[Analytical Perspectives]
[Economic and Accounting Analyses]
[1. Economic Assumptions]
[From the U.S. Government Publishing Office, www.gpo.gov]


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                          ECONOMIC ASSUMPTIONS

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                        1.  ECONOMIC ASSUMPTIONS

                               Introduction

  The prudent fiscal and monetary policies pursued during this 
Administration have fostered the healthiest economy in over a 
generation. Judged by the yardsticks of growth, jobs, unemployment, 
inflation, interest rates and the stock market, 1997 was a banner year. 
Real Gross Domestic Product (GDP) expanded by nearly 4 percent, the 
Nation's payrolls increased by 3.2 million jobs, and the unemployment 
rate fell to the lowest level in 24 years. Despite robust growth, 
inflation edged down; the rise in the Consumer Price Index excluding the 
volatile food and energy components last year was the smallest since 
1965. The combination of low inflation and low unemployment pulled the 
``Misery Index''--the sum of the inflation and unemployment rates--to 
its lowest level in three decades.
  Households and businesses have prospered in this environment. Wages 
and salaries after adjustment for inflation have increased faster than 
at any time in the past two decades. And thanks to unusually strong 
productivity growth for this stage of an expansion, profits also have 
grown at a healthy pace. The share of profits in GDP climbed to over 10 
percent last year, the highest it has been since 1968.
  Financial markets have responded to these favorable developments by 
bidding up the prices of bonds and equities. Long-term interest rates, 
which move in the opposite direction from bond prices, fell one-half 
percentage point last year. At year's end, the yield on the 30-year 
Treasury bond was below 6 percent, the lowest level in four years. In 
early January, the rate fell another one-quarter percentage point to the 
lowest level since this maturity was first regularly issued in 1977.
  The Dow Jones Industrial Average rose 23 percent during 1997, which 
followed a 68 percent gain during 1995-96. Since the end of 1994, the 
Dow average has doubled, making this the best three-year performance in 
the postwar period and the second best in the 101-year history of the 
Dow. The broader market indexes, the S&P 500 and the NASDAQ composite 
index, also doubled during these three years.
  These outstanding financial and nonfinancial achievements--fostered by 
sound fiscal and monetary policies--have further boosted business and 
consumer confidence. Businesses last year spent heavily on capacity-
expanding new plant and equipment; investment rose at a double-digit 
pace after adjustment for inflation. Consumer optimism soared. According 
to the University of Michigan Consumer Sentiment Index, optimism reached 
the highest level since the survey began in the early 1950s. Overseas 
investors also have expressed their confidence in the U.S. economy. With 
many financial markets around the world in turmoil, foreign investors 
increasingly turned to the safe haven provided by U.S. financial 
markets.
  The fundamental forces affecting the economy and prospective fiscal 
and monetary policies point to continued healthy economic conditions in 
the coming years. The budget is projected to reach balance in 1999--the 
first time that has occurred in three decades--and to remain in balance 
during the remainder of the 10-year planning horizon. A stronger dollar 
is likely to keep inflation low. While some may have thought that real 
growth in the recent past was too fast, in the future these concerns may 
well be eased by developments in Asia. Against this background, monetary 
policy should be able to accommodate continued economic growth with low 
inflation.
  The Administration projects real growth in the next few years to be 
around 2.0 percent per year, before rising to 2.4 percent in 2002-2007. 
The unemployment rate, which at current low levels may run the risk of 
igniting inflation, is projected to edge up slightly to a rate that the 
Administration conservatively estimates to be consistent with stable 
inflation. Nonetheless, millions of new jobs are expected to be created. 
Short-term interest rates are projected to decline and long-term rates 
are expected to remain relatively low as private and public credit 
demands ease and as expectations of continued low inflation are 
incorporated into bond yields. Beyond 1999, the Administration's 
economic projections represent expected trends rather than a definite 
cyclical pattern.
  Private forecasters have a similarly favorable view of the economic 
outlook. The January Blue Chip consensus forecast, an average of 50 
private forecasts, projected real growth, unemployment and inflation at 
rates nearly identical to those used in this budget. The projected 
interest rates were somewhat higher than in the budget assumptions. The 
similarity to the private sector forecasts is an indication that the 
Administration's assumptions are a reasonable, prudent basis for 
projecting the budget.
  The expansion that began in April 1991 has just completed 82 
consecutive months of growth, exceeding 17 of the 20 expansions of this 
century. By December of this year, the expansion will become the second 
longest U.S. expansion of all time and the longest peacetime expansion. 
If it continues through February 2000, this expansion will set a new 
longevity record, outlasting the current record of 106 months of 
uninterrupted growth in the 1960s. According to the Blue Chip survey, 
most private-sector forecasters now expect this to happen.
  This chapter begins with a review of recent developments and then 
discusses two statistical issues: the

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growing statistical discrepancy (the difference between the aggregate 
measures of output and income) and recent methodological improvements in 
the calculation of the Consumer Price Index. The chapter then presents 
the Administration's economic projections, followed by a comparison with 
the Congressional Budget Office's projections. The following sections 
present the impact of changes in economic assumptions since last year on 
the projected fiscal balance and the structural deficit. The chapter 
concludes with estimates of the sensitivity of the budget to changes in 
economic assumptions.

                       Fiscal and Monetary Policy

  When this Administration took office, its first priority was to 
reverse the 12-year trend of large, uncontrolled fiscal deficits. The 
Administration proposed, and Congress passed, the landmark Omnibus 
Budget Reconciliation Act of 1993 (OBRA) which set the budget deficit on 
a downward path. After having reached a postwar record of $290 billion 
in 1992--a huge 4.7 percent of GDP--the deficit has declined each year, 
falling to just $22 billion in 1997--just 0.3 percent of GDP. The last 
time the deficit share of GDP was this low was in 1970.
  The deficit reductions following OBRA have far exceeded predictions 
made at the time of its passage. OBRA was projected to reduce pre-Act 
deficits by $505 billion over the five years 1994-98. Over the five 
years 1993-97, the cumulative deficit reduction has been $811 billion. 
In other words, OBRA and subsequent developments have enabled the 
Treasury to issue $811 billion less debt than would have been required 
under previous law. By 1998, the cumulative deficit reduction from 1994 
through 1998 is estimated to be $1.1 trillion, more than double the 
original estimate.
  While OBRA fundamentally altered the course of fiscal policy towards 
lower deficits, it was not projected to eliminate the deficit. In the 
absence of further action, deficits were expected to begin to climb once 
again. To prevent this and bring the budget into surplus, last summer 
the Administration negotiated the Balanced Budget Agreement with the 
Congress. This budget proposes to achieve a surplus in 1999--three years 
earlier than originally projected. The last budget surplus was in 1969. 
OBRA and the Balanced Budget Agreement together are expected to reduce 
the deficit by a cumulative total of $3.3 trillion over 1993-2002 
compared with the pre-OBRA baseline.
  The economy has outperformed most forecasters' expectations in recent 
years and, at the same time, deficits have been much lower than 
projected. This is more than a coincidence. Lower deficits contribute to 
a healthy, sustainable expansion by reducing interest rates and boosting 
interest-sensitive spending in the economy. Rapid growth of business 
capital spending expands industrial capacity and boosts productivity 
growth. The extra capacity, in turn, prevents shortages and bottlenecks 
that might otherwise emerge.
  Lower interest rates also raise equity prices, which reduces the cost 
of capital to business and increases household wealth and optimism. The 
added impetus to business and consumer spending creates new jobs and 
business opportunities. The result is more production, more income, more 
jobs, more Federal revenues, and a smaller deficit--a virtuous circle of 
prosperity. That has been the experience of the past five years, and it 
will be the likely consequence of policies that achieve budget 
surpluses, and reduce Government debt.
  In this expansion, monetary policy shifted when necessary to prevent 
inflation from picking up, and shifted again to prevent the expansion 
from stalling when that seemed needed. In 1994 and early 1995, monetary 
policy tightened when rapid growth raised the possibility that 
inflationary pressures were about to build. During 1995 and early 1996, 
monetary policy eased because the expansion appeared to be slowing 
unduly and the risk of higher inflation had lessened. Since January 
1996, monetary policy has remained steady. The sole adjustment was in 
March 1997 when the federal funds rate target was raised one-quarter 
percentage point to its current level of 5\1/2\ percent.
  Stable monetary policy for the past two years has kept the 3-month 
Treasury bill rate in a narrow range around 5 percent. Long-term 
interest rates have fluctuated in response to the outlook for inflation 
and the deficit. When economic growth accelerated during the first four 
months of 1997, the yield on the 30-year Treasury bond edged up 50 basis 
points to 7.1 percent. During the remainder of the year, however, the 
rate fell over 100 basis points in response to low inflation, the 
agreement to balance the budget, the unexpectedly low 1997 budget 
deficit, and international developments. By early 1998, the yield had 
fallen to 5.7 percent.

