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The following is an analysis of the Summary section of the January 2001 CBO Budget and Economic Outlook. The text in *RED are comments included by the website host.

The Budget and Economic Outlook: Fiscal Years 2002-2011
January 2001
Section 2 of 15

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Summary

In the absence of significant legislative changes and assuming that the economy follows the path described in this report, the Congressional Budget Office (CBO) projects that the total surplus will reach $281 billion in 2001.

* “Assuming the economy follows the path described in this report…”

* The most pertinent assumption and disclaimer to the budget are stated in the first sentence. If the economy does not follow the path described in this report, the projections will no occur.

Such surpluses are projected to rise in the future, approaching $889 billion in 2011 and accumulating to $5.6 trillion over the 2002-2011 period.

* The surpluses are expected to rise in the future… The future years are always the most difficult to predict. The second sentence of the summary contains the often quoted “$5.6 trillion dollar surplus.”

That total is about $1 trillion higher than the cumulative surplus projected for 2001 through 2010 in CBO's July 2000 report. About $600 billion of the $1 trillion increase is due simply to shifting the 10-year horizon out one year, to 2011, and dropping 2001 from the total. The remaining $441 billion results mostly from changes in the economic forecast, which are offset in part by the cost of legislation enacted since CBO's previous report.

* The 2001 total surplus was $128.2 billion in 2001 versus the projected $281 billion.

http://www.cbo.gov/budget/historical.pdf

* The surpluses did not rise in the future.

* There is a $1 trillion adjustment from 6 months earlier, $600 billion from extending the projection to 2011 and $441 billion for changes in the economic forecast.

* Actual spending has been increased and it is assumed it will be paid for through future surpluses.

Perhaps more important to some policymakers, the on-budget surplus (which excludes the spending and revenues of Social Security and the Postal Service) is anticipated to equal $125 billion in 2001--a nearly $40 billion increase from its level in 2000. The on-budget surplus will continue growing over the 10-year period, CBO projects, exceeding $550 billion in 2011 and totaling over $3.1 trillion between 2002 and 2011.

* The 2001 on-budget projected surplus of $125 billion became a -$32.4 billion deficit. The budget projections were invalid by the end of 2001.

http://www.cbo.gov/budget/historical.pdf

* The projected on-budget surplus did not grow after 2000 and will not result in a $3.1 trillion surplus.

The growth of economic activity--as measured by real (inflation-adjusted) gross domestic product (GDP)--is likely to slow from its rapid pace of recent years to about 2.4 percent this calendar year. Spending by consumers and investment by businesses slowed late last year in response to the rise in interest rates during 1999 and early 2000 and to reduced expectations about future business conditions. Although the Federal Reserve Board in early January responded to the slower growth by lowering the federal funds rate, spending by consumers and businesses is likely to remain weak in the near term. However, lower interest rates this year will set the stage for moderately faster growth of spending next year. Thus, CBO forecasts that economic growth will climb to about 3.4 percent in calendar year 2002.

* CBO’s 2.4% forecast was incorrect. The real GDP slowed to .75% in 2001.

* CBO’s 3.4% forecast was incorrect. The real GDP was 1.6% in 2002

http://eh.net/hmit/gdp/gdp_answer.php

How is it, then, that budget projections are getting better when the economy seems to be getting worse?

* Good question.

There are two main answers to that question. First of all, the dip in the economy is expected to be short-lived. CBO forecasts that economic growth will pick up again by the middle of 2001. Over the 2002-2011 period, CBO anticipates that growth of real GDP will average a little over 3 percent per year--about 0.3 percentage points above its 10-year projection in July. That increase reflects a change in CBO's method of calculating the contribution of capital to growth, revised data showing greater investment for the past three years, and higher projected levels of investment. Changes due to higher projections of GDP and other economic factors boost projected revenues by $802 billion from 2001 through 2010.

* The GDP rates were as follows. The 3% growth rate was not reached until 2004.

