    [Budget Supplement]
    [Creating an Age of Possibility]
    [2. Three Years of Progress]
    [From the U.S. Government Printing Office, www.gpo.gov]

      As President Clinton took office in January 1993, the economy was only
    then emerging from a long period of sluggish growth--beginning with the
    1990-1991 recession and continuing through an extremely weak recovery,
    marked by rising unemployment.
      The sluggishness exacerbated some serious long-term trends. Since the
    early 1970s, the incomes of most Americans have not grown as much as
    they once did--in fact, not much at all. As discussed in the previous
    chapter, only those atop the income ladder have enjoyed steady income
    growth. For others, the daily struggle to make ends meet has threatened
    to become a losing battle. For workers with only a high school
    education, times have been especially tough.
      The President campaigned on a pledge to restore widely shared
    prosperity, and he shaped his economic policies to achieve this primary
    goal. The huge Federal budget deficit was a major obstacle. Others
    included sluggish business investment, slow job growth, and the
    overgrown Federal Government, about which the public had grown deeply
    cynical.
      Three years later, our economy is stronger and the deficit is down
    even more than we had predicted. In dollar terms, the policies that we
    enacted with the last Congress have cut it almost in half, from $290
    billion in 1992 to $164 billion in 1995. As a share of the economy, we
    have cut it by over half, to 2.3 percent (see Charts 2-1 and 2-2).
      But as detailed in Chapter 1, we need further action to balance the
    budget once and for all.
      The Administration also has begun to significantly change the way that
    the Federal Government works. Under the leadership of the Vice
    President's National Performance Review, we are working to create a
    Government that ``works better and costs less.''

      Since January 1993, we have cut the number of Federal employees by
    over 200,000, to its lowest level in 30 years; the Federal share of the
    civilian workforce is at it lowest level since the 1930s. We are
    eliminating 16,000 pages of Federal regulations. We have reformed
    Federal procurement so that the Government now buys at the best price;
    no longer do we read news accounts of $600 hammers. (For more details on
    how we are making Government work, see Chapters 13 and 14.)

      Meanwhile, the Administration has employed Government where it does
    the most good--investing in education and training, protecting the
    environment and public health, helping people get needed health care,
    strengthening families by helping America's neediest children, and
    rewarding work. On the world stage, the President has strengthened
    American leadership and advanced American strategic and economic
    interests and values.
      Still, we have much more to do. Fully reversing the long-term trends
    that have weakened America will take time and enormous effort.
      This chapter reviews what we have done to meet the economic and social
    challenges that the Administration inherited three years ago. It
    describes how the economy and society have responded to these
    initiatives, and the economic path that we envision for the future.

                        WHAT THE ADMINISTRATION INHERITED

    Near-Term Economic Problems

      The President inherited an economy that had nominally escaped from
    recession, but had not yet resumed solid and sustainable economic growth
    either for the short term or further down the road.

      Unemployment: Unemployment rose sharply in late 1990 with the onset of
    recession. Though the recession technically ended in early 1991, growth
    was so weak for many months that unemployment continued to rise. In
    January 1993, unemployment was 7.1 percent,
    [[Page 20]]
    about a quarter-point higher
    than when the 1990-91 recession ended.
      Although the economy created some new jobs in the recovery of 1991-92,
    net job creation was weak. In the four years before January 1993, the
    economy created just 2.4 million net new jobs--about 51,000 a month.
    Over the same period, the labor force grew by 80,000 people each month.
    With the number of potential workers rising faster than the number of
    jobs, higher unemployment necessarily followed.

