CBO PAPERS CONGRESSIONAL BUDGET OFFICE AN ANALYSIS OF THE PRESIDENT S FEBRUARY BUDGETARY PROPOSALS. March 1993

Transcription

1 CBO PAPERS AN ANALYSIS OF THE PRESIDENT S FEBRUARY BUDGETARY PROPOSALS Mrch 1993 CONGRESSIONAL BUDGET OFFICE

2 Report Documenttion Pge Form Approved OMB No Public reporting burden for the collection of informtion is estimted to verge 1 hour per response, including the time for reviewing instructions, serching existing dt sources, gthering nd mintining the dt needed, nd completing nd reviewing the collection of informtion. Send comments regrding this burden estimte or ny other spect of this collection of informtion, including suggestions for reducing this burden, to Wshington Hedqurters Services, Directorte for Informtion Opertions nd Reports, 1215 Jefferson Dvis Highwy, Suite 124, Arlington VA Respondents should be wre tht notwithstnding ny other provision of lw, no person shll be subject to penlty for filing to comply with collection of informtion if it does not disply currently vlid OMB control number. 1. REPORT DATE MAR REPORT TYPE 3. DATES COVERED to TITLE AND SUBTITLE An Anlysis of the President s Februry Budgetry Proposls 5. CONTRACT NUMBER 5b. GRANT NUMBER 5c. PROGRAM ELEMENT NUMBER 6. AUTHOR(S) 5d. PROJECT NUMBER 5e. TASK NUMBER 5f. WORK UNIT NUMBER 7. PERFORMING ORGANIZATION NAME(S) AND ADDRESS(ES) Congressionl Budget Office,Ford House Office Building, 4th Floor,Second nd D Streets, SW,Wshington,DC, PERFORMING ORGANIZATION REPORT NUMBER 9. SPONSORING/MONITORING AGENCY NAME(S) AND ADDRESS(ES) 1. SPONSOR/MONITOR S ACRONYM(S) 12. DISTRIBUTION/AVAILABILITY STATEMENT Approved for public relese; distribution unlimited 13. SUPPLEMENTARY NOTES 14. ABSTRACT 11. SPONSOR/MONITOR S REPORT NUMBER(S) 15. SUBJECT TERMS 16. SECURITY CLASSIFICATION OF: 17. LIMITATION OF ABSTRACT. REPORT unclssified b. ABSTRACT unclssified c. THIS PAGE unclssified Sme s Report (SAR) 18. NUMBER OF PAGES NAME OF RESPONSIBLE PERSON Stndrd Form 298 (Rev. 8-98) Prescribed by ANSI Std Z39-18

3 CBO PAPERS AN ANALYSIS OF THE PRESIDENT'S FEBRUARY BUDGETARY PROPOSALS Mrch 1993 CONGRESSIONAL BUDGET OFFICE SECOND AND D STREETS, S.W. WASHINGTON, D.C. 2515

4 NOTES Unless otherwise indicted, ll yers referred to in Chpter 2 re clendr yers, nd ll yers in other chpters nd the ppendix re fiscl yers. Detils in the text nd tbles of this pper my not dd to totls becuse of rounding.

5 PREFACE The Congressionl Budget Office (CBO) hs prepred this nlysis of the President's Februry budgetry proposls t the request of the Sente Committee on Appropritions. The budget estimtes discussed in this report were relesed by CBO on Mrch 3, A summry of the report's findings ws provided in testimony to the House Committee on Wys nd Mens on Mrch 16, The report ws prepred by the stffs of the Budget Anlysis, Tx Anlysis, nd Mcroeconomic Anlysis Divisions under the supervision of C.G. Nuckols, Rosemry D. Mrcuss, nd Robert Dennis. Pul N. Vn de Wter ws responsible for Chpter I, John F. Peterson for Chpter II, Eric J. Toder for Chpter III, Michel A. Miller nd Robert Hle for Chpter IV, nd Kthy A. Ruffing for the ppendix. The estimtes of the President's revenue proposls were prepred by the Joint Committee on Txtion. The pper ws edited by Pul L. Houts, Sherry Snyder, nd Sherwood D. Kohn. Christin Spoor provided editoril ssistnce nd coordinted production. Jenne Burke, Mrion Curry, Jnice Johnson, Denise Jordn, Lind Lewis, L. Re Roy, nd Simone Thoms prepred the report for publiction. Mrch 1993 Robert D. Reischuer Director

6 CONTENTS I SUMMARY AND INTRODUCTION 1-1 CBO Budget Projections 1-1 The Administrtion's Proposls 1-6 Conclusions 1-14 H THE MACROECONOMIC IMPLICATIONS OF THE PRESIDENT'S BUDGET AND A REEXAMINATION OF THE CBO ECONOMIC FORECAST H-l How Will the Administrtion's Policies Affect the Economy? jq-1 Reexmining the CBO Forecst n-9 HI THE ADMINISTRATION'S REVENUE PROPOSALS HI-1 An Overview of the President's Tx Proposls Effects of Higher Mrginl Tx Rtes ffl-l HI-11 IV THE ADMINISTRATION'S DEFENSE PROPOSALS IV-1 Extent nd Sources of Svings Supporting n Active-Duty Force of 1.4 Million Effects of Alterntive Assumptions IV-1 IV-3 FV-7 APPENDIX CBO Bseline Budget Projections A-l

7 TABLES 1-1. CBO Estimtes of the Administrtion's Policy Proposls Differences Between CBO nd Administrtion Estimtes of the Administrtion's Proposed Budget CBO nd OMB Estimtes of Bseline Deficits CBO Estimtes of the Administrtion's Budgetry Proposls The Administrtion's Proposls for Discretionry Spending in Fiscl Yer 1994 I The Administrtion's Proposls for Mndtory Spending 1-13 II-1. Congressionl Budget Office Bseline, Administrtion, nd Blue Chip Economic Projections, Clendr Yers H-2 H-2. The Stndrdized-Employment Deficit H-4 III-l. m-2. III-3. IV-1. IV-2. IV-3. JCT/CBO Estimtes of the Clinton Administrtion's Revenue Proposls Chnges in Effective Tx Rtes Under the President's Tx Proposls, by Income Group Chnges in Effective Tx Rtes by Income Group: President's Tx Proposls, Food Stmps, nd Low Income Home Energy Assistnce Progrm The Clinton Administrtion's Pln nd CBO's Uncpped Bseline for Ntionl Defense The Clinton Administrtion's Pln nd the Bush Administrtion's Finl Budget for Ntionl Defense Possible Chnges in Funding to Mintin n Active-Duty Force of 1.4 Million Under the Clinton Administrtion's Pln ffl-2 ni-4 ni-7 IV-2 IV-4 IV-6

8 TABLES (Continued) A-l. Revisions to the CB Bseline A-4 A-2. The Deficit Outlook Under Current Policies A-5 A-3. Revenues by Sourc in the CBO Bselin nd Outlys by Ctegory A-6 A-4. CBO Bseline Proje tions for Mndtory Spending, Excluding Deposit insurnce A-8 A-5. How Tight Are the Discretionry Cps? A-9 A-6. The Ten-Yer Budg t Outlook A-1