                           Recent Developments

  Real Growth: The economy expanded an estimated 3.7 percent over the 
four quarters of 1997, up from 2.8 percent the prior year. As in 1996, 
the fastest growing sector was business fixed investment. During the 
first three quarters of 1997, business spending for new plant and 
equipment rose at a 13 percent annual rate after adjustment for 
inflation, led by an 18 percent advance in equipment spending. The 
biggest gains continued to be for information processing and related 
equipment, but businesses invested heavily in other forms of equipment 
and in structures as well.
  This exceptionally strong business capital spending has boosted 
productivity and expanded industrial capacity to meet current and future 
demands. Manufacturing capacity rose by more than 5 percent in each of 
the past three years. The last time capacity grew this rapidly was in 
the late 1960s. The extra capacity has helped keep inflation low by 
easing the bottlenecks that might otherwise have developed. In the 
fourth quarter of 1997, the manufacturing operating rate was near its 
long-term average, even though labor markets were much tighter than 
usual.
  Growth last year was also supported by robust household spending. Low 
unemployment, rising real incomes,

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and large capital gains have provided households with the resources and 
willingness to spend heavily, especially on discretionary purchases. 
Overall consumer spending after adjustment for inflation rose at a 4 
percent annual rate during the first three quarters of the year; 
spending on durable goods soared at a 9 percent pace.
  The same factors spurring consumption, along with relatively low 
mortgage rates, pushed new home sales during the first 11 months of 1997 
to their highest level since 1978. Buoyant sales and low inventories of 
unsold homes have provided a strong incentive for builders to start new 
construction. Housing starts remained at high levels last year, and 
residential investment, after adjustment for inflation, increased at 
nearly a 5 percent annual rate during the first three quarters of the 
year.
  Government purchases, on balance, made only a small contribution to 
GDP growth last year. Federal government spending in GDP after 
adjustment for inflation was about unchanged over the first three 
quarters. State and local spending rose at only a 2 percent rate during 
this period, despite the healthy fiscal surpluses that have resulted 
from sharply rising incomes and profits.
  The foreign sector was the primary restraint on growth last year, 
trimming real GDP growth by nearly 1 percentage point during the first 
three quarters of the year. Although exports expanded rapidly, import 
growth was even stronger. The widening of the net export deficit 
reflected the relatively faster growth of domestic demand in the United 
States than in our trading partners, and also the rise in the dollar. 
Last year, the dollar gained 12 percent on a trade-weighted basis on top 
of a 4 percent rise during 1996.

  Labor Markets: The performance of the labor market last year far 
exceeded most predictions. At the start of the year, most forecasters 
had expected the unemployment rate to rise slightly during 1997. 
Instead, the unemployment rate fell 0.6 percentage point to 4.7 percent 
by December 1997. November's rate was 4.6 percent. This is the lowest 
two consecutive months since March/April 1970. When this Administration 
took office, the unemployment rate was 7.3 percent. All demographic 
groups have benefited from the decline. Thirty-eight states had 
unemployment rates of 5.0 percent or less at the end of last year; only 
five had rates above 6.0 percent.
  The Nation's payrolls expanded by 3.2 million jobs last year, the 
biggest gain since 1994. Since the Administration took office in January 
1993, 14.3 million jobs have been created. Job growth was widespread 
across industries last year. The service sector accounted for most of 
the new jobs, but manufacturing industries increased their payrolls by 
over 200,000 jobs. State and local government payrolls also expanded, 
while Federal government employment continued to contract. The abundance 
of employment opportunities pushed the employment/population ratio up to 
64.1 percent by year-end, the highest level on record.

  Inflation: Despite rapid growth and the unusually low unemployment 
rate last year, inflation not only remained low, it actually declined. 
The broadest measure of inflation, the GDP chain-weighted price index, 
rose at just a 1.9 percent annual rate during the first three quarters 
of 1997, 0.4 percentage point less than during the four quarters of 
1996. The last time aggregate inflation was this low was in 1964. The 
Consumer Price Index (CPI) and the CPI excluding food and energy also 
increased less in 1997 than in 1996. The core CPI excluding food and 
energy rose just 2.2 percent last year, the slowest rise since 1965. The 
total CPI rose even less, 1.7 percent, because of falling energy prices.
  The favorable inflation performance was the result of several factors. 
The rise in the dollar has reduced the costs of imported materials and 
intensified price competition from imports. Non-oil import prices have 
fallen nearly every month in the past two years. Although the pace of 
wages and salaries picked up, overall compensation costs were restrained 
by continued low health-care inflation. Finally, robust investment in 
new plant and equipment has contributed to unusually strong productivity 
growth for this stage of an expansion, restraining inflation by 
offsetting gains in labor compensation. Unit labor costs have risen very 
slowly during the first three quarters of 1997.
  The absence of inflation pressures has implications for the estimate 
of the level of unemployment that is consistent with stable inflation. 
This threshold has been called the NAIRU, or ``nonaccelerating inflation 
rate of unemployment.'' Economists have been lowering their estimates of 
NAIRU in recent years in keeping with the accumulating experience that 
lower unemployment has not led to higher inflation, even after taking 
into account the influence of temporary factors. The economic 
projections for this Budget assume that NAIRU is 5.4 percent. That is 
0.1 percentage point less than estimated in the 1998 Budget assumptions 
and 0.3 percentage point less than in the 1997 Budget.
  By the end of 1997, the unemployment rate was about three-quarter 
percentage point below the current estimate of NAIRU. In the absence of 
special factors, if unemployment remains below NAIRU, inflation would 
eventually creep up. The Administration forecast for real growth over 
the next three years, however, is moderate enough to imply that 
unemployment will return to 5.4 percent.

                           Statistical Issues

  The U.S. statistical agencies endeavor to produce accurate measures of 
the economy's performance. Nonetheless, in recent years serious concerns 
have been raised about possible mismeasurement, especially of real GDP 
growth and of inflation.

