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

      Five years ago, at the beginning of the new millennium, optimism about
    the Nation's economic future abounded, but that period of optimism was
    followed by a succession of shocks whose cumulative severity was as
    great as any previous setback in the postwar period. Now, five years
    later, the effects of these shocks have been overcome and faith in the
    economy and the future are once again on the rise.

                                 Negative Shocks

      Six substantial shocks buffeted the economy starting in 2000.
      The stock market bubble  burst in March 2000; by October 2002, the
    market had lost half its value. Household equity wealth fell by $7
    trillion, wiping out two-thirds of the equity gain from the last half of
    the 1990s.
      Business investment slowed to a trickle beginning in mid-2000 as the
    stock market decline mirrored a dramatic revision in business
    expectations, and collapsed the following year as firms began to work
    off a huge overhang of what was now perceived to be excess capital. The
    over-investment was due in part to inflated expectations about the
    return on new technology and to a surge in Y2K-related computer hardware
    and software investment that ended abruptly in 2000. Not until 2003 did
    capital spending turn up. This nearly three-year slump was one of the
    longest and deepest in the postwar period.
      The terrorist attacks of September 11th and the possibility of even
    more dangerous attacks depressed consumer and business confidence for a
    time, while substantially increasing the resources that governments,
    families, and businesses needed to devote to security measures. The War
    on Terror, especially as fought through the campaigns in Afghanistan and
    Iraq, also contributed to heightened uncertainties. The increased
    uncertainty hampered investment planning and contributed to the slump in
    investment spending.
      Corporate accounting scandals were uncovered throughout 2002-2003.
    Although the scandals had been long in the making, their sudden
    revelation came as a further shock to confidence. The subsequent
    bankruptcy of some once-well-regarded corporations further shook
    investor confidence, and the revelation of conflicts of interest at
    several major accounting firms and Wall Street brokerage houses cast
    doubt on the reliability of the information and advice provided by them,
    again making investors leery of putting money at risk in the market. The
    scandals and the reaction to them had the effect of prolonging the slump
    in business investment.
      Recession or slumping growth mired major U.S. trading partners for
    most of this period which restrained U.S. exports, especially of
    manufactured goods. Output in Japan and in the European Union grew only
    1 percent per year on average during 2001-2003; outright declines
    occurred in several countries during this period.
      Oil prices doubled in 2003-2004. The benchmark price of West Texas
    intermediate crude oil jumped from $28 per barrel in May, 2003, to $55
    at its peak in late October, 2004. Prices moved down thereafter, closing
    the year at $42. On balance, however, the rise in oil prices slowed U.S.
    growth during 2004.

                                 Timely Response

      Policymakers responded quickly and appropriately to this series of
    adverse shocks. Expansionary policies, both fiscal and monetary, were
    adopted in a timely manner, and when combined with the inherent
    resilience of the American economy, succeeded in overcoming the forces
    of restraint and minimizing the actual downturn in 2001. From the peak
    in the fourth quarter of 2000 to its low point in the third quarter of
    2001, real Gross Domestic Product (GDP) edged down a mere 0.2 percent.
    Partly because of quick policy action, both consumer spending and
    housing investment held up much better during the 2001 slump than in
    previous business downturns, which helped limit the decline in real
    output. During the subsequent recovery through mid-2003, however, growth
    was not as robust as usual, which is not surprising in light of the
    shocks that continued to buffet the economy and the relatively mild
    downturn that limited the likely size of the rebound.
      Policymakers responded to the disappointing recovery by providing
    additional fiscal and monetary stimulus. This renewed stimulus worked,
    and as a result, the economy has achieved robust growth and an improved
    labor market since mid-2003 without a significant increase in inflation
    or interest rates. As 2005 begins, the near-term economic outlook is
    promising. A wide range of indicators suggests that the economy will
    continue to expand at faster than normal rates of growth. More than 100
    thousand new jobs are being created monthly, adding to the purchasing
    power of workers; consumer spending remains strong; businesses' capital
    spending is growing at a rapid rate, and order books are lengthening;
    home sales have reached record levels, boosting home prices and
    household wealth; and manufacturing production and exports are again
    expanding. The stock market finally bottomed in 2002, and it has risen
    sharply since last August, adding to household wealth and reducing the
    cost of capital to business. By early 2005, the major stock market
    indices had reached their highest levels since mid-2001.
      Looking beyond the next few years, the outlook is also encouraging.
    Over the long-run, the growth of out

    [[Page 188]]

    put and the standard of living depend critically on productivity growth,
    and there is reason to be optimistic here. Productivity growth
    accelerated in the second half of the 1990s, and surprisingly in view of
    the shocks of recent years, it stepped up again after 2000 to reach a
    pace not seen in over fifty years. A slowdown from this torrid pace is
    expected by the Administration and most other forecasters, but even with
    a slowdown, productivity growth is expected to remain strong over the
    next decade, and with it the rise in the standard of living.
      The Administration's near- and medium-term economic projections assume
    that the economy will not face exceptional disturbances in the coming
    years, unlike the last five. With that provision, the Administration
    anticipates strong, sustained growth, rising employment, and relatively
    low inflation and interest rates. The economic assumptions underlying
    the budget are close to those of the consensus of private-sector
    forecasts, and for real growth below those of the Congressional Budget
    Office. The prospects of a lengthy sustained expansion, exceptionally
    high productivity growth, and the Administration's policies mean that
    actual performance could exceed the official projections. In the
    interest of sound, prudent budgeting, however, the Administration has
    adopted a cautious economic forecast.

