Laurence Kotlikoff of Boston University talks with EconTalk host Russ Roberts about the fiscal health of the federal government of the United States. Kotlikoff argues that the U.S. government is essentially bankrupt because future taxes will fall hundreds of trillions of dollars short of expected expenditures. Kotlikoff argues this problem can be solved by redesigning our tax code, but without changes such as this, large reductions in spending or large increases in tax rates will be necessary.
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About this week's guest:
Laurence Kotlikoff's Home page
About ideas and people mentioned in this podcast episode:
Articles:
The 2013 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Trust Funds. PDF file.
Government Debt and Deficits, by Joseph J. Minarik. Concise Encyclopedia of Economics.
Taxation, by John J. Seater. Concise Encyclopedia of Economics.
National Income Accounts, by Mack Ott. Concise Encyclopedia of Economics.
Present Value, by David R. Henderson. Concise Encyclopedia of Economics.
Money Supply, by Anna J. Schwartz. Monetary base, M1, etc. Concise Encyclopedia of Economics.
John Maynard Keynes. Biography. Concise Encyclopedia of Economics.
Web Pages and Resources:
The Purple Plans.
Podcast Episodes, Videos, and Blog Entries:
Boudreaux on Public Debt. EconTalk.
Stevenson and Wolfers on Happiness, Growth, and the Reinhart-Rogoff Controversy. EconTalk.
Rabushka on the Flat Tax. EconTalk.
Frisby on Tax Reform. EconTalk.
Hennessey on the Debt Ceiling and the Budget Process. EconTalk.
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0:33
Intro. [Recording date: January 6, 2014.] Russ: Before we get started I want to encourage you again to send me your favorite episodes of 2013. Send me an email at mail@econtalk.org with the word 'Favorites' in the subject line. List 5 favorites. You can find all the episodes listed in chronological order by going to http://www.econtalk.org/archives.html which will list all 400-plus episodes of EconTalk. They are all available online, despite the fact that some of them I was a less skilled interviewer. They are all up there, going back to 2006.
1:16
Russ: Now, you've been writing for some time about America's fiscal problems. A lot of people disagree about how serious those problems are. You argue that they are serious. How bad is it? Guest: I think it's terrible. I think we are probably in worse fiscal shape and any developed country. The reason, Russ, is we've been piling up debts for over 6 decades; and when I say 'we' I'm referring to Republican and Democratic administrations and Congresses. And we've been hiding them. We've been keeping them off the books and using economic labels, words, to pretend that they are not real liabilities of the government. To give you an example, take the Social Security checks that your mother might be collecting right now. My mom is 94; she gets a monthly check. There is no way that anybody's going to take her check away. This is a payment that's coming from the Federal government. It comes in the form of a Treasury check, a check from the Treasury, which is a color yellow on green, and it looks just like the checks that come from the Treasury that are called principle plus interest payments on official government debt. But only the checks that are called principle plus interest payments on Treasury debt are being reported in terms of their value in the present--their present value--as being an official liability of the government. So we have all these obligations to something like 30-40 million current retirees and close to 80 million baby boomers who are about to start collecting Social Security benefits if they haven't already. All those obligations are not reported as part of the government's debt, so we are missing those off-the-book obligations. The accounting here is much worse, far worse than anything that Bernie Madoff, who ran that big pension Ponzi scheme engaged in, and anything that Enron engaged in. It's really horrendous because the true debts of the country total about $205 trillion. The official debt that's being reported is only about $12 trillion--it's in the hands of the public, the debt in the hands of the public. So we're missing the vast majority of the obligations. And this $205 trillion 'fiscal gap', which is what economists refer to this as, which is all the liabilities to paying my mom's Social Security benefits, your grandmother's Social Security benefits, etc., all the Medicare, Medicaid, other spending obligations--defense spending, paying for the President's lunch--those are all obligations. They are going to have to be paid. And then if we net out all the future taxes that are going to be coming in as projected, in both cases by the Congressional Budget Office (CBO), when you see in present value, the value in the present of this net obligation being $205 trillion. So we are in terrible shape. Our GDP (Gross Domestic Product), the national output that we produce, is about $17 trillion--we are talking about $205 trillion, which is many times a single year's GDP. We would have to raise taxes by close to 60% immediately and permanently, every single Federal tax, to come up with $205 trillion in present value. So the country really is bankrupt and nobody sees it because of the bookkeeping. Russ: Well, that sounds horrible. But a couple of thoughts seem a little cheerier. One is, this has been true for a long time. The major cause of this gap is the generosity of these promises combined with the magnitude of the number of people who are going to be owed these promises--that is, the baby boomers, which would be me, among those 80 million. I'm happy, by the way, to give mine up or to take less; but most people don't feel that way, as you point out. Most people expect to get that money. And the government would be very hard pressed--politicians would be very hard