    [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. One measure of the Government's performance
    is the extent to which it collects the taxes that are owed to it, and
    another is whether it delivers value in spending the taxes that it
    collects. Both of those questions are addressed below. In general, the
    Government's 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 as tentative; 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. This part presents
              information on national economic and social conditions. It
              begins with an analysis of tax compliance, including what can
              be done to improve it, and what resources might be made
              available with new efforts to assure compliance. 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, which are
              intended to show how the Government's efforts to improve
              social and economic outcomes might be measured.

                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 offers a useful way to
    examine the financial implications of Federal policies. This framework
    includes information about assets and liabilities such as might appear
    on a balance sheet, but it also includes long-run projections of the
    entire budget showing where future fiscal strains are most likely to
    appear. It includes an analysis of the Government's potential revenue
    and what can be done realistically through better education and more
    rigorous enforcement of the tax law to reach that potential. Measures of
    national wealth, which support future income and tax receipts, are
    presented along with an array of economic and social indicators showing
    potential pressure points that may require future policy responses.
      The Government's 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.

    [[Page 176]]

    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.
      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 veterans' 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'' that would appear on a balance sheet.
    Until the law is changed, 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 programmatic 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 grows 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 questions of whether the Government is
    collecting the full amount of taxes owed, whether the public is
    receiving value for its taxes paid, and whether Federal resources 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 13-7.

                       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 current presentation is an experimental approach for fulfilling
    this objective at the Federal 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, which is based on
    different data

    [[Page 177]]

    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 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 based on current and
              proposed laws, the tax gap, 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]]

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

            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 cover
                    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 but 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. Q06

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

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

    [[Page 179]]

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

            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 future 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
                    excluding taxes from 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.''
    ------------------------------------------------------------------------

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

    [[Page 180]]

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

      Table 13-1 looks at the Government's assets and liabilities
    retrospectively, 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 2006 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
    79 percent greater than it was in 1960. Meanwhile, Federal liabilities
    have increased by 246 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 in 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 has also reduced the Government's 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 $6.2 trillion or about
    $20,600 per capita. As a ratio to GDP, the excess of liabilities over
    assets reached a peak of 54 percent in 1995; it declined to 41 percent
    in 2000; it rose to 48 percent in 2004; and it has declined slightly
    since then to around 46 percent of GDP at the end of 2006. The average
    since 1960 has been 38 percent (see Table 13-1).

                                                         Table 13-1.  GOVERNMENT ASSETS AND LIABILITIES*
                                                 (As of the end of the fiscal year, in billions of 2006 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                             1960     1965     1970     1975     1980     1985      1990      1995      2000      2004      2005      2006
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                    ASSETS
    Financial Assets:
      Cash and Checking Deposits.........       48       69       43       35       54        35        47        49        65        38        36        51
      Other Monetary Assets..............        2        1        1        2        2         2         2         1         7         2         2         5
      Mortgages..........................       31       30       44       46       86        88       112        77        89        79        79        81
      Other Loans........................      114      157      197      199      255       331       235       190       226       228       218       209
        less Expected Loan Losses........       -1       -3       -5      -10      -20       -19       -22       -28       -43       -50       -42       -47
      Other Treasury Financial Assets....       69       86       76       68       96       142       226       272       248       334       318       302
                                          ------------------------------------------------------------------------------------------------------------------
          Subtotal.......................      263      341      356      340      474       579       601       562       592       631       610       602

    Nonfinancial Assets:
      Fixed Reproducible Capital:........    1,151    1,142    1,188    1,152    1,092     1,234     1,280     1,287     1,129     1,113     1,138     1,166
        Defense..........................      992      932      942      861      773       898       922       901       737       702       718       736
        Nondefense.......................      159      210      246      292      319       336       359       386       392       412       420       430
      Inventories........................      301      261      243      217      268       307       272       209       215       277       280       281
      Nonreproducible Capital:...........      487      500      480      710    1,139     1,220       964       719     1,078     1,484     1,839     1,896
        Land.............................      106      147      185      292      374       388       399       297       462       635       764       833
        Mineral Rights...................      381      354      295      418      765       832       564       422       616       849     1,076     1,062
                                          ------------------------------------------------------------------------------------------------------------------
          Subtotal.......................    1,940    1,903    1,911    2,080    2,498     2,762     2,516     2,216     2,422     2,875     3,257     3,343
                                          ------------------------------------------------------------------------------------------------------------------

    Total Assets.........................    2,202    2,244    2,267    2,419    2,972     3,341     3,117     2,777     3,014     3,505     3,867     3,944

                 LIABILITIES

    Debt held by the Public..............    1,313    1,351    1,202    1,221    1,519     2,511     3,421     4,547     3,960     4,557     4,725     4,829

    Insurance and Guarantee Liabilities:
      Deposit Insurance..................  .......  .......  .......  .......        2        10        82         6         1         1         1         1
      Pension Benefit Guarantee..........  .......  .......  .......       50       36        50        50        24        47        93        84        74
      Loan Guarantees....................  .......        1        3        7       14        12        18        34        43        46        49        48
      Other Insurance....................       36       32       25       23       31        19        23        20        19        19        42        20
                                          ------------------------------------------------------------------------------------------------------------------
          Subtotal.......................       36       33       28       80       84        92       173        84       110       160       177       143

    Pension and Post-Employment Health
     Liabilities:
      Civilian and Military Pensions.....      992    1,247    1,490    1,689    2,077     2,061     2,014     1,953     1,990     2,128     2,196     2,211
      Retiree Health Insurance Benefits..      238      299      357      405      498       494       483       468       454     1,052     1,157     1,132
      Veterans Disability Compensation...      218      274      328      363      372       307       277       303       642       981     1,155     1,154
                                          ------------------------------------------------------------------------------------------------------------------
          Subtotal.......................    1,448    1,820    2,175    2,457    2,947     2,862     2,774     2,724     3,085     4,161     4,508     4,497

    Environmental and Disposal                  78       96      116      131      158       187       220       287       350       264       267       305
     Liabilities.........................

