Order Code RL31414
CRS Report for Congress
Received through the CRS Web
Baseline Budget Projections:
A Discussion of Issues
Updated March 1, 2005
Marc Labonte
Analyst in Macroeconomics
Government and Finance Division
Congressional Research Service { The Library of Congress

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Baseline Budget Projections: A Discussion of Issues
Summary
Between January 2001 and January 2005, the Congressional Budget Office
(CBO) reduced its 10-year baseline projection for the period 2002-2011 from a peak
surplus of $5.6 trillion to a deficit of $2.6 trillion for three reasons. First, about one-
third of the reduction is due to technical revisions CBO made to its projections (e.g.,
to account for the smaller than predicted growth in tax revenues). Second, the
recession both reduced revenues and raised outlays automatically. This factor
accounts for less than one-tenth of the 10-year decline, and is only significant in 2002
and 2003. Finally, about 60% of the reduction was due to policy changes, the largest
of which was tax cuts, and the second largest of which was increased military
outlays. Even without a recession or technical revisions, policy changes alone would
have pushed the budget into deficit from 2003 to 2005.
Although large by historical standards, this dramatic revision in surplus
projections should not come as a surprise. Baselines are meant to project the future
budgetary path of current policy; they are not meant to be a “best guess” of future
budgetary outcomes. Without a baseline projection, policymakers would be in the
dark when planning the budget. Nevertheless, an overriding focus on the baseline
projection will lead to conclusions that can be radically misleading for three reasons.
First, baseline projections are only as accurate as the assumptions underlying
them. Arguably, a “better guess” of the probable path of the federal budget under
current policy might be achieved by modifying three assumptions in the CBO
baseline. One, that discretionary spending will remain constant as a share of GDP
rather than growing at the rate of inflation. Two, that military operations in Iraq and
Afghanistan will continue and should be counted in the baseline rather than omitted.
Three, that recent tax reductions, including alternative minimum tax (AMT) relief,
will be extended rather than allowed to expire. Modifying these baseline
assumptions and accounting for the additional debt service required to finance these
policies yield an estimate that the federal budget deficit would be $4.5 trillion more
over FY2006 through FY2015 period than that shown by the baseline projection.
The effects of the alternative assumptions grow over time: by 2015, the alternative
baseline deficit is $773 billion, compared to a CBO baseline surplus of $141 billion.
Second, budget baseline estimates and projections are highly sensitive to small
changes in underlying assumptions and economic factors. Economic forecasts
remain subject to extremely large margins of error, even over short time periods.
Thinking of the baseline projection as a certain outcome distorts the policymaking
process. Based on historical averages, there is a 25% chance that the budget will be
at least $67 billion back in surplus in 2009 — and a 25% chance that the deficit will
have grown to at least $274 billion more than the baseline projection.
Third, baseline projections are limited to a 10-year period, and thus give no
indication of the unique situation the U.S. faces beyond that horizon: the retirement
of the baby boomers. Under current policy, their retirement and rising medical costs
are likely to place an unsustainable strain on government finances. This report will
be updated periodically.

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Contents
What Baselines Can Do . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
What Baselines Cannot Do . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Discretionary Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Spending on Military Operations in Iraq and Afganistan . . . . . . . . . . . . . . . 4
Expiring Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Alternative Minimum Tax (AMT) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Accuracy of Forecasts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Troubles on the Horizon — Social Security, Medicare, and Medicaid . . . . . 8
What Happened to the Surplus? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Conclusion: The Sensitivity of the Baseline to Alternative Assumptions . . . . . 13
List of Figures
Figure 1. Discretionary Spending, 1962-2004 . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
List of Tables
Table 1. Probability Distribution of Deficit Outcomes Based on Historical
Projection Errors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Table 2. Long-Term Projected Federal Outlays, as a % of GDP . . . . . . . . . . . . . 9
Table 3. Changes to the Baseline Projections from 2001 to 2005 . . . . . . . . . . . 11
Table 4. Estimated Probability of Different Events Based on Information
Available February 2001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Table 5. Baseline Deficit Under Alternative Assumptions . . . . . . . . . . . . . . . . . 14

