Why the Government Needs to Budget over the Infinite Horizon

June 19, 2013

How far into the future should governments budget? Economic theory has a clear and rigid answer. But it's not one economists like to give, because it's not one people easily comprehend and it's not one that politicians, whose attention most economists covet, like to hear. The answer is that governments need to budget out to infinity, says Laurence Kotlikoff, a senior fellow with the National Center for Policy Analysis and economist at Boston University.

Infinity is a very long time. But economic theory also tells us that in budgeting out to infinity, we should place less weight on distant government expenditures and tax receipts. Specifically, we should include in our budgeting not actual future expenditures and taxes, but their present values.

  • Present value stands for the value right now, in the present. And the value right now of getting $1 in the future is smaller the longer you have to wait for it.
  • Take the just-released 2013 Trustees Report on Social Security's long-run finances. They claim an infinite horizon fiscal gap of $23.1 trillion separating the system's projected costs and taxes net of its trust fund.
  • This massive shortfall, which grew a whopping 8 percent last year, is 50 percent larger than U.S. gross domestic product and almost twice the federal debt held by the public.
  • Social Security began reporting its infinite horizon fiscal gap 2003. Back then it was $10.5 trillion. On an inflation-adjusted basis, the gap's risen 74 percent leaving the system in far worse shape than when the 1983 Greenspan Commission "fixed" it.

The Greenspan Commission, like the current Trustees, looked out only 75 years. In so doing, it ignored not just the 30 years between 2057 and 2087 now in the current 75-year window, but all the years after 2087, when today's and tomorrow's children will be alive.

  • For the U.S. government as a whole, the infinite horizon fiscal gap is a whopping $222 trillion.
  • Its elimination requires not a 32 percent immediate and permanent tax hike in Social Security FICA taxes or a 22 percent immediate and permanent cut in Social Security benefits, but either a 64 percent immediate and permanent tax hike in all federal taxes or a 40 percent immediate and permanent cut in all expenditures apart from servicing official debt.

So, Social Security's enormous fiscal problem is just a molehill in front of a mountain of horrendous obligations our politicians and their "trustees" are ignoring with their careful choice of words and their finite budgeting horizons.

Source: Laurence Kotlikoff, "Why the Government Needs to Budget over the Infinite Horizon," Yahoo! Finance, June 13, 2013.

 

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