IMF Study: Who Will Pay and How?

In April, the International Monetary Fund (IMF) released a study on the U.S. fiscal imbalance.  The analysis was issued in the form of a working paper not to be reported as representative of the views or policy of the IMF. But it sure gives some insight into the research the IMF is looking at to determine policy.

Here is a brief overview of the findings …

The Fiscal Gap

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 the IMF work paper. And IMF and Congressional Budget Office (CBO) forecasts imply that U.S. debt will rise rapidly relative to gross domestic product (GDP) in the medium- to long-term. 

The U.S. fiscal imbalance or “gap,” the study refers to measures the reduction in the deficit needed to keep the debt-to-GDP ratio from growing. So the gap is the country’s excess of expenditures including commitments to spend in the future compared to available current and future resources. The study also looks at the “generational” imbalance to illustrate how the burden to close the fiscal gap will be shared across generations. 

The U.S. fiscal gap associated with today’s federal fiscal policy is huge according to the IMF study. The U.S. fiscal gap is over 15 percent of GDP. This means that the relationship between fiscal revenues and spending would 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 low revenues from tax cuts and adjustments to the Alternative Minimum Tax (AMT) that have given taxpayers a significant break. Rising healthcare costs are pointed to as a large contributing factor boosting 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. 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 would need to raise taxes and/or cut payments substantially to avoid this dramatic and undesirable escalation of debt. And, the IMF wrote, “The longer they wait, the larger the necessary adjustment will be and the greater the burden on future generations.”

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

Since the main drivers of the fiscal gap are low revenues and increases in healthcare costs, what’s the answer? 

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 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; maybe as early as 2026. The study recommends entitlement reforms and measures to increase tax collection to restore fiscal sustainability.  

Suggestions to Close the Gap: “Menu of Pain”

Under most scenarios, the adjustment needed to eliminate the fiscal and generational gaps would entail significant adjustments in taxes and government payments. In one scenario, the federal government could restore fiscal balance by raising all taxes and cutting all payments immediately and indefinitely by 35 percent.

Alternatively, if the U.S. government were to repeal the tax cuts under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Jobs and Growth Tax Relief Reconciliation Act of 2001 (JGTREA), and if the Independent Payment Advisor Board (IPAB) 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. 

Postponing the Pain

Another important message from the IMF’s study suggests that postponing fiscal consolidation is costly. A 10- or 20-year delay in implementing fiscal adjustments would need larger additional increases in taxes and cost cuts, equaling 1 and 4 percent, respectively. 

So while this study is only one take on a bad situation, it’s clearly an eye opener in terms of what will be required for the U.S. to get to a balanced budget. 

But rather than counting on Washington to take the much-needed steps, you stand a much better chance of coming out unscathed by assuming greater control of your own future. The first step: Watch Martin’s American Apocalypse video online — for free!

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.