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Baseline Budget Projections:
A Discussion of Issues
In January 2001, the Congressional Budget Office (CBO) projected a baseline
budget surplus of $313 billion for FY2002 and a cumulative surplus of $5.6 trillion
over 10 years. Since then, an actual budget deficit of $158 billion was accrued in
FY2002 and baseline projections have been revised downward. CBO now projects
a 10-year cumulative baseline deficit of $2.6 trillion for the 2002-2011 period.1 For
the current 2005-2014 budget window, CBO projects that the budget would remain
in deficit throughout the budget window for a cumulative 10-year deficit of $0.9
trillion. What lessons can be drawn from this turn of events, and what role should
budget projections play in policy decisions?
What Baselines Can Do
Both CBO and the Office of Management and Budget (OMB) produce baseline
projections of the budget semi-annually. The purpose of the baseline is to project
revenues and outlays under current policy over the next 10 years. The best definition
of the baseline comes from CBO:
The baseline is intended to provide a neutral, nonjudgmental foundation for
assessing policy options. It is not “realistic,” because tax and spending policies
will change over time. Neither is it intended to be a forecast of future budgetary
outcomes. Rather, the projections ... reflect CBO’s best judgment about how the
economy and other factors will affect federal revenues and spending under
existing policies.2
Thus, headlines such as “CBO predicts that the national debt will be paid off by
2008” or “Changes in the baseline projections prove policy change was unaffordable”
are a misuse of the baseline. As indicated in the CBO quote, the baseline is not a
“best guess” of future policy outcomes.
The proper way to use a baseline is as a rule-of-thumb estimate for the
budgetary ramifications of current policy. This offers the policymaker a means to
measure the relative effects of proposed legislation in the context of the overall
1 Congressional Budget Office, The Budget and Economic Outlook, Jan. 2001-Jan. 2005.
Similar projections were made by the administration in Office of Management and Budget,
Budget of the United States Government, FY2002-FY2006. All estimates come from these
documents unless otherwise noted. The figures cited in this report have not been revised to
take into account policy changes made since Jan. 2005.
2 CBO, The Budget and Economic Outlook, Jan. 2001, p. 7. Instructions for creating the
baseline estimates are contained in the Budget Enforcement Act (BEA) as amended.

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CRS-2
budget. Current policy is very narrowly defined in these projections. It does not
include proposals made in adopted budget resolutions, bills passed by only one
chamber, or even bills passed by both chambers but not yet signed into law.
What Baselines Cannot Do
Without a baseline projection, policymakers would be in the dark when planning
the budget. Nevertheless, an overriding focus on the baseline projection can lead to
radically misleading conclusions. This is true for three reasons.
First, baseline projections are only as accurate as the assumptions underlying
them. Critics have argued that several of the underlying assumptions or rules
followed by CBO and OMB in making the budget baselines are not as realistic as
they could be. Applying alternative assumptions to the baseline could significantly
increase the projected size of the deficit. As discussed more fully below, the baseline
treatment of discretionary spending, supplemental spending on military operations
in Iraq and Afghanistan, expiring tax provisions, and the alternative minimum tax are
four assumptions that have been criticized.
Second, budget estimates and projections are highly sensitive to relatively small
changes in the underlying assumptions and economic factors. These changes can
have substantial effects on the deficit projection, and the effect on the projection
compounds when extrapolated into the future. In particular, our understanding of the
economy remains limited and economic forecasts remain subject to extremely large
margins of error, even over short time periods. Thinking of the baseline projection
as a certain outcome can distort the policymaking process.
Third, baseline projections are limited to current-year expenditures (for 10
years). While one would expect 10 years to be a more than adequate time horizon
to assess the course of future policy, the U.S. faces a unique situation beyond that
horizon: the retirement of the baby boomers. Under current policy, their retirement,
coupled with rising medical costs, would lead to a large expansion in funds dedicated
to Social Security and Medicare that is likely to place an unsustainable strain on
government finances. Since their retirement will mostly occur outside the 10-year
window, the baseline does not reflect this problem. In a narrow sense, it should not
reflect the problem, for the baseline is not supposed to advocate policy changes.
Nevertheless, to the extent that the baseline frames the budget debate, critics argue
that a baseline that makes unsustainable policy appear sustainable is misleading.
All three of these issues are discussed in detail below.
Discretionary Spending
Discretionary spending presents a special problem to budget estimators.
Accounting for about one-third of total outlays, it includes most spending in policy
areas such as the military, transportation, education, and the environment. Unlike
entitlements, there are few legal determinants of its levels; instead it is determined
annually at the “discretion” of legislators. Since almost all discretionary funding

