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Colloquy Podcast: The Debt Ceiling—and Beyond—with Laurence Kotlikoff

As politicians and pundits wring their hands over the debt ceiling, the economist and Boston University professor Laurence Kotlikoff, PhD ’77, says the United States is already bankrupt. He calculates the health care and pension obligations to the country's rapidly aging population in the many trillions of dollars, far outpacing tax revenue in the coming decades. And he says economic growth won't save us. But he claims to have a few proposals that may, as well as some advice about personal investing, saving, and spending in uncertain times.

This transcript has been edited for clarity and correctness.

So, let's start with the topic that's staring us in the face. How concerned are you about the prospect of default this summer as the result of the failure to raise the debt ceiling?

I'm pretty concerned. I think the Republican members of the House want to show that they can accomplish something, even if it's something that's destructive to the economy. They want to show that they didn't get there for nothing. They don't see probably much prospect of getting things passed through the Senate, let alone through the president, unless they cooperate.

And their whole schtick is, this is the enemy. We're at war. So they could just do this for demonstration purposes and watch the economy kind of melt down for a while and then pull back. I don't see the Democrats compromising on the kinds of things that they're suggesting.

Now, so how likely is this? I feel like maybe a 30 percent chance. But there are things that can be done that both sides can agree to.

Do you see the wrangling around the debt ceiling already having an impact on the economy?

I think it's probably raising rates. And as we get closer in, it's going to keep raising rates. I don't think this will get resolved until the last minute because that's generally the way the game here works.

If we fail to raise the debt ceiling and the country starts to default, what does that look like from a global economic perspective—from a garden-variety recession to “smoking rubble” kind of scale?

I think we're kind of talking closer to smoking rubble to tell you the truth because they would probably default on the debt holders as opposed to they could also default on Social Security beneficiaries or just not pay contractors for defense for ammunition for Ukraine. But they would probably default on the debt because a third of the debt is held by foreigners.

Now, you think that's a big fraction but actually, if you go back eight, 10 years, 50 percent of the US debt was held by foreigners. So the fact is that foreigners are, I think, getting out of US debt because they're worried about the US fiscal sustainability, about the insolvency of our country.

And certainly, what we're doing now is printing a lot of money to pay our bills. We're not raising taxes. And that's part of the reason that we have inflation. It's not the whole reason. There's obviously supply-side disruptions and Ukraine, energy cost increases, and disruption in production in China. But certainly, there's been a huge amount of money printed, in part to pay for Washington's spending.

And this increase in inflation, the price level, means that we've wiped out foreigners' holdings of US Treasury bonds and bills to the tune of about probably 12 percent in the last two years. So they've taken a huge hit on their holdings of US debt. So they're naturally saying, “No more. Let's get out of this.”

And if we defaulted, then they would definitely say, “OK, we're not going to buy a US debt for many years again.” And that could just lead to a major hike in interest rates that lasts for a long time until the US regains some credibility.

The federal government tells us that the national debt is around $31 trillion. You're saying it's much more than that. Break down the arithmetic for me.

With Alan Auerbach, who's a professor at Berkeley, we've developed something called fiscal gap accounting and generational accounting. These are kind of two connected analyses that say, look, you can't just look at official debt because, yes, it's an obligation. But there are all these debts that are off the books, like paying you, Paul, your Social Security benefits when you retire or me, my Social Security benefits for the rest of my life. These are obligations that are off the books. They're unfunded liabilities.

And when you put together the unfunded liabilities and the official liabilities and then you subtract the receipts that we're going to be getting in, the taxes, you do a full accounting—don't just look at the bills, but look at what you have to pay for the bills. You find that we have a huge fiscal gap. It's about 8 percent of GDP on an ongoing basis through the rest of time.

Now, raising 8 percent of GDP by, let's say, raising taxes, you would need about a 47 percent immediate and permanent increase in every single federal tax from now till the end of time. And I'm just speaking from developing these calculations using CBO, Congressional Budget Office, projections, the latest of February 23, 2023.

According to the trustees of Social Security, in table 6f1 of the 2022 Trustees Report, it says, Social Security is broke to the tune of $61 trillion. To put that in comparison, our GDP's about $24 trillion right now. So we're talking about a massive amount of red ink in that system.

