National Debt

America's Crushing Fiscal Gap

It's time to account for future government obligations.

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The U.S. government has racked up $12 trillion in public debt, a figure equivalent to nearly three-quarters of gross domestic product. Yet that massive sum pales in comparison to the costs of the federal government's unpaid promises, mostly in the form of health care and retirement benefits for seniors.

Although future commitments are not scored by the nonpartisan Congressional Budget Office (CBO), this off-the-books "fiscal gap" is real debt. Economists and lawmakers of all stripes are coming to recognize the need for honest fiscal-gap accounting. In July 2013, Sens. Tim Kaine (D-Va.) and John Thune (R-S.D.) introduced the Intergenerational Financial Obligations Reform (INFORM) Act, which would require the federal government to disclose unfunded obligations.

Estimates of future obligations vary. In 2012, using data from the Medicare and Social Security trustees, former Securities and Exchange Commission chairman Chris Cox and former House Ways and Means Committee chairman Bill Archer estimated that the U.S. faces an $86.8 trillion fiscal gap over the next 75 years. That same year, Cato Institute economist Jagadeesh Gokhale measured the gap using an approach he developed with the Wharton economist Kent Smetters. Under the CBO's baseline scenario, which assumes that certain federal laws will remain unchanged, Gokhale found a $54.4 trillion fiscal gap. Applying the same methods to the CBO's "alternative fiscal scenario," in which current tax and spending policies are assumed to change consistent with previous congressional practice (as opposed to the feckless promises of current politicians), Gokhale reports a $91.4 trillion gap.

Another estimate comes from James D. Hamilton, an economist at the University of California at San Diego. In a paper published last year by the National Bureau of Economic Research, Hamilton calculated the total value of off-balance-sheet federal liabilities, including housing support, loan guarantees, deposit insurance, Federal Reserve liabilities, and federal trust funds for social insurance programs. His total came to $70.1 trillion for 2012, six times larger than the on-the-books debt of $11.3 trillion.

Even those alarming figures are dwarfed by the numbers in a forthcoming paper that the Boston University economist Larry Kotlikoff wrote for the Mercatus Center at George Mason University. Kotlikoff calculates the current fiscal gap at roughly $200 trillion.

The variation among the estimates can be explained by different assumptions and methods. Cox and Archer simply added unfunded liability burdens-from programs such as Social Security, Medicare, and the federal employee pension system-to the "official" debt of $15.96 trillion reported in 2012. (Due to Hamilton's methodology, some portion of the official $15.96 trillion debt is counted in his unofficial total debt, so his "on-the-books" debt only amounts to $11.3 trillion.) Gokhale arrived at his estimate by subtracting the total present value of projected federal expenditures and total federal assets from the total present value of projected revenues.

Kotlikoff, by contrast, calculated what future generations must pay over their lifetimes to cover the fiscal gap, assuming each future generation's lifetime net tax payment rises in proportion to its labor earnings. By estimating tax payments as the difference in net tax burdens per capita on current newborns minus net tax burdens per capita on future generations, this calculation assumes lifetime net tax rates are the same regardless of when people were born.

The policy fix for the fiscal gap depends heavily on how you measure it. Using Gokhale's numbers, the federal government would need to either dramatically raise taxes or dramatically cut spending to eliminate the future imbalance. Using only tax increases, all taxes would need to increase by 25.5 percent under the baseline scenario; under the alternative fiscal scenario, they'd have to go up by 50.3 percent. (If you wanted to raise the funds with the income tax alone, it would have to go up 40.2 percent under the baseline scenario or 86.3 percent under the alternative scenario.) Relying only on spending cuts for Gokhale's gap would require a 21.3 percent decrease in spending under the baseline scenario or a 35 percent decrease under the alternative scenario. If you use Kotlikoff's calculations, closing the gap would take an increase in all federal taxes of 54.8 percent or an immediate and permanent 36.2 percent cut in non­interest federal spending.

Every estimate of the fiscal gap suggests that fast and fundamental reform is necessary to avoid catastrophe. The longer we wait to make fiscal adjustments, the more drastic the changes will have to be.

Because of the size of the burden, even minor government tweaks can have huge effects on the long-term numbers. In a December 2012 interview with Real Clear Politics, for instance, Kotlikoff estimated the fiscal gap at $222 trillion, $22 trillion more than in his upcoming Mercatus paper. The difference is mostly the result of two relatively small policy changes: the March 1, 2012, sequestration cuts (which reduced the growth of spending over nine years), and the January 1, 2012, fiscal cliff deal (which, among other things, increased the top marginal tax rate to its Clinton-era level and allowed the expiration of a 2 percent payroll tax cut implemented in 2010).

