IMF Warning

by Karl Denninger

After a consolidation process that took up most of the 1990s, the United States went through a substantial fiscal deterioration since 2001 as a result of the 2001 and 2003 tax cuts, the expansion of Medicare and the rapid increase of per-capital healthcare costs.

The “consolidation” in the 1990s?

Where was the “consolidation” in the 1990s?  The above chart, again, is simply computed by:

(⌂GDP – ⌂Debt) / 12-Month-Ago GDP

That is, how much GDP growth (in percentage) did you generate from organic growth?  Backing out the growth from promising to pay tomorrow is both appropriate and necessary, since all such promises to pay tomorrow are simply shifting tomorrow’s GDP into today’s column.  Such consumption thus will not occur tomorrow.

To the best of my knowledge The Market Ticker is the only place I’ve seen that chart.  It is simply ignored everywhere else, even though all the data required to compute it is in the GDP series and Fed Z1, and is part of the quarterly series that I opine on with every release.

If you remember, I said that a plausible budget would require $500 billion in cuts for at least the next three years, sequentially.  What does the IMF say right up front?

In other words, fiscal revenues and spending would need to change so that the primary balance predicted under that scenario improves by over 15 percentage points of U.S. GDP every year into the indefinite future starting next year.

$3.8 trillion X 15% = $570 billion in tax increases, spending cuts or some combination of the two.

Or is that really $14.7 trillion X 15% = $2.06 trillion in budget reductions, tax increases or both? 

Now they see a one-timer as possibly-effective if done and held.  I don’t.  The only way out of a debt trap is to pay down the debt, not stop the rate of increase.  Therefore it is required that we run a primary surplus, which, on the path I have put forward, would require approximately four years.  And incidentally, 4 years X $500 billion a year = $2 trillion – roughly.

Since the federal government has historically collected about 18.4 percent of GDP in tax revenues, mandatory programs may hence absorb all federal revenues sometime around 2050, or as early as 2026 when the cost of servicing the debt is included in the calculation.

Yep.  And long before that date – probably in the next two to three years – the market will discern that we’re going to go off that cliff.  When it does our ability to raise funds by the Federal Government through further borrowing will rise dramatically in cost.

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Once that occurs we are no longer able to make choices on entitlement reform and tax changes – they are forced upon us by creditors.

Under most scenarios, the fiscal adjustment needed to eliminate the fiscal and generational gaps would entail significant adjustments in taxes and/or transfers. Under the baseline scenario, for example, the federal government can restore fiscal balance by raising all taxes and cutting all transfer payments immediately and for the indefinite future by 35 percent.

Were the U.S. government to finally repeal the tax cuts enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA), and were the IPAB to succeed in curbing healthcare spending growth as provided in the IPAB mandate, reining in the fiscal gap would still require an immediate and permanent increase in all taxes and cut in all transfers of 26 percent.

I’ve been pounding this drum since 2007, because back then the adjustment was about 20%.  Our actions of the last four years have led us to where we are now, and place the adjustment at thirty five percent.

More importantly, if we don’t do it now and we keep spending more than we make, the required downward adjustment in spending (and upward in collected taxes – not rates, actual collected funds) will only get worse.  There is a point, impossible to accurately determine in advance, where the public simply revolts against the changes that need to be made and we instead get an economic and political collapse.

IMF Working Paper US

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