      Slow Growth: Weakness in the labor market reflected weak economic
    activity in general. The economy was growing, but very slowly. From the
    start of 1991, through the first quarter of 1993, real Gross Domestic
    Product, or GDP, grew at well under half the rate of economic recoveries
    since 1960 that lasted at least that long.
      The Credit Crunch: The U.S. financial system showed increasing strains
    in the 1980s. Individuals and corporations pushed their debt burdens
    higher and higher, and interest payments absorbed more and more income.
    While the amount of debt was rising, its quality was falling. Savings
    and loan institutions and banks made some extremely risky loans, many of
    which proved worthless.
      As losses to the Government's deposit insurance programs mounted, the
    problems of deteriorating credit quality and failing financial
    institutions became clear. Bank and thrift regulators began to close the
    failed institutions and the surviving ones raised their credit standards
    sharply. Many businesses, especially in areas with heavy concentrations
    of bad loans, had trouble getting needed credit.
      Meanwhile, individuals and businesses reduced their borrowing to
    improve their balance sheets and cut the burden of their interest
    payments. These steps led to slower consumer spending and less real
    estate investment. In cities across the country, new construction
    [[Page 21]]
    came to a halt as developers scrambled to find tenants for empty office
    buildings.

    Long-Term Problems

      The economy's cyclical problems were just part of what the new
    Administration faced. Underlying those problems were chronic conditions
    that had lasted over a decade. Among the most damaging were the Federal
    budget deficit, the fall in private saving, the slowdown in productivity
    growth, and the increase in income inequality.

      The Budget Deficit: The Government has incurred a deficit every year
    since 1969, but the deficit exploded in size in the 1980s--largely due
    to the fiscal policies of 1981 and the economic conditions of that day.
      The Administration and Congress cut income tax rates by 23 percent,
    reducing revenue by over four percent of GDP, and increased spending on
    defense. The tax cuts, higher defense spending, and second recession in
    two years combined to send the deficit soaring. By 1983, it had nearly
    tripled, to $208 billion, and since then has never fallen below $149
    billion.
      Higher and higher deficits brought more and more debt. From the start
    of the Republic to 1980, the Government had accumulated just under $1
    trillion in debt. From 1980 to 1992, the debt rose to $4 trillion.
      To be sure, a big deficit can help to stabilize the economy during a
    recession. But this deficit was harmful because it was ``structural'';
    it would continue even if the economy performed well. Despite numerous
    attempts to cut the deficit over the next decade, it threatened to reach
    unsustainable levels as this Administration assumed office.
      A structural deficit is important because it affects the Nation's pool
    of saving. Nations must set aside funds today to build the factories and
    machines that will generate income for tomorrow; what they set aside
    [[Page 22]]
    is their saving. It has two components: (1) private saving (by individuals
    and businesses); and (2) public saving (by Federal, State, and local
    governments).
      If the Federal Government borrows from that pool to finance its
    deficit, then the borrowed saving is not available to make productive
    private investment. With its big deficits, the Federal Government in the
    1980s massively drained our Nation's saving pool. Worse, as Federal
    deficits were rising, private saving was falling, making the Nation's
    saving problem worse.

      Private Saving: Private saving averaged 13.3 percent of GDP in the
    1960s, but dropped to 7.3 percent in the 1980s (see Chart 2-3). A fall
    in private saving affects investment and the trade balance in the same
    way as an increase in the budget deficit. Thus, the fall in private
    saving exacerbated the economic effects of the higher budget deficit.

      In the 1980s, lower national saving pulled down investment. To some
    extent, the drop in investment was offset by more borrowing from abroad.
    But that, in turn, led to other problems--including a rising trade
    deficit. Increased foreign borrowing converted the United States from
    the world's largest creditor to its largest debtor nation. To service
    those debts, the Nation will have to increase its exports over its
    imports for the foreseeable future (see Chart 2-4).

      Thus, because of the higher deficits and lower private saving, the
    1980s economic expansion was financed by debt to an unprecedented degree
    (see Chart 2-5). Much of the extra borrowing was not backed by more
    assets; thus, the borrowing raised the burden of debt service without
    providing a corresponding increase in resources to service the debt.
    High real interest rates, caused by the higher borrowing, further
    aggravated the problem.
    [[Page 23]]
    [[Page 24]]
    [[Page 25]]
      Debt left the economy vulnerable when recession struck in the 1990s,
    and it helps explain why the recovery was initially so weak. No strong
    recovery could occur until the unwise policies of the 1980s were
    reversed.
      The decline in saving and investment also contributed to another of
    the economy's chronic weaknesses--sluggish productivity growth.

