The Fiscal Gap
Table of Contents
…the lower prevalence of disability in later life is likely to mean that future costs of chronic health and nursing home care will be lower than in many current forecasts. Conventional thinking seems to ignore these changing numbers.
The "fiscal gap" is a concept developed to characterize the shortfall in the federal budget over the very long term.12 A consensus prevails among experts that the fiscal gap has grown larger in recent years, and some experts have estimated it to be as large as 7 percent of GDP. However, the fiscal gap concept, unless properly understood, can easily mislead because it is extremely sensitive to short-term economic and policy changes, and to the assumptions applied, while providing no sure guide to policy action.13
As an example of the extreme sensitivity to short-run fiscal changes, the CBO reported a decline in the fiscal gap from 5.4 percent of GDP in 1996 to only 0.5 percent in 1999 (thanks in part to higher-than-expected tax revenues).14 Since GDP went from roughly $7.8 trillion to $9.3 trillion during that period, the change meant that the fiscal gap declined from about $420 billion per year to under $50 billion per year within a span of three short years. What caused that dramatic reversal? There were no major changes in tax policy during that time. Some savings resulted from Medicare legislation enacted in 1997, but the main reason for the turnaround was the strong economy and the boom in the stock market, which caused revenues, especially capital gains, to grow rapidly. Since 2000, however, revenue-reduction measures, along with more rapid growth in health care costs, have reopened a large fiscal gap. Reversing that trend will require a sounder fiscal policy, better uses of health care dollars (i.e., greater value for dollars spent), and a strong economy.
While economic changes and policy actions affect the fiscal gap, different assumptions produce different estimates. Recent projections by leading experts have the fiscal gap ranging from 4.6 percent of GDP to 10.5 percent of GDP, depending on the assumptions about future policy and the length of the projection period.15 This is not to suggest that these estimates should not concern us, but that they are highly uncertain.
Finally, the fiscal gap is not an unequivocal guide to policy action. If the fiscal gap is 7 percent of GDP, as some estimates claim, what is the proper policy response? Will robust economic growth reduce the gap? Does it mean that entitlement programs, such as Medicare and Medicaid, are too costly, or just that the health care system of which they are a part is growing as a share of the economy? Does it mean that revenues are too low relative to commitments, requiring higher taxes? Or, does it mean that perhaps the economy is too weak, requiring policies that promote individual savings and increase growth? This is a matter for debate, but recent decisions have done little to advance any one of these approaches.