Federal fiscal programs.

Wakefield, Joseph C.

Federal Fiscal Programs

THE fiscal year 1989 budget veers from the fiscal course charted by the administration over the past 7 years. In the budget message, the President states that "This budget does not fully reflect my priorities" but instead complies with the bipartisan budget agreement negotiated by the Congress and the administration late last year. That agreement was made to meet the deficit-reduction targets for fiscal years 1988 and 1989 set by the Balanced Budget and Deficit Control Act of 1985, as amended last fall.

The budget, submitted to Congress in mid-February, embodies the Omnibus Budget Reconciliation Act of 1987 and the Continuing Resolution for 1988. These two acts provide the legislation needed to implement the budget agreement. They provide -- and the budget includes -- increased revenues, lower defense spending, and marginally lower nondefense spending. The administration proposes additional modest reductions from current services outlays that are required, according to the administration, to meet fully the targeted deficit.

The legislation implementing the bipartisan budget agreement pares $30 billion from the deficit projected last fall for 1988 and $46 billion from that projected for 1989. Part of the deficit reduction comes from revenue increases of $11.5 billion in 1988 and $17.5 billion in 1989. The reconciliation act provides for the bulk of these increases: Extension of the 3-percent telephone excise tax; extension of social security coverage to certain earnings, such as those of inactive duty reservists; acceleration of corporations' estimated tax payments; and repeal of the installment method of accounting. The administration proposes additional increases, mainly by an extension of medicare hospital insurance coverage to State and local government employees not currently covered.

The agreement-implementing legislation also reduces national defense outlays from those presented in the mid-session review of the budget. After reductions of $9.1 billion in 1988 and $18.2 billion in 1989, national defense outlays increase 3 percent in 1989, one-half of the increase planned last year. In real terms, according to the administration, national defense outlays decline 1 percent, in contrast to a 1.8-percent increase planned last year.

Nondefense spending, excluding social security and net interest, increases 2.9 percent in 1989, compared with a 5.3-percent increase planned last year. The agreement-implementing legislations provides for spending reductions in medicare, agricultural price supports, and the Postal Service and for substantial asset sales. The administration proposes additional modest spending reductions and certain asset sales to meet fully the targeted deficits.

Economic assumptions

According to the administration, "(the) forecast for 1988 takes account of the favorable effects of tax reform, i.e., full implementation in January 1988 of the reduced marginal tax rates mandated by the Tax Reform Act of 1986 and continued confidence in the preservation of the tax reform's incentives for growth and efficiency." Further, the forecast is based on expectations that the budget compromise will be followed and that demand growth in other industrial countries will be sufficient to sustain world output growth while the U.S. trade deficit is being reduced. "Also critical for the forecast is the assumption that monetary authorities will provide sufficient liquidity to support real growth without fueling an acceleration of inflation." Other economic assumptions underlying the fiscal year 1989 budget are shown in table 1.

GNP in constant dollars is forecast to increase 2.4 percent from the fourth quarter of 1987 to the fourth quarter of 1988 and 3.5 percent to the fourth quarter of 1989. Prices are not expected to accelerate in 1988 and 1989. According to the Council of Economic Advisers, "Acceleration of inflation is not seen as a likely danger in 1988." Although higher import prices are expected to continue to contribute to inflation, the Consumer Price Index is forecast to increase 4.3 percent (fourth quarter to fourth quarter), several tenths of a percentage point less than in 1987. The GNP deflator, which is not affected directly by import prices, is forecast to increase 3.9 percent in 1988. The 0.6-percentage-point step-up from 1987 primarily reflects a shifting of weights attached to different component prices used to calculate the deflator, not an acceleration of inflation. Prices, as measured by both the GNP deflator and the Consumer Price Index, are expected to increase less in 1989. Although slower real growth in 1988 is not expected "to bring further immediate reductions in the unemployment rate,.. some 1 1/2 million new jobs will be created as employment growth keeps pace with an expanding labor force." The stronger real growth in 1989 is expected to lower the unemployment rate to 5.5 percent by the fourth quarter of that year.

