Growth has improved in the past four years, compared to 1988-1992. In fact, privatesector GDP has grown since 1992 faster than in either of the two previous Administrations. Because the government component of GDP is shrinking now, whereas it rose rapidly in the 1980s, the overall numbers do not fully reflect this strength.

Still, several factors continue to hold the economy back. First, the stagnant saving and low investment of the 1980s and early 1990s are still having an effect. Only years of higher investment will offset the capital that was not put in place over the preceding 12 years. Second, the labor force is growing more slowly. And third, the recent slow growth of the major European economies and Japan has constrained the exports of even the newly revitalized and competitive U.S. economy.

What the Administration Has
Accomplished

When the President took office, the deficit was high and rising. It had reached almost five percent of GDP in 1992, and projections suggested that it would not fall below four percent of GDP even during the anticipated economic recovery over the following four years. Then, according to the projections, the deficit would rise again, and continue rising without limit in the future.

The President took action.

The Omnibus Budget Reconciliation Act of 1993 (OBRA 1993): Upon taking office, the President proposed a five-year deficit reduction program that was largely enacted later that year as OBRA 1993.

The law was designed to cut projected deficits from 1994 to 1998 by a total of $505 billion, cutting spending and raising revenues about equally. Of the spending cuts, about $100 billion came in entitlement programs, mostly in health care programs (although expanded health coverage offset some of the savings); other cuts came in discretionary spending and interest costs. All income tax rate increases fell on the top 1.2 percent of families. At the same time, the plan cut taxes for 15 million working families by expanding the Earned Income Tax Credit.

But, largely because the economy has performed better than expected, the Administration now projects that the plan will cut the 1994-98 deficits by $924 billion (see Chart III-4). Specifically, the plan helped cut interest rates and spur growth, thereby generating more Federal revenues and less spending on unemployment compensation and other social benefits. Lower interest rates also helped to cut Federal costs for deposit insurance and for servicing the debt. Meanwhile, the Administration's push for health care reform helped to slow the rise in health care inflation, thus helping to slow the growth in Medicare and Medicaid.

While cutting the deficit, the President's plan also shifted resources toward Administration priorities in education and training, the environment, science and technology, and law enforcement. These investments were intended to raise living standards and the quality of life, both now and in the future.

Budget Cuts Since OBRA 1993: The President has continued to cut the budget the right way-eliminating wasteful and lower-priority spending while preserving key investments. The President and Congress have scrapped over 200 programs and projects entirely, while cutting hundreds more. Spurred by the Vice President's National Performance Review, departments and agencies also have cut their workforces, streamlined programs, reduced paperwork, and overhauled their procurement systems.

The Economic Benefits: The President's success in cutting the deficit is paying huge dividends.

Falling deficits enabled the Federal Reserve to hold short-term interest rates low in 1993. In addition, the markets also reacted favorably, cutting long-term rates. Just as rising deficits increase investor uncertainty about credit demands, inflation, and currency fluctuations, the prospect of continually falling deficits into the future eases uncertainty, prompting investors to risk their money on the new factories and equipment that enhance productivity and, thus, make the economy

grow.

Short-term rates stayed low through the President's first year in office. As for long

term rates, the yield on 10-year Treasury notes fell below six percent in 1993-the first time since 1972 that the rate was this low. Lower long-term rates helped to stimulate investment in housing and business equipment, spurring the recovery.

Interest rates later rose somewhat as the economy expanded, but they remained at very low levels for a rapidly growing economy with such low unemployment. In fact, the last time the economy had unemployment as low as today, the rate on the 10-year Treasury bond was about two percentage points higher.

Future interest rates likely will depend on the success of efforts to balance the budget over the next five years. A bipartisan agreement this year would greatly foster chances of further cuts in both short- and long-term rates.

What have we learned? That, contrary to some views, deficit cutting can go hand

in-hand with economic growth-if the deficit cutting allows the Federal Reserve to maintain low interest rates, and if it's credible in the financial markets. In the months between the announcement and enactment of the President's 1993 economic plan, economic activity picked up. As shown in the monthly employment reports, job gains accelerated, and over the next four years, the economy created over 11 million new jobs-about 93 percent of them in the private sector (see Chart III-5).

The job gains occurred without an increase in inflation, which has been remarkably stable for several years. Although the Consumer Price Index (CPI) rose a bit more last year, the increase was due to faster increases in volatile food and energy prices, which experts do not expect to see again this year. If anything, the underlying rate of inflation has fallen (see Chart III-6).