                                 Policy Actions

      Fiscal Policy: The Administration proposed, and Congress enacted,
    significant tax relief in each of the past four years designed to
    overcome the shocks that were restraining the economy and restore strong
    growth of output, income, and jobs. In addition to providing much needed
    near-term stimulus, the 2001 and 2003 Acts also were designed to raise
    long-term growth by reducing the disincentives and distortions in the
    tax system. These Acts reduced marginal tax rates on income, dividends,
    and capital gains. Lower tax rates encourage individuals and businesses
    to produce more, save more, and invest more. More saving and investment
    create capital, add to economic growth, and raise the standard of
    living. The combined tax relief from the four Acts totaled $68 billion
    in fiscal year 2001, $89 billion in 2002, $159 billion in 2003, and $272
    billion in 2004, moderating to $189 billion in 2005.
      Economic Growth and Tax Relief and Reconciliation Act: This act
    lowered marginal income tax rates; reduced the marriage tax penalty; and
    created a new, lower 10 percent tax bracket, among other changes. In
    July 2001, near the low point of the 2001 recession, taxpayers began
    receiving rebate checks reflecting their lower liability with the new 10
    percent bracket; lower withholding schedules also went into effect at
    that time. With the benefit of hindsight, the fiscal stimulus from the
    tax relief was exceptionally well-timed: economic growth during the
    prior half-year had ground to a halt, yet it had resumed by year-end
    despite the terrorist attacks on September 11th.
      Job Creation and Worker Assistance Act: In March 2002, the President
    signed this Act, which was designed to halt the ongoing slide in
    business capital spending and to aid unemployed workers. The Act
    permitted immediate depreciation of 30 percent of the value of qualified
    new capital assets put in place during the three years ending in
    September 11, 2004. Accelerated depreciation provided an incentive for
    firms to invest. For a limited time, more of a qualified investment
    could be written-off for tax purposes, thereby lowering the cost of
    capital and providing an incentive for firms to speed up their capital
    spending. The Act also extended unemployment insurance benefits to
    workers who had exhausted their normal benefits.
      Jobs and Growth Tax Relief Reconciliation Act: In May 2003, the
    President signed both another extension of unemployment insurance
    benefits and the 2003 jobs and growth tax cut, which was designed to
    invigorate the lackluster recovery then underway. The Act lowered income
    tax rates, reduced the marriage penalty, raised the child tax credit,
    and raised the exemption amount for the individual Alternative Minimum
    Tax. Significantly, the Act reduced income tax rates on dividend income
    and capital gains, which reduced distortions in the tax code from the
    double taxation of corporate earnings. To stimulate business capital
    spending further, the Act raised the percentage of an asset's value that
    could be expensed immediately from 30 to 50 percent and lengthened the
    window of opportunity for businesses to take advantage of this benefit
    from September 11, 2004 to the end of the year. The Act also improved
    the outlook for small business investment and hiring by raising the
    maximum amount that a small business could expense from $25,000 per year
    to $100,000.
      Working Families Tax Relief Act: In October 2004, the President signed
    this Act, which extended parts of the President's tax relief plan that
    were scheduled to expire at the end of 2004 and reinstated several
    expired or expiring business-related tax incentives. In doing so, the
    Act protected taxpayers from several scheduled tax increases. The Act
    also provided tax relief to certain military personnel with families,
    and simplified the tax code for many families by creating a uniform
    definition of a qualifying child for tax purposes.
      The short-term benefits of the substantial tax relief of the past four
    years are evident in the strong expansion now underway. The longer-term
    benefits will be apparent in a more efficient allocation of the Nation's
    resources in coming years and a sustained increase in economic activity.

      Monetary Policy: During the past four years, monetary policy has been
    focused on overcoming negative shocks and restoring strong, sustained
    growth. From the beginning of 2001 through mid-2003, the Federal Reserve
    lowered the target Federal funds rate 13 times, from 6\1/2\ percent to 1
    percent. That low rate was maintained until June 2004 when the Federal
    Reserve began to increase the funds rate gradually. Over the course of
    2004, it became increasingly evident that the economy was once again
    growing strongly and labor mar

    [[Page 189]]

    kets were improving, which reduced the need for monetary stimulus.
      By December 2004, the Federal Reserve had raised the funds rate to
    2\1/4\ percent, a level that it believed was still accommodative. In its
    statement accompanying the December increase, the Federal Reserve
    indicated that it intended to move at a measured pace to reduce the
    accommodative stance of monetary policy further. As of early January,
    financial futures markets expected the funds rate to reach 3 percent by
    the end of 2005.
      As a result of the accommodative monetary policy along with low
    expected inflation and sub-par growth, interest rates fell sharply from
    mid-2000 to mid-2003. The 91-day Treasury bill rate tracked the path of
    the funds rate, dropping by about 5 percentage points from its 2000 peak
    to a plateau of about 1 percent from mid-2003 to mid-2004, then rising
    to 2.2 percent by the end of 2004. As is usually the case, the swings in
    the longer-term interest rates were less than those of short-term rates.
    The yield on the 10-year Treasury note, for example, fell three
    percentage points from mid-2000 to 3.2 percent by mid-2003. This was its
    lowest level since the late 1950s. The yield fluctuated around a mild
    upward trend from mid-2003 to the end of 2004, finishing the year at 4.2
    percent, a level that is still relatively low.
      Private-sector financial instruments followed a similar pattern to
    U.S. Treasuries. The rate on 30-year fixed rate mortgages, for example,
    fell to 5.2 percent in June 2003, which was its lowest level since the
    early 1960s. The mortgage rate, like the long-term Treasury yield, then
    fluctuated around an upward trend and by the end of December 2004 had
    reached a level of 5.7 percent. Even so, the mortgage rate remained
    below its level in any month from the mid-1960s to early-2003.
      Low interest rates have spurred interest-sensitive spending on such
    items as motor vehicles and housing. They have enabled homeowners to
    refinance their mortgages, saving on mortgage payments and enabling
    families to access some of their built-up home equity. Lower interest
    rates have enabled consumers, businesses, and governments to reduce
    their interest expenses. Finally, low rates have helped support the
    stock market.
      In late 2002, the stock market responded to the cumulative effects of
    fiscal and monetary stimulus and the prospects of strong, sustained
    growth. Equity prices rose rapidly from the end of the third quarter of
    2002 through the end of 2003. After remaining about unchanged during the
    first eight months of 2004, equity prices rose strongly once again. All
    told, from the beginning of October 2002 to the end of 2004, the S&P 500
    and the Dow Jones Industrial Average gained about 45 percent; the hard-
    hit, technology-laden NASDAQ soared 85 percent. By the end of 2004, the
    S&P, NASDAQ and the Dow were at their highest levels since June 2001.

