July 21 (Bloomberg) — Is the U.S. bankrupt?
That's the question that's been bouncing around since economist Laurence J. Kotlikoff posed it in a paper for the Federal Reserve Bank of St. Louis in the current issue of its Review journal. Kotlikoff's thesis brings to mind images of the U.S. edifice teetering, like General Motors Corp., or imploding, like Enron Corp.
The bankruptcy thought is reverberating in envious Europe, since it fits in with the continent's preconceptions. The U.K.'s Daily Telegraph hyped the idea with the headline, "U.S. 'Could Be Going Bankrupt."'
Kotlikoff's comparison of the U.S. to a failing company is too interesting to dismiss out of hand. The place to start is with the books, beginning with the liabilities.
Here the case is strong. As Kotlikoff, a professor at Boston University, points out, the ancient entitlement of Social Security is only the start of the problem. Medicare, Medicaid and President George W. Bush's new prescription drug plan make matters worse. Economists used to hope that economic growth would keep up with future increases.
The data suggest the opposite. In the past four years, Kotlikoff notes, real Medicare benefits have increased at an annual average of 3.5 percent per beneficiary, whereas real wages grew .002 percent. By Kotlikoff's math, the U.S. confronts a $65.9 trillion fiscal gap over the long term.
Kotlikoff does some painful arithmetic to show the present value of those liabilities. He looks at the average lifetime tax rate for Americans net, or after you subtract whatever they collect in transfers from government, including Social Security payments at the end of life.
A person starting out on Wall Street at $150,000 a year faces an effective annualized rate of 43 percent. For someone who earns $214,000 a year, the average lifetime tax rate will be 46 percent. And these rates apply before taxes rise to meet the anticipated liabilities. Kotlikoff suggests a brutal change: a switch to a national sales tax of 30 percent or even 33 percent.
On the revenue side things looks different. The U.S. government currently takes in several trillion dollars a year, much more than any single company. If the markets can talk themselves into believing that Anything.com, with nothing more than projected revenue, is a bright star, then the U.S. is the revenue sun in the universe.
What would a company do in the position of the U.S.? It would take its overflowing coffers and restructure the rest of the house around them.
And this is where we get to the problem, management. The chief executive officer, President Bush, has a mixed record. On the one hand he has increased the entitlements — those prescription drugs. On the other he has pursued Social Security reform. Indeed, Bush even described that drive in business terms: "I want to spend that capital," he said, referring to the support he garnered from voters in the 2004 election.
But the president gave up because he was distracted by the war and he didn't have enough votes to pass Social Security reform in Congress. This was weak. We all know Bush is capable of political single-mindedness when he feels like it. Otherwise he wouldn't have invaded Iraq or vetoed, just this week, legislation backing government sponsored stem-cell research.
The corporate board — Congress — deserves more of the blame. So much attention has been given to the current spending habits of Congress. But earmarks are nothing compared to lawmakers' failure to focus on entitlement reform. Republicans don't fight for restructuring, and Democrats block it.
Though you might get a different impression from all the bankruptcy chatter, the reality is that the U.S. has time on its side. Countries such as Italy or Japan are already in pension crises. If Congress merely rejiggered the Social Security formula so that pensions rose only with inflation, that would eliminate more than half of the program's long-term imbalance.
But there's a third guilty party: shareholders, in this case voters. Based on opinion polls, they don't rank reforming Social Security or Medicare as top priorities. This is the rough equivalent of failing to send in a proxy to elect a competent board of directors. This behavior is partly due to the escalation of violence in the Middle East. War trumps everything, especially entitlement reform.
Sheer denial also is at work. Younger generations are held hostage to grandma — the monetary transfer flows mostly one way. Yet rather than change a management that is failing them, younger shareholders are focusing on hour-to-hour subjects, such as, say, those earmarks, West Nile virus or gas prices. This is the corporate equivalent of enjoying the buzz the gadfly makes at the annual meeting, and then going home to wait out another year.
What's frustrating about this attitude is that the entitlement issue isn't going away. If shareholders won't do something about U.S. obligations, financial markets will do it for them in a fashion that makes Kotlikoff's 30 percent sales tax look mild.
We Americans are oddly arrogant on this topic. We still believe that what happened to Italy, Latin America or Great Britain in the 1960s or 1970s can't happen to us.
In this regard Kotlikoff is correct. Political bankruptcy doesn't sound as bad as business bankruptcy, or the bankruptcy of a sovereign nation. But in the long run, they can become the same thing.
(Amity Shlaes is a Bloomberg News columnist. Her opinions are her own.)
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