  Real Growth: In a perfect statistical world, the value of output would 
equal the value of income generated in its production, that is, GDP 
would match Gross Domestic Income (GDI). However, because the series are 
based on different source data, each with its own gaps

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and inconsistencies, the two measures are hardly ever identical. What is 
particularly unusual now is the wide and growing difference between 
product and income measures.
  This ``statistical discrepancy,'' defined as aggregate output minus 
aggregate income, was -$103 billion in the third quarter of 1997--a 
nearly record-setting 1.3 percent of nominal GDP. By comparison, in the 
first quarter of 1995, the statistical discrepancy was nearly zero, and 
two years earlier, in the first quarter of 1993, it was $71 billion. A 
swing of this magnitude means that during the past four and a half 
years, the annual average real growth rate measured from the familiar 
output side has been about 0.5 percentage point less than the growth 
rate measured from the income side. During the first three quarters of 
last year, real GDP rose at a 3.8 percent annual rate but real Gross 
Domestic Income at a 4.5 percent pace. In the third quarter of 1997, the 
divergence widened further. Real GDP growth was at a 3.1 percent annual 
rate, but real GDI surged at a 4.5 percent rate.
  The absence of a single, clear picture of the economy's actual growth 
performance is a cause for concern. It is difficult to know if growth is 
accelerating or decelerating; if actual growth is above or below the 
economy's potential growth rate; or even what the economy's potential 
growth rate is.
  Any estimate of potential growth depends on an estimate of trend 
productivity growth, which itself depends on recent data on actual 
growth. When there is a growing divergence between product and income 
measures, there is a comparable divergence in estimates of the 
productivity trend. For example, measured from the last cyclical peak to 
the third quarter of 1997, labor productivity growth has increased at a 
1.1 percent annual rate according to the official productivity 
statistics which measure output growth from the product side. Labor 
productivity growth measured from the income side, however, has risen at 
a 1.5 percent annual rate.
  It is unclear whether the product or the income side provides the more 
accurate measure of growth. The Bureau of Economic Analysis recognizes 
the shortcomings of both measures but believes that GDP is a more 
reliable measure of output than GDI (see The Survey of Current Business, 
August 1997, page 19). Other experts believe that GDI, or some figure 
between the two measures, may be more accurate.
  There is circumstantial evidence to suggest that growth may be faster 
than shown by the traditional GDP measure. The recent combination of low 
inflation and a rising profits share suggests that productivity growth 
is stronger than reported from the output side. Moreover, the unexpected 
strength of Treasury receipts in the last two years suggests that the 
output measure, and even the income measure, may be too low. While some 
of the higher receipts are from capital gains generated by the booming 
stock market, which are excluded from the national income accounts, this 
source does not fully account for the surge.
  The uncertainty surrounding actual growth and its trend makes it more 
difficult to determine appropriate monetary policy. From a budgetary 
perspective, estimates of receipts and expenditures have a larger degree 
of uncertainty because they are dependent on the forecast for growth. As 
shown in Table 1-6, ``Sensitivity of the Budget to Economic 
Assumptions,'' errors in forecasting real GDP growth can have a 
significant effect on the budget balance.

  Inflation: Accurate measurement of inflation has become increasingly 
important in recent years, even as inflation has been brought under 
control. Eliminating biases of even a few tenths of a percentage point a 
year can have important meaning relative to a goal of price stability 
when inflation is low, while it may have less significance when 
inflation is higher.
  In recent years, serious questions have been raised about the 
magnitude of bias in the Consumer Price Index. In December 1996, the 
Advisory Commission to Study the Consumer Price Index, appointed by the 
Senate Finance Committee, reported that the index overstated the actual 
cost of living by 1.1 percentage points per year. The Bureau of Labor 
Statistics (BLS), however, believes that the empirically demonstrated 
bias is significantly less.
  The BLS has instituted a number of methodological changes in recent 
years to improve the accuracy of the Consumer Price Index, and has 
announced several more changes that will be put in place this year and 
next. Taken together, these changes are estimated to result in a 0.7 
percentage point slower annual rise in the CPI by 1999. The changes 
instituted from 1995-1997 are estimated to have slowed the growth of the 
CPI by 0.3 percentage point per year; the forthcoming changes are 
expected to trim another 0.4 percentage point per year. Because the CPI 
is used to deflate some nominal spending components of GDP, a slower 
rise in the CPI translates into a faster rise in real GDP. By 1999, 
measured real GDP growth and, therefore, productivity growth, is likely 
to be boosted by 0.2 percentage point per year as a consequence of the 
cumulative improvements to the CPI since 1995.
  Two methodological improvements have been instituted beginning with 
the release of the CPI for January 1998: an updating of the expenditure 
weights, and a better technique for estimating quality improvements for 
computers. Together, the two changes are expected to slow CPI growth by 
0.2 percentage point per year.
  This year, the BLS updated the expenditure weights used in the CPI 
from a 1982-84 basis to 1993-95, using Consumer Expenditure Survey data. 
At the same time, BLS introduced a more accurate geographic sample based 
on the 1990 decennial census, and redefined the groupings of items. In 
the future, BLS expects to introduce updated expenditure weights more 
frequently than in the past, when there were approximately 10 years 
between updates.
  For computers and peripheral equipment, the BLS has now begun to use a 
hedonic regression procedure to distinguish price from quality changes. 
The esti

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mated value of an improvement obtained from this regression procedure is 
deducted from the observed price change for the product. For example, if 
the CPI sample of computer prices shows no change in the retail price of 
a new computer, but it is 20 percent better than the prior model as 
measured by the hedonic procedure, the CPI will report a corresponding 
drop in price for this model. A similar procedure has been adopted for 
estimating computer prices in the Producer Price Index and in the 
National Income and Product Accounts. It is especially important to 
measure accurately, and on a timely basis, the extraordinary leaps in 
computer power that must be a part of a meaningful measure of computer 
prices.
  For 1999, BLS has announced that it will select items to be sampled on 
a product rather than a geographical basis. This switch will allow more 
frequent sampling of categories with rapidly changing product lines, 
such as consumer electronics.
  A very important change next year will be the replacement of the 
current fixed-weighted Laspeyres formula by a geometric mean formula for 
combining individual price quotations at the lower level of aggregation 
in the CPI. Under certain assumptions, a CPI calculated using geometric 
means more closely approximates a cost-of-living index. Unlike the 
current fixed- weighted aggregation, the geometric mean formula allows 
for shifts in consumer spending patterns in response to changes in 
relative prices within categories of goods and services.
  Since last April, the BLS has been publishing an experimental CPI each 
month that uses geometric means for all lower level aggregation and has 
provided a historical series beginning with December 1990. If a 
geometric mean is used for all lower level aggregation, BLS estimates 
that the growth in the CPI would be slowed by about one-quarter 
percentage point per year. Partial adoption would result in a lesser 
impact. BLS is expected to announce shortly which categories will be 
shifted to geometric means next year and the likely impact on the growth 
of the CPI.

                          Economic Projections

  The economy's strong performance last year and the continuation of the 
virtuous circle of prosperity made possible by sound fiscal and monetary 
policies raises the possibility that actual economic developments may 
even be better than the assumptions--as has been the case in recent 
years. Nonetheless, it is prudent to base budget estimates on a 
conservative set of economic assumptions close to the consensus of 
private sector forecasts.

