Analytical Perspectives - 3. Stewardship

[Analytical Perspectives]
[Economic Assumptions and Analyses]
[3. Stewardship]
[From the U.S. Government Printing Office, www.gpo.gov]

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3. STEWARDSHIP

Introduction

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 or deficit, does not provide enough
information to evaluate fully the government's financial and investment
decisions. Indeed, changes in the annual budget deficit or surplus can
be misleading indicators of the government's financial condition. For
example, the temporary shift from annual deficit to surplus in the late
1990s did nothing to correct the long-term deficiencies in the nation's
major entitlement programs, which are the major source of the long-run
shortfall in federal finances. This would have been more apparent if
greater attention had focused on long-term measures such as appear in
this chapter. As important as the budget surplus or deficit is, it
should not be the only indicator used to judge the government's fiscal
condition.
While a private business may ultimately be judged by a single number--
the bottom line in its balance sheet--the national government is
ultimately judged on how its actions affect the country, and that is not
possible to sum up with a single statistic. The government is not
expected to earn a profit. Instead, its fiscal condition can only be
properly evaluated using a broad range of data and several complementary
perspectives. This chapter presents a framework for such analysis.
Because there are serious limitations on the available data and the
future is uncertain, this chapter's findings should be interpreted with
caution; its conclusions are tentative and subject to future revision.
The chapter consists of four parts:
Part I presents the government's physical and financial
assets and its legal liabilities summarized in Table 3-1. This
table corresponds most closely to a business balance sheet,
but it misses some of the government's unique fiscal
characteristics. That is why it needs to be supplemented by
the information in Parts II and III. The government's net
liabilities in Table 3-1 are dwarfed by its unfunded
obligations as presented in Part II.
Part II broadens the scope to evaluate the government's
long-run financial burdens and the resources available to meet
them. It presents possible paths for the federal budget that
extend far beyond the normal budget window and describes how
these projections vary depending on key economic and
demographic assumptions. The projections are summarized in
Table 3-2. This part also presents discounted present value
estimates of the funding shortfall in Social Security and
Medicare in Table 3-3.
Part III features information on national economic and
social conditions which are affected by what the government
does. The private economy is the ultimate source of the
resources the government will have to draw upon to meet future
obligations. Table 3-4 presents summary data for total
national wealth, while highlighting the federal investments
that have contributed to that wealth. Table 3-5 presents a
small sample of economic and social indicators.
Part IV concludes the chapter and explains how the separate
pieces of analysis link together. Chart 3-8 presents the
linkages in a schematic diagram.
The government's legally binding obligations--its liabilities--consist
mainly of Treasury debt and the pensions plus retiree health benefits
owed to federal employees, which are a form of deferred compensation.
These obligations have counterparts in the business world, and would
appear as liabilities 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. These obligations, however, are only a subset of
the government's total financial responsibilities. Indeed, the full
extent of the government's fiscal exposure through its various
programmatic commitments dwarfs the outstanding debt held by the public
or the balance between federal liabilities and assets. The commitment to
Social Security and Medicare alone amounts to several times the value of
outstanding federal debt or the net balance of government liabilities
less assets shown in Table 3-1.
The government has a broad range of programs that dispense cash and
other benefits to individual recipients and it also provides a wide
range of other public services that must be financed through the tax
system. The government is not constitutionally obligated, except in the
most general terms, to continue operating these programs, and the
benefits and services could be modified or even ended at any time,
subject to the decisions of the Congress and the President. Such changes
are a regular part of the legislative cycle. These programmatic
commitments cannot be thought of as ``liabilities'' in a legal or
accounting sense, but they will remain federal responsibilities for the
foreseeable future, and they are included in the long-run projections
presented in Part II; it would be misleading to leave out these
programmatic commitments in projecting future claims on the government
or calculating the government's long-run fiscal balance. It is true, of
course, that the federal government also has resources that

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go beyond the assets that would normally appear on a balance sheet.
These additional resources include the government's sovereign power to
tax. For this reason, the best way to analyze the future strains on the
government's fiscal position is to make a long-run projection of the
entire federal budget, as is done in Part II of this chapter, which
provides a comprehensive measure of the government's future cash flows.
Over long periods of time, government spending must be financed by the
taxes and other receipts it collects. Although the government can borrow
for temporary periods, it must pay interest on any such borrowing, which
adds to future spending. In the long run, a solvent government must pay
for its spending out of its receipts. The projections in Part II show
that under an extension of the estimates in this budget, long-run
balance in this sense is not achieved, mostly because of large
deficiencies in Social Security and Medicare.
The long run budget projections and the table of assets and
liabilities are silent on the issue of whether the public is receiving
value for its tax dollars or whether federal assets are being used
effectively. Information on those points requires performance measures
for government programs supplemented by appropriate information about
conditions in the economy and society. Recent changes in budgeting
practices should contribute to the goal of more complete information
about government programs and permit a closer alignment of the cost of
programs with performance measures. These changes are described in
detail in the main Budget volume, in chapter 1 of this volume, and in
the accompanying volume that describes the creation of the Program
Assessment Rating Tool (PART). This chapter complements the detailed
exploration of government performance with an assessment of the overall
impact of Federal policy as reflected in some general measures of
economic and social well-being.
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QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S ``BALANCE SHEET''

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1. According to Table 3-1, 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
fovernment properly 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.

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 successful. The returns on these
investments show up not as an increase in government
assets but as an increase in the general state of
knowledge and in the capacity of the country's citizens
to earn a living. A business's motives for investment
are quite different; a 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 or that of its owners. Because the federal
government's objectives are different, its balance sheet
behaves differently, and should be interpreted
differently.

2. Table 3-1 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 exceed the estimated value of the assets the
federal government actually owns. The government,
however, 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 operation even
though the government's current assets are less than its
current liabilities.

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

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The financial markets clearly recognize this reality. The

3. Why are Social Security and Medicare not shown as government
liabilities?

Future Social Security and Medicare benefits may be
considered as promises or obligations, but these
benefits are not a liability in the usual sense. The
government has unilaterally decreased as well as
increased these benefits in the past, and future reforms
could alter them again. The size of these promises is
shown in this chapter in two ways: Budget projections as
a percent of GDP from now through 2080, and the
actuarial deficiency estimates over roughly the same
period.

Other Federal programs exist that are similar to Social
Security and Medicare in the promises they make--
Medicaid, Veterans pensions, and Food Stamps, for
example. Few have suggested counting the future benefits
expected under these programs' as federal liabilities,
yet it would be difficult to justify a different
accounting treatment for them if Social Security or
Medicare were to be classified as a liability. There is
no bright line dividing Social Security and Medicare
from other programs that promise benefits, and all the
government programs that do so should be accounted for
similarly. In the long-range budget projections, the
entire budget is counted as it is in estimating the
government's total fiscal imbalance.

Furthermore, if future Social Security or Medicare
benefits were to be treated as a liability, then future
payroll tax receipts earmarked to finance those benefits
ought to be treated as a government asset. Tax receipts,
however, are not generally considered government assets,
and for good reason: the government does not own the
wealth on which future taxes depends. Including taxes on
the government's balance sheet would be incorrect, but
treating taxes for Social Security or Medicare
differently from other taxes would be highly
questionable.

Finally, under Generally Accepted Accounting Principles
(GAAP), Social Security is not considered to be a
liability, so not counting it as such in this chapter is
consistent with proper accounting standards.

