Key Issues > Fiscal Outlook > Federal Fiscal Outlook

Fiscal Outlook: Federal Fiscal Outlook

GAO's federal budget simulations provide a broad context for considering policy options. An understanding of fiscal exposures—programs that may expose the government to future spending—can also inform these considerations.

 

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Since 1992, GAO has published long-term fiscal simulations showing federal deficits and debt under different sets of policy assumptions. While the timing and pace of growth varies depending on the assumptions used, GAO's simulations illustrate that:

  • 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.

Federal Budget Path is Unsustainable over the Long Term

GAO runs two simulations. In the Baseline Extended simulation, which generally assumes current law continues, debt as a share of gross domestic product (GDP) A commonly used measure of domestic national income. GDP is the value of all goods and services produced within the United States in a given year and is conceptually equivalent to incomes earned in production. It is a rough indicator of the economic earnings base from which the government draws its revenues. declines in the short term before turning up again. In the Alternative simulation, in which some assumptions are changed to reflect historical trends, federal debt as a share of GDP grows throughout the period. These simulations show that, without policy changes, debt held by the public will surpass its historical high within the next 15-20 years.

 

Source: GAO.
Note: Data are from GAO’s Spring 2014 simulations based on the Trustees’ assumptions for Social Security and the Trustees’ and CMS Actuary’s assumptions for Medicare

Baseline Extended simulation data: txt pdf
Alternative simulation data: txt pdf

Key Drivers of Long-Term Spending Pressures

In both simulations, spending for the major health and retirement programs will increase as a share of GDP in coming decades.  Beyond the expansion in coverage under Medicaid and the exchanges, over the first few decades, this spending is driven largely by the aging of the population. The oldest members of the baby-boom generation are already eligible for Social Security retirement benefits and for Medicare, and, as shown in the figure below, 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.

Daily Average Number of People Turning 65 Each Year

Daily Average Number of People Turning 65 Each Year

Source: GAO analysis of U.S. Census Bureau data.

The longer-term outlook depends more heavily on assumptions about growth in health care spending for each beneficiary. One way of measuring growth in health spending per beneficiary is the rate of excess cost growth. Generally speaking, excess cost growth is the extent to which health care spending per person exceeds the growth rate of GDP per person. Excess cost growth leads to an ever-growing share of the nation's income being spent on health care. Excess cost growth averaged around 2 percent from 1975 to 2011. Going forward the Medicare Trustees and Congressional Budget Office (CBO) assume that excess cost growth will slow because of the financial pressure health care spending is putting on the federal government, states, businesses, and households. How and when this transition takes place, however, is highly uncertain. 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 inpayment mechanisms, or a longer-term change to the U.S. health care system resulting from increased efficiency and coordination.

Limited Budgetary Flexibility to Address Other Future Challenges

Increased spending for the major health and retirement programs in coming decades will contribute to a growing gap between revenue and spending.  The resulting growth in debt as a share of GDP and net interest costs will limit the government's flexibility to address emerging budget issues and as-yet unforeseen challenges, such as another economic downturn or a large-scale natural disaster. In addition, GAO has identified a variety of other fiscal exposures—responsibilities, programs, and activities that may legally commit or create the expectation for future federal spending. Over the past decade, some fiscal exposures have grown due to events and trends and the government’s response to them.  Increased attention to these fiscal exposures will be important for understanding risks to the federal fiscal outlook and enhancing oversight over federal resources.

Baseline Extended Simulation vs. Alternative Simulation

The Baseline Extended simulation generally assumes current laws, including the discretionary spending limits and other spending reductions established by the Budget Control Act of 2011(BCA) and revised by subsequent legislation continue into the future. The Alternative simulation illustrates what happens if historical trends continue. The simulations also illustrate two potential paths for future health care cost growth. In the Baseline Extended simulation, the cost-containment mechanisms enacted in the Patient Protection and Affordable Care Act are assumed to be fully implemented and effective, slowing growth of health care spending over the long term. However, the Trustees Social Security and Medicare Trustees. , Congressional Budget Office (CBO), and the Centers for Medicare & Medicaid Services (CMS) Actuary have questioned whether certain cost-containment mechanisms can be sustained over the long term. This is reflected in the Alternative simulation in which policies that would restrain spending growth are phased out over time.

