The Long-Term Cost

Sunday, September 28, 2008

THE $700 BILLION financial rescue plan pending in Congress may or may not stave off short-term economic collapse. We both hope and expect that it will. One thing the bailout cannot do, however, is correct the deep and long-neglected fiscal imbalances that brought us to this day. The United States' twin habits of consuming more than it produces and of promising more government services and benefits than it is willing to pay for have made us dangerously dependent on debt, public and private, to sustain our standard of living and to fund our government. These habits must end, lest we risk the country's long-term prosperity -- and the federal government's stability. Paid for with borrowed money, today's rescue plan will actually make matters worse in the short term. But it will be money well spent if we use the time it buys to put America's financial house in order.

Back in June -- before the government had assumed Fannie Mae and Freddie Mac's $5 trillion debt and before it had embarked on the most recent batch of financial bailouts -- the Government Accountability Office issued a report declaring that the federal government was on "an unsustainable long-term fiscal path." The government has committed to spend $54 trillion more than it would take to keep the budget deficit at the 2007 level (about 1.2 percent of gross domestic product) over the next 75 years. Though spending on wars in Iraq and Afghanistan and on other items have undoubtedly contributed, by far the biggest cause is the projected cost of Social Security, Medicare and Medicaid, brought on by an aging population. According to the GAO, existing law requires the government to spend $41 trillion more on these entitlements over the next 75 years than it can expect to receive in payroll taxes and premiums. Of this, $34 trillion is related to health-care programs.

Does 75 years seem remote? Well, the crunch actually begins much sooner than that -- in 2011, when Social Security's cash flow turns negative, because of the first wave of baby-boom retirements. No longer will the rest of government be able to live off the surplus in Social Security's trust fund. According to the GAO, the federal budget deficit -- projected at more than 3 percent of GDP next year -- is on a path to exceed 20 percent of GDP by 2050, unless we enact substantial reforms to our tax structure and entitlement programs.

The federal debt in August was just over $9.6 trillion, or about 65 percent of GDP -- better than, say, Japan (182 percent) or Italy (106 percent) but worse than historical U.S. norms. About a quarter of U.S. government debt is held by foreigners; we owe Japan and China about $500 billion each. Recent events will push their share higher. We are lucky to own the printing press that produces the currency, U.S. dollars, in which these debts are denominated. But we cannot inflate it away forever. Eventually, our creditors will demand higher interest in return for accepting pieces of paper backed by "the full faith and credit of the United States."

This has been one of the most exciting presidential races in recent memory, marked by the high drama of a young African American nominee's bid to make history and the even higher drama of the past few days. But, in light of the country's actual economic predicament, it has not been a terribly serious or even relevant campaign. Both Democrat Barack Obama and Republican John McCain have ignored the long-term entitlements crisis, making tax and spending promises that they cannot keep without borrowing more money, much of it from abroad. In the next 37 days, they must engage in a more realistic debate.

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