GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

United States General Accounting Office

Washington, DC 20548

Accounting and Information

Management Division

B-285914

July 26, 2000

The Honorable John M. Spratt, Jr.

Ranking Minority Member

Committee on the Budget

House of Representatives

Subject: Budget Issues: July 2000 Update of GAO’s Long-Term Fiscal Simulations

Dear Mr. Spratt:

At your request, we updated our long-term economic model using the latest economic and

budget assumptions from the Congressional Budget Office (CBO).1 Since 1992, GAO has

provided the Congress with a long-term perspective on alternative fiscal policy paths.2 This

perspective is important for broad fiscal policy as well as for budget decisions on individual

programs. At the macro level, the budget needs to provide a long-term framework grounded

on a linkage of fiscal policy with the long-term economic outlook. This requires a focus on

both overall fiscal policy and the composition of federal activity.

Long-term simulations are useful for comparing the potential outcomes of alternative fiscal

policies within a common economic framework. Such simulations can help Congress assess

the long-term implications of fiscal policy decisions that are made today. This is especially

true where a longer time horizon is necessary to understand the fiscal and spending

implications of the government's commitment. For example, the profound demographic

changes forecast for our population, beginning just beyond the 10-year budget window, will

have enormous consequences for Social Security and Medicare as well as the budget and the

economy as a whole.

While long-term simulations provide a useful perspective that is often lacking in budget

debates, they should be interpreted carefully. Given the range of uncertainty about future

economic changes and the responses to those changes, these simulations should not be

viewed as forecasts of budgetary or economic outcomes 50 or 75 years in the future. Rather,

1

Congressional Budget Office, The Economic and Budget Outlook: An Update, July 2000.

2

Budget Issues: Long-Term Fiscal Outlook (GAO/T-AIMD/OCE-98-83, February 25, 1998); Budget Issues:

Analysis of Long-Term Fiscal Outlook (GAO/AIMD/OCE-98-19, October 22, 1997); Budget Issues: Deficit

Reduction and the Long Term (GAO/T-AIMD-96-66, March 13, 1996); The Deficit and The Economy: An

Update of Long-Term Simulations (GAO/AIMD/OCE-95-119, April 26, 1995); and Budget Policy: Prompt

Action Necessary to Avert Long-Term Damage to the Economy (GAO/OCG-92-2, June 5, 1992).
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Page 2 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

they should be seen only as illustrations of the different budget and economic outcomes

associated with alternative policy paths based on common demographic and economic

assumptions.

Updated Simulations

Our simulations are based on the budget and economic assumptions contained in CBO's

updated July 2000 10-year projections. As agreed with your office, we simulated the

following three alternative fiscal policy scenarios.

• Save the Social Security Surpluses assumes that the Social Security surpluses are

retained and used to reduce debt held by the public. Unspecified policy actions (i.e.,

spending increases and/or tax cuts) are taken that eliminate the non-Social Security (i.e.

on-budget) surpluses through 2009 but retain the Social Security surpluses. These

unspecified actions are left in place through the end of the simulation period.

• Save the Social Security and Medicare Part A Surpluses assumes that both the Social

Security surpluses and the Medicare Part A surpluses are retained and used to reduce

debt held by the public. Unspecified policy actions (i.e., spending increases and/or tax

cuts) are taken through 2009 that result in unified surpluses equal to the Social Security

surpluses plus the Medicare Part A (Hospital Insurance) trust fund surpluses. These

unspecified actions are left in place through the end of the simulation period.

• Save the Unified Surpluses assumes that unified surpluses are used to reduce debt held

by the public and thereafter are allowed to accumulate and generate income. This

simulation follows CBO’s 10-year inflated baseline projections, which assume that

budget authority for discretionary spending grows with inflation from 2001 through

2009. Thereafter, we assume discretionary spending grows with the economy. This

scenario could be viewed as implausible, as the federal government would accumulate

considerable assets for a period of over 60 years once publicly held debt is retired.

Nonetheless, it provides a useful reference point against which to compare alternative

fiscal policy paths such as those discussed above.

The continued strength of the U.S. economy and the significant improvement in the budget

projections released by CBO this month compared to those released in January are reflected

in GAO’s updated long-term simulations. The results of these simulations are provided in the

enclosure to this letter. Figure 1 shows the fiscal paths under the three alternative scenarios.

Saving the Social Security surplus—a fiscal path receiving widespread endorsement—

produces unified budget surpluses for almost 20 years and eliminates the publicly held debt

by 2015. Under this scenario, deficits emerge again in 2019 (figure 1)—just as the Social

Security and Medicare programs are being strained by the retiring baby boom generation.