  Virtuous Circle of Prosperity: The economic assumptions summarized in 
Table 1-1 are predicated on the adoption of the policies proposed in 
this budget. The swing in the fiscal position from deficit to surplus is 
expected to support a continuation of the favorable economic performance 
of recent years. The shift from Federal Government dissaving to saving 
would pull interest rates down, stimulating private sector investment in 
new plant and equipment. The economy is likely to continue to grow, 
although at a more moderate pace than during 1997. While job 
opportunities are expected to remain plentiful, the unemployment rate is 
likely to rise gradually to a level consistent with stable inflation. 
New job creation would boost incomes and consumer spending and keep 
confidence at a high level. Continued low inflation would enable 
monetary policy to support economic growth. Growth, in turn, would 
further improve the budget balance.

  Real GDP, Potential GDP and Unemployment: Over the next three years, 
real GDP is expected to rise 2.0 percent per year. This shift to more 
moderate growth recognizes that by conservative, mainstream assumptions, 
growth has exceeded the pace that can be maintained on a sustained 
basis, which could eventually result in upward pressures on inflation. A 
slowdown has been expected for this reason. Also, the financial 
dislocations in Asia could contribute to this slowing of U.S. growth. 
From 2001-2007, growth is expected to average a slightly faster 2.4 
percent per year--the Administration's estimate of the economy's 
potential growth rate. Real GDP growth in 2008 is projected to slow to 
2.3 percent to reflect the beginning of the years of slower growth of 
the workforce as the baby-boomers begin to retire.
  The net export component of GDP is expected to restrain real growth by 
about 1 percentage point during 1998, as our export growth is curtailed 
by slower growth in Asia and the appreciation of the dollar. Thereafter, 
as the effects of the crisis abroad wane, export growth is likely to 
pick up slightly. Beginning with 1999, the foreign sector is not 
expected to make a large contribution, positive or negative, to overall 
growth.
  As has been the case throughout this expansion, during the next six 
years business fixed investment is expected to be the fastest growing 
component of GDP. Although residential investment is also expected to 
benefit from low mortgage rates, the high level of housing starts in 
recent years and underlying demographic trends may tend to reduce 
growth. Consumer spending, especially on durable goods, is also likely 
to moderate from the rapid pace of 1997. The fundamental factors 
supporting consumer spending are likely to remain favorable, although 
not quite to the same extent as during 1997. The government component of 
GDP will hardly grow through 2003. A decline in Federal consumption and 
gross investment is projected to be offset by moderate growth in State 
and local spending.
  Continued strong growth of business fixed investment and the output-
increasing effects of methodological improvements to the CPI noted above 
are expected to raise the measured trend of productivity growth during 
the next six years to 1.3 percent per year. By comparison, during the 
seven years following the last business cycle peak in the third quarter 
of 1990, productivity growth averaged 1.1 percent per year, as measured 
from the GDP side of the accounts.

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                     Table 1-1.  ECONOMIC ASSUMPTIONS \1\                                                          
                 (Calendar years; dollar amounts in billions)                                                      
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                                                                                                                    Projections                         
                                                                                   Actual --------------------------------------------------------------
                                                                                    1996     1997     1998     1999     2000     2001     2002     2003 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Gross Domestic Product (GDP):                                                                                                                           
  Levels, dollar amounts in billions:                                                                                                                   
    Current dollars.............................................................    7,636    8,080    8,430    8,772    9,142    9,547    9,993   10,454
    Real, chained (1992) dollars................................................    6,928    7,187    7,357    7,503    7,652    7,820    8,008    8,199
    Chained price index (1992 = 100), annual average............................    110.2    112.5    114.6    116.9    119.5    122.1    124.8    127.5
  Percent change, fourth quarter over fourth quarter:                                                                                                   
    Current dollars.............................................................      5.6      5.5      4.0      4.1      4.3      4.6      4.6      4.6
    Real, chained (1992) dollars................................................      3.2      3.6      2.0      2.0      2.0      2.3      2.4      2.4
    Chained price index (1992 = 100)............................................      2.3      1.9      2.0      2.1      2.2      2.2      2.2      2.2
  Percent change, year over year:                                                                                                                       
    Current dollars.............................................................      5.1      5.8      4.3      4.1      4.2      4.4      4.7      4.6
    Real, chained (1992) dollars................................................      2.8      3.7      2.4      2.0      2.0      2.2      2.4      2.4
    Chained price index (1992 = 100)............................................      2.3      2.0      1.9      2.0      2.2      2.2      2.2      2.2
                                                                                                                                                        
Incomes, billions of current dollars:                                                                                                                   
    Corporate profits before tax................................................      677      729      754      768      790      805      830      851
    Wages and salaries..........................................................    3,633    3,868    4,057    4,237    4,424    4,623    4,840    5,068
    Other taxable income \2\....................................................    1,693    1,786    1,859    1,915    1,975    2,046    2,128    2,213
                                                                                                                                                        
Consumer Price Index (all urban): \3\                                                                                                                   
    Level (1982-84 = 100), annual average.......................................    157.0    160.7    164.1    167.7    171.5    175.5    179.5    183.6
    Percent change, fourth quarter over fourth quarter..........................      3.2      2.0      2.2      2.2      2.3      2.3      2.3      2.3
    Percent change, year over year..............................................      2.9      2.4      2.1      2.2      2.3      2.3      2.3      2.3
                                                                                                                                                        
Unemployment rate, civilian, percent:                                                                                                                   
    Fourth quarter level........................................................      5.3      4.8      5.0      5.2      5.4      5.4      5.4      5.4
    Annual average..............................................................      5.4      5.0      4.9      5.1      5.3      5.4      5.4      5.4
Federal pay raises, January, percent:                                                                                                                   
    Military \4\................................................................      2.6      3.0      2.8      3.1      3.0      3.0      3.0      3.0
    Civilian \5\................................................................      2.4      3.0      2.8      3.1      3.0      3.0      3.0      3.0
                                                                                                                                                        
Interest rates, percent:                                                                                                                                
    91-day Treasury bills \6\...................................................      5.0      5.0      5.0      4.9      4.8      4.7      4.7      4.7
    10-year Treasury notes......................................................      6.4      6.4      5.9      5.8      5.8      5.7      5.7      5.7
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\1\ Based on information available as of early December 1997.                                                                                           
\2\ Rent, interest, dividend and proprietor's components of personal income.                                                                            
\3\ Seasonally adjusted CPI for all urban consumers. Two versions of the CPI are now 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.                 
\4\ Beginning with the 1999 increase, percentages apply to basic pay only; adjustments for housing and subsistence allowances will be determined by the 
  Secretary of Defense.                                                                                                                                 
\5\ Overall average increase, including locality pay adjustments.                                                                                       
\6\ Average rate (bank discount basis) on new issues within period.                                                                                     

  Potential GDP growth of 2.4 percent during the projection horizon can 
be decomposed into the trend growth of productivity, 1.3 percent per 
year, plus the growth of the labor force, estimated at 1.1 percent 
annually. The Administration's labor force projection assumes that the 
population of working age will grow 1.0 percent per year and that the 
labor force participation rate will edge up 0.1 percent per year.
  Both the labor force and participation rate assumptions are lower than 
recent experience. The participation rate has risen 0.4 percent per year 
since 1994, as falling unemployment and rapidly expanding job 
opportunities have strongly induced job-seeking. But with the labor 
force participation rate and employment/population ratio at post-World 
War II highs, it is prudent to project a slower rise in the coming 
years. In addition, the female participation rate, which had risen 
sharply during much of the postwar period, grew much slower during the 
1990s, and this trend is assumed to continue.
  The real GDP growth projection of 2.0 percent through 2000 is 
consistent with a gradual rise in the unemployment rate to 5.4 percent. 
Unemployment is then projected to remain on a plateau at that level from 
2001 onward, when real GDP growth averages the Administration's estimate 
of the economy's potential growth rate.

