Is the US already bankrupt?

[August1991]

The United States is heading for bankruptcy, according to an extraordinary paper published by one of the key members of the country's central bank.

A ballooning budget deficit and a pensions and welfare timebomb could send the economic superpower into insolvency, according to research by Professor Laurence Kotlikoff for the Federal Reserve Bank of St Louis, a leading constituent of the US Federal Reserve.

Daily Telegraph

Kotlikoff is a professor of economics at Boston University and sits on the board of the St. Louis Fed. (I somehow doubt that he could be characterized as one of its key members.) The Daily Telegraph seems to have gotten this from Kotlikoff's Feb 2006 paper:

The United States is essentially bankrupt and requires critical and immediate fiscal surgery thanks to decades of fiscal profligacy and the impending retirement of the baby boom generation. According to the latest projections of two of the nation’s finest economists, Jagadeesh Gokhale and Kent Smetter, the difference between the federal government’s present value of projected expenditures and the present value of projected receipts is $63.3 trillion. This fiscal gap is 8.2 percent of the present value of GDP, meaning that we need to devote that share of GDP every year for eternity to cover the shortfall.

Since federal personal and corporate income taxes represent 9.8 percent of GDP, one way to close the gap would be to immediately and permanently raise those taxes by roughly 84 percent (8.2 divided by 9.8). Advocating this hike is a political non starter. Enacting it could well be economically ruinous. Yet, doing nothing, and leaving this bill for our children and grandchildren to pay is neither feasible nor moral.

Link

Given the recent growth in US GDP, these scare tactics seem misplaced. And I always ignore any claims about "leaving bills for our grandchildren". (Unless someone has invented a time machine, it is impossible to borrow from the future. OTOH, we can leave the future a polluted, uninhabitable planet but that's another issue.)

Without going into the details of the Gokhale & Smetter paper, suffice to say that attempts to discount to the present the future value of government liabilities is fraught with danger to the point of absurdity. (Indeed, the projected bankruptcy of the US government turns critically on future medicare liabilities.)

OTOH, Kotlikoff's main point - once he's gotten people's attention - is an interesting discussion about how the US federal government must and could implement tax reform. For example:

The specific plan is to replace the personal income tax, the corporate income tax, the payroll (FICA) tax, and the estate and gift tax with a federal retail sales tax plus a rebate.

The rebate would be paid monthly to households, be based on the household’s demographic composition, and equal the sales taxes paid, on average, by the federal poverty line with the same demographics.

This would mean the US federal government would institute a GST but do away with existing federal taxes. (In the Canadian context, Kotlikoff proposal would mean raising the GST to about 22% and then abolishing the federal income tax.) Kotlikoff's GST rebate would be universal and would almost amount to a negative income tax since it would be the same for all. (My guesstimate of a Canadian 22% GST is a lowball. Kotlikoff has a US GST at 33% which would cover rebate costs and a larger tax take.)

I have to say that the proposal makes alot of sense. Unfortunately, VATs are exceptionally unpopular and politicians who introduce them usually become pariahs. No candidate in 2008 is going to propose this. Only a president not facing re-election would enact it, assuming Congress would ever go along.

IOW, economists must learn how to design tax systems taking into account the political system in which they would be enacted. Otherwise, it's a debate about the sex of angels.

Kotlikoff also has suggestions about social security and health care reform. His social security proposal is interesting and even contains a viable transition process but it misses the critical issue of who will have control over investment decisions. (Kotlikoff proposes an identical global equity index fund for all.) As to his proposal about medicare, speaking as a Canadian, all I can say is that Kotlikoff is very naive.

It's interesting that on these three proposals, Canada is well ahead of the US in its understanding of the associated problems. We have experience with a federal sales tax, we have understand well the problems of State-organized health insurance and we know about political interference in State-pension investment decisions.

----

So then, is the US bankrupt? Well, if you discounted to the present the various promises I've made to people, and then discounted to the present predictions of my future revenue streams, and then ignored that I have the power to change my promises (and my revenues) at will, then you might conclude I'm bankrupt.

IOW, the US government is not bankrupt because the US government can change at democratic will its obligations and its revenues. The government is simply not like you or me

[jdobbin]

It makes you wonder about the GST reductiion by the Conservatives. While popular, it is no replacement for income tax cuts.

