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

    [[Page 175]]

                                13.  STEWARDSHIP

                                  Introduction

      The budget is an essential tool for allocating resources within the
    Federal Government and between the public and private sectors, but
    current outlays, receipts, and the deficit give at best a partial
    picture of the Government's financial condition. Indeed, changes in the
    annual budget deficit or surplus can be misleading. For example, the
    temporary shift from annual deficits to surpluses in the late 1990s did
    nothing to correct the long-term fiscal deficiencies in the major
    entitlement programs, which are the major source of the long-run
    shortfall in Federal finances. This would have been more apparent at the
    time if greater attention had been focused on long-term measures such as
    those presented in this chapter. As important as the current budget
    surplus or deficit is, other indicators are also needed to judge the
    Government's fiscal condition.
      For the Federal Government, unfortunately, there is no single number
    that corresponds to a business's bottom line. The Government is judged
    by how its actions affect the country's security and well-being, and
    that cannot easily be summed up with a single statistic. Also, even
    though its financial condition is important, the Government is not
    expected to earn a profit. Its financial status is best evaluated using
    a broad range of data and several complementary perspectives. This
    chapter presents a framework for such analysis. Because there are
    serious limitations on the available data and the future is uncertain,
    this chapter's findings should be interpreted with caution; its
    conclusions are subject to future revision.
      The chapter consists of four parts:
        Part I explains how the separate pieces of analysis link
              together. Chart 13-1 is a schematic diagram showing the
              linkages.
        Part II presents estimates of the Government's assets and
              liabilities, which are shown in Table 13-1. This table is
              similar to a business balance sheet, but for that reason it
              cannot reveal some of the Government's unique financial
              features and needs to be supplemented by the information in
              Parts III and IV.
        Part III shows possible long-run paths for the Federal
              budget. These projections vary depending on alternative
              economic and demographic assumptions. The projections are
              summarized in Table 13-2 and in a related set of charts. Table
              13-3 shows present value estimates of the funding shortfall in
              Social Security and Medicare. Together these data indicate the
              scope of the Government's future responsibilities and the
              resources it will have available to discharge them under
              current law and policy. In particular, they show the looming
              long-run fiscal challenge posed by the Federal entitlement
              programs.
        Part IV returns the focus to the present. It presents
              information on national economic and social conditions. The
              private economy is the ultimate source of the Government's
              resources. Table 13-4 gives a summary of total national
              wealth, while highlighting the Federal investments that have
              contributed to that wealth. Table 13-5 shows trends in wealth
              and Table 13-6 presents a small sample of statistical
              indicators.

                PART I--A FRAMEWORK TO EVALUATE FEDERAL FINANCES

      No single framework can encompass all of the factors that affect the
    financial condition of the Federal Government, but the framework
    presented here is reasonably comprehensive and it offers a useful way to
    examine the financial implications of Federal policies. This framework
    includes balance-sheet information, but it also includes long-run
    projections of the entire budget showing where future fiscal strains are
    most likely to appear. It includes measures of national wealth, which
    support future income and tax receipts, and an array of economic and
    social indicators showing potential pressure points that may require
    future policy responses.
      The Government's legally binding obligations--its liabilities--consist
    in the first place of Treasury debt. Other liabilities include the
    pensions and medical benefits owed to retired Federal employees and
    veterans. These employee obligations are a form of deferred
    compensation; they have counterparts in the business world, and would
    appear as liabilities on a business balance sheet. Accrued obligations
    for Government insurance policies and the estimated present value of
    failed loan guarantees and deposit insurance claims are also analogous
    to private liabilities. These Government liabilities are discussed
    further in Part II along with the Government's assets. The liabilities
    and assets are collected in Table 13-1. The liabilities shown in Table
    13-1 are only a subset of the Government's overall financial
    responsibilities. Indeed, the full extent of the Government's fiscal
    exposure through programmatic commitments dwarfs the outstanding total
    of all acknowledged Federal liabilities. The commitments to Social
    Security and Medicare alone amount to many times the value of Federal
    debt held by the public.

    [[Page 176]]

      In addition to Social Security and Medicare, the Government has a
    broad range of programs that dispense cash and other benefits to
    individual recipients. A few examples of such programs are Medicaid,
    food stamps, veterans' pensions and health care. The Government also
    provides a wide range of public services that must be financed through
    the tax system. It is true that specific programs may be modified or
    even ended at any time by the Congress and the President, and changes in
    the laws governing these programs are a regular part of the legislative
    cycle. For this reason, these programmatic commitments do not constitute
    ``liabilities'' in a legal or accounting sense, and they would not
    appear on a balance sheet. They are Federal responsibilities, however,
    and will have a claim on budgetary resources for the foreseeable future.
    All of the Government's existing programs are reflected in the long-run
    budget projections in Part III. It would be misleading to leave out any
    of these programmatic commitments in projecting future claims on the
    Government or in calculating the Government's long-run fiscal balance.
      The Federal Government has many assets. These include financial
    assets, such as loans and mortgages which have been acquired through
    various credit programs. They also include the plant and equipment used
    to produce Government services. The Government also owns a substantial
    amount of land. Such assets would normally be shown on a balance sheet.
    The Government also has resources in addition to those that might be
    expected to appear on a balance sheet. These additional resources
    include most importantly the Government's sovereign power to tax.
      Because of its unique responsibilities and resources, the most
    revealing way to analyze the future strains on the Government's fiscal
    position is to make a long-run projection of the entire Federal budget.
    Part III of this chapter presents a set of such projections under
    different assumptions about policy and future economic and demographic
    conditions. Over long periods of time, the spending of the Government
    must be financed by the taxes and other receipts it collects. Although
    the Government can borrow for temporary periods, it must pay interest on
    any such borrowing, which adds to future spending. In the long run, a
    solvent Government must pay for its spending out of its receipts. The
    projections in Part III show that under an extension of the estimates in
    this Budget, long-run balance in this sense is not achieved, mostly
    because projected spending for Social Security, Medicare, and Medicaid
    grow faster than the revenue available to pay for them.
      The long-run budget projections and the table of assets and
    liabilities are silent on the question of whether the public is
    receiving value for its tax dollars or whether Federal assets are being
    used effectively. Information on those points requires performance
    measures for Government programs supplemented by appropriate information
    about conditions in the economy and society. Recent changes in budgeting
    practices have contributed to the goal of providing more information
    about Government programs and will permit a closer alignment of the cost
    of programs with performance measures. These changes have been described
    in detail in previous Budgets. They are reviewed in chapter 2 of this
    volume, and in the accompanying material that describes results obtained
    with the Program Assessment Rating Tool (PART). This Stewardship chapter
    complements the detailed exploration of Government performance with an
    assessment of the overall impact of Federal policy as reflected in
    general measures of economic and social well-being, shown in Table 13-6.

                       Relationship with FASAB Objectives

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

             3a. Whether the government's financial position improved or
                            deteriorated over the period.

           3b. Whether future budgetary resources will likely be sufficient
        to sustain public services and to meet obligations as they come due.

          3c. Whether government operations have contributed to the nation's
                           current and future well-being.
      The presentation here is an experimental approach for meeting this
    objective at the Government-wide level. It is intended to meet the broad
    interests of economists and others in evaluating trends over time,
    including both past and future trends. The annual Financial Report of
    the United States Government presents related information, but from a
    different perspective. The Financial Report includes a balance sheet.
    The assets and liabilities on that balance sheet are all based on
    transactions and other events that have already occurred. A similar
    table can be found in Part II of this chapter but based on different
    data and methods of valuation. The Financial Report also includes a
    statement of social insurance that reviews a substantial body of
    information on the condition and sustainability of the Government's
    social insurance programs. The Report, however, does not extend that
    review to the condition or sustainability of the Government as a whole,
    which is a main focus of this chapter, and it does not try to relate the
    Government's assets and liabilities to private wealth or broader
    economic and social conditions.
      Connecting the Dots: The presentation that follows is constructed
    around a series of tables and charts. The schematic diagram, Chart 13-1,
    shows how the different pieces fit together. The tables and charts
    should be viewed as an ensemble, the main elements

    [[Page 177]]

    of which are grouped in two broad categories--assets/resources and
    liabilities/responsibilities.
        The left-hand side of Chart 13-1 shows the full range of
              Federal resources, including assets the Government owns, tax
              receipts it can expect to collect given current and proposed
              law, and national wealth, including the trained skills of the
              national work force, that provide the base for Government
              revenues.
        The right-hand side reveals the full range of Federal
              obligations and responsibilities, beginning with the
              Government's acknowledged liabilities from past actions, such
              as the debt held by the public, and including future budget
              outlays needed to maintain present policies and trends. This
              column ends with a set of indicators highlighting areas where
              Government activity affects society or the economy.

    [[Page 178]]

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            QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S STEWARDSHIP

    ------------------------------------------------------------------------
    1.  According to Table 13-1, the Government's liabilities exceed its
     assets. No business could operate in such a fashion. Why does the
     Government not manage its finances more like a business?

                   The Federal Government has different objectives from a
                    business firm. The goal of every business is to earn a
                    profit, and as a general rule the Federal Government
                    properly leaves activities at which a profit could be
                    earned to the private sector. For the vast bulk of the
                    Federal Government's operations, it would be difficult
                    or impossible to charge prices that would even cover all
                    its expenses. The Government undertakes these activities
                    not to improve its balance sheet, but to benefit the
                    Nation.

                   For example, the Government invests in education and
                    research, but it earns no direct return from these
                    investments. People are enriched by these investments,
                    but the returns do not show up as an increase in
                    Government assets rather as an increase in the general
                    state of knowledge and in the capacity of the country's
                    citizens to earn a living and lead a fuller life.
                    Business investment motives are quite different;
                    business invests to earn a profit for itself, not
                    others, and if its investments are successful, their
                    value will be reflected in its balance sheet. Because
                    the Federal Government's objectives are different, its
                    balance sheet behaves differently, and should be
                    interpreted differently.

    2.  Table 13-1 seems to imply that the Government is insolvent. Is it?

                   No. Just as the Federal Government's responsibilities are
                    different from those of private business, so are its
                    resources. Government solvency must be evaluated in
                    different terms.

                   What Table 13-1 shows is that those Federal obligations
                    that are most comparable to the liabilities of a
                    business corporation exceed the estimated value of the
                    assets actually owned by the Federal Government. The
                    Government, however, has access to other resources
                    through its sovereign powers. These powers, which
                    include taxation, will allow the Government to meet its
                    present obligations and those that are anticipated from
                    future operations even though the Government's current
                    assets are less than its current liabilities.

                   Private financial markets clearly recognize this reality.
                    The Federal Government's implicit credit rating is among
                    the best in the world; lenders are willing to lend it
                    money at interest rates substantially below those
                    charged to private borrowers. This would not be true if
                    the Government were really insolvent or likely to become
                    so. Where governments totter on the brink of insolvency,
                    lenders are either unwilling to lend them money, or do
                    so only in return for a substantial interest premium.
    ------------------------------------------------------------------------

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    [[Page 179]]

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            QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S STEWARDSHIP

    ------------------------------------------------------------------------
    3.  Why are Social Security and Medicare not shown as Government
     liabilities in Table 13-1?

                   Future Social Security and Medicare benefits may be
                    considered as promises or responsibilities of the
                    Federal Government, but these benefits are not a
                    liability in a legal or accounting sense. The Government
                    has unilaterally decreased as well as increased these
                    benefits in the past, and future reforms could alter
                    them again. These benefits are reflected in this
                    presentation of the Government's finances, but they are
                    shown elsewhere than in Table 13-1. They appear in two
                    ways: as part of the overall budget projections in Table
                    13-2, and in the actuarial deficiency estimates in Table
                    13-3.

