In-Depth: Can the U.S. Achieve Long-Run Fiscal Sustainability?

The continual growth of federal nondefense spending in conjunction with the government's almost flat revenue-to-GDP ratio, which has fluctuated roughly between 15 and 20 percent since 1945, was the topic of the April 8 Dialogue with the Fed. If current trends continue, federal nondefense spending and tax revenues could prompt a fiscal crisis—which the U.S. has so far averted.

In his presentation, William Emmons, an assistant vice president and economist at the St. Louis Fed, discussed whether the United States can achieve long-run fiscal sustainability. Emmons explained that the cost drivers of Social Security, Medicare and other federal programs are very difficult to affect and present a challenge when trying to reduce or control spending.

Following the presentation, Kevin Kliesen, a research officer and business economist, offered his views on the topic. Kliesen and Emmons then answered questions from the audience in a session moderated by Julie Stackhouse, the senior vice president of Banking Supervision, Credit, Community Development and Learning Innovation. To see Emmons' presentation slides and videos of the dialogue, visit

What Happens When an Irresistible Force Meets an Immovable Object?

To visually explain the future fiscal situation of the United States, Emmons used a physics paradox—an irresistible force meeting an immovable object. He characterized nondefense spending growth as the irresistible fiscal force, and tax revenues as a share of GDP as the immovable fiscal object. This collision depicts a looming fiscal disaster, which could include: high inflation, default on government debt, and drastic benefit cuts and tax increases. To best understand the implications, Emmons analyzed trends in federal spending and taxes relative to GDP and posed two questions: First, how have we avoided a fiscal crisis so far? And, can we achieve long-run fiscal sustainability?

Can We Slow Spending Growth?

Since 1945, federal nondefense spending relative to GDP has quadrupled. Currently, this spending—on Social Security, Medicare and other programs—is approximately 20 percent of GDP and shows no signs of slowing. (See Figure 1 below.) "This is our irresistible force: Through all sorts of historic periods for all sorts of different reasons, federal nondefense spending has relentlessly grown faster than the overall economy," Emmons said.


Ratio of Federal Nondefense Spending to GDP

Figure 1

SOURCES: Congressional Budget Office/Haver Analytics
NOTE: Annual data through fiscal year 2012; CBO projections for 2013-2023 as of Feb. 2013

Emmons examined the popularity of federal spending programs like Social Security, Medicare and defense, and explained that the major cost drivers are health-care expenditures. He pointed out that health-care costs have risen faster than GDP and are projected to continue to do so. And, while Social Security is presently the largest budget item, it's projected to remain relatively flat over the next several decades. All other federal spending—including for defense—is declining. Emmons went on to explain that although interest rates on the debt are currently very low, they will return to more historically normal levels. Thus, given unchanged circumstances, the interest payments will eventually become the largest budget item.

Elaborating on why it won't be easy to slow spending growth, Emmons explained that the first obstacle is the popularity of major federal programs. He cited a March 24 CBS News poll that indicated strong majorities opposed spending cuts to Medicare, Social Security and, to a lesser extent, defense to reduce the deficit.[1] The immense popularity of the health-care programs, plus the program cost drivers that are very difficult to influence—including the aging population and the fact that health-care costs are rising faster than GDP—make it difficult to find a way to control or slow spending.

Can the U.S. Stabilize the Debt?

Emmons pointed out that the federal revenue-to-GDP ratio has been essentially flat since 1945. (See Figure 2 below.) Even with the current fiscal tightening, it is projected to return to its historic level (around 18 to 20 percent of GDP). So, when the federal spending-to-GDP ratio is combined with the federal revenue-to-GDP ratio, a fiscal crisis seems probable, Emmons suggested. (See Figure 3 below.) According to Congressional Budget Office (CBO) projections, the budget deficit will be at approximately 20 percentage points (or $3 trillion) by the end of the projection period.


Ratio of Federal Revenue to GDP

Figure 2

SOURCES: Congressional Budget Office/Haver Analytics
NOTE: Annual data through fiscal year 2012; CBO projections for 2013-2023 as of Feb. 2013


Budget Deficits

Figure 3

SOURCES: Congressional Budget Office/Haver Analytics
NOTE: Projections as of June 2012

"The result of these exploding budget deficits is that accumulated debt would also explode," said Emmons. Figure 4 (below) depicts the CBO's baseline scenario and its alternative fiscal scenario. The latter is the CBO's more plausible projection; however, both of these scenarios are unsustainable, as the ratio of debt-to-GDP goes up indefinitely. "That is the simplest and most pertinent measure of fiscal sustainability. Can we get the debt stabilized relative to the size of GDP? It's not the case that we have to pay off the debt, and it's not the case that the debt can't grow; it's just that it can't grow faster than the economy forever. That's the situation of fiscal unsustainability," Emmons explained. So, can the U.S. stabilize the debt? Historical evidence suggests that when other countries have hit these levels of debt-to-GDP, the ratios have been difficult to stabilize—but is the United States different?


