Government Accounting

Jason Delisle and Jason Richwine write,

The momentum for fair value accounting is building. The Congressional Budget Office has all but endorsed it, describing fair value as a “more comprehensive” accounting of costs. Scholars with the Federal Reserve, the Financial Economists Roundtable, and the Simpson-Bowles fiscal commission are on board as well. Reps. Paul Ryan and Scott Garrett have championed this issue in the House of Representatives, which passed legislation to put federal loan programs on fair value accounting earlier this year. That vote, however, mostly followed party lines, and the Senate has never advanced similar legislation.

If a private firm accounted for its future obligations the way that the government does, it would be prosecuted. One of the ideas I include in Setting National Economic Priorities (at this point, still vaporware) is government accounting reform.

People, Countries, and Debt

James Kynge writes about China,

Total debts owed by the government, companies and households have ballooned to 240 per cent of gross domestic product, virtually double the level at the time of the global financial crisis.

This ratio, it is true, remains modest next to some in the west; US debts stand at 322 per cent of GDP, Ireland’s at more than 400 per cent, while Greece and Spain are at about 300 per cent each.

Pointer from Tyler Cowen.

To me, it seems careless to add up the liabilities of government, companies, and households. I object to taking the sum of these numbers and saying “China owes ___.” The debt is not owed by an entity called the country of China. It is owed by disparate entities within the country of China. And much of it is owed to disparate entities within China.

Speaking of which, it also seems careless to ignore assets. Suppose somebody has a $300,000 mortgage and a $30,000 income. You might say, “wow, their debt is 1000 percent of their income!” But that is not so alarming if they have $1 million in assets (maybe the house itself is worth $1 million).

I’m not trying to dismiss the issue. Just the other night, one of my favorite economists pointed out that if the debt burden on the Chinese government starts to pinch, then it might have to stop buying (or even start selling) American government bonds. That could fuel a rise in interest rates, and then the debt burden of the American government would spike up. If that happens, have a nice day. But a high ratio of total liabilities of all of the entities within in a country to its GDP is at best a very imprecise indicator of financial distress.

Financial Report of the U.S. Government

The report is here. It looks interesting, but I find it difficult to parse. Liqun Liu, Andrew J. Rettenmaier, and Thomas R. Saving parse it this way:

The liabilities reported in the FRUSG at this time last year included $12 trillion in debt held by the public, $6.5 trillion in federal civilian and military employees’ accrued pension benefits and other retirement and disability benefits, and $1.3 trillion in other liabilities, producing total liabilities of $19.9 trillion.

They point out that the liabilities for Social Security and Medicare seem suspiciously small, because the report acts as if these could be erased quickly with the stroke of a (legislative) pen. Technically, that is true, but realistically it is not. Instead, Liu, et al, propose to include benefits payable to current retirees.

Adding the $16 trillion in accrued Social Security and Medicare benefits payable to current retirees produces a total of $35.8 trillion in federal liabilities. These accrued Social Security and Medicare benefits are larger than the debt held by the public and are 45 percent of the total.

Pointer from James Pethokoukis.

This is still not very satisfying.

1. The liabilities to pay benefits to those of us not yet eligible ought to be included.

2. If we are going to include future government expenditures as liabilities, then we ought to include future tax revenues as assets.

3. We ought to use a discounted present value concept, rather than treat dollars that will be spent or received 10 years from now as equal to dollars that will be spent or received today.

Conceptually, I believe that what we want is a present discounted value of assets (including future tax revenues) and liabilities under current law (or what CBO projects law to be under its more-plausible “alternative scenario”). You can then look at the change in these values from year to year as an accrual-accounting measure.

Government Accounting

Jason Delisle and Jason Richwine write,

the government’s official method for estimating cost is incomplete. It fails to incorporate the cost of the market risk associated with expecting future loan repayments. So-called “fair-value accounting,” an accounting method favored by the vast majority of finance economists as well as the CBO itself, factors in the cost of market risk. The difference transforms the official student-loan “profit” into a loss, for a budgetary swing of $279 billion over ten years. That figure demonstrates why the stakes are so high in the debate about fair-value accounting.

I recommend the entire essay. I would like to make changes to government accounting a top economic priority, because I think that avoiding a debt crisis ought to be a top priority.

If you ignore risk, then the government can appear to make a profit with all sorts of loans and loan-guarantee programs. I would go beyond fair-value accounting and subject the government budget to stress-testing, to give a measure of risk exposure.

Social Security as a Public Bad

Robert Fenge and Beatrice Scheubel write that they provide,

an empirical confirmation of the negative relationship between statutory old-age insurance or more broadly statutory social insurance and fertility. The effect amounts to a total reduction of approximately 1.7 marital births per 1000 between 1895 and 1907… [the] impact of pension insurance is comparable to the impact of an increase in urbanisation by 10-20%.

