I would like to open this year's update of the Irresponsibility Index with a short quote from the Associated Press, titled:

Bush's budget proposal is biggest

“WASHINGTON - In the nation's first-ever $3 trillion budget proposal, President Bush seeks to seal his legacy of promoting a strong defense to fight terrorism and tax cuts to spur the economy. Democrats, who control Congress, are pledging fierce opposition to Bush's final spending plan — perhaps even until the next president takes office....

The $3 trillion Bush's proposes spending in 2009 would be the first time that milestone has been reached. Bush also presided over the first budget to hit $2 trillion, in 2002. It took the government nearly 200 years to reach the first $1 trillion budget, which occurred in 1987 during the Reagan administration.”

 With that cheery intro, here are the five components of the Index, and the deficit or future liability associated with each:

1. Personal Savings – ½ of 1% of income.

The Personal Savings Rate is calculated by the U.S. Commerce Department's Bureau of Economic Analysis (BEA) each month. It compares the ratio of Personal Saving to Disposable Personal Income, without making any allowance for the value of assets, such as a stock portfolio or a house. In a sense it is a measure of household cash flow, and tells us whether American households are putting away cash; spending most of the cash they receive from all sources; or borrowing in order to spend more than their incomes. The interesting and alarming fact about U.S. personal savings is that it is below the level of other industrial countries; and it has been dropping since the mid-1990s. It has fallen from an average of 5.2% in the 1990s to one half of one percent in 2007. (U.S. Dept of Commerce, see http://research.stlouisfed.org/fred2/data/PSAVERT.txt)

By contrast, the personal saving rates from 1980 through 2001 averaged 13% in Japan, 12% in Germany, and 15% in France, with no steep declines after 1994. Canada’s personal savings rate, the personal saving rate declined after the mid-1990s, but remained higher than the U.S. rates, averaging 16% from 1980 through 1994 and 7% since 1994. This suggests that the importance of saving (or spending) is somewhat cultural, and that the U.S. is in fact a consumption society.

Federal Reserve Bank of San Francisco, downloaded 2/9/08 see:

http://www.frbsf.org/publications/economics/letter/2002/el2002-09.html

A graph of Personal Savings shows a steady trend lower over the last 12 years. Americans have steadily been spending more and saving less for more than a decade. The “wealth effect” of an inflated stock market, followed by an inflated housing market probably had a lot to do with this. When people feel wealthier, they have less incentive to save part of their salaries for the future. In September 2005, when the housing market was in full bloom, the personal saving rate out of disposable income was negative for four consecutive months, meaning that for an entire quarter people were spending more than 100% of their after-tax income.

Recent history suggests that people will spend when they feel they can – even if it means taking on more debt – and save when they must. For the near future, at least, I feel we must. I will leave the projections of the economic consequences to the economists, but it is a bad time to bet on the American consumer bailing out the economy.

An economist for the Credit Union National Association was quoted on MSNBC’s web site the day of the last Federal Reserve rate cut, saying that Americans are cutting back on spending despite the declining cost of credit because ““People are up to their eyeballs in debt.” (Mike Schenk, quoted in “Stocks Recoup Some Losses After Fed Cuts Rates,” downloaded on 1/22/08 from http://www.msnbc.msn.com/id/3683270/)

2. Government deficit and total debt - $163 billion and $9.2 trillion

• The federal government’s annual budget deficit for the fiscal year ending in September 2007 was $163 billion. This is actually lower than last year’s, and at 1.2% of GDP, is about half the historic (40-year) average of 4.3% of GDP. See this site: (http://treas.gov/press/releases/hp603.htm)
• The total U.S. debt, excluding projected liabilities for social security and Medicare, is growing daily, but now it is approximately $9.2 trillion. (See http://www.brillig.com/debt_clock/)

First let’s clear up the confusion between the budget deficit and our government’s total debt. I found this explanation on http://www.federalbudget.com/, which is a very readable web page examining the U.S. government’s debt problem. Here is an excerpt:

“Suppose you want to spend more money this month than your income. This situation is called a "budget deficit". So you borrow. The amount you borrowed (and now owe) is called your debt. You have to pay interest on your debt. If next month you don't have enough money to cover your spending (another deficit), you must borrow some more, and you'll still have to pay the interest on the loan. If you have a deficit every month, you keep borrowing and your debt grows. Soon the interest payment on your loan is bigger than any other item in your budget. Eventually, all you can do is pay the interest payment, and you don't have any money left over for anything else. This situation is known as bankruptcy.” (http://www.federalbudget.com/, downloaded 2/10/08)

Does a budget deficit of $163 billion matter? After all, it is only about 1.2% of our GNP? Well, each year we run a deficit, the total debt grows. Interest on the debt cost the U.S. taxpayers $406 billion in fiscal year 2006. Let’s compare this with the two other most expensive government departments: Defense (all military expenses) and Health and Human Services (Social Security and Medicare):

Annual interest on the national debt: $406 billion

Department of Defense: $638.9 billion

Health and Human Services: $525 billion.

