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

    [[Page 169]]

                            11. ECONOMIC ASSUMPTIONS

                                  Introduction

      The economic outlook appears brighter now than at any time in recent
    years. Expansionary fiscal and monetary policies, combined with the
    inherent resilience of the American economy, have finally succeeded in
    overcoming the forces of restraint that have held growth back. Barring
    adverse shocks, over the near-term there is good reason to believe that
    a self-sustaining and on-going expansion is at hand, one that will
    create more jobs, more income, and more consumer spending and business
    investment.
      From a longer-term perspective, the expansion should proceed briskly
    in the years ahead due to strengthened productivity growth and
    improvements in the tax system that will make it easier for markets to
    reward work and investment. A healthy economy will raise living
    standards and shrink the budget deficit when combined with restraint in
    Federal spending.
      Economic growth began to slow in 2000 following the stock market
    downturn that began in March. The decline showed up first in
    manufacturing, where employment peaked in July 2000. The overall economy
    contracted in the third quarter of 2000, and the slowdown turned into a
    brief, mild recession in early 2001 that was over by the end of the
    year. Although the economy began to expand in the fourth quarter of
    2001, the pace of growth was initially well shy of that of a normal
    recovery and the labor market weakened further. In a typical business
    recovery, employment begins to rise soon after the recession ends, but
    in this instance payroll employment sagged for many months following the
    recession trough.
      Beginning in mid-2003, however, there were gathering signs of self-
    reinforcing economic growth. In such a virtuous circle, rising
    employment adds to workers' incomes and supports consumer spending,
    which leads to additional increases in output and further gains in
    employment. Growing consumer confidence contributes to new spending and
    is further strengthened by continued growth and prosperity. Meanwhile,
    as businesses experience increased sales, orders, and profits, they are
    encouraged to boost capital spending, which creates still more jobs and
    income. Improved business conditions strengthen investor confidence in
    the economy's future, which drives up the stock market, boosting
    household wealth and reducing the cost of capital to business, which
    helps spur further growth.
      The process can continue as long as inflation and interest rates
    remain low and the economy does not bump up against supply constraints.
    With inflation and interest rates at their lowest levels in decades,
    there is good reason to expect that the strengthening economic forces
    now emerging will return the economy to high levels of labor and capital
    resource use.
      Productivity growth accelerated in the last half of the 1990s and has
    stepped up still further in the last three years. Some of the recent
    acceleration is very likely a temporary gain: cyclical pressures pushed
    firms to cut labor and other costs in the face of weak sales. Even
    taking such cyclical factors into account, however, the underlying pace
    of productivity growth appears to have improved significantly. If more
    rapid productivity growth is sustained, then future economic growth
    would be considerably stronger than most forecasters currently expect.
    Consistent with conservative forecasting, the Administration assumes
    productivity growth that is slower than recent experience and close to
    the average pace of the last four decades.
      The Administration's economic near- and medium-term projections
    reflect a reasonably sanguine view of the outlook, which is shared by
    most forecasters. The Administration's economic projections are similar
    to those of private sector forecasters and the Congressional Budget
    Office. However, after several years of generally disappointing economic
    news, it would not be surprising if the gathering positive cyclical
    forces propelled the economy forward even faster than is now generally
    anticipated.

                                 Policy Actions

      Fiscal Policy: During the first three years of this Administration,
    the President proposed and Congress passed three important tax relief
    measures that have helped pull the economy out of recession and provide
    a foundation for future growth.
        In June 2001, the President signed the Economic Growth and
              Tax Relief and Reconciliation Act (EGTRRA). It provided
              significant income tax rate reductions including lower
              marginal income tax rates; a reduction in the marriage tax
              penalty; and a new, lower, 10 percent tax bracket. Beginning
              in July 2001, 85 million taxpayers received rebate checks
              totaling $36 billion reflecting the new 10 percent bracket.
              The rebate and lower withholding rates bolstered consumer
              spending at a critical juncture, helping to return the economy
              to growth by the end of 2001.
        In March 2002, the President signed the Job Creation and
              Worker Assistance Act (JCWAA). The main provision of JCWAA
              reduced the tax disincentive for business to invest by
              permitting expensing on 30 percent of the value of qualified
              new capital assets, primarily equipment and software. This
              expensing provision created a temporary period of lower
              capital costs until the provision originally expired in
              September 2004. JCWAA

    [[Page 170]]

              was aimed directly at weak capital spending, a key reason why
              the business cycle recovery was much slower than usual. The
              Act also provided additional unemployment benefits for long-
              term unemployed workers who exhausted their regular
              unemployment insurance benefits.
        In May 2003, the President signed another extension of
              unemployment insurance benefits for individuals who had
              exhausted their regular benefits. He also signed the Jobs and
              Growth Tax Relief Reconciliation Act (JGTRRA) to provide
              additional stimulus to the subpar recovery. This legislation:

                1) Advanced the date at which the 2001 tax bill's lower
              marginal individual income tax rates were to take effect and
              made them retroactive to January 2003; raised the child tax
              credit for 2003 and 2004, with the 2003 increase given to
              families in the form of rebate checks during the summer;
              advanced the reduction in the marriage penalty; and raised the
              exemption amount for the individual Alternative Minimum tax
              (AMT) in 2003 and 2004. (Taxpayers pay the higher of their tax
              liability as determined by the regular income tax and the AMT
              calculation.)

                2) Reduced the individual income tax rates on dividend
              income and capital gains. The tax bill reduced to 15 percent
              the maximum tax rate on dividends which previously were taxed
              at the taxpayer's marginal tax rate, and it reduced the
              maximum tax rate on net capital gains (the excess of net long-
              term gains over net short-term losses) from 20 percent to 15
              percent. Tax rates on capital income were also reduced for
              those lower income families paying less than the maximum rate.
              The reductions in the tax rates on capital gains and dividends
              reduced a longstanding distortion in the tax code: the double
              taxation of corporate earnings that had lowered business
              investment and biased corporate financing against equity and
              in favor of debt.

