing the public debt would also fall, and

when that cost is included, the total savings exceed

$1.3 trillion. This path and the resulting savings are

no more than illustrative: the cumulative amount of

deficit reduction between 1996 and 2002 will depend

on the timing and nature of the policy changes chosen to achieve balance in 2002.

Many of the estimates in this appendix of the

economic effects of balancing the budget are based

on model simulations, which required additional assumptions about the nature of the policies chosen to

balance the budget. Those simulations assumed that

the budget would be balanced smoothly over the next

Table B-2.

Potential Economic Impacts of Balancing the Budget by 2002 Compared with

CBO's January Economic Forecast (By calendar year)

1996 1997 1998 1999 2000 2001 2002

Interest Rates (Percentage points)

Three-month Treasury bills -0.2 -0.4 -0.7 -0.9 -1.1 -1.1 -1.1

Ten-year Treasury notes -0.2 -0.5 -0.8 -1.1 -1.4 -1.7 -1.7

Real Gross National Product

Percentage change in level from base 0.1 0.2 0.3 0.4 0.6 0.7 0.8

Change in growth rate (Percentage points) 0.1 0.1 0.1 0.1 0.1 0.1 0.1

Real Gross Domestic Product

Percentage change in level from base

Change in growth rate (Percentage points)

0

0

0.1

0.1

0.2

0.1

0.3

0.1

0.3

0.1

0.4

0.1

0.5

0.1

SOURCE: Congressional Budget Office.
54 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Table B-3.

CBO's January Economic Forecast After Adjusting for the Economic

Impacts of Balancing the Budget (By calendar year, in percent)

1996 1997 1998 1999 2000 2001

SOURCE: Congressional Budget Office.

NOTE: CPI-U = consumer price index for urban consumers.

2002

Nominal GDP Growth

Real GDP Growth

Inflation (CPI-U)

Unemployment

Interest Rates

Three-month Treasury bills

Ten-year Treasury notes

4.7

1.8

3.4

5.7

5.5

6.8

5.3

2.5

3.4

5.8

4.9

6.2

5.3

2.4

3.4

5.9

4.5

5.9

5.2

2.4

3.4

6.0

4.2

5.6

5.2

2.4

3.4

6.0

4.0

5.3

5.3

2.4

3.4

6.0

4.0

5.1

5.3

2.4

3.4

6.0

4.0

5.1

seven years, following the illustrative path laid out

above. Moreover, they assumed that the policy actions would be on the outlay side of the budget rather

than on the revenue side. The broad conclusions apply, however, to many other ways of reaching balance, provided that those methods do not involve

changes in marginal rates of taxation on saving, on

the return from capital, or on labor. Finally, the simulations assumed that both financial markets and the

Federal Reserve would view the policy changes as a

credible route to balancing the budget.

Increased Growth

Balancing the budget by 2002 could allow the economy to grow modestly faster-by about 0.1 percentage point per year on average. By 2002, the annual

level of gross national product (GNP) might be about

0.8 percent higher than it would be if fiscal policy

continued on its current path.1 Moving to a balanced

budget would add to growth by redirecting resources

away from public and private consumption and toward investment and an improved national balance

The more familiar concept of gross domestic product (GDP)

measures only production in the United States and does not reflect

the decline in debt service to foreigners. Thus, GNP could increase

by some 0.8 percent in 2002, but GDP might increase by only 0.5

percent.

sheet—especially by cutting the current pace of borrowing from foreigners and eliminating the need to

service that debt.

In balancing the budget, private saving is likely

to decrease, although to what extent is highly uncertain. How much private saving drops off will depend

critically on how the deficit is reduced and whether

policy changes alter any of the tax factors that enter

into decisions to save. Without such changes in

taxes, private saving might fall by between 20 percent and 40 percent of the reduction in the deficit,

according to the models that CBO has analyzed.

Thus, national wealth would increase by between 60

percent and 80 percent of the cumulative reduction in

the deficit.

Some of the rise in national wealth would appear

as a higher level of capital stock (increasing productive capacity in the United States), and some would

show up as lower levels of borrowing from foreigners. No consensus exists on how much each of those

elements would change, but the range of possible

increases in productive capacity over the next seven

years is limited. The existing capital stock is large; it

takes years to change by a noticeable proportion.

Moreover, the models that CBO has examined predict an increase in private investment of only about

20 percent of the amount of reduction in the deficit.

Such an increase would raise the capital stock by
APPENDIX B ECONOMIC AND BUDGETARY IMPLICATIONS OF BALANCING THE BUDGET 55

about 2.2 percent in 2002, expanding productive capacity by about 0.5 percent.

