Long-Term Fiscal Outlook: Action Is Needed to Avoid the Possibility of a Serious Economic Disruption in the Future
Published: 2008-01-29T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO has for many years warned that our nation is on an imprudent and unsustainable fiscal path. During the past 3 years, the Comptroller General has traveled to 25 states as part of the Fiscal Wake-Up Tour. Members of this diverse group of policy experts agree that finding solutions to the nation's long-term fiscal challenge will require bipartisan cooperation, a willingness to discuss all options, and the courage to make tough choices. At the request of Chairman Conrad and Senator Gregg, the Comptroller General discussed the long-term fiscal outlook, our nation's huge health care challenge, and the shrinking window of opportunity for action.
section_title: What GAO Found
paragraphs: As we enter 2008, what we call the long-term fiscal challenge is not in the distant future. Already the first members of the baby boom generation have filed for early Social Security retirement benefits--and will be eligible for Medicare in only 3 years. Simulations by GAO, the Congressional Budget Office (CBO), and others all show that despite a 3-year decline in the budget deficit, we still face large and growing structural deficits driven primarily by rising health care costs and known demographic trends. Under any plausible scenario, the federal budget is on an imprudent and unsustainable path. Rapidly rising health care costs are not simply a federal budget problem; they are our nation's number one fiscal challenge. Growth in health-related spending is the primary driver of the fiscal challenges facing the state and local governments. Unsustainable growth in health care spending is a systemwide challenge that also threatens to erode the ability of employers to provide coverage to their workers and undercut our ability to compete in a global marketplace. Addressing the unsustainability of health care costs is a societal challenge that calls for us as a nation to fundamentally rethink how we define, deliver, and finance health care in both the public and the private sectors. The passage of time has only worsened the situation: the size of the challenge has grown and the time to address it has shrunk. The longer we wait the more painful and difficult the choices will become, and the greater the risk of a very serious economic disruption. It is understandable that the Congress and the administration are focused on the need for a short-term fiscal stimulus. However, our long-term challenge increases the importance of careful design of any stimulus package--it should be timely, targeted, and temporary. At the same time, creating a capable and credible commission to make recommendations to the next Congress and the next president for action on our longer-range and looming fiscal imbalance is called for.

section_title: Letter
paragraphs: I appreciate this invitation to talk with you about our nation’s long-term  fiscal outlook as we enter 2008—and the challenge it continues to present  for the future of America and Americans. Your decision to dedicate a  hearing to this important issue again demonstrates the seriousness with  which you and this Committee view our nation’s large and growing fiscal  challenge. Senators Conrad and Gregg, thank you for your leadership.
I wish I could say the long-term outlook is different than when I last  appeared before you on Halloween—but as all of you know, it is not.  Under any plausible scenario, the federal budget is on an imprudent and  unsustainable path. Long-term fiscal simulations by GAO, the  Congressional Budget Office (CBO), and others all show that despite a 3- year decline in the federal government’s unified budget deficit, we still  face large and growing structural deficits driven primarily by rising health  care costs and known demographic trends. The passage of time only  serves to worsen this situation: the size of the challenge has grown and the  time to address it has shrunk. Already the first members of the baby boom  generation have filed for early Social Security retirement benefits—and  will be eligible for Medicare in only 3 years. Although Social Security is  important because of its size, the real driver of the long-term fiscal outlook  is health care spending. Medicare and Medicaid are both large and  projected to continue growing rapidly in the future.
Everyone on this Committee is well aware of the nature and importance of  the challenge we face. Today, therefore, I will emphasize a few key points:    Although recent declines in the annual budget deficit are good news, our  longer-term fiscal outlook is worse—and absent meaningful action we will  face spiraling levels of debt.
Our long-term fiscal challenge is primarily a health-care challenge.    We face an increasing need and yet a shrinking window of opportunity for  action.