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CRS-3
comes through annual appropriations, Congress has significant control over the
amounts involved and there is no easy way to distinguish between “new policies” and
the extension of “current policy.” This means that there is no obvious growth rate
of discretionary spending to use in baseline budget forecasts. Arguably, the most
useful rate of baseline discretionary growth for policymakers is whatever rate is most
realistic.
Although the Budget Enforcement Act (BEA) as amended requires that OMB
and CBO assume discretionary spending will stay constant in inflation-adjusted terms
in their respective baselines, such an adjustment is not the only reasonable one. For
example, assuming discretionary spending grew at an average historical rate,
remained constant on a per-person inflation-adjusted basis, or remained constant as
a percentage of GDP would each produce different budget results for total
discretionary spending, total outlays, and the deficit than does the inflation-
adjustment requirement. A smaller rate of increase would slow overall outlay
growth, reducing the size of future deficit projections. A higher rate of increase
would speed total outlay growth, increasing future deficit projections.
The baseline assumption that overall discretionary spending will stay constant
in real, or inflation adjusted, terms has two implications. First, although
discretionary spending is assumed to keep up with inflation, there is no adjustment
for expected population growth. Under the baseline, therefore, future discretionary
spending can buy the same amount of roads or military equipment or government
services, but there will be fewer of them per person.
Second, since the economy, as measured by gross domestic product (GDP), is
assumed to grow in real terms over the next 10 years, but real discretionary spending
is assumed to remain constant, discretionary spending would fall as a percentage of
GDP. This implies that as society becomes wealthier, it will not want to spend any
of its additional wealth on government-provided discretionary goods and services.
Although there are undoubtedly some government-provided goods and services on
which people may not wish to spend their additional wealth, it is not obvious why
this would be true of total discretionary spending, as implied by the baseline. Over
10 years, assuming instead that discretionary spending stays constant as a percentage
of GDP would increase cumulative outlays by $1.4 trillion over the baseline levels.
If outlays are increased then, absent other policy changes, there will be a larger
national debt and higher outlay for debt service. In addition to raising discretionary
outlays by $1.4 trillion, assuming discretionary spending stays constant as a share of
GDP increases debt service costs by $0.3 trillion. The cost of this alternative
assumption grows over time — in 2015, it adds $359 billion to the deficit. Assuming
higher rates of discretionary spending growth is not inconsistent with the baseline’s
purpose, to project current policy.
Does recent history suggest what growth rate is most realistic for discretionary
spending? (Of course, some of the historical change in discretionary spending is due
to policy changes, which would not be reflected in a baseline.) As seen in Figure 1,
total discretionary spending has, in fact, fallen slowly as a percentage of GDP for
decades. Much of the decline in the 1990s came from a decline in military spending.
Non-defense discretionary spending rose slightly as a percentage of GDP in the
1970s, fell in the early 1980s, then stayed relatively constant through the 1990s.

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CRS-4
From 2001 to 2003, both defense and non-defense discretionary spending grew faster
than GDP.
While discretionary spending fell as a percentage of GDP, it grew more quickly
than the rate of inflation in all but one year between FY1975 and FY1989. Thus,
using the baseline assumption would have underestimated discretionary spending
throughout this period. In the 1990s, discretionary spending fell in real terms from
FY1990 to FY1995, but then grew more quickly than the rate of inflation from
FY1996 on. Removing the fall in defense spending, non-defense discretionary
spending grew more quickly than inflation throughout the 1990s, with the exception
of 1996.
At least for non-defense discretionary spending, assuming spending would stay
constant as a percentage of GDP is the only assumption that would not consistently
underpredict spending levels historically. For better or worse, the baseline
assumption that discretionary spending will stay constant in inflation-adjusted terms
through FY2014 would drop total discretionary spending as a share of GDP to
historically low levels.
Figure 1. Discretionary Spending, 1962-2004
14
12
10
GDP
8
age of
cent 6
Per
4
21962
1970
1978
1986
1994
2002
1966
1974
1982
1990
1998
Discretionary Spending
Non-Defense Discretionary Spending
Source: CBO
Spending on Military Operations in Iraq and Afganistan
Military activities in Iraq and Afghanistan and spending for the global war on
terrorism pose a particular problem for the latest baseline. Because no budget
authority was granted in FY2005 at the time the baseline was projected, these
expenditures are not included in the baseline this year or at any point over the next

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CRS-5
10 years.3 Yet the baseline under this assumption is not a projection of current policy
since it implies spending on Iraq and Afganistan would quickly cease. Although it
is not clear what shape spending on these activities will take in the future, CBO has
estimated that if activities in Iraq and Afghanistan continue at their present pace
through FY2007 and then slow down, federal outlays will increase by $418 billion
between FY2006 through FY2015. This increase in outlays would increase debt
service payments by $172 billion over the period.
Expiring Provisions
Some government spending and tax programs, especially tax credits, have
expiration dates. CBO is required to assume in their baseline estimates that all tax
measures (unless earmarked to a trust fund) and small spending programs will expire
as scheduled, since that represents current policy according to the law.4 The baseline
reflects this assumption by increasing revenues when the measure is due to expire,
or reducing outlays when the program is due to expire. But most of these expiring
provisions have proven very durable and are routinely extended. Some examples of
expiring tax provisions include credits or deductions for clean-fuel vehicles, qualified
zone academy bonds, welfare-to-work, medical savings accounts, research and
experimentation, and economic development empowerment zones.5
The routine renewal of minor tax provisions has made the proper baseline
treatment of expiring provisions tricky for years. But baseline treatment of expiring
provisions became particularly difficult after the decision to make the major tax cut
of 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA, P.L.
107-16) expire in 2010 due to congressional budget rules. Clearly, expiration of the
tax cut was not a goal of its proponents, and there have already been several
proposals to make it permanent, including the President’s FY2006 budget proposal.
CBO estimates that if all expiring tax provisions (except the AMT-related
provisions) were renewed, revenues would be reduced by $1,616 billion over 10
years, and the resulting debt service would increase outlays by $238 billion. Of this,
$1,321 billion is attributable to the expiration of EGTRRA and JGTRRA. In 2015,
making EGTRRA and JGTRRA permanent would increase the deficit by $292
billion (not including resulting debt service). These estimates do not include expiring
provisions related to the alternative minimum tax, which, if allowed to expire, would
“take back” some of the tax cuts. The problem for the baseline posed by the AMT
will be discussed in the next section.
3 See CBO, Op Cit, p. 9.
4 Until this year, OMB made similar assumptions to construct its baseline. This year, the
baseline was changed to incorporate certain policy changes, such as extending expiring tax
cuts and not extending “emergency” spending. To compare CBO and OMB baseline
estimates, use the OMB “BEA baseline deficit,” found in OMB, Analytical Perspectives,
Feb. 2005, p. 390.
5 See CRS Report RL32439, Temporary Tax Provisions (“Extenders”) Expiring in 2004,
by Pamela Jackson.

