The Trillion Dollar Question

The Daily Reckoning: Weekend Edition
Baltimore, Maryland
February 3-4, 2007
by Kate "Short Fuse" Incontrera


This past Wednesday, your DR editors, double-fisting extra large Dunkin Donuts coffee, hopped on the train and traveled to the belly of the beast. We planned on meeting the director of our upcoming documentary in Capitol Hill to do some reconnaissance work for the film.

Our first stop of the day was the Dirkson Office Building, where the U.S. Senate Budget Committee was having a hearing. We were ushered into a room…you know the kind of room, dear reader – it’s what you see when you speed past C-SPAN while channel surfing.

The subject of this particular hearing was "Solutions to Our Long-Term Fiscal Challenges." We settled in and checked our watches…we were a bit early, surely more would be joining us. Slowly, people who looked barely old enough to drink, much less vote, filtered in and sat on the "staff" side. Only two reporters joined us on the press side.

Four people were testifying: Bob Bixby, of The Concord Coalition; Dr. Stuart Butler, of The Heritage Foundation; Jason Furman, of The Bookings Institute and Joseph Minarik of The Committee for Economic Development. Senator Kent Conrad from North Dakota was presiding.

One of the major threats to our economy, began Senator Conrad, are the budget stresses from the baby boomers as they begin to retire en masse. He quoted Bernanke, who recently had this to say to the Senate Budget Committee: "If early and meaningful action is not taken, the U.S. economy could be seriously weakened. The longer we wait, the more severe, the more draconian, the more difficult, the objectives are going to be. I think the right time to start was about ten years ago."

After that uplifting remark from the Fed chairman, Conrad continued, "We need the will to put our fiscal house back in order…the sooner we act, the better."

Here’s the trillion-dollar question: how exactly do we get our "fiscal house" in order? We heard four testimonies with varying answers – but all four agreed that a balanced budget, and reforms to both Medicare and Social Security are necessary. How we are going to go about these reforms, is anyone’s guess…but here’s what these four had to say…

Bob Bixby began by saying, "Just as a family anticipating major new expenses, such as a home purchase or college education, must begin to save for these financial obligations, the federal government should be taking steps now to improve its fiscal position in anticipation of the cost associated with the retirement of the baby boom generation."

So, how do you balance the budget of the world’s biggest spender? You can’t just cut up its credit cards…you have to raise taxes…or cut taxes…correct indexing…reform entitlement programs – all of which were suggested at this hearing. But before your eyes glaze over, dear reader, let us assure you that we will just give you the bare bones description of the proceedings.

"A good first step," said Bixby, "in improving the budget outlook is to identify savings from elimination wasteful and unnecessary programs and increasing the efficiency of the other government programs, as well as eliminating narrowly targeted tax breaks that add to the complexity of the tax code without producing meaningful economic benefits. Such provisions divert resources form more pressing nation needs and increases public cynicism about the fairness of the federal budget.

"Similarly, as this Committee highlighted in a recent hearing, there is the potential for increased revenues by closing the ‘tax gap’ – the difference between taxes that are owed and the revenues that are actually collected."

The tax gap was something that was brought up in more than one testimony. While we understand that its unfair that some people get away with not paying taxes, what these testimonies suggest is that we dump more money into the IRS, so they can track people down. But…shouldn’t we be CUTTING spending?

Moving on…Stuart Butler pointed to unfunded obligations as a place to start when looking at the U.S. budget reform. "As Comptroller General David Walker has pointed out, this entitlement driven unfunded growth in spending will impose staggering financial burdens on our children and grandchildren.

"The total present value of unfunded federal obligations of the federal government, or fiscal exposure, is now $50.5 trillion ($38.8 trillion of which is due to Medicare and Social Security.)

"This exposure translates into a financial burden of $440,000 for every household or, put differently, a mortgage of $170,000 placed in the crib of each and every baby born in America."

Here, we are brought to another point of agreement in all four testimonies: Social Security and Medicare MUST be reformed. As Bixby points out, "Over the next 75 years, Social Security’s revenues are projected to hover in a narrow range around 13 percent of the nation’s taxable payrolls. The program’s costs, on the other hand, are projected to grow rapidly from 11 percent of the nation’s payrolls today to 15.5 percent in 2025 and more gradually thereafter to more than 18.7 percent by 2080.

"While the conventional view is that those rising costs will be due to the aging of the population, that view is incomplete. A deliberate policy of paying ever-higher real benefits is also a significant factor. Thus, from a policy perspective, if the aim of reform is to address Social Security’s financing problem at its source – rising costs – either adjusting the program for increasing longevity or constraining the growing value of its scheduled monthly benefits are the two most logical solutions."

Suggested reforms for Social Security: raising the "normal retirement age." As the baby boom generation is poised to retire, not only will benefit spans lengthen, but there will be a labor shortage to cope with. Bixby feels that "anything we can do to encourage people to work a few more years and employers to accommodate older workers will help the economy."

Other propositions for Social Security reform include treating Social Security benefits like private pensions for tax purposes, payroll tax increases, personal account options, focusing Social Security benefits on those who need them most – and (the most ‘creative’ option, in our opinion) changing the formula for determining initial benefits.