    Other Liabilities:
      Trade Payables and Miscellaneous...       31       38       49       60       94       123       169       140       121       209       217       222
      Benefits Due and Payable...........       24       28       38       40       51        57        68        79        90       109       120       129
                                          ------------------------------------------------------------------------------------------------------------------
          Subtotal.......................       55       66       87      100      145       180       237       219       212       318       337       351
                                          ------------------------------------------------------------------------------------------------------------------

    Total Liabilities....................    2,930    3,366    3,608    3,989    4,852     5,832     6,826     7,860     7,717     9,460    10,015    10,125

    Net Assets (Assets Minus Liabilities)     -727   -1,122   -1,341   -1,570   -1,880    -2,491    -3,709    -5,083    -4,702    -5,955    -6,147    -6,181
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Addenda:
    Net Assets Per Capita (in 2006          -4,032   -5,783   -6,551   -7,279   -8,242   -10,432   -14,802   -19,037   -16,627   -20,234   -20,696   -20,623
     dollars)............................
    Ratio to GDP (in percent)............    -24.9    -30.6    -30.6    -31.6    -31.6     -35.1     -44.7     -54.2     -41.1     -47.6     -47.5     -46.4
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    * This table shows assets and liabilities for the Government as a whole excluding the Federal Reserve System. Data for 2006 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 $600 billion at the end of 2006. 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 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 $47
    billion as of yearend 2006. 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

    [[Page 181]]

    amounted to about $1.2 trillion in constant 2006 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 2.2 percent.
    The Government also holds inventories of defense goods and other items
    that in 2006 amounted to about 24 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, 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

    [[Page 182]]

    1997-1998, rebounded in 1999-2000, fell again in 2001, and rose
    substantially in 2002-2006. These fluctuations have caused the estimated
    value of Federal mineral deposits to fluctuate as well. In 2006, as
    estimated here, the combined real value of Federal land and mineral
    rights was higher than it has ever been, but only 35 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 four years, and was at an
    all-time high in 2006. The Government's asset holdings are vast. As of
    the end of 2006, Government assets were estimated to be worth about $4
    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 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.
    The Government also has a responsibility to repair environmental damage
    that resulted from nuclear weapons production, and that cost has been
    included in the Table as well.
      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, 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
    $4.8 trillion at the end of 2006. Publicly held debt declined for
    several years in the late 1990s because of the unified budget surpluses
    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 $140 billion. 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, these insurance and
    guarantee liabilities are fairly small relative to total Federal
    liabilities or even the total debt held by the public. They were less
    than 2 percent of total liabilities in 2006.
       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 $4.5 trillion at the end of 2006 up from $3.1 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 Financial
    Report of the United States Government for 2006 and earlier years.
    Values for years prior to 1997 were extrapolated.
    ---------------------------------------------------------------------------
       Environmental and Disposal Liabilities: During World War II and the
    Cold War, the Federal Government constructed a vast industrial complex
    to study, produce and test nuclear weapons. Environmental contamination
    occurred at these sites. The estimated liability shown here is based on
    the cleanup costs required by Federal, State and local laws and
    regulations. The Department of Energy is responsible for managing this
    cleanup. The Department of Defense is also charged with cleaning up
    contamination from its waste disposal practices, leaks, spills and other
    risky activities. Together the cleanup costs are estimated to amount to
    around 300 billion dollars in present value. \3\
    ---------------------------------------------------------------------------
      \3\ Estimates of these liabilities were also derived from the
    Financial Report of the United States Government for 2006 and earlier
    years. Values for years prior to 1997 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 2004-2006 they remained lower than at any time from 1965
    through 2002. Despite the historically low interest rates, there are
    limits to how much debt the Government can assume without putting its
    finances in jeopardy. Over an extended time

    [[Page 183]]

    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. It is necessary to project the budget into the future to judge
    the prospects for long-run solvency. That is the subject of the next
    section.

                      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, 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
    entitlement program that provides medical assistance, including acute
    and long-term care to low-income persons including families with
    dependent children, as well as aged, blind or disabled individuals.
    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 future problems are often best addressed in the present. 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.
      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 account
    for about two-thirds of non-interest Federal spending even with the
    reforms proposed in this Budget. At the end of the projection period, in
    2080, the figure could rise to around three-quarters of non-interest
    spending. In other words, 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 expansion of the entitlement
    programs and the rise in the deficit unfold gradually. The budget
    deficit is projected to decline as the economy expands over the next
    several years until it reaches balance in 2012, while most of the baby
    boomers are still in the work force.

    [[Page 184]]

    The budget is projected to remain in surplus for some years after 2012,
    but the deficit eventually returns and then begins a steady increase.
    Without further 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. There is likely to be a crisis before that point is
    reached that will force budgetary changes, but the timing of the crisis
    and its resolution are impossible to predict, and timely, comprehensive
    entitlement reforms could avoid such a crisis.
       The revenue projections start with the budget's estimate of receipts
    under the Administration's proposals for the next five years. In the
    long run, receipts are assumed to return gradually to their average as a
    share of GDP over the last 40 years--18.3 percent.
      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.
      In past budgets, 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 run, however, their effects would be
    significant. Because these other reforms are not yet specified, the
    long-range projections shown here do not incorporate any Social Security
    reforms. Showing the personal account proposal in isolation would give a
    distorted picture of the budget effects of comprehensive Social Security
    reform. An alternative projection, however, that incorporates the impact
    of personal accounts is shown later in this presentation.
      The long-run budget outlook is highly uncertain. 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 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. (For a further discussion of the
    forecasting assumptions used to make these

    [[Page 185]]

    budget projections, see the technical note at the end of this chapter.)

                                                            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      18.3      18.3      18.3      18.3      18.3      18.3
      Outlays:
        Discretionary.............................................      10.1       8.7       6.3       6.6       4.8       4.8       4.8       4.8       4.8
        Mandatory:
          Social Security.........................................       4.3       4.3       4.2       4.2       4.9       5.8       6.0       6.1       6.3
          Medicare................................................       1.1       1.7       2.0       2.7       3.4       4.5       5.3       5.9       6.1
          Medicaid................................................       0.5       0.7       1.2       1.4       1.9       2.2       2.5       3.0       3.6
          Other...................................................       3.7       3.2       2.4       2.3       1.8       1.5       1.3       1.0       0.9
                                                                   -----------------------------------------------------------------------------------------
            Subtotal, mandatory...................................       9.6       9.9       9.8      10.6      12.0      14.0      15.1      16.0      16.9
        Net Interest..............................................       1.9       3.2       2.3       1.7       1.0       0.8       1.6       4.1       8.0
                                                                   -----------------------------------------------------------------------------------------
            Total outlays.........................................      21.7      21.8      18.4      18.9      17.8      19.7      21.4      24.9      29.7
      Surplus or Deficit (-)......................................      -2.7      -3.9       2.4      -0.6       0.5      -1.4      -3.1      -6.6     -11.4
      Primary Surplus or Deficit (-)..............................      -0.8      -0.6       4.7       1.2       1.5      -0.5      -1.6      -2.5      -3.4
      Federal Debt Held by the Public.............................      26.1      42.0      35.1      35.2      18.7      17.1      31.5      82.0     160.3
    --------------------------------------------------------------------------------------------------------------------------------------------------------

