Boring, Yes, But Fixing Accounting Rules Is Vital for Budget Sanity

Posted July 6, 2004 at 2:37pm

At a recent seminar about the economy, I heard an economist close to the Bush administration scoff at the notion that budget deficits are a big problem, then tout the administration’s record. He noted, “If you take out entitlements, the budget is basically in balance.” Very impressive. It is akin to saying, “If you take out the fact that your heart has stopped, your health is excellent.” Or to pick a more familiar analogy, “Other than that, Mrs. Lincoln, how was the play?” [IMGCAP(1)]

Finding an appropriate international role for America in the age of terrorism is the biggest challenge facing the country. But looming structural budget deficits, driven by the coming explosion in entitlement spending, is close behind. In just three years, the first wave of baby boomers becomes eligible for early retirement benefits. That is the first wave of a population of 77 million, including 8 million immigrants who are in the baby boom age group. It is by far the largest generation of soon-to-be retirees in our history.

But the baby boomers represent only one end of the squeeze. Meet the “geezer boomers.” The fastest-growing age group in America is the over-85 generation — and within that is the similarly expanding over-100 category. It is a good thing Willard Scott no longer works full-time on the “Today” show: He would not be able to keep up with the announcements of 100th birthdays.

As people live longer, they make increasing demands on the health care system — including not just Medicare but also the long-term care system that is by far the single largest component of the Medicaid program. And, of course, Americans will also collect Social Security benefits for ever-longer periods of time.

Put these inexorable demographic realities together with prudent projections of health care costs and inflation, and we get a bottom line as expressed by the trustees to these entitlement programs. We have $72 billion in unfunded obligations to future retirees — $10.4 trillion in Social Security and $61.6 trillion in the various parts of Medicare — plus an additional large sum (uncalculated, so far as I can tell) for Medicaid. That assumes no further expansion of the programs. And every year that we fail to act to set aside assets to fund these obligations, the numbers grow.

Today’s budget deficit is 4.2 percent of our GDP. That’s a large but not alarming number — a figure that, by itself, could be sustainable indefinitely without deeply damaging the economy. But any realistic projection of the revenue base that we can use to cover these future obligations shows a dismal future — one in which the deficit balloons to almost 16 percent of GDP by 2030, and nearly 29 percent of GDP by 2040. That is not merely unsustainable. It’s downright catastrophic — the equivalent of a suitcase nuclear bomb set off in the middle of our economy.

All of this is occurring while we blithely go about cutting the tax base and adding funding for a host of other problems, including homeland security, defense, the environment, education and highways — just to name a few that get overwhelming support from Congress and the American people. Our debate about “fiscal discipline” focuses overwhelmingly on the tiny share of the budget that is in discretionary domestic spending. Cut it all out and we still have staggering obligations and huge future deficits.

Whoever holds the reins of power next year, two things are virtually certain: We will cut taxes even more to deal with the looming problem of the alternative minimum tax, and we will expand the entitlement obligation by revising the Medicare prescription drug benefit to eliminate or reduce the “doughnut hole” that creates disparities in the benefit at different income levels.

Given the nasty nature of our politics and the intensity of partisan feeling these days, it may be equally certain that any move to restrain the growth of these entitlement programs will go nowhere. But if we do not confront this problem soon, and head-on, we will be handing our children and grandchildren an intolerable burden.

What to do? First, we need to be honest about it. And here Sen. Joe Lieberman (D-Conn.) has stepped in with a simple and straightforward way to compel honesty in the policymaking process. He wants to force the government to change its basic method of accounting from cash accounting to net present value accounting.

I know, I know, it sounds boring and meaningless — and some are apt to wonder what possible difference a change in accounting rules could make. The answer, though, is that it could make a major difference simply by changing the terms of debate.

The current standards focus the debate on the current year’s budget, with a nod to the coming 10 years (even as some politicians try to change that standard to five years). This process encourages turning a blind eye to problems that emerge or expand down the road, while simultaneously encouraging deceit in projecting future burdens.

Consider the sham approaches used to justify the tax cuts of 2001 — which, among other things, shrunk the estate tax to zero by 2010, only to be reinstated fully in 2011. There is no way that policy will stand — but it enabled the drafters of the tax cut to look fiscally prudent enough to elude budget rules in the Senate that would have imposed some fiscal discipline.

If we switch to net present value accounting, the debate would shift focus, toward comparing the real liabilities the government has (that is, the debt held by the public, along with the commitments to future generations in entitlement programs) plus ongoing and new programs such as defense and education, against the funding that will be available.

This would force a debate on priorities: What will the size of government be compared to our gross domestic product in 10 years or 20 years, given the net present value of our future revenues? As was the case with the pay-as-you-go provisions that successfully brought short-term fiscal discipline from 1990 until they expired a couple of years ago, the simple process of forcing every policy proposal, program expansion or tax cut to be gauged within a larger context will alter the voting context and also begin the process of educating voters, including older voters, about the consequences of our current policies.

To be sure, an accounting change will not bring miracles. The numbers are already out there and can be injected into the debate. The tough choices are going to remain tough, and the ability to create broad bipartisan consensus or cover for any change that cuts the growth of Social Security or Medicare will remain limited or nonexistent. But honest fiscal accounting is a necessary first step to begin to implement policy change. The embarrassing failure of the House last month to enact any real change in the budget process underscores the problems we face. Let’s hope Lieberman, and his allies in championing fiscal honesty such as Sen. John McCain (R-Ariz.), can prevail.

Norman Ornstein is a resident scholar at the American Enterprise Institute.