The Budget for Fiscal Year 2009
Released: 2008-09-11T00:00:00

Overview

The Bush Administration released The Budget of the U.S. Government, Fiscal Year 2009 on February 4, 2008. The full set of budget documents ( Budget, Appendix, Analytical Perspectives, Historical Tables , as well as several other supplemental budget documents) contains detailed budget information, including estimates of the budget without the proposed policy changes (known as "current service baseline" estimates), historical budget data, detailed budget authority, outlay and receipt data, selected analysis of specific budget-related topics, and the Administration's economic forecast. The budget documents outline the Administration's policy proposals and expectations from FY2008 through FY2013. The documents also discuss long-term fiscal issues facing the nation and provide historical data on previously enacted appropriations, past outlays and revenues, and other budget items.

The Administration foresees a steady improvement of the federal government's fiscal position, including a surplus of $29 billion in FY2013, the last year projected, although the FY2013 on-budget deficit, which excludes Social Security surpluses, is projected at $201 billion. Administration projections omit all costs of wars in Afghanistan and Iraq beyond FY2008 aside from a $70 billion supplemental request. Federal deficits are projected to rise rapidly after FY2020. Major Administration proposals include extensions of the expiring tax cuts, limited increases in domestic discretionary spending, and halting the expanding reach of the alternative minimum tax (AMT) for calendar 2008, but not for later years. Medicare and Medicaid are expected to grow more slowly than in recent years.

The congressional budget process, which includes the annual budget resolution and appropriations bills, begins once the Administration submits its budget to Congress. As Congress deliberates over the budget, the Administration often revises its proposals as it interacts with Members of Congress and as national and international economic conditions change.

On March 7, 2008, the House and Senate Budget committees reported budget resolutions ( S.Con.Res. 70 and H.Con.Res. 312 ). The House passed its budget resolution on March 13 by a 212 to 207 vote, and the Senate passed its version in the early hours of March 14 by a 51 to 44 vote. In each chamber, a large number of amendments were considered before adoption to budget resolutions. Both resolutions include a one-year alternative minimum tax (AMT) fix.

The House agreed to an amended version of S.Con.Res. 70 on May 14 without objection, which laid the groundwork for a conference committee. The budget conference report, H.Rept. 110-659 , was filed on May 20. The next day, the House cleared the way for consideration of the conference agreement by passing H.Res. 1214 . On June 4, 2008, the Senate passed the S.Con.Res. 70 conference report on a 48-45 vote, and the House passed it the next day on a 214-210 vote. House passage of the FY2009 budget resolution automatically passed and transmitted to the Senate legislation ( H.J.Res. 92 ) to raise the debt limit.

Budget Totals

Table 1 contains budget estimates for FY2009 from CBO, the Administration (the Office of Management and Budget, OMB), and Congress (House and Senate Budget Committees). Estimated budget totals can vary due to differing underlying economic, technical, and budget-estimating assumptions and techniques, as well as differences in policy assumptions. Minor differences in underlying assumptions, which may generate small short-term discrepancies, can produce wide divergences in projected long-term budget paths. Budget estimates issued by the President, CBO, Congress, or by others, should be expected to change as new data arrive or as economic conditions change.

The economic slowdown caused by financial turmoil and rising commodity prices that started in the third quarter of 2007 has continued to affect budget estimates and projections. Early in 2008, CBO predicted that economic growth would slow in calendar year 2008 and recover in 2009. The President's budget acknowledged economic challenges, but predicted strong growth in both 2008 and 2009. Over the course of 2008, the economy weakened according to many measures such as employment, although other measures such as economic growth and household consumption did not slow as much as some had expected. As a result of the deepening of the economic slowdown, OMB and CBO in summer 2008 adjusted forecasts of revenues downwards and outlays upwards. CBO's September 2008 baseline estimate for FY2009 revenues ($2.817 trillion) was $97 billion below its January figure ($2.720 trillion), while the September baseline estimate for outlays ($3.158 trillion) was $143 billion above the January estimate ($3.015 trillion).

Outlays and Budget Authority

Spending in Table 1 is shown in terms of outlays, which are federal funds disbursed in a given time period. Many budget documents also report spending in terms of budget authority, which reflects the amount of money federal agencies are legally allowed to spend. Budget authority has been compared to funds deposited into a checking account, which then can be used for federal purposes. Outlay data are more convenient for assessing the macroeconomic effects of the federal budgets, while analysts focusing on specific federal programs typically rely on budget authority figures. Appropriations legislation is generally framed in terms of budget authority, because Congress can control the amount of funds made available for specific purposes. The timing of federal outlays, on the other hand, often depends on administrative decisions of federal program officials, made within bounds set by Congress. This report focuses on outlays, rather than budget authority, in order to highlight broader effects of the federal budget on the economy.

Budget Estimates and Proposals

CBO Baseline Projections

CBO's first budget report for the FY2009 budget cycle, released in January 2008, contained current-law budget baseline and economic projections for FY2008 through FY2018. This report projected a FY2009 current-law baseline deficit of $198 billion, up slightly from the FY2007 deficit of $162 billion. This projection, however, assumed that AMT relief would lapse and that the FY2009 costs of wars in Iraq and Afghanistan would be a little less than costs in FY2008. That CBO baseline projection showed a surplus of $87 billion emerging in FY2012 that was expected to rise to $223 billion in FY2018.