                3) Raised the expensing provision of the 2002 tax bill from
              30 percent to 50 percent and extended the window for eligible
              investments from September 11, 2004 to the end of the year.
              Also, the maximum amount of new investment that a small
              business can expense was raised from $25,000 to $100,000.
      All told, the three tax relief bills provided $68 billion in tax
    stimulus in fiscal year 2001, $89 billion in 2002, $159 billion in 2003,
    $272 billion in 2004, and $171 billion in 2005. The total stimulus,
    including assistance to States and long-term unemployed workers, was
    even larger.
      Tax relief played a crucial role in ending the 2001 recession and then
    invigorating the recovery. It took two years, but the stimulus in the
    tax bills is finally producing the rapid economic growth that the
    economy needs and that will eventually generate new jobs and higher
    incomes. In addition to the near-term stimulus, the 2001 and 2003 Acts
    also made fundamental improvements in the Nation's tax system that will
    raise the long-term level of economic activity by reducing the
    disincentives and distortions in the system.
        The reductions in marginal tax rates mean that individuals,
              sole proprietorships, and partnerships will have more
              incentive to produce more, earn more, save more, and invest
              more.
        Lower tax rates on dividends and capital gains will lower
              the after-tax cost of purchasing capital equipment and
              software, thus raising the rate of investment. Lower tax rates
              will also shift investment to more productive uses by reducing
              distortions in the pattern of investment caused by the tax
              system. By reducing the bias in favor of debt over equity
              finance, lower tax rates on dividends and capital gains will
              encourage corporations to maintain stronger balance sheets.
        The reduction in the individual capital gains tax rates will
              encourage more high-risk, high-payoff investments essential to
              maintaining a dynamic economy and ensuring U.S.
              competitiveness in the world economy.
        Lower tax rates on capital income will help raise asset
              values and thereby improve household and business balance
              sheets.
      The short-term benefits of fiscal stimulus are already evident in the
    quick end to the recession in 2001 and the further surge in economic
    growth that occurred in the second half of 2003. The tax cuts have
    helped to transform an ailing economy into a healthier one. The longer-
    term benefits from an improved tax system will be evident in the years
    ahead as new incentives alter the behavior of individuals and businesses
    in ways that augment economic growth.
      Monetary Policy: Since early 2001 the Federal Reserve has aggressively
    pursued a policy aimed at restoring strong, self-sustaining growth. As
    it became clear that the abrupt slowing of growth in late 2000 would
    likely turn into a recession in early 2001, the Federal Reserve cut the
    federal funds rate sharply. Eventually, it lowered this key interest
    rate eight times, bringing it down from 6\1/2\ percent at the start of
    2001 to 3\1/2\ percent by August. In the months following the terrorist
    attacks of September 11th, the Federal Reserve cut the rate four more
    times bringing it to just 1\3/4\ percent by the end of the year, the
    lowest level since the early 1960s.
      As the economy began to expand beginning in the fourth quarter of
    2001, the Federal Reserve held the federal funds rate constant, but as
    the pace of growth proved disappointing and payrolls continued to
    contract, the Federal Reserve reduced the funds rate to 1\1/4\ percent
    in November 2002 and to 1 percent in June 2003. Even as growth
    accelerated in the second half of 2003, the Federal Reserve indicated
    that it intended to maintain an accommodative monetary policy for a
    considerable period of time.
      At the longer end of the maturity spectrum, interest rates declined
    sharply in late 2000 as markets perceived the slowdown in the economy.
    They remained

    [[Page 171]]

    about unchanged during 2001, and then resumed their decline in 2002 and
    the first half of 2003. At its low point in June 2003, the yield on the
    10-year Treasury note fell to 3.1 percent, three percentage points below
    its level three years earlier and the lowest level since the late 1950s.
    The yield rose during the second half of 2003 and finished the year at
    4.3 percent. With the exception of the past year and a half, this is the
    lowest level for the 10-year note since 1965.
      The decline in long-term interest rates that continued until mid-2003
    reflected slack credit demand, a reduction in inflation and in inflation
    expectations, and the easing of monetary policy. The final phase of the
    decline in rates in May through June 2003 also reflected some apparent
    confusion in financial markets regarding the Federal Reserve's
    intentions. The rise in long-term rates during the second half of 2003
    reflected a better understanding by market participants of Federal
    Reserve policy, along with the pickup in economic activity, and the
    expectation of further strengthening of the expansion in 2004.
      The trend in yields on long-term private sector instruments was
    similar to that of Treasury notes, declining to very low levels by mid-
    2003 and then rising to still relatively low levels by year's end. The
    yield on corporate AAA bonds closed the year at 5.6 percent, the lowest
    level since 1967. The rate on 30-year fixed rate mortgages finished the
    year at 5.8 percent, the lowest level since the early 1960s.

                               Recent Developments

      The economic expansion that began in late 2001 was restrained by a
    number of special factors. The stock market decline, which lasted from
    early 2000 until early 2003, was much longer--and much steeper--than in
    a typical business cycle. The market decline was prolonged by the
    corporate accounting scandals in 2002 that shook investor confidence.
    The erosion of consumer confidence was another negative factor that
    persisted until early 2003, well beyond the normal cyclical correction.
    Confidence was sapped not only by economic conditions in 2001-2002, but
    also by the terrorist attacks on September 11, 2001, and subsequent
    developments in the War on Terror which periodically heightened anxiety.
    Another factor holding back growth was the business capital stock
    overhang that had emerged in late 2000 and needed to be worked off. The
    overhang held down investment spending until mid-2003. Finally, slow
    growth, or even recession, in other leading industrial nations curtailed
    U.S. exports.
      These obstacles to growth had been overcome or greatly reduced by mid-
    2003. The stock market was on the rise again as the uncertainties
    surrounding the 2002 accounting scandals subsided and new legislation
    passed in 2002 led to wide-ranging reforms of corporate governance.
    Consumers and investors became more optimistic as the Administration and
    the American people together successfully met the domestic and
    international threats to the Nation's security at home and overseas.
    Businesses had largely eliminated the excess capital stock by mid-2003,
    and investment began increasing again. Growth abroad also picked up
    modestly. The attenuation of these special factors permitted the highly
    stimulative fiscal and monetary policies put in place in 2001-2003 to
    operate to full effect, restoring the economy to a healthy growth rate.
      The economy surged in the third quarter of 2003 as real GDP growth
    soared to an 8.2 percent annual rate, the fastest quarterly advance
    since 1983. Growth in the fourth quarter undoubtedly moderated from this
    stellar pace, but it appears to have remained robust. (The official
    estimate of fourth quarter growth was not available until after the
    Budget had gone to press.)
      A telling indication that the expansion has become healthier and more
    self-sustaining is the more balanced mix of the growth of GDP
    components. Unlike the initial phase of the expansion, which was
    dominated by consumer and Government spending, growth is now being
    propelled by business and consumer spending as Government spending
    growth slows.
      Components of Aggregate Demand: Business investment in equipment and
    software, adjusted for inflation, increased at an 18 percent annual rate
    in the third quarter, the fastest growth in 5\1/2\ years. Rising
    shipments of nondefense capital goods in October and November suggest
    that equipment investment made a substantial contribution to GDP growth
    in the fourth quarter as well. Business investment in structures has
    leveled off instead of declining as it had earlier. Given the usual
    lags, an upturn in spending on structures is increasingly likely this
    year.
      The stalwart of the expansion has been consumer spending, and it
    continued to expand rapidly at nearly a 7 percent annual rate in the
    third quarter. Consumption probably remained strong in the fourth
    quarter, as well. Individuals' discretionary spending, such as for new
    cars, has been especially robust. Residential investment has been the
    other mainstay of the expansion so far, spurred by relatively low
    mortgage rates. Residential investment spending rose at over a 20
    percent rate in the third quarter, the fastest pace in a decade. Housing
    starts in November reached the highest level in almost twenty years,
    which suggests another double-digit rise in residential investment in
    the fourth quarter.
      Other Indications of Stronger Growth:
        The Nation's payrolls have begun increasing again, and
              unemployment is on the decline. The unemployment rate fell
              from 6.3 percent in June to 5.7 percent in December. From July
              to December, employers added 278,000 workers to their
              payrolls, reversing the trend of shrinking payrolls of the
              prior months. However, the gain in December of only 1,000 jobs
              suggests that job creation at the end of the year was still
              well shy of the usual expansion pace. Further significant
              payroll gains are likely in 2004, although recent experience
              suggests that job growth may remain uneven through the early
              part of the year.

