Following the financial crisis, the budget deficit reached 10% of gross domestic product (GDP) in 2009 and 9% of GDP in 2010, a level that cannot be sustained in the long run. Concerns about long-term fiscal sustainability depend on the projected future path of the budget, absent future policy changes. While the recent growth in the budget deficit was due to short-term developments unrelated to entitlement spending on the elderly, the projected path of the budget in the long run primarily depends on the future path of entitlement spending. Thus, the increases in spending are not projected to subside after the baby boomers have passed away. Projected spending increases from 4.8% of GDP in 2010 to 6.1% of GDP in 2035, whereas revenues are projected to stay fairly constant as a proportion of GDP. In CBO's projection, federal health spending increases from 5.6% in 2011 to as much as 10.3% in 2035. If the government financed its rising budget deficit by increasing the money supply, the rate of inflation would also increase significantly along with interest rates. The deficits projected under current policy would exceed private saving and cause national saving to become negative. Once a pay-as-you-go system is up and running and suffers an adverse demographic shift, there is no reform that can avoid placing a burden on some participants in the system by making some present or future generation receive less than past generations. Trust Funds Cannot Finance Future Benefits From a Government-Wide Perspective

According to law, when benefit costs of Social Security and Medicare Part A exceed income, their trust funds can be drawn down to finance benefits. Any policy change that reduced the current budget deficit would reduce the government's future fiscal gap; likewise, current budget deficits increase that fiscal gap. But making the transition to a prefunded system makes current generations worse off, because the prefunding must be financed either through higher taxes or lower benefits. Consequences of such an approach are that some medical spending would cease and some would be shifted to private spending and private insurance. If Social Security is maintained on a pay-as-you-go basis, tax increases rising to 1.4% of GDP are projected to be needed by 2035 (assuming, because of the overall budget shortfall, that general revenues are unavailable). If taxes were raised today and the proceeds not saved, then the tax increases required in the future would not be reduced. The retirement of the baby boomers, increased life expectancy, and the rising cost of health care are projected to increase spending without any commensurate increase in revenues. To keep the overall budget on a sustainable path over the next 50 years, either the projected rise in Social Security, Medicare, and Medicaid spending will have to be contained, or tax revenues will have to be increased, or both. Grappling with the fiscal solvency issue is also complicated by the inability to bind future Congresses to a long-term spending path—even if policy changes that reduce spending or raise revenue are initially used to reduce the budget deficit, there is the risk that the fiscal improvement will be undone by future Congresses. What has already contributed to the fiscal imbalance is today's budget deficits, and the simplest and most concrete step that can be taken to reduce the fiscal gap is to reduce the current budget deficit. Debt-financed individual accounts, by themselves, are projected to worsen the fiscal outlook over the next 75 years and would not increase GDP or national saving. Medicare and Medicaid face much larger and more intractable financial problems than Social Security.
Following the financial crisis, the budget deficit reached 10% of gross domestic product (GDP) in 2009 and 9% of GDP in 2010, a level that cannot be sustained in the long run. Concerns about long-term fiscal sustainability depend on the projected future path of the budget, absent future policy changes. While entitlement spending made little contribution to current budget deficits, the retirement of the baby boomers, rising life expectancy, and the rising cost of medical care result in projections of large and growing budget deficits over the next several decades. Social Security outlays are projected to rise from 4.8% of GDP today to 6.1% of GDP in 2035, and federal health outlays (mainly on Medicare and Medicaid) are projected to rise from 5.6% today to as much as 10.3% of GDP in 2035. These increases in spending are not expected to subside after the baby boomers have passed away. Without any corresponding rise in revenues, this spending path would maintain unsustainably large and persistent budget deficits, which would push up interest rates and the trade deficit, crowd out private investment spending, and ultimately cause fiscal crisis.
To avoid this outcome, taxes would need to be raised or expenditures would need to be reduced. Altering taxes and benefits ahead of time would reduce the size of adjustments required in the future, if the proceeds were used to increase national saving. (Making changes ahead of time would also allow individuals time to adjust their private saving behavior.) National saving can be increased by reducing the budget deficit. But if the budget savings is subsequently offset by new spending or tax cuts, the government's ability to finance future benefits will not have improved. Individual accounts financed by increasing the budget deficit would not increase national saving or reduce the government's fiscal imbalance, and could exacerbate that imbalance over the 75-year projection.
Relatively small tax increases or benefit reductions could return Social Security to long-run solvency. Restraining the growth in Medicare and Medicaid spending is more uncertain and difficult, however. The projected increase in spending is driven more by medical spending outpacing general spending increases than by demographic change. But it is uncertain how to restrain cost growth because much of it is the result of technological innovation that makes new and expensive treatments available. If future medical spending grows more slowly than projected, then the long-term budget outlook improves dramatically. From a government-wide perspective, Social Security or Medicare trust fund assets cannot help finance future benefits because they are redeemed with general revenues at a time when the overall budget is in deficit.
The reason revenues are not projected to rise along with outlays is that these programs are financed on a pay-as-you-go basis: current workers finance the benefits of current retirees. In the future, there will be fewer workers per retiree. Once a pay-as-you-go system is up and running and faced with an adverse demographic shift, there is no reform that can avoid making some present or future generation receive less than past generations. Under current policy, future generations will be made worse off by higher taxes or lower benefits. Under a reform that increases national saving, some of that burden would be shifted to current generations. Overall, current budget deficits negate the system's limited existing prefunding, exacerbating the future fiscal shortfall. While entitlement spending on the elderly is the major driver behind future deficits, it played little part in the growth of the current budget deficit to unsustainable levels. Reducing the current deficit is the most straightforward and concrete step that can be taken today to reduce the future shortfall.