An Analysis of the Administration's Deficit Reduction Goal

An Analysis of the Administration's Deficit Reduction Goal

Order Code RS22073
March 2, 2005
CRS Report for Congress
Received through the CRS Web
An Analysis of the Administration’s
Deficit Reduction Goal
Gregg Esenwein and Marc Labonte
Government and Finance Division
Summary
The Bush Administration has set a goal of halving the deficit between FY2004 and
FY2009. The Administration proposes to reduce the deficit from an originally
forecasted $521 billion (4.5%) in FY2004 to $233 billion (1.5% of GDP) in FY2009.
The Administration can meet its deficit reduction goal if the following assumptions
made in its FY2006 budget proposal occur. First, alternative minimum tax (AMT) relief
is allowed to expire so that the AMT would take back most of the current reduction in
the regular income tax for a large number of taxpayers. Second, discretionary spending
falls from 8.2% of GDP to a historically low 6.1% of GDP. Third, spending on military
operations abroad will be negligible by FY2009. Finally, the cost of creating individual
accounts for Social Security as proposed by the Administration is not included in the
budget.
CRS has constructed a modified baseline budget which, arguably, provides a “best
guess” of the path of future deficits if current policy is extended. Under this alternative,
the deficit is projected to rise to $425 billion in FY2009. Thus, the Administration’s
proposed FY2009 deficit is the result of budgetary savings of $192 billion compared to
a baseline constructed by CRS reflecting current policy. This report will not be updated.
The Administration’s FY2005 budget proposal set a goal of halving the deficit
between FY2004 and FY2009. This goal was reiterated in its FY2006 budget proposal.
To analyze how the Administration plans to meet its goal of halving the federal budget
deficit, this report explains how the Administration’s FY2006 budget differs from current
policy using a modified baseline budget constructed by CRS.
The Congressional Budget Office (CBO) estimates a baseline budget based on
simple rules prescribed by law. CRS has constructed a baseline budget incorporating
alternative assumptions that arguably provides a “better guess” of the probable path of the
federal budget when current policy is extended. CRS modified the CBO baseline by
assuming that discretionary spending (excluding supplementals) will remain constant as
a percentage of gross domestic product (GDP), that military operations in Iraq and
Afghanistan will continue until FY2008, that expiring tax provisions will be extended,
Congressional Research Service { The Library of Congress

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and that individuals will be held harmless from the alternative minimum tax (AMT). The
alternative baseline is defined and estimated in CRS Report RS22045.1
The Administration’s Deficit Reduction Goal
In the FY2005 budget, the Administration estimated that the deficit in FY2004
would be $521 billion, and proposed to reduce the deficit to $237 billion — less than half
the FY2004 deficit — by FY2009.2 The actual deficit in FY2004 turned out to be $412
billion, considerably lower than originally estimated. (The difference in the estimated and
actual resulted from unexpected economic and technical adjustments, not from policy
changes.) In the FY2006 budget, the Administration forecasts, based on its policy
proposals, that the FY2009 deficit will be $233 billion. However in FY2005, the deficit
is projected to rise to $427 billion, which indicates that, at least in the short run, the
budget deficit is moving away from the Administration’s goal.
While this forecast shows a FY2009 deficit that is half the FY2004 deficit forecast
in the FY2005 budget, it would be more than half of the actual FY2004 deficit. However,
as a percentage of GDP, the Administration can still meet its goal of halving the budget
deficit since the actual FY2004 deficit was 3.6% of GDP while the forecast deficit in
FY2009 would be 1.5% of GDP.
Discretionary Spending
The Administration’s deficit reduction goals are partly dependent on discretionary
spending following a particular path over the next five years. This path for discretionary
spending shows a reduction in spending in nominal terms from FY2006 to FY2008,
before increasing at the rate of inflation in FY2009. This would represent a reversal of
past Administration policy since discretionary spending has been growing at an average
annual rate of 8% over the last four years in real terms.
How does this pattern compare to current policy? Since the level of discretionary
spending is determined through annual congressional appropriations, there is no obvious
measure of current policy carried forward into the future. In its baseline projections, CBO
is required to assume that discretionary spending under current policy remains constant
in real dollar terms in the future. If discretionary spending grew at the rate of inflation,
then it would be $116 billion higher than the Administration proposes in FY2009.
However, if supplemental spending were removed from the projections, as CBO assumes,
then it would be only $9 billion higher than the Administration proposes in FY2009.
The historical evidence, however, suggests that, over time, discretionary spending
tends to remain fairly constant as a percentage of gross domestic product (GDP). At least
in the case of non-defense spending, projecting discretionary spending as constant in real
dollar terms would have consistently underpredicted historic spending levels. Under the
1 CRS Report RS22045, Baseline Budget Projections Under Alternative Assumptions, by Gregg
Esenwein and Marc Labonte. For the CBO baseline, see Congressional Budget Office, Budget
and Economic Outlook: Fiscal Years 2006 to 2015, Jan. 2005. Due to technical and economic
differences, CBO baseline estimates vary slightly from the Administration.
2 Office of Management and Budget, Fiscal Year 2005 Budget, Feb. 2004, p 37.

