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| An Analysis of the President's Budgetary Proposals for Fiscal Year 2001 April 2000 |
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The Administration's economic assumptions for the next 11 years are similar to those of the Congressional Budget Office. Overall, the Administration's assumptions produce just $25 billion more in projected surpluses during the 2000-2010 period than CBO's do. That addition results from revenues that are $98 billion higher (primarily because the Administration forecasts more rapid growth in the price index of gross domestic product, which boosts taxable income) and outlays that are $73 billion higher (because the Administration assumes higher interest rates than CBO does over most of the projection period). The additional $25 billion in projected surpluses is less than 0.1 percent of projected revenues over that period.
Although the assumptions of CBO and the Administration are similar over the entire projection period, CBO's are more positive for the surplus than the Administration's from 2000 to 2005 and more negative in later years. The most important difference between the forecasts over the next few years is CBO's assumption that a larger share of GDP goes to taxable forms of income. In later years, the more rapid growth of nominal GDP in the Administration's forecast outweighs the fact that a smaller share of that GDP is taxed, so the Administration's assumptions lead to higher projected revenues.
Although the two forecasts are similar, they show some important differences from that of the Blue Chip consensus, an average of the forecasts produced by approximately 40 to 50 private-sector economists. The most recent Blue Chip forecast, published in March, predicts stronger growth than either CBO or the Administration for 2000 and for 2003 and subsequent years. Because the Blue Chip forecasters also expect the GDP price index to grow more rapidly than CBO does, annual average growth of nominal GDP is 0.7 percentage points faster over the next 11 years than in CBO's projections. The Blue Chip forecasters also project higher interest rates than CBO does.
The Blue Chip consensus forecast for 2000 is more optimistic
than that of either the Administration or CBO because it incorporates the
stronger-than-expected economic data released after the other two forecasts
were completed. Two factors may mute the impact that the Blue Chip's more favorable forecast will have on the budget surplus, however. First,
stronger growth in the Blue Chip forecast is accompanied by interest
rates that are higher than CBO projects, which will boost outlays. Second,
oil prices have risen more than any of the three forecasts anticipated,
which could raise interest rates further through expectations of higher
inflation. Higher oil prices could also trim GDP growth, offsetting some
of the strength of recent data. Other than that, however, those prices
would have little impact on the surplus (see Box 4-1).
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Oil prices have climbed much higher than the Congressional Budget Office (CBO) anticipated when it prepared its most recent economic forecast, in December. At that time, CBO predicted that West Texas intermediate crude oil would cost about $23 per barrel during the second quarter of 2000. By mid-March, however, the price had risen to $32 per barrel. Global demand for oil has exceeded supply by about 2 million barrels per day for more than a year, resulting in dwindling inventories and the spike in prices. Even if oil exporters boost production, prices are likely to remain higher than in CBO's forecast for several months, as the building of inventories puts pressure on limited refinery capacity. Higher oil prices can hurt the economy through at least two channels. First, higher prices for imported crude oil act like a tax on U.S. energy users. After paying the "tax," consumers and businesses have less to spend on other goods and services, so real (inflation-adjusted) gross domestic product (GDP) falls. Second, the rise in oil prices may lead the Federal Reserve to raise interest rates further to fight inflation than it would otherwise. Of course, if the Federal Reserve believes that higher oil prices are only temporary and that any inflationary impact will eventually disappear as prices recede, there will be no need for it to boost interest rates. The effects of higher oil prices on real GDP and interest rates are hard to predict. Thus, CBO has not made any budgetary estimates of those effects. However, it is possible to estimate the budgetary consequences of the more direct impact of higher oil prices: the effects on the growth of the consumer price index (CPI) and incomes. On the one hand, higher oil prices raise the CPI and thus boost the cost of federal programs that are indexed to it. On the other hand, the income of domestic oil producers rises, producing extra tax revenues and at least partially offsetting the impact from lower real GDP. Because changes in the CPI affect outlays only in the following year, the impact on revenues occurs before the impact on outlays. As a result, the net budgetary impact of a higher CPI and more income for oil producers would actually be positive in 2000 because the higher CPI would not affect spending until 2001. The size of the effect in 2001 would depend on how long high oil prices persisted. Assuming that the price of crude oil remained roughly $7 to $8 per barrel greater than CBO expected through the end of 2001 and that those increased prices had no impact on real GDP or interest rates, outlays in 2001 would be $3 billion to $4 billion higher, and revenues would be $4 billion to $8 billion higher. If, by contrast, crude oil prices returned to projected levels at the beginning of 2001, outlays would still be $3 billion to $4 billion higher, but the impact on revenues would be smaller. |
Real Growth and Unemployment
Both the Administration and CBO project that growth over the next 11
years will slow from its recent rapid pace. The Administration expects
real GDP to increase at an average annual rate of 2.7 percent, compared
with CBO's 2.8 percent. The two differ, however, in their estimates of
how sharp the slowdown will be and how long it will last (see Table 4-1).
