Genre: Public Finance
Author: Laurence J. Kotlikoff and Scott Burns
Title: The Clash of Generations: Saving Ourselves, Our Kids and Our Economy (Buy the Book)
Summary:
Over the last six decades, the United States has accumulated an outstanding $11 trillion in official debt, but this already outrageous figure leaves out the vast majority of implicit liabilities the government has taken on. Including commitments such as Medicare and Social Security, the true fiscal gap is estimated to be $211 trillion, fourteen times the nation’s GDP. This figure exceeds those of even those countries generally considered to be the most fiscally irresponsible, such as Italy and Spain.
The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy by Laurence J. Kotlikoff and Scott Burns investigates this fiscal crisis facing our country and proposes solutions for how to get out of it.
How did we reach this point? Several factors have contributed to this state of fiscal crisis, some seemingly positive on their face. For example, we have made great strides in the areas of medicine, sanitation, and safety; but while these advances greatly improve American citizens’ quality and length of life, they also create a massive elderly population dependent on government finances for support. Current estimates show the cost per retiree to be $30,000 per year.
Similarly, social programs passed under both Republican and Democratic administrations provide a number of positive benefits, but fail to address their costs. Kotlikoff and Burns liken these programs to Bernie Madoff’s Ponzi scheme, with younger generations continually forced to pay for the benefits of their elders in an ultimately unsustainable situation. This problem is further exacerbated by low domestic savings rates, which in turn lead to low levels of investment in domestic capital and lower economic growth.
The debt crisis is having profound effects on the way Americans live their lives. Economic uncertainty has led lowered marriage rates, increased the proportion of children born out of wedlock, and lowered home ownership rates. Other problems affecting younger generations include increases in student debt and an abysmal job market. Meanwhile, the elderly are staying in the labor force in increasing numbers, further hurting prospects for young Americans.
The authors propose several ways to address the problems currently facing the country, including reforming the financial system, implementing a new national healthcare plan, and making fundamental changes to taxes and Social Security. Under the “Purple Financial Plan,” the increasingly risky and complex activities of financial institutions would be eliminated, with banks forced to return to their core functions of intermediating between borrowers and lenders.
The “Purple Health Plan” would similarly seek to reduce complexity and waste generated by the existing fee-for-service Medicare system and employer-based insurance. Under the plan, all Americans receive a voucher to purchase a basic health plan with a targeted cost of 10% of GDP, and would also have the option to purchase supplement plans on their own. Competition between plan providers, as well as malpractice reform, would provide incentives to ultimately lower costs.
The authors view the current tax system as both unfair and discouraging of work and saving. In its place, they propose a progressive tax on consumption to replace the current income tax, a removal of the cap on the FICA tax, and an inheritance tax on amounts over $1 million. At the same time, they propose eliminating the corporate income tax, as well as all taxation of savings.
This system, they believe, will provide the proper incentives for work and savings, encourage foreign investment, and ultimately reduce the fiscal gap by $36 trillion. Their plan for Social Security involves phasing out the current system in favor of a system of personal accounts funded by eight percent of wages and invested in identical portfolios of broad financial assets. In doing so, the possibility of unfunded liabilities is eliminated and younger generations are no longer forced to finance older ones, in the process reducing the fiscal gap by $60 trillion.
America’s fiscal crisis is daunting, but it is not unsolvable if we are willing to take the necessary steps to right the ship, and most importantly, do so now. The almost 70 million Americans between the ages of eighteen and thirty-five must demand action now, or be faced with an unbearable burden for both themselves and their children.
This is not a Republican or Democratic problem. It is an American problem, and must be addressed by all Americans. The authors’ proposals are but a few of many potential solutions, but they represent a sober and realistic course of action, and are certainly steps in the right direction. Their plan, or something like it, needs to be put in place soon to protect the future of this country and its citizens.
INTRODUCTION
In The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy, Laurence J. Kotlikoff and Scott Burns discuss the fiscal turmoil currently facing the American economy. They state that government leaders have failed to solve the long-term financial crisis, and instead implemented short-term solutions to the problem. Kotlikoff and Burns present several solutions to implement today to protect our children’s future.
