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. 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.