CBO baseline projections are computed using certain assumptions set by law. These assumptions typically yield higher revenue estimates and projections of slower growth of discretionary spending relative to scenarios that independent forecasters consider likely. Three key assumptions incorporated in CBO baseline projections are that discretionary spending remains constant in inflation-adjusted terms; the 2001 and 2003 tax cuts fully expire after 2010 (as current law specifies); and the "patch" to the alternative minimum tax (AMT), which currently applies to tax year 2007, would lapse. After 2010, when most of the tax cuts from 2001 and 2003 expire, according to baseline projections, receipts grow substantially. The assumption that these tax cuts expire and that growth in discretionary spending is zero in real terms explains most of the declining deficit and the surpluses that emerge over the 10-year baseline forecast window. Nonetheless, unless major policy changes are made, federal deficits are expected to grow rapidly beyond the 10-year forecast window, largely because of rapidly growing health care costs and the retirement of the baby boomers.

CBO's January report also included estimated budgetary effects of selected policies on revenues and outlays. These included estimates of the costs of making the 2001 and 2003 tax cuts permanent and indexing the AMT for inflation to limit its expanding coverage. CBO also presented projections based on assumptions that differ from current-law baseline assumptions. One alternate projection assumed that discretionary appropriations increase at the rate of growth of gross domestic product (GDP), which leads to faster growth of outlays relative to the baseline. Another alternative projection assumed that total discretionary appropriations would be frozen at FY2008 levels, yielding slower growth in outlays relative to the baseline.

Estimated cost savings for troop reductions are also reported: reducing troops deployed to Iraq, Afghanistan, and other Global War on Terror postings to 75,000 by FY2013 would reduce outlays (including borrowing costs) by $250 billion over the FY2009-FY2013 period relative to baseline levels.

In February 2008, CBO issued an update of its economic projections due to new evidence of slower economic activity, interest rate cuts and other actions taken by the Federal Reserve, and the economic stimulus package. The revised estimates showed slightly faster economic growth in FY2008 due to fiscal stimulus measures, but slightly slower growth in FY2009, when those measures lapse. The cost of the economic stimulus package and slower economic growth imply increases in federal budget deficits in the short-run.

CBO Analysis of the President's Budget

At the beginning of March 2008, CBO published a preliminary analysis of the President's FY2009 Budget. This analysis included the effects of the Economic Stimulus Act of 2008 ( P.L. 110-185 ), which was projected to raise the FY2008 budget deficit by $152 billion and the FY2009 deficit by $16 billion. In addition, forecasts reflected lower interest rates, which helped increase projected economic growth rates and reduce borrowing costs. CBO estimated smaller short-run deficits than OMB, largely due to lower estimates of defense costs. On the other hand, CBO projected slightly higher deficits in later years.

Administration Projections and Proposals

President Bush's FY2009 budget proposed a permanent extension of most of the 2001 EGTRRA and 2003 JGTRRA tax cuts, as well as extending other expiring tax provisions. When borrowing costs are included, the President's proposals would raise the deficit by a projected $692 billion between FY2009 and FY2013 relative to the baseline, and by $2.7 trillion between FY2009 and FY2017, according to Administration estimates.

The Administration's proposals, according to its own estimates, would reduce mandatory spending by $96 billion over 5 years and by $309 billion over 10 years. Proposed policy changes include both spending reductions and some increases—termed "augmentations" by the Administration. The budget included a cost estimate of $637 billion over 10 years for proposed personal accounts for Social Security. The Administration estimated its mandatory spending proposals, including indirect effects and the outlay effects of tax proposals, would yield 5-year savings of $59 billion and a 10-year increase in spending of $359 billion. The proposed introduction of personal Social Security accounts is responsible for most of that projected increase.

The Administration's budget provided limited information for years beyond FY2013. The budget included estimates of the cumulative proposed revenue changes and proposed mandatory spending changes for the periods FY2009 through FY2013 and FY2009 through FY2018, but these projections omitted data for individual post-FY2013 years. Estimates for other components of the budget or for budget totals beyond FY2013 were also omitted.

The President proposed elimination or major reductions in 151 programs, which the Administration maintains would save $18 billion of budget authority in FY2009 compared to FY2008. Many of these proposals, affecting both discretionary and mandatory spending programs, were also proposed last year, when elimination or major reductions were proposed for 141 programs.

CBO Scoring of FY2009 Appropriations Bills

CBO estimates the spending totals for discretionary appropriations legislation according to the specifications of budget legislation, a process usually known as "scoring." For each category corresponding to a regular appropriations bill, CBO estimates new budget authority and outlays for non-emergency and emergency spending, along with a comparison with 302(b) allocations. Emergency spending is generally treated differently than non-emergency spending in budget legislation.

Projections of a Federal Surplus in FY2012

Both the CBO baseline projections and Administration forecasts show a budget surplus in FY2012, which would be the first surplus since FY2001. Independent analysts note these forecasts are based on assumptions chosen for the specific purpose of budgetary scorekeeping, rather than on assumptions meant to generate predictions of likely future outcomes. For example, funding for military operations after FY2009 is omitted for budgetary scoring purposes. Projected future outlays would be far higher were these war costs included in projections. These proposals also all assume a sharply larger portion of middle-income taxpayers will become subject to the alternative minimum tax (AMT) after calendar 2007, even though in recent years Congress and the President have agreed to annual fixes to limit the AMT's reach. Assuming that AMT fixes lapse boosts estimated tax revenues. The President's budget proposes no real growth in discretionary spending over the five years, while historically, discretionary outlays have been more likely to grow at the same rate as the overall economy.

Issues Regarding Budget Projections

Budget projections depend on models that reflect assumptions about the structure of the economy, expected tax and program changes, and how these interact, along with other factors that affect the budget. Changed economic conditions, such as faster or slower economic growth, higher or lower inflation, or new spending and tax policies, affect budget estimates and projections. In addition, technical components of the budget models may change as the structure of the economy evolves and as econometric techniques advance.

