[On Friday, I encountered the same old haystack of fiscal gloom-and-doom, but I also discovered a needle in that haystack. It was a bright ray of hope in the midst of the same, predictable doomsday message we’ve been hearing ad nauseam. This topic requires two separate articles, and this is number one of two.]
A Haystack and a Needle
The Concord Coalition’s Fiscal Doomsday Tour was in Seattle last week. They met with the editorial board of Seattle’s newspaper, the Seattle P-I, on Wednesday, Nov 29. Two days later, I listened to the entire podcast on my new iPod Shuffle Metal—what a fabulous little device, by the way. If you’d like to hear the whole thing, you can subscribe to the podcast by clicking the XML icon at this link (download “The Debt Bomb”). You’ll find it chock full of the usual gloom-and-doom message, but you’ll also find the bright ray of hope at 24:50 (24 minutes, 50 seconds). It’s a brief, easy-to-miss statement by Alison Fraser, Director of Economic Policy Studies at the Heritage Foundation. Here’s what she said—after (and before) much discussion by the rest of the group about our country's dire straits and grim prospects:
It's one thing to raise taxes that make it harder on all Americans, and it's another thing to do fundamental tax reform that makes the economy grow faster and get more revenues.
Three cheers for Alison Fraser. There’s a mountain of very important information packed into that sentence, and it will be the subject of article 2, which I’ll write later this week. I hope to talk to her before I write the article, but look for it in a few days in any case. In the meantime, this is still article one; it’s about the hay, not the needle.
Four Daydreams
Again, this article is about the hay in the haystack: that is, the doomsday-is-near road show that employs fear of national bankruptcy, repetition of undefined terms, false dilemma, and contextless scary numbers to communicate their message to the big media outlets. To my disappointment, softball questions were all the road-show folks got from the Seattle P-I’s editorial staff, not any of the questions I wish had been asked (see this and this).
Concord’s Fiscal Doomsday Tour is quite a contrast from the problem-solving process I experienced during my corporate career. In successful private-sector businesses large and small, effective managers define their terms, debate and agree on their priorities, define how they will measure results, then go about the process of managing to achieve those agreed-upon results. Undefined terms, failure to commit to goals, and failure to establish concrete, numerical measures are the ingredients of subsequent failure. (When you fail often enough in business, your boss or your competitors take you out of the game, and that creates a big incentive to get the process right. Sometimes, on a big enough problem, “often enough” means “once in a row.”)
Daydream #1: How business managers might approach the fiscal challenge
Let’s first agree that our nation has some fiscal challenges. But let’s hypothetically place that problem in a setting more like the private sector, where problem-solving skills make and break not just careers but entire businesses. Below is an abbreviated example of how success-oriented business managers might begin applying a planning and goal-setting process to the problem of our federal government's fiscal situation, with the overall goal of creating security and growing prosperity for future generations of Americans to enjoy and build upon:
Background: Current fiscal truths and measures
• The ratio of federal debt to GDP is 65%, which is far lower than its 1946 peak of 121%, while inflation and real interest rates continue their two-decade pattern of remaining low and steady. The portion of tax receipts required to pay net interest on the debt is less than 10%, down significantly in the last decade—due to economic growth and lower interest rates.
• Economic growth since 1946—not spending reductions or tax rate increases since 1946—is overwhelmingly responsible for bringing the debt ratio down, from its peak of 121% then, to 65% today (with some ups and downs on the way). Moreover, if that ratio carries with it an intolerable peak or tipping point to be avoided, no economist or financial expert has yet identified or substantiated it. Therefore, given that there was not even a hint of financial doomsday approaching in 1946 when the ratio was 121%, it seems entirely safe to assume that keeping the ratio under 80% should ensure that we remain a long distance from financial doomsday. Many economists on all sides of the ideological spectrum have confirmed the debt-to-GDP ratio as a key indicator for the economy; establishing a target control range for that number, and managing to that target range, is how we’ll define and measure “fiscal responsibility.”
