April 5, 2010

Is There A USPIGS In Our Future?

by Hal Gershowitz

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In the vernacular of financial commentary, “PIGS” is the term recently coined by the financial markets to refer to sovereign countries whose economies are virtually bankrupt and whose bonds are virtually worthless. These are the basket cases of the international economic system — Portugal, Italy (also Ireland ), Greece and Spain.  Recent evidence suggests that the fiscally irresponsible PIGS may soon have a new applicant for membership in their club.  Membership in this particular club is somewhat reminiscent of Groucho Marx’s famous remark that “I wouldn’t belong to any club that would have me for a member.” The new expanded club’s acronym is shaping up to be (you guessed it) USPIGS.  No, the United States is not about to go bankrupt.  Not yet, anyway. We are, however, pursuing the very same types of vast spending policies that brought the PIGS of Europe face to face with that real possibility.

What have we done recently to be considered for membership in this club of dubious distinction?  Last week, government budget personnel revised their estimate of when Social Security would begin running in the red from 2017 to, essentially, “right away.”  Yes, Social Security is broke…right now!  So much for government estimates.

The announcement of this distressing news was, it appears, kept well under wraps until Nancy Pelosi and Harry Reid along with a shamelessly compliant Democratic Congress safely ramrodded Obamacare, with its astonishing price tag, into law. The entitlement sinkhole just got an order of magnitude bigger.  “But,” one might ask,  “haven’t we been accumulating all the excess funds paid into Social Security all these years in a special trust fund.”  Well, not exactly.  In fact, not even almost exactly.  You see, the government has been vacuuming out the excess cash as soon as it comes in and spending the money (the money we all paid in) to pay the government’s current bills.  The trust-fund cash has been replaced all this time with IOU’s (that’s internal Treasury debt), which are now being called to meet current payment obligations.  These IOU’s are being replaced, of course, with even more IOU’s but this time there is no more cash to divert from payroll taxes to fund government operations. We have to borrow more.

The timing just couldn’t have been worse, with the multi-trillion-dollar Obamacare entitlement enacted into law by the Democrats, and Moody’s having just announced that our AAA credit rating could be in jeopardy if we don’t meet our economic growth projections. Those are the very same growth projections being compromised by our ever-spiraling deficits, our ever-growing national debt and by the federal and state tax collectors about to go on a government-mandated, national pick-pocketing binge.

We have, in a number of previous essays, cited the spending plans of the current Administration as irresponsible.  Not that there is anything inherently irresponsible with borrowing against future receipts to accomplish needed and worthwhile objectives so long as there is a credible repayment plan.  But when anyone, especially the government, spends borrowed money based on future expectations, then the principles upon which those expectations of future revenue are based have to be realistic and grounded in sound economic theory.  Sadly, the chickens have come home to roost on the past projections upon which Congress and the Administration have relied. And just as we have previously claimed they were doing (“cooking the books” with unrealistic forecasts to justify passage of the Obamacare legislation), the evidence is in that Congress has justified its profligate spending habits by basing expenditure decisions upon demonstrably unrealistic optimistic projections of economic growth while also understating the future costs of the laws they enact.

Entitlement costs, like those for greatly expanded health care, get baked into the annual budget (referred to in budget speak as non discretionary spending), even though the revenue going forward is quite variable.  As proof of that, the fact that Social Security is in the red seven years earlier than the government projections anticipated, is largely the result of the economic downturn.  The benefits are fixed while the economy, which produces the receipts from payroll taxes, is, extremely variable.  Picture a graph with two lines, moving from left to right, one to illustrate benefits (costs) and the other to illustrate income (social-security tax receipts). Obviously you would want the lines to move in tandem, ideally with the income line running ahead (above) the cost line.  When they run counter to one another, that is, when the cost line turns up and the income line turns down you have what we’ll call an insolvency gap.  Our current social-security insolvency gap is more than very troublesome. It has put us on the road to a fiscal train wreck. This is the type of wide-yawning gap that has driven Greece to its knees and threatens the other “PIGS” countries as well.

To be sure, this mess has been building for a long time and we can’t blame past irresponsibility on President Obama.  He, as the junior senator from Illinois, was still trying to find the way to his Senate office when the current crisis began to build during the Bush years. But now he is president and it is his responsibility to provide the leadership to resolve the mess, not to make it worse. Unfortunately, the president and his ill-timed redistributive policies are exacerbating, not alleviating our economic problems by rushing headlong to squeeze money out of the private sector and into the hands of a wide array of government programs essentially designed to redistribute private wealth. With fewer resources in the private sector it is almost axiomatic that government tax revenues from private economic activity will be constrained. Of course, at the same time, that the government continues to spend at an accelerated rate, Congress and the Administration project steady economic growth with no further downturns. We have seen how reliable those projections have been in the past.  Our national priority should be to do everything we can to foster economic growth.  Instead, we are doing just the opposite.

Further complicating the matter is that Obamacare imposes very substantial new costs on the states, nearly all of which are struggling mightily with their own budgets.  As we write this essay, The Sunday New York Times reports on its front page how states are now seeking to tax services, “…From Head To Toe.”  The federal government and the state governments are embarking on a colossal revenue chase to squeeze more and more taxes from the nation’s taxpayers.

It has been demonstrated that when public debt reaches 90% of GDP economic growth begins to deteriorate.  Add non-public debt (when we borrow from our own “lock boxes or trust funds”) such as what we owe to Social Security and our other totally unfunded liabilities, and the picture really starts to become very troublesome.  CBO now estimates that our deficits over the next ten years will be $1.2 trillion more than the Obama administration projected (why do these type of corrections always seem to come out right after we legislate massive new entitlement commitments?); and that we will have reached that 90% public debt to GDP ratio within the next ten years.