4. Why can't the government 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. The
government does not have a ``bottom line'' comparable to
that of a business corporation, but 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 many of the questions for
which government should be accountable. This framework
addresses budgetary integrity, operating performance,
stewardship, and systems and controls. FASAB has also
developed, and the government has adopted, a full set of
accounting standards. Federal agencies now issue audited
financial reports that follow these standards and an
audited government-wide consolidated financial report is
now being issued as well. In short, the federal
government does follow generally accepted accounting
principles (GAAP) just as businesses and state and local
governments do for their activities, although the
relevant principles differ depending on the
circumstances. 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.''

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

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5. When the baby-boom generation begins to retire in large numbers

The aging of the U.S. population will become dramatically
evident when the baby-boomers begin to retire, and this
demographic transition poses serious long-term problems
for federal entitlement programs and the budget. Both
the long-range budget projections and the actuarial
projections presented in this chapter indicate how
serious the problem is. It is clear from this
information that reforms are needed in these programs to
meet the long-term challenges. The need for reforms in
these programs are discussed further in the chapter
``The Real Fiscal Danger'' in the main Budget volume.

6. Would it make sense for the government to borrow to finance needed
capital--permitting a deficit in the budget--so long as the borrowing
did not exceed the amount spent on investments?

This rule might not actually permit much extra borrowing.
If the government were to finance new capital by
borrowing, it should plan to pay off the debt incurred
to finance old capital as the capital is used up. The
net new borrowing permitted by this rule should not
exceed the amount of net investment the government does
after adjusting for capital consumption. But, as
discussed in Chapter 7 of Analytical Perspectives,
federal net investment in physical capital is usually
not very large and has even been negative in some years,
so little if any deficit spending would have been
justified by this borrowing-for-investment criterion, at
least in recent years.

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 today 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 assets owned by the
federal government, which suggests they should not be
included for this purpose, even though they are an
important 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
of time is no justification for excluding them when
calculating the surplus or deficit.

Finally, the federal government must pursue policies that
support the overall economic well-being of the Nation
and its security interests. For such reasons, the
government may deem it desirable to run a budget
surplus, even if this means paying for its own
investments from current receipts, and there will be
other times when it is necessary to run a deficit, even
one that exceeds government net investment.
Considerations in addition to the size of federal
investment must be weighed in choosing the appropriate
level of the surplus or deficit.
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Table 3-1. GOVERNMENT ASSETS AND LIABILITIES *
(As of the end of the fiscal year, in billions of 2002 dollars)
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1960 1965 1970 1975 1980 1985 1990 1995 2000 2001 2002
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ASSETS
Financial Assets:
Cash and Checking Deposits................... 43 63 39 32 48 32 43 44 58 51 78
Other Monetary Assets........................ 1 1 1 1 2 2 2 1 6 12 18
Mortgages.................................... 28 27 40 42 78 79 101 69 79 76 75
Other Loans.................................. 103 142 178 178 227 298 211 165 192 196 202
less Expected Loan Losses.................. -1 -3 -5 -9 -18 -17 -20 -25 -38 -38 -38
Other Treasury Financial Assets.............. 62 78 68 62 87 128 203 243 221 235 258
-------------------------------------------------------------------------------------------------------
Total...................................... 237 308 321 305 424 521 539 497 518 531 592

Nonfinancial Assets:
Fixed Reproducible Capital................... 1,028 1,029 1,076 982 953 1,093 1,149 1,142 1,002 990 997
Defense.................................... 893 849 859 719 661 786 823 793 642 621 616
Nondefense................................. 135 180 217 263 291 307 326 349 360 369 381
Inventories.................................. 271 235 219 196 242 276 244 187 191 185 188
Nonreproducible Capital...................... 437 449 431 638 1,023 1,098 864 652 962 1,022 995
Land....................................... 95 132 166 263 335 349 358 276 414 435 485
Mineral Rights............................. 343 318 265 376 687 749 506 376 548 587 509
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Subtotal................................. 1,737 1,714 1,726 1,816 2,217 2,467 2,256 1,981 2,155 2,197 2,179
=======================================================================================================
Total Assets................................ 1,974 2,021 2,047 2,121 2,641 2,988 2,796 2,478 2,673 2,728 2,772

LIABILITIES
Financial Liabilities:
Debt held by the Public...................... 1,184 1,218 1,084 1,103 1,369 2,260 3,071 4,061 3,526 3,345 3,540
Trade Payables and Miscellaneous............. 34 38 45 59 85 111 162 133 101 92 85
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Subtotal................................... 1,218 1,256 1,129 1,162 1,454 2,372 3,232 4,194 3,627 3,437 3,625

Insurance Liabilities:
Deposit Insurance............................ 0 0 0 0 2 9 74 5 1 3 2
Pension Benefit Guarantee \1\................ 0 0 0 45 33 45 45 21 42 51 81
Loan Guarantees.............................. 0 0 2 7 13 11 16 30 38 39 39
Other Insurance.............................. 32 29 23 21 28 17 21 18 17 16 16
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Subtotal................................... 32 30 25 72 75 82 155 75 98 110 138

Federal Pension and Retiree Health Liabilities
Pension Liabilities.......................... 817 1,027 977 1,063 1,872 1,855 1,807 1,744 1,772 1,727 1,752
Retiree Health Insurance Benefits............ 196 246 234 255 449 445 433 418 398 792 807
-------------------------------------------------------------------------------------------------------
Total...................................... 1,013 1,273 1,212 1,318 2,321 2,299 2,241 2,162 2,169 2,519 2,560
=======================================================================================================
Total Liabilities............................... 2,264 2,558 2,366 2,553 3,850 4,754 5,628 6,431 5,894 6,065 6,323
Balance......................................... -290 -537 -319 -431 -1,209 -1,766 -2,833 -3,953 -3,221 -3,337 -3,531
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Addenda:
Balance Per Capita (in 2002 dollars)............ -1,607 -2,766 -1,557 -2,000 -5,299 -7,393 -11,316 -14,822 -11,401 -11,702 -12,340

Ratio to GDP (in percent)....................... -11.0 -16.2 -8.1 -9.6 -22.5 -27.7 -38.1 -47.2 -31.5 -32.8 -33.8
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* This table shows assets and liabilites 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.

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

Table 3-1 takes a backward look at the government's assets and
liabilities summarizing what the government owes as a result of its past
operations netted against the value of what it owns. The table gives
some perspective by showing this balance for a number of years beginning
in 1960. The assets and liabilities are measured in terms of constant FY
2002 dollars. Government liabilities have exceeded the value of assets
(see chart 3-1) over this entire period, but 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. When those prices
subsequently declined, Fed

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eral asset values declined and only recently have they regained the
level they had reached temporarily in the early 1980s.
Currently, the total real value of federal assets is estimated to be
40 percent greater than it was in 1960. Meanwhile, federal liabilities
have increased by 179 percent in real terms. The decline in the federal
net asset position has been principally due to persistent federal budget
deficits, although other factors have been important in some years. For
example, the decline from 2000 to 2001 was mainly due to a large
increase in promised federal health benefits for military retirees. The
increase in the discounted present value of these benefits was large
enough to offset a unified budget surplus and a rise in federal asset
values. The shift from budget deficits to budget surpluses in the late
1990s reduced federal net liabilities, which peaked in 1996. Currently,
the net excess of liabilities over assets is about $3.6 trillion, or
approximately $12,000 per capita, compared with net liabilities of $4.0
trillion (2002 dollars) and almost $15,000 per capita (2002 dollars) in
1995.

