United States General Accounting Office

GAO Report to Congressional Requesters

October 1997 BUDGET ISSUES

Analysis of Long-Term

Fiscal Outlook

GAO/AIMD/OCE-98-19

GAO United States

General Accounting Office

Washington, D.C. 20548

Accounting and Information

Management Division

B-278394 

October 22, 1997

The Honorable Pete V. Domenici

Chairman, Committee on the Budget

United States Senate

The Honorable John R. Kasich

Chairman, Committee on the Budget

House of Representatives

As you requested, this report updates our previous simulations of the

long-term economic impact of federal budget policy. In 1992, we first used

a macroeconomic model to simulate the effects of alternative fiscal policy

paths in promoting or inhibiting long-term economic growth and the

results supported the view that deficit reduction was key to our nation’s

long-term economic health.1

 In 1995, our updated simulations indicated

that a path of “no action,” under which current policies remain unchanged,

could not be sustained over the long run.2

 We identified three forces

driving the long-term growth of the budget deficit—health spending, Social

Security, and interest costs. Since our 1995 report was issued, the

Congress and the President have taken additional fiscal action to eliminate

the annual deficit, culminating in the recent passage of the Balanced

Budget Act of 1997 (BBA). The Congressional Budget Office (CBO) projects

that these actions, along with the recent strong performance of the

economy, will eliminate the deficit by 2002 and achieve several years of

budget surpluses.

In this report, we have updated our work to address the long-term budget

outlook following passage of BBA to help the Congress assess the long-term

consequences of current policies and alternatives. We used our long-term

economic growth model to simulate the path resulting from the BBA

through the year 2050 assuming no further policy changes (“no action”).

For this path, we adopted CBO’s 10-year budgetary and economic

projections, under which the federal government would run budget

surpluses from 2002 through 2007, the end of CBO’s forecast period.3

1

Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to the Economy

(GAO/OCG-92-2, June 5, 1992).

2

The Deficit and The Economy: An Update of Long-Term Simulations (GAO/AIMD/OCE-95-119,

April 26, 1995).

3

CBO’s budget projections, and thus our simulations using CBO data, reflect the net effect of the

Balanced Budget Act of 1997 as well as the Taxpayer Relief Act of 1997.

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In addition to simulating the long-term results of current fiscal policy, we

also developed several alternative fiscal policy paths to illustrate how

overall fiscal policy changes can affect future budgetary and economic

outcomes. While this report discusses the consequences of alternative

fiscal paths, it does not suggest any particular course of action, since the

choice of the most appropriate fiscal policy path is a policy decision to be

made by the Congress and the President. As discussed with your office,

three alternatives were chosen to represent different degrees of fiscal

restraint. Two of these alternatives follow the “no action” path in the early

years of the simulation period but then shift direction once deficits

reemerge in the second decade of the 21st century by maintaining either a

budget balance or modest deficits through the remainder of the simulation

period. A third alternative path would run larger surpluses than the “no

action” path in the near term and for a longer period of time.

Simulations are useful for comparing the potential outcomes of alternative

policies within a common economic framework but should not be

interpreted as forecasts of the level of economic activity 50 years in the

future given the range of uncertainty about future economic changes and

the responses to those changes.4

 Simulation results provide qualitative

illustrations, not quantitative forecasts, of the budget or economic

outcomes associated with alternative policy paths. In our simulations, we

employed a model originally developed by economists at the Federal

Reserve Bank of New York (FRBNY) that relates long-term gross domestic

product (GDP) growth to economic and budget factors. All models require

the use of assumptions to permit extrapolations to be made. For details of

the model’s assumptions, see appendix I.

Background Economic growth—which is central to many of our major concerns as a

society—requires investment, which, over the longer term, depends on

saving. The nation’s saving consists of the private saving of households

and businesses and the saving or dissaving of all levels of government. In

general, government budget deficits represent dissaving—they subtract

from national saving by absorbing funds that otherwise could be used for

investment. Conversely, government surpluses add to saving.

Since the 1970s, private saving has declined while federal budget deficits

have consumed a large share of these increasingly scarce savings. The

4

The impact of federal spending reduction on aggregate national saving and investment depends on

how consumers respond to such reductions. For example, a reduction in federal Medicaid spending

may result in greater private spending on nursing home care thereby diminishing the effect on total

national saving.

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result has been to decrease the amount of national saving potentially

available for investment.5

 Since we last reported on this issue in 1995,

private saving has remained low. However, federal budget deficits have

declined significantly from the levels of the 1980s and early 1990s, freeing

up some additional funds for investment. (See figure 1.) Nevertheless, total

national saving and investment remain significantly below the levels

experienced in the 1960s and 1970s. Economists have noted that these low

levels of saving and investment raise concerns for the nation’s future

productive capacity and future generations’ standard of living. As we have

said in our earlier reports, the surest way to increase the resources

available for investment is to increase national saving, and the most direct

way for the federal government to increase national saving is to achieve

and maintain a balanced federal budget. Running budget surpluses would

further increase saving and allow the government to reduce the level of

federal debt held by the public.