Saving both Social Security and Medicare Part A surpluses extends surpluses for one

additional year.
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Page 3 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

If all future unified surpluses were saved, deficits would not emerge until the second half of

the century. Our model implicitly assumes that once debt held by the public is retired in

2009, unified surpluses will continue to be saved. These surpluses accumulate as assets of

the government that would have to be invested. Again, the plausibility of this scenario is

open to question, particularly at the asset levels (negative debt) implied by the model shown

in figure 2.

Figures 3 and 4 show the composition of spending under two scenarios—Save the Social

Security Surpluses and Save the Unified Surpluses. By 2030, saving the Social Security

surpluses results in a “haircut” for spending on programs other than Social Security,

Medicare, and Medicaid. Under this scenario, there is increasingly less room for spending on

programs for national defense, the young, infrastructure, and law enforcement. Budget

flexibility declines drastically so that by 2050 Social Security and health absorb nearly all

federal revenue.

This suggests that the level of public savings resulting from saving the Social Security

surpluses will not by itself be sufficient to promote the budgetary flexibility needed to

accommodate both the projected growth in Social Security and health entitlements as well as

other important national priorities. Figure 5 illustrates the consequences of this simulation

for long-term economic growth: if only the Social Security surpluses are saved and no

changes are made in our health and retirement programs, GDP per capita growth slows and

eventually turns negative, resulting in a lower standard of living.

Model Assumptions

Our simulations are based on the budget and economic assumptions contained in CBO's

updated July 2000 10-year projections. After 10 years, we rely on the long-term actuarial

assumptions for the Social Security and Medicare programs.3 For Medicaid, we use the

growth rates assumed by CBO in its December 1999 report on long-term simulations.4

Interest spending is determined by interest rates—which are held constant over the long

term—and the level of federal debt held by the public, which depends on the path of

deficits/surpluses within each simulation. All other spending, along with federal revenue, is

assumed to grow at essentially the same rate as the economy.5 Table 1 summarizes the key

assumptions used in our model.6

It is important to reiterate that these results are sensitive to changes in the economy and the

budget. For instance, only 3 months ago, our simulation of the Save the Unified Surpluses

path showed deficits emerging in the 2030s, while the our updated simulation indicates that

3

The 2000 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and

Disability Insurance Trust Funds, The 2000 Annual Report of the Board of Trustees of the Federal Hospital

Insurance Trust Fund, and The 2000 Annual Report of the Board of Trustees of the Federal Supplementary

Medical Insurance Trust Fund.

4

Congressional Budget Office, The Long-Term Budget Outlook: An Update, December 1999.

5

This means that both revenues and other spending remain constant as a share of GDP.

6

For more information on our long-term model, see GAO/T-AIMD/OCE-98-83.
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Page 4 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

deficits would emerge more than 20 years later under this scenario. The difference in these

results was driven by the significant increases in CBO’s projected 10-year surpluses from

January to July of this year. Correspondingly, a reduction in projected surpluses of a similar

or greater size—whether due to policy actions or economic changes—would significantly

worsen the long-term budget outlook.7

-----

We will send copies of this letter to Representative John Kasich, the Chairman of your

committee; Senator Pete Domenici, Chairman, and Senator Frank Lautenberg, Ranking

Member, Senate Committee on the Budget; and the Honorable Jacob J. Lew, Director, Office

of Management and Budget. Copies will be made available to others on request.

Please contact me at (202) 512-9573 if you or your staff have any questions concerning this

letter.

Sincerely yours,

Paul L. Posner

Director, Budget Issues

Enclosure

7

For example, CBO estimates that if real economic growth is just 0.5 percent higher or lower each year

than projected, the surplus in 2010 could be $250 billion higher or lower. See The Budget and

Economic Outlook: An Update, July 2000, p. 22.
Enclosure

Page 5 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Results of GAO’s Long-Term Simulations

Source: GAO's July 2000 analysis.

Figure 1: Unified Deficits as a Share of GDP

Under Alternative Fiscal Policy Simulations

*Data end when deficits reach 20 percent of GDP.

**Incorporates CBO’s inflated baseline through 2009.

-5

0

5

10

15

20

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075

Percent of GDP

Save the Social Security

Surpluses*

Save the Unified Surpluses**

Save the Social

Security and Medicare

Part A Surpluses*
Enclosure

Page 6 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Source: GAO's July 2000 analysis.

