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posted on 27 December 2015

The Costs To Different Generations Of Policies That Close The USA Fiscal Gap

from the Congressional Budget Office

-- this post authored by Shinichi Nishiyama and Felix Reichling

There are five stylized changes in federal fiscal policy that would close a fiscal gap of 1.8 percent of GDP, and measures the costs that those policy changes would impose on different generations.

In 2014, the U.S. government's accumulated debt equaled 74 percent of the nation's gross domestic product (GDP), and it remains at about that percentage today. In the long-term budget projections issued by the Congressional Budget Office (CBO) in 2014, under then-current laws future spending was projected to exceed future revenues, and debt held by the public was projected to increase to 225 percent in 2089. A common measure of the government's fiscal imbalance is the fiscal gap - the size of the changes in noninterest spending or revenues that would be needed to make federal debt equal its current percentage of GDP at a specific date in the future. In 2014, CBO estimated that the 75-year fiscal gap was 1.8 percent of GDP; in other words, a permanent increase in federal revenues or reduction in federal spending equal to 1.8 percent of GDP each year starting in 2015 would cause debt to equal 74 percent of GDP, its 2014 level, in 2089.

This analysis examines five stylized changes in fiscal policy designed to close a fiscal gap of 1.8 percent of GDP and keep the debt-to-GDP ratio at 74 percent. The analysis looks at how the policies' costs to households in terms of higher taxes or lower transfers would affect the U.S. economy, aggregate net income, and the well-being (or welfare) of individual households. Policy changes designed to prevent unsustainable growth in debt would affect different types of households differently. For example, the effects of tax increases or benefit cuts would be different for low-income households than for high-income households, and different for poor households than for wealthy households. This analysis examines the effects of policy changes on different generations of households.

There are many possible combinations of fiscal policy changes that would close the fiscal gap and return debt as a percentage of GDP to a sustainable path. The benefits of closing the fiscal gap would be identical for all policies. However, it is not possible to measure any of the gains from moving from an unsustainable to a sustainable policy because an unsustainable policy - by definition - cannot be maintained indefinitely. In contrast, the costs imposed on different generations would depend on the specific policy chosen, and those differences in costs can be measured by CBO's overlapping-generations model. For those reasons, we focus on analyzing the costs to households, and the resulting effects on the macroeconomy, of implementing different policies to close the fiscal gap. That analysis allows us to answer the question of how policies rank in terms of costs imposed on different cohorts. (And because the benefits of closing the fiscal gap are the same for all policies, that analysis also provides a ranking of the overall effects of policies on different households.) Thus, our results provide information to lawmakers choosing among policies to close the fiscal gap. However, our results do not provide answers about who would benefit from closing the fiscal gap, whether closing the fiscal gap should be a priority, or whether lawmakers should start closing the gap now or later.

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