      Addendum, without the Budget's Mandatory Proposals:
        Mandatory Outlays.........................................       9.6       9.9       9.8      10.7      12.3      14.6      16.1      17.8      19.6
        Surplus or Deficit (-)....................................      -2.7      -3.9       2.4      -0.7       0.1      -2.3      -4.9     -10.7     -19.0
        Primary Surplus or Deficit (-)............................      -0.8      -0.6       4.7       1.0       1.2      -1.1      -2.6      -4.3      -6.1
        Federal Debt Held by the Public...........................      26.1      42.0      35.1      35.5      21.1      24.4      47.6     130.3     262.1
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Note: The figures shown in this table for 2020 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 Policy, Economic, and Technical Assumptions

      The quantitative results discussed above are sensitive to changes in
    underlying policy, economic, and technical assumptions. Some of the most
    important of these alternative 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 an extension of the Administration's policy proposals
    to control costs in the Medicare program. These reforms are expected to
    reduce Medicare expenditures relative to the actuarial projections in
    the 2006 Medicare Trustees' Report. Following the recommendations of its
    Technical Review Panel, the Medicare 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 rises faster than GDP throughout
    the projection period given that the Medicare population is expanding as
    the population ages, and that Medicare faces a substantial shortfall in
    earmarked income compared with projected outgo. Although rising faster
    than GDP, under these assumptions, Medicare grows less rapidly than it
    has historically, so that even without reform the program's growth is
    constrained. The effect of the Administration's proposals is to reduce
    the imbalance in Medicare by about $8 trillion over the 75-year
    forecasting horizon according to actuarial estimates. Instead of facing
    a $32 trillion shortfall the program would face a $24 trillion
    shortfall, if the Administration's proposals were adopted in full. The
    proposals would not eliminate the shortfall completely, but they would
    reduce it substantially.
      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, even with the Administration's proposals, 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. Entitlement Savings: The Administration has proposed a number of
    savings measures in entitlement programs in addition to the Medicare
    savings discussed above. These proposals, if adopted, would have ongoing
    budgetary effects. The chart below shows the long-run deficit with and
    without these reforms.

    [[Page 186]]

      3. Alternative Revenue Shares: In the base projection, tax receipts
    are held constant relative to GDP at their average over the last 40
    years--18.3 percent of GDP. Tax receipts have risen above this ratio
    from time to time, most recently at the end of the 1990s, but periods of
    high taxes have always been followed by tax changes that have restored
    the long-term average tax ratio. The chart below shows the effects of
    alternative receipts assumptions. Allowing receipts to rise to 18.6
    percent of GDP would reduce the long-run budget deficit, while holding
    receipts to 18.0 percent of GDP would have the opposite effect.

      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 a smaller
    immediate 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 increased again in the period 2000-2003.
    The underlying trend of productivity growth has clearly increased since
    the mid 1990s, and that increase is projected to persist in these long-
    run projections. This increase in productivity growth is one of the most
    wel

    [[Page 187]]

    come 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; it has
    grown 2.3 percent per year since 2000, and the projections here assume
    that real GDP per hour will continue to grow at a 2.3 percent annual
    rate. 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 between 1.9 and 2.0 births per woman in the future,
              just slightly below the replacement rate needed to maintain a
              constant population--2.1 births.

        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

    [[Page 188]]

              throughout the projection period, although at a much slower
              rate than has prevailed historically.

        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 85.1 years by 2080, and the
              average male lifespan is projected to increase from 74.7 years
              in 2004 to 81.8 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 per

    [[Page 189]]

    sistent 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 a huge financial deficiency, and it will be very difficult for
    the Government as a whole to maintain control of the budget without
    addressing these programs' financial problems.

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

                                        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 10 years from now. 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 between future benefits and income is estimated to be $6.4 trillion over the next 75
     years. Extending the horizon to perpetuity increases the imbalance to $15.3 trillion, excluding trust fund
     assets as these do not represent a source of funds from a unified budget perspective.

    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, people 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 190]]

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

                                            Medicare: The Long-Range Challenge

    Medicare finances health insurance for tens of millions of Americans, including most of the nation's seniors and
     many individuals with disabilities. It is composed of two programs: Hospital Insurance (HI) or Part A, which
     covers medical expenses relating to hospitalization and other institutional care, and Supplementary Medical
     Insurance (SMI) or Part B, which pays for physicians' services and other related expenditures. Starting in
     2006, Medicare began to offer a voluntary prescription drug benefit, Medicare Part D, which is funded out 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 2018. Looking at the long run, the
     Medicare actuaries project a 75-year unfunded promise of Medicare's HI trust fund of around $11.0 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 over the next 75 years of $32.3 trillion. Extending the horizon to perpetuity increases the total
     shortfall to $70.8 trillion. SMI's financing gap is covered by an unlimited tap on general revenues. According
     to the Medicare Trustees' 2006 report, ``Soon after 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 related and complementary health care services to its
     beneficiaries. The Medicare Prescription Drug, Improvement, and Modernization Act (MMA), which established Part
     D, also 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 that highlights the
     amount of general revenue transfers used to fund Medicare. If the percent of Medicare funding that is from
     general fund transfers reaches 45 percent within the current or next six years of the projection (2006-2012),
     the Trustees issue a finding of ``excess general revenue Medicare funding''. In their 2006 report, the Trustees
     found that general revenue funding would first reach 45 percent level in fiscal year 2012, within the seven-
     year window. If a finding is present in two consecutive Trustees' reports, then a ``Medicare funding warning''
     is triggered. This warning requires the President to propose legislation to restore Medicare spending to
     sustainable levels, but 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 under current-
    law. 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, but unlike
    those projections they do not reflect the Administration's proposals to
    reform the Medicare program and the effects those proposals would have.
    More recently, the trustees' reports have also included a projection of
    the deficiency in perpetuity. This is the clearest way to see the total
    imbalance in both programs.
      The present value of the Social Security imbalance over the next 75
    years was estimated to be $6.4 trillion as of January 1, 2006. The
    comparable estimate for Medicare was $32.3 trillion. These estimates
    exclude the trust fund balances because the balances do not represent a
    source of funds from a unified budget perspective. (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 2006 trustees' reports. These differ in some
    respects from the assumptions

