2010   Financial Report of the United States Government

United States Government Supplemental Information (Unaudited) for the Years Ended September 30, 2010, and 2009

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 could have important long-run effects on the budget outlook. The current assumption is that U.S. fertility will remain close to the replacement rate of approximately 2 children per woman. If the fertility rate were to increase significantly, there would be more workers in the future to support the elderly and to help service existing debt. Conversely, if the fertility rate were to fall below replacement, the strains on the budget would become even more severe. Improvements in mortality operate like a decline in fertility. Increases in immigration operate like an increase in fertility.

One of the most important assumptions underlying the projections is the expected growth of health care costs. Enactment of the ACA reduced the expected 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 shows the effect on future primary deficits of growth rates that are one percent higher or two percent higher than the growth rates in the base projection. The one percent higher health care cost growth scenario raises the average of non-interest spending less receipts over 75 years to 3.8 percent of GDP, compared to 1.9 percent of GDP assumed in the base projection and displayed in Table 1. The two percent higher health cost growth scenario raises the average of non-interest spending less receipts over 75 years even further, to 10.5 percent of GDP. The dramatic deterioration caused by higher health care cost growth shows the critical importance that effective implementation of the ACA has on the long-run fiscal outlook.

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 budget 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. Also, medical costs show a positive relationship with GDP, so higher GDP growth may be matched by higher Medicare and Medicaid spending. Real interest rates are another factor that affects the calculations. The higher are real interest rates, the more costly it is to sustain debt. 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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Last Updated:  December 07, 2011