The Nation's Long-Term Fiscal Outlook April 2007 Update: The	 
Bottom Line: Federal Fiscal Policy Remains Unsustainable	 
(04-JUN-07, GAO-07-983R).					 
                                                                 
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.	 
GAO's simulations were updated with new estimates for Social	 
Security and Medicare spending. GAO also modified its alternative
simulation so that Medicare spending follows a more realistic	 
path and revenues return to historical levels. GAO updates its	 
simulations three times a year as new estimates become available 
from CBO's Budget and Economic Outlook (January), Social Security
and Medicare Trustees Reports (spring), and CBO's Budget and	 
Economic Outlook: An Update (late summer). This product responds 
to congressional interest in receiving updated simulation	 
results.							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-983R					        
    ACCNO:   A70227						        
  TITLE:     The Nation's Long-Term Fiscal Outlook April 2007 Update: 
The Bottom Line: Federal Fiscal Policy Remains Unsustainable	 
     DATE:   06/04/2007 
  SUBJECT:   Balanced budgets					 
	     Budget cuts					 
	     Budget deficit					 
	     Deficit reduction					 
	     Econometric modeling				 
	     Economic analysis					 
	     Economic growth					 
	     Federal social security programs			 
	     Fiscal policies					 
	     Gross national product				 
	     Medicaid						 
	     Medicare						 
	     Fiscal imbalance					 

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GAO-07-983R

   

     * [1]What Drives Our Nation's Bleak Long-Term Fiscal Outlook?
     * [2]The Fiscal Gap--Another Way to Measure the Challenge
     * [3]What Is Assumed in GAO's Simulations?
     * [4]What Changed in This Update?
     * [5]PDF6-Ordering Information.pdf

          * [6]Order by Mail or Phone

The Nation's Long-Term Fiscal Outlook

April 2007 Update

United States Government Accountability Office

GAO

GAO-07-983R

The Bottom Line: Federal Fiscal Policy Remains Unsustainable

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

As in previous updates , GAO's current long-term simulations show
ever-larger deficits resulting in a federal debt burden that ultimately
spirals out of control. Figure 1 shows two alternative fiscal paths. The
first is "Baseline extended," which extends the Congressional Budget
Office's baseline estimates beyond the 10-year projection period, and the
second is an alternative based on recent trends and policy preferences.
For this update we modified the alternative simulation to reflect a return
to historical levels of revenue and a more realistic Medicare scenario for
physician payments. 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.

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. 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.

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.

GAO's simulations were updated with new estimates for Social Security and
Medicare spending. GAO also modified its alternative simulation so that
Medicare spending follows a more realistic path and revenues return to
historical levels.

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 (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
[7]http://www.gao.gov/special.pubs/longterm/ . For more information,
contact Susan J. Irving at (202) 512-9142 or [8][email protected]

Simulations are not forecasts or predictions. They are designed to ask the
question "what if?" GAO's "what ifs" include that discretionary spending
may grow slower (as in Baseline extended) or faster (as in the
alternative), and tax cuts may be allowed to expire (as in Baseline
extended) or be extended (as in the alternative), 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.

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., Medicare, Medicaid, Social Security).
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.

In their April 2007 report, the Medicare Trustees for the first time
issued a Medicare funding warning of projected "excess general revenue
funding" in the Medicare program. As required under the Medicare
Prescription Drug, Improvement, and Modernization Act of 2003, issuance of
the warning will require the President to submit to Congress, within 15
days after the release of the Fiscal Year 2009 Budget, proposed
legislation to respond to the warning. Congress is then required to
consider the legislation on an expedited basis.^1

Figures 2 and 3 look behind the deficit path to the composition of federal
spending under the two scenarios. 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 at about
historical levels as in the alternative simulation.

^1 The 2003 act requires the President to submit a proposal to Congress
for action if the Medicare Trustees determine in 2 consecutive years that
the general revenue share of Medicare spending is projected to exceed 45
percent during a 7-year period. For the purpose of this Medicare trigger,
general revenue is defined as the difference between program outlays and
dedicated financing sources (that is, Hospital Insurance (HI) payroll
taxes, the HI share of income taxes on Social Security benefits, state
transfers for Part D prescription drug benefits, premiums paid under Parts
A, B, and D, and any gifts received by the trust funds). For more
information on trigger mechanisms such as the one in the 2003 legislation
and the sustainable growth rate, which governs the formula used to update
physician fees, see Mandatory Spending Using Budget Triggers to Constrain
Growth, GAO-06-276 (Washington, D. C.: January 31, 2006).

