Thursday, April 09, 2009

All Those Trillions Must Mean Something, Right?!

Earlier this week, I discussed the meaninglessness of the gross federal debt as a measure of the U.S. government's fiscal position. I pointed out that of the current debt of roughly $11 trillion, about $5 trillion of that should not count as government debt because it is "intragovernmental holdings" of debt, accounting entries that keep track of what one agency of government owes another, not what the government owes its creditors. Almost all of the intragovernmental debt represents the value of Treasury securities held in the Social Security Trust Fund, which is currently growing by about $140-150 billion per year because Social Security taxes currently exceed benefits paid -- that is, the Social Security system is running a huge surplus.

I thought that at least that claim was uncontroversial, because the preference for using net debt rather than gross debt is bipartisan and essentially unchallenged. Earlier today, however, I came across the website for a recent PBS Frontline Documentary, "Ten Trillion and Counting," which interviewed a number of economists who are known to argue that current U.S. fiscal policy is unsustainable and which generally takes a sky-is-falling attitude toward the subject of government debt.

Since the title of the program clearly referred to the gross measure of federal debt, I was pleased to see that an economist at the Office of Management and Budget had sent a letter to the Frontline producers correcting their error. To their credit, the producers posted the letter on the website. Unfortunately, they also posted a response in which they announced that they "nonetheless stand by our decision to highlight what we consider to be the true dimensions of the problem by using the gross debt figure of $10 trillion -- now more than $11 trillion -- and counting." They were wrong to dig in their heels, and their unwillingness to change their minds provides an insight into the nature of the distorted public debate about the national debt.

The OMB economist, Thomas Gavin, pointed out that "[m]ost economists and budget analysts use debt held by the public -- and not gross debt -- as the most meaningful measure of the government's current fiscal position. This is a point of wide agreement among analysts, across political parties. ... And, this is a (perhaps rare) point on which this Administration agrees with the prior one." Gavin specifically addresses the significance of the debt held by the Social Security trust funds:
You might think that gross debt is a superior measure since intra-governmental debt is, in part, owed to the Social Security trust fund -- and, so, it might be thought to indirectly capture the federal government's obligations to future Social Security beneficiaries. But, this is not the way to do so. If you're interested in measuring the federal government's financial position going into the future, you have to take into account not just liabilities but also the federal government's main asset going forward -- namely, future tax revenues.
This is exactly right. Put simply, the IOU's in the trust funds represent the amount of money that the Social Security system will ultimately be able to demand from the Treasury when annual benefits exceed annual revenues (starting in about ten years). If Social Security ultimately needs to cash in all of those IOU's, it will be because future benefits will in the aggregate exceed future revenues by $5 trillion plus the total surpluses that we build up over the next decade. Gavin's point is that whether or not we tap out all of the IOU's depends on whether future tax revenues will fall short of future benefits and by how much. Frontline's producers respond to Gavin's argument essentially by ignoring it:
[I]ntra-governmental debt represents the future promises we have made. Due to the retirement of the baby boomers and rising health care costs, under some projections Medicare and Social Security will run out of money. If this happens, the trust funds for those programs will have to start cashing in those I.O.U.s, and to pay them the government will need to borrow more from the public. Or it could raise taxes to cover the shortfall, or it could make cuts to the programs to make them less expensive. If our future economy grows more robustly than expected, it will be easier to pay for these commitments, but the intragovernmental debt is not simply going to evaporate.
Actually, intragovernmental debt might indeed evaporate, at least inasmuch as it might never become a debt that must be paid. If, as one forecasting scenario used by the Social Security Trustees predicts, we will never tap out the trust funds, then those IOU's will never be cashed in. Future taxes will then pay for future benefits going forward, and there will be no need to honor the IOU's in the Trust Fund. This could also happen if -- as President Obama has suggested (and which I oppose for different reasons) -- benefits are cut and taxes raised such that the trust funds are not depleted even under more pessimistic predictions. In that case, by the way, workers today will have overpaid their Social Security taxes in order to cover a shortfall that never comes to pass.

On the other hand, the situation could become much worse, in which case the current intragovernmental holdings represent less than the total amount of money that future taxpayers would have to pay. A future Congress could refuse to cut benefits even if the trust funds become depleted, in which case future borrowing would be higher even than Frontline's approach would suggest.