Budget forecasts, unlike most other types of economic forecasts, are constructed in order to estimate the incremental costs of policy changes (i.e., scoring) in a consistent manner. If policy changes do occur, actual budget outcomes will then differ from baseline estimates. Technical factors and changes in economic conditions also affect budget forecasts. In recent years, OMB and CBO have provided information about how past forecasts have varied from actual results.

CBO has analyzed the track record of its budget estimates extensively and now routinely includes information about its forecast record of baseline projections in its budget publications. CBO also provides detailed explanations of why its projections differ from OMB projections. CBO routinely provides a breakdown of economic, legislative, and technical factors responsible for divergences between past forecasts and actual outcomes. The FY2009 budget documents contain an OMB analysis of the divergence between the Administration's February 2006 budget estimates and actual results for FY2007. Differences are decomposed into (1) legislative and administrative changes, (2) changed economic conditions, and (3) technical factors.

Budget estimates depend in part on some stable trends, such as population demographics. For instance, many baby boomers will retire in the next decade, leading to higher spending for Medicare and Social Security. Estimating the growth in these beneficiary populations eligible for these programs is relatively straightforward. Budget estimates also depend on factors that are difficult to predict, such as future productivity growth and business cycles. Some factors that effect federal revenues, such as financial market trends, can be extremely volatile.

Small changes in economic conditions, such as GDP growth, can produce large changes in the budget estimates. According to CBO estimates, a persistent 0.1% decrease in the real GDP growth rate would increase a deficit, including interest costs, by $61 billion cumulatively over a 5-year period and by $273 billion over 10 years. Faster GDP growth would decrease deficits. In addition, new government policies also affect budget estimates. For example, extending military operations in Iraq or Afghanistan or allowing tax cuts to lapse would also change the budget outlook.

Accuracy and Statistical Bias in Budget Forecasts

Budget projections are inherently uncertain. Two measures of the quality of economic forecasts are statistical unbiasedness , meaning that average forecast errors over time are close to zero, and accuracy , meaning that forecast errors should be small. An unbiased forecasting method may be of little use if forecast errors are large. On the other hand, some forecasting methods may sacrifice unbiasedness in order to gain greater accuracy. Most forecasters try to produce projections that are both unbiased and accurate, as far as possible.

The President's FY2009 budget includes measures that can be used to assess the accuracy and statistical bias of previous forecasts. The accuracy of forecasts generally declines as the forecast window extends to later years because more policy and economic changes can occur in the interim. OMB has analyzed February budget estimates of the deficit since FY1982 and estimated the standard deviation of $70 billion for the current fiscal year and $140 billion for the budget year estimate. The standard deviation of Administration budget year deficit/surplus estimates for the period FY1994-FY2001was $77 billion and $237 billion for the period FY2002-FY2007. The standard deviation for the corresponding four-years-ahead forecast was $284 billion, about four times larger.

OMB used its standard deviation estimate to compute upper and lower bounds for deficit projections. The gap between these upper and lower bounds at the end of a five-year period was over $1.1 trillion, suggesting that the Administration's $29 billion point estimate for the FY2013 surplus, like all five-years-ahead forecasts of fiscal balance, is imprecise.

Congressional Budget Action

On March 7, 2008, the House and Senate Budget Committees reported budget resolutions ( S.Con.Res. 70 and H.Con.Res. 312 ). The House passed an amended version of its budget resolution on March 13 by a 212 to 207 vote, and the Senate approved its version, also including amendments, in the early hours of March 14 by a 51 to 44 vote. In both chambers, a large number of amendments were considered. Both budget resolutions included a one-year fix for the AMT in tax year 2008. The House resolution included reconciliation instructions that would offset the cost of the AMT fix, while the Senate resolution omitted offsets for the AMT fix. According to media reports, the House resolution contained $25.4 billion more (including cap adjustments and advance funding) in non-emergency discretionary budget authority than the $991.6 billion figure requested by the President for FY2009.

The Senate budget resolution called for $21.8 billion in non-emergency discretionary budget authority above the level requested by the President. The Senate version presumes the key 2001 and 2003 tax cuts, including the 10% tax bracket and the child tax credit, would be extended beyond their scheduled 2010 expiration date. The Senate resolution also included a $35 billion economic stimulus package. Approval of House and Senate budget resolutions cleared the way for negotiations for a conference agreement. After several weeks of negotiation between House and Senate budget committees, the House agreed to an amended version of S.Con.Res. 70 on May 14 without objection, paving the way for a conference committee. The conference report ( H.Rept. 110-659 ) was filed on May 20, and on the next day, the House approved H.Res. 1214 , passed on a 220 to 199 vote, clearing the way for consideration of the conference agreement.

Conference Negotiations and Agreement

After several weeks of negotiation between House and Senate Budget Committees, the House agreed to an amended version of S.Con.Res. 70 on May 14 without objection, paving the way for a conference committee. The conference report ( H.Rept. 110-659 ) was filed on May 20, and on the next day, the House approved H.Res. 1214 , passed on a 220 to 199 vote, clearing the way for consideration of the conference agreement. On June 4, 2008, the Senate passed the S.Con.Res. 70 conference report on a 48-45 vote, and the House passed it the next day on a 214-210 vote. House passage of the FY2009 budget resolution automatically passed and sent to the Senate a resolution ( H.J.Res. 92 ) to raise the debt limit to $10.615 billion.