My remarks are based on GAO’s previous work, including various reports  and testimonies on our nation’s long-term fiscal challenges, health care,  and the need for budget process reform. These efforts were conducted in  accordance with generally accepted government auditing standards.
subsections: section_title: Despite Several Years of Declining Annual Budget Deficits, the Long-Term Outlook Has Worsened
paragraphs: Between fiscal years 2003 and 2007 the unified budget deficit declined.  Certainly declining deficits are better than rising deficits. But this decline  in the unified deficit is not an indicator that our challenge has eased. First,  even this short-term deficit is understated: It masks the fact that the  federal government has been using the Social Security surplus to offset  spending in the rest of government for many years. If we exclude that  Social Security surplus, the on-budget deficit—what I call the operating  deficit—in fiscal year 2007 was more than double the size of the unified  deficit. For example, the Department of the Treasury (Treasury) reported  a unified deficit of $163 billion and an on-budget deficit of $344 billion in  fiscal year 2007. The accrual-based net operating deficit reported in the  Financial Report of the United States Government was also significantly  higher than the unified deficit—$276 billion for fiscal year 2007. This  measure provides more information on the longer-term implications of  today’s policy decisions and operations than does either cash-based figure,  but it too offers an incomplete picture of the long-term fiscal challenge.
As we recently reported, several countries have begun preparing fiscal  sustainability reports to help assess the implications of their public  pension and health care programs and other challenges in the context of  overall sustainability of government finances. European Union members  also annually report on longer-term fiscal sustainability. The goal of these  reports is to increase public awareness and understanding of the long-term  fiscal outlook in light of escalating health care cost growth and population  aging, to stimulate public and policy debates, and to help policymakers  make more informed decisions. These countries used a variety of  measures, including projections of future revenue and spending and  summary measures of fiscal imbalance and fiscal gaps, to assess fiscal  sustainability. Last year, we recommended that the United States should  prepare and publish a long-range fiscal sustainability report every 2 to 4  years.
Despite these improvements in short-term deficits, the long-term outlook  continued to move in the wrong direction. Even in 2001—in a time of  annual surpluses—GAO’s long-term simulations showed a long-term  challenge, but at that time it was more than 40 years out. Although an  economic slowdown, decisions driven by the attacks of 9/11, and the need  to respond to natural disasters have contributed to the change in outlook,  they do not account for the dramatic worsening in the long-term outlook  since 2001. Subsequent tax cuts and the passage of the Medicare  prescription drug benefit in 2003 were also major factors, but they are not  the only actions that challenge fiscal discipline. For example, one might  also question the current farm bill in the face of reported record farm  income.
As the Committee knows, CBO’s latest projections show the deficit rising  in response to a weakening economy. Neither this increase nor the recent  declines tell us much about our long-term path. Rather, our long-term path  must inform how we deal with the near-term weakness.
Our real challenge then is not this year’s deficit or even next year’s; it is  how to change our current path so that growing deficits and debt levels do  not swamp our ship of state. Health care costs are still growing much  faster than the economy and our population is still aging. The retirement  of the baby boom generation and the rising health care costs will soon  place unprecedented and long-lasting stress on the federal budget, raising  debt held by the public to unsustainable levels.
Figure 1 shows GAO’s simulation of the deficit path based on recent trends  and policy preferences. In this we assume that the expiring tax cuts are  extended through 2017—and then revenues are brought to their historical  level as a share of gross domestic product (GDP)—that discretionary  spending grows with the economy and no structural changes are made to  Social Security, Medicare, or Medicaid.
Rapidly rising health care costs are not simply a federal budget problem;  they are our nation’s number one fiscal challenge. As shown in figure 2,  GAO’s fiscal model demonstrates that state and local governments— absent policy changes—will also face large and growing fiscal challenges  beginning within the next few years. As is true for the federal budget,  growth in health-related spending—Medicaid and health insurance for  state and local employees and retirees—is the primary driver of the fiscal  challenges facing the state and local governments.