WE’RE BANKRUPT
Over the last six decades, the United States has accumulated an outstanding $11 trillion in official debt. Kotlikoff and Burns state that wasteful and irresponsible generational policies have led to America’s dire fiscal situation. They write, “Our fiscal gap—the value in the present of all our future spending obligations (including servicing the official debt), net of all our future tax receipts… is fourteen times our nation’s GDP.”
Our unofficial IOU’s, or unofficial spending commitments, continue to grow daily, yet most Americans don’t realize the severity of the situation.
In calculating our unofficial IOU’s and our official debt, the United States true fiscal gap is $211 trillion.
We continuously read about the financial problems facing Portugal, Ireland, Italy, Greece, and Spain. However, few individuals know that we may be in worse fiscal shape than they are.
CATASTROPHIC SUCCESS
Several factors have contributed to the U. S. financial crisis. Over the last century, human life expectancy has increased. Thanks to modern medicine, clean water, safer foods, and better homes, Americans expect to live longer. The figure below shows the increase in life expectancy since 1900.
Fewer babies now die at childbirth and fewer children and adults die of disease.
As a result, there is an increase in productive years. This corresponds to more individuals paying taxes for a longer period of time. This appears that it would help the fiscal crisis; however, the authors discuss that these advances in modern medicine will create a population explosion.
They estimate that America will experience a 42 percent growth by mid-century. “Adding 42 percent more Americans will take us from 310 million inhabitants now to 439 million in 2050, an increase in 129 million mouths to feed, bodies to clothe, and minds to educate.”
As evidenced in the figure, there was a large increase in life expectancy of those sixty years and older. Researchers have estimated that in the next 50 years, there will be fewer children than people aged sixty and older. While many may deem this longevity to be a success, it also comes at a cost. As Kotlikoff and Burns state, “that money has to come from somewhere.”
Americans are also spending millions of dollars on health care to increase the length and quality of their lives. Currently, Medicare disburses 85 percent of its benefits to the elderly, while Medicaid pays out 70 percent of its benefits to this group.
Elderly and low income Americans are currently using these government programs at such an alarming rate that it is causing a huge strain on the budget. Our economy is not growing fast enough to support the medical needs of the elderly population.
Although this increase in life signals accomplishment, the cost per elderly is enormous. Current estimates show the cost to be $30,000 per retiree per year.
Kotlikoff and Burns write, “The gap between what we are willing to do and what longevity actually costs has gone to the extreme due to an unrelenting political failure to deal with the issue.” Americans are unwilling to pay more in taxes, and many employers are no longer willing to fund our retirement.
OUR MAGNIFICENT GOVERNMENT
Bernie Madoff is well known for the Ponzi scheme he devised, successfully swindling millions from unsuspecting clients. He is now serving many years in prison for these offenses. The authors compare the United States government to Madoff’s Ponzi scheme.
They feel that the government is currently using this same system to cover costs for Social Security, Medicare, and Medicaid. The government takes from the young and gives to the elderly, year after year, thus keeping the elaborate system in place. Program benefits have continued to expand, and retirees are not expected to pay for them. Instead, the next generation will receive the bill.
In 2006, President George W. Bush introduced Medicare Part D, which provided the elderly with new prescription drug benefits averaging $1,500 per year.
None of the recipients, “including senior billionaires like Warren Buffet, has been asked to pay a penny more in taxes to defray the program’s $16 trillion present value unfunded liability.”
In continuing his “no-child-left-solvent policy,” President Bush also cut capital gains and dividend tax rates, which are primarily paid by the elderly population. Thus, the elderly received additional benefits, and revenues were decreased. How will these unfunded liabilities be paid?
In 2008, Barack Obama was elected president and chose to continue the same reckless policies of the Bush administration. He implemented the Affordable Care Act, which includes provisions that recommend cutting costs to Medicare and Medicaid providers. Another provision in the Affordable Care Act is the expansion of coverage for 50 million Americans, who are currently uninsured.