Pointer from Brian Blackstone

Off hand, it would seem to me that any form of capital accumulation by the elderly could have this effect. Private pensions certainly, and perhaps even private savings for retirement. But it might be argued that there are huge negative externalities in public pensions, in that they allow you to benefit from my having children.

New York City Pensions

The NYT reports,

Next year alone, the city will set aside for pensions more than $8 billion, or 11 percent of the budget. That is an increase of more than 12 times from the city’s outlay in 2000, when the payments accounted for less than 2 percent of the budget.

I could see the same thing happening where I live, in Montgomery County, Maryland. At some point, citizens will be paying much of their taxes not for current services but instead to try to keep unsound pension systems afloat.

Megan McArdle writes,

The core problem is that returns have not tracked with the city’s optimistic projections. In 2012, the city finally lowered its projected return to 7 percent from 8 percent, but after decades of excessive optimism, that left it with a giant hole; the payments had to be stretched out over more than two decades in order to minimize the fiscal hit. Yet this still may not be enough; it’s possible that 7 percent is still too rosy.

And of course, as many people have pointed out, a private firm’s auditors would not sign off on this sort of pension accounting.

Two SNEP Goals Connected

Jed Graham writes,

The $2.8 trillion Social Security Trust Fund is on track to be totally spent by 2030, the Congressional Budget Office said Tuesday. That’s one year earlier than projected in 2013 and a decade earlier than the CBO estimated as recently as 2011.

Graham points out that lower estimates for employment are contributing to the more adverse outlook for Social Security. I would say that this links two of the three main goals for SNEP, one of which is to increase employment and another of which is to work toward a sustainable Federal budget.

In fact, the third goal, to get the FCC and the FDA out of the way of progress, also links to the other two.

Rubio Touches the Third Rail

Andrew Biggs writes,

Included in Sen. Rubio’s ideas are:

–Social Security solvency: Rubio would gradually increase the retirement age in line with life expectancies and reduce the growth of benefits for higher-earning individuals. In addition, Rubio favors strengthening the safety net for lower-income retirees.
–Delayed retirement: Rubio would eliminate the 12.4% payroll tax for retirement-age individuals to encourage them to stay in the work force. I really like this idea and wrote on it for the Wall Street Journal.
–Open the TSP: Rubio would allow workers who are not offered retirement plans by their employers to participate in the federal government’s Thrift Savings Plan, the DC pension for government employees. In a way, this builds upon the President’s myRA proposal, but allows for greater choice in investments.

I am a big fan of indexing the age of eligibility for retirement benefits to average life expectancy at age 60. I would like to see that done for Medicare as well. People can still retire when they are younger and healthier, but not on someone else’s nickel.

But Inequality is the Defining Problem of Our Time

Lawrence Kotlikoff writes,

The US fiscal gap now stands at an estimated $205 trillion, or 10.3 percent of all future US GDP. Closing this gap is imperative, and requires a fiscal adjustment of an immediate and permanent 37 percent reduction in spending (apart from servicing official debt), an immediate and permanent 57 percent increase in all federal taxes, or some combination of the two. The necessary size of this adjustment increases the longer it is put off.

Labor Force Participation Chartfight

1. John Cochrane presents a chart showing that over the last 25 years, the employment-population ratio tracks the ratio of people aged 25-54 to the total population.

Pointer from Mark Thoma. The chart is from Torsten Slok of Deutsche Bank.

2. John Taylor has a chart showing that the labor force participation rate is several percentage points that which was projected several years ago based on demographics. The chart comes from a paper by Chris Erceg and Andy Levin.

The first chart suggests that most of the decline in the employment/population ratio in recent years is due to demographic changes. The second chart suggests the opposite. How to reconcile the two?

3. And then there is Binyamin Appelbaum:

In February 2008, 87.4 percent of men in that demographic had jobs.

Six years later, only 83.2 percent of men in that bracket are working.

Pointer from Tyler Cowen.

My verdict is that Slok’s chart, referred to by Cochrane, is misleading. Here is the chart:

The way that the two lines are superimposed makes it appear that 2007 was a glorious year of over-employment, and the plunge in the employment-population ratio looks like a reversion to trend. Suppose you were to slide the blue line up vertically so that it just touches the red line at the peak in 2007. That would make the chart look much more like Appelbaum’s, shown below:

Some other issues:

–I suspect that some of the drop-off in employment has occurred among youth, who are outside of the 25-54 bracket that Slok uses.

–Another issue is what you think should have happened outside Slok’s bracket at the other end, namely 55-64 year olds. These are baby boomers, so that their share of the labor market has been soaring. The most likely reconciliation of the two charts is that the baby boomers have been retiring early at rates higher than historical norms.

As far as labor force participation goes, is 55 the new 65? If so, then somebody should trace out what that means for Social Security. Fewer people paying in and more people collecting disability cannot be a good thing for solvency.

Update: Cochrane offers another take, more nuanced.