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Twice a year, the General Accounting Office (GAO) publishes an update of the federal government’s long-term fiscal outlook. These updates generally make for gloomy reading, and the November 2010 report is no exception.

The GAO runs two main scenarios that project federal surpluses (har! har!) and deficits into the decades ahead. The first scenario builds upon the Congressional Budget Office’s “baseline” scenario for the next 10 years by extending it for another 30 years. The second “alternate” scenario incorporates a variety of taxing and spending adjustments to reflect the possibility, say, that Congress might choose to extend the Bush tax cuts for another 10 years, which would result in lower revenues, or that Congress will make the “doc fix” to Medicare, which would result in larger Medicare expenditures for physicians' fees.

Then the GAO crunches the numbers to show how big deficits will get. Neither scenario makes a pretty sight — the "alternate" scenario is especially frightening. A casual reader might easily surmise that actual deficits will lie somewhere in the yellow zone between the two scenarios. (For readers of my book Boomergeddon, the vertical line represents the year 2017, which is my best guess as to when the wheels fall off the bus.)

These projections assume that Congress takes no substantive move to curtail spending or raise revenues — they show, as it were, the cost of inaction. Over the next 65 years, notes the GAO update, the “fiscal gap” (the difference between revenues and expenditures) could amount to between 3% and 9.4% of the GDP. Of course, Congress will do something, though we can’t say what, so optimists could argue that these projections represent worst-case and not-very-likely scenarios.

If only that were true. There is little comfort to be found in the GAO report. If you project out 30 years, and then 65 years, the most important assumptions you make are not how to fine-tune future expenditures and tax revenues, which lie within a relatively narrow range, but what interest rates and economic growth rates will prevail. Unfortunately, the GAO does not address either of those assumptions. It largely takes the experience of the past 50 years or so and projects them, with minor modifications, into the future.

The authors of the GAO report can hardly be faulted for making somewhat arbitrary assumptions. They have to assume something, and it is not unreasonable to base those assumptions upon past experience. The difficulty is that trends are not always linear. They may stay linear for years or even decades, but unexpected factors dropping from the sky can send the trend lines spinning into wild tangents.

In“Boomergeddon, I make the case that the economic performance of the United States' economy over the next 20 to 30 years will likely be lower than what prevailed during the post-World War II era. Those reasons can be summarized as follows:

  1. The long hangover. Growth for the past 30 years was propelled by massive consumer debt accumulation. Consumers are no longer accumulating debt. Indeed, they are paying off (or forfeiting upon) debt. This de-leveraging will dull growth for years.
  2. Slower population growth, older workforce. Population growth historically has accounted for roughly half of economic growth. America’s population growth is slowing, ergo its growth rate will slow. Moreoever, America’s workforce is aging, and workers in their 50s and 60s tend to experience a decline in productivity.
  3. Increasing resource and environmental constraints. Thanks to China, India and other fast-growth developing nations, global demand for energy, raw materials and foodstuffs is increasing faster than supply. Rising prices will crimp economic growth globally.
  4. The 90% Rule. U.S. debt is roughly 90% of GDP, the level at which rising national indebtedness tends to be correlated with slower economic growth. As the GAO update states clearly, U.S. debt by 2020 will rival the nation’s peak indebtedness at the end of World War II. But there was an end to World War II and rising indebtedness in 1945 — there is no end to the entitlements driving debt higher today.
  5. Rise of the rent-seeking economy. The federal government controls a larger share of the nation’s GDP — through outright spending, tax expenditures, loan guarantees and regulations — than ever before. The capitalist system is morphing from a predominantly market-based form of competition to a rent-seeking form of competition. Government action tends to support traditional, slower-growth industries and to starve emerging, fast-growth industries of the future. (As for government subsidies of the “green” industry, I have one word — “Solyndra.”)

It is unrealistic, therefore, to assume that U.S. economic growth will continue at the same rate as in the past. Likewise, it is unrealistic to project the low, low interest rates of recent history into the indefinite future. The GAO assumes that interest rates (presumably the 10-year Treasury bond) of 5.1% last more or less forever. But today’s interest rate climate reflects a global capital glut resulting from high global savings, which likely will turn into a global capital shortage as populations age and begin drawing down their accumulated surpluses. A return to the 10% interest rates seen in 1990 — twice as high as the GAO assumption — could lead to catastrophic increases in interest payments, higher deficits, cumulative debt and even higher interest payments in a vicious spiral.

A modest suggestion to the GAO: When you update your report six months from now, let’s see a little growth-rate and interest-rate sensitivity analysis. What happens to your projections over 40 years if you make seemingly modest tweaks to your economic assumptions?

I can promise you, the future will look a lot uglier.

Disclosure: No positions.

Source: The GAO Update: Worse Than It Looks