This Selected Issues paper on the United States explains the behavior of inflation and unemployment during 1997–98. The paper highlights that a simple Philips curve equation relating inflation to the unemployment gap has overpredicted inflation since 1993. The mean forecast error for 1994–97 is greater than zero by an amount equivalent to two-thirds of the standard deviation of the forecast error. The paper also examines the developments in the U.S. stock prices. Alternative approaches to social security reform are also discussed.

Abstract

This Selected Issues paper on the United States explains the behavior of inflation and unemployment during 1997–98. The paper highlights that a simple Philips curve equation relating inflation to the unemployment gap has overpredicted inflation since 1993. The mean forecast error for 1994–97 is greater than zero by an amount equivalent to two-thirds of the standard deviation of the forecast error. The paper also examines the developments in the U.S. stock prices. Alternative approaches to social security reform are also discussed.

III. A POSTMORTEM ON THE ACHIEVEMENT OF FEDERAL FISCAL BALANCE1

1. Since FY 1992, the U.S. unified federal fiscal deficit has been on a steep descent, falling from 4.7 percent of GDP to 0.3 percent in FY 1997 (Chart 1). Moreover, the extent of this fiscal consolidation has been consistently more rapid than expected (Chart 2). Some of the improvement in the fiscal situation is attributable to the strength of the economic recovery since the 1990–91 recession, but policies enacted with the Omnibus Budget Reconciliation Act of 1993 (OBRA93) and subsequent legislation have also been major contributing factors. More specifically, the fiscal consolidation that has taken place since 1992 can be attributed primarily to three factors: (i) significantly less than half of the fiscal improvement was cyclical;2 (ii) almost half of the improvement in the structural budget deficit3 was the result of tax increases that raised the structural revenue-to-GDP ratio by an estimated 2 percentage points; and (iii) the remainder of the structural improvement occurred because defense and nondefense discretionary spending were cut by 1½ percentage points and almost ½ percentage point of GDP, respectively.

Chart 1.
Chart 1.

United States: Federal Government Fiscal Balance

(In percent, fiscal year)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Source: Historical Tables, Budget of the United States Government, Fiscal Year 1999.
Chart 2.
Chart 2.

United States: Unified Fiscal Deficit: Actual vs. Projections under Current Services and Budget Measures

(In billions of current dollars, fiscal year)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Sources: Budget of the United States Government, various issues, FY 1993–1998.

2. Estimates of the contribution made by the business cycle to the improvement in the federal fiscal deficit can vary significantly, as they depend on the estimated size of the output gap (actual minus potential GDP) and the estimated elasticities of tax revenues and outlays with respect to GDP. In its FY 1999 Budget document, the Administration estimates that 35 percent of the reduction in the budget deficit between FY 1992 and FY 1997 resulted from the cyclical improvement in the economy.4 The Congressional Budget Office estimates that just under 40 percent of the reduction in the actual budget deficit resulted from the cycle.5 In order to eliminate one source of uncertainty affecting estimates of the structural balance, identical elasticities were applied to alternative estimates of the U.S. output gap prepared by the IMF staff, the CBO, and the OECD (Chart 3).6 These estimates show that the lion’s share of the reduction in the deficit over the period FY 1992–97 occurred for reasons other than the cycle. Based on these estimates, the improvement in the structural balance accounted for between 3.4 and 3.7 percentage points of the total improvement of 4.4 percentage points of GDP.

Chart 3.
Chart 3.

United States: Actual vs Estimated Structural Federal Fiscal Balance(s) 1/

(In percent of actual/potential GDP)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Sources: Giorno, Claude, Pete Richardson, Deborah Roseveare, and Paul van den Noord, (OECD, 1995), Congressional Budget Office (1998), and Fund staff estimates.1/ Structural balances are obtained by applying OECD estimates of U.S. revenue and outlay elasticities to staff, CBO, and OECD estimates of the output gap from 1992–97, The elasticities applied are 1.1 percent and −0.2 percent for revenues and outlays, respectively.

