[House Hearing, 108 Congress]
[From the U.S. Government Publishing Office]



 
                   CBO'S ANALYSIS OF THE PRESIDENT'S
                        FISCAL YEAR 2004 BUDGET

=======================================================================

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED EIGHTH CONGRESS

                             FIRST SESSION

                               __________

             HEARING HELD IN WASHINGTON, DC, MARCH 25, 2003

                               __________

                            Serial No. 108-8

                               __________

           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

                       JIM NUSSLE, Iowa, Chairman
CHRISTOPHER SHAYS, Connecticut,      JOHN M. SPRATT, Jr., South 
  Vice Chairman                          Carolina,
GIL GUTKNECHT, Minnesota               Ranking Minority Member
MAC THORNBERRY, Texas                JAMES P. MORAN, Virginia
JIM RYUN, Kansas                     DARLENE HOOLEY, Oregon
PAT TOOMEY, Pennsylvania             TAMMY BALDWIN, Wisconsin
DOC HASTINGS, Washington             DENNIS MOORE, Kansas
ROB PORTMAN, Ohio                    JOHN LEWIS, Georgia
EDWARD SCHROCK, Virginia             RICHARD E. NEAL, Massachusetts
HENRY E. BROWN, Jr., South Carolina  ROSA DeLAURO, Connecticut
ANDER CRENSHAW, Florida              CHET EDWARDS, Texas
ADAM PUTNAM, Florida                 ROBERT C. SCOTT, Virginia
ROGER WICKER, Mississippi            HAROLD FORD, Tennessee
KENNY HULSHOF, Missouri              LOIS CAPPS, California
THOMAS G. TANCREDO, Colorado         MIKE THOMPSON, California
DAVID VITTER, Louisiana              BRIAN BAIRD, Washington
JO BONNER, Alabama                   JIM COOPER, Tennessee
TRENT FRANKS, Arizona                RAHM EMMANUEL, Illinois
SCOTT GARRETT, New Jersey            ARTUR DAVIS, Alabama
GRESHAM BARRETT, South Carolina      DENISE MAJETTE, Georgia
THADDEUS McCOTTER, Michigan          RON KIND, Wisconsin
MARIO DIAZ-BALART, Florida
JEB HENSARLING, Texas
GINNY BROWN-WAITE, Florida

                           Professional Staff

                       Rich Meade, Chief of Staff
       Thomas S. Kahn, Minority Staff Director and Chief Counsel



                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, March 25, 2003...................     1
Statement of:
    Douglas J. Holtz-Eakin, Director, Congressional Budget Office    24
Prepared statement and additional submission of:
    Mr. Holtz-Eakin:
        Letter in reponse to Mr. Wicker's request on CBO 
          transparency...........................................     3
        Prepared statement.......................................    33


       CBO'S ANALYSIS OF THE PRESIDENT'S FISCAL YEAR 2004 BUDGET

                              ----------                              


                        TUESDAY, MARCH 25, 2003

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 1:03 p.m. in room 
210, Cannon House Office Building, Hon. Jim Nussle (chairman of 
the committee) presiding.
    Members present: Representatives Nussle, Gutknecht, 
Hastings, Brown, Wicker, Diaz-Balart, Brown-Waite, Spratt, 
Moran, Lewis, Edwards, Baird, Cooper, and Majette.
    Chairman Nussle. I would like to call the Budget Committee 
to order. This is a full committee hearing entitled ``A 
Macroeconomic Analysis of the President's Budget.''
    Today, we are honored to have the Director of the 
Congressional Budget Office, Doug Holtz-Eakin. Dr. Holtz-Eakin 
is in his first hearing and first opportunity to come before 
the House Budget Committee. As someone who had an opportunity 
to interview all of the candidates, very worthwhile prospects 
for the Congressional Budget Office, let me just say how much I 
am pleased that you are here today and that we have an 
opportunity to kick things off.
    Today, the Budget Committee will hear from the 
Congressional Budget Office on its analysis of the President's 
fiscal year 2004 budget request. I realize, Dr. Holtz-Eakin, 
that you are most likely still experiencing quite a steep 
learning curve, only having been on the job at the 
Congressional Budget Office for a matter of weeks; but I want 
to thank you for taking time to present your testimony as 
opposed to just putting it forward.
    Many of the people listening may be wondering why we are 
holding a hearing on the President's budget request 5 days 
after the House passed its own budget, and that is a good 
question. Today's hearing is truly a first in the way in which 
we would like to view budget projections. In the analysis that 
we will hear today, the Congressional Budget Office has looked 
at the President's request using what many would term as a, 
quote, ``dynamic analysis.'' This is the first time that I am 
aware of this, and it is the first time that it has been 
produced.
    Over the years, there has been a great deal of discussion 
and concern regarding the methods used by the Congressional 
Budget Office to produce analysis or scores in budgets and in 
congressional policy. Currently, the Congressional Budget 
Office used what is often termed as a ``static model,'' to look 
at fiscal policy, while many in Congress have favored moving to 
a much more dynamic model. Unfortunately, the choice is not as 
simple as choosing one model over another.
    The current static model, as it is called, has some dynamic 
aspects, but it is clearly not a perfect model. Year after 
year, the economic forecast that we use and the analysis that 
has been provided has been by some measure way off. Instead of 
limiting ourselves to one model which we know is and has been 
flawed, I believe it is important that we have as much 
information and analysis as possible to make our decisions.
    However, as it stands today, there is really no sound 
alternative. Dynamic analysis, as it is called, may prove to be 
a great alternative or additional information to current 
methods, but at this point a reliable model is really not yet 
available. While economists know that certain policies affect 
the economy in specific dynamic ways, there is a great deal 
which we don't really know precisely yet. Over time, as we 
learn more, we can move closer to an alternative or more 
accurate method.
    When it comes down to it, I don't favor a static analysis 
over a dynamic analysis as much as I favor an analysis that is 
just plain more accurate. As this committee and the rest of 
Congress attempts to write budgets and determine the best 
policies, we need more reliable and accurate information. Just 
a slight deviation, a half a percent here or there, makes a 
huge difference in the baseline and the gross domestic product, 
economic growth, and it has huge ramifications as the years 
progress.
    There is no question we need a better system. I think the 
issue is one that both parties can and have agreed on.
    As each of us proposes new policies and changes to the 
current system, we need to have a better idea of the future 
impact of those policies, so today we take a first step down 
the path we hope toward a better model. It is very important 
that we all understand that this is just a first step. It is my 
hope that over the coming months and years, we are able to 
build on this foundation to develop a more accurate model.
    I appreciate the work that our Congressional Budget Office 
Director and his team have done in preparing this presentation 
for us today, but I think he will tell you that this is by no 
means a final product. It is a product that is a work in 
progress.
    So I want to thank you for coming today, Dr. Holtz-Eakin. 
We look forward to your testimony and the opportunity to query 
you about the methods and the models that you have chosen. With 
that, I would turn to Mr. Spratt for any opening comments he 
would like to make.
    Mr. Spratt. Mr. Holtz-Eakin, thank you very much for your 
work and your testimony today.
    I have only had a chance to have it reviewed, briefed about 
it, and also to take a quick cursory read of it, but I think it 
is a very, very solid piece of work. And what you have come up 
with is, to me, a validation of the baseline that you have been 
using.
    It seems to me that advertently your static line just about 
tracks the trend line of the eight or nine models that you have 
used. In any event, none of these models has a dramatic impact 
on growth and none, to the best of my reading, would hold out 
the hope that substantial tax cuts could be self replenishing, 
self funding over time.
    We look forward to your testimony and look forward to your 
presentation and thank you and your staff for the excellent 
work have you done here.
    Chairman Nussle. Dr. Holtz-Eakin, your entire testimony is 
presented and the report will be made part of the record. And 
you may summarize and proceed as you see fit. We appreciate it.
    [Letter submitted for the record:]

     Letter in Response to Mr. Wicker's Request on CBO Transparency

                               Congressional Budget Office,
                                     Washington, DC, July 30, 2003.
    Dear Mr. Wicker: Following a March 25, 2003, hearing of the House 
Budget Committee, at which the Congressional Budget Office (CBO) 
presented its Analysis of the President's Budgetary Proposals for 
Fiscal Year 2004, you requested that the agency disclose detailed 
information about the methods underlying the report.
    CBO holds dear the principle of transparency in its analyses, and 
toward that end, it has just published a detailed description of the 
methods employed for that March 2003 report. A copy of that 
description, ``How CBO Analyzed the Macroeconomic Effects of the 
President's Budget'' is enclosed. We are planning two more papers that 
will describe the CBO models used in the analysis in the way most 
commonly done in academic literature presenting the mathematical 
structure of the models and demonstrating their properties through 
simulations. We will provide copies of those papers to you.
    We would be glad to respond to any specific questions you may have 
about our analysis or to walk your staff through the methods that we 
used.
            Sincerely,
                                       Douglas Holtz-Eakin,
                                                     Director, CBO.

  HOW CBO ANALYZED THE MACROECONOMIC EFFECTS OF THE PRESIDENT'S BUDGET

                              Introduction

    The Congressional Budget Office (CBO) recently published its 
analysis of the potential macroeconomic effects of the proposals in the 
President's 2004 budget. The analysis concluded that those effects 
would be relatively small on net, reflecting both the relative size of 
the proposals (costing $2.7 trillion, including interest costs, in an 
economy projected to produce more than $144 trillion over the next 10 
years) and the fact that the budget contains measures that would work 
in different directions some proposals would increase incentives to 
work and save, while others would increase spending by government and 
families.
    This explains the methods and assumptions that CBO used to arrive 
at those results. (See Tables 1, 2, and 3 on pages 2, 4, and 6, 
respectively, for the main economic and budgetary results of CBO's 
analysis; see the Appendix for additional details.) CBO used five 
economic models in its analysis: two commercial macroeconometric 
forecasting models that focus on the short run dynamics of demand, by 
Global Insight and Macroeconomic Advisers, and three models constructed 
by CBO that focus solely on supply side effects a ``textbook'' growth 
model, a life-cycle model, and an infinite-horizon model.
    First, the paper reviews how CBO translated the provisions of the 
President's budget into terms that could be used in the various 
economic models. Second, it reviews how CBO treated several specific 
proposals that were particularly difficult to analyze. Third, it 
describes how CBO took the basic economic results and converted them 
into estimates of how they might affect the estimated cost of the 
proposals. Finally, it reviews in detail the structure of the models.

                     Inputs to the Economic Models

    The President's proposals would affect the economy in a number of 
ways. Some provisions would reduce marginal tax rates on labor and 
capital income, which would tend to encourage people to work and save. 
However, those and other provisions also would increase people's after-
tax income, which would tend to discourage work and saving. Other 
provisions would increase government consumption of goods and services, 
which would tend to crowd out investment in productive capital.
    Finally, some provisions, such as the reduction in double taxation 
of corporate income and the expansion of tax-free savings accounts, 
would have complex effects that CBO calculated outside of the economic 
models. For example, CBO estimated that the reduction in double 
taxation of corporate income would probably shift investment from the 
noncorporate sectors of the economy to the corporate sector and raise 
the value of corporate stock, among other things; the tax-free saving, 
CBO estimated, would raise private saving slightly on net over the 10 
years covered by the budget. Some of those effects could be translated 
into variables suitable for each model; others required modifying the 
initial results of the models. In making its projections, CBO analyzed 
only changes in Federal policies; it assumed that state and local 
governments' fiscal policies would remain at baseline levels.

 TABLE 1.--EFFECTS OF THE PRESIDENT'S BUDGETARY PROPOSALS ON REAL GROSS
                            DOMESTIC PRODUCT
             [Average percentage change from CBO's baseline]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
           Supply Side Model Without Forward-Looking Behavior

Textbook Growth Model.............................       -0.2       -0.7

            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.3       -1.5
    Higher taxes after 2013.......................        0.5        0.3
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.6       -0.5
    Higher taxes after 2013.......................        0.3        0.6
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......        0.2       -0.6
    Higher taxes after 2013.......................        0.9        1.4

            Macroeconometric Models, Supply Side Contribution

Macroeconomic Advisers............................       -0.3       n.a.
Global Insight....................................       -0.2       n.a.

     Macroeconometric Models, Supply Side and Cyclical Contributions

Macroeconomic Advisers............................        0.2       n.a.
Global Insight....................................        1.4       n.a.
Memorandum: Effect on Real Gross National Product
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.8       -2.0
    Higher taxes after 2013.......................        0.3          0
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: n.a. = not applicable.

The ``textbook'' growth model is an enhanced version of a model
  developed by Robert Solow. The life-cycle growth model, developed by
  CBO, is an overlapping generations general-equilibrium model. The
  infinite-horizon growth model is an enhanced version of a model first
  developed by Frank Ramsey. The models by Macroeconomic Advisers and
  Global Insight, which are available commercially, are designed to
  forecast short-term developments. The various models reflect a wide
  range of assumptions about the extent to which people are forward-
  looking in their behavior: in the textbook model and those by
  Macroeconomic Advisers and Global Insight, their foresight is the
  least, while in the infinite-horizon model, it is perfect and extends
  infinitely to include a full consideration of effects on descendants.
In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.

                    determining budgetary aggregates
    The different economic models required different levels of detail 
on spending and revenue categories. CBO's textbook growth model 
required only the overall change in the surplus or deficit each year. 
For the life-cycle and infinite-horizon models, spending needed to be 
broken out into government consumption and transfers. With a few 
exceptions, discretionary spending was classified as government 
consumption, while mandatory spending was classified as transfers. For 
the two macroeconometric models, government consumption was divided 
into defense and nondefense, and transfers were divided into health and 
nonhealth.
    CBO started with conventional ``static'' estimates of the impact of 
the President's budgetary proposals on aggregate spending and revenues; 
those estimates assumed baseline economic projections and excluded the 
budgetary implications of any macroeconomic effects of the proposals. 
Because CBO and the Joint Committee on Taxation (JCT) had not yet 
completed their estimates of the budgetary effects of the President's 
proposals, in its calculations of economic effects CBO relied on the 
administration's estimates of the budgetary costs of the proposals as 
published in the Fiscal Year 2004 Budget of the U.S. Government (for 
spending) and the General Explanations of the Administration's Fiscal 
Year 2004 Revenue Proposals (for revenues). The differences between CBO 
and JCT's estimates and the administration's estimates were small, 
however amounting to about $80 billion over 5 years and would not have 
meaningfully altered the estimated economic effects (see Table 4 on 
page 8).

   TABLE 2.--THE BUDGETARY IMPLICATIONS OF THE MACROECONOMIC FEEDBACKS
 [Cumulative change from CBO's conventional estimate of the President's
                     budget, in billions of dollars]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
           Supply Side Model Without Forward-Looking Behavior

Textbook Growth Model.............................        -45       -218

            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......        -44       -286
    Higher taxes after 2013.......................         57         91
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......        -78       -105
    Higher taxes after 2013.......................        -49        148
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......         27        -81
    Higher taxes after 2013.......................        122        321

            Macroeconometric Models, Supply Side Contribution

Macroeconomic Advisers............................        -57       n.a.
Global Insight....................................        -46       n.a.

     Macroeconometric Models, Supply Side and Cyclical Contributions

Macroeconomic Advisers............................        -75       n.a.
Global Insight....................................        231       n.a.
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: n.a. = not applicable.

    The administration estimated that (with interest costs excluded) 
the President's proposals would increase mandatory spending by $0.6 
trillion and decrease revenues by $1.5 trillion over the 2004-13 
period. The administration did not publish year-by-year spending 
numbers for the 2009-13 period, but, rather, a total amount. CBO 
distributed that amount evenly over those 5 years.
                calculating effective marginal tax rates
    In addition to their effects on the dollar amount of revenues, some 
of the President's proposals would lower the marginal tax rates on 
labor and capital income, thus altering incentives to work and to save. 
How CBO incorporated those effects into the models depended on the 
details of the models' construction.
    Numbers in this table reflect the positive or negative effects on 
the budget of the economic impacts shown in Table 1. They do not 
include the direct, or ``static,'' estimated cost of the proposals. The 
total impact of the proposals on the budget, including both those 
direct costs and the secondary effects shown above, are shown in Table 
3.
    The ``textbook'' growth model is an enhanced version of a model 
developed by Robert Solow. The life-cycle growth model, developed by 
CBO, is an overlapping generations general-equilibrium model. The 
infinite-horizon growth model is an enhanced version of a model first 
developed by Frank Ramsey. The models by Macroeconomic Advisers and 
Global Insight, which are available commercially, are designed to 
forecast short-term developments. The various models reflect a wide 
range of assumptions about the extent to which people are forward-
looking in their behavior: in the textbook model and those by 
Macroeconomic Advisers and Global Insight, their foresight is the 
least, while in the infinite-horizon model, it is perfect and extends 
infinitely to include a full consideration of effects on descendants.
    The two general-equilibrium models--the life-cycle growth model and 
the infinite-horizon growth model--use effective marginal tax rates on 
labor and capital income as inputs. Those rates represent an estimate 
of the marginal tax on the average dollar of additional income earned 
in the economy (that is, the average marginal rate faced by all 
recipients of labor or capital income, weighted by the fraction of 
overall income earned by each type of recipient). The effective tax 
rates summarize the impact of the President's proposals on marginal tax 
rates into two numbers (one for labor income and one for capital 
income).
    For most provisions, CBO computed the impact on effective marginal 
tax rates using a variant of a method developed by Martin Feldstein and 
Lawrence Summers (see Box 1 on page 10 for a list of the provisions 
whose effects CBO estimated in that way). With many details set aside, 
the method involves four steps:

 TABLE 3.--THE CUMULATIVE BUDGETARY IMPACT OF THE PRESIDENT'S PROPOSALS
                    INCLUDING MACROECONOMIC FEEDBACKS
     [Cumulative change from CBO's baseline, in billions of dollars]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
           Supply Side Model Without Forward-Looking Behavior

Textbook Growth Model.............................       -847     -2,126

            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -846     -2,194
    Higher taxes after 2013.......................       -745     -1,817
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -880     -2,013
    Higher taxes after 2013.......................       -753     -1,760
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......       -775     -1,989
    Higher taxes after 2013.......................       -680     -1,587

            Macroeconometric Models, Supply Side Contribution

Macroeconomic Advisers............................       -859       n.a.
Global Insight....................................       -848       n.a.

     Macroeconometric Models, Supply Side and Cyclical Contributions

Macroeconomic Advisers............................       -877       n.a.
Global Insight....................................       -933       n.a.
Memorandum:
Conventional Estimate of the Budgetary
Effect of the President's Proposals...............       -802     -1,908
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: n.a. = not applicable.

Numbers in this table reflect both the direct, or ``static'' estimated
  cost of the proposals (shown in the memorandum line) and the budgetary
  implications of the macroeconomic feedbacks from the proposals (shown
  in Table 1).

The ``textbook'' growth model is an enhanced version of a model
  developed by Robert Solow. The life-cycle growth model, developed by
  CBO, is an overlapping generations general-equilibrium model. The
  infinite-horizon growth model is an enhanced version of a model first
  developed by Frank Ramsey. The models by Macroeconomic Advisers and
  Global Insight, which are available commercially, are designed to
  forecast short-term developments. The various models reflect a wide
  range of assumptions about the extent to which people are forward-
  looking in their behavior: in the textbook model and those by
  Macroeconomic Advisers and Global Insight, their foresight is the
  least, while in the infinite-horizon model, it is perfect and extends
  infinitely to include a full consideration of effects on descendants.

In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.

     Calculate the average marginal income tax rate on each 
type of taxable income wages, interest, dividends, and so on for each 
year of the baseline. CBO obtained those rates by applying a tax 
calculation model to a large sample of the population in 2000. CBO 
modified the sample over future years to be consistent with the 
population projections of Social Security's trustees and CBO's economic 
projections. The model can accommodate the fact that individuals or 
households face different marginal tax rates depending on their income 
and family structure. When averaged across all taxpayers, those rates 
vary by type of income because different types are distributed 
differently across taxpayers. For example, dividends tend to be more 
concentrated than interest among higher-income taxpayers, so the 
average marginal tax rate on dividends tends to be higher than that on 
interest. For the taxes of C corporations, CBO used an average marginal 
tax rate of 29 percent.
     Calculate the notional amount of taxes that would have 
been collected on each type of income reported to the Internal Revenue 
Service (IRS) if it was all taxed at its average marginal rate from the 
first step. The notional amount of tax will exceed the actual amount 
because of various tax deductions and exemptions and because of 
progressivity in the rate schedule.
     Determine the overall average marginal tax rate on each 
type of income by dividing its notional tax by the corresponding amount 
of income reported in the national income and product accounts. The 
overall tax rate will be substantially lower than the rate from the 
first step because much income is not reported to the IRS partly 
reflecting noncompliance but mostly reflecting the fact that some 
income (for instance, fringe benefits, imputed income, contributions to 
tax free accounts, and earnings of such accounts) is not taxable.

   TABLE 4.--SOURCES OF DIFFERENCES BETWEEN CBO'S AND THE ADMINISTRATION'S ESTIMATES OF THE PRESIDENT'S BUDGET
                         [Cumulative change from CBO's baseline, in billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                                         Total,
                                                   2003     2004     2005     2006     2007     2008   2004-2008
----------------------------------------------------------------------------------------------------------------
                                            Administration's Estimate

Deficit Under the President's Budget...........     -304     -307     -208     -201     -178     -190     -1,084

                            Sources of Differences Between CBO and the Administration

Revenues
    Differences in baselines...................       24       -7      -30        7       35       55         60
    Policy differences.........................       -4       -8       -5        3        *       -2        -13
            Total Differences in Revenues......       20      -15      -35       10       35       52         47
Outlays
    Discretionary..............................       13       17       -1       -3       -3       -4          7
    Mandatory..................................
        Differences in baselines...............       -8        2        8       14       17       19         60
        Policy differences.....................        3        7       13        4        4        3         30
            Subtotal, mandatory................       -5        9       21       18       21       21         90
    Net interest...............................       -6      -10        6       12       12       11         31
            Total Differences in Outlays.......        3       16       26       27       30       28        128
All Differences................................       18      -31      -62      -17        6       24        -80

                                                 CBO's Estimate

Deficit Under the President's Budget...........     -287     -338     -270     -218     -173     -166     -1,164
Memorandum:
Economic Differences
    Revenues...................................      -10      -13        2       26       46       60        121
    Outlays....................................        *       -1       10       23       29       31         93
            Total..............................       -9      -12       -9        2       17       29         28
Technical Differences
    Revenues...................................       30       -2      -37      -16      -11       -8        -73
    Outlays....................................        3       17       16        4        *       -2         35
            Total..............................       27      -18      -53      -20      -11       -5       -108
----------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office; Joint Committee on Taxation.

Note: * = between -$500 million and $500 million.

     Calculate an overall average marginal tax rate on income 
from labor and from capital. For labor, sum the notional income tax on 
labor, the marginal payroll tax for Medicare and Social Security, and 
the self-employment tax all as a percentage of labor compensation. The 
calculation allows for the fact that the income of about 7 percent of 
workers exceeds the cap on Social Security taxes, meaning that those 
workers do not face those taxes on the margin. For capital, take a 
weighted average of the separate rates for interest; dividends; capital 
gains; rent; capital income of proprietors, partners, and owners of S 
corporations; and income of C corporations.
    The Feldstein-Summers approach, applied to the tax rate on capital, 
assumes that the marginal source of financing for firms is similar to 
the average. In other words, a large proportion of financing comes from 
untaxed sources, such as pension funds and individual retirement 
accounts. That assumption lowers the estimated effective marginal tax 
rate.
    CBO's calculations reflected a number of additional elements:
     CBO excluded interest on government debt and Federal 
Reserve earnings and taxes from the measure of capital income so that 
the result would reflect the marginal tax on an additional dollar 
invested.
     CBO's estimates of effective marginal tax rates assumed 
that workers would pay income tax on their and their employers' 
contributions to pension funds and retirement or similar accounts, even 
though those contributions are actually exempt from taxation. By 
contrast, CBO's estimates assumed that withdrawals would be untaxed, 
while in fact they are taxable. Those assumptions made it practical to 
calculate effective rates, and if the marginal rate faced at the time 
of contribution is the same as that faced at the time of withdrawal, 
the assumptions do not alter the estimated effective tax rates. But 
people may face lower marginal tax rates when they withdraw funds in 
their retirement years than they did during their working years. 
Because the calculation does not take that probabil ity into account, 
it may understate effective rates. However, CBO used those assumptions 
only to calculate effective tax rates; the estimated aggregate revenues 
that CBO used as an input assumed that contributions would be 
deductible and that withdrawals would be taxable.
     CBO's estimate of the marginal tax rate on capital gains 
allows for the deferral of taxes and the step-up in basis at death.
     CBO assumed that state and local taxes were 6 percent of 
individuals' reported income. To account for the portion of taxpayers 
who itemize and can claim those taxes as a deduction, CBO deducted 
about 62 percent of those tax receipts from the reported Federal tax 
base. CBO also assumed that state and local corporate taxes applied to 
income of C corporations at a rate of 5.6 percent and deducted all such 
tax receipts from the reported Federal tax base.
     CBO split the income of proprietorships and partnerships 
60-40 between labor and capital income.
    The provision in the budget that temporarily would allow firms to 
expense 30 percent of investment in equipment through 2004 would lead 
to shifts in the timing of tax payments and profits. Those shifts, 
unless adjusted for in some way, would distort the calculation of 
effective rates: 30 percent expensing reduces taxable income (and 
therefore tax payments) in the year of investment but raises it in 
following years because only the remaining 70 percent of investment can 
be depreciated over the normal tax life (7 years at most for nearly all 
equipment). Calculations based on those tax payments and profits would 
falsely suggest a disincentive to save in the years after 2004. In 
addition, profits in the initial years of the projection are unusually 
low because of cyclical factors, which could also distort the estimated 
effective rates. To avoid those problems, CBO calculated effective tax 
rates assuming that the shares of income from wages, dividends, 
interest, and other components for 2003-12 matched those projected for 
2013, when those shares are assumed to have settled to their long-term 
values. (Because of that adjustment, in calculating effective tax 
rates, CBO assumed, for example, that profits as a share of gross 
domestic product (GDP) would be 8.4 percent in 2003, the share 
projected for 2013, rather than 7.4 percent, the share that CBO 
actually projects for 2003.)
    CBO estimates that by 2013, the President's proposals would reduce 
the effective tax on labor income by about 1.3 percentage points and 
the effective tax on capital income by about 1.5 percentage points (see 
Table 5). CBO incorporated those estimated changes into the two 
general-equilibrium models, with no attempt to model changes in the 
shape of the rate schedule (for example, changes in progressivity).

                TABLE 5.--EFFECTIVE TAX RATES USED IN THE LIFE-CYCLE AND INFINITE-HORIZON MODELS
                                     [In percentage points by calendar year]
----------------------------------------------------------------------------------------------------------------
                                                       Labor                               Capital
                                       -------------------------------------------------------------------------
                 Year                     Current   President's                Current   President's
                                            Law      Proposals     Change        Law      Proposals     Change
----------------------------------------------------------------------------------------------------------------
                                                Life-Cycle Model

2002..................................        19.9         19.9           0        13.8         13.8           0
2003..................................        19.9         18.1        -1.8        13.8         12.6        -1.2
2004..................................        19.5         18.3        -1.3        13.7         12.6        -1.1
2005..................................        19.5         18.4        -1.1        13.7         12.6        -1.1
2006..................................        19.1         19.0        -0.1        13.5         12.5        -0.9
2007..................................        19.4         19.4           0        13.5         12.5        -0.9
2008..................................        19.6         19.6           0        13.5         12.5        -1.0
2009..................................        19.6         19.6           0        13.5         12.5        -1.0
2010..................................        20.1         20.1           0        13.5         12.5        -1.0
2011..................................        21.8         20.4        -1.5        14.1         12.6        -1.5
2012..................................        21.8         20.4        -1.5        14.1         12.6        -1.5
2013..................................        22.2         20.9        -1.3        14.1         12.6        -1.5

                                             Infinite-Horizon Model

2002..................................        34.0         34.0           0        16.7         16.7           0
2003..................................        34.0         32.3        -1.7        16.7         15.5        -1.2
2004..................................        33.7         32.5        -1.2        16.6         15.5        -1.1
2005..................................        33.7         32.6        -1.1        16.6         15.5        -1.1
2006..................................        33.3         33.2        -0.1        16.4         15.5        -0.9
2007..................................        33.5         33.5           0        16.4         15.5        -0.9
2008..................................        33.8         33.8           0        16.4         15.4        -1.0
2009..................................        33.8         33.8           0        16.4         15.4        -1.0
2010..................................        34.2         34.2           0        16.4         15.4        -1.0
2011..................................        35.9         34.5        -1.4        17.0         15.5        -1.4
2012..................................        35.9         34.5        -1.4        17.0         15.5        -1.4
2013..................................        36.3         35.0        -1.3        17.0         15.5        -1.5
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: For the effective rates calculated for the life-cycle model, the tax on labor income includes only the
  Federal income tax. The tax on capital income includes the Federal corporate and personal income taxes. For
  the infinite-horizon model, the tax on labor income includes federal, state and local income taxes and Federal
  Social Security and Medicare payroll taxes. The tax on capital income includes federal, state, and local
  income taxes on personal and corporate income. State and payroll taxes are not included in the estimates for
  the life-cycle model because that model treats those taxes separately.

    The levels of effective tax rates estimated for the two models 
differ because those used in the life-cycle model do not include 
payroll and state and local taxes; those taxes are included in the 
model separately from Federal income taxes. Despite the different 
levels of effective tax rates, though, the year-by-year changes from 
the rates in CBO's baseline are very close. (They differ only because 
of interactions between Federal taxes and state and local taxes for 
example, some state and local taxes can be deducted from the reported 
Federal tax base by households that itemize.)
   estimating changes in labor supply for models with no endogenous 
                     response to marginal tax rates
    The general-equilibrium models predict changes in labor supply on 
the basis of changes in marginal tax rates on labor and changes in 
current and future income. However, in the three remaining models that 
CBO used the textbook growth model and the two macroeconometric models 
there is little or no mechanism for marginal tax rates to affect labor 
supply. Therefore, for those models CBO separately estimated the effect 
of marginal rates on labor supply and then imposed the results on the 
models.
    In particular, to calculate the response of labor supply, CBO used 
the same model as it used to calculate effective tax rates. For each 
tax return in the model, it calculated marginal tax rates on labor as 
well as after-tax income both under current law and under the 
President's proposals. It then combined the changes in marginal tax 
rates and income with assumed substitution and income elasticities to 
predict the change in labor supply.
    CBO's calculations allowed for different effects for primary and 
secondary earners in a household and for effects that vary by income. 
For primary earners, the population-weighted uncompensated labor supply 
elasticity with respect to after-tax wages averaged 0.07 (the sum of an 
income elasticity of -0.07 and a compensated substitution elasticity of 
0.14). Within that average, primary earners in the first decile of 
earnings were assumed to have a net elasticity of 0.17, while earners 
in the top 40 percent, a net elasticity of 0.028. Secondary earners 
were assumed to have a compensated substitution elasticity of 0.75 and 
an elasticity with respect to after tax household income of -0.25. 
Those elasticities were based on a review of empirical estimates.
    CBO then directly adjusted labor supply in the textbook growth 
model and the macroeconometric models by the estimated percentage 
change derived from that method.
    In estimating the economic effects of marginal tax rates on labor 
income, CBO concentrated on the effect on hours of work supplied. 
Analysis of many other effects, such as shifts between taxable and 
nontaxable forms of income or changes in the portion of taxable income 
that is reported to the IRS, should already be included in the static 
revenue estimates of the Joint Committee on Taxation. There could be 
additional effects, however, on the intensity of work, but CBO did not 
include any such effects because of a lack of empirical evidence on 
which to base estimates.

       The Proposal to Reduce Double Taxation of Corporate Income

    The President's budget includes one proposal to reduce double 
taxation of corporate income that would have particularly complex 
economic effects. The proposal would eliminate taxation of dividend 
income paid out of profits that were already taxed at the corporate 
level. In addition, it would eliminate taxation of capital gains 
attributable to retained earnings that were already taxed at the 
corporate level.
    The proposal would have three important economic effects. First, it 
would reduce marginal tax rates on capital income and lower firms' cost 
of capital investment. Second, it would increase the market value of 
corporations. Third, reducing double taxation of corporate income 
would, over time, make the allocation of capital among different 
sectors of the economy more efficient.
    Economists have not agreed on how the taxation of dividends affects 
the economy. Two views are prevalent. Under the first (or 
``traditional'') view, the tax on dividends raises the cost of capital 
and reduces investment. Under the second (or ``new'') view, the tax on 
dividends permanently reduces the value of a firm but leaves unaffected 
both the cost of capital and investment by the firm.
    CBO's calculations reflect an average of the implications of those 
two views. That average was created in different ways in the different 
models. For the macroeconometric models, CBO made economic projections 
under two sets of assumptions for model inputs such as the cost of 
capital and the valuation of firms, with one set reflecting the 
traditional view and one set reflecting the new view. CBO then took the 
average of the economic variables from the two projections as its 
estimate. For the remaining models, the only variable for which the 
traditional view and the new view had different implications was the 
efficiency effects of the provision. CBO estimated those effects on the 
basis of prior research, adjusted its estimate to reflect an average of 
the two views, and then added it back into the model results.
    Corporate behavior probably more closely matches the assumptions of 
the first view indeed, that is what is generally taught to business 
school students. However, in an open economy, results are likely to 
lean toward the second view as long as capital is reasonably available 
in the world market at a price that is unaffected by U.S. tax policy. 
Firm evidence of the actual effects of dividend taxation policy in the 
United States is scarce. Given the difficulty of determining precisely 
how investment would respond to the President's proposal, CBO simply 
split the difference between the two views.
                       marginal taxes on capital
    The estimated effective tax rates on capital used in the life-cycle 
and infinite-horizon models (shown in Table 5) incorporate the effects 
of the proposal to reduce double taxation of corporate income. CBO 
calculated those effects outside the tax simulation model used to 
estimate the effects of most other provisions. Those effects do not 
differ under the traditional and new views of dividends.
    CBO assumed that the proposal to reduce double taxation of 
corporate income would allow corporations to shelter only about 80 
percent of their dividends in 2003 but that that proportion would rise 
to 90 percent over the next 5 years and then remain at that level. That 
rise has to do with the timing of tax payments.
    The amount of dividends and capital gains that a firm could shelter 
would be limited to the amount of its fully taxed profits. That amount 
would be measured as:

    fully taxed profits = corporate taxes * ( 1/0.35 -1)

    Where 0.35 is the top corporate tax rate and corporate taxes 
include foreign tax credits. The factor in parentheses indicates that a 
firm could shelter income equal to 1.86 times the amount of taxes it 
paid. CBO assumed that firms would probably shelter all of the 
dividends they could before sheltering their retained earnings (which 
would eventually show up as capital gains) because dividend income 
tends to be taxed at higher rates. Firms that, for whatever reason, 
incurred low corporate taxes in the first few years after the proposal 
became effective might not be able to shelter all of their dividends. 
However, over time, most firms will experience years when they pay more 
than enough taxes to shelter all of that year's dividends. Some of the 
extra increment can be carried over to shelter dividends in future 
years with lower tax payments, implying that the overall average share 
of dividends that can be sheltered rises over time.
    Once firms have sheltered all possible dividends, they can use any 
remaining amount of the extra increment to shelter retained earnings. 
CBO concluded that about 40 percent of the portion of capital gains 
that reflect retained earnings could be sheltered in that way.
    Of course, some of the sheltering would be redundant much corporate 
income accrues to firms or entities that are already untaxed. Under 
current law, the effective overall marginal tax on dividends is about 
19 percent, much lower than the effective statutory rate that applies 
to taxable shareholders. Tax rate changes and a 90 percent dividend 
exclusion under the President's plan would reduce the effective overall 
rate to about 5 percent. Likewise, the proposal would reduce the 
overall effective rate on capital gains from about 5 percent to roughly 
3 percent.
                            cost of capital
    The macroeconometric models require as an input an estimate of the 
effect of the proposal to reduce double taxation of corporate income on 
the cost of capital to firms. That effect differs under the traditional 
and new views of how dividend taxes affect economic behavior. Under the 
first view, reductions in both the effective tax rate on dividends and 
that on capital gains reduce the cost of capital. Under the second 
view, only the reduction of the effective tax rate on capital gains 
reduces the cost of capital. The reduction of the tax on dividends does 
nothing more than permanently raise the value of the shares of C 
corporations. (S corporations do not pay corporate tax, and, thus, 
their income would not qualify for an exclusion.) To represent the 
second view, CBO calculated the change in the marginal tax on capital 
as if the proposal would shelter about 40 percent of the retained 
earnings of C corporations but none of their dividends. CBO generated 
two economic projections with the two macroeconometric models, one 
using inputs consistent with the traditional view and one with the new 
view, and then took the average of the economic results.
    As with the estimate of the effective marginal tax rates on 
capital, described earlier, CBO calculated the proposal's impact on the 
cost of capital assuming that the shares of output coming from 
corporate profits, dividends, and retained earnings in 2013 would apply 
to all years between 2003-13. The shares in 2013 represent historically 
typical shares, while shares in earlier years are affected by the 
availability of extra expensing and cyclical factors.
                           valuation of firms
    Changes in the valuation of firms are important to the 
macroeconomic results, because they help determine what will happen to 
consumer wealth and consumer spending. In CBO's two forward-looking 
models (the life-cycle model and the infinite-horizon model), the 
simulated people in the models automatically calculate the wealth 
effect of the tax change with perfect foresight. However, the two 
macroeconometric models require an exogenous estimate of the increase 
in firms' valuation because those models contain no mechanism to 
automatically convert the present value of the expected change in 
stockholders' after-tax income into a change in equity prices. The 
estimated effect on the valuation of firms differs under the 
traditional view and new view of dividends.
    The structure of both models allows a reduction in taxation of 
dividends to affect consumption in two ways: through a reduction in tax 
payments, which increases disposable income, and through an increase in 
the value of firms, which increases wealth (and therefore affects 
consumption). However, both effects are reflections of the same thing 
the expectation of lower tax payments on dividends so including both 
would overstate the effect of the policy change on consumption. To 
avoid that double counting, CBO adjusted the models to eliminate the 
direct effects on consumption of the increase in disposable income 
stemming from lower taxes on dividends.
    Under the traditional view, reducing double taxation of corporate 
income reduces the cost of capital and increases investment. In the 
short run, stock prices rise because expected after-tax returns to 
investors increase. In the long run, however, additional investment 
will drive down the pretax return to capital. Thus, current 
shareholders initially benefit from the lower taxes on dividends, but 
eventually the higher investment raises the capital/labor ratio, 
increasing real wages and transferring the benefit of the lower taxes 
to workers. CBO estimated that under the traditional view of dividends, 
the President's proposal to reduce double taxation of corporate income 
would initially increase the market value of shares by 3 percent. That 
estimate reflected both the additional returns that investors would 
expect and their belief that the returns would be temporary. That 
estimate assumed that asset prices would respond immediately to 
increased expected future returns but that workers would not spend the 
extra income from higher wages (due to the larger capital stock from 
increased investment) until they received it.
    Under the new view, by contrast, cutting taxes on dividends 
permanently increases the value of firms but leaves unchanged the cost 
of capital and, therefore, investment. CBO estimated that under the new 
view, the President's proposal would permanently raise the value of the 
shares of corporations by some 10 percent, reflecting the present value 
of the expected decline in taxes under the assumption that the tax 
benefit would be permanent. CBO's estimate assumed, as discussed 
earlier, that the fraction of a marginal additional dollar of dividend 
income that was taxable would be the same as the fraction of average 
dividend income that was taxable. Other commentators have arrived at 
substantially higher estimates by assuming that all of a marginal 
change in dividend income would be taxable.
    CBO generated two economic projections with the two 
macroeconometric models, one using inputs consistent with the 
traditional view and one with the new view, and then took the average 
of the economic results.
                               efficiency
    Double taxation of corporate income causes deadweight loss 
principally because it shifts economic activity from the corporate to 
the noncorporate sector. In addition, it distorts the choice between 
equity and debt financing. The deadweight loss from those effects 
generates welfare costs that are partially reflected in a lower level 
of GDP because resources are not employed optimally. However, some of 
the efficiency losses such as the effect of the choice between debt and 
equity financing on individuals' asset portfolios, or changes in 
marginal incentives that are offset by income effects may not show up 
in output measures.
    To gauge the effect on output, CBO reviewed various of estimates of 
the impact of corporate taxation. Efforts to quantify the deadweight 
loss from corporate taxes have produced a wide range of estimates that 
are typically reported as welfare losses (including such items as the 
value of leisure) and not the effect on GDP. Translating the disparate 
conclusions of studies into an expected change in GDP from the 
President's proposal involves a large amount of judgment.
    The standard Harberger model, in which industries are either 
corporate or noncorporate, suggests efficiency costs of less than 20 
percent of corporate tax revenues, or about 0.4 percent of GDP at 
today's ratio of corporate taxes to GDP. Using time-series data, 
several studies estimate smaller effects of around 5 percent to 10 
percent of corporate taxes, or about 0.1 percent to 0.2 percent of GDP.
    Gravelle and Kotlikoff employ a different (``mutual-production'') 
model that measures the deadweight loss in an economy in which 
corporate and noncorporate production occurs within the same industry. 
Their work indicates a much higher deadweight loss, possibly exceeding 
100 percent of the tax, or 2 percent of GDP. That loss results from the 
greater substitution between corporate and noncorporate activities that 
exists when both occur in the same sector. Goolsbee concludes from work 
based on the mutual-production model that the estimates based on time-
series data are low, although the deadweight loss is still ``modest.''
    Estimates by Shoven and by Fullerton indicate losses of about 0.75 
percent to 1.5 percent of consumption, or about 0.5 percent to 1.0 
percent of GDP. But those estimates are based on average, rather than 
marginal, effective tax rates. Studies using average rates tend to 
estimate larger effects than those using theoretically preferable 
marginal rates.
    Finally, models incorporating the new view of dividends show very 
small losses, on the order of 0.014 percent of consumption. That is to 
be expected. Under the new view, after-tax returns to corporate and 
noncorporate activity are equilibrated by a fall in the price of 
corporate equity rather than by a differential in before-tax rates of 
return, substantially decreasing the distortion caused by the taxes.
    In 1992, Treasury estimated the effects of several different 
proposals to integrate the individual and corporate tax systems (none 
exactly like the current one) using both the Harberger model and the 
mutual-production model. The Harberger model estimated welfare gains 
ranging from 0.29 percent to 0.35 percent of consumption, or about 0.19 
percent to 0.23 percent of GDP. The mutual-production model estimated 
gains ranging from 0.53 percent to 0.74 percent of consumption, or 
about 0.35 percent to 0.49 percent of GDP. (In those proposals, the 
revenue loss was made up with a lump-sum tax, which is the appropriate 
assumption for CBO's current modeling strategy.)
    Relying on that evidence and taking the average of effects under 
the traditional and new views of dividends, CBO concluded that the 
impact of the President's proposal on the allocation of capital would 
raise GDP by about 0.14 percent (about $15 billion in 2003) once the 
capital stock was fully adjusted. That estimate resulted from averaging 
an effect of 0.28 percent under the traditional view of dividends with 
an effect of about zero under the new view. CBO assumed that fully 
adjusting the capital stock would take 10 years, with the addition to 
GDP increasing linearly over that period. CBO added that increment to 
the predictions of the textbook, the life-cycle, and the infinite-
horizon growth models.
    A slightly different procedure was appropriate for the two 
macroeconometric models, because those models incorporate multiple 
sectors and thus can reflect endogenously some of the efficiency 
effects of the President's proposal. In both models, changes in the 
cost of capital for business investment will automatically shift 
investment from the housing sector to the business sector. In practice, 
CBO ran the models twice, with assumptions corresponding to the 
traditional view and the new view of the effects of dividend taxation. 
Under the traditional view, CBO assumed that 75 percent of the 
efficiency effects of the proposal were captured within the models (the 
effects were not fully captured because the models cannot reflect 
efficiency gains from shifting capital into C corporations from other 
businesses). Under the new view, as before, there were no efficiency 
effects.
    For two reasons, CBO's estimate of efficiency effects did not 
include any gains from reducing the distortion in the decision of 
whether to finance investment by debt or by equity. First, most of 
those gains would show up in utility rather than GDP. Second, a large 
part of the efficiency gains might not be realized because of the 
President's proposal to expand tax-free savings accounts (to the extent 
that interest was untaxed, a new differential would arise between the 
tax treatment of dividends and interest).

