VoxEU Column Macroeconomic policy

Shattering the American dream: The US government’s Ponzi scheme

The sustainability of government finances is very much the topic of the day. But the issue poses serious questions for the future, particularly how well off today’s younger generations will be compared with their parents. This column argues that the Ponzi scheme being played by the US government amounts to "fiscal child abuse" and is close to game over. For today's children the American dream will be just that – a dream.

Fiscal sustainability and generational equity are two of the most pressing policy issues of our times. Yet these two highly related concerns are difficult to clearly define, let alone measure.

The standard metric of long-term fiscal imbalance is official government debt (Reinhart and Rogoff 2009). But, as shown in Green and Kotlikoff (2009), official debt, like time and distance in physics, is not a well-defined economic concept.

In physics, the measurement of time and distance depends on one’s frame of reference, which can be viewed as one’s language. Measurement of debt is also language dependent.

Unfortunately, language is highly flexible. And there is an infinite number of ways to label an economy’s fiscal policy in neoclassical economies with rational agents, no matter how well or how poorly such economies function. Each labelling convention results in a different history and projected future time path of official debt. The same holds true of taxes, transfer payments, disposable income, personal saving, private saving, government saving, private wealth, and government wealth. Each of these measures is devoid of economic content.

With the right labels, unsustainable fiscal policies are compatible with huge and exponentially growing reported surpluses. Likewise, sustainable policies are compatible with huge and exponentially growing deficits.

The timing of policy is also up for grabs. There is no use saying our fiscal problems lie in the future. They do with one set of words (our short-run cash flows look great) and don’t with another (our short-run cash flows look terrible). On the contrary, our fiscal problems lie in the state-contingent policy path being followed, and its analysis defies truncation.

In Kotlikoff (2011), one of us illustrates the ‘economics labelling problem’ with the following completely painless way of running massive surpluses forever. This example shows that even doing nothing can be labelled in a way that completely alters reported deficits, taxes, and transfer payments.

Double income taxes and lend each taxpayer’s extra payments right back to the same person. Then, when each taxpayer makes interest and principal payments on the loan, hand back to that same person these monies as new transfer payments. This policy raises enough revenue to eliminate this year’s deficit, since this year’s taxes rise while this year’s spending doesn’t. Next year and each year in the future, repeat this policy, but with ever larger tax hikes. This will permit the government to run massive surpluses over time, while doing nothing real. Moreover, since money given is money returned, the government can save postage by simply recording the new policy in its books.

If the debt is hopeless as a measure of sustainability and generational equity, what measures make sense? One answer is generational accounting and infinite horizon (ie non-truncated) fiscal-gap accounting (see Auerbach et al 1991; Gokhale and Smetters 2003; Gokhale and Raffelhüschen 1999). Both provide label-free measures of fiscal sustainability and generational policy and present a picture of the fiscal positions of countries that is wholly different from that based on official debt.

For example, US government liabilities (official debt plus the present value of projected future non-interest spending) exceed government assets (the present value of projected future taxes) by $211 trillion, roughly 14 times GDP. This fiscal gap is formed using Congressional Budget Projections and appears, when scaled by GDP, to exceed those of all other developed countries (Kotlikoff and Burns 2012).

Although fiscal-gap and generational accounting teach us important lessons, they are constructs derived from a world of certainty, not a world in constant, unpredictable flux. Measuring fiscal gaps and generational accounts in our uncertain world requires properly discounting for risk. But the difficulty of doing so has led to the standard, but unsatisfactory, practice of discounting with a single fixed rate.

Alternative approach to evaluating unsustainable policies

In Evans et al (2012), we take an alternative approach to evaluating unsustainable policies, namely simulating them. Specifically, we specify a stochastic general equilibrium model and determine via simulation how long it takes for the economy to reach “game over” – the point where current policy can no longer be maintained.

The policy is simple. The government takes (using whatever language it wants) a fixed amount each period from the young and hands it to the old, independent of the state of the economy, given by the size of the capital stock and the level of multifactor productivity. When the hit on the young exceeds their earnings, the game is over, with the government either extracting all the income of the young and terminating the economy or switching to a new policy regime, which leaves the young with something to eat.

Our simulations, based on an “overlapping generations” model calibrated to the US economy, produce an average duration to game over of roughly one century, with a 35% chance of reaching the fiscal limit in roughly 30 years.