Figure 2: Potential Fiscal Outcomes Under Baseline Extended

Revenues and Composition of Spending

Notes: In addition to the expiration of tax cuts, revenue as a share of
GDP increases through 2017 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.

Figure 3: Potential Fiscal Outcomes Under Alternative Simulation

Revenues and Composition of Spending

Note: Discretionary spending grows with GDP after 2007. 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 returns to
its historical level of18.3 percent of GDP plus expected revenues from
deferred taxes, i.e. taxes on withdrawals from retirement accounts.

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, Temporary Assistance for Needy Families (TANF), and farm price
supports.^2 The growth in Social Security, Medicare, Medicaid, and
interest on debt held by the public dwarfs the growth in all other types
of spending.

Under Baseline extended we follow the Congressional Budget Office (CBO)
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. At the end of the 10-year period,
revenues in Baseline extended are several points above the 20-year
historical average and discretionary spending is several points below the
20-year historical average. For the remainder of the simulation period,
revenues and discretionary spending are held constant as shares of the
economy, and for Social Security and Medicare, we use the Trustees' April
2007 intermediate estimates. The Medicare estimates assume the
continuation of current law, under which fees for physicians treating
Medicare patients would be cut in future years.^3

Under the alternative scenario in the first 10 years we assume that all
expiring tax provisions are extended, and the 2006 exemption amount for
the alternative minimum tax is continued but not indexed for inflation.
After the first 10 years revenues are allowed to return to their
historical share plus expected revenues from deferred taxes, i.e. taxes on
withdrawals from retirement accounts. Discretionary spending grows with
the economy throughout the simulation period. Over the long term, levels
of discretionary spending are slightly under the 20-year historical
average. The alternative scenario uses Medicare estimates developed by the
Centers for Medicare and Medicaid Services (CMS) that assume payment rates
to physicians will not be reduced as specified under current law.^4 As in
Baseline extended, after the first 10 years the alternative scenario uses
the Trustees' intermediate estimates for Social Security.

^2 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.

^3 The Trustees noted in their April 2007 report that Medicare
expenditures "are substantially understated because projected current-law
physician payment updates are unrealistically reduced under the
sustainable growth rate system [the statutory formula that governs fee
updates] by about 10 percent in 2008 and 5 percent in each subsequent year
through 2016. In practice, Congress is virtually certain to prevent some
or all of the scheduled reductions through new legislation, as it has for
2003 through 2007."

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 balance the budget would
require drastic change. Taxes as a share of GDP would have to increase by
about 40 percent or noninterest spending cut by about a third in order to
balance the budget in that year. If changes in personal income taxes were
the sole means used to balance the budget, these would increase by about
75 percent. 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.
(See table 1.)

^4 This reflects the fact that Congress has generally acted to prevent
payment rates from being reduced. CMS developed two illustrative Medicare
estimates that vary from the intermediate estimates. One set of estimates
assumes a 0.0 percent update to physician fees; the other assumes updates
for medical inflation. GAO's alternative simulation uses the 0-percent
update estimates. For more information on these estimates, see CMS' April
2007 memorandum "Projected Medicare Part B Expenditures under Two
Illustrative Scenarios with Alternative Physician Payment Updates,"
available at
[9]http://www.cms.hhs.gov/ReportsTrustFunds/05_alternativePartB.asp

Table 1: Fiscal Gap 2007-2081

                   Fiscal Gap             Change Required to Close Gap
                                                  Percentage      Percentage  
                                   Percentage     Increase in    Decrease in  
               Trillions of Share  Increase in Individual Income Non-Interest 
               2007 Dollars of GDP   Revenue         Taxes         Spending   
Baseline       $27.2      3.7%     19.9%          44.0%          20.3%     
Alternative    $54.5      7.4%     40.0%          88.1%          40.7%     

Source: GAO analysis.