9 CHAPTER I. SUMMARY AND INTRODUCTION The Clinton Administrtion hs proposed n mbitious progrm to encourge economic growth by cutting the budget deficit nd incresing government spending tht could hve long-term pyoffs. The Congressionl Budget Office (CBO) estimtes tht the Administrtion's proposls would reduce the deficit from $38 billion in 1993 to $25 billion in In contrst, with no chnge in budgetry policies, the deficit would swell to $322 billion in CBO's nlysis is bsed on the proposls nd estimtes described in the Administrtion's document A Vision of Chnge for Americ, which ws relesed on Februry 17, In erly April, the President will present forml budget contining detiled nd revised budget proposls s well s updted budget estimtes. Becuse the April budget is likely to modify or clrify some of the Administrtion's proposls, CBO's current nlysis must be viewed s preliminry. The Administrtion's proposls my lso be modified by the Congress, which is currently considering the budget resolution for fiscl yer CBO BUDGET PROJECTIONS CBO estimtes tht under current budgetry policies the federl deficit will totl $31.6 billion in 1993, $286.7 billion in 1994, nd $359.7 billion in 1998 (see Tble 1-1). These bseline projections ssume tht discretionry spending is held to the limits estblished by the Budget Enforcement Act (BEA) in 1994 nd 1995 nd grows t the sme pce s infltion fter CBO's current bseline budget projections incorporte minor revisions of those tht CBO relesed in Jnury in The Economic nd Budget Outlook: Fiscl Yers In CBO's estimtion, the Administrtion's budgetry proposls would dd $6.8 billion to the deficit in 1993 nd would reduce the deficit every yer therefter. Compred with the CBO bseline, the Administrtion's pln would reduce the deficit by $18.6 billion in 1994, $27.4 billion in 1995, nd $131.2 billion in Although the Administrtion's policies would, on blnce, reduce the deficit, its progrm includes mny proposed spending increses nd tx reductions. Most of these progrmmtic increses re lbeled s stimulus or investment proposls in the Administrtion's Februry 17 document, but some re included in the ctegory of "nondefense discretionry progrm svings." During the period, the Administrtion's pln provides totl of $355

10 TABLE 1-1. CBO ESTIMATES OF THE ADMINISTRATION'S POLICY PROPOSALS (By fiscl yer, in billions of dollrs) CBO Bseline Deficit Deficit Reductions Outlys Discretionry spending Mndtory spending Debt service Subtotl, outlys Revenues 1 " Totl, Reductions J2A Deficit Increses Outlys Discretionry spending Mndtory spending Debt service Subtotl, outlys Revenues'" Totl, Increses Totl Chnges Deficit Under the President's Budget s Estimted by CBO SOURCES: Congressionl Budget Office; Joint Committee on Txtion. NOTE: The budget estimtes reflect the proposls incorported in the President's budgetry messge of Februry 17,1993. In erly April, the President will present forml budget contining detiled nd revised budget proposls nd updted budget estimtes.. Assumes complince with the discretionry spending limits in the Budget Enforcement Act through 1995; discretionry outlys re ssumed to grow t the sme pce s infltion fter b. Increses in revenues re shown with negtive sign becuse they reduce the deficit. Estimtes of the Administrtion's revenue proposls were prepred by the Joint Committee on Txtion. 1-2

11 billion in net deficit reduction from the CBO bseline, representing $652 billion in gross reductions, prtly offset by $297 billion in increses. In comprison, the 199 budget summit greement provided for $482 billion in net deficit reduction over five yers. Differences Between CBO nd Administrtion Estimtes CBO's estimte of the deficit is lower thn the Administrtion's estimte in 1993, 1997, nd 1998, but higher in 1994, 1995, nd 1996 (see Tble 1-2). These differences tke into ccount differences in estimtes of the budget bseline nd the Administrtion's policy proposls. CBO's estimte of the bseline deficit is lower thn tht of the Administrtion in most yers, but CBO lso projects somewht smller svings from the Administrtion's proposls. Becuse the Administrtion's budget estimtes re bsed on CBO's economic ssumptions, ll of the differences between the Administrtion nd CBO reflect different methods of estimtion. CBO's bseline estimtes differ from those of the Administrtion in two key respects. First, CBO projects higher tx collections fter 1994 thn the Administrtion. Differing interprettions of recent trends in corporte income tx collections explin more thn hlf of this difference. Second, both the mount nd timing of spending for deposit insurnce remin in doubt. During the period, CBO projects higher outlys for deposit insurnce of $6 billion. CBO is more pessimistic thn the Administrtion bout the nticipted outlys for svings nd lons but less gloomy bout the prospects for the Bnk Insurnce Fund. For discretionry spending proposls, CBO hs generlly incorported the Administrtion's requested chnges in budget uthority, even where proposl is not clerly specified, but hs independently estimted the resulting chnges in outlys. For mndtory spending, such s Medicid or Medicre, CBO hs used its own estimtes of the specific policy chnges proposed by the Administrtion. In three cses reforming Federl Housing Administrtion insurnce, reforming power mrketing dministrtions, nd chnging debtmngement policies the Administrtion hs not yet outlined specific proposl, nd CBO's estimte therefore includes no svings for these items. Differences in estimtes of the Administrtion's policy proposls re concentrted in five res. First, the Joint Committee on Txtion's estimtes of the Administrtion's revenue proposls, which re shown in the ccompnying tbles, re bout $5 billion yer less thn the Administrtion's estimtes. Lower estimtes of the mounts generted by the proposed rte increses for 1-3

12 TABLE 1-2. DIFFERENCES BETWEEN CBO AND ADMINISTRATION ESTIMATES OF THE ADMINISTRATION'S PROPOSED BUDGET (By fiscl yer, in billions of dollrs) Administrtion's Estimte of the Deficit CBO Reestimtes of the Administrtion's Bseline Revenues" Deposit insurnce Other outlys Subtotl b -3.4 ~ b CBO Reestimtes of the Administrtion's Proposls Revenues" Debt mngement Medicre Py offsets Debt service Other outlys Subtotl Totl Reestimtes Deficit Under the President's Budget s Estimted by CBO SOURCES: Congressionl Budget Office; Joint Committee on Txtion; Office of Mngement nd Budget. NOTE: The budget estimtes reflect the proposls incorported in the President's budgetry messge of Februry 17,1993. In erly April, the President will present forml budget contining detiled nd revised budget proposls nd updted budget estimtes.. Increses in revenues re shown with negtive sign becuse they reduce the deficit. Estimtes of the Administrtion's revenue proposls were prepred by the Joint Committee on Txtion. b. Less thn $5 million. 1-4

13 high-income individuls nd the complince nd enforcement efforts represent most of this mount. Second, the Administrtion's estimtes ssume svings tht grow to lmost $5 billion in 1998 from chnges in debt-mngement policies. Becuse the Administrtion hs not detiled its specific chnges in debt-mngement policies, CBO's estimte does not include budgetry svings from this source. Achieving svings of the mgnitude the Administrtion ssumes would require shifting most or ll borrowing in long-term bonds nd much borrowing in medium-term notes to short-term securities. Third, CBO's estimtes of the svings from the proposed reductions in reimbursement of providers in the Medicre progrm re below those of the Administrtion. The differences vry by yer but pproch $2 billion in This difference in estimtes is lrgely ccounted for by the Administrtion's indvertent use of different economic ssumptions in estimting the effects of these proposls. Fourth, the Administrtion's estimtes omit the effect of the proposed reductions in federl civilin nd militry py on the level of Defense Deprtment contributions to the federl employee retirement progrms. Becuse the gency's contributions re set percentge of pyroll, reduction in py will lso shrink the mount of the gency's contributions, which re recorded in the budget s undistributed offsetting receipts. By neglecting to include this loss in receipts, the Administrtion underestimtes the deficit by mounts growing to $2 billion by Fifth, becuse CBO's estimte of the svings generted by the Administrtion's proposls is lower thn tht reported in A Vision of Chnge for Americ, CBO's estimte of the resulting reduction in the cost of servicing the federl debt is lso lower. By 1998, this difference reches $2.3 billion. Other reestimtes to outlys re smller, both individully nd in totl. CBO estimtes tht outlys from the stimulus pckge would be $2.1 billion lower in 1993 thn the Administrtion ssumes but higher by n equl mount over the period. CBO ttches higher svings to the Administrtion's proposls to replce gurnteed student lons with direct lons, extend customs fees, nd uction rights to use the electromgnetic spectrum. CBO hs lower svings estimtes, however, for the Administrtion's proposed reforms in urnium enrichment, hrdrock mining, frm price supports, Medicid, nd the federl buildings fund. 1-5