Figure 1: Effect of the Federal Budget

Deficit on Net National Saving

(1970-96)

1970-1979 1980-1989 1990-1993 1994-1996

0

2

4

6

8

10

12

Years

Percent of net national product

Available for capital formation Absorbed by the federal deficit

Note: Entire bar represents nonfederal saving net of capital depreciation. Shaded portion of bar

represents net national saving. Nonfederal saving is comprised of private saving and the

aggregate state and local government surplus/deficit.

Source: GAO analysis of U.S. Department of Commerce data.

5

The depressing effect of deficits on growth might have been mitigated had they financed higher levels

of public investment. However, as a share of GDP, federal investment spending has actually declined

over the past two decades.

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Our earlier work concluded that without further policy action,

commitments in federal retirement and health programs would together

become progressively unaffordable for the nation over time, and the

economic consequences would force belated and painful policy choices.

Growing deficits and the resulting lower saving would lead to dwindling

investment, slower growth, and finally a decline in real GDP. Living

standards, in turn, would at first stagnate and then fall. These findings

supported our conclusion that action on the deficit might be postponed,

but it could not be avoided.

The results of our past work have been very similar to the conclusions

reached by other government entities and private analysts. Most notably,

CBO published analyses based on its long-term model work in 1996 and

1997 that corresponded with our main findings.6

 Also, in 1994-95, the

Bipartisan Commission on Entitlement and Tax Reform reached similar

conclusions in its study of future fiscal trends.

Since our 1995 report, robust economic growth and policy action have

combined to sharply reduce the deficit and are projected by CBO to result

in budget surpluses in the near term. This report addresses the outlook for

the budget over the longer term. We will explore how recent progress

affects this outlook and the fiscal and economic impacts associated with

alternative long-term fiscal policy strategies.

Results in Brief Major progress has been made on deficit reduction in the past several

years, culminating in the passage of the Balanced Budget Act of 1997. The

balanced budget or surpluses that are projected would represent an

enormous improvement in the federal government’s fiscal position

through the next 10 years. Moreover, the improvements in national saving

and reduced debt and interest costs can be expected to produce tangible

gains in economic growth and budgetary flexibility over the longer term as

well. As a result, the emergence of unsustainable deficits is substantially

delayed under recently enacted fiscal policy. While our 1995 simulations

showed deficits exceeding 20 percent of GDP by 2024 if current policies

were not changed, our updated model results show that this point would

not be reached until nearly 2050.

Notwithstanding this progress, if no further action were taken, (a “no

action” scenario), our simulations indicate that federal spending would

6

Congressional Budget Office, The Economic and Budget Outlook: Fiscal Years 1997-2006, May 1996,

and Long-Term Budgetary Pressures and Policy Options, March 1997.

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grow faster than revenues soon after the baby boom generation begins to

retire in 2008. These higher spending levels would be driven by escalating

health and Social Security costs. Rising interest costs would compound

the deficit problem and take up an increasing share of the federal budget.

Our simulations show that growing deficits, left unchecked, would

eventually result in declining investment and capital stock and, inevitably,

falling living standards. Over the long term, the “no action” scenario is

unsustainable. Timely policy action can avoid these economic

consequences. While a “no action” simulation is not a forecast of what will

happen, it illustrates the nature of future fiscal challenges.

The alternative simulations illustrate the potential fiscal and economic

benefits of achieving a sustainable budget policy. According to our

simulations, a fiscal policy of balance through 2050 or extended periods of

surplus, for example, could shrink the burden of federal interest costs

considerably and also result in a larger economy over the long term. All of

these alternative policies would increase per capita GDP in 2050 by more

than 35 percent over a “no action” policy, but they would require

additional fiscal policy changes. Some of these changes may be difficult to

achieve, but over the long term they would strengthen the nation’s

economy and overall living standards. Early action would permit changes

to be phased in and so give those affected by changes in, for example,

Social Security or health care benefits, time to adjust.

In considering what fiscal adjustments to make, policymakers need to be

presented with more complete information on the costs of the

government’s existing long-term commitments. The budget’s current

structure and reporting mechanisms have not focused attention on such

commitments, nor has the budget process facilitated their explicit

consideration. Financial statements are beginning to provide some of this

information. Options to change budget reporting and process to improve

recognition of these commitments and prompt early action to address

potential problems warrant further exploration.

Policy Action

Contributes to

Improved Fiscal

Outlook

In recent years, the federal deficit has declined substantially from

$290 billion in fiscal year 1992—4.7 percent of GDP—to a CBO projected

level of $23 billion in fiscal year 1997—0.3 percent of GDP, which would be

the lowest level since 1974. This improvement is due, in part, to deficit

reduction initiatives enacted in 1990 and 1993 as well as to subsequent

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spending restraint.7 The Balanced Budget Act of 1997, coupled with the

strong recent performance of the economy,8

 is expected to extend this

recent progress by achieving a balanced budget in 2002 followed by

several years of budget surpluses on a unified budget basis.9

 The decline in

the deficit has significantly slowed growth in the federal debt held by the

public. As a share of GDP, this commonly used measure of federal debt is

projected by CBO to decline from about 50 percent in fiscal year 1993 to

30 percent in 2007.

