FOR IMMEDIATE RELEASE: July 31, 2003Many appreciate that the federal government's finances are shaky, but few realize how truly bad they are. Traditional accounting measures, such as debt and deficits, do not reveal the dire fiscal problems posed by Medicare and Social Security, argue Jagadeesh Gokhale, a senior economic adviser to the Federal Reserve Bank of Cleveland, and Kent Smetters, a former deputy assistant secretary for economic policy at the U.S. Department of the Treasury, in their new study, Fiscal and Generational Imbalances: New Budget Measures for New Budget Priorities (AEI Press, July 2003).
Current federal accounting practices tend to be retrospective--looking back to track accumulated debt--or only moderately forward-looking, projecting debt that will be incurred in some, but not all, future years. We know, for instance, that the government had at the start of this fiscal year accumulated about $3.5 trillion in debt held by the public. We should be asking, however, not how much money the federal government must come up with immediately to pay off outstanding debt but rather how much is needed now to place federal fiscal policies on a sustainable path. The answer--which Gokhale and Smetters term the government's "Fiscal Imbalance"--is a heart-stopping $44.2 trillion as of the start of the current fiscal year. The vast majority of this imbalance, just under $37 trillion, is due to Medicare; Social Security contributes another $7 trillion. In other words, although many people are concerned about the level of today's national debt, which reflects past overspending, the level of future overspending--mostly on entitlement programs--is projected to be more than ten times as large. Moreover, for each year that the federal government ignores this problem, the Fiscal Imbalance grows by about $1.6 trillion or by about four times this year's official deficit.
Because the government does not have an extra $44.2 trillion on hand today, it must raise an equivalent sum in present value by dramatically increasing taxes or drastically reducing spending in future years. For example, eliminating this Fiscal Imbalance could be accomplished by increasing payroll taxes by 16.6 percentage points immediately and forever, more than double the current payroll taxes on both employees and employers. Alternatively, income taxes could be hiked by two-thirds immediately and forever. Yet another alternative would be to cut Social Security and Medicare benefits by 45 percent immediately and forever. Even if all future federal discretionary spending (such as national and homeland defense, roads, bridges, transportation, education, and the administration of justice) were eliminated, we would still be left with a $1.8 trillion imbalance. Any of these options would have drastically negative economic consequences, and even larger changes would be required if they were not enacted immediately. In other words, the federal government's main entitlement programs need fundamental reforms; modest piecemeal reforms, as done in the past, will not do.
Why do we not see any movement toward real entitlement reform? Gokhale and Smetters argue that traditional budget measures not only significantly understate the government's financial shortfall, they bias policy against fundamental reforms. Some policies that could reduce the government's Fiscal Imbalance appear unattractive because they cause larger deficits in the near term. For example, using personal accounts to replace some of Social Security's future benefit payments would produce larger deficits in the short term. But such a reform would also decrease longer-term obligations, potentially by more in present value than the increase in short-term deficits. Under the government's current budget accounting, however, only the short-term costs would be reported, while the long-term gains would remain hidden.
At some point, the government must take action in order to place the nation's fiscal policies on a sustainable path. To help policymakers allocate the burden of future policy adjustments among different generations the authors propose using a "Generational Imbalance" measure. This measure helps distinguish between the contributions to the Fiscal Imbalance that are caused by past and living generations versus those caused by future generations. The Generational Imbalance would, for example, help remove the incentive for policymakers to try to eliminate the Fiscal Imbalance by simply proposing large increases in taxes or large benefit cuts on distant future generations.
Together, the Fiscal and Generational Imbalance measures can help lawmakers design reforms that are best suited to meet the retirement and health security challenges that face our nation today.
About the Authors
Jagadeesh Gokhale, a consultant to the U.S. Department of the Treasury from July to December 2002, is currently a visiting scholar at AEI and a senior economic adviser at the Federal Reserve Bank of Cleveland.
Kent Smetters was deputy assistant secretary for economic policy at the U.S. Department of the Treasury from 2001 to 2002 and a consultant to Treasury from August 2002 to February 2003. He is currently an assistant professor at the Wharton School, University of Pennsylvania.
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