    [Analytical Perspectives]
    [Economic and Accounting Analyses]
    [2. Stewardship: Toward a Federal Balance Sheet]
    [From the U.S. Government Publishing Office, www.gpo.gov]

                 2. STEWARDSHIP: TOWARD A FEDERAL BALANCE SHEET

                                   Introduction

      The Government's financial condition can only be properly evaluated
    using a broad range of data--more than would usually be shown on a
    business balance sheet--and several complementary perspectives. This
    chapter presents a framework for such analysis. No single table in the
    chapter is the equivalent of a Federal balance sheet, but taken as a
    whole, the chapter provides an overview of the Government's resources,
    the current and future claims on them, and some idea of what the
    taxpayer gets in exchange for these resources. This is the kind of
    assessment for which a financial analyst would turn to a business
    balance sheet, modified to take into account the Government's unique
    roles and circumstances.
      Because there are important differences between Government and
    business, and because there are serious limitations on the available
    data, this chapter's findings should be interpreted with caution; its
    conclusions are tentative and subject to future revision.
      The presentation consists of three parts:
         Part I reports on what the Federal Government owns and what
              it owes. Table 2-1 summarizes this information. The assets and
              liabilities in this table are a useful starting point for
              analysis, but they are only a partial reflection of the full
              range of Government resources and responsibilities. Only those
              items actually owned by the Government are included in the
              table, but the Government is able to draw on other resources.
              It can tax and use other measures to meet future obligations.
              The liabilities shown in the table include the binding
              commitments that have resulted from prior Government action,
              but the Government's responsibilities are much broader than
              this.
         Part II presents possible paths for the Federal budget that
              extend beyond the ten-year budget window. Table 2-2 summarizes
              this information. This part is intended to show the
              Government's long-run financial burdens and the resources that
              it will have available to meet them. Some future claims on the
              Government deserve special emphasis because of their
              importance to individuals' retirement plans. Table 2-3
              summarizes the condition of the Social Security and Medicare
              trust funds and how that condition changed between 1999 and
              2001.
         Part III features information on economic and social
              conditions which the Government affects by its actions. Table
              2-4 presents summary data for national wealth, while
              highlighting the Federal investments that have contributed to
              that wealth. Table 2-5 presents a small sample of economic and
              social indicators.

                        Relationship with FASAB Objectives

      The framework presented here meets the stewardship objective \1\ for
    Federal financial reporting recommended by the Federal Accounting
    Standards Advisory Board and adopted for use by the Federal Government
    in September 1993.
    ---------------------------------------------------------------------------
      \1\ Objectives of Federal Financial Reporting, Statement of Federal
    Financial Accounting Concepts Number 1, September 2, 1993. The other
    objectives are budgetary integrity, operating performance, and systems
    and controls.
    ---------------------------------------------------------------------------
               Federal financial reporting should assist report users in
         assessing the impact on the country of the Government's operations
              and investments for the period and how, as a result, the
        Government's and the Nation's financial conditions have changed and
        may change in the future. Federal financial reporting should provide
                   information that helps the reader to determine:

              3a. Whether the Government's financial position improved or
                            deteriorated over the period.

           3b. Whether future budgetary resources will likely be sufficient
        to sustain public services and to meet obligations as they come due.

               3c. Whether Government operations have contributed to the
                       Nation's current and future well-being.

      The presentation here explores an experimental approach for meeting
    this objective at the Government-wide level.

                What Can Be Learned from a Balance Sheet Approach

      The budget is an essential tool for allocating resources within the
    Federal Government and between the public and private sectors; but the
    standard budget presentation, with its focus on annual outlays,
    receipts, and the surplus/deficit, does not provide all the information
    needed for a full analysis of the Government's financial and investment
    decisions. A business is ultimately judged by the bottom line in its
    balance sheet, but for the national Government, the ultimate test is how
    its actions affect the country.

    [[Page 12]]

    ------------------------------------------------------------------------
         QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S ``BALANCE SHEET''
    ------------------------------------------------------------------------
    1.   According to Table 2-1, the Government's liabilities exceed its
     assets. No business could operate in such a fashion. Why does the
     Government not manage its finances more like a business?

                   The Federal Government has fundamentally different
                    objectives from a business enterprise. The primary goal
                    of every business is to earn a profit, and the Federal
                    Government leaves almost all activities at which a
                    profit could be earned to the private sector. For the
                    vast bulk of the Federal Government's operations, it
                    would be difficult or impossible to charge prices--let
                    alone prices that would cover expenses. The Government
                    undertakes these activities not to improve its balance
                    sheet, but to benefit the Nation--to foster not only
                    monetary but also nonmonetary values.

                   For example, the Federal Government invests in education
                    and research. The Government earns no direct return from
                    these investments; but the Nation and its people are
                    made richer if they are done successfully. The return on
                    these investments shows up not as an increase in
                    Government assets, but as an increase in the general
                    state of knowledge and in the earning capacity of the
                    country's citizens. A business's motives for investment
                    are quite different; business invests to earn a profit
                    for itself, not others, and if its investments are
                    successful, their value will be reflected in its balance
                    sheet. Because the Federal Government's objectives are
                    different, its balance sheet behaves differently, and
                    should be interpreted differently.

    2.   Table 2-1 seems to imply that the Government is insolvent. Is it?

                   No. Just as the Federal Government's responsibilities are
                    of a different nature than those of a private business,
                    so are its resources. Government solvency must be
                    evaluated in different terms.

                   What the table shows is that those Federal obligations
                    that are most comparable to the liabilities of a
                    business corporation exceed the estimated value of the
                    assets the Federal Government actually owns. However,
                    the Government has access to other resources through its
                    sovereign powers. These powers, which include taxation,
                    allow the Government to meet its present obligations and
                    those that are anticipated from future operations even
                    though the Government's assets are less than its
                    liabilities.

                   The financial markets clearly recognize this reality. The
                    Federal Government's implicit credit rating is the best
                    in the United States; lenders are willing to lend it
                    money at interest rates substantially below those
                    charged to private borrowers. This would not be true if
                    the Government were really insolvent or likely to become
                    so. Where governments totter on the brink of insolvency,
                    lenders are either unwilling to lend them money, or do
                    so only in return for a substantial interest premium.

                   In recent years, the Government's net liabilities have
                    leveled off and begun to shrink. By achieving a budget
                    surplus, the Government has been able to repay some of
                    its debts and reduce the balance between its liabilities
                    and its assets.

    3.   Why does the Government not keep a proper set of books?

                   The Government is not a business, and accounting
                    standards designed to illuminate how much a business
                    earns and how much equity it has could provide
                    misleading information if applied to the Government. In
                    recent years, the Federal Accounting Standards Advisory
                    Board (FASAB) has developed, and the Government has
                    adopted, a conceptual accounting framework that reflects
                    the Government's distinct functions and answers the
                    questions for which Government should be accountable.
                    This framework addresses budgetary integrity, operating
                    performance, stewardship, and systems and controls. The
                    Board has also developed, and the Government has
    ------------------------------------------------------------------------

    [[Page 13]]

    ------------------------------------------------------------------------
        QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S ``BALANCE SHEET''--
                                    Continued
    ------------------------------------------------------------------------

                   adopted, a full set of accounting standards. Federal

                   This chapter is intended to address the ``stewardship
                    objective''--assessing the interrelated condition of the
                    Federal Government and the Nation. The data in this
                    chapter illuminate the trade-offs and connections
                    between making the Federal Government ``better off'' and
                    making the Nation ``better off.'' The Government does
                    not have a ``bottom line'' comparable to the net worth
                    of a business corporation, and some analysts have found
                    the absence of a bottom line to be frustrating. But it
                    would not help to pretend that such a number exists when
                    clearly it does not.

    4.   Why is Social Security not shown as a liability in Table 2-1?

                   Future Social Security benefits are a political and moral
                    responsibility of the Federal Government, but these
                    benefits are not a liability in the usual sense. The
                    Government has unilaterally decreased as well as
                    increased Social Security benefits in the past, and
                    future reforms could alter them again. When the amount
                    in question can be changed unilaterally, it is not
                    ordinarily considered a liability.

                   Other Federal programs exist that are similar to Social
                    Security in the promises they make--Medicare, Medicaid,
                    Veterans pensions, and Food Stamps--to name a few. Yet
                    few would consider the future benefits expected under
                    these programs to be Federal liabilities. It would be
                    difficult, however, to justify a different accounting
                    treatment for them, if Social Security were to be
                    classified as a liability. There is no bright line
                    dividing Social Security from other programs that
                    promise benefits to people, and all such programs should
                    be accounted for similarly.

                   Furthermore, if future Social Security benefits were to
                    be treated as liabilities, logic would suggest that
                    future payroll tax receipts that are earmarked to
                    finance those benefits ought to be considered assets.
                    Other tax receipts, however, are not counted as assets
                    for good reasons, and drawing a line between Social
                    Security taxes and other taxes would be questionable.

                   Under Generally Accepted Accounting Principles, Social
                    Security is not considered to be a liability, so
                    omitting it from Table 2-1 is consistent with the
                    accounting standards developed for the Federal
                    Government by the Federal Accounting Standards Advisory
                    Board (FASAB).

    5.   It is all very well to run a budget surplus now, but can it be
     sustained? When the baby-boom generation retires, will the deficit not
     return even larger than ever before?

                   The aging of the U.S. population will become dramatically
                    evident when the baby-boomers begin to retire in less
                    than ten years. This demographic transition poses
                    serious long-term problems for the Federal budget and
                    its major entitlement programs. The current budget
                    surplus, however, will help the country address these
                    problems. The surplus means that there will be a
                    significant decline in Federal net interest payments
                    over the next several years. This is one key step
                    towards keeping the budget in balance when the baby-
                    boomers retire.

                   The second part of this chapter describes how the budget
                    is likely to evolve under various possible alternative
                    scenarios.
    ------------------------------------------------------------------------

    [[Page 14]]

    ------------------------------------------------------------------------
        QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S ``BALANCE SHEET''--
                                    Continued
    ------------------------------------------------------------------------

    6.   Would it be sensible for the Government to borrow to finance needed

                   The Government consumes capital each year in the process
                    of providing goods and services to the public. If the
                    Government financed new capital by borrowing, it should
                    also plan to pay off this debt as the capital was used
                    up. As discussed in Chapter 6 of Analytical
                    Perspectives, net investment in physical capital owned
                    by the Federal Government has often been negative
                    recently, so little if any deficit spending would
                    actually have been justified recently by this borrowing-
                    for-investment criterion.