[Jerry J. Fortin]

The Conservatives are fiscal morons but political spin masters. They are using the Liberal budget and fudging numbers to shift funding requirements and allocations. Wait and see what their numbers look like in spring with a new budget. They are currently spending more than the Liberals did and taking a reduction in revenue, how long can a surplus exist in that kund of economic environment? There is no doubt in my mind that we are looking at a tax cut in the next budget, but it will not work here the way it has in the states because we don't have the economic volume thaty they have and growth projections are not high enough to pay for the lost revenue. Don't forget the nanny state has a lot more social expenditures than our southern brothers.

That being said, I have been an advocate of income tax elimination for years and using a sales or transaction tax as a replacement. Hell you can drop off thousands of tax related clerical jobs, not just in government but private industry as well. But that won't work in Canada, it might in Alberta because we have a smaller population and a greater per capita rate of production along with our constantly expanding oil patch.

[geoffrey]

Jerry, Alberta was wise and didn't jump on the consumption tax bandwagon. We are solely taxed through income and it's very effective (I love the flat rate).

As well, there was a massive surplus last year, and it's going to be even bigger this year with Alberta's oil moola flowing to Ottawa. The CPC has plenty of play to stay in the black.

[ceemes]

Jerry, Alberta was wise and didn't jump on the consumption tax bandwagon. We are solely taxed through income and it's very effective (I love the flat rate).

As well, there was a massive surplus last year, and it's going to be even bigger this year with Alberta's oil moola flowing to Ottawa. The CPC has plenty of play to stay in the black.

Actually that is not entirely true. There is VAT in Alberta, but it is hidden and built into the costs of goods and services sold. I've recently returned to BC after spending a few months in Alberta servicing a contract. The costs of most goods in Alberta are equal to or even higher then those same goods in BC. My professional field is that of Transport Logistics and I can tell you honestly that the costs of bringing goods into Alberta, either via road or rail especially from the US or other parts of Canada is not all that much higher then it is to bring them into BC. In some cases, it is actually cheaper to bring goods into Alberta then into BC.

Another Albertan myth is that you take home more of your pay cheque, again after comparing my BC take home pay and Alberta take home pay, I found no meaningful differance. Both Provincial Governments hand their hands in my pockets for almost the same amount of coin per dollar. And giving the cost of living in Alberta, where a tiny one bedroom apartment in Calgary with hot and cold running cockroach's (if you even find a vacancy that is) will set you back $900 per month, Alberta is no bargin. Yes you can earn $15 an hour at the local Timmies, but you need to earn at least $20 just to keep a roof over your head and food on the table.

As for Alberta's oil moola going to Ottawa, I remember a time not all that long ago when Alberta had its hands in the Federal pocket pleading poverty and need. Now that the price of oil has reached almost obscene heights, Albertans are bemoaning the fact they now have to contribute to the rest of Canada. Funny how that works. If oil suddenly drops below $20 a barrel ($20 a barrel is the break even point for tar sands extraction), Alberta will once again become a have not Province, begging Ottawa for a handout or two.

[ceemes]

The United States is heading for bankruptcy, according to an extraordinary paper published by one of the key members of the country's central bank.

A ballooning budget deficit and a pensions and welfare timebomb could send the economic superpower into insolvency, according to research by Professor Laurence Kotlikoff for the Federal Reserve Bank of St Louis, a leading constituent of the US Federal Reserve.

Daily Telegraph

Kotlikoff is a professor of economics at Boston University and sits on the board of the St. Louis Fed. (I somehow doubt that he could be characterized as one of its key members.) The Daily Telegraph seems to have gotten this from Kotlikoff's Feb 2006 paper:

The United States is essentially bankrupt and requires critical and immediate fiscal surgery thanks to decades of fiscal profligacy and the impending retirement of the baby boom generation. According to the latest projections of two of the nation’s finest economists, Jagadeesh Gokhale and Kent Smetter, the difference between the federal government’s present value of projected expenditures and the present value of projected receipts is $63.3 trillion. This fiscal gap is 8.2 percent of the present value of GDP, meaning that we need to devote that share of GDP every year for eternity to cover the shortfall.

