| Gary D. Halbert President & CEO |
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FEDERAL DEBT EXPLODING - CRISIS, OR NO PROBLEM?
Introduction
In the last few months, we have seen one new study (however dubious) that
shows the government’s unfunded liabilities, mainly Social Security and
Medicare, are a staggering $44 trillion dollars, when in reality it
may be only around one-third of that amount, or around $16 trillion
. Just for comparison, the national economy (GDP) is apprx. $11 trillion.
In the same time, we have seen another very technical study that shows the
US government may be the beneficiary of a $12+ trillion tax windfall
in the next 35-40 years as Baby Boomers retire and pay taxes on their
retirement account withdrawals.
As usual, there is some misinformation in certain of these latest reports;
there are some bogus assumptions being made; and of course, the issues are
being spun in both directions – good and bad – depending on whose agenda
they best serve. In this E-Letter, we look at both sides of these latest
revelations.
A Dozen Trillion Here, A Dozen Trillion There…
Last month, we got to see the results of a major study commissioned last
year by then Treasury Secretary Paul O’Neil regarding the “real” size of the
government’s unfounded liabilities. The startling study
concluded that the “present value” of the USgovernment’s future obligations
was a cool $44 Trillion in the red! Yes, that’s $44 Trillion, with a
“T.”
For a few days, the study was widely reported in the media. Just to cite
one example, the Boston Globe carried an op-ed piece regarding the
eye-popping federal debt. The op-ed authors, Laurence Kotlikoff
and Jeffrey Sachs lamented about how President Bush was pushing for
tax cuts even while the government was going broke, somewhat reminiscent of
Nero playing his fiddle while Rome burned. They wailed:
“Our government is going broke. The Feds face bills that are far beyond
our capacity to pay – by $44 trillion to be precise. The longer we ignore
them, the bigger they get. Yet President Bush is working overtime to deepen
our fiscal trap.”
Not to be outdone, the Financial Times of Londonran a story on May 29
th discussing the same study. However, the FT had to up
the ante a bit by saying that the White House had suppressed the report
by not including it in the FY 2004 Federal Budget. Scandalous!!
Articles started to appear on the Internet which implied that this was
the reason O’Neil was fired by the Bush administration and replaced at
Treasury.
The most humorous to me were the ones that blamed the entire $44 trillion
shortfall on Bush’s policies – especially the most recent tax cut. The
recently enacted $350 billion tax cut, by the way, is just 0.8% of
the $44 trillion shortfall predicted in the report. The budget shortfall
consists almost entirely of Medicare ($36.6 trillion) and Social Security
($7.0 trillion), plus accumulated deficits.
(I know what you're thinking - that the current national debt of over $5
trillion does not appear to be represented in the $44 trillion shortfall.
Actually, it is. The study projects that the remainder of the federal
budget (defense and everything else the federal government does) is
projected to run a surplus in the future, offsetting all but $500 billion of
the existing national debt. Again, this is based on numbers calculated out
to eternity, plus some rosy assumptions, so take them for what they are
worth.)
You would think that a story about a $44 trillion cover-up would be
front-page news every day for months on-end. The Democrats and liberal
media would love to bludgeon Bush with such terrible news. However, few
mainstream media sources, newspapers and other sources have followed up on
the story and, other than various places on the Internet, the story has
almost completed faded from view.
So, we have to ask ourselves what happened to this story, and what is the
real truth behind the $44 trillion number? Here’s the real story.
Uncovering The Cover-Up
First, let’s debunk the cover-up theory. The purpose of the report
commissioned by the Treasury Department was to help policymakers evaluate
significant changes that need to be made in the Social Security and Medicare
programs. Therefore, it was not something that would be all that relevant
to the 2004 budget, even though parts of the study did appear in a section
of the budget and in the “Financial Report of the United States Government”
issued in March.
In addition, one of the study’s authors discussed its contents at length in
Congressional testimony on March 6th. On May 9th , the supposedly
suppressed report was the subject of a conference at the American Enterprise
Institute, and was posted on its website. After that came the May 19th
op-ed piece in the Boston Globe. If the Bush Administration was trying to
cover the report up, they weren’t doing a very good job of it.