Family Incomes, Poverty, and Inequality: More jobs, low inflation, and steady growth can foster a widely shared rise in living standards, as witnessed by the last two years. After many years of, at best, modest gains in median family income, 1995 witnessed one of the largest real gains in two decades-1.8 percent. Moreover, people in all kinds of households gained. Poverty fell for the second straight year (see Chart III-7), and groups at the bottom of the income distribution actually enjoyed larger percentage gains than those at the top.

The stronger investment climate also sent stocks much higher. The Dow-Jones Industrial Average has risen an average of 18 percent a year from December 1992 to December 1996-more than half again as fast as in the prior 12 years. Corporate profits, the underpinning for the value of stocks, also have soared. Just as important, the profit gains have not come at the expense of wages, which have risen in this period, but are mainly due to falling corporate interest

payments and a slowdown in employers' health insurance costs.

To be sure, the strong economy is not due to the President's budget policy alone. But just as surely, his policies have contributed to a stronger financial climate, enabled the Federal Reserve to maintain low interest rates, released extra saving for private investment, and showed skeptics that the Nation's leaders could cut the deficit. These successes have played their part in revitalizing the economy in the last four years.

What Remains To Be Done

The best way to preserve and strengthen the current economic expansion is to cut the deficit further. This budget reaches balance in 2002-a goal widely shared by Congress and the public. The President is committed to achieving it, and his previous success in cutting the deficit puts it well within reach.

But the goal of reaching balance is not without controversy. Some observers would

balance the budget every year-no matter what the circumstances; they even would enshrine the goal in the Constitution by passing an amendment to that effect. Others argue that further deficit cutting is unnecessary, if not economically harmful. Both of these visions are misguided.

A Balanced Budget Requirement: A requirement to reach balance every year is potentially harmful. Virtually all taxes, and many spending programs, respond automatically to changing economic conditions. That is, when the economy is weak and incomes fall, income tax revenues fall as well; unemployment compensation and other benefits also cushion the effect of the downturn consumer buying power. Without these "automatic stabilizers," economic downturns would be much worse.

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Consider what could happen under a balanced budget amendment. A weak economy would mean fewer tax revenues and more spending on unemployment and other programs. As a result, a balanced budget requirement could force a tax increase or spending cuts or both-in the middle of a recession. Those steps would make a weak economy even weaker.

Nor are any "escape hatches" from the budget-balancing requirement-for times of economic distress-guaranteed to work. One reason is that economists are notoriously slow to recognize economic downturns. Consequently, by the time they saw the slowdown and Congress acted to ease the balancedbudget requirement, the economic damage would be done. The better practice is to aim for balance, but to adjust budget policy according to circumstances.

A Reversal of Course: Allowing the deficit to begin rising again would be economically damaging. Admittedly, as some analysts argue, continued economic growth and low interest rates could keep Federal debt growing more slowly than the economy as a whole, and that would help to keep Federal interest costs under control. The problem is, the Nation faces some important challenges in the not-so-distant future for which we should begin to prepare. A balanced budget would be a good first step.

Today, the Nation is benefitting from its demography. Its largest population group— the "baby-boom" generation, born between 1946 and 1964-is entering its highest-earning years. They pay much more to the Government than they receive in direct benefits. But the situation will begin to change in about 12 years.

At that point, the oldest baby-boomers will become eligible for early retirement under Social Security. Because the next generation of taxpayers is smaller in size, they will contribute relatively less to the Government in revenues, making it harder to support the baby-boomers in their retirement. The President has already called for a bipartisan process to address that problem. But if we don't balance the budget beforehand, the challenge of supporting the baby boomers will only grow larger.

A balanced budget by 2002 will add a margin of safety into the budget to absorb the coming demographic burden-and any unforeseen problems before then. As illustrated in Chart III-8, if Congress enacts the President's budget and continues his proposed limits on Medicaid while controlling discretionary spending beyond 2002, the Government should be able to avoid an explosion of debt when the baby-boomers retire. (See Chapter 2 of Analytical Perspectives for a full discussion of the methodology underlying these projections.)

The Administration's Economic

Assumptions

This budget, like the Administration's previous budgets, is based on prudent assumptions about economic growth, interest rates, inflation, and unemployment for the foreseeable future. As with the previous budgets, the assumptions are close to the consensus among private forecasters. While the Administration believes that, with sound policies, our economy can do even better, we also believe that we should use prudent, mainstream economic assumptions for budget planning.

The Congressional Budget Office (CBO) also prepares economic assumptions with which to evaluate budget proposals. In the past four years, CBO's assumptions generally have