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Home Publications Blogs Beat the Press Larry Kotlikoff Tells Us Why We Should Not Use Infinite Horizon Budget Accounting

Larry Kotlikoff Tells Us Why We Should Not Use Infinite Horizon Budget Accounting

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Thursday, 31 July 2014 21:23

In a New York Times column, Boston University economist Larry Kotlikoff told readers why we should not use infinite horizon budget accounting. Kotlikoff showed how this accounting could be used to scare people to promote a political agenda, while providing no information whatsoever.

For example, after telling us how much money his 94-year-old mother is drawing from Social Security and a widow's benefit from his father's job he ominously reports:

"you’ll find that the program’s unfunded obligation is $24.9 trillion 'through the infinite horizon' (or a mere $10.6 trillion, as calculated through 2088). That’s nearly twice the $12.6 trillion in public debt held by the United States government."

Are you scared? Hey $24.9 trillion a really big number. That's more than even Bill Gates will see in his lifetime. Does it mean our kids will be living in poverty?

Not exactly. Kotlikoff could have pulled a number from the same table in the Social Security trustees report to tell readers that the unfunded liability is equal to 1.4 percent of future income. If we just restrict our focus to the 75-year planning horizon (sorry folks, we don't get to make policy for people living 100 years from now), the shortfall is 1.0 percent of GDP.

That's not trivial, but it is considerably less than the combined cost of Iraq and Afghanistan wars at their peak. Furthermore, if we go out 40 years and assume that our children get their share of the economy's growth (as opposed to a situation in which it all goes to Bill Gates' kids), their before tax income will be more than 80 percent higher than it is today.

This means that even if they pay 2-3 percentage points more in Social Security taxes to cover the cost of their longer retirements (they will live longer than us), they will still have incomes that are more than 70 percent higher than we do today. Are you scared yet?

Of course we may continue to see the same sort of upward redistribution in future decades as we have in the last three decades. In that case any increase in Social Security taxes will be a burden on our children and grandchildren. But they stand to lose far more from the upward redistribution than the tax increase, which should make anyone wonder why there is much attention focused on the latter. (Btw, most people have not see big gains in life expectancy, these gains, like the gains income, have been concentrated among the wealthy.)

It is also worth noting that the scary fiscal gap that Kotlikoff threatens readers with ($210 trillion is his final number) would disappear entirely if we paid the same amount per person for our health care as people in other wealthy countries. Currently we pay more than twice as much as the average for Germany, Canada, the U.K. and other rich countries with nothing to show for it in terms of outcomes. We pay twice as much because our doctors get paid twice as much, as do the drug companies and medical equipment makers. If we want to make sure that our kids enjoy a good standard of living, why not focus on these ripoffs and ways to end them rather than just scaring people with really big numbers. (Free trade would go a long way on this one, if only policy wasn't dominated by protectionists.)

The point here is straightforward. Kotlikoff's budget accounting is a way to produce really big  numbers to scare people so as to advance an agenda for cutting Social Security and Medicare. It is not a way to inform people, which should be the main purpose of our accounting. The public has to decide the balance of spending and taxes on various programs. They can only make decisions that reflect their concerns and values if they know what is at stake. Kotlokoff's accounting takes them in the opposite direction.

One other item that is worth mentioning on this issue is that the New York Times continues to ignore the assessment of its public editor, Margaret Sullivan and former Washington Bureau chief and current Upshot editor David Leonhardt. In reporting the NYT's commitment to putting numbers in a context that would be understandable to most of its readers Sullivan commented:

"Part of the problem, he [Leonhardt] said, is that 'the human mind isn’t equipped' to deal with very large numbers. When people see these numbers, he said, they read it as 'a lot of money' or 'a really big number.'"

That was written almost 10 months ago. Yet the paper's reporting on budget issues still just gives really big numbers, as did this column, providing no context that would make it understandable to readers. What possible excuse can there be for this failure? No one thinks these numbers are meaningful to more than a tiny fraction of the paper's readers. It is not difficult to use percentages -- all the NYT reporters can make the calculation with a computer in a fraction of second. What is going on here?