    [[Page 191]]

    used for the long-run budget projections described in the preceding
    section. Table 13-3 would show a smaller imbalance if the economic
    assumptions used for the budget had been used for the calculations. In
    addition, because the estimates are on the basis of current law, they do
    not reflect the Administration's proposals to reform Medicare. Under the
    Adminstration's proposals, the Medicare actuaries estimate that the
    imbalance would be reduced to about $24 trillion.
       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. 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 $15.3 trillion and for Medicare
    it is $70.8 trillion as of January 1, 2006. (Again, the Medicare
    estimate would be smaller if the effects of the Administration's policy
    proposals had been included in the calculation.)
      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 2006 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 $0.3 trillion more than they will collect in benefits. This
    can be seen by comparing the total deficiency in perpetuity, $15.3
    trillion, with the excess of benefits over taxes for current program
    participants, $15.0 trillion, from Table 13-3. In other words, the taxes
    that future participants are expected to pay will be almost 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 perpetuity shows that the benefits
    due future participants will eventually exceed projected payroll tax
    receipts and premiums by a huge margin. The projections into perpetuity
    shown at the top of Table 13-3 reveal that total Medicare benefits
    exceed future taxes and premiums by $70.8 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 relative
    to total output in the economy.

                 Table 13-3.  BENEFITS IN EXCESS OF FUTURE TAXES AND PREMIUMS--ACTUARIAL PRESENT VALUES
    ----------------------------------------------------------------------------------------------------------------
        In Perpetuity as of January 1, in Trillions of
                          Dollars                                                       2004       2005       2006
    ----------------------------------------------------------------------------------------------------------------
    Social Security......................................  ...........  ...........       11.9       12.8       15.3
    Medicare.............................................  ...........  ...........       61.9       68.4       70.8
                                                          ----------------------------------------------------------
    Social Security and Medicare.........................  ...........  ...........       73.8       81.2       86.0
    ----------------------------------------------------------------------------------------------------------------

    Over a 75-Year Projection Period as of January 1, in         2002         2003        2004       2005       2006
     Trillions of Dollars
    ----------------------------------------------------------------------------------------------------------------
    Social Security
      Future benefits less future taxes for those age 62          4.1          4.3         4.5        4.9        5.3
       and over..........................................
      Future benefits less future taxes for those age 15          7.2          7.4         8.0        8.7        9.6
       to 61.............................................
      Future benefits less taxes for those age 14 and            -6.7         -6.8        -7.3       -7.9       -8.5
       under and those not yet born......................
                                                          ----------------------------------------------------------
        Net present value for present and future                  4.6          4.9         5.2        5.7        6.4
         participants....................................

                                                          ----------------------------------------------------------
    Medicare
      Future benefits less future taxes for those age 65          2.5          2.8         3.8        4.0        4.2
       and over..........................................
      Future benefits less future taxes for those age 15         10.4         12.2        20.9       22.4       24.9
       to 64.............................................
      Future benefits less taxes for those age 14 and             0.4          0.8         3.4        3.6        3.3
       under and those not yet born......................
                                                          ----------------------------------------------------------
        Net present value for present and future                 13.3         15.8        28.1       29.9       32.3
         participants....................................

                                                          ----------------------------------------------------------
    Social Security and Medicare
      Future benefits less future taxes for those who             6.6          7.1         8.3        8.9        9.5
       have attained eligibility.........................
      Future benefits less future taxes for those over           17.6         19.7        28.9       31.0       34.5
       age 15 who have not yet attained eligibility......
      Future benefits less taxes for those age 14 and            -6.3         -6.0        -3.9       -4.3       -5.3
       under and those not yet born......................
                                                          ----------------------------------------------------------
        Net present value for present and future                 17.8         20.7        33.3       35.6       38.8
         participants....................................

    ----------------------------------------------------------------------------------------------------------------
    Addendum:
    Actuarial deficiency as a percent of the discounted
     payroll tax base:
      Social Security....................................       -1.87        -1.92       -1.89      -1.92      -2.02
      Medicare HI........................................       -2.02        -2.40       -3.12      -3.09      -3.51
    ----------------------------------------------------------------------------------------------------------------

      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 law. 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 necessarily mean that the
    Government saved the money recorded there. The trust fund surpluses
    could have added to national saving if overall government borrowing from
    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

    [[Page 192]]

    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 in the long
    run.
      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--TAX COMPLIANCE, NATIONAL WEALTH, AND SOCIAL INDICATORS

      To obtain a full picture of the Government's financial condition it is
    necessary to examine a broad range of additional information beyond the
    narrow list of Government-owned assets and liabilities. It is even nec

    [[Page 193]]

    essary to consider more information than is contained in the long-term
    projections of the budget. This final section presents a sample of such
    additional information. It is intended to provide insight into the full
    range of resources the Government can draw upon to meet its long-term
    obligations and also to indicate in a summary way what the Nation
    obtains in exchange for the resources it provides the Government.
      The first piece of additional information is analysis of compliance
    with the nation's tax laws, the so-called ``tax gap.'' The Government
    does not collect in a timely manner all of the taxes it is legally owed,
    as explained in detail below (along with some proposals to narrow the
    gap). That discussion is followed by an investigation of national wealth
    and the contributions the Federal Government has made to the wealth of
    private persons and other levels of government. The final section
    discusses a range of economic and social indicators which provide
    information about the outcomes of Government policies.