                   The Federal Government also funds substantial amounts of
                    physical capital that it does not own, such as highways
                    and research facilities, and it funds investment in
                    intangible ``capital'' such as education and training
                    and the conduct of research and development. A private
                    business would never borrow to spend on assets that
                    would be owned by someone else. However, such spending
                    is a principal function of Government. It is not clear
                    whether this type of capital investment would fall under
                    the borrowing-for-investment criterion. Certainly, these
                    investments do not create Federally owned assets, even
                    though they are part of national wealth.

                   There is another difficulty with the logic of borrowing
                    to invest. Businesses expect investments to earn a
                    return large enough to cover their cost. In contrast,
                    the Federal Government does not generally expect to
                    receive a direct payoff from its investments, whether or
                    not it owns them. In this sense, Government investments
                    are no different from other Government expenditures, and
                    the fact that they provide services over a longer period
                    is no justification for excluding them when calculating
                    the surplus/deficit.

                   Finally, the Federal Government must pursue policies that
                    support the overall financial and economic well-being of
                    the Nation. The Government may deem it desirable to run
                    a budget surplus, even if this means paying for its own
                    investments from current revenues, instead of borrowing.
                    Considerations in addition to the size of Federal
                    investment must be weighed in choosing the right level
                    of the surplus.

    7.   Is it appropriate to include the Social Security surplus when
     measuring the Government's consolidated budget surplus?

                   The Federal budget has many purposes. It should not be
                    surprising that, with more than one purpose, the budget
                    is presented in more than one way. None of these
                    measures is always right, or always wrong; it depends
                    upon the purpose to which the budget is put.

                   For the purpose of measuring the Government's effects on
                    the economy, it would be misleading to omit Social
                    Security or any other part of the budget, as all parts
                    of the budget affect the economy. For purposes of fiscal
                    discipline, leaving out particular Government activities
                    could actually be dangerous. The principle of a
                    ``unified'' all-inclusive budget has been used to
                    forestall the practice of moving favored programs off-
                    budget--which has been done to shield those programs
                    from scrutiny and funding discipline.

                   For setting fiscal policy, however, an alternative to the
                    unified budget is useful. In particular, the Congress
                    has moved Social Security off-budget. The purpose of
                    doing so was to stress the need to provide independent,
                    sustainable funding for Social Security in the long
                    term; and to show the extent to which the rest of the
                    budget had relied on annual Social Security surpluses to
                    make up for its own shortfall.
    ------------------------------------------------------------------------

    [[Page 15]]

      The data needed to judge its performance go beyond a simple measure of
    net assets. Consider, for example, Federal investments in education or
    infrastructure whose returns flow mainly to the private sector and which
    are often owned by households, private businesses or State and local
    governments. From the standpoint of the Federal Government's ``bottom
    line,'' these investments might appear to be unnecessary or even
    wasteful; but they make a real contribution to the economy and to
    people's lives. A framework for evaluating Federal finances needs to
    take Federal investments into account, even when the return they earn
    does not accrue to the Federal Government.
      A good starting point for analysis is Table 2-1, which shows the
    Government's assets and liabilities. This illustrative tabulation of net
    liabilities is based on data from a variety of public and private
    sources. It has sometimes been suggested that the Federal Government's
    assets, if fully accounted for, would exceed its debts. Table 2-1
    clearly shows that this is not correct. For many years, Government debts
    increased far more than did Government assets, although in recent years,
    Government budget surpluses have allowed the Government to reduce its
    debt and thereby lower its net liabilities.
      Table 2-1 presents the Government's binding obligations--such as
    Treasury debt and the present discounted value of the pensions owed to
    Federal employees as deferred compensation. These obligations have
    counterparts in the business world, and would appear on a business
    balance sheet. Accrued obligations for Government insurance policies and
    the estimated present value of failed loan guarantees and deposit
    insurance claims are also analogous to private liabilities, and are
    included with the other Government liabilities. These obligations form
    only a subset of the Government's financial responsibilities.
      The Federal Government also has resources that go beyond the assets
    that would normally appear on a balance sheet. These include the
    Government's sovereign powers to tax, regulate commerce, and set
    monetary policy. The best way to analyze how the Government uses these
    powers is to make a long-run projection of the Federal budget (as is
    done in Part II of this chapter). The budget provides a comprehensive
    measure of the Government's annual cash flows. Projecting it forward
    shows how the Government is expected to use its powers to generate cash
    flows in the future.
      The Government has established a broad range of programs that dispense
    cash and other benefits to individual recipients. The Government is not
    constitutionally obligated to continue payments under these programs;
    the benefits can be modified or even ended at any time, subject to the
    decisions of Congress. Such changes are a regular part of the
    legislative cycle. It is likely, however, that many of these programs
    will remain Federal responsibilities in some form for the foreseeable
    future.
      The numbers in the budget are silent on the issue of whether the
    public is receiving value for its tax dollars. Information on that point
    requires performance measures for Government programs supplemented by
    appropriate information about conditions in the economy and society.
    Some such data are currently available, but more measures need to be
    developed to obtain a full picture. Examples of what might be done are
    discussed below.
      The presentation that follows consists of a series of tables and
    charts. Taken together, they are the functional equivalent of a business
    balance sheet. The schematic diagram, Chart 2-1, shows how they fit
    together. The tables and charts should be viewed as an ensemble, the
    main elements of which are grouped in two broad categories--assets/
    resources and liabilities/responsibilities.

    [[Page 16]]

         Reading down the left-hand side of Chart 2-1 shows the
              range of Federal resources, including assets the Government
              owns, tax receipts it can expect to collect, and national
              wealth that provides the base for Government revenues.
         Reading down the right-hand side reveals the full range of
              Federal obligations and responsibilities, beginning with
              Government's acknowledged liabilities based on past actions,
              such as the debt held by the public, and going on to include
              future budget outlays. This column ends with a set of
              indicators highlighting areas where Government activity
              affects society or the economy.

    [[Page 17]]

             PART I--THE FEDERAL GOVERNMENT'S ASSETS AND LIABILITIES

      Table 2-1 summarizes what the Government owes as a result of its past
    operations netted against the value of what it owns for a number of
    years beginning in 1960. Assets and liabilities are measured in terms of
    constant FY 2000 dollars. Ever since 1960, Government liabilities have
    exceeded the value of assets (see chart 2-2). In the late 1970s, a
    speculative run-up in the prices of oil, gold, and other real assets
    temporarily boosted the value of Federal holdings, but subsequently
    those prices declined. \2\ Currently, the total real value of Federal
    assets is estimated to be about 27 percent greater than it was in 1960.
    Meanwhile, Federal liabilities have increased by 162 percent in real
    terms. The decline in the Federal net asset position was principally due
    to persistent Federal budget deficits and the relatively slow increase
    in Federal asset holdings.
    ---------------------------------------------------------------------------
      \2\ This temporary improvement highlights the importance of the other
    tables in this presentation. What is good for the Federal Government as
    an asset holder is not necessarily favorable to the economy. The decline
    in inflation in the early 1980s reversed the speculative run-up in gold
    and other commodity prices. This reduced the balance of Federal net
    assets, but it was good for the economy and the Nation as a whole.
    ---------------------------------------------------------------------------
      Since the mid-1990s, the shift from budget deficits to budget
    surpluses has sharply reduced Federal net liabilities. Last year rising
    energy prices and increased land values also contributed to a rise in
    the real value of Federal assets, which pulled down net liabilities even
    further. Currently, the net excess of liabilities over assets is about
    $3.2 trillion, or $11,500 per capita, com

                                                         Table 2-1.  GOVERNMENT ASSETS AND LIABILITIES *
                                                 (As of the end of the fiscal year, in billions of 2000 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        1960     1965     1970     1975     1980     1985     1990      1995      1998      1999      2000
    --------------------------------------------------------------------------------------------------------------------------------------------------------

                         ASSETS

    Financial Assets:
       Cash and Checking Deposits...................       42       61       38       30       46       30        41        42        49        64        56
       Other Monetary Assets........................        1        1        1        1        2        2         2         1         4         5         6
       Mortgages....................................       27       26       39       40       74       76        97        67        47        80        77
       Other Loans..................................      100      137      172      171      218      288       204       159       178       187       189
         less Expected Loan Losses..................       -1       -3       -4       -9      -17      -17       -19       -24       -47       -51       -37
       Other Treasury Financial Assets..............       43       55       24       31       39       39        97       151       131       140       144
                                                     -------------------------------------------------------------------------------------------------------
         Total......................................      212      277      269      265      362      419       422       397       361       425       435

    Nonfinancial Assets:
       Fixed Reproducible Capital...................      996      997    1,040      944      912    1,056     1,110      1106       999       980       974
         Defense....................................      865      822      830      691      633      760       795       768       664       642       624
         Nondefense.................................      131      175      210      253      279      296       315       338       335       338       350
       Inventories..................................      263      228      212      189      232      267       236       167       139       138       135
       Nonreproducible Capital......................      424      435      417      614      979    1,061       835       622       695       731       922
         Land.......................................       92      128      161      253      321      338       346       258       333       360       399
         Mineral Rights.............................      332      308      256      361      658      724       489       364       362       370       523
                                                     -------------------------------------------------------------------------------------------------------
           Subtotal.................................    1,683    1,660    1,669    1,747    2,122    2,385     2,180     1,895     1,833     1,849     2,031
                                                     =======================================================================================================
          Total Assets..............................    1,895    1,937    1,937    2,012    2,485    2,804     2,602     2,291     2,193     2,274     2,466

                       LIABILITIES

    Financial Liabilities:
       Debt held by the Public......................    1,124    1,159    1,048    1,061    1,306    2,174     2,965     3,930     3,862     3,715     3,410
       Trade Payables and Miscellaneous.............       15       21       23       31       55       82       117        90        75        73        73
                                                     -------------------------------------------------------------------------------------------------------
         Subtotal...................................    1,139    1,180    1,070    1,092    1,361    2,255     3,082     4,021     3,937     3,788     3,484

    Insurance Liabilities:
       Deposit Insurance............................        0        0        0        0        2        9        72         5         2         1         1
       Pension Benefit Guarantee \1\................        0        0        0       43       31       43        43        21        49        41        40
       Loan Guarantees..............................        0        0        2        6       12       11        16        29        35        35        37
       Other Insurance..............................       31       28       22       20       27       17        20        17        16        16        16
                                                     -------------------------------------------------------------------------------------------------------
         Subtotal...................................       31       28       24       70       73       80       150        72       102        95        95

    Federal Pension and Retiree Health Liabilities:
       Pension Liabilities..........................      794    1,006    1,196    1,360    1,792    1,793     1,746     1,689     1,664     1,688     1,684
       Retiree Health Insurance Benefits............      190      241      287      326      430      430       419       405       376       376       384
                                                          Total......................................      984    1,248    1,483    1,685    2,222    2,223     2,165     2,093     2,039     2,064     2,068
                                                     =======================================================================================================
    Total Liabilities...............................    2,154    2,456    2,578    2,847    3,655    4,559     5,398     6,187     6,079     5,947     5,646

    Balance.........................................     -259     -519     -641     -835   -1,171   -1,755    -2,796    -3,895    -3,885    -3,673    -3,180
    -------------------------------------------------------------------------------------------------------
    Addenda:........................................

