Detroit May Be Bankrupt, but as an American, You’re Not

BY Paul Solman  August 4, 2013 at 7:40 PM EDT
Paul Solman dispels the fear that the fate of Detroit foreshadows the fiscal future of America. Photo courtesy of Bill Pugliano/Getty Images.

Paul Solman dispels the fear that the fate of Detroit foreshadows the fiscal future of America. Photo courtesy of Bill Pugliano/Getty Images.

Earlier on this page, our regular Social Security columnist Larry Kotlikoff argued in favor of “generational accounting” and the recently introduced Intergenerational Financial Obligations Reform Act (INFORM Act), which he helped draft and which has garnered the support of 11 Nobel laureates in economics. He claims that Uncle Sam is grossly underestimating America’s official debt and borrowing from future generations of Americans.

I agree with Larry that “getting 11 economists, let alone 11 Nobel laureates, to agree on anything is no small feat” — not to mention signing up former Secretary of State George Schultz, who also supports the bill. An even greater feat, however, might be getting Larry Kotlikoff to give an inch on his generational accounting obsession. But let me give it a whirl, and in the process, try to provide some balance for readers to his broadside against our mutual Uncle Sam.

Sam’s “dirty tricks,” according to Larry are:

Using a finite rather than infinite time horizon for calculating his and our future obligations. That’s where the $222 trillion total tab that Larry cites as our nation’s true “fiscal gap” comes from. Over the next 50 or 75 or even 100 years, the gap between revenues and spending is much, much smaller.

Concealing the true enormity of future obligations by discounting them at too high a discount rate, thus implying that what happens to people (and debts) in the far future is hugely less important than what happens to them in the near future and present.

Nefariously mislabeling payroll taxes as “taxes” instead of “loans” and guaranteed benefits like Social Security as “transfer payments” instead of “repayment of debts.”

With regard to finite versus infinite time horizons, I’ve tried to parry Larry before, relying on the eminently expert economist Alicia Munnell, the Peter F. Drucker Professor of Management Sciences at Boston College’s Carroll School of Management who also serves as the director of the Center for Retirement Research at Boston College.

“Other stuff also happens over a long period of time,” Munnell pointed out in an interview this spring. “We have benefit commitments, but we also have people earning longer and payroll taxes being paid for longer and perhaps at a higher rate.”

Other stuff that may happen over a long period time: benefit trims for Medicare and Social Security, perhaps especially for the wealthy; a hike in the income ceiling currently capping payroll taxes for the well-to-do; extending the retirement age for both Social Security and Medicare, and it goes on. I mean seriously, who can possibly say what stuff will happen from here to eternity except that plenty will happen, and some of it will positively astound us.

Deborah Lucas, former assistant director at the Congressional Budget Office (CBO), is Sloan Distinguished Professor of Finance at MIT’s Sloan School of Management. She was kind enough to share her reaction to Larry’s INFORM Act.

“To be blunt,” she began, “I am strongly against this bill on both intellectual and procedural grounds. I think it is misguided to do fiscal gap estimates over an infinite horizon.

“The results of such analyses are extremely sensitive to highly uncertain assumptions about growth rates and discount rates. It also makes little sense to carry a current law baseline (the assumption that current laws will remain unchanged) out into the infinite future.

“Furthermore, if the fiscal gap were to become politically focal it can easily be gamed: for example, Congress could close the fiscal gap by legislating a huge increase in taxes 50 years into the future and of course, that would be overturned when the time came; it does nothing to encourage a reasonable time path of policy reforms.

“Policies that are unsustainable will change. To strongly make the point that fundamental fiscal reforms are needed, it doesn’t take reporting numbers where the economy goes to zero or the present value of future liabilities goes to infinity (which comes out of some of the models used for these analyses).

“Furthermore, CBO and Social Security (among other government agencies) already report on long-term imbalances at regular intervals.

“In preparing those reports, the question perennially comes up of how to best communicate the size of structural imbalances in a way that is policy-relevant. That debate has not been settled (to say the least — I’ve been in rooms with very prominent people arguing on both sides), and to legislate the solution is completely inappropriate. In fact, CBO in the last few years pulled back from emphasizing the infinite horizon.”

A former student of mine at Brandeis, Evyn Rabinowitz, is part of the generation Larry Kotlikoff worries about. But after reading Larry’s most recent argument on these pages, Evyn asked a question: Do we really want to be putting aside money today “for people hundreds of years in the future”? I’d go further and wonder if this isn’t a legitimate question to ask even about one’s future self: How much do I want to sacrifice in the present for some alte codger who may not even know who I am? (I’m not saying I’m sold on an answer, mind you, and my wife and I have in fact been assiduously saving for the older versions of ourselves. I do, however, think it’s a legitimate question.)

Larry’s second point, the one about discount rates, flows directly from Evyn’s question. How much is money a million years from now worth today? To whom? Is it unreasonable, say, to ask people to provide for their own progeny by borrowing from the future and investing the money themselves? What if I’m a starry-eyed techno-optimist of the Ray Kurzweil variety, or at least a techno-realist like the great economic historian Joel Mokyr, who posted here recently? Why not borrow from the bounteous new Atlantis of tomorrowland?

There’s no question that municipalities like Detroit have been pulling a fast one when it comes to their pensions and overall accounting by using too high a discount rate, as Larry explains and as we’ve reported for years. Our earliest explanation was about corporate pensions. More recently, we looked at the pension persiflage in Rhode Island, which you can watch here and here.
The story featuring the roguish former Providence Mayor Buddy Cianci was especially amusing and revealing.

Larry’s final point turns on what he calls “linguistics” and full disclosure. Here, as often, I’m of two minds. One mind thinks it’s ridiculous for the government to refer to the Social Security and Medicare “trust funds” as if they were stowed away somewhere, even more ridiculous to report government deficits (or surpluses, under President Clinton) without factoring in the future liabilities that Social Security and Medicare represent.

The other mind, however, thinks that if people understand what’s going on, the language doesn’t much matter. I can only say I have been doing my darndest to explain these issues since the 1980s on the NewsHour. I’d agree that it’s quirkily insightful to label payroll taxes as loans to the federal government. But is it an epiphany that will change public policy? I rather doubt it.

In the end then, is America bankrupt? Not so long as people in the world are willing to exchange their goods and services for U.S. dollars; not so long as Uncle Sam can tax us to pay our way, at least in part; not so long as many of the world’s most enterprising people flock here to create wealth. Call me Paulyanna, but I don’t see those trends coming to a halt anytime soon.

This entry is cross-posted on the Rundown — NewsHour’s blog of news and insight.