While many Americans supported this additional coverage for the uninsured, no one has determined a way to pay for it. This comes at a tremendous cost to the taxpayers. The authors state that all of the living presidents should not be able to look their grandchildren in the eye, as they are giving the elderly population more in benefits at the expense of their own grandchildren.
In 2009, the unfunded liabilities over the next seventy-five years of Medicare and Social Security were estimated to be $51.3 trillion. Currently, there are an insufficient number of people working to support benefits for the elderly population. The authors estimate that between now and 2050, the number of individuals over the age of 65 will increase by a massive 120 percent; however, the workforce population (ages 18 to 64) will only increase by 28 percent. This large disparity should cause grave concern for all of us.
The government also has difficulties in labeling what constitutes debt. The official debt does not accurately portray our countries true indebtedness.
The government is hesitant to correctly label debt, as it adversely affects the stability of the American economy.
The only accurate way to define the growing indebtedness of the United States is the fiscal gap.
America’s fiscal gap is fourteen times the U.S. GDP, while Greece stands at twelve times GDP. The U.S. fiscal gap is reportedly higher than that of Japan, Germany, France, Italy, and Spain.
In addition to Social Security, Medicare, and Medicaid, another major expense for the American economy is the defense budget. We all want our borders protected and to support our allies, yet it comes at a huge cost. The U.S. currently spends more on defense than the next 13 countries combined. With expected increases in federal programs as well as defense, the U.S. debt will continue to increase exponentially.
WHAT ARE WE DOING NOW?
The authors state that our national savings is currently less than our domestic investment, which corresponds to a negative account balance. This essentially means that other countries are investing more in the United States than Americans are investing abroad.
Our national savings rate was negative in 2009, and it is expected that it will go negative again and will stay negative. In the future, this will result in an even lower rate of domestic investment, which means that America will be adding less to its stock of capital—factories, machines, highways, etc. Therefore, a low savings rate results in low investment, which causes low productivity growth and low real wage growth.
A CHANGING AMERICA
Due to the United States debt crisis, there has been a considerable change in modern demographics. For example, many people have chosen to postpone “tying the knot,” due to the uncertainty of the economy. In 2000, 55.1 percent of Americans, ages twenty-five to thirty-four, were married.
In 2009, the percentage of married Americans fell to 44.9 percent. Moreover, there has been a large decline in marriages between American couples that face employment uncertainty and lack a college education.
Many American couples have made the choice to bypass marriage, yet begin a family together. Today, 40.6 percent of children are born out of wedlock.
These children who are born outside of marriage are more likely to be poor, have an unstable home, and have more health issues.
Another change that has occurred in the United States is the ability to achieve the American Dream—to own a home, to have an education that will provide a job with adequate income, and to enjoy a growing job market.
Prior to 2007, owning a home was the best way to consume, save, and invest all at the same time. Over the last half-century, home values would often rise at rates that were greater than the interest rates Americans paid on their mortgages. This enabled many Americans to enjoy large equities in their homes.
However, since 2007, the housing market has been fairly dismal. Homes have continued to lose their value, and many owe more on their mortgages than their homes are actually worth. Many young Americans have opted out of purchasing homes because they cannot afford them.
For younger Americans, not owning a home has several disadvantages. If rental costs increase, they will be forced to pay them. However, if they owned a home, they would have an established mortgage payment. Also, owning a home would produce equity if the housing market recovers.
While the younger generation is struggling, the elderly population has enjoyed many favorable tax benefits. In 1997, the Taxpayer Relief Act was passed, which allows capital gains of up to $500,000 on a home sale to be tax-free. This primarily benefits wealthy, older Americans by allowing them to realize a large capital gain with no tax consequences.
Another issue facing the younger generation is the significant increase in the number of individuals choosing to attend college.
These college students and graduates take on large amounts of student debt to pay for their expenses. During the summer of 2010, the total amount of student debt totaled $830 billion. College expenses are a huge burden and are expected to increase.
As students graduate from college, they are then forced to begin reducing their student loans. This debt affects their ability to take on other debts such as purchasing a car. When this book was written, the average student loan debt was between $23,000 and $28,000, and the average interest rate was between 6.8 and 7.9 percent.
