This article is from the January/February 2010 issue of Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org

This article is from the January/February 2010 issue of Dollars & Sense magazine.

Dear Dr. Dollar: In his book Colossus (2004), Niall Ferguson argues that a major problem with Social Security and Medicare is their underfunded liabilities—to the tune of $45 trillion. Ferguson uses a 2003 report by Jagadeesh Gokhale and Kent Smetters to substantiate the seriousness of the issue. Can you comment on the report and Ferguson’s claim?

—Charles M. LeCrone, Shelbyville, IL

In Colossus, Niall Ferguson, perhaps the most prolific apologist for the global military adventures of the U.S. government, worries that the United States may not be able to continue to play its role of maintaining order in the world. “Order,” he maintains, “is the necessary precondition for liberty.” (One wonders about the liberty of those peoples whose societies are rent asunder by U.S. occupying forces, to say nothing of those who have died in the process. But leave that aside.)

Ferguson’s argument is a variation of the idea of “imperial overreach,” by which imperial nations have tried to extend their power too far, placed too great a burden on their ability to finance the operations, thus weakened the economic basis of their power, and gone into decline. But for Ferguson, it is not the cost of foreign operations that “threatens the American with overreach. It is expenditure that is much closer to home.” Here he turns to the Gokhale-Smetters report, “Fiscal and Generational Imbalances” (2003), which, he tells us, shows that it is Social Security and Medicare expenditures that threaten the foundation of U.S. global operations.

The report purports to show that, given current levels of taxation and obligations, the present value of the future Social Security and Medicare expenditures will exceed revenues by $44.2 trillion dollars (not Ferguson’s $45 trillion, but let’s not quibble over $800 billion). Ferguson claims that this “unfunded liability” will have to be covered by increased taxes or reduced benefits, and he presents it as a very large amount of money. It is, he notes, four times the value of the country’s 2003 annual output. (Present value is the value now of future income or expenditures, discounted to reflect the fact that something in the future is worth less than something now. For example, with a discount rate of 5%, the present value of $1.05 next year is $1.00.)

As with so much of the misleading arguments about Social Security and Medicare, the Center for Economic and Policy Research has responded effectively to the Gokhale-Smetters report. In a paper titled “The Forty-Four Trillion Dollar Deficit Scare,” Dean Baker and David Rosnick point out that instead of comparing the present value of the future accumulated liability with current output, we should compare it with the present value of future accumulated output, which Gokhale and Smetters estimate at $682 trillion. So the future “unfunded liability” is equal to 6.5% of future output—not trivial but not nearly as scary as “four times the value of the country’s annual output.”

The gap could therefore be covered were taxes to increase by 6.5% of national output. Ferguson tells us that at present “Americans are scarcely undertaxed.” So it is “fanciful,” he claims, to expect tax increases of sufficient magnitude to handle the problem. Yet, most other high-income countries have much higher overall tax rates than does the United States, without apparent damage to their economic growth and prosperity. While a tax increase this large would certainly be politically problematic, there is no reason to dismiss it as economically outlandish. In any case, with his dismissal of tax increases, Ferguson leads his readers to the only possible solution: cut the benefits.

As Baker and Rosnick demonstrate, however, the problem does not lie with the programs but with the excessively high and absurdly increasing cost of medical services. It turns out that $36.6 trillion of Gokhale and Smitters’ $44.2 trillion comes form rising Medicare costs, which are driven by the rising cost of medical services. So the problem is the nature of our health care system—can you say “private insurance companies”?—not “excessive” entitlement programs. If the United States established a reasonable health care system, there would be no need for a large tax increase or a Social Security or Medicare cut.

Finally, whether or not any category of government spending is “excessive” depends on one’s judgment of the worth of the object of that spending. For Ferguson, apparently, social services for the elderly are not worth the money, but there is no limit to the value of the “order” imposed by the U.S. empire.

Arthur MacEwan is professor emeritus of economics at the University of Massachusetts at Boston and a Dollars & Sense Associate.

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