    Balance Per Capita (in 2000 dollars)............   -1,433   -2,670   -3,124   -3,867   -5,127   -7,338   -11,152   -14,771   -14,326   -13,422   -11,520

    Ratio to GDP (in percent).......................    -10.1    -16.0    -16.6    -19.0    -22.3    -28.2     -38.9     -47.7     -42.0     -38.0     -31.6
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    * This table shows assets and liabilities for the Government as a whole excluding the Federal Reserve System.

    \1\ The model and data used to calculate this liability were revised for 1996-1999.

    [[Page 18]]

    pared with net liabilities of $3.9 trillion (FY 2000 dollars) and
    $14,800 per capita (FY 2000 dollars) in 1995.

    Assets

      The assets in Table 2-1 are a comprehensive list of the financial and
    physical resources owned by the Federal Government.
      Financial Assets: According to the Federal Reserve Board's Flow-of-
    Funds accounts, the Federal Government's holdings of financial assets
    amounted to $0.4 trillion at the end of FY 2000. Government-held
    mortgages and other loans (measured in constant dollars) reached a peak
    in the mid-1980s. Since then, the value of Federal loans has declined.
    Holdings of mortgages rose sharply in the late 1980s and then declined
    in the 1990s, as the Government acquired mortgages from failed savings
    and loan institutions and then liquidated them.
      The face value of mortgages and other loans overstates their economic
    worth. OMB estimates that the discounted present value of future losses
    and interest subsidies on these loans is about $40 billion as of 2000.
    These estimated losses are subtracted from the face value of outstanding
    loans to obtain a better estimate of their economic worth.
      Reproducible Capital: The Federal Government is a major investor in
    physical capital and computer software. Government-owned stocks of such
    capital amounted to about $1.0 trillion in 2000 (OMB estimate). About
    two-thirds of this capital took the form of defense equipment or
    structures.
      Non-reproducible Capital: The Government owns significant amounts of
    land and mineral deposits. There are no official estimates of the market
    value of these holdings (and of course, in a realistic sense, much of
    these resources could or would never be sold). Researchers in the
    private sector have estimated what they are worth, and these estimates
    are extrapolated in Table 2-1. Private land values fell sharply in the
    early 1990s, but they have risen since 1993. It is assumed here that
    Federal land shared in the decline and the subsequent recovery. Oil
    prices declined in 1997-1998 but rebounded sharply in 1999-2000 causing
    the estimated value of Federal mineral deposits to fluctuate. (The
    estimates omit other types of valuable assets owned by the Government,
    such as works of art and historical artefacts, because the valuation of
    many of these assets would have little realistic basis, and because, as
    part of the Nation's historical heritage, most of these objects would
    never be sold.)
      Total Assets: The total real value of Government assets is lower now
    than at the end of the 1980s, mainly because of declines in defense
    capital, although Government asset values have risen strongly since
    1998. Even so, the Government's holdings are vast. At the end of 2000,
    the value of Government assets is estimated to have been about $2.5
    trillion.

    Liabilities

      Table 2-1 covers all those liabilities that would also appear on a
    business balance sheet and only those liabilities. These include various
    forms of Federal debt, Federal pension and health insurance obligations
    to civilian and military retirees, and the estimated liability arising
    from Federal insurance and loan guarantee programs.
      Financial Liabilities: Financial liabilities amounted to about $3.5
    trillion at the end of 2000. The single largest component was Federal
    debt held by the public, amounting to around $3.4 trillion. In addition
    to debt held by the public, the Government's financial liabilities
    include approximately $0.1 trillion in miscellaneous liabilities.
      Guarantees and Insurance Liabilities: The Federal Government has
    contingent liabilities arising from loan guarantees and insurance
    programs. When the Government guarantees a loan or offers insurance,
    cash disbursements may initially be small or, if a fee is charged, the
    Government may even collect money; but the risk of future cash payments
    associated with such commitments can be large. The figures reported in
    Table 2-1 are estimates of the current discounted value of prospective
    future losses on outstanding guarantees and insurance contracts. The
    present value of all such losses taken together is less than $0.1
    trillion. The resolution of the many failures in the savings and loan
    and banking industries has helped to reduce the liabilities in this
    category by about half since 1990.
      Federal Pension and Retiree Health Liabilities: The Federal Government
    owes pension benefits as a form of deferred compensation to retired
    workers and to current employees who will eventually retire. It also
    provides its retirees with subsidized health insurance through the
    Federal Employees Health Benefits program. The amount of these
    liabilities is large. The discounted present value of the benefits is
    estimated to have been around $2.1 trillion at the end of FY 2000. \3\
    ---------------------------------------------------------------------------
      \3\ The pension liability is the actuarial present value of benefits
    accrued-to-date based on past and projected salaries. The 2000 liability
    is extrapolated from recent trends. The retiree health insurance
    liability is based on actuarial calculations of the present value of
    costs for existing programs. It has only been estimated on a consistent
    basis since 1997. For earlier years the liability was assumed to grow in
    line with the pension liability, which may differ significantly from
    what the actuaries would calculate for this period.
    ---------------------------------------------------------------------------

    The Balance of Net Liabilities

      Because of its sovereign powers, the Government need not maintain a
    positive balance of net assets; the buildup in net liabilities since
    1960 did not damage Federal creditworthiness. By 1995 net liabilities
    had reached 48 percent of GDP. Since then, the net balance as a
    percentage of GDP has fallen for five straight years. The real value--
    adjusted for inflation--of net liabilities has also fallen by $0.7
    trillion (FY 2000 dollars), reflecting the shift from budget deficits to
    surpluses, and a recent recovery in some Federal asset prices. If the
    budget surplus is maintained, as projected in the President's Budget,
    the net balance will continue to improve.

    [[Page 19]]

             PART II--THE BALANCE OF RESOURCES AND RESPONSIBILITIES

      This part of the presentation describes long-run projections of the
    Federal budget that extend beyond the normal 5 to 10 year budget
    horizon. Forecasting the economy and the budget over such a long period
    is highly uncertain. Future budget outcomes depend on a host of
    unknowns--constantly changing economic conditions, unforeseen
    international developments, unexpected demographic shifts, the
    unpredictable forces of technological advance, and evolving political
    preferences. Those uncertainties increase the further into the future
    the projections are pushed. Long-run budget projections can be useful,
    however, in sounding warnings about future problems. Federal
    responsibilities extend well beyond the next decade. There is no time
    limit on the Government's constitutional responsibilities, and programs
    like Social Security are intended to continue indefinitely.

      The Threat to the Budget from the Impending Demographic Transition: It
    is evident even now that there will be mounting challenges to the budget
    early in this century. In 2008, the first of the huge baby-boom
    generation born after World War II will reach age 62 and become eligible
    for early retirement under Social Security. In the years that follow,
    there will be serious strains on the budget because of increased
    expenditures for Social Security and for the Government's health
    programs which serve the elderly--Medicare and increasingly Medicaid.
    Long-range projections can help define how serious these strains might
    become, and what would be needed to withstand them.
      The U.S. population has been aging for decades, but the impending
    demographic shift is now just over the horizon. The baby-boom cohort has
    moved into its prime earning years, while the much smaller cohort born
    during the Great Depression has been retiring. Together these shifts in
    the population have held down the rate of growth in the number of
    retirees relative to the labor force. The suppressed budgetary pressures
    are likely to burst forth when the baby-boomers begin to retire at the
    end of this decade.
      The pressures are expected to persist even after the baby-boomers are
    no longer here. The Social Security actuaries project that the ratio of
    workers to Social Security beneficiaries will fall from around 3\1/2\
    currently to around 2 as the baby-boomers retire, and because of lower
    fertility and improved mortality, that ratio is not expected to rise
    again. With fewer workers to pay taxes that support the retired
    population, the budgetary pressures on the Federal retirement pro

    [[Page 20]]

    grams will persist. The problem posed by the demographic transition is a
    permanent one.
      Another way to see the problem is to examine the projected spending on
    Social Security, Medicare, and Medicaid. Currently, these programs
    account for 46 percent of non-interest Federal spending; up from 30
    percent in 1980. By 2040, when most of the remaining baby-boomers will
    be in their 80s, these three programs could easily account for more than
    two-thirds of non-interest Federal spending. At the end of the
    projection period, the figure rises to over 75 percent of non-interest
    spending. In other words, under an extension of current budget policy,
    almost all of the budget would go to these three programs alone. That
    would considerably reduce the flexibility of the budget, and the
    Government's ability to respond to new challenges.
      Measured relative to the size of the economy, the three major
    entitlement programs now amount to 7 percent of GDP. \4\ By 2040, this
    share doubles to 14 percent, and in 2075 it is projected to reach 18
    percent of GDP. Current projections suggest, absent structural changes
    in the programs, that the Federal Government will eventually have to
    find 11 percent of GDP to cover future benefits.
    ---------------------------------------------------------------------------
      \4\ Over long periods when the rate of inflation is positive,
    comparisons of dollar values are meaningless. Even the low rate of
    inflation assumed in this budget will reduce the value of a 2000 dollar
    by almost 50 percent by 2030, and by 65 percent by 2050. For long-run
    comparisons, it is much more useful to examine the ratio of the surplus/
    deficit and other budget totals to the expected size of the economy as
    measured by GDP.
    ---------------------------------------------------------------------------

      The Shortfall in Social Security: Social Security is intended to be
    self-financing. Workers and employers pay taxes earmarked for the Social
    Security trust funds, and the funds disburse benefits. In recent years,
    the funds have been increasing in size as a result of a growing Social
    Security surplus. At the end of FY 2000, the combined Old Age, Survivors
    and Disability Insurance (OASDI) trust funds had reached $1 trillion.
    The demographic transition, however, is expected to reverse the buildup
    of the trust funds under current law. The program's actuaries project
    that by 2016, taxes flowing into the funds will fall short of program
    benefits and expenses. \5\ The funds are projected to continue to grow
    for some years beyond this point because of positive interest income,
    but by 2025, the trust funds will peak and begin to be drawn down; by
    2038, when the youngest baby-boomers will be in their 70s, the actuaries
    project that the OASDI trust funds will be exhausted. That would not
    mean that Social Security benefits would cease, because taxes are
    projected to cover about 70 percent of benefits at that point, but the
    program could no longer sustain promised benefits out of earmarked tax
    receipts alone (see accompanying box for a fuller discussion).