Since federal personal and corporate income taxes represent 9.8 percent of GDP, one way to close the gap would be to immediately and permanently raise those taxes by roughly 84 percent (8.2 divided by 9.8). Advocating this hike is a political non starter. Enacting it could well be economically ruinous. Yet, doing nothing, and leaving this bill for our children and grandchildren to pay is neither feasible nor moral.

Link

Given the recent growth in US GDP, these scare tactics seem misplaced. And I always ignore any claims about "leaving bills for our grandchildren". (Unless someone has invented a time machine, it is impossible to borrow from the future. OTOH, we can leave the future a polluted, uninhabitable planet but that's another issue.)

Without going into the details of the Gokhale & Smetter paper, suffice to say that attempts to discount to the present the future value of government liabilities is fraught with danger to the point of absurdity. (Indeed, the projected bankruptcy of the US government turns critically on future medicare liabilities.)

OTOH, Kotlikoff's main point - once he's gotten people's attention - is an interesting discussion about how the US federal government must and could implement tax reform. For example:

The specific plan is to replace the personal income tax, the corporate income tax, the payroll (FICA) tax, and the estate and gift tax with a federal retail sales tax plus a rebate.

The rebate would be paid monthly to households, be based on the household’s demographic composition, and equal the sales taxes paid, on average, by the federal poverty line with the same demographics.

This would mean the US federal government would institute a GST but do away with existing federal taxes. (In the Canadian context, Kotlikoff proposal would mean raising the GST to about 22% and then abolishing the federal income tax.) Kotlikoff's GST rebate would be universal and would almost amount to a negative income tax since it would be the same for all. (My guesstimate of a Canadian 22% GST is a lowball. Kotlikoff has a US GST at 33% which would cover rebate costs and a larger tax take.)

I have to say that the proposal makes alot of sense. Unfortunately, VATs are exceptionally unpopular and politicians who introduce them usually become pariahs. No candidate in 2008 is going to propose this. Only a president not facing re-election would enact it, assuming Congress would ever go along.

IOW, economists must learn how to design tax systems taking into account the political system in which they would be enacted. Otherwise, it's a debate about the sex of angels.

Kotlikoff also has suggestions about social security and health care reform. His social security proposal is interesting and even contains a viable transition process but it misses the critical issue of who will have control over investment decisions. (Kotlikoff proposes an identical global equity index fund for all.) As to his proposal about medicare, speaking as a Canadian, all I can say is that Kotlikoff is very naive.

It's interesting that on these three proposals, Canada is well ahead of the US in its understanding of the associated problems. We have experience with a federal sales tax, we have understand well the problems of State-organized health insurance and we know about political interference in State-pension investment decisions.

----

So then, is the US bankrupt? Well, if you discounted to the present the various promises I've made to people, and then discounted to the present predictions of my future revenue streams, and then ignored that I have the power to change my promises (and my revenues) at will, then you might conclude I'm bankrupt.

IOW, the US government is not bankrupt because the US government can change at democratic will its obligations and its revenues. The government is simply not like you or me

It has been argued that the US has already gone bankrupt back in 1971 and was only saved by Nixon cutting a deal with the House of Saud and OPEC.

When in 1970-1971 foreigners demanded payment for their dollars in gold, The U.S. Government defaulted on its payment on August 15, 1971. While the popular spin told the story of “severing the link between the dollar and gold”, in reality the denial to pay back in gold was an act of bankruptcy by the U.S. Government. Essentially, the U.S. declared itself an Empire. It had extracted an enormous amount of economic goods from the rest of the world, with no intention or ability to return those goods, and the world was powerless to respond— the world was taxed and it could not do anything about it.

From that point on, to sustain the American Empire and to continue to tax the rest of the world, the United States had to force the world to continue to accept ever-depreciating dollars in exchange for economic goods and to have the world hold more and more of those depreciating dollars. It had to give the world an economic reason to hold them, and that reason was oil.

In 1971, as it became clearer and clearer that the U.S Government would not be able to buy back its dollars in gold, it made in 1972-73 an iron-clad arrangement with Saudi Arabia to support the power of the House of Saud in exchange for accepting only U.S. dollars for its oil. The rest of OPEC was to follow suit and also accept only dollars. Because the world had to buy oil from the Arab oil countries, it had the reason to hold dollars as payment for oil. Because the world needed ever increasing quantities of oil at ever increasing oil prices, the world’s demand for dollars could only increase. Even though dollars could no longer be exchanged for gold, they were now exchangeable for oil.