                   Other Federal programs make similar promises to those of
                    Social Security and Medicare--Medicaid, for example. Few
                    have suggested counting future benefits expected under
                    these programs as Federal liabilities, yet it would be
                    difficult to justify a different accounting treatment
                    for them if Social Security or Medicare were to be
                    classified as a liability. There is no bright line
                    dividing Social Security and Medicare from other
                    programs that promise benefits to people, and all the
                    Government programs that do so should be accounted for
                    similarly.

                   Also, if Social Security and Medicare benefits were
                    treated as liabilities, then payroll tax receipts
                    earmarked to finance those benefits ought to be treated
                    as assets. This treatment would be essential to gauge
                    the size of the future claim. Tax receipts, however, are
                    not generally considered to be Government assets, and
                    for good reason: the Government does not own the wealth
                    on which future taxes depend. Including taxes on the
                    balance sheet would be wrong for this reason, but
                    without counting taxes the balance sheet would overstate
                    the drain on net assets from Social Security and
                    Medicare benefits. Furthermore, treating taxes for
                    Social Security or Medicare differently from other taxes
                    would be highly questionable.

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

    4.  Why doesn't the Federal Government follow normal business practice
     in its bookkeeping?

                   The Government is not a business, and accounting
                    standards designed to illuminate how much a business
                    earns and how much equity it has could provide
                    misleading information if applied naively to the
                    Government. The Government does not have a ``bottom
                    line'' comparable to that of a business corporation, but
                    the Federal Accounting Standards Advisory Board (FASAB)
                    has developed, and the Government has adopted, a
                    conceptual accounting framework that reflects the
                    Government's distinct functions and answers many of the
                    questions for which Government should be accountable.
                    This framework addresses budgetary integrity, operating
                    performance, stewardship, and systems and controls.
                    FASAB has also developed, and the Government has
                    adopted, a full set of accounting standards. Federal
                    agencies now issue audited financial reports that follow
                    these standards and an audited Government-wide financial
                    report is issued as well. In short, the Federal
                    Government does follow generally accepted accounting
                    principles (GAAP) just as businesses and State and local
                    governments do, although the relevant principles differ
                    depending on the circumstances. This chapter is intended
                    to address the ``stewardship objective''--assessing the
                    interrelated condition of the Federal Government and the
                    Nation. The data in this chapter illuminate the trade-
                    offs and connections between making the Federal
                    Government ``better off'' and making the Nation ``better
                    off.''
    ------------------------------------------------------------------------

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    [[Page 180]]

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            QUESTIONS AND ANSWERS ABOUT THE GOVERNMENT'S STEWARDSHIP

    ------------------------------------------------------------------------
    5.  When the baby boom generation retires, the deficit could become much
     larger than it ever was before. How is this reflected in the current
     evaluation of the Government's financial condition?

                   The aging of the population will become dramatically
                    evident when the baby boomers begin to retire, and this
                    demographic transition poses serious long-term problems
                    for Federal entitlement programs and the budget. Both
                    the long-range budget projections shown in this chapter
                    and the actuarial projections prepared for Social
                    Security and Medicare indicate how serious the problem
                    is. It is clear from this information that reforms are
                    needed in these programs to meet the long-term
                    challenges.

    6.  Does it make sense for the Government to finance needed capital by
     borrowing, which would permit a deficit in the budget, so long as the
     borrowing did not exceed the amount spent on investments?

                   This rule might not permit much extra borrowing. Even if
                    the Government financed new capital by borrowing, it
                    would need to pay off the debt incurred in this way as
                    the capital was used up. Only the net investment the
                    Government does after subtracting capital consumption
                    would be financed with a net increase in borrowing. As
                    discussed in Chapter 6, recently Federal net investment
                    in physical capital has not been very large and
                    occasionally it has even been negative, so little if any
                    deficit spending would have been justified by this
                    borrowing-for-investment criterion, at least in recent
                    years.

                   The Federal Government also funds substantial amounts of
                    physical capital that it does not own, such as highways
                    and research facilities, and it funds investment in
                    intangible ``capital'' such as education and training
                    and the conduct of research and development. A private
                    business would never borrow to spend on assets that
                    would be owned by someone else. However, such spending
                    is today a principal function of the Federal Government.
                    It is not clear whether this type of capital investment
                    would fall under the borrowing-for-investment criterion,
                    even though they are an important part of national
                    wealth.

                   There is another difficulty with the logic of borrowing
                    to invest. Businesses expect investments to earn a
                    return large enough to cover their cost. In contrast,
                    the Federal Government does not generally expect to
                    receive a direct payoff from its investments, whether or
                    not it owns them. In this sense, investments are no
                    different from other Government expenditures, and the
                    fact that they provide services over a longer period of
                    time is no justification for excluding them when
                    calculating the surplus or deficit.

                   Finally, the Federal Government pursues policies that
                    support the overall economic well-being of the Nation
                    and its security interests. For such reasons, the
                    Government may deem it desirable to run a budget
                    surplus, even if this means paying for its own
                    investments from current receipts, and there will be
                    other times when it is necessary to run a deficit, even
                    one that exceeds Government net investment.
                    Considerations in addition to the size of Federal
                    investment must be weighed in choosing the right level
                    of the surplus or deficit.
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    [[Page 181]]

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

      Table 13-1 takes a backward look at the Government's assets and
    liabilities summarizing what the Government owes as a result of its past
    operations netted against the value of what it owns. The table gives
    some perspective by showing these net asset figures for a number of
    years beginning in 1960. To ensure comparability across time, the assets
    and liabilities are measured in terms of constant FY 2005 dollars and
    the balance is also shown as a ratio to GDP. Government liabilities have
    exceeded the value of assets (see chart 13-2) over this entire period,
    but, in the late 1970s, a speculative run-up in the prices of oil and
    other real assets temporarily boosted the value of Federal holdings.
    When those prices subsequently declined, real Federal asset values
    declined and only recently have they regained the level they had reached
    in the mid-1980s.

      Currently, the total real value of Federal assets is estimated to be
    77 percent greater than it was in 1960. Meanwhile, Federal liabilities
    have increased by 244 percent in real terms. The decline in the Federal
    net asset position has been partly due to persistent Federal budget
    deficits that have boosted debt held by the public most years since
    1960. Other factors have also been important such as large increases in
    health benefits promised for Federal retirees and the sharp rise in
    veterans' disability compensation. The relatively slow growth in Federal
    asset values also helped reduce the net asset position.
      The shift from budget deficits to budget surpluses in the late 1990s
    temporarily checked the decline in Federal net assets. Currently, the
    net excess of liabilities over assets is about $5.7 trillion or about
    $19,000 per capita. As a ratio to GDP, the excess of liabilities over
    assets reached a peak of 52 percent in 1993; it declined to 38 percent
    in 2000; it rose to 46 percent in 2003; and it has declined slightly
    since then to around 45 percent of GDP at the end of 2005. The average
    since 1960 has been 36 percent (see Table 13-1).

                                                         Table 13-1.  GOVERNMENT ASSETS AND LIABILITIES*
                                                 (As of the end of the fiscal year, in billions of 2005 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                              1960     1965     1970     1975     1980     1985     1990      1995      2000      2003      2004      2005
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                    ASSETS
    Financial Assets:
      Cash and Checking Deposits..........       46       67       42       34       52       34        46        47        63        56        56        23
      Other Monetary Assets...............        2        1        1        1        2        2         2         1         7        10         2         2
      Mortgages...........................       30       29       43       45       83       85       108        75        86        78        76        76
      Other Loans.........................      111      152      190      190      247      320       227       174       145       124       121       117
        less Expected Loan Losses.........       -1       -3       -5      -10      -19      -19       -21       -27       -42       -50       -48       -41
      Other Treasury Financial Assets.....       67       84       73       66       93      137       219       263       240       326       320       338
                                           -----------------------------------------------------------------------------------------------------------------
          Subtotal........................      254      330      344      326      458      559       580       543       572       645       623       608

    Nonfinancial Assets:
      Fixed Reproducible Capital:.........    1,112    1,104    1,148    1,114    1,055    1,193     1,237     1,244     1,091     1,072     1,079     1,106
        Defense...........................      959      901      910      832      747      868       891       870       712       674       680       697
        Nondefense........................      153      203      238      282      308      325       346       373       379       398       399       408
      Inventories.........................      291      252      235      210      259      297       263       202       208       255       269       272
      Nonreproducible Capital.............      471      483      463      686    1,100    1,179       931       701     1,043     1,220     1,434     1,774
        Land..............................      102      142      179      283      361      375       386       293       448       535       611       729
        Mineral Rights....................      369      342      285      404      739      804       545       408       595       684       823     1,045
                                           -----------------------------------------------------------------------------------------------------------------
          Subtotal........................    1,874    1,839    1,846    2,010    2,414    2,668     2,431     2,147     2,342     2,546     2,782     3,152
                                           -----------------------------------------------------------------------------------------------------------------
    Total Assets..........................    2,128    2,169    2,190    2,336    2,872    3,228     3,012     2,690     2,914     3,191     3,406     3,760

                  LIABILITIES

    Debt held by the Public...............    1,269    1,305    1,161    1,180    1,467    2,426     3,306     4,394     3,826     4,133     4,418     4,590

    Insurance and Guarantee Liabilities:
      Deposit Insurance...................  .......  .......  .......  .......        2       10        80         5         1         1         1         1
      Pension Benefit Guarantee...........  .......  .......  .......       48       35       48        48        23        45        75        91        82
      Loan Guarantees.....................        *        1        3        7       14       12        17        33        42        38        44        48
      Other Insurance.....................       35       31       24       22       30       18        22        20        18        17        16        16
                                           -----------------------------------------------------------------------------------------------------------------
        Subtotal..........................       35       32       27       77       81       89       167        81       106       131       152       147

    Pension and Post-Employment Health
     Liabilities:
      Civilian and Military Pensions......      958    1,205    1,440    1,632    2,051    2,035     1,989     1,928     1,978     2,038     2,127     2,169
      Retiree Health Insurance Benefits...      225      283      338      383      481      477       467       452       438       980     1,020     1,125
      Veterans Disability Compensation....      211      265      317      351      360      297       268       293       620     1,008       951     1,123
                                           -----------------------------------------------------------------------------------------------------------------
        Subtotal..........................    1,394    1,752    2,095    2,366    2,892    2,809     2,723     2,673     3,036     4,026     4,098     4,416

    Other Liabilities:
      Trade Payables and Miscellaneous....       30       37       47       59       91      119       164       136       111       170       179       183
      Benefits Due and Payable............       23       27       37       39       49       55        65        76        87       106       106       117
                                           -----------------------------------------------------------------------------------------------------------------
        Subtotal..........................       53       64       84       98      140      174       229       212       198       276       285       301

    Total Liabilities.....................    2,751    3,153    3,366    3,721    4,580    5,498     6,425     7,359     7,166     8,566     8,952     9,454

    Net Assets (Assets Minus Liabilities).     -623     -985   -1,176   -1,385   -1,708   -2,270    -3,414    -4,669    -4,253    -5,376    -5,547    -5,694
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Addenda:

    Net Assets Per Capita (in 2005           -3,452   -5,076   -5,744   -6,422   -7,488   -9,506   -13,622   -17,489   -15,037   -18,445   -18,846   -19,163
     dollars).............................
    Ratio to GDP (in percent).............    -22.1    -27.8    -27.8    -28.9    -29.7    -33.1     -42.6     -51.5     -38.4     -45.9     -45.6     -45.2
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    * This table shows assets and liabilites for the Government as a whole excluding the Federal Reserve System. Data for 2005 are extrapolated in some
      cases.