      The Productivity Slowdown: Rising productivity holds the key to higher
    incomes. For 25 years after World War II, productivity growth averaged
    2.7 percent a year, the highest in U.S. history for that long a time
    period, and it reached three percent a year in the 1960s. Incomes rose
    substantially for most families, and workers grew accustomed to annual
    pay increases that outstripped inflation. The middle class expanded, as
    did opportunities for home ownership, education, and leisure.
      Since the early 1970s, productivity has grown an average of only about
    one percent a year, about a third as fast as before (see Chart 2-6).
    With slower productivity growth, the rapid rise in living standards came
    to an end. The Nation's promise of opportunity was in danger and
    Americans began to fear that, for the first time in U.S. history, future
    generations would not enjoy higher living standards than their parents.
      While the economy continued to grow, it did not grow as fast as in
    earlier decades. Moreover, growth depended more on the entry of new
    workers, especially married women, into the labor market. When growth in
    the labor force slowed, as at the beginning of the 1990s, productivity
    improvements alone could not sustain continued rapid increases in real
    GDP.

      Rising Inequality: Another chronic problem, aggravated by slower
    productivity growth and lower saving, was rising income inequality. For
    the lowest 60 percent of American
    [[Page 26]]
    families, the standard of living
    actually fell from 1979 to 1992. Only those at the top continued to
    enjoy substantial income gains.
      For families in the bottom 20 percent of income, real mean income was
    14 percent lower in 1992 than in 1973; for families in the top five
    percent, real income was 17 percent higher. As a result, the gap between
    the top and bottom incomes widened to record levels.

    The Social Repercussions

      Slow productivity growth and widening income inequality have effects
    throughout society. The difficulties of working families in making ends
    meet have raised the pressures on them and weakened the social fabric.
    The consequences have come to light in the economic and social
    statistics on poverty, social breakdown, and crime.
      The sluggish economy of the early 1990s was especially hard on the
    poor. The official poverty rate hit its low point in 1973, after falling
    sharply for most of the previous decade. Since then, increases in
    poverty during recessions have outpaced reductions in poverty during
    recoveries.
      By 1992, the poverty rate had risen to nearly 15 percent. That year,
    more than one in five of the Nation's children were poor.

                      WHAT THE ADMINISTRATION HAS ACHIEVED

      To bring the economy back to health, the Administration sought to
    tackle the budget deficit while promoting prosperity by investing in
    education and training, and science and technology; by opening new
    markets; and by keeping interest rates and inflation in check.

