[Economic Report of the President (2006)]
[Administration of George W. Bush]
[Online through the Government Printing Office, www.gpo.gov]

 
Overview


The expansion of the U.S. economy continued for the fourth
consecutive year in 2005. The President has laid out an agenda
to maintain the economy's momentum, foster job creation, and ensure
that America remains a leader of the global economy.
The President is advancing plans to make tax relief permanent;
restrain government spending to reduce the budget deficit;
strengthen retirement systems; make health care more affordable
and accessible; create an economic environment that encourages
innovation and entrepreneurship; enhance private incentives for
research and development; boost math and science education and worker
training; reform the immigration system and strengthen our borders;
continue to open markets to American goods and services; and reduce
America's dependence on foreign oil by diversifying our energy supply.
This Report reviews the state of the economy and the economic outlook,
and discusses a number of economic policy issues of continuing importance.
The Report highlights how economics can inform the design of better
public policy and reviews Administration initiatives.

The Year in Review and the Years Ahead

The economy has shifted from recovery to sustained expansion, having
absorbed the effects of the Gulf Coast hurricanes and large increases
in energy prices in 2005. Chapter 1, The Year in Review and the Years
Ahead, reviews the economic developments of 2005 and discusses the
Administration's forecast for the years ahead. The key points of
this chapter are:
 Real GDP grew strongly during 2005. Most components
of demand that accounted for growth in 2004--consumer
spending, business investment in equipment and software, and
exports--continued to do so in 2005.
 Labor markets continued to strengthen. Employers created 2
million new jobs in 2005, and the unemployment rate dropped
to 4.9 percent by year-end.
 Productivity growth remained well above its historical average in 2005.
 Inflation rose substantially at mid-year, but came down by year-end
as it reflected the movement of energy prices. In contrast, inflation
in the core consumer price index (CPI) (which excludes food
and energy prices) has remained in the moderate 2-percent
range.
 The Administration's forecast, consistent with consensus
private forecasts, shows the economic expansion continuing for the
foreseeable future.


Skills for the U.S. Workforce
Chapter 2, Skills for the U.S. Workforce, discusses the economics of
education, immigration, and job training. The key points are:
 Education is a key contributor to economic growth and individual
income.
 Advances in education levels have slowed over the past 25
years. The No Child Left Behind Act is working to reverse this trend
by making schools more accountable. If, however, we do not continue
to improve our schools, the U.S. standard of living could be
jeopardized in years to come.
 High-skilled immigrants make up a vital part of the U.S.
economy, particularly in the science and engineering sectors.
 Workers need to upgrade their skills continually to adapt to
and take part in an ever-changing economy.

Promoting a flexible and skilled labor force--through improved access
to high-quality primary, secondary, and post-secondary education, through
policies that attract the world's best and brightest to our shores, and
through investment in the continuing education and training of our
mobile workforce ï¿½ will ensure that the United States remains a
competitive leader in this rapidly changing world economy.

Saving for Retirement
Over the past few decades, concerns have mounted that Americans
have been preparing inadequately for retirement. The main points of
Chapter 3, Saving for Retirement, are:
 Most working-age Americans are on track to have more retirement
wealth than most current retirees. It is inherently difficult,
however, to assess whether these preparations are adequate for
most households.
 The decline in an often-cited aggregate personal saving rate
may not be cause for much alarm for retirement preparedness.
Much of this decline can be attributed to spending triggered
by wealth increases from capital gains on housing and financial assets.
 There are, however, a number of risks to the retirement
preparations of Americans. People today are living longer and
could face higher health-care costs in retirement than members
of previous generations. In addition, Social Security and many
defined-benefit pension plans are at risk.
 Both defined-benefit pensions and Social Security suffer from
fundamental financial problems that expose not just retirees
but all U.S. taxpayers to risk of substantial losses. The
Administration is focused on addressing these problems and
protecting the Nation's retirement security.


Improving Incentives in Health Care Spending
Health care spending in the United States has increased rapidly over
the past several decades, rising 44 percent in real per capita terms in
the past ten years alone. Some of the reasons for this marked rise reflect
higher-quality health care, such as improved technological options for
enhancing health and quality of life. Other factors, however, such as
poorly functioning markets for health care, may have led to excessive
spending and inefficient patterns of medical care utilization.
Chapter 4, Improving Incentives in Health Care Spending, reviews the
causes and consequences of health care spending growth and discusses
how the President's consumer-driven proposals can improve the health
care system. The key points are:
 Growth in spending on health care has been much more rapid
than general inflation, straining consumers, employers, and
government budgets.
 Perverse tax and insurance incentives have led to inefficient
levels and composition of spending on health care.
 Promoting a stronger role for consumers is a promising strategy
for improving health care value and affordability.


The U.S. Tax System in International Perspective

All governments face two important decisions. They must choose the
scope and scale of public goods and services to provide for their
citizens, and they must also decide how to collect the funds to
finance those public services. Chapter 5, The U.S. Tax System in
International Perspective, examines U.S. choices in the context of other
countries. It makes three key points:
 Fundamental choices about tax systems matter because they
affect the living standards of citizens.
 The United States has made different choices from other
countries. The United States has a relatively low tax burden
compared to the rest of the world, and we finance more of
that burden with a tax on personal income instead of consumption.
 When viewed in an international perspective, the U.S. system
has been significantly improved in recent years but could benefit
greatly from additional reforms, particularly those focused on the
taxation of capital income.