A college graduate “with a starting salary of $48,000 and $24,000 of student debt at 7 percent interest…will be committing 11.9 percent of income to loan repayment to pay off the debt in five years or seven percent of income to pay off in ten years.”
Many graduates are discovering that their student loan debt is too great and are acquiring jobs that do not cover their expenses. Because of this incredible debt burden, researchers have seen an increasing number of college graduates who are questioning their decision to attend college.
Graduating students are entering a job market that has been in poor condition the last few years, and the current forecast indicates it will not improve anytime soon. Young workers and those with limited education have been hit hardest by the decline in the job market.
Unfortunately, the number of people fifty-five and over in the workforce has increased greatly. These individuals are choosing to continue working due to their concern about their finances upon retirement.
Between 2010 and 2020, many baby boomers will retire, which should create jobs for these young people.
However, due to globalization, these young Americans will now be competing for jobs with cheap labor overseas. All of these changes are creating a firestorm for future generations. With concerns over employment, rising costs, taxes, and lowering benefits, the younger generations need assistance now.
WHAT DO THE YOUNGER GENERATIONS GET TO LOOK FORWARD TO?
Many of our elderly believe that they are entitled to receive their benefits because they have “paid their dues.” The government has done a great job thus far of taking from the young and giving to the elderly. Currently, 30 percent of all retirees are paying taxes on their Social Security benefits. However, when today’s young choose to retire, they will pay taxes on 85 percent of their benefits.
This younger generation can look forward to paying more in taxes than they will receive in benefits. Because the elderly population is expected to be greater than the number of children by half-century, these children will be forced to pay more than they can handle. These children should not have to pay for the debts of other generations.
The current condition of America is absolutely devastating. With home values declining, unemployment rising, benefits decreasing, taxes rising, debt skyrocketing, our fiscal gap at fourteen times GDP, and not saving or investing, the younger generation has too much on their plate for them to handle.
The future of America lies with this younger generation, and current politicians are more worried about reelection than the harm they are causing to the future of the United States.
Americans must start supporting policies and not people. We need reform in the financial, tax, and health care systems, as well as Social Security. To solve these problems, the authors have proposed implementing the Purple Plans, which will appeal to both Red Republicans and Blue Democrats. There is no more time to waste. The time has come for reform. The time to start is now.
FIXING THE FINANCIAL SYSTEM
The authors propose several ways to address the current problems. First, the U. S. Banking system should be examined. Since the collapse of our financial system in 2008, the United States has been slow to recover. Before the collapse, banks marketed and sold securities that appeared to be a safe investment, but in reality were extremely risky.
To prevent another collapse, the Fed continues to print money to invigorate the economy, which could result in hyperinflation. This crisis has caused our government to become absolutely broke.
To solve this problem, the authors propose implementing the Purple Financial Plan.
This plan would call for Limited-Purpose Banking (LPB), whereby banks can only intermediate between borrowers and lenders and savers and investors. This limits banks to their ultimate purpose, to intermediate and not gamble. The elements of LPB are displayed in the figure below.
Under LPB, all financial companies such as investment banks, commercial banks, credit unions, hedge funds, etc. “that operate with limited liability and engage in financial intermediation must operate in one way only: as mutual fund companies that market mutual funds to the public.” The owners of these financial companies would not be held responsible for the bank’s losses.
A typical mutual fund is one that pools money from many investors to invest in stocks, bonds, and other financial assets. A mutual fund, under LPB, cannot borrow money; therefore, LPB companies cannot fail.
These banks with limited liability would allow the public to choose what risks it wishes to bear by purchasing more or less risky mutual funds. However, if bank owners choose to operate with unlimited liability, borrowing money to operate, they will be personally liable for any debts they may incur.
The Purple Financial Plan also authorizes mutual fund companies to issue cash mutual funds. These mutual funds would be valued at $1 per share every day. The owners of cash mutual funds can write checks and use debit cards drawn from their own cash mutual fund.
This would be an effective payment system because there would be no chance of default.
