(00:00:00) Let me start by telling you just a short amount about the Congressional budget office. It's a nonpartisan organization that works for the Congress. We don't make recommendations. But we do analyze various policies and lay out what they're likely consequences are so that the Congress can have that information when it's making its decisions. Now, you have probably noticed that the economy is crucial to the federal budget because every few months you see another article in the paper that says, oh well the economy is doing worse. And so therefore the federal budget looks worse. So today what I'm going to do is start with a few remarks about our recent forecast for the economy, then turn to what that means for the budget and then get into the Dilemma that the Congress is facing and the kinds of things that they could do about it. We are just now coming out of the longest in the deepest recession since World War Two. The only good part of this recession has been the drop that it has wrought in the underlying rate of inflation. The underlying rate has come down from about 9 percent to about 6% a year ago. I was standing in front of groups not quite as distinguished as this but large groups and I was forecasting a recovery because that was what CBO saw and your the months went by and I got to be more and more difficult to be forecasting and Recovery because interest rates were staying so high and the economy was just refusing to cooperate with our forecast beginning last July interest rates did start to come down and now we seem to be on much stronger grounds when we forecast a recovery this year. If you look at the handouts that were left on your chairs, you'll see the specifics for our forecast that was released last month. That's there more. So that you can see what we're saying later on when you have a chance to look at it in detail just briefly it shows moderate growth in output and in employment, but even though there is this reasonable amount of growth. It's not enough to bring the unemployment rate down very quickly. We're still forecasting an average rate in 1984 of 9.8 percent. And as you look out into the future, we see it coming down to about seven and a half percent by (00:02:24) 1988. (00:02:27) Another thing I should tell you about this forecast is that it like all others really depends crucially on what happens to monetary policy and the fiscal policy and that means that it really is a very uncertain forecast. We have to plunk our money down some place so that we can provide the analyses to the Congress, but because it was so uncertain we decided we better have to Those as well one that's higher and one that's lower and both of those are also shown in table 1 but in short the basic forecast assumes that the Federal Reserve will handle monetary policy in a way that permits this moderate growth in the gross national product. And it also assumes that the Congress will handle fiscal policy in a way that avoids driving up long-term interest rates. Okay, so it's really I think crucial that you understand that if those two assumptions don't come to pass then neither will the forecast that you have before you Now, what does that forecast mean for the (00:03:31) budget? (00:03:33) All right. Well before I start looking at our numbers, let me tell you what our numbers are. We call them Baseline projections. They are what will happen to the federal budget if the economy behaves as we forecast if our tax laws remain as they are now and if our spending programs are not changed, so this is not a forecast of what will happen. It's a forecast of what will occur if there are no policy changes and the economy cooperates. The second thing that's important to know about these numbers is that we work for the Congress. So we base the numbers on the most recent congressional action. That means that they do not reflect the administration's defense request, which is much higher than the numbers in the most recent Congressional budget resolution on the other hand. They don't reflect the administration's requests for reductions in domestic (00:04:27) spending. (00:04:30) Okay. Now if we follow the current policies that we have on the books, you can see what happens to the deficit by looking at table to the third line in that table shows you a hundred ninety four billion dollars of deficit in 1983 growing to 267 billion dollars by 1988. To give you some perspective on what those numbers mean. The table also shows them as a percentage of the gross national product. You'll see that we're looking at 6.1% in 1983 dropping 25.6% the next year and then remaining at 5.6 percent throughout the period now, this is just enormously high if you look at the period from 1971 to 1981 when we had a major recession during that entire period our deficits averaged two percent of gross national product, so we are looking at an outlook for fiscal policy that something that's different from what we've seen before. What's worse those deficit numbers depend very much on the economy. If the economy performs better. That's nice. Then the deficit will drop down to about 3.6 percent of GNP by 1988 still very high. But better that you can see in the bottom half of table three on the other hand if monetary policy and fiscal policy are different from our assumptions and the economy performs poorly still grows, but grows more slowly then we could be looking at deficits of eight-point-one percent of GNP by the end of this period (00:06:10) so (00:06:11) all of this causes me at any rate to want to answer this question that Ed post which is why do we have these deficits? How did we get ourselves into this position? Well part of it is that we have a lot of slack in the economy right now and that explains a lot of the deficit in 1983 and people aren't That worried about the deficit and 83 or even the deficit in 84 because these deficits are going to help the economy to recover but those deficits that we have in 1985 and Beyond are the result of two other things first. We passed two tax bills in the last two years in 1981. We had a substantial tax cut 1982. We had a tax increase but the tax increase was small compared to the tax cut which means that as we look out over the future will have much lower revenues than we would have forecast in 1980 before those bills were passed. The second factor is that we're proposing to have substantial increases in spending for defense and for Social Security and for Medicare and