2012   Financial Report of the United States Government

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

The Sustainability of Fiscal Policy

One of the important purposes of the Financial Report is to help citizens and policymakers assess whether current fiscal policy is sustainable and, if it is not, 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 GDP (the debt-to-GDP ratio) is ultimately stable or declining.

As is discussed below, the projections in this report indicate that current policy is not sustainable. If current policy is left unchanged, the ratio of debt to GDP is projected to rise by a little less than 2 percentage points from 2013 to 2015 and then to fall each year until 2020 by a total of a little more than 1 percentage point. Growth in debt resumes in 2020 over the remainder of the 75-year projection window and eventually reaches 395 percent in 2087. Moreover, if the trends that underlie the 75-year projections were to continue, the debt-to-GDP ratio would continue to rise into the indefinite future.

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Current Policy Projections for Primary Deficits

A key determinant of growth in the debt-to-GDP ratio and hence fiscal sustainability is the primary deficit-to-GDP ratio. The primary deficit is the difference between non-interest spending and receipts, and the primary deficit-to-GDP ratio is the primary deficit expressed as a percent of GDP. As shown in Chart 1 , the primary deficit-to-GDP ratio grew rapidly in 2009 due to the financial crisis and the recession and the policies pursued to combat both. The ratio stayed large from 2010 to 2012 despite shrinking in each successive year, but is projected to fall rapidly between 2013 and 2018 as spending reductions called for in the Budget Control Act of 2011 (BCA) take effect and the economy recovers, reaching primary balance and remaining relatively flat and near zero through 2021. Between 2022 and 2039, however, increased spending for Social Security and health programs due to continued aging of the population is expected to cause the primary balance to steadily deteriorate and reach 2.3 percent of GDP in 2039. After 2039, the projected primary deficit-to-GDP ratio slowly declines to 1.7 percent of GDP in 2087 as the impact of the baby boom generation retiring dissipates.

The revenue share of GDP fell substantially in 2009 and 2010 and remained low in 2011 and 2012 because of the recession and tax reductions enacted as part of the 2009 American Recovery and Reinvestment Act (ARRA ) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 . The share is projected to return to near its long-run average as the economy recovers. After the economy has fully recovered around 2019, receipts are projected to grow slightly more rapidly than GDP as increases in real incomes cause more taxpayers and a larger share of income to fall into the higher individual income tax brackets.8 This projection assumes that Congress and the President will continue to enact legislation that prevents the share of income subject to the Alternative Minimum Tax from rising.

On the spending side, the non-interest spending share of GDP is projected to fall from its current level of 21.3 percent to about 20 percent in 2013 and stay at or below that level until 2026, and to then rise gradually to 22 percent of GDP in 2039 and 22.6 percent of GDP in 2087. The reductions in the non-interest spending share of GDP over the next two years are mostly due to the expected reductions in spending for overseas contingency operations, caps on discretionary spending and the automatic spending cuts mandated by the BCA, and the subsequent increases are principally due to faster growth in Medicare, Medicaid, and Social Security spending (see Chart 1 ). The retirement of the baby boom generation over the next 25 years is projected to increase the Social Security, Medicare, and Medicaid spending shares of GDP by about 1.4 percentage points, 1.8 percentage points, and 1.1 percentage points, respectively. After 2035, the Social Security spending share of GDP is essentially unchanging while the Medicare and Medicaid spending share of GDP continues to increase, albeit at a slower rate, due to projected increases in health care costs.

The ACA significantly affects projected spending for both Medicare and Medicaid. That reform expands health insurance coverage, includes many measures designed to reduce health care cost growth, and reduces the annual increases in Medicare payment rates. On net, the ACA is projected to substantially reduce federal expenditures over the next 75 years. The Medicare spending projections in Table 1 are based on the 2012 Medicare Trustees’ Report ’s current law projections, and those projections show a substantial slowdown in Medicare cost growth. The projections assume that Medicaid cost per unit of service grows at the same rate as Medicare cost growth per unit of service, so the ACA is also estimated to substantially slow Medicaid cost growth. These projections are subject to much uncertainty about the effectiveness of the ACA’s provisions to reduce health care cost growth. Even if those provisions work as intended and as assumed in this projection, Chart 1 shows that there is still a persistent gap between projected receipts and projected total non-interest spending.