CBO expects a shallower but more drawn out slowdown than the Administration
does.
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Table 4-1. Comparison of Economic Projections for Calendar Years 2000-2010 |
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| Forecast
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Projected
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| 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | |||
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| Nominal GDP (Billions of dollars) | |||||||||||||
| CBO | 9,692 | 10,154 | 10,610 | 11,069 | 11,544 | 12,054 | 12,589 | 13,148 | 13,734 | 14,362 | 15,024 | ||
| Administration | 9,685 | 10,156 | 10,621 | 11,105 | 11,644 | 12,236 | 12,847 | 13,477 | 14,118 | 14,777 | 15,471 | ||
| Blue Chip | 9,801 | 10,300 | 10,805 | 11,335 | 11,947 | 12,580 | 13,247 | 13,935 | 14,660 | 15,422 | 16,224 | ||
| Nominal GDP (Percentage change) | |||||||||||||
| CBO | 5.0 | 4.8 | 4.5 | 4.3 | 4.3 | 4.4 | 4.4 | 4.4 | 4.5 | 4.6 | 4.6 | ||
| Administration | 4.9 | 4.9 | 4.6 | 4.6 | 4.9 | 5.1 | 5.0 | 4.9 | 4.8 | 4.7 | 4.7 | ||
| Blue Chip | 5.9 | 5.1 | 4.9 | 4.9 | 5.4 | 5.3 | 5.3 | 5.2 | 5.2 | 5.2 | 5.2 | ||
| Real GDP (Percentage change) | |||||||||||||
| CBO | 3.3 | 3.1 | 2.8 | 2.6 | 2.6 | 2.7 | 2.7 | 2.7 | 2.7 | 2.9 | 2.9 | ||
| Administration | 3.3 | 2.7 | 2.5 | 2.5 | 2.8 | 3.0 | 2.9 | 2.8 | 2.7 | 2.6 | 2.6 | ||
| Blue Chip | 4.1 | 3.1 | 2.8 | 2.8 | 3.3 | 3.3 | 3.2 | 3.1 | 3.1 | 3.1 | 3.1 | ||
| GDP Price Indexa (Percentage change) | |||||||||||||
| CBO | 1.6 | 1.6 | 1.7 | 1.7 | 1.7 | 1.7 | 1.7 | 1.7 | 1.7 | 1.7 | 1.7 | ||
| Administration | 1.6 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | 2.0 | ||
| Blue Chip | 1.8 | 2.0 | 2.0 | 2.1 | 2.1 | 2.0 | 2.0 | 2.1 | 2.1 | 2.1 | 2.1 | ||
| Consumer Price Indexb (Percentage change) | |||||||||||||
| CBO | 2.5 | 2.4 | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | 2.5 | ||
| Administration | 2.6 | 2.4 | 2.6 | 2.6 | 2.6 | 2.6 | 2.6 | 2.6 | 2.6 | 2.6 | 2.6 | ||
| Blue Chip | 2.6 | 2.6 | 2.6 | 2.6 | 2.5 | 2.4 | 2.4 | 2.5 | 2.5 | 2.5 | 2.5 | ||
| Unemployment Rate (Percent) | |||||||||||||
| CBO | 4.1 | 4.2 | 4.4 | 4.7 | 4.8 | 5.0 | 5.0 | 5.1 | 5.2 | 5.2 | 5.2 | ||
| Administration | 4.2 | 4.5 | 5.0 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | ||
| Blue Chip | 4.0 | 4.2 | 4.5 | 4.7 | 4.7 | 4.7 | 4.6 | 4.7 | 4.7 | 4.7 | 4.7 | ||
| Three-Month Treasury Bill Rate (Percent) | |||||||||||||
| CBO | 5.4 | 5.6 | 5.3 | 4.9 | 4.8 | 4.8 | 4.8 | 4.8 | 4.8 | 4.8 | 4.8 | ||
| Administration | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | ||
| Blue Chip | 5.8 | 5.9 | 5.5 | 5.4 | 5.4 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | 5.2 | ||
| Ten-Year Treasury Note Rate (Percent) | |||||||||||||
| CBO | 6.3 | 6.4 | 6.1 | 5.8 | 5.7 | 5.7 | 5.7 | 5.7 | 5.7 | 5.7 | 5.7 | ||
| Administration | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | 6.1 | ||
