The Future After COVID: Fiscal Policy After the COVID-19 Pandemic

U.S. Debt on the Rise

One of the biggest challenges for the future of finance is the rising U.S. national debt.

Every economist, FOMC member, and Fed Chair warns about the negative impact high levels of debt are likely to have on long-term growth rates.

But these warnings go largely unheeded, leaving dismal scientists to play Cassandra.

You could say that U.S. fiscal conservatism largely died with the 2017 tax cuts. And yet most politicians and economists supported the CARES Act, which is a $2.3 trillion bill designed to help the U.S. economy weather the storm of the COVID-19 pandemic.1

I, too, believed it necessary to push through a significant fiscal stimulus bill.

After all, the U.S. economy in 2019 grew by $21.4 trillion (in current dollars) — or at about $1.8 trillion per month.2

That’s a big number. And with the U.S. economy in almost a full shutdown for a month as a result of COVID-19, that’s $1.8 trillion that would be lost forever.

It can’t really be recouped.

It is just lost.

And the economic and human toll is high.

Don’t get me wrong. I believe that the unnecessary increase in deficit spending and the national debt in normal times — or during periods of solid growth — is a big risk. And one of the reasons it is such a risky action is that during times of economic crisis, fiscal policy is mustered to help combat the risks of a recession or depression.

But if we use all of our fiscal policy power during years of feast, what shall we do in years of famine?

Fortunately, interest rates are exceptionally low, and the Fed is using its balance sheet to keep those rates artificially low. This means that issuing more debt now is not as big a problem as it could be — or as big a problem as it will be in the future.

Nevertheless, let’s face it: The U.S. national debt is a growing problem. At over $23.2 trillion, the national debt is not a small sum.3

By the end of this year, the national debt could be $28 trillion or more. 

Furthermore, if the $3 trillion stimulus bill that's passed through the House gets enacted into law, the national debt could exceed $30 trillion by the end of the year.

That is a lot of debt!

As you can see in Figure 1, the pace at which the U.S. national debt is rising has accelerated.

It took 205 years for the U.S. national debt to exceed $1 trillion, which happened in October 1981.

But it then took less than five years for the national debt to double to $2 trillion in April 1986.

The most recent doubling of the U.S. national debt occurred in the decade after the Great Recession. Hopefully the current slowdown will not cause it to double again.

Figure 1: Total U.S. Public Debt 4

Although not as pronounced as the trend in total U.S. government debt, the debt-to-GDP ratio has also risen sharply since the onset of the Great Recession in December 2007 (Figure 2).

Figure 2: Total U.S. Federal Debt as a Percent of GDP 5

One major negative impact of a high national debt is the drag on potential future U.S. economic growth as measured by gross domestic product — or GDP. Plus, debt exposures can be exacerbated by compounding interest on already outstanding government debt. 

For now, low interest rates all over the world have kept this specter at bay. But this could become a risk in the future, especially if central bank balance sheet expansion ceases to be as effective as stimulating economic growth.

Although some analysts are quick to note that the U.S. debt-to-GDP ratio is lower than other countries, it is also important to note that the U.S. economy is the largest in the world. This means that rising U.S. debt levels could make it more difficult for the global economy to absorb U.S. debt issuances over time.

Risks of Debt

As I noted in The Dumpster Fire Election last year, “the risk of recession would further increase the likelihood that the debt level and the debt-to-GDP ratio would rise between 2020 and 2024.”

And entitlements are a major source of additional imminent debt.

Unfortunately, while the U.S. national debt is large, the unfunded financial obligations stemming from U.S. entitlements are much larger — and are likely to compound U.S. debt problems in coming years. Simply put, entitlements pose the greatest threat to future U.S. government debt levels — and U.S. economic growth.

Entitlements

U.S. entitlements, including Medicare, Medicaid, and Social Security, are financed by payroll taxes from workers. Payroll taxes are separate from income taxes, and while income tax rates have fallen on fiscal policy changes, payroll taxes are on a one-way trip higher. You see, entitlements are wildly underfunded.

All the sovereign debt in the world totals around $60 trillion.6 That is the debt cumulatively held by all national governments in the world. But the size of unfunded U.S. entitlements might be more than three times that level.

That’s right: The unfunded, off-balance sheet obligations for Medicare, Medicaid, and Social Security could be $200 trillion.7

This level of off-balance sheet debt obligation existentially threatens the U.S. economy. The Heritage Foundation has taken calculations from the U.S. Congressional Budget Office about entitlements to create Figure 3, which looks quite catastrophic. Basically, by 2030, all U.S. tax revenue will be consumed by entitlements and the interest on the national debt. And these were the dismal calculations before the 2007 tax reform, additional budget deficits, and the 2020 CARES Act started increasing the national debt even more rapidly.

Figure 3: Tax Revenue Spent on Entitlements 9

The Grandfather of U.S. Social Security

Part of the problem with entitlements stems from their origins. The U.S. Social Security Administration website credits Otto von Bismarck as the grandfather of U.S. entitlements.8

Bismarck’s portrait is even on the U.S. Social Security Administration’s website (Figure 4).