pressed--not to keep those promises. But we've done that for a long time, haven't we? So one is, if it's really a problem, why hasn't it reared its ugly head; and in particular, if we are really bankrupt, why do people keep buying our bonds, and happily, at low interest rates? Guest: First question you had is, our issue here that you are raising is the fact that we've had this problem for a long time. It's true we've had the problem for a long time, but it's getting worse every year and at an accelerating pace because we have 78 million baby boomers who are about to collect on average about $40,000 in today's dollars when they are fully retired. So the fiscal gap this year could easily rise by $6 trillion because we are not paying it off--it's like your credit card bill; if you don't pay it off you have to pay interest on it. It gets bigger. If you don't pay the interest what you owe gets bigger. We are not paying the interest, let alone paying the principle of this obligation. So, because we are getting closer, the problem is getting closer, put it this way: I'm 62 as I speak with you right now. I'll be collecting my Social Security benefits in 8 years. Ten years ago I was 52. That problem was further off. It's value in the present ten years ago was smaller. So, because of the aging interacting with growth of the benefit levels for [?] health care, interacting with the number of baby boomers poised to collect benefits, these things are making the problem acute. We are getting very close to--we're not bankrupt in 20 years. We're really bankrupt today. It's just like Detroit. They could probably get by for a little bit longer, maybe a couple more years; they could sell off their art museum and some other things and squeeze by. But basically they are looking at the future and saying, 'Gee, we can't cover all the expenditures with the revenues we are going to be getting in, so we are bankrupt, and we are bankrupt right now.' And if you look at our situation, many, many economists have looked at it and come up with really the same answer, that we are doing phony-baloney accounting and that we actually are broke. And we need to get our fiscal house in order immediately. This doesn't mean that we can't invest in critical things that we need to investment in like education, infrastructure, research and development. But we may need to raise taxes; and I think we do need to raise taxes. But we also have to cut some of the spending. We have to get our health care spending in particular under control, but in a way that doesn't leave people uninsured. Russ: That'll be challenging. As we see right now. Guest: I have proposals--these are not bills before Congress or anything like that, but I have proposals that I've laid out for how to fix health care and stay within 10% of GDP. I wrote a book called The Health Care Fix--very simple plan, fits on a postcard; it's been endorsed by five Nobel Prize winners and many, many economists, top economists who aren't Nobel Prize winners. There are ways to fix these problems without and still give people a terrific policy and not have to go broke. But we don't have political leaders who are willing to say, look, you've got a system which is so screwed up you have to basically eliminate it and start from scratch, build from scratch. Rather than taking a bridge which is about to collapse and patching it up and then you know for sure you are going to have a disaster; it's going to collapse at some point. Better to knock it down and build a safe one.
10:11
Russ: I don't disagree with that. But let me try to find--make sure I've got the numbers right and what the implications are for other kinds of spending. The fiscal gap, what you are calling the fiscal gap, is $206 trillion, approximately? Guest: No, $205 trillion. Russ: Oh, phew. I thought it was 206. So $205. The amount of publicly admitted debt, the number that gets published when they say what's the debt--the debt you say is $12. I know there is a debate about how to measure that; some of that is being held now quite a bit at the Fed. Guest: Yes. So, just on that point: the gross debt is about $17 trillion. So the Treasury has borrowed about $17 trillion cumulatively from the public. But then the Fed has printed up about $5 trillion dollars' worth of dollar bills and bought that money. In effect they printed up $5 trillion and handed it to the Treasury to spend, because the Treasury takes that, when it issues debt, if the head of the Treasury, Secretary Lew, were to borrow some money from you right now, let's say he borrows $10,000 from you right now, Russ, he gets the $10,000 bucks. Now he's sitting there with an IOU. And then the Federal Reserve Chairman Bernanke [N.B. Yellen was not yet confirmed by Congress at the time this episode was recorded.--Econlib Ed.] comes and prints $10,000 bucks and buys back that IOU from you. Okay? So had the $10,000; you give it to Lew, the Treasury Secretary; now you are sitting here with an IOU, a government bond; Bernanke hands you $10000 bucks and takes back the IOU. Now, if you look at this shell game, you are still at the end of the day sitting there with the $10,000 bucks that you started with. Treasury Secretary has $10,000 bucks. And the Federal Reserve has this piece of paper which they can rip up. So what's gone on here is that the Federal Reserve has just been printing money, in this case, and in general, to pay the government's bills. And when countries are broke, that's what they resort to. They get their Central Bank just to print money, and eventually it leads to high inflation, hyperinflation. If you look at Argentina today; if you look at Zimbabwe, you look at countries that can't afford what they are trying to spend; they resort to central bank money creation. And that's what we've got going on in the United States right now. We've got the Federal Reserve printing up $0.29 for every dollar that's