Outlays

The Administration's budget proposed FY2009 outlays of $3,107 billion, about $92 billion above the CBO baseline. Both the Administration and CBO have issued projections of future federal outlays. In addition, the budget resolutions passed by House and Senate Budget Committees, which reflect Congress's priorities, specify future paths for spending and revenues. Table 2 summarizes these projections.

CBO Current-Law Baseline Projections

CBO's January 2008 baseline projections for FY2008-FY2018 showed outlays rising from 20.2% of GDP in FY2008 to 20.4% of GDP in FY2009, before falling to 19.3% of GDP in FY2013. Revised baseline projections issued in March 2008 estimated FY2008 outlays would be 20.4% of GDP and that FY2009 outlays would be 20.3% of GDP.

CBO's baseline assumptions, in which total discretionary spending increases at the rate of inflation, imply that projected discretionary spending falls as a percentage of GDP over time. Because CBO current-law baseline estimates assume that discretionary spending stays fixed in real terms as the economy grows, many analysts believe it understates likely future growth in discretionary spending. Table 3 summarizes the costs of discretionary spending under different assumptions.

According to September 2008 CBO projections, federal outlays (aside from the costs of wars in Iraq and Afghanistan) would grow by an additional $295 billion over the FY2009-FY2013 period were discretionary spending to grow at the same rate as the economy. On the other hand, if discretionary spending were fixed at FY2008 levels over the same period, federal outlays would drop by $420 billion relative to baseline trends.

Discretionary Defense Outlays

The CBO Baseline and Discretionary Defense Spending

Interpreting CBO's projection of future discretionary defense spending requires some background on how those projections are constructed. CBO's projections of future discretionary defense spending are based on enacted budget authority for discretionary defense programs for the current fiscal year, adjusted for inflation. The spending in the baseline projection can change significantly during the course of the year because of the enactment date of supplemental appropriations for war-related activities. In recent years, Congress has provided some funding for wars in Iraq and Afghanistan near the start of the fiscal year, but has enacted the majority of the funding later in the year. Thus, the baseline projections prepared by CBO in January and March contain only a portion of the funding that may ultimately be provided in that fiscal year. Those projections will understate expenditures for war if the number of deployed forces and the operational tempo remained unchanged from current levels.

CBO Projections of Discretionary Defense Spending

Discretionary defense spending, according to January 2008 CBO baseline projections, will rise from $549 billion in FY2007 to $572 billion in FY2008. Those CBO projections also show discretionary defense spending rising to $645 billion in FY2013 and to $723 billion in FY2018. Discretionary defense spending, 4.0% of GDP in FY2007, would fall to 3.6% of GDP in FY2013 and to 3.2% of GDP in FY2018 according to CBO baseline projections.

Alternative Defense Scenarios

CBO has also projected the budgetary effects of reducing the number of troops deployed to Iraq and Afghanistan, and elsewhere in the war on terrorism. In the first alternative scenario, all but 30,000 deployed troops to Iraq, Afghanistan, and related operations would be withdrawn by 2010, reducing projected discretionary spending and interest costs relative to the current-law baseline by about $425 billion over the period FY2009-FY2018. In the second alternative scenario, forces would be withdrawn more slowly—declining to 75,000 troops by 2013, which would add about $225 billion in projected discretionary spending and interest costs over the period FY2009-FY2018 relative to the current-law baseline. As noted above, the outlays in the January 2008 baseline were based on an extrapolation of the $86.8 billion in budget authority provided for war-related activities in 2008 as of January of that year.

Nondefense Discretionary Spending

CBO projects nondefense discretionary spending will rise from $493 billion in FY2007 to $520 billion in FY2008, to a projected $571 billion in FY2013, and to $637 billion in FY2018. Non-defense discretionary spending as a percentage of GDP, according to CBO baseline projections, will fall from 3.6% of GDP in FY2007 to 3.2% of GDP in FY2013, and to 2.8% of GDP in FY2018. Because current-law baseline projections are based on the assumption that discretionary spending does not grow in real terms while the economy is projected to continue growing, both the CBO and Administration projections show discretionary spending shrinking over time relative to GDP.

Mandatory Spending

The March 2008 CBO mandatory spending baseline projects an increase from $1,577 billion in FY2008 to $1,664 billion in FY2009. Mandatory spending, according to CBO projections, will increase to $2,031 billion by FY2013 and to $2,725 billion by FY2018. Mandatory spending as a share of GDP, according to CBO baseline projections, will change little, moving from 11.1% in FY2008 to 11.2% in FY2013. At the end of the 10-year time frame, CBO projections show mandatory spending edging up to 12.2% of GDP in FY2018.

Administration Projections

The Administration's FY2009 budget proposed $3,107 billion in outlays, rising to $3,399 billion in FY2013, the last year shown in the President's budget.

The proposals would boost funding for defense and homeland security spending in FY2008 and FY2009 and would hold growth in nondefense, non-homeland security discretionary spending below 1% a year, implying a slight decrease in real terms. The Administration proposed measures to slow the growth of Medicare and Medicaid and other mandatory programs slightly. Total mandatory spending, however, would increase under the proposals. The Administration also proposed spending $30 billion in FY2013 to fund personal Social Security accounts.

The proposed level of FY2009 outlays, $3,015 billion, exceeded the Administration's FY2009 current services baseline ($2,993 billion) by $114 billion (3.8%). Proposed FY2009 mandatory spending would be $18 billion below baseline. The Administration's budget showed net interest payments increasing from $260 billion in FY2009 to $300 billion in FY2009 due to increased federal borrowing.

The Administration's proposals would increase outlays to 20.7% of GDP in FY2009, up from 20.0% of GDP in FY2007. Between FY1966 and FY2006, outlays averaged 20.6% of GDP. By FY2012, the Administration's projections show outlays falling to 18.5% of GDP, lower than in any year since FY1966.

