Friday, February 18, 2011

Running on Empty

In 2005, I wrote the post below on the dangers of entitlement programs to our financial viability and national security. In the intervening six years, the challenges addressed in Pete Peterson's book are only larger and more frightening.

The battle lines drawn this week in Wisconsin mark only the start of a looming battle between public workers and private tax payers.  California, Illinois, New York, and other states face a "Sophies'" choice - raise corporate and income tax rates, slash workers from government payrolls, or renegotiate union contracts.  The future looks bleak, but I take comfort in one important fact. Our leaders will no longer be able to "kick the can" down the road. Moreover, as legislators seek to avoid cutting union benefits, they will be forced to slash discretionary funding for transportation, K12 education, higher education. Such cuts will inflame the voting public and driven an increase in political activity and voter participation. 

The public will, ultimately, side with investments in the future rather than continuing to stomach public entitlements that are much more generous than private employer benefits. The net result for public employees will be higher retirement ages, the elimination of defined benefit programs, and increased medical premium co-pay rates.  In many ways, a new class war is brewing - not, however, between rich and poor but between private sector employees and public sector employees. 

It is time for our leaders to address the roots of our fiscal ills - military spending, social security, medicare...We deserve an honest accounting and an all programs need to be on the table.

Several years ago, Pete Peterson, the founder of Blackstone and an ex-cabinet secretary, wrote an important and sobering book titled Running on Empty.

The book indicts both Republicans and Democrats for ignoring two troubling twin deficits - the the trade deficit and the budget deficit - which, he believes, may ultimately bankrupt the country. The hard-hitting book highlights the off-balance sheet, unfunded entitlement program liabilities that will fall due in the coming decades. With trillions of dollars in Medicaid, social security, and drug benefits promised to current and future retirees, he warns of some very hard choices that face the nation. For example, he estimates if Congress was forced to fund promised entitlement programs, we would face, "an immediate and permanent 60 percent hike in the federal income tax, or a 50 percent cut in Social Security and Medicare benefits."

Recently, news of corporate pension plans failing reminded me of Peterson's important book. For example, Delphi's unfunded pension liabilities present a scary harbinger of what is to come in corporate and government pensions. Delphi, the world's largest auto parts maker, faces an $11bn shortfall in its obligation to retirees. Delphi management, unable to negotiate with the unions, may file for bankruptcy, which would transfer the pension liability to the Pension Benefit Guaranty Corp, a government agency that insures pension plans. Unfortunately, the PBGC is itself underfunded, with assets of $56bn and liabilities of $79.2bn. Total corporate pension plan unfunded liabilities are estimated to be $450bn, well beyond the financial resources of the PBGC. Ultimately, tax payers will be liable for the failings of management to properly fund future obligations.

Roger Lowenstein wrote a wonderful NY Times Magazine articleThe End of Pensions, which provides scary and powerful insight into the failing of the defined benefit program and the massive state and local pension obligations that dwarf the corporate dilemma.

Why am I writing about this?

Economic growth is a function of investment. As entitlement spending drives deficits, we will need to finance them with either massive tax increases or massive borrowing to cover our shortfalls. As we borrow more, we will see a higher percentage of our tax base go to interest payments and the lions share of our local, state, and federal budgets go to entitlement spending that reward historical work rather than into investment programs that drive future growth. Both parties appear incapable of addressing this fundamental problem, and I hope that the writings of Peterson, Lowenstein, and others wake the electorate up to the scary prospects of a failing corporate and government pensions and the mortgaging of our future to fund entitlement programs.

1 comment:

  1. will, like your posts here. my take is healthcare is at the core of all these problems, and we are thinking about it totally wrong. if we don't solve this one, there is not a chance of getting out of this mess.