    [[Page 172]]

        Output in the hard-hit manufacturing sector turned around in
              2003. Manufacturing production during September through
              December rose at the fastest pace in nearly four years. The
              Purchasing Managers' Index, a forward looking indicator of
              manufacturing activity, reached 66 in December, the highest
              level in 20 years. A reading above 50 indicates an expanding
              manufacturing sector.
        Consumer and investor confidence has risen sharply. From
              their low points in March 2003, the University of Michigan
              Index of Consumer Sentiment increased nearly 20 percent
              through December and the Conference Board measure advanced
              almost 50 percent. A survey of investor confidence conducted
              by UBS/Gallup rose from a low reading of 5 in March to 104 in
              December.
        Corporate profit margins and overall profits expanded
              briskly in 2003, which should help foster further increases in
              business hiring and capital spending in 2004. In the third
              quarter, the share of profits in GDP reached 10 percent, the
              highest level since late 1997. Strong productivity growth,
              well in excess of the growth of labor compensation, has
              contributed to the growth of profits by lowering unit labor
              costs and raising profit margins.
        Stock markets have soared since March 2003. The S&P 500 and
              the Dow Jones Industrial average each gained about 30 percent
              during the last nine months of 2003; the NASDAQ, with its
              predominance of high-tech companies, rose 50 percent. The
              increase in equity values added almost $3 billion to household
              wealth from the end of March to the end of December and
              reduced the cost of equity capital to businesses.
        At the same time that economic activity has been picking up,
              inflation has been drifting lower. The core Consumer Price
              Index, which excludes the volatile food and energy components,
              increased a mere 1.1 percent in the 12 months ending in
              December 2003. That is the lowest rate in 40 years and well
              below the 2.7 percent increase at the recession's trough in
              November 2001. The rise in the overall CPI was 1.9 percent
              during the most recent 12 months. This was higher than the
              core rate mainly because of a jump in energy prices. The GDP
              price index increased 1.7 percent in the year ending in the
              third quarter of 2003. The absence of any significant
              inflationary pressures suggests that the Federal Reserve
              should be able to maintain an accommodative monetary policy
              for some time yet.
      Productivity and the Longer Run Outlook: Since the fourth quarter of
    2000, productivity in the nonfarm business sector has risen at a 4.4
    percent annual rate. That is much faster than the 1.4 percent average
    from 1974 to 1995 and faster even than the accelerated 2.5 percent pace
    during the latter half of the 1990s. While some of the recent step up is
    likely attributable to intense cost cutting during the recession and the
    subsequent slow recovery, and therefore transitory, a considerable part
    of the productivity improvement is likely to prove to be permanent.
    Strong productivity growth is the best foundation for continued economic
    growth.
      In summary, the accommodative stances of fiscal and monetary policy
    have combined to ignite a more vigorous expansion. Growth is likely to
    be above average this year, accompanied by further declines in
    unemployment and stronger employment gains. Beyond this year, solid
    productivity growth, low inflation, and an improved tax framework offer
    the prospect of a new, extended period of robust economic growth.

                              Economic Projections

      The Administration's economic projections are summarized in Table 11-
    1. These assumptions are close to those of the Congressional Budget
    Office and the average of private sector forecasters, as described in
    more detail below. The assumptions were based on information available
    as of late November. In December, the Bureau of Economic Analysis
    released a comprehensive revision of the National Income and Product
    Accounts. The Addendum to Table 11-1 presents the assumptions on a basis
    comparable to the revised national accounts.
      As the foregoing discussion suggests, the Administration is projecting
    the economy to improve steadily. The major contributors to economic
    growth this year are likely to be business investment and consumer
    spending, spurred by stronger income growth, the tax relief legislation
    of the past three years, the rise in stock market, and increased housing
    wealth. Spending on equipment and software could surge later this year
    as firms take advantage of the expensing provision scheduled to expire
    at year's end. To the extent that the timing of investment is shifted
    forward from 2005 to 2004, capital spending in early 2005 may be
    temporarily weakened. Businesses are also likely to add to their
    inventories in 2004, which were lean at the end of 2003.
      The foreign sector may once again make at least a modest positive
    contribution to growth because of an expected pick up of economic
    activity abroad and the recent decline in the value of the dollar, both
    of which should help U.S. exports. From February 2002 to the end of
    2003, the dollar declined 23 percent against the currencies of the major
    U.S. trading partners.
      Residential investment may not maintain the exceptionally high levels
    reached in late 2003 and so may make little, if any, contribution to
    growth. The contribution to real GDP growth from Government spending is
    also likely to be at most modest. At the Federal level, growth in
    spending on security requirements will be partly offset by more moderate
    spending growth in areas of lower priority. At the State and local
    level, growth of outlays will continue to be restrained as these
    governments strive to achieve balanced budgets.

                                                              Table 11-1.  ECONOMIC ASSUMPTIONS \1\
                                                          (Calendar years; dollar amounts in billions)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                          Projections
                                                      Actual 2002 ------------------------------------------------------------------------------------------
                                                                       2003         2004         2005         2006         2007         2008         2009
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Gross Domestic Product (GDP):
      Levels, dollar amounts in billions:
        Current dollars.............................     10,446       10,939       11,566       12,139       12,746       13,396       14,096       14,831
        Real, chained (1996) dollars................      9,440        9,730       10,163       10,528       10,886       11,248       11,607       11,969
        Chained price index (1996=100), annual            110.7        112.4        113.8        115.3        117.1        119.1        121.4        123.9
         average....................................
      Percent change, fourth quarter over fourth
       quarter:
        Current dollars.............................        4.3          5.8          5.2          4.9          5.0          5.2          5.2          5.2
        Real, chained (1996) dollars................        2.9          4.2          4.0          3.4          3.3          3.3          3.1          3.1
        Chained price index (1996=100)..............        1.3          1.5          1.2          1.4          1.6          1.8          2.0          2.0
      Percent change, year over year:
        Current dollars.............................        3.6          4.7          5.7          4.9          5.0          5.1          5.2          5.2
        Real, chained (1996) dollars................        2.4          3.1          4.4          3.6          3.4          3.3          3.2          3.1
        Chained price index (1996=100)..............        1.1          1.6          1.2          1.3          1.5          1.7          2.0          2.0