The overall $176 billion increase in outlays from FY2008 to FY2009 is due to many factors, including automatic cost-of-living adjustments in many federal programs, growth in populations eligible for program benefits, increased spending on military and veterans' programs, policy changes, and higher costs due to inflation of goods and services bought by the federal government.

Spending on Defense and Security

For FY2009, almost all of the increase in discretionary spending comes from what the Administration calls "security" activities, which comprise spending for defense, homeland security, and foreign affairs. Most of the proposed additional security funding is for the wars in Iraq and Afghanistan. Medium-term projections, however, show a decrease in defense spending, mostly due to the omission of post-FY2009 war costs. National defense spending, which OMB projects will reach 4.0% of GDP in FY2009, is projected to fall to 3.2% of GDP in FY2013.

Congress approved $86.8 billion in supplemental funding for FY2008. An additional $102.5 billion requested by the Administration has not been approved. In addition, the Administration has requested $70 billion in emergency supplemental funding for FY2009. On May 15, 2009, the House approved a military construction appropriations bill ( H.R. 2642 ) that would provide supplemental appropriations for FY2008 and FY2009. On May 22, the Senate approved an amended version of the bill that would provide $99.5 billion for FY2008 and $65.9 billion in FY2009 in supplemental appropriations to fund military operations in Iraq and Afghanistan.

Some analysts also note that while the Department of Defense accounts for the bulk of spending in the functional category of national defense, that category includes some Department of Energy programs as well as certain mandatory spending, such as contributions to military retirement programs. The Administration estimated spending on the national defense function will total $603.7 billion in FY2008 and proposes spending $670.7 billion in FY2009.

Non-defense or "Non-Security" Discretionary Spending

The Administration proposed $393.0 billion in net "non-security" discretionary budget authority for FY2009 and for subsequent years until FY2013, just slightly above the enacted FY2008 level of $392.7 billion (not counting $104.4 billion in supplemental and emergency funds enacted for FY2008). Holding "non-security" discretionary budget authority constant implies a proposed cut in real terms equal to the inflation rate, which CBO projects to run about 2% from FY2009 through FY2013.

The Administration proposed $482 billion in "non-security" discretionary outlays, just slightly above the estimated FY2008 level of $481 billion. According to Administration projections, "non-security" discretionary spending will decline sharply after FY2009, reaching $429 billion in FY2013.

Future federal health care spending is expected to remain close to the 5.3% of GDP projected for FY2009, although many analysts expect health care prices and costs to rise faster than GDP in the future. Federal spending on Medicare (net of beneficiary premiums) and Medicaid accounted for 4% of GDP in 2007. CBO current-law projections show that share rising to 7% in 2025, 12% in 2050, and 19% in 2082. Thus, federal spending on Medicare and Medicaid in 2082 is projected to take up about roughly the same proportion of GDP as total federal government spending took up in the late 1990s.

Mandatory Spending

Mandatory spending in the President's budget would grow by 5.5% ($1,551 billion) from FY2008 to FY2009 ($1,636 billion). According to the Administration, mandatory programs will increase from $1,636 billion in FY2009 (10.9% of GDP) to $2,034 billion in FY2013 (11.2% of GDP). The budget included proposals to reduce mandatory outlays from baseline levels by $17.1 billion in FY2009, with larger reductions in later years. The reductions would be achieved by slowing the growth of selected mandatory spending activities such as Medicare and Medicaid, among others. The Administration estimated that these measures would reduce total mandatory spending from baseline levels over the five-year period FY2009-FY2013 by $178 billion. By comparison, mandatory spending over the same period is projected to total over $9 trillion. The Administration's mandatory spending reductions would thus cut about 2% from mandatory spending over FY2009-FY2013. Even if those cuts were enacted, mandatory spending would remain the largest broad category of federal spending.

Net Interest

The President's FY2009 budget showed net interest outlays rising from $244 billion in FY2008 to $260 billion in FY2009, as growing federal debt outweighs the effects of lower interest rates. Federal debt has grown rapidly in recent years, and under the Administration's proposals, will continue to grow. Higher debt, even with lower interest rates, is projected to require higher net interest payments in the future. Proposed net interest outlays in FY2009 exceed the Administration's FY2009 current services baseline estimate by $3 billion. The Administration's policy proposals would raise FY2013 net interest outlays $18 billion above their current services estimate. According to Administration estimates, net interest payments will run about 1.7% of GDP over the five-year period.

Trends in Outlays by Category of Spending

Figure 1 shows spending trends by category as percentages of GDP. The figure shows actual outlays for defense, nondefense, mandatory, and net interest spending from FY2000 through FY2007; estimated amounts for FY2008; and the Administration's proposals from FY2009 though FY2013. According to those proposals, defense and nondefense discretionary spending as a share of GDP will decline over the five-year period FY2008-FY2013, while mandatory spending is projected to increase.

The downturn in defense and nondefense discretionary spending relative to GDP after FY2009 depends on the Administration's assumptions that nondefense discretionary spending falls after 2008 and that no additional spending is provided for the ongoing military operations overseas after FY2009.

The President's proposed limited reductions in mandatory spending from current service baseline levels keep mandatory spending as a share of GDP stable. The proposed introduction of private Social Security accounts in FY2013 would lift mandatory spending relative to GDP above the current services level.

Figure 2 shows historical data on outlays since FY1990 and five sets of projections of outlays as a percentage of GDP through FY2018:

the President's FY2009 budget proposal (February 2008), OMB's Current Service Baseline (February 2008), a March 2008 preliminary CBO analysis of the President's FY2009 proposals, and the January 2008 and March 2008 CBO baselines.

