[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

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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

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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

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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

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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.