Even though federal budget-deficit projections have increased sharply in recent years, they still don t accurately portray the long-run fiscal problems facing the United States. As the population ages, life expectancies increase, and health-care costs continue to grow, expenditures on Social Security and Medicare are expected to increase significantly, too. Although payroll taxes today exceed expenditures, in the not-too distant future these taxes will fall far short of anticipated expenditures. Over time, there will be an escalating gap between revenues and expenditures, which will have to be met by outright borrowing.
How can we measure the size of the gap? Economists Jagadeesh Gokhale of the Cato Institute and Kent Smetters of the University of Pennsylvania have developed a more comprehensive measure of nation s indebtedness. The method includes estimating the present value of the gap between the government s revenues and expenditures and adding it to the current national debt. In 2005 Gokhale and Smetters calculated this new total measure, which they call the fiscal imbalance, as approximately $63 trillion, or 5 times GDP. This is a huge number. Even during World War II, government debt was only 1.2 times GDP. In the long run, a fiscal imbalance of this size is not sustainable no one will lend the U.S. government that amount of money. Eliminating these imbalances will require dramatic increases in taxes or reduced expenditures. To maintain the current level of benefits, workers and firms would have to pay nearly 30 percent in payroll taxes about double what they pay today or income taxes would have to nearly double.
Alternatively, benefits programs could be scaled back. Gokhale and Smetters estimate that about 80 percent of the fiscal imbalance will stem from Medicare which pays the rising health-care costs for the elderly. What these numbers suggest is that our current health-care system for retirees will need to undergo fundamental reform to make it more sustainable. Otherwise, the United States will need to radically increase taxes to meet the shortfall.