                 Expansion of Tax-Free Savings Accounts

    The President's budget includes a proposal to form two new tax-free 
accounts, lifetime savings accounts (LSAs) and retirement saving 
accounts (RSAs). LSAs would be designed to facilitate everyday saving, 
and withdrawals could be made from them at any time without penalty. 
RSAs would be designed as a vehicle for retirement saving and would 
carry a penalty for early withdrawals. The new accounts would increase 
the amount that people could save tax-free. The effects of the accounts 
on saving are not easily analyzed within the models used by CBO, so the 
agency estimated those effects in a side calculation. (The proposals 
for savings accounts were therefore not included in CBO's calculation 
of the effective tax rates on capital.)
    The proposals would both raise the after-tax return to saving, 
generating a substitution effect that would tend to increase saving, 
and increase after-tax income, generating an income effect that would 
tend to increase consumption and reduce national saving. CBO estimated 
those two effects separately.
                          substitution effect
    The substitution effect applies only to people on the margin, that 
is, those who currently contribute the maximum tax-free amounts but who 
might save more if those amounts were increased. Those not on the 
margin are people who do not currently contribute the maximum tax-free 
amounts and people who do but who have enough taxable assets to shift 
so that they would not have to save more to take full advantage of 
additional opportunities for tax-free saving. To estimate the 
substitution effect, CBO estimated the saving of people on the margin 
and the change in the after-tax rate of return associated with LSAs and 
RSAs and applied an estimated elasticity to that change, adjusting 
saving accordingly.
    Who Is on the Margin? Tax advantages comparable to those offered by 
LSAs (specifically, the ability to withdraw funds at any time without 
penalty) do not currently exist. Hence, CBO needed to identify who 
would not be affected by the accounts on the margin those who have 
sufficient assets to shift into the accounts without saving any more. 
To accomplish that, CBO tabulated taxable assets in the 1998 Survey of 
Consumer Finances (SCF) and classified households by the number of 
years that they could fund an LSA for every person in the family 
(assuming a baseline of 2.6 percent net growth in assets per year). 
Beginning in the second year, the households had to be able to fund an 
RSA in the previous year for every worker in the family as well. 
Households that lacked enough existing assets to contribute the maximum 
to an account even in the first year were assumed to be on the margin 
in 2003 and all subsequent years; those who could fund the maximum 
contribution in the first but not the second year were assumed to be on 
the margin in 2004 and all subsequent years, and so forth. Those with 
enough assets to fund the maximum contribution through 2013 were 
assumed not to be on the margin at any time during the budgetary 
projection period.
    By contrast, the tax advantage offered by RSAs is comparable to 
that of Roth individual retirement accounts (IRAs) if one ignores the 
reduction in the age for penalty-free withdrawals from 59 and a half to 
58. For simplicity, CBO assumed that traditional IRAs and 401(k)s also 
had the same tax advantages, although that would be true only if a 
person's preretirement and postretirement tax rates were the same. By 
that reasoning, households that were not currently contributing the 
maximum to either their IRA or 401(k) were not on the margin. So CBO 
reclassified SCF assets by the number of years that they could fund 
both LSAs for all family members and RSAs for all workers but then 
scaled those assets by the percentage of workers receiving the maximum 
tax benefit from their IRA or 401(k) (ranging from 3 percent for lower-
income workers to 36 percent for the highest-income workers).
    Having identified households on the margin, CBO assigned a baseline 
level of saving to them. CBO estimated the overall level of saving to 
be 2.8 percent of personal income (based on the average over the past 5 
years) and distributed saving in proportion to assets.
    Change in the After-Tax Rate of Return. CBO used a case study model 
to calculate the after-tax rate of return for regular savings versus a 
Roth IRA using a 6 percent before-tax rate of return. CBO assumed that 
the President's proposals to accelerate the decrease in marginal tax 
rates and to reduce double taxation of corporate income were in place 
for regular savings (effectively exempting 40 percent of investment 
income from tax). CBO estimated the after-tax rate of return for five 
different marginal rates (15 percent, 25 percent, 28 percent, 33 
percent, and 35 percent). For LSAs, the after-tax rate of return was 
the same as the before-tax rate 6 percent. For RSAs, CBO assumed that 
30 percent would be subject to a penalty upon withdrawal, reducing the 
after-tax rate of return to 5.892 percent. For taxable accounts, the 
after-tax rate of return depended on the tax bracket. (See Table 6 for 
a summary of the results.)
    Results. CBO partitioned the SCF tabulations into the five income 
classes shown in Table 6, assumed to correspond to the five marginal 
tax rates. CBO then calculated the percentage change in the after-tax 
rate of return, applied an elasticity of 0.5, and multiplied the result 
by the savings deemed to be on the margin.
                             income effect
    An income effect applies to people who experience a reduction in 
taxes on the return to saving, whether or not they are on the margin. 
The reduction in taxes increases the value of a tax-free account 
relative to the value of a regular account. People can then save less 
and still receive the same after-tax income over their lifetime.
    Because the reduction would apply to the amounts that people were 
expected to contribute to LSAs and RSAs, CBO estimated those amounts 
using SCF data. CBO determined the maximum possible contribution by 
people on the margin in each year and added the maximum contribution 
for all those not on the margin because they could shift enough assets 
to fully fund the accounts.
    CBO attempted to reconcile its estimates of contributions with 
estimates of the revenue effects of the LSAs from the Department of the 
Treasury. CBO's estimates most closely approximated the pattern of 
Treasury's estimates assuming a withdrawal rate of 18 percent per year. 
To match the level of revenue losses as well as the pattern over time, 
however, CBO had to assume a relatively low rate of return of 2.5 
percent within LSAs. That low rate of return would be consistent with 
participants' converting interest bearing checking accounts, savings 
accounts, and money market accounts to LSAs.
    To estimate the percentage reduction in saving due to the income 
effect, CBO used the case study model, assuming a 4.5-year holding 
period and 2.5 percent rate of return for LSAs and a 21-year holding 
period and 6.0 percent rate of return for RSAs.
    CBO also scaled the estimated RSA contributions to eliminate 
households not currently contributing the maximum tax-free amount; they 
presumably would not increase their contributions and therefore would 
experience no income effect.

                    TABLE 6.--THE EFFECT OF TAX-FREE ACCOUNTS ON THE AFTER-TAX RATE OF RETURN
----------------------------------------------------------------------------------------------------------------
                                                                                   After-Tax Rate of Return (In
                                                                                   percent) by Type of Account
              Marginal Tax Rate (In percent)                 Income Class (In   --------------------------------
                                                                 dollars)         Taxable
                                                                                  Account      LSA        RSA
----------------------------------------------------------------------------------------------------------------
15.......................................................          Under 50,000     5.460      6.000      5.892
25.......................................................         50,000-99,999     5.100      6.000      5.892
28.......................................................       100,000-199,999     4.992      6.000      5.892
33.......................................................       200,000-499,999     4.812      6.000      5.892
35.......................................................      500,000 and Over     4.740      6.000      5.892
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: LSA = lifetime savings account; RSA = retirement savings account.

The table assumes that all accounts earn a pretax rate of return of 6 percent. The LSA would earn the full 6
  percent. The RSA would earn slightly less, because CBO assumed that 30 percent of withdrawals would be subject
  to a penalty for early withdrawal. Ordinary taxable accounts would earn an after-tax return on each extra
  dollar invested that depended on the marginal tax rate faced by the owner.

    The substitution and income effects together imply a small negative 
effect on saving in the early years of the projection period, moving 
gradually to a small positive effect in later years. CBO added those 
calculated changes in saving to the macroeconometric models: the 
substitution effect as a change in consumption, and the income effect 
as if income had changed. In the other models, the estimated changes in 
saving had virtually no effect on average GDP over the 10-year period.

               Extension of the Repeal of the Estate Tax

    The President's proposal to make permanent the repeal of the estate 
and gift taxes after 2010 was particularly difficult to analyze. To 
begin with, there is no clear consensus on people's motives for leaving 
bequests or even on whether bequests are typically the result of a 
deliberate saving plan. If bequests are accidental rather than 
deliberate, repealing the estate tax would not encourage saving. 
Moreover, analysts who believe that estate taxes affect consumption and 
saving disagree about the direction of the effect: a lower estate tax 
makes it cheaper for people to leave money to their heirs, which could 
encourage them to save more in order to leave larger bequests; in 
contrast, with a lower estate tax, people can leave the same after-tax 
bequest with less saving, which might induce them to save less. Also, 
all other things being equal, a lower estate tax increases the after-
tax size of bequests, which could lead potential recipients to increase 
their consumption and reduce their saving. Finally, although a great 
deal of attention has been focused on the effects of estate taxes on 
sectors such as agriculture or activities such as entrepreneurial 
ventures, there remains little agreement on those effects or their 
implications for the economy as a whole.
    Because so little is understood about how repealing the estate tax 
would affect consumption, CBO's estimates from all but the infinite-
horizon model assumed that in their consumption and saving, people 
would respond in the same way as they have, on average, to past 
spending or tax changes that affected the budget deficit. That 
assumption implies that people would spend about 60 percent of their 
increased after-tax income, boosting aggregate consumption. In the 
infinite-horizon model, however, CBO assumed that people would respond 
in the same way that they would to a change in lump-sum taxes. In that 
model, the assumption implies that people would save all of the 
increase in after-tax income from lower estate taxes and that 
consumption would not rise.

  Translating the Models' Outputs into Spending and Revenue Estimates

    Calculating the implications of the models' results for spending 
and revenues required estimates of the effects of the proposals on a 
number of income variables and on prices and interest rates. Those 
variables are a part of the normal output of the macroeconomic models 
by Global Insight and Macroeconomic Advisers. The textbook, life-cycle, 
and infinite-horizon growth models have very simple income categories, 
however. Because each of those models assumes that production follows a 
Cobb-Douglas function, the models predict that the change in GDP due to 
the President's proposals would be split into a change in total capital 
income of about 30 percent of the change in GDP, and a change in total 
labor compensation that accounts for the remaining 70 percent of the 
change in GDP. However, revenue estimates require additional details 
for domestic book profits; wages and salaries; dividends; personal 
monetary interest income, excluding that earned in publicly 
administered government employee retirement plans; both farm and 
nonfarm proprietors' income; and rental income.
    CBO assumed that wages and salaries would change in proportion to 
GDP. Because the models also assume that total labor compensation 
changes with GDP, the implication is that other labor income also 
changes in proportion to GDP. Since most of proprietors' income is 
payment for their work, CBO assumed that that income would change in 
the same way.
    CBO assumed that changes in personal interest income reflected 
changes in interest payments by businesses and by government and 
changes in interest payments to and from foreigners. CBO used its 
budget calculations to derive government interest payments. Under CBO's 
assumptions, business interest payments depended on both GDP and on 
interest rates: higher interest rates imply that a higher share of GDP 
is accounted for by business interest payments. CBO assumed that every 
increase of 100 basis points in interest rates would raise business 
interest payments as a share of GDP by 0.4 percentage points. That 
relationship is consistent both with the output from the 
macroeconometric models and with a historical regression of the share 
on a weighted average of interest rates.
    The two open economy simulations of the life-cycle model imply 
changes in the flows of capital income across the nation's borders. In 
those simulations, a part of the additional borrowing from the 
President's proposals is financed by higher borrowing from abroad. 
Consequently, the simulations also predict higher payments of capital 
income to foreigners that are reflected in weaker projections for gross 
national product than for GDP. The portion of those capital payments 
that are made in the form of interest which CBO estimated to be about 
75 percent must be subtracted from total interest payments in 
calculating taxable personal interest income because foreigners do not 
pay U.S. taxes on their interest income.
    The model, however, calculates capital payments to foreigners on 
the basis of an interest rate equal to the marginal product of capital, 
or roughly double the government's interest rate. That assumption 
overstates the interest payments made to foreigners and understates the 
share of total interest payments that goes to domestic investors and is 
therefore taxable. CBO therefore reduced its estimate of taxable 
interest income only by half of the model's estimate of interest 
payments to foreigners in the open economy simulations.
    CBO assumed that the sum of the shares of GDP constituted by 
economic profits and business interest payments remained constant; 
hence, any change in the interest share of GDP was reflected with the 
opposite sign in profits. That calculation implied that the share of 
depreciation in GDP was unchanged. Two factors would affect 
depreciation. First, the lower national saving would mean lower overall 
investment, which would tend to reduce depreciation. Second, because 
the President's proposals would tend to reduce the taxes on corporate 
investments relative to housing, more of each year's investment would 
go to business and less to housing. CBO's models do not currently 
distinguish between business and housing investment, so the agency was 
unable to determine the relative magnitude of those two effects and 
hence the sign of the impact on business investment and depreciation. 
For that reason, CBO kept the share of GDP devoted to depreciation 
unchanged. Under CBO's assumptions, dividends remained the same share 
of domestic economic profits as in the agency's baseline, and rental 
income changed by the same percentage as GDP.
    Once CBO translated the economic output from the models into the 
proper variables, the agency estimated the spending and revenue 
implications using its usual methods. The impact on revenues depended 
mostly on the level and distribution of different types of income, 
which in turn depended largely on overall output, interest rates, and 
price levels (as described above). The impact on spending depended 
largely on interest rates, price levels, and wages. It is important to 
note that CBO held discretionary spending at its baseline level in 
nominal dollars under any economic assumptions because the President's 
budget proposals specified dollar amounts. Consequently, in CBO's 
estimates, higher inflation, which tends to raise nominal revenues, 
does not affect discretionary spending and therefore tends to improve 
the budget balance.

                       Description of the Models

    This section provides a summary description of the models that CBO 
used in its analysis: the textbook growth model, the life-cycle model, 
the infinite-horizon model, and the two macroeconometric models.
                       the textbook growth model
    The textbook growth model is the model CBO uses to compute 
historical values of potential output and to estimate potential output 
in its 10-year baseline projections. It is an enhanced version of the 
Solow growth model. Real GDP in the nonfarm business sector (which 
accounts for roughly three-quarters of GDP) is determined by a Cobb-
Douglas production function of a capital aggregate, labor hours, and 
exogenous total factor productivity. The coefficient on capital in the 
production function equals 0.30 and that on labor equals 0.70. 
Specifically:
     Labor input is the number of hours worked.
     Capital input is an index of capital services that 
aggregates such services for four types of equipment (computers, 
software, communications equipment, and other equipment), as well as 
nonresidential structures, inventories, and land.
     Total factor productivity is calculated as a residual over 
history and projected on the basis of historical trends, adjusted for 
business cycles and changes in the measurement of prices.
    The model includes four additional sectors: government, farm, 
households and nonprofit institutions, and residential housing. 
Projected output in most of those sectors is based on their historical 
share of the labor force and historical productivity in the sectors. 
Output in the housing sector is a constant ratio to the stock of 
housing.
    The policies in the President's budget would affect output in the 
growth model primarily through the impact of higher deficits on 
investment and lower marginal tax rates on labor supply. The effect of 
changes in deficits on investment is the same whether it stems from 
changes in taxes, transfers, or government consumption. Therefore, the 
two key inputs that determine the estimated effects of the President's 
budgetary proposals are the overall change in the surplus and the 
estimated change in the labor supply.
    In the growth model, capital accumulation is determined by the rate 
of national saving and net capital inflows. Changes in the Federal 
surplus affect national saving and, therefore, private investment and 
the capital stock. The President's budget implies lower surpluses than 
those in CBO's baseline, which would tend to result in a lower 
projected capital stock, less output, and higher interest rates.
    The impact of changes in the Federal surplus on investment is 
partially offset by changes in private saving and capital inflows. 
Those offsets are determined by simple rules of thumb based on 
historical averages and the behavior of a variety of economic models. 
The private saving offset equals 40 percent of the initial change in 
the Federal surplus (for example, if the surplus falls by $1, private 
saving increases by 40 cents); the net-foreign-investment offset equals 
40 percent of the change in national saving (for example, if the change 
in national saving equals 60 cents, as in the previous example, the 
change in net foreign investment equals 24 cents, or 40 percent of 60 
cents, and domestic investment falls by 36 cents). Therefore, a 
decrease in the surplus not only causes domestic investment to fall but 
also causes capital inflows to rise, which implies higher net payments 
to foreigners in the future. Those higher payments subtract from 
domestic income, so when the surplus declines, gross national product 
(which is based on income) tends to fall by more than gross domestic 
product (which is based on domestic output).
    The textbook growth model does not automatically incorporate any 
effect of marginal tax rates on labor supply. Therefore, CBO estimated 
the effect on labor supply of the lower marginal tax rates under the 
President's budget in a side calculation, described previously, and 
added the estimated effect to the projected number of labor hours in 
the model. The growth model incorporates no direct effect of after-tax 
interest rates on consumption and saving, but private saving would rise 
under the President's budget because of the private-saving offset 
described above.
    The textbook growth model also has no internal method of taking 
account of how the President's proposal to reduce double taxation of 
dividends would affect the allocation of capital. That proposal would 
shift some investment from the housing and noncorporate business 
sectors to the corporate sector, which would tend to increase output. 
CBO estimated the magnitude of the effect on output in a side 
calculation, also described previously, and added it to the estimated 
changes in income derived from the growth model's projections.
    Finally, the textbook growth model also does not incorporate any 
demand-side effects; it assumes that output is always at its potential 
level. With output always at its potential, prices remain at their 
baseline levels there is no estimated effect of policy on inflation. 
The model also does not incorporate any explicit forward-looking 
response to future policy changes.
                          the life-cycle model
    The life-cycle model is a general-equilibrium growth model. It 
incorporates simulated households that make decisions about how much to 
work and save in order to make themselves as well off as possible over 
their lifetime. Those simulated households differ in their ages, 
working ability (measured by hourly wages), accumulated savings, and 
earnings histories (which determine their Social Security benefits). A 
household is assumed to consist of a married couple with some children. 
A household enters the economy when it is 20 years old.
    Every year, each household below age 80 may shift from its current 
working ability to another one (technically speaking, working ability 
follows a Markov process). That means future income, on an individual 
level, is uncertain in the model. However, the individual shocks to 
earnings cancel one another out in the aggregate, so aggregate earnings 
and output are not uncertain. There are eight distinct working-ability 
levels for each age below 80.
    At the end of each year, a fraction of the households die, 
according to current U.S. mortality rates. Households can live at most 
110 years; that is, the mortality rate at the end of age 109 is one.
    Each household chooses its optimal consumption, labor supply 
(working hours), and savings, taking a series of current and future 
factor prices (such as the interest rate and wage rate) and policy 
variables (such as marginal income tax rates) as givens. Households in 
the model can foresee those future factor prices and policy variables 
because they are assumed to know all future government policies as well 
as the current distribution of households does and because there are no 
aggregate shocks in the model.
    The utility function of a household is a constant relative risk 
aversion function of a Cobb-Douglas aggregate of consumption and 
leisure. The share parameter of consumption is 0.47, the elasticity of 
intratemporal substitution of consumption for leisure is 1.0, and the 
elasticity of intertemporal substitution is 0.5. The rate of time 
preference is chosen so that the capital stock is 2.7 times output, and 
the share parameter on consumption is chosen so that the average 
household supplies a total of 3,360 hours of labor in the baseline 
steady state (the estimated values in the U.S. economy).
    The model has a representative (but perfectly competitive) firm 
with Cobb-Douglas production technology. The share parameter of capital 
is assumed to be 0.30 and that of labor 0.70, just as in the textbook 
growth model.
    The model assumes two polar cases for the degree of openness of the 
economy a closed economy and a small open economy. In a closed economy, 
no international capital flow is assumed, and the trade surplus is 
assumed to be zero. The interest rate and the wage rate are determined 
by the domestic capital stock (which is equal to the sum of total 
private wealth and net government wealth) and labor supply. In a small 
open economy, a perfectly flexible international capital flow is 
assumed. The interest rate and the wage rate are fixed at their 
international levels. The domestic capital stock is determined by the 
labor supply of the economy, and the difference between domestic 
capital and national wealth (the sum of private wealth and net 
government wealth) is made up by international capital inflows (or 
outflows). Therefore, in a small open economy, the percentage change in 
GDP is equal to the percentage change in labor supply.
    The model includes a progressive Federal income tax that is modeled 
on the current rate structure, a flat state income tax, and a Social 
Security system calibrated to the existing one. For Federal income 
taxes, the statutory marginal rates are modified by two adjustment 
factors so that the effective tax rates on labor income and capital 
income are roughly the same as those in the U.S. economy. State and 
local taxes are assumed to be 4 percent after standard deductions and 
exemptions similar to the Federal ones. For the Social Security system, 
the payroll taxes for both the Old-Age, Survivors, and Disability 
Insurance (OASDI) and the Hospital Insurance portions of Medicare are 
included, as are OASDI benefits, at levels consistent with statutory 
formulas. To solve a dynamic model for equilibrium, the model economy 
has to be on a balanced growth path with a constant per capita real 
growth rate and population growth rate in the long run. To make the 
economy return to a balanced growth path, CBO needed to make some 
financing assumption to stabilize the debt-to-GDP ratio at some time in 
the future, because the tax cuts and spending increases in the 
President's proposals would otherwise result in an unsustainable 
increase in the debt/GDP ratio relative to the baseline.
    CBO assumed that the debt/GDP ratio was stabilized either by a 
permanent lump-sum tax increase or a cut in government consumption in 
the 11th year, that is, in the first year after the 10 years covered by 
the fiscal policy specified in the budget. In subsequent years, the tax 
increase or spending cut remains a constant share of economic output. 
Most of the policy change in the 11th year offsets the tax cuts and 
spending increases included in the budget, which are assumed to 
continue permanently. Increased interest costs and budgetary losses or 
gains due to the economic impacts of the budget also affect the size of 
the policy change that is required.
    In order to stabilize the ratio of debt to GDP, government 
consumption has to be cut by between 2.8 percent and 3.0 percent of GDP 
between 2013 and 2014, from about 0.6 percent of GDP above its baseline 
level in 2013 to about 2.2 percent to 2.4 percent below its baseline 
level in 2014. Lump-sum taxes must be raised by about 2.3 percent of 
GDP between 2013 and 2014, from about 0.8 percent of GDP below their 
baseline level in 2013 to about 1.5 percent above their baseline level 
in 2014.
    Those policy changes beyond the 10-year budget window are foreseen 
by households and can affect their behavior during the first 10 years. 
For instance, if taxes are going to be raised in 2014, people in the 
model will tend to work and save more in preparation. That additional 
work and saving tends to improve the budget balance, which is why the 
adjustment to lump-sum taxes required to stabilize the debt/GDP ratio 
is smaller than the required adjustment to government consumption. 
There is no similar impact of cuts in government consumption on work 
and saving because the model assumes that government consumption does 
not provide value to people. (Estimates assuming a future increase in 
marginal tax rates, not shown for brevity, fall between those assuming 
a future cut in government consumption and those assuming a future 
lump-sum increase in taxes.)
    The model assumes no intergenerational altruism, that is, the 
utility of children does not enter the utility function of parents. All 
of the bequests in the model are accidental, due to uncertain life 
span. For simplicity, the wealth left by the deceased households is 
collected and distributed to the working-age households (ages 20 to 64) 
in a lump-sum manner. (Each working-age household rationally expects to 
receive the future accidental inheritances when it makes decisions 
about consumption, labor supply, and saving.)
    The President's budgetary policies affect output in the life-cycle 
model mainly through reductions in marginal tax rates on labor and 
capital income, increases in after-tax income (from both reduced taxes 
and increased transfers), increases in government consumption, and 
changes in expected budgetary policies outside the 10-year projection 
period. CBO's method for calculating changes in the effective marginal 
tax rate on labor and capital income were described previously. CBO 
used the administration's spending and revenue projections to estimate 
changes in after-tax income and government consumption. (Most 
discretionary spending was classified as government consumption, and 
most mandatory spending was classified as transfers.) The reductions in 
marginal tax rates under the President's budget reduce projected tax 
revenues in the model somewhat; CBO made additional adjustments through 
lump-sum taxes to match the administration's revenue estimates. In the 
models, changes in transfers are also distributed on a lump-sum basis.
    Reductions in marginal tax rates on labor income affect labor 
supply by raising after-tax wages. That change induces households to 
increase their labor supply by raising the price of leisure relative to 
consumption. The response of labor supply to after-tax wages in the 
model depends on how the lost revenue is assumed to be financed outside 
the 10-year projection period. In a closed economy, the effective long-
run wage elasticity of labor supply with respect to after-tax wages is 
0.21 when the tax cut is financed by a cut in government consumption 
and 0.36 when it is financed by a lump-sum tax increase; in an open 
economy, the elasticities are 0.16 and 0.35, respectively. Those 
elasticities were calculated on the basis of the change in the steady-
state quantity of labor supplied relative to the change in after-tax 
wages from an across-the-board 10 percent tax cut.
    Reductions in taxes and increases in transfers that do not affect 
after-tax wages (such as child tax credits or a prescription drug 
benefit) tend to reduce households' labor supply through an income 
effect people tend to work less because they can maintain the same 
standard of living with less work.
    Reductions in the marginal tax rate on capital income tend to 
reduce current consumption and increase saving because they make future 
consumption relatively less expensive than current consumption. Once 
again, the effect on consumption depends on how the tax cut is assumed 
to be financed. In a closed economy, the long-run elasticity of savings 
with respect to the after-tax interest rate is 1.40 when the tax cut is 
financed by a cut in government consumption and 1.60 when it is 
financed by a lump-sum tax increase. In an open economy, the 
elasticities are 0.95 and 1.10, respectively.
    Government consumption affects behavior in the model by reducing 
the share of output available for private consumption and investment. 
Government consumption is not included in the utility function, so it 
is assumed to be pure waste. Alternatively, one could assume that 
government consumption is a perfect substitute for private consumption. 
In that case, the effect of a change in government consumption is the 
same as that of an equal change in transfers or lump-sum taxes.
                       the infinite-horizon model
    The infinite-horizon growth model is a Ramsey-type model similar in 
many ways to the life-cycle model. A simulated household chooses how 
much to work and consume in order to maximize its well-being over its 
lifetime. The basic forms of the utility function and production 
function are the same as in the life-cycle model, and government 
consumption is assumed to have no value. Like the life-cycle model, the 
infinite-horizon model requires an offsetting policy change to 
stabilize the debt-to-GDP ratio beyond the 10-year projection period. 
That policy change is fully foreseen and affects behavior over those 10 
years.
    Rather than including a set of overlapping households of different 
ages and earnings ability, the infinite-horizon model includes just one 
representative household. (That type of model is often called a 
``representative agent'' model.) Also, unlike the life-cycle model, 
there is no uncertainty about mortality or individual earnings ability; 
the household is assumed to know all future developments with 
certainty.
    The most important difference between the models is that the 
household in the infinite-horizon model behaves as if it expects to 
live forever, whereas the households in the life-cycle model expect to 
live only for a fixed period of time. That assumption of an infinite 
horizon is equivalent to an assumption that the household values its 
descendants' consumption as much as its own.
    CBO calibrated the share parameters on the Cobb-Douglas production 
function to match the capital and labor shares of income in the 
agency's forecast for 2003 and adjusted the discount rate to match the 
projected capital/output ratio.
    As with the life-cycle model, solving the infinite-horizon model 
requires that the tax cuts and spending increases in the President's 
budget be financed at some point in order to stabilize the debt/GDP 
ratio and return the economy to a balanced growth path. CBO assumed 
that that financing occurred through either a lump-sum tax increase or 
a cut in government spending in the 11th year of the projection.
    In order to stabilize the ratio of debt to GDP in the model, 
government consumption has to be cut by about 3.9 percent of GDP 
between 2013 and 2014, from about 0.6 percent of GDP above its baseline 
level in 2013 to about 3.3 percent below its baseline level in 2014. 
Alternatively, lump-sum taxes must be raised by about 3.5 percent of 
GDP between 2013 and 2014, from about 0.6 percent of GDP below their 
baseline level in 2013 to about 2.9 percent above their baseline level 
in 2014. The adjustments to stabilize the debt/GDP ratio are larger 
than in the life-cycle model because in the infinite-horizon model, the 
changes in marginal tax rates under the President's proposals, which 
are continued permanently after the 10th year of the projection, result 
in larger projected revenue losses than in the life-cycle model.
    The response of the labor supply to after-tax wages in the model 
depends on how the lost revenue is assumed to be financed outside the 
10-year projection period. The effective long-run wage elasticity of 
labor supply is 0.15 when the tax cut is financed by a cut in 
government consumption and 0.35 when it is financed by a lump-sum tax 
increase. Those elasticities are based on the change in the steady-
state quantity of labor supplied relative to the change in after-tax 
wages from an across-the-board 10 percent tax cut.
    There is no external sector in the infinite-horizon model; all of 
its projections assume a closed economy. As in the life-cycle model, in 
the infinite-horizon model the President's budgetary policies affect 
output mainly through reductions in marginal tax rates, increases in 
after-tax income, increases in government consumption, and changes in 
expected budgetary policies outside the 10-year projection period. The 
decreases in marginal tax rates tend to encourage the household to work 
and save more, which increases output and the capital stock, while the 
increases in after-tax income and government consumption tend to reduce 
saving and the capital stock. The infinite-horizon model uses the same 
values for changes in marginal tax rates, transfers, and government 
consumption as does the life-cycle model. After the new marginal tax 
rates are imposed, adjustments in lump-sum taxes are used to align the 
total change in revenues with the administration's estimates.
          macroeconomic advisers' and global insight's models
    The models by Macroeconomic Advisers and Global Insight are 
econometrically estimated models of the U.S. economy that combine 
demand-side (Keynesian) and supply side features. The demand-side 
features of those macroeconometric models are more obvious, especially 
in the short run: in both models, total output is always determined by 
demand for the components of output. Utilization of the factors of 
production adjusts to achieve that level of output.
    Supply side features of the models affect output insofar as they 
affect demand. The full effects do not occur immediately but only 
gradually, through the unemployment rate, prices, and interest rates. 
Suppose, for example, that a policy raises aggregate supply more than 
it does aggregate demand. In Macroeconomic Advisers' and Global 
Insight's models, that change will push the unemployment rate higher 
than what it would otherwise have been. All else being equal, that 
scenario puts downward pressure on inflation. Higher unemployment rates 
and lower inflation may lead the Federal Reserve to lower interest 
rates. Lower interest rates then increase demand for interest-sensitive 
items like consumer durables, business fixed investment, residential 
investment, and net exports (through a weaker dollar).
    To isolate the supply side impacts of policies in the 
macroeconometric models, CBO eliminated the Keynesian demand effects by 
changing interest rates so that the unemployment rate was brought back 
to baseline levels. Given that the models achieve supply side effects 
through changes in interest rates, that approach seemed reasonable. 
However, when CBO divided the estimated budgetary effects from the 
macroeconomic impacts of the President's proposals into supply side and 
demand-side portions, the interest rates in the supply side estimates 
changed only enough to reflect the impact of changes in the ratio of 
capital to output on the rate of return to capital, rather than at the 
high levels necessary to maintain baseline unemployment. Those high 
interest rates reflected demand-side pressures, so it made little sense 
to ascribe their budgetary effects to supply side effects.
    Another difference between the macroeconometric models and the 
life-cycle and infinite-horizon models is their treatment of 
expectations. While the life-cycle and infinite-horizon models are 
forward-looking, the macroeconometric models assume that people respond 
to economic changes in the same way as they have in the past, 
regardless of the source of those changes. So, for example, long-term 
interest rates are set according to the current state of the economy 
and do not take account of expected changes in the budget that will 
alter the state of the economy in the future. Thus, the financing 
assumption crucial to results from the life-cycle and infinite-horizon 
models is irrelevant in the macroeconometric models. CBO made no 
adjustments for that feature of the macroeconometric models. To the 
extent that expectations about future financing decisions play a role 
in economic outcomes, that may or may not have been a bad assumption.
    In the models by Macroeconomic Advisers and Global Insight, 
aggregate supply at full employment is determined by labor and capital 
in much the same way as in the textbook growth model. To estimate the 
labor supply response, CBO used the same calculation as in the textbook 
growth model. CBO then used that estimate in place of a smaller 
response built into Global Insight's model and no response in 
Macroeconomic Advisers' model. Capital responds through changes in 
investment. The supply side portion of changes in investment comes from 
changes in the cost of capital. Higher interest rates boost the cost of 
capital, reducing investment, while the tax provisions for dividends 
reduce the cost of capital, increasing investment.
    While budget policy can affect international capital flows in the 
macroeconometric models, those effects are probably incomplete. In both 
models, reduced national saving leads to higher interest rates, causing 
the dollar to appreciate, thus raising the trade deficit. Capital 
inflows rise to finance the higher deficit. Reduced national saving 
thus ultimately leads to capital inflows, just as in the textbook 
growth model. However, the models do not capture the fact that foreign 
taxpayers do not benefit from the proposal to reduce double taxation of 
corporate income and would therefore probably reduce their holdings of 
U.S. equities.
    CBO made two other changes to Global Insight's model. In the 
version of the model that was the starting point for CBO's estimates 
(the one that Global Insight used to produce its February forecast), 
growth in wages did not depend on the level of the unemployment rate, 
but only on its change. Thus, a permanent reduction in the unemployment 
rate produced only a temporary rise in wage inflation. Supply side 
effects on output were minimal. Therefore, CBO substituted a wage 
equation very close to the one included in the version of the model 
that Global Insight used to produce its March forecast, one in which 
wage growth depends on both the level of and change in the unemployment 
rate. A permanent reduction in the unemployment rate produces a 
continuous acceleration in wage and price inflation, restoring the 
importance of supply side effects.
    Also, in Global Insight's model, capital gains taxes depend on 
changes in stock prices. However, the model assumes that people treat 
higher capital gains taxes from a one-time rise in stock prices as if 
they will be permanent, and not as one-time events, and so reduce their 
consumption. Instead, CBO assumed that changes in receipts from capital 
gains taxes affect consumption only 10 percent as much as changes in 
receipts from other personal taxes.
    CBO constructed baselines for both models in which levels for GDP, 
aggregate price indexes, unemployment and interest rates, stock market 
appreciation, and the sunset provisions of tax legislation closely 
matched CBO's January 2003 forecast. In the baseline in Global 
Insight's model, CBO also aligned most incomes, taxes, and spending 
with CBO's forecast levels.
    To implement the President's proposals in the models, CBO changed 
tax rates and spending levels in line with the cost estimate from the 
Fiscal Year 2004 Budget of the U.S. Government and the General 
Explanations of the Administration's Fiscal Year 2004 Revenue 
Proposals, because CBO had not yet completed its Analysis of the 
President's Budgetary Proposals. Within the simulation, CBO changed tax 
rates by the same amount in every quarter of the year since income 
taxes are paid by calendar year, and it implemented higher spending by 
raising the appropriate categories of spending in each model.
    In both models, the extension of the research and experimentation 
credit reduces corporate income taxes. In Global Insight's model, that 
change boosts research and development spending, which raises 
productivity with a lag.
    CBO assumed that the proposals for lifetime savings accounts and 
retirement savings accounts would induce changes in consumption 
according to their estimated income and substitution effects. CBO 
spread the large income effect in 2003 evenly over the 10-year 
projection period.

                     Appendix A: Additional Results

    This section provides some results that go beyond those shown in 
Tables 1, 2, and 3.
    One of the important variables for estimating the budgetary effects 
of the President's proposals was the estimated effect on interest 
rates. Those rates affect both interest payments on the national debt, 
and, through their effect on the relative amounts of different types of 
income, tax revenues as well. Table 7 shows the effects of the 
President's proposals on interest rates, as estimated by various 
models.
    For the life-cycle and infinite-horizon models, the Congressional 
Budget Office (CBO) had to make an assumption about how the revenue 
losses and spending increases under the President's budget would 
ultimately be financed in order to stabilize the debt/gross domestic 
product (GDP) ratio. In CBO's main estimates, those financing changes a 
permanent (as a percentage of output) cut in government consumption or 
increase in lump-sum taxes were assumed to be made in 2014, the year 
after the end of the period covered by the budget. However, that choice 
of year is essentially arbitrary. Table 8 shows the estimated effects 
on real GDP assuming that the financing changes were instead made after 
2023.
    Those estimates differ from the ones assuming financing in 2014 
(shown in Table 1) for several reasons. In the life-cycle model, 
delaying the increase in lump-sum taxes results in a lower (or more 
negative) estimated impact on output, because current workers and 
retirees would not have to face the tax for as long before their death. 
That means they have less incentive to work harder and save more. By 
contrast, the timing of lump-sum taxes makes no difference in the 
infinite-horizon model, because the representative agent in that model 
(or children whose welfare he values as highly as his own) will 
eventually face taxes of an equivalent present value.
    The direction of the effect of changes in the timing of financing 
through government consumption depends on the specific model. The 
infinite-horizon model and the life-cycle model assuming a closed 
economy estimate that delaying the cut in government consumption 
results in a more positive or less negative impact on output. That is 
in part because of the timing of changes in the wage rate. When the 
financing is delayed, there is increasing crowding out of the capital 
stock between 2014-23, which greatly depresses the wage rate. The wage 
rate between 2004-13 is therefore high by comparison, resulting in a 
shifting of more labor into that period, and therefore a higher level 
of output relative to that when financing occurs earlier. By contrast, 
in the life-cycle model assuming a small open economy the wage rate is 
fixed by the world economy, so there is no similar effect, and delaying 
financing results in a slightly lower GDP over the first 10 years.
    The economic effects outside the budget window can differ 
substantially from those within the budget window. For the models 
without forward-looking behavior, the increase in the deficit under the 
President's budget would, if not offset, lead to rising crowding out of 
investment as the budgetary imbalance continued to increase, due to 
rising interest payments. In the forward-looking models, a more 
concrete answer can be given. In those models, the economy eventually 
reaches a steady state, in which the economic effects are constant as a 
share of output. Table 9 shows the economic effects in the life-cycle 
and infinite-horizon models once the economy has reached a steady 
state.
    The steady-state effects of the President's proposals with 
financing through an increase in lump-sum taxes tend to be more 
positive than those within the first 10 years for two reasons. First, 
in the life-cycle model within the first 10 years there are some people 
who will not be affected by the increased taxes because they will die 
before the increases occur, and therefore do not have to increase labor 
supply and reduce consumption in response. Second, in both models it 
takes time for the capital stock to grow to fully reflect the reduction 
in consumption and increase in labor supply that stems from the 
increased taxes. Note the key point that the taxes being raised are 
lump-sum taxes, which do not affect marginal incentives to work and 
save. The steady-state effects on output of finance through an increase 
in marginal tax rates would tend to be negative.
    The steady-state effects of the President's proposals with 
financing through a cut in government consumption differ from the 
effects within the first 10 years, but the sign of the difference is 
uncertain. On the one hand, a cut in government consumption allows 
greater private consumption for any given level of work, which tends to 
reduce labor supply. On the other hand, more resources are available 
for investment for any given level of private consumption, which tends 
to lead to increases in the capital stock. In the life-cycle model's 
results, the former effect dominates, and the steady-state effects on 
output (GDP in the closed-economy case and GNP in the open-economy 
case) are more negative than those within the 10-year window. In the 
infinite-horizon model results, the latter effect dominates, and the 
steady-state effects on output are more positive than those within the 
2004-13 period.

    TABLE 7.--LONG-TERM EFFECTS OF THE PRESIDENT'S BUDGET ON 3-MONTH
                           TREASURY BILL RATES
        [Average percentage-point difference from CBO's baseline]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
           Supply Side Model Without Forward-Looking Behavior

Textbook Growth Model.............................        0.1        0.4

            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......          0        0.2
    Higher taxes after 2013.......................          0        0.1
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......          0          0
    Higher taxes after 2013.......................          0          0
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......          0        0.1
    Higher taxes after 2013.......................          0          0

            Macroeconometric Models, Supply Side Contribution

Macroeconomic Advisers............................        0.2       n.a.
Global Insight....................................        0.3       n.a.

     Macroeconometric Models, Supply Side and Cyclical Contributions

Macroeconomic Advisers............................        1.5       n.a.
Global Insight....................................        0.9       n.a.
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: n.a. = not applicable.

The ``textbook'' growth model is an enhanced version of a model
  developed by Robert Solow. The life-cycle growth model, developed by
  CBO, is an overlapping generations general-equilibrium model. The
  infinite-horizon growth model is an enhanced version of a model first
  developed by Frank Ramsey. The models by Macroeconomic Advisers and
  Global Insight, which are available commercially, are designed to
  forecast short-term developments. The various models reflect a wide
  range of assumptions about the extent to which people are forward-
  looking in their behavior: in the textbook model and those by
  Macroeconomic Advisers and Global Insight, their foresight is the
  least, while in the infinite-horizon model, it is perfect and extends
  infinitely to include a full consideration of effects on descendants.
In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.
For the models by Macroeconomic Advisers and Global Insight, the supply
  side contribution to interest rate changes shown in the table reflects
  only the effect of changes in the ratio of capital to output on the
  rate of return to capital. In fact, the interest rates in the ``supply
  side'' projections had to be increased by much more to keep the
  unemployment rate at its baseline level. Those large increases stem
  from demand-side pressures, so categorizing them as supply side
  effects would make little sense. The numbers shown are the ones that
  were used in generating the budgetary effects shown in Table 1.