    ---------------------------------------------------------------------------
      \5\ The long-range projections discussed in this chapter are based on
    an extension of the Administration's economic projections from the
    budget, which is different from the economic assumptions used by the
    actuaries. Under the extended Administration projections this point
    would be reached in 2019, not 2016, and the other key dates would come
    later also.
    ---------------------------------------------------------------------------

    [[Page 21]]

    ------------------------------------------------------------------------

                       Social Security: The Long-Range Challenge

    For 65 years, Social Security has provided retirement security and disability insurance for tens of millions of
     Americans through a self-financing system. The principle of self-financing is important because it compels
     corrections to the system in the event of projected financial imbalances.

    Although Social Security is running surpluses today, OMB projects it will begin running cash deficits within 20
     years. Social Security's spending path is unsustainable, driven largely by the demographic trends of lower
     fertility rates and longer life spans. These trends indicate that the number of workers available to support
     each retiree will decline from 3.4 today to an estimated 2.1 in 2030. As a result, the Government will not be
     able to meet current-law benefit obligations at current payroll tax rates. At present, the Social Security
     system faces a closed-group actuarial deficit of $8.7 trillion.

    The size of Social Security's shortfall cannot be known with any precision. Under the Social Security Trustees'
     2001 intermediate-cost economic and demographic assumptions, the gap between Social Security receipts and
     outlays in 2040 will be 1.7 percent of GDP. Under their high-cost assumptions, the shortfall in that year would
     be 72 percent larger, or 2.9 percent of GDP.

    Long-range uncertainty underscores the importance of creating a system that is financially stable and self-
     contained. Otherwise, if pessimistic assumptions turn out to be accurate, the demands created by Social
     Security could compromise the rest of the budget and the Nation's economic health.

    Moreover, the current structure of Social Security leads to substantial generational inequities in the average
     rate of return people can expect from the program. While previous generations fared well, individuals born
     today on average can expect to earn less than a two percent rate of return on their payroll tax contributions.
     This estimate may overstate the rate of return, because it assumes no changes in current-law taxes or benefits
     even though meeting the projected financing shortfall through benefit cuts or additional revenues would further
     reduce Social Security's implicit rate of return for future cohorts. A 1995 analysis found that the cohort born
     in 2000 would experience a 1.7 percent rate of return before accounting for Social Security's shortfall, and a
     1.5 percent rate of return after adjusting revenues to keep the system solvent.

    One way to address the issues of uncertainty and declining rates of return, while protecting national savings,
     would be to allow individuals to keep some of their payroll taxes in personal retirement accounts. Giving
     workers the ability and the control to build wealth for their own retirement would lessen the pressure of
     adverse demographic trends on the long-range budget. Such accounts would reduce the need for a rapidly growing
     Government outlay by creating opportunities for younger workers to enjoy the fruits of higher rates of return
     in private equity markets. Personal retirement accounts could boost national savings, because they would be
     designed as investment vehicles. The current Social Security program, by contrast, is in essence a tax-and-
     transfer system that may or may not enhance national savings. The program's contribution to savings depends on
     Social Security's own financial status at any given point in time, as well as the extent to which the rest of
     the budget relies on Social Security surpluses to fund ongoing programs.

    ------------------------------------------------------------------------

    [[Page 22]]

    ------------------------------------------------------------------------

                            Medicare: The Long-Range Challenge

    According to the Medicare Trustees most recent 2001 report, the Hospital Insurance (HI) trust fund will go
     bankrupt in 2029, and spending will exceed taxes into the fund in 2016. The long-run outlook for the HI Trust
     Fund is measured by the actuarial balance. The actuarial balance reflects the financing changes needed (e.g.,
     benefit cuts, tax increase), expressed in terms of the tax rate increase required today to balance the HI Trust
     Fund over the next 75 years. In 2001, Trustees are projecting an actuarial deficit of -1.97 percent. This is a
     63 percent increase in the deficit over last year's estimate (-1.21 percent), due largely to the Trustee's
     acknowledgment that Medicare per capita expenditures will grow faster than they had previously assumed,
     outpacing per capita GDP growth by a full percent.

    But, Medicare actually has two trust funds, not one: the HI and the SMI trust funds. Like HI, growth in per
     beneficiary SMI expenditures are projected to outpace per capita GDP growth by a full percent. In the short
     run, a comprehensive analysis of the Medicare program that takes into account both of these trust funds reveals
     that there is already a Medicare deficit, not a surplus. In fact, over the next ten years 2002-2011, the
     Medicare program will require annual transfers from the general revenue fund totaling $1.2 trillion to meet
     program expenditures.

    The long-range projections of combined Medicare spending reveal substantial spending growth. Not only are per
     capita expenditures increasing rapidly, but the number of beneficiaries is skyrocketing as well. Between 2010
     and 2030, the number of persons age 65 and older will increase from 39.7 million to 69.1 million. As a result
     of this combination of factors, total Medicare expenditures are projected to quadruple as a percentage of GDP,
     from 2 percent in 2000 to 8 percent in 2075.

    The Administration is committed to working with Congress to reform Medicare in a manner which improves the long-
     term solvency of the entire program without raising Medicare payroll taxes.

    ------------------------------------------------------------------------

      And in Medicare: Medicare faces a similar problem. Income to
    Medicare's Hospital Insurance (HI) trust fund is projected to exceed
    outgo until 2016, but the HI fund is projected to reach zero in 2029,
    nine years earlier than the OASDI trust funds. Unlike Social Security,
    Medicare has never been completely self-financed. In addition to the HI
    program, Medicare also consists of Supplementary Medical Insurance
    (SMI), which covers medical bills outside of the hospital. SMI is funded
    by a combination of premiums charged to the beneficiaries, which cover
    about one-quarter of benefits, and general revenue. Even if the HI trust
    fund were to remain solvent indefinitely, Medicare as a whole would
    continue to be subsidized by the rest of the budget. As Medicare costs
    rise, the subsidy increases, but even today Medicare is not self-
    financing (see accompanying box for a fuller discussion).
      An Improved Long-Range Outlook.--At the beginning of the 1990s, when
    these long-run budget projections were first developed, the deficit was
    on an unstable trajectory. Given then-current economic projections and
    policies, the deficit was projected to mount steadily not only in dollar
    terms, but relative to the size of the economy. This pattern of rising
    deficits would have driven Federal debt held by the public to
    unsustainable levels. Policy actions during the 1990s reduced the
    deficits, and the strong economy that emerged in the second half of the
    1990s did even more to eliminate them.
      The unified budget is now projected to be in surplus for the next ten
    years. Even excluding the Social Security surplus, the rest of the
    budget is also projected to be in surplus over the same period. If
    realized, these surpluses will reduce the amount of Federal debt
    outstanding and lower the Government's net interest payments. In FY
    2000, net interest amounted to 2.3 percent of GDP; under current
    estimates, that could be cut to around 0.3 percent of GDP by 2010.
      If the policies and assumptions in the budget are extended beyond the
    ten-year budget window, the unified budget could continue in surplus for
    many more years. However, there is a wide range of uncertainty around
    such long-range projections. As discussed below, they are affected by
    many hard-to-foresee economic and demographic factors, as well as by
    future policy decisions.

      Economic and Demographic Assumptions.--Even though any such forecast
    is highly uncertain, long-run budget projections require starting with
    specific economic and demographic projections. The assumptions used as a
    starting point extend the Administration's medium-term economic
    projections, augmented by the long-run demographic projections from the
    2000 Social Security Trustees' Report.
         Inflation, unemployment and interest rates hold stable at
              2.5 percent per year for CPI inflation, 4.6 percent for the
              unemployment rate, and 5.7 percent for the yield on 10-year
              Treasury notes.
         Productivity growth as measured by real GDP per hour
              continues at the same constant rate as in

    [[Page 23]]

              the Administration's medium-term projections--2.1 percent per
              year.
         In line with the projections of the Social Security
              Trustees, U.S. population growth is expected to slow from 1
              percent per year in the 1990s to about half that rate by 2030.
         Labor force participation declines as the population ages
              and the proportion of retirees increases.
         Real GDP growth declines gradually after 2011 from around 3
              percent per year to an average annual rate of 2.3 percent,
              because labor force growth is expected to slow while
              productivity growth is assumed to be constant.
      The economic projections described above are set by assumption and do
    not automatically change in response to changes in the budget outlook.
    This is unrealistic, but it simplifies comparisons of alternative
    policies.

      Alternative Budget Projections.--Chart 2-4 below shows budget
    projections under alternative assumptions about discretionary spending.
    These projections generally assume that mandatory spending proceeds
    according to current law and proposed policy, without new programs or
    enhancements of existing programs except for those proposed in the
    budget. Under each of these alternatives, the major entitlement programs
    are expected to absorb an increasing share of budget resources.
         Social Security benefits, driven by the retirement of the
              baby-boom generation, rise from 4.1 percent of GDP in 2000 to
              6.3 percent in 2040. They continue to rise after that but more
              gradually, eventually reaching 6.8 percent of GDP by 2075. \6\
    ---------------------------------------------------------------------------
      \6\ These benefit estimates reflect the economic assumptions described
    above, which differ somewhat from the assumptions in the Social Security
    Trustees' Report. The benefit estimates were prepared by the Social
    Security actuaries using OMB economic assumptions.
    ---------------------------------------------------------------------------
         Medicare outlays net of premiums rise from 2.0 percent of
              GDP in 2000 to 5.0 percent of GDP in 2040, and 8.1 percent by
              2075.
         Federal Medicaid spending goes up from 1.2 percent of GDP
              in 2000 to 2.7 percent in 2040 and to 3.5 percent of GDP in
              2075.
         If discretionary spending is held constant in real terms,
              it would fall as a share of GDP from 6.3 percent in 2000 to
              3.1 percent in 2040, and to 1.9 percent in 2075.
              Alternatively, discretionary spending may be fixed as a share
              of GDP at the level reached in 2011, when the budget window
              closes, maintaining a constant 5 percent share of GDP through
              2075.

