Posted on 07/10/2006 10:59:12 AM PDT by Paul Ross
Synopsis
Is the United States bankrupt? Many would scoff at this notion. Others would argue that financial implosion is just around the corner. This paper explores these views from both partial and general equilibrium perspectives.
It concludes that countries can go broke, that the United States is going broke, that remaining open to foreign investment can help stave off bankruptcy, but that radical reform of U.S. fiscal institutions is essential to secure the nation’s economic future.
The paper offers three policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy: a retail sales tax, personalized Social Security, and a globally budgeted universal healthcare system.
_Preface
Is the U.S. bankrupt? Or to paraphrase the Oxford English Dictionary, is the United States at the end of its resources, exhausted, stripped bear, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors?
Many would scoff at this notion. They’d point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries.
Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mispricing securities; and that financial implosion is just around the corner.
This paper explores these views from both partial and general equilibrium perspectives. The second section begins with a simple two-period life-cycle model to explicate the economic mean-ing of national bankruptcy and to clarify why government debt per se bears no connection to a country’s fiscal condition. The third section turns to economic measures of national insolvency, namely, measures of the fiscal gap and genera-tional imbalance. This partial-equilibrium analy-sis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.
The world, of course, is full of uncertainty. The fourth section considers how uncertainty changes one’s perspective on national insolvency and methods of measuring a country’s long-term fiscal condition. The fifth section asks whether immigration or productivity improvements arising either from technological progress or capital deepening can ameliorate the U.S. fiscal condition.
--SNIP--[skipping ahead to the meat of the paper]
THE U.S. FISCAL CONDITIONAs suggested above, the proper way to consider a country’s solvency is to examine the life-time fiscal burdens facing current and future generations. If these burdens exceed the resources of those generations, get close to doing so, or simply get so high as to preclude their full collection, the country’s policy will be unsustainable and can constitute or lead to national bankruptcy. Does the United States fit this bill? No one knows for sure, but there are strong reasons to believe the United States may be going broke.
Consider, for starters, Gokhale and Smetters’s (2005) analysis of the country’s fiscal gap, which measures the present value difference between all future government expenditures, including servicing official debt, and all future receipts. In calculating the fiscal gap, Gokhale and Smetters use the federal government’s arbitrarily labeled receipts and payments. Nevertheless, their calcu-lation of the fiscal gap is label-free because alter-native labeling of our nation’s fiscal affairs would yield the same fiscal gap. Indeed, determining the fiscal gap is part of generational accounting; the fiscal gap measures the extra burden that would need to be imposed on current or future generations, relative to current policy, to satisfy the government’s intertemporal budget constraint.
The Gokhale and Smetters measure of the fiscal gap is a stunning $65.9 trillion! This figure is more than five times U.S. GDP and almost twice the size of national wealth. One way to wrap one’s head around $65.9 trillion is to ask what fiscal adjustments are needed to eliminate this red hole. The answers are terrifying. One solution is an immediate and permanent doubling of personal and corporate income taxes. Another is an immediate and permanent two-thirds cut in Social Security and Medicare benefits. A third alternative, were it feasible, would be to immediately and permanently cut all federal discretionary spending by 143 percent.
The Gokhale and Smetters study is an update of an earlier, highly detailed, and extensive U.S. Department of the Treasury fiscal gap analysis commissioned in 2002 by then Treasury Secretary Paul O’Neill.
Smetters, who served as Deputy Assistant Secretary of Economic Policy at the Treasury between 2001 and 2002, recruited Gokhale, then Senior Economic Adviser to the Federal Reserve Bank of Cleveland, to work with him and other Treasury staff on the study. The study took close to a year to organize and complete. Gokhale and Smetters’s $65.9 trillion fiscal-gap calculation relies on the same methodology employed in the original Treasury analysis. Hence, one can legitimately view this figure as our own government’s best estimate of its present-value budgetary shortfall. The $65.9 trillion gap is all the more alarming because its calculation omits the value of contingent government liabilities and relies on quite optimistic assumptions about increases over time in longevity and federal healthcare expenditures.
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Laurence J. Kotlikoff is a professor of economics at Boston University and a research associate at the National Bureau of Economic Research.
© 2006, The Federal Reserve Bank of St. Louis. Articles may be reprinted, reproduced, published, distributed, displayed, and transmitted in their entirety if copyright notice, author name(s), and full citation are included. Abstracts, synopses, and other derivative works may be made only with prior written permission of the Federal Reserve Bank of St. Louis.