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CRS-6
Alternative Minimum Tax (AMT)
The alternative minimum individual income tax (AMT) is a parallel tax system
that is meant to ensure that all taxpayers accrue at least some minimum tax liability.6
The baseline is meant to reflect current policy. Because of the reduction in regular
income tax rates and because the AMT is not indexed for inflation, more and more
people fall under it each year. JGTRRA increased the AMT exemption and changed
its treatment of tax credits temporarily, but the changes are due to expire at the end
of 2005. As a result, under current law the number of taxpayers falling under the
AMT would rise from 3 million in 2004 to 29 million, or 30% of all taxpayers, in
2010. Many critics have argued that this is not a realistic baseline assumption since
the AMT was originally intended to affect only a few very wealthy individuals.
Alternative scenarios that prevent the number of AMT taxpayers from
significantly growing would result in significantly larger deficit projections. For
example, if the higher AMT exemption and AMT treatment of tax credits were
extended, the deficit would increase by an estimated $385 billion over 10 years (not
including debt service). Critics argue that the interaction of the AMT under current
law with other policies also misrepresents the cost of those policies. For example,
a married couple with two children claiming the standard deduction and earning over
$90,000 a year in 2008 will find that more than 70% of their EGTRRA/JGTRRA tax
cut has been “taken back” by the AMT.7 Revenue estimates of the recent tax cuts,
including the baseline, assume that this would occur; if they did not, the revenue
estimates of the tax cuts would be much higher. If expiring AMT provisions were
extended and all other expiring tax provisions were made permanent, then the deficit
would increase by $533 billion over 10 years, not including debt service costs. This
is $148 billion more than the sum of the estimates of the two policy changes in
isolation.8
Accuracy of Forecasts
The baseline is inherently uncertain because it rests on a number of
unpredictable assumptions about the future. Indeed, it should be viewed not as a
precise estimate, but rather as the midpoint on a continuum of highly uncertain
outcomes. Even in the very near future, uncertainty looms large: between January
and August 2002, revisions in economic and technical assumptions reduced the
surplus for that year by $78 billion.
6 For more information, see CRS Report RL30149, The Alternative Minimum Tax for
Individuals, by Gregg Esenwein.
7 CRS Report RS21817, The Alternative Minimum Tax: Income Entry Points and “Take
Back” Effects, by Gregg Esenwein.
8 Data from CBO, Economic and Budget Outlook, Sep. 2004, p. 17 and Leonard Burman et
al., The Individual Alternative Minimum Tax: An Update, Tax Policy Center, Working
Paper, Sept. 2004. Burman et al. estimate that extending expiring AMT provisions without
indexing would cost $367 billion over 10 years if the tax cuts are allowed to expire and $571
billion over 10 years if the tax cuts are renewed.

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CRS-7
Table 1 shows the probability distribution for the deficit based on economic and
technical errors — not policy changes — to historical projections. In January 2005,
CBO projected that the baseline deficit would equal $368 in FY2005. If the
economic and technical errors in CBO’s January baseline projection are equal to the
historical average, there is a 25% chance that nine months later the actual deficit will
be above $430 billion and a 25% chance it will be below $306 billion. As the
projection moves further into the future, the errors get larger. In 2009, there is a 25%
chance that the budget will be at least $67 billion back in surplus under current policy
— and a 25% chance that the deficit will have grown to at least $274 billion more
than the baseline projection. With margins of error that large, baseline projections,
particularly in out years, cannot be counted on for accuracy, and like other economic
projections reaching that far out, they are not, by themselves, a meaningful basis for
policy decisions.
Table 1. Probability Distribution of Deficit Outcomes Based on
Historical Projection Errors
($ in billions)
2005
2006
2007
2008
2009
25% Chance That Baseline
-430
-410
-434
-448
-481
Deficit Will Exceed:
Current Baseline Deficit
-368
-295
-261
-235
-207
25% Chance That Baseline
-306
-179
-89
-22
67a
Deficit Will Be Smaller Than:
Source: CBO, The Uncertainty of Budget Projections, Feb. 2004.
a. Budget Surplus
The historical errors in CBO’s projections stem from two sources: errors in
CBO’s economic forecasts and “technical” errors, which refer to all changes in
budgetary outcomes that cannot be attributed to policy or economic changes.
The economic errors imply no shortcoming on the part of CBO; the accuracy of
their forecasts has typically been comparable to private sector forecasters.
Historically, economic forecasts have been particularly inaccurate at spotting turning
points in the business cycle, and the recent recession has been no exception. In
January 2001, CBO, the Administration, the Federal Reserve, and virtually all major
private forecasts predicted growth between 2.0% and 3.1% for the year. In reality,
the economy grew by 0.3%. If anything, uncertainty concerning the economy has
grown in recent years due to the sharp and unexpected acceleration in productivity
growth and fall in unemployment in the late 1990s. Looking to the future, forecasters
are highly uncertain how much of these changes should be considered permanent.9
9 For more information, see CRS Report RL32274, Uncertainty in the Natural Rate of
Unemployment, by Marc Labonte; and CRS Report RS20608, The U.S. Long-Term Growth
(continued...)

