What Is the Fiscal Gap and Why Does It Matter

The fiscal gap is a critical issue that affects us all. It's the difference between the government's total spending and its total revenue over a certain period, typically a year or a decade.

To understand the fiscal gap, let's consider the government's financial situation. The government's spending is primarily driven by its social security and healthcare programs, which account for about 50% of its total expenditure. This is a significant portion of the federal budget.

The fiscal gap matters because it has real-world consequences. If the government's spending exceeds its revenue, it can lead to a budget deficit, which can increase the national debt and ultimately affect economic growth.

The fiscal gap is a significant issue that affects the United States' financial future. It refers to the difference between the government's projected revenue and its projected spending over a certain period.

EY, a reputable accounting firm, calculates the fiscal gap in various ways, including different time horizons and debt levels. They estimate that under current law, the policy changes needed to keep future debt no higher than its current share of GDP (75%) are substantial.

To put this into perspective, EY estimates that under current law, policy changes totaling $9 trillion would be needed to keep future debt no higher than 75% of GDP over a 25-year time horizon. This translates to $27,300 per person.

A 50-year time horizon fiscal gap would require policy changes totaling $26 trillion, or $80,200 per person. The 75-year time horizon fiscal gap would require policy changes totaling $46 trillion, or $140,700 per person.

Here are the estimated policy changes needed to keep future debt no higher than 75% of GDP over different time horizons:

The fiscal gap is a serious issue that affects us all. Without addressing it, the US economy could face significant consequences.

Increased federal debt would crowd out private investment, leading to reduced labor productivity and real wages. This means individuals would have less ability to earn and save.

The longer we delay action on the debt, the larger the required spending cuts or revenue increases would have to be. It's like putting off fixing a leaky roof – the longer you wait, the more costly the repairs.

Additional reading: We No Longer except Personal Checks

The federal government's ability to respond to unexpected events, such as recessions or foreign conflicts, would be reduced. This is because the long-term increase in federal debt would take up a significant portion of the government's resources.

Rising debt increases the risk of a fiscal crisis, where investors lose confidence in the US and trigger a crisis. Predicting when this might happen is difficult, but it's a risk we can't afford to ignore.

Here are some potential consequences of not addressing the fiscal gap:

A fiscal deficit occurs when a country's government spends more money than it earns during the fiscal year. This means that more money goes out compared to how much comes in, resulting in spending exceeding revenue.

The size of a fiscal or national deficit depends entirely on a few factors, including the state of a country's economy and fiscal policies. Governments often run deficits when there are signs of a distressed economy, such as inflationary pressure or a recession.

Deficits are normally calculated and reported as a percentage of a country's GDP. They may also be reported as a dollar figure or a country's revenue (or income) less spending. A government that needs more money than it can spend typically borrows money from the public or other governments.

Here are some key factors to consider when understanding the deficit:

Governments often use fiscal deficits to encourage economic activity, such as by reducing taxes or increasing spending. However, this can also lead to a buildup of debt over time.

The U.S. debt crisis is a pressing issue that affects us all. The country's national debt, also known as fiscal debt, stands at a staggering $36.22 trillion as of January 27, 2025.

This debt is comprised of different types of debt, including debt held by the public, debt held by foreign countries, and trust funds held by the federal government. The breakdown is as follows:

High interest rates on U.S. Treasury securities increase the federal government's borrowing costs, making it harder to pay off the debt.

The U.S. debt crisis is a pressing concern, with the country's national debt standing at a staggering $37 trillion. This massive debt is on an unsustainable trajectory, and three successive downgrades of the U.S. credit rating should alarm elected leaders.

A fiscal deficit occurs when the government spends more than it earns in revenue, but this is different from fiscal debt, also known as national debt. The U.S. government's fiscal debt is accumulated over years of deficit spending and consists of various types of debt, including debt held by the public and debt held by foreign countries.

As of January 27, 2025, the U.S. government's fiscal debt was approximately $36.22 trillion, with $28.86 trillion held by the public and over $7.35 trillion covered by intragovernmental holdings.

Most of the federal debt is owed to domestic holders, but foreign ownership has increased significantly over the past 50 years.

Worth a look: 5 Years

The U.S. has had a history of running fiscal deficits, but it's interesting to note that there have been four fiscal surpluses since 1974.

The most recent surplus was in 2001, a significant event in the country's financial history.

The budget outlook is looking grim, with projected revenues stuck at around 18.0 percent of GDP, close to its historical share.

Under the most optimistic health-care projections, non-interest outlays will rise to 21.1 percent of GDP by 2040, and by 2089, the figure will rise to 22.9 percent of GDP.

This persistent gap between spending and revenues is a major concern, as it will continue to grow far into the future, even under the most optimistic projections.

The economy's debt-to-GDP ratio is also projected to soar, with both optimistic and pessimistic scenarios showing the ratio hitting 200 percent by 2054 and 2051, respectively.

Curious to learn more? Check out: Us Gdp 3rd Quarter

The 10-Year Budget Outlook is a crucial aspect of financial planning. The Congressional Budget Office (CBO) projects that the federal budget deficit will reach $1.2 trillion by 2033, a significant increase from the 2023 deficit of $0.7 trillion.

The CBO's projections are based on current laws and policies, and they assume that the government will continue to spend at current levels. This assumption is problematic, as it doesn't account for potential changes in government spending or revenue.

