I've taken the Forward, which is revealing, from the Gokhale-Smetters Report(PDF) and formatted it for posting here since the complete report is lengthy. I suppose the bottom line is it would be political suicide to actually advocate for phasing out either program, but it's not like the federales have never welched on a promise, eh?
This study exposes a serious financial accounting problem of great political importance and proposes a way to correct it. The subject is not the corporate accounting problems that have attracted so much public attention in recent years, but rather the accounting problems of the federal government itself, which have attracted almost no public attention.
Two long-established measures of federal finances continue to receive top billing in official government reports and to dominate policy debate in Washington and in the media. They are the “national debt”—the government’s outstanding debt from past borrowing yet to be repaid—and the budget deficit or surplus for the current year and the next several years. These measures were perfectly adequate when government spending was mainly for roads and battleships and payments to discrete groups, such as farmers, that could be adjusted in the short term. A budget deficit or surplus might be justified by immediate public contingencies— or might indicate that taxes or expenditures were too high or too low. The national debt, like the debt of a corporation, might be justified by current expenditures expected to yield positive returns in future years—or might indicate profligate spending or inadequate tax collections. Political debate over these matters had a reasonable connection to fiscal reality because the accounting numbers covered roughly the same periods of time as the government’s actual spending commitments and revenue projections.
But that is not the case today. Two large social insurance programs, Social Security and Medicare, now account for more than one-third of all federal spending, and this share will increase vi FISCAL AND GENERATIONAL IMBALANCES dramatically with the retirement of the baby-boom generation. Both programs consist of long-term commitments—to provide income and medical insurance benefits to older citizens far into the future. And both are, for the most part, unfunded: they are financed not by savings to meet future commitments but by contemporaneous transfers, now and in the future, from wage earners paying payroll taxes to retirees and others receiving benefits. These program features confound the conventional accounting measures. The differences between future benefit payments and future tax collections are not part of either the government’s debt or budget measures.
It is not only the current size of Social Security and Medicare that makes the accounting omission a serious one. Although the financial commitments involved will be paid far into the future, they affect the savings behavior of younger people today— both programs are deeply embedded in the political expectations and immediate economic choices of all Americans. And the rapidly approaching “demographic transition” to a society with a much higher ratio of older to younger people will make the current expedient of pay-as-you-go financing unsustainable before long. Accurate accounting has a practical purpose: to reveal the consequences of current practices and to clarify the nature of the choices we face. In the absence of accurate accounting, political debate over some of the most momentous issues of the age is proceeding in an empirical vacuum, and has become much more confused and desultory than it needs to be. American citizens are being misinformed, to their serious detriment, in both their political and private choices.
Gokhale and Smetters propose a new set of accounting measures to supplement the conventional ones. “Fiscal Imbalance” adds to the federal government’s current public debt the present value of the difference between all projected federal non-interest spending and all projected federal revenue. “Generational Imbalance” indicates how much of the Fiscal Imbalance arises from older generations shifting tax burdens to younger (including yet-unborn) generations. Together, these measures provide a comprehensive accounting of the “total future debt”—most of it now hidden—implicit in today’s policies and the distribution of that debt across age groups.
The Gokhale-Smetters measures cast an alarming light on the federal government’s financial circumstances. The current Fiscal Imbalance is $44.2 trillion, almost all of it a consequence of Social Security and Medicare. That is more than ten times larger than the government’s current debt from past borrowing—and it is growing many times faster than current budget deficits are growing the debt. Fiscal Imbalance is, to repeat, a present-value calculation, not a sum of future dollar expenditures; our government would need to appropriate the nation’s entire gross domestic product for the next four years to meet the Social Security and Medicare commitments it has already made. And the Fiscal Imbalance is about to deteriorate further. As this monograph goes to press, Congress is poised to expand Medicare benefits sharply without any corresponding taxes to pay for them, to the extent of adding many trillions more (perhaps the equivalent of another year’s total GDP) to the government’s current Fiscal Imbalance.
One can of course argue over the economic and demographic assumptions on which Gokhale and Smetters base their calculations (they are the same assumptions used by the Office of Management and Budget in the administration’s most recent Budget). But no amount of adjusting would alter the essential conclusion: In the absence of economic or demographic developments dramatically different from anything anticipated, massive tax increases or benefit reductions are inevitable.
For this reason, the introduction of Fiscal Imbalance and Generational Imbalance measures into the government’s financial reports will be resisted by political activists with discrete agendas. Those who favor tax cuts regardless of the government’s spending commitments will fear that the massive Fiscal Imbalance will be a powerful weapon in the hands of those seeking higher taxes. Those who wish to maintain Social Security and Medicare in their current forms will fear that the Fiscal and Generational Imbalance figures will be a powerful weapon in the hands of those who wish to supplant the programs with personal retirement savings accounts.
A careful reading of this study will show that the latter group have more to fear than the former. The enormity of the current imbalances is primarily a result of the impossibility of sustaining Social Security and Medicare through pay-as-you-go financing— the requisite payroll taxes would soon become crushing and selfdefeating. Pre-funding these programs through personal savings accounts is a far more powerful means of restoring fiscal balance than tax increases, and would almost certainly be worth the explicit borrowing necessary to accomplish the transition; indeed, that may be the only feasible means of saving the programs.
But the larger teaching of Gokhale and Smetters’s research is entirely nonpartisan: The dynamics of democratic politics and policy innovation have produced a powerful bipartisan machine for winning the support of today’s voters, especially older voters, by placing massive, concealed financial burdens on the young and the unborn. The new financial measures proposed here will not abolish those dynamics, but one hopes that they might make short-term political appeals more disciplined and cautious—and perhaps create opportunities for political entrepreneurs to fashion new appeals to those who wish to maintain our current prosperity for generations to come.
CHRISTOPHER DEMUTH
President
American Enterprise Institute
for Public Policy Research