THE COMING GENERATIONAL STORM
Laurence J. Kotlikoff & Scott Burns
FUTURECASTS online magazine
Vol. 7, No. 7, 7/1/05.
A "conspiracy of denial:"
| Intentional ignorance of inconvenient facts
characterizes the financial planning of the U.S. government and the governments
of many of the world's advanced nations. In "The Coming Generational Storm:
What You Need To Know About America's Economic Future," Laurence J.
Kotlikoff and Scott Burns reveal the Alice in Wonderland accounting fictions that permit
the U.S. government to ignore the unsustainable nature of the nation's
Everyone has too much invested in the entitlement welfare Ponzi scheme to acknowledge the inevitability of its collapse.
Today's leaders finesse today's problems by making
promises of future benefits that are far beyond the means available for
fulfillment. Nothing better typifies this tendency than the recent legislation
that adds a vast prescription drug benefit program onto an already obviously
unsustainable Medicare system.
There is simply no way for the post-baby boom generations to fulfill these obligations.
The U.S. now has unfunded
future obligations of about $51 trillion. This is a very
conservative estimate. It is about 4.5 times the
size of today's Gross Domestic Product (GDP). There is simply no way for the
post-baby boom generations to fulfill these obligations.
The authors expect that inflation will ultimately be the financial poison of choice for dealing with this mess. Vast amounts of money will have to be created to meet the rapidly expanding costs of "the nations implicit entitlement obligations." This will lead to ruinous rates of price inflation. They view market reactions in mid 2004 as evidence that the markets are already feeling the noxious effects of these unsustainable burdens.
Even before the new prescription drug program, Medicare costs were increasing more than 2 1/2 times faster than the wages that provide the resources to pay them.
It is the unfunded Medicare and Medicaid benefits that
constitute the primary unsustainable burden. This burden dwarfs that of Social
Security. Even before the new prescription drug program, Medicare costs were
increasing more than 2 1/2 times faster than the wages that provide the
resources to pay them. By 2012, the first of 77 million baby boomers will become
eligible for Medicare benefits.
Moreover, these figures are based on conservative
calculations that have historically underestimated the pertinent population
trends, the authors point out. Nor will these trends end with the demise of the
baby boomers, since it is also related to factors of declining female fertility
rates and continuing advances in longevity.
This demographic phenomenon is worldwide - except in the
Muslim world and in Africa.
| There are lies, damn lies, and
statistics, as Mark Twain famously remarked. Even worse (as FUTURECASTS
pointed out), there are
government statistics. (See, "Economic
Statistics and Macro Econometrics: The Figures Lie,") The book goes
into considerable detail over just how bad government statistics are. Indeed,
they are awful - and getting worse as the pressure increases to understate the
nation's exploding financial problems.
To measure the nation's real debts - "the
fiscal burden we are leaving our kids" - the authors employ "generational accounting." This technique has been widely applied by
international financial agencies and by central banks and finance ministries in
many countries. It is used in the U.S., but the results are not widely
The Medical entitlements and Social Security implicit debts alone total about $72 trillion. To pay for them will require a doubling of payroll taxes by 2030 or a tripling by 2075 - an obviously impossible course of action.
Implicit debt is the major factor. It is the
present value of all the transfer payments - Social Security, Medicare and
Medicaid and food stamps and other welfare programs - to present generations.
The medical entitlements and Social Security implicit debts alone total about
$72 trillion. To pay for them will require a doubling of payroll taxes by 2030
or a tripling by 2075 - an obviously impossible course of action.
The Democrats refuse to consider benefit cuts, and the Republicans refuse to consider tax increases, and neither party wants to push too hard against the position of the other party for fear of losing some voters in the middle.
That these massive entitlements are unsustainable
is obvious. So, what is the political response of the Bush (II) administration
and Congress? They have enacted a major increase in the Medicare entitlement -
for prescription drugs - and have presided over major increases in discretionary
spending - even though the nation is increasingly burdened by the increasing expenses of a new
conflict of long duration. Throw in some tax reductions, and the official debt,
too, has ballooned.