The shift of resources to investment and net exports may not go smoothly, however. Balancing the

budget implies a substantial amount of restraint overall, averaging some 0.4 percent of GDP each year for

seven years. (Usually, fiscal restraint lasts for two

years or less.) If the Federal Reserve failed to offset

restraint, consumption could fall more quickly than

investment and net exports rise, with the result that

the economy could weaken in the short run. The

Federal Reserve might welcome fiscal restraint if the

economy seemed close to overheating, for example.

Moreover, even if the Federal Reserve sought to offset fiscal restraint with a more expansionary monetary policy, the effects of monetary policy on the

economy are uncertain, both in their size and timing.

Because a perfect offset would be too much to expect, budget balancing risks some temporary reduction in real GDP.

Nevertheless, the danger of a substantial downturn seems small, provided that changes in spending

and taxes follow a relatively smooth path and are

credible to both financial markets and the Federal

Reserve. Given such credibility, long-term interest

rates are likely to fall and help boost domestic investment, and the Federal Reserve could act early to reduce short-term rates. The annual amount of restraint, moreover, does not seem unmanageable, provided that the deficit is reduced reasonably smoothly.

Although some bumps could occur along the way,

those short-term problems should not interfere with

the investment and gains in productivity that would

bring increased growth between now and 2002.

The Federal Reserve's actions could also affect

the rate of inflation. On the one hand, inflation could

rise temporarily because lower interest rates in the

United States would reduce the value of the dollar

and raise the price of imports. On the other hand, if

the Federal Reserve targeted nominal GDP, inflation

could eventually fall by as much as the growth in real

GDP. In short, the net effect on inflation cannot be

predicted with any confidence.

Lower Interest Rates

Economists disagree widely over the effect of fiscal

policy on interest rates. Some believe that the openness of U.S. capital markets ensures that real rates

cannot stray far from those in other countries, and

thus they would give little credence to any fiscally

induced change in real rates. Others, using models of

the U.S. economy alone, cite much larger impacts:

according to one of those models, balancing the budget could reduce long-term interest rates by as much

as 400 basis points.

Good arguments exist for a more reasonable

range that encompasses the uncertainty about the

likely effects of balancing the budget—a range of

from 100 to 200 basis points. A drop of that magnitude from CBO's baseline forecast would leave real

long-term rates at between 1 percent and 2 percent--

lower than they have been since the 1950s-and real

short-term rates close to zero. During the 1970s,

short-term rates fell below the rate of inflation

largely because of unanticipated increases in inflation

and inappropriately expansionary monetary policy.

But in periods without such policy mistakes, real

short-term interest rates have rarely been as low as

zero.

How quickly rates would fall depends on many

poorly understood factors, but the drop in rates would

probably anticipate any actual reduction in the deficit

by a year or so. Long-term interest rates, for example, might respond to announced future reductions in

the deficit if those reductions seemed credible-and

as the Congress proceeds along the path of deficit

reduction, credibility is likely to increase. The timing of a fall in short-term rates would depend on

when the Federal Reserve acted, which—given the

long lags in the effect of monetary policy on the

economy-could also anticipate the actual decline in

the deficit. CBO has assumed, relatively conservatively, that the reduction in both long- and short-term

rates might occur over a five- to six-year period.

Some analysts might argue that long-term rates could

respond even faster, as for instance they did after en-
56 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

actment of the Omnibus Budget Reconciliation Act

of 1993. But the evidence on the cause of that drop

is mixed: the sharp decline in long-term rates in

1993 could also be attributed to falling expectations

about inflation—and in any case the decline was

partly reversed within a year. Moreover, long-term

rates did not fall quickly following enactment of a

similar fiscal package in 1990. With such conflicting

evidence, some caution about the likely speed of reductions in interest rates seems warranted.

Very Large Reductions in

Rates Seem Unlikely

One widely used model, developed by Data Resources Inc. (DRI), predicts an exceptionally large

drop in interest rates as the deficit falls-nearly 400

basis points in the simulations carried out by CBO.

(When DRI carries out similar simulations, it uses

different auxiliary assumptions and arrives at somewhat smaller impacts on rates. The drop in interest

rates is still, however, much larger than that derived

from other models.) In the DRI model, domestic saving and investment respond much more slowly to

changes in interest rates than is the case in the other

models CBO examined. Consequently, interest rates

must fall substantially in order for investment to replace the public and private consumption lost to fiscal restraint.

Such large reductions in rates lack credibility

from another point of view: when combined with

CBO's base forecast of interest rates, they would

push real rates well below those that prevailed in the

1950s and 1960s, when the deficit was generally expected to remain under control. Indeed, the DRI results imply that negative real interest rates would persist for years.

