Peter Peterson, the Former Chairman of the New York Economics Council, Lehman Brothers, and the Blackstone Group, has articulated in his book Running on Empty the growing financial crises that confront the United States. Sadly, our dire financial outlook does not derive from the cyclical nature of our capitalist economy but rather from a whole host of government entitlement programs, military expenditures, tax policies that are ideology based rather than rationally responsible initiatives. Peterson cites a number on non-partisan responsible economic think tanks who not only share his concerns but have publicly raised similar concerns. Stated differently, main stream economic experts not lunatic wings on the fringes are highlighting the coming nightmare.

 

Our fiscal problems rest with the policies of both political parties who embrace expenditure programs totally out of context with our financial abilities to sustain such policies without destroying the economic livelihood of future generations. Cost-benefit analysis of a whole host of government programs is no longer seriously discussed. No elected official raises the specter of the likelihood of financial insolvency because it is inexpedient in the current political environment. Instead, we embrace further expenditures without appropriate tax policies. We should make Porky Pig our national mascot since most spending measures make certain that “no lobbyist or special interest group is left behind.”

 

Let me share with you some “eye-popping numbers.” In today’s dollars, the annual budget deficit grows about $1.6 trillion dollars and the cash-flow deficit from Medicare and Social Security will grow to $519 billion in today’s dollars. These deficits are unsustainable at some future time. That is, the fiscal melt down could occur in five years or in twenty when the cost of financing these escalating deficits will become unsustainable domestically or unpalatable to our foreign lenders. 

 

Let me state the problem in terms of the average family. Roughly speaking, the net present value of debt per family is about $200,000 or slightly twice our liquid assets per family. Moreover, since our debt per family is growing at double digit rates, each year’s incremental deficit makes the problem more onerous and insoluble. Assuming a borrowing cost of 5%, financing the deficit is costing $10,000 per family in present value terms. If interest rates rise or alternatively as the present value of the debt per family increase the carrying costs become more burdensome until insolvency occurs.

 

What does this unfunded liability mean in laymen’s terms? It means that the annual costs of funding each year’s liability will grow to more than 10% of the Gross Domestic Product over the next twenty-five years, leading to an economic quagmire. These deficits are structural; that is, they will grow irrespective of how well the economy performs. Thus, at some point they will undermine the American Dream of each generation enjoying a higher real standard of living.

 

Peterson cites a whole host of responsible economic groups such as the International Monetary Fund who have warned the United States that we are careening toward insolvency. Specifically, the IMF pointed out that the huge and growing imbalance between what the federal government has promised to pay in future benefits and what it can reasonably expect to collect in future taxes are woefully out of line. The long-term structural deficit now exceeds 500 percent of gross domestic product. In order to close the gap, the IMF projected an immediate and permanent 60 percent hike in federal income tax or a 50% cut in Social Security and Medicare benefits. 

 

Moreover, many reputable non-partisan groups such as the American Enterprise Institute, the International Monetary Fund, and the Brookings Institution calculate that the unfunded liability could be double to triple the Treasury estimates of our current unfunded liability of $27 Trillion.

 

“If you find our deficit numbers are making your head spin, do not worry. Just remember that they are all big and they are all bad” explained David Walker, the comptroller general of the nonpartisan General Accounting Office.

 

Even worse, to fund our deficit, the United States is dependent upon foreign capital. Last year, the United States imported capital from foreigners at an unprecedented rate—four billion dollars every working day. Moreover, our twin deficits—domestic and foreign—are expected to grow for the foreseeable future.

 

Peterson coyly commented that “supply side economics” means that foreigners supply most the goods and all the money.  Our current account deficit now exceeds 5% of the Gross Domestic Product, a percentage that portends the high likelihood of a financial crisis. The aging population of our creditors, Japan and Europe, exacerbates the problem, because they will eventually need to pay for their own retirement systems.

 

Paul Volker, possibly our greatest Chairman of the Federal Reserve System, predicts we face a 75 percent chance of a crisis within five years. In order to remedy the problem, we cannot just impose higher taxes or grow out of our financial mess. Financing the Social Security and Medicare through higher contributions would require payroll taxes to increase by 50% by 2020 and 350% by 2040 according to the Social Security Administration. Alternatively, we cannot “cut taxes” and grow our way out of the problem because Social Security and Medicare benefits which are tied to wages. Under current provisions, these benefits become more generous as wages rise.

