Thursday, August 07, 2014

How Is This Still a Thing? "Generational Accounting" (Part II)

-- Posted by Neil H. Buchanan

In my Dorf on Law post two days ago, I described the surprising and unwelcome return of something called "generational accounting," which the economist Laurence Kotlikoff and various co-authors have been hawking for the past twenty years.  This was a bit of a bad acid flashback for me, because I had written extensively about this in a law review article that was published in 2005.  To find this staring out at me from my morning newspaper on the first day of August in 2014 was, to say the least, an unpleasant development.

Kotlikoff has spent much of his career claiming that the United States government is going "bankrupt," using an accounting method to measure what he calls the "fiscal gap" in a way that makes it seem as if current budgetary policy is completely out of control.  He was given space on the NYT op-ed page last Friday, where he trotted out his usual rhetorical tricks, ending with a smarmy claim that budgetary policy  is "a moral issue. Will we continue to hide most of the bills we are bequeathing our children?"

My post on Tuesday described the dishonest rhetoric that Kotlikoff uses to sell his snake oil.  I promised that my next post would describe the substance, such as it is, of his claims.  As we shall see, this is a case of an ideological agenda masquerading as rigorous accounting.  Kotlikoff is an anti-government conservative, spinning scare stories about "inflationary, easy-money policies," government accountants who hide the nation's actual "credit card bills," and powerful old people who steal the birthright of future generations.  That he has managed to find an audience among leaders of both U.S. political parties is truly depressing.

What is a "fiscal gap"?  Kotlikoff and his colleagues claim that it is the only true and honest way to measure the government's finances.  Rather than focusing on the year-by-year deficit, they claim that they can measure the totality of all current and future government borrowing, adjust it to present value, and express total indebtedness for all time in that single number.  As I noted on Tuesday, Kotlikoff claims that this number went from $205 trillion to $210 trillion from 2012 to 2013, giving a "true deficit" of $5 trillion for 2013 alone, not the official $680 billion that was reported by the (presumptively dishonest) government.  Of course, Kotlikoff persistently fails to report these numbers as a percentage of GDP (which corresponds to our ability to pay for the debt).  Even his highest numbers are actually no more than about 7% of infinite-horizon GDP.  But that is not scary enough for his purposes.

The idea that we ran a five trillion dollar deficit in a single year is, on its face, implausible, as I explained yesterday.  But let us set that aside for a moment.  How do we get to $210 trillion in "honest" government debt, when the official debt held by the public was only bumping up against $12 trillion for the first time in 2013?  Simple, says Kotlikoff.  We have promised more benefits in the future than we will collect in taxes, so we will be running huge deficits in the future.  How far into the future?  Infinitely far.  Regarding the part of the long-term gap that Kotlikoff attributes to Social Security, he says that the infinite-horizon gap is $24.9 trillion, whereas the gap using a 75-year window is $10.6 trillion.  In other words, almost sixty percent of Social Security's supposedly "hidden credit card bill" is derived from a guess about what the system will pay, versus what it will collect, from 2089 through eternity.

Still, Kotlikoff has argued repeatedly that it is "arbitrary" to cut off the forecast at any particular date.  But if his claim is that today's oldsters are hoodwinking their children and grandchildren by not having the government publish the forecasts of Social Security's finances in the years after sea levels have risen by three feet, then maybe we should not take him terribly seriously.

More centrally, Kotlikoff and his defenders claim that they are merely describing what will happen under "current law," that is, if nothing is changed from today onward.  Thus, the claim is that this is an "early-warning system" -- not a prediction, but a call to arms.  But what is "current law"?  Kotlikoff takes it to mean that all government taxing and spending laws are kept on the books forever, as is, while demographic changes and key economic variables proceed on predicted paths.

But that is not how government programs would ever work.  If the idea is that, as Kotlikoff repeatedly says, we must act now in order to prevent catastrophe in the future, then we need to know what future law will look like, not what it most definitely will not look like.  For example, before Congress indexed tax brackets to inflation in 1981, one would have predicted under a "current law" forecast that everyone would eventually pay the highest income tax rate, as inflation pushed even the lowest incomes to higher nominal levels.  But that would never happen, even without official indexing, because Congress would never let it happen.  (Indeed, before 1981, Congress periodically reset rates in light of inflationary "bracket creep.")

