What is Fiscal Gap Accounting?
So first of all, I will freely admit. I don't know much about fiscal gap accounting. Actually, I don't know much about accounting, PERIOD. I HATED accounting in college! It was a miracle I passed!
However, at times it is best to know some experts in the field, in this case it would be Dr. Laurence Kotlikoff. And I learned about Larry and fiscal gap accounting from David McKnight's Power of Zero Podcast.
You have probably heard numerous times about our debt to GDP ratio is over 100% yet hey, it's not as bad as Japan's because they are over 250%, right?
But saying Japan’s debt to GDP ratio is higher than the US really isn’t the truth. In fact it is actually WORSE. The US has a higher debt to GDP ratio if you factor in fiscal gap accounting. What is that you say?
Let’s for a moment imagine a working class family: a mother, a father and their young son. Combined they make $70,000 for the household income and their net worth is slowly approaching $100,000. Between their mortgage and some credit card debt they have $70,000 total in debt. Since their income is $70,000 and their debt is $70,000 this could be portrayed as a debt to income ratio of 100%. At face value this is very similar to how the US government measures their debt to GDP ratio.
However, let’s say that one day the parents decide 'you know, we want to have the absolute BEST schooling for our son and we think he wants to become a world famous surgeon. Let's pay for up to $700,000 for his education!'
Now, is this a debt? TECHNICALLY no. The money hasn’t been earmarked yet nor has the money been earned even to pay for it yet. It is essentially a promise for the future. In the business world this would be considered an off balance sheet liability. If you’re familiar with the Rich Dad, Poor Dad's financial statements, this $700,000 would not show up under income, expenses, assets, or liabilities.
But if you believe that your word is your bond and promises shouldn’t be broken the $700,000 will come in to play at some point. This is where fiscal gap accounting comes in. So if we take $700,000 + $70,000 that gets us $770,000. Taking into account all liabilities INCLUDING unfunded liabilities, the family's debt to income ratio is no longer 100%; It is now a STAGGERING 1,100%!
So how does fiscal gap accounting work? Very simply, it is taking the present value of a future obligation and having that amount set aside for the future. So versus just making a promise to pay for up to $700,000 for junior's education to become a surgeon, factoring in an 18 year timeframe, an 8% inflation adjusted return, mom and dad would have to put aside $170,000 to have $700,000+ available in the future.
Obviously, most couples don't have that kind of cash an hand.
Now let's take this on a national level, with the promises of Social Security, Medicare and Medicaid.
This is the problem that every politician has practically ignored for several decades and it is one of the few bipartisan things amongst the Republicans and Democrats. Just ignore it, stick your head in the sand and hope it all goes away. Yes, our national debt is approaching $30 trillion. However, our total unfunded liabilities is somewhere in the realm of $100,000,000,000,000 to $150,000,000,000,000 depending on who you ask and how they factor in their numbers.
Regardless this is a LOT higher than the official debt that is touted.
David McKnight worded this I think best in a podcast two years ago, What is the Fiscal Gap?
How much money would we have to have in a savings account today to earn the money at treasury rates of around 3% to pay for all the promises we have made? Oh, only about $239 trillion according to Larry.
Ok, so last I checked we don't have that kind of money just sitting around. And since we DON'T practice fiscal gap accounting, what do we as a nation do? Larry, David and economists have come to 1 of 3 answers.
- Raise revenue (taxes) by 51%
- Cut spending by 35%
- Some combination of the above
But typically we do the opposite. We did this with the Bush tax cuts in 2001 at the same time that we started the War on Terror AND added Medicare Part D.
We did this in late 2017 with the Trump tax cuts AND increased spending, to the tune of a $1 trillion dollar deficit annually! And this was BEFORE Covid hit the economy in 2020! Eh, a $3 trillion bill here, a $1.9 trillion bill there and now we are talking about an infrastructure bill.
So basically since 2000, as a country we continue to cut taxes, increase spending (usually on welfare and warfare) and have the Fed simply print the difference. Modern Monetary Theory at its best!
So what if we continue to ignore the problem like we have for the last 4 decades?
What if we continue to rack up debt, increase spending and have annual deficits year after year?
Well, eventually, we could face a sovereign debt crisis, which I will be covering in my next blog.
Sign up today to get automatically notified about my new blogs and newsletters so you never miss out!
To Your Wealth And Freedom
Financial Education for your Financial Freedom