The prospect of man-made economic collapse produces realistic equity premiums. Our simulations also show that both the fiscal gap (measured with constant as well as risk-adjusted discount rates) as well as the equity premium rise as the economy gets closer to hitting its fiscal limit, suggesting that the fiscal gap and the equity premium, even with fixed-rate discounting, may be good indicators of unsustainable policy.

So far we have studied “game over” using a simple two-period model. Our goal is to simulate more realistic models using the sparse grid technique of Kreuger and Kubler (2006) and the Generalised Stochastic Simulation Algorithm developed by Judd et al (2012). Yet, even at this stage, it is clear that maintaining unsustainable generational policies of the kind being conducted in the US and other developed countries is playing with fire.

While our current and intended future simulations will teach us about the timing of America’s end game, there is strong evidence that Uncle Sam’s Ponzi scheme has already done tremendous economic damage to the country.

In the lifecycle model, the young, because they have longer remaining lifespans than the old, have much lower propensities to consume out of their remaining lifetime resources. This prediction is strongly confirmed for the US by Gokhale et al (1996).

Hence, in taking from young savers and giving to old spenders, which Uncle Sam has spent six decades doing on a massive scale, the lifecycle model predicts a major decline in US net national saving associated with a major rise in the absolute and relative consumption of the elderly. This is precisely what the data show.

In 1965, the US net national saving was 15.6% of net national income. Last year, it was just 0.9%. And, according to Gokhale et al (1996) and Lee and Mason (2012), the secular demise in US saving has coincided with a spectacular rise in the consumption of older Americans relative to that of younger Americans.

As Feldstein and Horioka (1980) document, US net domestic saving tracks US net national saving. Hence, postwar intergenerational redistribution has not only lowered net national saving; it has also reduced net domestic investment, from 14.0% of national income in 1965 to just 3.6% in 2011. This decline in the rate of net domestic investment is, no doubt, playing a major role in the slow growth in US wages. Indeed, the level of private-sector average real earnings per hour, exclusive of fringe benefits, is lower today than it was 40 years ago.


We call this America’s “fiscal child abuse”. If it continues, it will no doubt shortly drive the national saving rate, which was negative 1.2% in 2009, into permanent negative territory and further reduce net domestic investment and prospects for real wage growth. This, plus the massive lifetime tax bills being dumped on our children, will transform the American dream into something it has never been – just a dream.


Auerbach, A J, J Gokhale, and L J Kotlikoff (1991), "Generational Accounts: A Meaningful Alternative to Deficit Accounting", NBER, Tax Policy and the Economy, 5:55-110.
Evans, R W, L J Kotlfikoff, and K Phillips (2012), “Game Over – Simulating Unsustainable Fiscal Policy”, in AAlessina and F Gavazzi (eds.), Fiscal Policy After the Financial Crisis, NBER.
Feldstein, M and C Horioka (1980), "Domestic Saving and International Capital Flows", The Economic Journal, 90:314-329.
Gokhale, J and B Raffelhüschen (1999), “Population Aging and Fiscal Policy in Europe and the United States”, Economic Review, Federal Reserve Bank of Cleveland.
Gokhale, J and K Smetters (2003), Fiscal and Generational Imbalances: New Budget Measures For New Budget Priorities, The American Enterprise Institute.
Gokhale, J, L J Kotlikof and J Sabelhaus (1996), "Understanding the Postwar Decline in United States Saving: A Cohort Analysis”, The Brookings Papers on Economic Activity.
Green, J and L J Kotlikoff (2009), “On the General Relativity of Fiscal Language”, in A J Auerbach and D Shaviro (eds.), Key Issues in Public Finance – A Conference in Memory of David Bradford, Harvard University Press.
Judd, K, L Maliar and S Maliar (2011), “Numerically Stable and Accurate Stochastic Simulation”, Quantitative Economics, 2:173-210.
Kotlikoff, L J (2011), “Some Deficit Magic for the Super Committee”, Bloomberg.com. 15 November.
Kotlikoff, L J and S Burns (2012), The Clash of Generations, MIT Press.
Lee, R and A Mason (2011), Population Aging and the Generational Economy, Edward Elgar Publishing.
Reinhart, C M and K Rogoff (2009), This Time is Different, Princeton University Press.

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