being spent by Uncle Sam. The Federal Reserve, which is printing $0.29 cents of it out of thin air. So that's another problem that we face, which is very high inflation because all the money that's being printed and all the money the Fed will need to continue to print in order to help pay the government's bills because the bills are out of control and the taxes are too low to cover the bills. Russ: But the optimist would respond and say, I think two things. The optimist would say: There isn't any inflation. We've printed $5 trillion and look, there's been nothing. So there's nothing to worry about. And they'd also say--and this is what I'd like to get at with the numbers' precision--if the actual true indebtedness of the United States is $217 trillion--is the fiscal gap $205 over the $12 or $205 over the $17? Guest: $205 versus the $12. Russ: Okay. So $205 is the extra amount that we need relative to the $12? Guest: It includes the $12. Russ: Okay. So we really owe $205; but we only publicly admit to owing $12. Guest: The $205 is the net number. It's net of all the future taxes to pay it. Russ: I understand. So one unfortunate consequence of that arithmetic is, I think--and I'm not on this side, but many are: 'Well, then we don't have to worry about the $12. That's nothing. So in the short run we need to get the economy going; we have to borrow more money, or print more money, it doesn't matter; we need to get the economy going; we've got too many people unemployed.' And what people are worrying about, about the deficit or the debt in any one year--a trillion dollar addition to our debt each year, roughly, in the last 4 years--that's nothing. It's the difference between $212 and $204--forget it. That's a rounding error. What's your response to those two points--inflation and the 'therefore we should be spending like crazy now?' Guest: Economies are slow to adjust and recognize realities, but when they do, things happen pretty quickly. So, right now you have folks on Wall Street, they see these problems but they are waiting for other people on Wall Street to see them. And I just spoke with about 50 bond traders, and they are very interested in whether or not the government is broke and whether or not we are going to have inflation. And what the true fiscal situation is. So I tell them about that; they have a lot of questions. Then they ask me at the end of the session: What do other bond traders think? And: What are the other bond traders going to [?]? Russ: Sure. Guest: What they are interested in is making money in a pack and losing money in a pack, and if you have a bond trader that loses money by himself, he loses his job. If other people lose money with him, no problem. So at some point the entire bond market will flip and we will have interest rates go up and we'll have inflation take off. The United States cannot indefinitely print, pay for these obligations with money creation. It can't print $205 trillion dollars. The basic money supply, which is called M1 as you know--let's see: today's M1 is probably about $2 trillion or so. It's not $200 trillion; it's not $10 trillion. So there's a limit to how much money is able to going to be printed, and it may be a few years before everybody understands it. But over time the official deficit will start getting bigger and bigger. If you look at the CBO's projections of our fiscal affairs, which is called their 'Alternative Fiscal Scenario Projection', and they've done their best to hide this from the public. But they put out what's called the 'Baseline Extended Budget Forecast,' based on forecast which is a complete fabrication of what they really think; and they also have put out, but rather quietly, this Alternative Fiscal Scenario, which shows the official debt, as it's currently measured, exploding through time. Russ: And the difference between the two is that the so-called 'baseline' has assumptions that have never held for very long, assumptions about cuts in payments to doctors for Medicaid and Medicare and things like that, right? That's what the difference between the Baseline and the Alternative. The Baseline is this rosy think that "everyone agrees" is not true. Guest: Yes. Exactly. Everyone in the CBO agrees it is not true. But that's why they have this Alternative Fiscal Scenario that shows just [?]. And even with the Baseline Extended Forecast you've got a $50 trillion dollar fiscal gap. It's a quarter of the right number but it's still very big. Wall Street somehow failed to see the crash in 1987; they seemed to fail to see the crash in 1929; in 2008 they didn't see the crash. The value of Lehman Brothers' stock was quite high even a month or two before it went to $0. Bear Sterns' stock was quite high even a week before it went down the tubes to like $2 a share. So, Wall Street is not a place to look for perspicacity in terms of what's coming, honest or reasonable forecasts of what's coming. They are always behind the 8 ball, as far as I can tell. But the CBO doesn't lie. The demographics don't lie. At least the CBO doesn't lie when it comes to their Alternative Fiscal Scenario. They are saying, look, you've got this many baby boomers, 78 million. They are going to be collecting Medicare, Medicaid, Social Security benefits. And we can reasonably say how big they are; and they are going to collect them at these dates; and that's going to be like $3 trillion each year in today's dollars when they are fully retired. That's a huge amount of money that we are not prepared for. This is just like Detroit saying these firemen and policemen and teachers, and it knows pension payments to, and ignoring the fact that obligation is around the corner; and then they turn the corner and they can't pay those bills. And they declare bankruptcy. So how does the United States declare bankruptcy? Well, it's declaring it by printing money. Because that's the easiest thing to do.
