The current estimate for the 2001 surplus is $158 billion, the second highest in history. This is lower than the $281 billion surplus estimated in the April Budget. The lower surplus is due largely to the year-long economic slowdown and the decision to incorporate immediate fiscal stimulus, in the Economic Growth and Tax Relief Reconciliation Act. The 2002 surplus projection is $173 billion, compared to April's $231 billion estimate. Over the 10 years from 2002 to 2011, the surplus totals $3,113 billion, down from the $3,433 billion estimated in April.

Both this year and next year, the overall budget surpluses are equal to the surpluses generated by Social Security payroll taxes (and interest earnings). The President and Congress are both committed to preserving the Social Security surplus for debt reduction. As a result, the additional surplus available for new spending or further tax relief in the next few years is limited. In order to fully reserve the Social Security surplus for debt reduction, any further initiatives beyond those included in this review will also have to be accompanied by offsets in other areas.

Tax Relief for Working Americans

From the Administration's first day in office, President Bush worked to deliver on his campaign promise of meaningful tax relief. This package, which was originally crafted to ensure long-term economic growth and to return excess surplus funds to taxpayers, became even more urgent as the extent of the economic slowdown became apparent. Congress moved with exceptional speed in response to the President's plan. On June 7, 2001 the President signed the Economic Growth and Tax Relief Reconciliation Act of 2001.

This historic measure of tax relief reduces the bottom marginal tax rate from 15 percent to 10 percent, delivering savings to every income taxpayer, and reduces the top rate to a maximum of 35 percent. It also doubles the child tax credit from $500 to $1,000, enhances incentives for investment in education, eliminates the marriage penalty, phases out the death tax, and encourages retirement saving.

Of immediate importance, the tax measure includes a rebate provision that puts $38 billion in savings from the new 10 percent bracket quickly and directly back in the taxpayers' hands. The rebate checks, which taxpayers are receiving in the months of July, August, and September, could not have come at a better time to invigorate today's shaky economy. Economic growth has slowed steadily for over a year to a point that it has nearly stopped. The rebate checks will help prevent further deterioration by supporting consumer spending.

Reserving the Social Security Surplus for Debt Reduction

A strong bipartisan consensus has arisen in this country, and in the Congress, to preserve very large surpluses as a threshold condition of public finance. Both parties and both the Legislative and Executive Branches, in this Administration and the previous one, have concurred in maintaining a surplus at least the size of the Social Security surplus.

The update of the budget outlook in this Mid-Session Review foresees continued large surpluses above the size of the Social Security surplus for all years in the budget horizon. The President is determined to preserve surpluses at this level, and to continue using these funds for the steady reduction of outstanding publicly held debt.

Changes in the Economic and Budget Outlook Since April

Since the President submitted his budget in April, the extent of the economic slowdown has become more evident. In retrospect, its length and depth are clear: the stock market began to fall in March, 2000; manufacturing employment in August, 2000; and GDP growth in the third quarter of 2000. Overall, the economy has grown at only a 1.3 percent rate since the second quarter of last year, including an estimated 0.7 percent annual growth rate in the most recently completed quarter. As discussed in a subsequent section of this review, the Administration—and other forecasters—believe that recent interest rate cuts by the Federal Reserve, coupled with the fiscal stimulus from the Economic Growth and Tax Relief Reconciliation Act, will spur the economy back to solid, sustainable growth by next year.

Table 1. CHANGE IN BUDGET POLICY SURPLUSES

(In billions of dollars)

Economic weakness, coupled with the tax rebate action that is designed to counteract that weakness, results in a lower surplus outlook this year and next year. In the current year, economic revisions and technical factors reduce the surplus $46 billion from the April estimate, a difference of about two percent of receipts. Tax rebates and related provisions account for $40 billion, a legislated shift in timing of corporation income tax receipts reduces the surplus another $28 billion, and supplemental spending for meeting national defense and other needs uses $5 billion. This combination of factors and a technical adjustment described below still leaves a very small on-budget surplus for 2001.

In 2002, economic and technical revisions are slightly smaller than in 2001. The effect of the tax relief provisions stays level at about $40 billion, while the shift of corporate receipts is recaptured. The net result is a small on-budget surplus.

One factor artificially reducing the 2001 on-budget surplus from the April estimate is an upward revision to the Social Security trust fund due to reestimates of payroll taxes paid in previous years. As explained in the accompanying box, this practice has the effect of inflating the current Social Security surplus by adding credits during 2001 for taxes actually paid and collected in 2000, 1999, and earlier years. This reduces the apparent 2001 on-budget surplus by $6 billion. Correcting this distortion by assigning the extra revenues to their appropriate year makes clear that there is a small on-budget surplus in 2001. OMB will review with the Department of the Treasury the possibility of prospective changes to record the adjustments in the correct years.

Over the full 10-year budget horizon, the surplus outlook is relatively unchanged from April. The unified surplus total for 2002 through 2011 is now estimated at $3,113 billion, down from the $3,433 billion estimated in the April Budget. The largest factor in the reduction is incorporating the outyear implications of the Administration's $18.4 billion defense amendment for 2002. This is the first installment, totaling $209 billion, of investment in restoring our national defense capabilities after years of neglect. The tax bill, because it was scaled back during Congressional consideration, increases the surplus slightly relative to the April Budget (which assumed the President's proposals), while the 10-year economic and technical adjustments reduce the surplus by $46 billion.

This update to the President's budget increases the resources set aside for Medicare modernization, and an integrated prescription drug benefit, to $190 billion over the period 2004 to 2011. This new estimate is consistent with the Framework to Strengthen Medicare that the President announced on July 12th and is $37 billion more than was allocated in total to additional Medicare spending in the April Budget submission over 10 years.