3. Actual tax revenues and revenues adjusted for cyclical developments (structural revenues) have risen steadily since FY 1992, from 17.8 percent of GDP in FY 1992 to 19.8 percent in FY 1997 (Chart 1).7 The strength of revenues has largely reflected measures adopted under OBRA93 which caused both personal and corporate income tax revenues to climb (Chart 4).8 Other revenues, including social insurance taxes and contributions, were essentially unchanged in relation to GDP during the period. The increase in total tax revenues accounts for about 45 percent of the actual deficit reduction since FY 1992. Questions have been raised whether the strength of revenues, particularly in FY 1996 and FY 1997, might be the result of temporary factors including realized capital gains associated with the rising stock market. Of the $106 billion by which the Administration’s FY 1998 current services deficit projection exceeded the actual deficit in 1997 (Chart 2, lower right panel), the Council of Economic Advisers (1998, pp. 48–49) estimates that just $20 billion were unanticipated capital gains tax receipts.

Chart 4.
Chart 4.

United States: Revenue Trends

(In percent)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Source: Historical Tables, Budget of the United States Government, Fiscal Year 1999.

4. Outlays adjusted for cyclical developments (structural outlays) also declined, from about 22 percent of GDP in FY 1992 to as low as 20 percent in FY 1997 (Chart 5). The reduction in outlays reflects a relatively steep decline in discretionary spending and comparatively small declines in mandatory spending and interest outlays.9 Discretionary outlays declined from 8.7 percent of GDP in 1992 to 6.9 percent in 1997, while “Programmatic” mandatory spending10 fell from 11.2 percent of GDP in FY 1992 to 10.8 percent in FY 1997 (Chart 6).

Chart 5.
Chart 5.

United States Actual and Estimated Structural Federal Outlays

(In percent of actual/potential GDP)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Sources: Giorno, Claude, Pete Richardson, Deborah Roseveare, and Paul van den-Noord, (OECD, 1995), Congressional Budget Office (1998), and Fund staff estimates.
Chart 6.
Chart 6.

United States Manadatory, Discretionary, and Net Interest Outlays

(In percent of GDP)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Source: Historical Tables, Budget of the United States Government, Fiscal Year 1999.1/ “Programmatic” mandatory spending refers to mandatory spending, less undistributed offsetting receipts, including from the sale of government assets.

5. At 8.7 percent of GDP in FY 1992, total discretionary outlays were the lowest they had been since at least World War II, and were significantly lower than the 10 percent level maintained from the mid-1970s through the mid-1980s. During the defense build-up of the early to mid-1980s, nondefense discretionary spending had slowed significantly, declining from 5.2 percent of GDP in 1980 to 3.5 percent in FY 1987. The consolidation in nondefense discretionary spending began to show some signs of reversal between FY 1989 and FY 1993 as it rose to 3.8 percent of GDP in FY 1993; however, nondefense discretionary spending fell to 3.4 percent of GDP in FY 1997.11 Cuts in defense outlays were the single largest direct contributor to the reduction in discretionary spending as a share of GDP since FY 1992 (Chart 7). Defense spending declined from 4.9 percent of GDP in 1992 to 3.4 percent in FY 1997. This so-called “peace dividend,” other things being equal, is 35 percent of the reduction in the actual budget deficit and 41 percent of the staff’s estimate of the decline in the structural budget deficit since FY 1992.

Chart 7.
Chart 7.

United States The Composition of Outlays

(In percent of GDP)

Citation: IMF Staff Country Reports 1998, 105; 10.5089/9781451839500.002.A003

Sources: Historical Tables, Budget of the United States Government, Fiscal Year 1999.1/ Includes education, training, employment, social services, Medicaid, and veterans benefits and services.

6. The reduction in “programmatic” mandatory spending from 11.2 percent of GDP in FY 1992 to 10.8 percent in FY 1997 was a significant reversal of the sharp increase in such spending in the years just prior to 1992 (Chart 6). This reversal, however, is almost entirely the result of a decline in income security outlays (Chart 7), largely attributable to a cyclical drop in unemployment compensation of almost ½ percent of GDP from 1992 to 1997.12 At the same time, Medicare outlays continued their steady upward climb, from 1.9 percent of GDP in 1992 to 2.4 percent in 1997, while Social Security outlays were roughly stable at 4½ percent of GDP over the same period. Total programmatic mandatory spending on a cyclically adjusted basis was stabilized at about 10¾ percent of GDP from FY 1992 to FY 1997.