• Economic growth in the two generations since 1946 explains the continued confidence the financial markets have in the USA's creditworthiness and future prospects; a confidence that is reflected in today's low inflation and real interest rates. Sustaining that condition indefinitely should be a long-term goal.
• Widespread misunderstanding of the beneficial effects of economic growth still causes the media, the opinion leaders, and therefore the public, to focus on a false dilemma: "cut spending or increase tax rates." As a result, the media, the opinion leaders, and therefore the public, almost unanimously ignore the third and most effective solution, "increase economic growth." Overcoming that misunderstanding is vitally important for the well-being of the next two generations.
Actions items and quantitative targets:
• Better-inform the mainstream media and the public as to the benefits that economic growth has delivered in the past, and can continue to deliver in the future.
• Redefine "balanced budget" to mean "the federal budget that would result in no change in the ratio of debt-to-GDP"—in other words, the budget that yields an economic growth rate equal to the debt growth rate. The extremely important by-product of that change is that it forces “GDP growth” into the debate, whether our politicians and opinion leaders like it or not. Growth matters, and growth-friendly policies matter. Contrary to widespread opinion, growth does not “just happen.” [For economists: It is endogenous, not exogenous.] We can cause it; we can choose to forgo it; but we cannot afford to continue just taking it for granted.
• Establish short run fiscal policies that fully-fund national security enhancement programs, while "balancing the budget" if possible (see new definition above). Important note: Properly securing the nation's citizens and institutions will take precedence over (even) the new definition of "budget balance"—a lesson we learned the hard way as a result of our late 1990s experiences and the subsequent , costly developments.
• Establish the long run fiscal policy target of keeping the debt-to-GDP ratio between 80% and 40%, and the net interest portion of tax receipts lower than 12%. Instruct the GAO and CBO to project, publish, and publicly defend long-run projections for the ratio of debt to GDP, and its closely-related coverage ratio, net interest as a percent of tax receipts.
Obstacles to consider and overcome
Obstacle 1. Baby boomer retirements will soon reduce the ratio of workers to retirees, thereby increasing social security's cost-per-taxpayer. With insufficient increases in income-per-taxpayer or in the number of taxpayers, social security would take a larger percentage bite out of each taxpayer’s income.
Obstacle 2. Medicare and Medicaid programs will increase the healthcare benefits available to the elderly, thereby increasing those programs' cost-per-taxpayer. With insufficient increases in income-per-taxpayer or in the number of taxpayers, Medicare and Medicaid would take a larger percentage bite out of each taxpayer’s income.
Obstacle 3. Increasing tax rates is always a highly unpopular idea, whether it is income tax rates, payroll tax rates, or other tax rates. If economic growth is insufficient to eliminate the need for tax rate increases, public resistance to tax rate hikes will place upward pressure on the ratio of debt-to-GDP.
Obstacle 4. Last but not least, the biggest obstacle of all is getting politicians, the media, and other opinion leaders to stop peddling the false dilemma of "cutting spending or increasing tax rates," and start adding “economic growth” to the public discourse. [When millions of workers get a raise or a higher paying new job, they pay more taxes while simultaneously enjoying more take-home pay. That’s “economic growth.”] Abandoning the false dilemma requires courage. It requires trust that the general public, with a little help from opinion leaders, would quickly come to understand the “brand new” idea of “economic growth” as a third way to ensure continued financial soundness.
That’s Daydream #1, a brief depiction of how a business management team might begin to structure the fiscal problem solving process. Now let’s get back to the real world. In my view, if any of the four obstacles above is insurmountable, it’s the fourth one: the Courage Gap. The requisite courage seems to be in very short supply, so if that obstacle is to be overcome, it will have to come from popular pressure. I can’t see it coming from the leaders in place; I predict we'll either have to replace them, or drag them kicking and screaming to the correct topic of debate.
If that sounds like an overstatement, try the following exercise illustrating the formidable magnitude of the Courage Gap. Try to picture each of the following, one at a time, in your mind’s eye. [Three more of my daydreams.]