    [[Page 24]]

                              Table 2-2.  LONG-RUN BUDGET PROJECTIONS OF 2002 BUDGET POLICY
                                                    (Percent of GDP)
    ----------------------------------------------------------------------------------------------------------------
                                               2000    2005    2010    2020    2030    2040    2050    2060    2075
    ----------------------------------------------------------------------------------------------------------------
    Discretionary Grows with Inflation
      Receipts..............................    20.6    19.2    18.6    18.6    18.7    18.7    18.8    18.8    18.7
      Outlays...............................    18.2    17.1    15.8    15.2    15.6    15.8    15.9    16.5    18.9
         Discretionary......................     6.3     5.9     5.2     4.3     3.7     3.1     2.7     2.3     1.9
         Mandatory..........................     9.7    10.0    10.3    12.1    14.1    15.2    16.1    17.2    19.2
           Social Security..................     4.1     4.1     4.2     5.3     6.2     6.3     6.3     6.5     6.8
           Medicare.........................     2.0     2.2     2.3     3.1     4.1     5.0     5.8     6.6     8.1
           Medicaid.........................     1.2     1.4     1.7     2.1     2.4     2.7     3.0     3.2     3.5
           Other............................     2.4     2.2     2.0     1.7     1.4     1.2     1.0     0.9     0.8
         Net Interest.......................     2.3     1.1     0.3    -1.2    -2.1    -2.5    -2.9    -2.9    -2.2
      Surplus/Deficit(-)....................     2.4     2.1     2.8     3.4     3.0     2.9     2.9     2.3    -0.2
      Primary Surplus/Deficit (-)...........     4.7     3.3     3.1     2.1     0.9     0.4     0.0    -0.6    -2.3
      Federal Debt Held by Public...........    34.7    17.5     2.3   -25.5   -42.3   -50.8   -56.8   -58.2   -41.7

    Discretionary Grows with GDP
      Receipts..............................    20.6    19.2    18.6    18.6    18.7    18.7    18.8    18.8    18.7
      Outlays...............................    18.2    17.1    15.8    16.1    17.7    19.3    21.1    23.7    29.5
         Discretionary......................     6.3     5.9     5.2     5.0     5.0     5.0     5.0     5.0     5.0
         Mandatory..........................     9.7    10.0    10.3    12.1    14.1    15.2    16.1    17.2    19.2
           Social Security..................     4.1     4.1     4.2     5.3     6.2     6.3     6.3     6.5     6.8
           Medicare.........................     2.0     2.2     2.3     3.1     4.1     5.0     5.8     6.6     8.1
           Medicaid.........................     1.2     1.4     1.7     2.1     2.4     2.7     3.0     3.2     3.5
           Other............................     2.4     2.2     2.0     1.7     1.4     1.2     1.0     0.9     0.8
         Net Interest.......................     2.3     1.1     0.3    -1.1    -1.4    -0.9     0.0     1.5     5.3
      Surplus/Deficit(-)....................     2.4     2.1     2.8     2.5     1.0    -0.5    -2.3    -4.8   -10.8
      Primary Surplus/Deficit (-)...........     4.7     3.3     3.1     1.5    -0.4    -1.5    -2.3    -3.3    -5.5
      Federal Debt Held by Public...........    34.7    17.5     2.3   -21.8   -27.5   -17.8     1.3    31.7   108.0
    ----------------------------------------------------------------------------------------------------------------

      There is an important caveat to these results, however. The Federal
    Government is assumed to acquire financial assets once the publicly held
    Federal debt has been run down. This would be a unique departure for the
    Government, and it would encounter significant obstacles. Under current
    policy, the Government's investment options would be quite limited.
    Moreover, if the Federal Government were to own a large share of the
    Nation's financial assets, the economy's dynamism could be undermined by
    the Government's influence over what had been private economic choices.
    This could reduce the efficiency of the capital markets and lower the
    long-term rate of economic growth. These negative effects are not
    considered in these simulations.
      Overall, it seems unlikely that the Government would ever accumulate a
    large net stock of assets, but these long-range projections show what
    could happen absent policy changes, and they indicate that policy makers
    will soon need to consider the issue of Government ownership of private
    assets. If spending was increased or taxes adjusted from year-to-year in
    order to avoid Government's accumulation of private assets, the budget
    could remain in balance through 2050, assuming real discretionary
    spending is held constant in the long run. Alternatively, if
    discretionary spending grows with GDP in the long run, the budget is
    projected to stay in balance until 2028, while avoiding a buildup of
    assets.

      The Effects of Alternative Economic and Technical Assumptions.--The
    results discussed above are sensitive to changes in underlying economic
    and technical assumptions. Some of the most important of these
    alternative economic and technical assumptions and their effects on the
    budget outlook are discussed below. Each highlights one of the key
    uncertainties in the outlook.
      1. Health Spending:  OMB's long-range projections for Medicare follow
    the latest projections of the Medicare actuaries reflected in the
    Medicare Trustees' Report. For many years, those projections included a
    slowdown in the rate of growth of real per capita Medicare spending in
    the long run. Recently, the Technical Review Panel on the Medicare
    Trustees' Reports has recommended raising the long-run projected growth
    rate in real per capita Medicare costs, and the Medicare Trustees
    adopted this assumption in their 2001 report. The Panel recommended
    projections in which ``age-and gender-adjusted, per-beneficiary spending
    growth exceeds the growth of per-capita GDP by 1 percentage point per
    year.'' \7\ In Chart 2-4, real per capita Medicare benefits are assumed
    to rise at this rate, which is about 60 percent greater than assumed in
    previous Medicare Trustees' Reports.
    ---------------------------------------------------------------------------
      \7\ Technical Review Panel on the Medicare Trustees' Reports, ``Review
    of Assumptions and Methods of the Medicare Trustees' Financial
    Projections,'' December 2000.
    ---------------------------------------------------------------------------
       Eventually, the rising trend in health care costs for both Government
    and the private sector will have to end, but it is hard to know when and
    how that will happen. ``Eventually'' could be a long way off. Improved
    health and increased longevity are highly valued, and society may be
    willing spend a larger share of income on them than it has heretofore.
    There are many reasonable alternative health cost and usage projections,
    as well as variations in the demographic projections to which they can
    be applied. Innovations in health care

    [[Page 25]]

    are proceeding rapidly, and they have diverse effects on the projection
    of costs. Likewise, the effects of greater longevity on Medicare and
    especially Medicaid costs are uncertain.
      2. Discretionary Spending: The assumption used to project
    discretionary spending is essentially arbitrary, because discretionary
    spending is determined annually through the legislative process, and no
    formula can dictate future spending in the absence of legislation.
    Alternative assumptions are made for discretionary spending. In one
    case, discretionary spending is held constant in real terms, growing
    only with projected inflation. Alternatively, discretionary spending is
    assumed to keep pace with the growth in GDP. Growth with inflation
    implies that the real value of Federal services is unchanging over time,
    which has the implication that the size of Federal discretionary
    spending would shrink relative to the size of the economy. The second
    alternative for current policy considered in Chart 2-4 and Table 2-2
    allows discretionary spending to increase with GDP. This implies that
    discretionary spending increases in real terms whenever there is
    positive real economic growth.
      3. Productivity: The rate of future productivity growth is perhaps the
    most powerful of the uncertainties affecting the long-run budget
    outlook. Productivity in the U.S. economy slowed markedly and
    unexpectedly after 1973. This slowdown was responsible for a slower rise
    in U.S. real incomes for the next two decades. Recently, productivity
    growth has increased. Since 1995, productivity has grown about as fast
    as it did during the 25-year period prior to 1973. The revival of
    productivity growth is one of the most welcome developments of the last
    several years. A higher rate of growth makes the task of preserving a
    balanced budget much easier; a lower productivity growth rate has the
    opposite effect. Although the long-run growth rate of productivity is
    inherently uncertain, productivity growth in the United States has
    averaged about 2 percent per year for over a century, and is projected
    to continue at that rate in these projections.
      4. Population: The key assumptions underlying the model's demographic
    projections concern fertility, immigration, and mortality.
         The demographic projections assume that fertility will
              average around 1.95 births per woman in the future, slightly
              below the replacement rate needed to maintain a constant
              population.
         The rate of immigration is assumed to average around
              900,000 per year in these projections. Higher immigration
              relieves some of the pressure on population from low
              fertility.
         Mortality is projected to decline. The average female
              lifespan is projected to rise from 79.5 years to 85.0 years by
              2075. Men do not live as long as women on average, but their
              lifespan is also projected to increase, from 73.8 years in
              2000 to 80.9 years by 2075. A Technical Panel to the Social
              Security Trustees reported that the improvement in longevity
              might be greater than this. If so, growth of the three big
              entitlement programs could be even faster.

      Conclusion.--Since the early 1990s, the long-run budget outlook has
    improved significantly, but the outlook remains highly uncertain. Under
    some scenarios, the unified budget surplus could continue for many
    years, but with alternative assumptions, the deficit returns much
    sooner. Although there is an extended period of budget surpluses under
    most current projections, how big the surpluses will be and how long
    they will last remain quite uncertain. Under an adverse combination of
    assumptions, the fiscal picture could deteriorate, leading to an
    unsustainable debt build-up. With more favorable assumptions, however,
    there would be a constantly rising unified budget surplus through the
    75-year projection period. The enormous range of possible outcomes
    highlights the sensitivity of long-term projections to specific
    assumptions and cautions against undue reliance on any particular
    projection path.
      While the overall budget outlook has improved, the entitlement
    programs are still expected to give rise to budget strains. Fundamental
    changes are needed to preserve the basic promises embodied in Social
    Security and Medicare.