Needless to say, policy changes can push the total up as well. In 2005 Smetters and Gokhale estimated that the gap had grown by nearly $20 trillion since 2002, thanks largely to the Medicare prescription drug entitlement championed by President George W. Bush.

There is another change that could drastically affect the fiscal gap numbers. When the Social Security trust funds run dry (which is currently projected to happen in 2033), the program is required by law to revert to a pay-as-you-go system, meaning that total benefits cannot exceed payroll tax revenue in any given year. Current estimates assume that the resulting reductions in benefits could be as steep as 25 percent. Yet most of the numbers cited above assume that Congress will change the law so that these cuts never go through. That assumption may be wrong.

Even without taking the full fiscal gap into account, the CBO's more realistic extended alternative baseline projects that our debt level will explode from 73 percent of GDP today to almost 200 percent of GDP by 2038. It may not be realistic to assume that Washington will maintain the status quo. In 1983, when the Social Security program was in dire financial straits, Congress enacted reforms that included tax increases, retirement-age increases, and benefit changes. Additional changes like those would reduce the fiscal gap significantly.

For years lawmakers have been making promises without having to pay for them, and they have managed to keep the resulting debt off the books. Now the pressure is mounting to at least change the way we account for future obligations. Transparency is a small but necessary first step.

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  2. Does it count as “debt” if you can refuse to pay it without any legal repurcussions? I mean, the politicians could just vote to stop making entitlement payments at any time.

    Calling it “debt” may be convenient, but really it is much worse than debt. It’s just a promise made by some manifestly unscrupulous people.

    1. See, what they’re banking on is exploitation of resources in space, which will bring great wealth and inflation, cleansing our debt like a firehouse cleanses the Beast Called Man.

    2. You assume that legal repercussions are the only ones that matter.

      Sure, Congress *could* stop paying entitlements at any time, problem is actually doing so, especially doing so in short notice would create social unrest on such a massive scale that greek riots would look like a joke

      1. I liked Harry Browne’s plan if he were elected. The government’s fiscal year runs from October 1st through September 30th. If he were elected in November and inaugurated in January, people living off the dole would have over 10 months advance notice to make other arrangements, like finding a job.

        1. Lawyers would say that for Harry to drop people from the poverty rolls would require congressional action. And I agree.

          The good news is the way Obama is ingoring the law and executing it the way he wants it, then a Harry Browne could do what you suggest.

          The bad news, is that’s unlikely to happen, and instead, we’re more likely to get some president that takes away our freedoms by ignoring the constitutionality of what they do. Because what they want to do is get rich spending your money. Unfortunately, that’s what we’ve been eelction.

  3. All this worrying about spending and borrowing sounds like that Tea Party crazy talk.

    1. Exactly.

      Krugman says it’s ok because we can always just print more money. He even laughed at those concerned about US Federal deficit spending when he said it..

      He won a Nobel Prize in economics ya know. Not sure if it was the same year Yasser Arafat won his for Peace or not.

      1. I know of this guy who won a Nobel peach prize, rained hell on multiple countries using drones and bombed Libya. True story.

      2. Yup, even Tony on this site’s comments just the other day told me it is impossible for the US government to go bankrupt

  4. Can you imagine if the government had to use GAAP instead of their pixy-dust accounting standard?

    1. “In our professional opinion, the organization is insolvent.” signed,
      any CPA firm.

      If a public corporation did this, the senior officers would be in jail and the stockholders would be suing everyones’ asses off. Of course, the voters all (except for Libertarians) don’t have clean hands either.

      1. Enron was more fiscally prudent than the USG is.

      2. Well – Jon Corzine is a free man.

        1. Corzine should be living in jail, considering the millions he stole from ordinary citizens and farmers.

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  6. Take a look at the 1300 federal agencies, Google (list of federal agencies) some of the titles will get you laughing while some will anger you. Give it a look from A – Z.

    1. I just finished Gates book “Duty”. It is overwhelming the number of Under Secretaries to the Deputy Director of Changing the Toilet Paper Roll we have on the payroll in the Federal Government.

    2. I’d love to see a diagram of these agencies and how they relate to each other. I imagine there is plenty of duplication of activity and responsibility through the government.