The point is that the amount of aggregate intragovernmental debt holdings is simply unrelated to the ultimate burden that promised future benefits will impose on future taxpayers. Five trillion dollars is neither an upper nor a lower bound. It is a meaningless number. Gavin is thus correct to say that "[t]here's an active debate among analysts as to how best to summarize the federal government's financial position going into the future -- but using gross debt is clearly not the right way to do so." Frontlines' producers misunderstand the fact that future benefits and taxes might change, believing that somehow that means that the current amount of intragovernmental holdings actually means something.

Moreover, as my post on Monday pointed out, these debt numbers have no meaning out of context (and precious little meaning even after they are put in context). Whether the national debt is $6 trillion or $11 trillion or some other number, what does that mean? The debate to which Gavin refers has to do with estimates of net borrowing in the future, which only begins to mean something when measured against income (GDP) in the future. Even the scariest-sounding projections out there, with net future debt having a present value of roughly $80 trillion, have to be put in the context of a present value of all future income of roughly $1400 trillion, for a debt-to-GDP ratio of approximately 6%. And again, what does that number mean? What is the right number, and why should we believe that it is zero or that any other number is wrong?

As I have suggested in recent postings, technical expertise is neither necessary nor sufficient to speak intelligently about public policy. When it comes to accounting concepts with specific meanings, however, it turns out that some amount of knowledge is actually necessary. Apparently, none of that matters to those who have decided to hype a big round number.

-- Posted by Neil H. Buchanan

11 comments:

bobmossnj said...

Neil Buchanan is being disengenuous about the debt held by the Social Security trust fund. Of course, it would evaporate if we raise taxes and cut benefits sufficiently. But that's true of any debt burden, light or heavy. The way to get rid of it is to sacrifice. The problem is, residents of democracies have other priorities than sacrificing. And that's in the face of an ever-decreasing ratio of workers to retirees. If we try to compensate by encouraging immigration of young workers, we'll simply hasten the end of civilization due to environmental disaster. We can't keep increasing the world's population to maintain our living standards, because there's already not enough land, or even fresh water, to go around. Something's gotta give.

Brian Thomas said...

Neil,

I agree that it is a complex issue and that the treasury securities "owned" by the social security trust fund feels differently than the debt owed to the public -- but it also seems wrong to just pretend that it isn't real.

How do you feel about government and military pension liabilities? Should we just pretend that any amount used to "fund" these future liabilities isn't debt and shouldn't be counted as such because we might choose to raise taxes in the future and/or cut benefits?

Of course the U.S. could always default on its obligations or inflate its way out of them so maybe we shouldn't count any debt regardless of who holds it.

The government has collected a levy that is explicitly labeled to fund social security benefits -- in all likelihood these amounts are less than are necessary to fund the current amount of promised benefits. Yet, you would suggest that we account for these amounts by reducing the amount of outstanding debt of the government -- would you feel differently if instead of being invested in U.S. treasuries they were invested in European sovereign debt? Would you find it scandalous if an insurance company accounted for whole life insurance premiums received without considering the probable future liabilities to its policy holders?

It is true that reneging on its promises to future retirees is likely easier than defaulting on treasury debt held by the public, but it would be reneging on a promise nonetheless. I believe that it would be particularly difficult to reduce benefits so that there was a significant perpetual surplus in the "trust fund" associated with Social Security.

Ironically, our current national debt is likely understated, not overstated because it doesn't account for the liability associated with its promise to future retirees.

In sum, to the extent the vastness of our "national debt" is utilized to point out the potential for future government initiated inflation or significant future government "revenue enhancements" it seems that one should consider the amounts "owed" to the social security fund.

Randeg said...

Wow! This is too much to swallow in one sitting. I never knew there was such a thing as intra-governmental debt. But regardless of whether we use the gross debt or exclude the intra-governmental debt does not mean much because as you said this might evaporate and may become a debt that does not have to be repaid.

Evelyn Guzman
http://www.debtchallenges.com/bonus.html (If you want to visit, just click but if it doesn’t work, copy and paste it onto your browser.)

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