The Nation's Long-Term Fiscal Outlook: September 2006 Update	 
(15-SEP-06, GAO-06-1077R).					 
                                                                 
Since 1992, GAO has published long-term fiscal simulations of	 
what might happen to federal deficits and debt levels under	 
varying policy assumptions. GAO developed its long-term model in 
response to a bipartisan request from Members of Congress who	 
were concerned about the long-term effects of fiscal policy. In  
1992 GAO said: "The federal budget is structurally unbalanced.	 
This will do increasing damage to the economy and is		 
unsustainable in the long term. Regardless of the approach	 
chosen, prompt and meaningful action is essential. The longer it 
is delayed, the more painful it will be." These words are as	 
relevant today as when GAO first published them. GAO updates its 
simulations three times a year as new estimates become available 
from the Congressional Budget Office's (CBO) Budget and Economic 
Outlook (January), Social Security and Medicare Trustees Reports 
(early spring), and CBO's Budget and Economic Outlook: An Update 
(late summer).							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-1077R					        
    ACCNO:   A60964						        
  TITLE:     The Nation's Long-Term Fiscal Outlook: September 2006    
Update								 
     DATE:   09/15/2006 
  SUBJECT:   Balanced budgets					 
	     Budget deficit					 
	     Deficit reduction					 
	     Econometric modeling				 
	     Economic analysis					 
	     Economic growth					 
	     Federal social security programs			 
	     Fiscal policies					 
	     Future budget projections				 
	     Gross national product				 
	     Medicaid						 
	     Medicare						 
	     Budget cuts					 
	     Fiscal imbalance					 
	     Social Security Program				 

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GAO-06-1077R

     

     * The Fiscal Gap-Another Way to Measure the Challenge
     * What Is Assumed in GAO's Simulations?
     * What Changed in This Update?

The Nation's Long-Term Fiscal Outlook

September 2006 Update

United States Government Accountability Office

GAO

GAO-06-1077R

The Bottom Line: Today's Fiscal Policy Remains Unsustainable

Figure 1: Unified Surpluses and Deficits as a Share of GDP under
Alternative Fiscal Policy Simulations

GAO's current long-term simulations continue to show ever-larger deficits
resulting in a federal debt burden that ultimately spirals out of control.
The timing of deficits and the resulting debt build up varies depending on
the assumptions used, but under either optimistic ("Baseline extended") or
more realistic assumptions, current fiscal policy is unsustainable.

Simulations are not forecasts or predictions. They are designed to ask the
question "what if?" GAO's "what ifs" are that discretionary spending may
grow faster or slower, and tax cuts may be renewed or allowed to expire -
but in both cases, the Nation's long-term fiscal future is "at risk."
Under any reasonable set of expectations about future spending and
revenues, the risks posed to the Nation's future financial condition are
too high to be acceptable.

GAO's Long-Term Fiscal Simulations

Since 1992, GAO has published long-term fiscal simulations of what might
happen to federal deficits and debt levels under varying policy
assumptions. GAO developed its long-term model in response to a bipartisan
request from Members of Congress who were concerned about the long-term
effects of fiscal policy.

In 1992 GAO said: "The federal budget is structurally unbalanced. This
will do increasing damage to the economy and is unsustainable in the long
term. Regardless of the approach chosen, prompt and meaningful action is
essential. The longer it is delayed, the more painful it will be." These
words are as relevant today as when GAO first published them.

GAO updates its simulations three times a year as new estimates become
available from:

           o  CBO's Budget and Economic Outlook (January),
           o  Social Security and Medicare Trustees Reports (early spring),
           and
           o  CBO's Budget and Economic Outlook: An Update (late summer).

This product responds to congressional interest in receiving updated
simulation results. Additional information about the GAO model, its
assumptions, data, and charts can be found at
http://www.gao.gov/special.pubs/longterm/ . For more information, contact
Susan J. Irving at (202) 512-9142 or [email protected]

By definition, what is unsustainable will not be sustained. The question
is how our current imprudent and unsustainable path will end. At some
point, action will be taken to change the Nation's fiscal course. The
sooner appropriate actions are taken, the sooner the miracle of
compounding will begin to work for the federal budget rather than against
it. Conversely, the longer action to deal with the Nation's long-term
fiscal outlook is delayed, the greater the risk that the eventual changes
will be disruptive and destabilizing. Acting sooner rather than later will
give us more time to phase in gradual changes, while providing more time
for those likely to be most affected to make compensatory changes.

What Drives Our Nation's Bleak Long-Term Fiscal Outlook?

The long-term fiscal outlook results from a large and persistent gap
between expected revenues and expected spending.

The spending that drives the outlook is primarily spending on the large
federal entitlement programs (i.e., Social Security, Medicare, Medicaid).
The retirement of the baby boom generation is one key element of this. In
2008 the first boomers will be eligible to draw "early retirement" Social
Security benefits, and in 2011 the first boomers will become eligible for
Medicare. Over the following 2 decades America's population will age
dramatically, and fewer workers will be asked to support ever larger costs
for retirees.

Although Social Security is a major part of the fiscal challenge, contrary
to popular perception, it is far from our biggest challenge. Spending on
the major federal health programs (i.e., Medicare and Medicaid) represents
a much larger and faster growing problem. Over the past several decades,
health care spending on average has grown much faster than the economy,
absorbing increasing shares of the Nation's resources, and this rapid
growth is projected to continue. For this reason and others, rising health
care costs pose a fiscal challenge not just to the federal budget but to
American business and our society as a whole.

