The Fiscal Nightmare of the Welfare State

Bloggers post what they claim to be the “scariest economic chart” or the “chart of the century.” Indeed, many data sets are frightening, but none more so than the tables found here (PDF). Jagadeesh Gokhale compiled these figures on European debt. This data shows incontrovertibly that modern government has failed. These countries are all insolvent and will eventually default. (See Table 1, Page 8.)

All Western democracies are on death row. The unlimited welfare state is the cause. Some governments are delusional, believing they can continue on their present paths. Others cling irrationally to hopes of some miraculous reprieve. All are dead men walking.

Government has always been inefficient and mostly ineffective. For most of history that was inconsequential, because governments had limited roles. Monarchies and various forms of authoritarianism had no reason to buy votes. That changed when participative government was instituted. The dangers of participative government devolving into democracy were well understood:

A democracy cannot exist as a permanent form of government. It can only exist until the voters discover that they can vote themselves largess from the public treasury. From that time on the majority always votes for the candidates promising the most benefits from the public treasury, with the result that a democracy always collapses over loose fiscal policy, always followed by a dictatorship — Alexander Fraser Tytler, 18th century historian and jurist

Remember, democracy never lasts long. It soon wastes, exhausts, and murders itself. There is never a democracy that did not commit suicide. —  John Adams

In the 1880s Otto von Bismark instituted the first welfare state. Other governments followed with varying time lags. The Progressive Era in the U.S. created the Federal Reserve and the federal income tax, both in 1913. They provided powers to the federal government never intended by the Constitution. In the late 1930s, the U.S. started a social security system, the last developed country to do so.

Once democracy was unleashed, citizens voted themselves benefits. Keynesian economics assisted politicians in their quest for votes. James Buchanan and Richard Wagner observed in Democracy in Deficit:

With the completion of the Keynesian revolution, these time-tested principles of fiscal responsibility were consigned to the heap of superstitious nostrums that once stifled enlightened political-fiscal activism.

The last barrier to fiscal irresponsibility was removed in 1971 with the introduction of universal fiat currency. In the last 50 years, the U.S. has not had a true surplus. Keynes’ theory, which envisioned deficits in slow economies offset by surpluses otherwise, was co-opted by the political classes. In less than seventy-five years, all welfare states were insolvent.  To illustrate this point, the U.S. will be used.

The U.S. government has $12.5 trillion of funded debt, almost 90% of last year’s GDP. That is a critical level according to Reinhart and Rogoff based on their 800-year study of sovereign bankruptcies. Serious, funded debt is not the major problem. Unfunded entitlements (Social Security, Medicare and Medicaid) are. These are estimated to be $106 trillion.

The gross domestic product of the U.S. was $14.1 trillion last year, meaning total debt was 840% of GDP. But the Gokhale table  shows the U.S. at 500% of GDP rather than 840%. That number reflects the present value of the unfunded liabilities out to 2082. The larger number, provided by the trustees of the plans, is based on an infinite time horizon. (Gokhale provides the rationale why this horizon is proper in his study on page 4.)

The study shows European debt at 484% of GDP, but this seriously understates their liabilities. The study reflects numbers only out to 2051. Were the numbers calculated to 2082, they would be larger than the U.S. number. Furthermore, if the calculation were done on an infinite time horizon, it would exceed the U.S. figure of 840%.

Because the data were unavailable, precise numbers cannot be determined. Three important reasons support the conclusion that they are worse than the U.S.:

• The U.S. unfunded liability for Social Security when calculated to 2082 is only one-third of the liability when calculated to infinity. Total U.S. unfunded liabilities to infinity are 100% larger than the 2082 number.
• Europe’s economy grows slower than the U.S., exacerbating its welfare burden in the future.
• The demographics in Europe (fewer young people supporting the old) are more severe, imposing more imbalances on social systems in the future.

Based on these considerations, it appears that the European average of 484% would be substantially higher than the U.S. figure of 840% if calculated comparably.

The numbers are actually far worse for all countries when shown against tax revenues — the means by which they can service commitments. In one of my blog posts titled “Spiraling to Bankruptcy” I showed that the U.S. cannot possibly service its commitments. The analysis used numbers from one year ago, less unfavorable than current numbers. From that post:

Send in an Additional $1,525,000 With Your Tax Return:

To further put the problem into perspective, the federal government owes about $112 TRILLION in actual debt and social promises. Assuming a total population of 315 million people, the portion of federal government debt that is owed by every man, woman and child in this country is about $381,000! Or, a family of four owes $1,525,000 of which they are unaware. This amount is in addition to whatever mortgages, credit card debt, car loans or other loans a family might have.

The federal government collects about $2.5 trillion in total revenues a year. That is from all sources of taxes and fees. Think of that as an individual’s annual gross salary. The debt owed by the government can be looked at as a great big mortgage. Thus, we have a family that has a mortgage 44.8 times greater than gross salary. That would be the equivalent of a man earning $50,000 gross salary having a mortgage of $2,240,000! An interest-only mortgage at 6% would require the family to pay annual interest of $134,000 per year. A conventional mortgage would be much higher. The example becomes even more ludicrous when one recognizes that taxes, food, clothing, savings, etc. all have to be subtracted from gross pay to determine what is left for debt service.

Debt Death Spiral:

The federal government is in what is known as a Debt Death Spiral. They are unable to pay the actual and implied interest on their debt. Hence, the unpaid balance is added back to the amount owed, making the problem worse next year. This debt spiral is growing exponentially. There is no way to escape a certain mathematical end.

The U.S. is insolvent. Mathematically, it is impossible to service the obligations without defaults. It is highly improbable that inflation can solve the problem, although that will probably be tried. Europe is in a worse condition. Japan, not shown, is in a similar state.

In the U.S., the numbers are even worse than they appear. Gimmickry extends beyond accounting. For a sampling, see my blog post “Government is 79% of the Economy.” In addition, more than unfunded entitlements are unaccounted for. Per the Wall Street Journal:

The bigger issue is that all of Fan[nie] and Fred[ie]’s liabilities, whether kept inside the companies or hidden in a dark corner of the Treasury, are now Uncle Sam’s responsibility. Moving their bad assets into a new Baddie Mae would only preserve the fiction that there is a difference between the government’s obligations and those of Fan and Fred. Not even Barney Frank could believe that any more.

Proper accounting for Fannie and Freddie would add over $5 trillion of additional government debt. That would raise the debt obligation of the U.S. government to $18 trillion, well above the 90% of GDP that Reinhart and Rogoff consider critical.

The welfare state, a relatively recent historical concept, appears to have failed miserably all around the world. Markets will eventually put all of these states out of their misery, but probably not before more damage is done. It is sadly ironic that the first democracy, Greece, may be the first casualty.