    Incomes, billions of current dollars:
        Corporate profits before tax................        665          756          891        1,181        1,134        1,134        1,175        1,222
        Wages and salaries..........................      4,996        5,101        5,356        5,686        6,008        6,347        6,687        7,030
        Other taxable income \2\....................      2,411        2,487        2,609        2,681        2,727        2,791        2,888        3,016

    Consumer Price Index: \3\
        Level (1982-84=100), annual average.........      179.9        184.0        186.6        189.4        192.8        196.8        201.5        206.6
        Percent change, fourth quarter over fourth          2.2          2.0          1.4          1.6          1.9          2.2          2.5          2.5
         quarter....................................
        Percent change, year over year..............        1.6          2.3          1.4          1.5          1.8          2.1          2.4          2.5

    Unemployment rate, civilian, percent:
        Fourth quarter level........................        5.9          5.9          5.5          5.3          5.2          5.1          5.1          5.1
        Annual average..............................        5.8          6.0          5.6          5.4          5.2          5.1          5.1          5.1

    Federal pay raises, January, percent:
        Military \4\................................        6.9          4.7         4.15          3.5           NA           NA           NA           NA
        Civilian \5\................................        4.6          4.1          4.1          1.5           NA           NA           NA           NA

    Interest rates, percent:
        91-day Treasury bills \6\...................        1.6          1.0          1.3          2.4          3.3          4.0          4.3          4.4
        10-year Treasury notes......................        4.6          4.0          4.6          5.0          5.4          5.6          5.8          5.8

    ADDENDUM: \7\
    Gross Domestic Product (GDP), revised:
      Levels, dollar amounts in billions:
        Current dollars.............................     10,481       10,984       11,612       12,187       12,796       13,449       14,151       14,890
        Real, chained (2000) dollars................     10,083       10,397       10,858       11,248       11,630       12,017       12,401       12,788
        Chained price index (2000=100), annual            103.9        105.7        107.0        108.4        110.0        111.9        114.1        116.4
         average....................................
      Percent change, fourth quarter over fourth
       quarter:
        Current dollars.............................        4.2          5.9          5.2          4.9          5.0          5.2          5.2          5.2
        Real, chained (2000) dollars................        2.8          4.3          4.0          3.4          3.3          3.3          3.1          3.1
        Chained price index (2000=100)..............        1.4          1.5          1.2          1.4          1.6          1.8          2.0          2.0
      Percent change, year over year:
        Current dollars.............................        3.8          4.8          5.7          4.9          5.0          5.1          5.2          5.2
        Real, chained (2000) dollars................        2.2          3.1          4.4          3.6          3.4          3.3          3.2          3.1
        Chained price index (2000=100)..............        1.5          1.6          1.2          1.3          1.5          1.7          2.0          2.0

    Incomes, billions of current dollars, revised:
        Corporate profits before tax................        745          845          992        1,313        1,261        1,262        1,307        1,359
        Wages and salaries..........................      4,975        5,092        5,352        5,682        6,004        6,342        6,682        7,025
        Other taxable income \2\....................      2,349        2,401        2,515        2,587        2,634        2,701        2,796        2,923
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    NA = Not Available.
    \1\ Based on information available as of late November 2003.
    \2\ Dividends, rent, interest and proprietors' income components of personal income.
    \3\ Seasonally adjusted CPI for all urban consumers.
    \4\ Percentages apply to basic pay only; 2002, 2003, and 2004 figures are averages of various rank- and longevity- specific adjustments; percentages to
      be proposed for years after 2005 have not yet been determined.
    \5\ Overall average increase, including locality pay adjustments. Percentages to be proposed for years after 2005 have not yet been determined.
    \6\ Average rate, secondary market (bank discount basis).
    \7\ Assumptions adjusted to reflect comprehensive revisions to GDP and incomes released by the Bureau of Economic Analysis in December 2003.

      Real GDP and Unemployment: The economy is projected to grow 4.4
    percent in 2004 measured on a calendar year-over-year basis, compared
    with 3.1 percent in 2003. During the next few years, real growth is

    [[Page 174]]