So everybody is—and the Republicans are correct to be pushing on doing something to fix this. You can raise all taxes forever by 47 percent, or you could cut all spending forever by about a third. And if you raise the taxes, you won't have to cut the spending. If you cut the spending, you won't have to raise the taxes. Or you could do some combination of these two horrible things.

Do we need social insurance? We absolutely do need it. Do we need to force people to save? Yes. And Social Security does that in large part. Do we need to force people to buy insurance and give them disability protection? And all these things are important. But we can't give insurance to older people out of the pockets of younger people. Older people—each cohort really needs to pay for its own insurance. It needs to pull its own risk together. We can't be continually taking from Peter to pay Paul.

Is the problem primarily that the population of older folks is getting larger, that that population is living longer, or that costs, particularly in health care, are rising, or some combination of all those factors?

It's a combination. I mean, if you think about projected outlays for everything, for defense, for the president's lunch, for gassing up Air Force One, for paying Social Security benefits, Medicare, Obamacare subsidies, all these things—food stamps—they depend on the demographics. They depend on the—Social Security benefits are linked to the labor productivity of the workers during their working days. All of these things interact to produce the entire path of outlays. And they also interact to produce the path of receipts.

And so when you have a society where your population is aging, you're going to have less receipts in present value, and you're going to have more benefits in present value. When you have a society where the productivity growth rate is slowing down, you're going to have less receipts in present value and somewhat less benefits. But the reduction in receipts will be bigger in present value than the reduction in benefits.

Your colleague Paul Krugman, you've sparred with him a little bit. He's argued that, except for a spike during the pandemic, healthcare costs as a percentage of GDP have more or less plateaued over the last 15 years. CBO in 2009 projected that Medicare spending would be between 10 percent and 11 percent of GDP by 2052. Their most recent estimates this year are much lower, just under 6 percent by 2052. So my question to you is, do you take heart from any of this?

Well, absolutely, I mean I did read Paul's—I thought it was an excellent column. And I often or occasionally agree with Paul. But the CBO has been adjusting these health growth rate assumptions through time as the data showed that things were looking better. And I hope, if we don't do anything, that that would save us. We are spending 8 percent of GDP on health care, 18.3 percent or so. Other countries are getting much better health care outcomes on a budget of about 11 percent, 10 percent of GDP. So that right there is how we can deal with our fiscal gap.

If we can run our health care system the way the Swedes do, for example—they have about the fourth best outcome. We're like 21st in terms of health care outcomes. They're spending around 11 percent. We're spending 18.5 percent or so.

So right now, as of this February, the CBO, which has a good set of economists—and they're professionals. And they're trying to project based on being cautious but not overly cautious. They are producing projections that are suggesting a massive fiscal gap.

And it's one thing for Paul to say, OK, things are not as bad as the CBO projected five years ago. Amen. But it's another thing for him to not have done the calculation from—based on the numbers that they are now projecting that suggests we're in terrible shape.

And let's hope that Paul's right, that things keep getting better and that the CBO keeps adjusting in this downward direction. But we can't take the risk. What I really mean by that is we can't impose that risk on our kids because that's like not paying attention to climate change, right? Hey, it’s somebody else's problem. It's our kids problem or future generations. What are they going to do for me, right? It's the same thing with the fiscal insolvency of the country. I say insolvency because that's what the average numbers suggest. It doesn't suggest zero on average, it's not—which is Paul's suggestion that maybe we really don't have a problem. We have a problem. It's staring us in the phase based on the CBO's latest numbers that take into account what's been happening of late. And we can't just ignore it because we're leaving our kids at risk.

Now we get to the part where we talk about your proposals. Talk more about this re-envisioned Social Security.

So on Social Security, what I would do is freeze the current system in place. So that means you pay off all the accrued liabilities. You pay off everybody who's, like me, collecting Social Security. We continue collecting exactly what we're now getting. You, Paul, you haven't collected yet. But when you do, you'll get exactly your benefits as calculated based on your earnings record up to this date, OK? But your earnings record will be filled with zeros is beyond this date. So this is how we just phase out the old system.

