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Sequestration, deficit, debt? Our real problem is the future ‘fiscal gap’

child in t-shirt photo
To close the fiscal gap we must permanently increase
current and future tax revenue by 64 percent, cut non
-interest spending by 40 percent — or pass a
combination of tax increases and spending cuts in this
range.

Here’s a quick quiz: Which of these numbers is most relevant to arguments about the federal budget?

  1. $110 billion
  2. $1.4 trillion
  3. $16.7 trillion
  4. $211 trillion 


(a) is the amount by which federal government spending is being reduced annually over the next 10 years through sequestration, (b) is the federal government’s budget deficit in fiscal year 2012 and (c) is the current public debt of the United States. If you’ve followed the recent debates about sequestration, debt ceilings and fiscal cliffs, you’ve probably seen these figures lobbed by one side at another like hand grenades.

So what about (d)?

My guess is you haven’t seen that one, but according to Boston University economist Laurence Kotlikoff, it’s the most important number of them all.  The $211 trillion figure is the fiscal gap — the total amount we are committed to spend now and in the future under current law minus the total amount we are committed to collect now and in the future in net taxes.  (To be precise: The fiscal gap is the difference between the present value of current and future spending and the present value of current and future net taxes, where net taxes are the difference between taxes collected and transfer payments.)

Clashing generations

Kotlikoff sets out the case in his 2012 book, “The Clash of Generations.” In particular, to close the fiscal gap we must permanently increase current and future tax revenue by 64 percent, cut non-interest spending by 40 percent — or pass a combination of tax increases and spending cuts in this range. And the longer we wait, the greater the pain of tax increases and spending cuts will be.

How did this happen? Two sets of policies opened the fiscal gap. First, we successfully reduced old-age poverty through Social Security and, especially, Medicare. The chart below tells the story:

Poverty rates by age: 1959 to 2011 

poverty rates chart
Source: U.S. Census Bureau, Current Population Survey, 1960 to 2012 Annual Social and Economic Supplements.
Note: The data points are placed at the midpoints of the respective years.

Poverty rates for over-65 people fell by 50 percent from 1965 to 1975 and have remained below 15 percent since then. (By contrast, child poverty and working-age poverty fell until 1970, rose in the early 1980s, and have since fluctuated with the business cycle.)

Second, we fought the Cold War and the war on terror by devoting roughly two-thirds of all federal spending on goods and services to defense and homeland security. The Soviet threat disappeared between 1989 and 1991, but we are still fighting Al Qaeda.

You may not have noticed, but both of these policies were financed identically: by taxing current workers.

In the case of Social Security and Medicare, the taxes were transferred directly to retirees with the promise that when current workers retired, they would get transfers from younger workers. With regard to defense, we did not collect enough taxes to cover defense spending so the government borrowed what it needed on the financial markets and then serviced the debt by… taxing future workers.

Same policy, with one called “transfers” and the other called “borrowing.”

Built-in imbalance

The result is a system that has a built-in imbalance between what we have promised in terms of spending (both in defense and transfers) and taxes. A $211 trillion imbalance.

The arguments about sequestration, fiscal cliffs and the like won’t change this, nor will the budget proposals offered by the House, Senate or president. And Kotlikoff demonstrates that we cannot solve our problems by increasing economic growth, encouraging immigration or any of the other nostrums peddled by pundits from the right to the left. The simple fact remains that we have committed to spend more in the future than we have promised to tax ourselves.  

So where do we go from here? Kotlikoff has a series of proposals called “the purple plans.” (Get it?  Red and blue blend to make purple…) The gist of these plans is to encourage households and government to save more and consume less, and to target government transfers towards those who need them most.

I think there is a larger point to be drawn from the $211 trillion fiscal gap. The threats of old-age poverty and the Cold War have passed, yet we still have a fiscal policy fashioned to meet these enemies. We need to recognize new challenges, such as childhood poverty and threats from non-state actors, then formulate sustainable fiscal policies that will shrink the fiscal gap and meet our children’s needs. It’s the least we can do for them.

