This is the accessible text file for GAO report number GAO-07-510R 
entitled 'The Nation's Long-Term Fiscal Outlook: January 2007 Update' 
which was released on February 23, 2007. 

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United States Government Accountability Office: 

GAO: 

The Nation's Long-Term Fiscal Outlook: 

January 2007 Update: 

GAO-07-510R: 

The Bottom Line: Federal Fiscal Policy Remains Unsustainable: 

Figure 1: Unified Surpluses and Deficits as a Share of GDP under 
Alternative Fiscal Policy Simulations: 

[See PDF for image] 

Source: GAO's January 2007 analysis. 

[End of figure] 

Sidebar: GAOs Long-Term Fiscal Simulations: 

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 long-term effects of fiscal policy. 

In 1992 GAO said: "The federal budget is structurally unbalanced. This 
will do increasing damage to the economy and is unsustainable in the 
long term. Regardless of the approach chosen, prompt and meaningful 
action is essential.  The longer it is delayed, the more painful it 
will be." These words are as relevant today as when GAO first published 
them. 

GAO updates its simulations three times a year as new estimates become 
available from: 
* CBOs Budget and Economic Outlook (January), 
* Social Security and Medicare Trustees Reports (early spring), and: 
* CBOs Budget and Economic Outlook: An Update (late summer).  

This product responds to congressional interest in receiving updated 
simulation results.  Additional information about the GAO model, its 
assumptions, data, and charts can be found at [Hyperlink, 
http://www.gao.gov/special.pubs/longterm/]. For more information, 
contact Susan J. Irving at (202) 512-9142 or irvings@gao.gov

GAO's current long-term simulations continue to show ever-larger 
deficits resulting in a federal debt burden that ultimately spirals out 
of control. Figure 1 shows two alternative fiscal paths. As described 
below "Baseline extended" builds on the Congressional Budget Office 
(CBO) baseline--and results over the long term in revenues several 
points above the 20-year historical average and discretionary spending 
several points below the 20-year historical average. The modifications 
in the alternative scenario result over the long term in both revenues 
and discretionary spending slightly under the 20-year historical 
average. Although the timing of deficits and the resulting debt build 
up varies depending on the assumptions used, both simulations show that 
we are on an unsustainable fiscal path. 

Under "Baseline extended" we follow CBO's baseline for the first 10 
years: tax provisions that are scheduled to expire are assumed to do so 
(including the temporary increase in the alternative minimum tax (AMT) 
exemption amount) and discretionary spending is assumed to grow with 
inflation. Under the alternative scenario we assume all expiring tax 
provisions are extended, the 2006 exemption amount for the alternative 
minimum tax is continued but not indexed for inflation, and 
discretionary spending grows with the economy. In both simulations, 
after the first 10 years (i.e., the end of the projection period) both 
revenues and discretionary spending are held constant as a share of the 
economy. 

Simulations are not forecasts or predictions. They are designed to ask 
the question "what if?" GAO's "what ifs" are that discretionary 
spending may grow faster or slower, and tax cuts may be renewed or 
allowed to expire - but in both cases, the Nation's long-term fiscal 
future is "at risk." Under both sets of expectations about future 
spending and revenues, the risks posed to the Nation's future financial 
condition are too high to be acceptable. 

By definition, what is unsustainable will not be sustained. The 
question is how and when our current imprudent and unsustainable path 
will end. At some point, action will be taken to change the Nation's 
fiscal course. Importantly, the sooner appropriate actions are taken, 
the sooner the miracle of compounding will begin to work for the 
federal budget rather than against it. Conversely, the longer action to 
deal with the Nation's long-term fiscal outlook is delayed, the greater 
the risk that the eventual changes will be disruptive and 
destabilizing. Acting sooner rather than later will give us more time 
to phase in gradual changes, while providing more time for those likely 
to be most affected to make compensatory changes. 

What Drives Our Nation's Bleak Long-Term Fiscal Outlook? 

The long-term fiscal outlook results from a large and persistent gap 
between expected revenues and expected spending. 

The spending that drives the outlook is primarily spending on the large 
federal entitlement programs (i.e., Social Security, Medicare, 
Medicaid). The retirement of the baby boom generation is one key 
element of this. In 2008 the first boomers will be eligible to draw 
Social Security "early retirement" benefits, and in 2011 the first 
boomers will become eligible for Medicare. In the succeeding 2 decades 
America's population will age dramatically, and relatively fewer 
workers will be asked to support ever larger costs for retirees. 

