The Exchange

Obama, Romney and the Fiscal Gap

The Exchange

By Laurence Kotlikoff, guest columnist

Dear President Obama and former Governor Romney,

To one of you worthy gentlemen will fall the task of leading our nation for the next four years. Doing so requires your full understanding of the fiscal challenges our nation faces.  I write by myself, but I speak, I believe, for the vast majority of economists in warning you that our nation's fiscal policy is gravely endangering our country's future and is in far worse shape than is commonly believed.

Understanding the Fiscal Gap

Based on the Congressional Budget Office's June Alternative Fiscal Scenario projections, the present value gap separating all future projected federal expenditures and taxes is $222 trillion. Last year's fiscal gap was $211 trillion. Hence, over the past year, our nation's fiscal gap grew by $11 trillion, which is coincidentally roughly the size of total "official" debt held by the public. The gap grew so dramatically thanks to the combination of low taxes and high spending and the fact that the baby boomers are quickly approaching full retirement, bringing the value of their promised benefits closer to the present.

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I put quotes around the word official because which government obligations are labeled official versus unofficial is, from an economics perspective, entirely arbitrary. The fiscal gap looks at all obligations regardless of their labels or their timing, and, thus, is invariant to the choice of language. This is no surprise. Fiscal policy concerns economics, not linguistics.

One might counter that "official" obligations are more likely to be honored. In fact, the opposite it true. It is, for example, far easier to renege, in real terms, on principal and interest payments on Treasury bonds than it is to renege, in real terms, on benefit payments to Social Security recipients. The government need simply open up the printing press. The ensuing inflation will wipe out the real value of the Treasuries, which are not inflation-indexed, while preserving the real value of Social Security benefits, which are.

The fact that Treasuries are a "legal" obligation and Social Security benefits are not offers no comfort to those receiving interest and principal on their Treasuries, but in watered-down dollars. Opening up the printing presses is not a hypothetical policy -- it's underway.  Since 2007, the Federal Reserve has more than tripled the monetary base and, thereby, laid the foundation for a tripling of the price level.

To reiterate, economics labeling problem means that the federal debt and its annual change, the deficit, are linguistic constructs that bear no relationship to the country's underlying fiscal policy, let alone its sustainability. The fiscal gap is the only appropriate metric to consider.

Have your economic advisers raised this issue with you? If not, they are doing you and our country a terrible disservice. As indicated, the meaningless official debt measure is one-twentieth the size of the real problem — the fiscal gap. Eliminating the fiscal gap requires either an immediate and permanent 64 percent increase in the time-path of total federal revenues or an immediate and permanent 40 percent cut in the time-path of all discretionary spending and transfer payments, or some combination of these awful remedies.

Alternatively, we can adopt radical structural reforms of our fiscal institutions, such as those laid out at www.thepurpleplans.org, which will eliminate the fiscal gap as fairly and efficiently as possible. What we can't do is wait for a fairy God mother. The longer we wait, the more older generations escape paying their share of the fiscal gap and the larger the bill left to our kids.

As you are aware, economists know very few things for sure. But we can tell when a country is broke. Our country is broke. It's not broke in 30 years or in 20 years or in 10 years. It's broke today and to the tune of $222 trillion.

How We Got Here

We did not get into this position overnight. We spent 60 years running a policy of Take As You Go, in which older generations "tax" younger generations, but while promising the young huge benefits when old in exchange. It is these off-the-books promises that constitute the bulk of the obligations underlying our horrendous fiscal gap.

This massive Ponzi scheme has not only driven our country broke, it's also wiped out national saving. In 1950 our national saving rate was 15 percent. Last year it was 1 percent. Unfortunately, last year was no anomaly. National saving has been declining, with some temporary upticks, for 60 years.

The decline in saving was caused not by higher rates of government consumption, but by much higher rates of household consumption. And the group whose consumption has risen most rapidly -- indeed, meteorically -- is the elderly. In 1960, the typical 75-year-old consumed about 20 percent less than the typical 35-year-old. Today that 75-year-old is consuming about 40 percent more than the typical 35-year-old, with a large part of that consumption reflecting health-care services paid for by Medicare and Medicaid. In short, Take As You Go was combined with Consume All You Can.

Investment Is Slipping

Nations that don't save don't invest. So it's no surprise that our rate of domestic investment, which was also 15 percent in 1950 now stands at just 5 percent. Were foreigners not investing in our country (recorded as our current account deficit), our domestic investment rate would also be 1 percent. Countries that don't invest neither grow very fast nor experience much real wage growth. Sadly, that story fits our bill.

Eliminating the enormous fiscal sword of Damocles, which hangs over our heads as well our children's, cannot be accomplished by cutting taxes or raising spending. Neither supply-side nor demand-side magic will pay our bills. It's time for you gentlemen to tell the country the truth about its fiscal condition and to come up with realistic solutions that do not involve waving magic wands.

Laurence J. Kotlikoff is a William Fairfield Warren Professor of Economics at Boston University and president of Economic Security Planning, Inc. He blogs at www.kotlikoff.net.

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