The improving fiscal outlook over the near term carries longer term

benefits as well, as illustrated by comparing our current “no action”

simulation with our 1992 and 1995 modeling results. (See figure 2.) Our

initial modeling work in 1992 indicated that even in the short term,

prospective deficits would fuel a rapidly rising debt burden. Intervening

economic and policy developments led to some improvement by the time

we issued our 1995 report, as shown by a modest shift outward of the “no

action” deficit path. Nonetheless, both our 1992 and 1995 “no action”

simulations indicated that deficits would have reached 20 percent of GDP in

the 2020s. In contrast, the 1997 “no action” path—which follows CBO’s

10-year forecast—indicates small and shrinking deficits over the next few

years, followed by a decade of surpluses. Following the enactment of the

BBA in 1997, our simulation indicates that deficits would not reach the

20-percent level until nearly 2050. For purposes of comparison, the highest

deficit level reached since World War II was 6.1 percent of GDP in 1983.

Figure 3 illustrates the improvement in the long-term outlook for the

federal debt as a share of GDP stemming from recent policy actions and

economic developments.

7

Recent legislation attempting to control the deficit included the Omnibus Budget Reconciliation Act

of 1990, the Budget Enforcement Act of 1990, and the Omnibus Budget Reconciliation Act of 1993.

8

Policy action accounted for about 25 percent of the recent improvement in CBO’s budget estimates.

The remainder of the improvement was due primarily to economic factors.

9

The unified budget includes annual Social Security trust fund surpluses. These surpluses are expected

to be temporary, peaking at $140 billion (including interest) in 2009 before declining and eventually

turning to deficits in the following decade. For additional information, see Federal Debt and Interest

Costs, CBO, May 1993, and Federal Debt: Answers to Frequently Asked Questions (GAO/AIMD-97-12,

November 27, 1996).

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Figure 2: Deficit Paths Under GAO’s

Past and Present “No Action”

Simulations

1997 2002 2010 2020 2030 2040 2050

-5

0

5

10

15

20

25

Years

Percent of GDP

 No action 

1992

 No action 

1995

 No action after BBA 

1997

Long-Term

Implications of

Current Fiscal Policy

Path

These recent fiscal improvements represent substantial progress in the

near term toward a more sustainable fiscal policy. However, longer term

problems remain. As in our earlier work, a “no action” policy remains

unsustainable over the long term. (See figure 2.) While the federal budget

would be in surplus in the first decade of the 21st century, deficits would

reemerge in 2012, soon after the baby boom generation begins to retire.

These deficits would then escalate, exceeding 6 percent of GDP before 2030

and exceeding 20 percent of GDP by 2050.

A comparison of federal debt to the size of the economy tells a similar

story—near-term improvement followed by potentially unsustainable

growth as the baby boomers retire. (See figure 3.) In the early years of the

simulation period, budget surpluses produce a substantial reduction in the

absolute size of the debt as well as in the relationship of debt to GDP, from

today’s level of around 50 percent to about 20 percent in 2015. However, at

that point, the debt to GDP ratio begins to rise rapidly, returning to today’s

levels in the late 2020s and growing to more than 200 percent by 2050.

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Figure 3: Debt-to-GDP Ratios Under

GAO’s Past and Present “No Action”

Simulations

1997 2010 2020 2030 2040 2050

0

50

100

150

200

250

Years

Percent of GDP

 No action 

1992

 No action 

1995

 No action after BBA 

1997

Such levels of deficits and debt imply a substantial reduction in national

saving, private investment, and the capital stock. Given our labor force

and productivity growth assumptions, GDP would inevitably begin to

decline. These negative effects of rapidly increasing deficits and debt on

the economy would force action at some point before the end of the

simulation period. Policymakers would likely act before facing probable

consequences such as rising inflation, higher interest rates, and the

unwillingness of foreign investors to invest in a weakening American

economy. Therefore, as we have noted in our past work, the “no action”

simulation is not a prediction of what will happen in the future. Rather, it

underscores the need for additional action in the future to address the

nation’s long-term fiscal challenges.

The primary causes of the large deficits in the “no action” simulation are

(1) the aging of the U.S. population, which corresponds to slower growth

in the labor force and faster growth in entitlement program spending, and

(2) the rising costs of providing federal health care benefits. In 2008, the

first baby boomers will be eligible for early retirement benefits. As this

relatively large generation retires, labor force growth is expected to slow

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considerably and, eventually, stop altogether. These demographic changes

mean fewer workers to support each retiree. Between 1997 and 2025, the

number of workers per Social Security beneficiary is projected to drop by

33 percent. Without a major increase in productivity, low labor force

growth will inevitably lead to slower growth in the economy and in federal

revenue. As slow growth in the labor force constrains revenue growth, the

large retired population will place major expenditure demands on Social

Security, Medicare, and Medicaid. In just 15 years, the Social Security

trustees estimate that the program’s tax revenue is expected to be

insufficient to cover current benefits. While the recent Balanced Budget

Act included some actions to restrain growth in Medicare spending and

increase income from beneficiary premiums, the program is still expected

to grow faster than the economy over the next several years. According to

CBO estimates, the Hospital Insurance Trust Fund portion of Medicare will

be depleted in 2007, even before retiring baby boomers begin to swell the

ranks of Medicare beneficiaries.10 Medicaid spending will also be under

increasing pressure as the population ages because a large share of

program spending goes to cover nursing home care.