14 Alterntive Bseline Concepts The budgetry svings generted by the Administrtion's proposls cn be mesured using severl lterntive budget bselines (see Tble 1-3). CBO's estimtes use s their strting point the CBO bseline, which ssumes complince with the discretionry spending cps estblished by the Budget Enforcement Act of 199. One lterntive is the uncpped bseline, which ssumes tht discretionry spending in the period grows t just the rte of infltion. The Administrtion's Februry 17, 1993, document employs still third bseline concept, in which nondefense discretionry spending keeps pce with infltion, but defense discretionry spending is held to the levels proposed in the Bush Administrtion's Jnury 1992 budget request (with vrious djustments). The existence of competing bselines nd competing estimtes cretes considerble confusion. The Administrtion, for exmple, sttes tht its policies will reduce the 1997 deficit by $14 billion-the difference between the Administrtion's bseline of $346 billion nd its budget estimte of $26 billion. Using the sme bseline concept s the Administrtion but its own estimting methods, CBO would show reduction of $122 billion-from $327 billion to $25 billion. Compred with the CBO bseline deficit of $322 billion, however, the Administrtion's reductions totl only $117 billion in For the period, CBO would estimte svings of $4 billion using the Administrtion's bseline concept nd $355 billion using the CBO bseline. The differences in the figures rise becuse some of the Administrtion's discretionry svings re needed simply to comply with the BEA's spending cps. THE ADMINISTRATION'S PROPOSALS Three-qurters of the $355 billion in cumultive deficit reduction contined in the Administrtion's progrm would stem from increses in revenues nd only one-qurter from cuts in outlys. Extension of expiring tx increses nd spending cuts would generte $6 billion of the reduction in the deficit. Continuing vrious tx credits nd other revenue-losing provisions, however, would cost $22 billion. The Administrtion would increse domestic discretionry spending but reduce defense nd mndtory spending. The spending increses would exceed the cuts through 1995, but the spending reductions would dominte in lter yers. By 1998, the proposed increses in txes nd reductions in spending re more evenly blnced. The rtio of revenues to gross domestic product (GDP) 1-6

15 TABLE 1-3. CBO AND OMB ESTIMATES OF BASELINE DEFICITS (By fiscl yer, in billions of dollrs) CBO Estimtes Uncpped Bseline Deficit Reductions Bush Administrtion's defense proposls* Debt-service svings Subtotl.2 _b ^ ^L Administrtion Bseline Deficit Further Reductions Required to Meet Discretionry Cps Discretionry spending Debt-service svings Subtotl -.2 b Cpped Bseline Deficit OMB Estimtes Uncpped Bseline Deficit Reductions Bush Administrtion's defense proposls* Debt-service svings Subtotl _Q -5.3 ^ ^L Administrtion Bseline Deficit SOURCES: Congressionl Budget Office; Office of Mngement nd Budget.. Includes djustments to the Bush Administrtion's request s estimted by the Clinton Administrtion. b. Less thn $5 million. c. Assumes complince with the discretionry spending limits in the Budget Enforcement Act through 1995; discretionry outlys re ssumed to grow t the sme pce s infltion fter

16 would rise from 18.5 percent in 1993 to 19.7 percent in 1998-close to the postwr record of 2.2 percent reched in Over the sme period, spending would decline from 23.5 percent to 22.6 percent of GDP (see Tble 1-4). Revenues The Administrtion hs proposed some 3 revenue-rising items, s well s smller number of tx reductions designed to stimulte investment nd rewrd work. The mjor revenue risers re n increse in income tx rtes for highincome individuls nd corportions, elimintion of the limit on ernings subject to the pyroll tx for Hospitl Insurnce, inclusion in djusted gross income of 85 percent (insted of 5 percent) of Socil Security benefits bove the current income thresholds, nd estblishment of brod-bsed energy tx. The investment proposls include temporry incrementl investment credit, permnent investment credit for smll businesses, extension of the reserch nd experimenttion credit nd other expiring preferences, nd expnsion of the erned income credit. Discretionry Spending The Budget Enforcement Act estblished seprte dollr limits on defense, interntionl, nd domestic discretionry spending for fiscl yers 1991, 1992, nd A single overll limit pplies to discretionry spending in 1994 nd The Administrtion hs proposed extending the discretionry spending limits through 1998, but it hs not yet suggested ny specific levels. In CBO's estimtion, the Administrtion's budget is within or ner the current limits on discretionry budget uthority for 1994 nd 1995, but exceeds the limits on outlys. In 1994, totl discretionry outlys exceed the cp by $9.7 billion (see Tble 1-5). Of this mount, $6.4 billion represents the 1994 outlys from the 1993 stimulus pckge, which the Administrtion proposes to tret s n emergency requirement. Under the terms of the BEA, the discretionry spending limits re incresed to mke extr room for emergency ppropritions. Even excluding the outlys from the stimulus pckge, the Administrtion's request exceeds the 1994 outly cp by $3.3 billion. The Administrtion's proposls exceed the cp on discretionry outlys by n even lrger mount in Leving out $3.2 billion in outlys from the stimulus pckge, discretionry outlys brech their limit by $11.6 billion. 1-8

17 TABLE 1-4. CBO ESTIMATES OF THE ADMINISTRATION'S BUDGETARY PROPOSALS (By fiscl yer) In Billions of Dollrs Revenues 1,142 1,242 1,329 1,412 1,485 1,552 Outlys 1,45 1,51 1,586 1,634 1,69 1,781 Deficit Debt Held by the Public 3,289 3,56 3,821 4,58 4,29 4,549 As Percentge of GDP Revenues Outlys Deficit Debt Held by the Public Memorndum: Gross Domestic Product (In billions of dollrs) 6,173 6,58 6,855 7,22 7,543 7,873 SOURCE: Congressionl Budget Office. NOTE: The budget estimtes reflect the proposls incorported in the President's budgetry messge of Februry 17,1993. In erly April, the President will present forml budget contining detiled nd revised budget proposls nd updted budget estimtes. 1-9

18 TABLE 1-5. THE ADMINISTRATION'S PROPOSALS FOR DISCRETIONARY SPENDING IN FISCAL YEAR 1994 (In billions of dollrs) Ctegory Budget Authority Outlys Budget Authority Outlys Budget Authority Outlys Defense Interntionl Domestic Generl science, spce, nd technology Energy Nturl resources nd environment Agriculture Commerce nd housing credit Trnsporttion Community nd regionl development Eduction, trining, employment, nd socil services Helth Medicre Income security Socil Security Veterns' benefits Administrtion of justice Generl government Allownces Subtotl, domestic Totl, Discretionry Spending Discretionry Cps b n.. n.. Difference n.. n.. SOURCE: Congressionl Budget Office. NOTE: n... = not pplicble.. Less thn $5 million. b. End-of-session limits s estimted by CBO. 1-1

19 Within the discretionry spending ctegory, the Administrtion proposes continued rel reductions in defense nd rel increses in most res of domestic spending. Defense discretionry budget uthority, which totled $274 billion in 1993, would drop to $264 billion in 1994 nd $249 billion by 1997«cut of 21 percent in rel terms. At the sme time, domestic discretionry budget uthority would grow from its current level of $29 billion to $262 billion~ rel increse of 7 percent. The Administrtion proposes to increse rel discretionry spending in most domestic functions of the budget. By fr the lrgest increses would go to eduction nd relted progrms notbly, Hed Strt; elementry, secondry, nd postsecondry eduction; summer youth employment nd trining; new ntionl service progrm for youth; nd new trining progrm for dislocted workers. Compred with the uncpped CBO bseline, the President's progrm would dd $4. billion in budget uthority (BA) nd $2.5 billion in outlys to the eduction function in 1994, nd $13.4 billion in BA nd $12.7 billion in outlys in Discretionry helth progrms would lso receive substntil increses in funding bove the uncpped bseline~$1.2 billion in BA in 1994 nd $6.2 billion in Additionl resources would be focused on reserch relting to AIDS nd women, s well s on prevention of substnce buse. The President lso proposes lrge increses in spending for science (for Ntionl Science Foundtion reserch nd the Ntionl Aeronutics nd Spce Administrtion), trnsporttion (for highwys nd mss-trnsit grnts), nd income security (for housing ssistnce; the Specil Supplementl Food Progrm for Women, Infnts, nd Children; nd low-income home energy ssistnce). The Administrtion's proposed reductions in domestic discretionry spending emphsize cross-the-bord cuts in wide rnge of federl progrms. The Administrtion trets mny but not ll of these cuts s llownces rther thn ssigning them to specific budget functions. Eliminting py increses for civilin gencies in 1994 nd limiting py increses during the next three yers would reduce discretionry outlys by $1.6 billion in 1994 nd $3.5 billion in Eliminting 1, federl jobs would sve $.9 billion in 1994 nd $1.6 billion in An dditionl $.6 billion in 1994 nd $4.2 billion in 1998 would be sved by further "stremlining" of the federl government. Still other unspecified dministrtive svings would totl $.5 billion in 1994 nd $3.5 billion in Unlike the proposed chnges in revenues nd mndtory spending, the Administrtion's discretionry proposls cnnot ll be encted into lw this yer, but will depend on future Congressionl ction. Extending the limits on discretionry spending would constrin the totl mount of ppropritions, but Ml

