2011 March 05 Saturday
Laurence Kotlikoff: America Already Bankrupt

Laurence Kotlikoff, an econ prof at Boston U who writes extensively on the US budget and unfunded entitlements, has a piece on Bloomberg about how America is really already bankrupt.

Our country is bankrupt. It’s not bankrupt in 30 years or five years. It’s bankrupt today.

Want proof? Look at President Barack Obama’s 2010 budget. It showed a massive fiscal gap over the next 75 years, the closure of which requires immediate tax increases, spending cuts, or some combination totaling 8 percent of gross domestic product. To put 8 percent of GDP in perspective, this year’s employee and employer payroll taxes for Social Security and Medicare will amount to just 5 percent of GDP.

I keep harping on this theme because it is one of the long term developments that will blow up in our faces during the lives of most people reading this. We will suffer declining living standards for this reason among others.

Look at the growth in net interest payments as a budget item and you can see the crisis develop. The graph at that link us from the White House Office of Management and Budget. So it is an overly optimistic projection of the future. various projected cost controls assumed by the Obama Administration will not happen. Plus, economic growth won't happen due to Peak Oil.

Even without considering approaching the US federal fiscal train wreck future generations of Americans are facing retirement at lower living standards.

A new report by McKinsey & Company, the consulting firm, is gloomy about retirement. The report, Restoring Americans’ Retirement Security: A Shared Responsibility, says, “The average American family faces a 37 percent shortfall in the income they will need in retirement,” meaning “the average household will face a retirement savings shortfall of nearly $250,000 by the time of retirement.

Note that's McKinsey, not a stock brokerage trying to get more customers. The article explains some of the reasons why the outlook for retirees is worse: A larger fraction of retiree income will go toward rising Medicare insurance premiums. Plus, taxes will rise. So even if Social Security payments stay the same adjusted for overall inflation the overall inflation rate understates the decline in buying power which retirees will experience.

Since the US government will not be able to maintain the currently projected path of combined Social Security and Medicare expenditures the need to save for one's retirement is even greater than conventional wisdom would suggest.

State and local government pensions are similarly in trouble. Their assumptions for future investment returns are overly optimistic. It was possible to have a few decades of rapid growth in stock prices after stock prices became very depressed in the Great Depression and after they became depressed during the 1970s. But we are now in a period where 8% yearly stock market investment returns are no longer realistic.

Update: The amount of money getting paid out of Defined Benefit retirement plans is going to fall by an order of magnitude.

Younger households (30-to-39 years old) across all income levels face the biggest retirement challenge with RRIs ranging from 47 to 64, but they have the greatest ability to recover by changing their behaviors. This group must rely almost entirely on personal savings (DB payouts will provide one-tenth of the retirement income of their parents’ generation), and historically it has not saved. These households have, however, started to adapt their savings behavior, at least in the higher-income groups. And although they still are not saving enough, they have the benefit of time to build their nest eggs.

I do not think most people under the age of 50 realize how poor they are going to be in retirement. The McKinsey report makes for good reading both on a personal level (maximize your retirement plan contributions) and on a policy level (make it easier for employers to offer retirement plans among other points).

Share |      By Randall Parker at 2011 March 05 02:51 PM  Economics Retirement

map said at March 5, 2011 5:21 PM:

I really do not understand the thrust of articles like these. How does McKinsey know how much a person will need at retirement? Certainly such projections as "37% shortfalls" would make sense if we assume that a person's spending remains constant over their lifetime. Old people, however, tend to reduce their spending in old age, buying smaller houses, eating less, and having fewer expenses once their children are gone. It sounds like McKinsey's projections don't take into account this obvious point.

One has to wonder what the agenda is of leaving out this information

no i don't said at March 7, 2011 11:45 AM:

America is more than just bankrupt. America is now too frightened; frigtened of everything: immigration, atheism, socialism, koreans, terrorism, unemployment, arabs, politeness, russians, sex, freedom, ufo's etc.

Wolf-Dog said at March 7, 2011 11:12 PM:

America is indeed suffering from a serious spiritual crisis, where the value of the individual, or the average individual's ability to control his/her destiny is questioned. Perhaps the source of this malaise is at least in part the foreign trade deficit. The government deficit spending compensates for the money that the upper class takes from the majority plus the money that the majority of the US population loses by means of trade deficit. But this time the foreign trade deficit attained much higher dimensions, in such a way that it is also causing chronic unemployment. Government subsidy for working people can actually enhance employment if the purchases are made in the US, but if the subsidy (government deficit) is lost to foreign trade deficit, then this no longer helps cure unemployment, it only helps to prevent unemployed people from starving and the economy getting even worse, but the chronic problem persists.

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