Did IMF Say USA Is DOA?

Recent International Monetary Fund statements on U.S. fiscal solvency have been alarming. But do they point to a future debt of $202 trillion?

Boston University econ prof. Laurence J. Kotlikoff has put together some pleasingly apocalyptic documentation:

Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: "Directors welcomed the authorities' commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP."

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: "The U.S. fiscal gap associated with today's federal fiscal policy is huge for plausible discount rates." It adds that "closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP."

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

Double Our Taxes

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It's also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.

Is the IMF bonkers?

No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

It's from the CBO's alarming Budget Outlook that Kotlikoff builds his case for the $202 trillion fiscal gap, then ends with a malediction against both demand siders and supply siders: "Our country is broke and can no longer afford no- pain, all-gain 'solutions.'"

I'm inclined to share in Kotlikoff's skepticism that supply-side solutions—absent an almost total spending cut that would be politically impossible—can close this gap. The U.S. Treasury's credit should by all logic be shot at this point, so it's hard to see how a repeat of Reagan-era tax cuts, currency stabilization and borrowing to cover the deficit could still be applied. While there are many nice things to say about the Reagan Administration, it ended with public debt much larger than it was at the beginning, and it arguably accustomed Washington to an insidious type of government growth that seemed painless only because it was continually rolled over into bigger debt. I'd still say Reagan made the right bet: The U.S. economy was resilient enough to handle a much bigger debt load at the time. That time is over.

I should note, however, that the evidence should be showing up in the cost of public debt service, and so far the evidence has not been found: Yields on 10-year Treasury notes are so low they're practically giving them all away. But the IMF's Selected Issues paper predicts a spike in interest rates is on its way:

In sum, analysis both on the basis of investor portfolios and saving-investment balances suggest that, on current policies, the sizeable projected increases in U.S. public debt will likely put upward pressure on government borrowing costs in the medium term.

There's a silver lining here: the prospect that increasing costs for public debt, coupled with popular hatred of inflation and the political weakness of people my age as we approach retirement, could actually force some radical changes in the old-age benefits that are at the center of all these horrible statistics. The apocalypse, like Achilles, is always just about to overtake us, but never quite does.