                               Recent Developments

      Economic Growth: Beginning in the second quarter of 2003, the
    contractionary forces that had held back growth during the initial phase
    of the recovery gave way to stronger forces of expansion. During the
    year ending in the first quarter of 2004, inflation-adjusted Gross
    Domestic Product (GDP) increased 5.0 percent, the fastest advance of any
    four-quarter period in nearly two decades. Growth moderated to a 3.3
    percent pace in the second quarter, but then picked up in the third
    quarter to a substantial 4.0 percent rate. Growth in the fourth quarter
    continued at a healthy pace. (Official estimates of fourth quarter
    growth were not available at the time the Budget was printed.) Although
    still relatively strong, growth in 2004 was hampered by the rise in oil
    prices.
      Labor Market: In response to this stronger growth of output, the labor
    market also improved markedly. The Nation's payrolls began to increase
    in September 2003; by December 2004, there were 2.5 million more jobs
    than at the August low. (Based on preliminary indications from the
    Bureau of Labor Statistics, this figure is likely to be revised up, to
    at least 2.6 million, in the benchmark revision that will become
    available in early February after the Budget is printed.) The
    unemployment rate, which reached a peak of 6.3 percent in June 2003,
    fell to 5.4 percent by December 2004. Although still above its long-run
    sustainable rate, the level of the unemployment rate at the end of last
    year was lower than the average for the decades of the 1970s, 1980s, and
    1990s.
      Components of Aggregate Demand: During the six quarters from the
    second quarter of 2003 through the third quarter of 2004 (the latest
    quarter available when the Budget went to press), real GDP grew at a
    robust 4.6 percent annual average rate. That was a significant
    improvement from the sub-par 2.1 percent average pace during the first
    six quarters of the recovery. Faster growth of both consumer and
    business spending were largely responsible for the shift.
      Consumer spending accounts for 70 percent of GDP, so its faster growth
    recently played a significant role in boosting overall growth. Consumer
    confidence took an upturn in early 2003, and as labor markets began to
    improve a few months later, consumers became increasingly willing and
    able to spend. During the six quarters ending in the third quarter of
    2004, real consumer spending increased at a 3.9 percent annual rate, up
    from 3.3 percent during the prior six quarters. The saving rate, which
    had already declined to a historically low 1.0 percent by early 2003,
    fell even further to a mere 0.3 percent by November 2004. Underlying the
    gains in consumer spending have been increasing household wealth, led by
    higher home and stock prices, and rising after-tax incomes, supported by
    an improving labor market and tax relief.
      Low mortgage interest rates and growing incomes also contributed to an
    exceptionally strong housing market. During the six quarters ending in
    the third

    [[Page 190]]