A Lack of Effect on Interest Rates

Also Seems Unlikely

Those who expect deficit reduction to have little or

no impact on interest rates probably overstate their

case as well. Their argument is that because the U.S.

capital market is wide open to lending to and borrowing from foreigners, interest rates in the United States

cannot long deviate from world rates. As a result,

real interest rates cannot respond to changes in the

U.S. budget deficit.

The United States, however, is a big enough

player that changes in its markets can affect world

capital markets. In the early 1980s, for example, the

rise of government borrowing in the United States,

together with tight monetary policy at the beginning

of the decade, was blamed for increases in world interest rates. Those high rates precipitated a crisis for

developing countries like Mexico that had borrowed

too freely in the 1970s.

U.S. interest rates can, moreover, deviate persistently from foreign rates, provided that the expected

returns to foreigners investing in the United States

remain similar to those that foreigners would receive

for investing in their own economies. The return for

foreigners investing in the United States comprises

two elements: the interest paid (in dollars) on U.S.

liabilities, and the expected capital gains or losses (in

German marks or Japanese yen) that occur as exchange rates shift. Changes in the expected movements of currency values allow fiscal excess to raise

interest rates in the United States above those in foreign economies-as occurred in the early 1980s. Correspondingly, fiscal restraint will reduce U.S. interest

rates by more than the reductions occurring in other

countries that do not undergo the same contraction.

(Initially, fiscal restraint and lower interest rates in

the United States will lead to a drop in the value of

the dollar relative to other currencies, but subsequently the dollar will begin to appreciate.)

CBO has examined one model that incorporates

the two elements noted above. The MSG model simulates how foreign interest rates would fall and how

exchange rate movements would permit changes in

the differential between U.S. and foreign rates.2 The

model predicts a decline of 160 basis points in interest rates by 2002 under a balanced budget.

Interest rates may also differ among nations because the liabilities of different countries do not appear exactly the same to investors. Although capital

See Warwick McKibbin and Jeffrey Sachs, Global Linkages:

Macroeconomic Interdependence and Cooperation in the World

Economy (Washington, D.C.: Brookings Institution, May 1991).
APPENDIX B ECONOMIC AND BUDGETARY IMPLICATIONS OF BALANCING THE BUDGET 57

Table B-4.

Change in the Federal Deficit Resulting from the Economic Impacts of Balancing

the Budget by 2002 (By fiscal year, in billions of dollars)

1996 1997 1998 1999 2000 2001 2002

Change Resulting from Lower

Interest Rates

Outlays (Net Interest)

Revenues (Federal Reserve earnings)3

Subtotal

Change Resulting from Higher

GDP (Revenues)

Total Effect on Deficit

-2

_b

-2

-3

-6

^5

-7

-12

-To

-14

-20

T7

-23

-28

_4

-24

-32

-36

5

-31

-10

-41

-42

5

-37

-13

-50

SOURCE: Congressional Budget Office.

NOTE: These estimates assume that the budget is balanced by 2002. Outstanding debt depends only on the budget deficit and is unaffected

by the changes reflected in this table. Consequently, no further savings in servicing the debt accrue from these changes.

a. Revenue reductions are shown as positive because they increase the deficit.

b. Less than $500 million.

markets are well integrated, they are not perfectly

meshed, and in some, the opportunities for hedging

are limited. Moreover, if the United States was to

continue on its current fiscal track, the risk of holding

dollar securities could rise.

CBOfs Estimate

Although the extremes of the range of impacts on

interest rates can be ignored, narrowing the range any

further than to between 100 and 200 basis points

proves difficult. CBO's estimates, shown in Table

B-2, split that range, since they imply that a weighted

average of interest rates would drop by 150 basis

points over six years. (The weights are 25 percent on

short-term rates and 75 percent on long-term rates

and roughly reflect the shares of short- and long-term

securities in current federal borrowing from the public.) Long-term rates drop more than short-term

ones, on the assumption that the policies undertaken

to balance the budget will put the long-term fiscal

outlook on a more sustainable path than is possible

under current policies.

The Uncertainty of the

Economic Estimates

The estimates in Tables B-2 and B-3 are subject to

two kinds of uncertainty. The first, which has been

discussed at length, is the substantial uncertainty

about the effects of balancing the budget, assuming

that other outcomes match CBO's January expectations. The second kind of uncertainty arises because

many things will happen-not just in the area of fiscal

policy but in the rest of the economy—that CBO

could not anticipate in its January forecast. For example, the forecast did not anticipate that growth in

GDP for the fourth quarter of 1994 would be revised

upward to 5.2 percent; neither did it anticipate the

weakness of the dollar against the yen.

