Is the United States Bankrupt?

FEDERAL RESERVE BANK OF ST. LOUIS REVIEW ^ | July 1, 2006 | Laurence J. Kotlikoff

[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 CONDITION

As 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.

_____________________________________________________

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.

[pigdog]

"OK, so we're doomed without the Fairtax. "

That's not what was said, but we are "doomed" to do less well economically (and from the standpoint of individual freedom) by sticking with the existing tax system.

Please give a link to the SCOTUS ruling that you say ruled the federal government did no have the authority to levy a national sales tax. Otherwise the comment will just be ignored.

There have been SCOTUS rulings that said (and these have been posted several times on these tax threads) that the 16th gave the US no new taxing powers. In past years the income tax has been ruled both constitutional and unconstitutional in point of fact. SCOTUS can't seem to make up its mind.

Your "solutions" seem pretty empty since all I have seen so far amount to further government control and manipulation of the economy and the taxpayer. I'd rather see that ended by a tax law like the FairTax where anyone who wished to save and invest could do do so tax free and with complete transparency to the government and be free of their influence. Anything allowing the government to get it "oar in the water" is a non-starter. There's far too much governmental influence/control of individual resources as it is. Let's get rid of it.

And thanks I plan to continue working on the FairTax and once we pass it there will be a sizable surge of economic activity - and it won't be because the government was able to direct it, either.

[RipSawyer]

You can't "not spend" more than you were spending.

>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Well, that is what I was taught too but nearly everyday now I hear a news report with terms like "500 times smaller" or "300 percent less" so apparently the old rules don't apply anymore. Whenever I question this sort of construction some supposed scientist or engineer proceeds to lambast me for being out of date or something. I suppose I will have to go back to school to learn the new math.

[expat_panama]

I doubt the government can or will spend much of its "net worth".

It's a business thing.   Net Worth = Assets – Liabilities (from here)

Sure, the idiot press talks about "paying for tax-cuts" etc., but spending involves using up assets, not liabilities or net worth (with or without the "")..

fwiw, a big chunk of assets are stuff like cash on hand and funds owed to the government.  Some people like to think they're Scrooge McDuck trying to fill a money bin, but they're idiots.  Before I want the government to make me pay taxes, it first has to spend it's cash on hand before I give it any more.   Doing this won't make the US go bankrupt; not even "bankrupt".

[expat_panama]

I see you missed the unfunded $65.9 trillion fiscal-gap laying in commitments this government has signed us all and our children on to.

No, everyone knows that. 

I just didn't want to ramble on with stuff like the treasury will tax those payments to the tune of $20 trillion, that the payments are due in 30 years so at 2.5% inflation they'll amount to $33 trillion, --not to mention the fact that our kids will be smart enough to scrap those stupid entitlements long before any of that stuff ever comes up.

Dang, you got me rambling again!

[ancient_geezer]

Fine, however I really would like you to cite that U.S. Supreme Court ruling you say exists concerning a lack of authority for the national government to levey a general retail sales tax.

Especially considering that retail sales taxes are indirect taxes laid uniformly, i.e. with the same rate and law without regard to location in the United States, a tax definitely within the powers of Congress to lay and collect under Article I, Section 8, clause 1 of the Constitution.

[ancient_geezer]

so at 2.5% inflation they'll amount to $33 trillion

 

"this figure as our own government’s best estimate of its present-value budgetary shortfall."

Apparently you missed the statement, thus in present dollars would be a true $65 trillion.

Inflated future dollars, with which those future budgetary commitments would be made, would be a substantially higher number due to lower valued dollars after loss of purchasing power to provide the same benefit.

[expat_panama]

I really would like you to cite that U.S. Supreme Court ruling you say exists ...   ...Especially considering ... a tax definitely within the powers of Congress to lay and collect under Article I, Section 8, clause 1 of the Constitution.

Dang -nobody tells me anything around here, why am I always the last guy to get the news!!!

I tell you what, I share my link about the sales tax ruling if you share me your link that says the SCOTUS is now making sense and is following the Constitution. 

Amazing, --learn something new every day...