The Purple Financial Plan also establishes the Federal Financial Authority (FFA), which would become America’s only financial regulator. The FFA would hire private companies to “verify, appraise, rate, and disclose all aspects of all the financial securities held by LPB mutual funds.” Because the private companies would only work for the FFA, all ratings would be fair and accurate.
Implementing the Purple Financial Plan would be simple. Banks would be told to discontinue borrowing and purchasing risky assets on their own accounts, change their checking accounts to cash mutual funds and “use their reserves… to back their cash mutual funds dollar for dollar,” “begin marketing mutual funds,” and “pay out the cash flow from the banks’ remaining assets less liabilities as dividends.”
THE HEALTHCARE SOLUTION
The healthcare system in America is in dire need of assistance. Our government is currently spending $2.5 trillion on healthcare per year. Our current system leaves one in six Americans uninsured, and health care costs are skyrocketing.
Under Medicare’s fee-forservice system, Americans receive health care services and the government pays a negotiated fee to providers. The more services the doctors and hospitals provide, the larger the bill.
Many times healthcare providers order more services than are necessary to avoid malpractice lawsuits. Under the current healthcare system, employer-based health care allows employers to choose health care plans for employees. Also, many insurance companies charge the same premiums for those who are healthy and those who are not.
For these reasons, the authors propose the Purple Health Plan, based on seven principles:
- Everyone needs a healthcare plan and should be allowed to purchase supplemental coverage.
- Everyone should have their own choice of doctors and hospitals.
- Everyone “who can pay for their healthcare plans should do so through taxes and copayments.”
- The government will allocate ten percent of GDP on healthcare.
- Everyone should be able to afford health plans and should not punish those with existing illness or bad genes.
- The system must give adequate incentives to prohibit constant use of health care services.
- Reform is needed to prevent health care providers from engaging in defensive medicine.
The Purple Health Plan has many benefits. It would completely dispose of Medicare, Medicaid, and employer-based health care. Below the Purple Health Plan is shown.
Under the Purple Health Plan, each American would receive a basic healthcare voucher annually.
The size of the voucher would depend on the recipient’s health. However, no more than ten percent of GDP would be allocated to healthcare expenses. This allocation allows doctors to have the ability to decline to provide additional services.
The Purple Health Plan forces insurers to provide a basic health plan and insures that no one can be turned away from coverage. The Purple Health Panel, comprised of doctors, is established under this plan. These doctors determine the basic plan components and make adjustments as the economy grows.
Under the Purple Health Plan, each American has the choice of their insurance provider. By doing this, people have the right to choose their own doctors and hospitals.
The Purple Health Plan is essential because it manages government healthcare spending. This plan would reduce our fiscal gap by $130 trillion, and would protect the younger generation from paying massive amounts of taxes for healthcare expenditures.
DEALING WITH TAXES
Our current system of taxes is extremely complex and unfair. Many of the poor pay higher marginal and average tax rates than the wealthy. This system is extremely ineffective, and discourages work and saving. Many employees choose not to work additional man-hours, as they will be taxed further.
Also, the current tax system taxes our savings accounts, so if we decided to save one dollar the “present value of what we get to spend if we spend in the future is less than one dollar.” Therefore, we need a system that is simple, promotes work and saving, and is efficient.
The authors introduced the Purple Tax Plan as a solution to our current tax system.
This plan is straightforward and encourages the economy to save, to grow, to create jobs, and to distribute higher wages. The Purple Tax Plan has three main features: the sales tax, the FICA tax, and the inheritance tax.
First, the plan “replaces the federal personal and corporate income taxes as well as the estate and gift tax with a broad-based, low-rate, progressive consumption tax.” A 17.5% nominal consumption tax will be placed on all goods and services. The plan provides a monthly payment, the demogrant, as a rebate to all households up to a certain level of spending. The demogrant ensures that those who are at or below the poverty line will pay no sales tax, on net, on their consumption.
This plan entails a FICA payroll tax that exempts the employee “half of the tax on the first $40,000 of earnings” and eliminates the ceiling on taxable earnings. The plan places the inheritance tax rate above $1 million.