       Actuarial Balance in the Social Security and Medicare Trust Funds:

      The Trustees for the Social Security and Hospital Insurance trust
    funds issue annual reports that include projections of income and outgo
    for these funds over a 75-year period. These projections are based on
    different methods and assumptions than the long-run budget projections
    presented above, although the budget projections do rely on the Social
    Security assumptions for population growth and labor force growth after
    the year 2011. Even with these differences, the message is similar: The
    retirement of the baby-boom generation coupled with expected high rates
    of growth in per capita health care costs will exhaust the trust funds
    unless further remedial action is taken.
      The Trustees' reports feature the 75-year actuarial balance of the
    trust funds as a summary measure of their financial status. For each
    trust fund, the balance is calculated as the change in receipts or
    program benefits (expressed as a percentage of taxable payroll) that
    would be needed to preserve a small positive balance in the trust fund
    at the end of 75 years. Table 2-3 shows the changes in the 75-year
    actuarial balances of the Social Security and Medicare trust funds from
    1999 to 2001. There were improvements in the consolidated OASDI trust
    fund and a deterioration in the HI trust fund. The changes were due to
    revisions in the actuarial assumptions. In the case of the OASDI funds,
    a small improvement in the economic assumptions was made, along with a
    similar change in the technical assumptions. For the HI program the
    Trustees revised their economic and technical assumptions. The change in
    economic and demographic assumptions made a small improvement in the
    actuarial balance, but this was more than offset by the large change in
    technical

    [[Page 26]]

     Table 2-3.  CHANGE IN 75-YEAR ACTUARIAL BALANCE FOR OASDI AND HI TRUST
                        FUNDS (INTERMEDIATE ASSUMPTIONS)
                         (As percent of taxable payroll)
    ------------------------------------------------------------------------
                                               OASI     DI     OASDI    HI
    ------------------------------------------------------------------------
    Actuarial balance in 1999 Trustees'        -1.70   -0.36   -2.07   -1.46
     Report.................................

    Changes in balance due to changes in:...
       Legislation..........................    0.00    0.00    0.00   -0.02
       Valuation period.....................   -0.06   -0.01   -0.07   -0.03
       Economic and demographic assumptions.    0.06    0.01    0.07    0.10
       Technical and other assumptions......    0.18   -0.01    0.17    0.20
                                             -------------------------------
         Total Changes......................    0.18   -0.01    0.17    0.25

    Actuarial balance in 2000 Trustees'        -1.53   -0.37   -1.89   -1.21
     Report.................................
    Changes in balance due to changes in:...
       Legislation..........................    0.00    0.00    0.00   -0.03
       Valuation period.....................   -0.06   -0.01   -0.07   -0.04
     Economic and demographic assumptions...    0.10    0.01    0.11    0.08
       Technical and other assumptions......   -0.04    0.04    0.00   -0.77
                                             -------------------------------
         Total Changes......................   -0.01    0.04    0.03   -0.76

    Actuarial balance in 2001 Trustees'        -1.53   -0.33   -1.86   -1.97
     Report.................................
    ------------------------------------------------------------------------

    assumptions. The Trustees adopted the recommendations of their Technical
    Review Panel and boosted the growth rate of real per capita Medicare
    spending substantially. The actuarial deficiency in Medicare now exceeds
    the deficiency calculated for Social Security.

                      PART III--NATIONAL WEALTH AND WELFARE

      Unlike a private corporation, the Federal Government routinely invests
    in ways that do not add directly to its assets. For example, Federal
    grants are frequently used to fund capital projects by State or local
    governments for highways and other purposes. Such investments are
    valuable to the public, which pays for them with taxes, but they are not
    owned by the Federal Government and would not show up on a conventional
    balance sheet for the Government.
      The Federal Government also invests in education and research and
    development (R&D). These outlays contribute to future productivity and
    are analogous to an investment in physical capital. Indeed, economists
    have computed stocks of human and knowledge capital to reflect the
    accumulation of such investments. Nonetheless, such hypothetical capital
    stocks are obviously not owned by the Federal Government, nor would they
    appear on a balance sheet as a Government asset.
      To show the importance of these kinds of issues, Table 2-4 presents a
    national balance sheet. It includes estimates of national wealth
    classified into three categories: physical assets, education capital,
    and R&D capital. The Federal Government has made contributions to each
    of these categories of capital, and these contributions are shown
    separately in the table. Data in this table are especially uncertain,
    because of the strong assumptions needed to prepare the estimates.
      The conclusion of the table is that Federal investments are
    responsible for about 7 percent of total national wealth. This may seem
    like a small fraction, but it represents a large volume of capital--$5
    trillion. The Federal contribution is down from around 9 percent in the
    mid-1980s, and from around 12 percent in 1960. Much of this reflects the
    shrinking size of the defense capital stocks, which have gone down from
    12 percent of GDP to 7 percent since the end of the Cold War.

    Physical Assets:

      The physical assets in the table include stocks of plant and
    equipment, office buildings, residential structures, land, and the
    Government's physical assets such as military hardware and highways.
    Automobiles and consumer appliances are also included in this category.
    The total amount of such capital is vast, around $39 trillion in 2000,
    consisting of $33 trillion in private capital and $6 trillion in public
    capital; by comparison, GDP was about 10 trillion.
      The Federal Government's contribution to this stock of capital
    includes its own physical assets plus $1 trillion in accumulated grants
    to State and local Governments for capital projects. The Federal
    Government has financed about one-fourth of the physical capital held by
    other levels of Government.

    Education Capital:

      Economists have developed the concept of human capital to reflect the
    notion that individuals and society invest in people as well as in
    physical assets. Investment in education is a good example of how human
    capital is accumulated.
      This table includes an estimate of the stock of capital represented by
    the Nation's investment in formal education and training. The estimate
    is based on the cost of replacing the years of schooling embodied in the
    U.S. population aged 16 and over; in other words, the idea

    [[Page 27]]

                                                                   Table 2-4.  NATIONAL WEALTH
                                                (As of the end of the fiscal year, in trillions of 2000 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                       1960    1965    1970    1975    1980    1985    1990    1995    1998    1999    2000
    --------------------------------------------------------------------------------------------------------------------------------------------------------

                                 ASSETS

    Publicly Owned Physical Assets:

      Structures and Equipment......................................     2.0     2.2     2.8     3.4     3.6     3.8     4.2     4.6     4.9     5.0     5.0
         Federally Owned or Financed................................     1.1     1.2     1.4     1.4     1.5     1.8     1.9     2.0     1.9     1.9     2.0
           Federally Owned..........................................     1.0     1.0     1.0     0.9     0.9     1.1     1.1     1.1     1.0     1.0     1.0
           Grants to State and Local Governments....................     0.1     0.2     0.3     0.5     0.6     0.7     0.8     0.9     0.9     1.0     1.0
         Funded by State and Local Governments......................     0.8     1.0     1.4     1.9     2.1     2.1     2.3     2.6     2.9     3.1     3.0
      Other Federal Assets..........................................     0.7     0.7     0.6     0.8     1.2     1.3     1.1     0.8     0.8     0.9     1.1
                                                                     ---------------------------------------------------------------------------------------
        Subtotal....................................................     2.7     2.9     3.4     4.2     4.8     5.1     5.2     5.4     5.7     5.9     6.0

    Privately Owned Physical Assets:
      Reproducible Assets                                                6.9     7.9     9.6    12.3    15.8    16.9    19.1    20.8    23.0    24.0    25.1
         Residential Structures.....................................     2.6     3.1     3.7     4.7     6.3     6.6     7.5     8.4     9.4     9.9    10.3
         Nonresidential Plant and Equipment.........................     2.8     3.1     3.9     5.1     6.5     7.2     8.0     8.8     9.7    10.1    10.6
         Inventories................................................     0.6     0.7     0.8     1.0     1.3     1.2     1.3     1.3     1.4     1.4     1.5
         Consumer Durables..........................................     0.8     1.0     1.2     1.4     1.7     1.8     2.3     2.4     2.5     2.6     2.7
      Land..........................................................     2.0     2.4     2.7     3.5     5.4     6.2     6.4     4.7     6.1     6.6     7.3
                                                                     ---------------------------------------------------------------------------------------
        Subtotal....................................................     8.9    10.2    12.4    15.8    21.2    23.1    25.4    25.6    29.1    30.6    32.5

    Education Capital:
      Federally Financed............................................     0.1     0.1     0.2     0.3     0.4     0.6     0.7     0.8     1.0     1.0     1.1
      Financed from Other Sources...................................     6.0     7.6    10.3    12.7    16.5    19.9    25.6    28.3    32.3    34.4    36.3
                                                                     ---------------------------------------------------------------------------------------
        Subtotal....................................................     6.1     7.7    10.5    13.0    16.9    20.5    26.4    29.1    33.3    35.4    37.4

    Research and Development Capital:
      Federally Financed R&D........................................     0.2     0.3     0.5     0.5     0.6     0.7     0.8     0.9     0.9     1.0     1.0
      R&D Financed from Other Sources...............................     0.1     0.2     0.3     0.4     0.5     0.6     0.8     1.1     1.3     1.3     1.4
                                                                     ---------------------------------------------------------------------------------------
        Subtotal....................................................     0.3     0.5     0.8     0.9     1.0     1.3     1.6     2.0     2.2     2.3     2.4
                                                                     =======================================================================================
    Total Assets....................................................    17.9    21.4    27.1    33.9    44.0    50.0    58.7    62.0    70.3    74.2    78.3

    Net Claims of Foreigners on U.S. (+)............................    -0.1    -0.2    -0.2    -0.1    -0.3     0.0     0.8     1.5     2.5     3.4     3.4

    Balance.........................................................    18.0    21.6    27.2    34.0    44.3    50.0    57.9    60.5    67.8    70.8    74.9
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    ADDENDA:........................................................

     Per Capita Balance (thousands of dollars)......................    99.4   111.2   132.7   157.3   194.1   209.1   230.9   229.5   250.0   258.8   271.4
     Ratio of Balance to GDP (in percent)...........................     7.0     6.7     7.1     7.7     8.4     8.0     8.0     7.4     7.3     7.3     7.4
     Total Federally Funded Capital (trillions 2000 $)..............     2.1     2.3     2.7     3.1     3.8     4.3     4.5     4.5     4.7     4.8     5.1
     Percent of National Wealth.....................................    11.4    10.7     9.8     9.1     8.5     8.7     7.8     7.4     6.9     6.8     6.8
    --------------------------------------------------------------------------------------------------------------------------------------------------------

    is to measure how much it would cost to reeducate the U.S. workforce at
    today's prices (rather than at its original cost). This is more
    meaningful economically than the historical cost, and is comparable to
    the measures of physical capital presented earlier.
      Although this is a relatively crude measure, it does provide a rough
    order of magnitude for the current value of the investment in education.
    According to this measure, the stock of education capital amounted to
    $37 trillion in 2000, of which about 3 percent was financed by the
    Federal Government. It is nearly equal to the total value of the
    Nation's stock of physical capital. The main investors in education
    capital have been State and local governments, parents, and students
    themselves (who forgo earning opportunities in order to acquire
    education).
      Even broader concepts of human capital have been suggested. Not all
    useful training occurs in a schoolroom or in formal training programs at
    work. Much informal learning occurs within families or on the job, but
    measuring its value is very difficult. However, labor compensation
    amounts to about two-thirds of national income, and thinking of this
    income as the product of human capital suggests that the total value of
    human capital might be two times the estimated value of physical
    capital. Thus, the estimates offered here are in a sense conservative,
    because they reflect only the costs of acquiring formal education and
    training.