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CRS-8
This is troublesome because even small changes in the underlying economic forecast
lead to significant changes in baseline estimates.
In the 1990s, most technical errors derived from tax revenues growing even
more quickly than CBO predicted given the rate of economic growth. For example,
the stock market boom created larger than expected capital gains revenues. Likewise,
much of the downward revision in the baseline forecast in 2001 was attributable to
the fact that tax revenues fell more in the recession than CBO predicted. If a policy
change or tax cut cost more in reality than its original “score,” this would also appear
as a technical error. Technical changes to the baseline since January 2001 are about
four times as large as economic changes, and are about five times as large in the out-
years of the forecast.
What does this uncertainty imply for policymaking? It implies that half of the
time policymakers will find themselves with more money than anticipated, half the
time they will find themselves with less. Setting goals such as balancing the budget
or reducing the deficit by half by changing policy according to the amount needed
under the baseline does not ensure they will occur; in fact, the probability that they
will occur is only 50%.
This section has discussed uncertainty caused by technical and economic
factors. There is also policy uncertainty — for example, spending on future wars and
natural disasters — which is not incorporated in baseline projections.
Troubles on the Horizon — Social Security, Medicare,
and Medicaid
Unlike corporations, the government considers only current-year liabilities in
its budget for two reasons. First, it is typically assumed that only the current budget
surplus or deficit affects aggregate demand in the current economy. Second, unlike
corporations, the government has the power to alter its revenue (taxes) or spending
levels as necessary to meet almost any future funding need. Critics have argued that
since the baseline projects the budget for only the next ten years, it is unable to guide
policymakers on longer term policy issues under the current accounting system.
Long-range projections indicate that the government faces very large liabilities in its
Social Security, Medicaid (which covers long-term care), and Medicare programs
beginning in the second decade of this century under current policy. The retirement
of the baby boom generation, rising medical costs, and longer life expectancy will put
enormous pressure on government finances. If the government used accrual-basis
accounting like corporations, then unfunded liabilities would be recorded in the
current year deficit as they were accrued, and current deficit projections would be
much larger.10
9 (...continued)
Rate: Has It Increased?, by Craig Elwell.
10 In testimony before the House Financial Services Committee on Feb. 12, 2003, Federal
Reserve Chairman Alan Greenspan proposed that the government adopt accrual-basis
accounting, like corporations, in order to take into account the implicit liabilities of the
(continued...)

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CRS-9
The benefits of these “pay as you go” programs are funded by current workers.
Over the next 30 years, the ratio of workers per beneficiary is expected to fall from
3.4 to about 2. Table 2 illustrates the projected path of future government outlays
under current policy. In 2000, total spending on Social Security, Medicaid, and
Medicare equaled 7.4% of GDP. By 2035, spending is projected to equal about 14%
of GDP, yet revenue from the payroll tax is projected to stay relatively constant. The
difference between future spending on these programs and the government’s future
tax revenue is the “unfunded liability” that can only be financed through higher taxes,
lower benefits than promised under current law, or the issuance of debt. One study
has placed the government’s total unfunded liabilities at $48 trillion in present value
terms.11 The liabilities cannot be financed solely through debt issuance, however,
because the size and persistence of the shortfall would quickly lead to unsustainably
large budget deficits. As shown in the table, under current revenue policy, total
outlays would rise from 20.3% in 2005 to 40.4% in 2075. This large rise occurs
under the assumption that all spending outside Social Security, Medicare, and
Medicaid would fall to 7.6% by 2025, its lowest level in the post-war period, and
continue to fall to 6.9% of GDP by 2075. Budget deficits would become
unsustainably large, probably by the 2040s. To balance the budget each year under
these spending assumptions, taxes would need to rise continually, to 27.1% of GDP
in 2075 from 16.3% of GDP in 2004.12
Table 2. Long-Term Projected Federal Outlays, as a % of GDP
Social
Other
Total Outlays
Budget
Security,
Spending
Fiscal Year
(Including
Surplus/
Medicare,
(Excluding
Interest)
Deficit(-)
and Medicaid
Interest)
2000 (act.)
7.4
8.7
18.4
2.4
2005
8.1
10.7
20.3
-3.5
2015
9.6
7.9
19.4
-0.9
2025
12.1
7.6
21.8
-2.7
2035
14.3
7.4
24.8
-5.2
2055
16.8
7.1
30.8
-10.0
2075
20.2
6.9
40.4
-18.4
Source: OMB, Analytical Perspectives of the U.S. Government, FY2006, p. 209.
Note: Table assumes that current revenue policy remains constant (revenue would rise somewhat as
a percentage of GDP because of real bracket creep”).
10 (...continued)
entitlement programs.
11 Jagdeesh Gokhale and Kent Smetters, Fiscal and Generational Imbalances (Washington,
DC: AEI Press, 2003).
12 For more information, see CRS Report RL32747, Social Security and Medicare:
Economic Implications of Current Policy, by Marc Labonte.