                                     Assets

      Table 13-1 offers a comprehensive list of the financial and physical
    resources owned by the Federal Government.
       Financial Assets: According to the Federal Reserve Board's Flow-of-
    Funds accounts, the Federal Government's holdings of financial assets
    amounted to $0.6 trillion at the end of 2005. Government-held mortgages
    (measured in constant dollars) reached a peak in the early 1990s as the
    Government acquired mortgages from savings and loan institutions that
    had failed. The Government subsequently liquidated most of the mortgages
    it acquired from these bankrupt savings and loans. Meanwhile, Government
    holdings of other loans

    [[Page 182]]

    have been declining in real terms since the mid-1980s. The face value of
    mortgages and other loans overstates their economic worth. OMB estimates
    that the discounted present value of future losses and interest
    subsidies on these loans was around $50 billion as of yearend 2005.
    These estimated losses are subtracted from the face value of outstanding
    loans to obtain a better estimate of their economic worth.
       Reproducible Capital: The Federal Government is a major investor in
    physical capital and computer software. Government-owned stocks of such
    capital have amounted to about $1.1 trillion in constant dollars for
    most of the last 45 years (OMB estimate). This capital consists of
    defense equipment and structures, including weapons systems, as well as
    nondefense capital goods. Currently, less than two-thirds of the capital
    is defense equipment or structures. In 1960, defense capital was over 90
    percent of the total. In the 1970s, there was a substantial decline in
    the real value of U.S. defense capital and there was another large
    decline in the 1990s after the end of the Cold War. Meanwhile,
    nondefense Federal capital has increased at an average annual rate of
    around 2\1/4\ percent. The Government also holds inventories of defense
    goods and other items that in 2005 amounted to about 25 percent of the
    value of its fixed capital.
       Nonreproducible Capital: The Government owns significant amounts of
    land and mineral deposits. There are no official estimates of the market
    value of these holdings (and of course, in a realistic sense, many of
    these resources would never be sold). Researchers in the private sector
    have estimated what they are worth,

    [[Page 183]]

    however, and these estimates are extrapolated in Table 13-1. Private
    land values fell sharply in the early 1990s, but they have risen since
    1993. It is assumed here that Federal land shared in the decline and the
    subsequent recovery. Oil prices have been on a roller coaster since the
    mid-1990s. They declined sharply in 1997-1998, rebounded in 1999-2000,
    fell again in 2001, and rose substantially in 2002-2005. These
    fluctuations have caused the estimated value of Federal mineral deposits
    to fluctuate as well. In 2005 as estimated here, the combined real value
    of Federal land and mineral rights was higher than it has ever been, but
    only 30 percent greater than in 1982. These estimates omit some valuable
    assets owned by the Federal Government, such as works of art and
    historical artifacts partly because such unique assets are unlikely ever
    to be sold and partly because there is no comprehensive inventory or
    realistic basis for valuing them.
       Total Assets: The total value of Government assets measured in
    constant dollars has risen sharply in the past three years, and was
    higher in 2005 than ever before. The Government's asset holdings are
    vast. As of the end of 2005, Government assets were estimated to be
    worth about $3.8 trillion or 30 percent of GDP.

                                   Liabilities

      Table 13-1 includes all Federal liabilities that would normally be
    listed on a balance sheet. All the various forms of publicly held
    Federal debt are counted, as are Federal pension and health insurance
    obligations to civilian and military retirees including the disability
    compensation that is owed the Nation's veterans, which can be thought of
    as a form of deferred compensation. The estimated liabilities stemming
    from Federal insurance programs and loan guarantees are also shown. The
    benefits that are due and payable under various Federal programs are
    also included, but these liabilities reflect only binding short-term
    obligations, not the Government's full commitment under these programs.
      Future benefit payments that are promised through Social Security and
    other Federal income transfer programs are not Federal liabilities in a
    legal or accounting sense. They are Federal responsibilities, however,
    and it is important to gauge their size, but they are not binding in the
    same way as a legally enforceable claim would be. The budget projections
    and other data in Part III are designed to provide a sense of these
    broader responsibilities and their claim on future budgets.
       Debt Held by the Public: The Federal Government's largest single
    financial liability is the debt owed to the public. It amounted to about
    $4.6 trillion at the end of 2005. Publicly held debt declined for
    several years in the late 1990s because of the unified budget surpluses
    that emerged at that time, but as deficits returned, publicly held debt
    began to increase again.
       Insurance and Guarantee Liabilities: The Federal Government has
    contingent liabilities arising from the loan guarantees it has made and
    from its insurance programs. When the Government guarantees a loan or
    offers insurance, cash disbursements are often small initially, and if a
    fee is charged the Government may even collect money; but the risk of
    future cash payments associated with such commitments can be large. The
    figures reported in Table 13-1 are estimates of the current discounted
    value of prospective future losses on outstanding guarantees and
    insurance contracts. The present value of all such losses taken together
    is about $0.1 trillion. As is true elsewhere in this chapter, this
    estimate does not incorporate the market value of the risk associated
    with these contingent liabilities; it merely reflects the present value
    of expected losses. Although individually many of these programs are
    large and potential losses can be a serious concern, relative to total
    Federal liabilities or even the total debt held by the public, these
    insurance and guarantee liabilities are fairly small. They were less
    than 2 percent of total liabilities in 2005.
       Pension and Post-Employment Health Liabilities: The Federal
    Government owes pension benefits as a form of deferred compensation to
    retired workers and to current employees who will eventually retire. It
    also provides civilian retirees with subsidized health insurance through
    the Federal Employees Health Benefits program and military retirees
    receive similar benefits. Veterans are owed compensation for their
    service-related disabilities. While the Government's employee pension
    obligations have risen slowly, there has been a sharp increase in the
    liability for future health benefits and veterans compensation. The
    discounted present value of all these benefits was estimated to be
    around $4.4 trillion at the end of 2005 up from $3.0 trillion in 2000.
    \2\ There was a large expansion in Federal military retiree health
    benefits legislated in 2001.
    ---------------------------------------------------------------------------
      \2\ Estimates of these liabilities were derived from the 2005
    Financial Report of the United States Government and Reports from
    earlier years. Values for some prior years were extrapolated. .
    ---------------------------------------------------------------------------

                         The Balance of Net Liabilities

      The Government need not maintain a positive balance of net assets to
    assure its fiscal solvency, and the buildup in net liabilities since
    1960 has not significantly affected Federal creditworthiness. Long-term
    Government interest rates in 2003 reached their lowest levels in 45
    years, and in 2004-2005 they remained lower than at any time from 1965
    through 2002. Despite the continued good performance of interest rates,
    there are limits to how much debt the Government can assume without
    putting its finances in jeopardy. Over an extended time horizon, the
    Federal Government must take in enough revenue to cover all of its
    spending including debt service. The Government's ability to service its
    debt in the long run cannot be gauged from a balance sheet alone. To
    judge the prospects for long-run solvency it is necessary to project the
    budget into the future. That is the subject of the next section.

    [[Page 184]]

                      PART III--THE LONG-RUN BUDGET OUTLOOK

      A balance sheet, with its focus on obligations arising from past
    transactions, can only show so much information. For the Government, it
    is also important to anticipate what future budgetary requirements might
    flow from current laws and policies. Despite the uncertainty surrounding
    the assumptions needed for such estimates, very long-run budget
    projections can be useful in sounding warnings about potential problems.
    Federal responsibilities extend well beyond the next five or ten years,
    and problems that may be small in that time frame can become much larger
    if allowed to grow.
      Programs like Social Security and Medicare are expected to continue
    indefinitely, and so long-range projections for Social Security and
    Medicare have been prepared for decades. Budget projections for
    individual programs, even important ones such as Social Security and
    Medicare, however, cannot reveal the Government's overall budgetary
    position. Only by projecting the entire budget is it possible to
    anticipate whether sufficient resources will be available to meet all
    the anticipated requirements for individual programs. It is also
    necessary to estimate how the budget's future growth compares with that
    of the economy to judge how well the economy might be able to support
    future budgetary needs.
      To assess the overall financial condition of the Government, it is
    necessary to examine the future prospects for all Government programs
    including the revenue sources that support Government spending. Such an
    assessment reveals that the key drivers of the long-range deficit are,
    not surprisingly, Social Security and Medicare along with Medicaid, the
    Federal program that helps States provide health coverage for low-income
    people and nursing home care for the elderly. Medicaid, like Medicare
    and Social Security, is projected to grow more rapidly than the economy
    over the next several decades and to add substantially to the overall
    budget deficit. Under current law, there is no offset anywhere in the
    budget large enough to cover all the demands that will eventually be
    imposed by Social Security, Medicare, and Medicaid.
      Future budget outcomes depend on a host of unknowns--constantly
    changing economic conditions, unforeseen international developments,
    unexpected demographic shifts, the unpredictable forces of technological
    advance, and evolving political preferences to name a few. These
    uncertainties make even short-run budget forecasting quite difficult,
    and the uncertainties increase the further into the future projections
    are extended. While uncertainty makes forecast accuracy difficult to
    achieve, it enhances the importance of long-run budget projections
    because people are risk averse. It is not possible to assess the
    likelihood of future risks without projections. A full treatment of all
    the relevant risks is beyond the scope of this chapter, but the chapter
    does show how long-run budget projections respond to changes in some of
    the key economic and demographic parameters. Given the uncertainties, a
    useful first step is to work out the implications of expected
    developments on a ``what if'' basis.

                      The Impending Demographic Transition

      In 2008, the first members of the huge generation born after World War
    II, the so-called baby boomers, will reach age 62 and become eligible
    for early retirement under Social Security. Three years later, they will
    turn 65 and become eligible for Medicare. In the years that follow, the
    elderly population will steadily increase, putting serious strains on
    the budget because of increased expenditures for Social Security and for
    the Government's health programs serving this population.
      The pressures are expected to persist even after the baby boomers are
    gone. The Social Security actuaries project that the ratio of workers to
    Social Security beneficiaries will fall from around 3.3 currently to a
    little over 2 by the time most of the baby boomers have retired. From
    that point forward, because of lower fertility and improved mortality,
    the ratio is expected to continue to decline slowly. With fewer workers
    to pay the taxes needed to support the retired population, budgetary
    pressures will continue to grow. The problem posed by the demographic
    transition is a permanent one.
      Currently, the three major entitlement programs--Social Security,
    Medicare and Medicaid--account for 43 percent of non-interest Federal
    spending, up from 30 percent in 1980. By 2035, when the remaining baby
    boomers will be in their 70s and 80s, these three programs could easily
    account for nearly two-thirds of non-interest Federal spending. At the
    end of the projection period, in 2080, the figure rises to around three-
    quarters of non-interest spending. In other words, under an extension of
    current-law formulas, almost all of the budget, aside from interest,
    would go to these three programs alone. To say the least, that would
    severely reduce the flexibility of the budget, and the Government's
    ability to respond to new challenges.

