Federal fiscal programs.

Wakefield, Joseph C. ; Ziemer, Richard C.

THE fiscal year 1986 budget, submitted to Congress in early February, would fundamentally alter the scope and scale of Federal fiscal programs and significantly change the Federal Government's relationship with some parts of the economy, especially agriculture and State and local governments. To help reduce the large and growing deficit, the budget proposes a 1-year freeze in total outlays other than for debt service. The freeze would not be applied across-the-board; it would be achieved by a combination of selective freezes, terminations, reductions, and management improvements in individual programs. National defense outlays, while reduced from the estimate included in the mid-session review of the 1985 budget, continue to increase, as do outlays for Social Security benefits.

The budget proposes sbustantial reductions from current services outlays--that is, outlays that would take place without policy changes. The reductions are in medicare, in agricultural and other subsidies to business and upper income groups, in numerous grants to State and local governments, in Federal payroll costs, and in credit programs. A freeze is proposed for automatic annual cost-of-living adjustments for some entitlement program benefits other than Social Security, for means-tested programs, and for programs for the disabled. A number of immediate terminations, including local government revenue sharing and additions to the strategic petroleum reserve, as well as phaseouts, including crop insurance and grants for the construction of sewage treatment plants, are proposed.

The budget also proposes to increase a variety of fees--such as loan origination fees, customs fees, and navigation fees--paid by users and beneficiaries of Federal services. The budget does not include any proposal for tax reform and simplification, although the administration plans to submit a proposal later. The minor tax changes that are proposed increase receipts, on balance, in 1986 by only $0.2 billion.

National defense spending increases 12.6 percent in 1986; in real terms, according to the administration, the increase is 8.3 percent. This level of spending would push total spending for national defense for the fiscal year 1982-86 period to $1.2 trillion, or about 27 percent of total budget outlays for the period. The budget continues the pattern of large increases for procurement--up 19.1 percent in 1986--and smaller increases in operation and maintenance--up 6.7 percent--and in compensation of millitary personnel--up 7.2 percent. Much of the procurrement spending increase is for strategic nuclear programs: The administration is requesting $6.2 billion for 48 B-1 bombers, $4.7 billion for a Trident submarine and missiles, and $4.0 billion for 48 MX missiles. A large increase--22.3 percent--is proposed for research and development, with emphasis on strategic weapons programs, including the Star Wars program, the space-based defense against nuclear missiles.

Nondefense spending declines 2.4 percent in 1986; in real terms, the decline is 6.1 percent. Excluding debt service and social security, nondefense spending declines 12.1 percent, reflecting the administration's freeze program. The only major function to show an increase is health, reflecting an increase in medicaid. The largest proposed reductions are in agriculture and energy.

The administration proposes to include all currently off-budget entities in the coverage of the unified budget; the budget estimates, in total and by function, reflect this proposal. Among the off-budget entities proposed for inclusion are the Federal Financing Bank (FFB), the strategic petroleum reserve, and the Postal Service.

Economic assumptions

The economic assumptions underlying the fiscal year 1986 budget are shown in table 1. In addition, monetary policy is assumed to avoid excessive stimulus, while providing sufficent liquidity to sustain the expansion. According to the Council of Economic Advisers, the economic assumptions for 1986 reflect projected trends and should not be interpreted as year-to-year forecasts."

GNP in constant dollars is forecast to increase at a constant rate of 4 percent through calendar years 1985 and 1986. From the fourth quarter of 1984 to the fouth quarter of 1985, personal consumption expenditures are excpected to increase 4.3 percent, about the same as in 1984. Residential investment--with housing starts of 1.7 million--is expected to increase 1.7 percent, about one-half the 1984 increase. Nonresidential investment is expected to increase 6.8 percent, considerably below the 1984 increase but still faster than GNP. The increase in Federal purchases over the four quarters of 1985 is 2.2 percent, down from 14.2 percent over the preceding four quarters, due to assumed cuts in purchases in late 1985. State and local purchases are expected to increase at a slower pace--2.7 percent--in 1985 than in 1984.

With moderate expansion of the money supply and continued real growth in GNP, prices--as measured by the GNP deflator--are expected to increase 4.3 percent over the four quarters of 1985. Employment is expected to increase 2.3 million in 1985, compared with 3.5 million in 1984, leading to a decline in the unemployment rate to 7 percent by the fourth quarter of 1985.

