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CBO'S ECONOMIC PROJECTIONS

• Changes to CBO's Economic Forecast
• Comparison with the Administration's Assumptions

CBO'S AND THE ADMINISTRATION'S BASELINE ESTIMATES

• Revisions to CBO's Baseline
• Differences from the Administration's Current-Services Baseline

THE PRESIDENT'S BUDGETARY POLICIES

• Policy Proposals Affecting Discretionary Spending
• Policy Proposals Affecting Mandatory Spending
• Policy Proposals Affecting Revenues
• Differences Between CBO's and the Administration's Estimates of Policy Proposals

An Analysis of the President's Budgetary Proposals for Fiscal Year 2003

At the request of the Senate Committee on Appropriations, the Congressional Budget Office (CBO), with assistance from the Joint Committee on Taxation (JCT), has estimated the effects of the President's budgetary proposals for fiscal year 2003 using its own economic and technical estimating assumptions. Several main points emerge from that analysis.

• CBO estimates that under the Administration's proposals, the budget would record a deficit of $121 billion in 2003 and $51 billion in 2004 but revert to annual surpluses thereafter. Over the five-year period from 2003 through 2007, the budget would run a cumulative deficit of $33 billion; over the 10-year period from 2003 through 2012, it would record a cumulative surplus of $681 billion (see Table 1). The on-budget accounts, which exclude the spending and revenues of Social Security and the Postal Service, would remain in deficit throughout the 10-year period.⁽¹⁾



• In conjunction with its analysis of the President's budget, CBO has updated the baseline projections that it published in January.⁽²⁾ (Those projections estimate the future path of spending and revenues if current laws and policies do not change.) The update incorporates new technical assumptions and a slight revision of CBO's economic forecast. It also encompasses legislative action through March 6, 2002. (The economic stimulus package, which was enacted after that date, is discussed in Box 1.) CBO currently projects that under the assumptions of the baseline, the federal government would run a surplus of $5 billion this year and $6 billion next year. Surpluses would total $489 billion over the 2003-2007 period and $2.4 trillion over the 2003-2012 period. That 10-year total is $0.1 trillion higher than the figure CBO published in January.



• Relative to that updated baseline, the President's budget would reduce projected surpluses in each year through 2012, CBO estimates. Over 10 years, that reduction would total $1.7 trillion; excluding debt service, 55 percent of the reduction would result from increases in spending and 45 percent from decreases in revenues.



• On the spending side of the budget, the President proposes to raise discretionary outlays by $295 billion above baseline levels between 2003 and 2012--comprising an increase of $483 billion in defense spending offset by a reduction of $188 billion in nondefense spending. Outlays for mandatory programs would exceed baseline levels by another $436 billion over the 10-year period, CBO estimates, mainly because of proposals to restructure and expand Medicare; assist people who lack health insurance; change the funding mechanism for the health benefits of military retirees under age 65; and increase spending on agriculture, food, and nutrition programs. (Those figures exclude the Administration's proposal that federal agencies pay the full cost of benefits for their employees as such benefits accrue.)



• On the revenue side of the budget, the President proposes to reduce receipts by $602 billion between 2003 and 2012, according to estimates by JCT and CBO. More than 60 percent of that reduction, or $379 billion, would occur in the last two years of the period, largely as a result of extending the tax cuts enacted last June that are scheduled to expire at the end of 2010. The President's budget would lower revenues in 2003 by $73 billion; $65 billion of that reduction comes from the Economic Security Plan, an unspecified proposal to stimulate the economy through tax cuts and additional spending.



• Overall, the Administration proposes to spend about $2.1 trillion--or 19.5 percent of the nation's gross domestic product (GDP)--in 2003 (see Table 2). Total spending would rise to an estimated $3.1 trillion by 2012, but because the economy is expected to grow, federal spending as a share of GDP would drop to 17.8 percent. Revenues under the President's budget would increase from 18.4 percent of GDP in 2003 to 19.1 percent in 2012, despite the anticipated growth of the economy.

CBO's Economic Projections

In the light of economic data released over the past three months--particularly the Bureau of Economic Analysis's (BEA's) preliminary estimates for the fourth quarter of 2001--CBO has modified its economic outlook for calendar years 2002 and 2003. Compared with the forecast that it published in January, CBO's current forecast anticipates faster growth of real and nominal GDP during 2002 and larger corporate profits in 2001 through 2003 (see Table 3). Projected levels of GDP and other major economic variables in 2004 through 2012 remain unchanged.
 