For the federal government increased spending and rising deficits will  drive a rising debt burden. At the end of fiscal year 2007, debt held by the  public exceeded $5.0 trillion. Figure 3 shows that this growth in our debt  cannot continue unabated without causing serious harm to our economy.  But this is only part of the story. The federal government has been  spending the surpluses in the Social Security and other trust funds for  years; if we include debt held by those funds, our total debt is much  higher—$9.0 trillion. On September 29, 2007, the statutory debt limit had  to be raised for the third time in 4 years; between the end of fiscal year  2003 and the end of fiscal year 2007 the debt limit had to be increased by  one-third. Although borrowing by one part of the federal government from  another may not have the same economic and financial implications as  borrowing from the public, it represents a claim on future resources and  hence a burden on future taxpayers and the future economy.
As alarming as the size of our current debt is, it excludes many items,  including the gap between future promised and funded Social Security and  Medicare benefits, veterans’ health care, and a range of other  commitments and contingencies that the federal government has pledged  to support. If these items are factored in, the total burden in present value  dollars is estimated to be about $53 trillion. I know it is hard to make  sense of what “trillions” means. One way to think about it is this: Imagine  we decided to put aside and invest today enough to cover these promises  tomorrow. It would take approximately $455,000 per American  household—or $175,000 for every man, woman, and child in the United  States.
Clearly, despite some progress in addressing our short-term deficits, we  have not made progress on our long-term fiscal challenge. In fact, we have  lost and continue to lose ground absent meaningful action (see fig. 4).
section_title: Our Long-Term Fiscal Outlook Is Driven by Health Care
paragraphs: Although Social Security is a major part of the fiscal challenge, it is far  from our biggest challenge. Spending on Medicare and Medicaid  represents a much larger, faster growing, and more immediate problem. In  fact, the federal government’s obligations for Medicare Part D alone  exceed the unfunded obligations for Social Security. Health care spending  systemwide continues to grow at an unsustainable pace, eroding the  ability of employers to provide coverage to their workers and undercutting  their ability to compete internationally. Finally, despite spending far more  of our economy on health care than other nations, the United States has  above average infant mortality, below average life expectancy, and the  largest percentage of uninsured individuals. In short, our health care  system is badly broken.
Medicare and Medicaid spending threaten to consume an untenable share  of the budget and economy in the coming decades. The federal  government has essentially written a “blank check” for these programs. In  contrast, other industrialized nations have put their health care programs  on a budget, even ones with national health care plans. We should  consider imposing limits on federal spending for health care sooner rather  than later. Figure 5 shows the total future draw on the economy  represented by Social Security, Medicare, and Medicaid. Although Social  Security in its current form will grow from 4.2 percent of GDP today to 6.3  percent in 2080, Medicare and Medicaid’s burden on the economy will  almost quadruple—from 4.7 percent to 17.7 percent of the economy.  Unlike Social Security, which grows larger as a share of the economy and  then levels off, Medicare and Medicaid continue to grow during this  projection period. Furthermore, these projections assume growth in  Medicare and Medicaid spending of GDP per capita plus about 1 percent  on average—a rate that is significantly below recent historical experience  of about 2.5 percent above GDP per capita. But even with this “optimistic”  assumption, the outlook is daunting. It is clear that health care is the main  driver of our long-term challenge. In fact, if there is one thing that could  bankrupt America, it’s runaway health care costs. We must not allow that  to happen.
Changing the path of health care spending is much more complicated than  dealing with Social Security. Unlike Social Security, Medicare spending  growth rates reflect not only a burgeoning beneficiary population, but also  the escalation of health care costs at rates well exceeding general rates of  inflation. The growth of medical technology has contributed to increases  in the volume and complexity of health care services, and information on  the cost and quality of health care is not readily available.
subsections: section_title: Systemwide Growth in Health Care Spending Driven by Certain Factors
paragraphs: Public and private health care spending continues to rise because of  increased medical prices and increased utilization due to growth in the  number, or volume, of services per capita, and use of more intense, or  complex, services. Moreover, the actual costs of health care consumption  are not transparent. Consumers are largely insulated by third-party payers  from the cost of health care decisions. As shown in figure 6, total health  care spending is absorbing an increasing share of our nation’s GDP. From  1976 through 2006, total public and private spending on health care grew  from about 8 percent to 16 percent of GDP. Total health care spending is  projected to grow to about 20 percent of GDP by 2016.