  TABLE 8.--EFFECT OF THE PRESIDENT'S BUDGETARY PROPOSALS ON REAL GROSS
DOMESTIC PRODUCT, ASSUMING THEY ARE FINANCED AFTER 2023 RATHER THAN 2013
             [Average percentage change from CBO's baseline]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.2       -1.0
    Higher taxes after 2013.......................        0.1       -0.4
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.7       -0.6
    Higher taxes after 2013.......................       -0.3       -0.1
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......        0.8        0.9
    Higher taxes after 2013.......................        0.9        1.4
Memorandum: Effect on Real Gross National Product
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.9       -2.2
    Higher taxes after 2013.......................       -0.4       -1.3
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: In models with forward-looking behavior, CBO had to make
  assumptions about how the President's budget would be financed beyond
  the period covered by the budget. These results show the estimated
  economic effects of the President's proposals if they were financed by
  cutting government consumption or raising taxes after 2023, rather
  than after 2013 as in most of CBO's other published results. Results
  are shown only for the life-cycle and infinite-horizon models, because
  only in those models does the timing of financing affect the results.

The life-cycle growth model, developed by CBO, is an overlapping
  generations general-equilibrium model. The infinite-horizon growth
  model is an enhanced version of a model first developed by Frank
  Ramsey.


   TABLE 9.--LONG-RUN STEADY-STATE EFFECT OF THE PRESIDENT'S BUDGETARY
                PROPOSALS ON REAL GROSS DOMESTIC PRODUCT
             [Average percentage change from CBO's baseline]
------------------------------------------------------------------------
                                                               Effect on
                                                               Real GDP
------------------------------------------------------------------------
            Supply Side Models with Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.................        -1.8
    Higher taxes after 2013.................................         0.7
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.................        -0.2
    Higher taxes after 2013.................................         1.6
Infinite-Horizon Growth Model
    Lower government consumption after 2013.................         0.6
    Higher taxes after 2013.................................         2.5
Memorandum: Effect on Real Gross National Product
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.................        -2.4
    Higher taxes after 2013.................................         0.3
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: The life-cycle growth model, developed by CBO, is an overlapping
  generations general-equilibrium model. The infinite-horizon growth
  model is an enhanced version of a model first developed by Frank
  Ramsey. In those models, the effect of the President's proposals on
  the economy eventually (after several decades) stabilizes at a
  permanent level as a percentage of GDP. This table shows those long-
  run, permanent effects, which can differ substantially from the
  effects within the 10-year period covered by the budget.

In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.

 BOX 1.--PROVISIONS WHOSE EFFECTS ON EFFECTIVE MARGINAL TAX RATES WERE 
              ESTIMATED USING THE FELDSTEIN-SUMMERS METHOD

    The provisions whose effects on effective marginal tax rates were 
estimated using the Feldstein-Summers method included these:
     Accelerate the expansion of the 10 percent individual 
income tax rate bracket;
     Accelerate the reduction in individual income tax rates;
     Accelerate the expansion of the 15 percent individual 
income tax rate bracket for married taxpayers filing joint returns;
     Accelerate the increase in the standard deduction for 
married taxpayers filing joint returns;
     Accelerate the increase in the child tax credit;
     Provide relief to individuals from the minimum tax; and
     Permanently extend provisions expiring in 2010 (except for 
the extension of the repeal of estate and generation-skipping transfer 
taxes and the modification of gift taxes, which were analyzed 
separately).
    By the administration's estimates those provisions account for $788 
billion of the $1.461 trillion cost of the President's revenue 
proposals over the years from 2004-13. The proposal to eliminate double 
taxation of corporate income (with a 10-year cost of $385 billion) 
would also affect the marginal tax rate on capital, but the 
Congressional Budget Office (CBO) estimated that effect in a separate 
calculation (described later). The proposals to expand the availability 
of tax-free savings accounts (with a 10-year cost of $1 billion) would 
also affect the marginal tax rate on capital, but their effect on the 
incentive to save would be complex, so CBO estimated it separately from 
its calculation of effective tax rates.

 STATEMENT OF DOUGLAS J. HOLTZ-EAKIN, DIRECTOR, CONGRESSIONAL 
                         BUDGET OFFICE

    Mr. Holtz-Eakin. Thank you, Mr. Chairman, for the chance to 
be here; Congressman Spratt, for your opening remarks.
    I do commend to you the entire report, which will be 
submitted for the record. What I will try to do in a short 
amount of time is to summarize our CBO analysis of the 
President's budgetary proposals and divide my remarks into 
three specific areas.
    I will begin by a brief summary of the findings in our 
interim report, which was released a little over 2 weeks ago; 
summarize in a great deal more detail the macroeconomic 
analysis of the President's budgetary proposals, that is, the 
new information released today; then I would like to close with 
a few comments about how this particular effort fits into CBO's 
larger work effort in analyzing budgetary proposals.
    To summarize the interim report, which came out on March 7, 
CBO conducted that analysis with an attempt to get the 
information to the Budget Committees in time for their markups. 
The interim report contained the conventional analysis, and it, 
at least to my eye, really had a couple of key findings that I 
will highlight as a prelude to the macroeconomic analysis.
    First, after looking at the performance to date in fiscal 
year 2003 of the receipts that have flowed into the U.S. 
Treasury, we elected to revise our baseline outlook for 
receipts, lowering our estimate by $30 billion in 2003 and 2004 
and by smaller amounts thereafter.
    Second, we rolled into our estimates of outlays the laws 
passed in the fiscal year 2003 omnibus. And with those 
revisions, the baseline outlook was for a deficit of the amount 
$246 billion in 2003, $200 billion in fiscal year 2004 and then 
diminishing deficits thereafter, turning to surpluses in the 
latter years of a 10-year budget window and a cumulative 
surplus of $891 billion.
    We then turn to our analysis of the President's budgetary 
proposals, and in that regard, I think there are three major 
messages that came out of the standard analysis. No. 1, 
following the guidance of the Budget Committees and the 
convention of previous years, we produced 10-year budget 
estimates of the President's proposals, although the 
administration supplied information regarding only the first 5 
years of the budget window. This required us to make some 
judgments about the impacts of the President's proposals in the 
last 5 years of the budget window; and in some cases, 
differences between the CBO estimates and the administration's 
estimates can be traced to those judgments that we were forced 
to make.
    The second is that under the President's proposals in that 
conventional analysis, the basic character of the budgetary 
outlook was to have run large deficits in the near term--$287 
billion in fiscal year 2003, $338 billion in fiscal year 2004--
and then diminishing thereafter with a cumulative total of $1.8 
trillion over the 10-year budget window. The rough pattern in 
the administration's estimates and CBO's estimates coincided, 
peaking in fiscal year 2004 and diminishing thereafter to much 
smaller deficits in the outyears of the budget window.
    Turning to specific policies, the real news was that there 
were no great differences between the CBO estimates and the OMB 
estimates of the President's proposals. So in contrast to any 
events of past years, where there were marked differences in 
the scoring of budgetary proposals, by and large the CBO and 
OMB estimates coincided. The one notable exception that I will 
flag for you is our estimate of the impact of the President's 
Medicaid proposals, which indicates a larger budgetary cost 
than OMB does; and that appears to us to be an artifact of a 
much lower baseline level of spending in the CBO baseline than 
in the OMB baseline, but without the last 5 years in the 
administration's estimates we can't be certain.
    Given that, we then turn today to our analysis of the 
macroeconomic impacts of the President's budgetary proposals. 
The key features of this analysis are really in three pieces. 
The first key feature is that underneath any impact of the 
budget on the macroeconomy and, thus, feedback effects from the 
macroeconomy into the budgetary outlook--higher or lower 
outlays, higher or lower receipts--is the core impact on 
economic growth; and to capture that impact, CBO employed a 
wide variety of formal economic models into which we inserted 
the President's budgetary proposals and did our analysis.
    These models differ in the degree to which they feature 
different aspects of the growth process in an actual economy. 
We, for example, have as one part of our analysis a traditional 
economic growth model, which focuses on the core fundamentals 
by which an economy can grow over the long term. Economies by 
and large grow by accumulating greater amounts of capital, 
giving up consumption in the present to save for the future, by 
accumulating labor as the population grows and acquires skills, 
and by becoming technologically more proficient through 
research and development and other channels.
    Several of our models feature aspects of the growth process 
in which the private sector looks forward and anticipates the 
economic landscape in the years to come. This is a desirable 
feature of models in a setting where some of the President's 
proposals, such as the dividend proposal, are intended to 
impact financial markets, where financial analysts will 
anticipate future tax implications of each activity undertaken. 
We seek to get a handle on the importance of that forward-
looking aspect in some of the models that we choose and indeed, 
we push this to an extreme in which the private sector is quite 
savvy about the outlook in the future. As people look beyond 
their own lifetime to the impact on the economic setting for 
their children and, in the process, anticipate an entire future 
sequence of budgetary and other policies.
    At the other end of the spectrum, we also employ models 
that take account of short-run business-cycle dynamics and are 
meant to accentuate the impact and make clear the impact of 
budgetary proposals on the degree to which the economy will 
recover and grow, not by accumulating more fundamental factors 
of production, but instead grow by utilizing the existing 
factors, the workers and the factories, more extensively. That, 
in laymen's terms, is simply a cyclical recovery, which can 
influence receipts and outlays through faster economic growth 
in the near term.
    The second feature of our analysis that I would like to 
point out to you is, we make every attempt to analyze the 
budgetary implications of the President's proposals in a 
comprehensive fashion. We have endeavored to enter into our 
formal analysis each of the receipt proposals that the 
President delivered in his budget. We have taken into account 
all the outlay proposals as best as we can, enter them into our 
analysis and divided them between government consumption, 
transfer payments to individuals, and a variety of other ways 
in which outlays might affect the economy. And as a result, our 
analysis is an estimate of the impact from the budget as a 
whole and cannot be traced to any single element of the 
President's proposals.
    It is a comprehensive analysis. I think the spirit in which 
this should be interpreted is that CBO has always tried to 
incorporate into its January baseline or its summer mid-session 
reviews the impact of current policies on the performance of 
the economy. What we have done in this analysis is essentially 
attempt to anticipate the kinds of impacts these policies would 
have on our baseline and do it in a fashion which is more 
timely for purposes of the Budget Committee's consideration.
    Now, in the process of employing some of these models, 
particularly the ones where the private sector looks forward to 
the future economic landscape, we are, by necessity, forced to 
make some assumptions about the kinds of policies that will be 
in place beyond the 10-year budget window. Let me be specific 
about the way this works.
    Under the President's proposals, the debt-to-GDP ratio in 
the United States would rise from about 17 percent to 34 
percent in our conventional analysis. As a result, there is 
more debt outstanding at the termination of the budget window 
on which interest payments will be owed. In the absence of some 
other policy change, higher taxes or lower spending of some 
type, the government will have to borrow to cover these 
interest payments; and if one were to just mechanically run 
that process into the future, there would be an ever-increasing 
debt load and it would spiral in an unstable fashion. The model 
simply will not permit one to enter that kind of a policy into 
them.
    So model discipline requires that we make some assumptions 
about the way in which that hole generated by the additional 
debt will be filled in the government budget. We have chosen to 
do that in as clear a fashion as we can by taking one or two 
extreme assumptions.
    The extreme assumption on one side is that taxes will be 
raised immediately after the budget window, equal to the hole 
necessary to cover these interest payments, about 2.5 percent 
of GDP--don't quote me on the precise number; the staff could 
do the calculation for those who are interested--or that 
government consumption will be cut by about 3 percent of GDP. I 
don't offer those as realistic outlooks for U.S. fiscal policy; 
I point them out as the kind of formal economic policy 
evaluation required when using these kinds of models. We can 
come back to the impact of that in the analysis.
    The last feature of the analysis that I will mention to you 
before turning to results is that we have tried very carefully 
to delineate between supply side growth effects, those impacts 
which come from greater labor supply in the economy, greater 
accumulation of capital and technology, and thus, permanently 
higher economic growth from those cyclical growth impacts, the 
ones that simply may be traced to faster recovery toward the 
full employment of the existing stock of resources.
    Now, I think it is essential to make that delineation in 
the interest of analytic clarity. It is also useful for 
policymakers to be aware that our estimates of the cyclical 
growth impacts depend greatly on the assumptions we make about 
monetary policy; we are forced to make assumptions of those 
kinds in doing this analysis. And it is also true that cyclical 
recoveries are not typically something that come about as a 
result of deliberate government policy; instead, they are 
derived from the private sector finding new investment 
opportunities, paring its inventories, and otherwise having a 
natural correction to the business cycle. We have tried to lay 
out those two different sources of growth in what we do.
    Let me turn now briefly to some of the results in our 
analysis and despite my pedigree as a college professor and my 
innate fascination with a geek's refuge, which is charts, 
graphs, and numbers--I have tried to restrict myself to only 
six such presentations. We have the Armageddon of charts, 
numbers, and analyses underneath the surface here; if you so 
desire, you are welcome to further details.
    In doing this, I want to focus not on the numbers per se, 
but on the patterns that are revealed by the numbers. I would 
be happy to discuss the numbers at length, but I think it would 
be in the interest of the committee to really focus on the 
patterns that are displayed.
    Let me begin with the first key result, which is, on 
balance, our conventional estimate of the deficit as a reliable 
indicator of the budgetary outlook for this set of proposals 
even after we examine the macroeconomic impacts of the 
President's proposals.
    Now, to see that displayed on the graph, which you have in 
the package, that I hope is before you, are our estimates in 
nine different scenarios, combinations of particular economic 
models and assumptions about policy beyond the budget window. 
And the black line you see at the bottom is the static, or 
conventional, estimate of the cumulative budget deficit over 
the years 2004-08. The bars show alternative estimates that 
would be produced following macroeconomic feedbacks, using the 
alternative models. And you may read these in any way you so 
desire with your eye, but in our view, on balance, the 
conventional estimate is a very good indicator of the budgetary 
outlook in comparison to estimates including the macroeconomic 
impacts. Some are above the static estimate, or conventional 
estimate; some are below the conventional estimate; and the 
range of uncertainty is displayed in the graph, I think, quite 
clearly.


    The same lesson is true in the outyears of the budget 
window if you look beyond 2008. Here we display results for 
fewer models. We simply do not attempt to push business cycle 
models past their abilities to forecast fluctuations in the 
economy. We focus on models that are designed to estimate long-
term economic growth.
    Again, you see the same pattern. Some models deliver higher 
deficits than the conventional estimate, some produce lower 
deficits. The range of uncertainty is a bit larger because the 
time horizon is greater. And I think anyone who is familiar 
with CBO's history of emphasizing the uncertainty of long-term 
budget projections will find this pattern hardly surprising. So 
those, I think, are part of the key features we found when 
doing this, when you get to the bottom lines.
    Underneath this are a couple of other lessons. The small 
dynamic impacts reflect the small scale of these proposals in 
the overall size of the U.S. economy. The U.S. economy is an 
$11 trillion economy. Taken year by year or over the budget 
window, on average, the President's proposals for receipts are 
roughly 1 percent of GDP, $100 billion, and his proposals for 
outlays are even smaller, about 0.5 percent of GDP. So the 
small impact of these budgetary proposals on the overall 
economy and, thus, on the budgetary outlook is not surprising 
when the scale of the proposals is viewed in perspective to the 
size of the U.S. economy.


    What you can see in the chart is that for a variety of 
models, these proposals have small macroeconomic impacts. The 
average impact on the difference between our baseline level GDP 
and our level of GDP including budgetary impacts is small, 
under a percent in absolute value. Some impacts are positive; 
some are negative.
    Now, the corresponding picture is the one which reflects 
that in budget numbers. What we display on the chart for your 
perusal are the specific budget numbers that are underneath 
those bar charts that I showed you at the outset, which give 
you the range of feedback from the macroeconomy to the budget 
outlook.
    I should stress----
    Mr. Spratt. Could I ask you where do these appear in your 
book? They are hard to see on the screen.
    Mr. Holtz-Eakin. They should be in the chart pack in front 
of you, which I hope will be easy for you to see. And they are 
also on page 52 of the entire report.
    I encourage the Congressman not to focus on the numbers, 
but the pattern in them as I continue my remarks. As an 
economist, I would urge everyone to remember that you should 
not judge policy proposals by their dollar value alone. Indeed, 
it would be a mistake to evaluate these budgetary proposals 
simply by their scale relative to the economy.
    It is also true that budgetary proposals can have important 
incentive effects and alter the private sector's desires to 
undertake risks, supply labor, and otherwise affect the long-
run path of the economy.


    One of the reasons in our view that we have the pattern of 
small overall impacts that we see in these results is that the 
composition of the proposals in the President's budget is not 
uniformly growth oriented. Indeed, some of the proposals may 
raise labor supply, may enhance capital formation, and help 
long-run growth, but others foster larger government 
consumption or enhanced private sector consumption. That 
greater consumption is at odds with the need to save, to 
accumulate capital and, thus, have faster long-run growth. And 
the mixed composition of the budgetary proposals leads, on 
average, to the small growth impacts that we see in these 
results.
    The last message that I would give in terms of broad, 
overall results has to do with the difference between short-run 
cyclical growth effects and long-run supply side growth 
effects. Everything you have seen so far focuses on long-run 
supply side growth effects.
    If we turn to the next slide, we can see that there is a 
very, very large difference in the typical macroeconomic model 
between the supply side contribution, something typically 
measured in the first panel in tenths of a percentage point for 
GDP growth, and the cyclical contribution. The fact that the 
U.S. economy could grow more quickly back to its fuller 
potential, see lower unemployment, use factories to their full 
capacity--those impacts are much larger, ranging on the order 
of 1.6 percentage points in the Global Insight model, half a 
percentage point for real GDP in the macroeconomic adviser's 
model.
    As I said at the outset, I believe those results should be 
viewed with some caution for two reasons. One reason is 
budgetary in nature. In analyzing the President's proposals, we 
implemented his discretionary outlay targets as they were 
delivered in the President's budget.


    If you look at that table, one of the things that you can 
see is that nominal GDP, the value of production that includes 
inflation, is much larger than the growth in real GDP, the 
value of growth adjusted for inflation. So part of what goes on 
in those budgetary impacts is that spending is frozen in 
nominal terms, while the inflation-based gains are taxed to 
provide greater receipts; those, I think, are not indicative of 
real budgetary implications of actual policies.
    And the second reason to have some caution interpreting 
those results is that they depend heavily on the requirement 
that these policies be implemented at a point when the economy 
is operating below its full potential, that they be implemented 
in a timely fashion to help it to get back quickly to its full 
potential. And the long history of systematic attempts to do 
that in the United States and elsewhere is one that does not 
lend great confidence to such a conclusion. And there are other 
sources of this cyclical recovery, most notably the Federal 
Reserve policy.
    So, in closing, I guess I would like to put these specific 
results in the context of the larger issue of how CBO does its 
analysis.
    It is CBO's view that it is useful to try to anticipate and 
understand the macroeconomic consequences of budgetary 
proposals. As I mentioned before, our analysis is typically a 
backward-looking affair, where we look back at actual proposals 
and try to build their impacts into our baseline. To 
incorporate into our analysis of the President's proposals 
their potential macroeconomic impacts, we think, is a useful 
addendum to the policy process.
    I would hasten to add that in the end, the usefulness will 
be determined by the Budget Committee and that we would seek to 
continue, modify, otherwise alter such an analysis as the 
committee finds useful in its deliberations; and I look forward 
to working with you in that process.
    The second thing I would like to highlight is the 
complexity involved in this analysis. Having sat through just a 
few of the numbers and a high-speed explanation of what went 
into it, you have an appreciation for the enormous amount of 
work that was required to undertake what I view to be a highly 
professional and systematic analysis of the President's 
budgetary proposals. One cannot underestimate the complexity of 
doing this. One can see from the results the range of 
uncertainty involved. For all those reasons, while we view that 
analysis as useful, we view it, at best, as a supplement to the 
budget process at this point in time--until the analysis can be 
honed to a degree where the complexity becomes smaller and the 
band of uncertainty becomes narrower.
    My last two remarks have to do with both the process and 
the results. On the process, we have tried very hard to be 
transparent and clear to those readers of the report and anyone 
interested in doing such analysis. We view it as important step 
in CBO's efforts to bring macroeconomic impacts into the 
analysis that everyone understand exactly how it was done, and 
we look forward to working with the committee in answering any 
further questions that might arise about our analysis.
    Finally, I would close with the observation with which I 
opened. Having done the analysis in as careful and 
comprehensive a fashion as we can, our read of the bottom line 
is that the conventional estimate of the budgetary outlook is a 
good, reliable indicator of the budgetary outlook even after 
accommodation of the macroeconomic impacts.
    I thank you for your patience in what is an unusually long 
presentation. I would be happy to answer your questions.
    [The prepared statement of Mr. Holtz-Eakin follows:]

 Prepared Statement of Douglas J. Holtz-Eakin, Director, Congressional 
                             Budget Offfice

An Analysis of the President's Budgetary Proposals for Fiscal Year 2004

    At the request of the Senate Committee on Appropriations, the 
Congressional Budget Office (CBO), with contributions from the Joint 
Committee on Taxation (JCT), has prepared this analysis of the 
President's budgetary proposals for fiscal year 2004. CBO estimates 
that under the President's proposals, the deficit in 2003 and 2004 
would rise to $287 billion and $338 billion, respectively (see Tables 1 
and 2 on pages 33 and 34). For 2003, revenues would remain nearly 
unchanged from 2002, while outlays would increase by 6.6 percent under 
the President's plan. The following year, revenues would grow by 2.7 
percent, while outlays would climb by 4.8 percent. As a share of the 
economy, revenues would dip below 17 percent in 2004 and outlays would 
reach nearly 20 percent, thereby producing a total budget deficit equal 
to 3 percent of gross domestic product (GDP).
    Under the President's plan, over the 2004-13 period, revenues would 
grow at an average annual rate of 6.1 percent, while the growth in 
outlays would slow to an average annual rate of 4.9 percent. Over those 
10 years, under the President's policies deficits would persist but 
slowly decline, totaling roughly $1.8 trillion. However, annual 
deficits would be small as a percentage of the economy less than 2 
percent in most years.
    In a departure from the practice of recent years, the 
administration has submitted year-by-year estimates of its budgetary 
proposals for a 5-year period instead of a 10-year period. Since the 
mid-1990s, lawmakers generally have used the 10-year period as the 
basis for making baseline budget projections and for measuring the 
costs of legislative proposals. But citing the uncertainty of making 
budget projections and estimates, especially in later years, the 
administration has not provided annual estimates for fiscal years after 
2008. CBO has documented the uncertainty involved in budget projections 
and estimates, but in preparing this report, it has continued recent 
practice and has provided year-by-year estimates of the President's 
proposals for the 2009-13 period.
    Overall, CBO's estimates of the President's budgetary proposals are 
similar to those of the administration. For the 2004-08 period, CBO 
estimates a cumulative deficit of $1.2 trillion under the President's 
policies; the administration estimates $1.1 trillion.
    Constructed according to rules specified in law and intended to 
serve as a neutral benchmark, baseline projections estimate what the 
future path of spending and revenues would be if current laws and 
economic assumptions remained unchanged. In conjunction with its annual 
analysis of the President's budget, CBO has updated its 110-year 
baseline projections that it published in January. CBO's revised 
baseline reflects the projected effects of increased spending resulting 
from the omnibus appropriation act for 2003 (Public Law 108-7), which 
was enacted in February; technical revisions that reduce estimates of 
Federal revenues in the near term; other information that has become 
available since January; and associated increases in debt-service 
costs. The economic assumptions that underlie this baseline are 
unchanged from those for the previous projections.
    CBO's revised baseline, which follows a pattern that is similar to 
its January projections, shows a deficit of $200 billion for 2004. 
Baseline deficits drop steadily thereafter and yield to small but 
growing surpluses after 2007. Under current laws and policies, over the 
2004-08 period, deficits would total about $360 billion averaging 0.6 
percent of GDP over that period. Steadily mounting surpluses in later 
years would produce a cumulative surplus of almost $900 billion for the 
10-year period from 2004-13. That projected surplus relies heavily on 
the assumed expiration at the end of 2010 of the tax cuts enacted in 
the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA); 
that assumption, which is required by law, contributes about $600 
billion to the projection of the cumulative surplus.
    CBO estimates that the President's budget would increase deficits 
(or eliminate surpluses) relative to CBO's baseline in all years of the 
10-year period. Those differences (including associated debt-service 
costs) sum to about $800 billion for the first 5 years and about $2.7 
trillion for all 10 years. Nevertheless, CBO estimates that under the 
President's budget, deficits would decline in most years. As a 
percentage of GDP, the deficit under the President's policies is 
projected to fall to 0.6 percent in 2013. Under such a scenario, debt 
held by the public would remain roughly near its current share of the 
economy throughout the period (though nearly twice the level in CBO's 
baseline by the end of 2013).
    Excluding debt service, about two-thirds of the increase in 
deficits under the President's budget (relative to the baseline) would 
be caused by reductions in revenues. The President proposes tax 
policies that would lower receipts by about $1.5 trillion between 2004-
13. About 40 percent of that drop in revenues would occur from 2011-13 
as a result of the President's proposal to permanently extend 
provisions of EGTRRA that expire at the end of 2010. Another 15 percent 
of the total decrease in revenues would occur in 2004 and 2005, largely 
from proposals to enact new tax cuts and to accelerate certain tax cuts 
that are scheduled to go into effect in later years. Nonetheless, 
cumulative revenues under the President's budget would represent 18.3 
percent of total GDP for the 10-year projection period about the 
historical average for Federal revenues since World War II.
    CBO estimates that on the spending side, the President's budget 
would increase outlays by $725 billion (excluding debt service) for the 
2004-13 period relative to CBO's baseline. More than 85 percent of that 
total would come from the President's proposals to change various 
mandatory spending programs, the largest of which is his proposal to 
reform Medicare estimated by the administration to increase outlays by 
about $400 billion over the 10-year period. (CBO cannot estimate the 
cost of that proposal because the details are not yet available.) The 
President's proposals for programs funded by discretionary 
appropriations, as extrapolated by CBO beyond 2008, would increase 
outlays by $104 billion over the next 10 years relative to CBO's 
baseline. Defense outlays would rise by $211 billion and nondefense 
outlays would drop by $108 billion under the President's budget. Total 
spending under the President's budget would average 19.6 percent of GDP 
for the 2004-13 period, CBO estimates about the same share as in 2002.
    In this report, CBO has estimated the President's budgetary 
proposals using traditional conventions and practices that do not 
include the proposals' possible macroeconomic effects. However, the 
administration's proposals could affect the economy, which in turn 
would influence their budgetary impacts. To help better inform the 
Congress about those economic effects, CBO also prepared a 
macroeconomic analysis of the administration's proposals. Presented in 
the last section of this report, that analysis uses various models and 
assumptions to indicate the range of potential economic and budgetary 
impacts of the President's proposals.
    CBO's baseline projections and its reestimate of the President's 
budgetary proposals are subject to uncertainty. Neither of those 
estimates include the costs of the military conflict with Iraq and its 
aftermath, which could add tens of billions of dollars in spending this 
year and could have large effects on the budget in future years (see 
Box 1). Nor do those estimates include other possible demands on the 
budget, such as additional spending that may be necessary to respond to 
terrorist attacks or other contingencies. Furthermore, changes in 
economic growth from projected levels or changes in other economic 
factors also would affect the budget, especially Federal revenues.

                       Changes to CBO's Baseline

    Both CBO and the administration construct baseline budget 
projections according to rules set forth in law, primarily the Balanced 
Budget and Emergency Deficit Control Act of 1985 and the Congressional 
Budget and Impoundment Control Act of 1974. In general, those laws 
instruct CBO and the Office of Management and Budget to project Federal 
spending and revenues under current laws and policies. As a result, 
baselines are not intended to be predictions of future outcomes; 
rather, they serve as neutral benchmarks that lawmakers can use to 
gauge the effects of spending or revenue proposals, such as those in 
the President's budget.
    Compared with its January projection, CBO's updated estimate of the 
deficit for 2003 under current law has grown by $47 billion (see Table 
3). Almost two-thirds of that change stems from lower projected 
revenues, reflecting weakness in collections to date. For the 2004-13 
period, CBO has reduced its projection of the cumulative surplus by 
$446 billion, nearly three-quarters of which derives from enactment of 
the omnibus appropriation act in February.
                   overview of cbo's baseline outlook
    CBO estimates that in the absence of additional spending or tax 
legislation, the deficit will grow from $158 billion in 2002 to $246 
billion in 2003 (see Table 4). Although that amount would be one of the 
largest deficits recorded in dollar terms, at 2.3 percent of GDP, it 
would be well below the share of the economy that deficits accounted 
for in the 1980s through the mid-1990s. As a share of GDP, deficits 
peaked at 6 percent in 1983. If current laws and policies remained 
unchanged, CBO projects, deficits would decline after 2003 and switch 
to surpluses in 2008. Over the 2004-08 period, the cumulative deficit 
would total $362 billion more than double CBO's previous projection. 
For the full 10-year projection period, CBO estimates a cumulative 
surplus of $891 billion.
    The surpluses that are projected to emerge in 2008 mount steadily 
and accelerate after 2010, when the EGTRRA tax cuts are scheduled to 
expire. Because of that assumed expiration and because projections are 
most uncertain in the later years of the projection period, the 10-year 
figure should be interpreted cautiously: surpluses projected for the 
last 3 years of the period total $1.1 trillion, whereas the preceding 7 
years show a cumulative deficit.
    At the end of 2002, debt held by the public totaled $3.5 trillion, 
or 34 percent of GDP (see Table 5). Under CBO's baseline projections, 
such debt declines steadily after 2007, dropping to $3 trillion (17 
percent of GDP) by the end of 2013. However, just past the 10-year 
baseline period loom significant strains on the budget that will 
intensify as the baby boom generation ages and that may require 
significant increases in Federal borrowing.
                     the omnibus appropriation act
    In CBO's baseline, the Consolidated Appropriations Resolution for 
2003 (also known as the omnibus appropriation act) is projected to 
increase the deficit by $14 billion in 2003 and to reduce the 
cumulative surplus by $330 billion over the 2004-13 period. Spending 
projected as a result of that legislation is estimated to add $82 
billion in debt-service costs over the 10 years.
    When CBO prepared its January projections, only two of the 13 
regular appropriation acts those for defense and military construction 
had been enacted for 2003. Programs and activities funded in the other 
11 acts were operating under a temporary continuing resolution. 
However, the President and the Republican leadership had apparently 
agreed that regular appropriations for 2003 should total about $751 
billion in budget authority, so CBO adjusted its baseline to that 
level. The omnibus appropriation act, which was enacted on February 20, 
2003 (for the fiscal year that began on October 1, 2002), consolidated 
the 11 outstanding appropriation bills into one and boosted total 
discretionary budget authority for 2003 to $766 billion.
    The $15 billion increase in budget authority relative to CBO's 
January projections will add $9 billion to discretionary outlays in 
2003, CBO estimates. About two-thirds of that increase is for defense 
programs. As specified in the Deficit Control Act, CBO extrapolated the 
2003 level of appropriations through 2013, which results in a 
cumulative increase in defense outlays of $121 billion and an increase 
in nondefense outlays of $78 billion over the projection period.
    In addition to providing funding for discretionary programs, the 
omnibus legislation also boosted mandatory spending. Increased 
agricultural assistance will add $3 billion to outlays in 2003. Higher 
payments to physicians for services that they provide to Medicare 
beneficiaries will add almost $1 billion in outlays this year. The 
rates paid to those physicians were scheduled to drop by 4.4 percent on 
March 1, 2003, but based on a provision in the omnibus appropriation 
act, the administration replaced the decrease with an increase of 1.6 
percent. For 2004-13, CBO estimates that the change in rates for 
payments to physicians will boost Medicare spending by $53 billion.
                   technical changes to the baseline
    Other changes in CBO's estimates have increased the projected 
deficit for 2003 by $33 billion and reduced the cumulative surplus over 
the 2004-13 period by $116 billion. Most of those technical revisions 
to the baseline occur over the next 3 years and are concentrated on the 
revenue side of the budget.
    The near term outlook for revenues has dimmed a bit since CBO 
published its January projections. In light of recent data on withheld 
taxes, CBO has lowered its estimates of revenues by $30 billion in 2003 
and by more than $60 billion over the 2004-08 period. The largest 
changes, in 2003 and 2004, amount to about 1.5 percent of total 
projected revenues in those years.
    On the basis of new information from the President's budget, from 
year-to-date data on spending and receipts, and from other sources, CBO 
has also made technical reestimates of outlays. Because of faster-than-
expected defense spending on operations and maintenance which funds 
such activities as maintaining a presence in Afghanistan, fighting the 
global war on terrorism, and conducting military operations in Iraq CBO 
now anticipates discretionary outlays to be $4 billion higher in 2003. 
CBO has also increased its estimate of Medicare outlays by $3 billion, 
mostly because of higher-than-anticipated spending recorded since 
September.
    Offsetting some of the additional spending for this year is a net 
reduction in the estimated subsidy cost for credit programs. The budget 
includes dozens of programs that either guarantee loans made by private 
financial institutions or provide direct loans to individuals or 
businesses. Accurately projecting loan repayments, defaults, and 
changes in interest rates over the life of credit programs is 
difficult, and errors are inevitable. In every year since 1994, Federal 
agencies have reestimated the cost of the credit subsidy for loans and 
guarantees that were made in previous years. Although the net budgetary 
impact of those changes is to reduce outlays by more than $1 billion 
for 2003, some agencies have reported sizable reestimates to the Office 
of Management and Budget. For example, the Export-Import Bank plans a 
negative adjustment of more than $3 billion, while the Department of 
Education's revision will boost outlays by almost $2 billion.
    The largest technical change that CBO made in its estimates of 
outlays over the 2004-13 period (other than a change in debt-service 
costs) was a $32 billion increase for Medicaid. CBO raised its 
projection because of such factors as higher spending on managed care, 
the enrollment of more children because of states' outreach efforts and 
the creation of the State Children's Health Insurance Program (SCHIP), 
and the approval of additional waivers that allow Medicaid programs to 
provide prescription drug benefits to low-income Medicare 
beneficiaries. In CBO's baseline, those increases are partly offset by 
lower spending to reflect efforts by states to address their difficult 
budgetary conditions by further restricting eligibility for Medicaid.
    In addition, CBO upped its estimate of outlays for discretionary 
programs by $11 billion over the 10-year period, largely on the basis 
of information reported in the President's budget. That amount includes 
a mix of small increases and decreases in spending that raise net 
outlays by about $1 billion per year.
    Partially offsetting those increases are revised estimates for 
Medicare, which reduce projected outlays by $10 billion over the 2004-
13 period. On the basis of updated information, CBO reduced its 
projected rate of increase in per capita spending for hospice services 
and for services furnished by therapists, health centers, and hospital-
based laboratories.
    Under CBO's baseline, as a result of the technical revisions that 
decrease projections of revenues and increase estimates of outlays, the 
Treasury will need to borrow more than it otherwise would have over the 
2004-13 period. By CBO's estimate, such additional borrowing would 
raise net interest payments by $39 billion over the decade.

    Differences from the Administration's Current Services Baseline

    Both CBO and the administration estimate that if current laws and 
policies remained in place, the budget would show a deficit for several 
years. The administration projects a deficit of $158 billion in 2004, 
turning into a small surplus in 2006; CBO projects the emergence of a 
surplus in 2008. For the 5-year period from 2004-08, CBO's projection 
of the cumulative deficit exceeds that of the administration by $248 
billion (see Table 6).
                 differences in projections of revenues
    In projecting revenues, CBO's baseline over the period from 2004-08 
is very similar to the administration's higher by about 0.5 percent. 
That relatively small difference obscures some larger deviations in 
specific years. CBO's revenue baseline is higher than the 
administration's by $24 billion in 2003 then falls below the 
administration's by $30 billion by 2005. Thereafter, CBO's baseline 
projection gradually moves higher than the administration's, with the 
difference reaching $55 billion in 2008.
    Differing economic projections explain most of the differences in 
the estimates of revenues. For 2003 and 2004, CBO forecasts a lower 
level of taxable income than the administration does. Thereafter, CBO 
projects a higher level of income resulting from higher estimates of 
corporate profits and nonwage personal income thereby leading to the 
higher projection of revenues over the entire 2004-08 period.
    Offsetting some of that difference attributable to differing 
economic projections are technical estimating differences between CBO 
and the administration that is, differences in the estimated amount of 
revenue generated by a given macroeconomic projection. For 2003, CBO 
projects a total of $34 billion in higher receipts from such technical 
factors. Much of that difference stems from the administration's 
decision to reduce its estimate of revenues by $25 billion (without 
allocating it to any specific revenue source) to reflect uncertainty. 
For 2005, CBO projects $32 billion less in revenues than the 
administration does because of technical estimating differences about 
such factors as the effects of the expiration of the tax cuts for 
businesses enacted last year in the Job Creation and Worker Assistance 
Act of 2002 and assumptions about the permanence of the recent weakness 
in individual income tax receipts. For 2006-08, the technical 
differences are much smaller.
                 differences in projections of outlays
    On the spending side of the budget, CBO's baseline for outlays is 
$6 billion higher for 2003 than the administration's. CBO's March 
baseline includes the additional funding provided in the omnibus 
appropriation legislation, which was enacted after the administration 
completed its projections. In addition, CBO anticipates higher defense 
outlays than does the administration. For mandatory spending, however, 
CBO's baseline is lower than the administration's by $8 billion 
primarily because of different estimates of outlays for Medicaid, 
refundable tax credits, and student loans. Because CBO projects lower 
enrollment in Medicaid, its estimates of spending for that program 
continue to be below the administration's throughout the projection 
period.
    Overall, for the 2004-08 period, CBO's estimate of total outlays 
exceeds the administration's by $309 billion; discretionary spending 
accounts for about 70 percent of that difference. CBO's projections of 
discretionary spending are higher than the administration's largely 
because CBO included the spending from the omnibus appropriation 
legislation, used a higher rate of inflation to project budget 
authority for spending not related to Federal pay, and assumed a faster 
rate of spending for defense appropriations.
    The remaining 30 percent of the difference in projected outlays 
over the 5-year period stems mostly from divergent estimates for Social 
Security, Medicare, and net interest. Because CBO projects a higher 
consumer price index (CPI), automatic increases in benefits to Social 
Security recipients are higher in CBO's baseline than in the 
administration's. CBO also estimates that real (inflation-adjusted) 
benefits will grow more quickly and that retroactive disability income 
payments will be greater over the period. CBO's estimates for Medicare 
include the effect of the administration's decision to boost the rates 
paid to participating physicians, while the administration's estimates, 
which were prepared before that decision, do not. In addition, CBO 
anticipates higher Medicare spending in 2003 and more rapid growth in 
that spending over the 2004-08 period. Although CBO's estimates of net 
interest are lower than the administration's in the near term (because 
of lower projections of interest rates and a different assumption about 
the mix of securities issued by the Treasury), they surpass the 
administration's starting in 2005 (as CBO's projections of interest 
rates are then above those of the administration).