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Current Policy Projections for Debt and Interest Payments

The primary deficit projections in Chart 1 , along with projections for interest rates and GDP, determine the projections for the debt-to-GDP ratio that are shown in Chart 2 . That ratio was 73 percent at the end of fiscal year 2012, and under current policy is projected to be 78 percent in 2022, 145 percent in 2042, and 395 percent in 2087. The continuous rise of the debt-to-GDP ratio indicates that current policy is unsustainable.

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The change in debt held by the public from one year to the next is approximately equal to the unified budget deficit, the difference between total spending and total receipts.9 Total spending is non-interest spending plus interest spending. Chart 3 shows that the rapid rise in total spending and the unified deficit is almost entirely due to projected interest payments on the debt. As a percent of GDP, interest spending was 1.4 percent in 2012, and under current policy is projected to reach 5 percent in 2029 and 21 percent in 2087.

Another way of viewing the deterioration in the financial outlook in this year's report relative to last year's report documented in Table 2 is in terms of the projected debt-to-GDP ratio in 2086. This ratio is projected to reach 388 percent in this year's report, which compares with 287 percent projected in last year's report.

The Fiscal Gap

The fiscal gap measures how much the primary surplus (receipts less non-interest spending) must increase in order for fiscal policy to achieve a target debt-to-GDP ratio in a particular future year. In these projections, the fiscal gap is estimated over a 75-year period, from 2013 to 2087, and the target debt-to-GDP ratio is equal to the ratio at the beginning of the projection period, in this case the debt-to-GDP ratio at the end of fiscal year 2012 (73 percent of GDP).

Table 3 reports that the 75-year fiscal gap under current policy is estimated at 2.7 percent of GDP, which is 13.5 percent of the 75-year present value of projected receipts and 12.4 percent of the 75-year present value of non-interest spending. As noted in Table 1 , the difference between projected programmatic (non-interest) spending and receipts is 1.7 percent of GDP. However, eliminating this primary deficit of 1.7 percent of GDP is not sufficient to stabilize the debt-to-GDP ratio. Because interest rates are assumed to exceed the growth rate of GDP, reaching primary balance would leave debt rising relative to GDP. In order to fully close the fiscal gap, annual primary surpluses over the next 75 years must average 1.0 percent of GDP.

The Cost of Delay in Closing the 75-Year Fiscal Gap

The longer policy action to close the fiscal gap is delayed, the larger the post-reform primary surpluses must be to stabilize the debt-to-GDP ratio by the end of the 75 year period. Varying the years in which reforms are initiated while holding constant the ultimate target ratio of debt to GDP helps to illustrate the cost of delaying policy changes that close the fiscal gap. The reforms considered here increase the primary surplus relative to current policy by a fixed percent of GDP starting in the reform year. Three such policies are considered, each one beginning in a different year. The analysis shows that the longer policy action is delayed, the larger the post-reform primary surplus must be to bring the debt-to-GDP ratio to 73 percent of GDP in 2087. Future generations are harmed by policy delay because delay necessitates higher primary surpluses during their lifetimes, and those higher primary surpluses must be achieved through some combination of lower government benefits and higher taxes.

Table 3:
Cost of Delaying Fiscal Consolidation
Period of Delay Change in Average Primary Surplus
No Delay: Reform in 2013 2.7 percent of GDP between 2013 and 2087
Ten Years: Reform in 2023 3.2 percent of GDP between 2023 and 2087
Twenty Years: Reform in 2033 4.1 percent of GDP between 2033 and 2087
Note: Reforms taking place in 2012, 2022, and 2032 from the 2011 Report were 1.8, 2.2, and 2.8 percent of GDP.

As previously shown in Chart 1 , under current policy, primary deficits occur in nearly every year of the projection period. Table 3 shows primary surplus changes necessary to make the debt-to-GDP ratio in 2087 equal to its level in 2012 under each of the three policies. If reform begins in 2013, then it is sufficient to raise the primary surplus share of GDP by 2.7 percentage points in every year between 2013 and 2087 in order to have a debt-to-GDP ratio in 2087 equal to the level in 2012. This raises the average 2013-2087 primary surplus-to-GDP ratio from -1.7 percent to +1.0 percent.