Daydream #2: A Democrat
Try to picture a Capitol Hill Democrat standing up in front of the C-SPAN cameras and saying:
If tax rate increases would be growth-unfriendly, reducing workers’ take-home pay, reducing the job-creation rate, or reducing the attractiveness of the USA as a place to create new, better businesses—all of which hurt our economy’s overall growth rate—I promise to support keeping tax rates as they are instead of hiking them, and will support reducing them again in the future if that, too, would foster more growth and better jobs. Secure economic growth is a higher priority than tax rate hikes, for the long-run good of our grandchildren.
Daydream #3: A Republican
Now try to picture a Capitol Hill Republican standing up in front of the C-SPAN cameras and saying:
I support policies that enhance the USA’s economic growth rate—a process that will create more rich people out of the ranks of the poor and the middle class—a process that will in all likelihood topple some of our current rich, many of whom work today in overconfident, underperforming businesses. Get used to an increasing number of rich people; get used to exporting old, costly, obsolete jobs to make room for new, higher-paying, more productive jobs; and get used to seeing no sympathy from me for businesses that can’t make it without government subsidies. Any business that can't compete needs to get out of the way. Secure economic growth is my highest priority, for the long-run good of our grandchildren.
Daydream #4: An appointed official
Finally, try to picture a public official standing up in front of an audience that’s been taught for generations to fear the words “deficit” and “debt” whenever they are preceded by the word “federal.” In your mind’s eye, try to picture that official saying:
Folks, I have a confession to make. Too many of us have been peddling half-truths and single-entry-accounting, and it’s time that came to a stop. We’ve been scaring you with huge, obscure numbers such as “$50 trillion present value of future liabilities”—without telling you whether that’s acceptable or unacceptable—why or why not—and if not, what we, the so-called experts, think an “acceptable” level would be for such an obscure number. We’ve been using that obscure, contextless number to back up our assertion that this country has been“fiscally irresponsible”—but we haven’t defined that term either, much less how to measure it.
We’ve been leading you to believe that federal borrowing is poison, and that we therefore must “balance the government’s dollar budget”—without reminding you of several truisms: that borrowing money for good investments is sound financial practice; that protecting our nation is a good investment; that growing our economy is another good investment; and that a better goal would therefore be to “balance the ratio of debt to GDP”—that is, the ratio of our debt the size of our economy.
We’ve been implying to you that our nation is bankrupt, or will be soon, without defining that important term, and without explaining why the bond markets and foreign exchange markets disagree vehemently with that assertion—otherwise, they’d already have driven inflation and interest rates sky high, instead of continuing to invest confidently in our nation’s future.
We’ve been peddling the false dilemma that we must either “cut spending or raise tax rates” without revealing that economic growth is a third solution—and a much-preferred solution at that, because it yields growing tax receipts without an increase in tax rates.
It’s time our half-truth, incomplete arguments came to a stop; it’s time we, your opinion leaders, started talking about how to enhance our nation’s economic growth rate. It’s time we supplanted our negative message with positive proposals for improving productivity rates, job-creation rates, innovation rates, skills acquisition rates, and legal immigration rates. It’s time we started promoting hope and confidence, instead of peddling fear.
It’s time we started behaving like confident leaders with convictions about how to ensure national security and sustained economic growth—instead of behaving like distressed bean-counters with no positive ideas, only warnings about our bleak future and complaints about how oblivious and ignorant everybody else is. It’s time opinion leaders like me started behaving less like Ebenezer Scrooge, whose top priority was the money, instead of what the money would buy; it’s time we started behaving more like Ronald Reagan, who had no qualms about spending money for good investments in long-term security and growth, and borrowing what was necessary for those good investments.
See what I meant? Those daydreams are ultrafantasies, aren’t they? I told you it would be hard to picture those in your mind’s eye. Never mind that the only thing capable of guaranteeing a stable currency, low interest rates, low inflation, affordable security, and long-term viability for our social insurance system is a vibrant, growing economy; nobody is talking about how to enhance the economy’s growth. Why not? Because it upsets the political applecart, and places government bureaucrats way, way outside their comfort zone.