    Research and Development Capital:

      Research and Development can also be thought of as an investment,
    because R&D represents a current expenditure that is made in the
    expectation of earning a future return. After adjusting for
    depreciation, the flow of R&D investment can be added up to provide an
    estimate of the current R&D stock. \8\ That stock is estimated to have
    been about $2 trillion in 2000. Although this is a large amount of
    research, it is a relatively small portion of total National wealth. Of
    this stock, about 40 percent was funded by the Federal Government.
    ---------------------------------------------------------------------------
      \8\ R&D depreciates in the sense that the economic value of applied
    research and development tends to decline with the passage of time, as
    still newer ideas move the technological frontier.
    ---------------------------------------------------------------------------

    Liabilities:

      When considering how much the United States owes as a Nation, the
    debts that Americans owe to one an

    [[Page 28]]

    other cancel out. This means they do not belong in Table 2-4, which is
    intended to show National totals only, but it does not mean they are
    unimportant. The only debt that appears in Table 2-4 is the debt that
    Americans owe to foreign investors. America's foreign debt has been
    increasing rapidly in recent years, because of the rising deficit in the
    U.S. current account, but even so, the size of this debt remains small
    compared with the total stock of U.S. assets. It amounted to 4 percent
    of total assets 2-4 in 2000.
      Most Federal debt does not appear in Table 2-4 because it is held by
    Americans; only that portion of the Federal debt held by foreigners is
    included. However, comparing the Federal Government's net liabilities
    with total national wealth gives another indication of the relative
    magnitude of the imbalance in the Government's accounts. Currently,
    Federal net liabilities, as reported in Table 2-1, amount to about 4
    percent of net U.S. wealth as shown in Table 2-4.

                            Trends in National Wealth

      The net stock of wealth in the United States at the end of FY 2000 was
    about $75 trillion. Since 1980, it has increased in real terms at an
    average annual rate of 2.7 percent per year--only slightly more than
    half as fast as it averaged from 1960 to 1980--4.6 percent per year.
    Public physical capital formation has slowed even more drastically.
    Since 1980, public physical capital has increased at an annual rate of
    only 1.1 percent, compared with 3.0 percent over the previous 20 years.
      The net stock of private nonresidential plant and equipment grew 2.4
    percent per year from 1980 to 2000, compared with 4.4 percent in the
    1960s and 1970s; and the stock of business inventories increased even
    less, just 0.7 percent per year on average since 1980. However, private
    nonresidential fixed capital has increased much more rapidly since
    1995--3.9 percent per year--reflecting the recent investment boom.
      The accumulation of education capital, as measured here, has also
    slowed down since 1980, but not as much. It grew at an average rate of
    5.2 percent per year in the 1960s and 1970s, about 0.9 percentage point
    faster than the average rate of growth in private physical capital
    during the same period. Since 1980, education capital has grown at a 4.0
    percent annual rate. This reflects both the extra resources devoted to
    schooling in this period, and the fact that such resources were
    increasing in economic value. R&D stocks have grown at about 4.3 percent
    per year since 1980, the fastest growth rate for any major category of
    investment over this period, but slower than the growth of R&D in the
    1960s and 1970s.

                   Other Federal Influences on Economic Growth

      Federal investment decisions, as reflected in Table 2-4, obviously are
    important, but the Federal Government also contributes to wealth in ways
    that cannot be easily captured in a formal presentation. The Federal
    Reserve's monetary policy affects the rate and direction of capital
    formation in the short run, and Federal regulatory and tax policies also
    affect how capital is invested, as do the Federal Government's policies
    on credit assistance and insurance.

                                Social Indicators

      There are certain broad responsibilities that are unique to the
    Federal Government. Especially important are fostering healthy economic
    conditions, promoting health and social welfare, and protecting the
    environment. Table 2-5 offers a rough cut of information that can be
    useful in assessing how well the Federal Government has been doing in
    promoting these general objectives.

      The indicators shown here are a limited subset drawn from the vast
    array of available data on conditions in the United States. In choosing
    indicators for this table, priority was given to measures that were
    consistently available over an extended period. Such indicators make it
    easier to draw valid comparisons and evaluate trends. In some cases,
    however, this meant choosing indicators with significant limitations.
      The individual measures in this table are influenced to varying
    degrees by many Government policies and programs, as well as by external
    factors beyond the Government's control. They do not measure the
    outcomes of Government policies, because they generally do not show the
    direct results of Government activities, but they do provide a
    quantitative measure of the progress or lack of progress in reaching
    some of the ultimate values that Government policy is intended to
    promote.
      Such a table can serve two functions. First, it highlights areas where
    the Federal Government might need to modify its current practices or
    consider new approaches. Where there are clear signs of deteriorating
    conditions, corrective action might be appropriate. Second, the table
    provides a context for evaluating other data on Government activities.
    For example, Government actions that weaken its own financial position
    may be appropriate when they promote a broader social objective. The
    Government cannot avoid making such trade-offs because of its size and
    the broad ranging effects of its actions. Monitoring these effects and
    incorporating them in the Government's policy making is a major
    challenge.
      It is worth noting that, in recent years, many of the indicators in
    this table have turned around. The improvement in economic conditions
    has been widely noted, but there have also been some significant social
    improvements. Perhaps, most notable has been the turnaround in the crime
    rate. Since reaching a peak in the early 1990s, the violent crime rate
    has fallen by over 25 percent. The turnaround has been especially
    dramatic in the murder rate, which was lower in 1999 than at any time
    since the 1960s.

                       An Interactive Analytical Framework

      No single framework can encompass all of the factors that affect the
    financial condition of the Federal Gov

    [[Page 29]]

    Table 2-5.  ECONOMIC AND SOCIAL INDICATORS
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
           General categories                              Specific measures                         1960     1965     1970     1975     1980     1985     1990     1995     1998     1999     2000
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    Economic:
       Living Standards.............  Real GDP per person (1996 dollars).........................   13,145   15,587   17,445   18,909   21,523   23,971   26,832   28,673   31,470   32,512   33,837
                                         average annual percent change (5-year trend)............      0.7      3.5      2.3      1.6      2.6      2.2      2.3      1.3      2.3      2.9      3.4
                                      Median Income (1999 dollars):
                                         All Households..........................................      N/A      N/A   35,232   34,980   35,850   36,568   38,168   37,251   39,744   40,816      N/A
                                         Married Couple Families.................................   30,386   35,390   42,420   44,072   46,844   48,153   50,853   51,447   55,377   56,676      N/A
                                         Female Householder, No Spouse Present...................   15,356   17,206   20,545   20,288   21,069   21,150   21,583   21,526   22,652   23,732      N/A
                                      Income Share of Lower 60% of All Families..................     34.8     35.2     35.2     35.2     34.5     32.7     32.0     30.3     29.8     29.8      N/A
                                      Poverty Rate (%) \1\.......................................     22.2     17.3     12.6     12.3     13.0     14.0     13.5     13.8     12.7     11.8      N/A

       Economic Security............  Civilian Unemployment (%)..................................      5.5      4.5      4.9      8.5      7.1      7.2      5.5      5.6      4.5      4.2      4.0
                                      CPI-U (% Change)...........................................      1.7      1.6      5.8      9.1     13.5      3.5      5.4      2.8      1.6      2.1      3.4

       Employment...................  Increase in Total Payroll Employment Previous 12 Months          0.4      2.2     -0.1      0.5     -0.3      2.0      0.4      0.4      1.9      1.9      1.3
                                       (millions)................................................
                                      Managerial or Professional Jobs (% of civilian employment).      N/A      N/A      N/A      N/A      N/A     24.1     25.8     28.3     29.6     30.3     30.2

       Wealth Creation..............  Net National Saving Rate (% of GDP)........................     10.2     12.1      8.2      6.6      7.5      6.1      4.6      4.7      6.6      6.0      5.6

       Innovation...................  Patents Issued to U.S. Residents (thousands)...............     42.3     54.1     50.6     51.5     41.7     45.1     53.0     64.5     90.7     94.1     91.2
                                      Multifactor Productivity (average annual percent change)...      0.8      2.8      0.8      1.1      0.8      0.6      0.5      0.6      1.1      N/A      N/A

    Environment:....................
      Air Quality...................  Nitrogen Oxide Emissions (thousand short tons).............   14,140   16,579   20,928   22,632   24,384   23,198   24,049   24,921   24,454      N/A      N/A
                                      Sulfur Dioxide Emissions (thousand short tons).............   22,227   26,750   31,161   28,011   25,905   23,658   23,660   19,181   19,647      N/A      N/A
                                      Lead Emissions (thousand short tons).......................      N/A      N/A      221      160       74       23        4        4        4      N/A      N/A

      Water Quality.................  Population Served by Secondary Treatment or Better (mils)..      N/A      N/A      N/A      N/A      N/A      134      155      166      N/A      N/A      N/A

    Social:
       Families.....................  Children Living with Mother Only (% of all children).......      9.2     10.2     11.6     16.4     18.6     20.2     21.6     24.0     23.6     22.4      N/A

       Safe Communities.............  Violent Crime Rate (per 100,000 population) \2\............      160      199      364      482      597      557      732      685      568      525      N/A
                                      Murder Rate (per 100,000 population) \2\...................        5        5        8       10       10        8        9        8        6        6      N/A
                                      Murders/Manslaughter (per 100,000 Persons Age 14 to 17)....      N/A      N/A      N/A       11       13       10       24       24       13       11      N/A

      Health........................  Infant Mortality (per 1000 Live Births)....................     26.0     24.7     20.0     16.1     12.6     10.6      9.2      7.6      7.2      7.1      N/A
                                      Low Birthweight [<2,500 gms] Babies (%)....................      7.7      8.3      7.9      7.4      6.8      6.8      7.0      7.3      7.6      7.6      N/A
                                      Life Expectancy at birth (years)...........................     69.7     70.2     70.8     72.6     73.7     74.7     75.4     75.8     76.7      N/A      N/A
                                      Cigarette Smokers (% population 18 and older)..............      N/A     41.9     39.2     36.3     33.0     29.9     25.3     24.6     24.0      N/A      N/A

      Learning......................  High School Graduates (% of population 25 and older).......     44.6     49.0     55.2     62.5     68.6     73.9     77.6     81.7     82.8     83.4      N/A
                                      College Graduates (% of population 25 and older)...........      8.4      9.4     11.0     13.9     17.0     19.4     21.3     23.0     24.4     25.2      N/A
                                      National Assessment of Educational Progress \3\:
                                        Mathematics High School Seniors..........................      N/A      N/A      N/A      302      300      301      305      307      308      308      N/A
                                         Science High School Seniors.............................      N/A      N/A      305      293      286      288      290      295      295      295      N/A

       Participation................  Individual Charitable Giving per Capita (2000 dollars).....      225      270      323      343      374      385      427      410      526      N/A      N/A
                                      (by presidential election year)............................   (1960)   (1964)   (1968)   (1972)   (1976)   (1980)   (1984)   (1988)   (1992)   (1996)   (2000)
                                      Voting for President (% eligible population)...............     62.8     61.9     60.9     55.2     53.5     52.8     53.3     50.3     55.1     49.0    52.0
    ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
    N/A = Not applicable.