New people coming up will just have zeros on their record. They'll never get any benefits under the old system. So it's a gradual phase out. And then you maintain the payroll tax to pay the existing—these accrued benefits. You maintain it as long as you need to in order to cover those benefits. And then you have every worker contribute 10 percent of their pay to what I call a personal security account. And this personal security system involves these contributions, 10 percent of pay, being split 50/50 between spouses or legal partners.

So if somebody stays home to watch the kids or homeschool the kids or whatever, they're going to be treated equally in terms of Social Security. They'll have an equal size account if they get divorced. I mean, half the people are getting divorced, or maybe 40 percent. So that's very important to be treating couples that way.

And then you'll have the government making matching contributions on behalf of the poor and the unemployed and the disabled. So we're going to have progressivity. That's where the progressivity will come in—right up front.

Now, all this money then is in these accounts with everybody's name on their own account. And all the money is then pooled and invested in a global index fund of stocks and bonds and real estate trusts. And so now you have a globally diversified portfolio. Everybody's getting exactly the same return. The government would guarantee that, when you got to retirement age, that your account balance would be at least what you put in, adjusted for inflation.

So the government would be guaranteeing a zero real return. But that's, in effect, guaranteeing that you don't lose what you put in. And now, after you reach 57, the government would take each birth cohort's account—personal security account balances and collectively sell those off over the next 10 years gradually.

And when they sell these securities in the global index, they would buy inflation-indexed bonds, Treasury Inflation-Protected bonds. And then the government would use those securities to pay inflation-indexed annuities to each of us based on—in proportion to the size of our account holdings when we hit retirement age.

So this is really just a rationalization of what Social Security is trying to do. It's trying to provide insurance, protection for divorcees. It's trying to provide progressivity in case you become unemployed, become disabled, or just poor. It's trying to provide longevity insurance.

So all these elements are there. I would maintain the disability benefits program the way it is. And the survivor benefit program, that could also be set up in a more rational way than we now have. So I'm for all of the social insurance features that the current system has. I just want us to start basically from scratch and reformulate this.

And now we'll have a fully funded system because the money in there is invested—our contributions are invested in real assets, not handed over directly to older people. But rather there's something real there.

Now, that is a system that can eliminate much of the $61 trillion unfunded liability of Social Security and give younger people—yes, they'll have to keep paying the payroll tax. Yes, they're going to have to pay this 10 percent for saving. But it will give them something real as opposed to a Social Security system that they're going to have to pay into but maybe get nothing out from.

All right, so now I want to hear about the Kotlikoff plan for universal health care.

It would cover everybody in the country. So here's how it works. You would get, in effect, a voucher—or your insurance company that you choose would get a voucher that's based on your pre-existing conditions.

So Paul, you might, let's say, have diabetes and thyroid issues and blah, blah, blah. And the government would have, from your electronic medical records, this information. And they would say, OK, on average, Paul is going to be 30 percent more expensive than the typical 40-year-old. And so therefore, we're going to send to whatever insurance company you choose, health maintenance organization basically—they would send a check at the beginning of the year to cover your expected costs. And that would be all they would get.

So they would have an incentive to keep you healthy because if you're not going to be healthy, they're going to have to pay more. And they would also have to meet—provide standard care. This is one of the concerns of the current Medicare Part C system, which is that there's not enough standardization so there's that—these insurance companies are kind of cherry-picking.

But many of them, the companies are providing excellent care. But there are, I mean, a minority who are trying to cheat the system. And that needs to be precluded from what we're proposing here. And that can be done.

But anyway, you get this—you choose a plan. If you don't like it after a year, you swap to a different—you switch to a different plan. Now we have—your preexisting conditions are not an issue here because nobody can turn—no plan can turn you down. And you're not going to be penalized for having diabetes, right? And nobody wants it. That shouldn't happen.

Everybody's covered in the country. We pay taxes to cover the cost of the system. And through time, the competition should reduce the costs dramatically and get us to around 11 percent. Now, why do I say that with a lot of confidence? Because if you look at the Japanese system, if you look at the French system, if you look at the German system, you look at the Swiss system, the Israeli system, the Swedish system, these all—all these systems have very similar setups and are costing only about 11 percent, 12 percent of GDP.