Productivity increase is significantly less than the rate of increase of entitlement burdens - and there is a limit to how high taxes can go without crippling the economy.
The authors recognize that productivity growth will
permit future generations to bear far higher burdens than present generations.
With just 2% productivity growth, lifetime earnings should double from
generation to generation. Nevertheless, this increase is significantly less than
the rate of increase of entitlement burdens - and there is a limit to how high
taxes can go without crippling the economy.
Money is fungible. The division of the budget into discrete "funds" for various purposes paid for by revenues from dedicated taxes - i.e., Social Security, Medicare, etc. - is an obvious fiction.
The government "fiscal gap" has been
calculated as $45 trillion as of 2030 - assuming that the tax rate burden
remains the same as today. This is four times the size of today's
annual output. The Federal Reserve has calculated the nation's net worth as less
than $40 trillion. "We are thus technically bankrupt," the authors
assert. If the nation waits 15 years to begin tackling the problem, the fiscal
gap increases to about $76 trillion.
The Medicare drug benefit as currently calculated increases the fiscal gap by $6 trillion to $51 trillion.
The authors estimate the vast increases in taxation that
would be needed to eliminate the fiscal gap in the absence of benefit cuts.
(These calculations, too, are irrelevant. Substantial tax increases are
politically undoable and economically disastrous.)
However, the authors are correct in their expectation
that governments will frequently botch even the relatively easy task of asset
sales - and frequently misspend the proceeds in ways that further undermine
All the surplus funds received from payroll taxes have already been spent for other government needs. A government budget is in reality just one pile of receipts and one pile of expenses - with one overall surplus or deficit - with increases and decreases impacting all segments equally.
THERE ARE NO "TRUST FUNDS." All the surplus funds received from payroll taxes have already been spent for other government needs. A government budget is in reality just one pile of receipts and one pile of expenses - with one overall surplus or deficit - with increases and decreases impacting all segments equally. It is the current existence of future obligations above reasonable expectations of future receipts that is the complicating factor. (One obvious exception - of limited application - arises from self financing programs like toll roads.)
Nevertheless, the authors' assertion is clearly correct that what is
needed is generational accounting - something the government avoids like the
| Factors that are expected to increase
the resources available for the nation's future needs are reviewed by the
authors. These include productivity increases, capital deepening, capital
inflows from abroad, inheritance flows from increasingly prosperous parents to
their children, employer retirement benefits, immigration of younger workers,
supply-side "voodoo" economics, and that ever popular standby - the
elimination of waste, fraud and abuse (like the shmoo in the Lil Abner cartoon
strip - a resource of bottomless extent).
The authors repeatedly slam supply-side "voodoo" economics. They repeat the oft heard assertion that the 1980s tax cuts failed to increase revenues and thus caused the surge in budget deficits of that decade. They claim the same thing is happening now, with tax revenues at just 16.2% of 2004 GDP - well below post WW-II averages.
The murky calculation of "productivity growth" is
discussed at some length by the authors. They explain some of the ways in which
productivity growth was overstated in the 1990s.
| Running the monetary printing presses and more modern
methods of expansion of the money supply is, as a practical matter, the most
likely way the government will initially try to pay the nation's obligations.
Inflation will not pay down the government's entitlement obligations, since those obligations rise faster than any degree of inflation that the electorate is likely to tolerate.
No politician will propose the kind of tax increases and/or benefit cuts required, so monetary expansion and subsequent price inflation will be the initial major response to the nation's financial problems. The authors provide some historical perspective on inflation and some explanation of its processes.
However, inflation will not pay down the government's entitlement
obligations, since those obligations rise faster than any degree of inflation
that the electorate is likely to tolerate. The authors provide some
explanation of why entitlement costs always soar out of control. The costs of the other goods and
services that government buys will rise at least as fast as inflation. Thus,
inflation will not come close to resolving the issue. (But it will in its own
right inflict societal pain that the electorate will ultimately refuse to tolerate).
