Deficit Accounting is a Generational Ponzi Scheme
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By Laurence Kotlikoff,
The Fiscal Times
November 8, 2011

Our county is in far worse fiscal shape than our politicians are disclosing. Our official debt in the hands of the public is huge, totaling 70 percent of GDP. But our official debt leaves out most of our nation’s liabilities.

These unofficial debts refer to our future mandatory and non-mandatory spending obligations. Mandatory spending references Social Security, Medicare, Medicaid and other entitlement benefits. Non-mandatory spending includes defense expenditures, civil servants' salaries, highway and other infrastructure costs, and government-sponsored research.

Of course, the government can also count on future taxes to help pay these bills. The difference between our government's total liabilities -- its official debt plus unofficial debt (measured in present value) -- less its official assets plus its unofficial assets (the present value of projected future taxes) -- is call the fiscal gap.

The fiscal gap tells us whether our government's long-term finances are in balance -- whether its assets can cover its liabilities. Unfortunately, the answer is no. In fact, our country's fiscal gap, calculated based on the Congressional Budget Office's June 22, 2011 long-term forecast (known as the Alternative Fiscal Scenario) is simply enormous. It's $211 trillion or 14 times GDP!

The fiscal gap is our nation's credit card bill. If we don't pay it or at least interest on it, it will get bigger. And it is getting bigger. It rose by $6 trillion between this year and last. Closing the fiscal gap by raising taxes alone requires an immediate and permanent 64 percent increase in the personal income tax, the corporate income tax, the FICA payroll tax, the estate and gift tax, and all federal excise taxes. Closing the fiscal gap by cutting spending, other than interest on official debt, requires an immediate and permanent 40 percent cut in all mandatory and non-mandatory expenditures.

Measured relative to GDP, the U.S. may actually have the largest fiscal gap of any developed country. By comparison, Greece's fiscal gap is about 12 times GDP, and Germany's is about 3 times GDP. This is true notwithstanding our more favorable demographics.

Why is our real fiscal gap so large? About 60 percent of the gap reflects faster projected future growth in federal healthcare spending than is projected for GDP. The CBO projects spending on Medicare, Medicaid, Child Health and Infant Protection, and the new Health Exchanges to rise over the next seventy-five years, from 5.6 to 19.4 percent of GDP. Hence, one painless way to cut the fiscal gap is to keep federal healthcare spending even with the size of the economy.

Why hasn't the fiscal gap shown up in the official debt figures? Our politicians have been very careful to keep most of the promises they've made us off the books. They've done this by taking "taxes" from young workers and promising them large benefits in retirement in return. Had they called the monies so taken "borrowing," our official debt would be vastly larger than is now reported, an estimated $211 trillion. Yes, trillion

In economics, the debt is also a figment of
language rather than a fundamental concept
.

Unfortunately, nothing in economics pins down how the government should label its receipts and payments. This is called the economics labeling problem. As in physics, where time, distance, and mass all depend on the frame of reference or language of the observer, in economics, the debt is also a figment of language rather than a fundamental concept. The infinite horizon fiscal gap, in contrast, is a fundamental concept. It's size is invariant to the government's fiscal labeling conventions.

All Ponzi schemes rely on fraudulent accounting, and postwar generational policy is a Ponzi scheme, plain and simple. This is not to deny the enormous benefits provided to those on the receiving end of the scheme, many of whom are highly deserving and would otherwise have languished in poverty with little or no healthcare.

How we treat our first, second, third, and
future borns -- is the moral question of our day.

Unfortunately, we are now reaching the end of the chain letter with too few young workers earning far too little to buy into our politicians' unaffordable promises. Whether or not you prefer my proposed means to eliminate the fiscal gap, one thing is clear. We can't leave a $211 trillion bill to our children, grandchildren, and future descendants. The bill is simply far too large for them to handle. And how we respond to this crisis -- how we treat our first, second, third, and future borns -- is the moral question of our day.

How we got here is instructive. But where we go from here is critical. Congress and the White House are now engaged in a highly publicized effort to achieve budgetary savings of $1.2 trillion over the next ten years, while the fiscal gap just rose by $6 trillion in a single year! They are getting away with their fiscal child abuse by measuring our fiscal challenges based on economically meaningless official debt figures rather than the fiscal gap. The fiscal gap has its own challenges, relying as it does on projections far into the future. But it is the only measure of a nation's solvency that is free of the labeling problem and, thus, the only reasonable guide to the actual fiscal policy we are conducting.

To move away from fraudulent federal bookkeeping and force politicians to focus on the fundamentals of our generational policy, I’m asking readers to endorse the Purple Generational Balance plan. Purple is the combination of red and blue, and both red Republicans and blue Democrats have an equal stake in and responsibility toward our American's children. The Purple Generational Balance plan calls not for meaningless budget balance. It calls for a) fiscal gap accounting, b) generational accounting, which shows how both current policy and proposed policy changes are impacting and will impact current and future generations, and c) the adoption of policies that achieve generational balance, which requires that each cohort pay, over its adult lifetime, the same share of its lifetime labor income in taxes net of transfer payments received.

No one can get blood from a stone, and no economy can tax its young more than 100 percent of what they earn. We are not there yet, but we are heading in that direction. Hence, achieving generational balance is not only a moral imperative. It's a matter of economic survival.

In addition to his current work on generational accounting, Lawrence Kotlikoff,  professor of economics at Boston University, has developed “Purple Plans” on taxes and healthcare.