Both simulations show spending on interest, Social Security, and the major health programs absorbing increasing shares of revenue. When "all other spending"—or spending on such categories as national defense, homeland security, veterans' health care, mass transit, education, and basic research for future economic growth—is included, deficits reach 11 percent of GDP in 2030 in GAO’s Alternative simulation.

 
  • Net Interest
  • Social Security
  • Medicare & Medicaid, CHIP, and exchange subsidies
  • All other spending
  • Revenue

Source: GAO.
Note: Data are from GAO's Spring 2014 simulation based on the Trustees'
assumptions for Social Security and Medicare.
Baseline Extended Simulation data: txt pdf

 
  • Net Interest
  • Social Security
  • Medicare & Medicaid, CHIP, and exchange subsidies
  • All other spending
  • Revenue

Source: GAO
Note: Data are from GAO's Spring 2014 simulation based on the Trustees'
assumptions for Social Security and the CMS Actuary’s assumptions for Medicare.
Alternative Simulation data: txt pdf

 

Closing the Fiscal Gap

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. As we move forward, the federal government will need to make tough choices in setting priorities and ensuring that spending leads to positive results.

The fiscal gap is the difference between revenue and noninterest spending that would need to be closed in order to keep debt at the end of the period from exceeding today’s level. The 75-year fiscal gap under our Baseline Extended simulation is 3.8 percent of GDP. The 75-year fiscal gap in our Alternative simulation is 7.7 percent of GDP. Closing the gap requires tax increases, spending reductions, or, more likely, a combination of the two. For example, to close the fiscal gap under our Alternative simulation, revenue would have to increase by roughly 43 percent, or noninterest spending would have to be reduced by about 31 percent (or some combination of the two) on average per year over a 75-year period to keep debt held by the public as a share of GDP in 2088 from exceeding about 72.1 percent of GDP (its level at the beginning of 2014). Even more significant changes would be needed to reduce debt to lower levels.

Further, delaying action increases the size of actions needed and the risk that the eventual changes will be disruptive and destabilizing to the economy and individuals. If no actions were taken for the next decade, a revenue increase of about 52 percent or a noninterest spending cut of about 36 percent or some combination of the two would be required on average per year over the remaining 65-year period under the Alternative simulation to bring debt held by the public back to its 2014 level by 2088.
 

 
  • Solely through revenue increases
  • Solely through spending cuts

Source: GAO
Baseline Extended Simulation data: txt pdf

 
  • Solely through revenue increases
  • Solely through spending cuts

Source:GAO
Alternative Simulation data: txt pdf

A simulation is a hypothetical—a “what if?”  GAO runs two simulations of the federal budget that illustrate the potential implications of different policy choices. Each simulation represents a bundle of budgetary and policy assumptions carried far out into the future. The simulations are not intended as predictions about the future. Rather, they can facilitate comparisons of the potential long-term budgetary consequences of alternative fiscal policy paths.

Major Health and Retirement Programs

The Baseline Extended simulation follows the Trustees 2013 intermediate projections for Social Security and Medicare, and Congressional Budget Office (CBO)'s September 2013 long-term projections for Medicaid adjusted to reflect excess cost growth consistent with the Trustees' assumptions.

In the Alternative simulation, Medicare spending is based on the Centers for Medicare & Medicaid Services  Office of the Actuary's (CMS Actuary) alternative projections that assume reductions in Medicare physician rates do not occur as scheduled under current law at the time, and that certain cost-containment mechanisms intended to slow the growth of health care costs are not sustained over the long term.

GAO also runs simulations using CBO's long-term projections for Social Security and the major health entitlements; the results are consistent with GAO's simulations based largely on the Trustees' projections.

Discretionary Spending and Revenue

The Baseline Extended simulation follows CBO's February 2014 baseline for the first 10 years, which generally reflects current law. The baseline includes the effects from tax provisions that have expired, such as the research and experimentation tax credit, or are scheduled to expire, such as the expansion of the earned income tax credit.The baseline also reflects the discretionary spending caps and automatic enforcement procedures in effect through 2021 under current law and assumes discretionary spending grows with inflation from 2022 to 2024. After 2024, revenue and spending other than interest on the debt and large entitlement programs (Social Security, Medicare, and Medicaid) are held constant as a share of Gross Domestic Product (GDP). Over the long term, revenue as a share of GDP is higher and discretionary spending lower than historical averages.

