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This report provides material that supplements the Congressional Budget Office's (CBO's) The Economic and Budget Outlook: An Update (July 1, 1999). In accordance with CBO's mandate to provide objective and impartial analysis, this document contains no recommendations.

The analysis was prepared by Frank Russek of CBO's Macroeconomic Analysis Division under the supervision of Robert Dennis. David Arnold provided research assistance.

Sherry Snyder edited the report, and Liz Williams proofread it. Dorothy Kornegay and Linda Lewis Harris assisted in the production of the report. Kathryn Quattrone prepared the final version for publication, and Laurie Brown prepared the electronic versions for CBO's World Wide Web site (www.cbo.gov).
 

Dan L. Crippen
Director
July 30, 1999
 
 

Much of the budget surplus projected by the Congressional Budget Office (CBO) for this year and next arises because the economy is operating at an unsustainably high rate. Under current tax and spending policies, CBO projects that the budget surplus will amount to $120 billion in fiscal year 1999 and $161 billion in 2000. But when the economic effects that are likely to be transitory are taken into account (along with other factors discussed below), the resulting surplus--the so-called standardized-employment surplus--is only $12 billion for this year and $69 billion for next year (see Table 1).
 

CBO's estimate of the standardized-employment budget relies heavily on CBO's estimate of potential gross domestic product (GDP)--the level of GDP compatible with stable inflation--and on how actual GDP varies around potential GDP over time (see Figure 1). The estimate of potential GDP is based on a growth model that takes into account trends in hours worked, the capital stock, and the productivity of those two factors of production. It is consistent with CBO's estimate of the NAIRU--the nonaccelerating inflation rate of unemployment--which is now 5.5 percent. Revisions of the underlying assumptions or methodology used to estimate potential GDP will alter the estimates of the standardized-employment budget (see Box 1).
 

Figure 1. GDP and Potential GDP

SOURCES: Congressional Budget Office; Department of Commerce, Bureau of Economic Analysis.

NOTE: Values are plotted using a logarithmic scale.

a. Chain weighted.

GDP is now about 3 percent higher than CBO's estimate of potential GDP. That economic strength is mirrored in the unemployment rate, which at 4.3 percent in mid-1999 is near a 30-year low and is substantially lower than the NAIRU. On average over the next 10 years, however, the unemployment rate will probably be closer to the NAIRU, and the economy will operate closer to potential than it does now. Consequently, the cyclical component of the budget surplus is projected to be smaller, on average, in the years ahead.

CBO's measure of the standardized-employment budget removes from federal outlays and revenues the effects of departures from potential GDP and the NAIRU. When GDP is above potential GDP, as it now is, the cyclical bulge in revenues is removed from actual revenues. Similarly, when the unemployment rate is below the NAIRU, the cyclical savings in unemployment benefits and other transfer programs are added back to outlays. Those adjustments thus remove variations in the budget totals attributable to cyclical factors.

The standardized-employment budget also excludes outlays for deposit insurance, receipts from spectrum auctions and asset sales, and the effects of calendar quirks and other timing adjustments. Transactions such as deposit insurance, spectrum auctions, and asset sales are largely transitory and have little impact on current economic developments because they are simply exchanges of existing assets. Calendar or timing adjustments correct the fiscal year budget totals for meaningless aberrations in the pattern of revenues and outlays that occur when, for example, there are 13 monthly payments in one year and 11 in the next.

CBO estimates that the standardized-employment budget will change from a slight deficit in 1998 to a surplus of 0.8 percent of potential GDP in 2000 (see Table 1). Most of that change occurs next year and largely reflects declines in discretionary outlays and net interest payments. When interest payments are excluded to more clearly isolate the discretionary component of budget policy, the increase in the standardized-employment surplus in 2000 (shown in Table 1 under "Primary Surplus") is about half as large as it is when interest payments are included (see "Total Surplus").

By 2009, under current tax and spending policies, the standardized-employment surplus would reach 3 percent of potential GDP--higher than in any previous year. (Historical estimates are in Tables 2, 3, and 4.) Virtually all of that improvement would result from a steady decline in interest payments and discretionary outlays as shares of potential GDP. Excluding interest payments, the primary standardized-employment surplus after 2000 is stable relative to potential GDP.