         Improving Tax Fairness and Federal Finances through Better Tax
                                   Compliance

      The Internal Revenue Service (IRS) collects over 95 percent of total
    Federal receipts, $2.4 trillion in 2006. However, not every dollar of
    tax legally owed is actually paid. In general, taxpayers comply with the
    law by filing returns and paying their taxes on time, but some do not
    comply either because they do not understand their obligations due to
    the complexity of the tax law or because they seek to avoid those
    obligations.
       Tax Compliance: In 2006, the IRS released updated results of its
    first large study in two decades of the difference between taxes owed
    and taxes actually paid--the ``tax gap.'' The IRS estimated that
    taxpayers initially underpaid by $345 billion in 2001. This equates to a
    voluntary compliance rate of 84 percent. Late payments and IRS
    enforcement action reduced this to a net tax gap of $290 billion,
    raising the net compliance rate to 86 percent. The Department of the
    Treasury does not have estimates of the tax gap for the years after
    2001. It is possible, however, that lower tax rates, more aggressive
    enforcement by the IRS, and an improved economic environment have tended
    to decrease the gap, although inflation and the overall growth of the
    economy have tended to increase compliance rates over the past six
    years.
      Due to changes in methodologies, comparisons between the 2001
    estimates and those from earlier studies should be made cautiously.
    However, it does appear that the voluntary compliance rate has not
    changed much since the 1980s. The IRS previously reported voluntary
    compliance rates of 87 percent in 1988, 86 percent in 1985, and 84
    percent in 1983. While the overall rate seems to have moved relatively
    little over time, each one percentage point change significantly impacts
    revenue. A one percentage point improvement would increase revenue by
    $21 billion per year based on 2001 numbers.
      The IRS's compliance estimates, primarily based on random audits of
    individuals and businesses, are not precise, but give a good general
    sense of the size of the tax gap and patterns in compliance. This sort
    of information is critical for effectively targeting IRS enforcement
    programs to yield the greatest improvement with the smallest cost and
    burden on taxpayers. The IRS' estimates are most accurate for
    underpayments of known taxes as recorded in IRS financial systems, and
    for individual income tax compliance studied through the recent random
    National Research Program (NRP) study. Non-filing estimates come from
    studies of census data and are somewhat less precise. The weakest
    portions of the IRS' estimates are in areas where no recent studies have
    been completed and the IRS is relying on older data (e.g., for
    partnerships and corporations).
      The gross tax gap results from a variety of honest taxpayer errors and
    intentional noncompliance. Of the total, 82 percent comes from
    underreporting of tax liability (see chart). A significant portion of
    the gap also comes from underpayment of known tax debts and people who
    fail to file returns. Individual income taxes, the largest source of
    Federal receipts, account for 71 percent of the tax gap.

    [[Page 194]]

      The highest compliance rates come in areas where the IRS has good
    information about income, because it is reported by third parties (e.g.,
    Form W-2, reporting wage income from employers and Form 1099, reporting
    various third party payments, including interest from banks). The IRS
    estimates that 95 percent of income with third-party reporting but no
    withholding (e.g., interest income, dividends) is declared on taxpayer
    returns. Where there is tax withholding, as in the case of most wages,
    nearly 99 percent of the amounts reported by payers is declared on
    taxpayer returns.

      Conversely, error rates are high for income with little or no third-
    party reporting. For example, an estimated 43 percent of the tax gap
    comes from business income that should be reported on individual returns
    (Forms 1040) but goes unreported to the IRS (see chart). .
       Improving Tax Compliance: While the tax gap can never be entirely
    eliminated, reducing the gap by improving compliance is important
    because non-compliant taxpayers impose unacceptable burdens on other
    taxpayers and on Federal finances.

         Table 13-4.  SOURCES OF THE TAX GAP FROM INCOME UNDERREPORTING
    ------------------------------------------------------------------------
                                                                    Percent
                                                    Contribution   Share  of
                                                      to the Tax      the
                                                       Gap  in      Overall
                                                       Dollars      Tax Gap
    ------------------------------------------------------------------------

    Business income underreported by individuals           148           43
    Non-business income underreporting and                  88           26
     improper deductions and credits..............
    Corporate income underreporting...............          30            9
    Other underreporting..........................          19            6

    Total Underreporting..........................         285           84
    ------------------------------------------------------------------------

      The challenge is to find ways to improve compliance without unduly
    burdening compliant taxpayers or the economy. For example, as noted
    above, income reported to the IRS by third parties is claimed on tax
    returns at a far higher rate than other income. Requiring third-party
    reporting of all income would likely raise compliance levels. However,
    this is not possible in all cases and even where it is possible it might
    require burdensome new reporting requirements for individuals and
    businesses. For example, individuals paying a contractor or purchasing a
    car might be required to file reports to the IRS reporting these
    transactions. Such broad expansions of reporting requirements would be
    excessively burdensome, and that this consideration outweighs the gains
    they might bring in increased compliance.
      Similarly, requiring much more detailed documentation, such as
    evidence supporting claims for deductions and credits or providing
    accounting records supporting business income claims, would quite
    possibly improve compliance. In some cases more detailed documentation
    may be appropriate. However, unless carefully targeted, this is likely
    to impose an unacceptable increase in cost on both taxpayers and the IRS
    and to decrease privacy.
      Another approach to improving compliance would be to change the tax
    code to remove tax benefits wherever there is the potential for abuse.
    For example, deductions for non-cash giving could be prohibited. This
    would prevent the overstatement of charitable deductions by some
    taxpayers. However, it would also impose a tax increase on the millions
    of taxpayers who currently take legitimate deductions for non-cash
    giving. Compliant taxpayers are likely to regard this approach as overly
    broad. Finally, much higher audit rates might improve compliance, but
    would be extremely expensive

