An important purpose 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 (debt to GDP) is stable over time. The discussion below focuses on balancing revenues and expenditures over time, and does not consider fairness or efficiency implications of the reforms necessary to achieve sustainability.
It is shown below that, under current policy, the ratio of debt to GDP is projected to rise continuously over the next 75 years, eventually exceeding 350 percent in 2085. If these projections were extended beyond 2085, the deficit excluding interest would continue as the population continues to age and if the other assumptions made for the 75-year horizon continue to hold. The persistence of the deficit excluding interest beyond the 75-year horizon implies that the ratio of debt to GDP would continue to grow beyond the 75-year horizon. The continuing rise in this ratio means that current policy is unsustainable.
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 simply the primary deficit expressed as a percent of GDP. As shown in Chart 1, the primary deficit-to-GDP ratio grew rapidly in 2008 and 2009 due to the financial crisis and the recession and the policies pursued to combat both, and is projected to fall rapidly to near zero as the economy recovers. The projection period begins in 2011. After 2020, the primary deficit-to-GDP ratio is projected to increase, reaching 2 percent in 2030 and remaining at or above 1.8 percent through the end of the 75-year projection period and beyond.
The level of revenues as a percentage of GDP has been depressed by the recession and tax reductions enacted as part of the ARRA. As the economy recovers and the tax cuts expire, it is projected that the revenue share of GDP will return to near its long-run average. Beyond that point individual income taxes are projected to grow gradually as increases in real incomes cause more taxpayers and a larger share of total income to fall into higher 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 projected increase in non-interest spending as a percentage of GDP is principally due to growth in Medicare, Medicaid, and Social Security spending, as is shown in Chart 2. The Social Security spending share of GDP is projected to increase about 1.2 percentage points over the next 25 years as the baby boom generation retires. The same demographic patterns will affect Medicare spending. After 2035, the Social Security spending share of GDP is relatively steady, while the Medicare spending share of GDP continues to increase, albeit at a slower rate, due to projected increases in health care costs. For the same reason, Medicaid spending is also projected to rise over time.
Both Medicare and Medicaid have been significantly affected by the recently passed health reform legislation, the Affordable Care Act (ACA). An effect of the reform is to expand health coverage. The long-term budgetary effect will depend on the effectiveness of provisions designed to reduce health care cost growth. The 2010 Medicare trustees' report projects that the new law could hold down future Medicare cost growth substantially compared with previous projections if fully implemented. The Medicare spending projections in this Report are based on the projections in the 2010 Medicare Trustees Report. If the trustees' report projections hold true, there will be a substantial slowdown in future Medicare and Medicaid spending growth. That assumption is reflected in these long-run fiscal projections. However, even with this reduced Medicare and Medicaid spending, there is still a persistent gap between projected receipts and projected total Federal non-interest spending.
The primary deficit projections in Chart 1, along with projections for interest rates and GDP, determine the projections for the ratio of debt held by the public to GDP that are shown in Chart 3. That ratio was 62 percent at the end of fiscal year 2010, and under current policy, it is projected to exceed 70 percent in 2020, 130 percent in 2040, and 350 percent in 2085. Continued upward pressure on spending for the elderly after 75 years because of increasing longevity implies that the debt-to-GDP ratio would continue to rise beyond that point if there is no change in policy. The continuing rise of the debt-to-GDP ratio suggests that current policy is unsustainable.
Chart 3 also displays the projection of debt held by the public as a percent of GDP as published in the 2009 Financial Report. The 2010 projection is lower than the 2009 projection in every year of the projection period, with the size of the gap increasing rapidly over time. The reduction in projected debt has decreased the size of the fiscal gap dramatically since 2009. The improved outlook this year is almost entirely attributable to lower projected spending for Medicare and Medicaid and increased projected receipts that result from the ACA. The lower level of projected publicly held debt relative to last year's projection reflects lower projected primary deficits. As reported in Table 1, primary deficits over the 75-year projection average 1.9 percent of GDP. For comparison, the projections in last year's report implied that the average primary deficit would be 5.5 percent of GDP. As noted, this improvement in projected primary deficits is largely attributable to the enactment of the ACA.
The change in debt held by the public from one year to the next is equal to the unified budget deficit, the difference between total spending and total receipts.9 Total spending consists of non-interest spending plus interest spending. Chart 4 reveals clearly 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 2010, and under current policies it is projected to reach 5 percent by 2030 and 19 percent by 2085.
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 2011 to 2085, and the target debt-to-GDP ratio is equal to the ratio at beginning of the projection period, in this case the end of fiscal year 2010 debt-to-GDP ratio of 62 percent of GDP.
The 75-year fiscal gap under current policy is estimated at 2.4 percent of GDP, as reflected in Table 2. As noted in Table 1, the difference between projected programmatic (non-interest) spending and receipts is 1.9 percent of GDP (reflecting the deficit condition of excess spending over receipts). However, eliminating this primary deficit of 1.9 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 will still leave debt rising relative to GDP. The average primary surplus needed to return the debt-to-GDP ratio to its initial level and fully close the fiscal gap is 0.5 percent of GDP per year.
The longer policy action to close the fiscal gap is delayed, the larger the post-reform primary surplus must be to stabilize the debt-to-GDP ratio by the end of the 75 year period. Varying the years in which reforms are introduced 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 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 stabilize the debt-to-GDP ratio in 2085. Future generations are harmed by policy delay because higher primary surpluses imply lower spending and/or higher taxes than would be needed with earlier deficit reduction.
As previously shown in Chart 1, under current policy, primary deficits occur in virtually every year of the projection period. Table 2 shows primary surplus changes necessary to make the debt-to-GDP ratio in 2085 equal to its level in 2010 under each of the three policies. If reform begins in 2011, then it is sufficient to raise the primary surplus share of GDP by 2.4 percentage points in every year between 2011 and 2085 in order to have a debt-to-GDP ratio in 2085 equal to the level in 2010. This raises the average 2011-2085 primary surplus-to-GDP ratio from -1.9 percent to 0.5 percent. In contrast, if reform is begun in 2021 or 2031, the primary surplus must be raised by 2.9 percent and 3.7 percent of GDP, respectively, in order to reach a debt-to-GDP ratio in 2085 equal to the level in 2010. The difference between the primary surplus boost starting in 2021 and 2031 (2.9 and 3.7 percent of GDP, respectively) and the primary surplus boost starting in 2011 (2.4 percent of GDP) is a measure of the additional burden policy delay would impose on future generations. This policy change could take the form of a reduction in spending, an increase in taxes, or some combination of both that produced the same improvement in the budget surplus. The costs of delay are due to the debt-to-GDP ratio rising during the interim period, which increases the future 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 2085, since the starting debt-to-GDP ratio will be higher.
These estimates likely understate the cost of delay because they do not assume interest rates will rise as the debt-to-GDP ratio grows. If a higher debt-to-GDP ratio increases the interest rate, 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 2010 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 2010 level.
|Period of Delay||Change in Average Primary Surplus|
|No Delay: Reform in 2011||2.4 percent of GDP between 2011 and 2085|
|Ten Years: Reform in 2021||2.9 percent of GDP between 2021 and 2085|
|Thirty Years: Reform in 2031||3.7 percent of GDP between 2031 and 2085|
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)
9 Debt 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 net to zero in the long-range projections. (Back to Content)