The Trouble With Entitlements

The Cord Cutter Guide doesn’t usually get political. But my long time friend had some interesting observations worth sharing.

A guest post by Daniel Lowe

More than one-half of money spent by US federal government is for entitlements, mostly social security, unemployment benefits, and health care. The government gets this money through taxes and fees, from borrowing, or by printing it (which is what happens when the FED buys government bonds). When government borrows, this borrowing adds to the total debt.

 

The Federal Reserve  in DC courtsey DonkeyHotey Flickr

The Federal Reserve in DC courtsey DonkeyHotey Flickr

The total debt is a large number, but this does not mean the debt is unmanageable.  For example, if you make $100,000 a year and have debts totaling $100,000, you can probably manage the debt.  If you make $20,000 a year and have $100,000 in debt, the debt might be unmanageable.  The ratio of debt to income is important to understanding the manageability of personal debt.  The ratio of total debt to GDP is important to understanding the manageability of federal debt.

 

Today, the debt to GDP ratio is about 76 percent. Only once before has the debt to GDP ratio reached such a high level and that was during World War II.  Previously, the US has experienced three rapid increases in the debt to GDP ratio that coincide with the Civil War, World War I, and World War II.  At the conclusion of each of those wars, government paid off debt so that debt to GDP rapidly fell to normal levels below 30 percent.

 

However, starting around 1980, the debt to GDP ratio began to increase in the absence of war.  Reagan cut taxes without cutting spending and the first Bush continued along that line.  Clinton balanced the budget and the debt to GDP ratio temporarily declined.  Then, the second Bush increased entitlement spending with Medicare prescription drug benefits.  Now, Obama is increasing entitlements with the Affordable Care Act.

 

Demographics drive future entitlement spending.  Just 25 years from now, there will be 79.1 million US residents 65 years old or older.  Today, the number is 44.7 million.  This increase in the number of people past working age will push up the cost of entitlement spending.

 

Many old people would not be such a big problem if there were many young people to support them.  Unfortunately, the demographics do not work out that way.  The ratio of people 18 – 64 years old to people 65 and older was around 5.0 in 2000.  Today, the ratio is about 4.4.  This ratio will fall to 2.7 with the passing of just 25 more years.

 

The Congressional Budget Office projects the debt to GDP ratio may increase to 81 percent by 2024, jump to 138 percent by 2033, and explode to 190 percent by 2038.

 

At some point before the debt to GDP ratio soars to 190 percent, the cost of borrowing money (interest rates) might increase a great deal because lenders will recognize the risk that the government will default or print money to pay its debts.  Higher interest rates would increase the cost of servicing the debt and this would drive up the debt to GDP faster than the Congressional Budget Office assumed in making its projections.  The debt to GDP ratio could reach 190 percent earlier than 2038.

 

Two countries currently have debt to GDP ratios greater than 190 percent and those are Japan and Greece.

 

Japan is currently printing money to cover its deficits.  This printing is transferring wealth from creditors, mostly Japanese people, to debtors, mostly the Japanese government. If the Japanese government blows this money on projects that do not increase wealth, which is what they have been doing, this means the Japanese baby boomers will live less well off in retirement than they had thought.

 

Greece cannot print money.  Non-Greek people hold about two-thirds of Greece’s debt. This means that Greece is short of cash, which means that Greece is having trouble buying things in the world market, which means the Greek people are experiencing a decline in living standards.

 

At some point, a rising debt to GDP ratio brings a decline in living standards.  It would be a good thing to let 50-year-olds know today that entitlements will not give them the lifestyle they expect to have 25 years from now.  Telling them now would prompt these baby boomers to make preparations. However, telling such a truth would probably reduce a politician’s popularity, so, politicians have an incentive to postpone confronting the problem with entitlement spending.   Most likely, twenty years from now, the increasing debt to GDP ratio will simply hand the then 70-year-olds a lower standard of living.

 

If I were a provider of financial services, I might pitch those services now, saying my advice will help you avoid a future low standard of living; however, I am not an advisor. Moreover, if US wealth production declines because less people work and more take entitlements, then maintaining living standards may become impossible.

 

A large majority of people facing lower living standards might turn on a smaller number of people that possess bank accounts, homes, stocks, bonds, rental property, etc. The protests and riots we see abroad could happen here. Under the influence of such majorities, there is no telling what legislators would do. If legislators have a mind to do so, they can take wealth away from those that have it and distribute to those that do not.


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One Response to The Trouble With Entitlements

  1. Len Mullen says:

    Our government pretends to be green. Businesses pretend to be green. Both concurrently drive a consumer economy which…

    1) browns the environment
    2) makes people covet stuff they cannot afford
    3) spurs hatred and violence

    Instead of blaming consumers and politicians for the current situation, I propose we reorganize as a sustainable community.

    Taxes:
    Eliminate income and property taxes
    Rely 100% on consumption taxes

    Healthcare:
    Develop a national consensus around what the safety net should consist of, amend the Constitution to legally make this part of the national safety net, and pay for all of this out of the national budget.

    Stipend:
    Develop a national consensus around what the safety net should consist of, amend the Constitution to legally make this part of the national safety net, and pay for all of this out of the national budget.

    Education:
    Develop a national consensus around what the safety net should consist of, amend the Constitution to legally make this part of the national safety net, and pay for all of this out of the national budget.

    Realigning our community as a libertarian culture with a substantial safety net will ensure the needy are taken care of. Shifting the cost of all this from income and real estate will transform our consumer culture into a service culture which will move jobs from slave wage importers to living wage service providers.

    People will repair cars, grow gardens, and mend clothes because it is less expensive than replacement. Because so much production is overseas, the transformation will actually create domestic jobs. Not moving so much stuff across the globe is green and an economy independent of imports and exports does not need a very large military.

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