Budget Issues: July 2000 Update of GAO's Long-Term Fiscal Simulations
(Correspondence, 07/26/2000, GAO/AIMD-00-272R).

Pursuant to a congressional request, GAO updated its long-term economic
model using the latest economic and budget assumptions from the
Congressional Budget Office (CBO).

GAO noted that: (1) the continued strength of the U.S. economy and the
significant improvement in the budget projections released by CBO this
month compared to those released in January are reflected in GAO's
updated long-term simulations; (2) saving the Social Security surplus--a
fiscal path receiving widespread endorsement--produces unified budget
surpluses for almost 20 years and eliminates the publicly held debt by
2015; (3) under this scenario, deficits emerge again in 2019--just as
the Social Security and Medicare programs are being strained by the
retiring baby boom generation; (4) saving both Social Security and
Medicare Part A surpluses extends surpluses for one additional year; (5)
deficits under the Save the Social Security Surplus scenario emerge
sooner than in the comparable simulations modelled under the January
baseline; (6) the larger on-budget surpluses in the new CBO forecast
mean that the actions required under this simulation to eliminate those
surpluses are correspondingly greater; (7) since this path assumes that
those actions remain in place, a larger spending and revenue imbalance
materializes sooner as entitlement spending pressures grow; (8) if all
future unified surpluses were saved, deficits would not emerge until the
second half of the century; (9) GAO's model implicitly assumes that once
debt held by the public is retired in 2009, unified surpluses will
continue to be saved; (10) these surpluses accumulate as assets of the
government that would have to be invested; (11) again, the plausibility
of this scenario is open to question, particularly at the asset levels
implied by the model; (12) the level of public savings resulting from
saving the Social Security surpluses will not by itself be sufficient to
promote the budgetary flexibility needed to accommodate both the
projected growth in Social Security and health entitlements as well as
other important national priorities; and (13) if only the Social
Security surpluses are saved and no changes are made in the nation's
health and retirement programs, gross domestic product per capita growth
slows and eventually turns negative, resulting in a lower standard of
living.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-00-272R
     TITLE:  Budget Issues: July 2000 Update of GAO's Long-Term Fiscal
	     Simulations
      DATE:  07/26/2000
   SUBJECT:  Deficit reduction
	     Budget surplus
	     Budget cuts
	     Fiscal policies
	     Economic analysis
	     Balanced budgets
	     Econometric modeling
	     Budget deficit
	     Future budget projections
	     Gross national product
IDENTIFIER:  Social Security Program
	     Medicare Program

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GAO/AIMD-00-272R

B-285914

July 26, 2000

The Honorable John M. Spratt, Jr.

Ranking Minority Member

Committee on the Budget

House of Representatives

Subject: Budget Issues: July 2000 Update of GAO's Long-Term Fiscal
Simulations

Dear Mr. Spratt:

At your request, we updated our long-term economic model using the latest
economic and budget assumptions from the Congressional Budget Office (CBO).
Since 1992, GAO has provided the Congress with a long-term perspective on
alternative fiscal policy paths. This perspective is important for broad
fiscal policy as well as for budget decisions on individual programs. At the
macro level, the budget needs to provide a long-term framework grounded on a
linkage of fiscal policy with the long-term economic outlook. This requires
a focus on both overall fiscal policy and the composition of federal
activity.

Long-term simulations are useful for comparing the potential outcomes of
alternative fiscal policies within a common economic framework. Such
simulations can help Congress assess the long-term implications of fiscal
policy decisions that are made today. This is especially true where a longer
time horizon is necessary to understand the fiscal and spending implications
of the government's commitment. For example, the profound demographic
changes forecast for our population, beginning just beyond the 10-year
budget window, will have enormous consequences for Social Security and
Medicare as well as the budget and the economy as a whole.

While long-term simulations provide a useful perspective that is often
lacking in budget debates, they should be interpreted carefully. Given the
range of uncertainty about future economic changes and the responses to
those changes, these simulations should not be viewed as forecasts of
budgetary or economic outcomes 50 or 75 years in the future. Rather, they
should be seen only as illustrations of the different budget and economic
outcomes associated with alternative policy paths based on common
demographic and economic assumptions.

Updated Simulations

Our simulations are based on the budget and economic assumptions contained
in CBO's updated July 2000 10-year projections. As agreed with your office,
we simulated the following three alternative fiscal policy scenarios.

   * Save the Social Security Surpluses assumes that the Social Security
     surpluses are retained and used to reduce debt held by the public.
     Unspecified policy actions (i.e., spending increases and/or tax cuts)
     are taken that eliminate the non-Social Security (i.e. on-budget)
     surpluses through 2009 but retain the Social Security surpluses. These
     unspecified actions are left in place through the end of the simulation
     period.

   * Save the Social Security and Medicare Part A Surpluses assumes that
     both the Social Security surpluses and the Medicare Part A surpluses
     are retained and used to reduce debt held by the public. Unspecified
     policy actions (i.e., spending increases and/or tax cuts) are taken
     through 2009 that result in unified surpluses equal to the Social
     Security surpluses plus the Medicare Part A (Hospital Insurance) trust
     fund surpluses. These unspecified actions are left in place through the
     end of the simulation period.

   * Save the Unified Surpluses assumes that unified surpluses are used to
     reduce debt held by the public and thereafter are allowed to accumulate
     and generate income. This simulation follows CBO's 10-year inflated
     baseline projections, which assume that budget authority for
     discretionary spending grows with inflation from 2001 through 2009.
     Thereafter, we assume discretionary spending grows with the economy.
     This scenario could be viewed as implausible, as the federal government
     would accumulate considerable assets for a period of over 60 years once
     publicly held debt is retired. Nonetheless, it provides a useful
     reference point against which to compare alternative fiscal policy
     paths such as those discussed above.