But there’s a bright ray of hope: the needle in the haystack I already mentioned. Alison Fraser’s magic wand. I’ll cover it in detail next time. [UPDATE: Here's the link to Part 2.]
Great post. I think the problem is that politicians like to simplify the problem beyond usefulness and play on people's ignorance of the real issues, invoking fear that only they have the solution for.
I have a proposed alternative to add to the discussion to help pay for some of the future liabilities that doesn't get much consideration.
Currently, $3.1 trillion of the $8.5 trillion U.S. government debt is intragovernmental. It is primarily bonds held in the Social Security Trust fund. These government bonds in the trust fund earn a fairly low interest rate, especially considering that the funds are being used primarily for people's retirement.
Why doesn't the government sell those bonds to the public and, with the proceeds, buy a set of well diversified stocks. International diversification is a plus. Something like the Vanguard total stock market index fund, plus some international fund as well. A low cost, minimal management portfolio of diversfied stocks.
Just to show how much of a difference it would make:
With $3.1 trillion in government bonds earning roughly 5% annual interest, we can expect, after a 30 year period, for the bonds to be worth $13.4 trillion. The stock market has historically returned approximately 10% annual returns. With a 10% annual return, we can expect the portfolio of $3.1 trillion stocks to grow to roughly $54.1 trillion dollars! That's a difference of $40.7 trillion dollars, or 300% more assets.
The common objection to this approach is, "what about the increased risk?" and "do we really want the government owning a significant amount of private assets?"
To the first objection, I think that the government would be able to handle the risk as long as the portfolio of stocks didn't become too large an amount. We could hire some of the best finance people in our country to tackle the problem of protecting the country from the riskiness of the market by having the proper mix of stocks and bonds and evaluating several "worst case" type scenarios. Finance theory is pretty well developed and I think it wouldn't be much of an issue to tackle the problem from that perspective. Every company that has defined benefit pension plans invests a significant amount of their retirement assets in the stock market. I don't see any reason why the government would not be able to have something similar for its retirement account.
Additionally, during a bear market, the U.S. government could always issue a greater than normal amount of debt to pay for current retiree benefits rather than selling off too great a portion of retirement assets. We can of course have the financial planners determine a maximum % of assets that can be sold from the portfolio to stay solvent in the future. Also, during bear markets, interest rates tend to be lower than the average, as the U.S. economy is slowing or in recession, typically prompting the FED to cut interest rates. During bull markets, the government could sell an additional amount of the stocks in the portfolio to pay off the additional debt it took on. On top of that, the government will typically be receiving a greater amount of tax recipts. The government could thus weather the ups and downs in the stock market much better than an individual person could. If the stock market crashes right when someone is about to retire, they wouldn't have much recourse. The government, however, will still have people contributing into the system during a recession, able to handle the flucuations much easier.
The other objection is about not wanting the government to control a significant portion of corporations. This indeed is somewhat of a concern. I think the problem is overblown, however, by fear of government. I think the system could be designed to not allow the governmet to excercise its influence in corporate affairs though the voting power it receives from its ownership stake. Perhaps we could let different groups in the private sector vote the proxies for the various companies, they would be compensated based on the returns of the group of companies they voted for. Each private financial group would be ranked amongst the other groups based on average returns over perhaps a 3-5 year period (which should be influenced by voting in a good board of directors and voting for the best interests of the shareholders for other proxy votes). The compensation would be significant for the companies to do their research and vote in the best manner possible. I'm sure a reasonable system could be worked out. Also, despite this negative, the potential benefits need to be taken into consideration. The amount of extra assets available for the retirement account is probably worth this negative in my opinion.
This could be just one possible solution to the looming entitlement burden. This, perhaps along with increasing the eligibility age for benefits by a few years, would be the best way to reduce the pain from the transition to the baby boomer retirement.
Of course, I wholely support growth friendly policies as the third leg to the problem.
Posted by: Stephen Reed | 03 December 2006 at 19:36
Steve Conover wrote: "Those daydreams are ultrafantasies, aren’t they?"
Yes, they are.