    quarter of 2004, real residential investment rose at a 10.5 percent
    average annual rate, a considerable step up from the 5.2 percent pace
    during the initial six quarters of the expansion. Housing starts during
    the six quarters through the third quarter of last year were at the
    highest level in 25 years; home sales were at the highest level since
    recordkeeping began in the 1960s. Housing starts, home sales, and real
    residential investment eased during the second half of 2004, in part
    because of the rise in mortgage rates from their 2003 lows and in part
    because housing activity had risen to unsustainable levels. While the
    level of housing investment is expected to remain strong, housing is not
    projected to lead the expansion in 2005-2010.
      The turnaround in business capital spending  was even more dramatic
    and it contributed significantly to the step-up in the pace of overall
    economic activity. During the latest six quarters of available data,
    real business fixed investment grew at an average annual rate of 11.3
    percent. In contrast, investment fell at a 6.2 percent pace during the
    prior six quarters. Underlying the recovery of capital spending has been
    the acceleration of overall output, more favorable financial conditions
    including low interest rates, a rising stock market, and the temporary
    provision of accelerated depreciation that expired at the end of 2004.
    Business investment is expected to continue at a rapid rate as the
    expansion matures.
      The foreign sector was a small drag on overall growth during the six
    quarters through the third quarter of 2004, trimming about one-third of
    a percentage point from GDP growth. That was an improvement over the
    first six quarters of the expansion when net exports reduced growth by
    about three-quarters of a percentage point on average. Throughout the
    expansion, growth of U.S. exports was restrained by slow growth
    overseas. The exchange value of the dollar peaked in February 2002,
    declining 12 percent on a trade-weighted basis against the currencies of
    our major trading partners by September 2004. During the last three
    months of 2004, the dollar declined another six percent, which should
    work to reduce the U.S. trade imbalance during 2005. Although this has
    been a substantial decline, it has merely retraced an earlier run-up so
    that by mid-January 2005 the dollar had returned to its level of 1997.
      The government sector grew more slowly during the latest six quarters.
    Real Federal purchases continued to grow strongly, at a 6.1 percent
    annual rate, led by spending on the War on Terror, but real State and
    local purchases increased at a slow 0.3 percent pace, down from 2.4
    percent during the first six quarters of the expansion. State and local
    governments restrained spending to cope with exceptionally large fiscal
    deficits created by the sharp fall-off in revenues from mid-2001 to
    early-2002. Although State and local government revenues are on the rise
    again, their combined revenues had only returned to their level in early
    2001 by the third quarter of 2004.
      Productivity Growth: In contrast to the initial six quarters of the
    expansion when output growth was entirely accounted for by strong
    productivity growth, during the subsequent six quarters both increased
    labor hours and productivity have contributed to increased output. Since
    the official business cycle peak in the first quarter of 2001,
    productivity has risen at a remarkable 4.2 percent average annual rate.
    By way of contrast, during 1996 through 2000, productivity growth
    averaged 2.5 percent per year, and during 1974 through 1995,
    productivity growth was a mere 1.4 percent on average. Usually
    productivity growth surges temporarily during the initial phase of a
    recovery and then slows markedly. In the current expansion, productivity
    growth during the six quarters ending in the third quarter of 2004 was
    even faster than during the prior six quarters.
      The exceptional productivity performance during the last four years
    has helped keep inflation low and thereby enabled the Federal Reserve to
    focus monetary policy on overcoming shocks and restoring sustainable
    growth. Because of robust productivity growth, businesses have not had
    to rely on labor input to the extent they otherwise might have, which
    has hampered employment. Over the long term, however, the faster the
    growth of productivity, the faster will be the growth of our output and
    standard of living. In the long run, faster productivity growth will not
    permanently restrain employment growth.
      Inflation: The Consumer Price Index (CPI) rose 3.3 percent during
    2004, up from 1.9 percent during 2003. Much of the pick up was due to a
    surge in energy prices, which rose at a 17 percent annual rate, compared
    with just 7 percent during 2003. Excluding the volatile food and energy
    components, the core CPI rose 2.2 percent during 2004, compared with 1.1
    percent during 2003.
      Higher energy prices may have indirectly contributed to higher core
    inflation as they fed through to the costs of non-energy goods and
    services. Businesses also may have increased their markup of prices over
    unit labor costs, which had been subdued by weak demand earlier in the
    expansion. Reflecting the decline in crude oil prices in the closing
    months of 2004, gasoline prices moved down in November and December,
    suggesting that the energy-related upward push on the CPI was abating.
      Summary: Entering 2005, the economy appears poised for continued
    strong expansion. Overall growth, led by consumer and business spending,
    is at a pace that suggests the steady creation of new jobs and a lower
    unemployment rate. Core inflation, although higher than in 2003, is
    still relatively low. Interest rates, too, are at historically low
    levels.

                              Economic Projections

      The Administration's economic projections, based on information
    available as of early December, are summarized in Table 12-1. These
    assumptions are close to those of the Congressional Budget Office and
    the con

    [[Page 191]]

    sensus of private-sector forecasters, as described in more detail below
    and shown in Table 12-2. In brief, the assumptions call for a
    continuation of the recent trends of strong, sustained growth, improving
    labor markets, low inflation, and, even allowing for a projected rise in
    the next few years, relatively low interest rates.
      Real GDP, Potential GDP, and Unemployment Rate: Real GDP, which is
    estimated to have increased 4.4 percent in 2004 on a year-over-year
    basis, is projected to increase 3.6 percent this year. During the next
    few years, growth is likely to continue to exceed the long-run potential
    growth rate. As a result, the unemployment rate, at 5.4 percent in
    December, is projected to decline to 5.1 percent at the end of 2006 and
    then remain at that level. That rate is the center of the range that is
    thought to be consistent with stable inflation. The main sources of
    growth in demand in coming years are likely to be business capital
    spending, net exports, and to a lesser extent, consumer spending. The
    contributions to overall growth from residential investment and the
    government sector are expected to be small at best.

                                                              Table 12-1.  ECONOMIC ASSUMPTIONS \1\
                                                          (Calendar years; dollar amounts in billions)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                          Projections
                                                   Actual   2003  ------------------------------------------------------------------------------------------
                                                                       2004         2005         2006         2007         2008         2009         2010
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Gross Domestic Product (GDP):
      Levels, dollar amounts in billions:
        Current dollars.........................       11,004         11,731       12,392       13,083       13,797       14,537       15,306       16,112
        Real, chained (2000) dollars............       10,381         10,842       11,233       11,626       12,011       12,395       12,782       13,179
        Chained price index (2000=100), annual          106.0          108.3        110.4        112.6        114.9        117.3        119.8        122.3
         average................................
      Percent change, fourth quarter over fourth
       quarter:
        Current dollars.........................          6.2            6.3          5.5          5.6          5.4          5.4          5.3          5.3
        Real, chained (2000) dollars............          4.4            3.9          3.5          3.4          3.2          3.2          3.1          3.1
        Chained price index (2000=100)..........          1.7            2.3          1.9          2.0          2.1          2.1          2.1          2.1
      Percent change, year over year:
        Current dollars.........................          4.9            6.6          5.6          5.6          5.5          5.4          5.3          5.3
        Real, chained (2000) dollars............          3.0            4.4          3.6          3.5          3.3          3.2          3.1          3.1
        Chained price index (2000=100)..........          1.8            2.1          1.9          2.0          2.1          2.1          2.1          2.1

    Incomes, billions of current dollars:
        Corporate profits before tax............          874            998        1,307        1,276        1,265        1,266        1,270        1,292
        Wages and salaries......................        5,104          5,345        5,649        5,988        6,340        6,719        7,104        7,502
        Other taxable income \2\................        2,311          2,451        2,549        2,675        2,798        2,917        3,047        3,181

    Consumer Price Index: \3\
        Level (1982-84=100), annual average.....        184.0          188.9        193.4        197.8        202.5        207.4        212.4        217.5
        Percent change, fourth quarter over               1.9            3.4          2.0          2.3          2.4          2.4          2.4          2.4
         fourth quarter.........................
        Percent change, year over year..........          2.3            2.7          2.4          2.3          2.4          2.4          2.4          2.4