Unified budget

The unified budget deficit decreases from $222.2 billion in fiscal year 1985 to $180.0 billion in fiscal year 1986 (table 2 and chart 1). Of the $42.2 billion decline in the 1986 deficit, over one-half is the result of two factors: $11.0 billion is the result of including off-budget entities in the budget and $12.5 billion is the result of a decline in new loans for low-rent public housing. The deficit of off-budget entities declines to $1.5 billion in 1986 from $12.5 billion in 1985. The FFB accounts for $10.3 billion of this decline; the decline in its deficit is largely the result of a proposal to terminate several lending programs. The decline in low-rent public housing loans reflects a decline from an unusually large outlay--$14.3 billion--in 1985 by the Department of Housing and Urban Development to purchase public and Indian housing loans for which the tax-exempt status has been questioned because of a provision of the Deficit Reduction Act of 1984; in 1986, these outlays amount to $1.8 billion. Excluding these two factors, the deficit declines $18.8 billion.

Receipts increase $56.8 billion--or 7.7 percent--in 1986, to $793.7 billion. Receipts in 1985 are $736.9 billion, up 10.6 percent from 1984. Proposed legislation and administrative actions increase receipts, on balance, $0.2 billion in 1986. The largest proposed increases are $0.6 billion in taxes levied to finance the Hazardous Substance Response Trust Fund (commonly referred to as Superfund), which pays for the cleanup of hazardous waste sites, and $0.4 billion for a speedup in the deposit of State and local government social security payroll taxes. The largest reductions are $0.7 billion for a 3-year extension of the research and experimental expenditures tax credit, which is scheduled to expire December 31, 1985, and $0.4 billion for a tuition tax credit of 50 percent of tuition expenses paid to private elementary and secondary schools for qualified dependents.

Outlays increase $14.6 billion--or only 1.5 percent--in 1986, to $973.7 billion. Outlays in 1985 are $959.1 billion, up $107.3 billion, or 12.6 percent. The 1986 increase is the net result of $58.8 billion in increases and $44.2 billion in decreases. Table 3 shows the change in unified budget outlays by function; three functions--national defense, social security and medicare, and net interest--account for 95 percent ofd the $58.8 billion of increases. The $44.2 billion of decreases is largely the result of proposals to cut nondefense outlays except Social Security benefits. (Net interest is indirectly reduced by the effect of the other functional reductions on the increase in debt.) Reductions in agriculture and in energy and an increase in undistributed offsetting receipts account for about 40 percent of the reductions. The decline in housing assistance, a subfunction of income security, is the result of the unusually large increase in 1985 discussed earlier.

Current services estimates

Current services estimates show what receipts and outlays would be without policy changes. They are neither recommended amounts nor forcasts, but rather are a base with which administration or congressional proposals can be compared. The level of outlays generally is that needed to maintain ongoing Federal programs and activities at fiscal year 1985 levels in real terms. The major exception is for national defense; the current services reflects enacted 1985 appropriations and administration policy in the 1985 mid-session review.

Unified budget receipts in 1986 are $0.6 billion lower than current services receipts, reflecting proposed tax reductions of $1.6 billion and tax increases of $1.0 billion (table 4). The largest proposed tax reduction is the extension of the research and experimental expenditures tax credit and the largest tax increase is the speed-up of the State and local government deposit of Social Security taxes. Receipts are also reduced by a proposed 5-percent reduction in Federal employee pay, effective January 1, 1986; the pay reduction lowers contributions for retirement and for life insurance.

Unified budget outlays are $50.8 billion lower than current services outlays; proposed program reductions ($51.5 billion) exceed proposed increases ($0.7 billion). Current services outlays for national defense are reduced $8.9 billion, or 3.0 percent. Outlays for nondefense programs are reduced $42.6 billion, or 5.8 percent. Farm income stabilization programs are reduced $5.3 billion, and include a proposal to set Commodity Credit Corporation (CCC) price support loan rates and subsidy target prices in alignment with market prices. Medicare outlays are reduced $4.1 billion, mainly by proposals to freeze payments to hospitals under the prospective payment system at 1985 levels and to extend the existing freeze on payments to physicians until October 1986. The termination of local government revenue sharing in 1986, 1 year before the current authorization expires, reduces outlays $3.8 billion. The termination of further additions to the strategic petroleum reserve, a part of the reduction in the energy function, reduces outlays $1.5 billion.

According to the budget, current services outlays for discretionary programs are 20 percent of budget outlays in 1986, and current services outlays for entitlements and other mandatory programs are 43 percent. The former--such as housing, mass transit, and pay raises--are reduced a net $21.2 billion, and the latter--such as medicare, medicaid, and farm price supports--are reduced $13.9 billion. The remaining reductions--$12.0 billion--are in national defense ($8.9 billion) and in net interest ($3.1 billion). Undistributed offsetting receipts, which are offset against total outlays, are higher by $3.6 billion. The impending sale of the Conrail system accounts for $1.2 billion of the increase and proposed user fees are processing fees on passengers and commercial carriers entering the United States by land or sea ($0.5 billion) and fees for dreding harbors and inland waterways ($0.6 billion).

