2011   Financial Report of the United States Government

United States Government Supplemental Information (Unaudited) for the Years Ended September 30, 2011, and 2010

The Sustainability of Fiscal Policy

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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 only 1.2 percent from 2013 to 2022, before resuming faster growth over the remainder of the 75-year window, eventually exceeding 280 percent by 2086.  The continuing rise in this ratio by the end of the 75-year horizon means that current policy is unsustainable.  If these projections were extended beyond 2086, deficits excluding interest would persist as the population continues to age and if the other assumptions made for the 75-year horizon continue to hold.  Persistence of the primary deficit beyond the 75-year horizon implies that the ratio of debt to GDP would continue to grow beyond the 75-year horizon. 

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 and stayed large in 2010 and 2011 due to the financial crisis and the recession and the policies pursued to combat both. The primary deficit ratio is projected to fall rapidly between 2012 and 2019 (turning to surplus in 2015) as spending reductions called for in the BCA take effect and the economy recovers.  Between 2019 and 2035, 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.  A primary deficit is expected to reappear in 2025 that reaches 1.3 percent of GDP in 2035.  After 2035, the projected primary deficit-to-GDP ratio slowly declines as the impact of the baby boom generation retiring dissipates.  Between 2035 and 2086, the projected primary deficit averages 0.9 percent of GDP.

The revenue share of GDP fell substantially in 2009 and 2010 and increased only modestly in 2011 because of the recession and tax reductions enacted as part of the 2009 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 and the temporary tax cuts expire.  After the economy is fully recovered, 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.9  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.

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On the spending side, the non-interest spending share of GDP is projected to fall from its current level of 22.6 percent to about 20 percent in 2013, and stay at or below that level until 2026, and to then rise gradually and plateau at about 22 percent beginning in about 2040.  The reduction in the non-interest spending share of GDP over the next two years is mostly due to the caps on discretionary spending and the automatic spending cuts mandated by the BCA, and the subsequent increase is principally due to growth in Medicare, Medicaid, and Social Security spending (see Chart 2).  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, 1.3 percentage points, and 1.0 percentage points, respectively.  After 2035, the Social Security spending share of GDP is relatively steady, 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.

Both Medicare and Medicaid projections continue to be significantly affected by the enactment of the ACA in 2010.  The reform expands health insurance coverage, but the long-term budgetary effect will depend on the effectiveness of provisions designed to reduce health care cost growth. The 2011 Medicare trustees’ report reflects the ACA and thus projects reductions in future Medicare cost growth as called for by the new law.  If the trustees’ report projections hold true, there will be a substantial slowdown in future Medicare spending and following the projections methodology outlined above there will also be a slowdown in future Medicaid spending growth.   However, even with this reduced growth in Medicare and Medicaid spending, there is still a persistent gap between projected receipts and projected total Federal non-interest spending. 

Table 2:
Components of Change (pv Dollars in Trillions)
Non-Interest Spending Less Receipts: FY 2010 16.3
Components of Change:
    Change due to Enacted Legislation -11.0
    Change in Economic Assumptions 2.4
    Change in Reporting Period 1.0
    Change in Technical Assumptions -2.3
Total -9.9
    Non-Interest Spending Less Receipts: Fy 2011 6.4

The overall 75-year present value net excess of non-interest spending over receipts expressed in Table 1 of $6.4 trillion (0.7 percent of the 75-year present value of GDP) for the 2011 projections can be expressed in terms of funding sources.  In these projections there is an excess of receipts over spending of $6.0 trillion or 0.7 percent of GDP among programs funded by the government’s general revenues but an imbalance of $12.4 trillion or 1.4 percent of GDP among Social Security (OASDI) and Medicare Part A, which are funded by payroll taxes and which are not funded in any material respects by the government’s general revenues.  By comparison, the 2010 projections showed that programs funded by the government’s general revenues had an imbalance of $5.3 trillion or 0.6 percent of GDP while the payroll tax funded programs had an imbalance of $11.0 trillion or 1.3 percent of GDP.10 While the imbalance for payroll tax funded programs has actually risen modestly since 2010, programs funded by general revenues are no longer in imbalance in 2011 and show a large present value surplus more than offsetting the increase in the dedicated imbalance. This speaks further to the gains brought about through the BCA in 2011.

