2010   Financial Report of the United States Government

Management's Discussion & Analysis

The Long-Term Fiscal Outlook: "Where We Are Headed"

While the Government´s immediate priority is to continue to foster economic recovery, there are longer term fiscal challenges that must ultimately be addressed. Persistent growth of health care costs and the aging of the population due to the retirement of the 'baby boom' generation and increasing longevity will make it increasingly difficult to fund critical social programs, including Medicare, Medicaid, and Social Security.

Fiscal Sustainability

An important purpose of the Financial Report is to help citizens and policymakers assess whether current fiscal policy is sustainable and, if it is not, to highlight the urgency and magnitude of policy reforms necessary to make it sustainable. A sustainable policy is one where the ratio of debt held by the public to Gross Domestic Product (the debt–to-GDP ratio) is stable in the long run. Sustainability concerns only whether long-run revenues and expenditures are in balance; it does not concern fairness or efficiency implications of the reforms necessary to achieve sustainability.

To determine if current fiscal policies are sustainable, the projections discussed here assume current policies will be sustained indefinitely and draw out the implications for the growth of debt held by the public as a share of GDP. The projections are therefore neither forecasts nor predictions. If policy changes are enacted, perhaps in response to projections like those presented here, then the projections will of course prove to be untrue.

The projections in this Report indicate that the trajectory of current policy is not sustainable. If current policies are kept in place indefinitely, the debt to GDP ratio is projected to exceed 350 percent in 2085 and to rise continuously thereafter. Closing the gap between spending and receipts over the next 75 years (the "75-year fiscal gap") is estimated to require some combination of spending reductions and revenue increases that amount to 2.4 percent of GDP over the period. While the precise size of the fiscal gap is highly uncertain, there is little question that current fiscal policies cannot be sustained indefinitely.

It is important to address the Nation´s fiscal imbalances soon. Delaying action increases the magnitude of spending reductions and/or revenue increases necessary to stabilize the debt-to-GDP ratio. For example, it is estimated that the magnitude of reforms necessary to close the 75-year fiscal gap is 50 percent larger if reforms are concentrated into the last 55 years of the 75-year period than if they are spread over the entire 75 years.

The estimates of the cost of policy delay in this Report assume policy does not affect GDP. Reducing deficits too abruptly would be counterproductive if it slows the economy´s recovery. In the near term, it is crucial to strike the proper balance between deficit reduction and economic growth.

The Primary Deficit, Interest, and Debt

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The primary deficit - the difference between non-interest spending and receipts – is the only determinant of the ratio of debt to GDP that the Government controls directly. (The other determinants are interest rates and growth in GDP). Chart H shows receipts, non-interest spending, and the difference – the primary deficit – expressed as a share of GDP. The primary deficit-to-GDP ratio grew rapidly in 2008 and 2009 due to the financial crisis and the recession, and the policies pursued to combat both, and is projected to fall rapidly to near zero as the economy recovers. After 2020, the primary deficit-to-GDP ratio is projected to increase, reaching 2 percent in 2030 and remaining at or above 1.8 percent through the end of the 75-year projection period and beyond.

The revenue share of GDP fell substantially in 2009 and 2010 because of the recession and tax reductions enacted as part of the Recovery Act and is projected to return to near its long-run average as the economy recovers and the Recovery Act tax cuts expire. After the economy is fully recovered, receipts are projected to grow slightly more rapidly than GDP as increases in real incomes cause a larger share of income to fall into higher individual income tax brackets. These projections assume that Congress and the President will continue to enact legislation to prevent the share of income subject to the Alternative Minimum Tax from rising.

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The projected increase in non-interest spending as a percent of GDP is principally due to growth in spending for Medicare, Medicaid, and Social Security. As shown in Chart I, the Social Security and Medicare spending shares of GDP are each projected to increase about 1-1/2 percentage points over the next 25 years as the baby boom generation retires. After 2035, the projected Social Security spending share of GDP is relatively steady, while the projected Medicare spending share of GDP continues to increase, albeit at a slower rate, due to projected increases in health care costs. The Medicaid spending share of GDP is also projected to rise over time for the same reasons.

The primary deficit projections in Chart H, along with those for interest rates and GDP, determine the projections for the ratio of debt to GDP that are shown in Chart J. That ratio was 62 percent at the end of fiscal year 2010 and under current policy is projected to exceed 70 percent in 2020, 130 percent in 2040, and 350 percent in 2085. Continued aging of the population due to increasing longevity will place upward pressure on the debt-to-GDP ratio beyond 75 years if there is no change in policy.