For 1988, the Council based the real GNP increase (fourth quarter to fourth quarter) on the following assessment. Personal consumption expenditures are expected to increase 1.9 percent, up from 0.6 percent in 1987. The Council notes that "it was widely anticipated late last year that there would be some downward adjustment in consumer spending, (and) it appears that much of that adjustment occurred in the fourth quarter," when consumer spending actually fell. The modest 1.9-percent increase in 1988 is slightly below the projected growth rate of real disposable income. Nonresidential fixed investment is expected to increase 4.4 percent, compared with 3.7 percent in 1987. "The improving trade picture, which is lifting capacity utilization rates in manufacturing industries, will provide much of the motivation for increased investment." Residential investment is expected to increase 3.4 percent, in contrast to a 2.9-percent decline in 1987; housing starts of 1.7 million reflect the lower interest rates in 1988. Inventories are expected to "accumulate at a slower and more sustainable pace," reflecting the renewed growth of final sales. Net exports are expected to provide "nearly half of overall output growth," as the expansion of exports continues and the growth of imports is restrained. Federal purchases of goods and services are expected to decline 4.6 percent, compared with a 2.9-percent increase in 1987; the decline in 1988 reflects the bipartisan budget agreement to reduce the deficit. State and local purchases are expected to increase 2.9 percent, about the same as in 1987.

Current services estimates

Current services estimates show what receipts and outlays would be without policy change. In concept, they are neither recommended amounts nor forecasts; they are a base with which administration or congressional proposals can be compared. The level of receipts generally assumes that tax changes occur as scheduled under current law. The level of outlays generally is that needed to maintain ongoing Federal programs and activities in real terms. The major exception is for national defense, for which the current services level of outlays is defined to be the same as the administration's unified budget proposal. The current services estimates for fiscal years 1988 and 1989 embody the Omnibus Budget Reconciliation Act of 1987 and the Continuing Resolution for 1988.

Unified budget receipts in 1989 are $0.7 billion higher than current services receipts, reflecting the administration proposals to increase receipts, as previously discussed (table 2). Unified budget outlays are $8.2 billion lower than current services outlays; proposed program reductions ($16.4 billion) exceed program increases ($8.3 billion).

The largest program increase -- $2.2 billion -- is for education, including $0.5 billion for compensatory education for the disadvantaged. Increased spending for a proposed space station, the shuttle program, and basic research contribute to the $1.6 billion increase for general science, space, and technology. Increased spending for Federal law enforcement and correctional activities contribute to the $1.4 billion increase in the administration of justice. A proposal to link cost-of-living adjustments for veterans disability compensation to the annual change in the Consumer Price Index accounts for one-half of the $0.8 billion increase in veterans benefits and services.

The largest program reduction -- $6.3 billion -- is for a new function, central Federal credit activities. The new function is to record the nonsubsidy elements of the various Federal credit activities, and the reduction is

Table: Table 1. -- Economic Assumptions Underlying the Fiscal Year 1989 Budget

 TABLE: Calendar year
 TABLE: Actual Estimates

TABLE: 1986 1987 1988 1989

Table: Table 2. -- Relation of Current Services Budget to Unified Budget (Billions of dollars)

TABLE: Fiscal year

TABLE: 1988 1989

Table: Federal Fiscal Position: Surplus or Deficit (-) the result of a proposal to reform these activities. A proposal to substitute private loans for Rural Electrification Administration loans reduces energy outlays $1.7 billion. A proposal to terminate all Amtrak subsidies accounts for about one-half of the reduction in ground transportation. The administration is proposing further reductions in indirect medical education payments and limits on graduate medical education payments to reduce outlays for medicare by $1.0 billion. The administration also proposes to sell the naval petroleum reserves, reducing current services outlays $3.2 billion.

Unified budget

The unified budget deficit decreases from $146.7 billion in fiscal year 1988 to $129.5 billion in fiscal year 1989 (table 3 and chart 1). Of the $17.2 billion decline in the deficit, $9.0 billion is the result of an assumed decline in the current services budget deficit and $8.2 billion is the result of administration deficit-reduction proposals.

Receipts increase $55.5 billion -- or 6.1 percent -- in 1989, to $964.7 billion. Receipts in 1988 are $909.2 billion, up 6.5 percent from 1987. Administration proposals increase receipts $0.7 billion in 1989. The largest proposed increase is $1.6 billion from the extension of medicare hospital insurance coverage to State and local government employees not currently covered by social security. This increase is partly offset by proposals to make permanent the research and experimentation tax credit and to liberalize the allocation rules; combined, these proposals reduce receipts $1 billion.

