Management's Discussion & Analysis

An Unsustainable Fiscal Path

An important purpose of the Financial Report is to help citizens understand current fiscal policy and the importance and magnitude of policy reforms necessary to make it sustainable. This Financial Report includes the SLTFP and a related Note Disclosure (Note 23). The Statements display the present value of 75-year projections of the federal government’s receipts and non-interest spending¹⁹ for fiscal year 2018 and fiscal year 2017.

Fiscal Sustainability

A sustainable fiscal policy is one where the debt-to-GDP ratio is stable or declining over the long term. The projections in this Financial Report indicate that current policy is not sustainable. As discussed below, if current policy is left unchanged, the debt-to-GDP ratio is projected to rise from its current level of 78 percent in 2018 to 84 percent by 2022, to over 100 percent by 2030, and to 530 percent in 2093 and to even higher levels, thereafter. Preventing the debt-to-GDP ratio from rising over the next 75 years is estimated to require some combination of spending reductions and revenue increases that amount to 4.1 percent of GDP over the period. While this estimate of the “75-year fiscal gap” is highly uncertain, it is nevertheless nearly certain that current fiscal policies cannot be sustained indefinitely.

Delaying action to reduce the fiscal gap increases the magnitude of spending and/or revenue changes necessary to stabilize the debt-to-GDP ratio. For example, the magnitude of spending cuts and/or revenue increases necessary to close the gap rises about 20 percent if reforms are delayed ten years, and about 46 percent if reform is delayed 20 years.

The estimates of the cost of policy delay assume policy does not affect GDP or other economic variables. Delaying fiscal adjustments for too long raises the risk that growing federal debt would increase interest rates, which would, in turn, reduce investment and ultimately economic growth.

The projections discussed here assume current policy²⁰ remains unchanged, and hence, are neither forecasts nor predictions. Nevertheless, policy changes must be enacted so that actual financial outcomes will be different than those projected.

The Primary Deficit, Interest, and Debt

The primary deficit – the difference between non-interest spending and receipts – is the determinant of the debt-to-GDP ratio over which the government has the greatest control (the other determinants include interest rates and growth in GDP). Chart H shows receipts, non-interest spending, and the difference – the primary deficit – expressed as a share of GDP. The primary deficit-to-GDP ratio spiked during 2009 through 2012 due to the 2008-09 financial crisis and the ensuing severe recession, as well as the increased spending and temporary tax reductions enacted to stimulate the economy and support recovery. These elevated primary deficits resulted in a sharp increase in the ratio of debt to GDP, which rose from 39 percent at the end of 2008 to 70 percent at the end of 2012. As an economic recovery took hold, the primary deficit ratio fell, averaging 1.9 percent of GDP over 2013 through 2018. This primary deficit ratio was still high enough that the debt-to-GDP ratio increased further, ending 2018 at 78 percent. The primary deficit ratio is projected to rise to 2.9 percent in 2019 and then shrink slightly through 2024 as the economy grows. After 2024, however, increased spending for Social Security and health programs due to the ongoing retirement of the baby boom generation and increases in the price of health care services is projected to result in increasing primary deficit ratios that reach 3.0 percent of GDP in 2028. The primary deficit ratio peaks at 4.1 percent in 2039, gradually decreases beyond that point as aging of the population continues at a slower pace, and reaches 2.5 percent of GDP in 2093.

Primary deficit trends are heavily influenced by tax receipts. Receipts as a share of GDP were markedly depressed in 2009 through 2012 because of the recession and tax reductions enacted as part of the American Recovery and Reinvestment Act of 2009 (ARRA) and the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. The share subsequently increased to 18 percent of GDP by 2015, then decreased to 16.5 percent in 2018, following enactment of the Tax Cuts and Jobs Act of 2018 (TCJA), below its 30-year average of 17.3 percent.

Receipts are projected to grow slightly more rapidly than GDP over the projection period as increases in real incomes cause more taxpayers and a larger share of income to fall into the higher individual income tax brackets.

Non-interest spending as a share of GDP is projected to rise gradually from 18.7 percent in 2018 to 21.0 percent  in 2029, and ends at 22.6 percent in 2093. Beginning in 2020, these increases are principally due to faster growth in Medicare, Medicaid, and Social Security spending (see Chart G). Over the next 25 years, the aging of the baby boom generation is projected to increase the Social Security, Medicare, and Medicaid spending shares of GDP by about 1.0 percentage points, 1.7 percentage points, and 0.6 percentage points, respectively. After 2035, the Social Security spending share of GDP remains relatively stable, while the combined Medicare and Medicaid spending share of GDP continues to increase, albeit at a slower rate, due to projected increases in health care costs.