The Administration's outlook runs through FY2013, while the CBO outlook runs through FY2018. The figure includes actual outlays as a percentage of GDP for FY2000 through FY2007 and average (FY1966-FY2007) outlays as a share of GDP.

The President's proposed outlays fall sharply after FY2009, a result of the Administration's proposals to reduce discretionary spending, both defense and nondefense, and to moderate the rate of growth in some mandatory programs. By FY2012, spending as a percentage of GDP would be at the same level as in FY2001. In FY2011 and later years, according to CBO projections, the President's spending levels (which omit war costs in those years) run about 1% of GDP lower than current-law baseline projections.

An alternative CBO estimate incorporates two important assumptions that directly affect outlays. First, discretionary appropriations grow at the same rate as the overall economy, in contrast to the baseline assumption that discretionary spending is constant in real terms. Second, the number of troops deployed in Iraq and Afghanistan as well as other anti-terror activities is assumed to fall to 75,000 by FY2013. Both of these assumptions increase outlays above the current-law baseline projections, increasing the deficit (or reducing a possible future surplus), increasing federal debt and subsequent net interest payments. The alternative estimate includes these higher net interest payments. In addition, the alternative estimate for outlays includes the outlay effects of the changes that occur in the alternative estimate for receipts, which is described in more detail in the next section. These outlay effects, for the most part, reflect higher net interest payments.

Outlays By Function

Federal spending can be classified by superfunction, function, and subfunction of government. Superfunctions are National Defense, Human Resources, Physical Resources, and Other Functions. Functional breakdowns of federal spending reflect resources directed towards particular goals and cut across usual bureaucratic boundaries. For example, the National Defense function (and superfunction) includes spending by parts of the Department of Energy as well as the Department of Defense outlays, which comprise the bulk of National Defense outlays. Other Department of Energy outlays fall within the Physical Resources superfunction. In some cases, such as spending on Coast Guard patrols in major ports that support commerce, recreation, and national security, outlays are not easily and neatly divided between subfunction.

Figure 3 shows FY2008 outlays by function as estimated by the Administration. National defense, at an estimated 22.4% of FY2008 outlays, accounts for the largest share of federal spending. Social Security and Medicare are the next largest functional categories.

Receipts

Administration and CBO projections of the future path of federal receipts are summarized in Table 4 . Because economic conditions strongly affect federal revenue streams, forecasts of federal receipts beyond the immediate short term are necessarily imprecise.

The last few fiscal years have seen unexpectedly rapid growth in receipts, in part due to strong economic growth. After three years of falling receipts from FY2000 through FY2003, federal receipts grew by 5.5% from FY2003 to FY2004, by 14.5% from FY2004 to FY2005, and by 11.8% from FY2005 to FY2006. Receipts, according to OMB, rose from 16.4% of GDP in FY2004, the lowest level for receipts since FY1959, to 18.8% of GDP in FY2007.

Recent indications of slower economic growth are expected to slow the growth of federal receipts, at least in the short run. Corporate tax receipts and capital gains receipts can be especially sensitive to cyclical economic conditions. In addition, tax provisions of the Economic Stimulus Act of 2008 will temporarily reduce federal revenues' share of GDP. Both CBO and OMB estimate that federal revenues as a share of GDP will drop in FY2008 and will then gradually rise in the following years.

Administration Revenue Projections

Receipts rise, in current dollars, by 7.1% ($179 billion) from FY2008 to FY2009 under the Administration's FY2009 budget proposal. Over the five-year forecast, receipts in nominal terms rise by $907 billion, a 36% increase over FY2008. The President's proposals would extend and make permanent most of the tax cuts slated to expire at the end of calendar 2010 or before. Tax reductions in the Administration's economic stimulus proposals, according to OMB, will push federal receipts, as a share of GDP, to 17.6% in FY2008. That share is then projected to rise to 18.8% in FY2013.

Excise and other receipts were both less than 1% of GDP for all years shown. The Administration projects that corporate income taxes, which rose to 2.7% of GDP in FY2006 and FY2007, will decline slowly to 2.1% of GDP in FY2013. Social insurance receipts, at 6.4% of GDP in FY2008, remain stable through FY2013. The Administration projects that individual income taxes, having fallen from 10.3% of GDP in FY2000 to 7.0% of GDP in FY2004, will rise to 9.4% of GDP in FY2013, about 1% of GDP below their FY2000 level.

Administration Revenue Proposals

The Administration estimated that making the 2001 and 2003 tax cuts permanent would reduce cumulative receipts by $635 billion from baseline levels between FY2009 and FY2013 and by $2,076 billion between FY2008 and FY2017. Administration revenue proposals, apart from proposals incorporated in the Administration baseline, would reduce receipts by an estimated $228 billion in the first 5 years and by $233 billion over 10 years.

The budget also proposes a one-year fix to limit expansion of the AMT's coverage through calendar 2008 at an estimated cost of $46.7 billion. The AMT will cover a rapidly growing proportion of middle-class taxpayers unless a sequence of temporary AMT fixes or a permanent change in the AMT's structure is enacted. No fix for subsequent years was proposed, although Congress has passed and the President has signed AMT fixes each year in recent years.

CBO estimates that indexing AMT thresholds for inflation would cost on average $72.4 billion a year over the next 10 years, plus another $18.9 billion in debt financing costs. Although the President's budget called for limiting the growing reach of the AMT, it omitted estimates of the five-year cost of such a fix. Omitting these estimates, in effect, increases the Administration's post-FY2009 estimates of federal receipts substantially above what they would be with an AMT fix.