The primary reason they are ultrafrantasies is that almost nobody understands enough about economic systems to be able to make daydreams 2 through 4 happen (daydream 1 is somewhat more plausible to me, though still a stretch).
The blessing and the curse of a democracy is that the elected officials tend to reflect the general population. The vast majority of the population can't calculate a percentage, doesn't have any idea what an exponential curve (for growth) is, can't possibly grasp the concept of debt-to-GDP ratios, etc. and it's unlikely that our elected officials are going to rise to the task of being able to explain it all to their constituents. It will not and cannot happen.
Fortunately, the Wisdom of the Crowds seems to have prevailed anyway. Steve wants debt to be 60% of GDP and lo and behold, it is! People like Steve versus people like the Concord Coalition have managed to push and pull us to an adequately optimal position on most economic issues. Amazing!!!
Posted by: Bret | 04 December 2006 at 13:06
Federal law prohibits funding the Trust Funds with common stock. Laws can be changed, but I wouldn't hold my breath for this stricture to be lifted.
Further, and more importantly, WHY would any rational person believe that government is better able to get a higher return on taxpayers' monies than the individual taxpayers can themselves?
Either abolish Social Security, or privatize it. The only 'safety net' is the dependency attitude of those in government.
'Be free.'
'Be free.'
Posted by: a Duoist | 05 December 2006 at 04:49
"....nobody is talking about how to enhance the economy’s growth. Why not? Because it upsets the political applecart, and places government bureaucrats way, way outside their comfort zone."
____________________________________
Steve,
It also upsets the federal reserve. I keep harping on the same issue. Monetary policy, as measured by the yield curve, is too tight. While Bernanke has stated that inflation is the boogeyman I seriously doubt there isn't a target GDP growth rate in his head and 2-2.5% GDP growth is getting us nowhere.
Posted by: Bob | 05 December 2006 at 13:25
"do we really want the government owning a significant amount of private assets?"
___________________________________
A socialist would.
Posted by: Bob | 05 December 2006 at 13:28
I like the idea of using the stockmarket to pay for future liabilities, yet I would be wary by so much government involvement. All I would do to the social security system is to price index benefits (perhaps after a slight boost to help placate AARP) and that system will be solvent. Instead of diverting current social security tax funding to private accounts, a better policy would be to create universal 401(k) accounts on top of the current system as I've seen outlined by Gene Sperling in 'The Pro-Growth Progressive'. These accounts could be matched generously at low levels of savings, providing increased incentives for people who are not in the habit of saving to begin doing so, and thereby increasing national savings. Yes, individuals would have to deal with volatility, and if they are scared into keeping their retirement savings in cash or bonds, for better or worse thats their decision. The benefit of having individuals invest is that the government would be too big of an investor. Any sizable change in its asset allocation would move markets substantially. Also, I wouldn't be convinved that the government could own a substantial portion of corporate America and be kept for exercising direct control (and limits on direct control of assets by owners would seem to undermine property rights). In all, having this system would allow people to receive ever rising retirement incomes as the economy grows (and give people a stake in a rising economy) and take pressure off of government finances, while leaving the social security benefit as a floor to guarantee some income security.
The major fiscal problem in the future will be Medicare. According to the Social Security and Medicare Trustee Reports for 2006, Medicare's unfunded liability is $70.5 trillion compared to social security's unfunded liability $13.4 trillion. I'm pretty sure if we switch to price indexing with social security, that unfunded liabiilty disappears (then we only have to grow the economy by the same rate as the growth of the elderly population to keep social security the same proportion of GDP it is today - it would be a tragedy in its own right if the economy's growth was too slow for that to happen). Ultimately, I don't believe we will ever see levels of debt that are excessive relative to GDP if we can reform Medicare so that cost growth is much closer to the rate of GDP growth.
The two most important economic policies will be to a) maintain a decent trend pace of economic growth with low inflation and b) reform Medicare. If we do that, I agree completely with Steve that occassional budget deficits of a a few percent GDP are of no concern - particularly if those deficits are funding security or important technological research as both in my view are very important to growth.
Posted by: J | 06 December 2006 at 19:29