In the “no action” simulation, Social Security spending as a share of GDP

increases by nearly 50 percent between now and 2030. By 2050, it

approaches twice today’s level. Health care spending, fueled by both an

increased number of beneficiaries and (in the early years of the simulation

period) rising per beneficiary costs, would grow even more

rapidly—doubling as a share of GDP by 2030 and tripling by 2050. As Social

Security and health spending rise, their share of federal spending grows

tremendously. (See figure 4.) By the mid-2040s, spending for these

programs alone would consume more than 100 percent of federal

revenues.

10Congress and the President have recognized the need for further changes in Medicare by establishing

a National Bipartisan Commission on the Future of Medicare as part of the BBA.

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Figure 4: Long-Term Change in

Composition of Spending as a

Percentage of GDP Under “No Action”

Simulation

1997 2030 (BBA) 2050 (BBA)

0

10

20

30

40

50

Years

Percent of GDP

Social Security Medicare & Medicaid Net interest All other spending 

Revenue

After initially declining, interest spending also increases significantly in

the “no action” simulation. In the early years of the simulation period,

budget surpluses reduce the burden of interest spending on the economy.

However, when the surpluses give way to deficits, this decline is reversed.

Growing deficits add substantially to the national debt. Rising debt, in

turn, raises spending on interest, which compounds the deficit problem,

resulting in a vicious circle. The effects of compound interest are clearly

visible in figure 5, as interest spending rises from about 3 percent of GDP in

1997 to over 12 percent in 2050.

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Figure 5: Net Interest as a Percentage

of GDP Under “No Action” Simulation

1997 2010 2020 2030 2040 2050

0

2

4

6

8

10

12

14

Years

Percent of GDP

Alternative Fiscal

Policies Would

Change Long-Term

Economic Outcomes

Alternatives to a “no action” policy illustrate the fiscal and economic

benefits associated with maintaining a sustainable course. According to

one definition, under a sustainable fiscal policy, existing government

programs can be maintained without a continual rise in the debt as a share

of GDP.

11 Under an unsustainable policy, such as “no action,” the debt

continually rises as a share of GDP. As illustrated in our past reports and

CBO’s work,12 a number of different policy paths could be sustained over

the long term. In our current work, we tested three different long-term

fiscal strategies, one that would allow for modest deficits, one that would

maintain a balanced budget, and one that would include an extended

period of surpluses. (See figure 6.)

11For a detailed analysis of sustainability, see Olivier Blanchard, Jean-Claude Chouraqui, Robert P.

Hagemann, and Nicola Sartor, “The Sustainability of Fiscal Policy: New Answers to an Old Question,”

OECD Economic Studies, no. 15 (Autumn 1990). See also The Canadian Institute of Chartered

Accountants, Indicators of Government Financial Condition, April 1997.

12Congressional Budget Office, Long-Term Budgetary Pressures and Policy Options, March 1997.

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Figure 6: Alternate Deficit/Surplus

Paths

1997 2002 2010 2020 2030

-2

0

2

4

6

8

Years

Percent of GDP

No action

after BBA

Constant

debt burden*

Maintain

balance

Save SS

surplus**

Note: Overlapping lines enhanced for clarity. As discussed in the text, these lines represent

identical paths.

*Debt-GDP ratio is maintained at lowest level reached in “no action.”

**Social Security surpluses (including interest) are saved from 2000-2018, then balance is

maintained.

The “constant debt burden” simulation follows the “no action” path

through 2015. From this point on, the debt is held constant as a share of

GDP, rather than increasing as in the “no action” simulation.13 To prevent

the debt burden from rising from its 2015 level of about 20 percent of GDP,

the federal government would have to hold annual deficits to roughly

1 percent of GDP. While not insignificant, this deficit level is relatively small

compared to the federal deficits of recent years or to deficits in other

industrial nations. For example, the European Union has established a

deficit target of 3 percent of GDP for countries participating in the common

currency arrangement.

13Prior to 2016, the debt declines as a share of the economy due to the improved fiscal outlook for the

near term.

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The “maintain balance” simulation also follows the “no action” path for the

early part of the simulation period. In 2012—the year that deficits

reemerge under “no action”—a balanced unified budget would be

achieved. Balance would then be sustained through the remainder of the

simulation period.

Going beyond balance by running larger budget surpluses for a longer

period of time than in the other simulations would yield additional

economic benefits by further raising saving and investment levels. For our

“surplus” simulation, we chose as a goal ensuring that annual Social

Security surpluses (including interest that is credited to the fund) add to

national saving. To achieve this goal, the federal government would run

unified budget surpluses equal in size to the annual Social Security

surpluses—which the Social Security Trustees estimate will peak at

$140 billion in 2009. Such a policy means that the rest of the federal

government’s budget would be in balance. Social Security’s surpluses

(including interest income) are projected to end in 2018. Beginning in

2019, our simulation follows a unified budget balance identical to the path

in our balance simulation.

