Laurence Kotlikoff’s latest article in the Federal Reserve
Bank of St. Louis Review has instigated a flurry of commentary
on the state of domestic policies. Kotlikoff poses the question,
“Is the United States Bankrupt?” Despite the colorful language with
which he describes the state of affairs, his answer is “no.” In
Kotlikoff’s view, the United States is not yet in bankruptcy, but
it’s headed that way.
Almost all of the ensuing media discussion of Kotlikoff’s
argument has failed to focus on his central point. The Wall
Street Journal recently provided a lot of mumbo-jumbo about
how our national “balance sheet” is healthy and national wealth
rising rapidly — a transparent effort to dispel any doubts that
the economy’s condition, and by implication Bush policy, is sound.
But, again, Dr. Kotlikoff’s thesis is about the economy’s future
condition, not its current one.
Kotlikoff’s claim is supported by several carefully calibrated
computer analyses that show how the promise to provide many
trillions of dollars to today’s citizens — of which $67 trillion
are unfunded — would spell disaster in years to come. Over the
next 20 years, 76 million people — fully one-fourth of the total
population — will transition into retirement, compounding the
problem dramatically.
Because we believe that the government would somehow secure our
retirements, we are saving and investing less of our earnings.
Personal saving, which has trended lower since the early 1980s,
recently entered negative territory. And the longer the government
maintains its unfunded benefit promises, the longer our
under-saving behavior is likely to persist.
The impact of public policies on private economic behavior could
result in a vicious downward spiral. Two dynamic and mutually
reinforcing forces are operating today: First, currently unfunded
federal obligations are accruing interest and growing larger over
time, making it more difficult to raise the resources to pay for
them. Second, the growth of worker productivity is declining and
will continue to decline as a result of lower prior saving and
capital formation. The pick-up in productivity since the mid-1990s
appears to be reversing its course: growth in U.S. output per hour
declined from 4.1 percent per year in 2002 to 2.3 percent in 2005.
If this slide persists, resources to pay for growing obligations
will have to be raised from a smaller future economic pie.
The outcome of these two forces would be higher future tax
rates, which would not only further dampen productivity, but also
reduce the amount worked — following the same pattern as Europe
since the 1980s. That implies progression toward reduced living
standards, if not national bankruptcy.
Scary as this outlook is, the reaction of some pundits is yet
scarier: Many have blithely dismissed the analysis as based on
unrealistic assumptions. The Wall Street Journal, for
example, suggests that Kotlikoff’s prognosis rests on the “false
assumption that the current level of [entitlement] benefits will
ever be paid.” That view, however, just replaces one false
assumption with another. If one-fourth of Americans join the ranks
of retirees, they would gain strong incentives to crush any attempt
at scaling back the growth of entitlements.
Nor can the traditional method of cutting federal obligations —
allowing inflation to do it for us — be employed in the case of
Social Security and Medicare entitlements. Social Security is
indexed to inflation and Medicare provides “in kind” benefits —
whereby the government pays cash not to retirees but to medical
providers for services rendered to retirees. With inflation-linked
defaults inoperative and explicit defaults politically infeasible,
the only — temporary and self-defeating — way to stave off
bankruptcy would be to increase taxes on workers. The simple lesson
here is that the longer we procrastinate in reforming entitlements
— under faint hopes that faster economic growth will solve our
fiscal problems — the larger future tax hikes will have to be.
There is a yet deeper point that many commentators appear to
miss: that well crafted, direct, and immediate fiscal adjustments
to curb the current overextension of entitlements would themselves
prove to be pro-growth policies. They would reduce the misdirection
of private resources into current consumption rather than saving
and investment.
Most observers appear to interpret the phrase “faster economic
growth” to mean growth at rates faster than today’s. Instead, they
should compare future growth rates under reformed entitlement
policies with those that would result if today’s policies were
maintained. As Kotlikoff shows, future growth would be much slower
unless we scale back promised benefits and establish a stable and
credible tax structure. These reforms are crucial to the continued
health of the economy.