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

    Federal pay raises, January, percent:
        Military \4\............................          4.7           4.15          3.5          3.1           NA           NA           NA           NA
        Civilian \5\............................          4.1            4.1          3.5          2.3           NA           NA           NA           NA

    Interest rates, percent:
        91-day Treasury bills \6\...............          1.0            1.4          2.7          3.5          3.8          4.0          4.1          4.2
        10-year Treasury notes..................          4.0            4.3          4.6          5.2          5.4          5.5          5.6          5.7
    --------------------------------------------------------------------------------------------------------------------------------------------------------
     NA = Not Available.
    \1\ Based on information available as of December 3, 2004.
    \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; 2003 and 2004 figures are averages of various rank- and longevity- specific adjustments; percentages to be
      proposed for years after 2006 have not yet been determined.
    \5\ Overall average increase, including locality pay adjustments. Percentages to be proposed for years after 2006 have not yet been determined.
    \6\ Average rate, secondary market (bank discount basis).

      Potential growth is approximately equal to the sum of the trend rates
    of growth of the labor force and of productivity. Potential GDP growth
    is projected to be 3.2 percent through 2008, and then edge down to 3.1
    percent during 2009-2010, primarily because of an assumed slowing in
    labor force growth. The labor force is projected to grow about 1.2
    percent per year through 2008 on average, slowing to about 0.8 percent
    yearly on average during 2009-2010 as increasing numbers of baby boomers
    enter retirement.
      Trend productivity growth is assumed, conservatively, to be 2.6
    percent per year. That pace is noticeably below the average since the
    business cycle peak in the first quarter of 2001 (4.2 percent per year).
    It is, however, close to the pace during 1996-2000 (2.5 percent) and not
    far from the average since the official productivity series began in
    1947 (2.3 percent).

    [[Page 192]]

      Inflation: Inflation increased in 2004, in large part because of the
    surge in energy prices. With the recent easing of these prices,
    inflation is likely to be lower in 2005. On a year-over-year basis, the
    CPI is projected to increase 2.4 percent this year and remain close to
    that level in each year through 2010. This inflation rate is lower than
    the average during each decade of the 1970s, 1980s, and 1990s. The GDP
    chain-weighted price index is projected to increase around 2.0 percent
    in each year through 2010, slightly less than the CPI, which is the
    usual pattern.
      The forecast of low inflation reflects the current very low core
    inflation rate, modest inflationary expectations, the additional
    downward pressure on wages and prices that will persist until excess
    labor and capital resources are fully re-employed, and the Federal
    Reserve's focus on removing policy accommodation at a measured pace so
    as to avoid an over-heated economy.
      Interest Rates: As usually occurs during an expansion, interest rates
    are projected to rise. The 3-month Treasury bill rate, which was 2.2
    percent at the end of December, is expected to increase to 4.2 percent
    by 2010. The yield on the 10-year Treasury note, 4.2 percent at the end
    of last year, is projected to increase to 5.7 percent by 2010. The
    larger increase at the shorter end of the maturity spectrum than at the
    longer end is also typical of past cyclical experience.
      The forecast rates are historically low: the projected averages for 3-
    month and 10-year Treasuries during 2005-2010 are lower than the
    averages for these instruments during each decade of the 1970s, 1980s,
    and 1990s. The relatively low projected yields are due largely to the
    relatively low projected inflation rate. Adjusted for inflation, the
    projected real interest rates are close to their historical averages.
      Income Shares: The share of labor compensation in GDP is projected to
    rise from its low level in 2004 while the share of corporate profits is
    projected to decline from the unusually high levels of 2004 and
    anticipated for 2005. In recent years, growth of labor compensation
    adjusted for inflation has not kept up with the growth of productivity.
    During the projection period, however, labor compensation is expected to
    catch up, which would raise the labor share in GDP back to its
    historical average.
      Among the components of labor compensation, the wage share in GDP is
    expected to rise from its recent low level while the share of
    supplements to wages and salaries is expected to remain at around the
    high level reached in 2004. The supplement share in GDP has risen
    because of rapidly growing health insurance contributions paid by
    employers and by sharply higher employer contributions to defined-
    benefit pension plans.
      Corporate profits before tax as shown in Table 12.1 jumps sharply as a
    share of GDP in 2005 because of the end of the accelerated depreciation
    permitted by the 2002 and 2003 tax acts. Accelerated depreciation
    lowered profits before tax compared with what they otherwise would have
    been in 2003 and 2004 by allowing firms to write off more of their
    investment sooner. After 2004, however, corporate profits before tax
    will increase both because new investment will not qualify for the
    temporary acceleration and because the remaining depreciation permitted
    on investment that used this provision will be less.
      Among the other income components, the share of personal interest
    income in GDP is projected to decline reflecting the low nominal
    interest rates of recent years. The remaining shares of the tax base
    (dividends, rental income, and proprietors' income) are projected to
    remain relatively stable at around their 2004 levels.

