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On January 26, 2000, the Congressional Budget Office (CBO) released its report The Budget and Economic Outlook: Fiscal Years 2001-2010, which presents CBO's projections of federal revenues and outlays over that period. This supplement provides projections of the standardized budget through fiscal year 2010 (see Tables 1 through 4 at the end of this page). As in the January report, those projections are shown using three variants of the baseline, each of which reflects a different assumption about discretionary spending. The "inflated" variation assumes that discretionary spending grows at the rate of inflation after 2000. The "freeze" variation pegs discretionary budget authority to the level enacted for the current year, plus amounts already enacted for 2001. The "capped" variation assumes that discretionary spending equals CBO's estimates of the statutory caps through 2002 and grows at the rate of inflation thereafter.

The standardized budget adjusts revenues and outlays for the effects of the business cycle. During economic downturns, revenues automatically fall as incomes decline, and outlays automatically increase as unemployment rises. Because of those cyclical effects, changes in the actual budget surplus can give misleading signals about the stance of fiscal policy. The standardized budget also includes adjustments for factors that do not have an impact on short-term growth, such as asset sales and meaningless shifts in the timing of receipts between one fiscal year and the next.

The calculations of the standardized budget also incorporate several new adjustments.⁽¹⁾ The most important of those for the period from 1996 to 2010 are as follows:

• An estimate of capital gains tax collections has been removed because large fluctuations in those taxes can distort the measured effects of the budget on short-term growth.
  
  
• An estimate of the inflation component of interest payments is now excluded because those payments are simply an early return of principal to bondholders and are likely to be saved rather than spent.
  
  
• An estimate of large changes in withheld taxes that are not matched by a change in tax liabilities is now largely excluded because such changes are not likely to have much effect on spending for the majority of consumers.

The overall stance of fiscal policy--as measured by the increase in the standardized-budget surplus as a share of potential gross domestic product (GDP)--moderately dampened short-term growth in 1999 and will do so again in 2000 (see Table 1). In part, that restraint reflects slower growth of real interest payments. Tax and spending legislation in recent years has not been an important factor. If discretionary spending is held to the current caps in 2001, fiscal policy will be much more restrictive next year. Otherwise, its effect on short-term growth will be less restrictive.

In all three variations of the baseline, the projected improvement in the standardized-budget surplus during the next decade is substantial, reaching at least 2.8 percent of potential GDP by 2010. A significant decline in both discretionary spending and real interest payments measured relative to potential GDP is largely responsible for the rosier outlook (see Table 3). Even if discretionary spending keeps up with inflation, real economic growth will reduce that spending as a share of potential GDP from 6.5 percent in 2000 to 5.3 percent in 2010. The other variations of the baseline, which assume greater restraint in discretionary spending, imply larger declines relative to potential GDP.

In the case of revenues, the standardized-budget estimates rise from 18.9 percent of potential GDP in 2000 to 19.2 percent in 2010, despite a decline in the unadjusted estimates from 20.8 percent to 19.8 percent. That increase in standardized revenues, which excludes capital gains taxes and changes in revenues attributable to the business cycle, mainly reflects two factors that boost the growth of individual income taxes. First, effective tax rates rise over time as growth of real incomes pushes taxpayers into higher tax brackets--an effect known as real bracket creep. Second, the projection of revenues assumes that taxable retirement income grows faster than potential GDP. Consequently, taxes on that income are assumed to rise relative to potential GDP.

1. The new adjustments and revised historical estimates will be the subject of a forthcoming CBO memorandum.