    [[Page 195]]

    and unless properly targeted could be unduly burdensome to honest
    taxpayers.
      The Administration has developed a carefully targeted plan for
    reducing the tax gap, which is described in the Department of the
    Treasury's ``A Comprehensive Strategy for Reducing the Tax Gap'' (see
    www.ustreas.gov/press/releases/hp111.htm). This document lays out a
    multi-year, seven-part strategy to improve compliance without imposing
    undue burdens on taxpayers. The Budget provides a $410 million
    initiative in the IRS to begin implementing this strategy. Components of
    the strategy include:
      Reduce Opportunities for Evasion: The Administration will pursue
    carefully targeted tax law changes to promote compliance while causing
    minimal taxpayer burden and IRS cost increases. The Budget includes 16
    legislative proposals, such as expanding third party information
    reporting where it can be done with acceptable levels of taxpayer burden
    (e.g., including payments to corporations in existing third-party
    reporting requirements and requiring brokers to report the cost basis
    for certain securities' sales). (See chapter 17, ``Federal Receipts''
    for a full description of these legislative proposals.)
      Multi-Year Commitment to Research: Improved research on tax gap causes
    and potential remedies will help the IRS target its enforcement and
    service programs to achieve the greatest possible impact at the lowest
    cost.
      Investments in Information Technology: Modernized computer systems
    will give IRS staff the tools they need to improve efficiency, service
    and compliance.
      Improve Compliance Activities: Through reengineering and selected
    funding increases the IRS will improve the effectiveness of its
    enforcement efforts to increase the fairness of the tax system by
    ensuring that everyone pays their share.
      Taxpayer Service: Improved service will help taxpayers avoid
    unintentional errors and will make filing easier. Improved telephone
    service, new internet tools, and increases in electronic filing have
    already helped taxpayers file more accurate returns with less effort.
      Reform and Simplify the Tax Law: Simplifying the tax law will reduce
    unintentional errors caused by a lack of understanding. Simplification
    will also reduce the opportunities for intentional evasion and make it
    easier for the IRS to administer the tax laws.
      Coordinate with Partners and Stakeholders: Closer coordination is
    needed between the IRS and state and foreign governments to share
    information and compliance strategies. Closer coordination is also
    needed with practitioner organizations, including bar and accounting
    associations, to maintain and improve mechanisms to ensure that advisors
    provide appropriate tax advice.
      Collectively these efforts will reduce the tax gap and improve the
    fiscal situation of the Government. Equally important, better compliance
    will improve the fairness of the tax system. Implementation depends on
    effective IRS leadership, to improve factors such as technology
    investments and reengineering processes, as well as the active support
    of the Congress to implement tax law changes and provide funding for
    these improvements.

                   The Federal Contribution to National Wealth

      The Government relies on private wealth to support its activities. It
    also contributes to that wealth. 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, 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, these investments augment future tax receipts. The return on
    investment that comes back to the Government in the form of higher
    taxes, however, is far less than what a private investor would require
    before undertaking a similar investment.
      The Federal Government also supports education and research and
    development (R&D). These outlays contribute to future productivity and
    are analogous to investments 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 balance sheet.
      To show the importance of these kinds of issues, Table 13-5 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 13-5
    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 13-5.  NATIONAL WEALTH
                                                (As of the end of the fiscal year, in trillions of 2006 dollars)
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                                                    1960     1965     1970     1975     1980     1985     1990     1995     2000     2004     2005     2006
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                       ASSETS
    Publicly Owned Physical Assets:
      Structures and Equipment..................      2.3      2.6      3.2      3.9      4.2      4.4      4.8      5.3      6.0      6.9      7.4      7.6
        Federally Owned or Financed.............      1.3      1.4      1.5      1.7      1.8      2.0      2.2      2.3      2.3      2.4      2.5      2.6
          Federally Owned.......................      1.2      1.1      1.2      1.2      1.1      1.2      1.3      1.3      1.1      1.1      1.1      1.2
          Grants to State and Local Governments.      0.2      0.2      0.4      0.6      0.7      0.8      0.9      1.0      1.2      1.3      1.4      1.4
        Funded by State and Local Governments...      1.0      1.2      1.6      2.2      2.4      2.4      2.6      3.0      3.7      4.5      4.9      5.0
      Other Federal Assets......................      0.8      0.8      0.7      0.9      1.4      1.5      1.2      0.9      1.3      1.8      2.1      2.2
                                                 -----------------------------------------------------------------------------------------------------------
            Subtotal............................      3.1      3.3      3.9      4.8      5.6      5.9      6.0      6.2      7.3      8.7      9.5      9.7

    Privately Owned Physical Assets:
      Reproducible Assets.......................      7.7      8.8     10.8     13.9     18.1     19.2     21.9     24.2     29.4     33.8     35.3     35.5
        Residential Structures..................      3.0      3.5      4.2      5.3      7.3      7.5      8.6      9.8     12.2     15.2     16.0     16.1
        Nonresidential Plant & Equipment........      3.0      3.4      4.3      5.7      7.4      8.1      9.1      9.9     12.0     13.1     13.7     13.6
        Inventories.............................      0.8      0.8      1.0      1.3      1.6      1.4      1.5      1.6      1.8      1.8      1.8      1.9
        Consumer Durables.......................      0.9      1.1      1.3      1.6      1.9      2.1      2.7      3.0      3.4      3.7      3.8      3.9
      Land......................................      2.3      2.7      3.1      4.1      6.3      7.1      7.3      5.5      8.5     11.7     14.0     15.3
                                                 -----------------------------------------------------------------------------------------------------------
            Subtotal............................     10.0     11.6     14.0     18.0     24.3     26.3     29.2     29.7     37.9     45.4     49.3     50.8

    Education Capital:
      Federally Financed........................      0.1      0.1      0.3      0.4      0.5      0.7      0.8      1.0      1.3      1.5      1.6      1.7
      Financed from Other Sources...............      6.4      8.6     11.5     14.6     18.7     21.8     27.1     31.8     40.6     45.8     46.9     48.4
                                                 -----------------------------------------------------------------------------------------------------------
            Subtotal............................      6.4      8.7     11.8     15.0     19.2     22.5     27.9     32.9     41.9     47.3     48.5     50.0

    Research and Development Capital:
        Federally Financed R&D..................      0.2      0.4      0.5      0.6      0.7      0.8      0.9      1.0      1.1      1.2      1.3      1.3
        R&D Financed from Other Sources.........      0.1      0.2      0.3      0.4      0.5      0.7      1.0      1.2      1.7      2.0      2.1      2.1
                                                 -----------------------------------------------------------------------------------------------------------
            Subtotal............................      0.3      0.6      0.9      1.0      1.2      1.5      1.9      2.3      2.8      3.2      3.3      3.5

                                                 -----------------------------------------------------------------------------------------------------------
    Total Assets................................     19.8     24.2     30.5     38.9     50.3     56.2     65.1     71.0     89.9    104.7    110.6    114.0

    Net Claims of Foreigners on U.S.............     -0.1     -0.2     -0.2     -0.1     -0.4      0.1      0.9      1.6      3.2      4.7      5.8      6.1