The final death-knell of the cover-up theory came about when the
Financial Times interviewed the authors of the report and they denied
that it had been suppressed. Once these facts became known, the press lost
interest and that’s why you haven’t seen it again. However, I didn’t see
op-ed pieces by the likes of Kotlikoff and Sachs setting the record
straight, but maybe that’s a bit too much to hope for.
What About That $44 Trillion?
Even if we dispense with a cover-up, there’s still the matter of a report
out there that says the US is $44 trillion in the hole on a present-value
basis. It turns out that this is a bogus number, at least as far as
I, and many other more qualified sources, are concerned.
As mentioned above, the Treasury Department commissioned the study to help
policymakers evaluate various scenarios when considering changes to Social
Security and Medicare. As you know, one of the Bush Administration’s
[stated] big plans is to privatize part of Social Security and allow
taxpayers to invest it themselves.
In many governmental reports, Social Security and Medicare expenditures
are projected out over the next 75 years. Just imagine how difficult it
is to project all of the factors that will affect Social Security funding
for 75 years. That’s 75 years’ worth of changing inflation rates, interest
rates, life expectancies, health issues, health-care costs, etc. – just to
name a few.
However, when privatization was factored in, it showed to be very expensive
over a 75-year time window because the full benefit of privatization would
not be realized until toward the end of that period. Therefore, the
Treasury-commissioned study pushed out the timeframe for projections to
ETERNITY. Come on, who can predict 75 years, much less eternity?
The Report Turns Out to Be… A Joke, More Or Less
The report is flawed for several good reasons. First, the accuracy of
projected values 75 years into the future is questionable at best.
Projecting out in perpetuity (forever?) is simply impossible. Next, a very
small adjustment in the projected interest rates or inflation rates could
produce a huge present-value effect due to the power of compounding. A
one-half percent difference in inflation or interest rates could make a
difference of trillions of dollars.
Finally, the report seems to imply that, if the government had the extra $44
trillion today, it would invest it wisely for the future and not spend it on
pork-barrel projects or tax cuts. To me, this is the biggest flaw
of all – assuming that politicians will act responsibly when considering the
effects of their actions on future generations. And who knows if the
public would want the government running huge surpluses. In any event, had
politicians acted responsibly in the past, we wouldn’t have the problems
with Social Security and Medicare that we do today.
Most importantly, the report shows that 2/3 of the $44 trillion comes
about AFTER the 75-year time window usually used for Social Security
analysis. Recent estimates peg the shortfall at the end of 75
years at only $16 trillion vs. the $44 trillion over perpetuity.
You may be thinking… $16 trillion or $44 trillion… who cares? It still
spells a financial disaster. Actually, this is exactly what I have thought
for many years. But there is some very good news on the horizon, or at
least some potentially very good news for the long-term.
As I will discuss below, this $16 trillion shortfall may be substantially
offset (or even more than offset) by an under-estimated stream of future tax
revenue.
The $12+ Trillion Tax Windfall
A hot new working document is making the rounds in Washington circles and
elsewhere that has politicians licking their chops! In short, the new
research study concludes that there will be a huge tax windfall of $12
trillion or more between now and 2040, resulting from taxes that will be
paid on money coming out of retirement accounts during that period.
As you know, if you have money in a retirement account (IRA, 401(k), pension
plan, etc., etc. – anything but a Roth IRA), you will have to pay taxes on
that money whenever you take it out. While government number-crunchers
factor these retirement tax revenues into their annual budget projections,
apparently no one has forecasted the effects of these tax revenues over the
next 35-40 years – generally the same time as the worst of the Social
Security and Medicare crisis is expected to occur. Well, now someone has.
Hoover Institution economist, Michael Boskin, has just released a
preliminary 131-page research study which estimates that the taxation of
pension assets, including IRAs, 401(k)s and all other retirement plans
(except the Roth IRA) will yield a $12 trillion (in today's dollars)
windfall to the federal government between now and 2040. And
maybe even more.
