IMF: Major Changes Required to Close U.S. Fiscal Imbalance – Here’s Why, What and How

The United States is facing an unsupportable fiscal situation due to the combination of high deficits, aging population and growth in government-provided healthcare benefits according to a working paper by the International Monetary Fund (IMF). Their forecast implies that U.S. debt will rise rapidly relative to gross domestic product (GDP) in the medium- to long-term unless MAJOR adjustments in taxes and government payments are made to reduce the current fiscal and generational gaps and to avoid any further undesirable escalation of debt. [Let's look at the details.] Words: 790

So says www.MoneyandMarkets.com in an article* which Lorimer Wilson, editor of www.munKNEE.com,  has further edited ([  ]), abridged (…) and reformatted below  for the sake of clarity and brevity to ensure a fast and easy read. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement. The article goes on to say:

The Fiscal Imbalance or “Gap”

The U.S. fiscal imbalance or “gap” (i.e. the reduction in the deficit needed to keep the debt-to-GDP ratio from growing) in association with today’s federal fiscal policy… is over 15 percent of GDP which means that the relationship between fiscal revenues and spending will need to improve by more than 15 percent of GDP each year indefinitely into the future. That sounds like a big number and certainly a challenge for the U.S. to accomplish.

What’s the Cause?

The main drivers of the fiscal gap cited are:

1. low revenues from tax cuts,
2. adjustments to the Alternative Minimum Tax and
3. rising healthcare costs which will boost mandatory spending above 18 percent of GDP by 2050. 

Generational Gap

The U.S. generational imbalance is large too, according to the analysis. Current generations of Americans are receiving public resources, while future generations are expected to foot the bill.

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Unless Americans living today pay more taxes or there is a pullback in government spending, future taxpayers will face net rates that are about 21½ percentage points higher! The government will need to raise taxes and/or cut payments substantially to avoid this dramatic and undesirable escalation of debt…

Financial Crisis Impact

The IMF’s take is that the financial crisis has had minimal affect on the size of the U.S. fiscal gap because it is a relatively short-term phenomenon. The real drivers are future and growing imbalances anticipated between the country’s revenue intake and expense outlays.

Healthcare vs. Tax Cuts

In comparison to the rapid rise in healthcare spending above 18 percent of GDP by 2050, the tax cuts contemplated in the December 2010 tax bill [would] have a minor effect of about 2 percent of GDP. Historically the government collects about 18.4 percent of GDP in tax revenues, which could be eaten up by the expected rise in healthcare costs as early as 2026. [As such,] the study recommends entitlement reforms and measures to increase tax collection to restore fiscal sustainability.  

 Concluding Suggestions to Close the Gap: “Menu of Pain”

Under most scenarios [see three below] the adjustment needed to eliminate the fiscal and generational gaps would entail significant adjustments in taxes and government payments

1. The federal government could restore fiscal balance by raising all taxes and cutting all payments immediately and indefinitely by 35 percent
2. If the U.S. government were to repeal the tax cuts under the Economic Growth and Tax Relief Reconciliation Act of 2001, the Jobs and Growth Tax Relief Reconciliation Act of 2001, and if the Independent Payment Advisor Board established to control excess growth in healthcare were to succeed in reining in costs, the fiscal gap would still require an immediate and permanent increase in all taxes and cuts in spending of 26 percent
3. if such fiscal consolidation were postponed by 10- or 20-years it would require larger additional increases in taxes and cost cuts, equaling 1 and 4 percent, respectively. 

…and the IMF concludes:

“The longer they wait, the larger the necessary adjustment will be and the greater the burden on future generations.”

*http://www.moneyandmarkets.com/imf-study-who-will-pay-and-how-44048 

(Source: Abstract “An Analysis of U.S. Fiscal and Generational Imbalances: Who Will Pay and How?,” IMF Working Paper, Western Hemisphere Department, Prepared by Nicoletta, Giovanni Callegari, and Julia Guerreiro, Authorized for distribution by Charles Kramer, April 2011. Note:  The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working papers describe research in progress by the author(s) and are published to elicit comments and to further debate.)

Editor’s Note:

• The above article consists of reformatted edited excerpts from the original for the sake of brevity, clarity and to ensure a fast and easy read. The author’s views and conclusions are unaltered.
• Permission to reprint in whole or in part is gladly granted, provided full credit is given as per paragraph 2 above.
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