Let’s explain what that means exactly, as Jason Furman of The Bookings Institute puts it:

"Policymakers indexed Social Security benefits, the tax brackets, and other parameters of tax and spending programs to adjust for the cost of living. The Consumer Price Indices currently used for indexation employ and outdated procedure that overstates inflation. Specifically, they ignore the fact that consumers partially insulate themselves from shifting prices by switching to goods whole relative price is falling. Although policymakers should not substitute their judgment for the nonpartisan professionals at the Bureau of Labor and Statistics (BLS), policymakers should pick a more accurate measure of the cost of living. A good candidate is the Chained CPI-U (C-CPI-U) that BLS started released on a monthly basis in 1999.

"To date, this index is running 0.5 percentage point lower that the traditional CPI. If all federal programs and taxes switched to the C-CPI-U, by the end of the decade the government would save more than $40 billion, with the bulk of the savings divided roughly equally between preventing de facto Social Security benefit increases and tax cuts that Congress never intended. Over time, the savings would continue to grow."

Did you get all that? Basically, what Furman is proposing is that we use a different measure to calculate cost of living – one that is running lower than the current CPI, so we can give people less in the way of benefits. Oh, and then they could avoid that pesky task of actually telling people that’s what’s happening. Don’t you just love politicians?

Moving on to Medicare – which is an even bigger problem than Social Security for our economy…

Medicare spending has expanded 12 percent in 2006 and will grow 13 percent more in 2007. Combined Medicare and Medicaid costs will surge 8 percent per year and Social Security costs by 6 percent annually. These programs will rise from 8.5 percent to 10.7 percent of GDP as the baby boomers begin to retire.

In other words, we’re in quite a pickle with healthcare – and interestingly, while there was quite a bit of time and suggestions in this hearing dedicated to Social Security reform, solutions for the Medicare problem were definitely lacking.

Some proposed to convert the current tax exclusion for employer-sponsored insurance into a tax credit or a voucher. This, in their words, would make the subsidy more progressive, provide a bigger incentive for people to get insurance, remove the incentive to have more generous insurance and make the financing of healthcare more transparent.

As you can see, our government has some tough decisions to make going forward – and unfortunately, there is some dissention among those who make these decisions. To this end, Pete Peterson wrote this in his 2004 book, Running on Empty:

"If America chooses the right future, it will be because we learn again to cooperate politically and embrace a positive vision of what our nation can become. Yes, we have to make some tough choices. But instead of obsessing over the tax hike that outrages us, or the benefit cut that shocks us, we need to focus on everything our nation can achieve if we all made an effort to come to terms with our future."

In closing, Senator Conrad echoed Peterson’s sentiment in saying, "The solution to these problems is not ‘our way or no way.’ If there is no compromise, we will continue to prevent action. I don’t believe either party can do this on their own – both sides need to give in."

Attending this hearing was an eye-opening experience for your editors (that is, for the moments we weren’t nodding off – we can’t help but wonder how Strom Thurmond managed all those years). We got to see the people that are concerned about the path we are on – but, in many ways, we were disappointed. The turnout to the hearing by the press was pretty pathetic…and many of the solutions to these fiscal problems are laughable.

On the other hand, we don’t have any better solutions to these problems…debt, deficits, unfunded liabilities – it’s all very complex, not to mention politicial. There are clearly no quick fixes and a lot of bureaucratic BS involved. On the bright side, it is nice to know that there are at least some people in our country who are waving the red flags and realize that our fiscal situation is unsustainable. Now they just need to learn how to play nicely together. Heh. Heh.

Short Fuse
The Daily Reckoning

P.S. "The Social Security system was considered to be a great improvement of the Roosevelt era," we wrote in Empire of Debt. "It was supposed to provide a cushion of cash for retired people – so they wouldn’t have to eat dog food in their old age. But never was a shiny bell cast by world improvers without a big crack in it somewhere…Social Security reduced the availability of capital and indirectly reduced capital investment. Like other taxes, Social Security made people poorer – by reducing the rate of economic growth."

You can read all about what has been called the "Ten Thousand Commandments" in Empire of Debt. Get your copy here:

The Most Feared Book in Washington!

THIS WEEK in THE DAILY RECKONING: Snoozing at your desk again and missed an issue of the DR? Never fear, we have all of this week’s issues catalogued for you, below, because we never sleep…

Confessions of a Newsletter Man   02/02/07
by Bill Bonner

"The newsletter business can be a fairly dangerous, even cutthroat business to enter into. Some people do it on a whim, and some do it merely because they have no reason not to. Bill Bonner reminisces about a few industry legends…"

Corporate America to the Rescue?   02/01/07
by Dr. Kurt Richebacher

"The Good Doctor is back – and still wondering why our friends at the Fed seem to think that the U.S. economy is ‘sound’ – even though all the signs seem to be saying otherwise. Read on…"

The Rising Liquidity Wave    01/31/07
by Puru Saxena

"During the past year, the ongoing monetary inflation, credit growth and expanding liquidity environment drove up prices in various markets. Apart from rising interest rates and unrest in the Middle East, we did not get any major negative developments on the economic front, which also helped the global markets. Puru Saxena looks forward to the year ahead to see what we can expect from the various asset classes…"

How David Slew Goliath    01/30/07
by Mark Skousen

"Two world-renowned economists passed away in 2006: Milton Friedman and John Kenneth Galbraith. Frequent DR contributor Mark Skousen recently attended the American Economic Association meeting where both economists were honored – and gives his full report below…"

Feed Your Kids Pig Chow    01/29/07
by The Mogambo Guru

"With a crowd of onlookers urging him forward, the Mighty Mogambo attacks the insanity of Bernanke’s Fed policy with great vehemence and Icky Mogambo Spittle (IMS). Find out how inflation could be the cause of great change in your children’s diets, as the Mogambo explains why you might need to…"