These are the three largest sources of government expenditures by far. If we could significantly reduce the government debt, we could save about $400 billion a year. Unfortunately, despite the lower annual budget deficit, total government debt is going to go much higher. Why? Because we have made Social Security and Medicare commitments that we simply cannot afford to pay!

3.  Social Security: $25 trillion

The International Monetary Fund, which usually frets about runaway fiscal policies in developing countries, (on January 18^th)  released a report that warned of the dangers to the global economy posed by the United States’ lack of spending discipline, its reliance on foreign creditors, and its failure to plan adequately for future government liabilities.

(Daniel Gross, “How Bush is Plundering Social Security to Close the Deficit,” from http://www.slate.com/id/2093707/, downloaded 1/19/08.)

You will read varying descriptions of Social Security’s projected deficits, most of them influenced by the political position of the authors. I had to go through a number of web-based sites to get past the disingenuous numbers and find a good statistic for the deficit.

What is the “real” social security deficit? Let’s reference one of the best think tanks on government policy: the CATO Institute. You can see their analysis of the social security system at this link: http://www.socialsecurity.org/daily/03-24-03.html.

The Social Security Trustees report for 2003 (now five years old) gave this assessment:

Social Security's net cash shortfall over the next 75 years totals $25.33 trillion in 2003 dollars…. That figure assumes today's surpluses are saved; if surpluses are not saved, then from 2018 through 2077 Social Security faces gross cash deficits of $26.40 trillion (in $2003), an increase of $1.37 trillion from the 2002 report. (Editor’s note: the surpluses are not being saved. They are dumped into the General Fund and spent, which is why the Bush administration’s deficits are not larger today.)

At current trends, social security will have a cash deficit (more money being paid out than coming in) in 2018. Social Security is already paying less to its beneficiaries than they have invested over their working lives. It’s a bad deal even for today’s beneificiaries unless they live to over the age of 100 to collect benefits. It’s a bad deal for young people because by 2018 the current surplus of payments over benefits will run out and the system will run deficits into the future.

Social Security will use up its Trust Fund (or draw down its bank account) from 2018 to 2042. Social Security, like the small business example above, would be better off if it restructured before reaching bankruptcy.

The Social Security system ran a modest surplus for much of the last 20 years. The current surplus is about $160 billion per year .Instead of placing these surplus funds in a “lock box” for future beneficiaries, the government has simply been spending the cash and replacing it with Treasury notes.  It is only because the government has been spending money from the social security trust fund that our annual budget deficit is in the $200 billion range.

At current trends, the Trust Fund’s bonds will be exhausted by 2042. If you are 20 years old today, the Trust Fund will have no assets – cash or Treasury bonds – to pay your retirement benefits when you are 54 years old. In that case, according to the CATO analysis, benefits would have to be cut by an estimated 27% to meet dedicated tax revenues from the paychecks of workers in 2042. (http://www.socialsecurity.org/daily/03-24-03.html, downloaded 2/20/08)

The injustice in this system is twofold. First, it represents an income transfer from middle-class working people to retirees who, as a group, are wealthier than the contributors. Here is an item from the Department of Health and Human Services Administration on Aging:

The median net worth of the elderly households (with a householder aged 65+) in 2000 was $108,885, as compared to $55,000 for the total population.” (see http://www.aoa.gov/prof/statistics/profile/2003/16.asp.)

Secondly, benefits that have been promised for decades to working-class people will not be there when they retire. No one in the current presidential race is bringing this issue to the forefront of the debate because the American people do not want to be told that their paycheck deductions are being spent on someone else’s retirement, and that the money will not be there for their own retirement.

These people were told all of their working lives that social security would take care of them in their retirement years. The promise of government dependency creates government dependency. Conversely, a system that encourages saving for one’s own retirement fosters a sense of individual responsibility and encourages saving.

The economic argument for privatization, or an option to put your social security taxes in a private account is simple: it is a better deal for workers. Investing even a small portion of one’s paycheck over an entire working career results in a very large retirement savings account through the effect of compound interest. You don’t have to invest in high-performance stocks to make this work! At only 6% per year, your savings account doubles every ten years.