As shares of GDP, total receipts in the President's budget are expected to remain near their 40-year (FY1966-FY2007) average of 18.3% throughout the five-year budget horizon. CBO's baseline revenue estimates (revised, March 2008), which exclude the extension of the 2001 and 2003 tax cuts, are larger, rising to 20.0% of GDP in FY2012.

CBO Revenue Projections

The March 2008 CBO preliminary analysis of the President's FY2009 policy proposals projected slightly lower revenues in FY2008 than the President's budget, in part because the CBO estimate reflected recent fiscal stimulus legislation. In later years, CBO revenue estimates of the Administration's budget were very close to or slightly above OMB projections. CBO baseline revenue estimates released in March 2008 were lower than January estimates, in large part due to the passage of the Economic Stimulus Act of 2008. To a lesser extent, baseline revenue projections changed due to changing economic conditions. CBO baseline revenue projections show receipts rising once the 2001 and 2003 tax cuts expire, rising from 18.6% of GDP in FY2010 to 20.0% of GDP in FY2012.

CBO also calculated revenue estimates and projections using alternative policy assumptions. The alternative estimate assumes the extensions of all expiring tax cuts, an annual adjustment to the AMT to halt its expanding coverage, and the interaction effect of the extensions and the AMT. AMT reform would interact with the extension of the 2001 and 2003 tax cuts, producing greater revenue losses than the two changes separately. These alternative policies, according to CBO estimates, would produce slower growth in receipts, both in dollars and as shares of GDP, compared to CBO's current-law baseline. Table 5 summarizes CBO estimates of the five-year costs of selected revenue policies.

If the costs of permanently extending the EGTRRA and JGTRRA tax cuts, which the Administration has proposed, were included in the baseline, a projected future deficit would be larger by $692 billion, aside from financing costs, over the five-year period FY2009-FY2013. Similarly, indexing the AMT for inflation, which Congress has done on a temporary basis in recent years, would raise the five-year deficit projection by $313 billion. The costs of indexing the AMT and of extending EGTRRA and JGTRRA tax cuts interact in important ways. Costs of the EGTRRA and JGTRRA tax cuts would be much larger if the AMT did not cover as many households.

Revenue Projections in Historical Perspective

Figure 4 shows the level of historical and projected federal receipts as a percentage of GDP. Historical receipts are shown for FY2000 through FY2007. The figure shows CBO baseline revenue projections from January and March 2008 budget reports, the President's February 2008 budget submission for FY2009, a March 2008 CBO analysis of the President's revenue proposals, and the OMB current service baseline. Federal receipts averaged 18.4% of GDP over the period FY1990-FY2006, indicated by the horizontal line.

Revenue projections for the OMB Current Service baseline and the CBO current-law baseline remain close through FY2010. Baseline projections for FY2008 computed before passage of the Economic Stimulus Act of 2008 show higher revenues, of course, than later projections. CBO baseline estimates for FY2011 and later years are substantially higher than projections of future revenue for the President's budget. CBO projects that receipts will rise to 20.3% of GDP in FY2018.

Federal Revenues By Type

Figure 5 shows trends in federal revenue sources as a percentage of GDP since FY1990 as well as OMB projections, which extend until FY2013, and CBO baseline projections, which extend until FY2018. Federal revenue sources strongly affected by cyclical economic conditions and major legislative changes, such as individual and corporate income taxes, have varied sharply over time. Other revenue sources, such as social insurance taxes, have been stable as a share of the economy. Individual income taxes are the largest revenue source for the federal government, followed by off-budget social insurance taxes. Social Security payroll (OASDI) taxes comprise nearly all of the off-budget social insurance tax category.

Deficits and Surpluses

Deficits occur when Congress and the President enact policies that cause federal spending to exceed federal receipts. Deficits increase government debt held by the public, generally increasing net interest payments. Surpluses occur when federal receipts exceed outlays, which reduces federal debt held by the public. This can, in turn, reduce net interest payments. Many economists believe that running surpluses when economic growth is strong and deficits when the economy is weak helps dampen macroeconomic fluctuations. The federal government last ran a surplus in FY2001, which amounted to $128 billion or 1.3% of GDP.

Long-term CBO and OMB projections both show substantial increases in budget deficits in the years after FY2020. These deficits result from a projected gap between rising federal outlays and revenues. The growth of health care spending, as well as demographic changes, plays an important part of those fiscal trends.

Table 6 summarizes Administration and CBO projections of total federal deficits and surpluses. The FY2007 total deficit, $162 billion, was well below the Administration's estimate in the FY2008 budget.

Administration Deficit Projections

The President's February budget estimated the FY2008 deficit at $410 billion (1.6% of GDP) and a small surplus of $29 billion in FY2013. The Administration's current service baseline estimates, which assume no policy changes, showed surpluses appearing in FY2010, two years earlier than the budget reaches a surplus. The dramatic increase in the FY2008 and FY2009 deficits compared to the FY2007 deficit is largely due to fiscal stimulus measures enacted to respond to weakening economic conditions, higher military spending, and various legislative changes.

Reaching the budget's deficit reduction goals during the next five years, according to the Administration, requires strict limits on the growth in total discretionary spending and slower growth of entitlement spending. Some of the President's proposals would increase spending or reduce receipts, requiring larger spending reductions in other areas of the budget, since the Administration has opposed using tax increases to reduce the deficit. If war costs, which are omitted for post-FY2009 years in the President's budget, continue at high levels, deficit reduction efforts will face additional challenges.