Figure 7 shows the debt-to-GDP paths associated with the various

simulations. Under the “constant debt burden” simulation, the debt-GDP

ratio remains around 20 percent, which is the lowest point reached in “no

action.” Under both the “balance” and “surplus” simulations, the debt-GDP

measure would decline to less than 10 percent of GDP—levels that the

United States has not experienced since before World War I.

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Figure 7: Debt-to-GDP Ratios Under

GAO’s Four Fiscal Policy Simulations

1997 2010 2020 2030

0

10

20

30

40

50

60

70

Years

Percent of GDP

 No action 

 after BBA 

 Constant 

 debt burden* 

 Maintain 

 balance 

 Save SS 

 surplus** 

*Debt-GDP ratio is maintained at lowest level reached in “no action.”

**Social Security surpluses (including interest) are saved from 2000-2018, then balance is

maintained.

Each of the alternative simulations would require some combination of

policy or program changes that reduce spending and/or increase revenues.

We make no assumptions about the mix of those changes in our analysis.

We recognize that such actions would not be taken without difficulty.

They would require difficult choices resulting in a greater share of national

income devoted to saving. While consumption would be reduced in the

short term, it would be increased over the long term. Early action would

permit changes to be phased in and so give those affected by changes in,

for example, Social Security or health care benefits, time to adjust.

For both the federal government and the economy, any of the three

alternative simulations indicates a vast improvement over the “no action”

path. Sharply reduced interest costs provide the most striking budgetary

benefit from following a sustainable policy. Currently, interest spending

represents about 15 percent of federal spending, a relatively large share

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that is a consequence of the deficits of the 1980s and early 1990s. As noted

above, after shrinking in the early years of the “no action” simulation,

interest costs increase sharply over the long term. In contrast, under the

alternative simulations, the interest burden shrinks dramatically. (See

figure 8.) By 2050, under either a balance or surplus policy, interest

payments would represent 1 percent or less of total spending. Even under

the less austere “constant debt burden” simulation, interest would account

for only about 5 percent of spending.

Figure 8: Net Interest as a Share of

Total Spending in 2050 Under GAO’s

Four Fiscal Policy Simulations

0

5

10

15

20

25

30

35

28.8

4.8

1.0 0.5

Net interest

Percent of total spending

No action

after BBA 

Constant

debt burden 

Maintain

balance 

Save SS

surplus*

*Interest spending equals less than 1 percent of total spending.

The economic benefits of a sustainable budget policy include increased

saving and investment levels and faster economic growth, which results in

higher living standards. For example, under any of our alternative

simulations, per capita GDP would nearly double between 1996 and 2050. In

contrast, under “no action,” growth in living standards would slow

considerably and living standards themselves would actually begin to

decline around 2040. By 2050, they would be nearly 40 percent lower than

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under the balance simulation. This difference results from a wide gap in

private investment. Under “no action,” large deficits eventually drive

private investment spending down to zero while, for example, a balanced

budget policy could produce a doubling of investment, as shown in table

1.14 In the “no action” simulation, capital depreciation would outweigh

investment, resulting in a diminishing capital stock and, eventually,

contributing to a falling GDP.

Table 1: The Economy and Fiscal

Position in 1996 (Actual) and 2050

(Simulated)

In per capita 1997 dollars

1996

2050—

“No action”

2050—

“Balance”

Percent difference

between “no action”

and “balance” in 2050

Real GDP $29,300 $40,900 $56,500 38%

Debt Held by the Public $14,500 $107,100 $2,400 –98%

Nonfarm business

investment $3,000 $0 $6,700 N/A

Nonfarm capital stock $29,400 $17,400 $59,900 244%

Note: Based on Social Security Administration population projections.

Figure 9 compares the path of per capita GDP under “no action” to a

balanced budget policy. This difference graphically shows the emerging

gap in long-term living standards that results from shifting fiscal policy

paths. Although the “maintain balance” path would lead to higher living

standards, the rate of growth would be significantly lower than that

experienced over the past 50 years. Such a rate would be extremely

difficult to attain given the slowdown in productivity growth that has

occurred in recent decades.

14Long-range simulations are quite sensitive to underlying assumptions and involve a large range of

uncertainty. Hence, the amounts in table 1 should not be viewed as precise “point” estimates. Rather,

they indicate the general magnitude of the differences that might result from different fiscal policy

paths.

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Figure 9: GDP per Capita Projected

Under the “No Action” and “Balance”

Simulations

1946 1955 1965 1975 1985 1997 2010 2020 2030 2040 2050

0

10,000

20,000

30,000

40,000

50,000

60,000

Years

Per capita 1997 dollars

 Historical 

data

 No action 

after BBA

 Maintain 

balance

Source: GAO analysis of 1946-1996 historical data, GAO’s GDP simulations, and Social Security

Administration population projections.