    Budget Policy

      The President and the last Congress enacted the Omnibus Budget and
    Reconciliation Act of 1993, designed to reduce the deficits by a
    combined $505 billion over five years, 1994-98. Because the economy has
    performed better than even the Administration had predicted, we now
    expect those deficits to fall by $697 billion over the same period, even
    without further steps to reduce them.
      The President's 1993 economic plan, which still governs U.S. fiscal
    policy, achieved over half of its $505 billion of deficit reduction
    through spending cuts ($255 billion), and the rest through tax measures
    designed to increase the progressivity of the tax code and also raise
    revenue. It made deep cuts in discretionary spending and entitlement
    programs. It extended through 1998 the annual limits, or ``caps,'' on
    discretionary spending that Congress first imposed in 1990. (This budget
    would extend them even further.) In addition, it cut entitlements by $98
    billion.
      Nevertheless, the President's plan also expanded the Earned Income Tax
    Credit (EITC), which rewards work for those in the lowest-income
    brackets. The EITC makes work pay. It offers a positive inducement to
    low-income families to enter the working world and avoid the cycle of
    dependency. The plan raised the rate of the EITC, expanded it to provide
    tax relief to more lower-income working families with children, and
    extended the credit to apply, at lower rates, to low-income workers
    without children.
      In the 1993 plan, only one revenue increase affected typical American
    households--a 4.3 cent per gallon increase in the Federal excise tax on
    gasoline. The change was well timed; it occurred while gas prices were
    falling, so it imposed little or no extra burden on households.
    Moreover, the plan brought down interest rates, saving these typical
    households sizable sums on home mortgages and auto and other consumer
    loans.
      All told, about 90 percent of the revenue increases came from
    households with incomes of over $100,000. To be sure, no one ever wants
    to raise taxes. But this change was appropriate--given the pressing need
    to cut the deficit, and given that high-income families prospered so
    much in the preceding decade. And with the plan at least partly
    responsible for growth in the economy and the stock market since 1993,
    these people have prospered in the last three years.
      Largely due to the President's plan and the economic growth it helped
    spur, the deficit fell from $290 billion in 1992 to
    [Page 27]]
    $164 billion in
    1995; we expect it to remain near this level through 1997. This Nation
    now has the smallest deficit, relative to the size of its economy, of
    any developed country in the world except Norway.
      At the same time, even with total discretionary spending rising far
    less than inflation, the President has worked with Congress to
    reallocate funds to programs that invest in the future and, thus, spur
    economic growth. While the private sector plays the lead role in
    creating growth, the Federal Government must play a key supporting role.
      Among other things, the President and Congress increased funding for
    Head Start; Goals 2000 educational reforms; college scholarships;
    dislocated worker assistance; research and technology; environmental
    protection; the national forests and parks; Clean Water and Safe
    Drinking Water revolving funds; community policing; and the operations
    of the FBI, the Immigration and Naturalization Service, and Federal
    prisons.
      The President and Congress also created and funded the Americorps
    program that enables students to work in communities while earning funds
    for college; the Charter Schools program to support public school
    choice; the School-to-Work Opportunities Act to help young people make a
    smooth transition from high school to work; and the Federal Direct
    Student Loan program to make borrowing cheaper and more effective, and
    to ease the burden of repayment.

    Economic Achievements

      By addressing the deficit, the Administration helped resolve the
    economy's short-run problems. The President's plan enabled the Federal
    Reserve to maintain low interest rates throughout 1993, and financial
    markets responded by lowering long-term rates.
      For example, the yield on ten-year Treasury notes fell from 6\3/4\
    percent in late 1992 to 5\3/4\ percent by the end of 1993, helping to
    end the credit crunch. Interest rates have fluctuated since 1993, but
    with the fall in the deficit freeing up resources for private
    investment, investment has boomed ever since.
      Real growth accelerated in 1993, but inflation remained firmly in
    check. Within two years, unemployment fell below six percent, producing
    the lowest combined rates of unemployment and inflation in three decades
    (see Charts 2-7 and 2-8).

      Job Growth Up, Unemployment Down: Since January 1993, the economy has
    added 7.7 million net new jobs, an average of 214,000 a month (see Chart
    2-9). Over seven million were in the private sector. Over half of the
    new jobs were in the high-paying professional or managerial categories.
    The economy created over a million new jobs in the basic industries of
    construction and manufacturing, including the bellwether automobile
    industry.

      Economic Growth Up: Also since January 1993, real GDP has risen at a
    2.6 percent annual rate, roughly triple the average growth rate of the
    prior three years and faster than such economies as Japan's and
    Germany's (see Charts 2-10 and 2-11). Since the first quarter of 1993,
    private sector GDP--excluding government--has grown by 3.2 percent a
    year.