Changes to CBO's Economic Forecast

The economy is currently rebounding in a remarkable fashion, and many forecasters agree with Federal Reserve Board Chairman Alan Greenspan that a recovery is well under way. When CBO and the Administration prepared their forecasts in December, most economists thought that the economy was headed downward in the fourth quarter of 2001, reflecting both the need to correct an excess of corporate investment in recent years and the trauma of the September 11 attacks. However, the economy has done much better than forecast. It grew at an annual rate of 1.4 percent in the fourth quarter, according to the BEA's recent estimates, and more than made up its losses from the brief downturn of the previous quarter. Moreover, although CBO (like many forecasters) anticipated a mild upturn in the first or second quarter of 2002, recent data suggest that the economy is surging ahead. Private-sector forecasts of real growth in the first quarter range from less than 1 percent to more than 4 percent at an annual rate.

The surprises in recent data involve both consumer and business spending. Consumption has been extremely strong since September, contradicting expectations about the effects of post-September 11 weakness in the stock market, job losses, and consumers' concerns about security. Some of the strength in the fourth quarter was attributable to sales incentives for cars, although other consumption remained robust. More surprising, consumption spending has been higher than expected in the first two months of 2002.

Evidence of a rebound in business investment in the first quarter of 2002 is more tentative, but it points in the same direction. Orders and shipments of capital goods suggest some upturn in that sector. News stories about commercial construction have been less positive, but after sharp declines since March 2001, the January data for industrial, commercial, and other nonresidential construction showed an encouraging increase. The largest contribution of the business sector--and the most uncertain--is inventory accumulation. In the fourth quarter of 2001, inventories dropped by $120 billion (at an annual rate, in 1996 dollars). New data for January show that the decline in inventories may be at an end. That would add several percentage points to GDP growth (at an annual rate) in the first quarter.

The economy's greater-than-anticipated output in recent months appears to reflect unexpected productivity growth. The unemployment rate fell in February and may have peaked sooner than expected. But hours worked and employment are still broadly in line with the previous forecasts. Labor productivity grew at a revised annual rate of 5.2 percent in the fourth quarter, and some forecasters now expect similar growth in the first quarter. The income generated through that higher productivity seems likely to accrue to owners of capital. Consequently, CBO has raised its projections of corporate profits through the end of 2003. By contrast, tax receipts suggest that the near-term outlook for wages and salaries has not changed, despite the apparent recovery of spending and output.

On the basis of recent data, CBO has raised its estimate of the real growth of GDP to 1.7 percent for calendar year 2002. It has also increased its forecast for the level of corporate profits in 2002 by 16 percent from the forecast published in January. CBO's revised outlook is similar to that in the March Blue Chip survey of some 50 economic forecasters (see Table 4). Near-term forecasts have changed rapidly since mid-February. The March Blue Chip survey raised the consensus forecast for real growth in 2002 to 2.0 percent from the 1.5 percent forecast in February. The very strong data published at the turn of the month may not be fully reflected in the March Blue Chip, so the consensus forecast may rise further.
 

The outlook for growth in coming months, however, is extremely uncertain, as it usually is around turning points in the business cycle. Several factors may be adding to the current uncertainty. First, this winter has been unusually warm, which may be distorting a number of economic indicators. Second, forecasters who expect relatively strong growth anticipate a rapid return to inventory building, but that is among the hardest elements of the economy to predict. Third, other sectors that usually contribute vigorously to growth during cyclical recoveries--especially autos and housing--are unlikely to play the same role this time. It remains unclear to what extent the auto sales of the past few months have simply borrowed from future sales. Moreover, investment in housing remained strong throughout the recession and probably cannot contribute much more to growth than it is already doing. Fourth, important sectors of the economy may continue to suffer from overcapacity, which would tend to dampen any increase in capital spending. That problem is perhaps most evident for telecommunications and, in some markets, for commercial office space. Last, the strength of foreign demand is uncertain because many other countries' economies are also close to turning points.