CBO Deficit Projections

CBO, by law, must use assumptions for current-law baseline projections that some analysts consider optimistic. Baseline revenue projections assume that temporary fixes to halt the expanding coverage of the AMT expire at the end of 2008, as current law specifies, and that the 2001 and 2003 tax cuts expire at the end of 2010. These assumptions boost revenues considerably compared to restricting AMT expansion and extending the tax cuts. Baseline outlay projections assume that discretionary spending will grow at the rate of inflation, which is at a slower rate than it has grown recently, and that mandatory spending grows with eligible populations and cost-of-living adjustments.

Some projections based on alternative assumptions depict a more pessimistic fiscal outlook than the path of shrinking deficits and future surpluses indicated by CBO current-law baseline projections.

March 2008 Baseline Projections

In March 2008, CBO released revised current-law baseline projections, which incorporated costs of the Economic Stimulus Act and superceded projections issued in January. The revised CBO current-law baseline projections showed a FY2008 deficit of $357 billion, a $70 billion surplus in FY2013, and a $202 billion surplus in FY2018. CBO current-law baseline projections showed the federal deficit falling after FY2010, both in dollar terms and as a percentage of GDP, through the end of the budget window in FY2018. Surpluses were projected to appear from FY2012 through FY2017.

The March 2008 CBO analysis estimated that the President's budget proposals would lead to a FY2008 deficit of $396 billion, $39 billion above the baseline level. The CBO also projected that the President's budget would generate a FY2009 deficit of $342 billion, well above the revised baseline projection of a $207 billion FY2009 deficit.

September 2008 Baseline Projections

In September 2008, CBO released updated budget and economic projections. The projected deficit for FY2008 rose to $407 billion and $438 billion for FY2009. If Congress passes an AMT "patch," as it has in previous years, projected revenues would fall and projected deficits would rise. The September 2008 projections also do not reflect any costs that may occur as a result of the deprivatization of Fannie Mae and Freddie Mac.

On-Budget Deficits

The total federal deficit (or surplus) is the sum of the off-budget and on-budget deficits or surpluses. The U.S. Postal Service net profits or losses and Social Security revenues net of beneficiary payments are by law considered off-budget entities. Since FY1985, Social Security surpluses have led to growing off-budget surpluses, which has reduced the size of the total deficit. Table 7 summarizes projections of on-budget deficits. No projection shows a surplus within the next 5 or 10 years. The FY2007 on-budget deficit, which excludes a large Social Security surplus and a small Postal Service surplus, was $344 billion.

The Longer Run

OMB, CBO, and GAO agree that over a longer time period, one beginning in this decade and lasting far into the century, the current mix of federal fiscal policies is unsustainable. The nation's aging population, combined with rising costs per beneficiary for health care that seem likely to continue rising faster than per capita GDP, raises spending in federal programs for the elderly to such an extent that the government faces constantly rising deficits and a compounding federal debt burden. CBO has concluded that "under any plausible scenario, the federal budget is on an unsustainable path."

Keeping future federal outlays at 20% of GDP, approximately its current share, and leaving fiscal policies unchanged, according to CBO projections, would require drastic reductions in all spending other than that for Medicare, Social Security, and Medicaid. A former CBO Acting Director stated that, "by 2030 ... spending for those programs [Medicare, Social Security, and Medicaid] is projected to reach roughly 15 percent of GDP.... If that increase happened..., the rest of the budget would have to be cut by more than half" to keep overall spending close to 20% of GDP.

A CBO report on the long-term fiscal outlook concluded that

over the next half-century, the United States will confront the challenge of conducting its fiscal policy in the face of the retirement of the baby-boom generation.... Under current policies, the aging of the population is likely to combine with rapidly rising health care costs to create an ever-growing demand for resources to finance federal spending for mandatory programs, such as Medicare, Medicaid, and Social Security.... Attaining fiscal stability in the coming decades will probably require substantial reductions in the projected growth of spending and perhaps also a sizable increase in taxes as a share of the economy.

The Administration indicated similar concerns about the outlook for the budget over the long term in the President's FY2009 budget.

The current structure of the Federal Government's major entitlement programs will place a growing and unsustainable burden on the budget in the long-term.... By 2050, spending on these three entitlement programs [Social Security, Medicare, and Medicaid] is projected to be more than 15 percent of GDP, or more than twice as large as spending on all other programs combined, excluding interest on the public debt.

The Social Security, Medicare, and Medicaid programs present different challenges to the long-term fiscal position of the federal government. Estimates of the long-term fiscal gap between Social Security (OASDI) outlays and Social Security revenues as a proportion of long-term GDP are generally much smaller than estimates of the long-term fiscal gap between Medicare (HI, Part B, and Part D) outlays and revenues. These long-term estimates of fiscal imbalances are especially sensitive to changes in assumptions regarding productivity growth and interest rates. Some analysts willing to make more felicitous assumptions about productivity growth present a more optimistic long-term outlook for Social Security.

Spending projections for Medicare and Medicaid are sensitive to changes in medical inflation. In past years, many projections that medical inflation would slow have turned out to be overly optimistic.

Unexpected events, such as the hurricanes in 2005 or an economic downturn, can change the short-term budget outlook. The interplay of policy, demographics, and medical care costs, however, will in large part determine the long-term budget outlook. The retirement of the baby boom generation, which will rapidly expand the population eligible for federal programs serving the elderly, along with continuing increases in health care costs, will put enormous pressure on the federal budget. Without policy changes, these programs could overwhelm the rest of the budget. Not only will the programs themselves be stressed, but their growth could easily limit the government's flexibility in meeting its obligations or new needs as well as overwhelm the economy's ability to provide the resources needed for the expanded programs.