Spending Beyond Our Means: How We Are Bankrupting Future Generations
By Jagadeesh Gokhale
February 13, 2013
Executive Brief:
Current U.S. fiscal policy, including the recently concluded “fiscal cliff” debt deal, is placing an enormous financial burden on today’s children and on future generations in order to deliver government benefits to current middle-aged workers and their elders. Standard government accounting methods hide that intergenerational transfer from the public and make it difficult to calculate how large the transfer is. Intergenerational resource transfers will grow larger as the composition of budget receipts and expenditures changes with relatively faster growth of age- and gender-related social insurance programs. Intergenerational redistributions through federal government operations could substantially affect different generations’ economic expectations and choices and exert powerful long-term effects on economic outcomes.
This paper updates earlier calculations of generational accounts and fiscal and generational imbalance measures based on the Congressional Budget Office’s (CBO) March 2012 Budget Outlook Update. It finds that the fiscal imbalance embedded in the federal government’s current law (Baseline) policies amounts to 5.4 percent of the present value of future U.S. gross domestic product (GDP), or 11.7 percent of the present value of future payrolls. However, given past precedents, federal current-law policies are unlikely to be implemented.
The CBO’s “Alternative Fiscal Scenario,” which eliminates several current-law policies so as to be consistent with past congressional practice, would increase the fiscal imbalance to 9.0 percent of the present value of GDP, or 19.7 percent of the present value of payrolls. Generational accounting calculations show that under both Baseline and Alternative policies, today’s middle-aged workers would receive such large federal transfers by way of present-valued Social Security and Medicare benefits that their prospective lifetime net tax burdens are almost fully eliminated.
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Introduction
Official estimates of the financial effects of government policies and proposed policy changes typically only describe the effects of those policies over a short time frame, typically 10 years. Fully characterizing those policies requires a much longer time frame, to comprehend how they will affect citizens beyond the 10-year time horizon and to distinguish those effects for different generations. Such an exercise would fully reveal how those policies affect a nation’s long-term fiscal health, which generations of citizens are made “winners” and which are made “losers,” and whether the sum total of those effects is equitable.
Such analysis for major developed nations first began to appear more than two decades ago. It follows the theoretical work of Harvard economist Martin Feldstein and others, who pointed out that public pension and health programs, such as Social Security and Medicare, can cause substantial wealth redistributions across generations.1 Such redistributions occur because initial older generations receive windfall benefits from such programs without a history of having paid payroll taxes when working in the past. If the generosity of pension and health benefits is increased over time by increasing benefits and taxes concurrently—as has occurred in the U.S. Social Security and Medicare systems—subsequent retiree generations may also receive more in lifetime benefits than their lifetime payroll taxes. That is, the pecuniary returns from social insurance benefits could significantly exceed the average returns they would have received had they saved for retirement themselves and invested their savings in private capital markets in the absence of such programs.
The fiscal burden of excess benefits paid to such participants in public pension and health programs—so-called “legacy debt”— must be imposed on subsequent generations once taxing capacity peaks and especially if demographic shocks, such as fertility declines, reduce the size of the working cohort and erode the payroll tax base. Under such conditions, social benefits can no longer be paid as promised and future participants must acquiesce to smaller benefits from national social insurance systems relative to average market returns.
Intergenerational wealth redistributions are also implicit in other government programs through tax and spending policies targeting different population groups by age and gender. How large are such wealth redistributions? Constructing estimates to address this question is very difficult because it involves combining micro-data surveys with budget information to estimate cohortspecific lifetime taxes, transfers, and public benefits on an ongoing basis. However, a limited and partial sense of the magnitudes involved can be obtained via generational accounting metrics developed in the last two decades.2
Unfortunately, generational accounting studies—which had argued for complementing official cash-flow deficit and debt measures with generational accounts to indicate the government’s fiscal condition—were not successful in persuading policymakers to regularly report and consider intergenerational redistribution effects when deciding on new fiscal policies. Official deficits and debt metrics continue to be used as key indicators and guideposts for fiscal policymaking. Somewhat more successful was the offspring of generational accounting—measurements of fiscal and generational imbalances—in communicating the government’s aggregate debt: the sum of its explicit net liabilities plus its “implicit debt” on account of prospective taxes and expenditures under current budget policies and practices.3 At least these metrics are now regularly reported by Social Security and Medicare trustees in their annual reports to indicate how far from sustainability those programs’ finances are under their current tax and benefit policies.