List of References

  • Budget of the United States Government, Fiscal Years 1993–98.

  • Congressional Budget Office, 1998, The Economic and Budget Outlook: Fiscal Years 1999–2008, (January).

  • Council of Economic Advisers, 1998, Economic Report of the President, (February).

  • Giorno, Claude, Pete Richardson, Deborah Roseveare, and Paul van den Noord, 1995, “Estimating Potential Output, Output Gaps and Structural Budget Balances,” OECD (Paris), Economics Department Working Paper No. 152.

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  • Leidy, Michael, 1998, “The Achievement of Federal Fiscal Balance in the United States: How Did We Get Here from There?” unpublished paper.

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1

Prepared by Michael Leidy.

2

Uncertainties in the measurement of the output gap (actual minus potential GDP) and of revenue and outlay elasticities tend to be relatively large, and thus, it is impossible to say precisely how much of the deficit reduction was a result of cyclical improvement in the economy.

3

The “structural” fiscal balance refers to the fiscal balance that would have resulted had GDP equaled its potential value. In other words, the structural balance eliminates that part of the fiscal balance that is attributable to the state of the business cycle.

4

FY 1999 Budget of the United States Government: Analytical Perspectives, p. 12.

5

CBO (1998, p. 109).

6

For a description of the methodology used in these estimates, see Leidy (1998).

7

Applying the OECD (1995) estimate of 1.1 for the income elasticity of U.S. federal tax revenues implies that for any deviation of actual from potential GDP of less than 5 percent, other things being equal, the ratio of revenues to GDP remains constant up to one decimal point. Thus any change in actual revenues to GDP up to one decimal point given small changes in GDP relative to potential GDP must reflect a change in structural revenues to GDP.

8

OBRA93 took a number of steps including raising the top marginal income tax rate on households from 31 percent to 36 percent; imposing a 10 percent surtax on taxable income over $250,000; making personal exemptions a decreasing function of household incomes over $162,700; raising the top marginal corporate tax rate from 34 percent to 35 percent; reducing a number of allowable business expenses; repealing the Medicare health insurance wage base cap; and increasing the taxable portion of social security benefits. For a detailed description of the revenue provisions of OBRA93, see the Budget of the United States Government, Analytical Perspectives, Fiscal Year 1995, pp. 36–39.

9

Most of the government’s spending authority is provided by permanent laws (mandatory spending). Mandatory spending includes Social Security, Medicaid, Medicare, and other entitlement programs. Debt service is also provided for under permanent laws but is usually treated separately from other elements of mandatory spending. Discretionary spending is authorized annually through appropriations legislation and includes such items as defense, transportation, energy and water development, administration of justice, agriculture, veterans affairs, and international affairs.

10

“Programmatic” mandatory spending refers to mandatory spending, less undistributed offsetting receipts, including from the sale of government assets. Included are Social Security outlays, net outlays for deposit insurance, outlays for means-tested entitlements, and other mandatory outlays.

11

The capacity to maintain control over this category of spending appears to be largely attributable to the statutory spending caps established under OBRA93.

12

Income security includes general retirement and disability; federal employee retirement and disability; unemployment compensation; food and nutrition assistance; Supplemental Security Income; Family and other support assistance; the earned income tax credit; housing assistance; and offsetting receipts.

United States: Selected Issues
Author: International Monetary Fund
  • View in gallery

    United States: Federal Government Fiscal Balance

    (In percent, fiscal year)

  • View in gallery

    United States: Unified Fiscal Deficit: Actual vs. Projections under Current Services and Budget Measures

    (In billions of current dollars, fiscal year)

  • View in gallery

    United States: Actual vs Estimated Structural Federal Fiscal Balance(s) 1/

    (In percent of actual/potential GDP)

  • View in gallery

    United States: Revenue Trends

    (In percent)

  • View in gallery

    United States Actual and Estimated Structural Federal Outlays

    (In percent of actual/potential GDP)

  • View in gallery

    United States Manadatory, Discretionary, and Net Interest Outlays

    (In percent of GDP)

  • View in gallery

    United States The Composition of Outlays

    (In percent of GDP)