  Inflation: With unemployment expected to be slightly below NAIRU 
during the next three years, inflation is projected to creep up by about 
one-quarter percentage point by 2000. The CPI is projected to increase 
2.3 percent in that year and the subsequent years of the forecast 
horizon; the GDP chain-weighted price index is projected to increase 2.2 
percent in 2000 and beyond. The relatively small 0.1 percentage point 
difference between the two inflation measures is narrower than in the 
past because of recent and forthcoming methodological improvements to 
both indexes.
  Despite the relatively tight labor market in the next few years, 
inflation is projected to remain low, partly because of two temporary 
factors. The rise in the dollar is expected to hold down import prices 
and intensify price competition from imported goods and services. In 
addition, wide profit margins provide a cushion that will enable firms 
to absorb cost increases without having to pass them on fully into 
higher prices.

[[Page 9]]

  Moreover, as discussed above, the methodological improvements to the 
CPI will offset some of the rise that might otherwise occur. By 1999, 
the improvements instituted this year and next will trim about 0.4 
percentage point off of the annual rise in the CPI. These same 
improvements are likely to restrain the rise in the GDP chain weighted 
price index by about 0.1 percentage point per year.

  Interest Rates: The assumptions, which were finalized in early 
December, project a gradual decline in short- and long-term interest 
rates consistent with the improved fiscal balance and low inflation. By 
2001 the 91-day Treasury bill rate is expected to be 30 basis points 
lower than the fourth quarter 1997 average; the yield on the 10-year 
Treasury bond is projected to be 20 basis points lower.
  The sharp drop in long-term rates in early 1998 has already driven 
long-term rates below the levels anticipated in the economic 
assumptions. Recent developments, including the improved budget outlook, 
may have caused market participants to lower their expectations for 
inflation and credit demands. The turmoil in Asian markets may have 
fostered further portfolio adjustments into the safe haven of U.S. 
bonds. In light of these developments, it is possible that long-term 
rates will be lower on average than those in the economic assumptions. 
Financial markets, however, can be quite volatile; the recent drop in 
long rates could prove to be temporary.

  Incomes: The moderating of real growth during the projection horizon 
is expected to shift the distribution of national income slightly, 
augmenting the share going to labor while trimming the unusually high 
profits share in GDP. On balance, total taxable income is projected to 
decline gradually as a share of GDP.
  Between 1997 and 2003, aggregate wages and salaries are projected to 
rise 31 percent in nominal terms and 15 percent after adjustment for 
inflation. Corresponding to the rise in the wage share, corporate 
profits before tax are projected to rise just 16 percent in nominal 
terms from 1997 to 2003, a markedly slower pace than in recent years. By 
2003, taxable profits as a share of GDP are projected to be about 1 
percentage point lower than the 30-year high reached during 1997. The 
favorable impact of lower interest rates on the debt service payments of 
the corporate sector helps to cushion the impact on profits of the 
expected shift of income back toward wages.
  Lower interest rates will pull down the share of personal interest 
income in GDP because the household sector is a net lender in the 
economy. Little change is expected in the shares of other components of 
taxable income (dividends, rents and proprietors' income).

                           Comparison with CBO

  The Congressional Budget Office (CBO) develops economic projections 
used by Congress in formulating its budget policy. In the executive 
branch, the analogous function is performed jointly by the Treasury, the 
Council of Economic Advisers (CEA), and the Office of Management and 
Budget (OMB). These two sets of economic projections can be compared 
with one another, but differences in their preparation should be borne 
in mind:
    The Administration's projections always assume that the 
          President's policy proposals in the budget will be adopted in 
          full. In contrast, CBO normally assumes that current law will 
          continue unchanged; thus, it makes a ``pre-policy'' or 
          baseline projection, while the Administration's projections 
          are ``post-policy.''
    The two sets of projections are often prepared at different 
          times. The Administration's projections must be prepared 
          months ahead of the release of the budget. Differences in the 
          Administration's and CBO's near-term forecasts, therefore, can 
          be due to the availability of more recent data to CBO; a 
          direct comparison with the CBO near-term projections is not 
          always meaningful. Timing differences are much less likely to 
          play an important role in any differences in outyear 
          projections, however.
  Table 1-2 presents a summary comparison of the current CBO and 
Administration projections. 

    Real GDP: The projections of real GDP growth are quite 
          similar. The Administration projects that real GDP will grow 
          at an average annual rate of 2.2 percent from 1998 through 
          2003; CBO projects a 2.1 percent rate.
    Inflation: Both the Administration and CBO expect inflation 
          to continue at a slow, steady rate over the next several 
          years. For the chain-weighted GDP price index, CBO assumes 
          that inflation will average 2.3 percent a year over the 1998-
          2003 period while the Administration projects a 2.1 percent 
          average for that span; CBO expects the annual rate of change 
          in the CPI to average 0.4 percentage point higher than the 
          Administration forecast over the same period.
    Unemployment: CBO projects unemployment to rise from its 
          fourth quarter average of 4.7 percent to 5.9 percent by 2003, 
          slightly above its estimate of the NAIRU. The Administration 
          believes unemployment will average its estimate of the NAIRU, 
          5.4 percent, during 2001 to 2003.
    Interest rates: Both the Administration and CBO expect a 
          similar decline to a level of 4.7 percent by the year 2001 for 
          the 91-day bill rate. The Administration, however, projects a 
          slightly greater (0.2 percentage point) decline in long-term 
          rates than does CBO.
    Income distribution: Both CBO and the Administration project 
          a decline in the profits share of GDP, although both also 
          expect a shift of income from personal interest income to 
          corporate profits. In part because the Administration assumes 
          a slightly larger decline in long-term interest rates than 
          does CBO, it projects less of a decline in the profits share. 
          CBO projects a slightly higher wage and salary share of GDP 
          than does the Ad

[[Page 10]]

                Table 1-2.  COMPARISON OF ECONOMIC ASSUMPTIONS                                 
                          (Calendar years; percent)                                           
----------------------------------------------------------------------------------------------------------------
                                                                                 Projections                    
                                                           -----------------------------------------------------
                                                              1998     1999     2000     2001     2002     2003 
----------------------------------------------------------------------------------------------------------------
Real GDP (chain-weighted): \1\                                                                                  
  CBO January.............................................      2.3      1.9      1.9      2.0      2.2      2.3
  1999 Budget.............................................      2.0      2.0      2.0      2.3      2.4      2.4
                                                                                                                
Chain-weighted GDP Price Index: \1\                                                                             
  CBO January.............................................      2.1      2.2      2.4      2.5      2.4      2.5
  1999 Budget.............................................      2.0      2.1      2.2      2.2      2.2      2.2
                                                                                                                
Consumer Price Index (all-urban): \1\                                                                           
  CBO January.............................................      2.4      2.5      2.7      2.8      2.8      2.8
  1999 Budget.............................................      2.2      2.2      2.3      2.3      2.3      2.3
                                                                                                                
