# Baseline Budgeting Exercise 1. Consider the case of a publicly-f...

## Question

Baseline Budgeting Exercise

1. Consider the case of a publicly-financed retirement program. Under current law, the program has 1 million beneficiaries each of whom receives a benefit of \$10,000 per year.
Given current eligibility rules, government statisticians estimate that the population of beneficiaries will grow at a rate of 5% per year. In addition, current law requires that benefits be increased for inflation each year at a rate of 3%. Suppose, however, that based on new research showing that the annual inflation rate is 2% instead of 3%, the Presidentâ€™s budget proposes that the annual inflationary increase in benefits should be 2%.
a. Calculate the 10 year budgetary impact of the proposed policy change in the Presidentâ€™s budget. (25 points)
b. Opponents of the proposed change argue that under the proposed new policy, beneficiaries of the program will suffer a cut. Supporters of the proposed change counter by saying that the proposed change is not a cut, but an increase. Citizens following the debate who have not taken a public budgeting course are confused.
How would you explain this to them? (25 points).
2. Suppose that under current law an income tax can be characterized as follows: (1) in years 1-5, \$500 million is subject to tax, which includes a package of temporary tax cuts that exempt \$200 million of income from taxation; (2) these temporary tax cuts are scheduled to expire at the end of year 5; (3) income is taxed at a rate of 30% for the ten years running from 1-10; and (5) income grows at a rate of 3% per year. In past years, when the package of temporary tax cuts was scheduled to expire, it has been renewed for another temporary period.
a. What is the current law revenue base-line for years 1-10? (25 points)
b. How would an extension of the tax cuts from years 6 - 10 be scored (e.g. counted) relative to the current law revenue baseline? (15 points)
c. How would extending the tax cuts from years 6 - 10 be scored relative to the current policy baseline? (10 points)
Note, if you want to graph your results, you are welcome to do so, but graphing is not required for a complete answer.

## Solution Preview

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1.
Since there are 1 million beneficiaries, the total budget, with an average rate of \$10,000 per beneficiary, is 1 million * \$10,000 = \$10,000 million. While the growth rate remains the same at 5% in both the cases, the rate of inflation used is 3% as per current law and the total value of benefits is calculated as \$167,792,597,538. If the inflation is assumed to be 2%, the total value of benefits is expected as \$158,674,931,904. Thus implementation of new policy would reduce the benefits by \$167,792,597,538 - \$158,674,931,904 = \$9,117,665,634. Thus the level of expenses would reduce if the rate of 2% is used....

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