The Real Debt

Saturday, October 30, 2004

For the long-term future of the U.S. economy, the most important question in the 2004 election will be how aggressively President Bush addresses Senator Kerry’s signature economic charge—that Bush budget deficits have saddled the government with crushing debt.

Handled assertively and self-confidently, this debt issue can seal the election for the president and set up the United States to solve one of its gravest economic challenges. The key? Addressing the total federal debt problem, not just the small part on which Kerry has focused.

Kerry is obsessed with the roughly $4 trillion of federal bonds in public hands—which is normally referred to as the “federal debt.” But this level of government bonding is not out of line with historical norms, including norms in very prosperous times.

Since 1965, publicly held debt has averaged 31.1 percent of gross domestic product (the low was 18.3 percent in 1974; the high, 44.4 percent in 1993). This year, working from government projections, it will be around 32 percent—hardly a catastrophe. And its drop from the 1993 peak to 28 percent of GDP eight years later shows that, with a little less spending and a little more economic growth, it can quickly plummet (even, conceivably, to levels that might create problems for the capital markets, where U.S. government bonds play a vital role in sophisticated portfolio strategies).

But the nation has a real debt problem—a major and potentially crushing one. It turns on what Washington is committed to spending in the future on Social Security and (especially) Medicare, beyond what the taxes dedicated to those programs are expected to bring in.

A 2003 study from the American Enterprise Institute translated the unfunded liabilities of Medicare and Social Security into easy-to-understand terms. What, the authors asked, is the present-value equivalent in bonded debt not covered by current reserves or taxes of the government’s future obligations under Social Security and Medicare? Their answer? $7 trillion for Social Security, $36.6 trillion for Medicare.

That’s more than 10 times the size of the “federal debt.”

These numbers have risen from zero in the mid ’60s; now they vastly exceed any gap that can be closed with traditional spending cuts or quick-fix tax hikes, whether on the rich or anyone else. They will require entirely new strategies—strategies that Kerry vowed in accepting his party’s nomination to oppose and Bush vowed in his acceptance speech to enact.

In this year’s State of the Union Address, the president mentioned personal accounts for Social Security and Medicare only in passing. But internal White House pulse polls reportedly registered a dramatic spike of approval for each. Touching these issues was once deemed “the third rail of American politics”—but now putting more of these two funds under the control of those who pay for and will benefit from them registers as a plus with a majority of voters.

Such reforms could substantially reduce the overhanging obligations in each program. The reason? Both suffer at least in part from a problem endemic to almost all of government: astonishingly poor productivity.

A 2001 study for the National Center for Policy Analysis covered the past 128 years. It found that, despite big ups and downs, the average rate of return on diversified stock portfolios for any 35-year period was 6.4 percent and never below 2.7 percent. Today, according to NCPA, most young people entering the labor market can expect Social Security to deliver a rate of return below 2 percent.

A recent survey of the heath-care industry by Harvard Business School professor Regina Herzlinger told a similar tale: From 1978 to 2001 the third-party and government-dominated health-care sector has seen its productivity drop 24 percent. In the same period, productivity in the entire non-farm economy grew 42 percent.

For both Social Security and Medicare, increasing the productivity of dollars invested simply to the levels of the private economy could solve the unfunded liability problem or reduce it to where other measures would be capable of solving it.

So this is the bold move by which President Bush could fix our true debt problem: Move Social Security and Medicare away from their current 1930s, productivity-trap model and into the 21st century. Following most of the U.S. economy and most of the modern world, make these funds more consumer driven and consumer controlled.

By aggressively embracing consumer-driven reforms in his New York acceptance speech, President Bush transformed the 2004 elections into a referendum on the future, which may be part of why he got such a convincing post-convention bounce. And he started the nation toward solving one of its greatest economic challenges, not the largely imaginary challenge of the “national debt” but the true challenge of the real debt.