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Chart J also shows the 2009 Financial Report projection of the debt to GDP ratio. The 2010 projection is lower than the 2009 projection in every year of the projection period almost entirely as a result of the Affordable Care Act (ACA), which is projected to significantly lower Medicare spending and raise receipts. Further, as discussed in Note 26, there is uncertainty about whether the projected reductions in health care cost growth will be fully achieved. Note 26 includes an alternative projection to illustrate the uncertainty of projected Medicare costs.

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The change in debt held by the public from one year to the next is essentially equal to the unified budget deficit, the difference between total spending (which consists of non-interest spending plus interest spending) and total receipts. Chart K shows that the rapid rise in total spending and the unified deficit is almost entirely due to projected interest payments on the debt. Interest spending was 1.4 percent of GDP in 2010 and under current policies is projected to reach 5 percent in 2030 and 19 percent in 2085.

The Fiscal Gap and the Cost of Delaying Policy Reform

It is estimated that preventing the debt-to-GDP ratio from rising over the next 75 years would require running primary surpluses over the period that average 0.5 percent of GDP. This compares with an average primary deficit of 1.9 percent of GDP under current policy. The difference, the "75-year fiscal gap," is 2.4 percent of GDP.

Table 7 illustrates the cost of delaying policy to close the fiscal gap by comparing three policies closing the fiscal gap that begin on different dates. The first policy begins immediately; it increases the primary surplus by 2.4 percent of GDP in every year between 2011 and 2085. This is accomplished by invoking some combination of spending reductions and revenue increases that amounts to an average of 2.4 percent of GDP in every year. The second policy shown in Table 7 begins in 2021. Because debt grows unabated between 2010 and 2020 and the same fiscal consolidation must be squeezed into ten fewer years, the primary surplus must increase by 2.9 percent of GDP in every year between 2021 and 2085 in order to close the 75-year fiscal gap. Similarly, beginning the policy change in 2031 requires that the primary surplus increase by 3.7 percent of GDP in every year between 2031 and 2085 in order to close the 75-year fiscal gap. The difference between the primary surplus boost starting in 2021 and 2031 (2.9 and 3.7 percent of GDP, respectively) and the primary surplus boost starting in 2011 (2.4 percent of GDP) is a measure of the additional burden policy delay would impose on future generations. Future generations are harmed by policy delay because the higher is the primary surplus during their lifetimes the greater is the difference between the taxes they pay and the programmatic spending they benefit from.

Table 7: Cost of Delaying Fiscal Consolidation
Period of Delay Change in Average Primary Surplus
No Delay: Reform in 2011 2.4 percent of GDP between 2011 and 2085
Ten Years: Reform in 2021 2.9 percent of GDP between 2021 and 2085
Thirty Years: Reform in 2031 3.7 percent of GDP between 2031 and 2085

Conclusion

The United States took a potentially significant step towards fiscal sustainability in 2010 by enacting the ACA. The legislated changes for Medicare, Medicaid, and other parts of the health care system hold the prospect of lowering the long-term growth trend for health care costs and significantly reducing the long-term fiscal gap. But even with the new law, the debt-to-GDP ratio is projected to increase continually over the next 75 years and beyond if current policies are kept in place, which means current policies are not sustainable. Subject to the important caveat that policy changes are not so abrupt that they slow the economy´s recovery, the sooner policies are put in place to avert these trends, the smaller are the revenue increases and/or spending decreases necessary to return the Nation to a sustainable fiscal path.

While this Report´s projections of expenditures and receipts under current policies are highly uncertain, there is little question that current policies cannot be sustained indefinitely.

These and other issues concerning fiscal sustainability are discussed in further detail in the Supplemental Information section of this Report.

Statement of Social Insurance – A Current Look at a Possible Future

For the "social insurance" programs -- Social Security, Medicare, Railroad Retirement, and Black Lung - the Statement of Social Insurance (SOSI) reports: (1) the actuarial present value of all future program revenue (mainly taxes and premiums) - excluding interest - to be received from or on behalf of current and future participants; (2) the estimated future scheduled expenditures to be paid to or on behalf of current and future participants; and (3) the difference between (1) and (2). Amounts reported in the SOSI and in the supplemental information in this report are based on each program´s official actuarial calculations. By accounting convention, the general revenues are eliminated in the consolidation of the financial statements at the governmentwide level and as such, the general revenues that are used to finance Medicare Parts B and D are not included in these calculations even though the expenditures on these programs are included.

The SOSI provides perspective on the Government´s long-term estimated exposures and costs for social insurance programs. Table 8 summarizes amounts reported in the SOSI. From Table 8, net social insurance expenditures are projected to be approximately $31 trillion as of January 1, 2010 for the "Open Group", a decline from net expenditures of $46 trillion projected in the 2009 Report15. Much of this decrease is attributable to estimated effects of the ACA on the Medicare program. As discussed in Note 26, there is uncertainty about whether the projected reductions in health care cost growth will be fully achieved. While these expenditures are not considered Government liabilities, they do have the potential to become expenses and liabilities in the future, based on the continuation of the social insurance programs' provisions contained in current law.

