Long-Term Fiscal Outlook: Long-Term Federal Fiscal Challenge Driven Primarily by Health Care
Published: 2008-06-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: GAO was asked to provide its views on the long-term fiscal outlook. This statement addresses four key points: (1) the federal government's long-term fiscal outlook is a matter of utmost concern; (2) this challenge is driven primarily by health care cost growth; (3) reform of health care is essential but other areas also need attention which requires a multipronged solution; and (4) the federal government faces increasing pressures yet a shrinking window of opportunity for phasing in needed adjustments. GAO's simulations of the federal government's long-term fiscal outlook were updated with the Trustees 2008 intermediate projections and continue to indicate that the long-term outlook is unsustainable. This update combined with GAO's analysis of the fiscal outlook of state and local governments demonstrates that the fiscal challenges facing all levels of government are linked and should be considered in a strategic and integrated manner. Since 1992, GAO has published long-term fiscal simulations of what might happen to federal deficits and debt levels under varying policy assumptions. GAO developed its long-term model in response to a bipartisan request from Members of Congress who were concerned about the longterm effects of fiscal policy. Information about GAO's model and assumptions can be found at http://www.gao.gov/special.pubs/longterm/ .
section_title: What GAO Found
paragraphs: Long-term fiscal simulations by GAO, the Congressional Budget Office (CBO), and others all show that despite a decline in the federal government's unified budget deficit between fiscal years 2003 and 2007, it still faces large and growing structural deficits driven primarily by rising health care costs and known demographic trends. Simply put, the federal government is on an unsustainable long-term fiscal path. Although Social Security is important because of its size, over the long term health care spending is the principal driver--Medicare and Medicaid are both large and projected to continue growing rapidly in the future. Rapidly rising health care costs are not simply a federal budget problem. Growth in health-related spending is the primary driver of the fiscal challenges facing state and local governments as well. Unsustainable growth in health care spending also threatens to erode the ability of employers to provide coverage to their workers and undercuts their ability to compete in a global marketplace. Public and private health care spending continues to rise because of several key factors: (1) increased utilization of new and existing medical technology; (2) lack of reliable comparative information on medical outcomes, quality of care, and cost; and (3) increased prevalence of risk factors such as obesity that can lead to expensive chronic conditions. Addressing health care costs and demographics--and their interaction--will be a major societal challenge. The longer action on reforming heath care and Social Security is delayed, the more painful and difficult the choices will become. The federal government faces increasing pressures yet a shrinking window of opportunity for phasing in adjustments. In fact, the oldest members of the baby-boom generation are now eligible for Social Security retirement benefits and will be eligible for Medicare benefits in less than 3 years. Additionally, in addressing this fiscal challenge it will be important to review other programs and activities on both the spending and revenue sides of the budget.

section_title: Letter
paragraphs: I appreciate this invitation to talk with you about the federal government’s  long-term fiscal outlook. Under any plausible scenario, the federal budget  is on an unsustainable path. Long-term fiscal simulations by GAO, the  Congressional Budget Office (CBO), and others all show that despite a  decline in the federal government’s unified budget deficit between fiscal  years 2003 and 2007, it still faces large and growing structural deficits. This  long-term path is driven primarily by rising health care costs and known  demographic trends. In fact, the oldest members of the baby-boom  generation are now eligible for Social Security retirement benefits and will  be eligible for Medicare benefits in less than 3 years. According to the  Social Security Administration, nearly 80 million Americans will become  eligible for Social Security retirement benefits over the next two  decades—an average of more than 10,000 per day. Although Social  Security is important because of its size, the principal 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.
Today, I will emphasize a few key points:  the federal government’s long-term fiscal outlook is a matter of utmost  concern,  this challenge is driven primarily by health care cost growth,  reform of health care is essential but other areas also need attention—this  is a multipronged problem that requires a multipronged solution, and  the federal government faces increasing pressures yet a shrinking window  of opportunity for phasing in adjustments needed by individuals in the  public and private sectors.