 

Addendum:

Since Kotlikoff would present his infinite horizon accounting as a comprehensive measure of the burdens of government debt it is important to point out that in very important ways it is not. Perhaps the most obvious is the granting of patent and copyright monopolies. These monopolies are essentially ways in which the government finances innovation and creative work. In Kotlikoff's accounting, if the government were to commit itself to spend 0.3 percent of GDP (@ $50 billion a year) to finance the research and development of new drugs, this would be added to his infinite horizon debt calculation. However if the government grants patent monopolies that raise the price of drugs by 2.0 percentage points of GDP (@$340 billion a year) this will not appear in Kotlikoff's debt calculations even though the burdens to future generations will be far greater.

In the same vein, if the government sells off assets it will reduce its debt, while there is no measure of the additional costs imposed on future generations from no longer having the benefit of the asset. For example if the government sells off the air waves, so that future generations have to pay large fees for telecommunications, Kotlikoff's measure of debt will not pick up these fees. The same would apply to the use of any natural resource like beaches and parks.

Finally, the measure takes no account of environmental costs. If the government spends money now on reducing greenhouse gas emissions, this will directly add to Kotlikoff's measure of the debt. On the other hand, if it opts not to spend, and thereby subjects future generations to enormous expenses due to damage from storms and rising oceans (including the budgetary expense of dealing with disasters) there is no measure of the resulting liability created.

In short, Kotlikoff's measure is far from being a comprehensive assessment of future liabilities created by current government actions. It selectively imputes costs associated with some programs, while completely ignoring other costs which could be considerably larger and as readily quantifiable.

 

Comments (17)Add Comment
...
written by coberly, August 01, 2014 12:16
well, one thing is that most people don't understand percents either. even the smart people drive themselves crazy with percents. one example is "will have to raise the SS tax 33%!" but they forget that it's 33% of a 6% tax, or 2%.

and the other thing is that when I tell people that they could pay for social security by raising their own tax 80 cents per week each year (in today's money) they tell me they "get tired of hearing it", or they want to bargain it down to 40 cents by adding an extra year to the retirement age...

in other words people are stupid, and unless the good guys get it together and start telling people the truth in terms they can understand, the bad guys will scare them in into letting them kill social security in all but name.
I hate censorship
written by EMIchael, August 01, 2014 12:36
But for the good of the human race, Kotlikoff should not be allowed to speak.

The idea that people are paying him money to "teach" their kids is beyond scary.

I mean seriously, this is the guy that couldn't even add up the Fair Tax revenues. And he was making those revenues up!
I often wonder
written by Lord, August 01, 2014 1:16
what their real motivation is. Ostensibly it is debt, yet I have doubts that is it since raising taxes is never an option. There is also a puritanic virtue being promoted against idle hands and retirement itself. Finally there is the desire to oppose redistribution as they fear the burden will fall on the wealthy, whether through higher taxes, lower asset values, or more expensive labor, having squeezed all they can out of the rest. This is usually deigned the desire for smaller government.
Lord, corporate and wealthy donors have disguised our actual class warfare ...
written by jaaaaayceeeee, August 01, 2014 1:25

Lord, corporate and wealthy donors have been disguising the actual class warfare in this country for many decades, under poors blaming, debt hawksterism, patriotic, Keynesian weaponized spending, claims of fiscal conservatism (that are anything but), etc. But contractionary fiscal policies are still contractionary.
...don't cry for me, Argentina...
written by medgeek, August 01, 2014 5:20
Thanks for an informative post as always, Dean. Did you or anyone else notice Kotlikoff's subtle reference to "...Argentina's likely default..."? Between vulture funds, scary accounting and massive upward redistribution of income and wealth, we have quite a financial system indeed.
When All Else Fails, Compare the Cost of Something to Itself: Are You Scared Yet?
written by Last Mover, August 01, 2014 5:41

Actually infinite horizon accounting is among the lesser evils of the neofascist Ministry of Propaganda crowd beating the goose step drum of unfunded mandates.

Take health care costs for example. No need to project future costs there, just compare it in current dollars to other developed nations at two or three times the cost to America with worse outcomes, no infinite horizon needed. But somehow the differential never makes it into the fearmonger ratings of unfunded mandates.

More broadly ask a corollary question about innovation and productivity, for which the same crowd beats the drum loudly to privatize and deregulate everything in sight.

Now that they've had their wish while attempting to strangle the last victim - SS, such efficiency would translate by definition into huge reductions in future costs on an infinite horizon basis.

So where's the beef? Why aren't these cost saving advances included in the calculations? For example it should raise the real income value of future SS streams dramatically via reduced nominal prices.

Could it be, just be, that the whole line of economic propaganda from the Ministry keeps blowing up in their face as fast as they keep replacing it with more of the same contradictions?

So they're reduced to comparing something to itself over an infinite horizon because they know well that the obvious comparison - the true opportunity cost of the alternative such as privatized SS or single payer health care - would put them out of business in short order should it put a dent in MSM.
Typical
written by Larry Signor, August 01, 2014 10:06
Kotlikoff routinely sets up the equation so that it always points to financial disaster. Fear mongering, not economic analysis, has been his tool. His claim to fame is that healthcare costs represent 60% of our unfunded future liabilities. Not exactly new news. His solution? Scrap our entire health care system and turn it into a voucher (block grant) system. Really novel thinking.
...
written by skeptonomist, August 01, 2014 10:25
Yes, Kotlikoff's method of accounting is totally absurd (see the comments on the op-ed at the Times, including mine). According to this method we should be in a panic about the "unfunded" obligation into the infinite future for defense spending, among other things. Of course neither defense spending nor SS payments are "funded" in advance - every year the money is taken in and then paid out immediately. The general fund does owe SS most of the amount in the Trust Fund, which is actually money owed mostly to baby boomers for their retirement, but this is a small part of current total debt.

It is ironic that Krugman has a column about how united economists are on some things, but then the in the same issue the Times has this piece of drivel from Kotlikoff, who is supposed to be a bona-fide economist. Somehow people, apparently including economists, just don't get the difference between funded and unfunded retirement programs.
policy a century from now
written by David Cay Johnston, August 01, 2014 10:28
In a generally smart piece, Dean writes one thing I think is not quite on the mark...

"sorry folks, we don't get to make policy for people living 100 years from now..."

Many policies today are more than 100 years old. Equal protection (14th Amendment), direct election of senators (17th Amendment). Both are under assault right now.

Our economy today grows in good part from policies of the first half of the 20th Century, especially investments in physics, chemistry and math.... Policies today can have very long lasting effects...
patents yield transfers, not a "burden"
written by pete, August 01, 2014 10:28
If the representative individual owns shares of drug companies, then the price of drugs, if they are indeed above risk adjusted return to R&D, will flow to the shareholder. As with Warren Buffet, if you see monopoly rents, such as Coca Cola, buy the company.
...
written by coberly, August 01, 2014 12:10
i wrote kotlikoff showing him that just paying for Social Security as we go... it would cost an average of an extra 20 cents per week per year over the next 75 years, but would show up as about an extra 80 cents per week per year for the first 20 years or so of that time.... would eliminate the "unfunded present value deficit of 20 5 Trillion Dollars!

at first he said it was impossible. that told me he had no idea what "present value" is, beyond knowing how to plug numbers into his calculator. eventually he realized I was right, but then observed that that would mean that ultimately the "as we go" tax rate would reach 16% of payroll and said the people would never stand for that.

and there he could be right. the people are too stupid to pay (save) 16% of their money so they can retire in comfort when they are too old to work and will need at least 20,000 dollars a year for at least 20 years. despite the fact that they will be making twice what we are making now, and maybe four times as much as our grandparents who tried to save 10% of their much smaller income in order to be able to retire on much less than $20,000 per year (in "real" dollars) for a retirement they did not expect to last ten years.

So my take away... Kotlioff is dishonest or insane, but he gets away with it because people are stupid.

Sorry folks, I don't mean to be mean. But you need to think.
...
written by Kat, August 02, 2014 7:03
Thanks for taking the time to write Kotlikoff, coberly.
maybe i shouldn't call people stupid
written by coberly, August 02, 2014 12:56
People are not any more stupid than.. well, than the limits of human cognition generally. And I probably shouldn't say stupid because that makes them think i am insulting them and comparing them to someone who THEY think is "stupid."

All I am saying is that it has seemed nearly impossible to get people to think "i will need to retire some day. It will cost a lot of money. I need to save a lot of money. But inflation will eat it up as fast as I save it. But if I "invest" it, I could lose it all. But if I put some of it into Social Security the government will guarantee it against inflation and market losses and even insure me against not having been able to save enough to retire."

Because the bad guys will scare them to death with "10.6 TRillion (or 20.5 Trillion.. or 212 Trillion...) Dollar Unfunded Deficits!

Or, which is much the same thing... adding up all those eighty cents per week and finding out that twenty years from now it adds up to a "16% tax!" because by then they have forgotten that the whole point was to "save enough money to retire." and they can't imagine that 16% of what they will be making in 20 or 40 years will still leave them with more money than they have today... and that 16% is not "lost"... it's just "saved" for when they will need it most.

They don't get it.
Thick? Or Intentionally Misleading?
written by bakho, August 02, 2014 1:49
Is Kotlikoff Thick? Or Intentionally Misleading? You decide.

Social Insurance for the elderly is also a subsidy to the younger members of the family. Many of the younger members work and pay SS taxes in support.
Ask young people, would you rather pay SS taxes or have your elderly mother-in-law move into your too small house?

The Wealthy elites resent SS because it transfers money from the wealthy to the poor (mostly through payroll taxes) and the elderly don't really need to SS and may pay taxes on SS income. We tried the 401K experiment and it has failed royally to deliver income security to many elderly. Wealthy elites only care about lining their own pockets and hold the rest of us in contempt. They are truly Malefactors.
SS is not a "subsidy" nor a "transfer"
written by coberly, August 02, 2014 6:29
bakho

not quite. those workers who end up relatively well off will have paid for their Social Security benefits. they will get more in benefits than those who end up relatively poor, but they will get back a lower "return on investment." the difference is roughly the difference between a 5% return for the poorer and a 2% return for the richer. that difference is "the cost of insurance." just as the guy whose house burns down gets a bigger return on his insurance premium "investment" than the guy whose house does not burn down. you might call this a "transfer" but it is a transfer most people are willing to pay for, and prefer to be one of those whose house did not burn down to one of those lucky folk who got the big return on their fire insurance investment.

the difference may be too subtle for some people... especially because the bad guys are always lying about it. but the fallacy of "the rich" complaining about "their money" going to the poor is the fallacy of someone asking for his insurance premiums back because his house did not burn down before he sold it.

SS is extremely valuable to workers, but NOT because it "transfers money from the wealthy to poor."

nor is SS a "subsidy" to the young. it is a good thing for the young for the reasons you mention. but it is not a subsidy. the "old" paid for their benefits. and those who tell you that "the young are paying for the old" don't understand the first thing about banking... in which the interest collected by some old person withdrawing his money from the bank when he retires is paid for by the money some young person is putting into the bank to save (with interest) for his own retirement. the interest comes from the growth in wages over time... so that a young person saving the same PER CENT of his wages is putting more money into the bank than the old person did who paid the same percent of his wages. that more money is where the "interest" comes from. and those who say "oh, no, the interest from the bank comes from investments in productive enterprises are missing the point. you could, if people were sensible, offer the same deal as Social Security on a strictly private business basis. the only reason it has to be a "tax" is that most people wouldn't get around to "saving" enough money even if the return could be guaranteed as well as the SS guarantee. and SS has to be just about "everyone in" in order to work.
I'm with coberly
written by Troy, August 02, 2014 7:46
• FICA sequesters ~1/8th of our paychecks, preventing us masses from bidding up the cost of housing (rents and mortgage payments) with that money, so in that way it takes money from the ownership class.

• Gov't spending doesn't disappear into a black hole, every dollar the gov't spends enters money stream immediately, especially money directed at the 99%

• wonder what the infinite horizon of

http://research.stlouisfed.org/fred2/series/CP/

looks like. Funny how the panic mongers never bring that up.

...
written by coberly, August 03, 2014 6:21
Troy

I think I found another way SS takes money from the ownership class: A normal person works until he has "enough" and then tries to enjoy what he has. But the boss doesn't make any money from your "leisure." On the other hand, the boss does make about a dollar for every dollar you make. So the longer he can keep you working the richer he gets. ("every year a person delays retirement adds 90,000 dollars to the GDP"... note, very few people are getting 90,000 dollars per year in pay.)

Something like this may have made sense when we were a poor country and every little bit of production helped. But now that even the poor can afford to retire, well.. the rich can't stand to see "idle hands."

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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