If someone who is 20 years old works for 40 years and invests an average of $300 per month over that working lifetime (less in the early years and more as their pay increases), they could have a personal account worth over half a million dollars at retirement: large enough to provide them with a secondary income and a source of cash for education and medical expenses. Best of all, they would own that account, and could put it in trust for their children.

Use a calculator or a compound interest table to figure this out, and you will see that an average payment of $300 per month for 40 years, compounded at a modest rate of 6% per year results in a personal savings account worth $590,000. That $300 is about the same monthly contribution of a person earning $40,000 a year and having 7.5% of each check taken for social security. Bet you didn’t know that, did you?

The reason Congress hasn’t fixed the Social Security crisis is politics. The most likely solutions -- raising taxes, cutting benefits, establishing private accounts or some combination of the three -- all face strong opposition from one of the strongest, most politically-connected lobbies in existence: AARP. The 20-something workers who likely will pay the cost for Congressional inaction don’t have nearly the same clout. If you are in college today, you had better get educated about this issue and start voting. The Baby Boomers are going to stick you with a bill you cannot afford to pay! That's not my opinion; it's arithmetic.

4. Medicare: $27.8 trillion over the next 75 years

“At the end of last year George W. Bush signed the Medicare Modernization Act of 2003 into law in the name of “honoring the commitments of Medicare to all our seniors.” The bulk of the law provided prescription drug subsidies for the elderly, at an estimated cost of between $400 billion and more than $1 trillion over the next decade. Less than four months later, the Medicare’s Board of Trustees issued a report citing Bush’s subsidy as a major reason that the program would go bankrupt by 2019, seven years earlier than the board predicted last year.”

Anthony Gregory, “The Bankruptcy of Medicare,” downloaded on 1/15/08 from http://www.independent.org/newsroom/article.asp?id=1294, which has an interesting discussion of Medicare’s history, and congressional efforts to contain costs.

The program provides assistance to 42 million people, which is nearly the same number of beneficiaries as social security has! That costs us $325 billion a year. (see http://www.msnbc.msn.com/id/7053462/,)

Care for an example of why Medicare is going broke and Bush’s prescription drug benefit plan (Medicare Modernization Act of 2003) will just hasten its demise? It is for two reasons: Medicare is not means tested, and the drug benefit plan pays drug companies the full price for their drugs. The prescription drug benefit alone will add at least $40 billion a year to Medicare’s expenses over the ten year period from 2003 to 2013..

Some government agencies (the Veteran’s Administration, for example) bargain with drug providers to get discounts. The VA gets as much as a 50% reduction in price from pharmaceutical companies, and passes the savings on to its veteran members. No similar bargaining provision was included in the Medicare Act of 2003 (the prescription drug provision, particularly). Obviously, Medicare represents a very large market, and has a lot of bargaining muscle. Why was the prescription drug benefit not designed to allow the government to bargain with drug companies for the lowest possible price to the taxpayers?

I have a 64 year-old business partner friend went to have his shoulder examined, and he was told that for shoulder surgery and removal of the bone spurs, the total charges for the doctor, the operating room, and an overnight hospital stay would be about $27,000. His insurance would knock that figure down to about $14,000 to $16,000. (Doctors and hospitals deliberately inflate their charges, knowing that insurance companies will disallow about 50%. They get a tax break for the portion that is disallowed.) My friend would be out of pocket $6,000 for the deductible, plus a portion of the charges above the deductible.

He has decided to wait one year to have the operation when he is eligible for Medicare coverage. His total cost under Medicare: $458. Guess who pays the balance: You do.

Incidentally, the reason I now support some form of universal government-sponsored health care is because we are already paying for the health care of indigent and uninsured people, but it is “off the books” of the government. Worse, it’s mostly emergency room care, which is the most inefficient way to provide medical coverage because there is no continuity in the doctor-patient relationship. For about 47 million Americans without insurance the emergency room has taken the place of a primary care doctor. ER doctors cannot follow up with the same patient over time and recommend measures so a condition does not get worse; change their diet; give them drugs that lower their cholesterol; or recommend physical therapy; just to give a few examples.

Even worse, many people have chronic conditions; cannot afford health insurance; and cannot get treated at emergency rooms. They have to go without treatment or rely on friends and relatives to help pay for treatment. The system is broken. Think a universal health care system would be expensive? Here is an analysis of health care costs by Kaiser Permanente (the Kaiser Family):

Health care costs have been rising for several years. Expenditures in the United States on health care surpassed $2 trillion in 2006, almost three times the $714 billion spent in 1990, and over eight times the $253 billion spent in 1980. Stemming this growth has become a major policy priority, as the government, employers, and consumers increasingly struggle to keep up with health care costs. In 2006, U.S. health care spending was about $7,026 per resident and accounted for 16% of the nation’s Gross Domestic Product (GDP).

