Kotlikoff Argues for Generational and Fiscal Gap Accounting

Aug 5, 2013

Detroit's recent bankruptcy makes it the largest municipal bankruptcy in our nation's history as the city seeks to restructure $18 billion in debt. However, this didn't just happen overnight, it was the result of years of deficit spending and inadequate revenues compounded and demonstrated in particular by its pension program. In an article in The Business Desk, Larry Kotlikoff argues that Washington has shown many of the traits Detroit did enroute to its ultimate bankruptcy. In his article, he discusses the accounting used by both entities to either keep certain liabilities off their books or give the appearance that the shortfall is much less than it actually is.

Kotlikoff primarily refers to the differences between the official public federal debt and the long-term fiscal gap in his argument for a new generational accounting system, much like the one proposed in "The INFORM Act" which he helped design and which is championed by the millennial organization The Can Kicks Back.

The debt Uncle Sam publicly acknowledges -- official federal debt in the hands of the public -- is now $12 trillion. But the true measure of our debt -- the one suggested by economic theory -- is the fiscal gap, which totals $222 trillion. The fiscal gap is the present value of all future expenditures, including servicing outstanding official federal debt, minus the present value of all future receipts.

Detroit's main means of hiding its true liabilities was discounting its future obligations at a rate far higher than appropriate, thus giving the appearance that less saving was needed to cover the shortfall.

Washington's dirtier trick has been to keep virtually all of its future liabilities off the books, which creates the vast ocean separating the fiscal gap and the official debt. Decisions about what debts to put on and what debts to keep off the books are not grounded in economics; this duplicitous accounting is grounded in linguistics.

This said, acknowledging our potential fiscal obligations and deciding how to deal with them rules out neither productive government investments in infrastructure, education, research or the environment nor pro-growth tax reform. The fiscal gap tells us whether current policy is sustainable, what's needed to make current policy sustainable, and the tradeoff between adjusting policy now or later.

The current system of accounting may lead to some shortsighted behavior, especially the non-consideration of many of the unfunded liabilities the federal government faces down the road. Generational accounting, he argues, could help remedy this by making long-term budgetary effects explicit. This type of accounting is by no means a new phenomenon, as many countries and well-known agencies have actually been using it, or a version of it, for quite some time.

Foreign governments and international agencies like the International Monetary Fund have being doing fiscal gap and generational accounting either on a routine or periodic basis for decades. This analysis has led Norway to set up a Generational Trust that preserves oil revenues for future generations. It's led the Dutch to reform their pensions without overly burdening today's and tomorrow's Dutch children. And it's influenced generational policymaking in countries as near as Canada and as far away as New Zealand. In contrast, the U.S. continues to let official debt determine its generational policy.

This may change in the near future with The INFORM Act slowly working its way through the legislative process. The Act could result in more responsible fiscal policy making by analyzing current and future policies in a context that is more conducive to long-term thinking and planning.