The Purple Tax Plan also eliminates all taxation of savings. By developing saving incentives and by taxing wealth, the Purple Tax Plan will lead to increased tax savings. This will also enable the elderly to contribute their share, as they are the group with the largest wealth.
Another key component of the proposed tax changes is the abolishment of the corporate tax.
This would result in the United States becoming the lowest-tax country, thereby encouraging foreign investment. The largest benefit to be gained by implementing the Purple Tax Plan is the reduction of our fiscal gap by $36 trillion.
THE SOCIAL SECURITY FIX
Another key component to be addressed is Social Security. Our current Social Security system is in trouble financially and is extremely complex. The system is 29 percent underfunded and has many rules that are too complicated to understand.
For many Americans, Social Security is their only means of saving.
If the current system continues, there are a few choices: hurt the young by taxing them more, take benefits from the elderly, or hurt both the young and the old. However, the authors proposed a better approach to the Social Security problem by implementing the Purple Personal Security Plan.
This plan would freeze the current system by paying existing Social Security beneficiaries their full benefits. The current workers would also receive their accrued benefits. Thereafter, the current system would be phased out over time.
The new plan would require workers to contribute eight percent of their wages to personal security accounts. Half of these monies would be deposited into their individual account, and the other half would be deposited to their spouses account. The government would match contributions to personal security accounts made by the poor, unemployed, and the disabled.
Every personal security account would be invested in a global market-weighted index fund of stocks, government and corporate bonds, mortgages, and other financial assets. This would ensure that each participant’s account earned the same rate of return, ensure diversification, and ensures that each participant’s account balance would be equal to or greater than what they contributed.
When the participant is between the ages of 61 and 70, the personal security accounts for each cohort are sold to the market and converted to treasury inflation protected securities (TIPS). The Purple Personal Security Plan protects the younger generation from paying for the current systems unfunded liability, is easier to understand, and promotes saving. This plan also is expected to reduce our fiscal gap by $60 trillion.
START NOW
There are a few things we can do as individuals now to improve our own economic situation. It is essential for Americans to take control of their futures, and begin planning for retirement.
First, we can save and invest in the least expensive tools possible. The authors believe that we should invest in index funds because many of them have little or no fees. An index fund is a mutual fund that is constructed to match a market portfolio. Investors in index funds will receive an adequate return, while also keeping their expenses low.
Another method of improving our financial stability is by making choices about how we live our lives. Retirees may begin withdrawing their Social Security benefits at the age of sixty-two. However, many do not realize the longer they work, the better their Social Security benefits will be.
For those born after 1953, for each additional year worked, their social security benefits will rise between seven and eight percent per year. Many retirees own their own homes, yet it may be desirable to sell them upon retirement. They could choose to find rental property, or relocate to a new city or country with a lower cost of living.
This will result in huge cost savings.
For far too long, individuals relied on government programs to support them in their retirement years. It is important for those working now to begin planning for life after retirement. This will enable them to enjoy a much brighter future and a better quality of life.
CONCLUSION
There is a solution to the financial crisis facing America. It is simple, efficient, and easy to implement. The Purple Plan is our next step to improve our condition. The Purple Health Plan would reduce our fiscal gap by $127 trillion, and the Purple Social Security Plan would cut another $59 trillion.
Lastly, the Purple Tax Plan would reduce the fiscal gap by $36 trillion, leaving the gap with $11 trillion to spare. This plan will give hope to the younger generation and avoid massive tax hikes to combat a debt crisis.
In addition, individuals must also take responsibility for their own retirement planning.
We cannot rely on the government to take care of us. We must plan for the future, and the future is now.
This is not a Republican or Democratic problem. It is an American problem. We should be forward thinking, and take steps now to get this plan passed. There are almost 70 million Americans between the ages of eighteen and thirty-five.
These individuals must stand together and say, “Enough is enough.”
Britt always taught us Titans that Wisdom is Cheap, and principal can find treasure troves of the good stuff in books. We hope only will also express their thanks to the Titans if the book review brought wisdom into their lives.