One of the most important assumptions underlying the projections is the future growth of health care costs. As discussed in Note 22, these future growth rates – both for health care costs in the economy generally and for Federal health care programs such as Medicare, Medicaid, and Affordable Care Act (ACA) exchange subsidies – are highly uncertain. In particular, enactment of the ACA in 2010 and the Medicare Access and CHIP Reauthorization Act (MACRA) in 2015 established cost controls for Medicare hospital and physician payments whose long-term effectiveness is still to be demonstrated. The Medicare spending projections in the long-term fiscal projections are based on the projections in the 2018 Medicare trustees’ report, which assume the ACA and MACRA cost control measures will be effective in producing a substantial slowdown in Medicare cost growth. As discussed in Note 22, the Medicare projections are subject to much uncertainty about the ultimate effects of these provisions to reduce health care cost growth. For the long-term fiscal projections, that uncertainty also affects the projections for Medicaid and exchange subsidies, because the cost per beneficiary in these programs is assumed to grow at the same reduced rate as Medicare cost growth per beneficiary.

As discussed in Note 23, the primary deficit projections reported in the Fiscal Year 2018 Financial Report increased compared to those reported in the Fiscal Year 2017 Financial Report. These increases are attributable to a number of factors, but in great part to: (1) use of fiscal year 2018 actual budget results that differed from projections made in prior years, including lower corporate and individual income tax receipts, and higher non-defense discretionary spending as a result of the increased discretionary spending caps in the Bipartisan Budget Act of 2018 (BBA 2018); and (2) revised assumptions, including those related to corporate income taxes to reflect enactment of the TCJA, and to growth in discretionary spending. For the Fiscal Year 2018 Financial Report, corporate income tax receipts are assumed to be the same share of GDP as projected in the 2018 Midsession Review, which incorporates the expected effects of the TCJA. In addition, the projections assume that individual income and estate and gift tax provisions of the TCJA are permanently extended; Congressional action is required to make this change. With regard to discretionary spending, previous statements assumed that it followed the caps established by the Budget Control Act of 2011 (BCA) and then grew with nominal GDP in the years after caps expired. However, discretionary spending has not been limited to the caps established in the BCA. Instead, budget deals in 2013, 2015, and 2018 raised the caps in each of the years 2014 through 2019. Therefore, as a reasonable representation of current policy, the 2018 projections assume that discretionary spending grows at the same rate as nominal GDP beyond 2019, rather than being limited to the statutory caps, subject to Joint Committee on Deficit Reduction spending controls. Congressional action is required to make this change. GDP, interest, and other economic and demographic assumptions are the same as those that underlie the most recent Social Security and Medicare trustees’ report projections, adjusted for historical revisions that occur annually. See Note 23—Long-Term Fiscal Projections for more information about the assumptions used in this analysis.

The primary deficit-to-GDP projections in Chart G, projections for interest rates, and GDP growth rates are the primary determinants for the debt-to-GDP ratio projections shown in Chart H. That ratio was 78 percent at the end of fiscal year 2018 and under current policy is projected to be 84 percent by 2022, over 100 percent by 2030, and 530 percent in 2093. The change in debt held by the public from one year to the next is approximately equal to the budget deficit, the difference between total spending and total receipts. The debt-to-GDP ratio rises continually in great part because higher levels of debt lead to higher net interest expenditures, and higher net interest expenditures lead to higher debt.²¹The continuous rise of the debt-to-GDP ratio indicates that current policy is unsustainable.

These debt-to-GDP projections are higher than the corresponding projections in both the fiscal year 2017 and fiscal year 2016 Financial Reports. For example, the last year of the 75-year projection period used in the fiscal year 2016 Financial Report is 2091. In the fiscal year 2018 Financial Report, the debt-to-GDP ratio for 2091 is projected to be 513 percent, which compares with 293 and 252 percent projected for that same year in the fiscal year 2017 Financial Report and the fiscal year 2016 Financial Report, respectively. ²²

The Fiscal Gap and the Cost of Delaying Policy Reform

The 75-year fiscal gap is one measure of the degree to which current policy is unsustainable. It is the amount by which primary surpluses over the next 75 years must, on average, rise above current-policy levels in order for the debt-to-GDP ratio in 2093 to remain at its level in 2018 (78 percent). The projections show that projected primary deficits average 3.2 percent of GDP over the next 75 years under current policy. If policies were adopted to eliminate the fiscal gap, the average primary surplus over the next 75 years would be 0.8 percent of GDP, 4.1 percentage points higher than the projected present value of receipts less non-interest spending shown in the basic financial statement. Hence, the 75-year fiscal gap is estimated to equal 4.1 percent of GDP. This gap represents 21.9 percent of 75-year present value receipts and 18.6 percent of 75-year present value non-interest spending. The fiscal gap was estimated at 2.0 percent in the 2017 Financial Report, 2.1 percentage points lower than estimated in this Report.