20 nnul pproprition bills will determine how the totl is llocted mong individul progrms. Mndtory Spending The Medicre progrm ccounts for more thn hlf of the proposed cuts in mndtory spending (see Tble 1-6). Mjor svings would be chieved bymintining the rtio of premium chrges to benefit pyments for Supplementry Medicl Insurnce t its 1995 level; extending other expiring provisions, including those tht mke Medicre the secondry pyer for certin beneficiries nd curtil pyments for hospitl cpitl expenditures nd outptient deprtments; nd reducing hospitl reimbursement rtes. The Administrtion would lso cut pyments for medicl eduction in hospitls, clinicl lbortories, nd physicins not in primry cre. In three other progrms, svings would lso rise lrgely from extending current svings provisions tht re scheduled to expire. These items include eliminting the option for lump-sum pyment in Civil Service retirement, extending the limit on pension benefits pid to certin veterns in nursing homes, nd continuing Customs Service merchndise nd pssenger processing fees. Additionl svings would be chieved by reducing frm price support pyments, replcing the gurnteed student lon progrms with direct federl lons, eliminting personl cre s mndtory benefit nd mking other reductions in Medicid, nd uctioning future rights to use the electromgnetic spectrum. Increses in mndtory spending re concentrted in three res. An extension of emergency unemployment compenstion through October 2,1993, hs lredy clered the Congress nd ws signed into lw on Mrch 4. The Administrtion lso proposes to increse spending on Food Stmps nd to expnd the erned income tx credit (EITC) for low-income wge erners; the refundble portion of the EITC ppers s n outly in the budget. Debt Held bv the Public The Administrtion's proposls would slow but not hlt the growth of federl debt reltive to the size of the economy. On its current course, debt held by the public will swell from $3. trillion (51 percent of GDP) t the end of 1992 to $4.8 trillion (62 percent of GDP) in Under the Administrtion's pln, the debt would rech $4.5 trillion, or 58 percent of GDP, in six yers. The Administrtion's proposl for direct lons to college students would dd $

21 TABLE 1-6. THE ADMINISTRATION'S PROPOSALS FOR MANDATORY SPENDING (By fiscl yer, in billions of dollrs) Reductions Medicre premiums Extend other expiring Medicre provisions Reduce hospitl reimbursement Other Medicre svings Subtotl, Medicre ^2, Frm price supports Student lons Medicid Civil Service retirement Veterns' benefits Customs user fees Spectrum uctions Py offsets Other Totl, Reductions _ Increses Unemployment compenstion Food Stmps Erned income tx credit Other Totl, Increses 3.3 _Q _ Totl Chnges SOURCE: Congressionl Budget Office,. Less thn S5 million. 1-13

22 billion to the debt in 1998 but would be mtched by roughly equl increse in interest-erning ssets. CONCLUSIONS The proposls outlined in A Vision of Chnge for Americ would mke substntil contribution to reducing the deficit, but they re not sufficient to solve the long-run problem. Both CBO nd the Administrtion estimte tht, under the President's policies, the deficit would decline only through 1997 nd then resume its rise. By the Administrtion's own projections, the deficit would rech bout $4 billion, or 4 percent of GDP, by 23. The Administrtion pins its hopes for further deficit reduction on its helth reform proposls, which re scheduled for relese in erly My. CBO hs frequently pointed out, however, tht reforming the helth cre system is unlikely to curb government spending quickly. In the short run-sy, over the next 1 yers-it will be exceedingly difficult to relize significnt budgetry svings s long s ny reform proposl extends coverge to the uninsured, voids shifting costs to privte pyers, nd mintins mny of the desirble spects of the current system. A more promising pth to still lower deficits would be to mke further reductions in progrms or to scle bck the proposed increses in the President's budget pln, s both the House nd Sente Committees on the Budget hve done. 1-14

23 CHAPTER H. THE MACROECONOMIC IMPLICATIONS OF THE PRESIDENT'S BUDGET AND A REEXAMINATION OF THE CBO ECONOMIC FORECAST Enctment of the Administrtion's budget proposls would ffect the pttern of economic growth over the next few yers nd would ultimtely rise the economy's level of output. The Administrtion's estimtes of the economic effect of its proposls, long with other fctors, re incorported in its policy forecst (see Tble II-1). Since the Administrtion used the Congressionl Budget Office's (CBO's) economic forecst in prepring its bseline budget, CBO both nlyzed the impct of the Administrtion's progrm nd reexmined its own economic forecst. HOW WILL THE ADMINISTRATION'S POLICIES AFFECT THE ECONOMY? The Administrtion's proposls re likely to hve little net effect on the economy in the next few yers, but they my rise infltion slightly nd hve probbly lredy contributed to decline in long-term interest rtes. The portion of the proposls ddressed to short-run stimulus is smll nd some of its effects re spred out over few yers. The longer-term proposls for reducing the federl deficit re scheduled to be phsed in smoothly, so tht their overll impct in ny one yer is lso limited. The process of deficit reduction inevitbly wekens growth for time, s CBO described in its most recent Economic nd Budget Outlook. If the recent decline in long-term interest rtes persists, however, it will help offset the effects of deficit reduction for the next few yers. But even with the ssistnce of the decline in interest rtes, the President's pckge is not likely to strengthen the economy in reltion to the CBO bseline through the mid-199s. Eventully, the reduction in the deficit nd the support given to investment will increse the productive potentil of the economy, but these effects will probbly not show up in incresed output nd incomes until well beyond the period covered by the current budget projections. Clerly, the effect of the progrm in 1993 nd 1994 depends on how soon the Congress tkes ction. Unemployment compenstion hs lredy been extended; this nlysis ssumes tht progrms for summer jobs will be encted soon nd tht the bulk of the pckge will be pssed by this September. CBO's outly estimtes of the Administrtion's proposls nd the Joint Committee on Txtion's revenue estimtes re used throughout. The budget resolutions pssed by the House nd the Sente incorporte plns for more deficit restrint thn tht proposed by the Administrtion. Those plns would tend to weken growth in the ner term slightly more thn the Ad-