                              An Unsustainable Path

      These long-run budget projections show clearly that the budget is on
    an unsustainable path, although the rise in the deficit unfolds
    gradually. The budget deficit is projected to decline as the economy
    expands over the next several years, while most of the baby boomers are
    still in the work force. As the baby boomers begin to reach retirement
    age in large numbers, the deficit begins to rise. In about 10 years, the
    deficit as a share of GDP is projected to reach a low point and then
    begin an inexorable increase. Without reforms, by the end of this
    chapter's projection period in 2080, rising deficits would have driven
    publicly held Federal debt to levels well above the previous peak level
    relative to GDP reached at the end of World War II. Long before that
    point is ever reached there is likely to be a crisis that will force
    budgetary changes, but the tim

    [[Page 185]]

    ing of the crisis and its resolution are impossible to predict.
      The revenue projections start with the budget's estimate of receipts
    under the Administration's proposals. In the long run, receipts are
    assumed to increase as people's real incomes rise. The income tax is
    indexed for inflation, but not for real growth, so as real incomes rise,
    the effective income rate increases. This tendency is partly offset
    because many excise taxes are not indexed and therefore tend to decline
    in real terms as inflation pushes up the price level. Furthermore,
    payroll taxes are based on cash wages and the share of cash wages in
    total compensation and in overall GDP has been declining as workers
    receive a larger share of their compensation in the form of untaxed
    fringe benefits. These offsetting tendencies are not powerful enough,
    however, to prevent the overall tax share from rising somewhat in the
    long run. In the projections summarized in Table 13-2, the ratio of
    receipts to GDP rises to around 22 percent by the end of the 75-year
    period.\3\
    ---------------------------------------------------------------------------
      \3\ The Alternative Minimum Tax is also scheduled to take a growing
    share of income under current law, because its parameters are not
    indexed to inflation. That increase is not assumed to continue in these
    projections because it would imply a fundamental change in the tax
    system.
    ---------------------------------------------------------------------------
      In the past, these long-run budget projections have jumped off from
    the end point for the current budget. This year's Budget includes the
    effects of adding personal retirement accounts to Social Security.
    Personal accounts are one element within a set of larger reforms that
    would restore solvency to Social Security. The Administration has not
    yet specified a complete set of reforms to achieve solvency. Within the
    current budget horizon, these other reforms would not have significant
    budget effects. In the long range, however, their effects would be
    significant. Because these other reforms are not yet specified, the
    long-range projections shown here do not incorporate personal retirement
    accounts. Showing the personal account proposal in isolation would give
    a distorted picture of the budget effects of comprehensive Social
    Security reform.
      The long-run budget outlook is highly uncertain (see the technical
    note at the end of this chapter for a further discussion of the
    forecasting assumptions used to make these budget projections). With
    pessimistic assumptions, the fiscal picture deteriorates even sooner
    than in the base projection. More optimistic assumptions imply a longer
    period before the pressures of rising entitlement spending overwhelm the
    budget. But despite the unavoidable uncertainty, these projections
    clearly show that under a wide range of forecasting assumptions, the
    resources generated by the programs themselves will be insufficient to
    cover the long-run costs of Social Security and Medicare.

                                        Table 13-2.  LONG-RUN BUDGET PROJECTIONS
                          (receipts, outlays, surplus or deficit, and debt as a percent of GDP)
    ----------------------------------------------------------------------------------------------------------------
                                               1980    1990    2000    2010    2020    2030    2040    2060    2080
    ----------------------------------------------------------------------------------------------------------------

    Receipts................................    19.0    18.0    20.9    17.9    18.9    19.4    20.0    21.3    22.4

    Outlays:
      Discretionary.........................    10.1     8.7     6.3     6.1     5.6     5.6     5.6     5.6     5.6
      Mandatory:
        Social Security.....................     4.3     4.3     4.2     4.2     4.9     5.8     5.9     6.1     6.4
        Medicare............................     1.1     1.7     2.0     2.8     3.7     5.0     6.1     7.9    10.4
        Medicaid............................     0.5     0.7     1.2     1.5     1.9     2.1     2.3     2.8     3.3
        Other...............................     3.7     3.2     2.4     2.3     1.9     1.6     1.4     1.1     0.9
                                             -----------------------------------------------------------------------
          Subtotal, mandatory...............     9.6     9.9     9.8    10.8    12.4    14.4    15.7    17.8    21.0

      Net Interest..........................     1.9     3.2     2.3     1.9     1.4     1.5     2.3     4.7     9.4
                                             -----------------------------------------------------------------------
        Total outlays.......................    21.7    21.8    18.4    18.9    19.4    21.6    23.6    28.2    36.1

    Surplus or Deficit (-)..................    -2.7    -3.9     2.4    -1.0    -0.6    -2.2    -3.6    -6.9   -13.7

    Primary Surplus or Deficit (-)..........    -0.8    -0.6     4.7     0.9     0.9    -0.6    -1.3    -2.1    -4.2

    Federal Debt Held by the Public.........    26.1    42.0    35.1    37.5    26.2    28.8    43.3    88.6   177.4
    ----------------------------------------------------------------------------------------------------------------
    Note: The figures shown in this table for 2015 and beyond are the product of a long-range forecasting model
      maintained by the Office of Management and Budget. This model is separate from the models and capabilities
      that produce detailed programmatic estimates in the Budget. It was designed to produce long-range forecasts
      based on additional assumptions regarding growth of the economy, the long-range evolution of specific
      programs, and the demographic and economic forces affecting those programs. The model, its assumptions, and
      sensitivity testing of those assumptions are presented in this chapter.

             Alternative Economic, Technical, and Policy Assumptions

      The quantitative results discussed above are sensitive to changes in
    underlying economic and technical assumptions. Some of the most
    important of these alternative economic and technical assumptions and
    their effects on the budget outlook are discussed below. They generally
    show that there are mounting deficits under most reasonable projections
    of the budget.
      1. Health Spending: The projections for Medicare over the next 75
    years are based on the actuarial projections in the 2005 Medicare
    Trustees' Report that include the effects of the Medicare Prescription
    Drug and Modernization bill enacted in 2003.\4\ Following the
    recommendations of its Technical Review Panel, the Medi

    [[Page 186]]

    care trustees assume that over the long-run ``age-and gender-adjusted,
    per-beneficiary spending growth exceeds the growth of per-capita GDP by
    1 percentage point per year.'' This implies that total Medicare spending
    will rise faster than GDP throughout the projection period.
    ---------------------------------------------------------------------------
      \4\ The long-run projections do not incorporate the Administration's
    proposal for automatic spending reductions in Medicare if the program's
    future reliance on general revenues exceeds the threshold of 45 percent
    of expenditures established in the Medicare Modernization Act. This
    proposal is intended to encourage Congress and the President to reach
    agreement on reforms to slow Medicare spending to bring it back in line
    with the 45 percent threshold. Assuming that these automatic reductions
    would continue each year throughout the 75-year projection period would
    result in an unrealistic projection of Medicare spending.
    ---------------------------------------------------------------------------
      Eventually, the rising trend in health care costs for both Government
    and the private sector will have to end, but it is hard to know when and
    how that will happen. Improved health and increased longevity are highly
    valued, and society has shown that it is willing to spend a larger share
    of income on them than it did in the past. Whether society will be
    willing to devote the large share of resources to health care implied by
    these projections is an open question. The alternatives highlight the
    effect of raising or lowering the projected growth rate in per capita
    health care costs by \1/4\ percentage point.

      2. Discretionary Spending: The projection of discretionary spending is
    essentially arbitrary, because discretionary spending is determined
    annually through the legislative process, and no formula can dictate
    future spending in the absence of legislation. Alternative assumptions
    have been made for discretionary spending in past budgets. Holding
    discretionary spending unchanged in real terms is the ``current
    services'' assumption used for baseline budget projections when there is
    no legislative guidance on future spending levels. Extending this
    assumption over many decades, however, is not realistic. When the
    population and economy grow, as assumed in these projections, the demand
    for public services is very likely to expand as well. The current base
    projection assumes that discretionary spending keeps pace with the
    growth in GDP in the long run, so that spending increases in real terms
    whenever there is real economic growth. An alternative assumption would
    be to limit the percentage increase in discretionary spending to the
    increase in population plus inflation, in other words, to hold the real
    per capita inflation-adjusted level of discretionary spending constant.
    This along with the projected rise in tax revenue produces a small
    budget surplus. Even in this case, the entitlement problem is not solved
    but the threat to the budget is postponed for several decades.

    [[Page 187]]

      3. A Constant Revenue Share: In the base projection, individual income
    tax receipts gradually rise over time relative to GDP. This increase
    reflects the higher marginal tax rates that people face as their real
    incomes rise. Eventually, these higher rates would bring the ratio of
    receipts to GDP to unprecedented levels--22 percent after 75 years.
    Alternatively, receipts might be expected to hold within some long-run
    historical range.

    [[Page 188]]

     Over the last 40 years, for example, receipts have averaged 18.2
    percent of GDP. Tax receipts have risen above this ratio from time to
    time, most recently at the end of the 1990s, but those periods of high
    taxes have always been followed by tax changes that have restored the
    average tax ratio. Although such changes require legislation and so are
    not implied by current law, a plausible alternative is to hold the
    receipts ratio constant relative to GDP. In that case, the deficit rises
    somewhat faster than in the base assumptions.
      4. Productivity: The rate of future productivity growth has a major
    effect on the long-run budget outlook. It is also highly uncertain. Over
    the next few decades an increase in productivity growth would reduce
    projected budget deficits appreciably. Higher productivity growth adds
    directly to the growth of the major tax bases, while it has only a
    delayed effect on outlay growth even assuming that in the long-run
    discretionary spending rises with GDP. In the latter half of the 1990s,
    after two decades of much slower growth, the rate of productivity growth
    increased unexpectedly and it has increased again since 2000. This
    increase in productivity growth is one of the most welcome developments
    of the last several years. Although the long-run growth rate of
    productivity is inherently uncertain, growth in real GDP per hour
    averaged 2.2 percent per year from 1948 through 1973 and again from 1995
    through 2004. It has grown 2.6 percent per year since 2000, and the
    projections here assume that real GDP per hour will grow at a 2.3
    percent annual rate. If the recent increase in trend productivity growth
    is sustained, it might continue growing faster than the historical
    average for some time to come. The alternatives highlight the effect of
    raising the projected productivity growth rate by \1/4\ percentage point
    and the effect of lowering it by the same amount.

      5. Population: The key assumptions for projecting long-run demographic
    developments are fertility, immigration, and mortality.
        The demographic projections assume that fertility will
              average around 1.9 births per woman in the future, just
              slightly below the replacement rate needed to maintain a
              constant population--2.1 births.

    [[Page 189]]

        The rate of immigration is assumed to average around 900,000
              per year in these projections. Higher immigration relieves
              some of the downward pressure on population growth from low
              fertility and allows total population to expand throughout the
              projection period, although at a much slower rate than has
              prevailed historically.

    [[Page 190]]

        Mortality is projected to decline, i.e., people are expected
              to live longer. The average female lifespan is projected to
              rise from 79.6 years in 2004 to 85.2 years by 2080, and the
              average male lifespan is projected to increase from 74.6 years
              in 2004 to 81.7 years by 2080. A technical panel to the Social
              Security Trustees recently reported that the improvement in
              longevity might even be greater.

             Actuarial Projections for Social Security and Medicare

      Social Security and Medicare are the Government's two largest
    entitlement programs. Both rely on payroll tax receipts from current
    workers and employers for at least part of their financing, while the
    programs' benefits largely go to those who are retired. The importance
    of these programs for the retirement security of current and future
    generations makes it essential to understand their long-range financial
    prospects. Both programs' actuaries have calculated that they face
    persistent long-run deficits. How best to measure the long-run imbalance
    in Social Security is a challenging analytical question; the imbalance
    may be even more difficult to measure in Medicare, which includes both
    Hospital Insurance (HI), funded through the payroll tax, and
    Supplementary Medical Insurance (SMI), financed through premiums and
    general revenues. Under reasonable assumptions, however, each program
    embodies such a huge financial deficiency, and it will be very difficult
    for the Government as a whole to maintain control of the budget without
    addressing both of these programs' financial problems.

    [[Page 191]]

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

                                        Social Security: The Long-Range Challenge

    Social Security provides financial security for the elderly, the disabled, and survivors. The Social Security
     system is intended to be self-financing over time. The principle of self-financing is important because it
     compels corrections in the event that projected benefits consistently exceed dedicated receipts.

    While Social Security is running surpluses today, it will begin running cash deficits within 12 years. Social
     Security's spending path is unsustainable under current law. The retirement of the baby-boom generation, born
     following World War II, will begin to increase greatly the number of Social Security beneficiaries within five
     years. Demographic trends toward lower fertility rates and longer life spans mean that the ratio of retirees to
     the working population will remain permanently higher following the baby boomers' passage through the system.
     The number of workers available to support each beneficiary is projected to decline from 3.3 today to 2.2 in
     2030, and to continue to decline slowly from there. This decline in the workforce available to support retiree
     benefits means that the Government will not be able to meet current-law benefit obligations at current payroll
     tax rates.