In these projections, closing the fiscal gap requires running substantially positive primary surpluses, rather than simply eliminating the primary deficit. The primary reason is that the projections assume future interest rates will exceed the growth rate of GDP. Achieving primary balance (that is, running a primary surplus of zero) implies that the debt grows each year by the amount of interest spending, which under these assumptions would result in debt growing faster than GDP.

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Table 6 shows the cost of delaying policy reform to close the fiscal gap by comparing policy reforms that begin in three different years. Immediate reform would require increasing primary surpluses by 4.1 percent of GDP on average between 2019 and 2093 (i.e., some combination of reducing spending and increasing revenue by a combined 4.1 percent of GDP on average over the 75-year projection period). Table 6 shows that delaying policy reform forces larger and more abrupt policy reforms over shorter periods. For example, if policy reform is delayed by 10 years, closing the fiscal gap requires increasing the primary surpluses by 4.9 percent of GDP on average between 2029 and 2093. Similarly, delaying reform by 20 years requires primary surplus increases of 6.0 percent of GDP on average between 2039 and 2093. The differences between the required primary surplus increases that start in 2029 and 2039 (4.9 and 6.0 percent of GDP, respectively) and that which starts in 2019 (4.1 percent of GDP) is a measure of the additional burden that delay would impose on future generations. Future generations are harmed by policy reform delay, because the higher the primary surplus is during their lifetimes the greater the difference is between the taxes they pay and the programmatic spending from which they benefit

Conclusion

The past 11 years saw the national debt nearly double as a share of GDP, bringing it to a level not seen since shortly after World War II. The debt-to-GDP ratio is projected to rise over the 75-year projection period and beyond if current policy is unchanged, which implies that current policy is not sustainable and must ultimately change. If policy changes are not so abrupt as to hinder economic growth, then the sooner policies are adopted to avert these trends, the smaller the changes to revenue and/or spending that would be required to achieve sustainability over the long term. While the estimated magnitude of the fiscal gap is subject to a substantial amount of uncertainty, there is little doubt that current policy is not sustainable.

These long-term fiscal projections and the topic of fiscal sustainability are discussed in further detail in Note 23 and the RSI section of this Financial Report.

Social Insurance

The long-term fiscal projections reflect government receipts and spending as a whole. The SOSI focuses on the government's “social insurance” programs: Social Security, Medicare, Railroad Retirement, and Black Lung.²³ For these programs, the SOSI reports: (1) the actuarial present value of all future program revenue (mainly taxes and premiums) - excluding interest - to be received from or on behalf of current and future participants; (2) the estimated future scheduled expenditures to be paid to or on behalf of current and future participants; and (3) the difference between (1) and (2). Amounts reported in the SOSI and in the RSI section in this Financial Report are based on each program’s official actuarial calculations.

Table 7 summarizes amounts reported in the SOSI, showing that net social insurance expenditures are projected to be $53.8 trillion over 75 years as of January 1, 2018 for the “Open Group,” an increase of $4.8 billion over net expenditures of $49.0 trillion projected in the 2017 Financial Report.²⁴ The current-law 2018 amounts reported for Medicare reflect the physician payment levels expected under the MACRA payment rules and the ACA-mandated reductions in other Medicare payment rates, but not the payment reductions and/or delays that would result from trust fund depletion.²⁵ Similarly, current-law projections for Social Security do not reflect benefit payment reductions and/or delays that would result from fund depletion. By accounting convention, the transfers of general revenues are eliminated in the consolidation of the SOSI at the governmentwide level and as such, the general revenues that are used to finance Medicare Parts B and D are not included in these calculations. For the FY 2018 and 2017 SOSI, the amounts eliminated totaled $32.9 trillion and $30.0 trillion, respectively. SOSI programs and amounts are included in the broader fiscal sustainability analysis in the previous section, although on a slightly different basis (as described in Note 23).

