28.10.06

CONTINGENT LIABILITIES. David M. Walker, the head of the Government Accountability Office (does that really sound better than Government Accounting Office) is on a national tour drawing attention to potential large increases in the national debt.

People who remember Ross Perot's rants in the 1992 presidential election may think of the federal debt as a problem of the past. But it never really went away after Perot made it an issue, it only took a breather. The federal government actually produced a surplus for a few years during the 1990s, thanks to a booming economy and fiscal restraint imposed by laws that were passed early
in the decade. And though the federal debt has grown in dollar terms since 2001, it hasn't grown dramatically relative to the size of the economy.

But that's about to change, thanks to the country's three big entitlement programs - Social Security, Medicaid and especially Medicare. Medicaid and Medicare have grown progressively more expensive as the cost of health care has dramatically outpaced inflation over the past 30 years, a trend that is expected to continue for at least another decade or two.

To some extent, the report misleads. The entitlement programs have been contingent liabilities all along. During the late 1990s, Social Security payments in excess of current benefit payments were counted as additional general revenues, hence the government was able to show an operating surplus, even though those payments are supposed to imply future claims against the so-called trust fund. Remind me again, why was the creation of private Social Security accounts, in which an asset exists alongside a liability, such a bad idea? And Social Security is a relatively small problem. But note in the excerpt the reliance on dubious accounting. It's more accurate to say "Social Security taxes currently exceed payouts, but the government is not writing down a contingent liability for the future benefits these taxes represent."

Medicare so dominates the nation's fiscal future that some economists believe health care reform, rather than budget measures, is the best way to attack the problem.

"Obviously health care is a mess," says Dean Baker, a liberal economist at the Center for Economic and Policy Research, a Washington think tank. "No one's been willing to touch it, but that's what I see as front and center."

Social Security is a much less serious problem. The program currently pays for itself with a 12.4 percent payroll tax, and even produces a surplus that the government raids every year to pay other bills. But Social Security will begin to run deficits during the next century, and ultimately would need an infusion of $8 trillion if the government planned to keep its promises to every beneficiary.

Calculations by Boston University economist Lawrence Kotlikoff indicate that closing those gaps - $8 trillion for Social Security, many times that for Medicare - and paying off the existing deficit would require either an immediate doubling of personal and corporate income taxes, a two-thirds cut in Social Security and Medicare benefits, or some combination of the two.

Does anybody really think that doubling the tax rates would bring in the expected revenue stream, or would that be the mother of all contractionary fiscal policies? And I do wish reporters would be more sensitive to laws of conservation in economics.

Why is America so fiscally unprepared for the next century? Like many of its citizens, the United States has spent the last few years racking up debt instead of saving for the future. Foreign lenders - primarily the central banks of China, Japan and other big U.S. trading partners - have been eager to lend the government money at low interest rates, making the current $8.5-trillion deficit about as painful as a big balance on a zero-percent credit card.

In her part of the fiscal wake-up tour presentation, [Brookings economist Diane Lim] Rogers tries to explain why that's a bad thing. For one thing, even when rates are low a bigger deficit means a greater portion of each tax dollar goes to interest payments rather than useful programs. And because foreigners now hold so much of the federal government's debt, those interest payments increasingly go overseas rather than to U.S. investors.

More serious is the possibility that foreign lenders might lose their enthusiasm for lending money to the United States. Because treasury bills are sold at auction, that would mean paying higher interest rates in the future.

And it wouldn't just be the government's problem. All interest rates would rise, making mortgages, car payments and student loans costlier, too.

U.S. consumers could stop the Chinese from lending money to the government tomorrow if they wanted to. It's very simple. If consumers stop buying Chinese goods, those dollars stop accumulating in Chinese banks, and the Chinese central bank no longer has them to bid at Treasury auctions.

The consequences of that choice are left to the reader as an exercise.

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