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Administration’s budget, discretionary spending would fall from 8.2% of GDP in FY2005
to 6.1% of GDP in FY2009. This would be discretionary spending’s lowest share of GDP
in the modern budget era; in the past 25 years, discretionary spending has fluctuated
between 6.3% and 10.0% of GDP.
In FY2009, the Administration’s budget shows discretionary spending to be $952
billion. If discretionary spending (excluding supplemental military spending) remained
constant as a percentage of GDP, it would be $1.06 trillion in FY2009. Thus, under these
assumptions, the Administration’s proposal would represent a 10% reduction in
discretionary spending from current policy extended to FY2009. This reduction does not
include additional debt service since higher spending, absent other changes, would
increase the national debt.
Spending on Military Operations. In planning a five-year budget, military
operations in Iraq and Afghanistan pose a particular problem because it is hard to predict
what magnitude spending on these activities will take in the future. In light of this
uncertainty, the Administration’s approach is to not include or include only minor
amounts reflecting future military operations in these theaters as supplemental spending.3
However, at least over the last budget year, this approach has led to a significant
undercounting of spending on military operations. In its 2005 budget, the Administration
included no supplemental military budget authority for FY2005. But through February
2005, the Administration requested, in total, $82 billion in supplemental budget authority
to cover military operations over the next five years, not including accompanying debt
service.
Supplemental outlays equaled $71 billion in FY2004 and are projected to equal $60
billion in FY2005. In the FY2006 budget, the Administration requests $25 billion in
supplemental military spending in FY2006. Supplemental spending declines in the out-
years, totalling only $1 billion in FY2009. If the Administration repeats in the future the
practice it followed in FY2005 of financing military operations through supplementals,
then the actual deficit will be larger than proposed, making it difficult for the
Administration to meet its FY2009 deficit reduction target.
Social Security
The Administration has recently proposed creating individual accounts under the
Social Security system. While many of the specifics of the proposal have not yet been
announced, by all indications these accounts will significantly reduce federal revenues,
at least in the short run. Yet none of these costs, nor accompanying debt service, is
included in the Administration’s FY2006 budget. As a result, if Social Security is altered
as proposed by the Administration within the five-year budget window, then the goal of
halving the deficit by FY2009 will not be met.
3 Likewise, supplemental spending on non-military emergencies (e.g., natural disasters) is
assumed to be zero in the Administration’s budget, unlike in the CBO baseline. While
emergency spending can obviously not be accurately projected, it is almost always higher than
zero. This assumption reduces outlays by $12 billion in FY2009.