24 TABLE n-1. CONGRESSIONAL BUDGET OFFICE BASELINE, ADMINISTRATION, AND BLUE CHIP ECONOMIC PROJECTIONS, CALENDAR YEARS Forecst Projected Rel GDP (Percentge chnge, yer over yer) CBO Administrtion Blue Chip GDP Defltor (Percentge chnge, yer over yer) CBO Administrtion Blue Chip Consumer Price Index* (Percentge chnge, yer over yer) CBO Administrtion Blue Chip Civilin Unemployment Rte (Percent) CBO Administrtion Blue Chip Three-Month Tresury Bill Rte (Percent) CBO Administrtion Blue Chip Ten-Yer Tresury Note Rte (Percent) CBO Administrtion Blue Chip* SOURCES: Congressionl Budget Office; Office of Mngement nd Budget; Eggert Economic Enterprises, Inc., Blue Chip Economic Indictors. NOTES: The CBO forecst is bsed on dt vilble through December 1992 nd does not reflect fourth-qurter dt for gross domestic product or the consumer price index published in Jnury The Blue Chip forecsts re bsed on survey of privte forecsters published on Mrch 1, The Administrtion used CBO's economic forecst hi its budget clcultions. The forecst lbeled "Administrtion" in this tble reflects the Administrtion's own forecst nd includes its estimte of its own progrms' effects.. Consumer price index for ll urbn consumers (CPI-U). b. The Blue Chip does not project 1-yer note rte. The vlues shown here re bsed on the Blue Chip projection of the A bond rte, djusted by CBO to reflect the estimted spred between A bonds nd 1-yer Tresury notes. n-2

25 ministrtion's proposls nd dd little more to the potentil growth of the economy in the long term. But the dditionl spending cuts re not lrge enough to ffect the outlook significntly. Chnges in the Federl Deficits One of the most importnt mesures of the economic impct of the President's proposls is the chnge in the stndrdized-employment deficit. This hs two spects: in the short run, the government deficit (djusted for the effects of the business cycle) is hndy mesure of the fiscl stimulus provided by the budget; nd in the longer run, reductions in the government deficit indicte how much less of ntionl sving the government is bsorbing, leving more for privte investment nd reducing the need for finncing from brod. In reltion to CBO's bseline projections, the Administrtion's progrm dds little to the stndrdized-employment deficit (nd thus provides tiny fiscl stimulus) in In 1994 it would reduce the deficit, which contributes to long-term gols but does nothing to increse short-term growth. The progrm increses the deficit trivilly in 1993~by.1 percent of gross domestic product (GDP)--nd then reduces it by.2 percent of GDP in 1994 (see Tble H-2). By this mesure, the proposls imply smll fiscl restrint mounting to some.2 percent of GDP over the two-yer period. 2 The dditionl restrint would continue through 1998, when the President's proposls would bring the stndrdized-employment deficit to 2.8 percent of GDP, s compred with 4.4 percent in the CBO bseline. Such reduction in government borrowing ims t incresing the productive potentil of the economy by shifting resources out of consumption uses spending by households nd government nd into investment uses. This shift in resources would llow privte investment to be finnced with less relince on foreign borrowing. But the shift would probbly not occur swiftly or pinlessly nd, tken by itself, would suppress economic ctivity for number of yers. 1. The deficit mesure most relevnt for this clcultion is the stndrdized-employment deficit, which purges the deficit of the effects of the business cycle nd removes outlys for deposit insurnce, which CBO believes hve little concurrent effect on the economy. The outlys for deposit insurnce primrily represent n exchnge of ssets nd, therefore, do not directly increse the current income or welth of the privte sector or dd to privte demnd. 2. Both versions of the budget resolution those pssed by the House nd the Sente would chnge the net fiscl restrint over the next two yers by less thn.1 percent of GDP. n-3

26 TABLE II-2. THE STANDARDIZED-EMPLOYMENT DEFICIT In Billions of Dollrs CBO Bseline President's Budget s Estimted by CBO As Percentge of Potentil GDP CBO Bseline' President's Budget s Estimted by CBO SOURCE: NOTE: Congressionl Budget Office. These mesures of fiscl policy exclude outlys for deposit insurnce nd llied contributions for Opertion Desert Storm.. This mesure ssumes complince with the Budget Enforcement Act's discretionry spending limits in 1994 nd 1995; fter 1995, discretionry spending is ssumed to increse t the rte of infltion. Just how much economic ctivity would be held down depends in prt on how the Federl Reserve responds to the fiscl ction. If the Federl Reserve cts ggressively to temper the fll in output by lowering short-term interest rtes nd incresing money growth before the economy wekens, much of the output loss could be voided. If, however, the Federl Reserve follows, rther thn leds, the economy, output loss will probbly be greter. CBO hs ssumed tht the Federl Reserve will offer mild offset to the fiscl restriction by mintining money growth t the rte tht would hve previled in the bsence of the deficit reduction. Under this ssumption, CBO hs estimted tht deficit reduction progrm bout twice s lrge s the President's proposl one tht would eliminte the deficit over the next five to 1 yers-- might reduce the short-run growth rte of the economy by bout one-hlf of percentge point for period of between three nd five yers. 3 The uncertinty in this estimte lrgely reflects economists' imperfect knowledge of the wy fiscl policy ffects the economy, s well s uncertinty bout the Federl Reserve's response. The President's proposl, which reduces the deficit by smller 3. See Congressionl Budget Office, The Economic nd Budget Outlook; Fiscl Yers (Jnury 1993), Chpter 5. n-4

27 increments, would hve correspondingly smller short-term costs nd provide smller long-term benefits. These estimtes include the norml effect of lower government borrowing on cpitl mrkets. Reducing deficits reduces interest rtes becuse it wekens the economy nd becuse the federl government reduces its own demnd for credit. The erly effect of the nnouncement of the President's progrm seems to hve been fr greter thn norml, however. Long-term interest rtes fell by bout.6 percentge points in the first three months of Although quick response to the progrm ws lwys theoreticl possibility, few economists expected so rpid nd lrge drop in rtes. In ddition to the President's progrm, number of other fctors might hve ffected the recent behvior of the cpitl mrket. Among these fctors re possible mrket ressessment of expecttions of future nonfederl demnds for cpitl nd developments in the rest of the world. Economists hve long thought tht long-term rtes were high, given the wekness in the economy nd the outlook for infltion. The spred between long- nd short-term interest rtes ws extrordinrily high during 1992, nd long-term interest rtes lso ppered to be high when djusted for infltion. Mny nlysts ttributed the high rtes to fers of worldwide shortge of cpitl during the 199s or to incresed uncertinty bout the size of future deficits nd their effect on interest rtes. 4 If those fctors were importnt, the drop in rtes this yer could be ttributed in prt to delyed ressessment of the implictions of future demnd nd supply of cpitl on interest rtes nd not solely to ressessment of future deficits. It is likely tht U.S. cpitl mrkets hve lso been ffected by the worsening news bout the economies of Europe nd Jpn. 5 Officils of Germny's Bundesbnk now think the sitution is sufficiently serious to llow interest rtes to fll modestly, nd the mrkets my nticipte nother decline. Jpn's economy is lso experiencing very slow growth. Becuse world cpitl mrkets re tightly linked, the wekness in these economies lowers U.S. interest rtes. The net effect of these fctors hs been to lower interest rtes much fster thn the President's progrm would hve been expected to lower them. This will 4. See Congressionl Budget Office, The Economic nd Budget Outlook. 5. Bd foreign news lso helps resolve nother puzzle: why hsn't the U.S. dollr deprecited? Theory nd pst experience suggest the dollr should fll if deficits re expected to fll becuse the outlook for U.S. interest rtes should be reduced. A weker outlook for foreign economies, however, lso presges lower interest rtes brod, nd this tends to mke the U.S. exchnge rte pprecite. The lower expecttion for foreign interest rtes my hve offset the deprecition tht the new U.S. budget policy would otherwise produce. n-5