20:28
Russ: I agree with you. But wouldn't Ben Bernanke and other economists of stature argue--I don't agree with them, but don't they argue that: Of course in the long run there are going to be some problems but we are going to grow a lot in the meanwhile. We'll have some political solutions. The main thing right now is to get the economy back to health, to get growth back in the 3-4% range, which would help reduce this problem. Guest: Russ, the CBO projections already incorporate the economy getting back to full employment within a couple of years. So even if you spent extra money now to get the economy back to full employment a little bit faster, and you could do that--it would pay for itself, which is the kind of Keynesian magic that Paul Krugman of the New York Times' op ed page has been selling, kind of demand side magic, voodoo economics as I would view it, you'd still have an enormous fiscal gap. It's not like these problems are going to go away. The CBO is already projecting the economy will be back to full employment in a couple of years. So it's not that you can spend your way out of this problem or cut taxes out of your way of this problem. What we've got is a vast populace of economists who have been well trained who think that people on the far right and the far left who are getting so much press attention when it comes to economic policy pronouncements, that's people like Art Laffer who say that you can cut taxes presumably to zero and get more revenue; and then you've got people like Paul Krugman who say you can spend as much as you want and it will pay for itself, the economy will expand so rapidly it will pay for itself. Well, the vast majority of economists think this is voodoo economics and they don't believe it. And there's no real evidence to support it. We've spent a lot of money, wasted a lot of money, given much bigger bills to our kids, and it hasn't turned the economy around. Because the economy really, in my view--and I'm not a full-fledged macroeconomist, so there's my [?] disagree--but I think the economy is very fickle. If everybody believes there are going to be bad times, they take individual actions to make that happen. If they believe there will be good times, they'll get that to happen. So you have Lehman Brothers fail on September 15, 2008. It fails. And everybody in the press and the politicians start talking about the Great Depression. And the searches on Google spike like crazy for the Great Depression. And very quickly employers start laying off vast numbers of people. Now, if you look at it in physical terms, Lehman Brothers' building didn't collapse; none of the people were killed. Nothing physical happened to the economy's productive capacity. But all these employers started hearing stories about the Great Depression, and they said: I'm going to have to fire my employees, my workers, before my customers don't show up; I'm going to get ahead of this problem. And over the next 19 months 8.5 million Americans were thrown onto the streets, were laid off, in droves--700,000 a month, almost a million people a month were being laid off at the end of 2008. Now that's a coordinated failure. That's coordination failure--everybody coordinates in bad times, making them happen. And spending more money to fix things, having this TARP (Troubled Asset Relief Program) bill that Henry Paulson put forth, $700 billion to try and save Wall Street, having the Federal Reserve engage in great, fantastic and unprecedented money printing to try and save the economy, have the President come up with the Cash for Clunkers, this big stimulus bill--all this stuff may have scared the economy even more and kept the economy in a state of fear. When Roosevelt said fear--what is it? Russ: 'We have nothing to fear but fear itself.' Guest: I think that's the most insightful few words about the actual macroeconomy that anybody's ever stated. Right now the economy is doing better. It's not because of the Fed policy, I don't think, of printing a lot of money and keeping interest rates low, or the government's extension of unemployment benefits or any of its spending. I think it's because people have been pessimistic for a long time and it's hard to keep Americans down psychologically. And now they are just a little bit more upbeat and they are turning things around.
25:42
Russ: Well, I think there's something to that. When people ask me if the Great Depression wasn't ended by WWII, which I don't think it was--I think that's a very difficult case to make--and if it wasn't ended by the New Deal, which I don't think it was, they say, 'Well, what did end it?' And I always say: People got tired of being depressed and pessimistic. They said: Let's go invest in something; let's take a chance. So I do think animal spirits--that's an untestable theory, though. Pretty untestable. People have tried to test some aspects of it. Ironically, it's a Keynesian story to some extent: it's a story about animal spirits. And I think they do matter. We don't know how much is the problem. Guest: It's not a Keynesian story. It's a Keynes story. Keynes himself [?] in his book and it's kind of like the Bible, you can make of it what you want--we are talking about the General Theory of Employment and Prices, his masterwork. It's written in a way that anybody can take anything from it. But Keynes himself rejected simple Keynesianism, crude Keynesianism of the kind that Paul Krugman is advocating. You've got people like Krugman and Larry Summers and other economists on what I would say the far Left or at least the Left who say we just need to spend more and more money to get the economy turned around. But the funny thing is they don't give you any theoretical framework for where that's coming from. The standard Keynesian model is one in which prices are supposed to be too high--either regular retail prices for consumption goods and services or wages are being set too high. But when Lehman Brothers failed in 2008, I don't know anybody, any employers, who went out and raised their prices sky high or any unions or set of workers who started setting their wages too high. And the prescription that comes from models where wages are set too high, yes, is to spend more money or to print more money. But that's not the right description or set of conditions that we are looking at. We are looking at collective panic that led to this recession. And their spending more money and printing more paper is not necessarily going to alleviate the panic. It may deepen the panic. So, what President Bush should have done the day after Lehman Brothers failed is to have [?] New York, all the press conference right in front of the Lehman Brothers building, and say: 'Take a look at this building; has it fallen down? It still looks pretty solid to me; I'm going to tap on its wall and see if it crumbles. And look at all these people walking out of the building. Yeah, they've been fired, but they are going to go get new jobs. And if you in the country want to panic and bring the economy down and sell all your assets at fire sale prices, we, the government, are going to buy up all those stocks and bonds that you are selling for nothing and print money; and [?] low-paying bonds; we'll print money, and we'll make a killing in the market. So, be my guest. Step right up.' Russ: But you know what actually did happen is that most of the people who worked at Lehman Brothers were re-hired by Barclay's, who bought the building. Barclays didn't buy Lehman Brothers, but my understanding is they rented or bought the floor that Lehman Brothers was on. But a lot of the same people. They avoided all the obligations that they didn't want to take on if they'd bought the actual company. Guest: So, had the President explained that, and said, 'Look, it's still in operation. If you are worried about the banking system collapsing, we've got a huge bank that can handle all your transactions called the Federal Reserve, the bank of banks. You need to use a bank, use this one.' Okay? But he didn't get it across to the public to calm the public. He left the public panicked. He said, basically, the sky is falling in. And he said this in a public way. And he panicked himself, and so did all his Cabinet Members. And of course, President Obama--well, he was a candidate at the time--was also interested in making this out to be a [?] of problems and he could come and fix it. But nobody seems to put their finger on the problem like Roosevelt did. You would have thought, you know, if I had been the President I would have not only gone to New York and talked about the [?] but I would have taken the top talents and employers, the ones who had the most employees, put them in a big room, had NFL (National Football League) football players at each doorway to keep people from leaving. I would have let them leave had they really insisted on leaving, but when physically [?] them, but I'd make clear that I wanted them to stay. And then I would start talking to them about not firing anybody. About turning this situation around. And not only hiring back who they just fired, but hiring more people. And if they all do it, guess what? They would all have more customers. Because but they have to do it [?] together; I would talk about collective, coordinated hiring as a policy to engage in. Russ: Yeah, that's called jawboning. Meaning persuasion without the use of force. It doesn't have a great history in political effectiveness. Guest: Well, it had a good history when President Kennedy used it with the steel companies, as you know, in the early 1960s, to keep prices down. And Hoover tried this to some extent, but I don't know if it was that effective or if we had the communication technology to try and make a sociodrama[?] the entire country could see. Russ: But we didn't have the NFL, either, so they could easily have got out of the room. Guest: Uh, yeah. Exactly. Russ: Sorry about that.