Addressing the unsustainability of health care costs is a major  competitiveness and societal challenge that calls for us as a nation to  fundamentally rethink how we define, deliver, and finance health care in  both the public and the private sectors. A major difficulty is that our  current system does little to encourage informed discussions and  decisions about the costs and value of various health care services. These  decisions are very important when it comes to cutting-edge drugs and  medical technologies, which can be very expensive but offer no advantage  over their alternatives.
Medical technology is a major contributor to growth in health care  spending. For example, one study found that the average amount spent per  heart attack case increased nearly $10,000 per case after controlling for  inflation, or 4.2 percent real growth per year between 1984 and 1998.  Nearly half of the cost increases resulted from people getting more  intensive technologies—such as cardiac catheterization—over time. In  some cases, new technology can lead to overdiagnosis and the excessive  use of resources. One study cites the use of spinal magnetic resonance  imaging (MRI) as one example. Researchers find that diagnostic spinal  MRI sometimes reveals abnormalities having no clinical relevance.  According to the study, some physicians act on this information and  perform unnecessary surgery that can lead to complications.
Obesity, smoking, and other population risk factors can lead to expensive  chronic conditions; the increased prevalence of such conditions—for  example, diabetes and heart disease—drives growth in the utilization of  health care resources and therefore in spending. Obesity has been the  subject of several recent studies focusing on associated health care cost  increases. For example, one study attributes 27 percent of the growth in  inflation-adjusted per capita spending between 1987 and 2001 to the rising  prevalence of obesity and higher relative per capita spending among obese  individuals.
section_title: Fundamental Challenges in Containing Health Care Spending Growth
paragraphs: Both public and private payers face fundamental challenges in the struggle  to contain health care spending growth. One of the challenges involves the  unbridled use of technology and society’s unmanaged expectations.  Experts note that the nation’s general tendency is to treat patients with  available technology when there is the slightest chance of benefit to the  patient, even though the costs may far outweigh the benefit to society as a  whole. They note that the discipline of technology assessment has not kept  pace with technology advancements.
Today’s employers, which finance a substantial share of the health care of  the privately insured population, are seeking more information on health  care technology costs and benefits. Although the Food and Drug  Administration (FDA), for example, evaluates new medical products based  on safety and efficacy data submitted by manufacturers, it does not  evaluate whether the new products are cost-effective compared with  existing products used for the same treatment indications. In turn,  Medicare, which generally relies on FDA approval decisions, does not  evaluate whether new technologies are superior, either clinically or  economically, compared with technologies already covered and paid for  by the program. Further exacerbating the situation, consumers, spurred by  advertising and the Internet, demand access to new medical technology  without knowledge of its value, safety, or efficacy.
Another cost containment challenge for all payers relates to the market  dynamics of health care compared with other economic sectors. In an  ideal market, informed consumers prod competitors to offer the best  value. However, without reliable comparative information on medical  outcomes, quality of care, and cost, consumers are less able to determine  the best value. Insurance masks the actual costs of goods and services,  providing little incentive for consumers to be cost-conscious. Similarly,  clinicians must often make decisions in the absence of universal medical  standards of practice. Under these circumstances, medical practices vary  across the nation, as evidenced by wide geographic variation in per capita  spending and outcomes, even after controlling for patient differences in  health status.
section_title: Solutions to Health Care Cost Growth Are Likely to Be Incremental
paragraphs: In recent years, policy analysts have discussed a number of incremental  reforms aimed at moderating health care spending, in part by unmasking  health care’s true costs. Some call for devising new insurance strategies to  make health care costs more transparent to patients. Currently, many  insured individuals pay relatively little out of pocket for care at the point  of delivery because of comprehensive health care coverage—precluding  the opportunity to sensitize these patients to the cost of their care.