Unemployment rate: \2\                                                                                          
  CBO January.............................................      4.8      5.1      5.4      5.6      5.8      5.9
  1999 Budget.............................................      4.9      5.1      5.3      5.4      5.4      5.4
                                                                                                                
Interest rates: \2\                                                                                             
  91-day Treasury bills:                                                                                        
    CBO January...........................................      5.3      5.2      4.8      4.7      4.7      4.7
    1999 Budget...........................................      5.0      4.9      4.8      4.7      4.7      4.7
                                                                                                                
  10-year Treasury notes:                                                                                       
    CBO January...........................................      6.0      6.1      6.0      5.9      5.9      5.9
    1999 Budget...........................................      5.9      5.8      5.8      5.7      5.7      5.7
                                                                                                                
Taxable income \3\ (share of GDP):                                                                              
  CBO January.............................................     79.0     78.3     77.7     77.3     77.0     76.7
  1999 Budget.............................................     79.1     78.9     78.6     78.3     78.0     77.8
----------------------------------------------------------------------------------------------------------------
\1\ Percent change, fourth quarter over fourth quarter.                                                         
\2\ Annual averages, percent.                                                                                   
\3\ Taxable personal income plus corporate profits before tax.                                                  

          ministration. Overall, CBO's taxable income share of GDP 
          declines from 79.1 percent for 1997 to 76.7 percent for 2003; 
          the Administration's assumptions also show a decline, but only 
          to 77.8 percent for 2003. Both forecasts thus recognize that 
          the 1997 share is historically high, in large measure 
          reflecting the discrepancy in recent GDP and GDI growth rates 
          discussed earlier in this Chapter.
  CBO has a good economic forecasting record. During much of the 1980s, 
its forecasts were more accurate than those of the Administrations then 
in office. The record over the last five years, however, has been more 
mixed. Since it took office in 1993, this Administration has placed high 
priority on careful and prudent economic forecasts. Economic performance 
in the last four years has been better than assumed by the 
Administration, while exceeding CBO's assumptions by an even wider 
margin. The Administration's cautious approach to forecasting is one of 
the reasons that actual deficits have consistently come in below 
expectations since 1993.
  The differences in economic assumptions between the Administration and 
CBO have been small--smaller than they were under previous 
Administrations, and well within the usual range of error in such 
projections. CBO's assumptions and those used in this Budget are 
unusually close, and both are similar to private sector forecasts such 
as the Blue Chip consensus. However, even small differences in economic 
assumptions can yield sizable differences in budget projections when 
extended over a long planning horizon. Given the positive economic 
outlook in the United States--steady growth, robust job creation, and 
low inflation and interest rates with none of the excesses that 
foreshadow an economic downturn--there are sound reasons for believing 
that the Administration's projection is likely to be close to the actual 
outcome.

              Impact of Changes in the Economic Assumptions

  The economic assumptions underlying this budget are similar to those 
of last year. Both budgets anticipated that achieving a balanced budget 
would result in a significant decline in interest rates that would serve 
to extend the economic expansion at a moderate pace, while helping to 
maintain low, steady rates of inflation and unemployment. A shift to a 
balanced budget and the ensuing lower interest rates were also expected 
to shift income from interest to profits. This would have favorable 
effects on budget receipts and the deficit, because profits are on 
average taxed more heavily than interest income. 

  The changes in the economic assumptions since last year's budget have 
been relatively modest, as Table 1-3 shows. The differences are 
primarily the result of more favorable economic experience in 1997 than 
was anticipated. Economic growth was stronger than expected in 1997, 
while inflation and unemployment were lower. Because of this favorable 
experience, the projected annual averages for the unemployment and 
inflation rates have been reduced slightly. At the same time, interest 
rates are again assumed to decline in this

[[Page 11]]

 Table 1-3.  COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 1998 AND 1999 BUDGETS                  
                 (Calendar years; dollar amounts in billions)                                  
----------------------------------------------------------------------------------------------------------------
                                                     1997     1998     1999     2000     2001     2002     2003 
----------------------------------------------------------------------------------------------------------------
Nominal GDP:                                                                                                    
  1998 Budget assumptions \1\....................    8,005    8,379    8,786    9,226    9,686   10,167   10,674
  1999 Budget assumptions........................    8,080    8,430    8,772    9,142    9,547    9,993   10,454
                                                                                                                
Real GDP (percent change): \2\                                                                                  
  1998 Budget assumptions........................      2.0      2.0      2.3      2.3      2.3      2.3      2.3
  1999 Budget assumptions........................      3.6      2.0      2.0      2.0      2.3      2.4      2.4
                                                                                                                
GDP price index (percent change): \2\                                                                           
  1998 Budget assumptions........................      2.5      2.6      2.6      2.6      2.6      2.6      2.6
  1999 Budget assumptions........................      1.9      2.0      2.1      2.2      2.2      2.2      2.2
                                                                                                                
Consumer Price Index (percent change): \2\                                                                      
  1998 Budget assumptions........................      2.6      2.7      2.7      2.7      2.7      2.7      2.7
  1999 Budget assumptions........................      2.4      2.1      2.2      2.3      2.3      2.3      2.3
                                                                                                                
Civilian unemployment rate (percent): \3\                                                                       
  1998 Budget assumptions........................      5.3      5.5      5.5      5.5      5.5      5.5      5.5
  1999 Budget assumptions........................      5.0      4.9      5.1      5.3      5.4      5.4      5.4
                                                                                                                
91-day Treasury bill rate (percent): \3\                                                                        
  1998 Budget assumptions........................      5.0      4.7      4.4      4.2      4.0      4.0      4.0
  1999 Budget assumptions........................      5.0      5.0      4.9      4.8      4.7      4.7      4.7
                                                                                                                
10-year Treasury note rate (percent): \3\                                                                       
  1998 Budget assumptions........................      6.1      5.9      5.5      5.3      5.1      5.1      5.1
  1999 Budget assumptions........................      6.4      5.9      5.8      5.8      5.7      5.7      5.7
----------------------------------------------------------------------------------------------------------------
\1\ Adjusted for July 1997 NIPA revisions.                                                                      
\2\ Fourth quarter-to-fourth quarter.                                                                           
\3\ Calendar year average.                                                                                      

                                     

budget, but the decline is smaller in percentage points, in part because 
the deficit has already fallen much faster than expected.
  The net effects on the budget of these modifications in the economic 
outlook are shown in Table 1-4. The largest effects come from higher 
receipts during 1998-2002 due to higher projected levels of taxable 
incomes. In all years through 2003, there are higher outlays for 
interest due to the smaller expected decline in interest rates, offset 
by lower outlays for cost-of-living adjustments to Federal programs due 
to lower rates of inflation. A more favorable economic outlook since 
last year improves the budget balance by $38 billion for 1998 and by $15 
billion in 2003.