                   The President's Budgetary Policies

    Overall, CBO's and the administration's estimates of the 
President's budget are similar (see Table 7). Both anticipate that 
deficits will peak in 2004: CBO projects a deficit of $338 billion that 
year and the administration, one of $307 billion. For the 2004-08 
period, CBO projects a cumulative deficit of $1.2 trillion; the 
administration estimates a deficit of $1.1 trillion. Beyond 2008, under 
the President's proposals, the deficit would decline in most years, 
reaching a low of $102 billion in 2013, CBO estimates. The 
administration did not provide such estimates beyond 2008.
                  policy proposals affecting revenues
    The President's budget proposes several changes to tax law that 
would significantly reduce revenues over the next decade. His proposals 
include an economic growth package, the extension of a number of 
expiring tax provisions, a variety of new tax incentives, a few 
simplifications of the tax code, and miscellaneous changes in the 
administration of taxes and other items. Many of the proposals to spur 
growth and extensions of expiring provisions relate to features of the 
Economic Growth and Tax Relief Reconciliation Act of 2001.
    CBO and the Joint Committee on Taxation estimate that the proposals 
would reduce revenues by $35 billion and increase outlays by $4 billion 
through their effects on refundable credits in 2003 (see Table 8). For 
the 2004-13 period, CBO and the JCT anticipate that the proposals would 
reduce revenues by $1.5 trillion and increase outlays by $96 billion. 
As a share of projected gross domestic product, the revenue reductions 
would average 1.0 percent over the 10-year period, with the largest 
reductions occurring in the final 3 years. A few of the proposed 
changes would increase revenues, contributing $3 billion over 10 years.
    Proposals accelerating and making permanent the changes in EGTRRA 
account for about 55 percent of the revenue reductions in the package. 
A proposal to eliminate the double taxation of dividends constitutes an 
additional 27 percent. The most significant proposals are these:
    Extend EGTRRA's Expiring Provisions. Currently, all provisions of 
EGTRRA still in effect on December 31, 2010, are set to expire the 
following day. The President's proposal would permanently extend all of 
those provisions, which include reductions in the marginal income tax 
rate, the child tax credit, relief from the so-called marriage penalty, 
education incentives, the repeal of the estate tax and associated 
modifications of gift and other taxes, retirement income provisions, 
and other incentives. The total reduction in revenues during the 10-
year period would be $602 billion, and the increase in outlays would be 
$22 billion. In all cases save one, the reductions in revenues would 
occur after 2010. In the case of estate taxes, some revenue effects 
would occur shortly following the provision's passage, as taxpayers 
altered their estate planning in expectation of the permanent repeal of 
the taxes.
    Exclude Dividends from Double Taxation. Currently, income from 
corporate activity is subject to being taxed twice, once under the 
corporate income tax and then again when taxpayers receive dividends or 
realize capital gains on their corporate stock. Under the President's 
proposal, taxpayers would be able to exclude from their individual 
income tax liability dividends on which corporate taxes had already 
been paid. Additionally, shareholders would receive an increase in 
their cost basis for tax purposes for amounts of corporate earnings not 
distributed as dividends but on which corporate taxes had been paid 
(thereby reducing capital gains liability upon realization). The 
proposal, which would become effective for corporate distributions 
beginning January 1, 2003, is estimated to reduce revenues by nearly $8 
billion in 2003 and by $388 billion over the 2004-13 period.
    Accelerate Individual Income Tax Cuts Scheduled Under EGTRRA. 
Currently under EGTRRA, an expansion of the 10 percent tax bracket is 
scheduled to take place in 2008, a reduction in tax rates is scheduled 
for 2006, an expansion of the 15 percent bracket and an increase in the 
standard deduction for joint filers (the provisions addressing the 
marriage penalty) are set to phase in from 2005-09, and an increase in 
the child tax credit is slated for 2010. The President proposes to make 
all of those features effective for tax year 2003 (and includes an 
advance payment, or ``rebate,'' of the higher child tax credit). The 
JCT estimates that those provisions would reduce revenues by $25 
billion in 2003 and $211 billion over the 2004-13 period. They would 
also increase outlays for refundable credits by $23 billion over the 
next decade. (For a more detailed discussion of this proposal's effect 
on outlays, see page 13.)
    Permanently Extend the Research and Experimentation Tax Credit. 
Corporations can take a tax credit of 20 percent on certain research 
expenditures above a base amount. The credit is currently scheduled to 
expire on June 30, 2004, but the President proposes to make it 
permanent. The cost of doing so is estimated to be $56 billion between 
2004-13.
    Increase the Amount of the Alternative Minimum Tax Exemption. The 
alternative minimum tax (AMT) is a parallel income tax system with 
fewer exemptions, deductions, and rates than the regular income tax; 
taxpayers pay the greater of the regular tax or the AMT. Without 
changes in the AMT, many taxpayers would not receive the full benefits 
of the EGTRRA tax cut. Hence, EGTRRA provided for an increase in the 
AMT exemption but only through tax year 2004. The President proposes to 
increase the exemption under the AMT in 2003 and 2004 and to extend it 
through 2005. After that, the AMT would revert to its pre-EGTRRA form. 
The resulting loss of revenue is estimated to be $1 billion in 2003, 
$36 billion between 2004-06, and nothing thereafter.
    Increase Expensing Provisions for Small Businesses. Businesses are 
currently permitted to expense (take the whole cost as a deduction in 
the first year instead of depreciating it over several years) up to 
$25,000 of investment in certain equipment. The benefit is phased out 
at investment levels exceeding $200,000. As part of his economic growth 
package, the President proposes to raise the amount permitted to 
$75,000, allow expensing for certain computer software (for which it is 
currently disallowed), and raise the investment level at which the 
benefit begins to phase out to $325,000. The proposal would be 
effective retroactively to the beginning of calendar year 2003. The 
cost is estimated to be about $1 billion in 2003 and $27 billion from 
2004-13.
    Allow an Above-the-Line Deduction for Long-Term Care Insurance. The 
costs of long-term health insurance are currently treated largely as 
other medical expenses are. Taxpayers can take a deduction from taxable 
income if they itemize deductions and have total medical expenditures 
exceeding 7.5 percent of their adjusted gross income (AGI). The 
proposal would permit a deduction of premiums for long-term health care 
insurance (up to current annual limits) regardless of whether taxpayers 
itemized and without any percentage floor. The provision would be 
phased in through 2007. The cost from 2004-13 would be $18 billion.
    Allow Nonitemizers to Deduct Charitable Contributions. Taxpayers 
who itemize can currently reduce their taxable income by the amount of 
their charitable contributions. The President proposes to allow a 
deduction for nonitemizers (those who take the standard deduction) of 
up to $250 for individuals and $500 for joint filers for charitable 
contributions exceeding those amounts. The provision would become 
effective at the beginning of tax year 2003 and be indexed thereafter. 
The cost would be less than $1 billion in the first year and $15 
billion over the 2004-13 period.
    Provide a Tax Credit for Developers of Affordable Single Family 
Housing. The President proposes to create a new tax credit analogous to 
the existing low-income housing tax credit (LIHTC) for single family 
homes. The LIHTC applies to low-income rental units; the single family 
housing tax credit would apply to new or rehabilitated homes intended 
for eligible lower income families. Like the LIHTC, the credit would be 
allocated to states and localities to be awarded to projects. Recapture 
rules would be implemented in the event that homes were resold to 
ineligible purchasers. Credit allocations would begin in calendar year 
2004. The 2004-13 cost would be nearly $15 billion.
    Provide a Refundable Tax Credit for Health Insurance. The President 
proposes to create a refundable income tax credit for the cost of 
health insurance. The credit would be worth up to $1,000 per adult and 
$500 per child (for up to two children). It could cover a maximum of 90 
percent of the cost of insurance for individual taxpayers with a 
modified adjusted gross income of $15,000 and lesser amounts for 
individuals with higher income, phasing out completely at a modified 
AGI of $30,000. It would become effective at the beginning of calendar 
year 2004. In total, the proposal would reduce revenues over the 2004-
13 period by $13 billion and increase outlays by $51 billion.
    Expand Tax-Free Savings Plans. A variety of individual retirement 
accounts (IRAs) currently exist that can be used not only for 
retirement but for other purposes (such as education). The President 
proposes to unify many of those accounts into two tax-free savings 
vehicles retirement savings accounts (RSAs) and lifetime savings 
accounts (LSAs) and to expand their applicability.
    For RSAs, individuals could contribute up to $7,500 annually, and 
no income limits would apply. Contributions would be taxable, but all 
earnings on the accounts would accumulate tax free. Withdrawals without 
penalty could occur after age 58 or because of death or disability. 
Accounts currently held in Roth IRAs would become RSAs. Additionally, 
traditional IRAs and nondeductible IRAs could be converted into RSAs in 
the same way as they currently can be converted to Roth IRAs.
    Individuals could also contribute up to $7,500 annually to lifetime 
savings accounts with the same tax treatment as RSAs and, again, 
without limits based on income. However, withdrawals from LSAs could be 
taken for any purpose and at any age. Balances currently held in Archer 
medical savings accounts, Coverdell education savings accounts, and 
qualified state tuition plans could be converted into balances in LSAs.
    Over the 2004-13 period, the net revenue loss due to the expansion 
of tax-free savings plans would be nearly $7 billion. However, there 
would be a net revenue gain of almost $2 billion in 2003 and $10 
billion from 2004-08. Revenue gains would occur from 2003-07 because 
many of the current vehicles receiving favorable tax treatment collect 
contributions on a pretax basis. Contributions to the new vehicles, 
however, would be made on an after-tax basis. As a result, the proposal 
would increase Federal revenues at the time the contributions were made 
(but reduce revenues when withdrawals went untaxed later on).
    Extend Nonrefundable Personal Tax Credits Against the AMT. Except 
under a temporary provision, individuals cannot take certain personal 
credits, such as the dependent care credit and HOPE Scholarship and 
lifetime learning credits, against their liability under the 
alternative minimum tax. The temporary provision, which permitted 
taxpayers to take the full amount of these credits against the AMT, was 
scheduled to expire in 2001. That provision has been extended through 
tax year 2003. The President proposes extending the exemption another 2 
years through tax year 2005. The 2004-06 revenue loss would be $1 
billion, and there would be no losses beyond 2006.
    Other Proposals. The President also proposes a large number of 
additional tax changes, including a variety of additional incentives 
for charitable giving and health care; incentives related to education, 
energy, and the environment; additional simplification of the tax code; 
changes in tax administration; the extension of additional expiring 
provisions; and reform of unemployment compensation. Altogether, those 
provisions would reduce revenues by $66 billion over the 2004-13 
period.
           policy proposals affecting discretionary spending
    The President's budget would boost discretionary budget authority 
for fiscal year 2004 to $787 billion, CBO estimates, a 2.7-percent 
increase over the $766 billion enacted for 2003 (see Table 9). That 
increase would be smaller than the 4.2 percent jump in discretionary 
budget authority between 2002 and the current level for 2003. (The 
increase for 2003 may ultimately exceed 4.2 percent if the Congress 
provides additional funding for the war with Iraq and other needs.)
    The President submitted his budget before the omnibus appropriation 
act was enacted. In the budget, the administration assumed that 
appropriations for 2003 would total $749 billion, nearly $17 billion 
less than the level contained in the act. Starting from that base of 
$749 billion, the request for 2004 sought an increase of 4.4 percent in 
discretionary budget authority. From 2004-08, the President would 
increase discretionary budget authority at an average annual rate of 
4.7 percent for defense activities and 2.3 percent a year for 
nondefense programs. In CBO's baseline over that same period, which 
assumes that discretionary spending grows at specified rates of 
inflation, budget authority for both defense and nondefense programs 
rises at an average annual rate of 2.6 percent.
    If no further legislation is enacted that affects spending in 2003, 
CBO anticipates that discretionary outlays will total $805 billion this 
year. Under the President's budget, discretionary outlays would rise to 
$836 billion next year and to $922 billion by 2008 (see Table 10).
    National Defense. The President's budget for 2004 would continue 
the upward trend in defense spending that began in the mid-1990s but at 
a slower pace than in recent years. The proposed budget would add $8 
billion in discretionary budget authority for defense programs an 
increase of 2 percent over the amount currently appropriated for 2003. 
By comparison, increases in budget authority averaged about $30 billion 
a year over the past 3 years. CBO estimates that the $8-billion 
increase along with spending from budget authority previously provided 
would boost defense outlays for 2004 by $14 billion over CBO's 
estimated level for 2003.
    The 2004 request would increase funding for pay raises and other 
benefits for service members (by almost $4 billion), the development of 
new weapon systems (by $4 billion), and defense programs within the 
Department of Energy and various other agencies (by $2 billion). The 
administration also proposes to reduce funding from the levels 
appropriated for 2003 for operations and maintenance and revolving 
funds (by almost $1 billion) and for military construction and family 
housing (by $1 billion). The 2004 request for the military personnel 
and operations and maintenance accounts does not include explicit 
funding for continuing the U.S. military presence in Afghanistan and 
prosecuting the war on terrorism and does not account for military 
operations in Iraq. (Nor does the funding appropriated for 2003 for 
defense explicitly include much of the money needed to conduct those 
operations in this fiscal year.) According to public statements by 
officials of the Department of Defense, the administration will instead 
rely on supplemental appropriations to provide funding for those 
missions. After accounting for those activities, the increases in 
funding for defense for 2003 and 2004 may substantially exceed the 
levels witnessed in recent years.
    For 2005-08, the President's budget envisions an average annual 
rate of growth of 4.7 percent in budget authority for national defense, 
although that growth does not include funding for continued 
antiterrorism activities or for dealing with the aftermath of the war 
with Iraq.
    Nondefense Programs. The President is proposing for 2004 a 3.5 
percent increase in appropriations for nondefense discretionary 
activities above the level enacted for 2003, CBO estimates, including 
funds for the new Department of Homeland Security (see Box 2). With 
those funds excluded, the growth rate for nondefense budget authority 
for 2004 would drop to 2.2 percent.
    Among the budget functions that would receive the largest increases 
are community and regional development, which would receive a boost in 
funding of over 21 percent to increase grants to first responders which 
include firefighters and state and local law enforcement personnel and 
to cover payments for disaster relief (activities that both now fall 
within the jurisdiction of the new Department of Homeland Security). In 
addition, international affairs would receive an increase of almost 13 
percent in 2004. The President proposes to use that money to create the 
Millennium Challenge Account (which is designed to provide assistance 
to countries thatfollow sound economic and social policies), increase 
military and economic assistance to certain states in the Middle East 
and South Asia, and pay for reconstruction programs in Afghanistan. 
Education, training, employment and social services would receive more 
than a 6 percent increase, with much of that going for increases in 
elementary, secondary, and postsecondary educational activities.
    By contrast, the President seeks to reduce funding for some budget 
functions below what has been enacted for 2003. Included in that group 
is the administration of justice, which would receive a cut of 5.8 
percent, accomplished in part by reducing funding for the Department of 
Justice's grants to states (by $1.8 billion) and reducing election 
reform grants to states (by $1.5 billion). Natural resources and the 
environment would receive 4.4 percent less than in 2003 and agriculture 
would receive 7.6 percent less.
             policy proposals affecting mandatory spending
    The President's proposals would add $621 billion to mandatory 
spending over the 2004-13 period, CBO estimates. Proposals involving 
Medicare and Medicaid would account for 75 percent of that increase 
(see Table 8).
    Medicare. The President's budget proposes an allowance of $400 
billion for an initiative to modernize Medicare that would restructure 
aspects of the program and provide coverage for outpatient prescription 
drugs. The administration estimates that the initiative would cost a 
total of $400 billion through 2013; however, the budget does not 
provide sufficient details for CBO to make its own estimate.
    Medicaid and the State Children's Health Insurance Program. The 
President's budget contains a proposal that would allow states to 
voluntarily convert their Federal funding for Medicaid and the State 
Children's Health Insurance Program into block grants. The grants, 
called State Health Care Partnership Allotments, would be based on 
spending levels in 2002 and would grow each year thereafter. States 
that participated would enjoy much broader flexibility in providing 
health benefits than current law allows, particularly for beneficiaries 
who currently are covered at the states' discretion. (States that did 
not participate would be unaffected by the proposal.) The 
administration anticipates that states accounting for half of total 
Medicaid and SCHIP spending would choose the block grant option.
    Again, the President's budget did not provide enough details for 
CBO to provide an independent estimate of Federal outlays for that 
proposal. Key features of the proposal that have not been specified 
include the exact method that would be used to calculate the base 
amount for the block grants, the rates at which they would grow in 
later years, and the degree of additional flexibility that would be 
given to participating states. Therefore, in preparing this report, CBO 
incorporated the administration's estimate of Medicaid and SCHIP 
spending for states assumed to choose the block grants. Because the 
budget does not display projections of Medicaid or SCHIP spending for 
the 2009-13 period, CBO projected spending for those years by taking 
the administration's projections for 2008 and inflating them using the 
annual growth rates for Medicaid and SCHIP incorporated into CBO's 
baseline.
    CBO used the administration's estimate of total spending for 
Medicaid and SCHIP in evaluating the proposal; however, underlying 
differences in baseline spending projections between CBO and the 
administration lead to very different estimates of the proposal. CBO 
estimates that, relative to what spending would be if current laws and 
policies remained unchanged, the proposal would increase the Federal 
Government's outlays for Medicaid and SCHIP by $38 billion over the 
2004-08 period and by $73 billion over the 2004-13 period. By contrast, 
the administration estimates that the proposal would cost the Federal 
Government $9 billion over the 2004-08 period and save $0.1 billion 
over the 2004-13 period. CBO expects lower spending under current law 
than does the administration; thus, the shift to block grants at the 
amounts estimated in the budget by the administration (and used by CBO) 
would result in a larger increase in spending relative to CBO's 
baseline projections.
    In addition, several other much smaller proposals affecting 
Medicaid and SCHIP would increase outlays by about $1.5 billion from 
2004-08 and decrease total outlays by about $1 billion from 2004-13, 
CBO estimates.
    Refundable Tax Credits. The administration's tax proposals would 
add an estimated $96 billion to outlays over the 2004-13 period because 
a number of the proposals involve refundable tax credits (see the 
discussion of the proposals affecting revenues for further description 
of the proposed changes, pages 8 and 9). In particular, the President 
proposes to accelerate an expansion of the child tax credit and make it 
permanent, to extend the expansion of the earned income tax credit 
enacted in 2001, and to introduce two new refundable tax credits (one 
for health insurance and another for education). Accelerating the child 
tax credit and other tax relief so that they applied in 2003 would 
increase outlays by $4 billion in that year and $23 billion from 2004-
10, JCT estimates. Permanently extending EGTRRA would increase spending 
on those two credits by about $22 billion from 2011-13. The health 
insurance credit would add $23 billion to outlays over the 2005-08 
period and $51 billion through 2013.
    Postal Service. Under the President's budget, changes would be made 
to the way the U.S. Postal Service finances retirement benefits for 
many of its current and former employees. The Office of Personnel 
Management projects that under current law, the Postal Service will 
eventually overfund its pension obligations for its workers by as much 
as $71 billion. Under the proposal, the Postal Service's payments to 
the retirement fund would decline by about $3 billion to $5 billion a 
year.
    The budgetary impacts would flow from two aspects of the proposed 
change: the loss of receipts to the Civil Service Retirement System 
trust fund (which is on-budget) and the response of the Postal Service 
(whose net cash flow is classified as off-budget) to a sizable 
reduction in one of its major expenses. CBO estimates that the total 
budgetary effect of the proposal (that is, combining both on-budget and 
off-budget impacts) would be a cost of nearly $38 billion over the 
2004-13 period, as the result of lower postage rates and additional 
spending by the Postal Service for operations, capital investments, or 
both.
    Customs User Fees. Under current law, customs user fees expire on 
September 30, 2003. The President has proposed extending those fees, 
which CBO estimates would increase offsetting receipts by $18 billion 
over the 2004-13 period.
    Other Initiatives. The President has proposed that states, rather 
than the Federal Government, pay the administrative costs of running 
their unemployment compensation programs. Under that proposal, states 
would be expected to fund those activities on their own, probably 
through their employment taxes. (Receipts and outlays from state 
accounts for employment taxes are included in the Federal budget.) CBO 
estimates that the proposal would add about $17 billion to mandatory 
spending over the 2004-13 period. At the same time, discretionary 
appropriations for those activities would be reduced by similar 
amounts.
    The President has also requested $3.6 billion for 2003 to enable 
states to create personal reemployment accounts. Under that proposal, 
states could provide individuals who were likely to exhaust their 
regular unemployment benefits with bonuses of up to $3,000 to be used 
toward the costs of job training or overcoming other barriers to 
employment. If individuals were reemployed within a certain period of 
time without spending the entire benefit, they could keep the 
remainder. CBO estimates that the bulk of the requested funds would be 
spent in 2004.
    The President's budget proposes to open a portion of the coastal 
plain of the Arctic National Wildlife Refuge to oil and gas leasing and 
development. By CBO's estimate, leasing sales from such a program would 
generate receipts (net of payments to Alaska) totaling $2 billion over 
the 2006-08 period.
    The President's budget includes four legislative proposals that 
would affect offsetting receipts from licenses awarded by the Federal 
Communications Commission (FCC) for use of the electromagnetic 
spectrum. The proposals would impose new fees on licenses used for 
analog television broadcasts and on licenses awarded by methods other 
than auctions, allow certain agencies to spend some auction receipts 
without further appropriations, and extend the FCC's authority to 
conduct auctions beyond 2007. Overall, CBO estimates that implementing 
those proposals could increase net outlays by $5 billion over the next 
5 years (largely because some auctions would be delayed) but would 
reduce outlays by more than $2 billion over the 10 years from 2004-13.
      differences between cbo's and the administration's estimates
    The differences between the administration's estimates and the JCT 
and CBO's estimates of the proposals in the President's budget 
affecting revenues are relatively small through 2008 compared with the 
total costs of the proposals, although the differences increase in 
later years. According to the JCT and CBO's estimates, the proposals 
would reduce revenues by $13 billion more than the administration 
projects for the 2004-08 period (see Table 11). The JCT and CBO 
estimate greater reductions in revenues than the administration does 
for several provisions, most notably for the increase in expensing for 
small businesses ($7 billion less in revenues); the dividend exclusion 
($6 billion less); and the acceleration of the EGTRRA tax cuts ($5 
billion less). The JCT and CBO also estimate a smaller increase in 
revenues from the expansion of tax-free savings accounts ($4 billion 
less). In the other direction, the JCT and CBO expect smaller net 
reductions in revenues from the two provisions affecting the AMT ($17 
billion more) and the research and experimentation tax credit ($4 
billion more).
    For the 2004-13 period, the JCT and CBO estimate revenue losses 
that exceed the administration's estimate by $148 billion. The largest 
differences are from the proposals to extend the EGTRRA tax cuts ($103 
billion) and to provide a dividend exclusion ($28 billion).
    On the outlay side, a number of significant differences exist 
between CBO's and the administration's estimates of the President's 
proposals. The largest differences occur in estimates of discretionary 
spending; however, the variation almost entirely reflects underlying 
differences in baselines rather than different assumptions about the 
effects of the President's request. CBO's baseline for discretionary 
spending is higher than the administration's because CBO incorporated 
the effects of the omnibus appropriation act (which was enacted after 
the administration had released its budget) and because of other, 
technical factors. As a result, although the administration estimated 
that its policies would raise discretionary outlays by $218 billion 
between 2004-08 compared with its own baseline, when measured against 
CBO's baseline such spending is only $7 billion higher over those 5 
years.
    For mandatory outlays, CBO estimates that the President's proposals 
would increase spending by $239 billion over the 2004-08 period or by 
roughly $30 billion more than the administration estimated for the 
proposals. Most of that difference results from the proposal to allow 
states to convert their funding for Medicaid and SCHIP into block 
grants. CBO's estimate of the impact of that proposal is $29 billion 
higher than the administration's because CBO measured the cost against 
a lower baseline estimate of spending.
    Another significant estimating difference between CBO and the 
administration involves the President's proposal to reduce the Postal 
Service's payments to the Civil Service Retirement System. The 
administration assumes that the Postal Service would initially use all 
of the realized savings to pay off its debt (which has no net budgetary 
impact), while CBO assumes that most of the funds would be used for 
capital projects and other operating costs or to postpone postal rate 
increases. Over the 2003-08 period, the difference would amount to $8 
billion in outlays. For the proposal to create personal reemployment 
accounts, CBO's and the administration's estimates of total outlays for 
those accounts are the same ($3.6 billion) but CBO expects that the 
accounts would take longer to set up than does the administration; 
consequently, CBO anticipates that all of the outlays would occur in 
2004 and 2005, while the administration expects significant outlays in 
2003.
    Other major differences involve the effects of certain tax 
proposals on outlays. Because the JCT and CBO assume lower 
participation than the administration does for the refundable health 
tax credits, CBO expects the proposal to increase outlays by $37 
billion less over the 2004-13 period than the administration does. In 
addition, the JCT and CBO expect the refundable child tax credit to 
increase outlays by $4 billion less than the administration does. 
Finally, the administration anticipates that holding lease sales for 
the right to develop oil and gas resources in the Arctic National 
Wildlife Refuge would generate gross receipts from bonus bids totaling 
$2.6 billion over the next 5 years. In contrast, CBO estimates that 
receipts from such sales would total over $4 billion (half of which 
would go to the state of Alaska).

          CBO's and the Administration's Economic Assumptions

    Because the administration's economic forecast assumes larger tax 
bases for 2003 and 2004, it generates higher estimates of revenues for 
this year and the next; however, the opposite is true in subsequent 
years, when CBO's economic projections generate higher estimates of 
revenues. For the early years of the 10-year projection period, the 
administration's forecast of wages and salaries plus profits the income 
categories that have the largest effect on revenue projections is 
greater than CBO's, but that difference is reversed during 2005. That 
pattern is largely the result of the difference between the 
administration's and CBO's forecasts for the GDP price index. The 
administration's forecast has consistently faster growth of real GDP 
than CBO's. However, because the administration's forecast for growth 
of the GDP price index is more than 0.2 percentage points lower than 
CBO's, the administration's projection of nominal GDP begins to fall 
significantly below CBO's during 2004 (see Table 12).
    That pattern is reinforced by differences in the projected 
relationship of the major tax bases to GDP. The administration assumes 
that the total share of income going to wages and salaries plus profits 
is higher than CBO does through 2005 and slightly lower thereafter.
    However, there are two aspects of the administration's projections 
that partially offset the pattern in the latter years. The expectations 
for interest rates and unemployment are significantly lower than CBO's, 
particularly after 2004. The administration's projection of the 
unemployment rate averages 0.2 percentage points below CBO's from 2003-
08; its projection of 3-month Treasury bill rates averages 70 basis 
points below CBO's projection for 2005-08. Those differences reduce the 
projected cost of servicing the national debt and the costs associated 
with unemployment.

   The Potential Macroeconomic Effects of the President's Budgetary 
                               Proposals

    The overall macroeconomic effect of the proposals in the 
President's budget is not obvious. For example, some provisions in the 
proposals would lower marginal Federal tax rates on labor and capital 
income. By themselves, those provisions would tend to increase labor 
supply, investment in productive capital (such as factories and 
machines), and the economy's output. However, the proposals also would 
promote the consumption of goods and services by both the government 
and the private sector, which would tend to reduce investment. CBO's 
analysis suggests the proposals, on net, would probably increase labor 
supply but decrease investment and the stock of capital.
    Largely because of those two opposing effects, the net effect on 
economic output could be either positive or negative with the 
difference depending not only on how the private sector would respond 
to the proposals themselves, but also on how the proposals would 
influence what budgetary policies people might expect in the future. 
Importantly, regardless of its direction, the net effect on output 
through long-term changes to the supply side of the economy including 
fundamental ``inputs'' such as labor supply or the stock of capital 
would probably be small. Under most assumptions, the proposals' supply-
side effects would raise or lower the level of output by less than a 
percentage point, on average, from 2004-13.
    That modest effect on the economy is not surprising. Taken 
altogether, the proposals would provide a relatively small impetus in 
an economy the size of the United States'. Excluding any economic 
effects, CBO estimates that in 2004 the President's proposals would 
reduce revenues by $117 billion, or 1.0 percent of gross domestic 
product, and would raise spending (including interest costs) by $21 
billion, or 0.2 percent of GDP. From 2004-08, the proposals would 
reduce revenues by $454 billion, or 0 .7 percent of cumulative GDP, and 
increase spending by $348 billion, or 0.5 percent of GDP.
    The economic impacts should not, of course, be evaluated on a 
dollar basis alone. For example, as noted above, the proposals would 
alter marginal tax rates on capital and labor. Over the long term, the 
effects of budgetary policies depend on the degree to which they alter 
incentives to acquire skills, work, save, innovate, and undertake 
investments. Indeed, a subset of the President's proposals are intended 
to increase those incentives. Those proposals would not operate in 
isolation, however. The remainder of the revenue proposals and those 
that would increase spending embody few such incentives. They likely 
would tend to reduce growth in the long run by increasing government 
and private consumption, at the expense of saving and investment.
    Taking account of the budget's potential effects on the economy 
could change the estimated budgetary cost of the President's proposals. 
But as with the macroeconomic effects, the direction of the influence 
could be positive or negative and is unlikely to be dramatic (see 
Figure 1). CBO estimates that the supply-side economic effects of the 
budgetary proposals could add as much as 10 percent to their cumulative 
cost or subtract as much as 15 percent over the period from 2004-08, 
and add as much as 15 percent or subtract as much as 17 percent over 
the period from 2009-13. The estimated cumulative deficit from 2004-08 
varies from as much as $1,242 billion to as little as $1,042 billion 
when supply-side effects are included, compared with an estimated 
$1,164 billion under baseline assumptions; the estimated cumulative 
deficit from 2009-13 varies from as much as $942 billion to as little 
as $335 billion when supply-side effects are included, compared with an 
estimated $656 billion under baseline assumptions (see Figure 2).
    In addition to benefiting from supply-side growth from the 
accumulation of greater technologies, skills, labor supply, and capital 
over the long term, the U.S. economy may grow faster in the near term 
through ``demand-side,'' or cyclical, growth greater utilization of the 
existing labor force, factories, and economic capacity. From a demand-
side perspective, budgetary policies that raise consumption (and other 
purchases) may increase economic growth temporarily, especially if the 
economy is operating below its potential. Including such demand-side 
effects would make the overall macroeconomic impacts somewhat larger, 
raising economic output by as much as 1.4 percent on average from 2004-
08. However, the direction of the budgetary effect is ambiguous, 
largely because the rise in GDP is estimated to be accompanied by a 
rise in interest rates.
    While the demand-side effects would in some cases be somewhat 
larger than the supply-side effects over the next 5 years, such effects 
are temporary, and they should be viewed cautiously even when the 
economy is operating below its potential. First, the economy is likely 
to experience a cyclical recovery in the absence of budgetary policies 
that boost aggregate demand. Recoveries typically stem primarily from 
economic adjustments in the private sector. Moreover, the Federal 
Reserve may adjust monetary policy to aid recovery. Second, changes in 
spending and taxes can help boost the economy out of recession only if 
they are correctly timed they must be enacted at a point of subpar 
economic growth and in a fashion timely enough to lead (and not follow) 
the recovery. Past experience in the United States and elsewhere 
suggests deliberate attempts to employ budgetary policies to aid 
cyclical recoveries have had little systematic success.
    One key determinant of the net macroeconomic impact of a proposed 
policy change is how it would affect people's expectations of what 
taxes and other government policies they might face in the future (see 
Box 3). For example, to the extent people expect that proposals to 
lower taxes now will lead to higher taxes in the future, they are more 
likely to increase saving, and perhaps work more, today. But such 
effects on expectations are very hard to determine. Tax cuts could make 
people believe that taxes are more likely to rise in the future to 
finance the interest payments, or that spending is more likely to be 
cut. Alternatively, people might not worry much about future policy 
changes.
                 how fiscal policy affects the economy
    The aggregate production of goods and services changes over time in 
two distinct ways. First, the economy's underlying potential to 
generate output rises with increases in the quantity and quality of the 
labor force, the size of the stock of productive capital, and the level 
of technological know-how. Economists refer to those three determinants 
of potential output as ``supply-side'' variables because they determine 
the quantity of goods and services that the economy is capable of 
supplying. Supply-side changes have a lasting effect on the economy.




    Second, actual economic output cycles around its potential level, 
as unemployment rises and falls and the stock of capital is used more 
or less intensively. Those movements are referred to as demand-side, or 
cyclical, variations because they occur as the total demand for goods 
and services moves above and below the level of potential output. 
Unlike movements in the supply side of the economy, cyclical changes 
are temporary built-in corrective forces tend to move the economy back 
toward the potential level determined by the supply side.
    When the economy is below its potential level of output, policies 
that increase aggregate demand can increase output without running the 
risk of accelerating inflation. The President's budget would add to 
demand both by cutting taxes and increasing some transfer payments 
which would increase the disposable income people had available to 
spend and by increasing the government's own spending on goods and 
services.
    The demand-side effects of budgetary policies depend critically on 
the way the Federal Reserve responds to them in its monetary policies. 
That response in turn depends on the state of the business cycle. For 
example, during a recession, the Federal Reserve would be unlikely to 
increase interest rates to offset budgetary policies that increased 
aggregate demand, but if the economy was robust, the Federal Reserve 
might do so.
    But business cycles cannot be projected with any degree of 
reliability beyond a few years, and the same would be true of the 
Federal Reserve's actions. Consequently, CBO's analysis of the demand-
side effects of the President's budgetary proposals is restricted to 5 
years. In contrast, CBO evaluates supply-side effects over a 
conventional 10-year window.
    In the United States, both supply-side and demand-side economic 
developments depend on the choices of millions of individuals about 
things such as what and how much to buy, how much to save and what 
assets to hold, and where and how much to work. While government 
spending and tax policies can influence those choices, and therefore 
the economy, the impact of budgetary changes on the economy is limited. 
Although the government plays a crucial role in establishing the legal 
and institutional framework within which the economy operates, once 
that general framework is in place, personal circumstances and 
preferences play a much larger role in people's behavior than do 
marginal changes in government policies.
    The following sections review how the policies in the President's 
budget might affect the economy, first examining supply-side effects 
that would change potential output and then turning to demand-side 
effects.
    The Quantity and Quality of Labor. The overall quantity and quality 
of labor is an important determinant of potential output. Most simply, 
an increase in the overall number of hours worked in the economy raises 
potential output. In addition, increases in educational attainment, the 
amount of training provided, workers' level of experience, or their 
degree of effort on the job raise the quality of each hour worked, 
increasing output. Some analysts might assert that the policies in the 
President's budget would affect the quality of labor. However, the ways 
in which budgetary policies affect labor quality are not well 
understood. For that reason, CBO's analysis concentrated on the effect 
of the budget proposals on the hours of labor supplied.
    The President's budget would affect the hours of labor in two main 
ways. First, a number of provisions, such as accelerating the increase 
in the child tax credit and exempting most dividend income from 
taxation, would increase after-tax income without changing marginal tax 
rates. Such increases tend to reduce the number of hours worked because 
people can maintain the same standard of living with less work. Second, 
provisions such as the acceleration and extension of EGTRRA's 
reductions in marginal tax rates would increase the after-tax 
compensation for each additional hour of work in addition to raising 
after-tax income. Evaluating the effect of such rate reductions on 
labor supply is complicated by the fact that they have opposing effects 
people earn more for each extra hour they work, which tends to 
encourage work, but can earn the same after-tax income in fewer hours, 
which tends to discourage work. Most studies, however, find that, on 
net, reductions in marginal tax rates increase labor supply, primarily 
by drawing secondary earners into the labor force.
    To estimate the effect of lower marginal tax rates, CBO estimated 
the changes in the effective marginal tax rate on labor income the rate 
at which the average additional dollar of compensation for labor is 
taxed (see Table 13). The percentage point changes are smaller than the 
change in statutory income tax rates under the President's proposals 
because some of the compensation that people receive for working such 
as employer provided health benefits is not taxed.
    Provisions in the budget proposals that would affect the level of 
the capital stock could also change compensation per hour of work by 
affecting productivity. If the proposals led to lower investment, that 
would imply a smaller stock of productive capital and therefore lower 
wages. A positive effect on investment would have the opposite effect. 
CBO incorporated those secondary influences on labor supply into its 
analysis.
    CBO estimates that, overall, the President's budget would increase 
the number of hours worked somewhat that is, the positive effect of 
lower marginal tax rates would outweigh the negative effect of 
increased after-tax income.
    The budget's policies could also affect labor supply by changing 
people's expectations of future policies. The budget's proposals would 
increase the Federal budget deficit, which could lead people to expect 
that some time in the future, taxes would have to be increased or 
transfer payments (such as unemployment compensation or Social 
Security) or government services would have to be cut to finance the 
Federal Government's increased interest payments. If people expect to 
face higher tax rates on labor in the future, they may try to work more 
before the rates go up and work less when the rates are higher. Even if 
they expect simply to have to pay more taxes (whether or not the 
marginal tax rate on labor goes up) or receive less transfer payments 
or government services, they may try to work and save more now in order 
to have more resources to compensate for the larger burden in the 
future. It is difficult to gauge, however, the degree to which people 
make decisions with so much foresight, the time horizon they consider 
in making plans, and the future policy changes they might expect. To 
deal with that uncertainty, in its analysis CBO used various 
assumptions about people's degree of foresight and expectations of 
future policies.
    The Size and Composition of the Capital Stock. The President's 
budgetary policies would affect the size of the capital stock the 
nation's stock of productive equipment such as factories and 
information systems primarily through their impacts on government and 
private consumption and, therefore, on investment. The policies would 
directly increase government consumption relative to the level in CBO's 
baseline. That increased government consumption would tend to reduce 
investment in productive capital by reducing the resources available.
    Some of the effect of higher government consumption on investment 
would probably be offset by an increase in the amount of foreign 
capital that was invested in the United States. However, most of the 
returns to those investments would accrue to foreigners and therefore 
would not be available to U.S. residents. For that reason, the 
additional foreign investment would not necessarily increase the 
resources available to Americans in the long run.
    The President's budgetary policies would also influence private 
consumption in a number of ways. For one, the budget would increase 
disposable income through reduced taxes and increased transfer payments 
(such as a Medicare prescription drug benefit). That would tend to 
boost consumption, because people would probably spend some of that 
extra disposable income.
    However, some tax proposals in the President's budget would tend to 
reduce consumption by increasing the after-tax rate of return on 
savings. Accelerating and making permanent EGTRRA's reductions in 
marginal tax rates, reducing the share corporate income subject to 
double-taxation, and expanding tax-free savings accounts would all 
reduce the marginal tax rates on income from savings. (For a detailed 
analysis of the President's proposals concerning double taxation and 
savings accounts, see Box 4.) Overall, those changes would increase the 
after-tax return on savings.
    CBO estimated the average effective marginal tax rate on capital 
income the rate at which the average additional dollar of capital 
income is taxed with and without the budget's policies to estimate the 
changes in the rate of return on savings (see Table 14). Those changes 
in effective tax rates are smaller than the changes in statutory income 
tax rates under the President's proposals because some capital income 
(such as that which flows into tax-free savings accounts or pension 
funds) is not taxed.
    The proposed reductions in taxes on capital income would raise the 
return on savings and affect consumption in two opposing ways, just as 
lowering the marginal tax rate on labor income has opposing effects on 
labor supply. The increase in the rate of return on savings would raise 
savers' wealth by increasing their current and future after-tax returns 
which would tend to increase current consumption but also increase the 
gain in future consumption for every dollar saved, which would tend to 
increase saving and reduce current consumption.
    Perhaps partly for that reason, analysis based on empirical data 
tends to estimate that changes to the return on savings have a 
relatively small effect on consumption, which could be positive or 
negative. However, some models of behavior predict a large negative 
effect on consumption.
    CBO attempted to span that range of estimates: some economic models 
used by the agency in its analysis assume that the rate of return on 
savings has little or no effect on consumption, while others assume 
that increasing the rate of return on saving reduces consumption and 
increases saving significantly.
    Finally, as described in the previous section, the increased 
deficits under the President's budget might lead some people to 
anticipate changes in policy in the future. If people expected higher 
taxes, lower transfer payments, or less government services in the 
future, they might tend to reduce consumption in order to build up 
savings to compensate for those anticipated policies. CBO used a range 
of assumptions about those expectations in its estimates.
    The President's proposal to make permanent the repeal of the estate 
and gift tax after 2010 is particularly difficult to analyze. To begin 
with, there is no clear consensus regarding the motive for leaving 
bequests, or even whether they are typically the result of a deliberate 
savings plan. If they are not, repealing the estate tax would not 
encourage saving. Moreover, those who believe that estate taxes affect 
consumption and saving disagree about the direction of the effect. A 
lower estate tax makes it cheaper for people to leave money to their 
heirs, which could encourage them to save more to leave larger 
bequests. In contrast, with a lower estate tax, people can leave the 
same after-tax bequest with less saving, which might induce them to 
save less. Also, other things being equal, a lower estate tax increases 
the after-tax size of bequests, which could lead potential recipients 
to increase their consumption and reduce their saving. Finally, 
although a great deal of attention has been focused on the role of 
estate taxes in sectors such as agriculture or activities such as 
entrepreneurial ventures, the implications for the economy as a whole 
are less clear.
    Because so little is understood about how repealing the estate tax 
would affect consumption, most of CBO's estimates assumed that in their 
consumption and saving, people would respond in the same way as they 
have on average to past spending or tax changes that affected the 
budget deficit. That assumption implies that people would spend some of 
their increased after-tax income, increasing aggregate consumption. In 
one model, however, CBO assumed that people would respond in the same 
way they would to a change in lump-sum taxes, which have no effect on 
marginal incentives. That assumption implies that all of the increase 
in after-tax income would be saved, so consumption would not rise.
    Most of CBO's estimates indicate that the President's budget would 
increase the sum of private and government consumption on net, which 
would tend to imply somewhat less investment and a smaller capital 
stock. Only under the most dramatic assumption about foresight in which 
people are assumed to care just as much for future generations as they 
do for themselves did CBO estimate the President's budgetary proposals 
would lead to a bigger capital stock. In effect, if people have a 
sufficiently long time horizon, they may recognize and counter the 
deleterious effects of policy on capital formation and, thus, future 
standards of living.
    The President's budget could also affect potential output by 
changing the mix of capital over time. The proposal with the greatest 
potential to change the composition of the capital stock is the one to 
reduce double taxation of corporate income. Some corporate income is 
taxed twice: once at the corporate level by the corporate income tax 
and again at the personal level by the individual income tax. That tax 
treatment creates a distortion in the allocation of capital, 
discouraging investment in the corporate sector relative to the housing 
and noncorporate business sectors. As a result, less capital is held in 
the corporate sector than is efficient. The taxation of dividends also 
encourages firms to finance investment with debt rather then equity 
(because interest payments on debt are deducted from tax at the 
corporate level and so only taxed once), which may also lead to 
economic inefficiencies. Reducing the tax on dividends would lessen 
those inefficiences, thereby increasing overall economic output.
    Entrepreneurship and Technological Progress. Budgetary policies 
might conceivably affect the economy by influencing the rate of 
technological progress. That avenue is potentially important because 
new and improved processes and products are the source of most of the 
long-term growth in productivity. Unfortunately, however, economists 
have little basis for estimating how budgetary policies influence 
technological innovation. Because so little is understood about the 
sources of technological progress, CBO has not incorporated into its 
analysis any effects of the budget on technological progress.
    Demand-Side, or Cyclical, Effects. Government policies also affect 
the economy by adding to or subtracting from the total demand for goods 
and services in the economy. Increases in demand can cause firms to 
temporarily gear up production and hire more workers to meet the 
demand. That type of effect can be especially beneficial if the economy 
is operating below its potential, which, according to CBO's estimates, 
it currently is. In that case, if an adjustment to fiscal policy is 
well-timed, it can help move the economy back to equilibrium more 
quickly than it would have moved otherwise. Of course, if the 
adjustment is ill-timed, there are no such benefits, and there could be 
economic costs.
    Demand-side effects, however, can only temporarily raise or lower 
output above what it would have been otherwise with or without demand-
side effects, built-in economic forces tend to move output toward its 
potential level. Moreover, policies that increase demand by raising 
government or private consumption tend to lower output in the long run 
because they tend to eventually decrease investment and the size of the 
capital stock.
                   description of models and results
    CBO estimated the economic effects of the President's budget using 
several different models of the aggregate economy. Those models 
constitute simplified representations of the economy but differ 
substantially in the ways that they are constructed and the estimates 
that they produce. The models fall into two broad types. Three of the 
models that CBO used in its analysis a ``textbook'' growth model, a 
life-cycle growth model, and an infinite horizon growth model estimate 
only supply-side effects. Two commercial macroeconometric models also 
used by CBO emphasize business cycle aspects of the economy and are 
designed primarily to analyze demand-side effects, although they 
include some supply-side effects as well.
    Ten-Year Analysis of Supply-Side Effects. CBO analyzed the supply-
side effects of the President's budget on the economy through 2013 
using three models: a textbook growth model, a life-cycle growth model, 
and an infinite horizon growth model (see Box 5). The textbook growth 
model is not forward-looking it assumes that people do not explicitly 
incorporate expected future policies into their current plans. The 
life-cycle model is so called because it assumes that people make life-
long plans for working and saving but do not care about events after 
their death. By contrast, the infinite horizon model assumes that 
people care about the welfare of their descendants as much as they care 
about their own. That assumption means people behave as if they will 
live forever.
    The life-cycle and infinite horizon growth models produced 
estimates using three different assumptions for how the increased 
deficits under the budget will eventually be financed (those models 
require such an assumption about financing because they are forward-
looking). The life-cycle model also produced estimates using two 
different assumptions about how open the economy is to inflows of 
capital from abroad.
    The textbook growth model projection, which makes no assumption 
about future financing, estimates that the budget will decrease GDP by 
about 0.2 percent, on average, over the 2004-08 period and by 0.7 
percent over the 2009-13 period (see Table 15). That model does not 
assume any direct effect of lower marginal (as opposed to average) tax 
rates and a higher pretax interest rate on private consumption, but it 
does incorporate CBO's calculation of the effect of marginal tax rates 
on labor supply.
    The estimates produced by the life-cycle and infinite horizon 
models depend critically on how the President's budgetary policies 
affect people's expectations of budgetary policies beyond 2013. The 
life-cycle growth model projects that if people think the President's 
budgetary proposals would be financed by eventual decreases in 
government consumption, economic output would decrease by between 0.3 
and 0.6 percent over the 2004-08 period compared with CBO's baseline 
and by between 0.5 and 1.5 percent over the 2009-13 period. However, 
the life-cycle model projects that if people think the proposals would 
be financed through a future lump-sum tax increase an equal dollar tax 
increase levied on everyone the proposals would raise output by between 
0.3 and 0.5 percent over the first 5 years and by between 0.3 and 0.6 
percent during the second. (Estimates assuming a future increase in 
marginal tax rates, not shown for brevity, fall between those assuming 
a future cut in government consumption and those assuming a future 
increase in lump-sum taxes.) Estimates assuming an eventual increase in 
taxes tend to be more positive because people, as represented in the 
model, work and save more inside the 10-year projection period in 
preparation for the tax increase but not for a cut in government 
spending, which the model assumes people do not value. (Assuming that 
government consumption was valued as highly as personal consumption 
would lead to an estimate similar to the one assuming a lump-sum tax 
increase.)
    The estimated economic effects of the budget also depend on the 
extent to which the economy is open or closed. Assuming an open economy 
one in which international capital flows freely to keep U.S. interest 
rates equal to fixed world rates tends to lead to larger estimates of 
GDP on average over the 2004-13 period. However, that result occurs 
partly because investment is boosted by inflows of foreign capital, and 
most of the profits from the investments financed by those inflows go 
to foreigners rather than U.S. residents. The income of U.S. residents 
(represented by gross national product (GNP) in Table 15) is actually 
lower under the assumption of an open economy, despite the higher 
domestic output. (In a closed economy, GDP and GNP are identical, so 
the effect on GNP assuming an open economy can be compared directly 
with the effect on GDP assuming a closed economy.)
    The proposals would have the most positive effect on output if 
people behaved as assumed in the infinite horizon model and expected 
the proposals would be financed with a lump-sum tax increase. In that 
case, the proposals would raise output by 0.9 percent over the first 5 
years and 1.4 percent over the second. As with the life-cycle model, 
assuming that people expect future cuts in government spending leads to 
more negative effects on output an increase in GDP of 0.2 percent 
during the first 5 years and a decrease of 0.6 percent during the 
second. The infinite horizon model tends to predict more positive 
effects than the life-cycle model if people expect a future tax 
increase because, as they are represented in the infinite horizon 
model, people know that they (or their descendants, whom they care 
about as much as themselves) are going to bear the burden of any future 
increase in taxes.
    The economic changes from fiscal policy would in turn affect the 
budget through 2013 (see Table 16). Under different assumptions, the 
economic effects of the President's proposals could increase their cost 
by as much as 10 percent or decrease their cost by as much as 15 
percent over the 2004-08 period and could increase their cost by as 
much as 15 percent or decrease their cost by as much as 17 percent over 
the 2009-13 period.
    Two of the most important effects on budgetary cost are the effect 
of output on revenues and the effect of interest rates on the 
composition of income and on interest costs. The models focusing on 
supply-side effects do not reflect any response of monetary policy to 
budgetary changes; the effects on interest rates stem only from the 
influence of changes in the capital stock on the rate of return to 
capital. That assumption is common to many projection models.
    Five-Year Analysis Including Demand-Side Effects. CBO used 
macroeconometric forecasting models created by Macroeconomic Advisers 
(MA) and Global Insight (GI), private forecasting firms, to analyze 
both demand-side and supply-side effects of the President's budgetary 
proposals on the economy over the next 5 years. (The analysis was 
limited to 5 years because of the increasing unreliability of estimates 
of demand-side effects over longer periods.) The macroeconometric 
models consist of sets of equations describing the relationship between 
various economic variables, based for the most part on how they have 
behaved in the past.
    Although those models are the most common type used by businesses 
trying to plan for the future, they have some disadvantages, especially 
for longer-run analyses. First, although the MA and GI models have 
supply-side growth models embedded in them, their design concentrates 
on demand-side economic effects. Consequently, they are not well suited 
to analyze policies intended to elicit supply-side effects.
    Second, the macroeconometric models are not forward-looking they 
assume that people do not behave as though they have specific 
expectations about future policies or economic developments. Instead, 
people are assumed to respond to economic changes in the same way as 
they have in the past, regardless of the source of those changes. For 
example, in response to the tax proposals in the President's budget, 
which would raise disposable income, people as represented in the 
models would increase consumption by about as much as they have, on 
average, when disposable income rose in the past. However, people may 
actually increase consumption less in response to a tax cut than they 
would in response to some other change that raised income, such as an 
increase in productivity, because they feel that the tax cut is more 
likely to be reversed in the future.
    The lack of forward-looking behavior in the macroeconometric models 
implies that specific policy changes scheduled to occur in the future 
do not affect current behavior. For example, in extending EGTRRA's tax 
cuts, the President's proposal would sharply reduce taxes in 2011-13. 
That would increase expected future after-tax income, which might cause 
people to increase consumption today. In the macroeconometric models, 
however, those tax cuts would affect consumption only when they 
occurred. As noted above, economists do not agree about the degree to 
which people base their behavior on expectations about future, as 
opposed to current, events.
    As constructed, the macroeconometric models incorporate small or no 
effects from tax changes on the supply of labor, so CBO had to adjust 
the models' equations to incorporate its own estimates of those 
effects. To augment the models, CBO estimated the effects of changes in 
taxes on labor supply in a separate calculation that accounted for the 
potential effects of the budgetary proposals on both marginal tax rates 
and after-tax income. That calculation used data on a large sample of 
taxpayers and incorporated a larger response to changes in marginal tax 
rates among secondary earners than among primary earners. CBO then 
introduced the resulting estimated changes in labor supply into the 
macroeconometric models.
    CBO attempted to estimate the demand- and supply-side effects of 
the President's budget separately by producing two sets of estimates. 
In one, CBO ran the models as they normally are, assuming that monetary 
policies allowed both demand- and supply-side effects. In the second, 
CBO attempted to isolate supply-side effects by altering interest rates 
in the models in such a way as to hold the unemployment rate at its 
baseline level. That procedure is equivalent to assuming that the 
Federal Reserve would offset all of the demand-side effects of the 
proposals but none of the supply-side effects. The approach fairly 
accurately measures the implications of the proposals for potential (or 
noncyclical) GDP, but it implies substantial increases in interest 
rates that reflect the suppression of demand stimulus. CBO took the 
difference between the two projections as its estimate of the demand-
side effects on various economic variables.
    The MA and GI models predict that the policy changes in the 
President's budget would have positive demand-side effects on economic 
output because of the effect of higher government consumption, lower 
taxes, and increased transfer payments (see Table 17). Both models 
predict that those changes would add a cyclical boost of about 1 
percent to GDP in 2004. For the next few years after that, the GI model 
predicts that the cyclical boost would add growing amounts to GDP. In 
the MA model, by contrast, the boost to output is much more temporary 
and completely dissipates by 2007. The differences between the two 
projections reflect in part on differences in how the models predict 
the Federal Reserve would respond to the President's program.
    The estimated supply-side effects of the President's budget are 
very similar in both models. Initially, higher labor supply due to the 
drop in marginal tax rates on labor income leads output to increase by 
a few tenths of a percent at most. However, from 2006-10, marginal tax 
rates are not changed (they are already scheduled to fall under current 
law because of EGTRRA's tax cuts). The primary supply-side effect in 
2006-08 is the crowding out of capital due to higher government and 
private consumption, which decreases output by about half a percent on 
average.
    The estimated economic effects in turn could influence the budget 
in a number of ways. Other things being equal, the higher output 
predicted by the models suggests greater revenues. However, the models 
also predict higher interest rates, which imply higher interest 
payments on the Federal debt. Higher interest rates also imply that 
more of capital income will be earned as interest and less as profits. 
Because interest income is taxed at a lower rate, on average, than 
profits, that shift can lower revenues. Finally, higher interest rates 
also lead to an appreciation of the dollar and greater inflows of 
foreign capital. The more valuable dollar lowers the price of imports, 
which tends to decrease the consumer price index, but not the GDP 
deflator (which includes only the prices of goods and services produced 
in the United States). Because the CPI affects a number of government 
spending categories, but the GDP deflator is more important in 
determining tax revenues, those changes in price indexes that result 
from an appreciated dollar can have a positive effect on the budget 
balance. More generally, the increased demand under the President's 
proposals leads to higher inflation in both the CPI and GDP deflator, 
which tends to improve the budget balance. Higher inflation translates 
into higher revenues. However, only mandatory spending such as Social 
Security benefits is assumed to increase with higher inflation. The 
levels of discretionary spending in the President's budget are stated 
in dollar terms and are therefore assumed to be unaffected by changes 
in prices. That assumption implies a decrease in the purchasing power 
of those fixed spending levels when prices rise above their baseline 
levels.
    The economic effects estimated by one model would decrease the cost 
of the President's proposals, on net, while those estimated by the 
other would increase them. CBO estimates that the net economic changes 
predicted by the GI model would lessen the cumulative budget deficit by 
$231 billion over the 2004-08 period, offsetting nearly 30 percent of 
the estimated $802 billion cost of the budget's proposals assuming no 
macroeconomic feedbacks (see Tables 18 and 19). The economic changes 
predicted by the MA model would, on net, increase the cumulative budget 
deficit over the same period by an estimated $75 billion, adding about 
9 percent to the cost of the President's proposals. In both cases, most 
of the effects on the budget would stem from the demand-side effects of 
the proposals.
    The difference between the estimates derives primarily from the 
fact that the MA model predicts that the President's proposals would 
increase inflation by more than the GI model does. Tighter monetary 
policies in the MA model, to fight inflation, imply higher interest 
rates than in the GI model. The interest rates in the MA model are high 
enough that the increased interest cost on the Federal debt outweighs 
the effect of increased output on revenues, leading to a deterioration 
in the budget balance.