Implicit debt is simply the government’s prospective revenue shortfall relative to the government’s expenditures on public goods and services, including the provision of public pension and health care benefits. If current tax and spending policies together with demographic trends, which are reasonably accurately predictable, imply a shortfall of future revenues, the size of that shortfall should inform current policymaking. Unfortunately, such metrics remain unreported by many agencies that are responsible for estimating the structural condition of the government’s current budget policies and practices.
The fiscal and generational imbalance and generational accounting studies also illuminate how standard short-term metrics of fiscal policy—national deficits and annual debt—are potentially misleading. For example, toward the end of the 1990s, official debt and deficit metrics suggested a much improved fiscal condition and induced U.S. policymakers to enact massive increases in public spending, tax cuts, and new payas- you-go financed entitlements such as the Medicare prescription drug program. Had policymakers based their decisions on broader fiscal and generational imbalance measures, they might have adopted more conservative fiscal policies.
This study presents updated estimates of fiscal and generational imbalances for the United States. It shows that the U.S. fiscal condition has deteriorated since the last set of updates published in 2006. The study also calculates generational accounts for the United States to show the fiscal burdens that current generations face. The calculations incorporate a quirk about current U.S. fiscal policies: Congress has adopted one set of fiscal policies on its books, but it appears to be following an Alternative set of policies in practice by amending current-law policies just as their implementation becomes imminent. The continual shift away from current-law policies is motivated by political pressure to avoid calamitous economic outcomes that are expected to follow the sharp spending cuts and tax increases built into current-law policies. This study calculates the “give-away” to current generations that such lawmaker behavior would imply.
The results indicate that the Alternative fiscal trajectory—for that matter, even the current-law trajectory—is far from sustainable. Those imbalances must be resolved at some future time through tax increases and/or spending reductions—precisely the policies that Congress is seeking to avoid in the short term. If they are not resolved, the same calamitous economic consequences are likely to occur in the future, probably with even greater intensity.
Public Policy Debates on the U.S. Budget: Caught in a Prisoner’s Dilemma
The CBO’s March 2012 federal budget projections for years 2013–224 show that
federal outlays on long-term entitlement programs such as Social Security, Medicare, Medicaid, and other long-term retirement and health programs such as federal civilian and military retirement and veterans benefit programs, already constitute 50 percent of projected gross federal outlays.5 Congressional Budget Office projections also show that these programs will take up 67 percent of the federal budget by the end of its 10-year budget window.6 And given that population aging will continue well beyond 2022, these
programs’ budget share is expected to grow even larger during coming decades.
The growth of social insurance programs that impose a distinct and stable pattern of retirement and other benefits, and the taxes levied to fund them by age and gender, means that the federal government’s ability to redirect resources across generations will grow much stronger over time. It is well known that the federal government redistributes income and wealth across economic classes— from high earners and the rich toward lowincome and poor groups. During coming decades, however, the federal overnment’s role in redistributing resources from working adults toward other generations, primarily toward retirees, will also grow larger.
Indeed, it could be argued that the chief reason for the government’s dire fiscal outlook is its inextricable involvement in intergenerational resource redistribution through programs such as Social Security, Medicare, and others. However, most of the oxygen in the public debate about the role of government in society is exhausted on the government’s role in redistributing resources intragenerationally—from economically well-off citizens toward others. Indeed, the intragenerational discussion provides the distraction that prevents all rational discussion about intergenerational accounting.
The underlying problem is a prisoner’s dilemma: if both major political parties could agree to a deal on entitlement reform—to effectively save and invest resources for the future needs of an aging population—and if both were able to faithfully sustain and execute it, the economic benefits to the public in terms of an equitable intergenerational allocation of resources and efficient economic incentives would be immense. But being distrustful of the other party, each believes that agreeing to such a deal would risk loss of political power: too many of their supporters might become disappointed, and the deal would be undercut when the opposing party gains power by squandering those savings on their current redistributive priorities. Yet failure to reach a deal before it’s too late increases the size of the fiscal imbalance and increases barriers to a deal, making an eventual calamitous economic outcome more likely. The fact that official budget agencies are refusing to report large outstanding implicit debt embedded in entitlement programs—debt that will eventually compel huge resource transfers from future to current generations—only allows the lopsided emphasis on classwarfare in public policy debates to fester.
CBO’s Federal Budget Projections
The federal government’s fiscal situation is dire. According to the CBO, this fiscal year’s difference between tax receipts and federal spending will be a gaping $1.2 trillion, or almost 8 percent of the nation’s GDP.7 The cumulative deficit under the CBO’s Baseline projection—wherein currently scheduled laws governing taxes and expenditures are assumed to be fully implemented—is projected at $2.9 trillion over 10 years (2013–22).
