2012   Financial Report of the United States Government

United States Government Required Supplementary Information (Unaudited) For the Years Ended September 30, 2012, and 2011

Alternative Scenarios

The long-run outlook for the budget is extremely uncertain. This section illustrates this inherent uncertainty by presenting alternative scenarios that vary several key assumptions.

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 projected fertility, mortality, or immigration rates could have important long-run effects on the projections. Higher than projected immigration, fertility, or mortality rates would improve the long-term fiscal outlook. Conversely, lower than projected immigration, fertility, or mortality rates would result in deterioration in the long-term fiscal outlook. The remainder of this section will focus on two important variables that can also impact fiscal projections: the growth rate of health 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 cost growth rates, Table 4 shows the effect on the cost of closing the fiscal gap as well as delaying closure of the fiscal gap of per capita health care cost growth rates that are one percentage point higher or two percentage points higher than the growth rates in the base projection. If reform is initiated in 2013, eliminating the fiscal gap requires that the 2013-2087 primary surplus increase by an average of 2.7 percent of GDP in the base case, 5.6 percent of GDP if per capita health cost growth is 1 percentage point higher, and 8.7 percent of GDP if per capita health cost growth is 2 percentage points higher. The cost of delaying reform is also increased if health care cost growth is higher, due to the fact that debt accumulates more rapidly during the period of inaction. For example, the lower part of Table 4 shows that delaying reform initiation from 2013 to 2023 requires that 2023-2087 primary surpluses be higher by an average of 0.6 percent of GDP in the base case, 1.2 percent of GDP if per capita health cost growth is 1 percentage point higher, and 1.8 percent of GDP if per capita health cost growth is 2 percentage points higher. The dramatic deterioration of 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.

Table 4
Impact of Alternative Health Cost Scenarios on Cost of Delaying Fiscal Reform
  Primary Surplus Increase (%of GDP) Starting in:
Scenario 2013 2023 2033
Base Case: 2.7 3.2 4.1
1% pt. higher per person health cost growth 5.6 6.7 8.5
2% pt. higher per person health cost growth 8.7 10.5 13.2
       
 
Increments to Required Primary Surplus if Reform is Delayed from 2013 to:
   
2023
2033
Base Case:   0.6 1.4
1% pt. higher per person health cost growth   1.2 2.9
2% pt. higher per person health cost growth   1.8 4.5
NOTE: Increments may not equal the subtracted difference of the components due to rounding.

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. Table 5 displays the effect of several alternative scenarios using different nominal interest rates than assumed in the base case on the cost of closing the fiscal gap as well as delaying closure of the fiscal gap. If reform is initiated in 2013, eliminating the fiscal gap requires that the 2013-2087 primary surplus increase by an average of 2.7 percent of GDP in the base case, 2.9 percent of GDP if the interest rate is 0.5 percentage point higher in every year, and 3.2 percent of GDP if the interest rate is 1.0 percentage points higher in every year. The cost of delaying reform is also increased percent of GDP if the interest rate is 1.0 percentage points higher in every year. The cost of delaying reform is also increased if interest rates are higher, due to the fact that interest paid on debt accumulates more rapidly during the period of inaction. For example, the lower part of Table 5 shows that delaying reform initiation from 2013 to 2023 requires that 2023-2087 primary surpluses be higher by an average of 0.6 percent of GDP in the base case, 0.7 percent of GDP if the interest rate is 0.5 percentage point higher in every year, and 0.9 percent of GDP if the interest rate is 1.0 percentage points higher in every year. To show the effects of achieving primary balance and lowering long-term debt-to-GDP and interest rates, lowering nominal interest rates by one-half percentage point from the base projection starting in 2013 lowers the cost of reform over the three periods, to 2.4 per year starting in 2013, 2.8 percent per year starting in 2023, and 3.5 percent per year starting in 2033.

Table 5
Impact of Alternative Interest Rate Scenarios on Cost of Delaying Fiscal Reform
  Primary Surplus Increase (%of GDP) Starting in:
Scenario 2013 2023 2033
Base Case: Average of 5.5 percent over 75 years 2.7 3.2 4.1
0.5 percent higher interest rate in each year 2.9 3.6 4.7
1.0 percent higher interest rate in each year 3.2 4.1 5.5
0.5 percent lower interest rate in each year 2.4 2.8 3.5
       
 
Increments to Required Primary Surplus if Reform is Delayed from 2013 to:
   
2023
2033
Base Case: Average of 5.5 percent over 75 years   0.6 1.4
0.5 percent higher interest rate in each year   0.7 1.8
1.0 percent higher interest rate in each year   0.9 2.3
0.5 percent lower interest rate in each year   0.4 1.1
NOTE: Increments may not equal the subtracted difference of the components due to rounding.

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 conservatively assumed to be somewhat below its long-run trend. 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 for which 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 about neutral in the long run.


Last Updated:  February 27, 2013