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Assets

Table 3-1 offers 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 $0.6 trillion at the end of FY 2002. Government-held
mortgages and other loans (measured in constant dollars) reached a peak
in the early 1990s as the government acquired mortgages from failed
savings and loan institutions. The government has liquidated most of the
mortgages it acquired from bankrupt savings and loans in the 1990s, but
since that process was completed federal mortgage holdings have begun to
increase again.
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 2002.
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 have amounted to about $1.0 trillion in constant dollars for
most of the last 40 years (OMB estimate). This capital consists of
defense equipment and structures, including weapons systems, as well as
nondefense capital goods. Currently, about 60 percent of the capital is
defense equipment or structures. In 1960, defense capital was about 90
percent of the total. In the 1970s, there was a substantial decline in
the real value of U.S. defense capital and there was another large
decline in the 1990s after the end of the Cold War. Meanwhile,
nondefense Federal capital has increased at an average annual rate of
around 2-\1/2\ percent.
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, many of
these resources would never be sold). Researchers in the private sector
have estimated what they are worth, however, and these estimates are
extrapolated in Table 3-1. 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 have
been on a roller coaster since the mid-1990s. They declined sharply in
1997-1998, rebounded in 1999-2000, fell again in 2001, and rose in 2002.
These fluctuations have caused the estimated value of federal mineral
deposits to fluctuate as well. (These estimates also omit some valuable
assets owned by the federal government, such as works of art and
historical artifacts, because there is no realistic basis for valuing
them, and because, as part of

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the nation's historical heritage, these objects are never likely to be
sold.)
Total Assets: The total value of government assets measured in
constant dollars is lower now than it was in the 1980s, mainly because
of declines in defense capital and inventories in the late 1990s
following the end of the Cold War. Government asset values have risen
strongly since 1998, however, propelled by sharply rising land prices
and because the decline in defense capital has ended. The government's
asset holdings are vast. At the end of FY 2002, government assets are
estimated to be worth about $2.8 trillion.

Liabilities

Table 3-1 includes all the liabilities that would appear on a business
balance sheet, but only those liabilities. All the various forms of
publicly held federal debt are counted, as are federal pension and
health insurance obligations to civilian and military retirees. The
estimated liability arising from federal insurance and loan guarantee
programs is also shown. Other obligations, however, including the
benefit payments under Social Security and other income transfer
programs are not shown in this table because these are not liabilities
in a legal sense. The budget projections and other data in Part II
provide a sense of these broader obligations.
Financial Liabilities: Financial liabilities amounted to about $3.6
trillion at the end of 2002, down from a peak value of $4.3 trillion in
1996. The single largest component of these liabilities was federal debt
held by the public, which amounted to around $3.5 trillion at the end of
FY 2002. In addition to the debt held by the public, the government owes
about $0.1 trillion in miscellaneous liabilities. The publicly held debt
declined for several years because of the unified budget surplus at the
end of the 1990s, but recently it has begun to increase again.
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 are often small initially, and 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 3-1 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 about
$0.1 trillion. As is true elsewhere in this chapter, this estimate does
not incorporate the market value of the risk associated with these
contingent liabilities.
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 civilian retirees with subsidized health insurance through
the Federal Employees Health Benefits program and military retirees
receive similar benefits. The amount of these liabilities is large and
growing. The discounted present value of the benefits is estimated to
have been around $2.6 trillion at the end of FY 2002 up from $2.2
trillion in 2000.\1\ The main reason for the increase was a large
expansion in federal military retiree health benefits legislated in
2001.
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\1\ The pension liability is the actuarial present value of benefits
accrued-to-date based on past and projected salaries. The 2002 liability
is extrapolated from recent trends. The retiree health insurance
liability is based on actuarial calculations of the present value of
benefits promised under existing programs. Actuarial estimates are only
available since 1997. For earlier years the liability was assumed to
grow in line with the pension liability, and for that reason may differ
significantly from what the actuaries would have calculated for this
period.
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The Balance of Net Liabilities

The government need not maintain a positive balance of net assets to
assure its fiscal solvency, and the buildup in net liabilities since
1960 has not significantly damaged federal creditworthiness. Government
interest rates in early 2003 were at their lowest levels in over a
generation. There are limits, however, to how much debt the government
can assume without putting its finances in jeopardy. Over some time
horizon, the federal government must take in enough revenue to cover all
of its spending including debt service.

PART II--THE LONG-RUN BUDGET OUTLOOK

A traditional balance sheet with its focus on past transactions can
only show so much information. For the government, it is important to
anticipate what future budgetary requirements might flow from future
transactions. Even very long-run budget projections can be useful in
sounding warnings about potential problems despite their uncertainty.
Federal responsibilities extend well beyond the next five or ten years,
and problems that may be small in that time frame can become much larger
if allowed to grow.
Programs like Social Security and Medicare are intended to continue
indefinitely, and so long-range projections for Social Security and
Medicare have been prepared for decades. Budget projections for
individual programs, even ones as important as Social Security and
Medicare, do not provide a gauge of the overall budgetary position. Only
by projecting the entire budget is it possible to anticipate whether
sufficient resources will be available to meet all the anticipated
requirements. It is also necessary to estimate how the budget's future
growth compares with that of the economy to judge how well the economy
might be able to support future budgetary needs.
To assess the overall financial condition of the government, it is
necessary to examine the future prospects for all government programs
including the revenue sources that support government spending. Such an
assessment reveals that the key drivers of the long-range deficit are,
not surprisingly, Social Security and Medicare. Other programs have
significant implications for

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the long-range outlook also. Medicaid, the Federal program that helps
states provide health insurance for low-income people and nursing home
care for the elderly, is projected to grow rapidly over the next several
decades and to add substantially to the overall budget deficit. Nowhere
in the budget is there a large enough offset to reduce the strains
imposed by Social Security, Medicare, and Medicaid in the long run.
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 to name a few. The
uncertainties increase the further into the future the projections
extend. Uncertainty, however, enhances the importance of making long-
term projections because people are generally averse to risk, and
knowing what the risks are requires projections. A full treatment of
these risks is beyond the scope of this chapter, although it does show
below how the budget projections respond to some of the key economic and
demographic parameters. Given the uncertainties, the best that can be
done is to work out the implications of expected developments on a
``what if'' basis. Despite the uncertainties, long-run projections are
needed to evaluate the government's true fiscal condition.

The Impending Demographic Transition

In 2008, the first members 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, the elderly population
will skyrocket, putting serious strains on the budget because of
increased expenditures for Social Security and for the government's
health programs serving this population.
The pressures are expected to persist even after the baby-boomers
expire. 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 by the time most of the baby-boomers are retired. Because of
lower fertility and improved mortality, that ratio is not expected to
rise again. With fewer workers to pay the taxes needed to support the
retired population, the budgetary pressures will continue. The problem
posed by the demographic transition is a permanent one.
Currently, the three major entitlement programs--Social Security,
Medicare, and Medicaid--account for 45 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 two thirds of non-interest federal spending. At the
end of the projection period, the figure rises to three-quarters of non-
interest spending. In other words, under an extension of current-law
formulas and the policies in the budget, almost all of the budget would
go to these three programs alone. That would severely reduce the
flexibility of the budget, and the government's ability to respond to
new challenges.