                                     

Table 1-4.  EFFECTS ON THE BUDGET OF CHANGES IN ECONOMIC ASSUMPTIONS SINCE LAST YEAR              
                            (In billions of dollars)                                            
----------------------------------------------------------------------------------------------------------------
                                                              1998     1999     2000     2001     2002     2003 
----------------------------------------------------------------------------------------------------------------
Budget totals under 1998 Budget economic assumptions and                                                        
 1999 Budget policies:                                                                                          
  Receipts................................................  1,630.0  1,714.3  1,775.4  1,855.1  1,947.3  2,032.4
  Outlays.................................................  1,677.9  1,745.0  1,796.8  1,846.8  1,874.5  1,964.5
                                                           -----------------------------------------------------
      Deficit (-) or surplus..............................    -47.9    -30.7    -21.4      8.3     72.8     67.8
                                                                                                                
Changes due to economic assumptions:                                                                            
  Receipts................................................     27.9     28.4     18.2      7.5      2.0     -4.2
  Outlays:                                                                                                      
    Inflation.............................................     -4.4     -8.1    -12.4    -16.8    -20.8    -25.3
    Unemployment..........................................     -5.4     -4.2     -2.4     -1.0     -1.0     -1.1
    Interest rates........................................      0.7      3.4      7.3     10.6     12.7     13.7
    Interest on changes in borrowing......................     -1.0     -2.8     -4.2     -5.1     -5.8     -6.5
                                                           -----------------------------------------------------
      Total, outlay decreases (net).......................    -10.1    -11.8    -11.7    -12.4    -14.9    -19.2
                                                           -----------------------------------------------------
      Increase in surplus or reduction in deficit.........     38.0     40.2     29.9     19.9     17.0     15.0
                                                                                                                
Budget totals under 1999 Budget economic assumptions and                                                        
 policies:                                                                                                      
  Receipts................................................  1,657.9  1,742.7  1,793.6  1,862.6  1,949.3  2,028.2
  Outlays.................................................  1,667.8  1,733.2  1,785.0  1,834.4  1,859.6  1,945.4
                                                           -----------------------------------------------------
      Deficit (-) or surplus..............................    -10.0      9.5      8.5     28.2     89.7     82.8
----------------------------------------------------------------------------------------------------------------


[[Page 12]]

                     Structural vs. Cyclical Balance

  When the economy is operating above potential as it is currently 
estimated to be, receipts are higher than they would be if resources 
were less fully employed, and outlays for unemployment-sensitive 
programs (such as unemployment compensation and food stamps) are lower. 
As a result, the deficit is smaller or the surplus is larger than it 
would be if unemployment were at NAIRU. The portion of the surplus or 
deficit that can be traced to such factors is called the cyclical 
surplus or deficit. The remainder, the portion that would remain with 
unemployment at NAIRU (consistent with a 5.4 percent unemployment rate), 
is called the structural surplus or deficit.
  Changes in the structural balance give a better picture of the impact 
of budget policy on the economy than does the unadjusted budget balance. 
The level of the structural balance also gives a clearer picture of the 
stance of fiscal policy, because this part of the surplus or deficit 
will persist even when the economy returns to normal operating levels.
  In the early 1990's, large swings in net outlays for deposit insurance 
(the S&L bailouts) had substantial impacts on deficits, but had little 
concurrent impact on economic performance. It therefore became customary 
to remove deposit insurance outlays as well as the cyclical component of 
the surplus or deficit from the actual surplus or deficit to compute the 
adjusted structural balance. This is shown in Table 1-5.

  Because unemployment is projected to be quite close to NAIRU over the 
forecast horizon, the cyclical component of the surplus is small. For 
the period 1997 through 2000, the unemployment rate is slightly below 
the estimated NAIRU of 5.4 percent, resulting in cyclical surpluses. 
Deposit insurance net outlays are relatively small and do not change 
greatly from year to year. The adjusted structural surplus or deficits 
in this budget display much the same pattern of year-to-year changes as 
the actual deficits. The most significant point illustrated by this 
table is the fact that of the $268 billion reduction in the actual 
budget deficit between 1992 and 1997 (from $290 billion to $22 billion), 
35 percent ($94 billion) resulted from cyclical improvement in the 
economy. The rest of the reduction stemmed primarily from policy 
actions--mainly those in the Omnibus Budget Reconciliation Act of 1993, 
which reversed a projected continued steep rise in the deficit and set 
the stage for the remarkable cyclical improvement that has occurred.

            Sensitivity of the Budget to Economic Assumptions

  Both receipts and outlays are affected by changes in economic 
conditions. This sensitivity seriously complicates budget planning, 
because errors in economic assumptions lead to errors in the budget 
projections. It is therefore useful to examine the implications of 
alternative economic assumptions.
  Many of the budgetary effects of changes in economic assumptions are 
fairly predictable, and a set of rules of thumb embodying these 
relationships can aid in estimating how changes in the economic 
assumptions would alter outlays, receipts, and the surplus or deficit.
  Economic variables that affect the budget do not usually change 
independently of one another. Output and employment tend to move 
together in the short run: a higher rate of real GDP growth is generally 
associated with a declining rate of unemployment, while weak or negative 
growth is usually accompanied by rising unemployment. In the long run, 
however, changes in the average rate of growth of real GDP are mainly 
due to changes in the rates of growth of productivity and labor supply, 
and are not necessarily associated with changes in the average rate of 
unemployment. Inflation and interest rates are also closely 
interrelated: a higher expected rate of inflation increases interest 
rates, while lower expected inflation reduces rates.
  Changes in real GDP growth or inflation have a much greater cumulative 
effect on the budget over time if they are sustained for several years 
than if they last for only one year.
  Highlights of the budget effects of the above rules of thumb are shown 
in Table 1-6.
  If real GDP growth is lower by one percentage point in calendar year 
1998 only and the unemployment rate rises by one-half percentage point, 
the fiscal 1998 deficit would increase by $9.1 billion; receipts in 1998 
would be lower by about $7.5 billion, and outlays would be higher by 
about $1.5 billion, primarily for unemployment-sensitive programs. In 
1999, the receipts shortfall would grow further to about $16.2 billion, 
and outlays would increase by about $5.5 billion relative to the base, 
even though the growth rate in calendar 1999 equals the rate originally 
assumed. This is because the level of real (and nominal) GDP and taxable 
incomes would be permanently lower and unemployment higher.

                   Table 1-5.  ADJUSTED STRUCTURAL BALANCE                                                        
                          (In billions of dollars)                                                                
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                       1992     1993     1994     1995     1996    1997    1998    1999    2000    2001    2002    2003 
--------------------------------------------------------------------------------------------------------------------------------------------------------
Unadjusted deficit (-) or surplus..................   -290.4   -255.0   -203.1   -163.9   -107.4   -21.9   -10.0     9.5     8.5    28.2    89.7    82.8
  Cyclical component...............................    -72.5    -57.2    -27.8     -8.4     -4.2    21.4    30.1    19.6     9.0  ......  ......  ......
                                                    ----------------------------------------------------------------------------------------------------
Structural deficit (-) or surplus..................   -217.9   -197.8   -175.3   -155.5   -103.2   -43.4   -40.1   -10.0    -0.4    28.2    89.8    82.8
  Deposit insurance outlays........................     -2.3    -28.0     -7.6    -17.9     -8.4   -14.4    -4.5    -4.5    -1.9    -1.4    -1.2    -0.3
                                                    ----------------------------------------------------------------------------------------------------
Adjusted structural deficit (-) or surplus.........   -220.3   -225.8   -182.9   -173.4   -111.6   -57.8   -44.6   -14.5    -2.3    26.7    88.6    82.5
--------------------------------------------------------------------------------------------------------------------------------------------------------

[[Page 13]]