                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 12-2 compares the 2006
    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
    generally assumes that the President's Budget proposals will be enacted.
    The CBO baseline projection assumes that current law as of the time the
    estimates are made remains forever unchanged. Despite their differing
    policy assumptions, the three sets of economic projections, shown in
    Table 12-2, 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 12-2.  COMPARISON OF ECONOMIC ASSUMPTIONS
                                                                        (Calendar years)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                    Projections
                                                                  ------------------------------------------------------------------------------   Average,
                                                                       2005         2006         2007         2008         2009         2010       2005-10
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    GDP (billions of current dollars):
      2006 Budget................................................     12,392       13,083       13,797       14,537       15,306       16,112
      CBO January................................................     12,396       13,059       13,766       14,486       15,210       15,940
      Blue Chip Consensus January \2\............................     12,398       13,066       13,762       14,496       15,265       16,098

    Real GDP (chain-weighted): \1\
      2006 Budget................................................        3.6          3.5          3.3          3.2          3.1          3.1          3.3
      CBO January................................................        3.8          3.7          3.7          3.4          3.1          2.9          3.5
      Blue Chip Consensus January \2\............................        3.6          3.4          3.2          3.2          3.1          3.3          3.3

    Chain-weighted GDP Price Index: \1\
      2006 Budget................................................        1.9          2.0          2.1          2.1          2.1          2.1          2.0
      CBO January................................................        1.8          1.5          1.7          1.8          1.8          1.8          1.7
      Blue Chip Consensus January \2\............................        2.0          2.0          2.1          2.1          2.1          2.1          2.1

    Consumer Price Index (all-urban): \1\
      2006 Budget................................................        2.4          2.3          2.4          2.4          2.4          2.4          2.4
      CBO January................................................        2.4          1.9          2.1          2.2          2.2          2.2          2.2
      Blue Chip Consensus January \2\............................        2.5          2.3          2.4          2.4          2.4          2.4          2.4

    Unemployment rate: \3\
      2006 Budget................................................        5.3          5.2          5.1          5.1          5.1          5.1          5.2
      CBO January................................................        5.2          5.2          5.2          5.2          5.2          5.2          5.2
      Blue Chip Consensus January \2\............................        5.2          5.2          5.1          5.1          5.1          5.1          5.1

    Interest rates: \3\
      91-day Treasury bills:
        2006 Budget..............................................        2.7          3.5          3.8          4.0          4.1          4.2          3.7
        CBO January..............................................        2.8          4.0          4.6          4.6          4.6          4.6          4.2
        Blue Chip Consensus January \2\..........................        3.0          3.8          4.1          4.3          4.2          4.2          3.9

      10-year Treasury notes:
        2006 Budget..............................................        4.6          5.2          5.4          5.5          5.6          5.6          5.3
        CBO January..............................................        4.8          5.4          5.5          5.5          5.5          5.5          5.4
        Blue Chip Consensus January \2\..........................        4.7          5.3          5.6          5.6          5.6          5.6          5.4
    --------------------------------------------------------------------------------------------------------------------------------------------------------
     Sources: Congressional Budget Office; Blue Chip Economic Indicators, Aspen Publishers, Inc.
    \1\ Year-over-year percent change.
    \2\ January 2005 Blue Chip Consensus forecast for 2005 and 2006; Blue Chip October 2004 long-run extension for 2007 - 2010.
    \3\ Annual averages, percent.

      For real GDP, the Administration, CBO, and the Blue Chip Consensus
    anticipate strong growth this year. The Administration projects 3.6
    percent growth on a year-over-year basis, about the same as the private
    sector consensus and slightly below CBO's forecast. For calendar year
    2006, the Administration, at 3.5 percent, is mid-way between the
    consensus (at 3.4 percent), and CBO's 3.7 percent. Thereafter, the
    Administration's projection is very close to the consensus growth rate
    but generally below CBO's. Over the six-year span as a whole, the
    Administration and the private sector consensus both project a 3.3
    percent average annual growth rate, CBO 3.5 percent.
      All three forecasts anticipate continued low inflation in the range of
    1.5 to 2.1 percent as measured by the GDP chain-weighted price index,
    and between 1.9 and 2.5 percent as measured by the CPI, with CBO lower
    than the Administration and the private sector consensus, which are
    close to each other. The three unem

    [[Page 193]]

    ployment rate projections are also similar with a projected rate just
    above 5 percent in the later years of the forecast. All three project
    slightly rising interest rates during the next few years, with CBO's
    increase slightly larger than those of the Administration and the
    private sector projection.

                         Changes in Economic Assumptions

      The economic assumptions underlying this Budget are similar to those
    of the 2005 Budget, as shown in Table 12-3.
      As in last year's Budget, real GDP growth is expected to be 3.6
    percent in 2005 on a year-over-year basis and moderate gradually to 3.1
    percent in the outyears. Consequently, the levels of real GDP projected
    this year are little changed from those of the 2005 Budget when
    allowance is made for the Commerce Department's historical revisions to
    the National Income and Product Accounts released in July 2004. The
    level of nominal GDP is now projected to be higher than in the 2005
    Budget because of a faster-than-expected rise in the GDP price index
    last year and higher projected GDP inflation in the coming years.
      The unemployment rate projection is virtually identical to last
    year's. As in the 2005 Budget, the rate is expected to decline to 5.1
    percent by 2007 and remain at that relatively low level. Interest rates
    are expected to trend upward, as before. However, by 2009 the 3-month
    Treasury bill rate is projected to be 0.3 percentage point lower than in
    the 2005 Budget, and the yield on the 10-year Treasury note is expected
    to be 0.2 percentage point lower.