The U.S. Capital Account Surplus
The United States conducts an enormous number of trade and financial
transactions with other countries. In 2004, the U.S. ran a current
account deficit of $668 billion. This deficit meant the U.S. imported
more goods and services than it exported. The counterpart to the
U.S. current account deficit was a capital account surplus of an
equal amount. This surplus meant that foreign investors purchased
more U.S. assets than U.S. investors purchased in foreign assets,
and the U.S. received net foreign capital and financial inflows.
Chapter 6, The U.S. Capital Account Surplus, makes several key points:
 The size and persistence of U.S. net capital inflows reflects
a number of U.S. economic strengths as well as some shortcomings.
 The recent rise in U.S. net capital inflows in part reflects
global economic conditions as well as policies in some
Asian countries and weak growth in several European economies that
led to greater net capital outflows from these countries.
 Encouraging greater global balance of capital flows would
be helped by steps in several countries, such as higher domestic
saving in the U.S., stronger economic growth in Europe and Japan,
and greater exchange rate flexibility and financial sector reforms
in Asia.


The History and Future of International Trade

While economic research and historical evidence show the benefits of
trade outweigh the costs, trade liberalization has always brought
anxieties in the United States and throughout the world. There have
always been temptations to retreat to economic isolationism, but the
Administration rejects that notion. The key points in Chapter 7, The
History and Future of International Trade, are:
 Over the past 70 years, policymakers across political parties
have consistently recognized the importance of international
commerce, and have achieved major trade liberalization both
here and abroad.
 The net payoff to America from these achievements has been
substantial. For example, studies have estimated the annual payoff
from U.S. trade and investment liberalization thus far averages
$5,000 per American.
 A number of barriers to trade remain, especially in services,
and the benefits of eliminating these barriers are significant.
One study found removing all remaining barriers to trade in
services would lead to an additional $7,000 in annual income
for the average American family of four. The Administration
is working to open these markets in global, regional, and
bilateral negotiations.

The U.S. Agriculture Sector

In 2005, the Federal government spent approximately $20 billion on
agricultural support payments in a sector forecast to produce
approximately $270 billion of output. In addition, the United States
maintains barriers to the import of some commodities, and these
barriers raise the domestic prices of these commodities relative
to world prices. To what extent do these many payments and trade
barriers serve a public purpose? Are they needed to maintain a
healthy U.S. agricultural sector? Could alternative policies achieve
this goal?  Chapter 8, The U.S. Agricultural Sector, addresses
these and other questions. The key findings of this chapter are:
 Most farmers do not benefit from commodity subsidies.
 Support to agriculture can be provided in many forms that are
potentially less market- distorting than existing commodity
subsidies.


The U.S. Financial Services Sector

Most people interact regularly with the financial services sector,
such as when they make deposits at banks or obtain loans from them.
Nevertheless, understanding what this sector does can be difficult.
Why do individuals go to intermediaries like banks for mortgages, rather
than skip intermediaries and deal directly with savers? And why do
financial service firms ask for so much information before making a
loan and, afterward, place so many restrictions on borrowers?
Chapter 9, The U.S. Financial Services Sector, explores what financial
services do for an economy, how financial development relates to
economic performance, and how financial services can be effectively
regulated. The key points are:
 The U.S. financial services sector addresses informational
problems that can otherwise keep financial capital from
finding productive uses. The sector tends to deliver these
services in a cost-effective manner.
 Financial services facilitate innovation and thus encourage
economic growth. They might also bolster economic stability.
 Financial regulation should protect consumers and ensure the
system's safety and soundness. Moving too far in the direction
of public regulation, however, can stifle the productivity
and innovation necessary for the economy to enjoy fully the
benefits of financial services. An effective financial
regulatory system appropriately balances the costs and
benefits of public regulation.

The Role of Intellectual Property
in the Economy

The founders of this country believed that intellectual property
was so important that one of the grants of power to Congress under
the Constitution was ''To promote the Progress of Science and the
useful Arts, by securing for limited Times to Authors and Inventors
the exclusive Right to their respective Writings and Discoveries.''
Economic research over the past two centuries confirms the importance
of intellectual property. The key points of Chapter 10, The Role of
Intellectual Property in the Economy, are:
 Intellectual property rights create incentives for individuals
and firms to invest in research and development, and to
commercialize inventions by allowing them to profit from
their creations.
 Well-defined and enforced intellectual property rights are
important to economic growth.
 The Administration continues to enforce vigorously the
rights of American intellectual property owners.


Recent Developments in Energy

Chapter 11, Recent Developments in Energy, discusses energy
markets--systems that connect consumers and suppliers of energy
products, where prices are determined by what buyers will pay and
what sellers will accept. The chapter reviews developments in markets
for crude oil, refined petroleum products, and natural gas, as well
as developments in the electricity-generation sector. The key points are:
 Increased scarcity and rising prices over time will encourage
conservation, increase incentives for exploration, and
stimulate the development of new, energy-efficient
technologies and alternative energy sources.
 In the near term, unexpected disruptions to energy supply
and distribution networks may continue to affect consumers
and businesses. Hurricanes Katrina and Rita demonstrated
that competitive markets play a central role in allocating
scarce energy resources, especially during times of natural
disaster or national emergency.
 The continued expansion of energy markets through regional
and global trade can further increase our resilience to energy
supply disruptions.
 Policies that reduce U.S. vulnerability to energy disruptions,
encourage energy efficiency, and protect the environment can
be beneficial supplements to markets. These policies can be
made more effective and less costly when designed based on
economic incentives.