Figure 4: Otto von Bismarck 10

Bismarck was a powerful politician known for his use of Realpolitik, a political doctrine built on pragmatism to advance national self-interests. For him, entitlements were convenient and expedient. Unfortunately, that is no longer the case. Today, entitlements threaten to crush the U.S. economy with increased levels of debt. And without reform, they could decimate the U.S. workforce.

Bismarck’s system was also sustainable. His system guaranteed a pension to German workers over 70, but the average life expectancy in Germany in the late 1880s was only 40.10

In other words, so few people were expected to receive the benefits that the program’s cost would be negligible. 

Bismarck rigged entitlements to help crush his political opponents without having to pay out. But the current entitlement system in the United States is an unfunded off-balance sheet liability that threatens to crush the entire economy.

Plus, fixing entitlements presents a horrible dilemma as many Americans rely heavily on entitlements for income (Figure 5).

Figure 5: Expected Importance of Social Security 12

But how did this system break down? Bismarck had such a good thing going. What happened? 

This can be answered in one word: demographics.

Demographics

U.S. population growth has slowed sharply, and this demographic shift appears unstoppable. Plus, as birthrates have fallen, life expectancy has also risen. This compounds the funding shortfalls for entitlements. Worse still: No president, senator, or congressman can change U.S. demographics. This is bigger than one person.

And its discussion is unlikely to be anywhere near the 2020 presidential election — and other coming elections as well. 

Population growth in the United States has fallen from annual rates of over 1.5 percent per year during the 1950s and early 1960s to just 0.7 percent since 2011.13

Some of this slowing in population growth is due to a decline in the U.S. fertility rate. In general, fertility rates have been dropping globally, but according to demographer Jonathan Last, the U.S. fertility rate is still relatively high at 1.93.14

However, even though the U.S. total fertility rate is relatively high compared to other industrialized nations, it is below the 2.1 percent “golden number” required to maintain a population, according to Last.15

This is a huge problem for maintaining entitlements. After all, the entitlement system worked really well in 1940, when there were 159.4 workers per beneficiary (Figure 6). But it is more challenging since that number fell to only 2.8 in 2013. 

Plus, it is likely to fall to 2 workers per beneficiary by 2040.16 

Entitlements are under siege from both sides: The birthrate has fallen — and life expectancy has risen.

In addition to lower birthrates, U.S. life expectancy has doubled since Bismarck implemented entitlements in Germany in 1889 — from around 40 years to above 80 years. Plus, the age at which people receive U.S. entitlements benefits has actually been lowered from 70 to 65. On top of a significantly larger population being eligible to receive entitlements, the medical costs required to support an aging population have also risen.

Everything might be OK — if U.S. population growth were extremely robust.

But it is not.

Plus, the current administration is pushing hard to reduce illegal immigration to the United States. While this can have some benefits for society and the economy in some ways, it can also reduce population growth and lower the average U.S. birthrate.

Population growth has slowed to less than half the rate seen during the baby boom years, and the total U.S. fertility rate is below the “golden number” that is required to maintain a population. As Last notes, “Social Security is, in essence, a Ponzi scheme. Like all Ponzi schemes, it works just fine — so long as the intake of new participants continues to increase.”18

Unfortunately, entitlements are nearing a breaking point.

A big problem with slowing birthrates is the manifestation of a shrinking tax base at the same time that unfunded financial obligations are rising. This means that the unfunded $200 trillion or more in future entitlements payments will be borne by an increasingly smaller proportion of workers in the population. 

In the longer term, declines in birthrates, increased longevity, rising healthcare costs, falling labor force participation rates, and overincentivized automation are likely to accelerate and exacerbate the problems of the U.S. national defined benefits programs known as entitlements — programs that worked best financially when the age at which one received benefits exceeded life expectancy by 30 years.

But the entitlements system was ignored during the 2016 presidential election, during the 2017 tax reform, and in the 2018 midterms.

And it is being ignored now in the 2020 election cycle.

COVID-19 Implications for Fiscal Policy

As in other areas, the COVID-19 pandemic has exposed systemic weaknesses already present. The national debt and entitlements risks were already in play before the federal government had to pull the trigger on a $2.3 trillion fiscal policy bailout to keep the economy alive during what has become essentially a mandated shutdown.

The future of fiscal policy looks like one of additional fiscal stimulus, ever-higher debt levels, and unaddressed entitlements. On top of those risks, there is also a chance that the free money individuals are sent during this crisis could become a permanent political fixture.

And it could even become part of the broader discourse on universal basic income — or UBI.

Universal basic income (UBI) is the notion that everyone will be paid a flat salary, regardless of whether or not they work.

And the biggest problem with universal basic income is that we simply cannot afford it.

U.S. entitlement obligations, which could be as high as $200 trillion, make a further, permanent expansion of ongoing U.S. budgetary obligations for UBI virtually impossible. 