31:52
Russ: So, let me ask you a different question. We are talking about the longer run perspective. Of course, the long run can come tomorrow. If I understand you correctly, you are saying: In these kinds of situations, things are fine until they are not. And then suddenly, the case of Greece being an example, or other, many, many examples throughout history, countries, banks, institutions look okay; and then all of a sudden they are not. They lose confidence; and that process is not well understood. Guest: Right. Russ: I get listeners who ask me, they send me email saying: Well, what's the level of debt we can run and be okay? Russ: And I always respond: There's no such number; it's a psychological factor. So why don't you talk about that and talk about the Reinhart and Rogoff work, which seemed to suggest to some people that there is maybe a cutoff at which point things start to get, at least, negative for growth. But is there any cutoff for a precipitous fall off the table? Guest: Well, I think if people really understood the situation the fall off the table would have been 20 years ago or 10 years ago. Or certainly today. So, we have here, in capacity--the government hasn't made clear, it's intentionally not made clear for decades, what the true fiscal position is. The fiscal gap that thousands of economists advocate, that we start[?] reporting at a government level--those numbers-- Russ: But this isn't a secret. Not only does every EconTalk listener this week know about it, but every economist knows about it. Most pundits know about it. Every politician knows about it. It's true there are people in Dubuque, Iowa who are leading normal lives because they have too many things to do aren't paying attention to it. Guest: I don't know but the CBO put out its Alternative Fiscal Scenario, its Extended Baseline Forecast, in October, and they didn't reveal the Alternative Fiscal Scenario until people like myself started screaming at them. Two days later they stick it into an Excel spread sheet. Meanwhile the press reports that the country's fiscal policy looks pretty good. So, I don't think they know about it. I think they've been intentionally--I think the government has intentionally kept this information out of the public's eye. I prepared a fiscal gap and generational accounting analysis because--why generational accounting? Because the fiscal gap, if it's not paid for by current adults, will be left or be dumped into the laps of our kids. So Alan Auerbach and I, and Jagadeesh Gokhale, Alan's a professor at Berkeley, I'm at Boston University, Gokhale is now at Cato but he was at the time a grad student with me at Boston U., we did a study in the first full year of the Clinton Administration's term on fiscal gap accounting, to be included in the President's budget. And that document, which we worked on with the OMB (Office of Management and Budget) staff the entire fall of 1993 was censored by Gene Sperling, who was the Deputy Director of the National Economic Council, two days before it was supposed to be included in the President's budget. So, you tell me why that happened. Now, Sperling, under this Administration has been made Head of the National Economic Council--I'm not sure he still is, but he has been director. Under George W. Bush, Treasury Secretary Paul O'Neill commissioned a fiscal gap study; had a team of economists working on it for almost a year; put together the study. It was supposed to be published in the President's budget. December 7, 2002, they fire O'Neill. Dick Cheney, who was the Vice President, announced that O'Neill was leaving--you know, one thing the guy resigned or anything. It was a very insulting way that he fired Secretary O'Neill. Anyway, two days later, the guys preparing the study find out that that's not going to be in the President's budget any more. So this is two examples of censorship of the truth. That if you look at how Medicare Part D was introduced into legislation and how Rick Foster, who was the Chief Actuary at Medicare, how he was muzzled, he'll tell you--just google it. So I'm not saying we have a collective conspiracy of everybody in Washington to hide the truth. But we've seen enough real examples of people lying and hiding the truth and censoring the facts to know that the public doesn't know it's being kept in the dark.