Long-Term

Commitments Not

Adequately Reflected

in Budget Reporting

and Process

Long-term economic simulations are a useful tool for examining the

balance between the government’s future obligations and expected

resources. This longer term perspective is necessary to understand the

fiscal and spending implications of key government programs and

commitments extending over a longer time horizon.15

The future implications of current policy decisions reflected in our

simulations and in other financial reports are generally not captured in the

budget process. The budget is generally a short-term, cash-based spending

plan focusing on the short- to medium-term cash implications of

government obligations and fiscal decisions. Accordingly, it does not

provide all of the information on the longer term cost implications

stemming from the government’s commitments when they are made. While

the sustainability of the government’s fiscal policy is driven primarily by

future spending for social security and health care commitments, the

federal government’s commitments and responsibilities extend far beyond

these programs. These commitments may, themselves, result in large costs

15Budget Process: Evolution and Challenges (GAO/T-AIMD-96-129, July 11, 1996).

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that can encumber future fiscal resources and unknowingly constrain the

government’s future financial flexibility to meet all its commitments as

well as any unanticipated or emerging needs.

Information about the cost of some of these commitments will be

increasingly available as agencies produce audited financial statements.

We anticipate that they will provide additional information on long-term

commitments, including such items as environmental cleanup and

insurance. For example, in its 1996 financial statements, the Department

of Energy reported a cost of $229 billion to clean up its existing

contaminated sites. The Department of Defense will also be developing

and reporting cleanup costs in financial statements. The Office of

Management and Budget has estimated that the government is likely to

have to pay $31 billion in future claims resulting from the federal

government’s insurance commitments. The first audited governmentwide

financial statements will be issued for fiscal year 1997. This represents a

key step in the government’s efforts to improve financial management and

provide greater transparency and accountability for the costs of

government commitments and programs.

The key challenge facing budget decisionmakers is to integrate this

information into the budget process. A range of options can be considered.

A logical first step would be to include understandable supplemental

financial information on the government’s long-term commitments and

responsibilities in the budget. For example, in a recent report we

concluded that supplemental reporting of accrual-based costs of insurance

programs would improve recognition of the government’s commitments.16

Other options to refine the budget process or budget reporting to improve

the focus on these commitments and prompt early action to address

potential problems can be explored. For example, long-term simulations of

current or proposed budget policies could be prepared periodically to help

the Congress and the public assess the future consequences of current

decisions. Another option, which would supplement the current practice

of tracking budget authority and outlays, would be to provide information

to permit tracking the estimated cost of all long-term commitments

created each year in the budget.

16See Budget Issues: Budgeting for Federal Insurance Programs (GAO/AIMD-97-16, September 30,

1997).

Page 18 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
B-278394 

Objectives, Scope and

Methodology

In this report, the analysis of alternative fiscal policy paths relies in

substantial part on an economic growth model that we adapted from a

model developed by economists at the FRBNY. The model reflects the

interrelationships between the budget and the economy over the long term

and does not capture their interaction during short-term business cycles.

The main influence of budget policy on long-term economic performance

is through the effect of the federal deficit on national saving. Conversely,

the rate of economic growth helps determine the overall federal deficit or

surplus through its effect on revenues and spending. Federal deficits

reduce national saving while federal surpluses increase national saving.

The level of saving affects investment and, in turn, GDP growth.

Budget assumptions in the model rely, to the extent practicable, upon the

baseline projections in CBO’s September 1997 report, The Economic and

Budget Outlook: An Update, through 2006, the last year for which CBO

projections are available in a format usable by our model. These estimates

are used in conjunction with our model’s simulated levels of GDP. For

Medicare, we assumed growth consistent with CBO’s projections and the

Health Care Financing Administration’s long-term intermediate

projections from the Medicare Trustees’ April 1997 report. For Medicaid

through 2006, we similarly assumed growth consistent with CBO’s budget

projections. For 2007 and thereafter, we used estimates of Medicaid

growth from CBO’s March 1997 report, Long-Term Budgetary Pressures and

Policy Options. For Social Security, we used the April 1997 intermediate

projections from the Social Security Trustees throughout the simulation

period. Other mandatory spending is held constant as a percentage of GDP

after 2006. Discretionary spending and revenues are held constant as a

share of GDP after 2006. Our interest rate assumptions are based on CBO

through 2006 and then move to a fixed rate. (See appendix I for a more

detailed description of the model and the assumptions we used.)

We conducted our work from September to October 1997 in accordance

with generally accepted government auditing standards. We received

comments from experts in fiscal and economic policy on a draft of this

report and have incorporated them as appropriate.

We are sending copies of this report to the Ranking Minority Members of

your Committees, interested congressional committees, the Director of the

Congressional Budget Office, and the Director of the Office of

Management and Budget. We will make copies available to others upon

Page 19 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
B-278394 

request. The major contributors to this report are listed in appendix II. If

you have any questions concerning this report, please call me at

(202) 512-9573.