Although Social Security is a major part of the fiscal challenge, it is 
far from our biggest challenge. Spending on the major federal health 
programs (i.e., Medicare and Medicaid) represents a much larger and 
faster growing problem. In fact, the federal government's obligations 
for Medicare Part D alone exceed the unfunded obligations for Social 
Security. Over the past several decades, health care spending on 
average has grown much faster than the economy, absorbing increasing 
shares of the Nation's resources, and this rapid growth is projected to 
continue. For this reason and others, rising health care costs pose a 
fiscal challenge not just to the federal budget but to American 
business and our society as a whole. 

Figures 2 and 3 look behind the deficit path to the composition of 
federal spending under the two scenarios. In these figures 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, our national 
parks, highways and mass transit, foreign aid, plus "mandatory 
spending" on the smaller entitlement programs such as Supplemental 
Security Income, TANF, and farm price supports.[Footnote 1] The growth 
in Social Security, Medicare, Medicaid, and interest on debt held by 
the public dwarfs the growth in all other types of spending. 

Both figures show that the estimated growth in the major entitlement 
programs leads to an unsustainable fiscal future--whether revenues as a 
share of GDP are above historical levels over the past 20 or 40 years, 
as in Baseline extended, or somewhat below them as in the alternative 
simulation. 

Figure 2: Potential Fiscal Outcomes Under Baseline Extended: 

[See PDF for image] 

Source: GAO's January 2007 analysis. 

Note: In addition to the expiration of tax cuts, revenue as a share of 
GDP increases through 2017 mainly due to (1) real bracket creep, (2) 
more taxpayers becoming subject to the AMT, and (3) increased revenue 
from tax-deferred retirement accounts. After 2017, revenue as a share 
of GDP is held constant--implicitly assuming that action is taken to 
offset increased revenue from real bracket creep, the AMT, and tax- 
deferred retirement accounts. 

[End of figure] 

Figure 3: Potential Fiscal Outcomes Under Alternative Simulation: 
Discretionary Spending Grows with GDP After 2007 and All Expiring Tax 
Provisions are Extended: 

[See PDF for image] 

Source: GAO's January 2007 analysis. 

Note: AMT exemption amount is retained at the 2006 level through 2017 
and expiring tax provisions are extended. After 2017, revenue as a 
share of GDP is held constant--implicitly assuming that action is taken 
to offset increased revenue from real bracket creep, the AMT, and tax- 
deferred retirement accounts. 

[End of figure] 

These figures also show that waiting makes the size of the problem 
worse. For example, even under GAO's "Baseline extended" scenario-- 
under which revenues rise to about 20 percent of GDP and discretionary 
spending falls to below 6 percent of GDP--waiting until 2040 to close 
the gap would require drastic change. Taxes as a share of GDP would 
have to increase by about 40 percent or total spending cut by almost a 
third in order to balance the budget in that year. Sudden, drastic 
changes of either kind--and revenues at such a level--are outside post- 
World War II historical experience in this country. 

The Fiscal Gap--Another Way to Measure the Challenge: 

Many ways exist to measure the long-term fiscal challenge. One 
quantitative measure is called "the fiscal gap." The fiscal gap is the 
amount of spending reduction or tax increases needed to keep debt as a 
share of gross domestic product (GDP) at or below today's ratio. 
Another way to say this is that the fiscal gap is the amount of change 
needed to prevent the kind of debt explosion implicit in figure 3. The 
fiscal gap can be expressed as a share of the economy or in present 
value dollars. 

For GAO's "Baseline extended" simulation, closing the fiscal gap would 
require spending cuts or tax increases equal to 3.6 percent of the 
entire economy each year over the next 75 years, or a total of $26 
trillion in present value terms. For GAO's alternative simulation, the 
gap is 7.5 percent of the economy, or about $55 trillion in present 
value terms. To put this in perspective, if we were to invest enough 
today to pay off these amounts over the next 75 years, the sums needed 
would amount to about $87,000 to $182,000 per person, or about $208,000 
to $435,000 for each full-time worker. 

Under either set of assumptions, the size of the change we would need 
to make in the federal budget would be larger than last year's unified 
deficit--and that is just the change in the first year of the 75-year 
window. Waiting even 10 years to close the fiscal gap would require 
larger, more drastic changes. For example, under GAO's Baseline 
extended simulation the fiscal gap would grow from 3.6 percent of the 
economy today to 4.7 percent in 2017 simply by waiting to act. 