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The basis of the Administration’s proposal is to allow workers to divert a certain
percentage of their payroll taxes into individual accounts. This means that payroll tax
receipts will decline by the full amount of funds diverted into these individual accounts
and can, therefore, no longer be used to finance current Social Security benefit payments
and other government expenditures. Social Security benefits for current retirees could be
cut or taxes could be raised to offset the effects of these accounts on the deficit over the
next five years, but the Administration has ruled out both options. If no other adjustments
are made, the deficit will increase by the amount by which tax receipts are reduced.
On February 2, the Administration proposed that individual accounts equal to 4% of
taxable payroll be introduced in 2009, slowly phased in over time, and participation in the
accounts be on a voluntary basis. These conditions would significantly reduce their
effects on the deficit in FY2009. However, if the proposal were fully implemented in
FY2009, the effects on the deficit would be large. With full participation, individual
accounts equal to 4% of taxable payroll — absent other changes — would increase the
budget deficit by about 1.6% of GDP. In FY2009, 1.6% of GDP would equal $235
billion.
Revenue Issues
When comparing revenue totals under the President’s budget proposal to current
policy, a significant issue is the treatment of expiring tax provisions. Although the
Administration includes an extension of the 2001 and 2003 tax cuts in its FY2006 budget,
the major portion of the revenue loss from extending these tax cuts does not show up until
after 2010. Hence, these extensions would increase the deficit by only $31 billion in the
deficit-target year of FY2009, but by a cumulative $1,036 billion from FY2011 to
FY2015 (not including associated debt service).
While the Administration proposes to extend the tax cuts, it does not include or does
not extend through FY2009 the full array of expiring tax provisions (unrelated to the 2001
and 2003 tax cuts) in its budget. The most important expiring tax provisions that are
omitted from the Administration’s FY2006 budget relate to the individual alternative
minimum tax (AMT). The AMT was originally enacted in 1969 to make sure that certain
high-income taxpayers were not able to escape their “fair share” of the federal income tax
through the use of special deductions, exemptions, and credits.4 However, because of the
recent reductions in the regular income tax and the fact that the AMT is not indexed for
inflation, there will be a significant increase in the number of middle to upper-middle
income taxpayers affected by the AMT in the near future. In 1999, about 1 million
taxpayers were affected by the AMT, but estimates suggest that by 2009 almost 30 million
taxpayers will be subject to the AMT under current policy.
To counteract the effects of the AMT, Congress has increased the AMT basic
exemption and allowed certain personal tax credits to offset AMT tax liability. However,
to minimize the future revenue loss, these changes have only been enacted for one or two
years at a time, and are now scheduled to expire at the end of 2005. Allowing the
increased AMT exemption to expire at the end of 2005 means that, by 2009, the AMT
4 See CRS Report RL30149, The Alternative Minimum Tax for Individuals, by Gregg Esenwein.

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will “take back” much of the regular income tax relief provided in 2001 and 2003.5
Because the revenue estimates of extending the expiring tax relief are based on the
increased AMT exemption expiring after 2005, the revenue estimates of these extensions
assume the AMT take-back effect will occur. As a result, the budgetary costs of the
2001/2003 tax cuts are understated relative to what they would be if taxpayers were held
harmless from the AMT. To provide taxpayers with the full amount of regular income
tax relief would require, at the least, that the AMT exemption increase be extended
throughout the period that the Administration has set for its goal of halving the federal
deficit.
CBO estimates that reforming the AMT by extending the higher AMT exemption
and indexing the AMT for inflation, so that it does not take back the reductions in the
regular income tax, would reduce revenues by $137 billion over the FY2006 through
FY2009 period, not including debt service.6 In FY2009 alone, holding the AMT
harmless would reduce federal revenues by $50 billion.7 If all expiring tax provisions,
including the AMT, were extended, revenues would equal $2,576 billion in 2009 —
compared to the Administration’s proposal, under which revenues equal $2,650 billion
in that year.
Conclusions
The Administration has produced a budget proposal that cuts the deficit in half from
FY2004 to FY2009. To analyze how that goal is to be accomplished, this report
compares the Administration’s proposal to the budget under current policy. This report
assumes that the “best guess” of current policy in FY2009 is represented by the CBO
baseline, modified according to the following assumptions. First, that discretionary
spending (excluding supplementals) will remain constant as a share of GDP. Second, that
all expiring tax provisions will be extended throughout the five year budget window.
Third, that expiring AMT relief will be extended rather than allowing the AMT to “take
back” the reductions in the regular income tax. Fourth, that debt service will be higher
in FY2009 because of the previous three modifications and because some spending on
military operations was assumed to continue through FY2008. The alternative baseline
does not include the costs of any modifications to Social Security (as is the case with the
Administration’s budget).
As is shown in the table below, when current policy is measured under this
alternative, the budget deficit does not decline by half in dollar terms or as a percentage
of GDP. Rather, the deficit increases in dollar terms (though not compared to the original
5 See CRS Report RS21817, The Alternative Minimum Tax (AMT): Income-Entry Points and
‘Take Back’ Effects, by Gregg Esenwein.
6 CBO defines reform as extending the increased AMT exemption and indexing the exemption
amount and AMT tax brackets for inflation. Allowing all personal tax credits to offset AMT tax
liability would increase the revenue loss of this policy alternative.
7 The Administration has indicated that it expects AMT reform will be addressed in the context
of fundamental tax reform. The revenue effects, if any, of fundamental tax reform are not
included in the FY2006 budget projections. The Administration has further stated that it wants
fundamental tax reform to be revenue neutral which means that if the AMT is held harmless then
other taxes would have to rise by $50 billion in FY2009 to offset the cost of AMT reform.