28 help boost growth in 1993 nd, in 1994, offset much of the effects of the fiscl restrint tht will occur in tht yer. How the Investment Tx Credit Chnges the Story Chnges in government borrowing, lthough they re useful indictor, do not tke into ccount ll the effects of fiscl policy. The President's progrm includes mesure the temporry, incrementl investment tx credit (ITC)~tht is designed in prt to increse the leverge of fiscl policy by stimulting privte investment spending t reltively low cost to the budget. If successful, the ITC would encourge dditionl investment. The budgetry cost would be reduced becuse the credit is designed to pply only to investment bove n mount bsed on investment in previous yers (see Chpter HI). Thus, this progrm holds the promise of reltively lrge increses in privte investment spending t low budgetry cost. According to CBO's estimtes, however, the temporry, incrementl ITC exerts only modest dditionl leverge. Ech dollr of tx credit is likely to generte bout one nd hlf dollrs in dditionl privte investment during 1993 nd Thus, the dditionl leverge from the FTC, in reltion to the clcultions lredy incorported in the stndrdized-employment deficit, mounts to only bout $5 billion in This mount is smll in reltion to the size of the economy. (The impct is likely to be more concentrted in 1994 becuse of the dministrtive complexities of n incrementl ITC nd possible dely in writing regultions.) Looking forwrd nother yer, this credit will not be vilble to new investment in 1995 nd lter yers, though nother element of the President's progrm would mintin permnent ITC for smll business only. The mjority of the new investment tht the temporry ITC will stimulte in 1994 will probbly come from investment tht would otherwise hve tken plce in Thus, in 1995 the overll fiscl restrint will be mgnified by policy-induced reduction in privte investment. The proposl includes provisions to penlize compnies tht llow their investment to drop too much in 1995, but the effect of these provisions is uncertin. The Effect on Employment Estimtes of the employment effects will mirror those of the proposls on the level of rel GDP. Given the likelihood tht the Administrtion's proposls will mke little difference to the overll economy for the next few yers, totl H-6

29 employment will not be gretly ffected. The level of employment will probbly be similr to the bseline levels. The Administrtion hs climed tht its proposls will crete n dditionl 5, jobs by the end of Additionl job cretion of tht mgnitude would only be likely if rel GDP t tht time is bout.5 percentge points bove the bseline. On blnce, given the restrint of the deficit reduction, the slight offsetting stimulus from the ITC, nd the low interest rtes discussed bove, the level of GDP is likely to be pproximtely the sme s the bseline t the end of Therefore, even if the effects of the decline in interest rtes re included, it does not seem likely tht the Administrtion's proposls will significntly ffect the number of permnent jobs. The Administrtion lso clims tht its proposls will crete 7, summer jobs. The money proposed for the summer progrm could ctully fund tht number of jobs, so the mjor question is simply whether or not locl governments will be ble to ger up to spend the money in the time given. If the legisltive ction occurs lte, s it did lst yer, only smll mount of the pproprition will be spent this yer. The Effect on Infltion The Administrtion's policies will not foster higher infltion by stimulting demnd, but the proposed energy tx will probbly induce slightly higher infltion for few yers. As noted bove, the combined effect of the Administrtion's proposls nd the low interest rtes re not likely to rise the level of GDP bove the CBO bseline. Demnd growth, therefore, will not be stimulted so much s to strin the economy's productive cpbility. The energy tx, however, by directly rising the price of energy nd indirectly incresing costs for goods nd services tht use energy, will slightly increse the level of prices in generl. The energy txes will stimulte reltively smll increse of bout.5 percent in the level of prices by Becuse the energy txes would be pplied in three nnul increses beginning in July 1994, the.5 percent chnge in the price level would be spred out over the period. The rte of chnge of the level of prices would be higher in ech of those three yers by bout.1 to.2 percentge points. After the phse-in is complete, infltion would return to its bseline rte. H-7

30 The Effect of the Budget on the Level of Potentil GDP by 1998 The Administrtion's proposls would increse the level of the economy's potentil output by the end of the projection period. The increse in the potentil growth rte stems from the effect of lower federl deficits on ntionl sving nd investment. As the federl deficit flls, investment nd cpitl ccumultion will be greter thn in the CBO bseline nd the economy's potentil level of output will increse. Using stndrd growth model, potentil growth would be bout.1 percentge point greter by 1998 thn the 2. percent rte incorported in the bseline. Fctors Other Thn Deficit Reduction Tht My Help Potentil. Other spects of the Administrtion's proposls, specificlly the proposed increses in public infrstructure nd eduction nd trining, nd the privte investment cused by the permnent ITC, hve been cited s dditionl economic stimulnts. These policies re unlikely to dd significntly to the potentil growth rte of GDP during this decde, however, even though the progrms could hve merit. Some of these progrms, such s dditionl funding for Hed Strt nd bsic reserch nd development projects, could ultimtely increse potentil GDP, but will not do so soon. Hed Strt funding will not hve significnt effect on the potentil level of output until the children it ffects enter the lbor force. Bsic reserch expenditures lso hve long gesttion period before their product pplictions strengthen the economy. Other progrms, such s those tht improve the environment, my increse welfre, but few of the benefits will be included in GDP s it is currently mesured. Environmentl gins would rise potentil GDP only insofr s they incresed the productivity of cpitl or lbor in the production of goods nd services tht re included in GDP. An improvement in the helth of workers or slowing of the rte of deteriortion of production fcilities would be reflected in potentil GDP, but such gins re likely to hve smll impct, prticulrly in this decde. The permnent ITC nd investment in trnsporttion infrstructure, which in theory could stimulte more investment during the 199s, re too smll to ffect the level of potentil GDP significntly. The proposed increse in spending on public trnsporttion infrstructure would be bout $3 billion yer in the period. The mount is trivil in reltion to the mount of spending on public nd privte investment in the economy pproximtely $85 billion. Therefore, it will hve no discemble impct on long-run growth. In ddition, much of the benefit of better rods is reduction in commuting time, benefit tht is not mesured in GDP. H-8

31 The permnent ITC is lso likely to hve smll effect. Since only smll businesses qulify for the 5 percent permnent ITC, nd since they ccount for smll percentge of the privte cpitl stock, the ITC will not rise the level of the cpitl stock significntly. Will the Income Tx Increse Hurt Potentil? The President's proposls include shrp increse in the txtion of high incomes. The new top brcket of income tx rises two questions: how esy will it be for the rich to void the tx by shifting income into tx-fvored forms, such s cpitl gins; nd how much will the tx chnge ffect behvior tht is economiclly significnt, prticulrly work effort nd sving? Assuming, s Chpter HI concludes, tht ny shifting probbly will not hve significnt impct on revenues, the question of sving nd work effort remins. Work effort is unlikely to be ffected significntly. The thin evidence tht is vilble suggests tht chnges in income tx rtes my be importnt for work effort mong the poor, but less importnt for the bulk of the lbor force. Sving, however, could be ffected. For brod-bsed tx chnges, econometric evidence does not settle the question of whether tx increses reduce or increse privte sving, but the rich my be different in this respect. First, rich people generlly sve more of their incomes. Therefore, even if they do not chnge the percentge of their income tht they sve fter txes, txing them more hevily will discourge sving more thn incresing txes on broder segment of the popultion. Second, there is some evidence tht the svings of the rich re more sensitive to chnges in txes thn re the svings of moderte-income nd poor people (tht is, the rich will tend to mintin their consumption in the fce of n increse in income txes by reducing their sving rte). If so, the Clinton progrm will imply slightly smller long-term improvement hi productive cpcity becuse the increse in totl ntionl sving will be somewht smller. REEXAMINING THE CBO FORECAST As noted previously, there is little reson to ssume tht the Administrtion's proposls will hve mjor effect on economic growth or infltion over the next two yers. But hve ny other recent developments overtken the CBO bseline forecst? Some of the recent economic dt, such s the upwrd revision of the fourth-qurter rel GDP growth rte to 4.8 percent, hve led number of forecsters to rise their growth-rte projections for 1993 nd 1994, wheres others, noting the deteriorting sitution brod, rgue tht the outlook hs H-9