The social insurance trust funds account for all related program income and expenses. Medicare and Social Security taxes, premiums, and other income are credited to the funds; fund disbursements may only be made for benefit payments and program administrative costs. Any excess revenues are invested in special non-marketable U.S. Government securities at a market rate of interest. The trust funds represent the accumulated value, including interest, of all prior program surpluses, and provide automatic funding authority to pay for future benefits.

Table 8: Social Insurance Future Expenditures in Excess of Future Revenues
Dollars in Billions 2010 2009 Increase / (Decrease)
$ %
Open Group (Net):        
  Social Security (OASDI) $(7,947) $(7,677) $270 4%
  Medicare (Parts A, B, & D) $(22,813) $(38,107) $(15,294) -40%
  Other $(97) $(94) $3 3%
  Total Social Insurance Expenditures, Net
  (Open Group)
$(30,857) $(45,878) $(15,021) -33%
  Total Social Insurance Expenditures, Net
  (Closed Group)
$ (43,057) $(52,145) $(9,088) -17%
Social Insurance Net Expenditures as a % of Gross Domestic Product (GDP)*
Open Group 2010 2009  
  Social Security (OASDI) -0.9% -1.0%    
  Medicare (Parts A, B, & D) -2.7% -4.8%    
  Other 0.0% 0.0%    
Total (Open Group) -3.7% -5.8%    
Total (Closed Group) -5.1% -6.6%    
Source: Statement of Social Insurance (SOSI). Amounts equal estimated present value of projected revenues and expenditures for scheduled benefits over the next 75 years of certain 'Social Insurance' programs (e.g., Social Security, Medicare). 'Open Group' totals reflect all curent and projected program participants during the 75-year projection period. 'Closed Group' totals reflect only current participants.
* GDP values from the 2010 & 2009 Social Security and Medicare Trustees Reports represent the present value of GDP over the 75 years. As the GDP used for Social Security and Medicare differ slightly in the Trust Fund Reports, the two values are averaged to estimate the Total Net Expenditures as % of GDP.

The retirement of the "baby boom generation" and increases in health care costs are still anticipated to have a prolonged impact on the long-run financial condition of Medicare and Social Security, which is analyzed annually in the Medicare and Social Security Trustees´ Reports. According to the Medicare Trustees´ Report, the projected Medicare costs have decreased from last year´s projection because of program changes made in the ACA. Under current law, including the assumption of the full implementation of ACA program changes, spending on Medicare is projected to rise from its pre-recession level of 3.2 percent of GDP to 5.5 percent in 2035 and 6.4 percent in 2084. The Hospital Insurance (HI) Trust Fund is now expected to remain solvent until 2029, 12 years longer than was projected in the prior year, after which point tax income is estimated to be sufficient to pay 85 percent of benefits, declining to 77 percent in 2050 and then increasing to 89 percent by 2084.

As for Social Security (the Old Age Survivors and Disability Insurance Trust Funds or OASDI), combined spending is projected to rise from 4.8 percent of GDP in 2009 to 6.1 percent in 2035, before retreating to 5.9 percent in 2050. The Social Security Trustees´ Report indicates that annual OASDI income, including interest on trust fund assets, will exceed annual cost and trust fund assets will increase every year until 2025, at which time it will be necessary to begin drawing down on trust fund assets to cover part of expenditures until assets are exhausted in 2037. After trust fund exhaustion, continuing tax income would be sufficient to pay 78 percent of scheduled benefits in 2037 and 75 percent in 2084.16 Given that revenues for these programs are not projected to rise over time as a share of GDP, it is apparent that these programs are on a fiscally unsustainable path (as was previously discussed). Additional information from the Trustees Reports may be found in the Supplemental Information section of this Report.

As indicated earlier, GAO disclaimed an opinion on the 2010 SOSI, because of significant uncertainties (discussed in note 26), primarily related to the achievement of projected reductions in Medicare cost growth reflected in the 2010 SOSI.

Footnotes

15'Closed' Group and 'Open' Group differ by the population included in each calculation. From the SOSI, the 'Closed' Group includes: (1) participants who have attained eligibility and (2) participants who have not attained eligibility. The 'Open' Group adds future participants to the 'Closed' Group. See ‘Social Insurance’ in the Supplemental Information section in this report for more information. (Back to Content)

16A Summary of the 2010 Annual Social Security and Medicare Trust Fund Reports, pp. 10-11. (Back to Content)


Last Updated:  December 07, 2011