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The Budget and Economic Outlook: An Update August 2001

Recently enacted legislation and the continued sluggish behavior of the U.S. economy have reduced the projected federal budget surpluses for fiscal year 2001 and future years. The Congressional Budget Office (CBO) projects that the total budget surplus in fiscal year 2001 will be $153 billion--$122 billion lower than CBO estimated in May. About two-thirds of the decrease results from new legislation; one-third comes from a weaker economy and other factors. Despite that drop, if the $153 billion surplus materializes in 2001, it will equal 1.5 percent of gross domestic product (GDP), the second largest surplus as a share of the economy since 1951.

With a smaller total surplus, CBO now projects a small on-budget deficit for this year. (The on-budget accounts exclude the spending and revenues of Social Security and the Postal Service.) If current tax and spending policies are maintained and the economy performs as CBO estimates, CBO projects small deficits or surpluses in on-budget accounts for the next four years; however, steadily increasing on-budget surpluses reemerge by the middle of the decade. The projected surpluses would allow all public debt that is available for redemption to be retired by 2010.
 

The Budget Outlook

For the five years from 2002 through 2006, CBO projects surpluses totaling $1.1 trillion, which come almost entirely from off-budget accounts (see Summary Table 1). For the 10-year period through 2011, CBO estimates that under current policies, surpluses will total $3.4 trillion. Social Security makes up about three-quarters of that total. In 2010, the on-budget surplus reaches 1 percent of GDP, and the total surplus grows to 3 percent of GDP. Those estimates should be viewed cautiously, however, because future economic developments, technical estimating errors, and future legislative actions could produce substantial deviations.⁽¹⁾
 

Total surpluses for the 2002-2011 period are $2.2 trillion less than CBO projected in May, when it last published its budget baseline (see Summary Table 2). Legislative changes account for $1.8 trillion of that amount.
 

The Economic Growth and Tax Relief Reconciliation Act of 2001 (Public Law 107-16) is estimated to reduce revenues by $70 billion in 2001 and nearly $1.2 trillion over the 2002-2011 period. That law changed numerous tax provisions, including establishing a 10 percent tax bracket, lowering income tax rates, increasing tax credits for children, repealing the estate tax, lessening the so-called marriage penalty, raising the limits on contributions to retirement accounts, and enhancing education incentives. In addition, the law increases outlays for refundable tax credits by $4 billion in 2001 and $88 billion between 2002 and 2011.

Other legislation will also increase projected outlays through 2011. Providing additional assistance to farmers will increase spending by $5.5 billion in 2001, and the 2001 Supplemental Appropriations Act is projected to boost spending by $83 billion from 2002 through 2011. As a result of all legislative changes, interest payments will increase by $413 billion over the next 10 years, CBO estimates.

Lower projections of economic growth over the next few years, along with other revisions to the economic forecast, will diminish surpluses by $0.3 trillion between 2002 and 2011, according to CBO's projections. (Those revisions reflect changes in the economic outlook since January, when CBO last updated its economic assumptions.) Technical changes (those not driven by new legislation or by changes in the components of CBO's economic forecast) further reduce surpluses by nearly $200 billion.
 

The Economic Outlook

CBO has revised its economic forecast to reflect the weakness in the U.S. economy during the first half of 2001. Although economic growth has slowed nearly to a standstill, CBO believes that the economy will narrowly avoid recession and recover gradually next year. CBO now expects that the levels of both nominal and real (inflation-adjusted) GDP will be lower in 2001 and 2002 than it anticipated in January. CBO also has raised its estimates of the unemployment rate and long-term interest rates for the next few years and lowered its estimate of short-term interest rates. (CBO's economic forecast does not incorporate the revisions in GDP and related measures that were published in the Bureau of Economic Analysis' national income and product accounts at the end of July, after CBO had completed its forecast. Incorporating those revisions could move budget projections in either direction but probably not by very much.)

CBO's current forecast assumes that growth of real GDP will average 1.7 percent this calendar year and 2.6 percent next year--for both years, those rates are about three-quarters of a percentage point lower than CBO estimated in January (see Summary Table 3). Those forecasts are very uncertain, though, and growth that is significantly slower--or faster--cannot be ruled out.
 

Inflation, as measured by growth in the consumer price index for all urban consumers, is 0.4 percentage points higher for 2001 and 0.2 percentage points lower for 2002 than the estimates in the January forecast.

Short-term interest rates are projected to be lower in the next few years than CBO previously anticipated, but long-term rates are expected to be higher. Interest rates on three-month Treasury bills are forecast to be about a full percentage point lower for both 2001 and 2002 than the levels estimated in January. However, the interest rate paid on 10-year Treasury notes is projected to be between 0.3 and 0.4 percentage points higher than previously anticipated.

CBO does not forecast fluctuations of the economy beyond two years. Instead, it extends historical patterns in the factors--increases in the labor force, rising productivity, and the rate of national saving--that underlie the growth of potential GDP. After incorporating those patterns, CBO makes economic projections that extend three to 10 years out.

For 2003 through 2011, CBO projects that growth of nominal GDP will average 5.2 percent a year and that growth of real GDP will average 3.2 percent--levels slightly above those estimated in January. According to CBO's projections, inflation in the 2003-2011 period will average 2.5 percent, which is similar to the rate that was anticipated last winter. Interest rates over the period will average 4.9 percent for three-month Treasury bills and 5.8 percent for 10-year Treasury notes, CBO projects--figures that are also similar to January's.

1. For a more detailed discussion of uncertainties in forecasting and their implications for budget projections, see Chapter 5 of Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2002-2011 (January 2001).

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