But because of the policies enacted in response to COVID-19, UBI could become a permanent fixture.

That remains to be seen.

But a future of more debt and unaddressed entitlements seems far more certain.

And even without UBI, those are sufficient grounds to be concerned about long-term growth rates for the U.S. economy.

Hopes for Future Fiscal Prudence

Massive unfunded off-balance sheet debt obligations — à la entitlements — could eventually subvert stable Western financial systems, eradicating economic growth and introducing destabilizing factors that could subvert democracy itself.

Some reading this may see my views here as hyperbole.

And believe me, I wish they were. But sadly, they are not. And on a global scale, these problems are even worse.

The problems we have been ignoring could drastically impact economic and business growth expectations globally — especially in consumer-driven service economies, where drastically reduced incomes of retirees could dovetail with significantly increased payroll taxes for prime-age workers.

For the future of the economy and financial markets, the impact of these risks cannot be understated.

I understand that in the face of risks associated with total economic shutdown and systemic public health collapse, this is not a time to implement fiscal austerity.

It is, however, a time to reflect on how we might plan to be more fiscally responsible and prudent once this pandemic is behind us — so that we can act even more quickly the next time a crisis like this arises.

Of course, we may not see future fiscal prudence either.

But one can hope.

The Future After COVID

This is an excerpt from Jason Schenker's recent book The Future After COVID, which was released on 1 April 2020. It has been a #1 New Release for Macroeconomics on Amazon.

The Future After COVID is at www.FutureAfterCovid.com

Jason Schenker is one of the world's leading futurists. He is the Chairman of The Futurist Institute and the President of Prestige Economics.

?Jason is also an instructor for LinkedIn Learning.

Tags: #Disruption, #Technology, #Innovation, #LinkedInLearning, #SupplyChain, #Business, #Finance, #Economy, #Economics, #Coronavirus, #COVID19, #Jobs, #Work, #Leadership, #Strategy, #Future

Sources:

1. Committee for a Responsible Federal Budget. “What's in the $2 Trillion Coronavirus Relief Package?” Retrieved on 2 April 2020 from https://www.crfb.org/blogs/whats-2-trillion-coronavirus-relief-package.

2. Bureau of Economic Analysis. “Gross Domestic Product , Fourth Quarter and Year 2019.” Retrieved on 2 April 2020 from https://www.bea.gov/system/files/2020-02/gdp4q19_2nd_0.pdf.

3. U.S. Department of the Treasury. Fiscal Service, Federal Debt: Total Public Debt [GFDEBTN], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GFDEBTN, April 1, 2020.

4. Ibid.

5. Federal Reserve Bank of St. Louis and U.S. Office of Management and Budget, Federal Debt: Total Public Debt as Percent of Gross Domestic Product [GFDEGDQ188S], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/GFDEGDQ188S, April 1, 2020.

6. Desjardins, J. (6 August 2015). “$60 Trillion of World Debt in One Visualization.” Visual Capitalist. Retrieved 11 February 2017: https://www.visualcapitalist.com/60-trillion-of-world-debt-in-one-visualization/.

7. Mayer, J. (18 November 2015). “The Social Security Fa?ade.” Retrieved 11 February 2017: https://www.usnews.com/opinion/economic-intelligence/2015/11/18/social-security-and-medicare-have-morphed-into-unsustainable-entitlements.

8. U.S. Social Security Administration. “Social Security History: Otto von Bismarck.” Sourced from https://www.ssa.gov/history/ottob.html.

9. Image provided courtesy of The Heritage Foundation. Retrieved 11 February 2017: https://thf_media.s3.amazonaws.com/infographics/2014/10/BG-eliminate-waste-control-spending-chart-3_HIGHRES.jpg.

10. Twarog, S. (January 1997). “Heights and Living Standards in Germany, 1850-1939: The Case of Wurttemberg” as reprinted in Health and Welfare During Industrialization. Steckel, R. and F.

Roderick, eds. Chicago: University of Chicago Press, p. 315. Retrieved 11 February 2017: https://www.nber.org/chapters/c7434.pdf.

11. U.S. Social Security Administration. “Social Security History: Otto von Bismarck.” Sourced from https://www.ssa.gov/history/ottob.html.

12. U.S. Social Security Administration. Fast Facts and Figures About Social Security, 2017, p. 8.

Retrieved on 17 June 2019: https://www.ssa.gov/policy/docs/chartbooks/fast_facts/.

13. World Bank, Population Growth for the United States [SPPOPGROWUSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/SPPOPGROWUSA, June 5, 2018.

14. Last, J. (2013) What to Expect, When No One’s Expecting: America’s Coming Demographic Disaster. New York: Encounter Books, pp. 2-4.

15. Ibid., p. 3.

16. Last (2013), p. 109.

17. U.S. Social Security Administration. Retrieved 11 February 2017 from https://www.ssa.gov/history/ratios.html Last (2013) also uses a similar table in his book on p. 108.

18. Last (2013), p. 107.