OPINION

November 26, 2012, 6:41 p.m. ET

Cox and Archer: Why $16 Trillion Only Hints at the True U.S. Debt

Hiding the government's liabilities from the public makes it seem that we can tax our way out of mounting deficits. We can't.


By CHRIS COX AND BILL ARCHER

 
 
 
 
 
A decade and a half ago, both of us served on President Clinton's Bipartisan Commission on Entitlement and Tax Reform, the forerunner to President Obama's recent National Commission on Fiscal Responsibility and Reform. In 1994 we predicted that, unless something was done to control runaway entitlement spending, Medicare and Social Security would eventually go bankrupt or confront severe benefit cuts.
 
 
 
Eighteen years later, nothing has been done. Why? The usual reason is that entitlement reform is the third rail of American politics. That explanation presupposes voter demand for entitlements at any cost, even if it means bankrupting the nation.
 
 
 
 
A better explanation is that the full extent of the problem has remained hidden from policy makers and the public because of less than transparent government financial statements. How else could responsible officials claim that Medicare and Social Security have the resources they need to fulfill their commitments for years to come?
 
 
 
As Washington wrestles with the roughly $600 billion "fiscal cliff" and the 2013 budget, the far greater fiscal challenge of the U.S. government's unfunded pension and health-care liabilities remains offstage. The truly important figures would appear on the federal balance sheet—if the government prepared an accurate one.
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But it hasn't. For years, the government has gotten by without having to produce the kind of financial statements that are required of most significant for-profit and nonprofit enterprises.




The U.S. Treasury "balance sheet" does list liabilities such as Treasury debt issued to the public, federal employee pensions, and post-retirement health benefits. But it does not include the unfunded liabilities of Medicare, Social Security and other outsized and very real obligations.
 
 
 
As a result, fiscal policy discussions generally focus on current-year budget deficits, the accumulated national debt, and the relationships between these two items and gross domestic product. We most often hear about the alarming $15.96 trillion national debt (more than 100% of GDP), and the 2012 budget deficit of $1.1 trillion (6.97% of GDP). As dangerous as those numbers are, they do not begin to tell the story of the federal government's true liabilities. 



 
The actual liabilities of the federal government—including Social Security, Medicare, and federal employees' future retirement benefits—already exceed $86.8 trillion, or 550% of GDP. For the year ending Dec. 31, 2011, the annual accrued expense of Medicare and Social Security was $7 trillion. Nothing like that figure is used in calculating the deficit. In reality, the reported budget deficit is less than one-fifth of the more accurate figure.
 
 
 
Why haven't Americans heard about the titanic $86.8 trillion liability from these programs? One reason: The actual figures do not appear in black and white on any balance sheet. But it is possible to discover them. Included in the annual Medicare Trustees' report are separate actuarial estimates of the unfunded liability for Medicare Part A (the hospital portion), Part B (medical insurance) and Part D (prescription drug coverage).
 
 
 

As of the most recent Trustees' report in April, the net present value of the unfunded liability of Medicare was $42.8 trillion. The comparable balance sheet liability for Social Security is $20.5 trillion.
 
 
 
Were American policy makers to have the benefit of transparent financial statements prepared the way public companies must report their pension liabilities, they would see clearly the magnitude of the future borrowing that these liabilities imply. Borrowing on this scale could eclipse the capacity of global capital markets—and bankrupt not only the programs themselves but the entire federal government.
 
 
 
These real-world impacts will be felt when currently unfunded liabilities need to be paid. In theory, the Medicare and Social Security trust funds have at least some money to pay a portion of the bills that are coming due. In actuality, the cupboard is bare: 100% of the payroll taxes for these programs were spent in the same year they were collected.
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In exchange for the payroll taxes that aren't paid out in benefits to current retirees in any given year, the trust funds got nonmarketable Treasury debt. Now, as the baby boomers' promised benefits swamp the payroll-tax collections from today's workers, the government has to swap the trust funds' nonmarketable securities for marketable Treasury debt. The Treasury will then have to sell not only this debt, but far more, in order to pay the benefits as they come due.
 
 
 
When combined with funding the general cash deficits, these multitrillion-dollar Treasury operations will dominate the capital markets in the years ahead, particularly given China's de-emphasis of new investment in U.S. Treasurys in favor of increasing foreign direct investment, and Japan's and Europe's own sovereign-debt challenges.
 
 
 
When the accrued expenses of the government's entitlement programs are counted, it becomes clear that to collect enough tax revenue just to avoid going deeper into debt would require over $8 trillion in tax collections annually. That is the total of the average annual accrued liabilities of just the two largest entitlement programs, plus the annual cash deficit.
 
 
 
Nothing like that $8 trillion amount is available for the IRS to target. According to the most recent tax data, all individuals filing tax returns in America and earning more than $66,193 per year have a total adjusted gross income of $5.1 trillion. In 2006, when corporate taxable income peaked before the recession, all corporations in the U.S. had total income for tax purposes of $1.6 trillion. That comes to $6.7 trillion available to tax from these individuals and corporations under existing tax laws.