    expected to exceed the long-run potential growth rate. As a result, the
    unemployment rate is projected to decline gradually from its 5.7 percent
    level in December 2003 to 5.1 percent in 2007. This rate is in the
    center of the range that is thought to be consistent with stable
    inflation.
      Potential GDP: The growth of potential GDP is assumed to be 3.1
    percent per year. Potential growth is approximately equal to the sum of
    the trend growth rates of the labor force and of productivity. The labor
    force is projected to grow about 1.0 percent per year on average, a
    combination of a 1.1 percent increase in the working-age population and
    a slight decline in the labor force participation rate. Trend
    productivity growth in the nonfarm business sector is assumed to average
    2.3 percent per year, about the average during the past four decades, an
    extended period that encompasses rapid and slow productivity growth
    trends. The productivity assumption is a cautious one, especially in
    light of the 4.4 percent average growth rate in nonfarm productivity
    since the fourth quarter of 2000.
      Inflation: Inflation is expected to edge up slightly from its low
    levels in 2003. The GDP chain-weighted price index is projected to
    increase 1.2 percent this year, rising to 2.0 percent in 2008 and 2009.
    The CPI is expected to increase 1.4 percent this calendar year, and then
    move up to 2.5 percent in 2009. The difference between inflation
    measured by the CPI and the GDP price index in the outyears is
    consistent with historical experience.
      The forecast for low inflation in the coming years reflects the
    current very low inflation, the absence of inflationary expectations,
    the additional downward pressure on wages and prices that will persist
    until stronger growth eventually eliminates excess slack in the economy,
    and the demonstrated ability of the Federal Reserve in recent years to
    assure a reasonable degree of price stability. Not since the mid-1960s
    has there been a 10-year period with average inflation as low as is
    projected for 2000-2009.
      Interest Rates: As is usual during an expansion, interest rates are
    projected to rise. The 3-month Treasury bill rate ended 2003 at 0.9
    percent. It is expected to increase to 4.4 percent by 2009. The yield on
    the 10-year Treasury note ended last year at 4.3 percent. It is
    projected to increase to 5.8 percent by 2009.
      The larger increase at the short end of the maturity spectrum than at
    the longer end is the usual cyclical experience and reflects an assumed
    less accommodative monetary policy as the expansion matures. Rates start
    from such a low level currently that, despite their projected increase,
    interest rates on average during 2003 through 2009 are likely to be
    lower than during any other seven-year period since the mid-1960s.
    Adjusted for inflation, the outyear real interest rates are close to
    their historical averages.
      Income Shares: The share of taxable income in nominal GDP is projected
    to rise through 2005 and decline thereafter. The wage and salary share
    is projected to rise steadily through 2007 from a relatively low level
    in the third quarter of 2003. The share of the nontaxable component of
    labor compensation in GDP is expected to rise significantly over the
    forecast horizon. This component, called supplements to wages and
    salaries in the national income accounts, is composed of employer
    contributions for social insurance and employer-paid benefits, such as
    health insurance and pension contributions. Both health insurance and
    pension contributions are projected to rise more rapidly than taxable
    wages and salaries.
      The cost of health insurance purchased by employers rose at a double-
    digit pace in both 2002 and 2003. Employers have shifted some of the
    rise in insurance costs on to employees, and are likely to continue to
    do so. Nonetheless, the upward pressure on the employers' share of
    insurance premiums is expected to be substantial. Also, employers'
    contributions to defined-benefit pension plans are expected to increase
    significantly over the next few years. Firms must reduce the large
    underfunding of plans created by the fall in the stock market between
    2000 and 2003, lower assumed rates of return on fund assets, and the
    ongoing obligations for their workforce.
      The share of corporate profits before tax will be affected by the
    strength of the economy and the end of the temporary expensing
    provisions for qualified capital by the end of 2004. Healthy economic
    growth will help sustain the corporate profits share. On the other hand,
    the expensing provision will lower profits before tax this year compared
    to what they otherwise would have been by allowing firms to write off
    more of their investment sooner. After 2004, however, corporate profits
    before tax will increase both because new investments will not qualify
    for the temporary expensing provision and because the remaining
    depreciation on expensed investments will be lower. Taking these various
    factors into account, the corporate profits share is expected to
    increase slightly this year, jump sharply in 2005 when the receipts
    payback for expensing will begin, and then decline gradually thereafter.
      Among the other components of the tax base, the share of personal
    interest income in GDP is projected to decline significantly reflecting
    the relatively low nominal interest rates during the next six years. The
    remaining shares of the tax base (proprietors' income, rental income,
    and dividend income) are projected to remain relatively stable at around
    their 2003 levels.
      Summary: The economic news since the assumptions were finalized has
    generally been favorable, although job growth in December fell well
    below expectations. On balance, at the start of 2004, the upside risks
    to the near-term forecast may exceed the downside risks. Moreover, if
    the strong productivity performance of recent years continues at even a
    somewhat more moderate pace, then long-run growth may also be stronger
    than assumed here. On the other hand, growth may also be weaker than
    forecast if, for example, the economy is subjected to additional and
    significant adverse shocks.

    [[Page 175]]

                Comparison with CBO and Private-Sector Forecasts

      In addition to the Administration, the Congressional Budget Office
    (CBO) and many private-sector forecasters also make economic
    projections. CBO develops its projections to aid Congress in formulating
    budget policy. In the executive branch, this function is performed
    jointly by the Treasury, the Council of Economic Advisers, and the
    Office of Management and Budget. Private-sector forecasts are often used
    by businesses for long-term planning. Table 11-2 compares the 2005
    Budget assumptions with projections by the CBO and the Blue Chip
    Consensus, an average of about 50 private-sector forecasts.
      The three sets of economic assumptions are based on different
    underlying assumptions concerning economic policies. The private-sector
    forecasts are based on their appraisals of the most likely policy
    outcomes, which vary among the forecasters. The Administration forecast
    assumes that all Budget proposals will be enacted. The CBO baseline
    projection assumes that current law as of the time the estimates are
    made will remain forever unchanged. Despite their differing policy
    assumptions, the three sets of economic projections, shown in Table 11-
    2, are very close. The similarity of the Budget economic projection to
    both the CBO baseline projection and the Consensus forecast underscores
    the cautious nature of the Administration forecast.

                                                         Table 11-2.  COMPARISON OF ECONOMIC ASSUMPTIONS
                                                                        (Calendar years)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Projections                                    Average,
                                                                  ------------------------------------------------------------------------------------------
                                                                       2004         2005         2006         2007         2008         2009       2004-09
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    GDP (billions of current dollars):
      CBO January................................................     11,629       12,243       12,814       13,389       14,023       14,686
      Blue Chip Consensus January \2\............................     11,660       12,291       12,929       13,588       14,292       15,045
      2005 Budget................................................     11,612       12,187       12,796       13,449       14,151       14,890

    Real GDP (chain-weighted): \1\
      CBO January................................................        4.8          4.2          3.1          2.7          2.8          2.8          3.4
      Blue Chip Consensus January \2\............................        4.6          3.7          3.3          3.1          3.2          3.2          3.5
      2005 Budget................................................        4.4          3.6          3.4          3.3          3.2          3.1          3.5

    Chain-weighted GDP Price Index: \1\
      CBO January................................................        1.1          1.1          1.5          1.8          1.9          1.9          1.5
      Blue Chip Consensus January \2\............................        1.4          1.6          1.8          1.9          2.0          2.0          1.8
      2005 Budget................................................        1.2          1.3          1.5          1.7          2.0          2.0          1.6

    Consumer Price Index (all-urban): \1\
      CBO January................................................        1.6          1.7          2.0          2.2          2.2          2.2          2.0
      Blue Chip Consensus January \2\............................        1.7          2.1          2.3          2.4          2.4          2.4          2.2
      2005 Budget................................................        1.4          1.5          1.8          2.1          2.4          2.5          2.0

    Unemployment rate: \3\
      CBO January................................................        5.8          5.3          5.0          5.1          5.2          5.2          5.3
      Blue Chip Consensus January \2\............................        5.8          5.4          5.4          5.3          5.3          5.2          5.4
      2005 Budget................................................        5.6          5.4          5.2          5.1          5.1          5.1          5.3

    Interest rates: \3\
      91-day Treasury bills:
        CBO January..............................................        1.3          3.0          4.0          4.6          4.6          4.6          3.7
        Blue Chip Consensus January \2\..........................        1.3          2.6          3.7          3.9          4.1          4.1          3.3
        2005 Budget..............................................        1.3          2.4          3.3          4.0          4.3          4.4          3.3

      10-year Treasury notes: \3\
        CBO January..............................................        4.6          5.4          5.5          5.5          5.5          5.5          5.3
        Blue Chip Consensus January \2\..........................        4.7          5.4          5.5          5.6          5.6          5.6          5.4
        2005 Budget..............................................        4.6          5.0          5.4          5.6          5.8          5.8          5.4
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Sources: Congressional Budget Office; Aspen Publishers, Inc., Blue Chip Economic Indicators
    All forecasts adjusted to reflect December 2003 comprehensive revisions to the National Income and Product Accounts.
    \1\ Year over year percent change.
    \2\ January 2004 Blue Chip Consensus forecast for 2004 and 2005; Blue Chip October 2003 long run extension for 2006 - 2009.
    \3\ Annual averages, percent.