[ancient_geezer]

Your claim:

expat_panama #195: "Over a hundred years ago the US Supreme Court ruled that the federal government did not have the authority to levy a national sales tax"

Your response on challenge:

"I tell you what, I share my link about the sales tax ruling if you share me your link that says the SCOTUS is now making sense and is following the Constitution."

It would appear you are apparently passing gas.

[pigdog]

Sorry, but "net worth" has no relevance for paying money to entitlement benefactors. Nor do "assets" for the most part since the government seldom has little if any "cash on hand". They merely borrow it almost instantaneously when they think they need it.

"Before I want the government to make me pay taxes, it first has to spend it's cash on hand before I give it any more."

Sorry, too, to tell you that that's not the way things work. You'll cough up tax when he government sends "the man" out for it whether you think you want to or not. that's the way those sovereigns operate - maybe not in Panama, but here in the US.

[Ditto]

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.

OK. Help me out here.

Lets say I'm a 30 year-old with an annual income of $50,000 and I buy a house with a 30 year mortgage of $250,000, or 5 times my "GDP" and twice the size of my wealth in savings, cloths, furniture, vehicles, jewelry, etc. Am I bankrupt?

[pigdog]

Yup, you've got the picture.

[Toddsterpatriot]

Why would I do that?

Most doom and gloomers think buying gold will save their soul.

Gold doesn't pay interest or dividend, nor can it be said to be worth anything as an appreciable asset.

Excellent. Glad to hear you understand basic economics and are therefore not a goldbug.

Unfortunately, people are using less and less of their income dollars to do the latter for the strong disincentives of high marginal tax rates on savings and investing

I think you meant former? Tax rates on investing have been reduced. Or hadn't you heard?

as well as inflationary expectations.

Inflationary expectations make people less likely to invest? How do you figure?

As the savings rate with respect to discretionary income more than apply demonstrates. In fact they have begun to actually head into negative territory as a savings rate. The are becoming net debtors instead of net investor/savers of income.

How much of the negative savings rate is capital gains taxes paid? How much capital gains do Americans earn which are not included in the savings rate?

[pigdog]

The best tax rate on investment would be zero ... and that's what it is under the FairTax.

That would also help encourage more to save than at present - when the savings rate is, basically, zero. It also will help most taxpayers by boosting their purchasing power.

It's time for the FairTax!!!

[pigdog]

Not if you've gots lotsa credit cards ... Just keep on borrowing and never mind the interest. Guys on this thread say it doesn't matter.

[Toddsterpatriot]

The best tax rate on investment would be zero ... and that's what it is under the FairTax.

I'm agnostic on the Fair Tax idea. I agree that it could be a good deal for say a 22 year old, fresh out of college, but what about people who've been working and saving for a while?

Let's say I'm 65 years old and have $1,000,000 in Muni bonds paying 4%. I'm happy to collect my $40,000 every year and now the fair tax comes along and suddenly my tax free income gets hit with a 24%, 19%, or whatever sales tax rate. What do Fair Tax proponents have for people who no longer have income tax obligations?

[ancient_geezer]

Most doom and gloomers think buying gold will save their soul.

Sorry to disappoint. I just figure that we will find it necessary to cause government to change its ways to solve the fiscal crisis that our kids and grand kids are headed for with no change from the status quo.

Only G'd can save man's soul, so even their you are far off the mark.

Excellent. Glad to hear you understand basic economics and are therefore not a goldbug.

I never said I was, in fact if you had been aware of my posting history as regards the lack of solution in gold standards and such you would have known better.

I think you meant former? Tax rates on investing have been reduced. Or hadn't you heard?

Why are we taxing investing at all? That which you tax you get less of, not more. Just reducing such is a temporary bandaid at best.

In fact the marginal rate on a dollar earned, regardless of how it may be aquired, effectively raises the value of doing anything other than earning that next one.

Production suffers both from loss of capital input, as well as incentive to work. That is especially true where there are a gazillion government subsidies and incentives providing reasons to avoid that that next dollar because the change in the tax bite is more than the perceived value of consuming and taking the day off, or life off in some all to plentiful cases.

Inflationary expectations make people less likely to invest? How do you figure?

Makes it more desirable to spend for consumption today rather than invest and grow for tomorrow's security and less than better deal.

Given that true gains can be obtained without inflation, inflation merely assures that those on the margin making a choice of spend more now rather than save/invest to do so later, choose to consume rather than build wealth for future consumption.