The budget effects (including growing interest costs associated with 
higher deficits or smaller surpluses) would continue to grow slightly in 
later years.
  The budget effects are much larger if the real growth rate is assumed 
to be one percentage point less in each year (1998-2003) and the 
unemployment rate to rise one-half percentage point in each year. With 
these assumptions, the levels of real and nominal GDP would be below the 
base case by a growing percentage. The budget balance would be worsened 
by $153.3 billion relative to the base case by 2003.
  The effects of slower productivity growth are shown in a third 
example, where real growth is one percentage point lower per year while 
the unemployment rate is unchanged. In this case, the estimated budget 
effects mount steadily over the years, but more slowly, resulting in a 
$130.2 billion worsening of the budget balance by 2003.
  The effects of an abrupt and sustained one percentage point increase 
in the level of the unemployment rate (due, say, to a sudden rise in 
labor force participation relative to the base case), with no change in 
the level or growth rate of real GDP, are shown in a fourth example. In 
this case, unemployment-sensitive outlays would increase by amounts 
rising from $6.5 billion in 1998 to $12.4 billion in 2003. The effects 
on the surplus would be smaller (a $7.9 billion reduction in 2003), 
however, because under current law, federal unemployment tax collections 
would gradually rise during a period of sustained higher unemployment 
rates.
  Joint changes in interest rates and inflation have a smaller effect on 
the deficit than equal percentage point changes in real GDP growth, 
because their effects on receipts and outlays are substantially 
offsetting. An example is the effect of a one percentage point higher 
rate of inflation and one percentage point higher interest rates during 
calendar year 1998 only. In subsequent years, the price level and 
nominal GDP would be one percent higher than in the base case, but 
interest rates are assumed to return to their base levels. Outlays for 
1998 rise by $5.8 billion and receipts by $8.7 billion, for a decrease 
of $2.8 billion in the 1998 deficit. In 1999, outlays would be above the 
base by $14.2 billion, due in part to lagged cost-of-living adjustments; 
receipts would rise $17.6 billion above the base, however, resulting in 
a $3.4 billion improvement in the budget balance. In subsequent years, 
the amounts added to receipts would continue to be larger than the 
additions to outlays.
  If the rate of inflation and the level of interest rates are higher by 
one percentage point in all years, the price level and nominal GDP would 
rise by a cumulatively growing percentage above their base levels. In 
this case, the effects on receipts and outlays mount steadily in 
successive years, adding $62.6 billion to outlays and $106.5 billion to 
receipts in 2003, for a net increase in the surplus of $43.9 billion.
  The table also shows the interest rate and the inflation effects 
separately, and rules of thumb for the added interest cost associated 
with changes in the budget surplus or deficit (increased or reduced 
borrowing). The effects of changes in economic assumptions in the 
opposite direction are approximately symmetric to those shown in the 
table. The impact of a one percentage point lower rate of inflation or 
higher real growth would have about the same magnitude as the effects 
shown in the table, but with the opposite sign.
  These rules of thumb are computed while holding the income share 
composition of GDP constant. Because different income components are 
subject to different taxes and tax rates, estimates of total receipts 
can be affected significantly by changing income shares. However, the 
relationships between changes in income shares and changes in growth, 
inflation, and interest rates are too complex to be reduced to simple 
rules.

[[Page 14]]



          Table 1-6.  SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS                         
                             (In billions of dollars)                                            
----------------------------------------------------------------------------------------------------------------
                    Budget effect                       1998      1999      2000      2001      2002      2003  
----------------------------------------------------------------------------------------------------------------
             Real Growth and Employment                                                                         
                                                                                                                
Budgetary effects of 1 percent lower real GDP                                                                   
 growth:                                                                                                        
  For calendar year 1998 only: \1\                                                                              
    Receipts........................................      -7.5     -16.2     -18.7     -19.0     -19.5     -20.1
    Outlays.........................................       1.5       5.5       6.8       8.2       9.8      11.6
                                                     -----------------------------------------------------------
      Decrease in surplus (-).......................      -9.1     -21.8     -25.5     -27.2     -29.3     -31.7
                                                                                                                
  Sustained during 1998-2003: \1\                                                                               
    Receipts........................................      -7.5     -24.0     -43.4     -63.6     -85.2    -108.0
    Outlays.........................................       1.5       7.1      14.0      22.3      32.6      45.3
                                                     -----------------------------------------------------------
      Decrease in surplus (-).......................      -9.1     -31.1     -57.4     -86.0    -117.8    -153.3
                                                                                                                
  Sustained during 1998-2003, with no change in                                                                 
   unemployment:                                                                                                
    Receipts........................................      -7.5     -24.3     -44.5     -66.1     -89.4    -114.4
    Outlays.........................................       0.2       1.1       2.9       5.9      10.1      15.8
                                                     -----------------------------------------------------------
      Decrease in surplus (-).......................      -7.7     -25.4     -47.4     -71.9     -99.5    -130.2
                                                                                                                
Budgetary effects of 1 percent higher unemployment                                                              
 rate:                                                                                                          
  Sustained during 1998-2003, with no change in real                                                            
   GDP:                                                                                                         
    Receipts........................................         *       0.9       2.2       3.2       3.9       4.5
    Outlays.........................................       6.5       9.4      10.1      10.7      11.4      12.4
                                                     -----------------------------------------------------------
      Decrease in surplus (-).......................      -6.5      -8.5      -7.9      -7.5      -7.5      -7.9
                                                                                                                
            Inflation and Interest Rates                                                                        
                                                                                                                
Budgetary effects of 1 percentage point higher rate                                                             
 of:                                                                                                            
  Inflation and interest rates during calendar year                                                             
   1998 only:                                                                                                   
    Receipts........................................       8.7      17.6      17.5      16.2      17.0      17.9
    Outlays.........................................       5.8      14.2      11.9      11.5      11.1      10.5
                                                     -----------------------------------------------------------
      Increase in surplus (+).......................       2.8       3.4       5.6       4.7       5.9       7.4
                                                                                                                
  Inflation and interest rates, sustained during                                                                
   1998-2003:                                                                                                   
    Receipts........................................       8.7      26.7      45.4      63.8      84.1     106.5
    Outlays.........................................       5.9      20.7      32.8      44.0      53.6      62.6
                                                     -----------------------------------------------------------
      Increase in surplus (+).......................       2.8       6.0      12.7      19.8      30.5      43.9
                                                                                                                
  Interest rates only, sustained during 1998-2003:                                                              
    Receipts........................................       1.2       2.9       3.7       4.0       4.3       4.6
    Outlays.........................................       5.5      16.0      21.7      25.1      27.5      29.1
                                                     -----------------------------------------------------------
      Decrease in surplus (-).......................      -4.3     -13.0     -17.9     -21.2     -23.2     -24.4
                                                                                                                
  Inflation only, sustained during 1998-2003:                                                                   
    Receipts........................................       7.5      23.8      41.7      59.8      79.8     101.9
    Outlays.........................................       0.4       4.7      11.1      18.9      26.1      33.5
                                                     -----------------------------------------------------------
      Increase in surplus (+).......................       7.1      19.0      30.6      41.0      53.7      68.3
                                                                                                                
      Interest Cost of Higher Federal Borrowing                                                                 
                                                                                                                
Outlay effect of $100 billion additional borrowing                                                              
 during 1998........................................       2.9       5.5       5.6       5.8       6.0       6.3
                                                                                                                
----------------------------------------------------------------------------------------------------------------
* $50 million or less.                                                                                          
                                                                                                                
\1\ The unemployment rate is assumed to be 0.5 percentage point higher per 1.0 percent shortfall in the level of
  real GDP.