             Box 1.--Estimating the Costs of War With Iraq

    Last September, the Congressional Budget Office (CBO) was asked to 
gauge the costs of a war with Iraq. In its response, CBO explained that 
estimates of the total cost of a military conflict with Iraq and its 
aftermath are highly uncertain.\1\ They depend on many factors, 
including the strategy used, the duration of the conflict, the number 
of casualties, the equipment lost, and the need for reconstructing 
Iraq's infrastructure.
---------------------------------------------------------------------------
    \1\ See Congressional Budget Office, Letter to the Honorable Kent 
Conrad and John M. Spratt, Jr., regarding estimated costs of a 
potential conflict with Iraq, September 30, 2002.
---------------------------------------------------------------------------
    In that previous analysis, CBO examined two possible force levels 
among the many that might be used to prosecute such a war. It now 
appears that the example emphasizing U.S. ground forces (as opposed to 
emphasizing air forces) is much closer in size and composition to the 
contingent that the U.S. military is employing for the war; in fact, 
the number of U.S. ground forces ordered to the Persian Gulf area now 
exceeds the levels that CBO assumed in its September 2002 estimate by 
1\1/3\ divisions and one Marine brigade. CBO has updated its cost 
estimate for the ``heavy ground force'' accordingly.
    CBO now estimates that the incremental costs of deploying a heavy 
ground force to the Persian Gulf (that is, the costs incurred beyond 
the amounts budgeted for routine operations) could be about $14 
billion; after that, the incremental costs of prosecuting the war in 
Iraq could reach just over $10 billion during the first month of combat 
and subsequently fall to about $8 billion a month although CBO cannot 
estimate how long the war might last. After hostilities end, the costs 
to return that force to home bases could be approximately $9 billion, 
CBO estimates. Further, the incremental cost of an occupation following 
combat operations could vary from about $1 billion to $4 billion a 
month. CBO provided no estimate of the potential costs for 
reconstruction or for foreign aid that the United States might choose 
to extend after the conflict has ended.
    Regardless of the composition of the force used, multiple unknowns 
exist about how the conflict with Iraq will unfold. If the Iraqi 
leadership or selected elements of its military capitulates quickly, 
ground combat could be short, as in Operation Desert Storm. If urban 
fighting is protracted or Iraq uses chemical or biological weapons 
against regional military or transportation facilities, the war might 
last longer. Given such uncertainty, CBO's estimates of the monthly 
costs of operations exclude expenditures for decontaminating areas or 
equipment affected by chemical or biological weapons.
    The war with Iraq could lead to substantial costs in later years, 
but CBO did not include such costs either because their magnitude 
cannot be assessed even roughly or because they depend on highly 
uncertain decisions about future policies. For example, the United 
States might leave troops or equipment in Iraq, which could require the 
construction of new military bases. Also, sustaining the occupation 
over time could require either increases in overall levels of active-
duty and reserve forces or major changes in current policies on basing 
and deployment. Furthermore, the United States might provide Iraq with 
funds for humanitarian assistance and reconstruction, and it might 
provide substantial aid to allies and other friendly nations in the 
region.

            Box 2.--Requested Funding for Homeland Security

    For 2004, the President has requested about $35 billion in net 
discretionary budget authority for homeland security.\2\ About 55 
percent of that amount ($19 billion) would go to the new Department of 
Homeland Security and the balance ($16 billion) would go to other 
departments and agencies that also have responsibilities for homeland 
security.\3\
---------------------------------------------------------------------------
    \2\ That figure, which reflects estimates by the Office of 
Management and Budget (OMB), includes about $3 billion in offsetting 
fees for the Transportation Security Administration and the Department 
of State. In addition, according to OMB's estimates, about $3 billion 
in mandatory spending would go toward homeland security, much of that 
offset by receipts. Total gross budget authority in 2004 for homeland 
security would thus be $41 billion.
    \3\ The administration's definition of homeland security activities 
is not limited to those of the Department of Homeland Security. For a 
complete discussion of that definition, see Office of Management and 
Budget, Annual Report to Congress on Combating Terrorism (June 2002), 
available at www.whitehouse.gov/omb/ legislative/combating--
terrorism06-02.pdf.
---------------------------------------------------------------------------
    In total, the President requested about $27 billion in net 
discretionary budget authority for the Department of Homeland Security, 
but only about $19 billion of that amount would provide funding for 
activities that fall within the Office of Management and Budget's 
(OMB's) definition of homeland security. The $19 billion would fund 
activities such as those of the Transportation Security Agency ($2.3 
billion) and border enforcement and protection activities previously 
performed by the Customs Service and the Immigration and Naturalization 
Service ($7 billion). It also includes about $3.5 billion for the 
Department of Homeland Security's Office of Domestic Preparedness to 
provide state and local governments with grants and training to improve 
the ability of first responders (police, firefighters, and other 
emergency personnel) to address terrorist attacks. (The remaining $8 
billion of the $27 billion requested for the Department of Homeland 
Security would go to activities such as maritime safety and immigration 
services. Such activities are not included in the $35 billion total for 
homeland security because they are outside of OMB's definition.)
    Of the $16 billion for homeland security activities performed by 
other departments and agencies, almost $7 billion would go to the 
Department of Defense, $4 billion would go to the Department of Health 
and Human Services, and $2 billion would go to the Department of 
Justice.
    The Congressional Budget Office (CBO) cannot compare the 
administration's total request for homeland security for 2004 with 
amounts appropriated for 2003 because the administration has not 
finished reviewing the enacted spending levels to identify which 
funding falls within its definition of homeland security. When compared 
with the $29 billion in funding enacted for fiscal year 2002, however, 
the $35 billion request represents a 20 percent increase over the 2-
year period.
    The President is proposing a number of new programs for homeland 
security. The largest is Project BioShield, which would, among other 
things, create incentives to increase research for new vaccines. The 
President is requesting permanent, indefinite funding authority to 
enable the government to purchase vaccines as soon as they are 
demonstrated to be safe and effective. The administration estimates 
that this proposal would require about $890 million in mandatory budget 
authority in 2004 and would cost about $3 billion over the 2004-08 
period, but the President's budget did not provide enough details about 
this proposal for CBO to provide an independent estimate.
    The administration also proposes to increase funding for a number 
of existing programs. In particular, the President would increase 
funding for the Information Analysis and Infrastructure Protection 
Directorate of the Department of Homeland Security by about $650 
million to allow the organization to assess the vulnerability of 
critical infrastructure, such as power plants, dams, and bridges.
    In certain instances, the President's request for 2004 represents a 
decrease from 2003 levels. For example, although the administration 
currently estimates that about $9 billion in funding was enacted in 
2003 for the Department of Defense's homeland security activities, the 
President proposes to reduce that amount to about $7 billion in 2004, 
because significant purchases of force protection equipment in 2003 
would not be repeated in 2004.

        Box 3.--How Would the President's Proposals Be Paid For?

    According to the Congressional Budget Office's (CBO's) projections, 
the President's budgetary proposals imply a deficit in every year over 
the next decade and would keep the ratio of debt to gross domestic 
product (GDP) over that period close to its current level of 34 
percent. However, if spending and tax policies remained unchanged, as 
assumed under CBO's baseline, the ratio of debt to GDP would fall to 17 
percent. That higher level of debt under the President's budget would 
imply higher interest payments and thus would add to the budget's 
financing requirements after the end of the projection period in 2013.
    For some time, that added need could be met by running higher 
deficits. However, the Federal Government could not follow such an 
approach indefinitely. At some point in the future under the 
President's proposals, either taxes would have to be higher than they 
otherwise would have been, or spending would have to be lower.
    Some analysts might argue that the President's proposals be 
compared with an alternative standard that includes other policy 
changes, rather than be compared against CBO's current policy baseline, 
which assumes no policy changes. For example, compared with an 
alternative that included fewer tax cuts, less encouragement of 
investment, and more government spending, the President's proposals 
could look more favorable to growth. However, CBO has no basis on which 
to construct such an alternative for comparison, and all of its 
analyses of legislative proposals are made relative to baseline 
assumptions.

Box 4.--The Potential Economic Effects of the President's Proposals to 
Reduce Double Taxation of Corporate Income and Expand Tax-Free Savings 
                                Accounts

    Two provisions in the President's budget the proposal to reduce 
double taxation of corporate income by exempting from taxation most 
dividend income and some capital gains on corporate stock and the 
proposal to expand the availability of tax-free savings accounts have 
unusually complex economic effects.
               reduce double taxation of corporate income
    Under current law, some corporate income is taxed twice, once under 
the corporate tax and again when individuals receive taxable income in 
the form of dividends or capital gains. The President proposes to 
reduce significantly that double taxation of corporate income by 
eliminating individuals' tax liability for income that has already been 
taxed at the corporate level. The Congressional Budget Office (CBO) 
estimates that the proposal would eventually shelter some 90 percent of 
dividends and 40 percent of capital gains on corporate shares, although 
some of that sheltering would be redundant because only about half of 
dividends and one-quarter of those gains are now taxed.\4\ Because 
gains are effectively taxed at a lower rate than dividends and the 
proposal would shelter a smaller share of gains than of dividends, the 
dividend exclusion would account for more than 90 percent of the value 
of the reduction in revenues.\5\
---------------------------------------------------------------------------
    \4\ Dividends and capital gains are not taxed if they accrue to 
tax-free accounts or nontaxable entities such as pension funds and 
nonprofit institutions. In addition, some gains are not taxed because 
the owner of the asset dies before the gains are realized. In that 
case, taxes are levied only on increases in value after the owner's 
death the so-called step-up in basis at death.
    \5\ The effective tax rate on capital gains is relatively low in 
part because investors can defer the realization of the gains, because 
about half of all gains go untaxed on account of step-up in basis at 
death, and because some gains accrue to assets held in tax-free 
accounts.
---------------------------------------------------------------------------
    The proposal and its economic effects are complex. First, 
eliminating taxes on most dividends and some capital gains would reduce 
the overall taxation of capital income. In general, that might be 
expected to lower the cost of funds for businesses because they could 
pay investors less before taxes to yield the same after-tax return. But 
the extent of the reduction in the cost of capital is unclear: some 
analysts hold to a theory of corporate finance which implies that the 
reduction in the cost of capital would reflect only the less than 10 
percent of the tax saving stemming from the reduction in taxes on 
capital gains, while others hold that the reduction would reflect both 
the reduction of taxes on gains and the reduction of taxes on 
dividends.\6\ CBO has adopted a middle estimate of the implications of 
the President's proposal for the cost of capital for firms, largely 
because the proposal accords a saving incentive to a specific sector. 
In an open economy, such a targeted incentive would have results in 
between those predicted by either theory, even if the theory predicting 
a greater fall in the cost of capital was otherwise correct (as CBO 
normally assumes).\7\
---------------------------------------------------------------------------
    \6\ George R. Zodrow, ``On the 'Traditional' and 'New' Views of 
Dividend Taxation,'' National Tax Journal, vol. 44, no. 4, part 2 
(December 1991), pp. 497-509.
    \7\ Clemens Fuest and Bernd Huber, The Optimal Taxation of 
Dividends in a Small Open Economy, Working Paper No. 348 (Munich: 
CESifo 2000), available at www.cesifo.de.
---------------------------------------------------------------------------
    Second, the proposal would tend to increase shareholders' 
consumption by raising the value of their corporate stock. The 
interaction of the current schedule of accelerated depreciation and the 
proposed cut in taxes would reduce the distinction between new and old 
corporate capital, raising the value of the existing stock.\8\ More 
important, share values would rise to the extent that the tax savings 
were not immediately offset by lower pretax returns stemming from more 
investment. (To the extent that the tax proposal encouraged extra 
investment, the size of the capital stock would rise, decreasing the 
pretax rate of return to capital and offsetting the tax savings to 
shareholders.)
---------------------------------------------------------------------------
    \8\ Alan J. Auerbach and Laurence J. Kotlikoff, Dynamic Fiscal 
Policy (New York: Cambridge University Press, 1987), pp. 134-136.
---------------------------------------------------------------------------
    Corresponding to the disagreement about the size of the drop in the 
cost of capital, opinions differ about how much share values would 
rise. The theory of corporate finance that predicts a relatively large 
increase in share values predicts a relatively small decrease in the 
cost of capital, and vice versa. Because increased share values lead to 
more consumption, the President's proposal would help increase 
aggregate demand in the short run. However, the more it would help 
demand by raising consumption, the more it would hurt supply in the 
long run by lowering saving and investment. As with the cost of 
capital, CBO adopted a middle estimate for the increase in share 
values.
    Third, the proposal would lessen the disadvantage that the 
corporate sector now faces in the competition for capital. Currently, 
while some income from the corporate sector is taxed twice, the imputed 
income from owner-occupied housing is not taxed at all, and income from 
small businesses is taxed only once (at the personal level). That 
disparity in tax treatment leads to less investment in the corporate 
sector than is optimal for economic output. Lowering taxes on the 
corporate sector would allow that sector to attract additional capital 
from the other two sectors. In general, such a shift would improve 
efficiency, although it might conflict with other goals, such as 
supporting owner occupancy of homes or unincorporated businesses.
    Fourth, the proposal would tend to make equity financing more 
attractive to firms relative to debt financing, and it would make 
paying dividends more attractive relative to retaining earnings. 
Currently, interest payments are deductible from corporate income, so 
they are taxed only at the personal level. However, if a firm finances 
investment through equity, some of the returns are taxed at both the 
corporate and personal levels. So under the proposal, the difference 
between the effective tax on interest and equity returns would narrow. 
Also, because most investors currently face a lower tax rate on capital 
gains than on ordinary income and capital gains taxes are deferred 
until the gains are realized, firms are encouraged to retain earnings 
and build up the value of their stock rather than pay out dividends. 
Under the President's proposal, that incentive would no longer apply.
    The proposed reduction in the double taxation of corporate income 
would also interact with some of the President's other proposals and 
with current law. For instance, the President's proposal to expand tax-
free savings accounts would increase the share of personal assets held 
in tax-free accounts duplicating some of the effect that the proposal 
to reduce the double taxation of capital income would have on the cost 
of capital and on the allocation of capital among economic sectors. 
However, the expanded accounts would partly undo the impact that the 
proposal concerning double taxation would have in bolstering equity 
financing, because interest income (as opposed to dividends or gains) 
earned on assets in the accounts would not be taxed at either the 
personal or corporate level. That effect would be strengthened by the 
fact that the combination of the proposals would increase the share of 
interest-bearing assets in tax-free accounts there would be little 
incentive to hold equities in such accounts if their returns were 
already largely sheltered from taxes.
    In addition, corporate income taxes are currently temporarily low, 
both because firms have relatively low earnings as a result of the 
sluggish economy and because the temporary investment incentives in the 
Job Creation and Worker Assistance Act of 2002 reduce the taxes 
corporations pay on earnings. Because the President's proposal would 
eliminates taxes at the individual level only on income that was 
already taxed at the corporate level, the low corporate taxes would 
limit the initial impact of the proposal on firms' cost of capital. 
And, in general, the lower combined tax on corporate income would 
reduce the tax value of accelerated depreciation and the deductibility 
of corporate interest.
    CBO incorporated the effects of the proposal to reduce double 
taxation of corporate income into its analysis in two ways. For the 
macroeconometric models that CBO used, it estimated the effect of the 
proposal on the cost of capital in different economic sectors and on 
share values. CBO then incorporated those estimates into the models, 
and the models' equations determined the ultimate effect on the 
economy.
    For the supply-side models, CBO estimated the overall effect on the 
average cost of capital and incorporated that estimate into the models. 
Those models have no mechanism to estimate the effect of the 
reallocation of capital. To incorporate that effect, CBO reviewed 
outside estimates of the effect of that reallocation on output, 
determined a middle-range estimate, and added that amount to the 
models' underlying estimates of the effect on output. That procedure 
added an average of 0.1 percent to the estimated effect on gross 
domestic product over the 2004-13 period in those models.
                    expand tax-free savings accounts
    The President's budget includes a proposal to create retirement 
savings accounts (RSAs) and lifetime savings accounts (LSAs) to 
consolidate the current system of tax-free savings accounts for 
retirement and other purposes (such as education). The RSAs would 
replace the three-tiered system of traditional, Roth, and nondeductible 
individual retirement accounts (IRAs). Taxpayers could use the LSAs to 
consolidate other savings plans, including the Archer medical savings 
accounts, Coverdell education savings accounts, and qualified state 
tuition plans. The proposal would also up the contribution limits, 
eliminate some of the eligibility restrictions based on income, and 
liberalize some of the distribution rules.
    If the President's other proposals were also enacted, the proposal 
for savings accounts would not have any appreciable effect on the 
economy on average through 2013, CBO estimates.\9\ Most taxpayers would 
simply save the same amount in one of the new accounts as they would 
have saved in one of their current tax-free accounts. Moreover, people 
who currently have assets in taxable accounts could reduce their tax 
liability by selling those assets and putting the cash from the sale 
into the tax-preferred accounts an action that would have no effect on 
private saving. Most new saving would be done in small amounts by 
taxpayers with few taxable assets to shift.
---------------------------------------------------------------------------
    \9\ The assumption that all of the proposals in the budget are 
enacted is important because their effects interact. For example, as 
described above, the proposal to reduce double taxation of corporate 
income would lessen the incentive to invest equities in tax-free 
accounts because the returns to those equities would already be largely 
tax-sheltered. Therefore, fewer people might take advantage of the 
accounts.
---------------------------------------------------------------------------
    However, the effects beyond 2013 could be larger. CBO estimates 
that after the first few years, the proposals for new tax-free accounts 
would have a slight positive effect on saving that would increase after 
2013.

Box 5.--The Models That the Congressional Budget Office Used to Analyze 
  the Economic Effects of the President's Budget Over the Next Decade

    The Congressional Budget Office (CBO) used three models to estimate 
the effects of the President's budget from 2003-13: a textbook growth 
model, a life-cycle growth model, and an infinite horizon growth model.
    The textbook growth model, which CBO uses to produce projections of 
the economy's potential output for the agency's 10-year economic 
baseline, is an enhanced version of the model developed by Robert 
Solow, a pioneer of growth-accounting theory.\10\ It assumes that 
output is determined by labor supply, the capital stock, and total 
factor productivity (which represents the state of technological know-
how). The textbook growth model is not forward-looking people do not 
respond to expected future changes in government policy. The textbook 
growth model incorporates no effects from demand-side, or cyclical, 
variations in the economy; the model assumes the economy is always at 
its potential level.
---------------------------------------------------------------------------
    \10\ For a detailed description of the textbook growth model, see 
Congressional Budget Office, CBO's Method for Estimating Potential 
Output: An Update (August 2001).
---------------------------------------------------------------------------
    The estimates using the textbook growth model incorporate effects 
of marginal tax rates on labor supply, which CBO estimated in a side 
calculation. Those effects increase labor supply relative to the level 
in CBO's baseline.
    By contrast, the capital stock is lower than the baseline level 
because of increased government and private consumption, which crowds 
out investment. The decrease in the capital stock is limited by two 
factors, for which the model includes assumptions based on past 
relationships. First, the increase in private consumption is dampened 
because people are assumed to increase their private saving by 40 cents 
for every dollar that the deficit rises. Second, for every dollar that 
national saving (private plus government saving) falls, the amount of 
foreign capital invested in the United States is assumed to rise by 40 
cents. In the textbook growth model, changes in marginal tax rates on 
capital have no direct effect on spending by the private sector.
    The life-cycle growth model and the infinite horizon growth model 
differ in fundamental ways from the other models that CBO used in this 
analysis. The two models incorporate simulated people who make 
decisions about how much to work and save in order to make themselves 
as well off as possible over their lifetime. Their behavior is 
calibrated so that macroeconomic variables such as the total amount of 
labor supplied and the size of the capital stock match the levels 
occurring in the U.S. economy. In the life-cycle and infinite horizon 
growth models, people's consumption changes by a relatively large 
amount in response to changes in their after-tax rate of return on 
saving. Like the textbook growth model, those models do not allow for 
any demand-side effects.
    The people in the life-cycle and infinite horizon models are 
assumed to be forward-looking that is, they know all future changes in 
policy and alter their behavior accordingly. In terms of the degree to 
which people incorporate future events into their current behavior, 
this ``perfect foresight'' is at the other end of the range of possible 
assumptions from the assumption used in the growth model. Most people 
in the real world fall somewhere between those two extremes. However, 
in using those two assumptions, CBO has attempted to span a range of 
possible responses to the policies in the President's budget.
    Because people's behavior in the life-cycle and infinite horizon 
growth models depends in part on future policies, using those models 
requires making assumptions about budgetary policies beyond 2013, the 
end of the projection period. Policies that increase deficits must be 
offset at some point in the future by taxes that are higher or spending 
that is lower than it would have been in the absence of the increased 
deficits.
    The assumptions about how and when to offset the bill that comes 
due have a large influence on the estimated economic effects over the 
2003-13 period. That influence stems from the fact that people 
anticipate the offsetting policies and plan accordingly. In its 
analysis, CBO used two different assumptions about how the budget would 
be stabilized after 2013: that taxes would be raised by a lump sum for 
everyone and that government consumption, which the models assume does 
not enhance people's well-being, would be cut.\11\
---------------------------------------------------------------------------
    \11\ CBO also estimated economic effects assuming that marginal 
income tax rates, rather than lump-sum taxes, would be raised after 
2013. Those results are not presented because they lie between those 
under the assumptions of lump-sum tax increases and cuts in government 
consumption.
---------------------------------------------------------------------------
    In general, if people believe that some time after 2013 their taxes 
will rise, they will work more and consume less in order to build up 
savings in preparation. Therefore, the effects on economic output 
before 2013 tend to be relatively more positive under that assumption. 
If, however, people expect government consumption to fall in the 
future, rather than taxes to rise, they do not need to work and save 
more in preparation (under the assumption that such consumption does 
not enhance people's well-being). So the effects on output over the 
first 10 years tend to be relatively more negative under that 
assumption. (If, on the other hand, government consumption was valued 
by people as highly as they valued their own consumption, the predicted 
economic effects from assuming a future fall in spending would be the 
same as those from assuming a lump-sum increase in taxes. The actual 
impact of government consumption on people's well-being probably falls 
somewhere between those two extremes.)
    The life-cycle and infinite horizon growth models differ in what 
they assume about how far ahead people look in making their plans. The 
life-cycle model is calibrated so that the probability of death at a 
given age matches current U.S. mortality rates, and, as the name of the 
model suggests, people are assumed to take account of the impact of 
future economic or policy changes only on themselves and not on their 
children. In the infinite horizon model, however, people behave as 
though the well-being of their descendants is as important to them as 
their own. That leads them to behave as if they expect to live forever. 
While that assumption cannot be ruled out, there is some evidence 
against it.\12\
---------------------------------------------------------------------------
    \12\ See Joseph G. Altonji, Fumio Hayashi, and Laurence Kotlikoff, 
``Risk Sharing Between and Within Families,'' Econometrica, vol. 64, 
no. 2 (March 1996), pp. 261-294; Paul Evans, ``Consumers Are Not 
Ricardian: Evidence from Nineteen Countries,'' Economic Inquiry, vol. 
31, no. 4 (October 1993), pp. 534-548; and T.D. Stanley, ``New Wine in 
Old Bottles: A Meta-Analysis of Ricardian Equivalence,'' Southern 
Economic Journal, vol. 64, no. 3 (January 1998), pp. 713-727.
---------------------------------------------------------------------------
    The difference in the models' time horizons has an important effect 
on the resulting estimates. In both models, people expect the increase 
in deficits under the President's budget to be offset at some point in 
the future. However, a person in the life-cycle model, especially an 
older one, knows that he may die before an offsetting policy change 
occurs. Consequently, that person is less willing to work harder or 
save more during the 10-year projection period in order to compensate 
for any future tax increases.
    By contrast, people in the infinite horizon model are certain that 
they (or, equivalently, their descendants, whom they care about as much 
as they do themselves) will be alive when the offsetting policy change 
is made. That certainty implies that the expectation of a future 
increase in taxes will have a greater effect on their current work and 
saving than it does in the life-cycle model. For that reason, the 
infinite horizon model using the assumption of future tax increases 
produces the most positive estimates of the effect of the budget on the 
economy.
    In its analysis using the life-cycle model, CBO used two different 
assumptions about how open the economy is to flows of capital to and 
from other countries. One assumption is that the economy is completely 
closed no capital can flow into or out of the country. The other 
assumption is that the economy is completely open and cannot affect the 
world interest rate capital flows freely into and out of the country to 
keep the domestic interest rate equal to a constant world rate. The 
U.S. economy effectively behaves somewhere between those two extremes, 
because while it is relatively open to investment, it is so large that 
its economy can influence world interest rates. The estimated impact on 
U.S. incomes assuming an open economy tends to be more negative, or 
less positive, than that assuming a closed economy because of the 
premise that interest rates cannot rise. In a closed economy, policies 
that reduce the capital stock tend to increase interest rates, which 
gives people a greater incentive to save rather than consume and 
offsets some of the reduction in the capital stock and output.

                                   TABLE 1.--COMPARISON OF PROJECTED DEFICITS AND SURPLUSES IN CBO'S BASELINE AND IN CBO'S ESTIMATE OF THE PRESIDENT'S BUDGET
                                                                                    [In billions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Actual                                                                                                       Total,     Total,
                                                                  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                            CBO's Estimate of the President's Budget

On-Budget Deficit (-).........................................     -317     -452     -512     -464     -429     -404     -416     -421     -427     -458     -424     -434     -2,225     -4,389
Off-Budget Surplus............................................      160      165      174      194      211      231      250      268      286      304      318      331      1,061      2,569
                                                               ---------------------------------------------------------------------------------------------------------------------------------
    Total Deficit (-).........................................     -158     -287     -338     -270     -218     -173     -166     -153     -141     -154     -106     -102     -1,164     -1,820

                                                                                         CBO's Baseline

On-Budget Deficit (-) or Surplus..............................     -317     -408     -373     -317     -269     -240     -224     -207     -190      -73       88      128     -1,423     -1,678
Off-Budget Surplus............................................      160      163      173      195      212      231      250      268      286      304      318      331      1,061      2,568
                                                               ---------------------------------------------------------------------------------------------------------------------------------
    Total Deficit (-) or Surplus..............................     -158     -246     -200     -123      -57       -9       27       61       96      231      405      459       -362        891

                                                                         Difference (President's budget minus baseline)

On-Budget Deficit or Surplus..................................        0      -43     -139     -146     -160     -164     -192     -215     -237     -385     -511     -561       -802     -2,711
Off-Budget Surplus............................................        0        3        1       -1        *        *        *        *        *        *        *        *          *          1
                                                               ---------------------------------------------------------------------------------------------------------------------------------
    Total Deficit or Surplus..................................        0      -41     -138     -147     -161     -164     -192     -214     -237     -385     -511     -561       -802     -2,710
Memorandum:
Total Deficit (-) or Surplus as a Percentage of GDP
CBO's estimate of the President's budget......................     -1.5     -2.7     -3.0     -2.3     -1.7     -1.3     -1.2     -1.0     -0.9     -0.9     -0.6     -0.6       -1.8       -1.3
CBO's baseline................................................     -1.5     -2.3     -1.8     -1.0     -0.5     -0.1      0.2      0.4      0.6      1.4      2.4      2.6       -0.6        0.6
Debt Held by the Public as a Percentage of GDP
CBO's estimate of the President's budget......................     34.3     35.8     36.9     37.4     37.3     36.8     36.2     35.4     34.6     34.0     33.1     32.2       n.a.       n.a.
CBO's baseline................................................     34.3     35.5     35.5     34.7     33.5     31.9     30.2     28.3     26.3     23.7     20.3     16.8       n.a.       n.a.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: * = between -$500 million and $500 million; n.a. = not applicable.


                                                                   TABLE 2.--CBO'S ESTIMATE OF THE PRESIDENT'S BUDGET FOR 2004
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Actual                                                                                                       Total,     Total,
                                                                  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                     In Billions of Dollars

Revenues
    On-budget.................................................    1,338    1,325    1,349    1,512    1,654    1,782    1,889    2,000    2,112    2,216    2,343    2,480      8,186     19,338
    Off-budget................................................      515      532      558      588      619      651      685      719      756      792      830      870      3,101      7,067
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................    1,853    1,856    1,907    2,100    2,273    2,433    2,573    2,720    2,868    3,008    3,173    3,350     11,287     26,405
Outlays
    Discretionary spending....................................      734      805      836      849      867      889      922      952      980    1,011    1,031    1,064      4,363      9,402
    Mandatory spending........................................    1,106    1,183    1,243    1,310    1,387    1,466    1,552    1,645    1,742    1,855    1,944    2,079      6,958     16,223
    Net interest..............................................      171      155      166      210      237      252      265      275      287      295      303      310      1,130      2,599
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................    2,011    2,143    2,245    2,370    2,491    2,606    2,739    2,873    3,009    3,162    3,279    3,452     12,451     28,225
            On-budget.........................................    1,655    1,776    1,861    1,976    2,083    2,186    2,305    2,422    2,539    2,673    2,767    2,914     10,411     23,726
            Off-budget........................................      356      367      384      394      408      420      434      451      469      488      512      538      2,040      4,499
Deficit (-) or Surplus
    On-budget.................................................     -317     -452     -512     -464     -429     -404     -416     -421     -427     -458     -424     -434     -2,225     -4,389
    Off-budget................................................      160      165      174      194      211      231      250      268      286      304      318      331      1,061      2,569
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     -158     -287     -338     -270     -218     -173     -166     -153     -141     -154     -106     -102     -1,164     -1,820
Debt Held by the Public.......................................    3,540    3,852    4,178    4,460    4,691    4,875    5,051    5,213    5,362    5,524    5,636    5,744       n.a.       n.a.
Memorandum:
Gross Domestic Product........................................   10,337   10,756   11,309   11,934   12,582   13,263   13,972   14,712   15,480   16,250   17,013   17,851       n.a.       n.a.

                                                                                     As a Percentage of GDP

Revenues
    On-budget.................................................     12.9     12.3     11.9     12.7     13.1     13.4     13.5     13.6     13.6     13.6     13.8     13.9       13.0       13.4
    Off-budget................................................      5.0      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9        4.9        4.9
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     17.9     17.3     16.9     17.6     18.1     18.3     18.4     18.5     18.5     18.5     18.6     18.8       17.9       18.3
Outlays
    Discretionary spending....................................      7.1      7.5      7.4      7.1      6.9      6.7      6.6      6.5      6.3      6.2      6.1      6.0        6.9        6.5
    Mandatory spending........................................     10.7     11.0     11.0     11.0     11.0     11.1     11.1     11.2     11.3     11.4     11.4     11.6       11.0       11.2
    Net interest..............................................      1.7      1.4      1.5      1.8      1.9      1.9      1.9      1.9      1.9      1.8      1.8      1.7        1.8        1.8
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     19.5     19.9     19.9     19.9     19.8     19.6     19.6     19.5     19.4     19.5     19.3     19.3       19.7       19.6
            On-budget.........................................     16.0     16.5     16.5     16.6     16.6     16.5     16.5     16.5     16.4     16.5     16.3     16.3       16.5       16.4
            Off-budget........................................      3.4      3.4      3.4      3.3      3.2      3.2      3.1      3.1      3.0      3.0      3.0      3.0        3.2        3.1
Deficit (-) or Surplus
    On-budget.................................................     -3.1     -4.2     -4.5     -3.9     -3.4     -3.0     -3.0     -2.9     -2.8     -2.8     -2.5     -2.4       -3.5       -3.0
    Off-budget................................................      1.5      1.5      1.5      1.6      1.7      1.7      1.8      1.8      1.8      1.9      1.9      1.9        1.7        1.8
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     -1.5     -2.7     -3.0     -2.3     -1.7     -1.3     -1.2     -1.0     -0.9     -0.9     -0.6     -0.6       -1.8       -1.3
Debt Held by the Public.......................................     34.3     35.8     36.9     37.4     37.3     36.8     36.2     35.4     34.6     34.0     33.1     32.2       n.a.       n.a.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: n.a. = not applicable.