      For real GDP, the Administration, CBO, and the Blue Chip consensus
    anticipate strong growth this year. The Administration projects 4.4
    percent growth, slightly below the CBO and private sector consensus. For
    calendar year 2005, the Administration, at 3.6 percent, is again
    slightly below the Consensus (at 3.7 percent), and significantly less
    than CBO's 4.2 percent. Thereafter, the Administration's forecast
    remains close to the consensus growth rate. Over the six-year span as a
    whole, the Administration and the private sector consensus both project
    an average 3.5 percent annual growth rate, CBO 3.4 percent.
      All three forecasts anticipate continued low inflation of between 1
    and 2 percent as measured by the GDP chain-weighted price index, and
    between 1\1/2\ and 2\1/2\ percent as measured by the CPI. The
    unemployment rate projections are also similar. All three forecasts en

    [[Page 176]]

    visage slightly rising interest rates during the next few years. For
    short-term rates, the consensus forecast is slightly below the
    Administration's in the outyears, while CBO is higher. The three long-
    term interest rate projections are very close.

                         Changes in Economic Assumptions

      As shown in Table 11-3, the economic assumptions underlying this
    Budget have been revised significantly from those of the 2004 Budget.
      Real GDP growth accelerated beyond expectation in the latter part of
    2003 and for the year as a whole was a bit stronger, overall, than
    projected in last year's Budget. A year ago, the economic recovery
    appeared to be losing momentum; now, it is gaining speed. Consequently,
    the level of real GDP projected for this year is now a full percentage
    point higher than anticipated in last year's Budget, and the year-over-
    year growth rate is 0.8 percentage points higher. From 2005 onwards,
    moreover, real GDP growth in this budget is projected to be slightly
    above last year's projected rates.
      The level of nominal GDP is projected to be about one percentage point
    higher in each year, 2004-2009, than in last year's budget. That is
    primarily because actual real GDP was significantly higher in 2003, and
    is now expected to grow slightly faster during 2004-2008, than in last
    year's budget. The unemployment rate is expected to be somewhat higher
    than in last year's assumptions but ultimately to decline to 5.1
    percent, as before. Interest rates are projected to be lower during the
    next few years than was envisaged in last year's Budget, reflecting
    their current low levels. The short-term rate is expected to gradually
    approach last year's outyear assumptions, but long-term rates are now
    projected to be slightly higher. Adjusted for inflation, the real long-
    term rate is the same as in last year's budget.

                                          Table 11-3.  COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 2004 AND 2005 BUDGETS
                                                          (Calendar years; dollar amounts in billions)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                       2003         2004         2005         2006         2007         2008         2009
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Nominal GDP: \1\
      2004 Budget assumptions....................................     10,884       11,447       12,031       12,637       13,263       13,919       14,608
      2005 Budget assumptions....................................     10,939       11,566       12,139       12,746       13,396       14,096       14,831

    Real GDP (1996 dollars): \1\
      2004 Budget assumptions....................................      9,710       10,061       10,414       10,760       11,102       11,446       11,801
      2005 Budget assumptions....................................      9,730       10,163       10,528       10,886       11,248       11,607       11,969

    Real GDP (percent change): \2\
      2004 Budget assumptions....................................        2.9          3.6          3.5          3.3          3.2          3.1          3.1
      2005 Budget assumptions....................................        3.1          4.4          3.6          3.4          3.3          3.2          3.1

    GDP price index (percent change): \2\
      2004 Budget assumptions....................................        1.3          1.5          1.5          1.7          1.7          1.8          1.8
      2005 Budget assumptions....................................        1.6          1.2          1.3          1.5          1.7          2.0          2.0

    Consumer Price Index (percent change): \2\
      2004 Budget assumptions....................................        2.2          2.1          2.1          2.2          2.2          2.3          2.3
      2005 Budget assumptions....................................        2.3          1.4          1.5          1.8          2.1          2.4          2.5

    Civilian unemployment rate (percent): \3\
      2004 Budget assumptions....................................        5.7          5.5          5.2          5.1          5.1          5.1          5.1
      2005 Budget assumptions....................................        6.0          5.6          5.4          5.2          5.1          5.1          5.1

    91-day Treasury bill rate (percent): \3\
      2004 Budget assumptions....................................        2.0          3.6          4.3          4.4          4.4          4.5          4.5
      2005 Budget assumptions....................................        1.0          1.3          2.4          3.3          4.0          4.3          4.4

    10-year Treasury note rate (percent): \3\
      2004 Budget assumptions....................................        4.2          5.0          5.3          5.4          5.5          5.6          5.6
      2005 Budget assumptions....................................        4.0          4.6          5.0          5.4          5.6          5.8          5.8

    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ Not adjusted for December 2003 comprehensive revisions to the National Income and Product Accounts.
    \2\ Year over year.
    \3\ Calendar year average.

                 Sources of Change in the Budget since Last Year

      The sources of the change in the budget outlook from the 2004 Budget
    to the 2005 Budget are shown in Table 11-4. The second block shows that
    proposed and enacted legislation increases the deficit in 2004 and 2005
    but has little effect thereafter.
      The third block shows the effects on receipts and outlays from changes
    in economic assumptions. These include the effects of changes in
    assumptions for real growth, inflation, interest rates, unemployment,
    and the various taxable incomes.

                                     Table 11-4.  SOURCES OF CHANGE IN BUDGET TOTALS
                                                (In billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                            2004         2005         2006         2007         2008         2009
    ----------------------------------------------------------------------------------------------------------------
     (1) 2004 Budget
        Receipts......................      1,922        2,135        2,263        2,398        2,521        2,649
        Outlays.......................      2,229        2,343        2,464        2,576        2,711        2,843
                                       -----------------------------------------------------------------------------
          Unified budget deficit (-)..       -307         -208         -201         -178         -190         -194

     (2) Changes due to policy:
        Receipts......................        -17           15           38           33           23           19
        Outlays.......................         92           62           34           39           27           14
                                       -----------------------------------------------------------------------------
          Deficit increase (-), policy       -109          -48            4           -5           -5            4

     (3) Changes due to economic
     assumptions:
        Receipts......................        -39          -37          -41          -27          -10            4
        Outlays.......................        -22          -37          -33          -24          -14           -6
                                       -----------------------------------------------------------------------------
          Deficit increase (-),               -18            1           -8           -4            4           10
           economic...................

     (4) Changes due to technical
     factors:
        Receipts......................        -68          -77          -55          -53          -48          -56
        Outlays.......................         19           31            8           -1            1            2
                                       -----------------------------------------------------------------------------
          Deficit increase (-),               -87         -108          -63          -54          -48          -57
           technical..................