(http://www.kaiseredu.org/topics_im.asp?imID=1&parentID=61&id=358, downloaded 2/20/08)

5.              Pension Benefit Guarantees - $96 billion

Unless you have been away from your television and unable to watch the news for the last few years, you are probably aware that many private companies cannot meet their projected pension obligations. Unfunded shortfalls in private pension plans create the possibility that workers in these companies will never receive their full pension benefits, even though pensions are guaranteed by a government agency: the Pension Benefit Guarantee Corporation. Their estimate of the total underfunding (on a termination basis) among all insured plans is $600 billion - $450 billion for single employer plans and $150 billion for multi-employer plans. (see http://www.cbo.gov/ftpdoc.cfm?index=6426&type=0&sequence=0.)

The CBO report adds:

“Fortunately, most underfunded plans are not likely to be terminated because they are sponsored by financially healthy firms. Therefore, PBGC assesses the amount of underfunding among plans for which the agency considers default "reasonably possible." In fiscal year 2004, PBGC estimated its exposure to claims from such plans at $96 billion.”

So, the PBGC’s “reasonable” exposure is to make up the unfunded liabilities in private pensions is only $96 billion. What if the collective debts of the public and private sector; the low savings rate; and the collision of Social Security and Medicare with fiscal reality produces a recession? When “financially healthy” firms struggle through a recession, then what are the government’s potential liabilities for unfunded pensions? Using their own analysis, it must be somewhere between $96 billion and $600 billion.

In wrote in December 2005 that Congress and the President were doing nothing about the private pension crisis. Since then they passed the Pension Protection Act of 2006. The language in the act is so obtuse that one private financial company (Ameriprise Financial) published page 107 of the Act in a full-page ad in USA Today, and said, “There are 906 other pages just like it.” You had to read the page to get the joke. It was just unintelligible.

What the act proposes to do is to force companies to reveal the size of their potential pension liabilities in their financial statements. This would alert shareholders and boards of directors, who should provide some discipline over costs or provide an incentive for management to put aside more money to cover those costs. More important, this legislation will force public entities to calculate and publish their estimates of future retirement and medical liabilities. This legislation was overdue, and the resulting transparency in public finances is already spurring state legislatures to make financial reforms in their public pension systems.

The October 31, 2005 issue of Time magazine featured an article on the shortfall in both public and private pension funds. Time said that more than as many as 84% of state pension systems designed to cover public employees did not have the funds to pay the promised benefits. According to testimony from the Director of the Congressional Budget Office, the “vast majority” of private pension plans are under-funded, and the CBO used the $96 billion figure above as the “reasonable” exposure to loss from under-funded private plans.

Trouble is, in a recession, companies that are currently able to continue funding their under funded pension plans could file for bankruptcy and dump their pension liabilities into the taxpayers’ collective laps.

Every time a U.S. corporation files for bankruptcy, there is a possibility that the court will relieve it of responsibility for fully funding its own pension program. Those unfunded liabilities end up with the Pension Benefit Guarantee Corporation, which itself is under-funded. Retirees whose benefits exceed the PBGC maximums, or are subject to reduction under a 5-year phase-in rule, could see their retirement benefits drop.

To read the financial projections of pension default for yourself, follow this link: (http://www.cbo.gov/showdoc.cfm?index=6426&sequence=0)

Our private irresponsibility is surpassed by public irresponsibility. With the new legislation to provide transparency in the public sector, we now find that the states’ health care liabilities to retired teachers, firemen, police and other public workers exceed one trillion dollars. That is more than one and a half times the estimated under-funded liability of private pension plans, using Congressional Budget Office estimates.

Time notes the effect on the private sector worker:

“As a result, many employees in the private sector will get hit with a double whammy: while their pensions erode, increasingly they will be hit with cuts in government services and forced to pay higher taxes to cover the pensions of public employees, the kind they can only dream about” (“The Broken Promise,” Time, October 31, 2005, 33)

This update to the 2007 Irresponsibility Index came late, as I struggled to get accurate figures for Medicare and Social Security liabilities. I will be back with another update at the end of 2008. Until then…

Stay healthy.

Happy New Year 2008

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Want to know where your tax money goes? See this interesting and interactive web site: http://www.kowaldesign.com/budget/budget.html