32 worsened. A reexmintion of the forecst in light of recent developments indictes tht CBO's long-term interest rte forecst for 1993 ppers to be too high, but tht the forecsts for rel growth nd infltion re still resonble. The Blue Chip consensus estimtes, which build in forecsters' ssumptions for the finl form of the budget nd its effect, indicte growth in 1993 nd 1994 tht is slightly higher thn CBO's forecst. Blue Chip lso indictes slightly lower long-term interest rtes this yer nd significntly higher infltion in 1994 thn CBO forecst. Three Percent Growth for 1993 Is Still Resonble Forecst Although output grew more rpidly in lte 1992 thn CBO ssumed, there re strong resons for continuing to ssume tht growth in 1993 will be close to 3 percent. The long-term djustment problems mentioned in the CBO winter report re still present, corporte restructuring continues, commercil construction will remin wek, demogrphics will dmpen demnd for residentil construction, nd the household debt burden, lthough it hs esed somewht, is still high. The wekening of foreign demnd is new development. Forecsts for foreign growth hve been revised downwrd since December nd the dollr hs been somewht stronger thn CBO nticipted. The consensus forecst for Jpn's growth this yer is now 1.5 percent, 1 percentge point lower thn lst November's forecst. The forecst for growth in Germny in 1993 hs been similrly reduced from.7 percent growth to decline of 1. percent. In ddition, despite the fll of the dollr ginst the Jpnese yen, the trde-weighted vlue of the dollr ws bout 3 percent higher during the first qurter thn CBO forecst. These developments will mke U.S. export growth weker this yer thn the CBO bseline ssumed. Slower gins in personl consumption will lso constrin growth in the first hlf of this yer. The growth of consumption, which ws the strongest ctegory of demnd in the lst hlf of 1992, will probbly slow in the first hlf of this yer. Consumption outpced disposble income lst yer, dropping the personl sving rte in the second hlf of 1992 below tht of the first. It is likely tht households will try to mintin current sving rtes or even rebuild svings, nd such n effort will weken consumer demnd in the first hlf of this yer. By contrst to developments in foreign demnd nd consumption, the lower long-term interest rtes, if they remin low, will stimulte growth this yer. Although budget developments will hevily influence rtes in the coming months, it is resonble to ssume tht long-term interest rtes will remin t lest slightly n-io

33 below the CBO bseline. This will stimulte growth more thn ssumed in the bseline. On blnce, the lower interest rtes nd the worsening foreign outlook pproximtely offset ech other, resulting in little net effect on GDP growth for the yer. The qurterly pttern of growth will probbly be different thn ws previously thought, however. The unexpectedly strong growth in lte 1992 will be counterblnced by slightly weker thn expected growth in the first hlf of this yer s consumers retrench. The overll growth for the yer still ppers likely to be bout 3 percent. Comprison with the Recent Consensus Forecst The mjor difference for the next two yers between the CBO bseline forecst nd the current Blue Chip consensus lies in the forecst for infltion, lthough the consensus indictes slightly stronger rel growth nd lower long-term interest rtes this yer, nd higher interest rtes in subsequent yers (see Tble n-1). The Blue Chip forecsters expect significntly higher infltion in 1994 thn does CBO. Unless growth is much more rpid thn tht envisioned by the consensus forecst, CBO does not foresee infltionry pressures developing in Becuse growth of the lbor force will increse, the unemployment rte is likely to remin reltively high well into 1994 despite respectble pce of job cretion. Wges, therefore, will continue to be moderte in reltion to productivity gins through the forecst horizon. Pressures on fctories' cpcity to produce re lso unlikely to rise enough to rise the rte of infltion. Long-term interest rtes will probbly be slightly lower this yer thn the CBO forecst indicted. The Blue Chip, however, forecsts n increse in nominl interest rtes next yer. Most of the difference between the CBO nd the consensus forecsts for interest rtes in 1994 reflects different infltion ssumptions. After djusting for this difference, long-term interest rtes re slightly higher in the CBO bseline thn in the Blue Chip forecst. n-n

34

35 CHAPTER III. THE ADMINISTRATION'S REVENUE PROPOSALS The President's budget contins lrge number of revenue proposls. Some of the proposls extend provisions in the tx lw tht expired in 1992, or will expire in the next few yers, but mny of the proposls re new. The President's proposls include incresing income tx rtes on high-income individuls nd lrge corportions, extending the Hospitl Insurnce (HI) portion of the pyroll tx to ll the wges of the highest wge erners nd selfemployed individuls, txing higher proportion of Socil Security benefits, nd imposing new energy tx. The budget lso contins proposls tht broden the tx bse for some txpyers. The President's budget intends to return some of the revenue gins from tx-rte increses nd bse-brodening mesures in the form of tx incentives for wide vriety of ctivities. These proposls include restoring most of the tx incentives tht expired in 1992 nd prtilly reinstting some of the tx preferences tht the Congress eliminted or scled bck in the Tx Reform Act of AN OVERVIEW OF THE PRESIDENT'S TAX PROPOSALS The President's revenue proposls hve number of brod themes. First, the proposls s whole increse revenue to reduce the federl deficit. Second, the proposls rise lrge shre of the new revenues from high-income txpyers in order to shift the distribution of the tx burden mong income groups. Third, the proposls include mjor new tx on energy consumption. Fourth, some proposls either extend expiring tx incentives or introduce new ones. Finlly, number of smller proposls broden the tx bse, penlize certin ctivities, nd improve complince. Incresing Revenues Bsed on estimtes from the Joint Committee on Txtion (JCT), the President's proposls will increse net receipts by $28 billion in 1994 nd $267 billion through 1998 (see Tble III-l). Proposls tht increse revenues mount to $46 billion in 1994 nd $337 billion in the period. These increses re offset in prt by other proposls tht reduce revenues by $18 billion in 1994 nd $7 billion in 1994 through In ddition, proposed chnges in the erned income tx credit (EITC) increse outlys by bout $17 billion over the period.

36 TABLE ni-1. JCT/CBO ESTIMATES OF THE CLINTON ADMINISTRATION'S REVENUE PROPOSALS (By fiscl yer, in billions of dollrs) Stimulus nd Investment Proposls Investment Credits nd AMT Deprecition Enterprise Zones Expnd Erned Income Tx Credit* Exclude Cpitl Gins on Originl-Issue Smll Business Stock Extend Preferences Other Subtotl Revenue-Rising Proposls Increse Top Individul Tx Rte to 36%; 26% & 28% AMT; Increse AMT Exemption to $45,/533,75; 39.6% Rte on Txble Income Greter Thn $25,; Extend Phseout of Personl Exemptions nd Limit on Itemized Deductions Remove Cp on HI Txble Wge Bse b Include 85% of Socil Security Benefits in AGI Increse Income Tx Rte on Lrge Corportions Estblish Brod-Bsed Energy Tx" Extend 2.5 Cents per Gllon Gs Tx b Cp Possessions Tx Credit (Sec. 936) t 65% of Wges Restrict Deduction for Business Mels nd Entertinment to 5% Interntionl Tx Provisions Complince Provisions Chnge Corporte Estimted Tx Rules Other Subtotl , _M _M All Proposls Totl SOURCES: Congressionl Budget Office; Joint Committee on Txtion. NOTE: JCT = Joint Committee on Txtion; AMT = lterntive minimum tx; HI = Hospitl Insurnce; AGI = djusted gross income.. Two-thirds of the effect of expnding the EITC is in the form of refundble tx credits. The refundble portion is not included here; it is included with the outly proposls. b. Net of income tx offsets. III-2