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The future problem could be mitigated by “funding” the liabilities today through
government saving (i.e., running budget surplus). The surplus could be used to retire
the national debt, which frees up private saving for greater private investment, or
through some method of government investment in the private sector. Government
accumulation of private assets could occur either through the funding of individual
accounts or through direct government purchase. Economic theory sees little
macroeconomic difference between debt retirement, government accumulation of
assets, or the accumulation of assets in private accounts; the key is that the
government uses the surplus to increase national saving. While increasing the
national saving rate does not directly reduce these liabilities, by spurring greater
capital formation it increases the future size of the economy.13 A larger future
economy would ease the relative burden of paying for these future obligations. From
a budgetary perspective, the problems would be eased as well. If the government
used surpluses to purchase private assets today (centrally or through individual
accounts), those assets could later be sold to help pay benefits. Similarly, if the
government used surpluses to pay down the national debt, future interest payments
on the debt would be lower and the savings could be used to help pay benefits.
Critics can reasonably argue that although these problems are important, the
baseline is not the proper forum for raising them. A short-term tool cannot
accommodate the evaluation of long-term problems, they argue; longer term forecasts
already in existence are a more appropriate forum for this debate. With margins of
error so large even five years ahead, it would arguably be impractical to give, say, 75
year projections the institutional role in the budget debate that the baseline currently
occupies. And incorporating long-term liabilities into the baseline could be seen as
favoring this issue over other policy issues that people may believe to be equally or
more important. Some argue that including future obligations would alter the
baseline’s role from one of neutrality to advocacy, undermining its reputation for
impartiality. Nevertheless, it can be argued that to the extent the baseline frames the
budget debate and makes unsustainable policy appear sustainable, it is also in this
case misleading.
What Happened to the Surplus?
After peaking in January 2001, the baseline surplus projections have been
continuously revised downward. In just two years, the baseline projection for
FY2002 fell from a surplus of $313 billion to an actual deficit of $158 billion. The
13 This is the economic rationale behind proposals to “save” the Social Security surplus.
Increasing the holdings of U.S. Treasuries in the Social Security trust fund does not give the
government any real financial assets because the government is lending to and repaying
itself. Rather, many economists believe that if the Social Security surpluses are used to
retire debt, the shrinking federal debt should increase the future size of the economy through
increased private investment. The problem is that even the additional economic growth
implied by the increase in national saving spurred by an increased trust fund does not appear
to be enough to fund the current level of various program benefits for the large number of
baby-boom retirees that become eligible in the first three decades of this century. By
contrast, because of the unified budget deficit, the Social Security surplus is currently being
used to finance other government spending.

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CRS-11
10-year cumulative surplus for 2001-2011 fell from $5.6 trillion to a deficit of $2.6
trillion. For 2011 alone, the change to the baseline balance is almost $1 trillion.
Legislative, economic, and technical changes all played a large part in the decline,
as seen in Table 3. For the cumulative 10 year baseline, legislative changes were
responsible for about 60% of the change in the baseline, technical changes about one-
third of the shift, and economic changes about one-tenth of the shift. (These fractions
would change if the alternative assumptions discussed in this report were made.)
Table 3. Changes to the Baseline Projections from 2001 to 2005
($ in billions)
2002
2003
2002-
2004
2005
2006
2007
2008
2009
2010
2011
(act.)
(act.)
2011
Baseline
Projection
313
359
397
433
505
573
635
710
796
889
5,610
January 2001
Legislative
-150
-363
-519
-509
-486
-494
-531
-566
-621
-586
-4,825
Changes
Revenue
-81
-186
-272
-218
-188
-177
-176
-175 -191
-121
-1,784
Non-Defense
Discretionary
-12
-35
-49
-63
-60
-57
-55
-56
-56
-59
-502
Spending
Defense
-38
-84
-122
-123
-90
-83
-84
-85
-87
-92
-888
Spending
Mandatory
-14
-43
-41
-41
-60
-63
-69
-72
-74
-74
-551
Spending
Debt Service
-5
-15
-37
-60
-89
-117
-147
-177
-209
-243
-1,099
Economic
-120
-125
-63
-31
-48
-62
-54
-49
-38
-51
-640
Changes
Technical
-200
-270
-235
-258
-267
-277
-286
-302
-327
-333
-2,757
Changes
Total Changes
-469
-760
-818
-802
-799
-834
-869
-919
-986
-969
-8,226
Baseline
Projection
-158
-401
-422
-368
-295
-261
-235
-207
-189
-80
-2,590
January 2005
Source: CBO, Budget and Economic Outlook, January 2002 to January 2005, An Analysis of the President’s Budgetary
Proposals, March 2002 to March 2004.
Notes: Debt service refers to additional interest payments made on the national debt resulting from all legislative changes
to revenues or outlays. The forecast does not include legislative changes made since September 2004. Columns may
not be additive due to rounding. There is an inconsistency between the 2003 actual deficit and changes to the baseline
as reported by CBO. The actual deficit in 2003 is $26 billion lower than the changes to the baseline as reported by CBO.
The inconsistency comes from economic and technical changes to the baseline (which are not included in the table), not
policy changes.
Those observers who incorrectly use baseline projections as hard predictors of
the future express surprise that such a sudden reversal of fortune could occur.