My remarks are based on GAO’s previous work on a variety of issues,  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: The Long-Term Fiscal Outlook Remains Unsustainable
paragraphs: The unified budget deficit declined between fiscal years 2003 and 2007, but  this did not change the long-term path: it remains unsustainable.  Moreover, while the recent past shows some progress in the annual  unified deficit figures, any assessment of the federal government’s long- term fiscal outlook also needs to recognize the fact that the Social Security  cash surplus has been used to offset spending in the rest of government  for many years. In fiscal year 2007, for example, the “on-budget” deficit— the deficit excluding the Social Security surplus—was $344 billion, more  than double the size of the unified deficit of $163 billion. There is a limit to  how long the Social Security surplus will offset other spending. The rest of  the budget will feel the pressure when the Social Security cash surplus  begins to decline starting in 2011—less than 3 years from now. In 2017 the  Social Security cash flow turns negative—at that point the choices will be  increased borrowing from the public, reduced spending, or increased  revenue.
These dates call attention to the narrowing window. The real challenge  then is not this year’s deficit or even next year’s; it is how to change the  current fiscal path so that growing deficits and debt levels do not reach  unsustainable levels. By definition something that is unsustainable will  stop—the challenge is to take action before being forced to do so by some  sort of crisis. Health care costs are growing much faster than the economy,  and the nation’s population is aging. These drivers will soon place  unprecedented, growing, and long-lasting stress on the federal budget.  Absent action, debt held by the public will grow to unsustainable levels.
Figure 1 shows GAO’s simulation of the deficit path based on recent trends  and policy preferences. In this simulation, we start with CBO’s baseline  and then assume that (1) all expiring tax provisions are extended through  2018—and then revenues are brought to their historical level as a share of  gross domestic product (GDP) plus expected revenue from deferred  taxes—(2) discretionary spending grows with the economy, and (3) no  changes are made to Social Security, Medicare, or Medicaid.
Figure 2 looks behind the deficit path to the composition of federal  spending. It shows that the estimated growth in Medicare, Medicaid, and  to a lesser extent Social Security leads to an unsustainable fiscal future. In  this figure the category “all other spending” includes much of what many  think of as “government”—discretionary spending on such activities as  national defense, homeland security, veterans health benefits, national  parks, highways and mass transit, and foreign aid, plus mandatory  spending on the smaller entitlement programs such as Supplemental  Security Income, Temporary Assistance for Needy Families, and farm  price supports. The growth in Social Security, Medicare, Medicaid, and  interest on debt held by the public dwarfs the growth in all other types of  spending.
Rapidly rising health care costs are not simply a federal budget problem;  they are a problem for other levels of government and other sectors. As  shown in figure 3, 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 long-term fiscal challenges facing the state and local governments.  These simulations imply that state and local fiscal challenges will add to  the nation’s fiscal difficulties and suggest that the nation’s fiscal challenges  cannot be remedied simply by shifting the burden from one sector to  another.
If unchanged, the federal government’s increased spending and rising  deficits will drive a rising debt burden. At the end of fiscal year 2007,  federal debt held by the public exceeded $5 trillion. Figure 4 shows that  this growth in the federal government’s debt cannot continue unabated  without causing serious harm to the economy. In the last 200 years, only  during and after World War II has debt held by the public exceeded 50  percent of GDP.
But this is only part of the story. The federal government for years has  been borrowing the surpluses in the Social Security trust funds and other  similar funds and using them to finance federal government costs. When  such borrowings occur, the Department of the Treasury issues federal  securities to these government funds that are backed by the full faith and  credit of the U.S. government. Although borrowing by one part of the  federal government from another does 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. If federal securities held by those funds are included, the federal  government’s total debt is much higher—about $9 trillion as of the end of  fiscal year 2007. As shown in figure 5, total federal debt increased over  each of the last 4 fiscal years.
On September 29, 2007, the statutory debt limit had to be raised for the  third time in 4 years in order to avoid being breached; between the end of  fiscal year 2003 and the end of fiscal year 2007, the debt limit had to be  increased by about one-third. It is anticipated that actions will need to be  taken in fiscal year 2009 to avoid breaching the current statutory debt limit  of $9,815 billion.