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As shown in Table 1 and discussed above, the 2011 projection of the 75-year present value imbalance of spending over receipts of $6.4 trillion is a sizable drop from the 2010 projection, which measured the 75-year imbalance as $16.3 trillion. Table 2 breaks down the sources of the change in this key projection from 2010 to 2011 and clearly illustrates the projected effects of newly enacted legislation as the main driver of the change since last year. The changes due to enacted legislation shown on Table 2 reflect the effect on the long-term fiscal imbalance of the incorporation of the passage of key pieces of legislation since 2010 including the 2011 full year continuing resolution, as well as the BCA. The enactment of discretionary caps in the BCA improved the long run fiscal imbalance in the 2011 projections by $7.0 trillion and the additional deficit reduction from the automatic spending reductions improved the fiscal imbalance by $4.1 trillion.  Technical adjustments and changes to modeling assumptions improved the fiscal picture by $2.3 trillion since 2010.  The main source of these changes are actual budget numbers being lower than projected in 2010, as well as refinements to the fiscal projections model.  Also reflected are revised economic assumptions, as well as the effect of changing the projection period from 2011-2085 to 2012-2086, which collectively somewhat reduce the overall decreases brought about since 2010 from legislation.

Another way of viewing the improvement in the financial outlook in this year's Report relative to last year's Report is in terms of the projected level of publicly-held debt in 2085.  The ratio of publicly-held debt to GDP in 2085 is projected to reach 283 percent in this year's Report, which compares with 352 percent projected in last year's Report. 

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 ratio of debt held by the public to GDP that are shown in Chart 3.  That ratio was 68 percent at the end of fiscal year 2011, and under current policy, it is projected to exceed 76 percent in 2022, 125 percent in 2042, and 287 percent in 2086.  The continuous rise of the debt-to-GDP ratio illustrates that current policy is unsustainable.

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.11  Total spending consists of non-interest spending plus interest spending.  Chart 4 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 1.5 percent in 2011, and under current policies it is projected to reach 5 percent by 2031 and nearly 16 percent by 2086.

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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 2012 to 2086, 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 2011 debt-to-GDP ratio of 68 percent of GDP. 

The 75-year fiscal gap under current policy is estimated at 1.8 percent of GDP, as reflected in Table 3, which represents about 9% of the 75-year present value of projected receipts and of non-interest spending.  As noted in Table 1, the difference between projected programmatic (non-interest) spending and receipts is 0.7 percent of GDP (reflecting the deficit condition of excess spending over receipts).  However, eliminating this primary deficit of 0.7 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 will still leave debt rising relative to GDP.  The average primary surplus needed to return the debt-to-GDP ratio of 68 percent to its initial level and fully close the fiscal gap is 1.1 percent of GDP per year.

The Cost of Closing the 75-Year Fiscal Gap

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 2086.  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.

Table 3:
Cost of Delaying Fiscal Consolidation
Period of Delay Change in Average Primary Surplus
No Delay: Reform in 2012 1.8 percent of GDP between 2012 and 2086
Ten Years: Reform in 2022 2.2 percent of GDP between 2022 and 2086
Thirty Years: Reform in 2032 2.8 percent of GDP between 2032 and 2086
Note: Reforms taking place in 2011, 2021, and 2031 from the 2010 Report were 2.4, 2.9, and 3.7 percent of GDP.

As previously shown in Chart 1, under current policy, primary deficits occur in virtually every year of the projection period.  Table 3 shows primary surplus changes necessary to make the debt-to-GDP ratio in 2086 equal to its level in 2011 under each of the three policies.  If reform begins in 2012, then it is sufficient to raise the primary surplus share of GDP by 1.8 percentage points in every year between 2012 and 2086 in order to have a debt-to-GDP ratio in 2086 equal to the level in 2011.  This raises the average 2011-2086 primary surplus-to-GDP ratio from -0.7 percent to 1.1 percent.

In contrast to a reform that begins immediately, if reform is begun in 2022 or 2032, the primary surplus must be raised by 2.2 percent and 2.8 percent of GDP, respectively, in order to reach a debt-to-GDP ratio in 2086 equal to the level in 2011.  The difference between the primary surplus increasing in 2022 and 2032 (2.2 and 2.8 percent of GDP, respectively) rather than in 2012 (1.8 percent of GDP) is a measure of the additional burden policy delay would impose on future generations.  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 2086, 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 2011 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 2011 level.  The potential impact of changes in interest rates is among the variables explored in the following section.

Footnotes

9Projected revenues also account for increases (as a share of GDP) in employer-sponsored health insurance costs, which are tax exempt. (Back to Content)

10If payroll and self-employment taxes and related assets in the OASDI Trust Funds or Medicare Part A become insufficient to cover related benefits, as indicated by projections, additional funding for each of these two programs would be necessary or scheduled benefits would need to be reduced. If the government’s general revenues are insufficient to cover both mandated transfers to Medicare Parts B and D and spending for other general government programs funded by the government’s general revenues, either Medicare Parts B and D revenues (premiums and state transfers), or the government’s general revenues would need to be increased, spending for Medicare Parts B and D and/or other general government spending would need to be reduced, and/or additional amounts would need to be borrowed from the public. (Back to Content)

11Debt 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)


Last Updated:  February 14, 2012