Laurence Kotlikoff Laurence Kotlikoff is

Laurence Kotlikoff

Laurence Kotlikoff is worried. He thinks the medium term U.S. budget deficit is a cause of concern, and that U.S. unfunded political liabilities for Social Security and Medicare are unnerving.

His The National Interest paper with Niall Ferguson, "Going Critical. American Power and the Consequences of Fiscal Overstretch" draws on another paper by Jagadeesh Gokhale and Kent Smetters, "Fiscal and Generational imbalances: new Budget Measures for New Budget Priorities." Their starting point is a question asked and answered by Gokhale and Smetters:

"Suppose the government could, today, get its hands on al the revenue it can expect to collect in the future, but had to use it, today, to pay off all its future expenditures commitments, including debt service. Would the present value (the discounted value today) of the future revenues cover the present value of the future expenditures? The answer was a decided no: according to their calculations, the shortfall amounts to $45 trillion. To put that figure into perspective, it is twelve times larger than the current official debt and roughly four times the size of the country's annual output."

The bulk of these unfunded federal commitments are political commitments to the social security and Medicare programs (mostly to the Medicare program). Ferguson and Kotlikoff explore various outcomes. A "controlled" landing will require, above all else, a willingness to reform the Medicare program, which accounts for about 82% of the shortfall.

Countries often deal with fiscal crises through inflation.

"As is well known, printing money helps a government in fiscal difficulties in three ways. First, the government gets to exchange intrinsically worthless pieces of paper for real goods and services. Second, inflation waters down the real value of official debt. (At the end of World War I, all the major European combatants had accumulated public debts in excess of around two years' national income. But, by 1923, the Germans had rid themselves of nearly all their debt by printing so much money that the real value of government bonds fell close to zero.) Third, if the salaries of government workers are paid with a lag or only partially adjusted for inflation, inflation will lower their real incomes. The same holds true for welfare, Social Security and other government transfer payments, provided they are not index-linked..."

Inflation isn't likely to solve our problems:

"First, only a modest proportion of the federal government's $45 trillion budget gap would actually be reduced through a jump in inflation of the sort described above. Much of the government's tradable debt is of short maturity - indeed, fully a third of it has a maturity of one year or less. This makes it much harder to inflate away debt since any increase in inflationary expectations will force the government to pay much higher interest rates when it seeks to renew these short-dated bonds. Second, Social Security benefits are protected against inflation via an annual inflation adjustment. Medicare benefits are also effectively inflation-proof because the government unquestioningly pays whatever bills it receives."

Kotlikoff and co-author Scott Burns, are about to publish a book on the fiscal implications of our aging population: The Coming Generational Storm : What You Need to Know about America's Economic Future. The book will be published by the MIT Press. The book's website (with links to the prologue and first chapter) summarizes the book as follows:

"In 2030, as 77 million baby boomers hobble into old age, walkers will outnumber strollers; there will be twice as many retirees as there are today but only 18 percent more workers. How will America handle this demographic overload? How will Social Security and Medicare function with fewer working taxpayers to support these programs? According to Laurence Kotlikoff and Scott Burns, if our government continues on the course it has set, we'll see skyrocketing tax rates, drastically lower retirement and health benefits, high inflation, a rapidly depreciating dollar, unemployment, and political instability. The government has lost its compass, say Kotlikoff and Burns, and the current administration is heading straight into the coming generational storm.

But don't panic. To solve a problem you must first understand it. Kotlikoff and Burns take us on a guided tour of our generational imbalance, first introducing us to the baby boomers-- their long retirement years and "the protracted delay in their departure to the next world." Then there's the "fiscal child abuse" that will double the taxes paid by the next generation. There's also the "deficit delusion" of the under-reported national debt. And none of this, they say, will be solved by any of the popularly touted remedies: cutting taxes, technological progress, immigration, foreign investment, or the elimination of wasteful government spending.

So how can the United States avoid this demographic/fiscal collision? Kotlikoff and Burns propose bold new policies, including meaningful reforms of Social Security, and Medicare. Their proposals are simple, straightforward, and geared to attract support from both political parties. But just in case politicians won't take the political risk to chart a new direction, Kotlikoff and Burns also offer a "life jacket"-- guidelines for individuals to protect their financial health and retirement."

I read the first chapter, a lively survey of ongoing demographic changes in the U.S. Kotlikoff is writing for a wide audience. An example of the style:

"As years go, 1957 was notable, if primitive. Remote control for television sets had yet to be invented. This meant the 47.2 million sets in 39.5 million American households had their channels changed by hand, if you can imagine that. The sets were also relatively small and offered pictures only in black and white...

Oliver Hardy of Laurel and Hardy fame died, but Lyle Lovett was born. Lyle’s birth was not much noticed at the time because 1957 was the year we produced the most babies ever born in America in a single year. We did it at the rate of one baby every seven seconds, closing the year with 4.3 million newborns, from a total population of only 172
million.

You can get an idea of what a staggering feat that was by doing a modern comparison. In spite of having 100 million more Americans today, we produced fewer than 4 million newborns a year through the late 1990s..."

I learned about these papers from Arnold Kling and Alex Tabarrok.

Minor changes 3-2-04.