While today’s debt numbers are large, they do not represent a measure of  all future claims. They exclude a number of significant items, such as the  gap between currently scheduled Social Security and Medicare benefits  and the revenues earmarked for these programs as well as the likely cost  of veterans’ health care and a range of other commitments and  contingencies that the federal government has pledged to support. For  example, the Statement of Social Insurance in the 2007 Financial Report  of the United States Government disclosed that as of September 30, 2007,  for Social Security and Medicare alone, projected expenditures for  scheduled benefits exceed earmarked revenues (i.e., dedicated payroll  taxes and premiums) by approximately $41 trillion over the next 75 years  in present value terms. Of that amount, $34 trillion is related to Medicare  and $7 trillion to Social Security. While Social Security, Medicare, and  Medicaid dominate the long-term outlook, policymakers need to look at  other policies that limit flexibility—not necessarily to eliminate them but  to at least be aware of them and make a conscious decision about them.  Several years ago, we developed the term “fiscal exposures” to provide a  framework for considering the wide range of responsibilities, programs,  and activities that may explicitly or implicitly expose the federal  government to future spending.
Fiscal exposures vary widely as to source, extent of the government’s legal  obligation, likelihood of occurrence, and magnitude. They include not only  liabilities, contingencies, and financial commitments that are identified on  the balance sheet or accompanying notes, but also responsibilities and  expectations for government spending that do not meet the recognition or  disclosure requirements for that statement. By extending beyond  conventional accounting, the concept of fiscal exposure is meant to  provide a broad perspective on long-term costs and uncertainties. Fiscal  exposures include items such as retirement benefits, environmental  cleanup costs, the funding gap in Social Security and Medicare, and the life  cycle-cost for fixed assets. Given this variety, it is useful to think of fiscal  exposures as lying on a spectrum extending from explicit liabilities to the  implicit promises embedded in current policy or public expectations.
Many ways exist to assess the long-term fiscal challenge. One quantitative  measure is called “the fiscal gap.” This measures the amount of spending  cuts or tax increases that would be needed to keep debt as a share of GDP  at or below today’s ratio. The fiscal gap is an estimate of the action needed  to achieve fiscal balance over a certain time period such as 75 years.  Another way to say this is that the fiscal gap is the amount of change  needed to prevent the kind of debt explosion shown in figure 4. The fiscal  gap can be expressed as a share of the economy or in present value  dollars.
For example, under our alternative simulation closing the fiscal gap would  require spending cuts or tax increases equal to 6.7 percent of the entire  economy over the next 75 years, or about $54 trillion in present value  terms. To put this in perspective, closing the gap would require an  increase in today’s federal tax revenues of more than one-third or an  equivalent reduction in today’s federal program spending (i.e., in all  spending except for interest on the debt held by the public, which cannot  be directly controlled) and maintained over the entire period. Table 1  shows the changes necessary to close the fiscal gap over the next 75 years.
Policymakers could phase in the policy changes so that the tax increases  or spending cuts would grow over time and allow people to adjust. The  size of these annual tax increases and spending cuts would be more than  five times the fiscal year 2007 deficit of 1.2 percent of GDP. Delaying  action would make future adjustments even larger. Under our alternative  simulation, waiting even 10 years would require a revenue increase of  about 45 percent or noninterest spending cuts of about 40 percent. This  gap is too large to grow out of the problem. To be sure, additional  economic growth would certainly help the federal government’s financial  condition, but it will not eliminate the need for action.
section_title: The Federal Government’s Long- Term Fiscal Outlook Is Driven Primarily by Health Care
paragraphs: The large fiscal gap is primarily the result of spending on Medicare and  Medicaid, which continue to consume ever-larger shares of both the  federal budget and the economy. Federal expenditures on Medicare and  Medicaid represent a much larger, faster-growing, and more immediate  problem than Social Security. Medicare and Medicaid are not unique in  experiencing rapid spending growth, but instead this growth largely  mirrors spending trends in other public health care programs and the  overall health care system. A number of factors contribute to the rise in  spending, including the use of new medical technology and market  dynamics that do not encourage the efficient provision of health care  services. Addressing these challenges will not be easy.