This is not simply academic or esoteric chatter.  It matters and it matters a lot to every American family.   That $1.2 trillion miscalculation by the Obama Administration represents an additional debt of $10,000 per household above and beyond the federal debt each household is already carrying according to Heritage Foundation budget analyst Brian Riedl.  Keep in mind the federal public debt was a gaping $6.3 trillion or $56,000 per household when President Bush left office. Today, it stands at $8.2 trillion or $72,000 per household and, according to the CBO estimates, in less than ten years it looks like it could reach $20.3 trillion.  That would be $170,000 per household!  When we talk about the Administration or Congress passing debt onto our children that’s exactly what we are talking about.  Ultimately, our kids and their kids will pay to service that debt with additional taxes the government extracts from them or through vastly decreased value of their currency. Either way, their standard of living and their quality of life is certain to suffer.

James R Horney, a federal-budget analyst with the liberal Center on Budget and Policy Priorities acknowledges that lower tax revenue resulting from economic performance that is lower than government projections accounts for the biggest part of the deficit gap between the Administration’s estimates and the CBO’s. “The administration assumes GDP and incomes will be higher, and that translates into higher revenues than CBO expects. Relatively small differences in economic assumptions can add up to big differences over 10 years,” says Horney.

Budget analysts Riedl and Horney, one conservative and one liberal, both offer very worthwhile observations.  Their comments are also very instructive.  They illustrate how minor errors or miscalculations in projections can, over time, compound into major problems.  They also suggest the ease with which government staff can game the system to influence the score the CBO comes up with on any piece of legislation.  When constructing the assumptions that accompany a bill to the CBO for scoring, a little tinkering here and there can pretty much produce the score one wants.  The Administration’s Office of Management and Budget (OMB) can play the same game. Plug in a half percent more growth and more tax revenue here and there and PRESTO you can make a projected budget deficit neutral or even reduce a shortfall.

We, of course, don’t know if such chicanery was at work in the case of the healthcare bill.  We do, however, find it disheartening that the CBO didn’t discover, until two days after President Obama signed the healthcare bill into law, the disparity between the growth projections the Administration made and those that CBO considers to be realistic.  And as stated earlier in this essay, that turned out to be a $1.2 trillion late discovery.

The bad news is that in a little less than ten years our public debt will reach 90% of estimated GDP (sort of like the PIGS of Europe).  At the time Mr. Obama was elected President our public debt stood at 40% of GDP.  The good news is (well not exactly good news) we have time to do something about it.  The government can rethink the statist, redistributive course we are on and begin focusing on policies designed to grow the economy…to encourage private investment and sound risk taking…to leave as much wealth in the hands of the people as possible.

Based on his actions since he took office, President Obama is not of a mind to view the sudden insolvency of Social Security or the Administration’s $1.2 trillion miscalculation of the nation’s deficit over the next decade with alarm and rethink the course he is plotting. Rather, he and the Democratic Congress seem to be of a mind, instead, to think damn the torpedoes, full speed ahead. Their rhetoric and actions suggest that, given the current control they exercise, they see this as a once in a lifetime chance to vastly increase the role of government and to let the debt problem slide further down the road. It is far more satisfying to engage in expensive social engineering than in the hard choices necessary to cut spending.

We suspect, however, we do know what the mind of the voting public will be once the hard reality sinks in of where we are, where we are headed and the consequences to the nation of being a fiscal basket case where debt backed by the “full faith and credit” of the United States (our Treasury bonds), long viewed as the refuge of investor’s seeking safety, could be salable only if America paid much higher rates of interest.

What has happened to Portugal, Italy, Greece and Spain is not hard to fathom.  It is a mystery to no one who understands basic economics, unencumbered by partisan political philosophy.  The PIGS have borrowed to spend (and are committed to spend) more than they can ever hope to repay.  It’s that simple. In the case of Greece, they need some form of a bailout. The other three nations are not far behind unless they treat their current crisis as a wakeup call and quickly take painful remedial measures. It appears to us when we look at what Congress has just legislated and the president has signed into law, together with what the president’s other priorities seem to be, that we are about to follow the path well traveled by the basket cases of Europe.  Why in the world would we do that?

All comments regarding these essays, whether they express agreement, disagreement, or an alternate view, are appreciated and welcome. Comments that do not pertain to the subject of the essay or which are ad hominem references to other commenters are not acceptable and will be deleted.

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4 responses to “Is There A USPIGS In Our Future?”

  1. Peter Solomon says:

    Excellent understanding/explanation of the basic economic problem we face. Thank you.

  2. Iyablans says:

    Maybe armageddon under the “tyrant” Obama is just around the corner,as this blog continually suggests. Why then do I feel so much more comfortable with the state of the nation than I did one year ago when the collapse of our financial system seemed inevitable.
    Perhaps the “evil”cabal of Pelosi,Reid, and I suppose, throw in Barney Frank are hiding vital information from us.
    Despite the detailed projections from your scources on the future destruction of the American way of life as we have known it, I can’t help but feel more relaxed than on the last day of the recent republican debacle.

  3. We don’t think “armageddon” is just around the corner unless one considers Great Britain, Portugal, Italy, Ireland, Greece, Spain and the other European economic basket cases to be a glimpse of economic eschatology. We don’t think that’s the case. There’s a big difference between a miserable model and armageddon. We also carry no brief for President Bush or his regulators with respect to their management of the national fisc, a point we have made numerous times. We’re sure there are many others who “feel more relaxed now” than on the last day of the “recent republican debacle.” Let’s hope their relaxed state is not as that of the toad relaxing unaware of the pot beginning to boil.

  4. Iyablans says:

    eschatology….That is a new one for me. Thank’s.

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