                      Table 12-3.  COMPARISON OF ECONOMIC ASSUMPTIONS IN THE 2005 AND 2006 BUDGETS
                                      (Calendar years; dollar amounts in billions)
    ----------------------------------------------------------------------------------------------------------------
                                                         2004     2005     2006     2007     2008     2009     2010
    ----------------------------------------------------------------------------------------------------------------
    Nominal GDP:
      2005 Budget assumptions \1\....................   11,622   12,197   12,807   13,460   14,163   14,902   15,671
      2006 Budget assumptions........................   11,731   12,392   13,083   13,797   14,537   15,306   16,112

    Real GDP (2000 dollars):
      2005 Budget assumptions \1\....................   10,837   11,226   11,608   11,994   12,377   12,763   13,159
      2006 Budget assumptions........................   10,842   11,233   11,626   12,011   12,395   12,782   13,179

    Real GDP (percent change): \2\
      2005 Budget assumptions........................      4.4      3.6      3.4      3.3      3.2      3.1      3.1
      2006 Budget assumptions........................      4.4      3.6      3.5      3.3      3.2      3.1      3.1

    GDP price index (percent change): \2\
      2005 Budget assumptions........................      1.2      1.3      1.5      1.7      2.0      2.0      2.0
      2006 Budget assumptions........................      2.1      1.9      2.0      2.1      2.1      2.1      2.1

    Consumer Price Index (percent change): \2\
      2005 Budget assumptions........................      1.4      1.5      1.8      2.1      2.4      2.5      2.5
      2006 Budget assumptions........................      2.7      2.4      2.3      2.4      2.4      2.4      2.4

    Civilian unemployment rate (percent): \3\
      2005 Budget assumptions........................      5.6      5.4      5.2      5.1      5.1      5.1      5.1
      2006 Budget assumptions........................      5.5      5.3      5.2      5.1      5.1      5.1      5.1

    91-day Treasury bill rate (percent): \3\
      2005 Budget assumptions........................      1.3      2.4      3.3      4.0      4.3      4.4      4.4
      2006 Budget assumptions........................      1.4      2.7      3.5      3.8      4.0      4.1      4.2

    10-year Treasury note rate (percent): \3\
      2005 Budget assumptions........................      4.6      5.0      5.4      5.6      5.8      5.8      5.8
      2006 Budget assumptions........................      4.3      4.6      5.2      5.4      5.5      5.6      5.7

    ----------------------------------------------------------------------------------------------------------------
    \1\ Adjusted for July 2004 NIPA revisions.
    \2\ Year-over-year.
    \3\ Calendar year average.

                                                            Table 12-4.  ADJUSTED STRUCTURAL BALANCE
                                                                    (In billions of dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    1999     2000     2001     2002     2003     2004     2005     2006     2007     2008     2009     2010
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Unadjusted surplus or deficit (-)...........    125.5    236.2    128.2   -157.8   -377.6   -412.1   -426.6   -390.1   -312.1   -250.8   -232.9   -207.3
      Cyclical component........................     86.3    127.3     66.0    -62.8   -102.0    -60.2    -30.0    -13.4     -0.7     -0.2  .......  .......
                                                 -----------------------------------------------------------------------------------------------------------
    Structural surplus or deficit (-)...........     39.2    108.8     62.1    -95.0   -275.6   -351.9   -396.6   -376.6   -311.4   -250.6   -232.9   -207.3
      Deposit insurance outlays.................      5.3      3.1      1.6      1.0      1.4      2.0      0.3      1.0      2.3      2.3      2.2      1.8
                                                 -----------------------------------------------------------------------------------------------------------
    Adjusted structural surplus or deficit (-)..     44.5    111.9     63.7    -94.0   -274.1   -350.0   -396.3   -375.7   -309.1   -248.3   -230.7   -205.5
    --------------------------------------------------------------------------------------------------------------------------------------------------------
     NOTE: The NAIRU is assumed to be 5.2% through calendar year 1998 and 5.1% thereafter.

                        Structural and Cyclical Balances

      When the economy is operating below potential, as is projected to be
    the case for the next few years, the unemployment rate exceeds the long-
    run sustainable average consistent with price stability. As a result,
    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; the deficit is
    larger (or the surplus is smaller) than would be the case if the
    unemployment rate were at its sustainable long-run average. The portion
    of the deficit (or surplus) that can be traced to this factor can be
    called the cyclical component. The portion that would remain if the unem

    [[Page 194]]

    ployment rate was at its long-run value is then called the structural
    deficit (or structural surplus).
      Historically, the structural balance has often provided a clearer
    understanding of the stance of fiscal policy than has the unadjusted
    budget balance which includes a cyclical component. In the typical post-
    World War II business cycle, the structural balance has provided a
    clearer gauge of the surplus or deficit that would persist in the long
    run with the economy operating at the sustainable level of unemployment.
      Conventional estimates of the structural balance are based on the
    historical relationship between changes in the unemployment rate and
    real GDP growth on the one hand, and receipts and outlays on the other.
    For various reasons, these estimated relationships do not take into
    account all of the cyclical changes in the economy. One example of a
    cyclical phenomenon not captured in these estimates was the sharply
    rising stock market during the second half of the 1990s. It boosted
    capital gains-related receipts and pulled down the deficit. The
    subsequent fall in the stock market reduced receipts and added to the
    deficit. Some of this rise and fall was cyclical in nature. Receipts
    would probably be higher today, if the cyclical component were removed
    from the stock market, although recently the stock market has recovered
    some of its earlier losses with a positive effect on receipts. It is not
    possible, however, to estimate the cyclical component of the stock
    market accurately, and for that reason, all of the stock market's
    contribution to receipts is counted in the structural balance.
      Other factors unique to the current economic cycle provide other
    examples of less than complete cyclical adjustment. The extraordinary
    fall-off in labor force participation, from 67.1 percent of the U.S.
    population in 1997-2000, to 66.0 percent in 2004 appears to be

