Chapter 13

The Executive Branch publishes a report that accompanies its proposed budget each year called "Analytical Perspectives"¹. Chapter 13 of that document focuses on the long term impact of taxes and government spending. A more famous Chapter 13 is the section of the bankruptcy code that governs bankrupt people and firms. Of the two Chapter 13s, it seems highly likely that the former will lead the country into bankruptcy, and spawn much use of the latter.

It is safe to say that without significant changes to government budgets, a big crunch is coming. Budget experts in and out of government have been warning about the future for decades now.

In 2003, budget analysts Jagadeesh Gokhale and Kent Smetters defined and described the fiscal gap -- a measure of the gap between tax revenue and government spending projected far out into the future. They focused solely on the federal government. The degree to which spending matches revenues is the degree to which current policies are sustainable. Or not.

The two researchers projected current federal government revenue into perpetuity, then adjusted those future flows to their value today. Then they similarly projected government expenses into perpetuity and converted those numbers into today's value. In 2005 they updated their work. At that time, spending exceeded revenues by $63 trillion. That is $532,000 per US household. In Chapter 13 of the "Analytical Perspectives" report accompanying the 2009 budget (released in early 2008), the fiscal gap came to $785,000 per household.

Even if government policy does not change, this number grows at the rate of interest. Median household net worth is near $100,000. It's as if the average US household has taken on an additional mortgage of $785,000 but is not making payments. The interest keeps accumulating.

What is causing this serious problem? Two programs: Social Security and Medicare. The projections assume other government spending grows at the same rate as GDP -- which, by the way, is slower than those pieces of government have grown in the past.

Both are being driven by the rapidly expanding ranks of seniors -- which means more people to subsidize. And per person benefits for both outpace inflation. Social Security benefits grow faster than inflation by design. Medicare grows faster by accident because medical costs race ahead.

What next? Variations on three paths seem likely.

First is the status quo. The country cannot agree what should be done and therefore does nothing. People continue to plan for retirement based on the programs. Government borrows to fund the shortfall. Sound familiar?

At some point the government debt grows to such a weight that even the most rosy-eyed lenders foresee trouble collecting the money they have lent to the US Treasury. Interest rates rise, credit becomes scarce, the government cannot borrow. It commandeers photocopiers and prints money until all the world's toner is gone.

Big problem.

Ever heard about the Weimar Republic? If not, take it from the Jews, they know. Financial vertigo caused by excessive debt gave Hitler his big break. You get the idea. Seem extreme? Yes, it does.

The second possibility is that government raises taxes to cover the Boomers' retirement tab. This approach effectively puts the burden on younger people to pay for the great bulk of senior subsidies. The weight of paying the $785,000 plus interest per household falls to today's workers, tomorrow's workers and generations yet unborn, not to yesterday's workers, who reaped the benefit of it. As you might imagine, such a debt would squash family finances for a long time, perhaps several generations.

The third possibility is to cust senior subsidies. After all, unlike a mortgage, they are not contractual obligations. Even before LBJ's Great Society, the Supreme Court ruled that people have no legally binding right to Social Security payments. So benefits could be cut without legal repercussions to taxpayers. Cutting benefits puts the financial burden on the recipient of the benefits. Withdrawing subsidies from seniors certainly would make life less comfortable for all except the most wealthy. If done across the board, it would impose financial hardship upon multitudes.

This scenario ends with much less comfortable and less healthy retirements than planned, but it would leave a functioning economy for youngsters.

Is there a way out? Is there a Pot O' Gold?

One possible solution is a big rise in productivity - that is workers produce more or better products and services in the same amount of time. Productivity is the sole source of rising living standards across a whole economy. If productivity accelerates to near miraculous levels, the economy conceivably could produce enough to support the necessary tax burden without crushing subsequent generations of workers. It's a long shot, though. Such a large increase in productivity would be unprecedented.

A second possible Pot o' Gold could come from lowering medical costs. Despite large-scale experiments, nothing government nor insurance companies have done so far has made much of a dent in medical inflation. Some people believe that if government were to take over the 55% of the industry it does not control already, government could produce high-quality, universal coverage, and lower costs.

Other folks believe health consumers are already far too separated from their money in this system. The public ends up paying for every nickel of care. Yet when patients schedule treatment, they are indifferent to the cost because their relationship with the insurance company and other taxpayers insulates them from the immediate sting. If consumers controlled the money directly, the theory goes, they would use it more carefully.

Third, if the government sold all its assets, could it pay for these programs? The government uses most of the assets it possesses. Some folks would jump for joy if Congress sold off all its military hardware. Others might make the point that such a sale could come back to bite us. Even so, it would raise only a pittance compared with what the country needs.

Fourth is a perennial favorite: Soak the rich. It might make a dent in the debt, but total household net worth of $58 trillion doesn't come close to closing the gap. And it brings up sticky questions of fairness: How can one person ethically force another person to give up the fruits of her labor earned legally and fairly?

The opposite side says $100,000 means a lot less to Paris Hilton than it does to Joe Six-Pack; therefore Joe has a better right to it than Paris. It seems like a reasonable forecast to expect that Congress will tax Paris more, simply because there are more votes from middle-class and poor folks than from the rich. Even assuming the Treasury gains access to a huge chunk of rich people's money, though, it is not nearly enough to fill the fiscal gap.

Generational Imbalance

No money is set aside for either Social Security or Medicare, with the exception of the trust fund ruse that both programs employ. Retirees add very little to the coffers that support them. When today's retirees were working, they did indeed pay for yesterday's retirees. The burden was far lighter on yesterday's workers however. There were fewer retirees per worker a generation ago, and their benefits were less. And yes, yesterday's workers paid more in than yesterday's retirees took out, but the rest of government spent the surplus. The only way to get it back is to raise taxes again.

How fair, just, and equitable is it to ask workers to pay for previous generations' retirements? To get off the merry-go-round at some point, people will save enough for themselves. To pay for retirees, too, they have to pay double.

The argument that it is fair to ask workers to pay for elders' retirements is certainly open to challenge. It is not the youngsters' fault that retirees fueled the greatest consumer boom the world has ever seen and failed to squirrel away enough for retirement.

On the other hand, without the massive subsidies, retirees as a group are so short of funds that they will see a meaningful reduction in living standards.

What's a taxpayer to do? What do YOU think we should do?

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