when you have substantial increases in spending and you don't have as much revenues as the you thought you would have you wind up looking at Big deficits. (00:07:27) These (00:07:27) deficits are also extremely worrisome, especially in this period from 1985 on there's two different scenarios that cause us concerned one is that with the federal government trying to finance that amount the Federal Reserve may be very hard-pressed to continue and anti-inflationary policy. And that means that we could wind up going back to high inflation rates such as we saw in the recent past alternatively if you look at the credit markets and there is a recovery the normal increase in demand for credit from consumers and firms is going to collide with the demand for credit from the federal government to finance those deficits. The more the federal government's trying to finance. The higher interest rates are likely to be that tends to discourage borrowing by both consumers and firms which threatens the recovery Not only does it threaten the recovery, but it means that we will be dealing with a low investment economy and that lowers our chances for productivity growth. It means that we're not likely to be modernizing our plant and Equipment very rapidly so that we're not as competitive in world markets and both of those factors are very bad if what you would like to see is a rising standard of living in this country. Now if we saved more these deficits would not be a problem country like Japan routinely finances deficits that are larger relative to its gross national product than 5.6 percent. The problem is that our savings rates run around 6% And so we are looking at deficits that would absorb almost 90 percent of net private savings. We also wouldn't worry about these deficits if they were going to go away with a recovery, right if we only saw them in 84 and in 83, this would be fine, but we forecast these deficits even if the economy does recover at a reasonable rate. (00:09:23) So (00:09:24) with that as a problem that the Congress is facing I'd like to turn now to the decisions of the Congress is going to have to make in order to bring the deficits down and there are three basic factors of the Congress has to deal with one is how much do you want to bring the deficit down? Well, there's no right answer to that question. Nobody knows how much you need to get the deficit down to sustain this recovery, but lots of different measures come out to be between 1 and 3% And so for the sake of example CBO uses two percent of the gross national product in 1988 as a potential goal that if we want to reach that goal. We have to reduce the deficit in 1988 to about a hundred billion dollars, which means we have to cut it by a hundred and seventy billion dollars in that year alone. But in order to cut the deficit out there you sort of have to start sooner. So if you think about changes that we could make that would phase in you're talking about the equivalent of four hundred and sixty billion dollars over the next five years in deficit reductions get a second thing that Congress is going to have to confront is the timing of these policy changes if you do changes too quickly you're liable to abort the You wait too long you liable to drive up interest rates and abort the recovery. The problem is nobody really knows what is too soon. And what is too long? So we proposed this only as a problem a quandary. The Congress is going to have to deal with on the other hand. We can provide some information and that is that these kinds of changes are really going to dislocate taxpayers and beneficiaries of government programs. And from that point of view. You may want to start phasing things in as quickly as possible. So that people have some time to adjust. We also want to be reassuring to the financial markets and they have to believe that the deficits deficits are really going to come down and it seems likely that the best way to convince them is to start putting policy changes into place soon and all of that suggests that the Congress should be making these changes starting this year. Now the third and by far the most difficult decision that Congress is going to have to reach is how it should balance these policy changes between spending cuts and tax increases. Those are after all the only two ways you can cut the deficit and within the spending side. There is a question of balance between domestic cuts and defense (00:11:55) Cuts (00:11:57) now to indicate the magnitude of the changes involved in this dilemma. We've put together many different budget plans for the Congress one of which is shown in figure one of the handout all of the examples. We did were designed to reduce the deficit to about 2 percent of GNP. You can see on the top half of the figure that we and this particular illustration had spending cuts that were about the same magnitude as a tax increases leaving that difference between the two that you would wind up with of two percent of GNP. If you look at the bottom of the figure, it shows you some policy combinations that would get you there. For example, if you limited growth and defense after inflation to three percent that would save eighty 1 billion dollars from the CBO Baseline that would leave you looking for non-defense cuts of a hundred and twenty nine billion dollars. Over and above the savings that we assumed in these examples would come from the national Commission on Social Security reforms package of benefit cuts and tax increases and over and above the kicker that you get whenever you cut the deficit because if you cut the deficit you don't have to finance as much that means you have lower interest costs. So that's sort of the one good sign in all of this thing is that you do get a little free help whenever you cut the deficit through program changes. All right. Now that's that's talking about spending cuts and tax increases but that doesn't get us very far in terms of specific policy changes to talk about the spending side. I think it's really useful to see where the money goes now and even though the budget is incredibly complex. I don't know how many of you have seen it but it's about this thick and this wide and this tall and it is nothing but a mass of fine print numbers, but luckily for people who want to do tables like me, you can look at just four areas and you get most of the money table for that. I know that you've already turned to shows you this basic fact, I like the