    Net Wealth..................................     19.9     24.4     30.7     39.0     50.7     56.1     64.2     69.4     86.7     99.9    104.9    108.0
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                      ADDENDA:
      Per Capita Wealth (thousands of 2006 $)...    110.5    125.7    150.0    180.7    222.4    235.1    256.2    259.9    306.7    339.5    353.0    360.3
      Ratio of Wealth to GDP (in percent).......    682.9    665.2    700.3    784.4    853.2    790.8    773.8    740.2    757.3    798.3    810.5    810.2
      Total Federally Funded Capital (trils 2006      2.4      2.6      3.1      3.6      4.4      5.0      5.2      5.3      6.0      7.0      7.5      7.8
       $).......................................
            Percent of National Wealth..........     11.9     10.8     10.0      9.3      8.7      8.9      8.1      7.6      7.0      7.0      7.2      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: $7.8 trillion. The Federal contribution is down
    from 9 percent in the early 1980s and from 12 percent in 1960. Much of
    this decline reflects the relative shrinkage in the stock of defense
    capital, which has fallen from around 34 percent of GDP in 1960 to under
    6 percent in 2006.
       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, $60.5 trillion in 2006,
    consisting of $50.8 trillion in private physical capital and $9.7
    trillion in public physical capital (including capital funded by

    [[Page 196]]

    State and local governments); by comparison, GDP was around $13 trillion
    in 2006. The Federal Government's contribution to this stock of capital
    includes its own physical assets of $3.3 trillion plus $1.4 trillion in
    accumulated grants to State and local governments for capital projects.
    The Federal Government has financed over 20 percent 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 13-5 includes an
    estimate of the stock of capital represented by the Nation's investment
    in formal education and training. The estimate is based on the cost of
    replacing the years of schooling embodied in the U.S. population aged 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
    $50 trillion in 2006, 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 train

    [[Page 197]]

    ing, 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. \5\ That stock
    is estimated to have been $3.5 trillion in 2006. 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.
    ---------------------------------------------------------------------------
      \5\ 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. Table
    13-5 only shows National totals. Gross debt is important even though it
    does not appear in Table 13-5. 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.

                                         Table 13-6.  TRENDS IN NATIONAL WEALTH
                                            (Average Annual Rates in Percent)
    ----------------------------------------------------------------------------------------------------------------
                                                                        1960-06    1960-1973   1973-1995   1995-2006
    ----------------------------------------------------------------------------------------------------------------
    Real GDP........................................................        3.4         4.3         2.8         3.3
    National Wealth.................................................        3.7         4.5         3.1         4.1
    Private Physical Wealth.........................................        3.6         3.9         2.7         5.0
      Nonresidential Plant and Equipment............................        3.3         4.1         3.1         2.9
      Residential Structures........................................        3.7         4.0         3.1         4.6
      Consumer Durables.............................................        3.1         3.6         3.2         2.5
    Public Physical Wealth..........................................        2.6         2.8         1.6         4.2
    Net Education...................................................        4.6         5.9         4.1         3.9
    Net R&D.........................................................        5.2         8.6         3.9         3.9
    ----------------------------------------------------------------------------------------------------------------

      The only debts that show up in Table 13-5 are the debts Americans owe
    to foreigners for the investments that foreigners have made in the
    United States. 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. In 2006, it amounted to 5 percent of total
    assets including education and R&D capital.
      Federal debt does not appear explicitly in Table 13-5 because much 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 5.7 percent of net U.S. wealth as shown in Table 13-5.
    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 2006 was
    $108 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 4.1 percent since 1995. Productivity growth has also
    accelerated since 1995, following a similar slowdown from 1973 to 1995.

                                                           TABLE 13-7.  ECONOMIC AND SOCIAL INDICATORS
    --------------------------------------------------------------------------------------------------------------------------------------------------------
                        Calendar Years                        1960       1970       1980       1990       1995       2000       2004       2005       2006
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    Economic:
    Living Standards:
      Real GDP per person (2000 dollars) (a).............     13,840     18,392     22,666     28,429     30,128     34,759     36,415     37,241     38,136
        average annual percent change (5-year trend).....        0.6        2.3        2.6        2.3        1.2        2.9        1.4        1.4        1.9
      Real Disposable Personal Income Per Capita.........      9,735     13,563     16,940     21,281     22,153     25,472     27,254     27,318     27,761
        average annual percent change (5-year trend).....        1.2        3.2        2.1        1.8        0.8        2.8        2.1        1.4        1.6
      Median Income: All Households (2005 dollars).......        N/A     38,026     39,739     43,366     43,346     47,599     45,817     46,326        N/A
        average annual percent change (5-year trend).....        N/A        N/A        1.0        1.2        0.0        1.9       -0.8       -0.5        N/A
      Income Share of Lower 60% of All Households........       31.8       32.3       31.2       29.3       28.0       27.3       26.8       26.6        N/A
      Poverty Rate (%) (b)...............................       22.2       12.6       13.0       13.5       13.8       11.3       12.7       12.6        N/A

    Economic Security:
      Civilian Unemployment (%)..........................        5.5        4.9        7.1        5.5        5.6        4.0        5.5        5.1        4.6
      CPI-U (% Change)...................................        1.7        5.7       13.5        5.4        2.8        3.4        2.7        3.4        3.2
      Payroll Employment Increase (millions) (c).........       -0.4       -0.4        0.3        0.3        2.2        1.9        2.1        2.6        2.0
      Managerial or Professional Jobs (% of civilian             N/A        N/A        N/A       29.2       32.0       33.8       34.9       34.7       34.9
       employment).......................................

    Wealth Creation:
      Net National Saving Rate (% of GDP) (d)............       10.6        8.3        7.4        4.4        4.1        5.9        0.9        0.1        2.0

    Innovation:
      Patents Issued to U.S. Residents (thousands) (e)...       42.3       50.6       41.7       56.1       64.5       97.0       94.1       82.6        N/A
      Multifactor Productivity (average 5 year percent           0.8        0.8        0.8        0.6        0.6        1.2        1.7        N/A        N/A
       change)...........................................
      Nonfarm Output per Hour (average 5 year percent            1.8        2.1        1.1        1.6        1.5        2.5        3.2        3.1        3.0
       change)...........................................