| Blue Chip | 6.5 | 6.4 | 6.2 | 6.1 | 6.1 | 5.9 | 6.0 | 5.9 | 5.9 | 5.9 | 5.9 | ||
| Taxable Incomec (Billions of dollars) | |||||||||||||
| CBO | 7,748 | 8,054 | 8,336 | 8,631 | 8,950 | 9,296 | 9,666 | 10,051 | 10,455 | 10,883 | 11,325 | ||
| Administration | 7,714 | 8,001 | 8,281 | 8,568 | 8,912 | 9,302 | 9,717 | 10,132 | 10,549 | 10,977 | 11,419 | ||
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| SOURCES: Congressional Budget Office; Office of Management and Budget; Aspen Publishers, Blue Chip Economic Indicators (March 10, 2000). | |||||||||||||
| NOTE: Percentage changes are year over year. | |||||||||||||
| a. The GDP price index is virtually the same as the implicit GDP deflator. | |||||||||||||
| b. The consumer price index for all urban consumers. | |||||||||||||
| c. Taxable personal income plus corporate profits before tax. The Blue Chip does not project taxable income. | |||||||||||||
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In both forecasts, slower growth brings the unemployment rate up to more sustainable levels. By January 2000, that rate had fallen to 4.0 percent, producing the tightest labor market in 30 years. Both CBO and the Administration project that the unemployment rate will eventually rise to 5.2 percent--by 2003 in the Administration's forecast and by 2008 in CBO's. That rate is reached sooner in the Administration's forecast because real GDP growth slows from 3.3 percent in 2000 to just 2.5 percent in 2002 and 2003. Growth then rebounds to a rate that is strong enough to keep unemployment from rising further.
By contrast, the slowdown in real GDP growth is more gradual in CBO's forecast, with growth averaging 2.8 percent between 2000 and 2003, compared with 2.6 percent in the Administration's forecast. Largely as a result, CBO's projected unemployment rate is 0.5 percentage points below the Administration's in 2003. From 2003 to 2008, however, real GDP grows at an average annual rate of 2.7 percent in CBO's forecast, compared with 2.9 percent in the Administration's. That growth rate brings CBO's projection of the unemployment rate in line with the Administration's in 2008. After that, real GDP grows slightly faster in CBO's projection, reflecting slightly stronger growth of potential GDP. (Potential GDP is an estimate of the level of output that is consistent with the long-term level of the civilian unemployment rate.)
Real GDP growth in the Blue Chip consensus forecast follows a
pattern similar to the ones in CBO's and the Administration's forecasts
but is generally stronger. In all three forecasts, that growth slows each
year from 2000 to 2002 and remains below the growth of potential GDP in
2003. In response, unemployment rises through 2003 in all three forecasts.
From 2004 on, however, average growth in the Blue Chip forecast
is roughly 0.4 percentage points higher than in CBO's. The unemployment
rate in that forecast stabilizes at around 4.7 percent, lower than CBO
and the Administration project.
