US and UK governments are on course for fiscal calamity

The national budget reports of most developed nations are based on current cash flows of tax collections and government expenditures - and views on national indebtedness are based on metrics such as the current year’s deficit and the national debt accumulated from the past. The importance of deficit and debt measures has grown during recent decades with adoption of the European Stability and Growth pact, which relies heavily on those metrics to assess progress on economic convergence and to trigger corrective fiscal actions by EU member nations whose deficits and debts exceed allowances specified in the pact. These metrics are also widely used in the United States for characterising and evaluating federal fiscal policies.

These cash-flow-based measures of government indebtedness, however, are backward oriented – reflecting past outcomes and policies. To provide policy-relevant information, government indebtedness metrics should also include prospective debt - that which will be accumulated in the future under the continuation of current fiscal policies. This more comprehensive and forward-looking metric of a government’s ‘fiscal imbalance’ would be more useful as a reference point for debating how national fiscal policies might be changed for the better.  

The governments of many western developed economies have sizeable fiscal imbalances embedded in their fiscal policies - that is, their projected government receipts fall well short of future expenditure commitments under their current fiscal policies. A key reason for such large fiscal imbalances is that most of these nations have large baby-boomer cohorts in their populations that are entering retirement and will collect support payments from public pension and health care programmes while government taxes and other receipts are insufficient to fund those payment commitments and to fulfil other responsibilities for public service provision.

The fiscal imbalance measure informs on the total prospective shortfall of government resources relative to government expenditure commitments. But this measure does not indicate which generations contribute, and how much, to the total imbalance. Additional generational imbalance measures, which include past and projected resource shortfalls on account of specific generations could also be reported in official budget documents. Generational imbalance measures would be useful to analyse the distribution of fiscal costs across current and future generations under alternative adjustments to government fiscal policies. A new IEA monograph by this author, The Government Debt Iceberg, explores the extent of government indebtedness in the United States and EU nations in terms of fiscal and generational imbalance metrics.

For the United States, the monograph calculates and reports fiscal and generational measures based on the Congressional Budget Office’s March 2012 Budget Outlook. It finds the US federal fiscal imbalance to be 9.0 per cent of the present value of US GDP or 19.7 per cent of the present value of US payrolls under its current fiscal policies. It means that eliminating the fiscal imbalance embedded in current fiscal policies requires raising taxes or reducing expenditure commitments, separately or in combination, to the tune of 9 percent of GDP - beginning immediately and maintained throughout the future 

Fiscal imbalances are also reported for 25 European Union countries based on government budget information published by Eurostat. EU fiscal imbalances average 13.5 per cent of the present value of EU GDP. Resolving this fiscal imbalance would require an immediate and permanent levy of 27.2 per cent on annual labour compensation or, alternatively, a 23.2 per cent levy on annual consumption in EU nations on average. For individual EU member states, fiscal imbalances range from 3.7 per cent for Estonia to 32.8 per cent for Ireland. The major EU countries of Germany, France, Spain, the UK and Italy have fiscal imbalances close to the EU average: ranging from 15.4 per cent for Spain to 12.1 per cent for Italy. The United Kingdom’s fiscal imbalance of 13.6 per cent is close to the EU average.  

Such large fiscal imbalances portend significantly higher taxes, reduced government expenditures, or some combination of those two policies in the United States and in EU nations. The earlier that governments make corrective fiscal adjustments, the easier will it be for those affected to prepare for their future economic needs and security.

 

Jagadeesh Gokhale is a senior fellow at the Cato Institute and the author of The Government Debt Iceberg.

Just some thoughts from an accountant who deals with the business world but has little experience of how governments disclose their fiscal imbalances. It is not suggesting any changes to the article. There is a distinction to be made between a commitment and a liability: If a service such as health care has been delivered there is a liability at the date of the service, no matter if the supplier is to be paid the next year. When evaluating liabilities, clearly the cost of repairs made today to potholes in the road is a liability. The question arises how to consider the cost of fixing potholes visible today but not yet fixed, and what about the cost of fixing potholes likely to appear in the future? The cost of fixing the population’s health issues likely to appear in the future is a commitment. It will become a liability in due course, just as future tax revenue will become an asset to be consumed in meeting the liability. In state expenditure there is an important assumption that is consistently applied: that future costs will be covered by future (taxation) revenue, albeit the revenue sources do not particularly match the costs. This assumption is not made in corporate accounting and the recent “windfall” made by the government in taking over Royal Mail pension illustrates the difference in the two views. The divergence between government and business accounting rules can be exploited and the PFI legacy of the last decade is an example. Taxation is a proportional levy without any proportional benefit and this fact renders inoperable a large proportion of sound accounting rules applied in business. Surely if forecasts show a series of future deficits the cumulative value should be treated as a liability. After all, if these deficits were to continue for a sustained period there would be default. But then if there is default the liability will not be settled, therefore it is not a liability. Ultimately governments do deal with accumulated deficits though not usually through a default. Potholes do not get fixed, services become creaky, inflation erodes their debts, assets such as land, buildings and public companies get sold, taxation increases. Then new governments get voted in!

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