"I can't think about it now. I'll go crazy if I do.
I'll think about it tomorrow. After all, tomorrow is another day!" --- Scarlett
O'Hara, Gone With the Wind
Scarlett's words come to mind every time I think about how our government does its accounting. It makes me crazy. This is inconvenient since the subject comes with the territory of financial writing. Worse, I know you would prefer to floss, right now, rather than think about this topic. Please resist.
Our government does its accounts on a cash basis. It tells us what it collected in revenue. It tells us what it spent. It tells us how much it had to borrow to cover the difference. As you read this, it's short nearly $500 billion for the year and has accumulated formal indebtedness of $7 trillion.
Cash accounting works for Kool-Aid stands. It's a necessity for drug dealers. And it worked pretty well for the U.S. government until 1935. That was the year Social Security was created. Basically, our government entered the insurance business, collecting payroll tax premiums from workers in exchange for a promise of future income benefits. Overnight, Washington was the largest insurer in the world.
Private insurance companies don't operate on a cash basis because they are collecting premiums against a future liability. If you tried to run an insurance company on a cash basis you'd be in jail quicker than you can say "Fastow" because the authorities would consider it fraud.
But nearly 70 years after the creation of Social Security and nearly 40 years after the creation of Medicare, our government still operates on a cash basis. Future liabilities, when measured at all, are buried in obscure documents read by actuaries, but ignored by Representatives, Senators, and Presidents.
The best tool for measuring these liabilities is called generational accounting. Created by Boston University economist Laurence J. Kotlikoff and advanced by many others, it starts with a fundamental idea. The value, in today's dollars, of all the taxes we'll pay is equal to the value, in today's dollars, of all the benefits and expenses we'll receive. If the promised benefits exceed the expected tax collections, the difference is a debt foisted on future generations.
Last year I had the pleasure of writing a book with Professor Kotlikoff. "The Coming Generational Storm" is our effort to take the idea of generational accounting--- and the dilemma we face--- to a broad audience. The most recent generational accounting shows that promised benefits currently exceed future tax collections by $44.8 trillion. That's a big number. It's 6 times the total formal Treasury debt and 11 times the federal debt held by the public. The calculation was done before the new Medicare prescription drug plan added another $7 trillion. Equally important, the figure will grow by $8.1 trillion between now and the 2008 election, dwarfing the expected $1.6 trillion growth of our formal debt. Cash accounting measures the top of the iceberg, but ignores the bottom. Can you say Titanic?
To put that $44.8 trillion in perspective, compare it to our collective net worth. The most recent Federal Reserve measure clocks in at $42 trillion. In the world beyond government, that's considered a real problem.