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projection of $521 billion) and decreases modestly as a percentage of GDP between
FY2004 and FY2009.
The Administration can meet its deficit reduction goal compared to the originally
projected $521 billion deficit in FY2004 if the following assumptions made in the budget
come true. First, AMT relief is allowed to expire so that the AMT takes back most of the
reduction in the regular tax for a large number of taxpayers. Second, discretionary
spending falls to its lowest levels in the modern budget era. Third, there will be negligible
supplemental spending on military operations abroad by FY2009. Finally, the cost of
diverting part of the payroll tax from Social Security to individual accounts, as outlined
by the Administration, is not included in the budget. Significantly modifying any one of
these assumptions would cause the deficit to remain above half of its FY2004 level in
dollar terms or as a percentage of GDP. If the deficit reduction goal is expressed as a
percentage of GDP, then the goal would be easier to achieve, but would still require large
changes relative to current policy, as measured by the alternative baseline.
Budget Totals for FY2004 and FY2009 Under Different Assumptions
2004
2009
2004
Projected in
Actual
Administration’s
Alternative
Feb. 2004
Budget
Baseline
Discretionary Spending
billions of $
908
895
953
1,056
% of GDP
7.9
7.8
6.3
7.0
Revenues
billions of $
1798
1880
2,650
2,576
% of GDP
15.7
16.3
17.5
17.1
Budget Deficit
billions of $
521
412
233
425
% of GDP
4.5
3.6
1.5
2.8
Source: OMB, CRS calculations based on CBO data.
Notes: The alternative baseline is calculated by adding four assumptions to the CBO baseline. First,
discretionary spending (excluding supplementals) will remain constant as a share of GDP. Second, all
expiring tax provisions will be extended throughout the five year budget window. Third, expiring AMT
relief will be extended. Fourth, debt service will be higher because of the previous three assumptions and
because military operations were assumed to continue through FY2008. It does not include the costs of any
modifications to Social Security. CBO baseline budget totals are slightly different from OMB.
Budget projections are by no means certain. Historically, actual budget deficits,
adjusted to remove policy changes, have been much higher or lower than they were
originally projected to be. The probability of meeting a specific budgetary target would
increase by erring on the side of caution and budgeting more spending reductions and
revenue increases than would be needed in a world of perfect certainty.
Even if policy follows the path proposed in the Administration’s budget or the CBO
baseline, deficits would begin to rise again outside the budget window at an arguably
unsustainable pace. This occurs because the retirement of the baby boomers, longer life
expectancy, and rising medical costs are projected to place upward pressure on spending
for Social Security, Medicare, and Medicaid.