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Laurence Kotlikoff: “The U.S. Is Bankrupt”

Posted by Larry Doyle on August 12, 2010 1:20 PM |

Nobody likes being told they are broke. While the truth may hurt, when you’re broke, you’re broke. Are we as a nation broke? Laurence Kotlikoff believes we are and expresses as much today in a Bloomberg commentary, U.S. Is Bankrupt and We Don’t Even Know It,

Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.

What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.

Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt.

Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.

Is the IMF bonkers?

No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

‘Unofficial’ Liabilities

Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.

For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.

The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

$4 Trillion Bill

How can the fiscal gap be so enormous?

Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.

This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.

Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated phrase: “Something that can’t go on, will stop.” True enough. Uncle Sam’s Ponzi scheme will stop. But it will stop too late.

And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

Worse Than Greece

Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.

This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.

Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.

My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”

Kotlikoff touches a lot of points in this commentary. The implications for what he is writing are not insignificant. Do yourself a favor and reread his piece. Think about what the drag on our nation’s economy will be as we are faced with the enormous issues highlighted here. While our unofficial federal Ponzi schemes (Social Security et al) may give the appearance that ‘we’ll be all right’….when you’re broke, you’re broke.

That’s sense on cents!!


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  • Mike

    Entitlements have and will continue to suck this nation dry.

    Too many people would starve or die of disease if we got rid of them though. Ah well.

  • Since the Global Financial Crisis, many governments around the world have increased spending to help stop their economies slip into recession. Hence many countries have taken on more debt in the short term, the US is not alone.

    This kind of spending is quite common during economic recession periods, to stimulate growth.

    Though the good thing is we all have the opportunity to eliminate waste from our businesses, economies, political and financial systems. The trick is to recognize it, and do something about it.

  • Sean

    Unfortunately, this is how nations die.

    Just take a look at Greece as an example; their austerity measures will not work, because cutting government spending & increasing taxes will simply lower their GDP, which will cause their debt-ratio as a percentage of GDP to actually increase, not decrease. The same will happen here in the U.S. with austerity measures as-well; of-course, we have a built-in advantage in that we can print-up our own currency where Greece cannot. However, as the Fed has shown, it’s not so easy to conjure-up a little inflation to offset deflation; whe the Fed interferes with the economy, there’s a very fine line between conjuring-up a little inflation vs. conjuring-up a whole lot of it.

    The austerity in Greece will not work, and by the end of this year, Greece will be in IMF-receivership, and how do you think the citizens of Greece will-take to the fact that their nation’s finances are in even worse shape because of their austerity cutbacks? We’ve already seen riots and deaths in Greece over this, and it’s only just begun. Look for Greece’s democratically elected government to be replaced by a non-elected government sometime in 2011; after-all, a military junta ruled Greece as-recently as 1974. Look for the same to occur in Portugal and Spain shrtly thereafter, which were also ruled by dictatorships in the early ’70s.

  • Bill

    We have a demographics problem-an aging population.
    Yet, at the same time we have immigrants (both legal and illegal) clamoring to get into this country….Hmmm
    Shouldn’t there be a solution there? Maybe loosen immigration laws for a certain segment of the population (young people), offer one time amnesty for employed illegal immigrants, and start out offering lower entitlement payments to new citizens as you gradually reduce entitlement payments to existing citizens….gradually equalizing (lower) entitlement payments to the new and existing populations over time. Companies do this with Benefit/Pension plans all the time. Why can’t the US government?
    I am over simplifying to make a point but if you have too few young workers to support your aging population shouldn’t at least part of your solution be figuring out how to get more young workers in the country? I emphasize “part” because addressing the structural deficit in this country will require some hard choices and there is no simple solutuion. We can either start to make those hard choices now and try to solve the problem or be forced to make them later when it will be too late to avoid the disastrous consequences.

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