US Financial Catastrophe Predicted By British Think Tank

Entitled “The Government Debt Iceberg,” the latest report from The Institute of Economic Affairs (IEA) in London was meant primarily for British eyes, but there’s enough in there to concern Americans worried about how the United States will make good on its promises. Researched and written by Jagadeesh Gokhale, a senior fellow at the Cato Institute, the problem facing both the U.K. and the United States is the same: making promises without making provisions to fulfill them.

If a private business made a promise to a customer to be fulfilled over time, it would book that promise as a liability and make present plans to fulfill it. Not so the government. Gokhale says that governments use “backward-looking” financials — measuring only what has already been spent in the past — with little if any regard for, and certainly no strategy to pay for, promises made to be fulfilled in the future.

At present the U.S. government owes debtors, both private and public, foreign and domestic, more than $17 trillion, an amount about equal to the entire output of the American economy in one year. Put another way, it owes more than four times the total revenues taken in by that government in one year.

But, according to Gokhale, this greatly underestimates the real unfunded liabilities of the government, by a factor of seven. Taking into account future promises, the government’s debt is closer to $120 trillion.

Gokhale put the problem into perspective:

Western governments have developed unfunded social insurance programmes where retiree benefits are paid for from the taxes of the working-age population.

That means that an ageing population leads to rising expenditures that cannot be covered without increasing taxes on the young.

Politicians have known about population ageing for around 50 years but [have] ignored the problems it will create.

The solutions are going to be painful. He estimates that if the federal government were all of a sudden to come to its senses and begin to do real-world accounting for the promises politicians have made over the past decades, income taxes would have to double. Conversely, in order to balance the books, those promises would need to be cut in half.

Philip Booth, IEA’s program director, wrote: “We have never been in a situation like this before. It’s quite possible that we will not find our way through without serious social breakdown and/or mass emigration of the most mobile and productive people.“

Gokhale offers unlikely solutions. Countries can try to inflate their way out of those promises, reducing the future value of them to recipients. But, he says, “This is unlikely. Future pay-as-you-go social insurance obligations are generally price index-linked … and health care involves the provision of a set of services [that cost more over time].”

Nor is it likely that the economy can grow its way out of the burden. Economies already weakened by the Great Recession and heavily laden with regulatory demands and mandates and rules just won’t be robust enough to generate sufficient additional tax revenues to pay the elderly. The impasse is predictable and probably unsurmountable. Writes Gokhale:

In the United States, for example, entitlement programme beneficiaries who paid payroll taxes while working feel a strong moral and legal entitlement to retirement, survivor, health and other benefits….

They possess growing political clout to maintain those benefits as promised.

With little chance for higher taxes to pass muster with current workers, and no chance for significant cuts in benefits likely to be acceptable to retirees, what about the iceberg that Gokhale uses as a title for his report? When will the ship of state hit it? What then?

All good questions, none of which Gokhale answers. He thinks the first step is to force the government accounting office to begin issuing realistic projections about the true state of affairs about those unfunded liabilities.

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