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Choosing the Nation's Fiscal Future (2010)

Chapter: Appendix A: Fiscal Sustainability

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Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
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Appendix A
Fiscal Sustainability

DEFINITIONS AND USES

Economists typically call fiscal policy unsustainable if a country’s debt is growing faster than its gross domestic product (GDP) (see, e.g., Congressional Budget Office, 2007). This report defines sustainability in a closely related manner: a budget is sustainable if over a long period: (1) it has a stable ratio of debt-to-GDP and (2) revenues and spending that are parallel and likely to remain so. For this report, we define a “long period” as 75 years.

Others define fiscal sustainability somewhat differently (see, e.g. Organisation for Economic Co-operation and Development, 2007; Schick, 2005). For example, some assert that fiscal sustainability requires that the present value of future budget surpluses exceed the present value of future budget deficits (Anderson and Sheppard, 2009). This is a more stringent definition than that used in this report. Moreover, we believe that solvency, defined as an excess of expected income over expected expenses, is at the same time an insufficient and unnecessary condition for fiscal sustainability.

The definition of sustainability does not require specifying a target debt-to-GDP ratio, and any target is potentially arbitrary, especially if it is not subject to adjustment in light of new circumstances. Large debts can be paid back, yet small debts may not be sustainable if future income is insufficient. Moreover, government debt may remain high for decades and experience large fluctuations over time. For example, the British debt-to-GDP ratio has ranged between 20 and 270 percent and averaged 117 percent over the past 300 years. Although the debt may have been considered

Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
×

unsustainable on a number of occasions during that long period, the fact that the British government never defaulted meant that the budget was sustainable (Wyplosz, 2007).

Whatever debt-to-GDP ratio is chosen as a target for stabilization it must be low enough to inspire confidence by the investors who buy a nation’s debt. The target for stabilization chosen in this study, a debt-to-GDP ratio of 60 percent, is chosen both for its near-term feasibility and to minimize the risk of increasing debt in the future. The forward-looking part of the target relates to the second part of the definition of sustainability used here, that revenues and spending must remain closely aligned over a long horizon.

The arithmetic of stabilizing the ratio is straightforward. The debt cannot grow faster over any long period than does the economy. Arithmetically, the primary deficit—which is the difference between revenues and spending (other than for interest on the debt)—should be zero if the average interest rate on the debt equals the growth rate of the economy. If the annual interest payment on the debt is 5 percent of GDP and the deficit equals the interest payment, the debt will grow 5 percent annually. If the economy is also growing at a rate of 5 percent, the debt-to-GDP ratio will remain constant. If the interest payment on the debt as a percentage of GDP exceeds the growth rate of the economy, then a primary budget surplus is necessary to stabilize the debt. If the interest payment is less than the rate of growth of the economy, then a primary budget deficit may be consistent with fiscal sustainability (von Furstenberg, 1991).

FISCAL GAP

The Congressional Budget Office (CBO) and others have calculated a “fiscal gap” measure of the extent to which a long-term budget outlook departs from sustainability (with sustainability defined as a long-term balance between expected revenues and expected spending) (Auerbach, 1994; Congressional Budget Office, 2009). This measure is constructed from projections of annual revenues and spending. The federal government’s expected long-term flows of revenues and spending are represented by a single number, which is the present value of future payments to and from the Treasury Department, discounted by the time value of money to make them comparable with payments today.

The fiscal gap is therefore a present-value measure of the nation’s fiscal imbalance. That imbalance reflects shortfalls of revenues relative to spending estimated over a given period. The fiscal gap can be said to represent the extent to which the government would need to immediately and permanently raise tax revenues, cut spending, or use some mix of both to make

Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
×

the government’s debt the same size (relative to the size of the economy) at the end of a given period as it was at the beginning.

An advantage of the “fiscal gap” measure is that it condenses a long-term series of estimates into a single meaningful number that can be used to judge the required scale of corrective action and to compare with gap estimates made at different times or across budgets with different policy components. A disadvantage of the “fiscal gap” measure is the amount of mathematical sophistication required to interpret it.