Results

year	gdp change
2000	3.66%
2001	0.75%
2002	1.60%
2003	2.51%
2004	3.91%
2005	3.22%

* The CBO changed its method to forecast the GDP.

Second, recent economic conditions and actions by the Federal Reserve have led CBO to significantly reduce its forecast of interest rates in 2001 and 2002 (but that factor is not nearly as large as the first). Lower near-term interest rates and reduced levels of projected debt across the 10-year period (due to higher projected surpluses) combine to increase estimates of the surplus by about $140 billion from 2001 through 2010.

* The Federal Reserve was lowering the interest rates and this led the CBO to reduce its interest rates in 2001 and 2002. Also, the lower projected deficits reduced the interest expenses over the projection period.

* Why was the Federal Reserve lowering interest rates in 2000? The CBO states it is a result of “recent economic conditions”. Because the GDP clearly declined in 2001, the Federal Reserve was probably adjusting interest rates to react to the declining economy?

* Is it reasonable to project a 3%+ GDP growth rate when the Federal Reserve is cutting interest rates because of a slowing economy?

The Budget Outlook

The outlook for the federal budget over the next decade continues to be bright.

* Based on the actual GDP rates for 2001-2003, this optimism was overstated. See the previous GDP summary.

Assuming that current tax and spending policies are maintained, CBO projects that mounting federal revenues will continue to produce growing budget surpluses for the next 10 years.

* The CBO budgeting assumes current tax and spending policies for the next 10 years. This assumption is obviously contingent on the economy growing at the forecasted rate which it did not accomplish (See GDP numbers.)

CBO's updated budget outlook continues a trend of steady and sometimes dramatic improvement in budget projections since 1997, reflecting the continuing impact of strong economic growth over the past few years.

* CBO’s budget outlook (future) reflects the continuing impact of strong economic growth. This is in light of the known slowing economy as stated in the following.

Although there are signs that economic growth is moderating from recent robust levels, substantial budget surpluses remain on the horizon for the next decade in the absence of large changes in policy.

· Economic growth appears to be moderating. Again the assumption of no policy change is stated.

Over the longer term, however, budgetary pressures linked to the aging and retirement of the baby-boom generation threaten to produce record deficits and unsustainable levels of federal debt.

* Regardless of all the optimism, the baby-boom retirement threaten to produce record deficits and unsustainable levels of federal debt.

CBO projects that, in the absence of new legislation, total budget surpluses would grow from about 3 percent to more than 5 percent of GDP from 2002 through 2011.⁽¹⁾

* Budget surplus are expected to grow from the current 3% rate to 5% in 2002-2011 even though the CBO has indicated the economy is slowing. Why is the 5% future rate attainable while the current projected rate for 2000 is about 3%/? Is this reasonable? Is the 5% reasonable when considering “about 3%” is actually 2.41% ($236.2 billion divided by $9,817 billion)

Under current policies, total surpluses would accumulate to an estimated $2 trillion over the next five years and $5.6 trillion over the coming decade (see Summary Table 1). Such large surpluses would be sufficient by 2006 to pay off all debt held by the public that will be available for redemption.

* Obviously the projections have not been met. Such large surplus “would be” versus “will be.” The CBO recognizes this is a projection.

Summary Table 1. The Outlook for the Budget Under Current Policies (By fiscal year, in billions of dollars)
		Actual 2000	2001	2002	Total, 2002-2006	Total, 2007-2011	Total, 2002-2011
On-Budget Surplus		86	125	142	987	2,135	3,122
Off-Budget Surplus		150	156	171	1,019	1,468	2,488
	Total Surplus	236	281	313	2,007	3,603	5,610
SOURCE: Congressional Budget Office.

Within those totals, on-budget surpluses would accumulate to nearly $1 trillion over the next five years and about $3.1 trillion over the 2002-2011 period. On-budget surpluses would range between just over 1 percent to more than 3 percent of GDP.