Figure 2: Debt Held by the Public as a Share of

GDP Under Alternative Fiscal Policy Simulations

-50

0

50

100

150

200

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075

Percent of GDP

*Data end when debt reaches 200 percent of GDP.

**Incorporates CBO’s baseline through 2009, which assumes discretionary spending grows with inflation from 2000-2009.

Note: Although unified deficits emerge in 2056 under the Save the Unified Surpluses simulation, the stock of assets acquired up to that point are

not depleted until 2073.

Save the Social Security

Surpluses*

Save the Unified Surpluses**

Save the Social Security and

Medicare Part A Surpluses*
Enclosure

Page 7 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Source: GAO's July 2000 analysis.

Figure 3: Composition of Spending

as a Share of GDP Under the

Save the Social Security Surpluses Simulation













0

10

20

30

40

2000 2030 2050 2075*

Percent of GDP

Social Security Medicare & Medicaid  Net interest All other spending

Revenue

Note: Revenue as a share of GDP declines from its 2000 level of 20.5 percent due to unspecified permanent policy actions that reduce revenue

and increase spending to eliminate the non-Social Security surpluses.

*The Save the Social Security Surpluses simulation can only be run through 2061 due to the elimination of the capital stock.
Enclosure

Page 8 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Source: GAO's July 2000 analysis.

Figure 4: Composition of Spending

as a Share of GDP Under the

Save the Unified Surpluses Simulation





0

10

20

30

40

2000 2030* 2050* 2075

Percent of GDP

Social Security Medicare & Medicaid



 Net interest All other spending

Revenue

Note: Revenue as a share of GDP falls from its 2000 level of 20.5 percent to CBO’s 2009 level and is held constant at this level for the

remainder of the simulation period.

*In 2030 and 2050, all other spending is net of offsetting interest receipts.
Enclosure

Page 9 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Source: GAO's July 2000 analysis.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

110,000

120,000

130,000

2000 2005 2010 2015 2020 2025 2030 2035 2040 2045 2050 2055 2060 2065 2070 2075

Per capita 1999 dollars

Figure 5: GDP per Capita

Under Alternative Fiscal Policy Simulations

Note: The Save the Social Security Surpluses simulation can only be run through 2061 and the Save the Social Security and Medicare Surpluses

simulation can only be run through 2063 due to the elimination of the capital stock.

1999 Level

Save the Social

Security Surpluses

Save the Unified

Surpluses

Save the Social

Security and Medicare

Part A Surpluses
Enclosure

Page 10 GAO/AIMD-00-272R July 2000 Long-Term Fiscal Simulations

Source: GAO's July 2000 analysis.

Table 1: Model Assumption Summary

Model inputs Assumptions

Surplus/deficit CBO’s July 2000 inflated baseline through 2009; GAO simulations

thereafter

Social Security spending (OASDI) 2000 Social Security Trustees’ intermediate projections

Medicare spending (HI and SMI) 2000 Medicare Trustees’ intermediate projections

Medicaid spending CBO’s December 1999 long-term projections

Other mandatory spending CBO’s July 2000 inflated baseline through 2009; thereafter increases

at the rate of economic growth (i.e., remains constant as a share of

GDP)

Discretionary spending CBO’s July 2000 inflated baseline through 2009; thereafter increases

at the rate of economic growth

Revenue CBO’s July 2000 inflated baseline through 2009; in subsequent

years, receipts held constant at 20.0% of GDP (CBO’s ratio in 2009)

Saving rate: gross saving of the private sector and

state and local government sector

16.4%

Net foreign investment CBO’s projected 2000 nominal dollar level plus one third of any

change in gross national saving

Labor: growth in hours worked 2000 Social Security Trustees’ intermediate projections

Total factor productivity growth 1.5% (CBO’s July 2000 assumption)

Inflation (GDP price index) CBO through 2010; 1.8% thereafter (CBO’s projection in 2010)

Interest rate (average on the national debt) Average rate implied by CBO’s July 2000 inflated baseline interest

payment projections through 2007; 5.3% thereafter (based on CBO’s

assumption for the average rate on Treasury securities)

Notes:

(1) These assumptions apply to our base simulation, Save Unified Surpluses. For alternative fiscal policy simulations, certain assumptions are varied, which are noted

in the discussion of the alternative paths.

(2) In our work, all CBO budget projections were converted from a fiscal year to a calendar year basis. The last year of CBO’s projection period is fiscal year 2010,

permitting the calculations of calendar year values through 2009.

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