                              TABLE 3.--CHANGES IN CBO'S BASELINE PROJECTIONS OF THE DEFICIT OR SURPLUS SINCE JANUARY 2003
                                                                [In billions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                      Total,     Total,
                                   2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
Total Deficit (-) or Surplus as     -199     -145      -73      -16       26       65      103      140      277      451      508       -143      1,336
 Projected in January 2003\1\..
Changes to Revenue Projections       -30      -30      -20      -10        *        *        *        *        *        *        *        -61        -63
 (Technical)...................
Changes to Outlay Projections
    Legislative
        Discretionary..........        9       19       18       18       19       19       20       20       21       21       22         93        198
        Mandatory..............        4        3        3        4        5        6        7        6        6        5        4         22         50
        Debt service...........        *        1        2        4        5        7        9       11       13       15       17         18         82
            Subtotal,                 13       22       24       26       29       32       35       37       39       41       44        134        330
             legislative.......
Technical
    Discretionary..............        4        2        1        1        1        1        1        1        1        1        1          6         11
    Mandatory:.................
        Medicaid...............        1        2        3        2        3        3        3        4        4        4        4         13         32
        Medicare...............        3        1        *       -1       -1       -1       -1       -1       -1       -3       -3         -1        -10
        Debt service...........        *        1        3        4        4        4        5        5        5        5        5         16         39
        Other..................       -5       -4       -1       -1       -2       -2       -2       -2       -2       -3       -3        -10        -20
            Subtotal, mandatory       -1        1        5        4        4        4        5        6        6        3        4         18         42
            Subtotal, technical        3        2        6        4        5        6        6        7        7        4        5         24         53
                Total Outlay          17       25       29       31       35       38       42       44       46       45       48        157        383
                 Changes.......
Total Impact on the Surplus....      -47      -55      -50      -41      -35      -38      -42      -45      -46      -46      -49       -218       -446
Total Deficit (-) or Surplus as     -246     -200     -123      -57       -9       27       61       96      231      405      459       -362        891
 Projected in March 2003.......
Memorandum:
Total Legislative Changes......      -14      -22      -24      -26      -29      -32      -35      -37      -39      -41      -44       -134       -330
Total Technical Changes........      -33      -33      -26      -15       -6       -6       -7       -7       -7       -5       -5        -85       -116
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: * = between -$500 million and $500 million.

\1\ Those projections incorporated the assumption that discretionary budget authority would total $751 billion for 2003 and grow at the rate of
  inflation thereafter.


                                                                           TABLE 4.--CBO'S BASELINE BUDGET PROJECTIONS
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Actual                                                                                                       Total,     Total,
                                                                  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                     In Billions of Dollars

Revenues
    Individual income taxes...................................      858      869      924    1,011    1,089    1,176    1,259    1,349    1,447    1,649    1,819    1,939      5,458     13,660
    Corporate income taxes....................................      148      156      185      228      249      260      269      276      285      295      306      316      1,190      2,669
    Social insurance taxes....................................      701      725      766      811      856      901      944      989    1,037    1,085    1,134    1,188      4,276      9,708
    Other.....................................................      146      141      150      156      165      168      176      184      181      191      221      231        816      1,823
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................    1,853    1,891    2,024    2,205    2,360    2,504    2,647    2,798    2,949    3,220    3,479    3,674     11,741     27,860
            On-budget.........................................    1,338    1,360    1,466    1,617    1,741    1,853    1,963    2,078    2,193    2,427    2,650    2,804      8,640     20,793
            Off-budget........................................      515      532      558      588      619      651      685      719      756      792      830      870      3,101      7,067
Outlays
    Discretionary spending....................................      734      805      837      854      868      886      911      936      961      991    1,011    1,043      4,356      9,299
    Mandatory spending........................................   11,106    1,177    1,223    1,277    1,332    1,403    1,484    1,575    1,670    1,782    1,861    1,993      6,720     15,602
    Net interest..............................................      171      155      164      197      217      224      226      225      222      215      201      179      1,027      2,069
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................    2,011    2,137    2,224    2,328    2,417    2,513    2,621    2,736    2,853    2,989    3,074    3,215     12,103     26,970
            On-budget.........................................    1,655    1,768    1,839    1,935    2,010    2,093    2,187    2,285    2,383    2,500    2,562    2,677     10,063     22,471
            Off-budget........................................      356      369      385      393      407      420      434      451      470      488      512      539      2,040      4,499
Deficit (-) or Surplus
    On-budget.................................................     -317     -408     -373     -317     -269     -240     -224     -207     -190      -73       88      128     -1,423     -1,678
    Off-budget................................................      160      163      173      195      212      231      250      268      286      304      318      331      1,061      2,568
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     -158     -246     -200     -123      -57       -9       27       61       96      231      405      459       -362        891
Debt Held by the Public.......................................    3,540    3,816    4,013    4,142    4,212    4,233    4,217    4,165    4,077    3,854    3,456    3,003       n.a.       n.a.
Memorandum:
Gross Domestic Product........................................   10,337   10,756   11,309   11,934   12,582   13,263   13,972   14,712   15,480   16,250   17,013   17,851       n.a.       n.a.

                                                                                     As a Percentage of GDP

Revenues
    Individual income taxes...................................      8.3      8.1      8.2      8.5      8.7      8.9      9.0      9.2      9.3     10.1     10.7     10.9        8.7        9.5
    Corporate income taxes....................................      1.4      1.5      1.6      1.9      2.0      2.0      1.9      1.9      1.8      1.8      1.8      1.8        1.9        1.8
    Social insurance taxes....................................      6.8      6.7      6.8      6.8      6.8      6.8      6.8      6.7      6.7      6.7      6.7      6.7        6.8        6.7
    Other.....................................................      1.4      1.3      1.3      1.3      1.3      1.3      1.3      1.2      1.2      1.2      1.3      1.3        1.3        1.3
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     17.9     17.6     17.9     18.5     18.8     18.9     18.9     19.0     19.0     19.8     20.5     20.6       18.6       19.3
            On-budget.........................................     12.9     12.6     13.0     13.5     13.8     14.0     14.0     14.1     14.2     14.9     15.6     15.7       13.7       14.4
            Off-budget........................................      5.0      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9      4.9        4.9        4.9
Outlays
    Discretionary spending....................................      7.1      7.5      7.4      7.2      6.9      6.7      6.5      6.4      6.2      6.1      5.9      5.8        6.9        6.4
    Mandatory spending........................................     10.7     10.9     10.8     10.7     10.6     10.6     10.6     10.7     10.8     11.0     10.9     11.2       10.7       10.8
    Net interest..............................................      1.7      1.4      1.4      1.6      1.7      1.7      1.6      1.5      1.4      1.3      1.2      1.0        1.6        1.4
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     19.5     19.9     19.7     19.5     19.2     18.9     18.8     18.6     18.4     18.4     18.1     18.0       19.2       18.7
            On-budget.........................................     16.0     16.4     16.3     16.2     16.0     15.8     15.7     15.5     15.4     15.4     15.1     15.0       16.0       15.6
            Off-budget........................................      3.4      3.4      3.4      3.3      3.2      3.2      3.1      3.1      3.0      3.0      3.0      3.0        3.2        3.1
Deficit (-) or Surplus
    On-budget.................................................     -3.1     -3.8     -3.3     -2.7     -2.1     -1.8     -1.6     -1.4     -1.2     -0.4      0.5      0.7       -2.3       -1.2
    Off-budget................................................      1.5      1.5      1.5      1.6      1.7      1.7      1.8      1.8      1.8      1.9      1.9      1.9        1.7        1.8
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................     -1.5     -2.3     -1.8     -1.0     -0.5     -0.1      0.2      0.4      0.6      1.4      2.4      2.6       -0.6        0.6
Debt Held by the Public.......................................     34.3     35.5     35.5     34.7     33.5     31.9     30.2     28.3     26.3     23.7     20.3     16.8       n.a.       n.a.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: n.a. = not applicable.


                                                        Table 5.--CBO's Baseline Projections of Federal Interest Outlays and Federal Debt
                                                                                    [In billions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Actual                                                                                                       Total,     Total,
                                                                  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                    Federal Interest Outlays

Interest on the Public Debt (Gross interest)\1\...............      333      323      332      381      420      446      468      489      508      526      537      542      2,047      4,649
Interest Received by Trust Funds
    Social Security...........................................      -77      -84      -90      -98     -109     -121     -135     -150     -166     -183     -201     -220       -553     -1,473
    Other trust funds\2\......................................      -76      -72      -67      -72      -77      -81      -86      -90      -95     -100     -105     -111       -383       -885
        Subtotal..............................................     -153     -156     -157     -169     -185     -203     -221     -241     -261     -283     -306     -331       -936     -2,358
Other Interest\3\.............................................       -8      -11      -11      -14      -16      -18      -20      -22      -24      -26      -29      -32        -80       -214
Investment Income\4\..........................................        0        *       -1       -1       -1       -1       -1       -1       -1       -1       -1       -1         -4         -8
        Total (Net interest)..................................      171      155      164      197      217      224      226      225      222      215      201      179      1,027      2,069

                                                                                    Federal Debt, End of Year

Debt Held by the Public.......................................    3,540    3,816    4,013    4,142    4,212    4,233    4,217    4,165    4,077    3,854    3,456    3,003       n.a.       n.a.
Debt Held by Government Accounts
    Social Security...........................................    1,329    1,491    1,664    1,857    2,070    2,301    2,551    2,819    3,106    3,409    3,727    4,058       n.a.       n.a.
    Other government accounts\2\..............................    1,329    1,361    1,443    1,543    1,657    1,778    1,904    2,034    2,170    2,311    2,460    2,612       n.a.       n.a.
        Total.................................................    2,658    2,851    3,107    3,400    3,727    4,079    4,455    4,854    5,276    5,721    6,187    6,671       n.a.       n.a.
Gross Federal Debt............................................    6,198    6,667    7,119    7,542    7,939    8,312    8,672    9,018    9,353    9,575    9,643    9,673       n.a.       n.a.
Debt Subject to Limite........................................    6,161    6,645    7,097    7,520    7,917    8,289    8,650    8,996    9,330    9,551    9,619    9,649       n.a.       n.a.
Memorandum:...................................................
Debt Held by the Public as a Percentage of GDP................     34.3     35.5     35.5     34.7     33.5     31.9     30.2     28.3     26.3     23.7     20.3     16.8       n.a.       n.a.
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: n.a. = not applicable; * = between -$500 million and zero.

\1\ Excludes interest costs of debt issued by agencies other than the Treasury (primarily the Tennessee Valley Authority).

\2\ Principally the Civil Service Retirement, Military Retirement, Medicare, and Unemployment Insurance Trust Funds.

\3\ Primarily interest on loans to the public.

\4\ Earnings on private investments by the National Railroad Retirement Investment Trust.

\5\ Differs from gross Federal debt primarily because it excludes most debt issued by agencies other than the Treasury. The current debt limit is $6,400 billion.


    TABLE 6.--COMPARISON OF CBO'S MARCH 2003 BASELINE AND THE ADMINISTRATION'S FEBRUARY 2003 CURRENT-SERVICES
                                                    BASELINE
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                                         Total,
                                                   2003     2004     2005     2006     2007     2008   2004-2008
----------------------------------------------------------------------------------------------------------------
                                            CBO's March 2003 Baseline

Revenues
    On-budget..................................    1,360    1,466    1,617    1,741    1,853    1,963      8,640
    Off-budget.................................      532      558      588      619      651      685      3,101
                                                ----------------------------------------------------------------
        Total..................................    1,891    2,024    2,205    2,360    2,504    2,647     11,741
Outlays
    Discretionary..............................      805      837      854      868      886      911      4,356
    Mandatory..................................    1,177    1,223    1,277    1,332    1,403    1,484      6,720
    Net interest...............................      155      164      197      217      224      226      1,027
                                                ----------------------------------------------------------------
        Total..................................    2,137    2,224    2,328    2,417    2,513    2,621     12,103
            On-budget..........................    1,768    1,839    1,935    2,010    2,093    2,187     10,063
            Off-budget.........................      369      385      393      407      420      434      2,040
Deficit (-) or Surplus
    On-budget..................................     -408     -373     -317     -269     -240     -224     -1,423
    Off-budget.................................      163      173      195      212      231      250      1,061
                                                ----------------------------------------------------------------
        Total..................................     -246     -200     -123      -57       -9       27       -362

                            Administration's February 2003 Current-Services Baseline

Revenues
    On-budget..................................    1,335    1,475    1,646    1,738    1,825    1,919      8,603
    Off-budget.................................      532      556      590      615      644      673      3,078
                                                ----------------------------------------------------------------
        Total..................................    1,867    2,031    2,235    2,352    2,469    2,593     11,681
Outlays
    Discretionary..............................      785      795      813      825      843      862      4,138
    Mandatory..................................    1,185    1,221    1,269    1,318    1,387    1,465      6,660
    Net interest...............................      161      173      193      205      211      214        996
                                                ----------------------------------------------------------------
        Total..................................    2,131    2,189    2,276    2,348    2,440    2,541     11,794
            On-budget..........................    1,760    1,805    1,883    1,944    2,024    2,112      9,768
            Off-budget.........................      371      384      393      403      416      430      2,026
Deficit (-) or Surplus
    On-budget..................................     -425     -330     -237     -207     -199     -192     -1,166
    Off-budget.................................      160      172      197      211      228      243      1,052
                                                ----------------------------------------------------------------
        Total..................................     -264     -158      -40        5       29       51       -114

                                      Difference (CBO minus Administration)

Revenues
    On-budget..................................       24       -9      -29        3       29       44         38
    Off-budget.................................        *        2       -2        4        7       11         23
                                                ----------------------------------------------------------------
        Total..................................       24       -7      -30        7       35       55         60
Outlays
    Discretionary..............................       20       42       40       43       44       49        218
    Mandatory..................................       -8        2        8       14       16       19         60
    Net interest...............................       -6      -10        3       12       13       11         31
                                                ----------------------------------------------------------------
        Total..................................        6       35       52       69       73       79        309
            On-budget..........................        8       34       51       65       69       75        295
            Off-budget.........................       -2        1        1        4        4        4         14
Deficit or Surplus
    On-budget..................................       16      -42      -80      -62      -41      -31       -257
    Off-budget.................................        2        1       -2        *        3        7          9
                                                ----------------------------------------------------------------
        Total..................................       18      -42      -82      -62      -38      -25       -248
----------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office; Office of Management and Budget.

Note: * = between zero and $500 million.


   TABLE 7.--SOURCES OF DIFFERENCES BETWEEN CBO'S AND THE ADMINISTRATION'S ESTIMATES OF THE PRESIDENT'S BUDGET
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                                         Total,
                                                   2003     2004     2005     2006     2007     2008   2004-2008
----------------------------------------------------------------------------------------------------------------
                                            Administration's Estimate

Deficit Under the President's Budget...........     -304     -307     -208     -201     -178     -190     -1,084

                            Sources of Differences Between CBO and the Administration

Revenues
    Baseline differences.......................       24       -7      -30        7       35       55         60
    Policy differences.........................       -4       -8       -5        3        *       -2        -13
                                                ----------------------------------------------------------------
                Total Revenue Differences......       20      -15      -35       10       35       52         47
Outlays
    Discretionary..............................       13       17       -1       -3       -3       -4          7
    Mandatory
        Baseline differences...................       -8        2        8       14       17       19         60
        Policy differences.....................        3        7       13        4        4        3         30
            Subtotal, mandatory................       -5        9       21       18       21       21         90
    Net interest...............................       -6      -10        6       12       12       11         31
                                                ----------------------------------------------------------------
                Total Outlay Differences.......        3       16       26       27       30       28        128
All Differences................................       18      -31      -62      -17        6       24        -80

                                                 CBO's Estimate

Deficit Under the President's Budget...........     -287     -338     -270     -218     -173     -166     -1,164
Memorandum:
Economic Differences
    Revenues...................................      -10      -13        2       26       46       60        121
    Outlays....................................        *       -1       10       23       29       31         93
                                                ----------------------------------------------------------------
                Total..........................       -9      -12       -9        2       17       29         28
Technical Differences
    Revenues...................................       30       -2      -37      -16      -11       -8        -73
    Outlays....................................        3       17       16        4        *       -2         35
                                                ----------------------------------------------------------------
                Total..........................       27      -18      -53      -20      -11       -5       -108
----------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office; Joint Committee on Taxation.

Note: * = between -$500 million and $500 million.


                                      TABLE 8.--CBO'S ESTIMATE OF THE EFFECT OF THE PRESIDENT'S BUDGETARY PROPOSALS
                                                                [In billions of dollars]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                                                                                      Total,     Total,
                                   2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
--------------------------------------------------------------------------------------------------------------------------------------------------------
Baseline Deficit (-) or Surplus     -246     -200     -123      -57       -9       27       61       96      231      405      459       -362        891
 as Projected in March 2003 by
 CBO...........................
Effect of the President's
 Revenue Proposals
    Extend expiring EGTRRA             *       -1       -1       -1       -1       -2       -2       -2     -134     -224     -234         -5       -602
     provisions................
    Provide dividend exclusion.       -8      -23      -26      -29      -32      -36      -39      -44      -48      -52      -59       -147       -388
    Accelerate individual            -25      -78      -51      -27      -19      -15      -12       -8       -1        0        0       -190       -211
     income tax cuts...........
    Extend experimentation             0       -1       -3       -4       -5       -6       -7       -7       -7       -8       -8        -19        -56
     credit....................
    Increase AMT exemption.....       -1       -9      -14      -13        0        0        0        0        0        0        0        -36        -36
    Increase expensing for            -1       -3       -3       -3       -3       -3       -3       -2       -2       -2       -2        -15        -27
     small businesses..........
    Provide deduction for long-        0        *        *       -1       -1       -2       -2       -2       -3       -3       -3         -4        -18
     term care insurance.......
    Provide charitable                 *       -1       -1       -1       -1       -1       -2       -2       -2       -2       -2         -7        -15
     contribution deduction for
     nonitemizers..............
    Provide tax credit for             0        *        *        *       -1       -1       -2       -2       -3       -3       -3         -2        -15
     affordable single-family
     housing...................
    Provide refundable health          0        *       -1       -1       -1       -1       -1       -1       -2       -2       -2         -5        -13
     insurance credit..........
    Expand tax-free savings....        2        3        3        3        1        *       -2       -3       -4       -4       -5         10         -7
    Extend AMT treatment of            0        *        *        *        0        0        0        0        0        0        0         -1         -1
     nonrefundable personal
     credits...................
    Other proposals\1\.........       -1       -5       -7       -7       -7       -7       -7       -7       -7       -6       -6        -32        -66
                                ------------------------------------------------------------------------------------------------------------------------
                Total Revenue        -35     -117     -105      -87      -71      -74      -78      -81     -212     -307     -324       -454     -1,455
                 Effect........
Effect of the President's
 Outlay Proposals
    Discretionary spending
        Defense................        0       -1        2        8       13       22       28       32       34       36       38         44        211
        Nondefense.............        0        *       -7       -9      -10      -11      -11      -13      -14      -16      -17        -37       -108
            Subtotal,                  0       -1       -4       -1        2       11       17       19       20       20       21          7        104
             discretionary.....
    Mandatory spending
        Medicare\2\............        0        6       10       33       38       43       46       49       53       58       64        130        400
        Medicaid and SCHIP\3\..        0        8        7        9        8        9        9        9        8        4        1         40         72
        Health care tax credit.        0        0        5        6        6        6        6        6        6        5        5         23         51
        Earned income and child        4        1        5        4        4        4        4        2        *       11       11         17         45
         tax credits...........
        Postal Service.........        3        3        3        3        3        4        4        4        5        5        5         15         38
        Unemployment insurance.        0        0        0        *        1        2        3        3        3        3        3          2         17
        Reemployment benefits..        0        3        1        0        0        0        0        0        0        0        0          4          4
        Customs fees...........        0       -1       -1       -2       -2       -2       -2       -2       -2       -2       -2         -8        -18
        ANWR...................        0        0        0       -2        *        *        *        *        *        *        *         -2         -2
        Spectrum auctions......        0        0        *        *        2        2        *       -1       -1       -3       -3          5         -2
        Other..................       -2        1        4        3        2        1        1        1        1        1        1         11         17
            Subtotal, mandatory        6       20       33       55       63       68       70       72       73       83       86        239        621
        Net interest...........        *        3       13       20       28       39       50       65       80      102      131        103        530
                Total Outlay           6       21       42       74       93      118      136      156      173      205      237        348      1,255
                 Effect........
Total Impact on the Surplus....      -41     -138     -147     -161     -164     -192     -214     -237     -385     -511     -561       -802     -2,710
Deficit Under the President's       -287     -338     -270     -218     -173     -166     -153     -141     -154     -106     -102     -1,164     -1,820
 Proposals.....................
--------------------------------------------------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office; Joint Committee on Taxation.

Notes: * = between -$500 million and $500 million; EGTRRA = Economic Growth and Tax Relief Reconciliation Act of 2001; AMT = alternative minimum tax;
  SCHIP = State Children's Health Insurance Program; ANWR = Arctic National Wildlife Refuge.

Estimates of most of the revenue proposals were provided by the Joint Committee on Taxation and are preliminary.
\1\ Includes interaction effect from enacting all provisions together.

\2\ CBO did not have enough detail to make an independent estimate of the allowance for modernizing Medicare. Instead, it used the estimate contained in
  the President's budget.

\3\ CBO did not have enough detail to make an independent estimate of the proposal to allow states to convert their funding for Medicaid and SCHIP into
  a block grant. Instead, it calculated the cost of the proposal as the difference between the Administration's estimate of total spending for Medicaid
  and SCHIP (for states assumed to choose the grants) and CBO's baseline estimate.


TABLE 9.--COMPARISON OF DISCRETIONARY BUDGET AUTHORITY ENACTED FOR 2003 AND THE PRESIDENT'S REQUEST FOR 2004, BY
                                                 BUDGET FUNCTION
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                        Increase or Decrease (-)
                                                                  2003         2004    -------------------------
                       Budget Function                          Enacted      Request    Billions of
                                                                                          Dollars      Percent
----------------------------------------------------------------------------------------------------------------
Defense Discretionary.......................................        392.1        400.1          7.9          2.0
Nondefense Discretionary
    International affairs...................................         25.4         28.7          3.2         12.8
    General science, space, and technology..................         23.0         23.5          0.4          1.8
    Energy..................................................          3.2          3.7          0.5         15.2
    Natural resources and environment.......................         29.2         27.9         -1.3         -4.4
    Agriculture.............................................          5.7          5.3         -0.4         -7.6
    Commerce and housing credit\1\..........................          0.2         -0.5         -0.6         n.a.
    Transportation..........................................         22.6         22.7          0.1          0.4
    Community and regional development......................         11.7         14.2          2.5         21.1
    Education, training, employment, and social services....         72.9         77.5          4.6          6.3
    Health..................................................         49.5         49.6          0.2          0.3
    Medicare (Administrative costs).........................          3.8          3.7         -0.1         -1.6
    Income security.........................................         44.0         45.8          1.8          4.1
    Social Security (Administrative costs)..................          3.8          4.3          0.4         11.7
    Veterans benefits and services..........................         26.5         28.2          1.6          6.1
    Administration of justice...............................         36.3         34.2         -2.1         -5.8
    General government......................................         15.7         17.8          2.1         13.2
        Total Nondefense....................................        373.7        386.6         12.9          3.5
Total Discretionary.........................................        765.8        786.6         20.8          2.7
Memorandum:
Department of Homeland Security.............................         21.3         27.1          5.8         27.5
Transportation Obligation Limitations.......................         41.3         39.6         -1.7         -4.1
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: n.a. = not applicable.

\1\ Includes certain receipts (such as those from loan guarantees made by the Federal Housing Administration's
  Mutual Mortgage Insurance Program) and other collections (such as those from the Securities and Exchange
  Commission) that are recorded as negative budget authority and outlays.


                                                        TABLE 10.--DISCRETIONARY SPENDING UNDER THE PRESIDENT'S BUDGET AND CBO'S BASELINE
                                                                                    [In billions of dollars]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Actual                                                                                                       Total,     Total,
                                                                  2002     2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     2013   2004-2008  2004-2013
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
                                                            CBO's Estimate of Discretionary Spending Under the President's Budget\1\

Budget Authority
    Defense...................................................      361      392      400      419      440      460      480      493      507      521      536      550      2,199      4,807
    Nondefense................................................      374      374      387      395      403      413      424      435      446      458      469      482      2,021      4,310
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................      735      766      787      814      842      872      904      928      953      979    1,005    1,032      4,220      9,117
Outlays
    Defense...................................................      349      386      401      414      425      438      462      480      497      516      523      543      2,140      4,698
    Nondefense................................................      385      418      435      436      441      451      460      472      484      496      508      521      2,223      4,705
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................      734      805      836      849      867      889      922      952      980    1,011    1,031    1,064      4,363      9,402

                                                                            CBO's Baseline for Discretionary Spending

Budget Authority
    Defense...................................................      361      392      402      412      423      434      446      459      471      485      498      512      2,117      4,543
    Nondefense................................................      374      374      389      398      409      420      431      443      455      468      481      494      2,047      4,388
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................      735      766      791      810      832      854      877      901      927      953      979    1,007      4,164      8,931
Outlays
    Defense...................................................      349      386      402      411      418      425      440      452      465      481      487      505      2,096      4,486
    Nondefense................................................      385      418      436      442      450      461      471      484      496      510      524      538      2,260      4,812
                                                               ---------------------------------------------------------------------------------------------------------------------------------
        Total.................................................      734      805      837      854      868      886      911      936      961      991    1,011    1,043      4,356      9,299
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: Discretionary outlays are usually higher than budget authority because of spending from the Highway Trust Fund and the Airport and Airways Trust Fund, which is subject to obligation
  limitations set in appropriation acts. The budget authority for such programs is provided in authorizing legislation and is not considered discretionary.

\1\ The President's budget specifies discretionary spending only through 2008. The numbers shown here for discretionary spending after 2008 under the President's budget are projections by CBO
  using its baseline rates of inflation.


  TABLE 11.--COMPARISON OF CBO'S AND THE ADMINISTRATION'S ESTIMATES OF THE EFFECT OF THE PRESIDENT'S BUDGETARY
                                                    PROPOSALS
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                     CBO             Administration       Difference (CBO minus
                                           --------------------------------------------      Administration)
                                                                                       -------------------------
                                              Total,     Total,     Total,     Total,   Total, 2004- Total, 2004-
                                            2004-2008  2004-2013  2004-2008  2004-2013      2008         2013
----------------------------------------------------------------------------------------------------------------
Total Baseline Deficit (-) or Surplus as         -362        891       -114       n.a.         -248         n.a.
 Projected in March 2003 by CBO...........
Effect of the President's Revenue
 Proposals
    Extend expiring EGTRRA provisions.....         -5       -602         -6       -498            1         -103
    Provide dividend exclusion............       -147       -388       -140       -360           -6          -28
    Accelerate individual income tax cuts.       -190       -211       -185       -214           -5            3
    Extend experimentation credit.........        -19        -56        -23        -68            4           12
    Increase AMT exemption................        -36        -36        -26        -26          -10          -10
    Increase expensing for small                  -15        -27         -8        -15           -7          -13
     businesses...........................
    Provide deduction for long-term care           -4        -18         -7        -28            2           10
     insurance............................
    Provide charitable contribution                -7        -15         -6        -13           -1           -2
     deduction for nonitemizers...........
    Provide tax credit for affordable              -2        -15         -2        -16            *            1
     single-family housing................
    Provide refundable health insurance            -5        -13         -3         -2           -2          -12
     credit...............................
    Expand tax-free savings...............         10         -7         15          2           -4           -9
    Extend AMT treatment of nonrefundable          -1         -1        -18        -18           17          -17
     personal credits.....................
    Other proposals\1\....................        -32        -66        -32        -52           -1          -14
                                           ---------------------------------------------------------------------
                Total Revenue Effect......       -454     -1,455       -441     -1,307          -13         -148
Effect of the President's Outlay Proposals
    Discretionary spending
        Defense...........................         44        211        111       n.a.          -67         n.a.
        Nondefense........................        -37       -108        108       n.a.         -145         n.a.
            Subtotal, discretionary.......          7        104        218       n.a.         -211         n.a.
    Mandatory spending
        Medicare\2\.......................        130        400        130        400            0            0
        Medicaid and SCHIP\3\.............         40         72         10         -3           30           75
        Health care tax credit............         23         51         31         88           -7          -37
        Earned income and child tax                17         45         18         50           -1           -4
         credits..........................
        Postal Service....................         15         38          9         31            6            7
        Unemployment insurance............          2         17          2         17            *            *
        Reemployment benefits.............          4          4          2          2            2            2
        Customs fees......................         -8        -18         -8        -19            *            1
        ANWR (Net of payments to Alaska)..          *          *         -1         -2            1            1
        Spectrum auctions.................          5         -2          5         -4            1            2
        Other.............................          9         15         11          8           -1            8
            Subtotal, mandatory...........        239        621        209        568           30           54
    Net interest..........................        103        530        102       n.a.            *         n.a.
                                           ---------------------------------------------------------------------
                Total Outlay Effect.......        348      1,255        529       n.a.         -181         n.a.
Total Impact on the Surplus...............       -802     -2,710       -970       n.a.          168         n.a.
Total Deficit Under the President's            -1,164     -1,820     -1,084       n.a.          -80         n.a.
 Proposals................................
Memorandum:
Economic Growth Package\4\
    Effect on revenues....................       -388       -663       -359       -615          -28          -48
    Effect on outlays.....................         22         27         20         27            1            *
----------------------------------------------------------------------------------------------------------------
Sources: Congressional Budget Office; Joint Committee on Taxation; Office of Management and Budget.

Note: * = between -$500 million and $500 million; n.a. = not applicable; EGTRRA = Economic Growth and Tax Relief
  Reconciliation Act of 2001; AMT = alternative minimum tax; SCHIP = State Children's Health Insurance Program;
  ANWR = Arctic National Wildlife Refuge.

\1\ Includes interaction effect from enacting all provisions together.
\2\ CBO did not have enough detail to make an independent estimate of the allowance for modernizing Medicare.
  Instead, it used the estimate contained in the President's budget.
\3\ CBO did not have enough detail to make an independent estimate of the proposal to allow states to convert
  their funding for Medicaid and SCHIP into a block grant. Instead, it calculated the cost of the proposal as
  the difference between the Administration's estimate of total spending for Medicaid and SCHIP (for states
  assumed to choose the grants) and CBO's baseline estimate.
\4\ Includes seven provisions affecting revenues: acceleration of the 10 percent individual income tax bracket
  expansion, acceleration of the reduction in individual income tax rates, acceleration of marriage-penalty
  relief, acceleration of the increase in the child tax credit, elimination of double taxation of corporate
  earnings, increase in expensing for small businesses, and provision of alternative minimum tax relief to
  individuals. Also includes two provisions affecting outlays: personal reemployment accounts and the refundable
  portion of the child tax credit.


TABLE 12.--COMPARISON OF CBO'S, THE ADMINISTRATION'S, AND PRIVATE-SECTOR
        ECONOMIC PROJECTIONS FOR CALENDAR YEARS 2003 THROUGH 2008
------------------------------------------------------------------------
                                               Forecast       Projected
                                 Estimate ------------------    Annual
                                   2002                        Average,
                                             2003     2004    2005-2008
------------------------------------------------------------------------
Nominal GDP (Billions of
 dollars)
    CBO........................    10,443   10,880   11,465   \1\ 14,154
    Administration.............    10,442   10,884   11,447   \1\ 13,919
    March Blue Chip............    10,446   10,948   11,499         n.a.
Nominal GDP (Percentage change)
    CBO........................       3.6      4.2      5.4          5.4
    Administration.............       3.6      4.2      5.2          5.0
    March Blue Chip............       3.6      4.3      5.5      \2\ 5.4
Real GDP (Percentage change)
    CBO........................       2.4      2.5      3.6          3.2
    Administration.............       2.4      2.9      3.6          3.3
    March Blue Chip............       2.5      2.6      3.6      \2\ 3.2
GDP Price Index (Percentage
 change)
    CBO........................       1.1      1.6      1.7          2.1
    Administration.............       1.1      1.3      1.5          1.7
    March Blue Chip............       1.1      1.6      1.8      \2\ 2.2
Consumer Price Index
 (Percentage change)
    CBO........................       1.6      2.3      2.2          2.5
    Administration.............       1.6      2.2      2.1          2.2
    March Blue Chip............       1.6      2.3      2.3      \2\ 2.6
Unemployment Rate (Percent)
    CBO........................       5.8      5.9      5.7          5.3
    Administration.............       5.8      5.7      5.5          5.1
    March Blue Chip............       5.8      5.9      5.6      \2\ 5.2
10-Year Treasury Note Rate
 (Percent)
    CBO........................       4.6      4.4      5.2          5.8
    Administration.............       4.6      4.2      5.0          5.5
    March Blue Chip............       4.6      4.2      5.1      \2\ 5.7
Tax Bases\4\ (Percentage of
 GDP)
  Corporate book profits
    CBO........................       6.2      6.8      7.3          9.2
    Administration.............       6.3      7.1      7.2          8.4
Wages and salaries
    CBO........................      48.1     48.1     48.1         48.0
    Administration.............      48.1     48.5     48.7         48.7
Tax Bases\4\ (Billions of
 dollars)
  Corporate book profits
    CBO........................       653      739      842    \1\ 1,267
    Administration.............       659      771      830    \1\ 1,120
  Wages and salaries...........
    CBO........................     5,025    5,237    5,518    \1\ 6,782
    Administration.............     5,021    5,275    5,575    \1\ 6,757
------------------------------------------------------------------------
Sources: Congressional Budget Office; Office of Management and Budget;
  Aspen Publishers, Inc., Blue Chip Economic Indicators (March 10,
  2003); Department of Commerce, Bureau of Economic Analysis; Federal
  Reserve Board; Department of Labor, Bureau of Labor Statistics.

Notes: Percentage changes are year over year.

n.a. = not applicable.
Since the publication of an interim version of this report earlier this
  month, this table has been updated to include figures from the March
  Blue Chip survey.
\1\ Level in 2008.
\2\ Based on the 2005-2009 period.
\3\ The consumer price index for all urban consumers.
\4\ The Blue Chip survey does not include projections of tax bases.


                 TABLE 13.--CBO'S ESTIMATES OF THE EFFECTIVE MARGINAL FEDERAL TAX RATES ON LABOR
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                                     Tax Rates
                                                     Tax Rates         Under        Percentage-     Percentage
                  Calendar Year                    Under Current    President's        Point          Change
                                                        Law           Budget        Difference
----------------------------------------------------------------------------------------------------------------
2003                                                        30.0            28.2            -1.8            -5.9
2004                                                        29.7            28.4            -1.3            -4.3
2005                                                        29.7            28.5            -1.1            -3.8
2006                                                        29.2            29.2            -0.1            -0.3
2007                                                        29.5            29.5               0               0
2008                                                        29.7            29.7               0               0
2009                                                        29.7            29.7               0               0
2010                                                        30.2            30.2               0               0
2011                                                        32.0            30.5            -1.5            -4.6
2012                                                        32.0            30.5            -1.5            -4.6
2013                                                        32.4            31.0            -1.3            -4.1
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: Includes Federal individual income taxes and payroll taxes.


                TABLE 14.--CBO'S ESTIMATES OF THE EFFECTIVE MARGINAL FEDERAL TAX RATES ON CAPITAL
                                                  [In percent]
----------------------------------------------------------------------------------------------------------------
                                                                     Tax Rates
                                                     Tax Rates         Under        Percentage-     Percentage
                  Calendar Year                    Under Current    President's        Point          Change
                                                        Law           Budget        Difference
----------------------------------------------------------------------------------------------------------------
2003                                                        13.8            12.6            -1.2            -8.5
2004                                                        13.7            12.6            -1.1            -8.1
2005                                                        13.7            12.6            -1.1            -8.2
2006                                                        13.5            12.5            -0.9            -6.9
2007                                                        13.5            12.5            -0.9            -7.0
2008                                                        13.5            12.5            -1.0            -7.1
2009                                                        13.5            12.5            -1.0            -7.1
2010                                                        13.5            12.5            -1.0            -7.2
2011                                                        14.1            12.6            -1.5           -10.5
2012                                                        14.1            12.6            -1.5           -10.5
2013                                                        14.1            12.6            -1.5           -10.6
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: Includes Federal individual and corporate income taxes.


  TABLE 15.--CBO'S ESTIMATES, FROM SUPPLY-SIDE MODELS, OF THE EFFECT OF
   THE PRESIDENT'S BUDGETARY PROPOSALS ON REAL GROSS DOMESTIC PRODUCT
             [Average percentage change from CBO's baseline]
------------------------------------------------------------------------
                                                    2004-2008  2009-2013
------------------------------------------------------------------------
                    Without Forward-Looking Behavior

Textbook Growth Model.............................       -0.2       -0.7

                      With Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.3       -1.5
    Higher taxes after 2013.......................        0.5        0.3
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.6       -0.5
    Higher taxes after 2013.......................        0.3        0.6
Infinite-Horizon Growth Model
    Lower government consumption after 2013.......        0.2       -0.6
    Higher taxes after 2013.......................        0.9        1.4
Memorandum: Effect on Real Gross National Product
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.......       -0.8       -2.0
    Higher taxes after 2013.......................        0.3          0
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: The ``textbook'' growth model is an enhanced version of a model
  developed by Robert Solow, a pioneer of growth-accounting theory. For
  a detailed description of the model, see Congressional Budget Office,
  CBO's Method for Estimating Potential Output: An Update (August 2001).
  The life-cycle growth model, developed by CBO, is described in
  Shinichi Nishiyama and Kent Smetters, ``Consumption Taxes and Economic
  Efficiency in a Stochastic OLG Economy,'' Technical Paper 2002-6
  (December 2002), available from CBO's Macroeconomic Analysis Division
  or at www.cbo.gov/tech.cfm. The infinite horizon growth model is an
  enhanced version of a model first developed by Frank Ramsey; see
  Robert J. Barro and Xavier-I-Martin, Economic Growth (New York: McGraw-
  Hill, 1995). The three models reflect a wide range of assumptions
  about the extent to which people are forward-looking in their
  behavior: in the textbook model, their foresight is the least, while
  in the infinite horizon model, it is perfect and extends infinitely to
  include a full consideration of effects on descendants.
In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.
Real gross domestic product (GDP) is GDP adjusted for inflation.


 TABLE 16.--CBO'S ESTIMATES, FROM SUPPLY-SIDE MODELS, OF THE CUMULATIVE
              BUDGETARY IMPACT OF THE PRESIDENT'S PROPOSALS
                        [In billions of dollars]
------------------------------------------------------------------------
                                                 2004-2008    2009-2013
------------------------------------------------------------------------
Conventional Estimate of the President's               -802       -1,908
 Proposals\1\.................................

Budgetary Cost of the President's Proposals with Macroeconomic Feedbacks

Textbook Growth Model.........................         -847       -2,126
Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013...         -846       -2,194
    Higher taxes after 2013...................         -745       -1,817
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013...         -880       -2,013
    Higher taxes after 2013...................         -753       -1,760
Infinite-Horizon Growth Model
    Lower government consumption after 2013...         -775       -1,989
    Higher taxes after 2013...................         -680       -1,587

     Budgetary Savings or Cost (-) from Macroeconomic Feedbacks as a
               Percentage of the Conventional Estimate\2\

Textbook Growth Model.........................           -6          -11
Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013...           -6          -15
    Higher taxes after 2013...................            7            5
Open-Economy Life-Cycle Growth Model
    Lower government consumption after 2013...          -10           -5
    Higher taxes after 2013...................            6            8
Infinite-Horizon Growth Model
    Lower government consumption after 2013...            3           -4
    Higher taxes after 2013...................           15           17
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: The ``textbook'' growth model is an enhanced version of the model
  developed by Robert Solow, a pioneer of growth-accounting theory. For
  a detailed description of the model, see Congressional Budget Office,
  CBO's Method for Estimating Potential Output: An Update (August 2001).
  The life-cycle growth model, developed by CBO, is described in
  Shinichi Nishiyama and Kent Smetters, ``Consumption Taxes and Economic
  Efficiency in a Stochastic OLG Economy,'' Technical Paper 2002-6
  (December 2002), available from CBO's Macroeconomic Analysis Division
  or at www.cbo.gov/tech.cfm. The infinite horizon growth model is an
  enhanced version of a model first developed by Frank Ramsey; see
  Robert J. Barro and Xavier-I-Martin, Economic Growth (New York: McGraw-
  Hill, 1995). The three models reflect a wide range of assumptions
  about the extent to which people are forward-looking in their
  behavior: in the textbook model, their foresight is the least, while
  in the infinite horizon model, it is perfect and extends infinitely to
  include a full consideration of effects on descendants.

In models with forward-looking behavior, CBO had to make assumptions
  about how the President's budget would be financed after 2013. CBO
  chose two alternatives cutting government consumption or raising
  taxes.

\1\ CBO's estimate of the budgetary impact assuming no macroeconomic
  feedbacks.

\2\ A negative number means that the macroeconomic feedbacks are
  estimated to increase the budgetary cost; a positive number, that they
  are estimated to reduce it (or provide savings).


  TABLE 17.--CBO'S ESTIMATES OF THE EFFECTS OF THE PRESIDENT'S BUDGETARY PROPOSALS FROM MACROECONOMETRIC MODELS
                                     [Percentage change from CBO's baseline]
----------------------------------------------------------------------------------------------------------------
                                                                                                       Average,
                Type of Effect/Model                  2003    2004    2005    2006    2007    2008    2004-2008
----------------------------------------------------------------------------------------------------------------
                                         Nominal Gross Domestic Product

Supply-Side Contribution
    Macroeconomic Advisers.........................     0.3     0.1     0.2    -0.3    -0.3    -0.4         -0.1
    Global Insight.................................     0.2     0.4     0.3     0.2     0.1     0.2          0.2
Cyclical Contribution
    Macroeconomic Advisers.........................     0.1     1.3     1.6     1.9     1.2     0.9          1.4
    Global Insight.................................     0.3     1.1     1.7     2.1     2.6     2.9          2.1
Total Effect
    Macroeconomic Advisers.........................     0.4     1.4     1.7     1.6     0.9     0.5          1.2
    Global Insight.................................     0.5     1.5     2.0     2.3     2.6     3.1          2.3

                                Real (Inflation-Adjusted) Gross Domestic Product

Supply-Side Contribution
    Macroeconomic Advisers.........................     0.3       0       0    -0.5    -0.5    -0.6         -0.3
    Global Insight.................................     0.1     0.3     0.1    -0.2    -0.4    -0.6         -0.2
Cyclical Contribution
    Macroeconomic Advisers.........................     0.1     1.3     1.1     1.0    -0.1    -0.6          0.5
    Global Insight.................................     0.3     1.0     1.5     1.7     1.9     2.0          1.6
Total Effect
    Macroeconomic Advisers.........................     0.5     1.3     1.1     0.5    -0.6    -1.2          0.2
    Global Insight.................................     0.4     1.3     1.5     1.6     1.5     1.4          1.4

                                    Real Gross Private Domestic Investment\1\

Supply-Side Contribution
    Macroeconomic Advisers.........................     0.5    -3.9    -3.9    -5.7    -3.2    -3.8         -4.1
    Global Insight.................................     0.1    -1.1    -3.3    -4.8    -5.7    -6.2         -4.2
Cyclical Contribution
    Macroeconomic Advisers.........................     0.6     6.9     4.4     1.7    -5.2    -5.4          0.5
    Global Insight.................................     0.8     3.4     5.4     6.4     6.6     6.5          5.6
Total Effect
    Macroeconomic Advisers.........................     1.1     3.0     0.5    -4.0    -8.4    -9.2         -3.6
    Global Insight.................................     0.9     2.4     2.1     1.6     1.0     0.3          1.5

                                                   Employment

Supply-Side Contribution
    Macroeconomic Advisers.........................     0.2     0.4     0.2       0    -0.1       0          0.1
    Global Insight.................................     0.2     0.4     0.3     0.1    -0.1    -0.1          0.1
Cyclical Contribution
    Macroeconomic Advisers.........................       0     0.6     0.8     0.5       0    -0.5          0.3
    Global Insight.................................     0.1     0.6     1.0     1.2     1.3     1.2          1.1
Total Effect
    Macroeconomic Advisers.........................     0.3     1.0     1.0     0.6    -0.1    -0.5          0.4
    Global Insight.................................     0.3     0.9     1.3     1.3     1.2     1.1          1.2

                                                Real Consumption

Supply-Side Contribution
    Macroeconomic Advisers.........................     0.4     0.1       0    -0.2     0.1     0.1            0
    Global Insight.................................     0.2     0.5     0.6     0.7     0.8     0.8          0.7
Cyclical Contribution
    Macroeconomic Advisers.........................     0.1     1.2     1.1     0.9    -0.2    -0.7          0.4
    Global Insight.................................     0.3     1.0     1.3     1.3     1.4     1.4          1.3
Total Effect
    Macroeconomic Advisers.........................     0.5     1.3     1.1     0.7    -0.2    -0.6          0.5
    Global Insight.................................     0.5     1.4     1.9     2.0     2.2     2.2          2.0
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: The models, constructed by Macroeconomic Advisers and Global Insight (formerly DRI-WEFA), are designed
  primarily to capture short-run business-cycle developments. However, to estimate supply-side contributions,
  CBO incorporated assumptions that held the unemployment rate at its baseline level and thereby purged the
  simulations of cyclical effects.