bottom half that shows percentages. You can see that four areas defense Social Security the health programs Medicare and Medicaid and interest amount to 68 percent of all federal spending that's going to grow by 1988 to 76 percent of all federal spending and what the third column tells you. Is that those four areas will account for 93% of the growth in the entire budget? Now what we conclude from that is that if you're going to cut spending you cannot ignore defense or social security or Medicare and Medicaid now, the Administration has proposed one particular package of policy changes that would bring down the deficit and that their proposals are shown in figure 2 where you can see that the composition of the spending cuts that they're proposing is quite different from the illustration in Figure 1. If you look at the the top half of the table, you'll see that there are some spending cuts and there are some substantial tax increases, but if you look at the bottom half of the table, there's that solid black line that goes across it representing zero what you see is that they're talking about two hundred and six billion dollars of cuts and domestic programs, that would be offset by a 75 billion dollar increase in defense compared with the Congressional budget office Baseline, which represents the last budget resolution. By the Congress and so they have in order to get a hundred and thirty 1 billion dollars of net spending cuts. They have to find many more on the domestic side. They also have a very substantial tax increase would increase tax revenues to about 20% of the gross national product about 60% of this increase would occur in what they call a contingency tax increase to go into effect if the economy hasn't improved substantially by 1986. Okay, now should we enact the administration's proposals as they stand which as you know the Congress never does but if it were to that would cut the deficit by about three hundred and thirty billion dollars over the five-year period That's to compare to the 460 billion dollars. They would get you down to two percent of gross national product for the deficit and since they're not cutting back that far the end result would be that they'd have a deficit of about a hundred and sixty billion dollars or three point three percent of GNP. Now there are many many different alternatives to the administration's package that the Congress is considering in terms of reducing the deficit. Let me just mention a few of them and then turn to your questions, which I hope will concern a whole lot of different Alternatives. One thing that we could do is we could slow the growth and defense spending. But remember we now have to be talking about slowing it below the level in the Congressional resolution. If you were to slow it down to five percent growth in real terms, that would save about 20 billion dollars. If you cut it back to 3% you get about 80 billion dollars we could cut Medicare benefits. One thing we could do is increase cost sharing by recipients. So they would pay for more of the health services. They got if we combine that with better catastrophic insurance for them, we could still put together a package that would save about 10 million dollars over this period We could change the tax system we could get rid of indexing in the personal tax system. Go back to bracket creep. That would get us about 90 billion dollars over this same period we could raise corporate taxes. For example, we could change the life for depreciating buildings raise it from 15 years to 20 years that would generate about 19 billion dollars. She'll notice all of these numbers that I'm mentioning are not so large compared to 460 billion dollars. So the bottom line is that to really bring down the deficit. We are going to have to bite the bullet and do a great many of these different changes and that I think is the bottom line of the message. We really do need to tighten fiscal policy. If we don't we run severe risks of aborting the recovery, but if we're going to tighten fiscal policy, we're going to have to make policy changes that are really unappealing and we're going to have to start doing it pretty Now I think I should make one other remark and that is I'm an optimist and so given that I'm an optimist listening to that message. You can imagine what you might have heard if I were a (00:18:42) pessimist. (00:18:46) Okay, I would now like to turn to questions and answers because quite frankly, that's the part that I enjoy by far the (00:18:51) most. What would the picture of the budget be if you tried to divide out operating expenses from Capital expenses? In other words look at the federal budget the way we look at the City of Minneapolis has a budget or a business budget and would the deficit then be sold horrifying. (00:19:30) Well, I guess it's there's lots of reasons from a budget accounting point of view to want to separate out current expenses from Capital expenses. So, I mean, this is a perfectly logical way to handle it. The bottom line though is that we have enormous amounts of money that we are spending that we are not taking in in tax revenues that we're financing and those large deficits are much larger than the amount of Capital Improvements that we're putting into place and think back to table for right? I don't know how you count defense is that current consumption or is that a capital Improvement? You know, I think you could argue that one either way, but we really do give away a lot of money to beneficiaries through Social Security and Medicare and Medicaid give away a little bit of money to poor people. We right now are giving away a fair amount of money to the unemployed. All of that should should drum, but when you look at the amount of money that Do four things like mass transit and roads. This is a tiny part of the federal budget. So I don't think it makes a lot of difference to the message. (00:20:44) 77 the Congressional budget office projected that the Social Security tax increases would cost five hundred thousand jobs. Now, we've just going through another increase in the Social Security tax how many jobs additional jobs will be lost by these additional (00:20:59) taxes? I think when the Congressional budget office was a younger institution and back in that time period when other people as well as a congressional budget office, but we knew more than maybe we think we know right now we were willing to do things such as make estimates about Job