Perhaps you can explain how selling a highway would "prop up the GDP"?
He was right.
He was just ahead of his time...
But U.S. manufacturing output has not been shrinking; it has actually been growing. In 2004 it reached a record high according to a research report by the American Institute for Economic Research this February. It also stated, “on its own, the U.S. manufacturing sector would constitute the seventh-largest economy in the world, nearly matching China’s entire economy”. As far as the future, we’re very optimistic. We’re confident that our customers are transitioning to a healthier mix of high-value-added, innovative manufactured products that will be needed in both domestic and global markets. We plan to be here to service their needs for quality steel warehouse stock for years to come.
About the Author: Tom Brown is president of Cincinnati Steel Products Company, an independent, privately-owned steel processing center serving the Midwest. The company, founded in 1931, is celebrating its 75th year of service to manufacturers
And we produced almost $400 billion in May alone. So how are we enfeebled? How is China stealing all our manufacturing?
But not to worry, we're always told that the hemmhorrage(sic) will be healed like magic by insourcing.
Hemorrhage is a strange word to use to describe our rising manufacturing output. Maybe it doesn't mean what you think it means.
You're right about the stealing.....I've known that for some time and even though it's a future claim, it's going to amount some sort of 'rob peter to pay Paul' bookeeping entry.
Is there any reason to think he might not be an objective observer???
The loss of a job can be devastating to the individual and his or her family. No area of the country has felt it more than here in the Midwest, where manufacturing has been the backbone of our economy for more than a century. The declining number of manufacturing jobs is really part of a longer-term trend, not just a recent phenomenon. In 1950 manufacturing employment represented about 35% of private-sector jobs. By the year 2004 it had fallen to 12%. Yet, the U.S. is still the world’s biggest producer of manufactured goods. Of course, a key reason has been the constant improvements in productivity. One hour of work in 2000, produced four times as much manufacturing output as it did in 1950. The real culprit has been a mismatch between productivity and domestic demand for the past five years. We’ve had to rely on strong consumer spending, especially on homes and cars to carry the economy back to health. And going forward, we’ll see that the global economic picture will have a much bigger impact on U.S.-manufactured goods. In the steel processing business, our job is to work with manufacturers and help to keep them competitive. We are subject, as they are, to the ups and downs of the national and global economy. For instance, within the last 24 months we’ve seen our prices for steel rise and fall dramatically as China sucked up much of the world’s capacity to satisfy its enormous infrastructure building needs. Then, as Chinese mills came on line, they became a net exporter of steel products and prices at home, while still high, have settled down somewhat. ""It seems the common thought and discussion in the media right now is that all the manufacturing jobs in America have gone or are going offshore. It’s true that manufacturing employment is down about 10%, or about 1.6 million manufacturing jobs since the last recession began in November 2001. Economic recoveries such as we’re in right now usually restore those lost jobs. That doesn’t appear to be happening this time.
So even the "steel guy" seems to note a few bumps in the road.
What we really need to realize is:
It's time for the FairTax!!!
It will do precisely that while helping most taxpayers and the economy as well.
According to some pundits and political hustlers, free trade has led to a loss of "good manufacturing jobs." Let's look at it, but before doing so, let's first see whether we should work ourselves into a tizzy over other job losses.
In 1900, 41 percent of the U.S. labor force was employed in agriculture. Now, only two percent of today's labor force works in agricultural jobs. If declining employment is used as a gauge of an industry's health, agriculture is America's sickest industry.
Let's not stop with agriculture. In 1970, the telecommunications industry employed 421,000 workers in good-paying jobs as switchboard operators. Today, the telecommunications industry employs only 78,000 operators. That's a tremendous 80 percent job loss. What happened to all those agriculture and switchboard operator jobs? Were they exported to China and India by rapacious businessmen?
< snip >
How about the claim that our manufacturing jobs are going to China? The fact of business is, since 2000, China has lost 4.5 million manufacturing jobs, compared with the loss of 3.1 million in the U.S.
< excerpted >
View entire article here
At this rate of expansion, the Chinese Honda operation will surpass, by units (not profits) total U.S. Honda operations within five years.
Not to worry, we can still wash each others Hondas and sell sell to other folks.
As goods production declines as a share of current dollar GDP, services rise. Ain't it wonderful, we can all be HONDA salesmen.
The yuppie generation was not raised to pay-as-you-go, and it reflects in our policies. I don't know what they are thinking, that we will come out on top no matter what happens?