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CRS-12
However, tax cuts and increases in homeland security and military spending are
examples of policy changes that automatically reduce the baseline.
Since 2001, discretionary spending again grew faster than projected in the
baseline using the inflation adjustment. Revenue changes (overwhelmingly tax cuts)
are the single largest legislative change affecting the deficit; the second largest is
increases in military spending above the baseline.14 Legislated changes alone would
have produced a deficit from 2003 to 2005 even if there had been no economic or
technical changes to the baseline between 2001 and 2005. Note that the cost of these
policy changes are projections of their cost (as scored by CBO and Joint Tax
Committee) made at the time the policy was enacted. If policies turned out to be
more (less) expensive than the score, this would appear in the table as a negative
(positive) technical change.
The large change in the baseline for economic and technical reasons is also less
surprising if one is familiar with the historical inaccuracy of forecasts (see the
Accuracy of Forecasts section). While technical changes are an important factor in
the shift throughout the 10-year baseline window, the economic slowdown only
played a significant role in the shift to deficit in 2002 and 2003. Since the baseline
assumes the economy will be back to full employment in 2006 (and near full
employment in 2005), the 2001 recession plays no role in the deficit projections
going forward. Economic changes after 2003 relate to changes in CBO’s
assumptions of the economy’s long-run growth rate unrelated to cyclical
developments.
Debates about whether the recession, the tax cuts, or higher government
spending in 2001 “caused” the budget deficit cannot be answered in any simple,
objective way. In isolation, each could be said to have caused the deficit, but none
occurred in isolation. The question can be posed differently, however: what was the
probability that each of these three factors would cause a deficit based on the
information available at the time? To answer this question, one can examine the
baseline probability distribution constructed when these policy changes were being
decided.
The probability distributions CBO estimated for its baseline projections in 2001
were the best information policymakers had at the time to judge the affordability of
those policy changes. Table 4 offers some illustrative examples. While the
probability of the 2001 policy changes leading to a 2002 budget deficit was very low,
it increased significantly in the later years of the forecast for two reasons. First,
forecasting errors grow larger as the forecast moves farther into the future. Second,
the cost of the 2001 tax cut (EGTRRA) — which features several provisions that are
phased in over time — and debt service become larger over time. At 20%, the
probability that legislative changes would cause a budget deficit by 2006 is
significantly higher than the probability of a 2002 deficit even though the surplus was
forecast to rise from $311 billion in 2002 to $503 billion in 2006. The tax cut alone
had a 15% probability of returning the 2006 budget to deficit. (Of course, policy
14 Projections of military spending in the baseline are undercounted because the entire cost
of financing operations in Iraq has been excluded from the baseline in future years.

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CRS-13
changes made since the budget moved to deficit in 2002 would increase these
probabilities, but at that point the argument became moot.) The fact that these
probabilities were so low and still occurred points to the large uncertainty
surrounding baseline projections.
The choice of a balanced budget is only one possible policy benchmark;
policymakers may have had other goals for the level of surplus to maintain. For
instance, maintaining on-budget balance (i.e., “saving” the Social Security surplus)
had widespread bipartisan support in 2001 and was adopted in the “lockbox”
amendment to P.L. 106-554, which became law on December 21, 2000 (S.Amt. 3690
to H.R. 4577). One can use the same method to determine the probability that the
legislative changes made in 2001 would have led to an on-budget deficit. Based on
the 2001 probability distribution, the tax cut alone had a 20% probability of causing
an on-budget deficit in 2002 and a 35% probability in 2006. All legislative changes
made in 2001 had a 30% probability of causing an on-budget deficit in 2002 and a
45% probability in 2006.
Table 4. Estimated Probability of Different Events Based on
Information Available February 2001
Probability
Probability
Event
in 2002
in 2006
On-Budget Deficit Without Policy Changes
10%
20%
2001 Tax Cut Would Cause Deficit
Less than 5%
20%
2001 Additional Spending Would Cause Deficit
Less than 5%
10%
All 2001 Legislative Changes Would Cause Deficit
5%
25%
2001 Tax Cut Would Cause On-Budget Deficit
20%
40%
2001 Additional Spending Would Cause On-Budget
25%
30%
Deficit
All 2001 Legislative Changes Would Cause On-
35%
45%
Budget Deficit
Source: Author’s calculations based on CBO data.
Note: All results are rounded to nearest 5th percentile. Any hypothetical surplus smaller than the
amount of the Social Security surplus projected in the 2002 baseline is assumed to cause an on-budget
deficit.
Conclusion: The Sensitivity of the Baseline to
Alternative Assumptions
The budget baseline is meant to be a projection of current policy. This gives
lawmakers a means of evaluating how policy proposals affect the budget. The
baseline is not meant to be a prediction of the future. For a baseline to be useful, it