losses. It's not so clear to us. Now that we know exactly what the answer is. It seems likely that if you raise payroll taxes, you do make labor more expensive relative to Capital and all economists would argue that that will cost jobs. How many jobs is something that's a lot harder to know and we haven't done any estimates of that for the current package but one thought that occurs to me is that a lot of people think about taking social security off the budget and in case any of you are thinking about that what that basically does for you is it says that you're going to finance Social Security only through payroll taxes forever and by doing that time together, you're likely to be looking at much much higher. Our payroll taxes damn in the future unless we make significant changes to those programs. (00:22:11) I was in Washington two weeks ago and heard Senator Dole and Congressman Jones and they seem duly alarmed by the projected deficits. They also concur that everybody's Ox is going to get gored. If we're going to resolve these deficits and not abort the recovery how hopeful are you that the rest of Congress will understand the depth of this dilemma? (00:22:36) What my optimism definitely leaves me in the position of thinking that the Congress is going to be able to face up to these very difficult decisions and make the policy changes that are necessary to cut the deficit. I do think though that one of the things that's going to be crucial for that process is to have people throughout the country understands what the consequences are of not cutting spending or raising taxes because the Congress really does respond to constituent pressure. And if there are a lot of cases such as we're looking at right now with the withholding of income taxes from interest and dividends where there's been a major effort to change the enacting of that withholding that went into effect this past year. Then I'd have to start becoming more pessimistic. All right, the banks and Savings and Loans seem to have generated. More mail from constituents arguing against withholding from interest and dividends than they have ever seen on any issue before and part of the seems to be that people are being convinced that when they talk about 10 percent withholding that this means taking 10% of their savings, which is clearly not true and other people think that it's a 10% tax increase which is not true. It's strictly an enforcement measure to get people to pay the taxes that they owe okay, but even though it is strictly an enforcement measure so that people who are actually paying their taxes are not in some sense doing something that's sort of dumb because they're all these other people who aren't paying taxes. There is tremendous pressure on the Congress to end that withholding. Okay. Now if that should happen, I'm going to have to visit start re-evaluating my optimism and my pessimism, but what I'm hoping is that the Congress really will be able to withstand some of this pressure and that more importantly groups like this will be able to convey How important it is to make these policy changes so that there will be some pressure on the other (00:24:39) side. Yes, I have a question on the revenue side in your figure to hear you indicate that revenues will make up between 18 and 20 percent of the GNP you forecast that out through 88 to no matter what the alternative here. (00:24:59) Now this just it happens to be a coincidence that the example that I gave you and the administration's proposal came out to be the same. We did the example before they came out with their (00:25:09) budget. My question is it would be interesting to know historically what percentage of the GNP revenues has have been say in the period 1960 through 1980. (00:25:21) I can't go back as far as 1960 out of my memory. We reached an all-time high of 21 percent in 1981 and it had been growing over the preceding decade and now we have scheduled declined to about 19 percent of GNP. Maybe you made 18 percent somewhere in between the two. I don't know. Does anyone here know what taxes were back in the 1960s as a percent of GNP? No, sorry about that was substantially lower. I mean, I think that let me see what I can figure out from my brain. We had tremendous growth in Social programs over the 1960s. So I wouldn't be surprised if it was down like 15% (00:26:11) Oh, yes. My question is what we did is we've all been very impressed by the spectacular declines and oil prices recently. And as I see it these have a couple of direct implications for federal budget one is obviously that if oil prices go down much further currently projected receipts from the world windfall profits tax disappear. My impression is that that happens at around and all price of approximately $25. It's not too far away on the other hand. There's been a good deal of discussion in Congress about possibility of an oil import tax or some similar energy related measure that might take up some of the slack here. I was wondering if you had any thoughts about first place what some of the likely outcomes might be and secondly how sensitive some of the projections both Baseline high growth low growth and so forth how sensitive some of these are projections my B2 development such as the oil price decline, right? (00:27:18) Okay, there's several questions in there. But basically you have a story straight. We lose some revenues if oil prices go down. This is true on the other hand over all the economy is much much better off to have oil prices go down and think about what has happened to our economy when oil prices went up think about going backwards. This basically is very nice. There are some specific Industries the oil industry and drilling industry that would be adversely affected but there are a lot more users of oil both firms and consumers. So should the price of oil come down already. It's come down to 29. It was already effectively there before but should it come down a lot more than that? This is very good and we're in the process of looking at what that would mean in terms of our forecast. But basically the forecast would look better when Economy performs better that has a positive impact on revenues and I think that that positive impact would likely outweigh the loss in revenues from the oil tax. So from the point of view of the federal deficit, I think we would be ahead from the point of view of the economy. We would be very much ahead to have these oil prices come down.