In fact, Kotlikoff does not really commit himself to "current law."  For Social Security, as I described again last week in my Verdict column, current law (under the "intermediate forecast") would see benefits being cut by 1.2% of GDP in 2034, so that Social Security by definition cannot contribute to any fiscal gap thereafter.  Kotlikoff endorses CBO's "alternative fiscal scenario," which selectively does NOT rely on current policy, as the "most realistic" way to view future outcomes.  That all of those alternatives make matters look worse is hardly a coincidence.  (And Kotlikoff cannot deflect blame to CBO, because he has been a shameless and indefatigable policy entrepreneur and has -- amazingly -- managed to get CBO to adopt the essence of his approach on these very-long-term forecasts.)

What would a truly realistic forecast look like?  It depends on what costs are driving the long-term deficit predictions.  In my 2005 paper, I assessed a 2003 fiscal gap computation by two of Kotlikoff's students.  There, the total fiscal gap was computed to be $44.2 trillion.  (Note, then, that we supposedly ran up over $165 trillion in "true debt" -- $210 trillion minus $44 trillion -- from 2003 to 2013, or about $16 trillion per year.  Plausibility checks are a good thing.)  Of that $44.2 trillion, $7.1 trillion was from the not-actually-current-law Social Security gap, $0.5 trillion was for the entire federal government other than Social Security and Medicare, and the remaining $36.6 trillion was from Medicare.

Under the updated numbers that Kotlikoff was hawking last week, Social Security was only $24.9 trillion of the $210 trillion infinite-horizon fiscal gap, and (although Kotlikoff did not report it), the rest of the federal government's post-sequester-and-all-that budget is essentially in balance (and plausibly in the black), meaning that close to 90% of the long-term fiscal gap is attributable to whatever assumptions are driving the forecasts of future Medicare spending.

This, finally, is where some realism needs to come in.  These long-term forecasts are based on the key assumption that Medicare's cost growth will exceed overall inflation by some arbitrary amount every year, causing the Medicare budget to grow without limit, sucking up more and more of the economy.  Tilting the analysis still further, CBO tells us (here, Table 1-1) that under their alternative fiscal scenario, "After 2022, several policies that would restrain (Medicare) spending growth are assumed not to be in effect."

In other words, claiming that we currently have a huge fiscal gap really means that "current law, adjusted for 'realism' in a pessimistic alternative reality" will result in large excesses of Medicare spending over revenues.  (And if my puppies had continued to grow throughout their lives as much as they grew during their first year, they would have weighed 700 pounds each when they were ten years old.)  But this is completely ridiculous, because future Congresses can control those spending and revenue paths.  We will never face the future that the fiscal gap number purports to warn us about -- not because we have been warned, but because even a Congress that was mercifully spared the Kotlikoff nonsense would never allow things to follow the path necessary to generate those huge numbers.

At last, we reach the core of Kotlikoff's hucksterism.  If the defense is, "Well, this is not what's really going to happen, but only what could happen, if Congress never did anything, and if medical care costs never moderate," then what are we to make of the claim that we have all of these hidden credit card bills right now?  Not that we could one day owe much more, but that the only true way to measure our actual debt over the infinite future is to add up costs and benefits that will never come to pass?    (Brad DeLong and Dean Baker each offer further critiques of the dishonest mechanics of fiscal gap accounting, here and here, but the fundamental issue is that the long-term forecasts of "current law" or "alternative scenarios" are completely manipulable.)

Kotlikoff frequently claims that the U.S. is already "bankrupt."  Does he merely mean to use that term as a rhetorical flourish, or a deliberate overstatement, not to be taken literally?  He can speak for himself: "Sound fiscal gap accounting says the United States is bankrupt.  Bankruptcy is a strong term. But it is apt.  Future government receipts don’t cover future expenditures as things stand. Not nearly."  "As things stand," he says, we are bankrupt.  This is not a claim that the government could become bankrupt some day.  It is a claim that, because of a forecast of persistently excessive health care cost inflation, we are already bankrupt.  And it is a "moral issue" for us to be honest with our children about it.

Which raises an important question.  Where is the "generational accounting" in all of this?  In fact, it is even more dishonest than the fiscal gap gamesmanship.  That story, however, will have to wait until my next post.  For now, however, it is clear that the fiscal gap idea is itself bankrupt.  Masquerading as a way to non-arbitrarily measure future borrowing, it is merely a vehicle to allow scare-mongers to import conveniently dire assumptions into the analysis of the federal budget, in the name of hacking away at successful government programs.  Immoral, indeed.