Wednesday, June 19, 2013

Why the Government Needs to Budget over the Infinite Horizon

From the NCPA’s daily policy digest.


Why the Government Needs to Budget over the Infinite Horizon

June 19, 2013

How far into the future should governments budget? Economic theory has a clear and rigid answer. But it's not one economists like to give, because it's not one people easily comprehend and it's not one that politicians, whose attention most economists covet, like to hear. The answer is that governments need to budget out to infinity, says Laurence Kotlikoff, a senior fellow with the National Center for Policy Analysis and economist at Boston University.

Infinity is a very long time. But economic theory also tells us that in budgeting out to infinity, we should place less weight on distant government expenditures and tax receipts. Specifically, we should include in our budgeting not actual future expenditures and taxes, but their present values.

  • Present value stands for the value right now, in the present. And the value right now of getting $1 in the future is smaller the longer you have to wait for it.
  • Take the just-released 2013 Trustees Report on Social Security's long-run finances. They claim an infinite horizon fiscal gap of $23.1 trillion separating the system's projected costs and taxes net of its trust fund.
  • This massive shortfall, which grew a whopping 8 percent last year, is 50 percent larger than U.S. gross domestic product and almost twice the federal debt held by the public.
  • Social Security began reporting its infinite horizon fiscal gap 2003. Back then it was $10.5 trillion. On an inflation-adjusted basis, the gap's risen 74 percent leaving the system in far worse shape than when the 1983 Greenspan Commission "fixed" it.

The Greenspan Commission, like the current Trustees, looked out only 75 years. In so doing, it ignored not just the 30 years between 2057 and 2087 now in the current 75-year window, but all the years after 2087, when today's and tomorrow's children will be alive.

  • For the U.S. government as a whole, the infinite horizon fiscal gap is a whopping $222 trillion.
  • Its elimination requires not a 32 percent immediate and permanent tax hike in Social Security FICA taxes or a 22 percent immediate and permanent cut in Social Security benefits, but either a 64 percent immediate and permanent tax hike in all federal taxes or a 40 percent immediate and permanent cut in all expenditures apart from servicing official debt.

So, Social Security's enormous fiscal problem is just a molehill in front of a mountain of horrendous obligations our politicians and their "trustees" are ignoring with their careful choice of words and their finite budgeting horizons.

Source: Laurence Kotlikoff, "Why the Government Needs to Budget over the Infinite Horizon," Yahoo! Finance, June 13, 2013.

1 comment:

WilliamLarsen said...

Infinity and beyond. It is my opinion that looking "infinity" years out is not necessary.

What the 75 year solvency period does is lump all revenues and all expenses within that 75 years. What it leaves out is all the present value benefits earned by those who will not turn 67/apply for benefits within that 75 year window, yet at the very same time count the revenue paid by these workers to offset expenses/benefits during the 75 year window.

It is my opinion that it really is very simple to calculate the present value liabilities of OASI by looking solely at everyone who is age 18 and over. We can split them into groups (retired/workers) if you want.

Each cohort has a set number of workers and beneficiaries.

For those who are not working, they have no future benefit. For this group all that is needed is a new trust fund that simply is paid into for 51 yeas by those under 16. This fund would not pay a single benefit to anyone now under 16 for 51 years.

In 51 years, at 6.5% payroll tax, this group of people would enjoy a fully funded SS-OASI program without any of the liabilities of the current program.

So what is the present current liability of all workers and beneficiaries over age 16? Some may call it the infinite horizon liability, but the fact is we will all die within a set period of time. Therefore, the infinite time horizon is less than infinity and closer to 100 years.

What the infinite time horizon does is never address the legacy cost of starting Social Security. Until the legacy cost is addressed and paid for, we will see an infinite increase in the liability due to the time value of money over an infinite time period.

The infinite time horizon simply puts off dealing with the root cause.

As I have said many times; when a ponzi scheme implodes, it does so with great harm. However, unlike private ponzi schemes that naturally run out of funds or the ability to con new investors, Social Security is propped up by legislation, allowing it to continue and grow far larger than normal.