36:57
Russ: Well, I agree that the public doesn't know precisely what the numbers are. But I think a lot of people know that they are roughly, that they are "large." But I think the other question is there are people in our profession who argue that they are no big deal: 'They are large, but it's okay. It's not a big problem. Those are the folks who don't understand.' Guest: I don't understand these people, either. I don't know if they've got kids or grandkids, [?]. There are some people in the profession who think we can just print money up forever without any implications, that we won't ever have inflation. Now it could be that everybody in the world for the next 200 years starts wanting to use more and more dollars and we can just print them and take back all their goods and services just for printing money. That's a possibility. So there are extreme scenarios. But in the history of the world we haven't seen any country able to get by with running a fiscal policy like this, that is this out of control and involves this much printing of money. We've basically quadrupled, increased by a factor of roughly 4, what's called the monetary base, the amount of money that the Federal Reserve prints. And most of that right now is being held in the banks as reserves. But it could get loose and get into the bloodstream of the economy and start leading to price increases. Or people could just decide tomorrow that the government's printing money like crazy, which it is to pay for its bills, and therefore we are going to have an inflation and therefore I'm not going to stop holding long-term government bonds and nominal bonds, and I'm going to start turning money into a hot potato. And overnight inflation could take off because people think inflation is going to take off. And here again we have psychology with respect to the timing. Russ: What about in the shorter run? Let's talk about the $12 trillion that is owed in Treasuries, which if I understand it is financed in very short-term ways and world over. Which means that when interest rates begin to rise, which of course the Fed has been diligently keeping them down--at least that's the claim--our interest costs in the very near future--forget 2030 when the baby boomers are swelling in very, very large numbers. In very short order we could have some fiscal issues just because of the Treasuries, correct? Guest: Well, the Treasury debt, which is $12 trillion, about 70% of GDP, if that was our only problem we would have not a big problem paying off that debt over time. But we have your Medicare benefits to pay, your neighbor's Medicaid benefits, your Social Security benefits; Obamacare could turn out to be enormously expensive. We are not organizing getting everybody health insurance in a way that fixes a total spending cap-- Russ: I don't think they are bending the cost curve. Guest: No, they are not. So this is just irresponsible behavior on the parts of politicians of both sides who are trying to get the elderly's vote. When President Bush introduced Medicare Part D, which is prescription drug insurance for the elderly, he didn't produce an extra $15 trillion, add another $15 trillion to the fiscal gap. He didn't ask a single old person, including Warren Buffett to pay a penny for this extra form of social insurance. Now I think that older people need to have insurance against very high costs of paying for their medications. But I don't think that the bills should be left to some poor kids who are being born today or being born in 10 years. And that's what we are doing. So a lot of people like to portray this as the Right vs. the Left, the poor vs. the rich, but it's really adults vs. children. The government has engaged for decades, both parties, in take-as-you-go policies, each generation of all people gets to take from the young people and the young people are told, 'Don't worry, you'll get your chance to take from your kids when you are older.' Russ: It's a beautiful social contract. Guest: Yeah. Russ: I've always found it mildly offensive, compared to a true family relationship but some people can romanticize it. It's interesting. Guest: Generational theft. And it's all under the rug. And we have the [?] running rampant throughout the Federal government in terms of its accounting but also in the banking system. Nobody knows what any of these banks hold in terms of assets. There's no disclosure. The fact that Bear Stearns could be worth a lot of money a week before it bailed and worth nothing the day it failed--well, it didn't actually formally fail; it got bought up by J.P. Morgan Chase. The fact that it could move that quickly means that nobody had any idea whatsoever about the true assets that it held and what the value of those was. The whole thing was [?] banking--we believe that Bear Stearns has valuable assets because Bear Stearns tells us that it has valuable assets. Right up to the point where everybody says, I'm not sure but what I'm really not sure about is whether anybody else is sure, and I'm worried that they are going to pull their money out. So we had the hedge funds engage in a run on Bear Stearns because they thought other hedge funds were running. So, bingo. That's the fragility of the banking system, and that interacting with the leverage permitted the entire financial system basically to fall apart at a moment's notice because of the opacity. Nobody knew what those banks had. Just like if you go back to 1982 with the Tylenol scare. Are you familiar with that? Russ: I am. Guest: Okay. So what happened there was 4 bottles of Tylenol were tainted with cyanide in a couple of drug stores in Chicago. And 7 people died in short order from buying these bottles. And all around the world we had 30 million bottles of Tylenol. And everybody decided overnight all around the world--in Thailand where there are shelves, drugs [?]--that Tylenol was tainted because what was important about those Tylenol bottles was that there were no safety seals at that point. So there was no real disclosure as to what was in those bottles. Johnson & Johnson lost $100 million; they threw away all that Tylenol; 30 million bottles they recalled, threw it away, and put on safety seals, and put Tylenol back into the marketplace. And they did by putting on safety seals was to disclose what was inside the bottle. Russ: More or less. I'll just say more or less. But I'll take your point. Guest: More or less. Russ: It's not 100% still but it's higher than before, because a stranger couldn't walk into a drug store in Chicago and inject something into a bottle once it was on the shelf. Guest: Yeah, I'm sure you are right. And somebody inside Johnson & Johnson could still try and-- Russ: Correct. It's an interesting point. There's an enormous amount of trust inherent in our economic system no matter what. Guest: Yeah. But overnight we had the Tylenol market disappear, and it was because of poor bottles. And overnight we had an entire financial system fall apart because of some rumors about buyer loans and no-doc bonds and ninja loans, many of which were true, but we to this day don't know the extent of the fraudulent mortgages. But it doesn't take much when you have no information about what these banks hold to have everybody run on them. And that's what happened. And that's what needs to be fixed. We need to have financial reform--I call it 'limited purpose banking', which requires the banks to fully disclose everything they are holding and also to have no leverage--to be fully equity financed. And this is called mutual fund banking--that's another term for it; equity finance, mutual fund banking. But that's probably for another day. Russ: It is, but it's a very interesting issue and we've talked about it on this program.