An Unsustainable Path

These long-run budget projections show clearly that the budget is on
an unsustainable path, although the rise in the deficit unfolds
gradually. As the baby-boomers reach retirement age in large numbers,
the deficit is projected to rise steadily as a share of GDP. Under most
scenarios, well before the end of the projection period for this chapter
rising deficits would drive debt to levels several times the size of
GDP.
The revenue projections in this section start with the budget's
estimate of receipts under the Administration's proposals. They assume
that individual income tax receipts will rise somewhat relative to GDP,
and over the next several decades they eventually increase by
approximately 1 percent of GDP. This increase reflects the higher
marginal tax rates that people will face as their real incomes rise in
the future (the tax code is indexed for inflation, but not for real
economic growth). In terms of total receipts collected relative to GDP,
however, those income tax increases are largely offset by declines in
federal excise tax receipts, which are generally not indexed for
inflation, and in other taxes. The overall share of federal receipts in
GDP is projected to remain fairly steady around 19 percent, at the upper
end of the historic average of 17 to 19 percent that prevailed from 1960
through the mid-1990s.
The long-run budget outlook remains uncertain (see the technical note
at the end of this chapter for a discussion of the forecasting
assumptions used to make these budget projections). With pessimistic
assumptions, the fiscal picture deteriorates even sooner than in the
base projection. More optimistic assumptions imply a longer period
before the inexorable pressures of rising entitlement spending overwhelm
the budget. But despite unavoidable uncertainty, these projections show
that under a wide range of reasonable forecasting assumptions resources
will be insufficient to cover the long-run shortfalls in Social Security
and Medicare. Fundamental reforms are needed in these two programs to
preserve their basic promises.

Table 3-2. LONG-RUN BUDGET PROJECTIONS OF 2003 BUDGET POLICY
(Percent of GDP)
----------------------------------------------------------------------------------------------------------------
2000 2010 2020 2030 2040 2060 20800
----------------------------------------------------------------------------------------------------------------
Discretionary Spending Grows with GDP
Receipts............................................. 20.8 18.4 18.8 19.0 19.0 19.2 19.3
Outlays.............................................. 18.4 19.6 21.0 24.4 27.8 36.7 52.7
Discretionary...................................... 6.3 6.5 6.0 6.0 6.0 6.0 6.0
Mandatory.......................................... 9.8 11.3 13.2 15.5 16.8 19.0 22.8
Social Security.................................. 4.2 4.3 5.3 6.2 6.4 6.6 7.1
Medicare......................................... 2.0 2.6 3.4 4.6 5.5 7.0 9.3
Medicaid......................................... 1.2 1.9 2.4 2.7 3.2 4.0 5.0
Other............................................ 2.4 2.4 2.1 1.9 1.7 1.5 1.4
Net Interest....................................... 2.3 1.8 1.8 2.9 5.0 11.7 23.9
Surplus or Deficit (-)............................... 2.4 -1.2 -2.2 -5.4 -8.8 -17.5 -33.5
Primary Surplus or Deficit (-)....................... 4.7 0.6 -0.4 -2.5 -3.8 -5.8 -9.6
Federal Debt Held by the Public...................... 35.1 35.7 35.1 56.7 98.4 229.4 466.1
----------------------------------------------------------------------------------------------------------------

Alternative Economic and Technical Assumptions

The quantitative results discussed above are sensitive to changes in
underlying economic and technical assumptions. Some of the most
important of these alternative assumptions and their effects on the
budget outlook are discussed below. Each highlights one of the key
uncertainties in the outlook. All show that there are mounting deficits
under most reasonable projections of the budget.
1. Health Spending: The projections for Medicare over the next 75
years are based on the actuarial projections in the 2002 Medicare
trustees' report. Following the recommendations of its Technical Review
Panel, the Medicare trustees have set the long-run projected growth rate
assumed for real per capita Medicare costs so that ``age-and gender-
adjusted, per-beneficiary spending growth exceeds the growth of per-
capita GDP by 1 percentage point per year.''

[[Page 41]]

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 to spend a larger share of income on them than it has
heretofore. Whether society will be willing to devote the large share of
resources to health care implied by these projections, however, is an
open question. The alternatives highlight the effect of raising the
projected growth rate in per capita health care costs by \1/2\
percentage point and the effect of lowering it by a similar amount.

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 have been made for discretionary

[[Page 42]]

spending in past budgets. Holding discretionary spending unchanged in
real terms is the ``current services'' assumption used for baseline
budget projections. Extending this assumption over many decades,
however, may not be realistic. When the population and economy are both
expected to grow, as assumed in these projections, the demand for public
services is likely to expand, although not necessarily as fast as GDP.
The current base projection assumes that discretionary spending keeps
pace with the growth in GDP in the long run, so that spending increases
in real terms whenever there is real economic growth. An alternative
assumption would be that discretionary spending increases only for
inflation. In other words, the real inflation-adjusted level of
discretionary spending holds constant. This alternative moderates the
long-run rise in the deficit somewhat because the shrinkage in
discretionary spending as a share of GDP offsets the rise in entitlement
outlays to some extent.

3. Productivity: The rate of future productivity growth has an
important effect on the long-run budget outlook. It is also highly
uncertain. Over the next few decades an increase in productivity growth
would reduce the projected budget deficits appreciably. Higher
productivity growth adds directly to the growth of the major tax bases
while for many outlays it has only a delayed effect even assuming that
in the long-run discretionary outlays rise with GDP. In the latter half
of the 1990s, after two decades of much slower growth, productivity
growth increased unexpectedly to around 2.7 percent per year. The return
of higher productivity growth is one of the most welcome developments of
the last several years. Although the long-run growth rate of
productivity is inherently uncertain, it has averaged 2.2 percent since
1947. The long-run budget projections assume that real GDP per hour will
grow at a 2.2 percent annual rate over most of this century. The
alternatives highlight the effect of raising the projected productivity
growth rate by \1/2\ percentage point and the effect of lowering it by a
similar amount.

[[Page 43]]

4. Population: The key assumptions underlying the long-run demographic
projections concern fertility, immigration, and mortality:
The demographic projections assume that fertility will
average around 1.9 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 and
means that total population continues to expand throughout the
projection period, although at a much slower rate than has
prevailed historically in the United States.
Mortality is projected to decline. The average female
lifespan is projected to rise from 79.4 years in 2001 to 85.6
years by 2080, and the average male lifespan is projected to
increase from 73.8 years in 2001 to 81.4 years by 2080. A
technical panel to the Social Security trustees recently
reported that the improvement in longevity might even be
greater.

[[Page 44]]

[[Page 45]]

Actuarial Projections for Social Security and Medicare

Social Security and Medicare are the government's two largest
entitlement programs. Both rely on payroll tax receipts from current
workers and employers for at least part of their financing, while the
programs' benefits largely go to those who are retired. The importance
of these programs for the retirement security of current and future
generations makes it essential to understand their long-range financial
prospects. Although Social Security and Medicare's HI program are
currently in surplus, actuaries for both programs have calculated that
they face long-run deficits. How best to measure the long-run imbalances
in Social Security and in the consolidated Medicare program, including
SMI as well as HI, is a challenging analytical question, but reasonable
calculations suggest that each program embodies such a huge financial
deficiency that it will be very difficult for the government as a whole
to return to surplus without addressing each program's financial
problems.

[[Page 46]]

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

Social Security: The Long-Range Challenge

Social Security provides retirement security and disability insurance for tens of millions of Americans through
a system that is intended to be self-financing. The principle of self-financing is important because it compels
corrections in the event that projected benefits consistently exceed dedicated receipts.