Such events beyond the domain of fiscal policy

could easily obscure the impacts on growth and interest rates that balancing the budget would set in motion. For example, if the weakness of the dollar continues, the Federal Reserve might be unwilling to
58 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

lower interest rates as quickly as the budget-balancing scenario assumes. The estimates in Tables B-2

and B-3 should therefore be viewed with appropriate

caution: a few years down the road, it may be impossible to disentangle the effects of balancing the budget from other forces operating at the same time in

the U.S. economy.

Budgetary Effects

Budgetary savings would result from both the reduction in interest rates and the increase in real GDP and

GNP (see Table B-4). Lower interest rates would cut

the cost of federal payments for interest on the debt

held by the public. A portion of those interest payments goes to the Federal Reserve, which holds significant amounts of government securities. Because

the Federal Reserve returns its earnings to the federal

government, the smaller interest payment to the Federal Reserve (which is reflected in the estimate of the

effect of lower interest rates on net interest payments) is offset by a smaller amount of earnings returned to the government. The offset is shown separately because the collections from the Federal Reserve are recorded in the budget as revenues, rather

than as offsets to net interest outlays. The increase in

economic activity reflected in the faster growth of

GDP would generate additional revenues from income and payroll taxes and from customs duties.

The estimated increase in revenues also reflects a rise

in tax revenues on interest income. That rise occurs

because a smaller proportion of such income would

be paid to foreigners to service accumulated debt.
Appendix C

Major Contributors to the

Revenue and Spending Projections

T

he following Congressional Budget Office analysts prepared the revenue and spending projections in this

report:

Revenue Projections

Mark Booth Corporate income taxes, Federal Reserve System earnings, excise taxes

Drew McMorrow Excise taxes

Peter Ricoy Social insurance contributions, estate and gift taxes

Melissa Sampson Customs duties, miscellaneous receipts

David Weiner Individual income taxes

Spending Projections

Defense, International Affairs, and Veterans' Affairs

Elizabeth Chambers Military retirement, atomic energy, defense, military health care

Kent Christensen Defense

Christopher Duncan International affairs

Victoria Fraider Veterans' education and housing, defense (weapons)

Michael Groarke Veterans' housing and medical care

Raymond Hall Defense (weapons)

William Myers Defense (weapons)

Mary Helen Petrus Veterans' compensation, pensions, and medical care

Amy Plapp Defense (personnel)

Joseph Whitehill International affairs
60 AN ANALYSIS OF THE PRESIDENT'S BUDGETARY PROPOSALS FOR FISCAL YEAR 1996 April 1995

Human Resources

Wayne Boyington

Scott Harrison

Christie Hawley

Jean Hearne

Lori Housman

Deborah Kalcevic

Lisa Layman

Jeffrey Lemieux

Dorothy Rosenbaum

Robin Rudowitz

Kathy Ruffing

Connie Takata

John Tapogna

Natural and Physical Resources

Kim Cawley

Peter Fontaine

Mark Grabowicz

Theresa Gullo

David Hull

Mary Maginniss

Eileen Manfredi

Ian McCormick

Susanne Mehlman

David Moore

John Patterson

Deborah Reis

Rachel Robertson

Judith Ruud

Brent Shipp

John Webb

Other

Janet Airis

Edward Blau

Jodi Capps

Karin Carr

Betty Embrey

Kenneth Farris

Vernon Hammett

Ellen Hays

Sandra Hoffman

Jeffrey Holland

Civil Service Retirement, Social Security, Pension Benefit Guarantee

Corporation

Medicare

Unemployment insurance, training programs

Medicaid

Medicare

Education

Medicare

Federal employee health benefits, national health expenditures

Social services, food stamps, child nutrition

Medicaid

Supplemental Security Income, Social Security

Public Health Service

Aid to Families with Dependent Children, child support enforcement

Energy, pollution control and abatement

Energy, Outer Continental Shelf receipts

Science and space, justice, general government

Conservation, land management

Agriculture

Deposit insurance, Postal Service, legislative branch

Agriculture

Agriculture, water resources

Justice, Federal Housing Administration, general government

Spectrum auction receipts

Transportation

Recreation, water transportation

Community and regional development, natural resources

Deposit insurance

Housing and mortgage credit

Commerce, disaster relief

Appropriation bills

Authorization bills

Appropriation bills

Budget projections, historical budget data, other interest

Appropriation bills

Computer support

Computer support

Credit programs

Computer support

Net interest on the public debt, national income

and product accounts
APPENDIX C MAJOR CONTRIBUTORS TO THE REVENUE AND SPENDING PROJECTIONS 61

Deborah Keefe Computer support

Daniel Kowalski Credit programs

Catherine Mallison Appropriation bills

Robert Sempsey Appropriation bills

Susan Strandberg Budget projections, civilian agency pay


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