Ratio of Federal Debt Held by the Public to GDP

Figure 4

SOURCES: Congressional Budget Office/Haver Analytics
NOTE: Annual data through fiscal year 2012; CBO projections for 2013-2023 as of Feb. 2013

Why Haven't We Had a Fiscal Crisis Already?

Given that nondefense spending has continued to rise, while revenues have stayed flat, how has the United States gone so long without a crisis? Emmons proposed a few explanations. First, we have had an extended peace dividend, which refers to declining military spending. However, he pointed out that due to the defense cuts previously enacted, there isn't much left to cut; certainly not enough to absorb the soaring health-care costs expected over the next few decades. The second reason we've been able to avoid a fiscal crisis is the demographic dividend. "We've had the Baby Boomers—often defined as people born between 1946 and 1964—moving through their most productive years, swelling the labor force, increasing GDP growth, paying taxes—and at the same time, not collecting as many benefits as, say, a very young population or a very old population," said Emmons. As we are now moving to a permanently older population though, one consequence is that economic growth is likely to be slower (see Figure 5 below), and another is that government spending on health and retirement programs will be higher. Finally, some good luck and good policy in the 1980s and 1990s helped prevent a fiscal crisis. For instance, economic growth and the stock market were strong, reducing deficits.


CBO Estimate of Real Potential GDP Growth (5-year trailing average)

Figure 5

SOURCES: Congressional Budget Office/Haver Analytics
NOTE: Annual data through 2012; CBO projections for 2013-2024 as of Feb. 2013

In Light of These Obstacles, Can We Achieve Long-Run Fiscal Sustainability?

The issue, Emmons said, is that in general neither political faction nor the public seems to be willing to address the reality of what lies ahead in terms of the U.S. fiscal situation. Overall, it seems that one faction will not admit to the popularity of the major federal programs, such as Social Security and Medicare, whereas the other faction will not admit that the tax revenues needed to pay for these programs are not politically or economically feasible. Given these circumstances, will the United States have a fiscal crisis?

Emmons referenced This Time Is Different: Eight Centuries of Financial Folly, by Carmen M. Reinhart and Kenneth S. Rogoff.[2] Reinhart and Rogoff found that default on sovereign debt is more common than one might think. History is full of countries that lost control of their fiscal situations, ending in crisis. For example, Spain has defaulted 15 times during the last 450 years.

Implicit defaults through inflation or currency devaluation, though less obvious, are just as common, Emmons noted. For example, the United States implicitly defaulted on its debt by effectively reducing the value of its financial promises when it devalued the dollar against gold in 1933 and when it broke the link between the dollar and other currencies in 1971.

To Worry or Not To Worry about a Fiscal Crisis?

"The U.S. government will not default on its debt in the foreseeable future," Emmons said, suggesting no pressing need to worry. "Also, the Federal Reserve will not allow inflation to surge in the foreseeable future. With these two options off the table, the only way to achieve fiscal sustainability is through political action." Unfortunately, our political system seems gridlocked, and most members of the public seem hesitant to make sacrifices, as illustrated by the aforementioned poll. However, Emmons urged that "our political leaders must help the public understand spending and taxing realities." The public perception needs to change; the public must agree to make sacrifices—not all equally—but everyone should be involved.

A step in this direction, Emmons suggested, would be to separate the insurance function of government from redistribution. "Make the actual cost of government insurance programs transparent, so that everyone knows how much it costs to provide services—especially health care and retirement annuities," said Emmons.

Changing the Discussion: Be Transparent about the Cost of Benefits

Under current circumstances, federal nondefense spending and tax revenues are, respectively, an irresistible force meeting an immovable object, according to Emmons. "A series of temporary fixes has prevented a fiscal crisis so far, but those fixes are gone. The only plausible route to long-run fiscal sustainability is through political courage and leadership. Since we are not going to default on our debt or inflate away our debt, the only solution is political. We have to get the taxes and the spending to add up, and that's going to require shared sacrifice." However, to accept this sacrifice, the public must be informed—Emmons reinforced that transparency is the key. We must convince our political leaders to help the public better understand these realities and to emphasize that we are all in this together. Going forward, he suggested, we must initiate a more straightforward discussion about health-care costs, the role of the aging population and taxes.


  1. "Americans' Views on Washington, the President & the Budget Deficit," CBS News poll, March 20-24, 2013, [back to text]
  2. See chapters 4-9 and chapter 12 in This Time Is Different: Eight Centuries of Financial Folly, by Carmen M. Reinhart and Kenneth S. Rogoff. Princeton University Press, 2009. [back to text]


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