 

We cannot balance the budget without taking on major entitlement programs like Social Security and Medicare. In 2003 entitlements and interest on the national debt accounted for nearly two-thirds of federal spending. During the 1990’s we were able to absorb the growth of entitlement programs because we cut defense spending which dropped from 5 to 3% of the Gross Domestic Product and we had a higher percentage of people entering the work force versus new retirees.  Over the coming decade this windfall will reverse itself dramatically. Despite the incredible deficit of our Medicare program, both parties recently passed legislation that dramatically increased the cost of Medicare.

 

Peterson, a lifelong Republican, bemoans that the current Republican administration has presided over the biggest, most reckless deterioration of American finances in history.  

 

On top of our historical social programs, the Bush administration has dramatically increased costs through expenditures on the war on terror and the invasion of Iraq. The new requirements for homeland defense add significant burdens. Despite the need to meet these threats to our security, the Bush Administration has chosen to employ tax cuts rather than tax increases! 

 

The Bush Administration belief in tax cuts as a remedy is a fiscal policy based upon ideology not fact. That is, this administration has supported a major increase in a whole host of programs while cutting taxes. Peterson says that the current administration must have it all: guns, butter, and tax cuts. Lewis Gould, the author of a book Grand Old Party summed up our problems: “A conservatism that makes no demands and enforces no responsibilities is largely a rhetorical posture.”

 

Peterson finds both parties responsible for our fiscal mess. He reminds us of the Madison Avenue slogans we use to defend our tax and expenditure policies. That is, the current administration trumpets policies that commit the United States to spend literally trillions of dollars more in entitlement programs over the coming decades than citizens expect or can afford to pay. 

 

Peterson commented that the Republicans, who once prided themselves on fiscal conservatism, now believe in an indulgent fiscal philosophy. The Republicans feel that deficit spending energizes America by liberating taxpayers from the need to pay their own way. Deficits have become like an aspirin or perversely a “steroid”, a sort of fiscal wonder drug. We should take them regularly just to stay healthy and take lots of them whenever we are feeling out of sorts. In essence, the Republicans have embarked on a policy of massive and endless debt creation. 

 

Peterson argues that the Democrats are also fiscally irresponsible.  The Democrats have advocated a whole host of entitlement programs that have turned the federal government into a massive entitlement vending machine which operates by dispensing new benefits in return for organized political support by deferring costs as far as possible in the future. Federal benefits in real (inflation-adjusted) dollars have expanded six fold since 1965. This fact undermines Democratic charges that the Republicans have “slashed” our safety net. The ordinary tax payer can legitimately question whether the nation has seen a six fold improvement in the nation’s biggest domestic challenges, from poverty to education.

 

The net result of actions by both political parties is an economic scenario where we will be taxing at 18% of the Gross Domestic Product (GDP) by 2030 and spending at 32% of the GDP by 2030. This imbalance is economic suicide.

 

How big is the Problem? Currently, the Congress fails to recognize that we are not accounting annually for $1.5 trillion increase in the government’s unfunded liability. This unfunded liability which each year is calculated by the Treasury Department amounted to $27 trillion as of January 1, 2003. Unfunded liability is defined as the total value of benefits that are payable to—minus all the payroll taxes and premiums that are receivable from—every American today aged fifteen and over who is a participant in a federal program. Stated differently the combined shortfall in Social Security and Medicare was eight times the amount of total Government spending in fiscal 2002. It is roughly $200,000 per U.S. household—or double the value of all stocks, bonds, and mutual funds that Americans own. 

 

The problem becomes worse when we recognize that our annual net borrowing abroad now runs at about 5% of the Gross Domestic product. People who say that it is irrelevant that foreigners own an increasing part of America are in effect saying there is no difference between being a landlord and being a sharecropper.

 

The bottom line is simple: deficits drain critically needed national savings. Every noted economist would agree that no nation can sustain high investment without saving and fiscal responsibility. Moreover, over the last 40 years, the percentage of the federal spending for future-oriented investment from education, to defense, to public health shrank from 32% to 14% of total federal spending. On the other hand, benefits to individuals role from 25% to 59%. Sadly, our fiscal irresponsibility we someday lead to a terrible choice between obligations to our children or our obligations to our elders.