The President's April Budget proposed a program to help low income seniors and those with particularly high prescription drug costs get immediate assistance while Congress considered comprehensive reform. However, with the President's support, a consensus is now building in Congress which focuses on comprehensive Medicare modernization. The President's Framework to Strengthen Medicare and his budget reflect this emerging agreement, setting aside substantial resources to meet this objective which could be implemented as soon as 2004. The Administration is committed to continuing to work with the Congress on enacting legislation to strengthen Medicare consistent with the President's framework.

Although the Administration is committed to enacting comprehensive Medicare legislation soon, the President believes we must help seniors get the prescription drugs they need at an affordable price now. That is why the Administration has begun the voluntary Medicare Prescription Drug Discount Card program. This program will allow seniors access to the same kinds of drug discounts that other Americans with good private health insurance currently receive. The President believes that seniors, who face the heaviest burden for prescription drug costs, should not also have to pay the highest retail prices for drugs. The discount card is not a substitute for prescription drug coverage in a reformed Medicare system, but it will bring important relief to seniors who need it beginning next year.

Of the current 10-year total surplus, $2,538 billion is from the Social Security trust fund, down slightly from $2,583 billion in April. As noted above, the Administration is devoting as much of this amount as possible to the reduction of publicly held debt. After reserving the Social Security surplus, the remaining 10-year surplus is $575 billion, down from $850 billion in April, with most of this difference attributed to the $198 billion increase in spending on national defense and the additional commitment to Medicare.

The Best Course Forward

The government's finances are extremely sound. Only persistent, long-term economic weakness can threaten this position. Hence, promoting a return to vigorous growth must be our common objective. The best course forward is clear: first, we must contain spending over the coming year.

Last year's appropriations, agreed to 8 months ago by the last Congress and the last President, contained the largest one-year spending increase in history, about $50 billion over 2000. Obviously, a smaller surge in spending last year would have ensured a larger surplus today. The spending growth rates of 1999 through 2001 cannot be repeated if we are to preserve the on-budget surpluses that we have all worked so hard to create. Congress must limit this year's appropriations to the level of the 2002 Budget Resolution, including the defense amendment recently proposed by the President.

Second, Congress and the President must work together to continue restraining total spending in the next few years. Businesses, states, cities, and families do not hesitate to limit their spending when revenues diminish. The fifty state governments recently reported that collectively they are lowering spending growth from 8 percent last year to a more sustainable 3-1/2 percent in 2002. Spending in the federal domestic agencies exploded during the last three years, including growth of 45 percent at the Department of Health and Human Services and 27 percent at Department of Transportation. These departments can benefit from a period of digestion without great growth beyond these expanded levels.

The Administration is prepared where necessary to extend the principle of restraint to its own high priority initiatives. The Administration continues to propose several tax initiatives from the April Budget, with the effective dates delayed two years until January 1, 2004. In addition, the Administration proposes to fund other initiatives that can not be delayed within the additional discretionary resources provided in the budget resolution, and will work with Congress to revise these proposals as necessary to ensure their enactment.

There are a number of other items that may place demands on the budget. Consistent with the requirements of the Budget Enforcement Act, action on these or other items with additional costs to the budget must be accompanied by provisions to offset the costs to ensure that no automatic reductions are triggered. Alternatively additional requirements could be funded within the discretionary levels agreed to in the Congressional Budget Resolution including the defense amendment recently proposed by the President. Living within these constraints will ensure that the Social Security surplus is protected and can be fully reserved for debt reduction. Examples of these further requirements include:

• Farm bill. The costs of the farm bill now moving through Congress, which restructures farm programs through the next several years, will have to be offset where necessary to maintain on-budget surplus.

• Tax provisions. Several long-standing tax credits and other provisions expire at the end of 2001. The Administration supports the extension of these provisions in a fiscally responsible manner and looks forward to working with Congress to achieve that goal. These expiring provisions include Archer Medical Savings Accounts, the work opportunity tax credit, the welfare-to-work tax credit, provisions dealing with the minimum tax for individuals, and the treatment of active financial services income of foreign subsidiaries.

• Response to natural disasters. A high level of disaster related needs could require spending beyond the amounts assumed.

• Railroad Retirement Investment Trust. The House-passed Railroad Retirement and Survivors' Improvement Act (HR 1140) would authorize a new federal trust fund to purchase stocks and bonds. The purchases could amount to $15 billion. Under long-standing budget scoring rules, these purchases would be scored as outlays, the same as purchases of stocks, bonds, and any other asset by all agencies within the federal government. However, section 105 of the House-passed bill directs OMB and CBO not to score outlays for these purchases.

Regardless of how the purchases are scored, Treasury would have to pay for them in the same way—by using some of the budget surplus that otherwise would be used to redeem debt held by the public. If all of the purchases were made in 2002, they would exceed the non-Social Security surplus by $14 billion. Treasury would have to use $14 billion of the surplus generated by Social Security to finance the remainder.

This Mid-Session Review presumes a policy of fiscal restraint, but restraint does not mean paralysis. The President's management initiatives and the on-going review of programs at all levels will result in our ability to do more with the same or similar resources. In government, as in any business or family, the burden of proof must be placed on spending proponents to demonstrate the ongoing value received for whatever money is being spent today. Any healthy organization constantly searches for ways to redeploy money from less efficient to more efficient purposes, and it is past time for the federal government to adopt this outlook. We expect that improvements in managing resources that are already underway will pay greater dividends than the exclusive focus on incremental new resources. Excellence is defined by continuing to raise the bar of performance and achievement.

Table 2. CURRENT SURPLUS TOTALS

(In billions of dollars)