While Social Security is running surpluses today, it will begin running cash deficits within 20 years. Social
Security's spending path is unsustainable under current law because of the retirement of the baby-boomers and
demographic trends toward lower fertility rates and longer life spans. These trends imply that the number of
workers available to support each retiree will decline from over 3 today to just around 2 in 2030, and that the
government will not be able to meet current-law benefit obligations at current payroll tax rates.

The future size of Social Security's shortfall cannot be known with any precision, but a gap between Social
Security receipts and outlays emerges under a wide range of reasonable forecasting assumptions. Long-range
uncertainty underscores the importance of creating a system that is financially stable and self-contained.
Otherwise, if the pessimistic assumptions turn out to be more accurate, the demands created by Social Security
could compromise the rest of the budget and the nation's economic health.

The current structure of Social Security leads to substantial generational differences in the average rate of
return people can expect from the program. While previous generations have fared extremely well, the average
individual born today can expect to receive less than a two percent annual real rate of return on their payroll
taxes. Moreover, such estimates overstate the expected rate of return for future retirees, because they assume
no changes in current-law taxes or benefits even though such changes are inevitable to meet Social Security's
financing shortfall. As an example, a 1995 analysis found that for an average worker born in 2000 a 1.7 percent
rate of return would turn into 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 invest some of their payroll taxes in personal retirement accounts. The
President's Commission to Strengthen Social Security presented various options that would include personal
accounts within the Social Security framework.

------------------------------------------------------------------------
The 75-Year Horizon: In their annual reports and related documents,
the Social Security and Medicare trustees typically present calculations
of the 75-year actuarial imbalance or deficiency for Social Security and
Medicare. The calculations covers current workers and retirees, as well
as those projected to join the program within the next 75 years (this is
the so-called ``open-group'' calculation; the ``closed-group'' covers
only current workers and retirees). These estimates measure the present
discounted value of each program's future benefits net of future income.
They are complementary to the flow projections described in the
preceding section.
The present discounted value of the Social Security deficiency net of
the trust fund balance was estimated to be about $3 trillion at the
beginning of 2002, and the comparable estimate for Medicare's HI trust
fund was $5 trillion. But, as discussed above, this number does not
account for the fact that 75 percent of SMI expenses are not covered by
any specific financing source. From this perspective, the Medicare
unfunded promise is around $13 trillion. Even if the general fund
contribution to SMI were to continue into the future and grow at the
rate of inflation, the unfunded promise would be $11 trillion. These
estimates have been increasing in recent years as seen in Table 3-3.
(The estimates in Table 3-3 are based on the intermediate economic and
demographic assumptions used for the 2002 trustees' reports. These
differ in some respects from the assumptions used for the long-run
budget projections described in the preceding section, but the basic
message of Table 3-3 would not change if OMB assumptions had been used
for the calculations.)

[[Page 47]]

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

Medicare: The Long-Range Challenge

Medicare provides health insurance for tens of millions of Americans, including most of the nation's seniors. It
is composed of two programs: Hospital Insurance (HI), which covers medical expenses relating to
hospitalization, and Supplemental Medical Insurance (SMI), which pays for physicians' services and other
related expenditures. HI is self-financing through payroll taxes, while SMI is financed partly through
participants' premium payments, and partly through general revenue.

According to the Medicare Trustees' most recent report, projected spending for HI under current law will exceed
taxes going into the HI trust fund beginning in 2016, and the fund is projected to be depleted by 2030. Looking
at the long-run, the Medicare actuaries project a 75-year unfunded promise to Medicare's hospital insurance
(HI), or Part A, trust fund of $5 trillion. However, this measure tells only half the story because it does not
consider Medicare's other trust fund--the Supplementary Medical Insurance Trust Fund (SMI), or Part B. This
trust fund covers physician and outpatient services, which are projected to grow even faster than hospital
services. Medicare beneficiary premiums only cover 25 percent of SMI costs. The other 75 percent of SMI
expenses are not covered by any specific financing source. From this perspective, Medicare's total unfunded
promise is about $13 trillion. Even if the general fund contribution to SMI were to continue into the future
and grow at the rate of inflation, the unfunded promise would be $11 trillion.

The main reason for the projected future shortfall in Medicare is the substantial growth projected for total
Medicare spending. This is partly for demographic reasons. Beginning within ten years, the number of Medicare
beneficiaries is expected to rise very rapidly as the baby-boomers reach age 65 and become eligible for
Medicare. Between 2010 and 2030, the number of persons age 65 and older is expected to rise from under 40
million to nearly 70 million. Meanwhile, per capita spending is also expected to continue rising rapidly. The
growth in per beneficiary expenditures for SMI, like HI, is projected to exceed the growth rate of per capita
GDP by a full percentage point. Together these factors push up total spending very sharply. As a percentage of
GDP, Medicare outlays are projected by OMB to quadruple increasing from around 2 percent in 2002 to 9 percent
by 2080, which is faster than the growth of either Social Security or Medicaid, the other large rapidly growing
Federal entitlements.

The Administration is committed to working with the Congress to reform Medicare in a manner that does not make
this unfunded promise any larger.

------------------------------------------------------------------------
Limiting the calculations to 75 years understates the deficiencies,
because the actuarial calculations omit the large deficits that continue
to accrue beyond the 75th

[[Page 48]]

year. The understatement is significant, even though values beyond the
75th year are discounted by a large amount. The current deficiency in
Social Security is essentially due to the excess benefits paid to past
and current participants compared with their taxes. For current program
participants, the present value of expected future benefits exceeds the
present value of expected future taxes by about $11 trillion. By
contrast, future participants--those who are now under age 15 or not yet
born--are projected to pay in present value about $7 trillion more over
the next 75 years than they will collect in benefits over that period.
In fixing the horizon at 75 years, most of the taxes of these future
participants are counted without a full accounting for their expected
benefits, much of which will be received beyond the 75th year. For
Social Security, the present value of benefits less taxes in the 76th
year alone is nearly $0.1 trillion, so the omission of these distant
benefits amounts to several trillion dollars of present value.

Table 3-3. ACTUARIAL PRESENT VALUES OVER A 75-YEAR PROJECTION PERIOD
(Benefit Payments in Excess of Earmarked Taxes and Premiums, in trillions of dollars)
----------------------------------------------------------------------------------------------------------------
2000 2001 2002
----------------------------------------------------------------------------------------------------------------

Social Security
Future benefits less future taxes for those age 15 and over.......................... 9.6 10.5 11.2
Future benefits less taxes for those age 14 and under and those not yet born......... -5.8 -6.3 -6.7
Trust Fund Balance \1\............................................................... -0.9 -1.0 -1.2
Net present value for past, present and future participants........................ 2.9 3.2 3.4

Medicare
Future benefits less future taxes and premiums for those age 15 and over............. 9.9 12.5 12.9
Future benefits less taxes and premiums for those age 14 and under and those not yet -0.7 0.3 0.4
born.................................................................................
Trust Fund Balance \1\............................................................... -0.2 -0.2 -0.3
Net present value for past, present and future participants........................ 9.0 12.6 13.0

Social Security and Medicare
Future benefits less future taxes and premiums for those age 15 and over............. 19.5 23.0 24.1
Future benefits less taxes and premiums for those age 14 and under and those not yet -6.5 -6.0 -6.3
born.................................................................................
Trust Fund Balance \1\............................................................... -1.1 -1.3 -1.5
Net present value for past, present and future participants........................ 12.0 15.8 16.4

Addendum:
Actuarial deficiency as a percent of the discounted payroll tax base:
Social Security.................................................................... ...... ...... 1.87
Medicare (including both HI and SMI)............................................... ...... ...... 5.23
----------------------------------------------------------------------------------------------------------------
\1\ Reflects prior accumulated net cash flows including payments and taxes for those no longer alive.