We are teetering on the brink but it could be a long, tortuous descent. Sure there will be the rich, and the rest will be their slaves, cast into a daily struggle for survival. We are seeing some of the symptoms in increased aberrant behavior, crime, drugs.
We are a sick society and those who are propping it up won't be able to keep it up forever due to an ever-increasing undertow.
Your father wasn't off by many years. He may have been right on. Wasn't 1973 Roe vs. Wade? It may seem irrelevant, but that marked the beginning of our slide into the abyss of open and ubiquitous moral degeneracy.
We may not be divided territorily, but we surely will be divided along economic class and cultural lines. People of such diverse cultures do not get along and are not going to learn to get along, no matter what cute little books they will read in school. Gangs are a symptom of cultural malaise.
--have totally missed the point of a pretty good working paper, and that's the shame.
Sure, I'll disagree with Kotlikoff's goofy bankruptcy scenario but I'll be forgiving because he is right with the idea that there are a few course corrections that definately are in order (Social Security for one). I'll also disagree with the idea that somehow the only solution is flipping to a flat tax --IMHO that's a different solution for a different problem. Once again I'll be forgiving because Kotlikoff is in fact right that we need solutions that simply aren't 'in the box'. (Good commentary here).
But to say the reason we're bad off is because of China? --because of our manufacturing sector? Sheesh. Next thing we'll be hearing them telling us we want to bring back the gold standard or something...
I agree. I always laugh when panic-mongers conflate external debt with unfunded liabilities. External debt may require tax hikes which could reduce national or household wealth.
I'd like someone to explain how taxing a 25 year old to pay the Social Security of a 65 year old reduces total national wealth. If Social Security is canceled tomorrow does that somehow boost national wealth?
The tax proposed by Kotlikoff is not a VAT at all but the FairTax which is a national retail sales tax differing substantially from a VAT and it's surprising that one presumably versed in economics would fail to notice the difference. It operates nothing like a VAT (which taxes everything at every stage of production and embeds tax costs in the prices of goods and services much like the present income tax), but is a single-stage tax at the end-consumption (retail) level only, taking a thing once and only once. It is far simpler, less expensive, and less prone to abuse that either a VAT or an income tax.
The "33%" rate Kotlikoff names is based upon his assumption of none of the savings of the costs of the present income tax system operating to reduce prices but instead going entirely to benefit workers (along with the employer part of the payroll taxes) and causing prices to rise to a higher level because of it (along with no compliance cost savings), Other economists make the opposite assumptions and believe prices will drop 22 - 24% and workers will have only their existing takehome pay. Obviously the truth is somewhere between these two extremes.
Most economic studies find the 23% tax inclusive rate (which is the rate presently in the bill and is 29.87% tax exclusive) to result in some reduction in prices due to removal of the income tax costs and compliance costs with workers getting their full paycheck (not counting the ER payroll portion which would go toward reduced costs). Done this way, prices will decline somewhat with the income tax removal, workers will receive their full pay which - along with the prebate they may receive - will more than compensate them for the new prices after FairTaxes are added. IOW, a purchasing power increase for most taxpayers. Some will be greatly helped, some less so, but after all, the tax is designed to be revenue neutral so there should be very little change for most but removing the hidden costs of the income tax will raise disposable personal income somewhat overall.
Kotlikoff's bankruptcy scenario is based mainly upon the walloping and massive increase in social entitlement costs which are not sustainable under the present tax system as he clearly points out.
So? How much of that is Chinese base product, with minimal additional US contribution,...marked up to U.S. retail? Your bookkeeping misses the point completely.
It is especially telling that you blow off the actual vectors and growth indicators and their scope, after you explicitly wanted that comparison. Now you are already running for the tall grass and trying to throw sand in the eyes...t'sk.
As an aside, it should be mentioned that you can never have a realistic comparison vis-a-vis China so long as there is no adjustment for the Communist's strategy to deeply understate the value of their labor and hence their product.
Hemorrhage is a strange word to use to describe our rising manufacturing output. Maybe it doesn't mean what you think it means.
More likely "rising U.S. manufacturing output" doesn't mean what you think it means.
If only the money people make providing services could be used to buy goods. LOL!
Studies by Kotilkoff and others have clearly shown that this cannot continue or well soon (within about this next generation) run out of having enough workers with income to pay the freight. Keep in mind there is declining employment in many industries overall and in many instances wage levels decline also. But regardless, one wage earner is not going to be able to pay for the entitlements of 2, 3, 4, etc. of the oldsters.
And we're getting very close to that tipping point. Also see my comments in #157 about the best solution from a tax system standpoint.
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