The baby boomers begin to retire in 2008. Reality will then become increasingly undeniable as the succeeding years roll by.
| The crisis could come with relative suddenness soon thereafter,
the authors suggest. Stagflation - with double digit inflation and unemployment
woes running at the same time, and a depression soon thereafter - as in 1980 -
but with the added burden of unsustainable entitlements that can prevent recovery - is
a likely scenario.
| There is "a host of serious efficiency, equity
and information problems" with Social Security. The authors provide some of
As payroll taxes have risen, Social Security has become an economist's nightmare of perverse incentives.
| This simple income transfer system has slowly accreted 2,528
separate rules that nobody really understands - and is administered by a
computer program written in an ancient code that is incomprehensible to modern
programmers. As payroll taxes have risen, Social Security has become an
economist's nightmare of perverse incentives - especially for second earners and
The authors offer a reform proposal. For starters, the
financial gap caused by the plan is to be filled by a federal retail sales tax. Required payroll
taxes would be replaced by required contributions to individual personal
accounts owned by beneficiaries but controlled by the government and invested in
a "market weighted global index fund of stocks, bonds and real
estate." The "socialist" implications are readily acknowledged.
Medicare and Medicaid:
"There is no way that we can maintain Medicare's fee-for-service method of paying the elderly's health care bills."
It is the "fee-for-service method of paying the elderly's health care bills" that the authors believe is the key weakness in the system.
The authors' answer is a flexible annual voucher system. The size of each participant's voucher would vary according to their health that year. All medical records would be provided to the government for this evaluation process and for other medical purposes. Participants could then use that voucher to buy basic insurance suitable for their basic medical needs. Insurers and HMOs would be required to offer basic plans to all, and are free to market additional coverage to those who are willing to purchase it. Then comes the essential kicker - for cost growth containment.
The authors sum up:
| In the reasonable expectation that their advice
will not be taken, the authors take a grim view of prospects.
Social Security benefits are already being "cut."
Current figures (for what they are worth) indicate that the major entitlements will eat up about 16.7% of GDP by 2050 - more than double the 2000 figure. And, it gets worse form there. By 2075, they will eat up 21.7% of GDP - a figure larger than all government revenue, even during WW-II.
Qualified plans are "tax traps."
A few of the perverse aspects of the tax code are explained by the authors. Among other things, middle income people actually lose money by saving money in tax-deferred pension accounts. Qualified plans are "tax traps." The new Roth IRA accounts that are not tax deferred but that accumulate tax free are clearly the best option.
The government's financial problems are expected to be met with a
combination of evils - higher taxes, heavier government borrowing, inflation,
and negative after-tax interest rate returns on investments in government debt.
After taxes, even the TIPS - Treasury Inflation Protected Securities - can have
a negative real return. TIPS should thus be put in Roth IRA accounts.
Some advice for retirement saving plans is offered. The authors slam
the investment advising and financial planning industry and the excessive fees
they charge. They advise use of low fee market index funds and personal Roth IRA
accounts to reduce future tax burdens. (Why not just invest in index securities
like Spiders, Diamonds or Qubes?) With all its tax advantages, home
ownership is among the most important of personal investments.
They offer standard advice for increasing savings. Eliminate credit card and other consumer debt and put the interest savings into a Roth IRA. "Imagine what putting an extra $300 to $500 every month into a Roth IRA or paying off your mortgage might do for your long term financial health and security."
They advise a diverse investment strategy with core holdings of tax and
inflation advantaged I Savings Bonds and Treasury Inflation Protected
Securities, followed by unhedged international bond funds, precious metals
funds, energy funds and international equity funds. They are particularly fond
of prospects in China, but note the difficulties of investing in that still
risky venue. (China's economic reform program still has
some major problems to address.)
|Warnings about the financial disincentives for second earners are provided at the end of the book. The "lifetime marginal tax rate for second workers can be over 100 percent" they point out. Generally, its around 50%. However, add in the work related costs, child care expenses and stress induced spending, and the second earner can be slaving away for ridiculously small sums.
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Copyright © 2005 Dan Blatt