* The highest on-budget surplus occurred in 2000 when the surplus was .88% ($86.4 billion divided by $9,817 billion GDP). The CBO overstated the historical on-budget surplus for 2000 in January 2001. Is it reasonable to believe there will be a 3% on-budget surplus based on one year, 2000. In 1999 the on-budget surplus of $1.9 billion in a $9,268.4 billion economy results in a .0205% on-budget surplus.

Off-budget surpluses also would total about $1 trillion over the next five years and about $2.5 trillion through 2011. Off-budget surpluses alone would be sufficient to eliminate the debt available for redemption by the end of the 10-year period.

* $1 trillion over 5 years equals $200 billion per year.

The distinction between on- and off-budget surpluses is significant for the budget policy debate. Many lawmakers have declared their intent to preserve all off-budget surpluses, which consist principally of the surpluses generated by the Social Security trust funds, thereby reducing the outstanding public debt. As a result, on-budget surpluses are viewed by those lawmakers and others as establishing the budgetary boundaries for any new spending or revenue policies.

* Obviously this restraint was not met.

Changes Since July 2000

CBO's current budget outlook is more favorable than the one presented in July 2000. Since then, the Congress and the President have enacted legislation that, CBO estimates, increases projected spending over the 2001-2010 period by about $561 billion and reduces projected revenues by $37 billion, compared with the levels in CBO's July baseline (see Summary Table 2).

About two-thirds of that increase in projected spending results from extrapolating discretionary spending into the future on the basis of the level of appropriations for 2001.

* Does this mean an increase or no increase in spending after 2001?

Expanded health care benefits for military retirees and increased payments for Medicare--along with additional debt-service costs resulting from legislative changes--account for most of the rest of the decrease in the cumulative surplus. The effects of legislation, however, have been more than offset by changes in CBO's estimates of future revenues that add to projected surpluses.

* The two paragraphs above have actual spending commitments being offset by future revenue projections.

Summary Table 2. Changes in CBO's Projections of the Surplus Since July 2000 (By fiscal year, in billions of dollars)
					2001	2002	2003	2004	2005	2006	2007	2008	2009	2010	Total, 2001- 2010
July 2000 Projection of Total Surplus^a					268	312	345	369	402	469	523	565	625	685	4,561
Changes
	Legislative
		Revenues			-2	-2	-3	-3	-3	-4	-4	-5	-6	-5	-37
		Outlays^b			-12	-40	-46	-51	-56	-60	-66	-71	-77	-83	-561
			Subtotal		-14	-42	-49	-53	-59	-63	-70	-76	-83	-88	-598
	Economic
		Revenues			-6	7	32	56	72	88	106	128	148	173	802
		Outlays^b			7	14	10	10	12	16	19	24	29	37	178
			Subtotal		1	21	42	66	84	103	124	151	177	210	980
	Technical
		Revenues			33	29	24	20	15	11	9	7	4	2	153
		Outlays^b			-6	-7	-3	-5	-10	-14	-13	-12	-12	-12	-95
			Subtotal		27	22	21	15	6	-3	-4	-6	-8	-10	59
				Total Changes	13	*	14	28	31	36	50	70	86	111	441
January 2001 Projection of Total Surplus					281	313	359	397	433	505	573	635	710	796	5,002
Memorandum:
Total Change in Revenues					25	34	53	73	84	95	110	129	146	170	919
Total Change in Outlays^b					-12	-33	-38	-45	-53	-59	-60	-59	-60	-58	-478
SOURCE: Congressional Budget Office.
NOTE: * = less than $500 million.
a. The stated surplus assumes that discretionary spending grows at the rate of inflation after 2000 (one variation of the baseline described in CBO's July report).
b. Increases in outlays are shown with a negative sign because they reduce surpluses.

Most of the improvement in CBO's budget outlook since July results from changes in economic projections. Despite an expected short-term reduction in economic growth, CBO estimates that the economy will grow faster after 2001 than it estimated in July. That increase in growth boosts projected revenues by more than $800 billion over the 2001-2010 period.