The amounts reported in the SOSI provide perspective on the government’s long-term estimated exposures for social insurance programs. These amounts are not considered liabilities in an accounting context. Future benefit payments will be recognized as expenses and liabilities as they are incurred based on the continuation of the social insurance programs' provisions contained in current law. The social insurance trust funds account for all related program income and expenses. Medicare and Social Security taxes, premiums, and other income are credited to the funds; fund disbursements may only be made for benefit payments and program administrative costs. Any excess revenues are invested in special non-marketable U.S. government securities at a market rate of interest. The trust funds represent the accumulated value, including interest, of all prior program surpluses, and provide automatic funding authority to pay cover future benefits.

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Table 8 identifies the principal reasons for the changes in projected social insurance amounts during 2018 and 2017.

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¹Relates to SSA.

²Relates to HHS.
Note: Some totals may not equal sum of components due to rounding.

The following briefly summarizes the significant changes for the current valuation (as of January 1, 2018) as disclosed in Note 22, Social Insurance. Note 22 is compiled from disclosures included in the financial reports of those entities administering these programs, including SSA and HHS. See Note 22 for additional information.

• Change in valuation period (affects both both Social Security and Medicare): This change replaces a small negative net cash flow for 2017 with a much larger negative net cash flow for 2092. As a result, the present value of the estimated future net cash flows decreased (became more negative) by $1.9 trillion.
• Changes in demographic data, assumptions, and methods (affects both Social Security and Medicare): For the current valuation, the only change to the ultimate demographic assumptions was a small decrease of 10,000 Lawful Permanent Resident (LPR) immigrants per annum in the future. However, the starting demographic values and the way these values transition to the ultimate assumptions were changed. These changes included, but were not limited to lower birth rates than originally assumed, the observed persistent drop in the total fertility rate in recent years is now assumed to be a loss of potential births rather than just a deferral to this period, and higher death rates than projected in prior valuations for Medicare experience ages 65 and older. Overall, changes to these assumptions caused the present value of the estimated future net cash flows to increase (become less negative) by $700 billion.
• Changes in economic data and assumptions (affects Social Security only): The ultimate economic assumptions for the current valuation period are the same as those for the prior year valuation. However, the starting economic values and the way these values transition to the ultimate assumptions were changed. These changes included: the estimated level of potential GDP was reduced by about 1 percent in 2017 and throughout the projection period, meaning that cumulative growth in actual GDP is 1 percent less over the remainder of the projected recovery than assumed in the prior valuation; near-term interest rates were decreased, and lower than expected ratios of and assumed extended recoveries for labor compensation to GDP and taxable payroll to GDP. Overall, changes to these assumptions caused the present value of the estimated future net cash flows to decrease (become more negative) by $500 billion.
• Changes in Law or Policy: Between the prior and current valuation periods, no new laws, regulations, or policies were enacted that are expected to have significant effects on the OASDI or Medicare programs. However, the current valuations for each program do incorporate some notable changes with negligible effects on the present value of estimated cash flows:
  • For Social Security, the 2012 Deferred Action for Childhood Arrivals (DACA) program is assumed to be phased out over the next two years (the prior valuation assumed that the 2012 DACA program would continue indefinitely); and the TCJA includes the elimination of the individual mandate penalty of the Patient Protection and Affordable Care Act, which is expected to cause some individuals to drop employer-sponsored health insurance, increase OASDI-covered wages, and taxable payroll slightly.
  • For Medicare, legislation that affected the present value of estimated cash flows includes but is not limited to: The Disaster Tax Relief and Airport and Airway Extension Act of 2017 and the Bipartisan Budget Act of 2018 (BBA).
  Overall, these changes to these assumptions caused the present value of the estimated future net cash flows to decrease (become more negative) by $1.0 trillion
• Changes in economic and other healthcare assumptions (affects Medicare only): The economic assumptions used in the Medicare projections are the same as those used for the OASDI (described above) and are prepared by the Office of the Chief Actuary at SSA. In addition to the economic assumptions changes described above, the healthcare assumptions are specific to the Medicare projections. Changes to these assumptions in the current valuation include: utilization rate assumptions for inpatient hospital use and utilization rate and case mix assumptions for skilled nursing facilities were decreased; payment rates to private health plans are higher than projected in last year’s report; higher projected manufacturer rebates. The net impact of these changes caused the present value of the estimated future net cash flows to decrease (become more negative) by $1.5 trillion
• Change in Projection Base (affects Medicare only): Actual income and expenditures in 2017 were different than what was anticipated when the 2017 Medicare Trustees Report projections were prepared. Part A payroll tax income was lower and expenditures were higher than anticipated, based on actual experience. Part B total income and expenditures were higher than estimated based on actual experience. For Part D, actual income and expenditures were both lower than prior estimates. The net impact of the Part A, B, and D projection base changes is a decrease (become less negative) in the estimated future net cash flow by $900 billion.

