Measuring U.S. Fiscal Capacity using Discounted Cash Flow Analysis
We use discounted cash flow analysis to measure a country's fiscal capacity. Crucially, the discount rate applied to projected cash flows includes a GDP risk premium. We apply our valuation method to the CBO's projections for the U.S. federal government's deficit between 2022 and 2051 and debt in 2051. In spite of low rates, our current measure of U.S. fiscal capacity is lower than the debt/GDP ratio. Because of the backloading of projected surpluses, the duration of the surplus claim far exceeds the duration of the outstanding Treasury portfolio. This duration mismatch exposes the government to the risk of rising rates, which would trigger the need for higher tax revenue or lower spending. Reducing this risk by front-loading the surpluses also requires major fiscal adjustment.
We gratefully acknowledge financial support from NSF award 2049260. We are grateful to Andy Atkeson for suggesting this exercise to us. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
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