Not surprisingly, this new study has already caused some politicians to
declare that the gloom-and-doom predictions over the nation’s dangerous
financial imbalance (Social Security, Medicare, etc.) have been greatly
overstated for years. And they might be correct, but the devil is in the
details, as always. You can expect to hear much more about this in the days
and weeks ahead. So, let me outline the details in advance.
The Social Security & Medicare Crisis
On Social Security, you know the issue. The huge crunch of Baby Boomers
will be retiring somewhere around 2010-2030, and this we have been told for
years will bankrupt Social Security. Social Security is called the
“Third Rail” of politics – touch it and you die – and so
politicians avoid Social Security reform like the plague.
The other “Third Rail” is Medicare. Here you know the
issue as well. We are all living longer; new medical technologies and new
drugs are helping us all do that; but medical costs are going through the
roof, irrespective of other trends in inflation. No end is in sight, nor
arguably should there be, when it comes to living longer.
The crisis we are continually warned about is that as the Baby Boomers
retire, they will not only bankrupt Social Security, but they will also
create a crisis in the health care industry and Medicare. To hear the
gloom-and-doomers talk, this will result in the greatest depression in the
history of the world. And, we’re just over a decade away before its
supposed arrival.
Honestly, this is what I have believed for years. Yet as usual, things may
not be as dire as they seem. Let’s take a fresh look at the problem, based
on Boskin’s new study.
The Retirement Tax Windfall
According to the Federal Reserve, there is currently apprx. $11 trillion
in the various retirement plans around America (IRAs, 401(k)s, pension plans,
federal, state and local retirement funds, etc). If Americans had to pay
taxes TODAY on all the money in their retirement plans ($11 trillion), that
would generate apprx. $3 trillion in tax revenues based on current
tax laws. But because these taxes will be paid over the next 35-40 years,
the number will be much higher.
In addition, we have to consider that Americans will continue to contribute
more and more money to their retirement plans over the years ahead. And we
have to consider that these assets contributed to retirement plans will
continue to compound and grow over the next 35-40 years and longer, even as
the supposed Social Security/Medicare crisis unfolds.
The bottom line is, Boskin’s study concludes that the aggregate taxes on the
nation’s retirement plans will total at least $12 trillion between now and
2040. And it could be substantially higher depending on several variables.
If Boskin is accurate, the Social Security/Medicare crisis could be vastly
overstated!
Conclusions
The study showing that federal unfounded liabilities are $44 trillion was
ridiculous, in that it seemed to try to predict events in perpetuity, which
we all know is impossible. Boskin’s study on the federal tax revenues from
retirement account assets is far more believable, as it is based on the
here-and-now (known assets) and some reasonable projections (stock market
trends aside) on the growth of those assets over the next 35-40 years.
For many years I have believed, and I have warned about, a major financial
upheaval that would arrive in 2015-2020 or so due to the Social
Security/Medicare crisis. Not one to be a gloom-and-doomer, I have written
that I would not be surprised if this coming crisis threw the US into
another major depression. Now, I am not so sure. There may be
a solution.
Boskin’s revealing study will be debated, analyzed, and sliced-and-diced by
many in the weeks and months ahead. We will hear more about it (although
not by the Democrats who will view it as an advantage for Bush). I will
have more to say about it in future issues. Yet even though his tax
windfall numbers are sure to be revised (up or down), I wanted to share this
information with you now, because the federal debt and Social
Security/Medicare issues are something I have always been very concerned
about.
This is potentially very good news, but there is also a dire warning. I
hate to even bring it up, but I have to. If Boskin’s study becomes
widely accepted, can you imagine what the politicians (all of them) could do
with it? Would it be another prescription for even more massive government
deficit spending? Could they spend all of the projected 35-40 year windfall
over the next decade or so? You bet they could! After all,
they are about to pass a $400 billion prescription drug bill which will
affect not only the current deficit (est. $400 billion) and deficits far
into the future.
We’ll have to see how this plays out. I just wanted you to know about it,
since it is not getting much play in the press – YET. It will as soon as
both sides figure out what it means. Let’s hope it doesn’t result in a
“blank check” for our politicians.
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