    The size of Social Security's future shortfall cannot be known with precision, but a gap between Social Security
     receipts and outlays emerges under a wide range of reasonable forecasting assumptions. Long-range uncertainty
     underscores the importance of creating a system that is financially stable and self-contained. Otherwise, the
     demands created by Social Security could compromise the rest of the budget and the Nation's economic health.
     The actuarial shortfall is estimated to be $12.8 trillion over an infinite horizon.

    The current structure of Social Security leads to substantial generational differences in the average rate of
     return people can expect from the program. While previous generations have fared extremely well, the average
     individual born today can expect to receive less than a two percent annual real rate of return on their total
     payroll taxes (including the employer's portion, which most economists believe is ultimately borne by labor).
     Moreover, such estimates in a sense overstate the expected rate of return for future retirees, because they
     assume no changes in current-law taxes or benefits, even though such changes are needed to meet Social
     Security's financing shortfall. As an example, a 1995 analysis found that after adjusting revenues to keep the
     system solvent, a typical worker born in 2000 would receive a 1.5 percent rate of return instead of a 1.7
     percent rate of return.

    One way to address the issues of uncertainty and declining rates of return, while protecting national savings,
     would be to allow individuals to invest some of their payroll taxes in personal retirement accounts. The budget
     includes the estimated impact from the creation of personal accounts, funded through the Social Security
     payroll tax. The Administration has also embraced the concept of progressive indexing, which would
     significantly contribute to the solvency of the system by partially indexing the growth of benefits for higher-
     wage workers to inflation rather than wage growth.

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

    [[Page 192]]

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

                                            Medicare: The Long-Range Challenge

    Medicare provides health insurance for tens of millions of Americans, including most of the nation's seniors. It
     is composed of two programs: Hospital Insurance (HI) or Part A, which covers medical expenses relating to
     hospitalization, and Supplemental Medical Insurance (SMI) or Part B, which pays for physicians' services and
     other related expenditures. Starting this year, Medicare offers a voluntary prescription drug benefit, Medicare
     Part D, which is part of the SMI Trust Fund.

    Like Social Security, HI is intended to be self-financing through dedicated taxes. According to the Medicare
     trustees' most recent report, the Trust Fund is projected to be depleted in 2020. Looking at the long run, the
     Medicare actuaries project a 75-year unfunded promise to Medicare's HI trust fund of around $8.6 trillion (net
     present value). However, this measure tells less than half the story because it does not include the deficiency
     in Medicare's Part B and Part D programs. The main source of dedicated revenues to the SMI Trust Fund is
     beneficiary premiums, which generally cover about one-quarter of its expenses. SMI's funding structure creates
     an enormous financing gap for the program, and is the largest contributor to the total Medicare program
     shortfall of $29.9 trillion. SMI's financing gap is covered by an unlimited tap on general revenues. According
     to the Medicare Trustees 2005 report, ``When the Part D program becomes fully implemented in 2006, general
     revenue transfers are expected to constitute the largest single source of income to the Medicare program as a
     whole--and would add significantly to the Federal Budget pressures.''

    This bifurcated trust fund structure finances Medicare as if the program offers two separate, unrelated
     benefits, instead of recognizing that Medicare provides integrated, comprehensive health insurance coverage.
     The MMA took an important first step toward improving Medicare sustainability by requiring the Medicare
     Trustees' Report to include a new, comprehensive fiscal analysis of the program's financing and issue a warning
     if this analysis projects that the share of Medicare expenditures funded through general revenue funding
     exceeds 45 percent. However, while this warning requires the President to propose legislation to restore
     Medicare spending to sustainable levels, it does not mandate congressional action.

    The Budget proposes to strengthen the MMA provision by modestly slowing the rate of Medicare growth if the MMA
     threshold is exceeded. The lower growth would be achieved through a four-tenths of a percent reduction to all
     payments beginning the year the threshold is exceeded. The change would only take effect if the President and
     Congress fail to agree on legislation to bring Medicare spending back into line with the threshold established
     by the MMA. The reduction would grow by four-tenths of a percent every year the shortfall continues to occur.
     This proposal would improve Medicare's sustainability by slowing the rate of growth in spending.

    ------------------------------------------------------------------------
       The Social Security and Medicare Trustees' Projections: In their
    annual reports and related documents, the Social Security and Medicare
    trustees typically present calculations of the 75-year actuarial
    imbalance or deficiency for Social Security and Medicare. The
    calculation covers current workers and retirees, as well as those
    projected to join the program within the next 75 years (this is the so-
    called ``open-group''; the ``closed-group'' covers only current workers
    and retirees). These estimates measure the present value of each
    program's future benefits net of future income. They are complementary
    to the flow projections described in the preceding section. More
    recently, the trustees' reports have also included a projection of the
    deficiency in perpetuity. This is the clearest way to see the imbalances
    in both programs.
      The present value of the Social Security imbalance over the next 75
    years was estimated to be $5.7 trillion as of January 1, 2005. The
    comparable estimate for Medicare was $29.9 trillion. (The estimates in
    Table 13-3 were prepared by the Social Security and Medicare actuaries,
    and they are based on the intermediate economic and demographic
    assumptions used for the 2005 trustees' reports. These differ in some
    respects from the assumptions used for the long-run budget projections
    described in the preceding section, but Table 13-3 would still show
    large imbalances if the budget assumptions had been used for the
    calculations.) Doing the calculations for a 75-year horizon understates
    the deficiencies, because the 75-year actuarial calculations omit the
    large deficits that continue to occur beyond the 75th year. The
    understatement is significant, even though values in the distant future
    are discounted by a large amount. For example, merely adding an
    additional year to the estimating period would widen the imbalance for
    Social Security from $5.7 trillion to $5.8 trillion. Since 2004, the
    Social Security and Medicare actuaries have also presented the actuarial
    imbalances calculated in perpetuity without assuming a fixed horizon.
    Table 13-3 shows how much these distant benefits add to the programs'
    imbalances. For Social Security, the imbalance in perpetuity is $12.8
    trillion and for Medicare it is a staggering $68.4 trillion as of
    January 1, 2005.

    [[Page 193]]

      The imbalance estimated on a perpetuity basis is the amount that the
    Government would have to raise in the private capital markets to resolve
    the program's imbalance permanently (given current assumptions). If
    nothing else changes, the estimated imbalance will grow every year at
    approximately the rate of interest, just as an unpaid debt grows with
    interest each year it remains outstanding. For Social Security this
    implies an increase of approximately $600 billion in 2005 and growing
    amounts with every year that the imbalance remains unaddressed. The
    comparable imbalance in Medicare is much larger than the Social Security
    imbalance. The exact size of the imbalance is harder to estimate for
    Medicare because of greater uncertainty regarding the future growth of
    medical costs.
       Social Security: The current deficiency in Social Security is
    essentially due to the fact that past and current participants will
    receive more benefits than they have paid for with taxes (calculated in
    terms of present values). By contrast, future participants--those who
    are now under age 15 or not yet born--are projected to pay in present
    value about $0.8 trillion more than they will collect in benefits. This
    can be seen by comparing the total deficiency in perpetuity, $12.8
    trillion, with the excess of benefits over taxes for current program
    participants, $13.6 trillion, from Table 13-3. In other words, the taxes
    that future participants are expected to pay will be large enough to
    cover the benefits due them under current law, but not large enough to
    cover those benefits plus the benefits promised to current program
    participants in excess of the taxes paid by current program
    participants.
       Medicare: Extending the horizon to infinity shows that the benefits
    due future participants will eventually exceed projected payroll tax
    receipts and premiums by a huge margin. The infinite horizon projections
    shown at the top of Table 13-3 reveal that total Medicare benefits
    exceed future taxes and premiums by $68.4 trillion in present value.
    This is due to an expected excess of benefits over taxes for current
    participants over their lifetimes, but also for future generations.
    Unlike Social Security, the imbalance is not simply the inherited result
    of a pay-as-you-go program that was never fully funded, and which faces
    a demographic crunch. That is part of the problem, but even more
    fundamental is the assumption that medical costs continue to rise in
    excess of general inflation so that medical spending increases in
    proportion to total output in the economy.
      Passage of the Medicare Prescription Drug, Improvement and
    Modernization Act added substantially to Medicare's actuarial
    deficiency, as can be seen in the 75-year projections in Table 13-3
    comparing 2003 with 2004. The legislation also increased private sector
    participation and added new fiscal safeguards which may help address
    Medicare's financial shortfall, but how large the impact of these
    changes will be is uncertain and their effects are not captured in the
    figures reported here.

                                    Table 13-3.  ACTUARIAL PRESENT VALUES OF BENEFITS IN EXCESS OF FUTURE TAXES AND PREMIUMS
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                  In Perpetuity as of January 1, in Trillions of Dollars                                                                      2004     2005
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Social Security...................................................................  ...........  ...........  ...........  ...........     11.9     12.8
    Medicare..........................................................................  ...........  ...........  ...........  ...........     61.9     68.4
    Social Security and Medicare......................................................  ...........  ...........  ...........  ...........     73.8     81.2
    --------------------------------------------------------------------------------------------------------------------------------------------------------

         Over a 75-Year Projection Period as of January 1, in Trillions of Dollars           2000         2001         2002         2003       2004     2005
    --------------------------------------------------------------------------------------------------------------------------------------------------------

    Social Security
      Future benefits less future taxes for those age 15 and over.....................        9.6         10.5         11.2         11.7       12.6     13.6
      Future benefits less taxes for those age 14 and under and those not yet born....       -5.8         -6.3         -6.7         -6.8       -7.3     -7.9
        Net present value for past, present and future participants...................        3.8          4.2          4.6          4.9        5.2      5.7

    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Medicare
      Future benefits less future taxes and premiums for those age 15 and over........        9.9         12.5         12.9         15.0       24.6     26.3
      Future benefits less taxes and premiums for those age 14 and under and those not       -0.7          0.3          0.4          0.8        3.4      3.6
       yet born.......................................................................
        Net present value for past, present and future participants...................        9.2         12.8         13.3         15.8       28.1     29.9

    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Social Security and Medicare
      Future benefits less future taxes and premiums for those age 15 and over........  ...........       23.0         24.1         26.7       37.2     39.9
      Future benefits less taxes and premiums for those age 14 and under and not yet    ...........       -6.0         -6.3         -6.0       -3.9     -4.3
       born...........................................................................
      Net present value for past, present and future participants.....................  ...........       17.0         17.8         20.7       33.3     35.6
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Addendum:
    Actuarial deficiency as a percent of the discounted payroll tax base:
      Social Security.................................................................      -1.89        -1.86        -1.87        -1.92      -1.89    -1.92
      Medicare HI.....................................................................      -1.21        -1.97        -2.02        -2.40      -3.12    -3.09
    --------------------------------------------------------------------------------------------------------------------------------------------------------

    [[Page 194]]

