Analytical Perspectives - 2. Stewardship: Toward a Federal Balance Sheet

[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.
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\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.
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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.

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

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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.

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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.
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\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.
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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)
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1960 1965 1970 1975 1980 1985 1990 1995 1998 1999 2000
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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
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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
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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
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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
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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
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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
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* 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.

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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\
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\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.
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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.

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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

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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.