Laurence Kotlikoff: Fiscal Meltdown in Spitting Distance

Many problems are on the horizon for the government about their budget, with Medicare, Medicade and Social Security benefits expected to increase with the aging baby boomers.

Wednesday, 06 Apr 2011 08:16 AM
By Laurence Kotlikoff
MONEY NEWS

(Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning Inc., and author of “The Healthcare Fix.” The opinions expressed are his own.)

The two parties are having a heated debate over the Republican plan to slice $61 billion off Uncle Sam’s projected $3.6 trillion budget. If the Republicans get their way, the deficit will fall from 9.5 percent of gross domestic product to 9.1 percent. If they don’t, they’ll probably shut the government for a couple of days. Then they’ll compromise on, say, a $40 billion budget cut, having proved they gave it their best shot.

Arguing over lowering our deficit by just 0.4 percent of GDP when we need to run massive surpluses to deal with the baby boomers’ impending retirement is, pick your metaphor — rearranging the Titanic’s furniture, Nero’s fiddling, Custer’s Last Stand.

Is this malign fiscal neglect, or has Congress somehow missed what its own Congressional Budget Office is indicating? CBO’s baseline budget updates suggest the date for reaching what Carmen Reinhart, Kenneth Rogoff and other prominent economists believe is a critical insolvency threshold — a 90 percent ratio of federal debt held by the public to gross domestic product — has moved four years closer, in just nine months!

The CBO releases its realistic long-term forecast — the alternative fiscal scenario — every June. In between, it provides us with periodic updates of its unrealistic 10-year baseline scenario, based on “current law.” Congress, for political reasons, forces the agency to interpret current law in ways that generally make spending much lower and taxes much higher than is likely.

Take It Seriously

Consequently, no one should take the projected levels of spending and taxes in CBO’s baseline scenario seriously. But everyone should take very seriously updates to the baseline. Why? Because these changes give us a pretty good idea of how the next alternative fiscal scenario will differ from the previous one.

Last June’s analysis had us going critical (crossing the 90 percent debt-to-GDP threshold) in 2021. But back then the CBO assumed the Bush tax cuts wouldn’t be extended for the rich starting in 2011. In December, President Barack Obama dropped his demand to immediately raise taxes on the rich in exchange for a one-year cut in the payroll tax, which helps fund Social Security. So much for raising revenue at a time when we are borrowing 37 cents to cover each dollar of spending.

In January, the CBO modified its 10-year baseline forecast, taking into account the December deal. By my calculations, this meant the 90 percent threshold would be crossed in 2019.

What a Difference

A lot can change in a few weeks. In February, the president released his budget and, lo and behold, it proposes maintaining the Bush tax cuts for all except the rich not through 2013, as in the December deal, but indefinitely. In so doing, the president conveniently took the issue of tax increases off the next election’s table.

On March 18, when the CBO released a new forecast that incorporated the president’s budget, the 90 percent mark had moved up to 2017.

Actually, 2017 is optimistic. Uncle Sam’s creditors will soon start charging exorbitant interest rates — like those Greece, Ireland and Portugal now face. The market’s concern with those countries’ bonds is outright default, which is unlikely in the U.S. What is likely is rising inflation as the Federal Reserve continues to print vast quantities of money to help pay the Treasury’s bills.

I generally don’t give investment advice, but Bill Gross, co-founder of Pimco and manager of the world’s largest bond mutual fund, has it right. It’s time to your dump all but your very short-term U.S. Treasurys and other dollar-denominated bonds. A safer alternative is Treasury inflation protected securities, or TIPS.

Real Problem

To be clear, the real problem isn’t paying for our current spending. The real problem is paying for the 78 million baby boomers as they retire and claim their promised Medicare, Medicaid and Social Security benefits, and as spending on the new healthcare exchanges expands far beyond what’s been projected.

There is one bright spot. Paul Ryan, chairman of the House Budget Committee, has included a version of the Rivlin-Ryan Medicare plan in the Republican budget proposal. This bipartisan proposal, co-authored with Alice Rivlin, former CBO director and head of the Office of Management and Budget under Bill Clinton, would transform Medicare from its current fee-for-service, defined-benefit structure into a defined contribution system in which the government’s liability is strictly capped.

Rivlin-Ryan would be a huge step in the right direction, but what’s really needed is a complete redo that would keep total government healthcare spending where it is now, at about 10 percent of GDP.

Common Ground

To that end, I launched www.thepurplehealthplan.org last week to solicit endorsements for what I call the Purple Health Plan — a proposal that offers common ground to both Republicans and Democrats. To date, five Nobel laureates in economics, George Akerlof, Edmund Phelps, Thomas Schelling, Vernon Smith and William Sharpe, have signed on. So have other prominent economists.

If you’re a Democrat, don’t worry. This system is more or less what’s in place in Germany, Holland, Switzerland and Israel — hardly right-wing bastions. If you’re a Republican, don’t worry. This is a voucher system that’s fair to all and keeps government spending from exploding.

If you like the plan, please endorse it and share it with others. This includes the president and House Speaker John Boehner, who should take the Purple Health Plan and adopt it as their joint proposal.
© Copyright 2011 Bloomberg News. All rights reserved.

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