The CBO projects that the national debt will reach 185% of GDP by 2033, up from 137% in 2023. This increase in debt will make it more difficult for the government to respond to future economic downturns.

The 10-Year Budget Outlook also highlights the importance of addressing the growing cost of healthcare. The CBO projects that healthcare spending will increase by 5.5% per year, outpacing economic growth and putting pressure on the budget.

The government's ability to respond to future economic downturns will be severely limited by the growing national debt. This is a concern, as the government may not have the fiscal space to implement stimulus packages or other policies to support the economy during a downturn.

The CBO's projections assume that interest rates will remain low, which would reduce the cost of servicing the debt. However, this assumption is uncertain, and rising interest rates could increase the cost of debt servicing.

The long-term budget outlook is a concerning issue that affects us all. Under the most optimistic health-care projections, non-interest outlays will rise to 21.1 percent of GDP by 2040.

The good news is that revenues are projected to be constant at around 18.0 percent of GDP, close to its historical share. This means that the gap between spending and revenues persists, and indeed grows, far into the future.

By 2089, non-interest outlays will rise to 22.9 percent of GDP under the most optimistic scenario. This is a significant increase that will have a major impact on our economy.

The debt-to-GDP ratio is also a major concern. Under both the most optimistic and most pessimistic projections, the economy would pass its highest previous debt-to-GDP ratio (106.1 percent, in 1946) by 2033.

Projected debt-GDP ratios would hit 200 percent in 2054 under the most optimistic scenario. This is a staggering figure that highlights the need for responsible budgeting and fiscal planning.

In both the most optimistic and most pessimistic scenarios, the debt-to-GDP ratio would continue to grow in the following years. This is a worrying trend that we need to address now to avoid future financial crises.

Curious to learn more? Check out: What Is a Good Debt to Gdp Ratio

The fiscal gap accounting method has been criticized by economists, but their concerns are misplaced. Auerbach and Kotlikoff's generational accounting fully adjusts for productivity growth, assuming the lifetime net tax burden facing future generations rises by the economy's productivity growth rate.

A sustainable fiscal policy is defined as one where the debt-to-GDP ratio is stable or declining over the long term. The current policy is not sustainable, with the debt-to-GDP ratio projected to exceed 200 percent by 2049 and reach 535 percent in 2099.

Fiscal conservatives generally argue against deficits, favoring a balanced budget policy where spending equals revenue.

Broaden your view: Sustainable Investing Trends

The proposed "fiscal gap" accounting method has been criticized as fundamentally flawed by economists.

These criticisms center on the fact that fiscal gap accounting calculates the growth of future debt in current account terms, without taking into account the growth of future GDP.

Auerbach and Kotlikoff's generational accounting fully adjusts for productivity growth, assuming the lifetime net tax burden facing future generations rises for successive generations by the economy's productivity growth rate.

Closing the fiscal gap would require a 20 percentage point increase in the lifetime net tax rate, from 30 percent to 50 percent, for all young and future generations.

Broaden your view: Pensions and Lifetime Savings Association

Fiscal deficits are not universally regarded as a negative event. For example, influential economist John Maynard Keynes argued that deficit spending and the debts incurred to sustain that spending can help countries climb out of economic recession.

Fiscal conservatives generally argue against deficits, favoring a balanced budget policy where spending equals revenue, leaving neither a deficit nor a surplus.

The debt-to-GDP ratio was approximately 98 percent at the end of FY 2024, up slightly from approximately 97 percent at the end of FY 2023. This indicates that current fiscal policy is not sustainable.

Economists Dean Baker, Bradford DeLong, and Paul Krugman have criticized the proposed "fiscal gap" accounting method as fundamentally flawed. However, their critiques are misplaced, as Auerbach and Kotlikoff's generational accounting fully adjusts for productivity growth.

Preventing the debt-to-GDP ratio from rising over the next 75 years is estimated to require some combination of spending reductions and revenue increases that amounts to 4.3 percent PV of GDP over the period.

The U.S. government has run fiscal deficits since the nation declared independence, with Alexander Hamilton proposing issuing bonds to pay off the debts incurred by the states during the Revolutionary War.

The federal deficit has been a recurring issue, with President Franklin D. Roosevelt holding the record for the fastest-growing U.S. fiscal deficits during the Great Depression and World War II. He increased the deficit from 4.5% of GDP in 1932 to 26.8% in 1943.

In 2009, President Barack Obama increased the deficit to more than $1 trillion to finance government stimulus programs designed to fight off the Great Recession. This was a record dollar number, but only 9.7% of GDP.

A look at some recent deficit numbers is also telling. In 2020, the deficit reached $3.1 trillion, largely due to tax cuts and increased spending amid the COVID-19 pandemic and subsequent economic fallout. In 2024, the federal deficit reached $1.83 trillion.

Here are some key deficit numbers in recent years:

The federal deficit has been a persistent issue, with the U.S. government running deficits in most years since World War II.

A fiscal deficit is essentially a negative difference between a country's revenue and spending. This occurs when a government spends more than it earns in revenue.

A deficit isn't always a bad thing, it can actually help pull a country out of an economic slump.

However, long-term deficits can have a negative impact on a nation's economy. This is why policymakers need to be careful not to overextend themselves financially.

Here are some key areas where fiscal deficits can have an impact: