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“How Long to the Point of Know Return?”

June 20, 2018

Can we finally talk about the $21 Trillion Elephant in the Room? I know its been an entertaining/incredible/painful/awful (pick your adjective) l7 months since Trump office between the Russia investigation, immigration dysfunction, the hush money payouts to a former porn star, the trade wars, the interminable tweets from the White House etc. But maybe we can actually do something that will shape this country’s future– whether marked by a worldwide depression of unprecedented levels or one where at least there continues to be improving growth in incomes and employment.? Federal debt outstanding totals an eye-popping $21.2 trillion with state and local debt totaling an additional $3.1 trillion.

In addition, total debt in the US has soared to over $70 trillion (almost 3 times the debt burden in 2000). which includes federal debt at $21 trillion, state and local debt at $3 trillion, personal debt (mortgage/ credit card/student loans primarily) of $19 trillion. In other words as bad as the government being awash in red ink is–and it is clearly our worst financial problem–individual debt is also soaring.

The US debt time bomb is still ticking. In fact now it is ticking even louder and faster, but is still silent to most Americans, Congress and the Presidency. The CBO released its ten-year budget projections in April which included the new tax law enacted by Congress at the end of 2017.

  • On the positive side, the projections show a steady growth in tax revenues from $3.33 trillion in 2018 to $5.52 trillion in 2028 or an average of 5.2% per year.
  • On the negative side, total government spending or outlays will grow much faster from $4.1 trillion in 2018 to more than $7 trillion in 2028! 
  • As a result, the projections show the annual budget deficit growing once again from our current estimated “low” levels of about $665 billion  in 2017 to about $1 trillion in 2020 and $1.4 trillion by 2027.
  • The national  debt is currently $21.2 trillion or 105% of US GDP. (See if you really want to get depressed!). According to CBO figures, this debt burden will grow to approximately $24 trillion by 2022 and to about $32 Trillion by the end of 2028 or a growth in our US debt of about 50% in the next decade. This means that the total US debt will more than triple in the 20 years between 2007 and 2027 ($31 Trillion vs. $9 trillion in US debt in 2007) and will more than quintuple from 2000 to 2027 ( $31 Trillion vs. $5.6 Trillion in 2000).
  • In a few cases, the CBO projections are overly pessimistic. For example, while real GDP grows at about a 3% rate during 2018 and 2019, it falls to 2% in 2020 and grows only 1.5% to 1.8% thereafter. With the stimulus of the tax cuts and particularly the likely capital spending and associated productivity gains associated with allowing expensing of capital investment under tax reform, along with the large deficit spending projected for a number of years in the future, I think real GDP will probably grow faster than this and this means tax revenues should also grow faster.
  • On the other hand, on the spending side, the CBO projections are in my view VERY optimistic. They assume almost no increase in inflation from current roughly 2% levels. (CPI grows to 2.4% from current levels of 2.2% per year). They also assume that the interest on long-term treasury debt will only increase to about 3.7% (from today’s 3.0%) in the next 10 years which is still well-below normal levels. This assumption is particularly important as federal outlays on just paying interest on debt are very likely to exceed $1 trillion per year by the middle of next decade assuming we move to more “normal” interest rates. Even the CBO’s conservative interest assumptions result in it reaching $0.9 trillion in 2028  ( I would estimate about $1.3 Trillion in 2028). Still even with CBO’s comparatively low-interest rate assumptions interest on the debt will become the 3rd largest budget item for the federal government, passing defense spending of $0.8 trillion and after Social Security $1.8 Trillion and Medicare’s $1.5 Trillion in 2028.

So why doesn’t anybody seem to care?

First, there is the ridiculous misnomer of comparing our total GDP to total federal debt as if this comparison is meaningful. The comparison suggests that somehow we have “covered” our debt with our total economic output. But as economist and investment advisor Bob Wiedemer points out, the correct comparison is annual federal revenues vs total federal debt. Thus our true debt coverage ratio is much scarier –only 15%. (vs the roughly 100% coverage using the fallacious GDP to total debt ratio). To put this into perspective, imagine someone who makes $60,000 per year deciding to go on a luxury 6 month around-the-world vacation costing $400,000 and trying to do so with no money down thru a $400,000 unsecured loan. Would any banker or finance company make this loan?

Of course, our federal debt situation is a bit better because the federal government controls the printing of money which means as we did during most of the Obama years we can monetize the debt. The Fed buys treasury bonds by printing money, simultaneously keeping interest rates lower and financing some of the debt. But printing money is a temporary solution at best and one that is fraught with risk (most notably much higher inflation) that we have managed to dodge at least for now. But greater and greater debt levels and rising interest rates likely will have even more dire consequences for the economy and the deficit in the future, making even more money printing likely and rapid inflation/economic depression a very likely consequence.

Second, there is a political situation in this country that is unprecedented. We have a two-party system where neither party seems to be able to even agree on the most basic of economic issues. Republicans generally believe that greater economic growth will lead to increasing tax revenues which will eventually allow deficits to disappear or at least diminish its significance. Tax cuts and reform (i.e. the Tax Reform Act of 2017) and reduced regulations are the Republican “Supply-Siders” main methods for increasing growth. Also, Republicans view that discretionary non-Defense domestic spending  can be reined in and cut to help control the long-term spending. In contrast, Democrats are generally against spending cuts, except for Defense, and Democrats are also for tax increases (though mostly on the wealthy few) and are generally against tax cuts. My own view is that to get us out of this mess we need to take the best of both sets of solutions in order to get us out of this mess.

Third, with elections in November and the polarized political environment NO ONE is willing to talk about either Social Security or Medicare (or for that matter Medicaid). Excluding interest on the debt, in 2028, CBO projects $4.5 trillion of the $6.1 trillion of government expenditures or nearly THREE QUARTERS of all government expenditures will be spent on Social Security ($1.8 Trillion), Medicare ($1.5 Trillion) and Medicaid ($0.6 Trillion) or other government/veterans retirement and income programs ($0.6 Trillion). But any Republican who dares talk about possible cuts or changes in these programs will be almost certainly punished in the elections, while any Democrat who talks about payroll or other tax increases to fund the difference fears the same retribution from voters.

Bottom line, I don’t see any current actions that will change the CBO dire forecast very much and if anything I think the situation will likely be even worse, when you factor the strong likelihood of a recession and perhaps a major depression in the next 3-5 years. The problem of course is the greater the debt the more likely we will see increases in inflation, interest rates and ultimately a major stock market decline and crash, which will in turn will result in a major decline in the dollar value, further increase $ inflation, further exacerbating the deficit and debt problems greatly increasing unemployment, and lowering incomes.

So what do we do to prevent this nightmare from coming true? Clearly, we must start doing something NOW to deal with our burgeoning deficit and debt to give the markets some assurance that the US will eventually pay down some of its large federal debt, BEFORE the markets lose confidence in US treasuries and the stock market. I have in mind a multi-faceted strategy on Social Security, Medicare/Medicaid and discretionary government spending. For this blog, I will post about the “easiest” to deal with Social Security and leave the more difficult Medicare/Medicaid discussion for later.

Social Security

Social Security is inherently the most fixable of our current bankrupt government programs and it can be done by spreading the pain across a few of the main categories of funding and benefits. I believe it can also be done without changing the monthly benefits that current and future retirees are depending on, though it would mean somewhat more taxes on current workers and retirees as well as a delay of the official retirement age:

  • Raise the Full Benefit Retirement Age – With Americans who make it to their 60s increasing living past age 90, Currently the last Social Security law (passed in 1983) is gradually increasing the full benefit retirement age from 66 years gradually to 67 years over the next few years but this still means that Social Security is being paid to many for 20-25 years or even more. This of course is far longer than originally intended with the law designed to cover the last 10-15 years of life. Notably, more Americans are working into their late 60s and even their 70s than ever before. One possible change would be to accelerate full retirement age to 70 in five years and to 72 in 10 years.
  • Increase Taxation of Social Security Benefits for middle and upper-middle income retirees. – Currently, social security income is tax exempt for lower-income recipients(for married couples those whose “other income” totals less than $32,000 and 50% of benefits are taxable for those with “other income” between $32,000 and $44000. Above $44000, 85% of Social security benefits are taxable. (The actual formulas are actually more complicated than this….hey its the IRS!…but this gives you the general idea.) Because the new tax law significantly reduces the tax rates for lower and middle-income brackets, this means there will be less revenue from federal income taxes on social security benefits. One way to raise back some of these lost revenues is to make 100% of benefits taxable at the $44,000 threshold.
  • Increase Payroll Tax Limits for Social Security -In 2018, there is a 6.2% payroll tax for employees and employers for the first $128,400 in income with this income limit rising by inflation every year. Clearly, this is no longer enough to fund social security recipients as it once was, particularly with the increasing retirement of baby boomers over the next decade. One way to plug this gap would be to raise the tax limit to $150,000 in 2020 and then by $20,000 per year between 2020-25 until one reaches $250,000 in 2025. These tax limits would be indexed to inflation per the current law.

In 2018, Social Security Tax Receipts are estimated at about $0.9 trillion which are already less than  $1.0 trillion in total Soc. Security outlays. But without changes in the system, tax receipts in 2028 will total $1.4 trillion while outlays will swell to over $1.8 trillion in 2028 – a funding gap of more than $0.4 Trillion. I estimate that the changes noted above would eliminate this future funding gap by reducing outlays (due to fewer recipients in 2028 by raising the retirement age) paid to $1.6 trillion and increase tax receipts to $1.6- $1.7 trillion. (NOTE: My estimates are very rough because I don’t have access to all the data the CBO or the Administration has in making their projections, however, they are accurate enough I believe). Further they can be fine tuned to those actually doing detailed studies of the data. In addition, there are other levers at our disposal that I haven’t included above. For example, one would be to raise the payroll tax % on all income (say from 6.2% to 8% on both employees and employers), another would involve reducing future benefits slightly by using CPI inflation -1% for indexing. The point is there are a number of solutions that can spread the burden across younger workers and retirees and put the Social Security system back on a financially viable footing.

Though politically difficult, I actually believe Social Security is the best program to tackle first for Congress. For one, reasonable things can be done to bring the system in balance and have it start building up a trust fund again. And just getting SOMETHING done on the long-term budget and debt issue will hopefully be enough to settle (for a time) the increasing concerns of the markets over the total burgeoning US debt. In other words, it’s a good place to start. Will we? I think it depends not on Congress but the voters. If we demand a bipartisan solution now, we are much more likely to see one in the foreseeable future. Lets hope so, because we are getting closer to the “point of know (no) return”.


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