Op-Ed: American Nightmare

Public Finance International | October 1, 2013

The US government, and large parts of American society, have strayed from the principles and values on which the country was founded and that helped to make it great. The federal government has also grown too big; both it and many state and local governments have overpromised in relation to what they can actually deliver. The recent budgetary problems besetting Detroit, Chicago and other US cities are a stark reminder of what is at stake.

It is time for transformational reform at all levels of government, or else the US’s financial troubles will continue to worsen, and the economy will never achieve its potential. The past 12 years have seen a dramatic increase in the US’s fiscal challenges, and it is important to understand the key events that have shaped its current situation and future path.

For most of the initial 200 years of American history, spending was largely balanced with revenues – with the exception of times of war and major national emergencies, after which steps were taken to reduce debt burdens relative to GDP. But more recently, consistent peacetime deficits emerged, and then deficits became unsustainable and debt burdens mounted.

During the 1990s, several legislative agreements were reached by Congress and the president, many of which demonstrated political courage and fiscal responsibility. The Budget Enforcement Act of 1990 was part of a $500bn deficit-reduction plan over five years that established discretionary spending caps and ‘pay as you go’ (Paygo) rules for both taxes and spending. Paygo rules mean that any new spending or tax proposals must not add to the federal deficit.

Another major legislative agreement was the Omnibus Budget Reconciliation Act of 1993. Obra was designed to reduce the deficit by a projected estimate of almost $500bn over five years by increasing taxes on high earners. It also extended the Paygo rules from he BEA and the discretionary spending caps through 1998. In 1997, the Balanced Budget Act and Taxpayer Relief Act were passed. These acts sought $130bn in deficit reduction over five years, and extended Paygo and discretionary spending caps through the 2002 fiscal year.

Deficit reduction was clearly a priority throughout the 1990s, in part because of the visibility and related debates resulting from Ross Perot’s run for president in 1992. The resulting focus on fiscal responsibility, combined with an unanticipated economic boom in the late 1990s, resulted in actual economic growth and unemployment being much more positive than forecast at the start of the decade. Consequently, towards the end of the decade, the US government experienced surpluses; public debt as a percentage of GDP declined; and the country’s fiscal outlook appeared to be very positive.

But the fiscal course for the next decade shifted suddenly with the tragic events of September 11, 2001. In the aftermath of 9/11, there was a brief period of bipartisanship in Congress, but the terrorist events had a significantly negative impact on the economy.

These events were followed by several imprudent decisions in 2003 – arguably the most fiscally irresponsible year in US history – when Congress and the president passed additional tax cuts, despite the fact that deficits had returned; enacted extra and largely unfunded Medicare entitlements; and began a new, yet undeclared ‘war’ in Iraq that was charged to the nation’s credit card.

The economy continued to decline and, in 2008, the world entered the ‘Great Recession’. The housing bubble burst, in part due to irresponsible lending policies. Deregulation and low capital requirements caused the government to bail out financial institutions and take on private and corporate debts.

These bailouts were accomplished either by directly purchasing toxic assets through the Troubled Asset Relief Program and/or via short-term loans through a Term Asset-Backed Securities Loan Facility.

Shortly after President Obama assumed office, the American Recovery and Reinvestment Act of 2009 was passed. According to many independent and non-partisan observers, ARRA ensured the recession was not deeper, created jobs and helped to sustain the social safety net during the economic downturn. The bill included public works projects on infrastructure, social welfare provisions, short-term tax cuts, investments in education and renewable energy, and extended unemployment benefits. Even though the legislation was deemed to be necessary, it was projected to add $787bn to the deficit over 10 years.

Then, in 2010, the Patient Protection and Affordable Care Act was passed into law. Although health care reform was needed, the ACA served to increase federal health care promises when the US already had an estimated $37trn in unfunded Medicare promises. While the intention of the ACA was not to add to the deficit, there is significant uncertainty regarding whether many of the anticipated savings will be realised. As an example, the Office of the Chief Actuary of Medicare’s alternative cost estimate was $10 trillion higher in discounted present value than the Medicare Trustees’ following the passage of the bill.

In the past two years, the main fiscal events have been the 2011 debt ceiling, the ‘fiscal cliff’ and the sequester debates. As Congress is expected to enter yet another long, tenuous debate over raising the debt-ceiling limit this autumn, it does not seem likely that policymakers will achieve a specific and comprehensive fiscal ‘grand bargain’ in the near future.

Elected officials in government have so far failed to effectively address the four common challenges that all levels of government face: unfunded retirement obligations, escalating health care costs, outdated tax systems and spending more on consumption than investment. Policymakers should be attempting to achieve a grand bargain that tackles these four key issues, which collectively represent the disease that must be addressed to beat our fiscal cancer. It will take great political courage and leadership to address these in a coordinated and integrated fashion.

By far, the largest deficit the US faces is a leadership deficit. Presidents and the Congress, especially in the past 10 years, have not stepped up to the plate to address the structural deficits in a timely manner.  The president has the greatest impact on whether or not progress is made at the federal level, but governors, mayors and other chief executives have just as much opportunity and obligation to lead in connection with the finances of their states and municipalities. These officials should step up to the plate and take action, or run the risk of following in Detroit’s footsteps.

Detroit recently declared bankruptcy, which serves as an example for other cities and even states that face similar challenges. These cities and states need to restructure their finances, and must act quickly because, unlike the federal government, they cannot print money. The largest single problem for many state and local governments is their unfunded retirement obligations (such as pensions and retiree health care).

Historically, there have been situations where politicians and union leaders have worked together to create very generous retirement benefits that are not funded properly. Irresponsible benefit commitments that are not properly funded represent false promises. Elected officials have gotten away with these promises because they are accounted for on a cash-flow basis in the budget. As a result, accounting and disclosure are needed at all levels of government, but most importantly at the state and local level, and in regard to retirement benefits and inter-governmental dependencies.

Often, pension plans are only partially funded. States and cities must restructure their pensions and create different plans for new employees. They also need to curb abuses attributable to existing employees, and possibly cap indexing formulas for retirees. Steps should be taken to eliminate pension padding through adding overtime, vacation or sick time, and to curb double-dipping, where workers draw more than one pension from related employers.

More dramatic restructuring is required of retiree health care obligations. Most of these obligations are entirely unfunded. First, states should consider moving retirees onto the ACA exchanges to reduce some of the burden that would otherwise be felt by state taxpayers. Specifically, eligible pre-Medicare early retirees should be enrolled in the ACA  exchanges with a defined contribution-type premium-support subsidy. Furthermore, state and local leaders need to ensure that individuals collecting retirement health care benefits are actually retired. In this regard, individuals and their spouses should not be eligible for taxpayer-funded health care if they have access to health care at their place of employment.

Government employees should be provided with retirement benefits that are competitive and equitable. However, these benefits must also be affordable and sustainable. In addition, equity is a two-way street. These plans must be equitable to employees and retirees, as well as to current and future taxpayers. Achieving these objectives will require elected officials to restructure the current systems – hopefully sooner rather than later.

It’s time for America’s elected officials to demonstrate more leadership at all levels of government. Ultimately, we will need political reforms to help make our government more representative of and responsive to the public. This will take time, but by making them a reality, we will be able to address a whole range of key sustainability challenges in a more timely and responsible manner. And by doing so, our future will be better than our past.