    \1\ The poverty rate does not reflect noncash government transfers such as Medicaid or food stamps.

    \2\ Not all crimes are reported, and the fraction that go unreported may have varied over time.

    \3\ Some data from the national educational assessments have been interpolated.

    ernment. Nor can any framework serve as a substitute for actual
    analysis. Nevertheless, the framework presented here offers a useful way
    to examine the financial aspects of Federal policies. Increased Federal
    support for investment, the promotion of national saving through fiscal
    policy, and other Administration policies to enhance economic growth are
    expected to promote national wealth and improve the future financial
    condition of the Federal Government. As that occurs, the efforts will be
    revealed in these tables.

            TECHNICAL NOTE: SOURCES OF DATA AND METHOD OF ESTIMATING

                      Federally Owned Assets and Liabilities

    Assets:

      Financial Assets: The source of data is the Federal Reserve Board's
    Flow-of-Funds Accounts.

    Physical Assets:

      Fixed Reproducible Capital: Estimates were developed for the OMB
    historical data base for physical capital outlays and software
    purchases. The data base extends back to 1940 and was supplemented by
    data from other selected sources for 1915-1939. Data are presented in
    Chapter 6 of this volume.
      Fixed Nonreproducible Capital: Historical estimates for 1960-1985 were
    based on estimates in Michael J. Boskin, Marc S. Robinson, and Alan M.
    Huber, ``Government Saving, Capital Formation and Wealth in the

    [[Page 30]]

    United States, 1947-1985,'' published in The Measurement of Saving,
    Investment, and Wealth, edited by Robert E. Lipsey and Helen Stone Tice
    (The University of Chicago Press, 1989).
      Estimates were updated using changes in the value of private land from
    the Flow-of-Funds Balance Sheets and from the Agriculture Department for
    farm land; the value of Federal oil deposits was extrapolated using the
    Producer Price Index for Crude Energy Materials.

    Liabilities:

      Financial Liabilities: The principal source of data is the Federal
    Reserve's Flow-of-Funds Accounts.
      Insurance Liabilities: Sources of data are the OMB Pension Guarantee
    Model and OMB estimates based on program data. Historical data on
    liabilities for deposit insurance were also drawn from CBO's study, The
    Economic Effects of the Savings and Loan Crisis, issued January 1992.
      Pension Liabilities: For 1979-1999, the estimates are the actuarial
    accrued liabilities as reported in the annual reports for the Civil
    Service Retirement System, the Federal Employees Retirement System, and
    the Military Retirement System (adjusted for inflation). Estimates for
    the years before 1979 are extrapolations. The estimate for 2000 is a
    projection. The health insurance liability was estimated by the program
    actuaries for 1997-2000, and extrapolated back for earlier years.

                           Long-Run Budget Projections

      The long-run budget projections are based on long-run demographic and
    economic assumptions. A simplified model of the Federal budget,
    developed at OMB, computes the budgetary implications of these
    projections.
      Demographic and Economic Projections: For the years 2001-2011, the
    assumptions are identical to those used in the budget. These budget
    assumptions reflect the President's policy proposals. The economic
    assumptions in the budget are extended by holding constant inflation,
    interest rates, and unemployment at the levels assumed in the final year
    of the budget. Population growth and labor force growth are extended
    using the intermediate assumptions from the 2000 Social Security
    Trustees' report. The projected rate of growth for real GDP is built up
    from the labor force assumptions and an assumed rate of productivity
    growth. The assumed rate of productivity growth is held constant at the
    average rate of growth implied by the budget's economic assumptions.
      Budget Projections: For the period through 2011, the projections
    follow the budget. Beyond the budget horizon, receipts are projected
    using simple rules of thumb linking income taxes, payroll taxes, excise
    taxes, and other receipts to projected tax bases derived from the
    economic forecast. Outlays are computed in different ways. Discretionary
    spending is projected to grow at the rate of inflation or at the rate of
    growth in nominal GDP. Social Security is projected by the Social
    Security actuaries using these long-range assumptions. Federal pensions
    are derived from the most recent actuarial forecasts available at the
    time the budget was prepared, repriced using Administration inflation
    assumptions. Medicaid outlays are based on the economic and demographic
    projections in the model. Other entitlement programs are projected based
    on rules of thumb linking program spending to elements of the economic
    and demographic forecast such as the poverty rate.

                           National Balance Sheet Data

      Publicly Owned Physical Assets: Basic sources of data for the
    federally owned or financed stocks of capital are the Federal investment
    flows described in Chapter 6. Federal grants for State and local
    Government capital are added, together with adjustments for inflation
    and depreciation in the same way as described above for direct Federal
    investment. Data for total State and local Government capital come from
    the revised capital stock data prepared by the Bureau of Economic
    Analysis extrapolated for 2000.
      Privately Owned Physical Assets: Data are from the Flow-of-Funds
    national balance sheets and from the private net capital stock estimates
    prepared by the Bureau of Economic Analysis extrapolated for 2000 using
    investment data from the National Income and Product Accounts.
      Education Capital: The stock of education capital is computed by
    valuing the cost of replacing the total years of education embodied in
    the U.S. population 16 years of age and older at the current cost of
    providing schooling.
      The estimated cost includes both direct expenditures in the private
    and public sectors and an estimate of students' forgone earnings, i.e.,
    it reflects the opportunity cost of education. Estimates of students'
    forgone earnings are based on the year-round, full-time earnings of 18-
    24 year olds with selected educational attainment levels. These year-
    round earnings are reduced by 25 percent because students are usually
    out of school three months of the year. For high school students, these
    adjusted earnings are further reduced by the unemployment rate for 16-17
    year olds; for college students, by the unemployment rate for 20-24 year
    olds. Yearly earnings by age and educational attainment are from Money
    Income in the United States, series P60, published by the Bureau of the
    Census.
      For this presentation, Federal investment in education capital is a
    portion of the Federal outlays included in the conduct of education and
    training. This portion includes direct Federal outlays and grants for
    elementary, secondary, and vocational education and for higher
    education. The data exclude Federal outlays for physical capital at
    educational institutions because these outlays are classified elsewhere
    as investment in physical capital. The data also exclude outlays under
    the GI Bill; outlays for graduate and post-graduate education spending
    in HHS, Defense and Agriculture; and most outlays for vocational
    training.
      Data on investment in education financed from other sources come from
    educational institution reports on the sources of their funds, published
    in U.S. Depart

    [[Page 31]]

    ment of Education, Digest of Education Statistics.  Nominal expenditures
    were deflated by the implicit price deflator for GDP to convert them to
    constant dollar values. Education capital is assumed not to depreciate,
    but to be retired when a person dies. An education capital stock
    computed using this method with different source data can be found in
    Walter McMahon, ``Relative Returns To Human and Physical Capital in the
    U.S. and Efficient Investment Strategies,'' Economics of Education
    Review, Vol. 10, No. 4, 1991. The method is described in detail in
    Walter McMahon, Investment in Higher Education, Lexington Books, 1974.
      Research and Development Capital: The stock of R&D capital financed by
    the Federal Government was developed from a data base that measures the
    conduct of R&D. The data exclude Federal outlays for physical capital
    used in R&D because such outlays are classified elsewhere as investment
    in federally financed physical capital. Nominal outlays were deflated
    using the GDP deflator to convert them to constant dollar values.
      Federally funded capital stock estimates were prepared using the
    perpetual inventory method in which annual investment flows are
    cumulated to arrive at a capital stock. This stock was adjusted for
    depreciation by assuming an annual rate of depreciation of 10 percent on
    the estimated stock of applied research and development. Basic research
    is assumed not to depreciate. Chapter 6 of this volume contains
    additional details on the estimates of the total federally financed R&D
    stock, as well as its national defense and nondefense components (see
    Budget for Fiscal Year 1993, January 1992, Part Three, pages 39-40).
      A similar method was used to estimate the stock of R&D capital
    financed from sources other than the Federal Government. The component
    financed by universities, colleges, and other nonprofit organizations is
    estimated based on data from the National Science Foundation, Surveys of
    Science Resources. The industry-financed R&D stock component is
    estimated from that source and from the U.S. Department of Labor, The
    Impact of Research and Development on Productivity Growth, Bulletin
    2331, September 1989.
      Experimental estimates of R&D capital stocks have recently been
    prepared by BEA. The results are described in ``A Satellite Account for
    Research and Development,'' Survey of Current Business, November 1994.
    These BEA estimates are lower than those presented here primarily
    because BEA assumes that the stock of basic research depreciates, while
    the estimates in Table 2-4 assume that basic research does not
    depreciate. BEA also assumes a slightly higher rate of depreciation for
    applied research and development, 11 percent, compared with the 10
    percent rate used here.

                                Social Indicators

       The main sources for the data in this table are the Government
    statistical agencies. The data are all publicly available, and can be
    found in such general sources as the annual Economic Report of the
    President and the Statistical Abstract of the United States, or from the
    agencies' Web sites.