In contrast to a reform that begins immediately, if reform is begun in 2023 or 2033, the primary surplus must be raised by 3.2 percent and 4.1 percent of GDP, respectively, in order to reach a debt-to-GDP ratio in 2087 equal to the level in 2012. The difference between the primary surplus increase necessary if reform begins in 2023 and 2033 (3.2 and 4.1 percent of GDP, respectively) rather than in 2013 (2.7 percent of GDP) is a measure of the additional burden policy delay would impose on future generations. The costs of delay are due to increases in the debt-to-GDP ratio between 2012 and the year reform is initiated, which in turn increase the amount of interest that must be covered with the primary surplus. Delaying reform increases the cost of reaching the target debt-to-GDP ratio even if the target year is extended beyond 2087, since the starting debt-to-GDP ratio will be higher.

These estimates likely understate the cost of delay because they assume interest rates will not rise as the debt-to-GDP ratio grows. If a higher debt-to-GDP ratio causes the government borrowing rate to rise, making it more costly for the government to service its debt and simultaneously slowing private investment, the primary surplus required to return the debt-to-GDP ratio to its 2012 level will also increase. This dynamic may accelerate with higher ratios of debt to GDP, potentially leading to the point where there may be no feasible level of taxes and spending that would reduce the debt-to-GDP ratio to its 2012 level. The potential impact of changes in interest rates is explored in the "Alternative Scenarios" section.

Assumptions Used and Relationship to Other Financial Statements

A fundamental assumption underlying the projections is that current Federal policy—as defined below—does not change. The projections are therefore neither forecasts nor predictions. If policy changes are enacted, perhaps in response to projections like those presented here, then actual fiscal outcomes will of course be different than those projected.

Even if policy does not change, actual expenditures and receipts could differ materially from those projected here. This is because the long-range projections are inherently uncertain and because simplifying assumptions are made. One key simplifying assumption, for example, is that interest rates paid on public debt remain unchanged, regardless of the amount of debt outstanding. To the contrary, it is likely that future interest rates would increase if the debt rises as shown in these projections. To help illustrate this uncertainty, present value calculations under higher and lower interest rate scenarios are presented in the "Alternative Scenarios" section.

The projections in this section focus on future cash flows, and do not reflect either the accrual basis or the modified-cash basis of accounting. These cash-based projections reflect receipts or spending at the time cash is received or when a payment is made by the Government. In contrast, accrual-based projections would reflect amounts in the time period in which income is earned or when an expense n is incurred. The cash basis accounting underlying this section is consistent with methods used to prepare the SOSI and the generally cash-based Federal budget .

The following bullets summarize the assumptions used for the key categories of receipts and spending presented in Table 1 and in the related analysis:

Departures of Current Policy from Current Law

The long-term fiscal projections are made on the basis of current Federal policy, which in some cases is different from current law. The projections are made without regard to the statutory limit on outstanding Federal debt. In addition, the projections also assume continued discretionary appropriations throughout the projection period, the continued payment of Social Security and Medicare benefits beyond the projected point of trust fund exhaustion, extension of the 2001/2003 tax cuts, indexing of the current thresholds for the AMT, and the reauthorization of many mandatory programs with expiration dates prior to the end of the 75-year projection period. As is true in the Medicare trustees’ report and in the Statement of Social Insurance, the projections assume reductions in Medicare physician fees will occur as scheduled under current law.


8 Projected revenues also account for increases (as a share of GDP) in employer-sponsored health insurance costs, which are tax exempt. (Back to Content)

9Debt held by the public is also affected by certain transactions not included in the unified budget deficit, such as changes in Treasury’s cash balances and the nonbudgetary activity of Federal credit financing accounts. These transactions are assumed to hold constant at about 0.6 percent of present value GDP. (Back to Content)

10Medicare Part B and D premiums and State contributions to Part D are subtracted from the Part B and D spending displayed in Table 1. The total 75-year present value of these subtractions is $7.8 trillion, or 0.8 percent of GDP. (Back to Content)

11Christopher J. Truffer, John D. Klemm, Christian J. Wolfe, and Kathryn E. Rennie 2011 Actuarial Report on the Financial Condition for Medicaid, Office of the Actuary, Centers for Medicare and Medicaid Services, United States Department of Health and Human Services. (Back to Content)

12As indicated in the more detailed discussion of Social Insurance in Note 26 to the financial statements. (Back to Content)

Last Updated:  February 27, 2013