In short, if the government confiscated the entire adjusted gross income of these American taxpayers, plus all of the corporate taxable income in the year before the recession, it wouldn't be nearly enough to fund the over $8 trillion per year in the growth of U.S. liabilities. Some public officials and pundits claim we can dig our way out through tax increases on upper-income earners, or even all taxpayers. In reality, that would amount to bailing out the Pacific Ocean with a teaspoon. Only by addressing these unsustainable spending commitments can the nation's debt and deficit problems be solved.
 
 
 
Neither the public nor policy makers will be able to fully understand and deal with these issues unless the government publishes financial statements that present the government's largest financial liabilities in accordance with well-established norms in the private sector. When the new Congress convenes in January, making the numbers clear—and establishing policies that finally address them before it is too late—should be a top order of business.
 
 
 
 

Mr. Cox, a former chairman of the House Republican Policy Committee and the Securities and Exchange Commission, is president of Bingham Consulting LLC. Mr. Archer, a former chairman of
the House Ways & Means Committee, is a senior policy adviser at PricewaterhouseCoopers LLP.
 
 
 
 


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Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved



Inside America’s Tax Battle

Laura Tyson

26 November 2012
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BERKELEYAmerica’s recent presidential election answered the question of whether an increase in revenues will be part of the country’s long-run deficit-reduction plan. The answer is yes: there is now bipartisan agreement on the need for a “balancedapproach that includes revenue increases and spending cuts.
 
 
 
 


But there are still deep political and ideological divisions about how additional revenues should be raised and who should pay higher taxes. If a preliminary agreement on these questions is not reached by the end of the year, the economy faces a “fiscal cliff” of $600 billion in automatic tax increases and spending cuts that will shave about 4% from GDP and trigger a recession.

 
 
 
 
 
The majority of citizens agree with President Barack Obama that tax increases for deficit reduction should fall on the top 2-3% of taxpayers, who have enjoyed the largest gains in income and wealth over the last 30 years. That is why he is proposing that the 2001 and 2003 rate cuts for these taxpayers be allowed to expire at the end of the year, while the rate cuts for other taxpayers are extended.
 
 
 
 

So far, Obama’s Republican opponents are adamant that the cuts be extended for all taxpayers, arguing that increases in top rates would discourage job creation. This claim is not supported by the evidence. Recent research finds no link between tax cuts for top taxpayers and job creation. In contrast, tax cuts for the bottom 95% have a positive and significant effect on job growth.
 
 
 
 

During the past three decades, income inequality in the United States has increased significantly; indeed, the US now has the fourth-highest level of income inequality in the OECD, behind Chile, Mexico, and Turkey. At the same time, as the largest tax cuts have gone to high-income taxpayers, the US tax system has become considerably less progressive. The US needs fiscal measures that both curb the deficit and contain rising income inequality – and the inequality of opportunity that it begets.
 
 
 
 

But how should additional revenues be raised from top taxpayers to achieve these two goals? Most economists believe that increasing revenues by reforming the tax code and broadening the tax base is “probablybetter for the economy’s long-term growth than raising income-tax rates. The analytical case for this belief is strong, but the empirical evidence is weak.
 
 
 
 
 

In theory, higher marginal tax rates have well known negative effects – they reduce private incentives to work, save, and invest. Yet most empirical studies conclude that, at least within the range of income-tax rates in the US during the last several decades, these effects are negligible.
 
 
 
 
 
A recent Congressional Research Service report, withdrawn under pressure from Congressional Republicans, found that changes in the top income-tax rate and the rate on capital gains had no discernible effect on economic growth during the last half-century. A recent review of the economic literature by three distinguished academics found no convincing evidence that real economic activity responds materially to tax-rate changes on top income earners, although such changes do affect their tax-avoidance behavior. So Obama has evidence on his side when he says that allowing the tax cuts for high-income taxpayers to expire at the end of the year will not affect economic growth.
 
 
 
 

Republicans have proposed tax reforms in lieu of rate hikes on high-income taxpayers to raise revenues for deficit reduction. Obama has signaled that he is willing to consider this approach, provided it increases tax revenues from the top 2-3% by at least the same amount as higher rates while protecting other taxpayers.
 
 
 
 


The federal tax system is certainly in need of reform. Tax expenditures – which include all deductions, credits, and loopholesaccount for about 8% of GDP.




Indeed, the US tax code is riddled with special preferences and contains large differences in effective tax rates across individuals and economic activities. These differences distort decisions about investment allocation and financing.
 
 
 
 
 
Reforms that made the tax system simpler, fairer, and less distortionary would have a beneficial effect on economic growth, although economists concede that the size of this effect is uncertain and impossible to quantify.
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Because tax expenditures are so large, limiting them could raise a significant amount of additional revenue that could be used both for deficit reduction and to finance across-the-board cuts in income-tax rates. Analysis of the Simpson-Bowles and Domenici-Rivlin deficit-reduction plans by the nonpartisan Tax Policy Center confirms that this approach is arithmetically feasible. Reducing large regressive tax expenditures like preferential tax rates for capital gains and dividends and deductions for state and local taxes, and replacing deductions with progressive tax credits, could generate enough revenue to finance rate cuts for all taxpayers, increase the tax code’s overall progressivity, and contribute meaningfully to deficit reduction.
 