Federal sector

BEA has prepared estimates of the Federal sector on the national income and product accounting (NIPA) basis consistent with the unified budget estimates (table 2).

Estimates of the Federal sector are integrated conceptually and statistically with the rest of the NIPA's and 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 SURVE OF CURRENT BUSINESS.) Table 5 shows the relation between unified budget and NIPA receipts and table 6 shows the relation between unified budget outlays and NIPA expenditures. The proposed inclusion of off-budget entities in the unified budget eliminates a reconciliation item between the unified budget and the Federal sector of the NIPA's; these entities always have been included in the Federal sector.

Federal receipts on the NIPA basis in fiscal year 1986 are $826.6 billion, up $68.1 billion from 1985 (chart 2). The increase is the net result of an $81.4 billion increase due to higher tax bases and a $13.3 billion decrease due to tax changes (table 7). Enacted tax changes reduce receipts $16.0 billion in 1986 and proposed legislation increases taxes $2.7 billion Proposed legislation increases indirect business tax and nontax accruals $3.8 billion and reduces other receipt categories $1.1 billion. The major proposals increasing indirect business taxes are to put in place a variety of user fees and to use funds recovered by the Federal Government from pricing and allocation violations under the Emergency Petroleum Allocation Act of 1973 to finance various energy programs. (In the unified budget, the recovered funds are recorded as proprietary receipts and are offset against outlays.)

Federal expenditures on the NIPA basis in 1986 are $992.7 billion, up $44.2 billion from 1985; this increase is about one-half the increase in 1985 (chart3 and chart 4). Table 8 highlights the major factors that contribute to recent changes in Federal expenditures. The largest increase in 1986-$16.3 billion--is in "other" national defense purchases; combined with the increases in purchases of military hardware and paychanges, national defense purchases increase $30.2 billion, accounting for about 70 percent of the total increase. Net interest paid increases $13.2 billion and Social Security benefits increase $11.1 billion, including $7.5 billion for cost-of-living adjustments. Partly offsetting these increases are declines in agriculture subsidies, in revenue sharing, and in "other" nondefense purchases. The 5-percent civilian pay reduction results in a $0.9 billion decline in 1986.

Table 9 shows the relation between national defense outlays in the unified budget and national defense purchases on the NIPA basis. In 1986, outlays, which are measured on a checks-issued basis, increase slightly more than purchases, which are recorded largely on a delivery basis. This larger increase in outlays reflects the steep increase in procurement of military hardware, for which checks are issued prior to delivery.

Quarterly pattern.--Table 10 shows the major factors that affect the quarterly pattern of receipts and expenditures through fiscal year 1986. The Federal deficit declines steadily after the fourth quarter of 1984, with one interruption in the first quarter of 1986, when the second round of indexation under the Economic Recovery Tax Act (the first round was in the first quarter of 1985) holds down the increase in personal taxes. Receipts reflect the pattern of enacted and proposed tax changes and the administration's projected quarterly pattern of wages and profits. Expenditures reflect the pattern of proposed legislation and selected other items, such as a cost-of-living increases in retirement benefits.

Cyclically adjusted deficit.--Measures of the cyclically adjusted budget are estimates of what the budget 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 based on a "middle expansion" trend GNP and one based on a 6-percent unemployment rate trend GNP, are shown in table 11. (See the December 1983 SURVEY for a discussion of these trend measures of GNP and BEA's methodology for calculating cyclincally adjusted budgets.)

As measured using cyclical adjustments based on middle-expansion trend GNP, the Federal sector of the NIPA's was in deficit in calendar year 1983. The deficit widened in 1984 and will widen further in 1985 (table 11). On a quarterly basis, the deficit declined in the first half of 1983, but then increased in the second half, when the final withholding rate cut under the Economic Recovery Tax Act of 1981 became effective. The deficit increases further throughout 1984 before declining in most quarters of 1985 and 1986.

The cyclically adjusted budget based on middle-expansion trend GNP discussed above is associated with a middle-expansion trend unemployment rate that is 7.4 percent in 1983, falls to 7.3 percent by mid-1984, then remains at that rate through mid-1986. Table 11 also shows a measure of the cyclically adjusted budget based on a constant 6-percent unemployment rate. On this basis, the cyclically adjusted deficit is lower, but follows the same quarterly pattern.