Commentary

The US in the Red: How Are We Doing?

Recent upbeat reports about the labor market, housing, and the general economy appear to have sapped lawmakers’ energies from attempting a grand bargain on tax and entitlement reforms. But ignoring structural imbalances in the federal budget that are causing inexorable growth in the nation’s indebtedness threatens large tax burdens on younger and future generations, seriously compromising their economic freedoms.

Brief redux: The economic surge toward the end of the 1990s signaled an improved budget outlook and provoked massive public spending increases, tax cuts, and the Medicare prescription drug program. But the surge proved short-lived and those policies worsened the nation’s fiscal outlook. Post-2008 recession, the debt outlook continues to worsen significantly.

The window of opportunity to reform entitlement programs, and federal tax and spending policies generally is still open.”

Media coverage of the national debt is almost exclusively about the overt, or visible, national debt, which the U.S. Public Debt Bureau places at just under $17 trillion. The Congressional Budget Office and the Administration’s Office of Management and Budget also focus heavily on the gross national debt and subcategories such as debt held by the public and debt subject to the statutory borrowing limit.

Focus on such narrow debt measure is driven by the need to periodically increase the federal debt limit and enable the government to honor all debt service contracts and

current spending authorizations. But it restricts our attention to the immediate term and distracts from larger and more important concerns about structural imbalances in federal budget policies. A broader evaluation shows that, nascent economic recovery notwithstanding, current budget policies are part and parcel of a vortex of socioeconomic and political forces that are inexorably driving us toward a giant fiscal disaster.

The past is passé: When making budget policies, the $17 trillion of explicit federal debt—the result of past policies and outcomes—should not receive as much importance as prospective debt accumulation under today’s budget policies. And, unlike standard practice, prospective debt accumulation should be evaluated over horizons that are much longer than 10 years. Lawmakers might not have allowed all of those debt funded giveaways during the early 2000s had they based decisions on broader and longer term budget metrics.

A Samall Fraction

The official federal debt of $17 trillion is only a small fraction of the government’s true indebtedness: It includes only outstanding U.S. Treasury securities on which contractual future payments are due. But the government “owes” future payments to millions of additional individuals—those who will become eligible for Social Security, Medicare, unemployment, disability, food stamps, and other government entitlement and welfare programs. And the government “forgoes” tax collections from millions of others through tax preference programs, for example, for those with children, business expenses, low earnings, participants in qualified retirement saving programs, and home mortgage borrowers.

The words “owes” and “forgoes” are in quotes because such benefits expenditures and tax reductions are noncontractual. But some of them, such as federal Social Security and Medicare obligations, may be even more firmly “entrenched”: Entitlement program beneficiaries who “contributed” payroll taxes while working feel strongly “morally and legally entitled” to retirement, survivor, health, and other benefits and they possess growing political clout to maintain those benefits as “promised.” Indeed, the inviolate nature of Social Security and Medicare obligations may exceed that of federal contractual liabilities because, unlike most Treasury securities, entitlements are universally protected against inflation.

If by general consensus, entitlement benefits are considered sacrosanct, the unfunded component of federal entitlement obligations—those exceeding projected payroll tax revenues—should be included in national debt measures. The $17 trillion official figure only includes the contractual debt of the Treasury to the Social Security and Medicare trust funds—equal to the accumulated value of past payroll tax surpluses. But those trust funds fall woefully short of the total unfunded future payment obligations that Social Security and Medicare are facing.

Just in Time

Indeed, the unfunded components of all government expenditures should be included in indebtedness measures. On this score, it is noteworthy that the U.S. Congress adopts one set of fiscal policies on its books, but follows an alternative set of policies in practice: It amends budget laws just before they become current to protect particular groups’ economic interests. Such just-in-time changes have been enacted many times, to protect Medicare and Medicaid doctors from reimbursement cuts and prevent tax increases on middle income groups through broadening scope of the Alternative Minimum Tax. The continual shift away from current-law budget policies results in a “giveaway” to current generations the costs of which will inevitably be borne by future ones.

Using an average government interest rate to evaluate the federal government’s total projected payment obligations in today’s dollars and subtracting from that total the government’s projected receipts—under continuing periodic policy revisions as noted above—I find that the government’s future spending commitments exceed its prospective receipts by $91 trillion—a figure 5.5 times larger than the $17 trillion official national debt.

This estimate implies a fiscal imbalance of 9 percent of projected GDP or, alternatively, 19.7 percent of projected payrolls. Calculations on a generation-by-generation basis show that under today’s federal budget policies, middle-age workers would receive such large federal transfers by way of entitlement and other benefits that their net lifetime taxes would be almost fully eliminated.

Serious Shortcomings

At $66 trillion, Social Security and Medicare contribute more than 70 percent to total federal indebtedness of $91 trillion. Such a large fiscal imbalance indicates serious structural shortcomings in federal budget policies—benefits and tax subsidies that are simply unaffordable.

With 76 million baby-boomers shifting into retirement, much of future federal spending growth will arise in Social Security and Medicare. The way to provide for such spending increases would be to save and invest in the economy’s productive potential. We have not done so for four decades, all the while fully anticipating that baby boomers will eventually retire and demand payment of their lawful entitlement benefits.

The window of opportunity to reform entitlement programs, and federal tax and spending policies generally is still open. But the longer that we delay in restructuring those policies, the larger will future adjustment costs become. Reform delays will boost income expectations of older workers and retirees, inducing them to consume at a faster rate, and they will increase younger generations’ expectations of tax increases, inducing them to acquire fewer skills and work less. These inducements toward reduced saving, lower productivity, and less work will only steepen fiscal burdens on future working generations.

Total federal indebtedness—beyond just contractual payment obligations—must be eventually resolved through federal spending reductions or tax increases—precisely the policies that lawmakers abhor for their negative economic implications in the immediate future. But if these imbalances remain unresolved, growing indebtedness will eventually induce a calamitous economic outcome, probably with even greater intensity than the recent recession. That is, unfortunately, the vicious vortex of conflicting tradeoffs—one involving unavoidable long-term austerity—that lawmakers must carefully navigate. The earlier that they begin, the easier their task will be and the better and intergenerationally fairer the outcomes that could be achieved.

Jagadeesh Gokhale is a senior fellow at the Cato Institute, a member of the Social Security Advisory Board, and author of “Social Security: A Fresh Look at Policy Alternatives” (University of Chicago Press, 2010).