Outlays increase $38.3 billion -- or 3.6 percent -- in 1989, to $1,094.2 billion. Outlays in 1988 are $1,055.9 billion, up 5.1 percent from 1987. The 1989 increase is the net result of $52.6 billion in increases and $14.3 billion in decreases. Table 4 shows unified budget outlays by function; four functions -- national defense, social security, net interest, and medicare -- account for 60 percent of the $52.6 billion in increases. The $14.3 billion in decreases is the result of $7.7 billion in administration proposals and $6.6 billion in enacted legislation, particularly the Omnibus Budget Reconciliation Act of 1987. The largest decline -- $4.5 billion -- is for commerce and housing credit and reflects both proposed and enacted legislation. The enacted legislation includes the use of housing vouchers to replace lending for rural housing programs, reducing outlays $1.8 billion in 1989. A large increase in undistributed offsetting receipts in 1989 is the result of the proposals to sell the naval petroleum reserves and the Alaska Power Administration.

Federal sector

BEA has prepared estimates of the Federal sector on the national income and product accounts (NIPA) basis consistent with the unified budget estimates (table 2). Estimates of the Federal sector, which are integrated conceptually and statistically with the rest of the NIPA's, differ in several respects from the unified budget.

Unlike the unified budget, they exclude financial transactions, such as loans, and record several categories of receipts and expenditures on a timing basis that is different from the budget. (For a more detailed discussion of the differences, see the February 1980 Survey of Current Business.) Table 5 shows the relation between unified budget receipts and NIPA receipts, and table 6 shows the relation between unified budget outlays and NIPA expenditures.

Federal receipts on the NIPA basis are $1,029.1 billion in fiscal year 1989, up $55.3 billion from 1988 (chart 2). The increase is the net result of a $59.7 billion increase due to higher tax bases and a $4.4 billion decrease due to tax changes (table 7). The tax changes are the net result of a $16.8 billion decrease due to the Tax Reform Act of 1986, a $6.5 billion increase due to higher social security tax rates and bases, a $5.2 billion increase due to the Omnibus Budget Reconcilation Act of 1987, and a $0.7 billion increase due to proposed legislation. The Tax Reform Act reduces personal taxes and nontax receipts $16.0 billion. A proposal to exempt mutual fund shareholder expenses from the 2-percent floor for miscellaneous deductions reduces personal taxes, and the proposal to make permanent (with modifications) the research and experimentation tax credit reduces corporate profits tax accruals. The proposal to extend medicare hospital insurance coverage for State and local government employees increases contributions for social insurance.

Federal expenditures on the NIPA basis are $1,145.9 billion in 1989, up $47.8 billion from 1988 (charts 3 and 4). Table 8 highlights the major factors that contribute to recent changes in Federal expenditures. The largest increase in 1989 -- $13.6 billion -- is for social security benefits, including $9.2 billion for cost-of-living adjustments. Within purchases, the "other" category of nondefense purchases increases $7.1 billion, including $1.8 billion for space programs and $0.5 billion for the strategic petroleum reserve; purchases of agricultural commodities by the Commodity Credit Corporation (CCC) increase $7.0 billion. Medicare transfer payments increase $5.7 billion, and net interest paid increases $4.9 billion. Partly offsetting these increases are declines in the surpluses of the CCC and the Postal Service. The decline in the Postal Service surplus is partly due to a 16-percent average postal rate increase, effective in April 1988.

Table 9 shows the relation between national defense outlays in the unified budget and national defense purchase on the NIPA basis. In 1989, outlays, which are measured on a checks-issued basis, increase more than purchases, which are recorded on a delivery basis. The smaller increase in purchases reflects a decline in deliveries -- particularly for the B-1 bomber and the C-58 cargo plane.

Quarterly pattern. -- Table 10 shows the major factors that affect the quarterly pattern of receipts and expenditures through fiscal year 1989. Receipts reflect the pattern of enacted and proposed legislation and the administration's projected quarterly pattern of wages and profits. Expenditures reflect the pattern of proposed legislation and selected other items, mainly pay raises for Federal employees and cost-of-living adjustments in social security and Federal employee retirement benefits.