37 Among the revenue-rising proposls, bout 6 percent of the increse in revenue in 1994 through 1998 comes from increses in individul nd corporte income tx rtes, repel of the wge cp on the helth insurnce pyroll tx, incresed txtion of Socil Security benefits, nd increses in estte nd gift tx rtes. The increse in income tx rtes on high-income individuls by itself ccounts for bout one-third of the pickup in gross revenues nd lmost hlf of the net revenue gin (fter ccounting for revenue-losing proposls). Another qurter of the gross revenue pickup comes from the new energy tx nd extending the 2.5 cent portion of the motor fuels tx tht is llocted to generl revenues. Proposls to restrict some business nd individul deductions, eliminte some tx preferences, nd lter some provisions ffecting interntionl business would rise n dditionl 1 percent of the gross revenue. Investment incentives ccount for more thn three-fourths of the proposed revenue reductions in 1994 through The proposed temporry nd permnent investment tx credits nd revised rules for deprecition under the lterntive minimum tx (AMT) mke up lmost hlf of the revenue reduction; nother fifth comes from extending the tx credits for reserch nd experimenttion (R&E) nd low-income housing. The other mjor item is the proposed expnsion of the EITC, which would increse the deficit by bout $24 billion over five yers. About two-thirds of the budgetry cost of the expnded EITC is ccounted for by the refundble portion, which the Congressionl Budget Office (CBO) records s n increse in outlys. Redistributing the Tx Burden The President's proposls will shift greter shre of the federl tx burden to high-income txpyers. CBO estimtes tht the tx proposls (including the refundble portion of the EITC) will rise totl effective federl tx rtes (ETRs) on verge by bout 7 percent for fmilies in the top quintile of the income distribution, bout 3 percent for fmilies in the third nd fourth quintiles, nd bout 1 percent for fmilies in the second quintile, nd will reduce ETRs by bout 4 percent on verge for fmilies in the bottom quintile (see Tble III-2). The lower ETR in the bottom quintile is consequence of expnding the EITC. Within the top quintile, the increse in txes is reltively lrgest for fmilies with the highest incomes. Fmilies in the top 1 percent would ber more thn 55 percent of the burden of the new txes. The proposl would rise the ETR for these fmilies by lmost 2 percent, from bout 28 percent under current lw to bout 33 percent under the proposl. The new ETR for III-3

38 TABLE III-2. CHANGES IN EFFECTIVE TAX RATES UNDER THE PRESIDENTS TAX PROPOSALS, BY INCOME GROUP (In percent) Effective Tx Rtes Current Lw" Proposl Percentge Chnge in Effective After-Tx Tx Rte Income Shre of Chnge in Txes Income Quintile Lowest Second Third Fourth Highest All Fmilies Rnked by Adjusted Fmily Income Detil on Highest Quintile 81 percent to 9 percent 91 percent to 95 percent 96 percent to 99 percent Top 1 percent Fmilies Rnked by Dollr Income Income Level Less thn $1, $1, to $2, $2, to $3, $3, to $4, $4, to $5, $5, to $75, $75, to $1, $1, to $2, $2, or more All SOURCE: Congressionl Budget Office. NOTES: The estimtes ssume 1998 tx lw nd 1994 income levels. They include ll tx proposls except the enterprise zone proposl, the proposl on corporte estimted tx pyments, nd miscellneous complince mesures. Pretx fmily income is the sum of wges, slries, self-employment income, rents, txble nd nontxble interest, dividends, relized cpitl gins, nd ll csh trnsfer pyments. Income lso includes the employer's shre of Socil Security nd federl unemployment insurnce pyroll txes, nd the corporte income tx. For purposes of rnking by djusted fmily income, income for ech fmily is divided by the projected 1994 poverty threshold for fmily of tht size. Quintiles contin equl numbers of people. Individuls re treted s fmilies of one. Fmilies with zero or negtive income re excluded from the lowest income ctegory but re included in the totl. Chnges in individul income txes, premiums, nd entitlements re distributed directly to fmilies pying those txes nd premiums, or receiving those benefits. Chnges in pyroll txes re distributed to fmilies pying those txes directly, or indirectly through their employers. Chnges in federl excise txes re distributed to fmilies ccording to their consumption of the txed good or service. Chnges in corporte income txes re distributed to fmilies ccording to their income from cpitl.. Current lw reflects the scheduled expirtion of the limittion of itemized deductions, the phseout of personl exemptions, nd the 2.5 cent component of the gsoline tx tht goes into the generl fund. III-4

39 the top 1 percent would be slightly greter thn their ETR in 198 (bout 32 percent), but smller thn their ETR in 1977 (lmost 36 percent). The quintile rnkings used in the top pnel of Tble rry fmilies by djusted fmily income (API), mesure tht djusts for need bsed on fmily size. The results re similr when fmilies re rnked by dollr income, except in the lowest-income groups (see bottom pnel of Tble III-2). The ETR of the highest-income fmilies increses by the lrgest bsolute mount nd the lrgest percentge. Fmilies with incomes of more thn $2, would ber 6 percent of the dditionl tx burden, while fmilies with incomes of more thn $1, would py lmost 7 percent. The ETR for fmilies with incomes of more thn $2, would increse by bout 18 percent. The tx proposls ffect fmilies t the sme income level quite differently, s highlighted by the differences in the mesured chnges in the ETR for low-income txpyers between the two pnels of Tble III-2. As result, n increse or decrese in the tx burden for quintile s whole does not men the tx burden will chnge even in the sme direction for ny fmily within the quintile. The results by quintile re consistent with wide rnge of outcomes for seprte fmilies. For exmple, becuse the EITC in its current form goes to wge erners in fmilies with children, its effect is highly uneven within the bottom quintile. The verge ETR for fmilies without children in the bottom quintile increses under the proposl; t the sme time, the ETR flls substntilly for fmilies with children. Becuse the AFI mesure gives lrger fmilies lower rnking thn smller fmilies t the sme income level, it shows tx reduction for the bottom quintile s whole. In contrst, when fmilies re grouped by undjusted income levels, fmilies with incomes of less thn $2, experience n overll tx increse. This effect tkes plce becuse those groups contin reltively more single people nd fmilies without children, who would benefit less from the expnded EITC thn verge fmilies in the bottom quintile rnked by djusted fmily income. The energy tx lso vries in its impct within quintiles, depending on the proportion of its income tht fmily spends on gsoline, home heting oil, nturl gs, nd electricity. The net tx increse for low-income fmilies minly reflects the effects of the proposed new energy tx, lthough fmilies in ll income groups lso ber some of the burden of higher corporte income txes. To compenste low-income fmilies for the effects of the proposed energy tx, the President hs proposed increses in Food Stmps nd the Low Income Home Energy Assistnce Progrm (LIHEAP). The combined effects of the President's tx nd trnsfer proposls reduce the verge ETR (djusted for III-5

40 chnges in LIHEAP nd Food Stmps) for fmilies with income under $1, nd increse the verge ETR for fmilies with income between $1, nd $3, by less thn.2 percent (see Tble III-3). Fmilies with incomes of more thn $1, ber more thn 7 percent of the combined tx burden of dditionl txes nd trnsfer pyments (Food Stmps nd LIHEAP). CBO estimtes of the distributionl effects of the President's proposls differ from those of the Tresury Deprtment becuse of differences in methodologies. These methodologicl differences include different wys of mesuring income, grouping people into fmily or txpyer units, llocting the burden of txes collected from compnies mong income groups, nd projecting the most recently vilble income nd tx dt to future yers. In spite of those technicl differences, CBO nd Tresury estimtes of the distributionl impct of the President's proposls re qulittively similr. Both CBO nd Tresury estimtes show tht the burden of the tx proposls flls mostly on the highest-income fmilies. Both estimtes lso show tht the verge tx burden on fmilies in the lowest-income groups either declines or increses very modestly. Txing Energy The President proposes to impose new tx on consumption of British therml units (Btus) of energy. The tx rtes would be 25.7 cents per million Btus on col, nturl gs, nd nucler nd hydroelectric power nd 59.9 cents per million Btus on oil. The proposl would phse in these rtes over three-yer period beginning on July 1,1994, nd then index the rtes to infltion fter July 1, CBO clcultes tht the proposl, when fully phsed in, would increse the price of gsoline by 7.5 cents per gllon (bout 6 percent), home heting oil by 8.3 cents per gllon (bout 7 percent), nturl gs by 26.5 cents per million cubic feet (bout 4 percent), nd residentil electricity by.3 cents per kilowtt hour on verge (bout 3 percent). These price chnges would increse direct nnul energy costs by less thn $1 for the verge household. The totl cost of ll goods nd services, including the costs resulting from higher energy prices pid by businesses, would rise by over $2 per household. The Administrtion lists energy conservtion, environmentl improvement, nd improved ntionl security s benefits from txing consumption of Btus. The tx will promote ll of these objectives to some degree, but the gins re likely to be miniml. III-6