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Russ: I want to go back to the issue of the fiscal gap. Let's talk about government spending and the lack of transparency. Let's accept the point that this is--well, actually, let's forget whether my point is true or not. I could be right; you could be right; maybe people could be aware of it, maybe they aren't, maybe they are. We don't know. But let's suppose that at one point we do wake up either because there's more transparency, or because we realize that, oh my gosh, it really is a problem; the long run is here. And we have a serious fiscal problem. I'd like two pieces of analysis from you. One is, what do you think we ought to do in the face of the problem; and what do you think we would do in the face of the problem, if it were more widely known? Guest: Well, we need to have fundamental structural reform of our tax system, our Social Security system, our health care system. So, I have a series of plans. They are not yet legislation so I am not advocating specifics of bills at this point; but they are called the Purple Plans, if listeners want to go to www.purpleplans.org. They are called purple because they are designed to appeal to both people in the Right, who are red, and people on the Left, who are blue, and mixing red and blue leads to purple. So these are very simple plans that would eliminate the fiscal gap and produce fundamental reform in the tax system. I have a tax proposal there that involves consumption taxation. But I've come up with one recently which involves fixing up the income taxes, and that's called the Common Sense Tax. So, commonsensetax.org is the place to go to see that proposal. So, there are ways that this can be fixed. If we leave it in the hands of economists like you and me. You and I, Russ, could fix this country in a matter of weeks if we had complete dictatorial power-- Russ: I'm not as optimistic as you are. Guest: [?] screw things up. How else [?] the actual institutions are in this country, they could not be more poorly designed, and they are designed to drive us broke. Russ: But let's take the two parts, the two big pieces of the puzzle: taxes and spending. I'm a classical liberal. I want a much smaller government. It's easy for me to solve the problem. It would make a lot of people unhappy. I'd be killed probably or certainly thrown out of office. If I were a dictator there would probably be a coup. But it's easy for me to suggest a way to solve this problem, which is I don't believe in public provision of retirement benefits. I think that's infantilizing. I think people should stand on their own two feet. I think there should be charity for people who don't want to or who can't or who have bad luck, and so I have no problem with privately-organized aid to people. But it's easy for me to describe ways that government spending could shrink dramatically. I think defense spending is way too big; I don't think there should be farm subsidies. Those are easy to describe. The real issue is: Is there a way to make the system work under something remotely like the actual political constraints that we face? Now, yes, you and I could design a much better tax system, a much more effective tax system that didn't award accountants and tax lawyers and that didn't award special interests with special favors. A consumption tax. There are twenty that are better than we have now, that are easy to describe. Yes. But even those, it seems to me, would only raise a fairly limited amount of money relative to the amount of fiscal gap we are talking about. So ultimately--and again, Liberals and Conservatives disagree about this saying no--but it seems to me the promises to those baby boomers, that's a big problem. Without the reduction in spending, either means-testing Social Security and Medicare, which would be the obvious way to fix this and that's my prediction about how it will get fixed. There's really no other way to do it. Do you disagree with that? Guest: The problem is if we don't do this, really fix these systems fundamentally, we are going to end up with marginal tax rates that are sky high. They may not be explicit, but they are going to be implicit. Like for example, the Obamacare plan that's now being implemented, one of its problems is that it has very large subsidies but every dollar that you earn, you lose a lot of money in a subsidy if you are in that range where you are getting a subsidy. I've seen estimates of $0.25 on the dollar. So it's like an extra 25% marginal tax that people are facing. So you can easily get people onto the 60% marginal tax bracket. And if we keep raising these effective marginal taxes to 75, 80%, you'll have nobody with any interest in working. It will be a total mess. So what we need to do is get control of the spending, limit on the growth in health care spending, but do it in a way that everybody has a basic plan, health insurance plan; and have an efficient tax system that doesn't involve armies of lawyers and accountants to screw around with it. And have a Social Security system that people can understand. The Social Security system has thousands upon thousands of rules that nobody can remotely decipher. And it's completely underfunded; it's in probably worse shape by itself than Detroit is. If you look at it, it's 32% underfinanced, if you look at Table 4.B6 of the trustees report. We have to figure out what--both Republicans and Democrats at this point have agreed that we need a Social Security system; we need to force people that save and have some basic retirement income. They've all agreed effectively that we need to have universal health insurance. And there's consensus really that we shouldn't have a tax system that's crazy, but we want to have one that's progressive. Our system I don't think is all that progressive, if you really look at it carefully. Russ: It's somewhat progressive. Guest: Somewhat. But there's actually more consensus among these two sides. What's lacking is plans for how to fix them, because you've got 535 members of Congress, not a single one of them is a Ph.D. in economics. So they've made a mess. So it's time for them to start listening to economists now. You say it's not going to happen--they are not going to listen to me.