In figures 2 and 3 below, the category "all other spending" includes much
of what many think of as "government"-"discretionary" spending on such
activities as national defense, homeland security, veterans health
benefits, our national parks, highways and mass transit, foreign aid, plus
"mandatory spending" on the smaller entitlement programs such as
Supplemental Security Income, TANF, and farm price supports.1 The spending
increases for all these types of spending taken together are dwarfed by
the growth in spending for Social Security, Medicare, Medicaid, and
interest on debt held by the public. Figure 2, which shows results from
GAO's more realistic simulation, is a visual depiction of how the magic of
compounding will work against us if a gap between revenues and spending is
allowed to continue to grow.

Figure 2: Composition of Spending as a Share of GDP Assuming Discretionary
Spending Grows with GDP After 2006 and All Expiring Tax Provisions are
Extended

1 "Discretionary spending" refers to spending based on authority provided
in annual appropriations acts. "Mandatory spending" refers to spending
that Congress has authorized in legislation other than appropriations acts
that entitles beneficiaries to receive payment or that otherwise obligates
the government to make payment.

Estimated growth in the major entitlement programs results in an
unsustainable fiscal future regardless of whether one assumes future
revenue will be somewhat below or above historical levels as a share of
the economy.

These figures also show that waiting makes the size of the problem worse.
For example, under GAO's more optimistic simulation shown in figure 3,
waiting until 2040 means that as a share of the economy, either taxes
would need to be increased by almost 60 percent or total spending reduced
by a third in order to balance the budget in that year. Sudden, drastic
changes of either kind-and revenues at such a level--are outside
post-World War II historical experience in this country.

Figure 3: Composition of Spending as a Share of GDP Under Baseline
Extended

              The Fiscal Gap-Another Way to Measure the Challenge

Many ways exist to measure the long-term fiscal challenge. One
quantitative measure is called "the fiscal gap." The fiscal gap is the
amount of spending reduction or tax increases needed to keep debt as a
share of gross domestic product (GDP) at or below today's ratio. Another
way to say this is that the fiscal gap is the amount of change needed to
prevent the kind of debt explosion implicit in figure 2. The fiscal gap
can be expressed as a share of the economy or in present value dollars.

For GAO's "Baseline extended" simulation, closing the fiscal gap would
require spending cuts or tax increases equal to 4.5 percent of the entire
economy each year over the next 75 years, or a total of $34 trillion in
present value terms. For GAO's more realistic simulation, the gap is 8
percent of the economy, or about $61 trillion in present value terms. To
put this in perspective, if we were to invest enough today to pay off
these amounts over the next 75 years, the sums needed would amount to
about between $115,000 to $200,000 per person, or between about $270,000
to $485,000 for each full-time worker.

Under either set of assumptions, the size of the change we would need to
make in the federal budget would be larger than last year's unified
deficit-and that is just the change in the first year of the 75-year
window. Waiting even 10 years to close the fiscal gap would require
larger, more drastic changes. For example, under GAO's optimistic
simulation the fiscal gap would grow from 4.5 percent of the economy today
to 5.7 percent in 2016 simply by waiting to act.

Additional economic growth is critical and will help to ease the burden,
but the projected fiscal gap is so great that it is unrealistic to expect
we will grow our way out of the problem. To do so under any reasonable set
of assumptions would require double-digit real economic growth for many
decades to eliminate the long-term fiscal challenge. However, since the
end of World War II we have not seen economic growth of this kind. To be
sure, additional economic growth would certainly help the Nation's
financial condition and our ability to address our fiscal gap, but it will
not eliminate the need for action.

Other ways to think about the size of the long-term challenge may also be
found in http://www.gao.gov/cghome.htm

                     What Is Assumed in GAO's Simulations?

GAO's two simulations project current policies on revenue and spending
forward. The first is "Baseline extended," and the second is based on more
realistic assumptions given recent trends and assumed policy preferences.
They vary in how they deal with the first 10 years:

           o  Baseline extended. This takes the 10-year baseline estimates of
           the Congressional Budget Office (CBO) and extends them over a
           75-year period. By law, CBO is required to assume in its baseline
           estimates that discretionary spending grows at the rate of
           inflation--a slower growth rate than that witnessed in many recent
           years. CBO is also generally required by statute to assume no
           changes to today's laws. One implication of this is that CBO must
           assume that all tax cuts originally enacted in 2001 and 2003
           expire as currently scheduled.
           o  Discretionary spending grows with the economy (that is, with
           gross domestic product) and all expiring tax reductions are
           extended. This simulation alters two key assumptions of CBO's
           baseline. First, discretionary spending is allowed to grow with
           the economy in the first 10 years rather than being constrained to
           grow with inflation. Second, all expiring tax cuts are extended
           permanently.

At the end of the 10-year period we take the levels of revenue and
discretionary spending as shares of GDP and hold these constant for the
rest of the simulation period. Since 1992 we have held revenues and
discretionary spending constant as shares of GDP after the CBO estimation
period so as to make no policy assumptions. In addition, after the first
10 years, both simulations use the Social Security and Medicare Trustees'
75-year intermediate estimates for those programs and assume that promised
benefits will be paid in full.

                          What Changed in This Update?

The long-term outlook has not changed significantly since the last
simulations. Although this year's deficit outlook has improved, the
long-term continues to be unsustainable.

GAO's simulations were updated using CBO's 10-year baseline budget and
economic estimates in its August Budget and Economic Outlook: An Update.
CBO's report can be found at
http://www.cbo.gov/showdoc.cfm?index=7492&sequence=0

This product is based on GAO's work on the long-term fiscal challenge,
including reports and testimonies. These efforts were conducted in
accordance with generally accepted government auditing standards.

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