subsections: section_title: Health Care Costs Have Outpaced Economic Growth
paragraphs: Federal health care spending comprises a myriad of programs, but federal  obligations are driven by the two largest programs, Medicare and  Medicaid. Spending for these two programs threatens to consume an  untenable share of the budget and economy in the coming decades. Figure  6 shows the total future draw on the economy represented by Social  Security, Medicare, and Medicaid. While Social Security will grow from 4.3  percent of GDP today to 5.8 percent in 2080, Medicare and Medicaid’s  burden on the economy will more than triple—from 4.7 percent to 15.7  percent of the economy. Although some of the increased burden is due to  the aging of the population, the majority is due to increased costs per  beneficiary, some of which is the result of interaction between  demographics and health care spending. Consequently, unlike Social  Security, which will level off after growing as a share of the economy,  Medicare and Medicaid will continue to grow. The projections for  Medicaid spending assume a long-term cost growth rate consistent with  the long-term growth rate assumption of the Medicare Trustees—GDP per  capita plus about 1 percent on average. This growth rate, which would  represent a slowing of the current trend, is well below recent historical  experience of about 2.5 percent above GDP per capita.
The federal government and other public payers are not the only ones  facing rapidly rising health care expenses. Private payers face the same  challenges. As shown in figure 7, total health care spending from both  public and private payers is absorbing an increasing share of our nation’s  GDP. From 1976 through 2006, spending on health care grew from about 8  percent of GDP to 16 percent, and it is projected to grow to about 20  percent of GDP by 2016. While growth in public spending strains  government budgets, growth in private sector health care costs erodes  employers’ ability to provide coverage to their workers and undercuts  their ability to compete internationally.
When compared with other nations, the United States is an outlier in its  high level of health care spending. For example, in 2005, health care  accounted for about 15 percent of GDP in the United States, the largest  share among developed nations who are members of the Organization for  Economic Co-operation and Development (OECD). The United States also  ranks far ahead of other OECD countries in terms of per capita health  spending. In that same year, the United States spent $6,401 per person, a  level nearly twice that found in France, Canada, and Germany, and about  two and a half times higher than the levels found in Italy, Japan, and the  United Kingdom. Despite this higher level of health care spending, the  United States still fares poorly on many health measures. Compared to  other nations, the United States has above-average infant mortality, below- average life expectancy, and the largest percentage of uninsured  individuals. For example, according to the most recent published data  from OECD, the United States ranked 27 out of 30 in infant mortality and  24 out of 30 in life expectancy.
section_title: Systemwide Growth in Health Care Spending Is Driven by Certain Key Factors
paragraphs: Public and private health care spending continues to rise because of  several key factors, including the following:    Medical technology. While new and existing medical technology can lead  to medical benefits, in some cases technology can lead to the excessive  use of resources. On the one hand, experts agree that technology’s  contributions over the past 20 years—new pharmaceuticals, diagnostic  imaging, and genetic engineering, among others—have been, on the whole,  of significant value to the nation’s health. Such advances in medical  science have allowed providers to treat patients in ways that were not  previously possible or to treat conditions more effectively. On the other  hand, experts note that the nation’s general tendency is to treat patients  with available technology even when there is little chance of benefit to the  patient and without consideration of costs.
Market dynamics. 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. Many insured individuals pay relatively little out of pocket for  care at the point of delivery because of comprehensive health care  coverage. Current federal tax policies encourage such comprehensive  coverage, for example, by excluding employers’ contribution for premiums  from employees’ taxable income. These tax exclusions represent a  significant source of forgone federal revenue and work at cross-purposes  to the goal of moderating health care spending. Furthermore, 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.
Population health. Obesity, smoking, and other population risk factors  can lead to expensive chronic conditions, such as diabetes and heart  disease. The increased prevalence of such conditions drives spending as  the utilization of health care resources rises. For example, one study  indicated that the rising prevalence of obesity and higher relative per  capita health care spending among obese individuals resulted in 27  percent of the growth in inflation-adjusted per capita health care spending  from 1987 through 2001.
