IMF Effectively Pronounces the US Bankrupt (Duh)

♠ Posted by Emmanuel in , at 8/12/2010 12:06:00 AM
Now here is one of the increasingly rare breed of American who can unflinchingly and convincingly explain why the US is in a world of trouble. In 2006, Laurence Kotlikoff asked in an FRB St. Louis Review article, "Is the United States Bankrupt?" What follows is the conclusion he came up with in those innocent times when America had yet to breach the trillion-dollar annual deficit mark. It only made it past, oh, the $400 billion mark. Such incredible thrift, eh? It almost makes you want to have Bush back as an exemplar of economic stewardship compared to what passes for it nowadays. I can hear the Yanquis sighing with fondness as their country sinks further into its debt morass:
Countries can and do go bankrupt. The United States, with its $65.9 trillion fiscal gap, seems clearly headed down that path. The country needs to stop shooting itself in the foot. It needs to adopt generational accounting as its standard method of budgeting and fiscal analysis, and it needs to adopt fundamental tax, Social Security, and healthcare reforms that will redeem our children’s future.
To make a long story short, the United States has done none of those things. Instead of placing a priority on restoring a semblance of fiscal sanity, it has since embarked on a course of megadeficit spending.

And so we have Kotlikoff's new opinion piece in Bloomberg. Instead of beating around the bush like he did earlier, he cuts to the chase by relaying the opinion of the IMF that, yes, America is effectively bankrupt. Although this fact should be plenty obvious to all except the most jaded and mathlexic contenders for the Carl Spackler Award, it is good to hear coming from Kotlikoff. Also, despite IMF honcho Dominque Strauss-Kahn being more on the side of stimulus than consolidation, it's good to know his underlings essentially agree with criticisms of this brand of free lunch economics.

You've heard all the excuses for vapid "deficits don't matter"-style reasoning. Now, however, let's hear the lowdown from Kotlikoff:
Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”

But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP.”

The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.

Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.
This time, he ends by saying the US is in worse shape than Greece. I definitely agree that the solutions on the horizon do not look promising for Deficitlandia:
And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.

Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run. This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.

Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue. My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”
By the way, the IMF report Kotlikoff cites is a fine if sobering read. Thankfully, it doesn't tell you fanciful stories about how deficits don't matter since interest rates are so low and other balderdash so beloved by certain Amerocentric parts of the blogosphere. Here is the part on p. 54 he mentions in the op-ed:
7. The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates. Using the same discount rate (3 percent) used by the Trustees of the Social Security Administration (2009) in their own Social Security-specific fiscal gap analysis and by CBO (2010e), and the infinite horizon definition, the U.S. fiscal gap is about 14 percent of the present discounted value of U.S. GDP under the Staff’s Scenario. This implies that closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14 percent of U.S. GDP, that is to say that fiscal revenues and spending would need to change so that the primary balance predicted under that scenario improves by this amount every year into the indefinite future starting next year.Using the Alternative Scenario the fiscal gap increases to about 14½ percent of the present discounted value of GDP (owing to the assumption that tax cuts are made permanent).
And here is the conclusion. Needless to say, immediate corrective action is necessary:
14. Sizeable fiscal actions would be needed to close the U.S. fiscal and generational imbalances. Under current policies, the United States federal debt is projected to grow rapidly due to a combination of large budget deficits before and during the crisis, as well as, over the medium term, demographic factors and healthcare inflation. As part of the medium term adjustment, the authorities would need to raise taxes and/or cut transfers substantially to avoid an undesirable escalation of the debt-to-GDP ratio. The longer the wait, the larger the necessary adjustment will be and the greater the burden on future generations.
America is broke and there ain't nobody fixing it.