But the CBO’s 10-year Baseline projection is scarcely to be believed. Congress has consistently enacted exceptions to scheduled tax and spending laws in order to prevent economic harm to particular political interest groups (doctors, middle-class taxpayers, etc.) and will almost certainly do so again. Therefore the CBO also includes an “Alternative” scenario in its budget reports, one that suggests a 10-year cumulative deficit of $10.7 trillion.8
The expenditure cuts and tax hikes scheduled under the Baseline policy path would reduce future deficits by $7.8 trillion ($10.7 trillion minus $2.9 trillion) over the next 10 years compared to the Alternative policy path, where those changes are postponed until after 2022. Thus, if Congress continues its past practice of postponing the adoption of current-law fiscal policies, those of us alive during the next 10 years will enjoy a $7.8 trillion boost in public benefits—defense, retirement support, welfare payments, infrastructure construction, and so on—that we won’t pay for through higher net taxes. The extra public benefits we will enjoy will have to be paid for by future generations of taxpayers, either through smaller federal benefits or higher federal taxes.
The longer that Congress continues to allow the gap between federal taxes and benefits to persist, the larger it will grow as it accrues interest, at about 3.7 percent per year today as indicated by the interest rate on the government’s long-term securities. This means that we will consume $7.8 trillion of the nation’s income through extra government “benefits” that we will not “pay” for.9 The accumulated additional federal debt will then constitute a bill that will be presented to those alive after 2022—to ourselves, excluding those who die before 2022, and including
new entrants into the economic system such
as young workers and immigrants.
The Trouble with Standard Budget Accounting Metrics
Congress requires the CBO to report standard cash-flow deficit and debt measures, but these measures do not fully capture the federal government’s financial condition. Reported in billions and trillions of dollars, their implications at the individual taxpayer level are never communicated to the public. Cash-flow deficit and debt metrics, even when calculated over 10 years into the future as required by law (under the Congressional Budget and Impoundment Control Act of 1974), are essentially backward looking: they predominantly reflect the impact on the budget of past economic and budgetary outcomes. Policy changes, however, are always intended to alter future budget and economic outcomes, so it makes little sense to base those choices on backward-oriented metrics.10
Although it is standard practice to project budget outcomes 10 years into the future, doing so under today’s budget environment appears to be insufficient, especially for guiding future fiscal policy choices. The federal budget is much less flexible today compared to the 1970s, when Congress enacted the reporting requirements that are still in effect. As mandatory programs (entitlements) have increased in size relative to discretionary ones, the portion of the budget over which lawmakers exert direct control on an annual basis has shrunk considerably. Whereas policymakers can condition discretionary programs’ funding and expenditures on feasibility, needs, and preferences on a year-by-year basis, entitlement programs’ taxes and benefits are expected to treat many generations of participants fairly and equitably and, therefore, are expected to maintain their tax and benefit rules over long periods of time. Only minor and infrequent adjustments with long delays—often longer than 10 years—are usually deemed feasible. This allows affected populations to alter their expectations and adjust their private economic choices appropriately.
Another distinctive and relevant feature of social insurance programs is participation in them by individuals throughout their lifetimes—by paying taxes during their working years and receiving benefits when retired, and as survivors, dependents, disabled, or ill. The intergenerational “chain-letter” funding framework implies a constant renewal of federal obligations to successive young generations as their current payroll taxes extinguish benefit obligations to current retiree generations that were created earlier. Thus, although Congress has prescribed that financial projections looking 75 years ahead should be made for programs such as Social Security and Medicare, even this longer, but finite, horizon generates misleading results and could bias policymaking: Social Security’s total fiscal imbalance is severely underestimated even under a 75-year horizon because benefit obligations beyond 75 years—created under current laws by tax payments through the 75th year—remain uncounted.11 The full characterization of the program’s financial condition can be obtained only by calculating its fiscal imbalance in perpetuity.12
Thus, the “fiscal imbalance” metric—calculated in perpetuity and encompassing all government programs—consistently and fully reflects the implications of alternative policy choices and is well suited for evaluating the tradeoffs that they involve. These are choices that policymakers won’t be able to avoid, given the federal government’s worsening financial condition.13 And the “generational imbalance” metric—calculated for tax-transfer programs such as Social Security and Medicare, which cover participants’ entire lifetimes—reveals the intergenerational redistribution those programs bring about, providing important additional information about alternative policy tradeoffs.
Another shortcoming of 10-year debt and deficit measures is that no one knows ...
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