Comparison with the Administration's Assumptions

CBO's and the Administration's economic assumptions are fairly similar in their implications for budget projections. For 2002, the Administration's forecast of GDP growth is lower than CBO's, though the difference is made up in 2003 and subsequent years. Beyond 2002, the Administration assumes slightly lower inflation, as measured by the GDP price index, so its projection of nominal GDP remains below CBO's throughout the projection period (see Table 4). However, the Administration assumes that the major tax bases--wages and salaries, and corporate profits--will constitute a larger share of GDP than CBO does, and as a result, its projections of those tax bases are slightly above CBO's for much of the projection period. In addition to lower inflation, the Administration expects substantially lower interest rates and a lower unemployment rate than CBO does. All of those factors contribute to making the Administration's projections of outlays lower than CBO's over the 2003-2012 period.
 

CBO's and the Administration's Baseline Estimates

In general, both CBO's and the Administration's baselines are calculated according to statutory rules and guidelines in the 1985 Balanced Budget and Emergency Deficit Control Act and the 1974 Congressional Budget and Impoundment Control Act. The baseline serves as a policy-neutral benchmark that lawmakers can use to gauge the effects of new spending or revenue proposals, such as those in the President's 2003 budget.

Revisions to CBO's Baseline

In preparing its annual analysis of the President's budgetary proposals, CBO typically updates its baseline projections to take into account new information from the budget and other sources. CBO's current outlook for the budget is slightly more favorable than the one it published in January.⁽³⁾ In the absence of additional tax or spending legislation, the budget would show small surpluses in 2002 and 2003 ($5 billion and $6 billion, respectively) instead of the modest deficits projected previously (see Table 5). Under that assumption, the surplus would total $489 billion over five years, CBO estimates, and $2.4 trillion over 10 years, up from the previous projections of $437 billion and $2.3 trillion, respectively. Debt held by the public at the end of 2012 would total $1.1 trillion (see Table 6).
 

CBO has increased its baseline projections of revenues by $23 billion for 2002 and $15 billion for 2003 because of its upward reestimates for GDP and corporate profits in the near term (see Table 7). For years after 2003, increases to baseline revenue projections are relatively small, averaging just over a billion dollars per year. Most of the increases stem from receipts of the Universal Service Fund, which would be offset by additional spending of similar amounts.
 

Among the few pieces of legislation enacted between the January baseline and March 6 is Public Law 107-139, which amends the Higher Education Act of 1965 to establish fixed interest rates for student and parent borrowers and extends certain special allowances for lenders that would have expired for loans issued after June 2003. CBO estimates that the extension of the yield guarantee for private lenders and changes in interest rates charged for direct loans--as well as an increase in the volume of borrowers--will increase outlays by $9.5 billion over the 2003-2012 period.

Reductions in projected Medicare spending account for most of the changes to CBO's baseline since January. A variety of technical factors caused CBO to lower its projections of Medicare outlays over 10 years by nearly $80 billion.

• About $30 billion of the reduction stems from an analysis of newly published information on the rates to be paid to Medicare+Choice plans (health maintenance organization plans in Medicare) in 2003 and later years.



• About $35 billion of the decrease reflects the Administration's announcement of an effective date for a final rule concerning "pass-through" payments for hospital outpatient services and an analysis of new data on the cost of "buying down" (contributing more to) coinsurance paid by beneficiaries for hospital outpatient services.



• Another $15 billion of the reduction reflects an updated analysis of the effect on spending of the changing age distribution of the Medicare population, an improved method of constructing price indexes for projecting updates to Medicare's payment rates, and the effects of revised projections of outlays on premiums paid by beneficiaries.

Conversely, CBO increased its baseline projections of Medicaid spending for the 2003-2012 period by $21 billion. Much of that increase resulted from higher projections of enrollment and new waivers permitting Medicaid programs to offer prescription drug benefits to low-income Medicare beneficiaries. CBO also incorporated the savings generated by a recent regulation that limits the amount by which Medicaid's payments to hospitals may exceed payments based on Medicare's rules (the so-called upper payment limit).

Differences from the Administration's Current-Services Baseline

Both CBO and the Administration estimate that the budget will essentially be in balance this year under current laws and policies (see Table 8). CBO now projects a small surplus ($5 billion), and the Administration anticipates a small deficit ($9 billion). The difference between those figures mainly arises because CBO is forecasting lower short-term interest rates and projecting lower payments for Social Security benefits and the refundable portions of the earned income and child tax credits. Furthermore, CBO's estimate includes recoveries of overpayments in the Supplemental Security Income (SSI) program to reflect greater participation by SSI beneficiaries in Social Security's Disability Insurance (DI) program.⁽⁴⁾