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




[[Page 33]]
 
                             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

[[Page 34]]

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.
------------------------------------------------------------------------

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


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


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

               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


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

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.
------------------------------------------------------------------------


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

                                                     Table 3-1.  GOVERNMENT ASSETS AND LIABILITIES *
                                             (As of the end of the fiscal year, in billions of 2002 dollars)
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    1960     1965     1970     1975     1980     1985     1990      1995      2000      2001      2002
--------------------------------------------------------------------------------------------------------------------------------------------------------

                     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
                                                 -------------------------------------------------------------------------------------------------------
       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
                                                 -------------------------------------------------------------------------------------------------------
     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
                                                 -------------------------------------------------------------------------------------------------------
     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
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½

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
--------------------------------------------------------------------------------------------------------------------------------------------------------
* 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

[[Page 37]]

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.

                                     

[[Page 38]]





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

[[Page 39]]

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.
---------------------------------------------------------------------------
  \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.
---------------------------------------------------------------------------

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

[[Page 40]]

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
ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½ï¿½
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.