      General revenues have covered about 75 percent of SMI program costs
    for many years, with the rest being covered by premiums paid by the
    beneficiaries. In Table 13-3, only the receipts explicitly earmarked for
    financing these programs have been included. The intragovernmental
    transfer is not financed by dedicated tax revenues, and the share of
    general revenues that would have to be devoted to SMI to close the gap
    increases substantially under current projections. Other Government
    programs also have a claim on these general revenues. From the
    standpoint of the Government as a whole, only receipts from the public
    can finance expenditures.
      A significant portion of Medicare's actuarial deficiency is caused by
    the rapid expected increase in future benefits due to rising health care
    costs. Some, perhaps most, of the projected increase in relative health
    care costs reflects improvements in the quality of care, although there
    is also evidence that medical errors, waste, and excessive medical
    liability claims add needlessly to costs. But even though the projected
    increases in Medicare spending are likely to contribute to longer life-
    spans and safer treatments, the financial implications remain the same.
    As long as medical costs continue to outpace the growth of GDP and other
    expenditures, as assumed in these projections, the financial pressure on
    the budget will mount, and that is reflected in the estimates shown in
    Tables 13-2 and 13-3.
       The Trust Funds and the Actuarial Deficiency: The fact that a special
    account or trust fund exists does not mean that the Government
    necessarily saved the money recorded there. The trust fund surpluses
    could have added to national saving if debt held by the public had
    actually been reduced because of the trust fund accumulations. But it is
    impossible to know for sure whether this happened or not.
      At the time Social Security or Medicare redeems the debt instruments
    in the trust funds to pay benefits not covered by income, the Treasury
    will have to turn to the public capital markets to raise the funds to
    finance the benefits, just as if the trust funds had never existed. From
    the standpoint of overall Government finances, the trust funds do not
    reduce the future burden of financing Social Security or Medicare
    benefits, and for that reason, the trust funds are not netted against
    future benefits in Table 13-3. The eventual claim on the Treasury is
    better revealed by the difference between future benefits and future
    taxes or premiums.
      In any case, trust fund assets remain small in size compared with the
    programs' future obligations and well short of what would be needed to
    pre-fund future benefits as indicated by the programs' actuarial
    deficiencies. Historically, Social Security and Medicare's HI program
    were financed mostly on a pay-as-you-go basis, whereby workers' payroll
    taxes were immediately used to pay retiree benefits. For the most part,
    workers' taxes have not been used to pre-fund their own future benefits,
    and taxes were not set at a level sufficient to pre-fund future benefits
    had they been saved.
       The Importance of Long-Run Measures in Evaluating Policy Changes:
    Consider a proposed policy change in which payroll taxes paid by younger
    workers were reduced by $100 this year while the expected present value
    of these workers' future retirement benefits were also reduced by $100.
    The present value of future benefit payments would decrease by the same
    amount as the reduction in revenue. On a cash flow basis, however, the
    lost revenue occurs now, while the decrease in future outlays is in the
    distant future beyond the budget window, and the Federal Government must
    increase its borrowing to make up for the lost revenue in the meantime.
    If policymakers only focus on the Government's near-term borrowing
    needs, a reform such as this would appear to worsen the Government's
    finances, whereas the policy actually has a neutral impact.
      Now suppose that future outlays were instead reduced by a little more
    than $100 in present value. In this case, the actuarial deficiency would
    actually decline, even though the Government's borrowing needs would
    again increase if the savings occurred outside the budget window.
    Focusing on the Government's near-term borrowing alone, therefore, can
    lead to a bias against policies that could improve the Federal
    Government's overall long-run fiscal condition. Taking a longer view of
    policy changes and considering measures of the Government's fiscal
    condition other than the unified budget surplus or deficit can correct
    for such mistakes.

                      PART IV--NATIONAL WEALTH AND WELFARE

      Unlike a private corporation, the Federal Government routinely invests
    in ways that do not add directly to its assets. For example, Federal
    grants are frequently used to fund capital projects by State or local
    governments for highways and other purposes. Such investments are
    valuable to the public, which pays for them with its taxes, but they are
    not owned by the Federal Government and would not show up on a balance
    sheet for the Federal Government. It is true, of course, that by
    encouraging economic growth in the private sector, the Government
    augments future Federal tax receipts. However, the fraction of the
    return on investment that comes back to the Government in higher taxes
    is far less than what a private investor would require before
    undertaking a similar investment.
      The Federal Government also invests in education and research and
    development (R&D). These outlays contribute to future productivity and
    are analogous to an investment in physical capital. Indeed, economists
    have computed stocks of human and knowledge capital to reflect the
    accumulation of such investments. Nonetheless, such hypothetical capital
    stocks are obviously not owned by the Federal Government, nor would they
    appear on a typical balance sheet as a Government

    [[Page 195]]

    asset, even though these investments also contribute to future tax
    receipts.
      To show the importance of these kinds of issues, Table 13-4 presents a
    national balance sheet. It includes estimates of national wealth
    classified into three categories: physical assets, education capital,
    and R&D capital. The Federal Government has made contributions to each
    of these types of capital, and these contributions are shown separately
    in the table. At the same time, the private wealth shown in Table 13-4
    generates future income and tax receipts, which finance future public
    activities. The Nation's wealth sets the ultimate limit on the resources
    available to the Government.

                                                                  Table 13-4.  NATIONAL WEALTH
                                                (As of the end of the fiscal year, in trillions of 2005 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    1960     1965     1970     1975     1980     1985     1990     1995     2000     2003     2004     2005
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                       ASSETS
    Publicly Owned Physical Assets:
      Structures and Equipment..................      2.2      2.5      3.1      3.8      4.0      4.3      4.7      5.1      5.8      6.3      6.5      6.4
        Federally Owned or Financed.............      1.3      1.3      1.5      1.6      1.7      2.0      2.1      2.2      2.2      2.3      2.4      2.4
          Federally Owned.......................      1.1      1.1      1.1      1.1      1.1      1.2      1.2      1.2      1.1      1.1      1.1      1.1
          Grants to State and Local Governments.      0.2      0.2      0.3      0.5      0.7      0.8      0.9      1.0      1.1      1.2      1.3      1.3
        Funded by State and Local Governments...      0.9      1.1      1.6      2.1      2.3      2.3      2.5      2.9      3.6      4.0      4.2      4.0
      Other Federal Assets......................      0.8      0.7      0.7      0.9      1.4      1.5      1.2      0.9      1.3      1.5      1.7      2.0
                                                 -----------------------------------------------------------------------------------------------------------
          Subtotal..............................      2.9      3.2      3.8      4.7      5.4      5.7      5.8      6.0      7.1      7.8      8.2      8.5

    Privately Owned Physical Assets:
      Reproducible Assets.......................      7.5      8.6     10.6     13.5     17.6     18.6     21.1     23.4     28.4     31.0     32.6     33.6
        Residential Structures..................      2.9      3.4      4.0      5.2      7.0      7.3      8.3      9.5     11.8     13.6     14.5     15.2
        Nonresidential Plant & Equipment........      3.0      3.4      4.3      5.6      7.2      7.9      8.8      9.6     11.6     12.2     12.7     12.9
        Inventories.............................      0.7      0.8      1.0      1.2      1.5      1.4      1.5      1.5      1.7      1.6      1.7      1.8
        Consumer Durables.......................      0.9      1.0      1.3      1.5      1.8      2.0      2.6      2.9      3.3      3.5      3.6      3.7
      Land......................................      2.2      2.6      3.0      3.9      6.0      6.9      7.1      5.4      8.2      9.8     11.2     13.4
                                                 -----------------------------------------------------------------------------------------------------------
          Subtotal..............................      9.7     11.3     13.6     17.4     23.6     25.4     28.2     28.8     36.7     40.8     43.8     47.0

    Education Capital:
      Federally Financed........................      0.1      0.1      0.3      0.4      0.5      0.6      0.8      1.0      1.3      1.4      1.5      1.6
      Financed from Other Sources...............      6.3      8.5     11.4     14.3     18.2     21.3     26.4     31.0     40.0     44.0     45.5     46.6
                                                 -----------------------------------------------------------------------------------------------------------
        Subtotal................................      6.4      8.6     11.6     14.7     18.8     22.0     27.2     32.0     41.3     45.4     47.0     48.1

    Research and Development Capital:
      Federally Financed R&D....................      0.2      0.4      0.5      0.6      0.6      0.7      0.9      1.0      1.1      1.2      1.2      1.2
      R&D Financed from Other Sources...........      0.1      0.2      0.3      0.4      0.5      0.7      0.9      1.2      1.6      1.9      1.9      2.0
                                                 -----------------------------------------------------------------------------------------------------------
        Subtotal................................      0.3      0.6      0.8      1.0      1.2      1.4      1.8      2.2      2.7      3.0      3.1      3.3
                                                 -----------------------------------------------------------------------------------------------------------
    Total Assets................................     19.4     23.7     29.8     37.8     48.9     54.6     63.1     69.0     87.7     97.1    102.2    106.9

    Net Claims of Foreigners on U.S. (+)........     -0.1     -0.2     -0.2     -0.1     -0.4      0.1      0.8      1.6      3.1      4.1      4.3      5.5

    Net Wealth..................................     19.5     23.8     30.0     37.9     49.3     54.5     62.2     67.4     84.6     92.9     97.9    101.4
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                      ADDENDA:
    Per Capita Wealth (thousands of 2005 $).....    108.1    122.9    146.3    175.8    216.0    228.3    248.3    252.6    299.2    318.9    332.5    341.4
    Ratio of Wealth to GDP (in percent).........    691.4    673.1    707.2    789.8    857.7    794.9    776.0    744.5    764.6    793.6    805.0    805.0
    Total Federally Funded Capital (trillions         2.3      2.6      3.0      3.5      4.3      4.8      5.0      5.1      5.8      6.4      6.8      7.3
     2005 $)....................................
        Percent of National Wealth..............     11.7     10.7      9.9      9.3      8.7      8.9      8.0      7.6      6.9      6.9      6.9      7.2
    --------------------------------------------------------------------------------------------------------------------------------------------------------

      The table shows that Federal investments are responsible for about 7
    percent of total national wealth including education and research and
    development. This may seem like a small fraction, but it represents a
    large volume of capital: $7.3 trillion. The Federal contribution is down
    from 8.9 percent in the mid-1980s and from 11.7 percent in 1960. Much of
    this reflects the relative decline in the stock of defense capital,
    which has fallen from around 34 percent of GDP in 1960 to under 6
    percent in 2005.
       Physical Assets: The physical assets in the table include stocks of
    plant and equipment, office buildings, residential structures, land, and
    the Government's physical assets such as military hardware and highways.
    Automobiles and consumer appliances are also included in this category.
    The total amount of such capital is vast, $55.5 trillion in 2005,
    consisting of $47.0 trillion in private physical capital and $8.5
    trillion in public physical capital (including capital funded by State
    and local governments); by comparison, GDP was around $12 trillion in
    2005. The Federal Government's contribution to this stock of capital
    includes its own physical assets of $3.1 trillion plus $1.3 trillion in
    accumulated grants to State and local governments for capital projects.
    The Federal Government has financed about one-quarter of all the
    physical capital held by other levels of government.
       Education Capital: Economists have developed the concept of human
    capital to reflect the notion that individuals and society invest in
    people as well as in physical assets. Investment in education is a good
    example of how human capital is accumulated. Table 13-4 includes an
    estimate of the stock of capital represented by the Nation's investment
    in formal education and training. The estimate is based on the cost of
    replacing