Energy bulletin link

The biggest threat to the US as a military, economic and industrial power comes not from its ballooning debt, dependence of foreign goods, pending spike in pensions to baby boomers or even welfare moms, but rather from the Proposed Iranian Oil Bourse which will trade in Euro's and not in US Greenbacks. Added pressure is coming from China and Venezuela, who recently penned a major deal where China will buy oil from Venezuela and invests in the Venezuelian oil industry using Euros, not Greenbacks. Other OPEC nations, especially those who export and import mainly to Europe are also looking into trading in either just Euros or a mixture of Greenbacks and Euros. If the Euro replaces the US Greenback as the currency of choice for both oil exporters and importers, then the US dollar will crash to new lows, which would cause a major sell off of US dollars and causing nations such as China and Japan to call in their loans. That is the true treat to the US, not some rinky dink terrorist outfit or hordes of welfare moms.

[Toro]

The US is not bankrupt.

The US can simply change the terms of the social security and medicare and the liabilities disappear.

As I've written before, the Iranian oil bourse traded in euros is propogated by people with no understanding of capital flows.

[jdobbin]

The US is not bankrupt.

The US can simply change the terms of the social security and medicare and the liabilities disappear.

As I've written before, the Iranian oil bourse traded in euros is propogated by people with no understanding of capital flows.

I don't know that it would that simple but you do make a point. Whatever President or Congress that got rid of those would be shot on sight.

[geoffrey]

Actually that is not entirely true. There is VAT in Alberta, but it is hidden and built into the costs of goods and services sold. I've recently returned to BC after spending a few months in Alberta servicing a contract. The costs of most goods in Alberta are equal to or even higher then those same goods in BC. My professional field is that of Transport Logistics and I can tell you honestly that the costs of bringing goods into Alberta, either via road or rail especially from the US or other parts of Canada is not all that much higher then it is to bring them into BC. In some cases, it is actually cheaper to bring goods into Alberta then into BC.

Do you have evidence of this VAT other than conjecture?

Another Albertan myth is that you take home more of your pay cheque, again after comparing my BC take home pay and Alberta take home pay, I found no meaningful differance. Both Provincial Governments hand their hands in my pockets for almost the same amount of coin per dollar. And giving the cost of living in Alberta, where a tiny one bedroom apartment in Calgary with hot and cold running cockroach's (if you even find a vacancy that is) will set you back $900 per month, Alberta is no bargin. Yes you can earn $15 an hour at the local Timmies, but you need to earn at least $20 just to keep a roof over your head and food on the table.

Rent has nothing to do with government, nor should it. Hey, I'm only an accounting student so what do I know, but I can tell ya that the tax advantage in Alberta is considerble. Other Premiers have warned Alberta not to reduce taxes further as it would destroy their labour force. 10% Income flat tax, and very low corporate rates. Tax life is good here.

As for Alberta's oil moola going to Ottawa, I remember a time not all that long ago when Alberta had its hands in the Federal pocket pleading poverty and need. Now that the price of oil has reached almost obscene heights, Albertans are bemoaning the fact they now have to contribute to the rest of Canada. Funny how that works. If oil suddenly drops below $20 a barrel ($20 a barrel is the break even point for tar sands extraction), Alberta will once again become a have not Province, begging Ottawa for a handout or two.

You unfortunately are a vicitim of the Eastern Canadian syndrome, where they believe Alberta is only oil rich. Alberta hasn't received equalisation since the 50's. During Trudeau's assault on Alberta in the 80's, we were still paying as much per capita as Ontario into confederation. Now we pay 5 times per capita.

[BubberMiley]

Tax life is good here.

That may be so, but if you have to pay a half-mil for a bungalow, the $800 you might save on your tax bill doesn't go very far.

[geoffrey]

Tax life is good here.

That may be so, but if you have to pay a half-mil for a bungalow, the $800 you might save on your tax bill doesn't go very far.

Housing has nothing to do with the government, other than building permits...

I sure hope we don't go into the rent control world that just ends up putting so many more on the street.