      Inflation Under Control: The Consumer Price Index has risen an average
    of just 2.7 percent a year since January 1993, marking the smallest
    three-year rise since the mid-1960s (see Chart 2-12).
      Interest Rates Down: In the President's first year, long-term interest
    rates paid by home buyers, business investors, and the Government fell
    by over a point. Inflation fears temporarily reversed that drop in 1994,
    but interest rates fell again in 1995 as inflation fears proved
    unwarranted and chances for more deficit reduction rose. By the end of
    1995, long-term rates were down a full point from their levels of
    January 1993. Aside from a few months in 1993, long-term rates were at
    their lowest point since the 1960s (see Chart 2-13).
      Household Wealth Up: Lower interest rates improved the financial
    standing of households by making home ownership more affordable and
    boosting the stock market. The home ownership rate rose to 65.1 percent
    by the end of 1995, its highest since 1981. Meanwhile, the stock market
    has given its strong endorsement on the state of the economy. Since
    January 1993, the Dow-Jones Industrial average has risen by over 60
    percent, with 36 percent of the rise coming in 1995. All other major stock
    [[Page 28]]
    [[Page 29]]
    market indexes were up by corresponding amounts.
      Exports Up: U.S. exports of goods and services have risen at a rapid
    7.6 percent annual rate (after adjusting for inflation) since the first
    quarter of 1993. Merchandise exports have risen even quicker, at a 9.6
    percent rate. The export record is particularly impressive in light of
    the anemic growth in some of the other major industrialized countries.

      With other economies growing more slowly than America's, our imports
    should have grown faster than our exports. They did. Consequently, the
    trade deficit rose through the first half of 1995. But, as the gap in
    economic growth narrowed a bit in the second half of the year, so did
    the deficit--it fell between June and December of 1995, from $11.4
    billion to $6.8 billion. The bilateral deficit with Japan dropped from
    an annual rate of $64.7 billion in the first half of 1995 to $56.3
    billion in the second half.

    Progress Against Unfavorable Long-Term Trends

      As we have seen, the economy as a whole has improved markedly in the
    last three years. To be sure, we face the ongoing challenge of
    addressing the fundamental factors that determine long-term prosperity.
    Even for those, however, various signs of progress appeared in 1994, the
    last year for which statistics are available.
      That year, median family income rose while the poverty rate--and,
    importantly, the poverty rate for children--fell. Real incomes grew in
    all five quintiles of the income scale for the first time in five years
    (see Chart 2-14).

      Further improvement may have occurred last year, given the favorable
    levels of unemployment and growth in real income. The President's
    program is designed to do even more by creating opportunity and
    encouraging responsibility (see Chapters 5 through 12)
    [[Page 30]]
    and providing tax
    relief to millions of middle-income families (see Chapter 12).
      Productivity growth has only begun to rise, and the final pay-off of
    deficit reduction has not yet arrived. But the fundamental economic
    changes are in the right direction.
      In the coming years, the saving and investment boom of the last three
    years will generate higher incomes by enabling workers to produce and
    earn more. In the near term, the main effect of higher investment has
    been to lower unemployment--itself an early step toward greater
    prosperity.

                      A PRUDENT LOOK AT THE ECONOMIC FUTURE

      In its economic assumptions, the Administration projects a
    continuation of current favorable economic conditions. The assumptions
    are reasonable and conservative.\1\
      \1\For a more detailed explanation of the Administration's economic
    assumptions, see Analytical Perspectives, Chapter 1.
    ---------------------------------------------------------------------------
      Specifically, they project:
      Real GDP growth (on the new chain-weighted basis\2\) that
              averages 2.3 percent a year through 2002, in line with private
              forecasters and CBO--about a half-point a year less than what
              the Administration has achieved over the last three years;
      \2\The Government now measures growth on the new basis that the Bureau
    of Economic Analysis introduced in January 1996.
    ---------------------------------------------------------------------------
      The unemployment rate to remain stable at 5.7 percent, close
              to its current level and within the range that it has
              maintained for over a year;
    [[Page 31]]

    [[Page 32]]
      An increase in the CPI of about 2.8 percent a year from 1998
              to 2002, about the same as it averaged in the previous three
              years; and
      The 10-year Treasury bond rate to fall by 1.1 percentage
              points over the next four years as the deficit continues to
              decline. Over the past year, the rate has fallen by two
              percentage points.
      These economic assumptions presume that Congress adopts the
    President's proposals--most fundamentally that the President and
    Congress put the budget on a path to balance by 2002--and that the
    progress will be evident to households, businesses, and investors. For
    this reason, the Administration expects to see declines in interest
    rates, stimulating sustained growth and investment.
    [[Page 33]]