Paul L. Posner

Director, Budget Issues

Page 20 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Page 21 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Contents

Letter 1

Appendix I 

The Economic Model

and Assumptions

24

Appendix II 

Major Contributors to

This Report

28

Related GAO Products 32

Tables Table 1: The Economy and Fiscal Position in 1996 and 2050 16

Table I.1: Key Assumptions 26

Figures Figure 1: Effect of the Federal Budget Deficit on Net National

Saving

3

Figure 2: Deficit Paths Under GAO’s Past and Present “No

Action” Simulations

7

Figure 3: Debt-to-GDP Ratios Under GAO’s Past and Present “No

Action” Simulations

8

Figure 4: Long-Term Change in Composition of Spending as a

Percentage of GDP Under “No Action” Simulation

10

Figure 5: Net Interest as a Percentage of GDP Under “No Action”

Simulation

11

Figure 6: Alternate Deficit/Surplus Paths 12

Figure 7: Debt-to-GDP Ratios Under GAO’s Four Fiscal Policy

Simulations

14

Figure 8: Net Interest as a Share of Total Spending in 2050 Under

GAO’s Four Fiscal Policy Simulations

15

Figure 9: GDP per Capita Projected Under the “No Action” and

“Balance” Simulations

17

Page 22 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Contents

Abbreviations

CBO Congressional Budget Office

FRBNY Federal Reserve Bank of New York

GDP gross domestic product

HCFA Health Care Financing Administration

NIPA National Income and Product Account

OASDI Old Age Survivors’ and Disability Insurance

BBA Balanced Budget Act of 1997

Page 23 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Appendix I 

The Economic Model and Assumptions

This update of GAO’s work1 on the long-term economic and budget outlook

relies in large part on a model of economic growth developed by

economists at the Federal Reserve Bank of New York (FRBNY). The major

determinants of economic growth in the model include changes in the

labor force, capital formation, and the growth in total factor productivity.

To analyze the long-term effects of fiscal policy, we modified the FRBNY’s

model to include a set of relationships that describe the federal budget and

its links to the economy. The simulations generated using the model

provide qualitative illustrations, not quantitative forecasts, of the budget or

economic outcomes associated with alternative policy paths. The model

depicts the links between the budget and the economy over the long term,

and does not reflect their interrelationships during short-term business

cycles.

The main influence of budget policy on long-term economic performance

in the model is through the effect of the federal deficit or surplus on

national saving. Higher federal deficits reduce national saving while lower

deficits or surpluses increase national saving. The level of saving affects

investment and, hence, gross domestic product (GDP) growth.

GDP is determined by the labor force, capital stock, and total factor

productivity.2 GDP in turn influences nonfederal saving, which consists of

the saving of the private sector and state and local government surpluses

or deficits. Through its effects on federal revenues and spending, GDP also

helps determine the federal budget deficit or surplus. Nonfederal and

federal saving together constitute national saving, which influences private

investment and the next period’s capital stock. Capital combines with

labor and total factor productivity to determine GDP in the next period and

the process continues.

There are also important links between national saving and investment

and the international sector. In an open economy such as the United

States, a decrease in saving due to, for example, an increase in the federal

budget deficit, does not require an equivalent decrease in investment.

Instead, part of the saving shortfall may be filled by foreign capital inflows.

A portion of the net income that results from such investments flows

abroad. In this update, we retained the assumption in our prior work that

1

Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to the Economy

(GAO/OCG-92-2, June 5, 1992) and The Deficit and The Economy: An Update of Long-Term

Simulations (GAO/AIMD/OCE-95-119, April 26, 1995).

2

Total factor productivity reflects sources of growth not captured in aggregate labor and capital

measures, including technological change, labor quality improvements, and the reallocation of

resources to more productive uses.

Page 24 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Appendix I 

The Economic Model and Assumptions

net foreign capital inflows rise by one-third of any decrease in the national

saving rate.

Table I.1 lists the key assumptions incorporated in the model. The

assumptions used tend to provide conservative estimates of the benefit of

reducing deficits or running surpluses and of the harm of increasing

deficits. The interest rate on the national debt is held constant, for

example, even when deficits climb and the national saving rate plummets.

Under such conditions, the more likely result would be a rise in the rate of

interest and a more rapid increase in federal interest payments than our

results display. Another conservative assumption is that the rate of total

factor productivity growth is unaffected by the amount of investment.

Productivity is assumed to advance 1 percent each year even if investment

collapses. Such assumptions suggest that changes in deficits or surpluses

could have greater effects than our results suggest.

Page 25 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Appendix I 

The Economic Model and Assumptions

Table I.1: Key Assumptions

Model inputs Assumptions

Saving rate: gross saving of the private

sector and state and local government

sector

17.5% of GDP

Labor: growth in hours worked Follows the Social Security Trustees’

Alternative II projections

Total factor productivity growth 1%

Inflation rate Follows CBO through 2007; 2.7% thereafter

Interest rate (average on the national debt) Average effective rate implied by CBO’s

interest payment projections through 2006;

5.1% thereafter (CBO’s 2006 implied rate)

Surplus/deficit Follows CBO’s budget surplus/deficit as a

percentage of GAO’s GDP through 2006;

GAO simulations thereafter

Discretionary spending CBO through 2006; increases at the rate of

economic growth thereafter

Medicare CBO through 2006; increases at HCFA’s

projected rate thereafter

Medicaid CBO’s projections

OASDI Follows the Social Security Trustees’

Alternative II projections

Other mandatory spending CBO’s assumed levels through 2006;

increases at the rate of economic growth

thereafter

Receipts CBO’s assumed levels through 2006; in

subsequent years, receipts equal 19.9% of

GDP (2006 ratio)

Note: 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 2007, permitting the calculation

of calendar year values through 2006.