     (5) Total changes from 2004
     Budget:
        Receipts......................       -124          -99          -57          -47          -36          -33
        Outlays.......................         89           56           10           16           14           10
                                       -----------------------------------------------------------------------------
          Total deficit increase (-)..       -213         -155          -67          -63          -49          -43

     (6) 2005 Budget
        Receipts......................      1,798        2,036        2,206        2,351        2,485        2,616
        Outlays.......................      2,319        2,400        2,473        2,592        2,724        2,853
                                       -----------------------------------------------------------------------------
          Unified budget deficit (-)..       -521         -364         -268         -241         -239         -237

    ----------------------------------------------------------------------------------------------------------------
    Note: Changes in interest costs due to receipts changes included in outlay lines.

      Technical factors (block 4) are all changes in budget estimates that
    are not due to changes in economic assumptions or legislation. Examples
    of technical factors are revised demographic data from the 2000 Census
    and changes in estimating methodologies, including changes in the
    relationship between economic variables, income reported on tax returns,
    and actual tax collections.

    [[Page 177]]

                        Structural and Cyclical Balances

      When the economy is operating below potential and the unemployment
    rate exceeds the long-run sustainable average, as is projected to be the
    case for the next few years, receipts are lower than they would be if
    resources were more fully employed, and outlays for unemployment-
    sensitive programs (such as unemployment compensation and food stamps)
    are higher. As a result, the deficit is larger (or the surplus is
    smaller) than would be the case if the unemployment rate were at the
    sustainable long-run average. The portion of the deficit (or surplus)
    that can be traced to this factor is called the cyclical component. The
    portion that would remain if the unemployment rate was at its long-run
    value is called the structural deficit (or structural surplus).
      The structural balance can often provide a clearer understanding of
    the stance of fiscal policy than the unadjusted budget balance including
    the cyclical component. The structural balance shows the surplus or
    deficit that will persist even when the economy is operating at the
    sustainable level of unemployment.
      The estimates of the structural balance are based on the relationship
    between changes in the unemployment rate and real GDP growth on the one
    hand, and receipts and outlays on the other. As such, the relationships
    do not take into account other possible changes in the economy that
    might also be cyclically related. For example, the sharply rising stock
    market during the second half of the 1990s boosted capital gains-related
    receipts, and the subsequent fall in the stock market reduced receipts.
    Some of this rise and fall was cyclical in nature. It is not possible,
    however, to estimate this cyclical component accurately. As a result,
    both the unadjusted and structural balances are affected by cyclical
    stock market movements.
      From 1998 to 2001, the unemployment rate appears to have been lower
    than could be sustained in the long run. Therefore, as shown in Table
    11-5, in 1998 the structural surplus of $22 billion was less than the
    actual surplus of $69 billion. Likewise, in 1999-2001, the structural
    surplus continued to be smaller than the actual surplus, which was
    enlarged by the boost to receipts and the reduction in outlays
    associated with the low level of unemployment.
      On the other hand, in 2002, the unemployment rate was above what is
    currently thought to be the sustainable level and the actual deficit of
    $158 billion exceeded the structural deficit of $104 billion. Similarly
    in 2003, the actual deficit of $375 billion contained a cyclical
    component of about $74 billion. The structural deficit for that year was
    $302 billion. As the projected unemployment rate declines toward the
    sustainable level in the next few years, the projected unadjusted
    deficit is

    [[Page 178]]

    expected to decline to be about equal to the structural deficit in 2007
    and thereafter.
      In the early 1990s, large swings in net outlays for deposit insurance
    (the saving and loan bailouts) had substantial impacts on deficits, but
    had little concurrent impact on economic performance. It therefore
    became customary to estimate an adjusted structural balance that removed
    deposit insurance outlays as well as the cyclical component of the
    budget balance from the actual balance. Deposit insurance net outlays
    are projected to be very small negative numbers in the coming years.
    Therefore, the adjusted structural deficit and the structural deficit
    are nearly identical over the forecast horizon.

                                                            Table 11-5.  ADJUSTED STRUCTURAL BALANCE
                                                                    (In billions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    1998     1999     2000     2001     2002     2003     2004     2005     2006     2007     2008     2009
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Unadjusted surplus or deficit (-)...........     69.2    125.6    236.4    127.4   -157.8   -375.3   -520.7   -363.6   -267.6   -241.3   -239.0   -237.1
      Cyclical component........................     47.5     72.8    110.2     49.0    -53.4    -73.6    -39.1    -15.3     -5.1     -1.4      -.1  .......
                                                 -----------------------------------------------------------------------------------------------------------
    Structural surplus or deficit (-)...........     21.7     52.7    126.3     78.4   -104.4   -301.7   -481.6   -348.3   -262.6   -239.9   -239.0   -237.1
      Deposit insurance outlays.................     -4.4     -5.3     -3.1     -1.4     -1.0     -1.4     -1.5     -1.5     -1.0     -1.2     -1.9     -2.0
                                                 -----------------------------------------------------------------------------------------------------------
    Adjusted structural surplus or deficit (-)..     17.4     47.4    123.2     77.0   -105.5   -303.1   -483.1   -349.8   -263.6   -241.1   -240.8   -239.1
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Note: The NAIRU is assumed to be 5.2% through calendar year 1998 and 5.1% thereafter.

