FIGURE S-1 The long-run budget outlook.

FIGURE S-1 The long-run budget outlook.

will inevitably limit the nation’s future wealth by reducing the growth of capital stock and of the economy. It will also increase the nation’s liabilities to investors abroad, who currently hold about one-half of the federal government’s debt. If policies do not change, a large and increasing debt will expand the portion of the budget required to pay interest on the debt, especially if interest rates rise, and thereby reduce the resources available for all other government activities. Increasing debt also may contribute to a loss of international and domestic investor confidence in the nation’s economy, which would, in turn, lead to even higher interest rates, lower domestic investment, and a falling dollar.

As shown in Figure S-1, the current trajectory of the federal budget cannot be sustained. Without a course change, the nation faces the risk of a disruptive fiscal crisis, a risk that increases each year that action to address the growing structural deficit is delayed. With delay, the available options become more extreme and therefore more difficult, and even more pain is shifted to future generations.

In the next year or two, large deficits and more borrowing are unavoidable given the severity of the economic downturn. However, action ought to begin soon thereafter—the committee believes that fiscal 2012 (which begins October 1, 2011) is a reasonable time to start—to first slow the rapid increase of the federal debt relative to the economy and then, over several years, reduce it to a more desirable level.

A first step toward dealing with the country’s fiscal challenge is to specify a concrete test that can help to assess whether any budget is moving toward sustainability in a prudent manner. There are a variety of ways to measure fiscal prudence and numerous targets and time paths that could be connected to various measures. In order to design plausible scenarios to

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