* The improvement in CBO’s budget is the result of economic projections and not actual results. The CBO again acknowledges there is a short-term reduction in economic growth; however, the CBO expects the economy to improve in 2002. The improved future economic growth, in spite of the current downturn, will boost revenues.

* A review of the GDP numbers concludes the downturn was more than short-term.

year	gdp change
2000	3.66%
2001	0.75%
2002	1.60%
2003	2.51%
2004	3.91%
2005	3.22%

CBO projects that interest rates will be at least 1 percentage point lower in both 2001 and 2002 than previously forecast. As a result, projections of net interest are lower by $12 billion in 2001 and $21 billion in 2002. At the same time, higher revenue projections and other factors reduce the projected costs of servicing the debt by a total of $160 billion over the 10-year period.

* The interest rate previously forecast is not stated. The Fed Funds yearly average is as follows:

	average
Year	fed funds
1998	5.35%
1999	4.97%
2000	6.24%
2001	3.89%
2002	1.67%
2003	1.13%
2004	1.35%
2005	3.21%
2006	4.87%

Financial Forecast Center's Historical Economic and Market Data

Changes in factors other than legislation and the economic outlook (so-called technical changes) increase projected surpluses by $59 billion over 10 years. Technical changes to revenue projections increase surpluses by $153 billion--mostly reflecting an increase in projected realizations of capital gains in the first half of the period and collections of revenues in fiscal year 2000 that were greater than anticipated in July.

* Here is the first indication that Capital Gains for 2000 were higher than was projected in the first half of 2000.

* Why were Capital Gains higher than expected over a period of just 6 months?

Technical changes to outlay projections offset $95 billion of the increase in revenues between 2001 and 2010 through a mix of modifications in both directions. Among the largest are upward revisions for Medicaid and Social Security, which are only partially offset by downward reestimates for discretionary spending (mostly Section 8 housing assistance); estimates of greater receipts from auctions of licenses to use portions of the electromagnetic spectrum; and lower debt-service costs.

* Medicaid and Social Security are expected to rise.

Projections of Federal Debt

Between 1969 and 1997, the Department of the Treasury sold ever-increasing amounts of securities to finance continuing deficits. As a result, debt held by the public climbed each year, peaking at $3.8 trillion in 1997. But that trend has been reversed. Debt held by the public has dropped $363 billion, to $3.4 trillion at the end of fiscal year 2000.

* The debt historical numbers are correct.

CBO's baseline indicates that debt held by the public will continue to fall (see Summary Figure 1). If surpluses accrue as projected,

* “If surplus accrue as projected” is a clear indication of doubt and is a qualifier.

much of the current debt will be paid down over the next several years; however, a part of it--including some long-term bonds and savings bonds--will not be available for redemption during CBO's 10-year projection period. Therefore, in any given year, some debt will remain outstanding and incur interest costs, regardless of the size of the surplus. Under CBO's assumptions

* Were the assumptions valid in light of the discrepancies already presented?

for the baseline, surpluses exceed the amount of debt available for redemption beginning in 2006. After that point, surpluses not used to pay off debt accumulate and are assumed to earn a rate of return equal to the average rate projected for Treasury securities.

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Summary Figure 1.
CBO's Projections of Federal Debt, Uncommitted Funds, and Net Indebtedness (By fiscal year, in trillions of dollars)

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SOURCE: Congressional Budget Office.

a. CBO's term for the surpluses remaining in each year after paying down publicly held debt available for redemption. Uncommitted funds accumulate from one year to the next.

CBO displays the full effect of surpluses on the government's financial position with a new measure--net indebtedness--which combines the outstanding debt held by the public and the balance of uncommitted funds. In 2006, by CBO's estimates,

“CBO’s estimates” are not “CBO’s actuals”

the surplus would be large enough to reduce debt held by the public to $1,251 billion; however, another $28 billion would be available to the Treasury but not applied to debt redemption because the remaining debt will have not yet reached maturity, will not be available for repurchase at a price that the Treasury would be willing to pay, or will be held in nonmarketable form (for example, savings bonds). The government's net representation in financial markets (net indebtedness) would therefore total $1,223 billion--the difference between debt held by the public of $1,251 billion and $28 billion in uncommitted funds. Under CBO's baseline projections, net indebtedness turns negative after 2008, meaning that the balance of uncommitted funds at that point would exceed the remaining debt owed to the public.

The Economic Outlook

Real GDP is expected to grow half as fast in calendar year 2001 as it did in 2000, dropping from 5.1 percent to 2.4 percent.

* 2001 GDP dropped to .75%. CBO missed the first year GDP in the budget projection.

That rate of growth is expected to pick up in 2002 to 3.4 percent.

* 2002 GDP was 1.6%. CBO missed the second year GDP in the budget projection.

The rate of inflation, measured by the change in the consumer price index (CPI) for urban consumers, is expected to decline from 3.4 percent in calendar year 2000 to around 2.8 percent in 2001.

* The inflation rate in 2001 was 2.8%. The CBO forecasted was correct.

Federal Reserve Bank of Minneapolis - Consumer Price Index and Inflation Rates, 1913-

That projected decline reflects CBO's view that oil prices will fall somewhat from last year's level, although the underlying inflationary pressure from the tight labor market will remain.

* Oil prices

2000	$27.39
2001	$23.00
2002	$22.81
2003	$27.69
2004	$37.66
2005	$46.47
2006	$60.40

* Crude oil prices went above the 2000 price in 2003.

Historical Crude Oil Prices Table

* Unemployment Rate

	Annual
Year	Percent
1998	4.50%
1999	4.20%
2000	4.00%
2001	4.70%
2002	5.80%
2003	6.00%
2004	5.50%
2005	5.10%

* The tight labor market was subsiding after 2000.

CBO anticipates that growth of real GDP will average about 3 percent in the 2002-2011 period.

* Real GDP 2002 = 1.6%; 2003 = 2.51%, 2004 = 3.91%, 2005 = 3.22%

(CBO does not attempt to forecast year-to-year patterns in the business cycle more than two years ahead, but that average figure for economic growth takes into account a range of scenarios, including both a recession and the continuation of strong growth.)

* By law, CBO does not forecast beyond 2 years.

CBO also projects that CPI inflation will average 2.6 percent during that period, reflecting the agency's assumption about the level of inflation consistent with Federal Reserve policy.

* Inflation Rates

2000	3.4
2001	2.8
2002	1.6
2003	2.3
2004	2.7
2005	3.4
2006 est	3.3
http://www.minneapolisfed.org/Research/data/us/calc/hist1913.cfm

Given the projection of continued stable inflation, interest rates are expected to level off at rates similar to those seen in the second half of the 1990s. (See Summary Table 3.)

* The Fed Fund Interest Rates:

	average
Year	fed funds
1994	4.20%
1995	5.84%
1996	5.30%
1997	5.46%
1998	5.35%
1999	4.97%
2000	6.24%
2001	3.89%
2002	1.67%
2003	1.13%
2004	1.35%
2005	3.21%
2006	4.87%

* The projected leveling of interest rates to the second half of the 1990’s did not occur through 2006

Summary Table 3. CBO's Economic Projections for Calendar Years 2001-2011
	Estimated 2000	Forecast		Projected Annual Average
		2001	2002	2003-2006	2007-2011
Nominal GDP (Percentage change)	7.3	4.7	5.6	5.1	5.0
Real GDP (Percentage change)	5.1	2.4	3.4	3.1	3.1
GDP Price Index (Percentage change)	2.1	2.3	2.1	1.9	1.9
Consumer Price Index^a(Percentage change)	3.4	2.8	2.8	2.6	2.5
Unemployment Rate (Percent)	4.0	4.4	4.5	4.7	5.2
Three-Month Treasury Bill Rate (Percent)	5.8	4.8	4.9	4.9	4.9
Ten-Year Treasury Note Rate (Percent)	6.0	4.9	5.3	5.6	5.8
SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis; Department of Labor, Bureau of Labor Statistics; Federal Reserve Board.
NOTES: Percentage changes are year over year.
a. The consumer price index for urban consumers.

Uncertainty in the Projections

The baseline projections presented in this report represent the midrange of possible outcomes for the economy and the budget,

* Midrange means there are higher possibilities as well as lower possibilities. The baseline projection is just the midrange.

based on past and current trends and the assumption that current policies are not changed.

* The baseline projections are based on past and current trends and the current policies are not changed. The trends as observed by the GDP growth rate was not a trend that continued even to the first year of the projections.

But considerable uncertainty surrounds those projections for two reasons.

* CBO acknowledges there is considerable uncertainty.

First, the U.S. economy and the federal budget are highly complex and are affected by many economic and technical factors that are difficult to predict.

* CBO acknowledges there are many factors that are difficult to predict.

Second, future legislation is likely to alter the paths of federal spending and revenues.

* CBO acknowledges that legislation is likely to alter spending and revenues.

CBO does not predict future legislation--indeed, any attempt to incorporate future legislative changes in its baseline would undermine the usefulness of those numbers as the base against which to measure the effects of such changes. As a result, actual budgetary outcomes will almost certainly differ from CBO's baseline projections.

* CBO acknowledges the actual results will almost certainly be different.

Experience shows that although CBO's projection of the surplus for the coming fiscal year is likely to err, on average, by about 1 percent of GDP (excluding the effects of new legislation),

* 1% is approximately $100 billion. The CBO is acknowledging the surplus should error by $100 billion in the coming year. The projected surplus for 2001 was $281 billion and the actual surplus was $128.2 billion, a difference of $153 billion or 1.5%.

discrepancies can become more substantial over a five-year horizon. CBO has made 10-year projections only since 1992, so it is too soon to assess their accuracy; but 10-year projections are likely to be less accurate than five-year projections.

* CBO is not willing to assess their ability to make a 10-year projection. If the CBO acknowledges a likely error of $100 billion in the first year, their reluctance to project out 10 years seems reasonable, especially when you see the 2001 error was 1.5%.

In view of those uncertainties, the outlook for the budget can best be described as a fan of probabilities around the point estimates presented in this report. The fan is initially fairly narrow, but then widens as the period extends (see Summary Figure 2). The figure makes clear that nearby projections--other paths in the darkest part of the figure--have nearly the same probability as the baseline. Moreover, projections that are quite different from the baseline also have some significant probability of coming to pass. For example, the figure suggests some probability, albeit small, that the budget might fall into deficit in 2006, even without policy changes.

* CBO has just stated there is a possibility the budget will fall into deficit by 2006. This is a long way from a $5.6 trillion surplus in 2011.

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Summary Figure 2.
Uncertainty in CBO's Projections of the Total Budget Surplus Under Current Policies (By fiscal year)

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SOURCE: Congressional Budget Office.

NOTES: The figure shows the estimated likelihood of alternative projections of the surplus under current policies. The calculations are based on CBO's past track record. The CBO projections described in Chapter 1 fall in the middle of the darkest area. Assuming that policies do not change, the probability is 10 percent that actual surpluses will fall in the darkest area and 90 percent that they will fall within the whole shaded area.

Actual surpluses will of course be affected by legislation enacted during the next 10 years, including decisions about discretionary spending. The effects of future legislation are not included in this figure.

An explanation of how this probability distribution was calculated will appear shortly on CBO's Web site at www.cbo.gov/otherdoc.html

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1. These estimates assume that discretionary spending--which is provided and controlled in appropriation acts--grows over the 10-year period at the rates of inflation specified in the Balanced Budget and Emergency Deficit Control Act of 1985.