Additional economic growth is critical and will help to ease the 
burden, but the projected fiscal gap is so great that it is unrealistic 
to expect we will grow our way out of the problem. To do so under any 
reasonable set of assumptions would require double-digit real economic 
growth for many decades to eliminate the long-term fiscal challenge. 
However, since the end of World War II we have not seen economic growth 
of this kind. To be sure, additional economic growth would certainly 
help the Nation's financial condition and our ability to address our 
fiscal gap, but it will not eliminate the need for action. 

Other ways to think about the size of the long-term challenge may also 
be found in [Hyperlink, http://www.gao.gov/cghome.htm]: 

What Is Assumed in GAO's Simulations? 

GAO's two simulations project current policies on revenue and spending 
forward. The first is "Baseline extended," and the second is an 
alternative based on recent trends and policy preferences. They vary in 
how they deal with the first 10 years: 

* Baseline extended. This takes the 10-year baseline estimates[Footnote 
2] of the Congressional Budget Office (CBO) and extends them over a 75- 
year period. CBO assumes in its baseline estimates that discretionary 
spending grows at the rate of inflation--a slower growth rate than that 
witnessed in many recent years. CBO also assumes no changes to today's 
laws. As CBO recognized in its January 2007 Budget and Economic 
Outlook, this results in some very problematic assumptions. For 
example, since the Administration's request for supplemental 
appropriations of almost $100 billion had not been submitted at the 
time CBO published its Outlook, CBO noted that its January baseline 
omits some likely discretionary spending in 2007 for military 
operations in Iraq and Afghanistan. Another implication of following 
current law is that CBO assumes that all tax cuts originally enacted in 
2001 and 2003 are permitted to expire as currently scheduled, including 
the temporary increase in the AMT exemption amount. 

* Discretionary spending grows with the economy (that is, with GDP) and 
all expiring tax reductions are extended. This simulation alters two 
key assumptions of CBO's baseline. First, discretionary spending is 
allowed to grow with the economy in the first 10 years rather than 
being constrained to grow with inflation. Second, all expiring tax cuts 
are extended permanently. 

In each simulation, consistent with our practice of many years, at the 
end of the 10-year period we take the levels of revenue and 
discretionary spending as shares of GDP and hold these constant for the 
rest of the simulation period. We have done so in order not to make any 
long-range policy assumptions. In addition, after the first 10 years, 
both simulations use the Social Security and Medicare Trustees' 75-year 
intermediate ("best") estimates for those programs and assume that 
promised benefits will be paid in full. 

What Changed in This Update? 

Despite improvement in recent years and in near-term projections, the 
long-term outlook has not changed significantly since the last 
simulations: it remains unsustainable. 

As CBO noted, the favorable outlook suggested by its 10-year 
projections does not indicate a substantial change in the nation's long-
term budgetary challenges. CBO pointed out that changes in its baseline 
between August and January overstate the fundamental improvement in the 
underlying budget outlook because roughly half of the total change 
stems from the baseline's treatment of previous supplemental 
appropriations for disaster relief and the irregular pattern of funding 
for military operations in Iraq and Afghanistan. Importantly, one 
undeniable change from August is that we have moved closer to the start 
of the retirement of the baby boom generation and its fiscal 
consequences. 

GAO's simulations were updated using CBO's 10-year baseline budget and 
economic estimates in its January Budget and Economic Outlook: An 
Update. CBO's report can be found at [Hyperlink, 
http://www.cbo.gov/showdoc.cfm?index=7731&sequence=0]: 

This product is based on GAO's work on the long-term fiscal challenge, 
including reports and testimonies. These efforts were conducted in 
accordance with generally accepted government auditing standards. 

Additional information and related products can be found at: 

[Hyperlink, 
http://www.gao.gov/special.pubs/longterm/longtermproducts.html]: 

FOOTNOTES 

[1] "Discretionary spending" refers to spending based on authority 
provided in annual appropriations acts. "Mandatory spending" refers to 
spending that Congress has authorized in legislation other than 
appropriations acts that entitles beneficiaries to receive payment or 
that otherwise obligates the government to make payment. 

[2] The Balanced Budget and Emergency Deficit Control Act of 1985, 
which established rules that govern the calculation of CBO's baseline, 
expired, on September 30, 2006. Nevertheless, CBO continues to prepare 
baselines according to the methodology prescribed in that law.