The continued strength of the U.S. economy and the significant improvement
in the budget projections released by CBO this month compared to those
released in January are reflected in GAO's updated long-term simulations.
The results of these simulations are provided in the enclosure to this
letter. Figure 1 shows the fiscal paths under the three alternative
scenarios.

Saving the Social Security surplusa fiscal path receiving widespread
endorsementproduces unified budget surpluses for almost 20 years and
eliminates the publicly held debt by 2015. Under this scenario, deficits
emerge again in 2019 (figure 1)just as the Social Security and Medicare
programs are being strained by the retiring baby boom generation. Saving
both Social Security and Medicare Part A surpluses extends surpluses for one
additional year.

If all future unified surpluses were saved, deficits would not emerge until
the second half of the century. Our model implicitly assumes that once debt
held by the public is retired in 2009, unified surpluses will continue to be
saved. These surpluses accumulate as assets of the government that would
have to be invested. Again, the plausibility of this scenario is open to
question, particularly at the asset levels (negative debt) implied by the
model shown in figure 2.

Figures 3 and 4 show the composition of spending under two scenariosSave the
Social Security Surpluses and Save the Unified Surpluses. By 2030, saving
the Social Security surpluses results in a haircut for spending on programs
other than Social Security, Medicare, and Medicaid. Under this scenario,
there is increasingly less room for spending on programs for national
defense, the young, infrastructure, and law enforcement. Budget flexibility
declines drastically so that by 2050 Social Security and health absorb
nearly all federal revenue.

This suggests that the level of public savings resulting from saving the
Social Security surpluses will not by itself be sufficient to promote the
budgetary flexibility needed to accommodate both the projected growth in
Social Security and health entitlements as well as other important national
priorities. Figure 5 illustrates the consequences of this simulation for
long-term economic growth: if only the Social Security surpluses are saved
and no changes are made in our health and retirement programs, GDP per
capita growth slows and eventually turns negative, resulting in a lower
standard of living. These results underscore the continuing need to address
the sustainability of the Social Security, Medicare and Medicaid -->
programs[Author ID1: at Wed Jul 26 06:33:00 2000 ][Author:USGAO] [Author
ID1: at Wed Jul 26 06:33:00 2000 ]. [Author ID1: at Wed Jul 26 06:33:00 2000
]

Model Assumptions

Our simulations are based on the budget and economic assumptions contained
in CBO's updated July 2000 10-year projections. After 10 years, we rely on
the long-term actuarial assumptions for the Social Security and Medicare
programs. For Medicaid, we use the growth rates assumed by CBO in its
December 1999 report on long-term simulations. Interest spending is
determined by interest rateswhich are held constant over the long termand
the level of federal debt held by the public, which depends on the path of
deficits/surpluses within each simulation. All other spending, along with
federal revenue, is assumed to grow at essentially the same rate as the
economy. Table 1 summarizes the key assumptions used in our model.

It is important to reiterate that these results are sensitive to changes in
the economy and the budget. For instance, only 3 months ago, our simulation
of the Save the Unified Surpluses path showed deficits emerging in the
2030s, while the our updated simulation indicates that deficits would emerge
more than 20 years later under this scenario. The difference in these
results was driven by the significant increases in CBO's projected 10-year
surpluses from January to July of this year. Correspondingly, a reduction in
projected surpluses of a similar or greater sizewhether due to policy
actions or economic changeswould significantly worsen the long-term budget
outlook.

- - - - -

We will send copies of this letter to Representative John Kasich, the
Chairman of your committee; Senator Pete Domenici, Chairman, and Senator
Frank Lautenberg, Ranking Member, Senate Committee on the Budget; and the
Honorable Jacob J. Lew, Director, Office of Management and Budget. Copies
will be made available to others on request.

Please contact me at (202) 512-9573 if you or your staff have any questions
concerning this letter.

Sincerely yours,

[0x01 graphic]

Paul L. Posner

Director, Budget Issues

Enclosure

Results of GAO's Long-Term Simulations

[0x01 graphic]

[0x01 graphic]

[0x01 graphic]

[0x01 graphic]

[0x01 graphic]

[0x01 graphic]

(935369)

Congressional Budget Office, The Economic and Budget Outlook: An Update,
July 2000.[Author ID1: at Wed Jul 26 06:34:00 2000 ]

Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, February 25,
1998); Budget Issues: Analysis of Long-Term Fiscal Outlook
(GAO/AIMD/OCE-98-19, October 22, 1997); Budget Issues: Deficit Reduction and
the Long Term (GAO/T-AIMD-96-66, March 13, 1996); The Deficit and The
Economy: An Update of Long-Term Simulations (GAO/AIMD/OCE-95-119, April 26,
1995); and Budget Policy: Prompt Action Necessary to Avert Long-Term Damage
to the Economy (GAO/OCG-92-2, June 5, 1992).

The 2000 Annual Report of the Board of Trustees of the Federal Old-Age and
Survivors Insurance and Disability Insurance Trust Funds, The 2000 Annual
Report of the Board of Trustees of the Federal Hospital Insurance Trust
Fund, and The 2000 Annual Report of the Board of Trustees of the Federal
Supplementary Medical Insurance Trust Fund.

Congressional Budget Office, The Long-Term Budget Outlook: An Update,
December 1999.

This means that both revenues and other spending remain constant as a share
of GDP.

For more information on our long-term model, see GAO/T-AIMD/OCE-98-83.

For example, CBO estimates that if real economic growth is just 0.5 percent
higher or lower each year than projected, the surplus in 2010 could be $250
billion higher or lower. See The Budget and Economic Outlook: An Update,
July 2000, p. 22.

B-285914

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GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations
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