To close the fiscal gap under Baseline extended would require revenue
increases or programmatic spending cuts (i.e., in all discretionary
spending and spending on federal entitlement programs) equal to about 20
percent each and every year over the next 75 years. Under GAO's
alternative simulation, the required action would be even more
dramatic--about 40 percent. These annual tax increases and spending cuts
would exceed the fiscal year 2006 deficit of 1.9 percent of GDP. Delaying
action would make things worse. Under our alternative simulation, waiting
even 10 years would require a revenue increase of about 50 percent or
non-interest spending cuts of about 45 percent.

This gap is too large for us to grow our way out of the problem. It would
require decades of double-digit real economic growth, but the U.S. has not
had a single year of double-digit real economic growth since World War II.
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 [10]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, Baseline extended, takes the 10-year baseline
estimates^5 of the Congressional Budget Office (CBO) and extends them over
a 75-year period and the second, Alternative simulation, is based on
recent trends and policy preferences. As CBO recognized in its January
2007 Budget and Economic Outlook, its baseline estimates incorporate some
very problematic assumptions that we adjust for in our alternative
simulation as summarized below.

^5 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.

Table 2: Assumptions for Baseline Extended and Alternative Simulations

Model inputs      Baseline Extended              Alternative Simulation    
Revenue           CBO's January 2007 baseline    All expiring tax          
                     through 2017; thereafter       provisions are extended   
                     remains constant at 20.1       through 2017; thereafter  
                     percent of GDP (CBO's          equal to 40-year          
                     projection in 2017)            historical average of     
                                                    18.3% of GDP plus CBO's   
                                                    estimate of revenue from  
                                                    tax-deferred retirement   
                                                    plans                     
Social Security   CBO's January 2007 baseline    Same as Baseline Extended 
spending (OASDI)  through 2017; thereafter based                           
                     on 2007 Social Security                                  
                     Trustees' intermediate                                   
                     projections                                              
Medicare spending CBO's January 2007 baseline    Throughout simulation     
                     through 2017, thereafter based period, CMS's             
                     on 2007 Medicare Trustees'     intermediate projections  
                     intermediate projections       with alternative          
                                                    assumption of zero        
                                                    percent physician payment 
                                                    updates                   
Medicaid spending CBO's January 2007 baseline    Same as Baseline Extended 
                     through 2017; thereafter based                           
                     on CBO's December 2005                                   
                     long-term projections under                              
                     Scenario 2 that assume per                               
                     enrollee Medicaid spending                               
                     grows with GDP per capita plus                           
                     1 percent over the long term                             
Other mandatory   CBO's January 2007 baseline    Same as Baseline Extended 
spending          through 2017; thereafter                                 
                     increases at the rate of                                 
                     economic growth (i.e., remains                           
                     constant as a share of GDP)                              
Discretionary     CBO's January 2007 baseline    Increases at the rate of  
spending          through 2017; thereafter       economic growth starting  
                     increases at the rate of       in 2007                   
                     economic growth                                          

Source: GAO.

What Changed in This Update?

Despite some improvement in the near-term projections for Social Security
and Medicare, the long-term outlook has not changed: it remains
unsustainable.

GAO's simulations were updated using estimates from the Social Security
and Medicare Trustees. The Trustees' April 2007 reports can be accessed at

[11]http://www.ssa.gov/OACT/TR/index.html

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

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

Appendix: Update of GAO's January 2007 Alternative Simulation

GAO periodically revises the assumptions of its alternative simulation to
better illustrate a fiscal path that embodies recent trends and policy
preferences. For the April update, as described earlier in this report, we
revised the revenue and Medicare assumptions from those used in January.
Had we not made these revisions, the updated simulation would have looked
as shown in Figure 4. A comparison with the corresponding January 2007
chart (fig. 5) shows that the substitution of the Trustees 2007 Social
Security and Medicare estimates for their 2006 estimates did not
materially affect the long-term fiscal outlook.

Figure 4: Potential Fiscal Outcomes Under Alternative Simulation: GAO's
April 2007 Analysis

Revenues and Composition of Spending Assuming Discretionary Spending Grows
with GDP After 2007 and All Expiring Tax Provisions Are Extended

Notes: 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.

Figure 5: Potential  Fiscal Outcomes Under  Alternative Simulation:  GAO's
January 2007 Analysis

Revenues and Composition of Spending Assuming Discretionary Spending Grows
with GDP After 2007 and All Expiring Tax Provisions Are Extended

Notes: 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.

(450593)

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