How Large Is the Federal Government's Debt?

Studies | Federal Spending | Government

No. 263
Thursday, October 30, 2003
by Liqun Liu, Andrew J. Rettenmaier, and Thomas R. Saving

Measuring Total Debt

Is it possible to construct a meaningful annual measure of government fiscal policy that provides year-by-year accountability in straightforward accounting terms and in a manner consistent with the dynamic nature of fiscal policies? We believe so, and the main goal of this paper is to discuss several competing measures. We will discuss four different approaches along with the advantages and disadvantages of each.3

"The prepetuity open-group includes all current and future workers and beneficiaries, and assumes the system gose on forever."

The Perpetuity Open-Group Obligation. This measure is calculated by subtracting the present value of all future scheduled revenues from the present value of all future expected benefit payments. Future benefits and revenues are projected into the infinite horizon and discounted to the present using the long-run government borrowing rate. The term "open-group" indicates that new participants, in addition to those who are currently paying taxes or receiving benefits, are included in the calculation.

One criticism of this calculation is that it includes benefits to people not yet born, including all future generations. How do we know what these future citizens will think about Social Security or what benefits they will demand during their retirement years? On the other hand, in order to keep its promises to current workers, the government will need revenues from the next generation of unborn taxpayers. It seems unlikely that these future citizens will be willing to pay taxes their entire working lives and then forgo their own benefits. The same may be said of the generation that follows the next generation, the generation that follows that one, and so forth, indefinitely into the future.

The perpetuity open-group calculation is worth paying attention to precisely because once you start a pay-as-you-go system (in which each generation of taxpayers pays the previous generation's benefits), it is difficult to end.

"The 100-year closed-group includes everyone who is now in the system."

The 100-Year Closed-Group Obligation. This measure is equal to the present value of scheduled benefits less scheduled tax payments for people who are currently participating, either as taxpayers or as beneficiaries. As a practical matter, this includes everyone who is 15 years of age or older in the year in which the calculation is made. The term "closed-group" signifies that benefits for people below age 15 and people not yet born are ignored.

The advantage of this approach is that it is limited to people who are currently in the system and to whom an implicit promise has been made. It identifies the magnitude of the obligation new entrants to the system will have to pay to current participants in addition to the taxes that will be collected at the current tax rate. The potential disadvantage of this measure is that new entrants in the system will generate corresponding benefit claims as they pay taxes. For example, this approach assumes that new entrants like today's 14-year-olds pay payroll taxes for their entire work lives, but it ignores their retirement benefits.

The Accrued Obligation. This means the present value of all accrued benefits - that is, the sum of all benefits that have already been earned by each current participant, based on his or her past participation in the program. Since the calculation ignores new participants, the measure implicitly ignores future benefits that will be earned, even by those currently paying taxes. It also excludes any future payroll tax payments made by participants. Since it is primarily retrospective and only counts accrued benefits, with no offsetting future payroll tax revenues, of the four measures discussed here, it is the most similar to a firm's accrued pension liability. The accrued benefits measure has been referred to as the maximum transition cost in that it represents the cost of ending the system tomorrow and making good on the benefits that have been accrued by all current participants.

"Accrued obligations are the benefits people have already earned."

It can also be thought of as the current value of assets that would need to have been set aside in the past to pay for the benefits owed to current participants. This calculation would be the right one to make if we were going to end the system tomorrow. But given that the system is not prepaid, paying off the liability will require taxes from new workers who will expect to receive benefits of their own. Nonetheless this is the best measure of the implicit liability of the Social Security or Medicare system.

The 75-Year Open-Group Obligation. This measure, similar in construction to the perpetuity obligation, is equal to the present value of the difference between scheduled revenues and benefit payments for the next 75 years. The group is open to new participants. This is the calculation government actuaries have historically made and reported in the annual Trustees Reports of the Social Security and Medicare trust funds.

As in the previous two cases, this measure assumes we can have a cutoff point, beyond which we can ignore the benefits of those who have been paying taxes. In this case, the assumption is that we can ignore the benefits of someone who retires 75 years from now even though we are counting all the taxes we expect to collect from that person throughout his or her work life.

"The 75-year open-group is the system over the next 75 years, including current and future participants."

The 75-year open-group calculation has another problem. Although Social Security and Medicare finances will be in deficit much of the next 75 years, they will be even worse in all subsequent years. Thus, as we advance through time, each year's new calculation is worse than that of the previous year. Readers of the Trustees Reports are reminded that the outlook for elderly entitlements worsens each year as the time horizon is lengthened to include one more very bad year.

Relationships among the Four Measures. Together these four measures provide comprehensive methods of measuring the unfunded liabilities of Social Security and Medicare. Note that the last three measures are subsets of the first and the third measure is a subset of the second. The 100-year closed-group calculation is that part of the perpetuity open-group obligation that applies to current participants and the accrued obligation identifies that portion of the 100-year closed-group's benefits that have already been earned. The 75-year open-group unfunded obligation is simply the first 75 years of the perpetuity open-group obligation. The relation among these four measures is described in greater detail in the Appendix.

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