The proof lay in the what is happening to the utilization of income that lay in the personal income data.

 

How much of the negative savings rate is capital gains taxes paid?

None, as the savings rate is calculated from after tax income, (i.e. discretionary income).

Realized capital gains are a component of income, just as wages, dividends and interest are. The sum less taxes paid is the basis of discretionary income.

How much capital gains do Americans earn which are not included in the savings rate?

The savings rate is that faction of income left after taxes and spending for consumption. If it's negative, one is consuming in excess of their realized income and gains.

[Toddsterpatriot]

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.

The problem with discussing "unfunded liabilities" in the same sentence as "national wealth" is that these liabilities do not impact national wealth. They take money from one group of Americans (workers) and give it to another set of Americans (retirees). When you add the payment and the receipt together, it's a wash, as far as national wealth is concerned.

[Toddsterpatriot]

Sorry to disappoint. I just figure that we will find it necessary to cause government to change its ways to solve the fiscal crisis that our kids and grand kids are headed for with no change from the status quo.

I suspect payroll taxes will increase and Social Security benefits will be reduced. The nation will survive. Privatizing would be even better, but I won't hold my breathe.

I never said I was, in fact if you had been aware of my posting history as regards the lack of solution in gold standards and such you would have known better.

Sorry, not familiar with your history. I keep running into gloomers who are goldbugs. Sorry to incorrectly paint you with that brush.

Why are we taxing investing at all? That which you tax you get less of, not more. Just reducing such is a temporary bandaid at best.

I'm on board. The best Cap Gains rate is 0%.

Makes it more desirable to spend for consumption today rather than invest and grow for tomorrow's security and less than better deal.

Inflation makes me want to invest more in stocks which raise their dividends.

None, as the savings rate is calculated from after tax income, (i.e. discretionary income).

Sorry. Capital gains taxes paid are subtracted from income when determining savings.

Realized capital gains are a component of income, just as wages, dividends and interest are. The sum less taxes paid is the basis of discretionary income.

Are you sure capital gains are included? I've read many articles that say they are not. For instance:

Disposable personal income, as the Commerce Department measures it, currently does not include the capital gains that come to individuals when they sell stocks or other assets. There has been a long debate as to whether or not these gains are properly considered income, since they do not reflect any earnings from additional output but only changes in prices. We do not need to challenge the Commerce Department's definitions, which seek to portray the real changes in the economy. But in calculating the financial surplus available for investment, it is clearly a mistake to omit capital gains. Not only are capital gains a source of much business financing; during the 1980s, they reached unprecedented levels.

The Myth of a Savings Shortage

If you have a more recent source which backs up your assertion, I'd appreciate a link.

[ancient_geezer]

Sorry. Capital gains taxes paid are subtracted from income when determining savings.

That is what I said, personal savings is with respect to after tax income, (i.e. discretionary income.)

Are you sure capital gains are included?

No, looking over NIPA tables it does not appear to be included in disposable income.

Seeing that most of such sales are largely re-invested in like instruments it is not clear that one could reasonable include such as income as much as it would represent appreciation of old assets. Certainly it is not classifiable as current production income in the GDP sense. So you are probably correct.

Savings under NIPA measure appears to best be defined as that which is left after taxes and consumption out of current production income.

[pigdog]

Most taxpayers will benefit from an increase in purchasing power.

Under the FairTax, income - no matter from what source - is not taxed. Only consumption is taxed and used (already taxed) things are not taxed again. This puts the amount of tax you pay squarely under your control since you determine your own consumption.

To get one view of how pre-taxed savings could benefit, check this post.

Once again, your tax free income is still tax free. It's taxed only when you spend it for taxable things. And, don't forget, you also receive the prebate (unless you don't want it - it's optional).

Let's say you're married and that for 2006 you spent your entire $40,000 on taxable things. You'd have an effective FairTax rate of 11.73% since you'd have available a prebate of $4,508 to offset a good bit of your taxes. And with a little frugality you could do a good bit better while your tax-free investments continued to grow tax free.

And keep in mind, too, that if you spend the entire $40,000 under the present tax system, you'll pay tax in the form of hidden taxes that are embedded in everything you buy (whether new OR used).