2011   Financial Report of the United States Government

United States Government Supplemental Information (Unaudited) for the Years Ended September 30, 2011, and 2010

Alternative Scenarios

The long-run outlook for the budget is extremely uncertain and therefore it makes sense to consider possible alternative projections to indicate the range of uncertainty. There are many dimensions to the projections for which reasonable variations could be considered. Some of the key issues concern long-run economic and demographic assumptions. The long-run fiscal gap is partly the result of demographic patterns that have emerged over the last 50 years with lower birth rates and reduced mortality. The population is aging rapidly and will continue to do so over the next several decades, which puts pressure on programs such as Social Security, Medicare, and Medicaid nursing care. A shift in expected fertility, mortality, or immigration rates could have important long-run effects on the projections. Increases in immigration or fertility rates, or reduction in the mortality rate would improve the long-term fiscal projections. Conversely, decreases in immigration or fertility rates, or improvements in the mortality rate would result in deterioration in the long-term fiscal projections. The remainder of this section will focus on two important variables that can also impact fiscal projections: the growth rate of heath care costs and interest rates.

Effect of Changes in Health Care Cost Growth

One of the most important assumptions underlying the projections is the projected growth of health care costs. Enactment of the ACA in 2010 reduced the projected long-run growth rates of health care costs, but these growth rates are still highly uncertain. As an illustration of the dramatic effect of variations in health care growth rates, Chart 5 and Table 4 show the effect on future primary deficits as well as the present value imbalance of growth rates that are one percent higher or two percent higher than the growth rates in the base projection. Relative to the base assumption of 0 percent average excess health cost growth, the one percent higher health care cost growth scenario raises the 75-year present value of non-interest spending less receipts to 4.8 percent of GDP, compared to 0.7 percent of GDP assumed in the base projection. The two percent higher health cost growth scenario raises the 75-year present value of non-interest spending less receipts even further, to 7.5 percent of GDP. The dramatic deterioration on the long-run fiscal outlook caused by higher health care cost growth shows the critical importance of managing health care cost growth, including through effective implementation of the ACA.

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Table 4
Impact of Alternative Health Cost Scenarios on 75-year PV Imbalance
  75-Year Present Value Fiscal Imbalance:
Scenario Dollars in Trillions %GDP
Base Case: 0% Average Excess Health Cost Growth 6.4 0.7
1% Average Excess Health Cost Growth 42.7 4.8
2% Average Excess Health Cost Growth 66.5 7.5

Effects of Changes in Interest Rates

A higher debt-to-GDP ratio is likely to increase the interest rate on Government debt, making it more costly for the Government to service its debt. If a constant ratio of debt-to-GDP is not achieved and the ratio continues to rise continuously, long-term interest rates would be expected to rise further, worsening the debt ratio in the process. Chart 6 and Table 5 display several alternative scenarios where differing interest rate assumptions are used from the base case found in the Social Security trustees’ report. In the scenario where the interest rate rises a constant one-half percentage point above the base projection starting in 2012, the debt-to-GDP ratio in 2086 rises from 287 percent to 378 percent. As shown in Table 5, the present value imbalance falls from $6.4 trillion to $5.5 trillion. Adding a full percentage point to the base projection starting in 2012 raises the 2086 debt-to-GDP ratio to 502 percent, but drops the 75-year fiscal imbalance to $4.7 trillion. To show the effects of achieving balance and lowering long-term debt-to-GDP and interest rates, lowering interest rates by one-half percentage point from the base projection starting in 2012 in turn lowers the 2086 debt ratio to 220 percent; however lowering the interest rate raises the 75-year present value imbalance to $7.6 trillion. It is clear that there is risk to continuing down a path of rising debt-to-GDP ratios, with a compounding impact that could lead to even worse consequences if no policy actions are taken.

Other key economic assumptions in this report include the future growth rate of real GDP, which itself depends on assumptions such as future growth in the labor force and labor productivity. Historically, U.S. labor productivity has increased at a rate of about 2 percent or more per year, but there have been periods when productivity grew less rapidly and other periods in which it grew faster. Productivity growth has averaged 2.5 percent per year over the last 15 years, which is above its long-run trend. In these projections, the rate of productivity growth is assumed to be somewhat below its long-run trend, which is a conservative assumption. It is unlikely that higher productivity growth will be sufficient to resolve the long-run budget problem. Faster growth will lead to higher wages, which will lead to more tax revenue in the near term, but these gains will be partly offset by higher payments for Social Security and other benefit programs in the long term, because benefits are tied to wages. Inflation is not a major factor in these calculations. Changes in the trend rate of inflation have offsetting effects on future revenues and future spending, so the budget effect is more nearly neutral in the long run

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Table 5
Impact of Alternative Interest Rate Scenarios on 75-year PV Imbalance
  75-Year Present Value Fiscal Imbalance:
Scenario Dollars in Trillions %GDP
Base Case: 0% Average of 5.6 over 75 years 6.4 0.7
0.5 percent higher interest rate in each year 5.5 0.7
1.0 percent higher interest rate in each year 4.7 0.7
0.5 percent lower interest rate in each year 7.6 0.7

Last Updated:  February 16, 2012