Using CBO’s “current-law” baseline, Auerbach and Gale (2009) estimated the fiscal gap for the U.S. federal budget baseline in mid-2009 at around 4.4 percent of GDP for projected flows through 2085 and 6.25 percent of GDP if flows are projected over an indefinite horizon. Under alternative assumptions more similar to those used in this report, their estimates of the gap ranged from 7.44 to 9.36 percent.

REFERENCES

Anderson, B., and Sheppard, J. (2010). Fiscal futures, institutional budget reforms, and their effects: What can be learned? OECD Journal on Budgeting, 2009(3).

Auerbach, A.J. (1994). The U.S. fiscal problem: Where we are, how we got here, and where we’re going. In S. Fischer and J. Rotemberg, eds., NBER Macroeconomics Annual, pp. 141-175. Cambridge, MA: National Bureau of Economic Research.

Auerbach, A.J., and Gale, W.G. (2009). The Economic Crisis and the Fiscal Crisis, 2009 and Beyond. Available: http://www.taxpolicycenter.org/UploadedPDF/411843/_economic_crisis.pdf [December 2009].

Congressional Budget Office. (2007). The Long-Term Budget Outlook. Washington, DC: Congressional Budget Office.

Congressional Budget Office. (2009). The Long-Term Budget Outlook. Washington, DC: Congressional Budget Office.

Organisation for Economic Co-operation and Development. (2007). Paris, France: Organisation for Economic Co-operation and Development.

Schick, A. (2005). Sustainable budget policy: Concepts and approaches. OECD Journal on Budgeting, 5(1), 107-125.

von Furstenberg, G.M. (1991). Taxes: A license to spend or a late charge? Part three of The Great Fiscal Experiment, R.G. Penner, ed. Pp. 155-191. Washington, DC: Urban Institute Press.

Wyplosz, C. (2007). Debt Sustainability Assessment: The IMF Approach and Alternatives. HEI Working Paper No. 03/2007. Graduate Institute of International Studies, Geneva, Switzerland. Available: http://ideas.repec.org/p/gii/-2007.html [December 2009].

Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
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Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
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Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
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Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
×
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Suggested Citation:"Appendix A: Fiscal Sustainability." National Research Council. 2010. Choosing the Nation's Fiscal Future. Washington, DC: The National Academies Press. doi: 10.17226/12808.
×
Page 236
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A mismatch between the federal government's revenues and spending, now and in the foreseeable future, requires heavy borrowing, leading to a large and increasing federal debt. That increasing debt raises a serious challenge to all of the goals that various people expect their government to pursue. It also raises questions about the nation's future wealth and whether too much debt could lead to higher interest rates and even to loss of confidence in the nation's long-term ability and commitment to honor its obligations. Many analysts have concluded that the trajectory of the federal budget set by current policies cannot be sustained.

In light of these projections, Choosing the Nation's Fiscal Future assesses the options and possibilities for a sustainable federal budget. This comprehensive book considers a range of policy changes that could help put the budget on a sustainable path: reforms to reduce the rate of growth in spending for Medicare and Medicaid; options to reduce the growth rate of Social Security benefits or raise payroll taxes; and changes in many other government spending programs and tax policies. The book also examines how the federal budget process could be revised to be more far sighted and to hold leaders accountable for responsible stewardship of the nation's fiscal future.

Choosing the Nation's Fiscal Future will provide readers with a practical framework to assess budget proposals for their consistency with long-term fiscal stability. It will help them assess what policy changes they want, consistent with their own values and their views of the proper role of the government and within the constraints of a responsible national budget. It will show how the perhaps difficult but possible policy changes could be combined to produce a wide range of budget scenarios to bring revenues and spending into alignment for the long term. This book will be uniquely valuable to everyone concerned about the current and projected fiscal health of the nation.

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