    [[Page 195]]

    at least partly cyclical in nature, and most forecasters are assuming
    some rebound in labor force participation as the expansion continues.
    Since the official unemployment rate does not include workers who have
    left the labor force, the conventional measures of potential GDP,
    incomes and Government receipts understate the extent to which potential
    work hours have been under-utilized in the current expansion to date
    because of the decline in labor force participation.
      A third example is the fall-off in the wage and salary share of GDP,
    from 49.2 percent in 2000 to 45.5 percent in the third quarter of 2004.
    Again this change is widely suspected to be at least partly cyclical.
    Since Federal taxes depend heavily on wage and salary income, the
    larger-than-predicted decline in the wage share of GDP suggests that the
    true cyclical component of the deficit is understated for this reason as
    well.
      There are also lags in the collection of tax revenue that can delay
    the impact of cyclical effects beyond the year in which they occur. The
    result is that even after the unemployment rate has fallen, receipts may
    remain cyclically depressed for some time until these lagged effects
    have dissipated.
      For all these reasons, the current estimates of the cyclical deficit
    are probably understated and perhaps by a large margin. The current
    unemployment gap is only 0.3 percentage points, and the Administration
    forecasts that the gap will be closed within two years, but in the
    broader sense discussed above, the cyclical gap in receipts is likely to
    be much larger than this and will not close as quickly.
      From 1999 to 2001, the unemployment rate appears to have been lower
    than could be sustained in the long run. Therefore, as shown in Table
    12-4, in those years the structural surplus was 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.

                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 12-6.
      For real growth and employment:
        As shown in the first block, if in 2005 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 2005
              deficit is estimated to increase by $13.0 billion; receipts in
              2005 would be lower by $10.2 billion, and outlays would be
              higher by $2.8 billion, primarily for unemployment-sensitive
              programs. In fiscal year 2006, the estimated receipts
              shortfall would grow further to $21.8 billion, and outlays
              would increase by $8.1 billion relative to the base, even
              though the growth rate in calendar year 2006 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 2005-2010, the cumulative increase in the budget
              deficit is estimated to be $195 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 2005-2010, the
              cumulative increase in the budget deficit is estimated to be
              $529 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 2005 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 and 2006, outlays would be above the base by $11.0
              billion and $19.1 billion, respectively, due in part to lagged
              cost-of-living adjustments. Receipts would fall by $10.0
              billion in 2005, due to the temporary effect of higher
              interest rates on finanical corporations' profits and taxes,
              but then would rise by $28.4 billion above the base in 2006
              due to the sustained

    [[Page 196]]

              effects of inflation on the tax base, resulting in a $9.3
              billion improvement in the 2006 budget balance. In subsequent
              years, the amounts added to receipts would continue to be
              larger than the additions to outlays. During 2005-2010,
              cumulative budget deficits would be $38 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 $388 billion to outlays
              over 2005-2010 and $492 billion to receipts, for a net
              decrease in the 2005-2010 deficits of $104 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 are 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 and
              the short-term effect of interest rate changes on financial
              corporations' profits (and taxes).
        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 2005-2010. 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 197]]

                             Table 12-5.  SENSITIVITY OF THE BUDGET TO ECONOMIC ASSUMPTIONS
                                                (In billions of dollars)
    ----------------------------------------------------------------------------------------------------------------
                                                                                                           Total of
            Budget effect            2005        2006        2007        2008        2009        2010      Effects,
                                                                                                           2005-2010
    ----------------------------------------------------------------------------------------------------------------
     Real Growth and Employment

    Budgetary effects of 1
     percent lower real GDP
     growth:
      (1) For calendar year 2005
       only: \1\
        Receipts................       -10.2       -21.8       -24.3       -25.6       -27.0       -28.4      -137.2
        Outlays.................         2.8         8.1         8.8        10.6        12.5        14.7        57.4
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-       -13.0       -29.8       -33.0       -36.2       -39.5       -43.1      -194.6
           )....................

      (2) Sustained during 2005-
       2010, with no change in
       unemployment:
        Receipts................       -10.4       -34.0       -62.9       -94.5      -129.0      -166.3      -497.1
        Outlays.................           *         0.5         2.1         5.0         9.3        15.3        32.2
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-       -10.4       -34.5       -65.0       -99.5      -138.4      -181.6      -529.3
           )....................

    Inflation and Interest Rates

    Budgetary effects of 1
     percentage point higher
     rate of:
      (3) Inflation and interest
       rates during calendar
       year 2005 only:
        Receipts................       -10.0        28.4        37.1        24.7        26.0        27.4       133.6
        Outlays.................        11.0        19.1        17.5        16.3        15.7        15.5        95.2
                                 -----------------------------------------------------------------------------------
          Decrease in deficit          -21.0         9.3        19.6         8.3        10.3        11.9        38.4
           (+)..................

      (4) Inflation and interest
       rates, sustained during
       2005-2010:
        Receipts................       -10.0        22.7        67.2       100.7       136.0       175.1       491.7
        Outlays.................        11.4        34.5        56.9        76.8        95.0       113.3       387.8
                                 -----------------------------------------------------------------------------------
          Decrease in deficit          -21.4       -11.8        10.4        24.0        41.0        61.8       103.9
           (+)..................

      (5) Interest rates only,
       sustained during 2005-
       2010:
        Receipts................       -20.5       -11.4         6.3        11.8        16.0        20.9        23.1
        Outlays.................         8.8        24.3        37.0        46.0        53.3        60.1       229.5
                                 -----------------------------------------------------------------------------------
          Increase in deficit (-       -29.3       -35.7       -30.7       -34.1       -37.3       -39.2      -206.4
           )....................

      (6) Inflation only,
       sustained during 2005-
       2010:
        Receipts................        10.5        34.0        60.8        88.6       119.7       153.8       467.4
        Outlays.................         2.7        10.5        20.5        32.0        43.7        56.2       165.5
                                 -----------------------------------------------------------------------------------
          Decrease in deficit            7.8        23.6        40.3        56.6        76.0        97.6       301.9
           (+)..................

       Interest Cost of Higher
          Federal Borrowing

      (7) Outlay effect of $100          1.3         3.5         4.2         4.7         5.0         5.4        24.2
       billion increase in
       borrowing in 2005........
    ----------------------------------------------------------------------------------------------------------------
    * $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.