                                           Table 2-1.  ECONOMIC ASSUMPTIONS\1\
                                      (Calendar years; dollar amounts in billions)
    ----------------------------------------------------------------------------------------------------------------
                                                                            Projections
                                       1994  -----------------------------------------------------------------------
                                      Actual    1995     1996     1997     1998     1999     2000     2001     2002
    ----------------------------------------------------------------------------------------------------------------
    Gross Domestic Product (GDP):
      Levels, dollar amounts in
       billions:
        Current dollars............    6,931    7,254    7,621    8,008    8,417    8,848    9,295    9,772   10,268
        Real, chained (1992)
         dollars...................    6,604    6,742    6,888    7,047    7,212    7,380    7,553    7,730    7,911
        Chained price index
         (1992=100), annual average    105.0    107.6    110.6    113.6    116.7    119.9    123.1    126.4    129.8
      Percent change, fourth
       quarter over fourth quarter:
        Current dollars............      5.9      4.1      5.1      5.1      5.1      5.1      5.1      5.1      5.1
        Real, chained (1992)
         dollars...................      3.5      1.5      2.2      2.3      2.3      2.3      2.3      2.3      2.3
        Chained price index
         (1992=100), annual average      2.3      2.5      2.8      2.7      2.7      2.7      2.7      2.7      2.7
      Percent change, year over
       year:
        Current dollars............      5.8      4.7      5.1      5.1      5.1      5.1      5.1      5.1      5.1
        Real, chained (1992)
         dollars...................      3.5      2.1      2.2      2.3      2.3      2.3      2.3      2.3      2.3
        Chained price index
         (1992=100), annual average      2.3      2.5      2.8      2.7      2.7      2.7      2.7      2.7      2.7

    Incomes, billions of current
     dollars:
        Personal income............    5,750    6,104    6,416    6,716    7,025    7,337    7,664    8,031    8,434
        Wages and salaries.........    3,241    3,420    3,607    3,801    3,995    4,193    4,403    4,629    4,864
        Corporate profits before
         tax.......................      528      602      650      702      753      800      843      882      917

    Consumer Price Index (all
     urban):\2\
        Level (1982-84=100), annual
         average...................    148.2    152.4    156.6    161.3    165.9    170.5    175.3    180.2    185.2
        Percent change, fourth
         quarter over fourth
         quarter...................      2.6      2.7      3.1      2.9      2.8      2.8      2.8      2.8      2.8
        Percent change, year over
         year......................      2.6      2.8      2.8      3.0      2.8      2.8      2.8      2.8      2.8

    Unemployment rate, civilian,
     percent:
        Fourth quarter level.......      5.6      5.6      5.7      5.7      5.7      5.7      5.7      5.7      5.7
        Annual average.............      6.1      5.6      5.7      5.7      5.7      5.7      5.7      5.7      5.7

    Federal pay raises, January,
     percent:
        Military...................      2.2      2.2      2.6      3.0      3.1      3.1      3.1      3.1      3.1
        Civilian\3\................  .......      2.0      2.0      3.0       NA       NA       NA       NA       NA

    Interest rates, percent:
        91-day Treasury bills\4\...      4.3      5.5      4.9      4.5      4.3      4.2      4.0      4.0      4.0
        10-year Treasury notes.....      7.1      6.6      5.6      5.3      5.0      5.0      5.0      5.0      5.0

    ----------------------------------------------------------------------------------------------------------------
    NA=Not available.

    \1\Based on information available as of mid-January 1996.

    \2\CPI for all urban consumers. Two versions of the CPI are published. The index shown here is that currently
      used, as required by law, in calculating automatic adjustments to individual income tax brackets. Projections
      reflect scheduled changes in methodology.

    \3\Percentages for 1994-1996 exclude locality pay adjustments. Percentages to be proposed for years after 1997
      have not yet been determined.

    \4\Average rate (bank discount basis) on new issues within period.