A year ago, in January 2019, former IMF Chief Economist, Olivier Blanchard, delivered his now famous American Economic Association Presidential address (Blanchard 2019) with this bottom line: “Public debt may have no fiscal cost.” Blanchard’s reasoning? Interest rates on short-term US government bonds are generally lower than the economy’s growth rate. Hence, Uncle Sam can cover interest and principle payments on today’s borrowing simply by borrowing more tomorrow and so on through time. Since the economy grows, on average, faster than debt service, total debt gradually falls relative to GDP. In short, Uncle Sam can run a successful Ponzi scheme.
This past January, former Treasury Secretary, Lawrence Summers, concurred (Summers 2020). His preferred Ponzi scheme would, however, operate differently. He would permanently raise Social Security’s payroll tax to pay higher benefits to current and future retirees. Thanks to growth, each generation of retirees would get back more than it paid in; indeed, more than had it invested its contributions in government bonds. With initial retirees receiving more and current and all future workers earning a higher-than-market return on their contributions, Summer’s Ponzi scheme is, he suggests, a no brainer.
If all this sounds like the discovery of cold fusion, it is. It presumes economic growth is reliable. But next quarter’s growth isn’t assured, let alone growth through all eternity. Wars, epidemics, fertility declines, crazy policy, trade wars, automation, political unrest, … – none of these things, apparently, will ever be bad enough for long enough to produce ‘game over’. Game over occurs when government obligations exceed what can be extracted from the private sector. Venezuela is just the most recent example of the hundreds of countries through history whose sure thing, free-lunch, expansionary fiscal policy ran aground.
Were no Ponzi scheme in place, gambling with a small one wouldn’t be terrible. But the US, under both parties, has spent the post-war taking from the young and giving to the old – i.e. playing a Ponzi game, indeed, an ever expanding one. It has done so by running deficits, shifting taxation from asset income to wages, and by expanding Social Security, Medicare, and Medicaid, most of whose benefits are paid to the elderly.
These three entitlement programmes provide vital forms of insurance. But they were never financed on a pay-as-you-go basis, in which each generation pays for what it gets. Instead, they were financed on a take-as-you-go basis, with retirees collectively expropriating their children, while promising them their turn at doing the same.
Here’s the inconvenient truth. Our hydra-headed Ponzi schemes have failed spectacularly. Take Social Security. Table VIF1 in the system’s 2019 Trustees Report (Social Security Administration 2019) reports a whopping $43 trillion gap separating the present value of future outlays from the present value of receipts. Covering this shortfall requires immediately raising the system’s 12.4% FICA tax rate to 16.5%! Waiting to raise taxes will leave our children, and their children, facing an even larger tax hike.
A sure sign of a failed Ponzi scheme is when later workers get a far worse deal than early workers. Today’s and tomorrow’s workers will pay at least a third more in Social Security taxes per dollar of benefits than Baby Boomers paid. Their projected negative return on those taxes is far below prevailing returns on government bonds.
The combined unfunded liabilities of Medicare and Medicaid are bigger than Social Security’s. Indeed, for the entire federal fiscal system, the present-value funding gap is not $43 trillion, but $165 trillion – seven times this year’s GDP! As a share of GDP, the US’s fiscal gap is miles higher than that of any other developed nation.
Ponzi schemes come at a wage-growth cost. The elderly, with fewer years to live, spend at a higher clip than the young. Taking from young savers and giving to old spenders has dropped the US’s national saving rate from 13% in the 1950s and 1960s to 3 in the last two decades, producing a commensurate drop in our domestic investment rate. This, in turn, has meant lower labour productivity and wage growth. This, rather than inadequate demand (Summer’s pet peeve), is the main cause of secular stagnation. Given the US’s decades’ long miserable rate of wage growth and pending massive tax hikes, our children will be lucky to reproduce our living standard.1
Blanchard recognises the problem (House Budget Committee Democratic Caucus 2019). Academic lectures aside, he’s for reducing deficit finance. But Summers has drunk the cool aid. He would expand Social Security’s Ponzi game by almost one fifth, forcing our posterity to play economic roulette with even higher stakes. What about Social Security’s $43 trillion existing shortfall? Presumably, he would borrow in hopes that growth will save the day.
It’s time to get real. Uncle Sam’s ongoing, let alone expanded, Ponzi schemes constitute generational theft. The schemes are economically ruinous, morally repulsive, and the death knell of the American dream.
Blanchard, O (2019), “Public Debt and Low Interest Rates”, American Economic Review 109(4): 1197–1229.
House Budget Committee Democratic Caucus (2019), “Reexamining the Economic Costs of Debt”, 20 November.
Social Security Adminstration (2019), The 2019 OASDI Trustees Report.
Summers, L H (2020), “We don't need fewer entitlements for the middle class. We need more”, Washington Post, 20 November.