Medicare: A significant portion of Medicare's deficiency is caused by
the rapid expected increase in future benefits due to rising health care
costs. Some, perhaps most, of the projected increase in relative health
care costs reflects improvements in the quality of care, although there
is also evidence that medical errors and waste add unnecessarily to
health care costs. The rapid growth in the number of medical malpractive
cases and in the magnitude of the resulting awards and settlements has
also contributed to rising health care costs. Even though the projected
increases in Medicare spending are likely to contribute to longer life-
spans and safer treatments, the financial implications remain the same.
As long as medical costs continue to outpace the growth of other
expenditures, as assumed in these projections, the financial pressure on
the budget will mount, and that is reflected in the estimates shown in
Tables 3-2 and 3-3.
For current participants, the difference between the discounted value
of benefits and taxes plus premiums is nearly $13 trillion,
significantly larger than the similar gap for Social Security. For
future participants over the next 75 years, however, Medicare benefits
are projected to be roughly equal in magnitude to future taxes and
premiums. Unlike Social Security, future taxes do not exceed benefits
during this period, and the future generations' projected taxes do not
reduce the overall deficiency, even though benefits beyond the 75th year
are not counted. Extending the calculation beyond the 75th year would
add many trillions of dollars in present value to Medicare's actuarial
deficiency, just as it would for Social Security.
General fund revenues have historically covered about 75 percent of
SMI program costs, with the rest being covered by premiums paid by the
beneficiaries. In Table 3-3, only the receipts explicitly earmarked for
financing these programs have been included. The intragovernmental
transfer is not a dedicated source of funding, and the share of general
revenues that would have to be devoted to SMI to close the gap increases
substantially under current projections. Other government programs also
have a claim on these funds, and SMI has no priority in the competition
for future funding.
The Trust Funds and the Actuarial Deficiency: The current amounts in
the Social Security and Medicare trust funds are offset in Table 3-3
against future benefits to measure the net actuarial short-falls in the
two programs. This is an appropriate adjustment because the trust fund
balances represent the past excess of taxes over benefits for these
programs, but the government did not save those excess taxes in any
economically significant sense, and the trust funds will not help the
government as a whole meet its obligations to pay for future social
security benefits.
These are subtle points, but important ones. First, the simple fact
that a trust fund exists does not mean that the government necessarily
saved the money recorded there. Although the government could have saved
the Social Security and HI trust fund surpluses as they accumulated (in
the sense of adding to national saving) this would have required it to
use the trust fund surpluses to reduce the unified budget deficit (or
add to the unified surplus). In all likelihood, the government did not
save these surpluses in this way. Indeed, the large unified budget
deficits that prevailed during most of the time when the trust funds
were increasing suggests strongly that it did not, although to know this
for sure it would be necessary to know what the unified deficit would
have been in the absence of those trust fund surpluses, and that is not
really knowable.
Second, the assets in the trust funds are special purpose financial
instruments issued by the Treasury Department. At the time Social
Security redeems these instruments to pay future benefits, the Treasury
will have to turn to the public capital markets to raise

[[Page 49]]

the funds to redeem the bonds and finance the benefits, just as if the
trust funds had never existed. From the standpoint of overall government
finances, the trust funds do not reduce the future burden of financing
Social Security or Medicare benefits.
In any case, the trust funds remain small in size in comparison with
the programs' future obligations and well short of what would be needed
to pre-fund future benefits as indicated by the programs' actuarial
deficiencies. Historically, Social Security and Medicare's HI program
have been financed mostly on a pay-as-you-go basis, whereby workers'
payroll taxes were immediately used to pay retiree benefits. For the
most part, workers' taxes have not been used to pre-fund their own
future benefits, and until relatively recently, taxes were not set at a
level sufficient to pre-fund future benefits even had they been saved.
The Importance of Long-Run Measures in Evaluating Policy Changes:
Consider a proposed policy change in which payroll taxes paid by younger
workers were reduced by $100 this year while the expected present value
of these workers' future retirement benefits were also reduced by $100.
The actuarial deficiencies shown in Table 3-3 would not be affected by
such a plan: the present value of future benefit payments would decrease
by the same amount as the reduction in revenue. On a cash flow basis,
however, the lost revenue occurs now, while the decrease in future
outlays is in the distant future beyond the budget window, and the
federal government must increase its borrowing to make up for the lost
revenue in the meantime. If policymakers only focus on the government's
near-term borrowing needs, a reform such as this would appear to worsen
the government's finances, whereas the policy actually has a neutral
impact.
Now suppose that future outlays were instead reduced by a little more
than $100 in present value. In this case, the actuarial deficiency would
actually decline, even though the government's borrowing needs would
again increase. Focusing on the government's near-term borrowing alone,
therefore, can lead to a bias against policies that could improve the
federal government's overall fiscal condition. Taking a longer view of
policy changes and considering other measures of the government's fiscal
condition can correct for such mistakes.

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 its taxes, but they are
not owned by the federal government and would not show up on a
conventional balance sheet for the federal government. It is true, of
course, that by encouraging economic growth in the private sector, the
government augments future federal tax receipts. However, if the
investments are not owned by the federal government, the fraction of
their return that comes back to the government in higher taxes is far
less than what a private investor would require before undertaking a
similar investment.
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 typical balance sheet as a government asset, even though
these investments may contribute to future tax receipts.
To show the importance of these kinds of issues, Table 3-4 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 including
education and research and development. This may seem like a small
fraction, but it represents a large volume of capital--$6.7 trillion.
The federal contribution is down from around 9 percent in the mid-1980s
and from around 11 percent in 1960. Much of this reflects the shrinking
size of defense capital stocks, which have declined from around 12
percent of GDP to 7 percent since the end of the Cold War.

Table 3-4. NATIONAL WEALTH
(As of the end of the fiscal year, in trillions of 2001 dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1960 1965 1970 1975 1980 1985 1990 1995 2000 2001 2002
--------------------------------------------------------------------------------------------------------------------------------------------------------

ASSETS
Publicly Owned Physical Assets:
Structures and Equipment..................................... 2.0 2.3 2.9 3.5 3.7 3.9 4.3 4.7 5.4 5.5 5.5
Federally Owned or Financed................................ 1.2 1.2 1.4 1.5 1.5 1.8 1.9 2.0 2.0 2.0 2.1
Federally Owned.......................................... 1.0 1.0 1.1 1.0 1.0 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 0.5 0.7 0.8 0.8 1.0 1.0 1.1
Funded by State and Local Governments...................... 0.9 1.1 1.5 2.0 2.2 2.2 2.4 2.7 3.4 3.5 3.4
Other Federal Assets......................................... 0.7 0.7 0.7 0.8 1.3 1.4 1.1 0.8 1.2 1.2 1.2
---------------------------------------------------------------------------------------
Subtotal................................................... 2.7 3.0 3.5 4.3 5.0 5.3 5.4 5.6 6.5 6.7 6.7