    Environment:
      Air Quality:
        Nitrogen Oxide Emissions (millions of tons)......         18         27         27         26         25         23         20         19        N/A
        Sulfur Dioxide Emissions (millions of tons)......         22         31         26         23         19         16         15         15        N/A
        Carbon Monoxide (millions of tons)...............        N/A        197        178        144        120        102        N/A         89        N/A
        Lead Emissions (thousands of tons)...............        N/A        221         74          5          4          3          3          3        N/A
      Water Quality:
        Population Served by Secondary Treatment or              N/A         85        N/A        162        174        179        N/A        N/A        N/A
         Better (mils)...................................

    Social:
      Families:
        Children Living with Mother Only (% of all               9.2       11.6       18.6       21.6       24.0       22.3       23.7       23.4        N/A
         children).......................................
      Safe Communities:
        Violent Crime Rate (per 100,000 population) (f)..      160.0      364.0      597.0      729.6      684.5      506.5      463.2      469.2      482.2
        Murder Rate (per 100,000 population) (g).........        5.1        7.8       10.2        9.4        8.2        5.5        5.5        5.6        5.6
        Murders (per 100,000 Persons Age 14 to 17).......        N/A        N/A        5.9        9.8       11.0        4.8        4.6        N/A        N/A
      Health:
        Infant Mortality (per 1000 Live Births) (g)......       26.0       20.0       12.6        9.2        7.6        6.9        6.8        6.8        6.7
        Low Birthweight [<2,500 gms] Babies (%) (g)......        7.7        7.9        6.8        7.0        7.3        7.6        8.1        8.2        N/A
        Life Expectancy at birth (years).................       69.7       70.8       73.7       75.4       75.8       77.0       77.9        N/A        N/A
        Cigarette Smokers (% population 18 and older)....        N/A       39.2       33.0       25.3       24.6       23.1       20.8       20.9        N/A
        Overweight (% population 20-74 with Body-Mass           44.5       47.5       47.2       54.6       60.7       65.0       66.2        N/A        N/A
         Index)2.5)......................................
      Learning:
        High School Graduates (% of population 25 and           44.6       55.2       68.6       77.6       81.7       84.1       85.2       85.2        N/A
         older)..........................................
        College Graduates (% of population 25 and older).        8.4       11.0       17.0       21.3       23.0       25.6       27.7       27.6        N/A
        National Assessment of Educational Progress (h)
          Reading 17-year olds...........................        N/A        N/A      285.0      290.0      288.0      287.4      285.0        N/A        N/A
          Mathematics 17-year olds.......................        N/A        N/A      299.0      305.0      306.5      307.8      307.0        N/A        N/A
      Participation:
        Individual Charitable Giving per Capita (2000            281        381        373        465        449        692        639        N/A        N/A
         dollars)........................................

    (by election year)...................................     (1960)     (1972)     (1980)     (1984)     (1988)     (1992)     (1996)     (2000)     (2004)
        Voting for President (% eligible population).....       62.8       55.1       52.8       53.3       50.3       55.2       49.0       50.3       55.5
    --------------------------------------------------------------------------------------------------------------------------------------------------------
    (a) Forecast data are used for the fourth quarter of 2006.
    (b) The poverty rate does not reflect noncash government transfers such as Medicaid or food stamps.
    (c) The data for 2005-2006 reflect the expected 810,000 benchmark revision scheduled for February 2007.
    (d) 2006 through Q3 only.
    (e) Preliminary data for 2005.
    (f ) Not all crimes are reported, and the fraction that go unreported may have varied over time, preliminary data for 2006.
    (g) Provisional data for 2005-2006; data for 2006 through April.
    (h) Data for some years are interpoated.

      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 2006.
    It grew especially rapidly from 1960 to 1973, at an average rate of 4.1
    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.
    Privately owned residential structures and land have all grown much more
    rapidly in real value since 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. It grew at
    an average rate of 5.9 percent per year in the 1960s, 2.0 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 3.9 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. R&D

    [[Page 198]]

    stocks have also grown at an average rate of 3.9 percent per year since
    1995.

                   Other Federal Influences on Economic Growth

      Federal investment decisions, as reflected in Table 13-5, obviously
    are important, but the Federal Government also affects wealth in ways
    that cannot be easily

    [[Page 199]]

    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 credit and insurance policies.

                                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 13-7 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 13-7 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.
      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.
      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.
      Some of the trends in these indicators turned around in the 1990s. The
    improvement in economic conditions beginning around 1995 has been widely
    noted, and there have also been some social improvements. Perhaps, most
    notable has been the turnaround in the crime rate. After reaching a peak
    in the early 1990s, violent crime fell 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, although the last two years have
    seen an uptick in murders. The 2001 recession had a negative effect on
    some of these indicators: unemployment rose and real GDP growth
    declined, but as the economy recovered much of the improvement shown in
    Table 13-7 was preserved. Indeed, productivity growth, the best
    indicator of future changes in the standard of living, accelerated and
    has grown at a faster average rate since 2001 than at any comparable
    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 2007-2017, 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 2006 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 2.3 percent per year; the
              unemployment rate is constant at 4.8 percent; and the yield on
              10-year Treasury notes is steady at 5.3 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 0.3
              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 2.6 percent per year.

    [[Page 200]]

      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 2012, receipts follow the
    budget's policy projections. After 2012, receipts are assumed to return
    gradually to their share of GDP over the last 40 years, 18.3 percent,
    and to remain at that lower share over the long run. Discretionary
    spending follows the growth policies in the Budget over the next ten
    years and grows at the rate of growth in nominal GDP afterwards. Other
    spending also aligns with the Budget through the budget horizon, except
    that the Social Security program does not include the proposal to
    incorporate personal accounts in the program. Long-run Social Security
    spending is projected by the Social Security actuaries using this
    Chapter's long-range assumptions. Medicare benefits are projected based
    on the estimates in the 2006 Medicare trustees' report, adjusted for
    differences in the assumed inflation rate and the growth rate in real
    GDP per capita, and further adjusted for the estimated long-run effects
    of the Administration's policy proposals. Federal pensions are derived
    from the most recent actuarial forecasts available at the time the
    budget is prepared, repriced using Adminstration 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 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.
       Environmental Liabilities: The source of data for environmental
    liabilities was the Financial Report of the United States Government for
    2006 and previous years. Prior to 1994, the estimates were extrapolated
    assuming a constant ratio to GDP.

                             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 2006.
       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 2006 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.

    [[Page 201]]

      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. Department 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.