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Blink! US Debt Just Grew By US$11 Trillion
Perspective | 17 August 2012

Republicans and Democrats spent last summer battling how best to save US$2.1 trillion over the next decade. They are spending this summer battling how best to not save US$2.1 trillion over the next decade.

In the course of that year, the US government’s fiscal gap – the true measure of the nation’s indebtedness – rose by US$11 trillion.

The fiscal gap is the present value difference between projected future spending and revenue. It captures all government liabilities, whether they are official obligations to service US Treasury bonds or unofficial commitments, such as paying for food stamps or buying drones.

Some question whether “official” and “unofficial” spending commitments can be added together. But calling particular obligations “official” does not make them economically more important. Indeed, the government would sooner renege on Chinese holding US Treasuries than on Americans collecting Social Security, especially because the US can print money and service its bonds with watered-down US dollars.

For its part, economic theory sees through labels and views a country’s “official” debt for what it is – a linguistic construct devoid of real economic content. In contrast, the fiscal gap is theoretically well-defined and invariant to the choice of labels. Each labelling choice changes the mix of obligations between “official” and “unofficial”, but leaves the total unchanged.

Dangerous Growth
The US fiscal gap, calculated (by us) using the Congressional Budget Office’s realistic long-term budget forecast – the Alternative Fiscal Scenario – is now US$222 trillion. Last year, it was US$211 trillion. The US$11 trillion difference – this year’s true federal deficit – is 10 times larger than the official deficit and roughly as large as the entire stock of official debt in public hands.

This fantastic and dangerous growth in the fiscal gap is not new. In 2003 and 2004, the economists Alan Auerbach and William Gale extended the CBO’s short-term forecast and measured fiscal gaps of US$60 trillion and US$86 trillion, respectively. In 2007, the first year the CBO produced the Alternative Fiscal Scenario, the gap, by our reckoning, stood at US$175 trillion. By 2009, when the CBO began reporting the AFS annually, the gap was US$184 trillion. In 2010, it was US$202 trillion, followed by US$211 trillion in 2011 and US$222 trillion in 2012.

Part of the fiscal gap’s growth reflects changes in policy, such as the Bush and Obama tax cuts, the introduction of Medicare Part D, and the expansion of defense spending. Part reflects “natural” growth of existing programs, including growth in Medicare and Medicaid reimbursement rates. And part reflects the demographic time bomb US politicians are blithely ignoring.

When fully retired, 78 million baby boomers will collect, on average, more than 85 percent of per-capita gross domestic product (US$40,000 in today’s dollars) in Social Security, Medicare and Medicaid benefits. Each passing year brings these outlays one year closer, which raises their present value.

Governments, like households, cannot indefinitely spend beyond their means. They have to satisfy what economists call their “intertemporal budget constraint”. The fiscal gap simply measures the extent to which this constraint is violated and tells us what is needed to balance the government’s intertemporal budget.

The answer for the US is not pretty. Closing the gap using taxes requires an immediate and permanent 64 percent increase in all federal taxes. Alternatively, the US needs to cut, immediately and permanently, all federal purchases and transfer payments, including Social Security and Medicare benefits, by 40 percent. Or it can mix these terrible fiscal medicines with honey, namely radical fiscal reforms that make the economy much fairer and far stronger. What the government cannot do is pay its bills by spending more and taxing less. America’s children, whose futures are being rapidly destroyed, are smart enough to tell us this.

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