The Federal deficit declines substantially in the first quarter of calendar year 1988: Receipts increase strongly despite a decline in personal tax and nontax receipts that is due to the final rate reductions under the Tax Reform Act, and expenditures decline, reflecting a large drop in purchases of agricultural commodities by the CCC. The deficit again declines substantially in the second quarter as personal taxes rebound -- reflecting large temporary effects from the capital gains provisions of the tax act -- and expenditures continue to decline. The deficit increases slightly in the third quarter as receipts decline more than expenditures. Personal taxes more than account for the decline in receipts, reflecting the absence of the temporary effects of the capital gains provisions of the tax act. Agricultural subsidies and the CCC deficit account for the decline in expenditures. The deficit increases for two more quarters as expenditures grow faster than receipts, particularly in the fourth quarter of 1988 when CCC purchases and agricultural subsidies increase. The deficit then declines through the remainder of fiscal year 1989.

Cyclically adjusted deficit. -- Cyclically adjusted receipts, expenditures, and surplus or deficit are estimates of what these measures would be if the economy were moving along a trend GNP path -- a path free from cyclical fluctuations -- rather than along its actual path. Consequently, cyclical fluctuations in the economy do not affect cyclically adjusted budgets. Two measures of the cyclically adjusted budget, one a "middle-expansion" trend GNP and one based on a 6-percent unemployment rate trend GNP, are shown in table 11.

As measured using cyclical adjustments based on middle-expansion trend GNP, the Federal sector of the NIPA's was in deficit in calendar year 1986. The deficit declined in 1987 and is expected to continue to decline in 1988. In 1988 and 1989, the cyclically adjusted deficit follows a quarterly pattern very similar to that of the NIPA deficit. It declines substantially through mid-1988 and increases in the second half of the year. Thereafter, it is relatively stable, increasing slightly in early 1989 and declining for the rest of the fiscal year.

The cyclically adjusted budget based on middle-expansion trend GNP is associated with a middle-expansion trend unemployment rate of 7.4 percent. The cyclically adjusted deficit based on a 6-percent unemployment rate is lower, but follows the same quarterly pattern.

Table: Table 3. -- Federal Government Receipts and Expenditures (Billions of dollars)

 TABLE: Fiscal year
 TABLE: Actual Estimates
 TABLE: 1987 1988 1989

Table: Table 4. -- Unified Budget Outlays by Function (Billion of dollars)

 TABLE: Fiscal year Change from preceding
 TABLE: year
 TABLE: 1986 1987 1988 1989 1987 1988 1989

Table: Table 5. -- Relation of Federal Government Receipts in the National Income and Product Accounts to the Unified Budget (Billions of dollars)

TABLE: Fiscal year

TABLE: 1987 1988 1989

Table: Table 6. -- Relation of Federal Government Expenditures in the National Income and Product Accounts to the Unified Budget (Billions of dollars)

TABLE: Fiscal year

TABLE: 1987 1988 1989

Table: Table 7. -- Sources of Change in Federal Government Receipts, NIPA Basis (Billions of dollars)

 TABLE: Change from
 TABLE: preceding year

TABLE: 1987 1988 1989

Table: Table 8. -- Sources of Change in Federal Government Expenditures, NIPA Basis (Billions of dollars)

TABLE: Change from

TABLE: preceding fiscal

TABLE: year

TABLE: 1987 1988 1989

Table: Table 9. -- Relation of National Defense Purchases in the National Income and Product Accounts to National Defense Outlays in the Unified Budget (Billions of dollars)

 TABLE: Fiscal year
 TABLE: Actu- Estimates

TABLE: al

TABLE: 1987 1988 1989

Table: Table 10. -- Federal Government Receipts and Expenditures, NIPA Basis (Billions of dollars; quarters at seasonally adjusted annual rates)

 TABLE: Fiscal year Calendar year
 TABLE: Estimates Actual Estimates
 TABLE: Esti-
 TABLE: Actual Actual mate 1987 1988 1989
 TABLE: 1987 1987 1988
 TABLE: 1988 1989 I II III IV I II III IV I II III

Table: Table 11. -- Cyclically Adjusted Surplus or Deficit ( - ), NIPA Basis (Billions of dollars)

 TABLE: Based on middle- Based on 6-
 TABLE: expansion trend percent
 TABLE: GNP unemployment
 TABLE: rate trend GNP
 TABLE: Level Change
 TABLE: Level Change