Privately Owned Physical Assets:
Reproducible Assets.......................................... 7.1 8.1 10.0 12.8 16.5 17.4 19.7 21.5 25.9 26.4 27.4
Residential Structures..................................... 2.7 3.2 3.8 4.9 6.6 6.8 7.7 8.7 10.7 11.0 11.6
Nonresidential Plant and Equipment......................... 2.9 3.2 4.1 5.4 6.8 7.5 8.3 9.0 10.9 11.1 11.4
Inventories................................................ 0.6 0.7 0.8 1.1 1.3 1.3 1.3 1.4 1.5 1.5 1.4
Consumer Durables.......................................... 0.9 1.0 1.3 1.5 1.7 1.9 2.3 2.4 2.8 2.8 3.0
Land......................................................... 2.1 2.5 2.8 3.7 5.6 6.4 6.6 5.1 7.6 8.0 8.9
---------------------------------------------------------------------------------------
Subtotal................................................... 9.1 10.6 12.8 16.4 22.2 23.8 26.3 26.6 33.5 34.4 36.3

Education Capital:
Federally Financed........................................... 0.1 0.1 0.2 0.3 0.5 0.6 0.8 0.9 1.1 1.2 1.2
Financed from Other Sources.................................. 6.2 7.9 10.7 13.2 17.2 20.6 26.6 29.6 37.9 38.9 40.4
---------------------------------------------------------------------------------------
Subtotal................................................... 6.2 8.0 10.9 13.5 17.7 21.2 27.3 30.5 39.1 40.1 41.6

Research and Development Capital:
Federally Financed R&D....................................... 0.2 0.3 0.5 0.6 0.6 0.7 0.8 0.9 1.0 1.0 1.1
R&D Financed from Other Sources.............................. 0.1 0.2 0.3 0.4 0.5 0.7 0.9 1.1 1.5 1.6 1.7
---------------------------------------------------------------------------------------
Subtotal................................................... 0.3 0.5 0.8 0.9 1.1 1.3 1.7 2.0 2.5 2.6 2.7
=======================================================================================
Total Assets.................................................... 18.4 22.1 28.0 35.2 45.9 51.7 60.7 64.6 81.6 83.8 87.4
Net Claims of Foreigners on U.S. (+)............................ -0.1 -0.2 -0.2 -0.1 -0.4 0.0 0.8 1.5 2.9 2.8 3.2
Net Wealth...................................................... 18.5 22.3 28.1 35.3 46.3 51.7 59.9 63.1 78.7 81.0 84.2
��������������������������������������������������������������������������������������������������������������������������������������������������������
ADDENDA:
Per Capita Wealth (thousands of 2002 $)........................ 102.8 115.0 137.5 163.7 202.9 216.4 239.2 236.7 278.6 284.0 292.5
Ratio of Wealth to GDP (in percent)............................ 703.3 715.3 695.0 695.6 678.8 673.6 662.6 682.8 689.1 711.2 713.9
Total Federally Funded Capital (trils 2002 $).................. 2.1 2.4 2.8 3.2 3.8 4.4 4.6 4.6 5.3 5.4 5.5
Percent of National Wealth..................................... 11.4 10.7 9.8 9.1 8.3 8.6 7.7 7.3 6.7 6.7 6.6
--------------------------------------------------------------------------------------------------------------------------------------------------------

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 $43 trillion in 2002,
consisting of $36 trillion in private physical capital and $7 trillion
in public physical capital; by comparison, GDP was about $10 trillion in
2002. The federal government's contribution to this stock of capital
includes its own physical assets plus $1.1 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.

[[Page 50]]

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 goal 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
$42 trillion in 2002, 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 proposed. 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, which is why they are referred to as education capital rather
than human capital. They are that part of human capital that can be
attributed to formal education and training.

Table 3-5. ECONOMIC AND SOCIAL INDICATORS
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
General categories Specific measures 1960 1965 1970 1975 1980 1985 1990 1995 1999 2000 2001 2002
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Economic:
Living Standards......... Real GDP per person (1996 dollars).................... $13,145 $15,587 $17,445 $18,909 $21,523 $23,971 $26,832 $28,328 $31,741 $32,582 $32,354 $32,837
Average annual percent change (5-year trend)......... 0.7 3.5 2.3 1.6 2.6 2.2 2.3 1.1 2.6 2.8 2.2 1.9
Median Income (2000 dollars):
All Households........................................ N/A N/A $34,481 $34,219 $36,035 $37,059 $39,324 $39,306 $43,355 $43,162 $42,228 N/A
Married Couple Families.............................. $29,746 $34,620 $41,516 $43,113 $47,086 $48,798 $52,394 $54,284 $60,202 $60,748 $60,335 N/A
Female Householder, Husband Absent................... $15,032 $16,831 $20,107 $19,847 $21,177 $21,434 $22,237 $22,713 $25,209 $26,434 $25,745 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 29.6 29.3 N/A
Poverty Rate (%) \1\.................................. 22.2 17.3 12.6 12.3 13.0 14.0 13.5 13.8 11.8 11.3 11.7 N/A
Economic Security........ Civilian Unemployment (%)............................. 5.5 4.5 4.9 8.5 7.1 7.2 5.5 5.6 4.2 4.0 4.8 5.8
CPI-U (% Change)...................................... 1.7 1.6 5.8 9.1 13.5 3.5 5.4 2.8 2.2 3.4 2.8 1.6
Employment............... Increase in Total Payroll Employment Previous 12 -0.5 2.9 -0.5 0.4 0.2 2.5 0.3 2.2 3.1 1.9 -1.4 0.2
Months...............................................
Managerial or Professional Jobs (% of civilian N/A N/A N/A N/A N/A 24.1 25.8 28.3 30.3 30.2 31.0 31.3
employment)..........................................
Wealth Creation.......... Net National Saving Rate (% of GDP)................... 10.2 12.1 8.2 6.6 7.5 6.1 4.6 4.7 6.0 5.9 3.3 2.0
Innovation............... Patents Issued to U.S. Residents (thousands).......... 42.3 54.1 50.6 51.5 41.7 45.1 56.1 68.2 99.5 103.6 105.5 N/A
Multifactor Productivity (average annual percent 0.9 2.9 0.8 1.1 0.8 0.5 0.5 0.6 0.9 1.2 N/A N/A
change).
Environment:
Air Quality.............. Nitrogen Oxide Emissions (thousand short tons)........ 14,140 16,579 20,928 22,632 24,384 23,198 24,170 25,051 25,439 24,899 N/A N/A
Sulfur Dioxide Emissions (thousand short tons)........ 22,227 26,750 31,161 28,011 25,905 23,658 23,678 19,189 19,349 18,201 N/A N/A
Lead Emissions (thousand short tons).................. N/A N/A 221 160 74 23 5 4 4 4 N/A N/A
Water Quality............ Population Served by Secondary Treatment or Better N/A N/A N/A N/A N/A 134 155 166 N/A N/A N/A N/A
(mils)...............................................
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 22.4 22.3 22.7 N/A
Safe Communities......... Violent Crime Rate (per 100,000 population) \2\....... 160 199 364 482 597 557 732 685 523 507 504 491
Murder Rate (per 100,000 population) \2\.............. 5 5 8 10 10 8 9 8 6 6 6 6
Murders (per 100,000 Persons Age 14 to 17)............ N/A N/A N/A 5 6 5 10 11 6 5 N/A N/A
Health................... Infant Mortality (per 1000 Live Births) \3\........... 26.0 24.7 20.0 16.1 12.6 10.6 9.2 7.6 7.1 6.7 6.9 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 7.7 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 76.9 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 23.3 23.3 22.8 21.5
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 83.4 84.1 N/A 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 25.2 25.6 N/A N/A
National Assessment of Educational Progress (c)
Mathematics High School Seniors.................... N/A N/A N/A 302 299 301 305 307 308 N/A N/A N/A
Science High School Seniors........................ N/A N/A 305 293 286 288 290 295 295 N/A N/A N/A
Participation............ Individual Charitable Giving per Capita (2000 dollars) 235 282 338 359 391 402 446 423 561 563 573 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 51.2 .......
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
\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, 1999 data are preliminary.