Other steps include reforming the policies that give tax preferences to  insured individuals and their employers. These policies permit the value of  employees’ health insurance premiums to be excluded from the  calculation of their taxable earnings and exclude the value of the premium  from the employers’ calculation of payroll taxes for both themselves and  employees. Tax preferences also exist for health savings accounts and  other consumer-directed plans. These tax exclusions represent a  significant source of forgone federal revenue and work at cross-purposes  to the goal of moderating health care spending.
Proposals have been made to better target tax preferences to low-income  individuals and to change the tax treatment to allow consumers the same  tax advantages whether they receive their health insurance through their  employers or purchase it on their own.
As figure 7 shows, in 2006 the tax expenditure responsible for the greatest  revenue loss was that for the exclusion of employer contributions for  employees’ insurance premiums and medical care.
Another area conducive to incremental change involves provider payment  reforms. These reforms are intended to induce physicians, hospitals, and  other health care providers to improve on quality and efficiency. For  example, studies of Medicare patients in different geographic areas have  found that despite receiving a greater volume of care, patients in higher  use areas did not have better health outcomes or experience greater  satisfaction with care than those living in lower use areas. Public and  private payers are experimenting with payment reforms designed to foster  the delivery of care that is proven to be both better clinically and more  cost-effective. Ideally, identifying and rewarding efficient providers and  encouraging inefficient providers to emulate best practices will result in  better value for the dollars spent on care. The development of uniform  standards of practice could lead to more cost-effective treatments  designed to achieve the same outcomes.
The problem of escalating health care costs is complex because  addressing federal programs such as Medicare and the federal-state  Medicaid program will need to involve change in the health care system of  which they are a part—not just within federal programs. This will be a  major societal challenge that will affect all age groups. Because our health  care system is complex, with multiple interrelated pieces, solutions to  health care cost growth are likely to be incremental and require a number  of extensive efforts over many years. In my view, taking steps to address  the health care cost dilemma systemwide puts us on the right path for  correcting the long-term fiscal problems posed by the nation’s health care  entitlements. I have suggested in the past that we consider four elements  as pillars of any major health care reform effort:    Provide universal access to basic and essential health care.
Impose limits on federal spending for health care.  Implement national, evidence-based medical practice standards to  improve quality, control costs, and reduce litigation risks.
Take steps to ensure that all Americans assume more personal  responsibility and accountability for their own health and wellness.
As a nation, we need to weigh unlimited individual wants against broader  societal needs and decide how responsibility for financing health care  should be divided among employers, individuals, and government in an  affordable and sustainable manner. Ultimately, we may need to define a  set of basic and essential health care services to which every American is  ensured access. Individuals wanting additional services, and insurance  coverage to pay for them, would have that choice but would be required to  allocate their own resources. Clearly, such a dramatic change would  require a long transition period—all the more reason to act sooner rather  than later.
section_title: The Window of Opportunity Is Narrowing
paragraphs: As we enter 2008, what we call the long-term fiscal challenge is not in the  distant future. In fact, the first baby boomers already have filed for early  retirement benefits and will be eligible for Medicare benefits in less than 3  years. The budget and economic implications of the baby boom  generation’s retirement have already become a factor in CBO’s 10-year  baseline projections and that impact will only intensify as the baby  boomers age. As the share of the population over 65 climbs, demographics  will interact with rising health care costs. The longer we wait, the more  painful and difficult the choices will become. Simply put, our nation is on  an imprudent and unsustainable long-term fiscal path that is getting worse  with the passage of time.
The financial markets are noticing. Approximately 3 years ago, Standard  and Poor’s issued a publication stating that absent policy changes, the U.S.  government’s debt-to-GDP ratio was on track to mirror ratios associated  with speculative-grade sovereigns. Within the last month, Moody’s  Investors Service issued its annual report on the United States. In that  report, they noted their concern that absent Medicare and Social Security  reforms, the long-term fiscal health of the United States and our current  Aaa bond rating were at risk. These not too veiled comments serve to note  the significant longer-term interest rate risk that we face absent  meaningful action to address our longer-range challenge as well. Higher  longer-term interest costs would only serve to complicate our fiscal,  economic, and other challenges in future years.