In the Alternative simulation, expiring tax provisions, such as the research and experimentation tax credit, are extended to 2024. Discretionary spending reflects the caps established by the BCA and revised by subsequent legislation through 2021 but not the lower caps triggered by the automatic enforcement procedures. Over the long term, discretionary spending and revenue are held at historical averages.

Effects of Recent Legislation

The Bipartisan Budget Act of 2013 established higher limits on discretionary appropriations for fiscal years 2014 and 2015 but also extended sequestration for direct spending programs for 2 years through fiscal year 2023, and made other changes to direct spending and revenue.  In all, the Act reduced deficits over the next 10 years in our Baseline Extended simulation but did not significantly change the long-term federal budget outlook.

After CBO prepared its most recent baseline projections, legislation amending the Balanced Budget and Emergency Deficit Control Act of 1985 extended sequestration of direct spending until 2024. (Pub. L. No. 113-82, § 1, 128 Stat. 1009 (Feb. 15, 2014).

Economic Assumptions

Real GDP follows CBO's February 2014 baseline for the first 10 years and thereafter averages 2.1 percent based on the intermediate assumptions of the 2013 Social Security and Medicare Trustees reports.  The interest rate on debt held by the public is equal to the rate implied by CBO's February 2014 net interest payments for the first 10 years.  Thereafter, the interest rate gradually increases to 5.2 percent, based on CBO's September 2013 long-term projection.

GDP is held constant across simulations and does not respond to changes in fiscal policy. Also, the implied interest rate on debt held by the public in our simulations is held constant over the long term even when deficits climb. With large budget deficits, there could be a rise in the rate of interest and a more rapid increase in federal interest payments than our simulations display.

Downloadable Data for the Baseline Extended and Alternative Simulations

File Name
BASELINE EXTENDED: Trustees' assumptions for Social Security and Medicare TXT PDF
BASELINE EXTENDED: CBO's assumptions for Social Security and Medicare TXT PDF
ALTERNATIVE SIMULATION: Trustees' assumptions for Social Security and Medicare TXT PDF
ALTERNATIVE SIMULATION: CBO's assumptions for Social Security and Medicare TXT PDF


Key information from GAO's most recent simulations have also been included in this presentation.

Risk Sources for Fiscal Exposures

Americans expect a range of services and benefits from government for many reasons. For example, they expect that when they retire, the government will keep its commitment to provide them with Social Security and Medicare benefits. Similarly, Americans may expect that when natural disasters strike, the government will provide funding for emergency response and long-term recovery as it has in the past. In budgeting, such expectations are referred to as fiscal exposures—responsibilities, programs, and activities that may legally commit or create these expectations for future federal spending based on current policy, past practices, or other factors. The magnitude of this future spending is difficult to quantify and is not fully reflected in the budget. Nonetheless, fiscal exposures are significant, pervasive and pose a high risk to the American taxpayer.

Fiscal exposures fall along a spectrum of the government's legal commitment. In addressing a fiscal exposure, it is important to consider the source of the exposure. Fiscal exposures can be organized by five sources of risk: demographics and health care, economic downturns, environment and disasters, government operations, and security. These categories are not mutually exclusive and are not comprehensive of the government’s full range of fiscal exposures.

 
Looking for our recommendations? Click on any report to find each associated recommendation and its current implementation status.
Fiscal Exposures: Improving Cost Recognition in the Federal Budget
http://gao.gov/products/GAO-14-28

GAO-14-28: Published: Oct 29, 2013. Publicly Released: Oct 29, 2013.
Mandatory Spending: Using Budget Triggers to Constrain Growth
http://gao.gov/products/GAO-06-276

GAO-06-276: Published: Jan 31, 2006. Publicly Released: Jan 31, 2006.
Social Security Reform: Answers to Key Questions
http://gao.gov/products/GAO-05-193SP

GAO-05-193SP: Published: May 2, 2005. Publicly Released: May 2, 2005.
Tax Expenditures: Background and Evaluation Criteria and Questions
http://gao.gov/products/GAO-13-167SP

GAO-13-167SP: Published: Nov 29, 2012. Publicly Released: Jan 8, 2013.
Budget Process: Enforcing Fiscal Choices
http://gao.gov/products/GAO-11-626t

GAO-11-626t: Published: May 4, 2011. Publicly Released: May 4, 2011.

Portrait of Susan Irving

Susan J. Irving
Director, Strategic Issues
IrvingS@gao.gov
202-512-6806