The Nation's Long-Term Fiscal Outlook: January 2007 Update	 
(23-FEB-07, GAO-07-510R).					 
                                                                 
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-07-510R					        
    ACCNO:   A66204						        
  TITLE:     The Nation's Long-Term Fiscal Outlook: January 2007      
Update								 
     DATE:   02/23/2007 
  SUBJECT:   Balanced budgets					 
	     Budget cuts					 
	     Budget deficit					 
	     Deficit reduction					 
	     Econometric modeling				 
	     Economic analysis					 
	     Economic growth					 
	     Federal social security programs			 
	     Fiscal policies					 
	     Future budget projections				 
	     Gross national product				 
	     Medicaid						 
	     Medicare						 
	     Fiscal imbalance					 

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GAO-07-510R

   

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

The Nation's Long-Term Fiscal Outlook

January 2007 Update

United States Government Accountability Office

GAO

GAO-07-510R

The Bottom Line: Federal 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.
Figure 1 shows two alternative fiscal paths. As described below "Baseline
extended" builds on the Congressional Budget Office (CBO) baseline--and
results over the long term in revenues several points above the 20-year
historical average and discretionary spending several points below the
20-year historical average. The modifications in the alternative scenario
result over the long term in both revenues and discretionary spending
slightly under the 20-year historical average. Although the timing of
deficits and the resulting debt build up varies depending on the
assumptions used, both simulations show that we are on an unsustainable
fiscal path.

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]

Under "Baseline extended" we follow CBO's baseline for the first 10 years:
tax provisions that are scheduled to expire are assumed to do so
(including the temporary increase in the alternative minimum tax (AMT)
exemption amount) and discretionary spending is assumed to grow with
inflation. Under the alternative scenario we assume all expiring tax
provisions are extended, the 2006 exemption amount for the alternative
minimum tax is continued but not indexed for inflation, and discretionary
spending grows with the economy. In both simulations, after the first 10
years (i.e., the end of the projection period) both revenues and
discretionary spending are held constant as a share of the economy.

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 both sets of expectations about future spending and revenues, the
risks posed to the Nation's future financial condition are too high to be
acceptable.

By definition, what is unsustainable will not be sustained. The question
is how and when our current imprudent and unsustainable path will end. At
some point, action will be taken to change the Nation's fiscal course.
Importantly, 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 Social Security "early
retirement" benefits, and in 2011 the first boomers will become eligible
for Medicare. In the succeeding 2 decades America's population will age
dramatically, and relatively fewer workers will be asked to support ever
larger costs for retirees.

Although Social Security is a major part of the fiscal challenge, 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. In fact, the federal government's obligations for
Medicare Part D alone exceed the unfunded obligations for Social Security.
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.

Figures 2 and 3 look behind the deficit path to the composition of federal
spending under the two scenarios. In these figures 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 growth in Social Security, Medicare,
Medicaid, and interest on debt held by the public dwarfs the growth in all
other types of spending.

Both figures show that the estimated growth in the major entitlement
programs leads to an unsustainable fiscal future--whether revenues as a
share of GDP are above historical levels over the past 20 or 40 years, as
in Baseline extended, or somewhat below them as in the alternative
simulation.

^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.

Figure 2: Potential Fiscal Outcomes Under Baseline Extended

Revenues and Composition of Spending as a Share of GDP

Note: In addition to the expiration of tax cuts, revenue as a share of GDP
increases through 2017 mainly due to (1) real bracket creep, (2) more
taxpayers becoming subject to the AMT, and (3) increased revenue from
tax-deferred retirement accounts. After 2017, revenue as a share of GDP is
held constant--implicitly assuming that action is taken to offset
increased revenue from real bracket creep, the AMT, and tax-deferred
retirement accounts.

Figure 3: Potential Fiscal Outcomes Under Alternative Simulation:
Discretionary Spending Grows with GDP After 2007 and All Expiring Tax
Provisions are Extended

Revenues and Composition of Spending as a Share of GDP

Note: AMT exemption amount is retained at the 2006 level through 2017 and
expiring tax provisions are extended. After 2017, revenue as a share of
GDP is held constant--implicitly assuming that action is taken to offset
increased revenue from real bracket creep, the AMT, and tax-deferred
retirement accounts.

These figures also show that waiting makes the size of the problem worse.
For example, even under GAO's "Baseline extended" scenario--under which
revenues rise to about 20 percent of GDP and discretionary spending falls
to below 6 percent of GDP--waiting until 2040 to close the gap would
require drastic change. Taxes as a share of GDP would have to increase by
about 40 percent or total spending cut by almost 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.

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 3. 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 3.6 percent of the entire
economy each year over the next 75 years, or a total of $26 trillion in
present value terms. For GAO's alternative simulation, the gap is 7.5
percent of the economy, or about $55 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 $87,000 to $182,000 per person, or about $208,000 to $435,000 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 Baseline extended
simulation the fiscal gap would grow from 3.6 percent of the economy today
to 4.7 percent in 2017 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 an
alternative based on recent trends and policy preferences. They vary in
how they deal with the first 10 years:

           o Baseline extended. This takes the 10-year baseline estimates^2
           of the Congressional Budget Office (CBO) and extends them over a
           75-year period. CBO assumes 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 also
           assumes no changes to today's laws. As CBO recognized in its
           January 2007 Budget and Economic Outlook, this results in some
           very problematic assumptions. For example, since the
           Administration's request for supplemental appropriations of almost
           $100 billion had not been submitted at the time CBO published its
           Outlook, CBO noted that its January baseline omits some likely
           discretionary spending in 2007 for military operations in Iraq and
           Afghanistan. Another implication of following current law is that
           CBO assumes that all tax cuts originally enacted in 2001 and 2003
           are permitted to expire as currently scheduled, including the
           temporary increase in the AMT exemption amount.

           o Discretionary spending grows with the economy (that is, with
           GDP) 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.

In each simulation, consistent with our practice of many years, 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. We have done so in order not to make any long-range
policy assumptions. In addition, after the first 10 years, both
simulations use the Social Security and Medicare Trustees' 75-year
intermediate ("best") estimates for those programs and assume that
promised benefits will be paid in full.

^2 The Balanced Budget and Emergency Deficit Control Act of 1985, which
established rules that govern the calculation of CBO's baseline, expired,
on September 30, 2006. Nevertheless, CBO continues to prepare baselines
according to the methodology prescribed in that law.

What Changed in This Update?

Despite improvement in recent years and in near-term projections, the
long-term outlook has not changed significantly since the last
simulations: it remains unsustainable.

As CBO noted, the favorable outlook suggested by its 10-year projections
does not indicate a substantial change in the nation's long-term budgetary
challenges. CBO pointed out that changes in its baseline between August
and January overstate the fundamental improvement in the underlying budget
outlook because roughly half of the total change stems from the baseline's
treatment of previous supplemental appropriations for disaster relief and
the irregular pattern of funding for military operations in Iraq and
Afghanistan. Importantly, one undeniable change from August is that we
have moved closer to the start of the retirement of the baby boom
generation and its fiscal consequences.

- - -

GAO's simulations were updated using CBO's 10-year baseline budget and
economic estimates in its January Budget and Economic Outlook: An Update.
CBO's report can be found at
http://www.cbo.gov/showdoc.cfm?index=7731&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.

Additional information and related products can be found at

http://www.gao.gov/special.pubs/longterm/longtermproducts.html

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