    [[Page 196]]

    the years of schooling embodied in the U.S. population aged 15 and over;
    in other words, the goal is to measure how much it would cost to
    reeducate the U.S. workforce at today's prices (rather than at the
    original cost). This is more meaningful economically than the historical
    cost of schooling, and is comparable to the methods used to estimate the
    physical capital stocks presented earlier.
      Although this is a relatively crude measure, it does provide a rough
    order of magnitude for the current value of the investment in education.
    According to this measure, the stock of education capital amounted to
    $48.1 trillion in 2005, of which about 3 percent was financed by the
    Federal Government. It was approximately equal in value to the Nation's
    private stock of physical capital. The main investors in education
    capital have been State and local governments, parents, and students
    themselves.
      Even broader concepts of human capital have been proposed. Not all
    useful training occurs in a schoolroom or in formal training programs at
    work. Much informal learning occurs within families or on the job, but
    measuring its value is very difficult. Labor compensation, however,
    amounts to about two-thirds of national income with the other third
    attributed to capital, and thinking of total labor income as the product
    of human capital suggests that the total value of human capital would be
    two times the estimated value of physical capital if human capital
    earned a similar rate of return to other forms of capital. Thus, the
    estimates offered here are in a sense conservative, because they reflect
    only the costs of acquiring formal education and training, which is why
    they are referred to as education capital rather than human capital.
    They constitute that part of total human capital that can be attributed
    to formal education and training.
       Research and Development Capital: Research and Development can also
    be thought of as an investment, because R&D represents a current
    expenditure that is made in the expectation of earning a future return.
    After adjusting for depreciation, the flow of R&D investment can be
    added up to provide an estimate of the current R&D stock. \3\ That stock
    is estimated to have been $3.3 trillion in 2005. Although this
    represents a large amount of research, it is a relatively small portion
    of total National wealth. Of this stock, 38 percent was funded by the
    Federal Government.
    ---------------------------------------------------------------------------
      \3\ R&D depreciates in the sense that the economic value of applied
    research and development tends to decline with the passage of time, as
    still newer ideas move the technological frontier.
    ---------------------------------------------------------------------------
       Liabilities: When considering how much the United States owes as a
    Nation, the debts that Americans owe to one another cancel out. When the
    debts of one American are the assets of another American, these debts
    are not a net liability of the Nation as a whole. Table 13-4 only shows
    National totals. Gross debt is important even though it does not appear
    in Table 13-4. The amount of debt owed by Americans to other Americans
    can exert both positive and negative effects on the economy. Americans'
    willingness and ability to borrow have helped fuel the current expansion
    by supporting consumption and housing purchases. On the other hand,
    growing debt could be a risk to future growth, if the ability to service
    the higher level of debt were to become impaired.
      The only debts that show up in Table 13-4 are the debts Americans owe
    to foreigners for the investments that foreigners have made here.
    America's net foreign debt has been increasing rapidly in recent years,
    because of the rising imbalance in the U.S. current account. Although
    the current account deficit is at record levels, the size of the net
    foreign debt remains relatively small compared with the total stock of
    U.S. assets. It amounted to 5.5 percent of total assets in 2005.
      Federal debt does not appear explicitly in Table 13-4 because most of
    it consists of claims held by Americans; only that portion of the
    Federal debt which is held by foreigners is included along with the
    other debts to foreigners. Comparing the Federal Government's net
    liabilities with total national wealth does, however, provide another
    indication of the relative magnitude of the imbalance in the
    Government's accounts. Federal net liabilities, as reported in Table 13-
    1, amounted to 5.6 percent of net U.S. wealth as shown in Table 13-4.
    Prospectively, however, Federal liabilities are a much larger share of
    national wealth, as indicated by the long-run projections described in
    Part III.

                            Trends in National Wealth

      The net stock of wealth in the United States at the end of 2005 was
    $101 trillion, about eight times the size of GDP. Since 1960, it has
    increased in real terms at an average annual rate of 3.7 percent per
    year. It grew very rapidly from 1960 to 1973, at an average annual rate
    of 4.5 percent per year, slightly faster than real GDP grew over the
    same period. Between 1973 and 1995 growth slowed, as real net wealth
    grew at an average rate of just 3.1 percent per year, which paralleled
    the slowdown in real GDP over this period. Since 1995 the rate of growth
    in U.S. real wealth has picked up. Net wealth has been growing at an
    average rate of 4.2 percent since 1995, about the same rate as from 1960
    to 1973. Productivity growth has also accelerated since 1995, following
    a similar slowdown from 1973 to 1995.
      The net stock of privately owned nonresidential plant and equipment
    accounts for about 27 percent of all privately owned physical assets. In
    real terms, it grew 3.3 percent per year on average from 1960 to 2005.
    It grew especially rapidly from 1960 to 1973, at an average rate of 3.9
    percent per year. Since 1973 it has grown more slowly, averaging around
    3.0 percent per year. Plant and equipment did not experience a more
    rapid rate of growth over the last ten years compared with 1973-1995.
    Private plant and equipment grew 3.0 percent per year on average between
    1973 and 1995 and at the same rate from 1995 through 2005. Privately
    owned residential structures and land have all grown much more rapidly
    in real value since

    [[Page 197]]

    1995 than from 1973 to 1995, while the stock of consumer durables has
    grown less rapidly.
      The accumulation of education capital has averaged 4.6 percent per
    year since 1960. It also slowed down between 1973 and 1995 and has grown
    only slightly more rapidly since then. It grew at an average rate of 5.8
    percent per year in the 1960s, 1.9 percentage points faster than the
    average rate of growth in private physical capital during the same
    period. Since 1995, education capital has grown at a 4.2 percent annual
    rate. This reflects both the extra resources devoted to schooling in
    this period, and the fact that such resources have been increasing in
    economic value. Meanwhile, R&D stocks have grown at an average rate of
    4.0 percent per year since 1995.

                                         Table 13-5.  TRENDS IN NATIONAL WEALTH
                                            (Average annual rates in percent)
    ----------------------------------------------------------------------------------------------------------------
                                                                     1960-2005   1960-1973   1973-1995    1995-2005
    ----------------------------------------------------------------------------------------------------------------
    Real GDP......................................................          3.4        4.3          2.8          3.4
    National Wealth...............................................          3.7        4.5          3.1          4.2
    Private Physical Wealth.......................................          3.6        3.9          2.7          5.0
      Nonresidential Plant and Equipment..........................          3.3        3.9          3.0          3.0
      Residential Structures......................................          3.7        4.1          3.1          4.9
    Public Physical Wealth........................................          2.4        2.8          1.6          3.5
    Net Education.................................................          4.6        5.8          4.1          4.2
    Net R&D.......................................................          5.3        8.6          3.9          4.0
    ----------------------------------------------------------------------------------------------------------------

                   Other Federal Influences on Economic Growth

      Federal investment decisions, as reflected in Table 13-4, obviously
    are important, but the Federal Government also affects wealth in ways
    that cannot be easily captured in a formal presentation. The Federal
    Reserve's monetary policy affects the rate and direction of capital
    formation in the short run, and Federal regulatory and tax policies also
    affect how capital is invested, as do the Federal Government's policies
    on credit assistance and insurance.

                                Social Indicators

      There are certain broad responsibilities that are unique to the
    Federal Government. Especially important are preserving national
    security, fostering healthy economic conditions including sound economic
    growth, promoting health and social welfare, and protecting the
    environment. Table 13-6 offers a rough cut of information that can be
    useful in assessing how well the Federal Government has been doing in
    promoting the domestic portion of these general objectives.
      The indicators shown in Table 13-6 are only a subset drawn from the
    vast array of available data on conditions in the United States. In
    choosing indicators for this table, priority was given to measures that
    were consistently available over an extended period. Such indicators
    make it easier to draw valid comparisons and evaluate trends. In some
    cases, however, this meant choosing indicators with significant
    limitations.

    [[Page 198]]

                                                           TABLE 13-6.  ECONOMIC AND SOCIAL INDICATORS
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                            Calendar Years                            1960      1970      1980      1990      1995      2000      2003      2004      2005
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Economic:
    Living Standards:
      Real GDP per person (2000 dollars)..........................    13,840    18,392    22,666    28,429    30,128    34,759    35,456    36,590    37,560
        average annual percent change (5-year trend)..............       0.6       2.3       2.6       2.3       1.2       2.9       1.5       1.5       1.6
      Median Income:
        All Households (2004 dollars).............................       N/A    36,795    38,453    41,963    41,943    46,058    44,482    44,389       N/A
        Married Couple Families (2004 dollars)....................    31,742    44,302    50,245    55,910    57,927    64,825    63,955    63,630       N/A
        Female Householder, Husband Absent (2004 dollars).........    16,041    21,456    22,599    23,729    24,237    28,208    27,264    26,964       N/A
      Income Share of Lower 60% of All Households.................      31.8      32.3      31.2      29.3      28.0      27.3      26.9      26.8       N/A
      Poverty Rate (%) \1\........................................      22.2      12.6      13.0      13.5      13.8      11.3      12.5      12.7       N/A

    Economic Security:
      Civilian Unemployment (%)...................................       5.5       4.9       7.1       5.5       5.6       4.0       6.0       5.5       5.1
      CPI-U (% Change)............................................       1.7       5.7      13.5       5.4       2.8       3.4       2.3       2.7       3.4
      Payroll Employment Increase Previous 12 Months (millions)...      -0.4      -0.4       0.3       0.3       2.2       1.9       0.1       2.2       2.0
      Managerial or Professional Jobs (% of civilian employment)..       N/A       N/A       N/A      29.2      32.0      33.8      34.8      34.9      34.7

    Wealth Creation:
      Net National Saving Rate (% of GDP) \2\.....................      10.6       8.3       7.4       4.4       4.1       5.9       1.3       1.2       0.5

    Innovation:
      Patents Issued to U.S. Residents (thousands) \3\............        42        51        42        56        68       104       106       101       N/A
      Multifactor Productivity (average 5 year percent change)....       0.8       0.8       0.8       0.6       0.7       1.1       N/A       N/A       N/A
      Nonfarm Output per Hour (average 5 year percent change).....       1.8       2.1       1.1       1.6       1.6       2.5       3.2       3.3       N/A

    Environment:
      Air Quality:
        Nitrogen Oxide Emissions (thousands of tons)..............    18,163    26,883    27,079    25,529    24,956    22,598    20,728       N/A       N/A
        Sulfur Dioxide Emissions (thousands of tons)..............    22,268    31,218    25,925    23,076    18,619    16,347    15,943       N/A       N/A
        Carbon Monoxide (thousands of tons).......................       N/A   204,043   185,407   154,186   126,777   114,467   106,886       N/A       N/A
        Lead Emissions (thousands of tons)........................       N/A       221        74         5         4       N/A       N/A       N/A       N/A
      Water Quality:
        Population Served by Secondary Treatment or Better (mils).       N/A        85       N/A       162       174       179       N/A       N/A       N/A

    Social:
      Families:
        Children Living with Mother Only (% of all children)......       9.2      11.6      18.6      21.6      24.0      22.3      23.2      23.2      23.2
      Safe Communities:
        Violent Crime Rate (per 100,000 population) \4\...........     160.0     364.0     597.0     729.6     684.5     506.5     475.8     465.5     463.2
        Murder Rate (per 100,000 population) \4\..................       5.1       7.8      10.2       9.4       8.2       5.5       5.7       5.5       5.6
        Murders (per 100,000 Persons Age 14 to 17)................       N/A       N/A       5.9       9.8      11.0       4.8       N/A       N/A       N/A
      Health:
        Infant Mortality (per 1000 Live Births) (e)...............      26.0      20.0      12.6       9.2       7.6       6.9       6.9       6.7       6.6
        Low Birthweight [>2,500 gms] Babies (%) \5\...............       7.7       7.9       6.8       7.0       7.3       7.6       7.9       8.1       N/A
        Life Expectancy at birth (years)..........................      69.7      70.8      73.7      75.4      75.8      77.0      77.6       N/A       N/A
        Cigarette Smokers (% population 18 and older) \6\.........       N/A      39.2      33.0      25.3      24.6      23.2      21.6      20.9      20.9
        Overweight (% population 20-74 with Body-Mass Index >2.5).      44.5      47.5      47.4      55.3      59.3      64.7       N/A       N/A       N/A
      Learning:
        High School Graduates (% of population 25 and older)......      44.6      55.2      68.6      77.6      81.7      84.1      84.6      85.2       N/A
        College Graduates (% of population 25 and older)..........       8.4      11.0      17.0      21.3      23.0      25.6      27.2      27.7       N/A
        National Assessment of Educational Progress \7\
          Reading 17-year olds....................................       N/A       N/A       285       290       288       287       286       285       N/A
          Mathematics 17-year olds................................       N/A       N/A       299       305       307       308       307       307       N/A
      Participation:
        Individual Charitable Giving per Capita (2000 dollars)....       277       390       423       484       458       701       654       661       N/A

    (by presidential election year)...............................    (1960)    (1972)    (1980)    (1984)    (1988)    (1992)    (1996)    (2000)    (2004)
        Voting for President (% eligible population)..............        63        55        53        53        50        55        49        50        56
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    \1\ The poverty rate does not reflect noncash government transfers such as Medicaid or food stamps.
    \2\ 2005 through Q3 only.
    \3\ Preliminary data for 2004.
    \4\ Not all crimes are reported, and the fraction that go unreported may have varied over time, preliminary data for 2005.
    \5\ Data for 2004-2005 provisional, data for 2005 through June.
    \6\ Smoking data for 2005 through June.
    \7\ Data for some years are interpoated.