\1\ Includes investment in business plants and equipment, housing, and inventories.



  TABLE 18.--CBO'S ESTIMATES OF THE BUDGETARY IMPACT OF THE PRESIDENT'S PROPOSALS FROM MACROECONOMETRIC MODELS
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                                         Total,
                                                   2003     2004     2005     2006     2007     2008   2004-2008
----------------------------------------------------------------------------------------------------------------
Baseline Deficit (-) or Surplus................     -246     -200     -123      -57       -9       27       -362
Conventional Estimate of the President's             -41     -138     -147     -161     -164     -192       -802
 Proposals\1\..................................
Deficit Under the President's Proposals\1\.....     -287     -338     -270     -218     -173     -166     -1,164
Additional Budgetary Impact from Macroeconomic
 Feedbacks
    Macroeconomic Advisers' model..............        7       21        8      -10      -40      -54        -75
    Global Insight's model.....................       11       31       38       46       53       63        231
Deficit Under the President's Proposals with
 Macroeconomic Feedbacks Incorporated
    Macroeconomic Advisers' model..............     -280     -318     -262     -228     -212     -219     -1,239
    Global Insight's model.....................     -275     -307     -232     -172     -120     -102       -933
Memorandum:
Budgetary Impact of the President's Proposals
 with Macroeconomic Feedbacks Incorporated
    Macroeconomic Advisers' model..............      -34     -118     -139     -171     -204     -246       -877
    Global Insight's model.....................      -29     -107     -109     -115     -111     -129       -571

   Budgetary Savings or Cost (-) from Macroeconomic Feedbacks as a Percentage of the Conventional Estimate\2\

Macroeconomic Advisers' Model..................       16       15        5       -6      -24      -28         -9
Global Insight's Model.........................       27       22       26       28       32       33         29
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: The models, constructed by Macroeconomic Advisers and Global Insight (formerly DRI-WEFA), are designed
  primarily to capture short-run business-cycle developments.
The results presented here reflect both supply-side and cyclical contributions.
\1\ Assumes no macroeconomic feedbacks.
\2\ A negative number means that macroeconomic feedbacks are estimated to increase the budgetary cost; a
  positive number, that they are estimated to reduce it (or provide savings).


TABLE 19.--CBO'S ESTIMATES OF THE BUDGETARY IMPACT OF THE PRESIDENT'S PROPOSALS FROM MACROECONOMETRIC MODELS, BY
                                             SOURCE OF CONTRIBUTION
                                            [In billions of dollars]
----------------------------------------------------------------------------------------------------------------
                                                                                                     Total, 2004-
                                                 2003    2004    2005    2006    2007       2008         2008
----------------------------------------------------------------------------------------------------------------
                                              Cyclical Contribution

Revenues
    Macroeconomic Advisers....................       8      29      40      43      34           29          175
    Global Insight............................       9      25      43      61      79           96          304
Outlays
    Macroeconomic Advisers....................       2       4      22      41      60           66          193
    Global Insight............................       0      -2       5       4       9           10           27
Deficit (-) or Surplus
    Macroeconomic Advisers....................       6      25      18       2     -26          -37          -18
    Global Insight............................       9      27      38      57      70           86          277

                                            Supply-Side Contribution

Revenues
    Macroeconomic Advisers....................       0      -1      -2      -3      -4           -4          -14
    Global Insight............................       3       7       4      -1      -5           -3            2
Outlays
    Macroeconomic Advisers....................       0       3       9      10       9           12           43
    Global Insight............................       1       3       4      10      12           20           48
Deficit (-) or Surplus
    Macroeconomic Advisers....................       0      -4     -11     -13     -13          -16          -57
    Global Insight............................       2       4       0     -11     -17          -23          -46

                                     Cyclical and Supply-Side Contributions

Revenues
    Macroeconomic Advisers....................       8      28      38      40      30           25          161
    Global Insight............................      12      32      47      60      74           93          306
Outlays
    Macroeconomic Advisers....................       1       7      30      50      70           79          236
    Global Insight............................       1       1       9      14      21           30           75
Deficit (-) or Surplus
    Macroeconomic Advisers....................       7      21       8     -10     -40          -54          -75
    Global Insight............................      11      31      38      46      53           63          231
----------------------------------------------------------------------------------------------------------------
Source: Congressional Budget Office.

Note: The models, constructed by Macroeconomic Advisers and Global Insight (formerly DRI-WEFA), are designed
  primarily to capture short-run business-cycle developments. To estimate supply-side contributions, CBO
  incorporated assumptions that held the unemployment rate at its baseline level and thereby purged the
  simulations of cyclical effects.

    Chairman Nussle. I thank you, Dr. Holtz-Eakin, for your 
presentation, and I know members will have questions. Let me 
start off with just a few.
    This is your first opportunity to give us advice in this 
kind of public setting. I know you have met with members before 
and have been able to give us your advice but you talked at the 
end there about usefulness. I would like to go back to that.
    After you have had a chance to see this and digest the 
analysis--and you have been able to far more than we have--what 
would be your advice on its usefulness? How should we look at 
the information that we obviously need to do some more study 
on, even more than we are going to have an opportunity to 
provide today; but what would your advice be to us on how we 
should use the information that you have just given us?
    Mr. Holtz-Eakin. Well, I think there are probably three 
real lessons here.
    Lesson No. 1 is, to the extent that Members want to have a 
gauge for the budgetary outlook, the conventional estimate and 
these dynamic estimates coincide to a degree that allows you to 
have the same feeling about the budgetary outlook both before 
and after the analysis. So the bottom line on budgetary impacts 
in this context is relatively small, and you can go forward and 
do your work in formulating a budget for the Congress.
    The second lesson, I think, answers the question why are 
the budgetary analyses roughly the same before and after 
macroeconomic impacts. That has to do with the fact that 
overall, these proposals are small relative to an economy the 
size of the United States', and Members should learn the lesson 
that to move an economy of this size requires a tremendous 
amount in the way of policy levers and will not be done easily.
    One can't minimize the importance of raising the long-term 
growth rate of the United States by even two-tenths of a 
percentage point. Over long periods of time, that makes 
enormous differences in the standard of living, but moving it 
by a number as large as 1 percentage point is outside the range 
of historical experience--very hard to do.
    The last lesson is to look at the impacts of the budget 
proposals as a whole. I suspect that many people have their 
favorite budget proposals. Others have proposals that they 
haven't studied in great detail. There is always a temptation 
to view a bit of the budget in isolation.
    This set of budget proposals as a whole has this small 
impact because, on balance, it is not purely progrowth. It 
doesn't provide incentives for savings and investing uniformly. 
It also provides incentives for greater consumption directly 
through outlays, through health insurance tax credits, which 
are designed to enhance consumption of health insurance, and 
through some of the impacts on the private sector, which will 
not be uniformly saved but will also be consumed. That 
composition is a guide to economic policymaking, given Members' 
objectives--growth is not the only one that you might have--but 
given your objectives, you can look at the results and discern 
why it is that there are small macroeconomic impacts.
    Chairman Nussle. Do you apply the same three lessons for 
the time frames? It appears from your presentation, you tend to 
have two different time frames--a short term, about a 5-year 
window, and then a longer term outside that 5-year window.
    Are the same three lessons applicable to both time frames?
    Mr. Holtz-Eakin. Because my focus in those remarks is on 
long-term supply side sources, the growth, the same lessons 
apply over either time period.
    Chairman Nussle. And that is probably the interesting part 
of this because certainly there have been those who have come 
forward suggesting that the economic growth package that the 
President provided did indeed provide economic growth.
    And I don't want to put words in your mouth, so I want you 
to tell me if I am saying this right: What you are suggesting 
in a little bit more--hopefully, a little bit more English than 
the way you stated it is--the economic growth package is 
providing economic growth, but the spending side, both short 
term and long term, is holding that back in some regard to the 
point where, because of the size of the economy, we are not 
seeing the kind of economic growth claimed because of all the 
excess spending. The fact that there are deficits outside the 
current services baseline, as an example, in the outyears is 
dampening any possible signal of economic growth that the tax 
package alone might provide.
    And that is what you are suggesting: You can't look at 
one--you can't look at the growth package without also looking 
at the government consumption spending package and combining 
them for analysis.
    Am I saying that--I know it is different than the way you 
said it, but is that another way of saying it, or am I getting 
that right in my understanding?
    Mr. Holtz-Eakin. I am disappointed that my first answer 
wasn't in English. Let me try again.
    Chairman Nussle. I didn't mean that in a disrespectful way.
    Mr. Holtz-Eakin. It is a continuing tale of an economist's 
life. I wouldn't point to particular proposals.
    I think the spirit of your comment is right. I don't have 
specific estimates, and it is not possible to extract specific 
estimates of the President's growth proposals here. I would say 
that there are proposals in the budget which have incentives 
for saving and investment, reductions in marginal tax rates, 
elimination of the phase-outs of personal exemptions and 
itemized deductions, and things of that nature.
    There are also proposals on the receipt side, tax proposals 
that enhance consumption; health insurance tax credits come to 
mind as an example of that. And there are effects on the outlay 
side which can affect consumption as well.
    My message is that what matters for growth is the balance 
and the net impact of receipts proposals and outlay proposals 
for society's incentives to consume now versus save for the 
future.
    Chairman Nussle. I think the only other thing I would ask 
is, where do we go from here? You have done this now. This is 
the first opportunity to provide this analysis. What should we 
be asking CBO to do next with regard to modeling or analysis as 
we move forward? What is the next best thing, from what you 
have seen from this analysis, that we could ask to you do or 
that you would be able to provide us?
    Mr. Holtz-Eakin. I guess I can answer that in two ways. The 
first is, it would be useful for the committee to reflect on 
the analysis, take some time to digest it. I apologize for the 
fact that it has appeared only today, but I would emphasize 
just how much work was required to get it done even for a 
hearing today.
    Take some time to digest it, and look for places where you 
believe we could sharpen the analysis, provide you more 
details, make it more useful to your eyes, the presentation or 
the analysis per se.
    The second thing is, we can always improve the quality of 
the modeling. This is the first time CBO has undertaken the 
analysis in this time frame with this objective of analyzing 
the full set of the President's proposals. To the extent that 
this became something that was desirable to do on a regular 
basis, we could enhance our ability to enter different features 
of budgetary proposals into formal models; that requires 
literally just time, effort, and some programming, and we would 
be able to deliver then what we think would be improved 
estimates of the kinds of impacts you might be interested in 
learning about.
    Chairman Nussle. Thank you.
    Mr. Spratt.
    Mr. Spratt. Thank you, Dr. Holtz-Eakin. Let me go through 
your testimony again if I can hit what are, to me, the 
highlights of it.
    On page 16 of your report, the updated analysis of the 
President's budgetary proposals, you say that the overall 
macroeconomic effects of the proposals contained in the 
President's budget are not obvious. On one hand, you indicate 
that they could lower marginal Federal tax rates on labor and 
capital; that would increase labor and capital. On the other 
hand, they could promote consumption and that would decrease 
capital investment.
    The two could amount to a wash; at least they don't result 
in a net effect that is likely to be dramatic, to use your 
word. Is that correct?
    Mr. Holtz-Eakin. That is correct.
    Mr. Spratt. In particular, putting it in numbers--well, 
first of all, you say the minus effect on the economy is not 
surprising. Taken together, the proposals would provide a 
relatively small impetus in an economy the size of the United 
States'.
    Then you go on to say, CBO estimates that the supply side 
effects, page 17, of the budgetary proposals could add as much 
as 10 percent to cumulative costs, or subtract as much as 15 
percent over the period 2004-08 and add as much as 15 or 
subtract as much as 17 from 2009-13.
    So you have got as much upside potential as downside 
potential. Am I reading you correctly?
    Mr. Holtz-Eakin. That reflects the range of estimates you 
saw in those charts.
    Mr. Spratt. Let's turn the page and look at figure No. 1 on 
page 18 of your report. And out of 1, 2, 3 what is that, 9 
models you have used.
    Mr. Holtz-Eakin. Combinations of models and financing 
assumptions.
    Mr. Spratt. As I understand it, you adapted each one of 
these to make it sensitive to variables in the Federal budget 
that could change from time to time.
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. You spent some time adapting them to your 
particular purposes.
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. But they are all over the lot. I mean, you have 
got data points above and below the line. It would seem to me, 
that long horizontal line which, I take it, is your deficit 
under the President's proposal, assuming no macroeconomic 
effects, looks to be about the trend line between--amongst all 
those data points.
    Mr. Holtz-Eakin.I guess what I would caution you in 
deciding that they are all over the lot is, it is not the case 
that we took nine different models which were designed to do 
the same thing and got nine different answers.
    We took nine different combinations of models and financing 
assumptions, each of which was designed to stress a different 
portion of the genuine economic landscape. And it is not 
surprising to me that one would get different answers from 
that.
    Mr. Spratt. Once again, this is the problem with dealing 
with models. You have to simplify your assumptions and 
premises; and some models reflect some things, other models 
reflect other things, depending on what the model was designed 
for, right?
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. Looking at the next chart, the bar chart--which 
is about our level of understanding; you are wise to use bar 
charts. But the President's budget is, in most cases, pretty 
close to what you have already determined it to be, using and 
assuming no macroeconomic feedback. I think that is figure No. 
1 you have got up there now. Figure No. 2 is a bar chart with 
the President's--there you go.
    Mr. Holtz-Eakin. These are the two charts I started my 
presentation with.
    Mr. Spratt. Once again, they all cluster around the no 
macroeconomic feedback line. You are not far off. If you use 
these as a model--excuse me, if you use these as a method of 
checking how well your own judgments were about how 
macroeconomic effects were going to be felt in the outyears, 
this would probably tell you your trend line was about where it 
should be, wouldn't it?
    Mr. Holtz-Eakin. I think what it actually tells you is that 
our trend line, which comes from building the President's 
proposals into the baseline. The baseline reflects the same 
kind of modeling that we use to analyze some of the President's 
proposals. Indeed, these are consensus growth models over long 
periods.
    Mr. Spratt. But what you have got there, if you ran each 
one of these models that--having run these models, would you 
now go back and change your analysis of the President's budget, 
your statement, what the likely deficit is out through the next 
10 years?
    Mr. Holtz-Eakin. We have no intention of changing the 
numbers in the interim report. Indeed, this has always been 
viewed as a supplement designed to give the committee some 
insight into the overall macroeconomic impacts of the budgetary 
proposals.
    Mr. Spratt. What I am saying is, when you look at the 
results, you are saying we are right there, we are close, we 
are right there in the middle of most of these models.
    Mr. Holtz-Eakin. We are.
    Mr. Spratt. Using the method we have got?
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. So, like Monsieur Jordan, you were speaking 
prose and didn't even know it.
    Is there anything in any of the modeling that suggests that 
a tax cut can pay for itself over a period of 10 years' time?
    Mr. Holtz-Eakin. There is nothing in this modeling that 
would identify feedback effects from any specific tax proposal 
or any outlay proposal. What you will see are the net effects 
of all the proposals and, indeed, in some cases, the net 
effects of the President's proposals plus assumptions about 
financing beyond the budget window.
    Mr. Spratt. If you had applied these same models to the 
2001 tax cut, do you have any idea what sort of results you 
would have gotten? Would it have been about the same?
    Mr. Holtz-Eakin. I have no idea. If you ask us to do that, 
the staff will kill me.
    Mr. Spratt. I am not asking you to do that. We know now, we 
have got the disaster right there on the wall.
    Let me call it quits and let others ask some questions. I 
will have some more. Let me give everyone an opportunity to ask 
some questions too.
    Chairman Nussle. Ms. Brown-Waite.
    Mr. Gutknecht.
    Mr. Gutknecht. Mr. Chairman, thank you.
    As one who has argued for a long time that we do more 
dynamic scoring, we are both thankful and somewhat surprised 
and humbled that your model doesn't give us better news than we 
had hoped for. But I think it does help confirm that the 
economy is a lot bigger than we sometimes think it is and more 
complicated than we sometimes think it is. And the things that 
we do here in Washington, I think--sometimes, while they have 
an impact, I think we--there is a bit of arrogance about 
budgetary policy and so forth.
    I do want to confirm what the chairman said and, I think, 
you said, and that is that, clearly, helping Americans keep 
more of what they earn probably helps grow the economy faster 
than if you take more of that money into government. But if you 
spend it, you just have to borrow it, it almost has an equal 
drag effect.
    I want to focus just for a minute on looking outside of the 
box, because I think we focus so much on just tax and spending 
issues around this town that we forget there are a whole lot of 
things that we do here in Washington that ultimately can have, 
in many opinions, as big if, perhaps, not even a bigger impact 
on the overall economy.
    Let me give you a couple of examples, one specifically; and 
that is, for example, we passed here in the House about a week 
and a half ago a bill to limit tort liability as it related to 
malpractice. Some people have said that that actually could 
benefit the cost of health care in the United States by $30 
billion. Some people have said that if we pass total tort 
liability reform along the lines that many States have, that we 
can actually save the economy another $100 billion.
    One of the things I want to focus on this morning is--I 
need your help because of one of the issues I have been 
involved with--the high cost of prescription drugs in the 
United States. I put out a little brochure--I will give you one 
before you leave--and on the cover it says, ``If we want to 
allow Americans to keep and spend more than $600 billion over 
the next 10 years, here's a good place to start.'' It has got a 
picture of prescription drug bottles.
    On the inside, I actually quote from a study which CBO did, 
I believe late last fall, where they estimated over the next 10 
years, seniors, just seniors, people 65 and older, will spend 
over $1.8 trillion on prescription drugs. And this isn't my 
estimate, but an estimate by experts who, I think, are smarter 
than I am, who have actually done analysis of what Americans 
pay and what Europeans pay and Japanese pay and the rest of the 
industrialized world, all the G-7 countries what we pay versus 
what they pay for exactly the same drugs.
    Their estimate is, we could save at least 35 percent if we 
simply did with prescription drugs what we do with virtually 
every other product, and that is, allow open markets. And the 
estimate that works out to, if we save 35 percent, by a 
conservative estimate, 35 percent--I am not a good 
mathematician; 35 percent of $1.8 trillion is $630 billion.
    What I want you to do for us before the next several 
weeks--because we are going to get into this whole debate of 
whether or not we should have a prescription drug as part of 
Medicare--I would like to have CBO do a real analysis of what 
they believe, irrespective of what the FDA may say and what 
some of the henny-penny-the-sky-is-falling crowd would say. We 
need to get an honest analysis of what we actually could save; 
we would like to use CBO as the backdrop for that.
    Because I think it may actually be more than $630 billion. 
As a matter of fact, there were some experts in my office last 
week who said, for example, one of the most commonly prescribed 
drugs in America is Glucophage; and the average price for a 30-
day supply in America is $124.65. In Europe, that price is $22. 
But this expert told me last week in some parts of the world 
you can buy it for as little as $5. Those are huge differences.
    It seems to me we have got to begin to look at all of these 
areas if we want to have a stronger economy. So I am going to 
leave this with you. If you want to comment on that, you are 
more than welcome to. But I am going to ask specifically for 
CBO to give us some honest analysis of how much we could save 
if we simply open up markets.
    Yield back.
    Chairman Nussle. Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman. I just had a couple of 
questions. All these calculations about the upcoming deficits, 
was any calculation put in for the cost of the war?
    Mr. Holtz-Eakin. No.
    Mr. Scott. Where would those numbers go?
    Mr. Holtz-Eakin. Those would formally be entered into the 
outlay side of the various economic models.
    Mr. Scott. Has any proposal been made to offset the cost 
with additional revenues, to your knowledge?
    Mr. Holtz-Eakin. CBO is unaware of any proposals.
    Mr. Scott. So is it fair to say it would all go to 
increased deficit and increased interest?
    Mr. Holtz-Eakin. In the absence of a proposal, I don't know 
how it would be done.
    What the analysis shows are the implications of the 
President's budgetary proposals as they were delivered to us in 
February. And the nature of policies outside that, that set of 
proposals, is impossible for me to speculate on.
    Mr. Scott. Does your calculation include any fix for the 
AMT?
    Mr. Holtz-Eakin. No. We have strictly the current baseline, 
which would include whatever AMT increase we would see in the 
future, and then the President's proposals, which include some 
provisions for the AMT as related to acceleration of the 
marginal tax rate reductions but nothing beyond that.
    Mr. Scott. And do you have a calculation as to what it 
would cost to fix the AMT so that only a small portion of 
people would be paying it and not the vast majority?
    Mr. Holtz-Eakin. I do not. The Joint Committee on Taxation 
would be probably the best source of such a calculation.
    Mr. Scott. Do you know--when we voted on the tax cuts a 
couple of years ago, we were told that it would increase jobs. 
That didn't happen. Do you know what was wrong with the model 
projections that we were given in 2001?
    Mr. Holtz-Eakin. I am not familiar with exactly what you 
are referring to.
    Mr. Scott. It was my understanding that voting for the 
budget 2 years ago would create jobs and help the economy.
    Mr. Holtz-Eakin. CBO didn't have an analysis of a 
particular model that I am aware of.
    Mr. Scott. We have just heard a little bit about health 
care. The budget includes increases and outlays for Medicare 
that apparently do not meet the health care inflation. What 
happens to the health care expenses if we don't meet health 
care inflation with our increases in Medicare?
    Mr. Holtz-Eakin. The budgetary proposals that we analyzed 
included the number $400 billion. There was not a policy 
description that came with it for the President's proposals on 
Medicare--and beyond that, it is simply the Medicare baseline 
as laid out in our January projections. I would be happy to go 
through that.
    Mr. Scott. Did the President's budget meet your baseline on 
Medicare?
    Mr. Holtz-Eakin. The President's budgetary proposals would 
have been in addition to our baseline. They are additional 
outlays.
    Mr. Scott. That was the prescription drug benefit?
    Mr. Holtz-Eakin. It was $400 billion for prescription drugs 
and Medicare modernization; but we don't have policy details, 
so we took the $400 billion as a number at face value and 
implemented it.
    Mr. Scott. Do you expect to be able to pay the expenses 
that are incurred by senior citizens with the President's 
budget?
    Mr. Holtz-Eakin. I am not sure I can answer that question. 
The analysis of the budget as a whole doesn't really reveal 
that.
    Mr. Scott. Thank you.
    Yield back.
    Chairman Nussle. Mr. Hastings.
    Mr. Hastings. Thank you, Mr. Chairman.
    And thank you for being here today for, I guess, this new 
adventure that we are working on. I want to make just a couple 
of observations and then ask you a specific question on the tax 
policy.
    The chairman pointed out in his opening remarks that this 
is the President's budget, and yet the House has already acted 
on their own budget, and the Senate presumably will act very 
soon on their own budget, neither of which are very similar to 
this. So your caution to us about not looking at the numbers, I 
think, is taken very well.
    The second point I want to make is that I think we all know 
that anticipating revenues and expenditures in the future is a 
very inexact science. It is something that probably any number 
of forecasters have missed a lot. For example--and this is not 
any criticism of CBO, but I think, in the last 5 years, your 
projections were off by something like 3 percent of GDP, which 
is a pretty high number. I am not saying it as a criticism; I 
am saying, when you forecast ahead, it is a very inexact 
science, and it is a difficult thing to get your arms around.
    But what I would like to talk about and ask you, because I 
just briefly glanced at your report and haven't had a chance to 
look at all of it is, specifically, on the President's tax 
relief proposals, where a number of private forecasters have 
suggested that if these go into effect, then we will indeed 
have lower employment, more investment and so forth. And I am 
making the assumption, just hearing your exchange with Mr. 
Spratt, that at least you have a difference of opinion on that.
    I won't say anything. Just tell me--comment specifically on 
where private forecasters have suggested this will be very 
beneficial to the economy, where are you? Like that, or are you 
different? Comment on that, if you would.
    Mr. Holtz-Eakin. If I may, I will comment on three things.
    On that, specifically, I haven't seen the private sector 
forecasts, so I won't comment on the quality of their 
estimates. I will point that out that to the extent those 
forecasters are talking about one piece of this budget in 
isolation, be it tax proposals or spending proposals, it is a 
very different kind of analysis than what CBO has undertaken, 
which is to look at impacts of the budgetary proposals as an 
entire package. And for that reason, it is not surprising to me 
that you could get very different results.
    But I haven't seen the private sector forecasts in a 
detailed sense. I won't go and comment on them.
    I do want to touch on two things you said, if you will 
allow me. No. 1: the new adventure. I think what I would urge 
you to reflect on is that this really is not that new other 
than the timing. CBO always in its baseline projections tries 
to incorporate the economic impacts of policies that are in 
place. What we are trying to do here is essentially imagine a 
baseline that would have to be put in place if the President's 
budget was adopted as a whole. And so the exercise is not that 
much different from an economics point of view, but we are 
hoping it is useful from a policy point of view.
    Second is that it is true that we could be wrong. Suppose 
this budget were adopted exactly as it was laid out in the 
President's proposals; indeed, our analysis would not be 
exactly right regardless of which model we picked because the 
nature of a projection is to ignore some things about the 
future which, in fact, now we know to be true. In the presence 
of a war, there may be additional outlays. We will find out 
about that; we have no details about that.
    There are also impacts on the economy that would have to 
modify for those reasons. The nature of this analysis is to fix 
in place many things that one could reasonably argue would be 
different in the future.
    Mr. Hastings. Similarly, along that same line of thinking, 
prior to 9/11 with the instances of what happened on 9/11, 
everything was thrown out. You probably couldn't go to the bank 
on anything that was projected or forecast prior to 9/11 
because of 9/11; is that correct?
    Mr. Holtz-Eakin. 9/11 complicated forecasters' lives 
tremendously.
    Mr. Hastings. Thank you.
    Chairman Nussle. Mr. Edwards.
    Mr. Edwards. Thank you, Mr. Chairman. It seems to me, Mr. 
Chairman, the issue we are really reflecting on with this 
analysis is this question: Do massive tax cuts, in light of the 
largest deficit in the history of the United States, guarantee 
a huge spurt in economic growth in the country? If you take 
aside all the dynamic static modeling and all the technology 
that most folks cannot relate to, then it seems to me, in my 
opinion, this analysis is bad news for the free lunch 
philosophy--and I define that as those who say you can take the 
largest deficit in the history of our country, have a half a 
trillion to a $1 trillion tax cut, and then glibly argue that 
that tax cut is going to create so much economic growth that we 
will end up with a balanced budget without any really painful 
decisions--because that argument is based on the assumption 
that the tax cuts and all the consequences involved with it 
will create a significant increase in real economic growth 
beyond what would have occurred otherwise.
    And let me ask you, Dr. Holtz-Eakin, on your first chart 
now, I assume these nine economic models that are used, these 
are all in your opinion solid, reputable, economic models for 
forecasting; is that correct?
    Mr. Holtz-Eakin. That is correct.
    Mr. Edwards. Am I correct in interpreting that chart as 
saying in the nine models, a majority of them actually show a 
large deficit as a result of dynamic impact of the President's 
plan; is that correct?
    Mr. Holtz-Eakin. I have not counted the bars. A point of 
clarity. It is not nine different models. There are a variety 
of models, but there are different assumptions.
    Mr. Edwards. You say model A, model B, and there are a 
variety of different assumptions. You call it models A through 
I, and of those nine, five of them actually show a bigger 
deficit using dynamic growth assumptions versus the static 
model we have used in the past.
    It seems to me, Mr. Chairman, that is a bucket of cold 
water in the face of those who have been arguing glibly that, 
boy, the way we can get out of this historically high-deficit 
situation is pass the President's budget, and that half a 
trillion or $1 trillion worth of tax cuts is going to create a 
1 or 2 or 3 percent additional increase in the GDP above what 
we would have had otherwise.
    And it seems to me--let me ask you this. The first chart 
was for years 2004-08. Let us look at perhaps the long-term 
impact on your second chart. You have seven different models 
which may be a variation of each other, but seven different 
approaches in trying to estimate what the deficit would be 
under the dynamic versus static scoring. And like the first 
chart you had, in that case a majority show higher deficits 
versus those that show lower deficits using dynamic scoring. Is 
that correct? There are actually more models that show a higher 
deficit under dynamic scoring than lower deficits; is that 
right?
    Mr. Holtz-Eakin. I think there are four there.
    Mr. Edwards. So if you look at charts No. 1 and No. 2, and 
then you combine that with the statements in this report, Mr. 
Chairman, on page 16, ``the overall macroeconomic effect of the 
proposals in the President's budget is not obvious,'' as Mr. 
Spratt related to. It goes on to say, ``Importantly, regardless 
of its direction, the net effect on output through long-term 
changes to the supply side of the economy--including 
fundamental `input' such as labor supply or the stock of 
capital--would probably be small.''
    I am not intending to put you in hot water or in the middle 
of a partisan debate but just looking at the numbers--looking 
at what you have written on page 16 and looking at these two 
charts--what we are really seeing is this very happy assumption 
that a massive tax cut on top of the largest deficit in the 
history of the United States is not going to guarantee with 
certainty that we are going to have a huge spurt of economic 
growth beyond what we would have had without that budget 
proposal. Is that correct?
    Mr. Holtz-Eakin. Again, I cannot single out any piece of 
the budget. What I can stand by----
    Mr. Edwards. For those who are saying the President's 
budget proposal is an economic growth package, it is going to 
drive this train, drive this engine toward such growth in 
America that we are going to balance a budget without having to 
make tough spending cuts in veterans programs or Medicare or 
Medicaid as proposed by the Republican budget, this report 
really--I will just conclude, Mr. Chairman. I will just say in 
my opinion, based on the analysis, this report is horrible news 
for those suggesting that the President's package and these 
massive tax cuts are going to grow our way out of deficit. In 
fact, the majority of the models used by the CBO in this 
analysis show that the deficit would be larger compared to the 
static analysis of the economy. Thank you.
    Chairman Nussle. Mr. Brown.
    Mr. Brown. Let me just follow up on Mr. Edwards' 
questioning. The part of the analysis that you generated, are 
you saying that the tax effect would be a liability and not 
really create jobs or grow the economy by 1 percent? I think 
that is what the target was, for the tax cut to grow the 
economy at least an additional 1 percent. Are you assuming that 
the tax cuts would not be a positive impact on the economy?
    Mr. Holtz-Eakin. We go through each of the proposals, tax 
and outlay, and look at their economic incentives and their net 
impact on saving versus consuming in many cases, and then on 
balance look at the impact of the proposals as a whole. I 
cannot really trace any of the specific results to a specific 
policy. It is the net impact of the budgetary proposals.
    It is true that if you look at the effective tax rates--do 
we have that chart? One of the things you would be interested 
in knowing in analyzing the economic impacts is the marginal 
tax rate on labor income. What are the incentives to earn more? 
And you can see from the final column of that, that early in 
the budget window there are reductions in effective marginal 
tax rates, and late in the budget window as well. That comes 
from accelerating the marginal tax rate reductions and making 
them permanent.
    It is also true, if you look at the next chart, that the 
effect of many of the proposals is to lower the marginal 
effective tax rate on capital income. And those incentives in 
and of themselves are present in the analysis, but the results 
reflect everything that goes on as well: the increases in the 
outlay side, such as Medicare spending, things like that, and 
other tax policies that might not reduce marginal tax rates.
    Mr. Brown. Based on your analysis, what was the employment 
rate which you proposed and project in these numbers? Was it 6 
percent or 5 percent? Did you project it through the whole 
cycle? Not lowering that effect or the interest rates, how does 
that impact the overall picture?
    Mr. Holtz-Eakin. For the unemployment rate, what we do in 
the estimates which rely on supply side growth is to allow the 
economy to always be at full employment and basically keep 
unemployment at the baseline. I can get the specific number for 
you. In the short term, one would expect cyclical recovery to 
reduce unemployment rates; and indeed, depending on the model 
chosen, one does get a path of lower unemployment faster in 
those analyses. And we could get the specifics for you if you 
wanted.




    Mr. Brown. Let me ask you a final question. Did you run an 
analysis projecting if we did not do anything at all as far as 
any economic stimulus or any tax cut adjustments?
    Mr. Holtz-Eakin. This is an analysis of the President's 
budgetary proposals, and it is devoted to the task of comparing 
those proposals with our January baseline, and it is limited to 
that.
    Mr. Brown. Thank you, Mr. Chairman.
    Chairman Nussle. Thank you, Mr. Brown. Mr. Moran.
    Mr. Moran. Thank you very much, Mr. Chairman.
    And first of all, I want to say that the Director's report 
is reasonable, it is balanced, it is professional, and thank 
you. I think it is helpful to both sides in understanding the 
effect of dynamic scoring. But I do think you are going to find 
that most of us on this side of the aisle see dynamic scoring 
as nothing more than an attempt, or a scheme really, to 
camouflage the effects of irresponsibly deep tax cuts and 
ideologically driven spending cuts. And so that is why we are 
skeptical of dynamic scoring.
    The tax cuts that occurred in 2001 and 2002 did not prevent 
the loss of over 2.5 million jobs in the private sector, and it 
certainly did not prevent the turnaround of a $5.6 trillion 
surplus that the Bush administration inherited from the Clinton 
administration. We are now trillions of dollars in debt instead 
of having been trillions of dollars in surplus.
    That is particularly important, that we understand that the 
baby boom generation starts retiring in 5 years and will 
eventually double the number of people on retirement, and yet 
we are paying for these tax cuts by borrowing from Social 
Security and Medicare trust funds.
    In 1993 I was here, and I know Mr. Spratt and Mr. Lewis, 
several of us were here. At the time we heard any number of 
speeches from people on the other side of the aisle predicting 
dire consequences of the 1993 tax increases that were required 
to balance the budget that really were sequential from the 
first President Bush's attempts to balance the budget and have 
some marginal tax increases as well. None of those dire 
consequences materialized.
    Now somebody put this up. This must be divine. I do not 
know how it got here. But here is a quote from Newt Gingrich 
appearing on the screen. It says he said, ``The tax increase 
will kill jobs and lead to a recession, and the recession will 
force people off of work and onto unemployment and will 
actually increase the deficit.''
    That from the ideological standard bearer that I know the 
chairman and many others have looked to for wisdom, and this 
was his wisdom at the time in 1993, and typical of what his 
colleagues, Mr. Armey and Mr. Delay and others were saying. I 
think perhaps even the Chairman echoed some of that wisdom and 
insight. But it did not happen, did it?
    The 1990s were the strongest period of economic prosperity 
that this country has ever experienced. And yet it came on the 
heels of actual tax increases on the top wage earners, even 
though at the end of the nineties we looked back and found out 
that people at those top tax rates brought home more after-tax 
income than at any time in American history. So again, dynamic 
scoring and the supply side contention was totally wrong.
    Now, we could go back to 1981, President Reagan who came 
into office saying that any President that proposes an 
unbalanced budget should be impeached, who actually never 
offered a balanced budget in 8 years of his Presidency, but he 
came up with the 1981 tax cut, and all the supply siders said 
that it was going to be self-correcting, that the tax cut would 
more than pay for itself. And yet the deficits did not even 
narrow until we had to raise taxes under President Reagan in 
1982, 1984, 1987. Then we raised taxes under the first 
President Bush in 1989 and 1990. And finally President Clinton 
was able to turn the corner in 1993.
    If CBO had given us dynamic analyses, it seems that we 
would have even exacerbated the problems that were caused by 
the 1981, the 1993, and the 2001 tax cuts. So again we are kind 
of reticent about this stuff.
    Now, here is another one of these magic charts that will 
talk about the enormous disparity in terms of fiscal 
management. Are we about finished there, Mr. Chairman?
    Chairman Nussle. If you have a question and you are leading 
to a question, now would be the time to pose the question.
    Mr. Moran. You are so indulgent with me, Mr. Chairman, I 
really appreciate it.
    Chairman Nussle. I am learning a lot from history. This is 
new history I have never heard before.
    Mr. Moran. It is time for you to hear this, because I know 
among some of my colleague you do not hear this.
    Chairman Nussle. The gentleman may state his question.
    Mr. Moran. The question is, Mr. Director, what if the Joint 
Tax Committee was to come up with a budget that was scored 
through this dynamic analyses, how much latitude are you going 
to have? What if the JTC comes up with one analysis that 
differs from yours, theirs being based on dynamic analysis; 
what would you then do if we have two competing analyses of the 
effect of so-called dynamic scoring?
    Mr. Holtz-Eakin. I am not sure how that would arise. The 
joint committee has jurisdiction over scoring tax proposals, 
and this analysis is the comprehensive analysis of the 
President's budget in the spirit of doing a baseline exercise 
in advance. We would not ever be in a position of scoring just 
a tax proposal, so a competing estimate would not arise.
    Mr. Moran. Well, that answers my question, I guess, because 
we think the JTC will come up with a dynamically scored 
analysis of the tax cuts. Then it is up to you to give us your 
analysis of the outyear effects of the tax cuts plus spending, 
et cetera. But I am gathering that you would not necessarily be 
swayed off the course that you are currently on despite a JTC 
analysis that might differ from the analysis that you have 
presented us with today.
    Mr. Holtz-Eakin. It is an apples-to-oranges comparison. 
This analysis looks at the President's proposals. Broadly 
speaking, there is $1.5 trillion in tax cuts, $1.2 trillion in 
spending increases over the 10-year horizon. We look at the 
impact of the entire array. The joint committee has a different 
mandate.
    Mr. Moran. Fair enough. Thank you, Mr. Director. Thank you, 
Mr. Chairman.
    Chairman Nussle. Mr. Diaz-Balart.
    Mr. Diaz-Balart. Thank you, Mr. Chairman. I keep hearing 
the question as to what is the impact of the President's job 
growth program, and yet when I look at table 17 here, unless I 
am not reading it right, here it seems to pretty plainly say in 
black and white, in your numbers, that there is a short-term 
increase in real gross domestic product. Is that correct that 
if we--if you have chart No. 17. I do not know if you can put 
it up.
    Mr. Holtz-Eakin. We do have it, I think. [See Figure 4 or 
Table 17 in prepared statement.]
    Mr. Diaz-Balart. Again, here it has got total facts and it 
has got what looks like relatively substantial increases in 
real gross domestic product.
    Mr. Holtz-Eakin. This is the total contribution. We broke 
apart the supply side contribution, the cyclical contribution, 
but if you look at the totals you do see increases in real GDP 
over the near term.
    Mr. Diaz-Balart. So again, let me just make sure, because I 
am not the smartest guy in the world and I just got here.
    Let me see if this is correct because I keep hearing a lot 
of rhetoric and a lot of long, long, long, long statements--
excuse me, questions. I want to make sure that I get this 
right. What you are saying is in this proposal there is, 
according to these numbers, in the total effect a real 
inflation adjustment of gross domestic product increase, 
correct?
    Mr. Holtz-Eakin. Yes.
    Mr. Diaz-Balart. If I may, Mr. Chairman, and I will try to 
keep it to questions, but I guess you have allowed some 
flexibility to Members of the other side, it seems to me then 
this does create GDP, again--here it is, gross domestic product 
increases, No. 1, which is I think the whole purpose of the 
President's tax proposal, No. 1. In your opinion, do tax 
increases help or hurt the economy--vis-a-vis--as opposed to 
the President's proposed tax increases?
    Mr. Holtz-Eakin. Let me first comment on the term 
``create'' and go back to why I caution the interpretation of 
the short-run portions of these cyclical growth effects. The 
return of the economy from a business cycle slump to full 
employment is something that is going to happen one way or 
another: Federal Reserve policy, the natural corrective 
mechanisms in an economy. Our assumption that they can be 
ascribed to the President's budgetary proposals is an 
assumption that comes from an artifical Federal Reserve policy 
that is built into these simulations. I think it should be very 
clear that the cyclical growth effects are not in any sense 
created. Getting the economy back to full employment is 
something that will happen through one mechanism or another.
    With regard to your second question on impact of taxes per 
se, again I hate to repeat myself too often, but you cannot 
pull out of this any particular tax impact without confounding 
it with the other side of the budget, the outlay side. And 
again, when we went through the tax proposals, as we point out, 
some lowered effective marginal tax rates, but not all. Not all 
raised savings. Some promoted consumption.
    Mr. Diaz-Balart. Mr. Chairman, lastly, just to make sure I 
understand. Would it be fair to say that if you are able to 
control spending on one end and decrease taxes on the other 
end, then you would tend to have a positive effect, more 
positive than if you controlled taxes or you lower taxes and do 
not control spending, or if you increase taxes and do not 
control spending? Is that a fair assumption?
    Mr. Holtz-Eakin. I would pose it slightly differently, 
which is, to the extent that by controlling government 
consumption and changing taxes that promote private savings, 
you reduce consumption in the present, the economy will be more 
likely to grow. It is the balance of those impacts that 
matters.
    Mr. Diaz-Balart. Mr. Chairman, I have always pretty much 
assumed that is what you and a lot of us here have been saying. 
I just got here but I have been saying it for a long time, and 
I think these numbers bear it out, unlike what others would 
like to claim what these numbers say.
    Thank you, Mr. Chairman.
    Chairman Nussle. Mr. Cooper.
    Mr. Cooper. Thank you, Mr. Chairman.
    I realize that during a war it is hard for Members or the 
public to concentrate on what may seem to be arcane budget 
matters, but I think these are extraordinarily important issues 
for our people, and I appreciate the professionalism you have 
demonstrated, Dr. Holtz-Eakin. I think on our side of the 
aisle, our enemy is probably not dynamic scoring. Our enemy is 
nonprofessional economists, and you are a great professional. 
You have done a commendable job here, because this report--and 
I would encourage everyone, especially Members on the other 
side of the aisle, to read it--is actually a fair and balanced 
approach to the budget as I see it.
    As my colleague, Mr. Edwards, pointed out, five of the nine 
models or variation assumptions actually show larger deficits 
than the baseline without dynamic assumptions. And the four 
that do not show larger deficits but show smaller deficits all 
assume, as best I can tell, large tax increases after the year 
2014. That is not news that my colleagues on the other side of 
the aisle want to hear. But it is still the legitimate 
professional findings of your report.
    So at the risk of damaging your career by praising you, I 
commend the professionalism that you seem to have put into 
this, and I hope that you and your successors will continue to 
do that because legitimate scientific techniques should never 
be our enemy. What matters is when they are mishandled by folks 
who are not professionals.
    Can you give me an idea of the size of the tax increases 
that will be involved after the year 2013 in order to lower the 
size of the deficits that are projected?
    Mr. Holtz-Eakin. We can get you the precise number, but 
they would be in the neighborhood of 2-2\1/2\ percent of GDP if 
they were done instantaneously after 2013.
    Mr. Cooper. Can you translate that into plain English for 
the other side of the aisle?
    Mr. Holtz-Eakin. At current levels of GDP, that is on the 
order of $200 [billion] to $250 billion.
    Mr. Cooper. A year, forever?
    Mr. Holtz-Eakin. Yes.
    Mr. Cooper. Tax increases of $200 [billion] to $250 billion 
a year forever, in order to have smaller deficits. That is an 
important finding, I think. It is actually in your first slide 
if you penetrate to the assumptions.
    Second point. Last week we voted, the House of 
Representatives, by the whopping majority--I think of two 
votes--for the Republican budget, which had a primary 
assumption of finding enough savings in waste, fraud, and abuse 
in order to try to lower the size of the projected deficits. 
Now everyone is against waste, fraud, and abuse. Politicians 
have been against waste, fraud, and abuse for hundreds, maybe 
thousands of years.
    Can you tell me what the Federal Government's record is of 
rooting out waste, fraud, and abuse, especially in the near 
term, in order to find hundreds of billions of dollars of 
savings?
    Mr. Holtz-Eakin. As much as I would like to pretend I know 
something about everything, I am at a loss on the track record 
on waste, fraud, and abuse. But we can look it up for you.
    Mr. Cooper. In general, you would say it is not a 
commendable record. It is probably not even a good record. It 
is probably, in fact, a terrible record. Would that not be a 
fair assumption?
    Mr. Holtz-Eakin. To be honest, this is not an area of my 
expertise, and I will not characterize the record.
    Mr. Cooper. Would your staff hate you if we asked you to 
look up the Federal Government's record on waste, fraud, and 
abuse?
    Mr. Holtz-Eakin. As a good economist, I could say marginal 
hate is what matters, and it may be large.
    Mr. Cooper. Dr. Holtz-Eakin, you are aware that a month or 
so ago, hundreds of professional economists, including several 
Nobel Prize winners, wrote the following statement in an open 
letter: ``Passing the President's tax cuts in the President's 
2004 budget will worsen the long-term budget outlook and add to 
the Nation's projected chronic deficits. This fiscal 
deterioration will make the capacity of the government to 
finance Social Security and Medicare benefits, as well as 
investments in schools, health, infrastructure, and basic 
research much harder to fund. Moreover, the proposed tax cuts 
will generate further inequalities in after-tax income.''
    Are these professional economists all out to lunch? Are 
they wrong in this statement?
    Mr. Holtz-Eakin. They are entitled to their opinion. What I 
would say is that none of those are comprehensive analyses of 
the entire budget. And I repeat that I think that is the 
important message I would like to convey today--that the 
analysis should be done comprehensively.
    Mr. Cooper. I agree. And none of them have the pleasure of 
being the CBO director and they do not have the opportunity 
perhaps to make a comprehensive assessment. This was just an 
open letter, but it was a warning to the American public to 
watch out, because these issues are important, they do have 
consequences, and that is why this committee, and hopefully all 
House Members, should focus on these arcane details.
    One last question, Mr. Chairman. We are all pleased that 
interest rates are at all-time lows right now--or at least 40-, 
50-year lows. Have you done any work on the impact of, say, a 
doubling of those interest rates, even though they would be at 
still relatively low absolute levels, but what would that do to 
business psychology? If you think about dynamic scoring and 
adjusting in behavioral factors, what would a doubling of 
interest rates do to the average small business man? I know you 
have done a lot of research on understanding the behavior of 
small businesses. Is there any input or research that you can 
show me on that?
    Mr. Holtz-Eakin. What I can show you, what we can provide 
you the details on, are the interest rate paths that are built 
into this macroeconomic analysis as a whole. From an economics 
point of view, you have to know why interest rates go up. If 
they were to double in your example, the source of that 
increase is really an important consideration. There are 
interest rate responses in the various simulations we have 
done. I will be happy to discuss them with you.
    [The information refered to follows:]

  LONG-TERM EFFECTS OF THE PRESIDENT'S BUDGET ON 3-MONTH TREASURY BILL
                                  RATES
        [Average percentage-point difference from CBO's baseline]
------------------------------------------------------------------------
                                              Fiscal Years  Fiscal Years
                                                2004-2008     2009-2013
------------------------------------------------------------------------
           Supply Side Model Without Forward-Looking Behavior

Textbook Growth Model.......................          0.1           0.4

            Supply Side Models With Forward-Looking Behavior

Closed-Economy Life-Cycle Growth Model
    Lower government consumption after 2013.            0           0.2
    Higher taxes after 2013.................            0           0.1
Open-Economy Life-Cycle Growth Model Lower
 government consumption after 2013
    Lower government consumption after 2013.            0             0
    Higher taxes after 2013.................            0             0
Infinite-Horizon Growth Model
    Lower government consumption after 2013.            0           0.1
    Higher taxes after 2013.................            0             0

            Macroeconometric Models, Supply Side Contribution

Macrocconontic Advisers.....................          0.2          n.a.
Global Insight..............................          0.3          n.a.