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Russ: No, I said something worse than that. I said it would probably be better if they didn't. I like you; I haven't looked into the Purple Plans. They sound like they might be okay. I might like them relative to the current situation. But there are a lot of other economists you don't like. So I'm not really confident that if they start listening to economists, they will listen to the right ones. And I really don't think that the economists, once they have the opportunity to steer things, are going to steer them the way their textbooks or hearts or family values to care for their children and grandchildren would have them do. Don't you think that's the problem? Don't you think every member of Congress understands what a marginal tax rate is? Don't you think they understand that our tax system is rife with complexity? And they like it that way. It's not because they don't understand it. It's good for them. Guest: I think your understanding--I think that's an overstatement. You take the 535 members of Congress and you show them the equation for the benefit for a married person under Social Security, the mathematical equation, which has got 10 functions on the right-hand side; some are minimum functions; some are maximum functions; they are certainly not smooth functions. One is in four dimensions. They will have no idea right now, as we speak, of the complexity of the system that they've produced, of the fact that people can't remotely understand what they have put into place. Russ: I agree with that. Guest: The degree of knowledge about what they've actually done and what's going on is very limited. And it's time for economists to help save the country. So I have a different perspective. I think we need to prescribe solutions, not just describe the problems. And we can do it; and there is hope. And frankly, I realize that your libertarian views aren't necessarily the same as my views about what should be done, but you libertarians have a fundamental problem that you don't seem to get, I think, which is that you are altruistic; you care about people; and when people care about other people we have the free rider problem. Who is going to take care of other people? You say charity. But if I care about that person who has got a broken arm laying in the street, and I know you do, I let you go out and try and help them; and then you let me go out and try and help them. And the guy stays there in the street with a broken arm. That's what we have--it's a public good taking care of that person. Russ: That's one explanation. That's the textbook explanation. It's not the only explanation. Because we see lots of examples in our economy despite the size of government, despite the intensity, the government does lots of things crowding out private initiative--we see lots of areas where people donate and give and volunteer even though there's an incentive to free ride. Now, that means it's not as large as it would be. I certainly don't disagree with that. I certainly agree that private aid to the poor would not be as large as the government's budget for education. But that has nothing to do, fortunately, with how much education we get. We live in a world right now where public education is free, out of pocket, to every American, and yet people donate to private charities to give scholarships to kids to get them out of those "free" schools because they are so horrific. They don't free ride. They free ride maybe in the amount they give; they don't give the full amount they'd give if they could collectivize. Guest: I agree with you. We do have a lot of charity and people are very kind-hearted and they do go out in the street and grab that person with a broken arm. But it's not a guarantee. And so I think that we have to recognize that we are going to have the government involved pretty heavily in the economy. It has to be done at--you are right, a much more efficient scale and a smaller scale so it doesn't drive us broke. And that can happen. There is reason to be optimistic. There is also reason-- Russ: Before you add on, let's do the optimistic part. Guest: Well, you know--I think we need to have a politician come forward, and I think there are politicians I've met with in Washington who do embrace real radical reforms that can fix our problems and are looking at plans that I've proposed and that others are proposing and taking them seriously. So I'm keeping my fingers crossed and still fighting the good fight.
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Russ: I don't disagree with that in the sense that I do think it's possible that when things get really horrible, the normal interactions of the political parties and the 'where's mine' impulse that everybody has and that the political process tends to pamper--right? We live in a world where people have a temptation to live at the trough. And that includes my profession, our profession, the economists, who get a tremendous subsidy in my opinion through government. Our salaries are dramatically higher than they would be in a free market. So I think we're as bad as everybody else. But maybe there would come a day where things were so horrific that people would say, maybe we need to band together, and not just say: Where's mine? And that will require a change in our political incentives, is what I believe. It may also require a visionary. Which is a very tragic thing to count on, because most visionaries don't turn out to be very visionary, Left or Right. They always disappoint us. So to count on that visionary--my fantasy version of it is that visionary steps forward and says, We have to go back the Constitution; government does too many things that aren't allowed by it; we've got to go back to the values of the Founders. And that's a fantasy. I like the fantasy. But it's probably not going to happen. I don't know if we are going to get any other kind of visionary that would do any different in terms of improving things. I'm not sure any of them are realistic. One who listens to good economists is going to be a very difficult President to stay in office, it would seem to me. Guest: Me, too. But I do think that the problem is not going to get--if we wait for everybody in the country to recognize the situation it will be too late. Herb Stein, who was the Chairman of the Council of Economic Advisers under Nixon said that things that can't go on will stop. But what he really should have said is that things that can't go on will stop too late. And the hour is far beyond too late. We don't have a crisis in 20 years or 30 years or 10 years. We had a crisis 10 years ago, 15 years ago. We've got a disaster right now, and we have to fix it right now.