      The individual measures in this table are influenced to varying
    degrees by many Government policies and programs, as well as by external
    factors beyond the Government's control. They do not measure the
    outcomes of Government policies, because they generally do not show the
    direct results of Government activities, but they do provide a
    quantitative measure of the progress or lack of progress toward some of
    the ultimate values that Government policy is intended to promote.

    [[Page 199]]

      Such a table can serve two functions. First, it highlights areas where
    the Federal Government might need to modify its current practices or
    consider new approaches. Where there are clear signs of deteriorating
    conditions, corrective action might be appropriate. Second, the table
    provides a context for evaluating other data on Government activities.
    For example, Government actions that weaken its own financial position
    may be appropriate when they promote a broader social objective. The
    Government cannot avoid making such trade-offs because of its size and
    the broad ranging effects of its actions. Monitoring these effects and
    incorporating them in the Government's policy making is a major
    challenge.
      It is worth noting that, in recent years, many of the trends in these
    indicators turned around. The improvement in economic conditions
    beginning around 1995 has been widely noted, and there have also been
    some significant social improvements. Perhaps, most notable has been the
    turnaround in the crime rate. Since reaching a peak in the early 1990s,
    violent crime has fallen by a third. The turnaround has been especially
    dramatic in the murder rate, which has been lower since 1998 than at any
    time since the 1960s. The 2001 recession had a negative effect on some
    of these indicators: unemployment rose and real GDP growth declined for
    a time. But as the economy recovered much of the improvement shown in
    Table 13-6 was preserved. Indeed, productivity growth, the best
    indicator of future changes in the standard of living accelerated. Since
    2000, it has increased faster than in any other five-year period since
    the 1960s.

            TECHNICAL NOTE: SOURCES OF DATA AND METHODS OF ESTIMATING

                          Long-Range Budget Projections

      The long-range budget projections are based on demographic and
    economic assumptions. A simplified model of the Federal budget,
    developed at OMB, is used to compute the budgetary implications of these
    assumptions.
       Demographic and Economic Assumptions: For the years 2006-2016, the
    assumptions are drawn from the Administration's economic projections
    used for the budget. These budget assumptions reflect the President's
    policy proposals. The economic assumptions are extended beyond this
    interval by holding constant inflation, interest rates, and unemployment
    at the levels assumed in the final year of the budget forecast.
    Population growth and labor force growth are extended using the
    intermediate assumptions from the 2005 Social Security trustees' report.
    The projected rate of growth for real GDP is built up from the labor
    force assumptions and an assumed rate of productivity growth.
    Productivity growth is held constant at the average rate of growth in
    the budget's economic assumptions.
        CPI inflation holds stable at 2.5 percent per year; the
              unemployment rate is constant at 5.0 percent; and the yield on
              10-year Treasury notes is steady at 5.6 percent.
        Real GDP per hour, a measure of productivity, grows at the
              same average rate as in the Administration's medium-term
              projections--2.3 percent per year.
        Consistent with the demographic assumptions in the trustees'
              reports, U.S. population growth slows from around 1 percent
              per year to about half that rate by 2030, and slower rates of
              growth beyond that point. Annual population growth is only 0.2
              percent at the end of the projection period in 2080.
        Real GDP growth declines over time because of the slowdown
              in population growth and the increase in the population over
              age 65, who supply less work effort than younger people do.
              Historically, real GDP has grown at an average yearly rate of
              3.4 percent. In these projections, average real GDP growth
              eventually declines to around 2.5 percent per year.
      The economic and demographic projections described above are set by
    assumption and do not automatically change in response to changes in the
    budget outlook. This is unrealistic, but it simplifies comparisons of
    alternative policies.
       Budget Projections: For the period through 2011, receipts and outlays
    follow the budget's policy projections, except that the projections do
    not include Social Security personal accounts. In the long run, receipts
    are projected using simple rules of thumb linking income taxes, payroll
    taxes, excise taxes, and other receipts to projected tax bases derived
    from the economic projections. Discretionary spending grows at the rate
    of growth in nominal GDP. Social Security is projected by the Social
    Security actuaries using these long-range assumptions. Medicare benefits
    are projected based on the estimates in the 2005 Medicare trustees'
    report, adjusted for differences in the inflation rate and the growth
    rate in real GDP per capita. Federal pensions are derived from the most
    recent actuarial forecasts available at the time the budget is prepared,
    repriced using Administration inflation assumptions. Medicaid outlays
    are based on the economic and demographic projections in the model.
    Other entitlement programs are projected based on rules of thumb linking
    program spending to elements of the economic and demographic projections
    such as the poverty rate.

                     Federally Owned Assets and Liabilities

       Financial Assets: The principal source of data is the Federal Reserve
    Board's Flow-of-Funds Accounts.
       Fixed Reproducible Capital: Estimates were developed from the OMB
    historical data base for physical capital outlays and software
    purchases. The data base extends back to 1940 and was supplemented by
    data from other selected sources for 1915-1939. The source data are in
    current dollars. To estimate investment flows in constant dollars, it
    was necessary to deflate

    [[Page 200]]

    the nominal investment series. This was done using chained price indexes
    for Federal investment from the National Income and Product Accounts.
    The resulting capital stocks were aggregated into nine categories and
    depreciated using geometric rates roughly following those used by the
    Bureau of Economic Analysis in its estimates of physical capital stocks.
       Fixed Nonreproducible Capital: Historical estimates for 1960-1985
    were based on estimates in Michael J. Boskin, Marc S. Robinson, and Alan
    M. Huber, ``Government Saving, Capital Formation and Wealth in the
    United States, 1947-1985,'' published in The Measurement of Saving,
    Investment, and Wealth, edited by Robert E. Lipsey and Helen Stone Tice
    (The University of Chicago Press, 1989). Estimates were updated using
    changes in the value of private land from the Flow-of-Funds Balance
    Sheets and from the Agriculture Department for farm land; the value of
    Federal oil deposits was extrapolated using the Producer Price Index for
    Crude Energy Materials.
       Debt Held by the Public: Treasury data.
       Insurance and Guarantee Liabilities: Sources of data are the OMB
    Pension Guarantee Model and OMB estimates based on program data.
    Historical data on liabilities for deposit insurance were also drawn
    from CBO's study, The Economic Effects of the Savings and Loan Crisis,
    issued January 1992.
       Pension and Post-Employment Health Liabilities: The accrued
    liabilities for Federal retiree pensions and retiree health insurance
    along with the liability for Veterans disability compensation were
    derived from the Financial Report of the United States Government (and
    the Consolidated Financial Statement for some earlier years). Prior to
    1976, the values were extrapolated.
       Other Liabilities: The source of data for trade payables and
    miscellaneous liabilities is the Federal Reserve's Flow-of-Funds
    Accounts. The Financial Report of the United States Government was the
    source for benefits due and payable.

                             National Balance Sheet

       Publicly Owned Physical Assets: Basic sources of data for the
    federally owned or financed stocks of capital are the Federal investment
    flows described in Chapter 6. Federal grants for State and local
    government capital are added, together with adjustments for inflation
    and depreciation in the same way as described above for direct Federal
    investment. Data for total State and local government capital come from
    the revised capital stock data prepared by the Bureau of Economic
    Analysis extrapolated for 2005.
       Privately Owned Physical Assets: Data are from the Flow-of-Funds
    national balance sheets and from the private net capital stock estimates
    prepared by the Bureau of Economic Analysis extrapolated for 2005 using
    investment data from the National Income and Product Accounts.
       Education Capital: The stock of education capital is computed by
    valuing the cost of replacing the total years of education embodied in
    the U.S. population 15 years of age and older at the current cost of
    providing schooling. The estimated cost includes both direct
    expenditures in the private and public sectors and an estimate of
    students' forgone earnings, i.e., it reflects the opportunity cost of
    education. Estimates of students' forgone earnings are based on the
    minimum wage for high-school students and year-round, full-time earnings
    of 18-24 year olds for college students. These year-round earnings are
    reduced by 25 percent because students are usually out of school three
    months of the year. Yearly earnings by age and educational attainment
    are from the Bureau of the Census.
      For this presentation, Federal investment in education capital is a
    portion of the Federal outlays included in the conduct of education and
    training. This portion includes direct Federal outlays and grants for
    elementary, secondary, and vocational education and for higher
    education. The data exclude Federal outlays for physical capital at
    educational institutions because these outlays are classified elsewhere
    as investment in physical capital. The data also exclude outlays under
    the GI Bill; outlays for graduate and post-graduate education spending
    in HHS, Defense and Agriculture; and most outlays for vocational
    training. The Federal share of the total education stock in each year is
    estimated by averaging the prior years' shares of Federal education
    outlays in total education costs.
      Data on investment in education financed from other sources come from
    educational institution reports on the sources of their funds, published
    in U.S. Department of Education, Digest of Education Statistics. Nominal
    expenditures were deflated by the implicit price deflator for GDP to
    convert them to constant dollar values. Education capital is assumed not
    to depreciate, but to be retired when a person dies. An education
    capital stock computed using this method with different source data can
    be found in Walter McMahon, ``Relative Returns to Human and Physical
    Capital in the U.S. and Efficient Investment Strategies,'' Economics of
    Education Review, Vol. 10, No. 4, 1991. The method is described in
    detail in Walter McMahon, Investment in Higher Education, Lexington
    Books, 1974.
       Research and Development Capital: The stock of R&D capital financed
    by the Federal Government was developed from a data base that measures
    the conduct of R&D. The data exclude Federal outlays for physical
    capital used in R&D because such outlays are classified elsewhere as
    investment in federally financed physical capital. Nominal outlays were
    deflated using the GDP deflator to convert them to constant dollar
    values.
      Federally funded capital stock estimates were prepared using the
    perpetual inventory method in which annual investment flows are
    cumulated to arrive at a capital stock. This stock was adjusted for
    depreciation by assuming an annual rate of depreciation of 10 percent on
    the estimated stock of applied research and development. Basic research
    is assumed not to depreciate. These are the same assumptions used in a
    study published by the Bureau of Labor Statistics estimating the R&D
    stocks financed by private industry (U.S. De

    [[Page 201]]

    partment of Labor, Bureau of Labor Statistics, ``The Impact of Research
    and Development on Productivity Growth,'' Bulletin 2331, September
    1989). Chapter 6 of this volume contains additional details on the
    estimates of the total federally financed R&D stock, as well as its
    national defense and nondefense components.
      A similar method was used to estimate the stock of R&D capital
    financed from sources other than the Federal Government. The component
    financed by universities, colleges, and other nonprofit organizations is
    estimated based on data from the National Science Foundation, Surveys of
    Science Resources. The industry-financed R&D stock component is
    estimated from that source and from the U.S. Department of Labor, ``The
    Impact of Research and Development on Productivity Growth,'' Bulletin
    2331, September 1989.
      Experimental estimates of R&D capital stocks have been prepared by
    BEA. The results are described in ``A Satellite Account for Research and
    Development,'' Survey of Current Business, November 1994. These BEA
    estimates are lower than those presented here primarily because BEA
    assumes that the stock of basic research depreciates, while the
    estimates in Table 13-4 assume that basic research does not depreciate.
    BEA also assumed a slightly higher rate of depreciation for applied
    research and development, 11 percent, compared with the 10 percent rate
    used here.

        Sources of Data and Assumptions for Estimating Social Indicators

      The main sources for the data in this table are the Government
    statistical agencies. The data are all publicly available, and can be
    found in such general sources as the annual Economic Report of the
    President and the Statistical Abstract of the United States, or from the
    respective agencies' web sites.