  7. Social Security is not an entitlement, I paid into the SS from the time I was 16 and I started sixty years ago and from every paycheck there was a deduction for SS. The government is telling us it’s an entitlement but it is far from that.

    1. Thinking that doesn’t make it so. The SSA didn’t fund your account with your contributions. They paid someone else (a la Bernie Madoff).

      Yes, they promise to pay you back a certain amount monthly, but if you die, your heirs don’t get the NPV of that promise, they get some paltry death benefit.

      1. It’s not even a binding promise. The courts have ruled on that issue in the past. Social Security doesn’t legally owe anybody anything. You didn’t pay contributions you paid taxes, they just phrase it in a way to make people think there’s some kind of guarantee.

        1. Exactly. It’s also a Ponzi scheme, because the money you paid in went to earlier investors, and you’ll be depending on new investors to pay in as well if you plan to collect any Social Security.

    2. At least you don’t make the claim that they saved it for you in your own special account.

      That one always gets a laugh followed by a angry form whoever believed that.

  8. Of all the problems with our government, this is No. 1. There can be no social freedom without respect for private property, and much of that property will be confiscated to pay these bills.

  9. The official national debt is 16 trillion bucks, not 12 trillion. Some people don’t count debt held by government agencies like the SSA, but it’s the same taxpayers who have to pay that back.

    1. Yes, but that’s not an extra $4trillion in debt, that’s just SS money that will never be paid out.

      It’s too pessimistic to believe you won’t get any SS money, but if you read the actual “Trust” Fund report the trustees are pretty clear that SS will only be paying around 70% of what it should be paying by 2035.

      Also, Medicare will only have a little over half the money it needs. Personally, I’m hoping the money I get from SS will be enough to make up for the discrepancy in Medicare.

  10. Social Security was designed poorly. It doesn’t take in demographic realities like changes to life expectancy and the worker to retiree ratio. But its most glaring mistake is that politicians can raid the fund which of course they have.

    Benefits will have to be cut and taxes will have to be raised but those tweaks don’t fix the reality of a flawed program. It’s like putting a new timing chain and spark plugs on a 1935 Ford. Sure it might work for a few years but eventually the thing will leave you stranded. And the ride sucks.

    I think most Americans can see the need for a social safety net. It helps protect the most vulnerable citizens from unwarranted hardship. We don’t need the hundreds of programs that try to right every wrong while serving to employ millions of bureaucrats.

    1. Social Security was not designed poorly, it is a flawed and unworkable concept. As far a a safety net, I would rather depend on the willing charity of others than the forced confiscation of other people’s earnings. Government has proven itself incapable of doing a program like this.

  11. What we need is a personalized safety net. Right now the Federal government spends around 12% of GDP on various safety net schemes. That accounts to over $5000 for every person in the country. That money should act as an insurance voucher, HSA and retirement annuity. Each stage of your life requires different needs be met. Everyone needs catastrophic health insurance. Workers with families might need unemployment insurance. Retirees need income.

    For the majority of your life, all you would need is catastrophic health insurance and odds are you wouldn’t spend much on health care. The remainder of your $5000 you don’t spend on a catastrophic plan could be invested in a personalized retirement account and HSA to pay for deductibles and other out of pocket expenses. The account is fully yours and can be left to your heirs accounts at your demise.

    This acts as a kind of sovereign fund for U.S. citizens. Payments are pegged to GDP so they can’t get out of whack like the current system. Each person could invest their accounts in indexed mutuals and government bonds. They mutuals will give a much higher return over the course of ones life and the bonds are good for stability and to help service our debt.

    1. Why limit yourself when the government wants to give it all to you.

      What we need is a change in mindset. We need to assume responsibility for our own well being. The government’s role should be to get out of the way and allow me to take care of my own needs.

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  14. “Every estimate of the fiscal gap suggests that fast and fundamental reform is necessary to avoid catastrophe. The longer we wait to make fiscal adjustments, the more drastic the changes will have to be.”

    Of course no politician wants this to happen on their watch so what’s a career politician to do but kick this down the road for the “other” guy to deal with.

  15. Assuming that we’ll never be able to get away from the whole “safety net” concept “reform” social security like this:

    Select a date, say 1 Jan 2015 and decree that no one born after that date will receive a cent from social security. Instead they will be required to pay into a retirement account of their choosing. This stops the bleeding and gives people the type of system that many already believe they have. It also allows them to benefit from their labor if they are able to afford more than the minimum contribution.