We have made several modifications to the model, but the model’s

essential structure remains the same as in our previous work. We have

incorporated the change in the definition of government saving in the

National Income and Product Accounts (NIPA) adopted in late 1995 by

adding a set of relationships determining government investment, capital

stock, and the consumption of fixed capital.

The more recent data prompted several parameter changes. For example,

the long-term inflation rate is now assumed to be 2.7 percent, down from

3.4 percent in our 1995 report and 4.0 percent in our 1992 report. In this

update, the average federal borrowing rate steadily declines to 5.1 percent,

compared to our assumption of 7.2 percent in 1995 and 7.8 percent in 1992.

Page 26 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Appendix I 

The Economic Model and Assumptions

Our work also incorporates the marked improvement in the budget

outlook stemming from the Balanced Budget Act of 1997 reflected in the

10-year budget projections that CBO published in September 1997.

The distinction between the mandatory and discretionary components of

the budget remains important. We adopted CBO’s assumption from their

most recent 10-year forecast that discretionary spending equals the

statutory caps from fiscal years 1998 through 2002 and increases at the

rate of inflation from fiscal years 2003 through 2007. We assumed it would

keep pace with GDP growth thereafter.

Mandatory spending includes Health (Medicare and Medicaid), Old Age

Survivors’ and Disability Insurance (OASDI, or Social Security), and a

residual category covering other mandatory spending. Medicare reflects

CBO’s assumptions through 2006 and increases at HCFA’s projected rate in

subsequent years. Medicaid is based on CBO’s September 1997

assumptions; thereafter, it increases at the rates embodied in CBO’s

March 1997 report on the long-term budget outlook. OASDI reflects the

April 1997 Social Security Trustees’ Alternative II projections.

Other mandatory spending is a residual category consisting of all

nonhealth, non-Social Security mandatory spending. It equals CBO’s NIPA

projection for Transfers, Grants, and Subsidies less Health, OASDI, and

other discretionary spending. Through 2006, CBO assumptions are the main

determinant of other mandatory spending, after which its growth is linked

to that of GDP.

The interest rates for 1997 through 2006 are consistent with the average

effective rate implied by CBO’s interest payment projections. We assume

that the average rate remains at the 2006 rate of 5.1 percent for the rest of

the simulation period.

Receipts follow CBO’s dollar projections through 2006. Thereafter, they

continue at 19.9 percent of GAO’s simulated GDP, which is the rate projected

for 2006.

As these assumptions differ somewhat from those used in our earlier

reports, only general comparisons of the results can be made.

Page 27 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Appendix II 

Major Contributors to This Report

Accounting and

Information

Management Division,

Washington, D.C.

Christine E. Bonham, Assistant Director

Andrew D. Eschtruth, Evaluator-in-Charge

James R. McTigue, Jr., Senior Evaluator

MaryLynn Sergent, Senior Evaluator

Office of the Chief

Economist

Richard S. Krashevski, Economist

Page 28 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Page 29 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Page 30 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Page 31 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
Related GAO Products

Budget Issues: Budgeting for Federal Insurance Programs (GAO/AIMD-97-16,

September 30, 1997).

Retirement Income: Implications of Demographic Trends for Social

Security and Pension Reform (GAO/HEHS-97-81, July 11, 1997).

Addressing the Deficit: Budgetary Implications of Selected GAO Work for

Fiscal Year 1998 (GAO/OCG-97-2, March 14, 1997).

Federal Debt: Answers to Frequently Asked Questions (GAO/AIMD-97-12,

November 27, 1996).

Budget Process: Evolution and Challenges (GAO/T-AIMD-96-129, July 11, 1996).

Deficit Reduction: Opportunities to Address Long-standing Government

Performance Issues (GAO/T-OCG-95-6, September 13, 1995).

The Deficit and the Economy: An Update of Long-Term Simulations

(GAO/AIMD/OCE-95-119, April 26, 1995).

Deficit Reduction: Experiences of Other Nations (GAO/AIMD-95-30,

December 13, 1994).

Budget Issues: Incorporating an Investment Component in the Federal

Budget (GAO/AIMD-94-40, November 9, 1993).

Budget Policy: Prompt Action Necessary to Avert Long-Term Damage to

the Economy (GAO/OCG-92-2, June 5, 1992).

The Budget Deficit: Outlook, Implications, and Choices (GAO/OCG-90-5,

September 12, 1990).

(935248) Page 32 GAO/AIMD/OCE-98-19 Long-Term Fiscal Outlook
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