As you are aware, during the past 3 years, I have traveled to 25 states as  part of the Fiscal Wake-Up Tour. During the tour, it has become clear that  the American people are starved for two things from their elected  officials—truth and leadership.
Last fall, I was pleased to join you when you announced your proposal to  create a Bipartisan Task Force for Responsible Fiscal Action. As I said at  the time, I believe it offers one potential means to achieve an objective we  all should share: taking steps to make the tough choices necessary to keep  America great and to help make sure that our country’s, children’s, and  grandchildren’s future is better than our past. By introducing your  proposal to create a Bipartisan Task Force for Responsible Fiscal Action,  you have shown the kind of leadership that is essential for us to  successfully address the long-term fiscal challenge that lies before us. And  I want to note you are not alone. Several other members on both sides of  the political aisle and on both sides of Capitol Hill have also introduced  legislation seeking to accomplish similar objectives.
But we do need to act. The passage of time is shrinking the window for  action. Albert Einstein said the most powerful force in the universe is  compound interest and today the miracle of compounding is working  against us. After 2009 the Social Security cash surplus—which has  cushioned and masked the impact of our imprudent fiscal policy—will  begin to shrink, putting pressure on the rest of the budget. The Medicare  Hospital Insurance trust fund is already in a negative cash flow situation. I  hope we do not wait to act until the Social Security trust fund turns to  negative cash flow in 2017. Demographics narrow the window for other  reasons as well. People need time to prepare for and adjust to changes in  benefits. There has been general agreement that there should be no  change in Social Security benefits for those currently in or near  retirement. If we wait until the baby boom generation has retired, that  becomes much harder and much more expensive.
Mr. Chairman, Senator Gregg, Members of the Committee, meeting this  long-term fiscal challenge overarches everything. It is our nation’s largest  sustainability challenge, but it is not our only one. If we want to position  the United States to meet the challenges of this century both abroad and at  home, we must also tackle other challenges, including reexamining what  government does and how it does business. Last month, we published a  new report that lays out a possible path for change. The report is entitled  A Call for Stewardship: Enhancing the Federal Government’s Ability to  Address Key Fiscal and Other 21st Century Challenges. It provides 13  potential tools for Congress and the administration to use to begin to  confront our long-term fiscal and other challenges. I hope you find this  report useful in facilitating discussions and decisions about various  challenges facing our great nation in the 21st century.
Today it is understandable that many Americans and their elected  representatives are concerned about recent market declines and a slowing  economy. We have an obligation, however, to look at both the short term  and the long term. Whatever Congress and the President decide to do in  response to our current economic weakness, it is important to be mindful  of the danger posed by our long-term fiscal path. This long-term challenge  increases the importance of careful design of any stimulus package—it  should be timely, targeted, and temporary.
Budgets, deficits, and long-term fiscal and economic outlooks are not just  about numbers, they are also about values. It is time for all Americans,  especially baby boomers to recognize our collective stewardship  obligation for the future. In doing so, we need to act soon because time is  working against us. We must make choices that may be difficult and  unpleasant today to avoid passing an even greater burden on to future  generations. Let us not be the generation that sent the bill for its  conspicuous consumption to its children and grandchildren.
Thank you Mr. Chairman, Mr. Gregg, and Members of the Committee for  having me today. We at GAO, of course, stand ready to assist you and your  colleagues as you tackle these important challenges.
section_title: Contacts and Acknowledgments
paragraphs: For further information on this testimony, please contact Susan J. Irving at  (202) 512-9142 or irvings@gao.gov. Contact points for our Offices of  Congressional Relations and Public Affairs may be found on the last page  of this testimony. Individuals making key contributions to this testimony  include Jay McTigue, Assistant Director, and Melissa Wolf.
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