    The second part of this is the sour pill. Everyone will have to continue to pay into social security for at least a generation, perhaps two.

    Add in a few other tweaks like means testing SS benefits and tying the benefit age to actuarial tables and you’ve turned a system based on debt to one based on saving.

    This isn’t fairy dust and unicorns so it will never happen but I guarantee that it would give these people a different perspective on saddling future generations with the costs of entitlements.

  16. Can someone explain the difference between the $12 T of public debt that the article references and the $17+ T on the national debt clock? (Pls don’t say $5+ T.)

  17. I have a great deal of respect for Veronique’s knowledge and insight, but I can’t escape the feeling that she does not have a firm grasp of how our monetary system actually works. The federal government does not have a solvency constraint — that’s how our fiat currency system is designed. The constraint is inflation. The federal debt does not ever have to be “paid off”. These sort of discussions should be more focused on the ability to service the debt, and the size of that debt service in relation to the productive capacity of our economy.

    1. De Rugy understands just fine. Your line of thought is implicit in phrases in the article like “200 percent of GDP by 2038”. Sovereign bond markets historically become untenable after 125% of GDP. The US will lose its first world financial status long before then.
      No one here is arguing for 0 debt, which for a bureaucracy the size of the US government would be impossible for a whole host of reasons. The people who purchase government bonds expect them to be paid. When governments sell so many bonds that it would be mathematically impossible to ever pay the obligations on those bonds, people will stop buying them. That is the situation the US is fast approaching and that Europe is already coping with.

  18. There is one future uncertainty you have not mentioned, an uncertainty that, unlike the others, Congress does not control: The interest rate that lenders require in the bond markets. Thus far the Fed has been able to keep interest rates artificially low to allow low cost Treasury refinancing. But look at the 1% increase in rates that followed Bernanke’s first intimation that QE would have to start coming down.

    What are the interest rate assumptions in the various estimates of the fiscal gap? The committee for a Responsible Federal Budget reported last September, “The fastest growing part of the budget is not Medicare or Social Security, but in fact is the interest on the debt.” They go on to say, “If interest rates rise 1 point above projections, it will cost the government $1.2 trillion this decade and over $4 trillion the following decade.” See: http://crfb.org/sites/default/…..s_debt.pdf

    In short, interest rates will have to go up at some point, and the situation is far worse than even the worst case scenarios in this well researched paper.

    1. There are a whole host of issues that are caused by sovereign debt over commitments. However what you have pointed out is definitely one of the most apparent as a budget item and a looming fear behind discussions like these. Unfortunately, its usually the case that by the time a bond crisis is accurately reflected in interest rates the issue is completely unresolvable and crash is imminent.

  19. 1. Right now SS benefits are mostly taxable, in a completely nontransparent way. They should become 100% taxable, without qualification. This would be a way of partially “means testing” Social Security via a side door. Recall that the first 23K/year of taxable income received by a retired married couple is exempt from tax by the standard deduction and personal exemptions. The next 17K/year of income is taxed at a marginal rate of only 10%. Hence couples living on Social Security alone would pay little, if any, tax. But those with substantial private retirement incomes would pay more income tax than now.

    2. Social Security benefits should be indexed at the lesser of the CPI and an index of clerical and manual wages. Nobody should do better being retired on Social Security than they would be if they were holding down an average job.

    3. The Medicare payroll tax will probably have to rise from its current 2.9% to 4%. This tax has no ceiling.

    4. The ceiling on the FICA payroll tax will probably have to rise from 113K to about 200K.

    5. FICA was enacted in 1935. In 1930, the remaining life expectancy of men (women), conditional on their attaining age 65, was about 12 (13) years. In 2008, the figure for men (women) was 17 (20). Hence the normal retirement age should be gradually increased from 67 to 70, to take full effect by 2050. People could still retire at 62, but with a reduced benefit, as at present.
    See Table 21 in:
    http://www.cdc.gov/nchs/data/n…..r61_03.pdf

  20. Great article. It’s good to see de Rugy’s work on our unfunded liabilities, and have someone point out spending will be cut (mostly in Medicare and Social Security) some now, or more later. Veronique shows the alternative tax revenues, but we know government won’t be able to collect more than 20% of GDP because if it tries, it will get even less revenues as GDP goes down, and the US loses business to overseas competitors who don’t have to pay US taxes.

  21. In 2012, using data from the Medicare and Social Security

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