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CRS-14
should give as accurate a description of current policy as possible. Unfortunately,
there is no obvious definition of “current policy,” so some arbitrary assumptions must
be made to construct a baseline. Critics have questioned whether some of these
assumptions could be altered to be more realistic.
Arguably, a “better guess” of the probable path of the federal budget under
current policy extended might be achieved by modifying four assumptions in the
CBO baseline. First, that discretionary spending will remain constant as a share of
GDP rather than growing at the rate of inflation. Second, that military operations in
Iraq and Afganistan will continue and should be counted in the baseline rather than
omitted. Third, that recent tax reductions will be extended rather than allowed to
expire. Fourth, that the alternative minimum tax (AMT) relief will be extended
rather than allowing the AMT to “take back” the reductions in regular income tax.
Modifying these baseline assumptions and accounting for the additional debt service
required to finance these policies yield an estimate that the federal budget deficit is
likely to be $4.5 trillion more over FY2006 through FY2015 period than that shown
by the baseline projection. These changes are illustrated in Table 5. The effects of
the alternative assumptions grow over time: by 2015, the alternative baseline deficit
is $773 billion, compared to an official baseline surplus of $141 billion. (The table
is meant to serve as a technical illustration rather than a recommended alternative.
It indicates, as CBO notes, that the baseline is an inevitably arbitrary yardstick.)
Table 5. Baseline Deficit Under Alternative Assumptions
($ in billions)
Total
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2006-
2015
CBO baseline
-295
-261
-235
-207
-189
-80
71
85
115
141
-855
surplus/deficit
Iraq/Afghanistan
Operations
-70
-75
-65
—
—
—
—
—
—
—
-210
Discretionary
Appropriations
constant as % of
-15
-40
-68
-97
-126
-156
-186
-217
-249
-283 -1,437
GDP
Extend EGTRRA/
-3
-4
-11
-23
-19
-160
-259
-269
-281
-292 -1,321
JGTRRA
Other extenders
-2
-11
-19
-22
-28
-34
-39
-43
-46
-50
-295
Extend AMT
-13
-35
-40
-48
-54
-46
-30
-34
-40
-46
-385
Debt Service
-3
-11
-21
-31
-42
-62
-90
-124
-161
-204
-749
Total Modificationsa
-105
-174
-221
-218
-266
-470
-638
-723
-815
-914 -4,544
Modified baseline
-400
-435
-456
-425
-455
-550
-567
-638
-700
-773 -5,399
surplus/deficit
Source: CRS calculations based on CBO data.

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CRS-15
Notes: See text for details. CBO assumes in its alternative projection that military expenditures would
continue to exceed the baseline after 2008, but to avoid potential double counting in the table. CRS
assumes those expenditures would be absorbed in the general increase in discretionary spending. The
table does not include legislative changes made since January 2005.
a. When all tax provisions are extended jointly, there is an interactive effect that increases the total by
$148 billion over 10 years compared to the total found by adding the individual rows in the
table.
Another conceptual mistake sometimes made in reference to the baseline is the
assumption that the baseline projection will occur with certainty. The baseline is the
midpoint in an array of possible outcomes. Because our understanding of the
economy in general — and causes of the business cycle in particular — is limited,
there is a high degree of uncertainty surrounding these estimates, even over short
time intervals. Over longer time periods, uncertainty grows, which is an argument
counseling against policy changes whose budgetary effect grows over time.
One rule of thumb for budgeting calls for a balanced budget. Since budget
deficits decrease national saving and budget surpluses raise national saving, this view
is justified on the grounds that a balanced budget would keep government influence
on the national saving rate to a minimum. According to the official baseline, large
budget deficits are highly likely in the short run, but the budget would be close to
balance by the end of the 10-year window. There is a 30% chance that the budget
would return to surplus by 2009 under the CBO baseline — and a 30% chance that
it will be at least twice as large as CBO predicts.
Reasonable changes in baseline assumptions, made in Table 5 suggest that
under current policy the budget deficit will rise rather than fall throughout the 10-year
window. In this scenario, there is only a 5% probability of the budget returning to
balance on its own by 2009. Outside the 10-year window, budget deficits get larger
and current policy becomes unsustainable because of the budgetary pressures
associated with the retirement of the baby boomers. Current deficits exacerbate these
pressures

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