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

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. \2\ That stock
is estimated to have been $2.7 trillion in 2002. Although this
represents a large amount of research, it is a relatively small portion

[[Page 51]]

of total national wealth. Of this stock, about 40 percent was funded by
the federal government.
---------------------------------------------------------------------------
\2\ 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 another cancel out. In most
cases, the debts of one American are the assets of another American, so
these debts are not included in Table 3-4, because they are not a net
liability of Americans as a nation. Table 3-4 is intended to show
national totals only, but that does not mean that the level of debt is
unimportant. The amount of debt owed by Americans to other Americans can
exert both positive and negative effects on the economy. Americans'
willingness and ability to borrow safely helped fuel the expansion of
the 1990s, and continue to support consumption in the current recovery.
In contrast, bad debts, which are not collectible, can cause serious
problems for the banking system.
The only debts that appear in Table 3-4 are the debts Americans owe to
foreigners. America's foreign debt has been increasing rapidly in recent
years, because of the rising deficit in the U.S. current account.
Although the current account deficit has been at record levels recently,
the size of this debt remains small compared with the total stock of
U.S. assets. It amounted to 3.7 percent of total assets in 2002.
Federal debt does not appear explicitly in Table 3-4 because most of
it consists of claims held by Americans; only that portion of the
Federal debt which is held by foreigners is included along with the
other debts to foreigners. Comparing the federal government's net
liabilities with total national wealth does, however, provide another
indication of the relative magnitude of the imbalance in the
government's accounts. Currently, federal net liabilities, as reported
in Table 3-1, amount to 4.4 percent of net U.S. wealth as shown in Table
3-4. However, prospective liabilities are much larger share of national
wealth.

Trends in National Wealth

The net stock of wealth in the United States at the end of FY 2002 was
about $84 trillion, eight times

[[Page 52]]

the level of GDP. Since 1981, it has increased in real terms at an
average annual rate of 2.8 percent per year. The net stock of private
nonresidential plant and equipment grew 2.3 percent per year from 1981
to 2002. However, private nonresidential fixed capital has increased
much more rapidly since 1995--4.8 percent per year--reflecting the
investment boom in the latter half of the 1990s.
The accumulation of education capital, as measured here, grew at an
average rate of 5.3 percent per year in the 1960s and 1970s, about 0.8
percentage point faster than the average rate of growth in private
physical capital during the same period. Since 1981, 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 about
4.3 percent per year since 1981.

Other Federal Influences on Economic Growth

Federal investment decisions, as reflected in Table 3-4, 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 including sound economic growth, promoting health and social
welfare, and protecting the environment. Table 3-5 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 trends in these
indicators turned around. The improvement in economic conditions has
been widely noted, and 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 a third. The turnaround has been especially dramatic in
the murder rate, which was lower in 2000-2002 than at any time since the
1960s. The 2001 recession has had an effect on some of these indicators.
Unemployment has risen and real GDP growth has declined. But as the
economy recovers much of the improvement shown in Table 3-5 is likely to
be preserved.

PART IV--AN INTERACTIVE ANALYTICAL FRAMEWORK

No single framework can encompass all of the factors that affect the
financial condition of the federal government. 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 that goes beyond the standard measures of outlays,
receipts and the surplus/deficit. It includes information that might
appear on a federal balance sheet, but goes beyond that to include long-
run projections of the budget that can be used to show where future
fiscal strains are most likely to appear. It also includes measures that
indicate some of what society has gained economically and socially from
Federal programs funded through the budget.

Relationship with FASAB Objectives

The framework presented here meets the stewardship objective \3\ for
Federal financial reporting recommended by the Federal Accounting
Standards Advisory Board (FASAB) and adopted for use by the federal
government in September 1993.
---------------------------------------------------------------------------
\3\ Statement of Federal Financial Accounting Concepts, Number 1,
Objectives of Federal Financial Reporting, September 2, 1993. Other
objectives are budgetary integrity, operating performance, and systems
and controls.
---------------------------------------------------------------------------
Federal financial reporting should assist report users in
assessing the impact on the country of the government's operations
and investments for the period and how, as a result, the
government's and the Nation's financial conditions have changed and
may change in the future. Federal financial

[[Page 53]]

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 is an experimental approach for meeting this
objective at the government-wide level.

Connecting the Dots: The presentation above consists of a series of
tables and charts. Taken together, they serve some of the same functions
as a business balance sheet. The schematic diagram, Chart 3-8, shows how
the different pieces 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.
Reading down the left-hand side of Chart 3-8 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.

TECHNICAL NOTE: SOURCES OF DATA AND METHODS OF ESTIMATING

Long-Range Budget Projections

The long-range budget projections are based on long-range demographic
and economic assumptions. A simplified model of the federal budget,
developed at OMB, computes the budgetary implications of these
assumptions.

Demographic and Economic Assumptions: For the years 2003-2013, the
assumptions are identical to those used in the budget. These budget
assumptions reflect the President's policy proposals. The economic
assumptions are extended beyond 2013 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 2002 So

[[Page 54]]

cial 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. Productivity growth is held constant at the average
rate of growth implied by the budget's economic assumptions.
CPI inflation holds stable at 2.3 percent per year; the
unemployment rate is constant at 5.1 percent; and the yield on
10-year Treasury notes is steady at 5.6 percent, which are the
final values at the end of the budget forecast for each of
these variables.
Real GDP per hour grows at the same constant rate as in the
Administration's medium-term projections--2.2 percent per
year--through 2080.
U.S. population growth slows from around 1 percent per year
to about half that rate by 2030, and even less after that
point. Real GDP growth slows with the expected slowdown in
population growth. These implications follow from the
Trustees' intermediate demographic projections.
The economic and demographic 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.

Budget Projections: For the period through 2013, 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. Discretionary outlays grow at the rate of growth in
nominal GDP. Social Security is projected by the Social Security
actuaries using these long-range assumptions. Medicare benefits are
projected based on the estimates in the 2002 Medicare trustees' report,
adjusted for differences in the growth rate in GDP per capita. Federal
pensions are derived from the most recent actuarial forecasts available
at the time the budget is prepared, repriced using Administration
inflation and wage 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.

Federally Owned Assets and Liabilities

Financial Assets: The source of data is the Federal Reserve Board's
Flow-of-Funds Accounts. The gold stock was revalued using the market
value for gold.
Fixed Reproducible Capital: Estimates were developed from 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. The source data are in
current dollars. To estimate investment flows in constant dollars, it
was necessary to deflate the nominal investment series. This was done
using chain-weighted price indices for federal investment from the
National Income and Product Accounts (see chapter 7).
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 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.

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 1979-2001, 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 2002 is a
projection. The health insurance liability was estimated by the program
actuaries for 1997-2001, and extrapolated back for earlier years.

National Balance Sheet

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 7. 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 2002.
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 2002 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

[[Page 55]]

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. Department of Education, Digest of Education Statistics. Nominal
expenditures were deflated by the chain-weighted GDP price index 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 price index 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 7 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.
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 3-4 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.

Sources of Data and Assumptions for Estimating 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
agencies' web sites.