Projected net expenditures for Medicare Parts A and B declined significantly between fiscal year 2009 and fiscal year 2010 reflecting provisions of the ACA. As reported in Note 22, uncertainty remains about whether the projected cost savings and productivity improvements will be sustained in a manner consistent with the projected cost growth over time. Note 22 includes an alternative projection to illustrate the uncertainty of projected Medicare costs. As indicated earlier, GAO disclaimed opinions on the 2018, 2017, 2016, 2015 and 2014 SOSI because of these significant uncertainties.

Costs as a percent of GDP of both Medicare and Social Security, which are analyzed annually in the Medicare and Social Security Trustees’ Reports, are projected to increase substantially through the mid-2030s because: (1) the number of beneficiaries rises rapidly as the baby-boom generation retires and (2) the lower birth rates that have persisted since the baby boom cause slower growth in the labor force and GDP.²⁶ According to the Medicare Trustees’ Report, spending on Medicare is projected to rise from its current level of 3.7 percent of GDP to 5.9 percent in 2042 and to 6.2 percent in 2092. As for Social Security, combined spending is projected to generally increase from its current level of 4.9 percent of GDP to about 6.1 percent by 2038, declining to 5.9 percent by 2052 and then generally increase to 6.1 percent by 2092.²⁷ The government collects and maintains funds supporting the Social Security and Medicare programs in Trust Funds. A scenario where projected funds expended exceed projected funds received, as reported in the SOSI, will cause the balances in those Trust Funds to deplete over time. Table 9 summarizes additional current status and projected trend information, including years of projected depletion, for the Medicare and Social Security Trust Funds.

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Table 9: Trust Fund Status

As previously discussed and as noted in the Trustees’ Reports, it is apparent that these programs are on a fiscally unsustainable path. Additional information from the Trustees Reports may be found in the RSI section of this Financial Report.

Footnotes

¹⁹ For the purposes of the Statement of Long-Term Fiscal Projections and this analysis, spending is defined in terms of outlays. In the context of federal budgeting, spending can either refer to: (1) budget authority – the authority to commit the government to make a payment; (2) obligations – binding agreements that will result in either immediate or future payment; or (3) outlays, or actual payments made.  (Back to Content)

²⁰ Current policy in the projections is based on current law, but includes certain adjustments, such as extension of certain policies that expire under current law but are routinely extended or otherwise expected to continue (e.g., reauthorization of the Supplemental Nutrition Assistance Program).  (Back to Content)

²¹ The change in debt each year is also affected by certain transactions not included in the budget deficit, such as changes in Treasury’s cash balances and the nonbudgetary activity of Federal credit financing accounts. These transactions are assumed to hold constant at about 0.4 percent of GDP each year, with the same effect on debt as if the primary deficit was higher by that amount.  (Back to Content)

²² See the Note 23 of the Fiscal Year 2017 Financial Report of the U.S. Governmentfor more information about changes in the long term fiscal projections between fiscal years 2016 and 2017.  (Back to Content)

²³ The Black Lung Benefits Act (BLBA) provides for monthly payments and medical benefits to coal miners totally disabled from pneumoconiosis (black lung disease) arising from their employment in or around the nation's coal mines. See http://www.dol.gov/owcp/regs/compliance/ca_main.htm.  (Back to Content)

²⁴ 'Closed' Group and 'Open' Group differ by the population included in each calculation. From the SOSI, the 'Closed' Group includes: (1) participants who have attained eligibility and (2) participants who have not attained eligibility. The 'Open' Group adds future participants to the 'Closed' Group. See ‘Social Insurance’ in the Required Supplementary Information section in this Financial Report for more information.  (Back to Content)

²⁵ MACRA permanently replaces the sustainable growth rate (SGR) formula, which was used to determine payment updates under the Medicare physician fee schedule with specified payment updates through 2025. The changes specified in MACRA also establish differential payment updates starting in 2026 based on practitioners’ participation in eligible alternative payment models; payments are also subject to adjustments based on the quality of care provided, resource use, use of certified electronic health records, and clinical practice improvement. (Back to Content)

²⁶ A Summary of the 2018 Annual Social Security and Medicare Trust Fund Reports, p. 1-2 and the 2017 Medicaid Actuarial Report. (Back to Content)

²⁷ Percent of GDP amounts are expressed in gross terms (including amounts financed by premiums and state transfers). (Back to Content)