Inflation and Interest Rates
The Administration generally expects higher rates of inflation over the next 11 years than CBO does, but the differences are larger for the GDP price index than for the consumer price index (CPI). The Administration's forecast of CPI inflation is just 0.1 percentage point higher than CBO's in every year except 2001, when the forecasts are the same. However, the Administration expects the GDP price index to grow 0.3 percentage points faster, on average, over the projection period than CBO does.
On balance, the Administration's assumptions about inflation are more favorable for the budget outlook than CBO's are. Higher inflation boosts both revenues and outlays and thus has both positive and negative effects on the surplus. The positive effects come from a higher GDP price index, which increases both nominal GDP and taxable income (assuming that real GDP and the share of nominal GDP going to taxable income are unaffected). The negative effects come from a higher CPI, which affects the cost of several programs and the indexing of personal tax brackets and other tax parameters. Because the difference in projected growth rates is much greater for the GDP price index than for the CPI, the positive effects of the Administration's higher GDP price index on revenues far outweigh the negative effects of its higher CPI.
The Administration assumes steady interest rates through 2010--5.2 percent for three-month Treasury bills and 6.1 percent for 10-year Treasury notes. By contrast, CBO assumes that interest rates will follow the same moderate cycle as real GDP growth. That assumption reflects CBO's view that the Federal Reserve will raise interest rates this year to slow economic growth to a more sustainable rate. CBO therefore projects that the short-term rate will be 5.4 percent in 2000, 5.6 percent in 2001, and then fall, averaging 4.8 percent a year from 2004 on. In both CBO's and the Administration's projections, rates for 10-year Treasury notes follow a pattern similar to that for three-month Treasury bills but are 0.8 to 0.9 percentage points higher. The impact that differences in interest rates have on outlays fades over time as the amount of debt held by the public gradually declines.
The interest rate forecasts for 2000 that CBO made in December now look
optimistic. Early this year, rates for three-month Treasury bills had already
risen above the levels forecast by CBO and the Administration. Both the
Blue Chip forecast and the futures markets for the federal funds
rate imply further increases in short-term interest rates.
Income
Projections of revenues depend not only on total output (GDP) and the income generated in producing that output but also on the distribution of income among its various categories. Several categories of income--such as depreciation (wear and tear and obsolescence of business equipment and structures), employer-paid health insurance, and employers' contributions to retirement accounts and Social Security--are not taxed. Income in other categories is taxed, but at different rates. Corporate profits and wages and salaries are the most important income categories for projecting revenues because they are taxed at the highest effective rates. The smaller the projected share of nominal GDP that goes to taxable income, especially to the highly taxed categories, the lower government revenues will be.
From 2000 to 2004, CBO's projection of taxable income is higher than
the Administration's, boosting revenues by $5 billion to $10 billion a
year. That projection is higher, even though CBO's projection of nominal
GDP is lower, because CBO assumes a more gradual drop in the taxable share
of nominal GDP, especially in the categories of corporate profits and wages
and salaries, than the Administration does (see Figure 4-1). Nominal GDP
is slightly lower in CBO's forecast, despite higher real GDP, because CBO
anticipates slower growth for the GDP price index.
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Figure 4-1. Wages and Salaries Plus Corporate Before-Tax Profits |
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| SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Office of Management and Budget. |
| NOTE: The shaded vertical bars indicate periods of recession (measured from the peak to the trough of the recession). |
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From 2005 to 2010, however, the Administration projects higher taxable income than CBO does, increasing revenues by $23 billion a year. During that period, the Administration's more optimistic forecast for nominal GDP outweighs CBO's more optimistic forecast for taxable shares of GDP. By 2010, nominal GDP is 3.0 percent higher in the Administration's forecast than in CBO's. Taxable income is therefore higher in the Administration's projection, entirely because the Administration forecasts more rapid growth in the GDP price index. In total, the Administration's higher forecast for income boosts revenues by $98 billion, or less than 0.4 percent of total revenues, during the 2000-2010 period.
The share of GDP going to the taxable income categories of corporate profits and wages and salaries drops in both forecasts for several reasons. First, nontaxable income accounts for a larger share of GDP as high projected levels of investment boost depreciation's share of output and as fringe benefits resume their historical upward trend as a share of GDP. In addition, businesses will have higher interest costs, reducing corporate profits' share of GDP.