 
 
 

But the odds of such an outcome are very low: what is arithmetically feasible is unlikely to be politically possible. Efforts to cap popular tax expenditures will encounter strong opposition from Republicans and Democrats alike. Nonetheless, some tax reforms are likely to be a key component of a bipartisan deficit-reduction deal, because they provide Republicans who oppose increases in tax rates for high-income taxpayers with an ideologically preferable way to increase revenue from them.
 
 
 
 
 

Unfortunately, it will take time to negotiate tax reformsmore time than remains until the end of the year, when the 2001 and 2003 tax cuts are scheduled to expire for all taxpayers. But there is still time to negotiate an agreement that extends these cuts for the bottom 98%, and that contains temporary measures to cap deductions and credits for high-income taxpayers in 2013. Such an agreement could help to break the political impasse over whether and how much these taxpayers’ rates should rise next year, thereby preventing the US from falling over the fiscal cliff and back into recession.
 
 
 
 



Laura Tyson, a former chair of the US President's Council of Economic Advisers, is a professor at the Haas School of Business at the University of California, Berkeley.



Markets Insight

November 26, 2012 1:47 pm
 
Time to end the eurozone’s ad hoc fixes
 

We are fast approaching the third anniversary of the news from Athens in December 2009 that triggered the eurozone crisis.



The Greek government at the time announced that it had grossly understated the scale of its budget deficit. The persistent crisis is sorely testing the nerves of financial markets.


Urgently needed are bold official actions to end the uncertainty and start to build confidence. The architecture should be an agreement on an integrated package of key policy measures accompanied by clear implementing timelines.




Europe’s authorities have consistently underestimated the contagion impact of their ad hoc approaches and failed to learn from past sovereign debt experiences.




For example, I saw a similar saga in Latin America in the 1980s. The failures year upon year to find effective debt crisis resolution led to a lost development decade for the region.




The corner was turned only when Nicholas Brady, then US Treasury Secretary, developed a growth-orientated, market-based approach in 1989first with Mexico and then with 17 other sovereigns. The European leaders have failed to learn from this experience at great cost.




At a minimum, an integrated eurozone package should be finalised very soon, with timelines for implementation announced for the next six to nine months. This package should be based on the following essential steps.




First, a banking union must be put in place to separate banks from sovereigns. This would reformulate the balance of regulation in favour of enabling banks to lend more to small and midsized enterprises, which are the prime job creators in most economies, while also enhancing the credibility of Europe’s regulators.




The latest arguments over how much authority the European Central Bank should have and its relationships to the European Banking Authority and national regulators are worrying.




Progress here should not be undermined by turf battles, or by debates about whether the ECB’s powers should be confined to only the biggest banks.




From Northern Rock to Lehman Brothers we saw how crises can be triggered by smaller financial institutions in our intensively interconnected financial system. I hope there will be agreement soon to establish a single supervisor that can work closely with national regulators in a unified system.




Second, we need to ensure that the European Stability Mechanism and other financial safety nets, including sovereign bond buying by the ECB, and involving resources from the International Monetary Fund, are strong enough and managed in ways that can provide funds to governments on a scale and at a speed that builds confidence.




For example, action here is essential to resolve Greece’s difficulties. The eurozone governments, the ECB and IMF can tinker with the interest rates and maturities on Greece’s debts, but given that the country’s debt-to-GDP ratio is approaching 200 per cent, the situation is unsustainable, and especially so if the creditors keep demanding more budget austerity, so shrinking the real economy still further.




Robust eurozone financial structures need to be in place that can assist countries to transition from current conditions, where their financial difficulties are mounting and their unemployment rates are exceptionally high, to a sustainable growth-orientated path. Further delay on establishing financial support mechanisms will add to difficulties.



Third, the sustainability of the euro will be in doubt as long as the 17 governments responsible for the eurozone fail to agree on a fiscal compact.



The zone’s fundamental weaknesses, so exposed by the crisis, owe much to overly great reliance on monetary policy. While this is well recognised, Europe’s governments have yet to agree on a starting date for an effective fiscal compact.




There will not be financial market confidence even with the above integrated package of policies unless there are firm implementation timelines. Scepticism about the ability of Europe’s authorities to act on their rhetoric is now so substantial that announcing a schedule for concrete actions is imperative.




And this is urgent, because market pressures have repeatedly shown that policy makers have always far less time to act than they tend to believe.



The integrated package of measures that is needed has to be understood as providing a fresh basis to create confidence.



The success of the “Brady planlay in the fact that sovereign authorities built on it to show their own citizens there was a course to be pursued to establish stability and secure real growth.
They were able to muster public support and commitment, which is crucial for the successful resolution of sovereign debt crises.





William R Rhodes is president and chief executive of William R. Rhodes Global Advisors and author of ‘Banker to the World: Leadership Lessons from the Front Lines of Global Finance’



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Copyright The Financial Times Limited 2012.