                Sensitivity of the Budget to Economic Assumptions

      Both receipts and outlays are affected by changes in economic
    conditions. This sensitivity complicates budget planning because errors
    in economic assumptions lead to errors in the budget projections. It is
    therefore useful to examine the implications of possible changes in
    economic assumptions. Many of the budgetary effects of such changes are
    fairly predictable, and a set of rules of thumb embodying these
    relationships can aid in estimating how changes in the economic
    assumptions would alter outlays, receipts, and the surplus or deficit.
    These rules of thumb should be understood as suggesting orders of
    magnitude; they ignore a long list of secondary effects that are not
    captured in the estimates.
      Economic variables that affect the budget do not usually change
    independently of one another. Output and employment tend to move
    together in the short run: a high rate of real GDP growth is generally
    associated with a declining rate of unemployment, while moderate or
    negative growth is usually accompanied by rising unemployment. In the
    long run, however, changes in the average rate of growth of real GDP are
    mainly due to changes in the rates of growth of productivity and labor
    force, and are not necessarily associated with changes in the average
    rate of unemployment. Inflation and interest rates are also closely
    interrelated: a higher expected rate of inflation increases interest
    rates, while lower expected inflation reduces rates.
      Changes in real GDP growth or inflation have a much greater cumulative
    effect on the budget over time if they are sustained for several years
    than if they last for only one year. Highlights of the budgetary effects
    of the above rules of thumb are shown in Table 11-6.
      For real growth and employment:
        As shown in the first block, if in 2004 for one year only,
              real GDP growth is lower by one percentage point and the
              unemployment rate permanently rises by one-half percentage
              point relative to the budget assumptions, the fiscal year 2004
              deficit is estimated to increase by $12.2 billion; receipts in
              2004 would be lower by $9.3 billion, and outlays would be
              higher by $2.9 billion, primarily for unemployment-sensitive
              programs. In fiscal year 2005, the estimated receipts
              shortfall would grow further to $20.8 billion, and outlays
              would increase by $7.4 billion relative to the base, even
              though the growth rate in calendar 2005 equaled the rate
              originally assumed. This is because the level of real (and
              nominal) GDP and taxable incomes would be permanently lower,
              and unemployment permanently higher. The budget effects
              (including growing interest costs associated with larger
              deficits) would continue to grow slightly in each successive
              year. During 2004-2009, the cumulative increase in the budget
              deficit is estimated to be $187 billion.
        The budgetary effects are much larger if the real growth
              rate is permanently reduced by one percentage point and the
              unemployment rate is unchanged, as shown in the second block.
              This scenario might occur if trend productivity were
              permanently lowered. In this example, during 2004-2009, the
              cumulative increase in the budget deficit is estimated to be
              $511 billion.
        The third block shows the effect of a one percentage point
              higher rate of inflation and one percentage point higher
              interest rates during calendar year 2004 only. In subsequent
              years, the price level and nominal GDP would be one percent
              higher than in the base case, but interest rates and future
              inflation rates are assumed to return to their base levels. In
              2005, outlays would be above the base by $22.2 billion, due in
              part to lagged cost-of-living adjustments; receipts would rise
              $22.3 billion above the base, however, resulting in a $0.1
              billion improvement in the budget balance. In subsequent
              years, the amounts added to receipts would continue to be
              larger than the additions to outlays. During 2004-2009,
              cumulative

    [[Page 179]]

              budget deficits would be $23 billion smaller than in the base
              case.
        In the fourth block example, the rate of inflation and the
              level of interest rates are higher by one percentage point in
              all years. As a result, the price level and nominal GDP rise
              by a cumulatively growing percentage above their base levels.
              In this case, the effects on receipts and outlays mount
              steadily in successive years, adding $365 billion to outlays
              over 2004-2009 and $442 billion to receipts, for a net
              decrease in the 2004-2009 deficits of $78 billion.
      The table also shows the interest rate and the inflation effects
    separately. These separate effects for interest rates and inflation
    rates do not sum to the effects for simultaneous changes in both. This
    occurs largely because the gains in budget receipts due to higher
    inflation result in higher debt service savings when interest rates are
    assumed to be higher as well (the combined case) than when interest
    rates are assumed to be unchanged (the separate case).
        The outlay effects of a one percentage point increase in
              interest rates alone is shown in the fifth block. The receipts
              portion of this rule-of-thumb is due to the Federal Reserve's
              deposit of earnings on its securities portfolio.
        The sixth block shows that a sustained one percentage point
              increase in the GDP chain-weighted price index and in CPI
              inflation decrease cumulative deficits by a substantial $257
              billion during 2004-2009. This large effect is because the
              receipts from a higher tax base exceeds the combination of
              higher outlays from mandatory cost-of-living adjustments and
              lower receipts from CPI indexation of tax brackets.
      The last entry in the table shows rules of thumb for the added
    interest cost associated with changes in the budget deficit.
      The effects of changes in economic assumptions in the opposite
    direction are approximately symmetric to those shown in the table. The
    impact of a one percentage point lower rate of inflation or higher real
    growth would have about the same magnitude as the effects shown in the
    table, but with the opposite sign.

    [[Page 180]]

                             Table 11-6.  SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
                                                (In billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                                                                           Total of
            Budget effect            2004        2005        2006        2007        2008        2009      Effects,
                                                                                                           2004-2009
    ----------------------------------------------------------------------------------------------------------------
     Real Growth and Employment

    Budgetary effects of 1
     percent lower real GDP
     growth:
      (1) For calendar year 2004
       only: \1\
        Receipts................        -9.3       -20.8       -23.8       -24.9       -26.1       -27.5      -132.6
        Outlays.................         2.9         7.4         7.8         9.7        12.0        14.3        54.1
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-       -12.2       -28.3       -31.6       -34.6       -38.2       -41.8      -186.7
           )....................

      (2) Sustained during 2004-
       2009, with no change in
       unemployment:
        Receipts................        -9.5       -32.5       -61.1       -91.6      -124.7      -160.7      -480.1
        Outlays.................        -0.1         0.1         1.4         4.5         9.4        15.7        31.0
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-        -9.3       -32.6       -62.5       -96.0      -134.1      -176.5      -511.1
           )....................

    Inflation and Interest Rates

    Budgetary effects of 1
     percentage point higher
     rate of:
      (3) Inflation and interest
       rates during calendar
       year 2004 only:
        Receipts................        10.6        22.3        22.8        21.6        22.7        23.9       123.9
        Outlays.................        11.3        22.2        19.1        16.9        16.2        15.3       101.0
                                 -----------------------------------------------------------------------------------
          Decrease in deficit           -0.6         0.1         3.7         4.7         6.5         8.6        22.9
           (+)..................

      (4) Inflation and interest
       rates, sustained during
       2004-2009:
        Receipts................        10.6        34.1        59.4        84.4       111.8       142.2       442.5
        Outlays.................        11.5        34.3        53.9        71.3        88.2       105.7       364.8
                                 -----------------------------------------------------------------------------------
          Decrease in deficit           -0.9        -0.1         5.6        13.1        23.6        36.5        77.7
           (+)..................

      (5) Interest rates only,
       sustained during 2004-
       2009:
        Receipts................         1.8         4.4         5.7         6.4         7.0         7.7        33.0
        Outlays.................         9.4        25.1        35.3        42.9        49.8        56.9       219.4
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-        -7.6       -20.7       -29.7       -36.5       -42.8       -49.2      -186.5
           )....................

      (6) Inflation only,
       sustained during 2004-
       2009:
        Receipts................         8.8        29.6        53.6        77.7       104.4       134.0       408.2
        Outlays.................         2.1         9.4        19.1        29.4        40.1        51.4       151.4
                                 -----------------------------------------------------------------------------------
          Decrease in deficit            6.7        20.2        34.5        48.3        64.3        82.7       256.7
           (+)..................

       Interest Cost of Higher
          Federal Borrowing

    (7) Outlay effect of $100            0.6         2.2         3.4         4.3         5.1         5.5        21.2
     billion increase in the
     2004 unified deficit.......

    ----------------------------------------------------------------------------------------------------------------
    * $50 million or less.
    \1\ The unemployment rate is assumed to be 0.5 percentage point higher per 1.0 percent shortfall in the level of
      real GDP.