     Macroeconometric Models, Supply Side and Cyclical Contributions

Macroeconomic Advisers......................          1.5          n.a.
Global Insight..............................          0.9          n.a.
------------------------------------------------------------------------
Source: Congressional Budget Office.

Notes: For the models by Macroeconomic Advisers and Global Insight, the
  supply side contribution to interest rate changes shown in the table
  reflects only the effect of changes in the ratio of capital to output
  on the rate of return to capital. In fact, the interest rates in the
  ``supply side'' projections bad to be increased by much more to keep
  the unemployment rate at its baseline level. Those large increases
  heighten demand-side pressures, so it would make little sense to
  categorize them as supply side effects. The numbers here are the ones
  that were used in generating the budgetary effects shown in Table 19
  of Congressional Budget Office, An Analysis of the President's
  Budgetary Proposalsfor Fiscal Year 2004 (March 2003).

n.a. = not applicable.

    Mr. Cooper. I thank the Chair.
    Mr. Holtz-Eakin. Mr. Chairman, I would like to take a 
second to thank you for your kind comments about our report. I 
would like to report that the CBO staff is the source of the 
overall excellence. No single human being could have done this, 
so your comments should be directed to them.
    Chairman Nussle. And the Chair would stipulate to the 
gentleman's remark to the Federal Government's track record 
with regard to waste, fraud, and abuse--or, more importantly, 
politicians' track record with regard to that subject.
    Mr. Barrett.
    Mr. Barrett. Thank you, Mr. Chairman. Thank you, Mr. 
Director, for coming here today. We really appreciate it. I 
know the information you have presented today is on the 
President's budget, but the fact of the matter is last week we 
passed a slightly different budget which was our House budget. 
Are you familiar at all with that, Mr. Director?
    Mr. Holtz-Eakin. I am familiar at best with the broad 
outlines.
    Mr. Barrett. The way I understand it--and a lot of my 
colleagues are not addressing what I think is the crux of the 
matter--it is a two part formula, the way I understand it. The 
tax break, the tax cut, is a portion of the formula; but if you 
really want to kick the economy into high gear, if you want to 
see growth, you have got to do two things: You have got to cut 
taxes and you have got to rein in spending. And the budget that 
we passed in the House I think does both of those and I think 
balances the budget within 10 years.
    Does that not make sense Mr. Director, to attack the 
problem in a two pronged fashion, cut your spending, and cut 
your taxes? And if you looked at our budget the way you looked 
at the President's budget, taking those two factors into 
account, do you not think that the outcome would be much more 
favorable than what you had for the President's budget?
    Mr. Holtz-Eakin. It is not possible for me to really answer 
that question. One of the virtues, if that is the correct term, 
of the President's budgetary proposals is that that they are 
spelled out in tremendous detail. It is not enough simply to 
have dollar values on the spending side, dollar values on the 
receipt side. The details of the policy actually matter. Their 
impact on incentives, for example, on the tax side, or whether 
things are consumption or transfers on the government spending 
side.
    So it is sheer speculation for me to guess what would 
happen on any other budget that is not fully specified in the 
way the President's proposals were.
    Mr. Barrett. Let us take the concept and let's back up and 
talk in very general terms. Don't you think it makes better 
sense to attack a budget problem in a two pronged fashion by 
reining in your spending, cutting your spending, cutting your 
overhead, and putting more money back into the hardworking 
people's pockets in your district that know how to spend it 
better than we do in Washington?
    Mr. Holtz-Eakin. In my role as CBO Director, I do not make 
policy suggestions. It will come to the will of Congress as to 
what makes the most sense. Our role is to advise you. I think 
the lesson of today's simulations from the impact of the 
President's proposals is these proposals, on balance, do not 
uniformly raise savings incentives at the expense of 
consumption incentives. There is a mixed set of incentives on 
both sides of the budget constraint, and that's the source of 
the relatively small overall impact.
    Mr. Barrett. Thank you, Mr. Director. I yield back my time, 
Mr. Chairman.
    Chairman Nussle. Thank you. Mr. Lewis.
    Mr. Lewis. Thank you, Mr. Chairman. Thank you, Mr. 
Director, for being here. Welcome. You come from the academic 
community as well as being in government now. You come from a 
great university. And I just want to hear you say once more, as 
a member of the Ways and Means Committee as well as the 
Committee on the Budget, in your response to Mr. Cooper, are 
you telling us that after 2013 that tax increases will be $250 
billion a year forever; forever, I mean ever and ever?
    Mr. Holtz-Eakin. A more precise answer to that question 
would be in a model that requires perfect foresight on the part 
of the private sector, it would be necessary to impose a tax 
increase of that size in the model to offset the budgetary 
deficit created by the additional debt in the President's 
proposals. It is a model-specific result.
    Mr. Lewis. Thank you, Mr. Director.
    Mr. Cooper. It sounds like yes.
    Mr. Lewis. Will you agree that is a yes, right?
    Mr. Holtz-Eakin. In the context of the model, that is a 
yes.
    Mr. Lewis. Thank you Mr. Director. Mr. Director, do you 
think that sometimes, whether the tax cuts are large or small, 
are they the best answer to a big deficit?
    Mr. Holtz-Eakin. Again, it is not my role to provide a 
specific policy recommendation on tax cuts versus----
    Mr. Lewis. I am not asking you to recommend anything, but 
just to speculate and think a little bit. You come from an 
academic community.
    Mr. Holtz-Eakin. Among my first lessons on the job, I was 
to try to rein in some of my academic tendencies.
    Mr. Lewis. Is it possible to cut taxes too much? Is it 
possible?
    Mr. Holtz-Eakin. The level of taxes is determined by the 
overall level of government spending, which is the ultimate 
draw of the government, the burden that it places on the 
private economy, and the decision about the timing of these 
taxes, present versus future, about which will be financed by 
debt. It really cannot be simplified more than that.
    Mr. Lewis. Mr. Director, what do you think we should be 
doing to get this economy moving again? When this 
administration came into office, the previous administration 
had created more than 22 million jobs. We had a surplus and 
unbelievable growth in the economy. And now we have this 
growing deficit. And during the past 2 years, more than 8 
million people lost jobs. What can be done right now to get the 
economy moving----
    Mr. Holtz-Eakin. Again, it would be inappropriate for me to 
provide my personal policy proposals.
    Mr. Lewis. I am not asking you to make any recommendations. 
I am just asking you to think out loud, get out of the box.
    Mr. Holtz-Eakin. I can frame for you the kind of things 
that I think would be important. Going forward, it is I think 
widely recognized by private sector analysts that the economy 
will not grow faster and in a sustained fashion without a 
recovery in business investment. That is, I think, the 
consensus view to sustained faster economic growth.
    On the flip side, the economy has been held up for a number 
of years now by a very strong household sector, and it will not 
suffer a sharper decline without a deterioration in household 
spending.
    Mr. Lewis. Would you agree with the impending retirement of 
all the baby boomers, that cutting taxes now is very risky?
    Mr. Holtz-Eakin. Again, the specific recommendations on tax 
policy will lie in the hands of the Congress. We do know that 
going forward, with the retirement of the baby boom generation, 
that will accompany demographic shifts in the United States in 
which the number of retirees per worker will roughly double by 
2030. And in the presence of these pressures, the current 
programs, Medicare and Social Security, if run in their current 
capacity, will place some strain on the Federal budget.
    Medicare is a particularly vivid example of this, where 
over the next 75 years, if left to run as it is currently 
structured, it will rise from about 2\1/2\ percent of GDP, a 
little less than that, to something in excess of 9 percent of 
GDP. At current levels, half the Federal budget would simply be 
Medicare. Right now about 18 percent of GDP is devoted to 
receipts. So the impending retirement of the baby boom 
generation and the demographic shift that will come along with 
that will in fact place great challenges on the Federal fiscal 
policy in the future.
    Mr. Lewis. If you were speaking to your students this 
afternoon at the Maxwell School at Syracuse--it is a great 
university, I have been there a few times, I spoke at the 
university--what would you tell them about the economy? What 
would you say about this budget?
    Mr. Holtz-Eakin. I would deliver to them the same messages 
I delivered to this committee--which is that the net impacts on 
overall economic growth come in different flavors, short term 
and long term, and that the impact of the budget on incentives 
to accumulate saving for capital and technologies and labor 
supply will determine the long run impacts of the budget on the 
economy.
    Mr. Lewis. Thank you very much, Mr. Director.
    Mr. Chairman, before I conclude, the words that Speaker 
Gingrich spoke on August 6, 1995, ``At times history and fate 
tend to track us down,'' he spoke those words on the 28th 
anniversary of the signing of the Voting Rights Act by Lyndon 
Johnson. So just for the sake of history, since we are having a 
history lesson today.
    Chairman Nussle. Ms. Majette.
    Ms. Majette. Thank you, Mr. Chairman.
    Thank you, Mr. Director, for being here. In the budget 
analysis that you prepared, in box No. 3 on page 20, you asked 
the question, or the question is asked, how would the 
President's proposals be paid for? And in reading this, I think 
I understand what you are saying, but I also realize that at 
the time that this was written I believe we were not at war. 
And so the question that I have is, how would the cost of the 
war as it stands now--as I understand it, there would be 
required to be spent $75 billion by September 30, or that is 
what would be suggested, and that by some estimates that would 
cost a minimum of $20 billion per year over the next few years 
to stabilize the region. Assuming that those are minimum 
figures, how would that affect the analysis and the conclusions 
that you reached, particularly with respect to page 20, box 3, 
in which you say that for some time, the added need could be 
met by running higher deficits; however, the Federal Government 
could not follow such an approach indefinitely. At some point 
in the future under the President's proposal, either taxes 
would have to be higher than they otherwise would have been or 
spending would have to be lower. How do we reconcile that with 
what we know will be some additional costs, $75 billion plus 
some $20 billion a year over the next several years?
    Mr. Holtz-Eakin. The purpose of the box is to make as 
transparent as possible the modeling assumptions that CBO 
adopted in doing this analysis. I stress the context in which 
you want to look at that box is the context in which we have 
adopted formal economic models that emphasize foresight on the 
part of the private sector; literally perfect foresight, the 
ability to see into the future with absolute precision. It is 
not meant, obviously, as a depiction of economic reality. It is 
meant to capture the extent to which private market 
participants in financial markets and other investment 
decisions can see forward to the economic landscape.
    In that context, individuals in the models would know on 
January 1, 2003, the entire budgetary future of the United 
States--obviously not a realistic assumption, an extreme 
assumption. To the extent that there were additional outlays 
from a war or any other source that on net did not pay for 
themselves--and my suggestion is they would not--there would be 
additional debt outstanding at the close of the budget window. 
The interest on that debt would have to be paid for. In the 
absence of either cutting spending or increasing taxes, you 
would have to borrow to pay those interest costs. And running 
that strategy infinitely into the future would be self-
defeating and unstable. As a result, the model simply will not 
let us put such a policy into place.
    Instead we made the arbitrary, but hopefully clear, 
assumption that all this would be dealt with in an extreme 
fashion on the tax side or an extreme fashion on the spending 
side, and we would be done in 2014.
    Neither the spending nor the tax cut has to be the case, 
and neither would 2014 have to be the case. But it was meant to 
clarify the budget situation individuals would face in making 
their decisions. A long answer, but the models are not that 
complicated, and that is the context I wanted to make clear.
    Ms. Majette. Thank you.
    Chairman Nussle. Mr. Baird.
    Mr. Baird. I thank the Chairman. I thank Mr. Holtz-Eakin.
    Mr. Holtz-Eakin, many of the Members on both sides of this 
aisle spoke with great commitment a couple years back about 
this thing called the lockbox. It was about the weakest lockbox 
I could ever imagine, apparently. Your chart that has been 
presented a number of times, is that the unified budget 
surplus?
    Mr. Holtz-Eakin. Yes.
    Mr. Baird. So in other words, if we were to take Social 
Security and Medicare Trust Funds out of that, as virtually 
every member of this committee, as virtually every Member of 
the U.S. House of Representatives voted to do, those deficits 
would be substantially larger, I would guess.
    Mr. Holtz-Eakin. I would guess. We have not done that 
calculation.
    Mr. Baird. It is interesting that nobody has asked you to 
do that, in that, again, virtually every member of this 
committee and every Member of the Congress pledged that we 
would do that, and nobody has asked you to do it. Apparently 
when people stand up and make great speeches, and send out 
political fliers, and say we are going to put Social Security 
and Medicare in a lockbox, they do not then ask the CBO would 
you score this as if we were living up to the promises we made 
to taxpayers. I find that rather troubling.
    Even given that, as I look at this deficit over 2004-08, it 
is at least $1.2 trillion. I mean, sort of on average, as I 
average out these models more or less, is that reasonable?
    Mr. Holtz-Eakin. I will trust your math.
    Mr. Baird. It has got to be close to that. So $1.2 
trillion, not counting that we are borrowing from Social 
Security and Medicare.
    By the way, I found your statement interesting, that in 
2014 there will either be the need for extreme budget cuts or 
extreme tax increases. Apparently all of us need to think of a 
term limit around 2013, because that is when the getting is 
good. I would not want to run for a reelection in 2014, 
according to the models we have seen, if we don't change them 
sooner. When we do dynamic scoring, do you ever look at the 
cost of not investing?
    I had a delightful young lady in my office asking for 
additional funding in the TRIO Program, which is this program 
that helps economically disadvantaged folks move on to a higher 
education. What happens if we do some of these cuts, what are 
the costs in terms of the added cost to society, to people who 
get in trouble with the law or do not become as productive 
economically as they might? Do you ever factor that kind of 
thing in?
    Mr. Holtz-Eakin. We try to put into the analysis all the 
impacts for which we have good, solid, professional consensus. 
I am sure that there are impacts which are not in this analysis 
that some people might like, and we tried to highlight in the 
report those places where we felt we were unable to make a 
specific estimate.
    Mr. Baird. I hear the shibboleth often about the people 
spend their money better than their government, and there is 
some merit to that. But it is also true that government makes 
some good investments that actually save us money down the 
road, investments in education, investments in child nutrition, 
investments in job training, investments in infrastructure.
    Do you do anything to look at the infrastructure deficit 
that we are accruing when we do not spend our transportation 
dollars wisely? For example, repairing bridges or roads or 
repairing our schools. Is there any look at that? We look at, 
well, we are going to stimulate the economy. But one way I can 
stimulate my own household economy is my wife and I spent the 
weekend scraping our deck. It is a delightful exercise, but you 
have got to do it or that deck is going to degrade and you are 
going to pay money over time. We are deferring maintenance on 
our bridges, on our highway, on our MRAD ship fleet. On and on 
the list goes. Have you looked at the deferred maintenance cost 
and how that infrastructure deficit is accruing?
    Mr. Holtz-Eakin. In this analysis, I think all economists 
would agree on the principle that there are differences between 
investment and government consumption outlays. Two factors 
mitigate against putting that into the analysis that was 
presented today.
    No. 1, the President's budget does no distinguish between 
government investment and government consumption in its 
proposals, and for that reason we did not have that 
delineation. And the second. on the whole, the evidence is that 
to the extent there are impacts from those investments, they 
occur slowly and outside the 10-year budget window that we 
would present today.
    I do want to go back and clarify for the committee the 
negotiation of what would go on in 2014. The term ``extreme,'' 
in our view, is meant to characterize the outer bounds of the 
impacts on the simulations, not to have any sense of magnitude. 
In addition, it is important to emphasize this is not a 
forecast; this is a projection of what will happen if economic 
policy and the budgetary policy and the economy go on autopilot 
with this set of proposals. And in no way is it intended to 
suggest that this would be a necessary policy for the actual 
U.S. economy at that point in time.
    Mr. Baird. But if the President's budget were carried out?
    Mr. Holtz-Eakin. And in the absence of other factors, many 
of which we already know will in fact occur. For example, there 
is not an armed conflict in the Middle East in these 
projections.
    Mr. Baird. I appreciate that. I would just add that 
apparently this deficit, to my way of thinking, may be a good 
bit larger; first, because we have not included Social Security 
and Medicare trust funds as we promised we would not; and 
secondly, because I think there is an infrastructure deficit. 
But that is for another time.
    Thank you for your time.
    Chairman Nussle. Thank you. Mr. Spratt, do you have any 
additional questions? Thank you.
    Are there other members who wish to inquire again? Mr. 
Edwards.
    Mr. Edwards. I would like to focus on the issue of what 
happens if you have the proposed massive tax cuts in the 
administration proposal but Congress does not have the will, 
after giving a lot of speeches, to make the actual cuts. It is 
safe to assume that, long term, if you have the massive tax 
cuts and the spending cuts that the Bush administration has 
also recommended, if we do not stick within those guidelines so 
we actually have a larger deficit accompanying the tax cut, 
that would actually slow down the economic growth projected for 
the future; is that correct?
    Mr. Holtz-Eakin. In the analysis that we presented today, 
there are actually large increases in spending. As I mentioned 
earlier, there are about $1.2 trillion of increases in 
spending, not in cuts. So if there was another analysis we 
would have to----
    Mr. Edwards. But the point being, even though it is 
increased spending, there are some cuts proposed by the Bush 
administration such as cut in Federal aid to military children 
receiving a better education, that even this committee, 42 to 
1, voted not to cut. In a period of 7 days we went from $272 
billion proposed cut in Medicare, to Medicaid, in this 
committee, down to $155 billion reduction in present services 
for Medicare and Medicaid.
    So my point being, that while the Bush administration is 
proposing total expenditure increases, many of those may not 
keep up with inflation, and they have made some tough cuts that 
Congress will not even agree to. My question would be, if 
Congress has the tax cuts proposed by the administration but 
actually spends more than the administration proposes spending 
so you have a higher deficit, would that tend to slow down your 
growth projections to the future?
    Mr. Holtz-Eakin. To the extent that, on balance, the tax 
and spending mix favors consumption. So if the outlay side 
favors consumption and, on balance, the tax side favors 
consumption, we will not save and accumulate capital, and that 
will have smaller increments to supply side economic growth.
    Mr. Edwards. As a follow-up on that, Mr. Chairman, I think 
these numbers are correct, but I would like to confirm this, 
more or less. We hear a lot of budget hawks talking about let's 
make tremendous cuts. And I have great respect for Chairman 
Nussle, because he proposed some very painful cuts that lasted 
for 7 days, until the public found out about them, and I credit 
Mr. Nussle for being able to make some tough decisions in order 
to pay for the tax cut. But his colleagues on both sides of the 
aisle were not willing to make that cut, so those tough 
proposals lasted 7 days. I do not know why we should assume for 
10 years we will make these cuts.
    But let's get to the reality of cutting. Do I understand 
that if you take defense, Medicare, Medicaid, Social Security 
and interest on the national debt, approximately that 
represents about 70 percent of all Federal spending in any 
different year, would you assume that is approximately right, 
within 5 or 10 percent?
    Mr. Holtz-Eakin. We can stipulate that. We can check.
    Mr. Edwards. These may be yes or no answers. Of the five 
programs that, let us assume, represent almost three-fourths of 
all Federal spending, does the Bush administration budget 
propose more or less in defense spending?
    Mr. Holtz-Eakin. The proposals included increases in 
defense spending.
    Mr. Edwards. Does it propose more or less spending in 
Medicare?
    Mr. Holtz-Eakin. The proposals included a specific increase 
of $400 billion for the Medicare prescription drug program.
    Mr. Edwards. Does the Bush administration propose increases 
or decreases in Medicaid spending?
    Mr. Holtz-Eakin. The President's proposals had a Medicaid 
component which proved difficult for us to score because we 
have did not have the administration's projections of the last 
5 years of the budget window. Under the President's scoring, 
the administration found savings in the out years. The CBO 
score showed an increase of about $30 billion. That reflected 
the same level of Medicaid spending and what might be a 
difference in the underlying baseline.
    Mr. Edwards. So if we use CBO spending, Medicaid spending 
would go up. Social Security, under the President's budget, 
does that go up or down?
    Mr. Holtz-Eakin. I could be wrong; I do not remember 
specific proposals.
    Mr. Edwards. OK. Question mark on that one. And the final 
one, interest on the national debt obviously goes up a lot 
because of the tax cut; is that right?
    Mr. Holtz-Eakin. On balance, there is greater debt 
outstanding.
    Mr. Edwards. So in the real world, once we get past the 
budget hawk speeches, budget talks turn into budget doves 
pretty quickly when you actually look at the programs that 
represent three-fourths of Federal spending. So out of those 
five programs representing three-fourths of the Federal 
expenditures, the Bush administration, according to CBO, is 
increasing defense, Medicare, Medicaid, not sure about Social 
Security--we will give them the benefit of the doubt--and the 
interest on the debt. So the Bush administration budget 
proposal increases spending in four out of the five largest 
Federal programs; is that correct?
    Mr. Holtz-Eakin. The budgetary proposals do have these 
policies.
    Mr. Edwards. So in reality what we end up doing, Mr. 
Chairman, is after our speeches are given we end up pushing for 
more spending for those programs that represent three-fourths 
of the Federal budget, and it does not leave enough of the 
budget left to make these massive cuts we hear about. Thank you 
for the answers to those questions.
    Chairman Nussle. Mr. Diaz-Balart.
    Mr. Diaz-Balart. Let me see if I understood this right. I 
think when you were answering Mr. Cooper's question, you said 
that there would be the requirement of so-called tax increases 
or other alternatives to get to the baseline. Does that 
baseline assume that the tax cuts expire in whatever, 2011 or 
2014, or whenever that is?
    Mr. Holtz-Eakin. Yes.
    Mr. Diaz-Balart. Alright. So if those tax cuts were made 
permanent, then that number would be a lot smaller.
    Mr. Holtz-Eakin. Making the tax cuts permanent is part of 
the President's budgetary proposals, and so our analysis 
reflects that and all the other proposals in measuring 
differences from the baseline where they are soon to expire.
    Mr. Diaz-Balart. But your assumptions are they do expire.
    Mr. Holtz-Eakin. In the baseline they are assumed to 
expire, and in the analysis of the President's budget they are 
assumed to be made permanent as part of the budgetary 
proposals.
    Mr. Diaz-Balart. But I believe when you said ``getting back 
to the baseline,'' what were you talking about? Getting back to 
the baseline without the expiration? Maybe I misheard you, but 
I kept hearing you say ``getting back to the baseline.'' What 
baseline were you referring to then? The baseline with the 
expiration or without the expiration?
    Mr. Holtz-Eakin. I want to make sure I understand the 
context, because I am not sure I understand the question. If 
the question is about the policy outside the budget window, 
what is necessary outside the budget window is to ensure that 
there is stabilization of the debt-to-GDP ratio, no more; and 
the policy is mechanically implemented to make sure that 
happens. So that is the actual policy that is put into the 
formal modeling.
    I am still not sure I actually understand the question, 
because I don't remember the response, so I would be happy to 
work it out.
    Mr. Diaz-Balart. I could have sworn you said--I think it 
was to Mr. Cooper's question when he asked you how much would 
you have to raise taxes--and you said, to get to the baseline. 
Maybe I misunderstood.
    Mr. Holtz-Eakin. I will choose my words carefully. What is 
necessary in the models is to implement a change in either 
spending or taxes or some combination, but we chose simple 
versions in order to stabilize the debt-to-GDP ratio, and 
mechanically that is what is done.
    Mr. Diaz-Balart. Again, that is whether they expire or they 
do not?
    Mr. Holtz-Eakin. It is not tied to any specific policy in 
the budget in taxes or in outlays. The goal is to ensure in the 
model the government has a fiscal policy that is sustainable 
literally for the rest of time, without any tendency to have 
ever-increasing borrowing.
    Mr. Diaz-Balart. Again, but if you make those tax cuts 
permanent, would that not decrease that number?
    Mr. Holtz-Eakin. You cannot tie it to any specific 
proposal. It will be the balance of the impacts within the 
budget window from both the tax proposals and the spending 
proposals. You will arrive at 2014 in this little model 
universe and you will have to have an offset to stabilize GDP.
    Chairman Nussle. What is that percentage? Is that 17 
percent of debt-to-GDP ratio?
    Mr. Holtz-Eakin. Under the baseline, the debt-to-GDP ratio 
falls to 17 percent. Under the President's proposals in the 
conventional analysis, leaving aside the macroeconomic impacts, 
it stabilizes at 34 percent, roughly, as it is now.
    Chairman Nussle. What you are suggesting, though, is if you 
needed to increase taxes in 2013 or 2014, it would be to get it 
back to a ratio to GDP.
    Mr. Holtz-Eakin. It would be to make sure that you do not 
have an ever-increasing ratio of debt to GDP. It simply stops 
where it is at the end of the budget.
    Chairman Nussle. OK. Mr. Spratt.
    Mr. Spratt. On the same point, what you are saying as I 
understand it is that tax cuts are not fully self refunding, 
therefore deficits do occur, they mount steadily, and at some 
point they have to be dealt with, at least in a forward-looking 
model, which effectively assumes that you cannot have unending 
debt accumulation and deficit accumulation. At some point or 
another they are no longer sustainable. And therefore one of 
two things has to happen: Either government consumption has to 
be drastically lower or taxes have to be significantly raised.
    Mr. Holtz-Eakin. Certainly to stabilize the debt-to-GDP 
ratio, you must do one of those two things.
    Mr. Spratt. On this second chart you have here, estimates 
from supply side models of cumulative budgetary impacts of the 
President's proposal, on each one of those you are assuming 
that by 2013, there would have to be higher taxes because 
deficits--or significant spending increases--would no longer be 
sustainable.
    Mr. Holtz-Eakin. Or in some cases, in the textbook growth 
model, for example, there is no assumption that the private 
sector has this tremendous foresight. Instead, firms focus on 
year-to-year economic condition in making their labor supply 
and saving decisions. In those cases, no assumptions are 
required for policies beyond the budget window.
    Mr. Spratt. But if you have an infinite horizon, if you 
have a forward-looking model, then you have to factor this in, 
do you not?
    Mr. Holtz-Eakin. Yes.
    Mr. Spratt. Several of yours have that characteristic to 
them?
    Mr. Holtz-Eakin. Two of our models have that 
characteristic.
    Mr. Spratt. Two do. What is the percentage increase in 
taxes that is necessary at that point as a percent of GDP?
    Mr. Holtz-Eakin. The rough number would be 2, 2\1/2\ 
percent. We would have to find out exactly.
    Mr. Spratt. It is a huge increase, is it not?
    Mr. Holtz-Eakin. At the current levels of GDP, somewhere 
near $200 billion or $250 billion.
    Mr. Spratt. Would it not at that point in time be more 
difficult than it is now to cut spending because of the baby 
boomers' retirement and the fact that more and more will be 
drawing Social Security and Medicare benefits?
    Mr. Holtz-Eakin. I think the Congressman is more equipped 
to tell me how difficult cutting spending is. What we did in 
the model was simply stabilize the debt-to-GDP ratio.
    Mr. Spratt. With that I yield.
    Chairman Nussle. Actually, Mr. Spratt, you could probably 
ask me about that. Which is precisely the reason why we have 
tried to make small incremental decisions now with regards to 
spending as opposed to having to deal with those challenges in 
the future.
    Mr. Baird, do you have a final question?
    Mr. Baird. If I may, briefly. We have heard on this 
committee that deficits have been rising again but interest 
rates are lower, as if there is no connection. It seems to me 
that the interest rates are down because the Federal Reserve 
has set them down to try to stimulate the economy. Is it 
possible to sustain such low interest rates if we continue to 
expand the deficit and the debt accordingly?
    Mr. Holtz-Eakin. Interest rates are going to reflect the 
balance of demand for credit and supply of credit. The Federal 
Reserve is one player in that market. The government borrowing 
is a demander of credit in that market. The ultimate impact on 
interest rates will depend on other sources of supply and other 
demanders. But certainly deficits are one component of that.
    Mr. Baird. So we might see some increase in deficit or in 
interest rates if we continue to deficit spend.
    Mr. Holtz-Eakin. Depending on the other conditions, yes.
    Mr. Baird. Was that factored into your calculations?
    Mr. Holtz-Eakin. Yes.
    Mr. Baird. And to what degree, to what degree do you 
anticipate that interest rates might increase in response to 
continued government deficit spending?
    Mr. Holtz-Eakin. The precise relationship between what 
ultimately is the amount of government debt issued over, say, 
the 10-year window and the ultimate impact on interest rates 
differs by model. In the business cycle models, there is in 
fact an electronic Federal Reserve at play, affecting interest 
rates and reacting to conditions. So you get different 
relationships there. In growth models, interest rates are 
driven by the overall profitability of capital investments, 
which determine equity returns, and then bond returns run off 
of that. What we have found in simulations that we have 
presented today is that the relationship between additional 
debt outstanding and interest rates is in line with the broad 
macroeconomic consensus. Nothing special.
    Mr. Baird. The President has not called me yet to ask me 
what I think we ought to do with the budget. But if I were 
dealing with this myself and I wanted to put people back to 
work and stimulate the economy and create a long-term healthy 
economy, rather than tax cuts to the magnitude we have got now, 
I would substantially curtail them and instead invest in 
highways, infrastructure, educating our kids, things of that 
sort.
    My guess is--I think I know the answer to this--but you 
have only looked at the President's proposal. You have not 
looked at economically in terms of how many people would be 
back to work, what their taxes would be paid, what 
infrastructure we might create if we were to do something other 
than the President's budget. You have only been able to look at 
just the President's budget?
    Mr. Holtz-Eakin. Right. This analysis is devoted to those 
proposals.
    Mr. Baird. Thank you, Mr. Chairman.
    Chairman Nussle. Thank you.
    Just to wrap up today, I wanted to ask the question about 
where the $30 billion went. From January till today, obviously, 
you know, there has been an adjustment that you made in the 
baseline since January, and it is a two-part question. How did 
we miss, and where did it go are basically the two questions 
that I have with regards to this. And it is, I suppose to some 
extent, on topic because I guess my follow-up question will be, 
are there any other changes that we should begin as 
policymakers to anticipate as we continue down the year?
    Mr. Holtz-Eakin. On the change in the receipts baseline, we 
made a technical revision. It does not cause a change in our 
economic projections, which remain the same as in the January 
baseline. We examined the collections to date in fiscal year 
2003 from a variety of sources: the individual corporate tax 
payments, payroll taxes. I would point out, in real time we do 
not have information about, for example, whether a payment 
coming into the Treasury should have a label on it that says 
``individual income tax'' or have a label on it that says 
``payroll tax.'' If which knew which of those labels applied to 
a dollar coming in, it would be easier to tell if, for example, 
wages and salaries are suffering, payroll taxes are down, or 
the decline stems from some other source.
    Given the nature of the uncertainty, however, it still 
appeared that receipts coming in were weaker than had been 
anticipated originally. Our technical adjustment is an attempt 
to be as accurate as possible in the baseline projection going 
forward. That lowered ratio of receipts for a given level of 
economic activity seemed appropriate. That is the revision we 
made when we put out the interim report; I have no expectation 
of further changes going forward at this time. We will revisit 
the entire baseline as a matter of regular course during the 
summer.
    Mr. Baird. Could I ask a question? What he just said, I 
think, astonished me. Maybe I just want to get clarification.
    Are you saying that when we get a bunch of money in 
revenues, we don't know whether that is coming from Social 
Security payroll taxes or from income taxes? Am I missing 
something there?
    Mr. Holtz-Eakin. After the fact, after all the labels have 
been applied--you know, the returns have been filed and the 
various liabilities have been settled, and so forth, yes, we 
will know. But at the time a corporation, for example, remits 
to the Treasury its quarterly tax payment, it remits a sum that 
can include individual withholding plus payroll taxes.
    Mr. Baird. That is not clarified.
    Mr. Holtz-Eakin. We do not know the difference between 
those.
    Mr. Baird. I find that just astonishing. It seems to me 
that would be pretty fundamental.
    Chairman Nussle. How long a lag time before we do know, 
just so we understand? Is it the 2-year----
    Mr. Holtz-Eakin. Two years.
    Chairman Nussle. That is probably even more astonishing. I 
mean, it is one thing to not know it when we get it; it is 
another thing to not understand the analysis. That is part of 
the challenge that we have got here, and I think, you know, we 
are all just learning this as we go to some extent.
    But in part, the reason I asked the question is because--
and this is not to be critical of the either the analysis that 
you have provided here today or the good work that went into 
it, but if we are already--or if it is possible you can be $30 
billion off in a matter of 2 months for whatever reason, 
technical or whatever, however it is termed, that is a big--
that is a big number, I would think, in trying to project 
already--that is out of table--I think it is table 2, if I am 
not mistaken. I was looking at this. It is a $63 billion hit 
over 10 years to that baseline right there, just in 2 months.
    Now, obviously there could come a plus number at some point 
as well. I understand that is, in part, what happened during 
the last part of the 1990s. But I just--it is flabbergasting to 
me to see these adjustments and have to try and make decisions 
based on them, regardless of what model we apply. It appears 
that the current model that we have called our tax system is 
either difficult or impossible to predict or is just not 
performing to the degree that we expected it to when we passed 
the tax laws in the first place.
    Mr. Holtz-Eakin. We certainly do endeavor to forecast or 
project perfectly. That is simply not possible. I will point 
out the scale of a $30 billion change in the nearly $2 trillion 
Federal budget, ``big'' is in the eye of the beholder, but I 
would not have chosen that as an especially large adjustment.
    Chairman Nussle. Well, that is my--coming from a State 
where the words--where the speech ``million here, million 
there, and pretty soon it is real money,'' that is the reason I 
say that.
    I think the concern I have about this is that using the 
analogy that I sometimes criticize for the weather report, we 
are asking you to predict the weather and we are not allowing 
to you look out the window. That is, in part, what it is 
saying, that we are not giving you good information or we, the 
Treasury, is not getting you--or giving you--good information 
with which to make your projections.
    So you have these--whether they are big or small 
adjustments, they are big in the magnitude of making a decision 
for this year. $30 billion added to the bottom line is, at 
least in terms of the deficit, a big number. So I understand in 
a $10 trillion economy that is not big, but with regard to our 
deficit, it certainly is a pretty big increase.
    Mr. Holtz-Eakin. I want to make sure I am clear. It is not 
that the Treasury has this information and doesn't share it 
with CBO; the Treasury doesn't have the information either. It 
is a problem shared by others.
    Chairman Nussle. Mr. Baird.
    Mr. Baird. Do you mean when a corporation is sending the 
money to the Federal Government that--and maybe I am just 
clueless here, but--wouldn't be the first time--but that we 
don't, the Treasury doesn't get information in a clear enough 
fashion that says, this is how much we are giving the Treasury 
in terms of Social Security-Medicare withholding, this is how 
much we are paying in income tax, so it takes 2 years to sort 
that out?
    Why isn't that sort of a straight, separated-out line?
    Mr. Holtz-Eakin. I could speculate. I don't know.
    Mr. Baird. It just seems to me that we ought to fix that, 
that--I don't know how you can do your job. I can't imagine how 
we would ever pass a balanced budget amendment if for 2 years 
we don't even know where the money is coming from.
    You know, it helps to be a new guy around here sometimes--
not that new, but, boy, you can be surprised every day. But 
that is just astonishing to me.
    Mr. Holtz-Eakin. I am delighted to hear that it helps to be 
a new guy.
    Chairman Nussle. This may be the sort of thing for an 
additional hearing. That is the reason I brought it up with 
Secretary Snow when he came here. It is just vital if we are--
we know much more about the spending side, it appears to me, 
than we know about the tax side.
    Mr. Spratt. When Secretary Snow was here, he came by and he 
spoke to me as he left. He said, ``We do agree on one thing; 
Treasury should be able to do a better job of accounting for 
tax receipts on a current basis than we can now.'' So we have 
got his commitment, and we ought to take him up on it and hold 
a hearing. I support that.
    Chairman Nussle. I would rarely speak for all the members, 
but let me try.
    Dr. Holtz-Eakin, this was an eye-opening experience, and 
even more so, I think you did yourself and CBO a real credit 
today in the way the material was presented and the report. I 
think people who agree or disagree with the policy will find 
both comfort and a certain amount of sting in the analysis that 
you have provided. And that may, if nothing else, be the 
fairest of it all. We appreciate this.
    And we appreciate your following in this tradition from 
CBO, and we look forward to other opportunities in the future 
where we have this chance.
    Mr. Holtz-Eakin. Thank you, Mr. Chairman.
    Chairman Nussle. Thank you. If there is nothing else, then 
this hearing is adjourned.
    [Whereupon, at 3:10 p.m., the committee was adjourned.]

                                
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