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Comments (7)

Oh...One more thing....

Excellent points, but you are overlooking one potentially signifcant part of this discussion: demographics.

When you take into account that we are living longer lives, this also has an impact on both tax revenues and government spending. The following chart from CDC illustrates changes over the decades:

http://www.cdc.gov/nchs/data/nvsr/nvsr61/nvsr61_03.pdf

Advances in medical technology and treatment have also increased lifespans, although "quality of life" arguments can (and do) come into play.

I don't know that the threats to old age poverty have passed

Particularly for people in their 90's but I do believe fighting wars without paying for them is a bad idea.

Excellent article that lay the issues out clearly.

Now my questions is would universal single payer health care help?

Note to hysterics, you can always buy more health care.

The largest portion of the

The largest portion of the gap is the result of medical spending--$130 trillion according to the "purple plans".

With the exception of the defense industry, no other industry has a larger governmental subsidy than the medical industry--in the near future, government will be paying for half of all medical expenditure. Vast amounts of the public money (taxes) flow into the medical industry.

In our own state we have an economy that has its largest private employers in the medical sector. While that may have worked well in the past when medical expenditure was regarded as a wholly good thing, and was affordable due to the excess money in the system, what will the economy do when we run up against the wall of "not enough money"?

It seems to me that a good that has moved out of the reach of personal (and even shared, like insurance) expenditure, it's days as a viable venture are close to being over. The model has to change.

Back To The Future

By no means would I breath easy that old age poverty is gone for good. That is an incredibly naive thing to suggest.

Corporate America has abandoned pensions and foisted the 401K system on us, and it does not work. Now we're told that we must cut Social Security retirement income. That saws two of the three legs off of the retirement income stool. The third, personal savings, isn't looking good in view of declining real wages.

My grand parents enjoyed, and my parents are enjoying, a dignified retirement. For my generation and the one behind us, it may be back to buying cat food on sale to feed ourselves.

The 1% need not worry.

a. $110 billion

While sequestration might reduce some spending, the thought that total government spending will drop by that much each year for the next ten years is absurd. The fiscal gap must be hard to figure since we have no apparent spending limit although we can reasonably estimate how much money will come in. Good article and to the point!

In 2001 there was talk of

In 2001 there was talk of budget surpluses that could be used to strengthen Social Security and Medicare. Taxes were cut instead ,with deficits the result.

Now Social Security and Medicare are on the chopping block. Looks like the conservatives won.

What?

Mr. Johnston,

"You may not have noticed, but both of these policies were financed identically: by taxing current workers."

This is more than a tad condescending, of course we noticed, we were there. We noticed the big giant deficit Reagan created and we understood why. We watched the "peace dividend" evaporate, and we heard the excuses. We saw the Bush tax cuts and we noticed the big giant recession that followed. Some of us even noticed a war or two that haven't been paid for.

This conversation cannot be coherent without a time frame, and you've given us none. When and over what period of time is this $211 trillion due?

These are all manufactured crises. We can easily cut defense spending by at least 25%, how many of our 14 aircraft carriers and 70 submarines did we deploy against Iraq and Afghanistan? If we raise the SS wage exemption from $109K to $150K our earned benefits are covered for the foreseeable future. If we really wanted to put icing on the cake we could extend medicare and medicaid to everyone and bring our health care costs and quality into line with our peers.

This "saving more" idea that Kotlikoff prescribes is exactly what has produced Japan's stagnation isn't it? People can't save if they're not earning enough, and if they save on small wages it decreases over-all spending and triggers a recession or stagnation. The problem isn't what people are are saving, its what people are earning. The mechanisms for saving have also collapsed. Traditional pensions were replaced by ponzi schemes, and then wages dropped. Meanwhile the people who captured 90% of the economic growth over the last 20 years (that wold the top 1%-5%) are paying less taxes than everyone else as a share of their income.

This is all just a fancy way of pretending that wealth disparity isn't the problem, government spending is the problem. When are economists going figure this out?