November 27, 2014

GAO Report Underscores Need to Improve Long-Term Fiscal Outlook

President Obama and Congress may have put fiscal sustainability on the back burner, but the Government Accountability Office (GAO) has not. In its annual update of the federal government’s long-term fiscal outlook, released last week, GAO warns:

“Significant action to change the long-term fiscal path must be taken soon to minimize the disruption to individuals and the economy. The entire range of federal activities and spending—entitlement programs, other mandatory spending, discretionary spending, and revenue—will need to be re-examined.”

The report contains two simulations. One builds on the Congressional Budget Office (CBO) baseline (Baseline Extended Simulation) and the other assumes baseline changes “to reflect historical trends” (Alternative Simulation). These simulations are not forecasts. They are illustrations of possible outcomes based on broad policy assumptions.

As summarized by GAO, the simulations illustrate:

  • A fundamental imbalance between revenue and spending over the long term leads to continuous growth in debt as a share of gross domestic product (GDP), which is unsustainable.
  • Increases in spending are driven by an aging population and rising health care costs.
  • The growing gap between revenue and spending will further limit the federal government's flexibility to address future challenges.

The Baseline Extended Simulation is the more optimistic of the two. It assumes that discretionary spending will remain at a historically low level (5.2 percent of GDP) from 2024 on; that Medicare physician payments will be cut under the Sustainable Growth Rate formula that Congress usually alters; and that all expiring tax breaks will not be extended.

Even with these assumptions, which tend to lower spending and raise revenues from what is likely, the path ahead remains problematic. Here are some dubious milestones under the Baseline Extended Simulation:

  • 2029 - Interest payments on the debt exceed Medicare costs.
  • 2033 - Debt held by the public exceeds GDP; Social Security, Medicare, Medicaid and net interest consume all revenues.
  • 2039 - Interest payments exceed Social Security costs, becoming the largest federal government expense.
  • 2042 - The budget deficit hits 10 percent of GDP.
  • 2053 – Debt held by the public hits 200 percent of GDP.

Under the Alternative Simulation, which better reflects recent congressional action, the situation deteriorates even more rapidly. In that simulation:

  • 2026 – Interest payments on the debt exceed Medicare costs.
  • 2027 - Debt held by the public exceeds 100 percent of GDP.
  • 2028 - Social Security, Medicare, Medicaid and net interest consume all federal revenues.
  • 2029 - The budget deficit hits 10 percent of GDP.
  • 2031 - Interest payments exceed Social Security costs, becoming the largest federal government expense.
  • 2040 - Debt held by the public hits 200 percent of GDP.
  • 2042 - The deficit exceeds all government revenues.

Waiting to act will only make the necessary corrective measures more painful.

This can be seen by looking at the “fiscal gap” which measures the average combined spending cuts and/or tax increases needed annually to keep debt held by the public at today’s level (72 percent of GDP) over the next 75 years. The fiscal gap is now 3.8 percent of GDP under the Baseline Extended Simulation and 7.7 percent of GDP under the Alternative Simulation. If, however, action is delayed for 10 years, the fiscal gap rises to 24.9 percent and 51.8 percent of GDP respectively under the two simulations.

The GAO report is also useful in demonstrating the main budgetary cost drivers: population aging and rising health care costs.

As noted in the report, “the number of baby boomers turning 65 is projected to grow in coming years from an average of about 7,300 per day in 2011 to more than 11,000 per day in 2029. As a result, the share of the population over the age of 65 is projected to increase from roughly 13 percent to almost 20 percent during this time.”

Adding to the cost of serving more beneficiaries for health care programs is the extent to which health care costs per beneficiary exceed the annual growth rate of potential GDP (i.e., “excess cost growth”). The two simulations differ in their assumptions on excess cost growth, with the Baseline Extended Simulation being the more optimistic.

Significantly, the report notes: “Health care cost growth has slowed in recent years but it remains unclear whether this represents a temporary event related to the recent recession, a one-time shift reflecting structural changes in how care is delivered or in payment mechanisms, or a longer-term change to the U.S. health care system resulting from increased efficiency and coordination.”

While demographics and health care costs are projected to drive up programmatic spending, projected interest payments on the debt are highly dependent on the size of the accumulating deficits. This, in turn, brings revenues into the equation. Given any particular level of spending, lower revenues lead to higher deficits and higher interest payments on the debt.

The Baseline Extended Simulation assumes that revenues will reach 18.4 percent of GDP in 2024 and remain at that level. The Alternative Simulation assumes that revenues will gradually decline back to their 40-year average (17.4 percent of GDP) by 2030 and remain at that level. This is one reason why deficits and debt accumulate faster under the Alternative Simulation.

If revenues were allowed to grow, as they would naturally with economic growth and “bracket creep” pushing more taxpayers into higher brackets, deficits and debt would be lower than in either of the GAO simulations.

For example, in CBO’s latest long-term outlook, released in September 2013, non-interest spending is virtually identical to GAO’s Baseline Extended Simulation. However, revenues in the CBO outlook rise to 19.7 percent of GDP in 2038 (the last year of the CBO scenario). As a result, the debt in that year equals 100 percent of GDP in CBO’s baseline scenario rather than 124.7 percent under the otherwise similar GAO Baseline Extended Simulation.

This illustrates that while higher revenues can help reduce the growth of debt, even a significant tax increase from current law would not be enough to achieve fiscal sustainability.

These ominous numbers demonstrate how urgently corrective action is needed. Our leaders in Washington must get serious about making the tough choices to put our fiscal house in order. It is also incumbent on ordinary citizens to recognize how the budget problems affect them and to put pressure on Washington to address these problems. The key question is what steps will be taken, and when, to keep things from reaching a crisis.