Addressing these drivers will be a major societal challenge. Solving the  problem of the federal government’s escalating health care costs is  especially difficult, since changing programs such as Medicare and  Medicaid will involve changes, not just within these federal programs, but  to our country’s health care system as a whole. However, many experts  have recommended that the federal government could help drive  improvement in the health care system. For example, experts note the  need for strong financial incentives to overcome a lack of systems— including information systems—to reduce error and reinforce best  practices. Medicare—the single, largest purchaser of health care services  in the United States—could play a more active role in promoting a market  that rewards better performance through payment incentives that promote  the pursuit of improved quality and efficiency.
section_title: The Window of Opportunity Is Narrowing
paragraphs: Here in the first half of 2008, the long-term fiscal challenge is not in the  distant future. The first baby boomers have already retired. (See table 2.)  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 effect 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 action on reforming heath care  and Social Security is delayed, the more painful and difficult the choices  will become. Simply put, the federal budget is on an unsustainable long- term fiscal path that is getting worse with the passage of time.
The window for timely action is shrinking. Albert Einstein said the most  powerful force in the universe is compound interest, and today the miracle  of compounding is working against the federal government. After 2011 the  Social Security cash surplus—which has cushioned and masked the effect  of the federal government’s 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. 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 changes are delayed until the entire baby-boom  generation has retired, that becomes much harder and much more  expensive.
Meeting this long-term fiscal imbalance is the nation’s largest  sustainability challenge. Aligning the federal government to meet the  challenges and capitalize on the opportunities of the 21st century will  require a fundamental review of what the federal government does, how it  does it, and how it is financed. Attention should be focused not only on the  spending side of the budget but also on the revenue side. Tax  expenditures, for example, should be reexamined with the same scrutiny  as spending programs. Moving forward, the federal government needs to  start making tough choices in setting priorities and linking resources and  activities to results.
Meeting the nation’s long-term fiscal challenge will require a multipronged  approach bringing people together to tackle health care, Social Security,  and the tax system as well as    strengthening oversight of programs and activities, including creating  approaches to better facilitate the discussion of integrated solutions to  cross-cutting issues; and  reengineering and reprioritizing the federal government’s existing  programs, policies, and activities to address 21st century challenges and  capitalize on related opportunities.
There are also some process changes that might help the discussion by  increasing the transparency and relevancy of key financial, performance,  and budget reporting and estimates that highlight the fiscal challenge.  Stronger budget controls for both spending and tax policies to deal with  both near-term and longer-term deficits may also be helpful.
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  periodically prepare and publish a long-range fiscal sustainability report.  I am pleased to note that the Federal Accounting Standards Advisory  Board (FASAB) is considering possible changes to social insurance  reporting and has initiated a project on fiscal sustainability reporting.
Mr. Chairman, Senator Grassley, members of the committee—health care  may be the principal driver of the long-term fiscal outlook, but that does  not mean government should ignore other drivers. Demographics are a  smaller component than rapid health care cost growth, but the two  interact, and aging is not a trivial contributor to the federal government’s  long-term fiscal condition. We have suggested that to right the fiscal path  will require discussing health care and Social Security and looking at both  the spending and tax sides of the budget. Although these entitlements and  revenue drive the overall fiscal trends, it is also important that the federal  government look at other programs and activities. Reexamining what  government does and how it does business can help government meet the  challenges of this century in providing some specific and practical steps  that Congress can take to help address these long-term challenges. In this  effort Congress may find a report we published in December 2007 useful.  The report is entitled, A Call for Stewardship: Enhancing the Federal  Government’s Ability to Address Key Fiscal and Other 21st Century  Challenges.
Thank you Mr. Chairman, Senator Grassley, 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,  Director, Federal Budget Analysis, Strategic Issues at (202) 512-9142,  irvings@gao.gov, or Marjorie Kanof, Managing Director, Health Care at  (202) 512-7114, kanofm@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 James Cosgrove, Jay McTigue, Jessica Farb, and Melissa Wolf.
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