Tuesday, November 23, 2004

Making a bad measure even worse

Deficits are a bad measure of the government's fiscal position because they are short-term only. If you earned one dollar more than you spent this year but had to send quadruplets to Ivy League colleges next year, it would not make sense to think of yourself as having a "surplus" for the year, given that the enormous liability around the corner had crept closer.
This is why I urge use of the fiscal gap to measure how the government's finances are doing. The fiscal gap could be defined as the sum of currently outstanding national debt plus the present value of all expected future deficits under current policy. The fiscal gap has recently been estimated to stand at about $73 trillion, or seven times the value of annual production in our economy. Making President Bush's tax cuts permanent, plus fixing the alternative minimum tax, has been estimated to raise it to about $85 trillion.
Another measure I like is the "true budget deficit," as I call it (though it hasn't caught on with anyone else yet), or the increase of the fiscal gap during a given year. In 2003, mainly due to the Medicare prescription drug benefit as well as the tax cuts, President Bush and the Republican Congress ran up a true budget deficit in excess of $20 trillion, or more than twice total economic production for the year. Quite a spree by any measure.
Politicians usually prefer the official deficit measure to the fiscal gap or true budget deficit, because it enables them to play games and hide the long-term problems. But every now and then the myopia of a current year measure turns around and bites them on the bottom. The current Bush Administration push for individual accounts in Social Security is an example.
Suppose payroll taxes with a present value of $1 trillion were "diverted," over the next ten years, from the Social Security Trust Fund to individual accounts. But suppose this were fully paid for through a $1 trillion cut (in present value terms) in future Social Security benefits paid by the government. Under conventional government accounting, budget deficits over the next ten years would go up by more than $1 trillion, even though the fiscal gap would be unchanged.
The Administration and its supporters are understandably unhappy that deficits would be reported as higher even if things had not truly gotten worse. So, the Washington Post reports, they are thinking of "creative" (shudder) new strategies such as simply not reporting the effect on the deficits or on national debt. Glenn Hubbard and Kent Smetters rationalize this approach by noting that the higher explicit debt would be offset by lower implicit debt (i.e., unfunded Social Security commitments in the future).
Yes, but. What if the changes don't really reduce implicit Social Security debt? Or what if the offsets reduce it by only a tiny bit, relative to the expansion of explicit debt over the next ten years? For that matter, what if the Bush Administration shocks everyone by reducing future benefits by MORE than the reduction in current government revenues? In that case, shouldn't they get some credit for reducing the long-term fiscal problem?
The fiscal gap is a measure that takes care of these problems automatically without requiring a "creative" accounting solution. By the very rules of its computation, the fiscal gap would increase by the present value of the diverted payroll taxes and decrease by the reduction in implicit Social Security debt through the traditional Social Security system. It therefore would offer a correct measure of the overall net effect, which would show up as well in the true budget deficit for the year of the change.
By contrast, the approach suggested by Hubbard and Smetters (traditional deficit accounting plus a special rule to cover this case) is an invitation to disaster, or more precisely to deceit by Congress and the President. I might trust Glenn or Kent to design the special accounting rule - although frankly, I would have trusted Glenn a bit more four years ago, before he participated in the budget policies of the last four years - but Glenn and Kent would not in fact be the people deciding on the rule, either this time or when it is invoked as a precedent the next time. Letting Congress and the President decide to disregard new deficits and debt because of claimed offsets down the road would be akin to handing the old Enron management extra discretion over their financial reporting. So there is really no substitute for shifting to meaningful long-term measures. Ad hoc fixes, even when they can be rationalized, risk moving us in the direction of making our current bad measures even worse.

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