Now, you might say, well, isn't that intrusive? Why should we let Washington learn about people's health conditions? Guess what, we've been doing this for decades now with Medicare Advantage. Everybody that's in Medicare Advantage—and it's getting close to, at the margin, about 50 percent of older people who are going under Medicare are choosing this Medicare Advantage system because it is actually quite efficient and providing excellent care in general, with some bad apples.

But the way it works is that people get—have their health plan receive a voucher payment that's based on a calculation that's done down in Washington based on the person's preexisting conditions. They're risk-rated.

And so this information is being provided to Washington and then used to make a payment. So nothing I'm proposing is different from what's already happening in Medicare Advantage.

Taking into account everything that you've said and where we are and what's going on with social insurance and what's going on with the economy, what are some basics you can recommend? How should we think about investing, saving, and even spending?

Okay, so I've been working on this for quite a while. As you know, I developed a software company actually 30 years ago, and we have a tool called Maxifi Planner that people can buy, it's not expensive.

You want to figure out a baseline living standard spending path that is predicated on cautious assumptions about how much I'm going to earn and when I'm going to retire. And then you want to try and optimize over decisions like when did—how to handle Social Security, when you should take your retirement benefit. If you wait till 70, it's dramatically higher, 76 percent higher adjusted for inflation than it is if you start taking the benefit at 62.

So most people should be waiting till 70. Our software is called Maxifi because it says, let's set up a base plan. And then we're going to hit a button. And we're going to have the program robo-optimize, robo-maximize your lifetime spending, your discretionary spending, subject to—you're still meeting all these off-the-top expenses.

And then when it comes to think about investing risk—so one thing to do is play it completely safe and just invest in inflation-indexed bonds that are issued by the Treasury. And if we don't have a default, they'll be perfectly safe. And not invest in the stock market—but what if you want to do that? Well, one thing to do is to run the program's upside investing mode, which is, “Hey, I'm going to build a floor to my living standard by—well, I'm going to put some money in the stock market and maybe add to it and then think about when I'm going to take it out. But I'm not going to spend out of that until I actually take out money, something positive, and invest it in inflation-indexed bonds. So I'm only going to spend through my life out of things that I know are perfectly safe.” This produces a floor to your living standard and upside risk because when you take money out of the stock—if you have $100,000 in the stock market, now you're 40, when you start taking out, let's say, at 65, maybe gradually, well, likely there's going to be something there, so that you'll be able to convert maybe, if you take it out over 10 years, one-tenth when you're 65, one-ninth when you're 66.

And the program figures out—you get to see—I can set a floor in my living standard. If I put more into the stock market, my floor will be lower, but my upside will be higher. If I put less in the stock market through time, I will have a higher floor and a lower upside. And the interesting thing is that the stock market is so powerful in terms of generating positive returns that you don't need to put that much into the stock market to get a pretty good upside, to have your living standard be, in your old age here, in your 60s and beyond, two to three times higher with a decent probability.

We think about that being the risky investment. It could be a combination of risky things. But we're treating that as money in the casino. You don't count on winning. You go there for entertainment.

Now, the thing—the difference between the stock market and Vegas is that the stock market, since 1950, yielded about a 9.5 percent real return. So it's a fantastic stock market. It's just also extremely risky. And it's got huge variability.

This last year, the stock market, the S&P went down 20 percent. In 2000, it went down 50 percent. In 2008, it went down—between 2008 and 2009, it went down 53 percent. In the crash in '29—between '29 and '33—it went down 86 percent, a little bit less after inflation.

So there's no guarantee with the stock market. The stock market's not safer in the long run. If you invest today—if they're smart, they limit what they put in. And they don't spend any winnings until they've actually left the casino.

This is the same idea. Put the money in the—think about your stocks as a casino. And you don't want to spend any out of that until you have left the casino, until you've turned that—those stock holdings into inflation-indexed bonds that are the safest asset around. And that's the upside investing. So everybody can do that.

Princeton economist Ellora Derenoncourt

The Colloquy podcast is a conversation with scholars and thinkers from Harvard's PhD community on some of the most pressing challenges of our time—from global health to climate change, growth and development, the future of AI, and many others. 

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Produced by GSAS Communications in collaboration with Harvard's Media Production Center, the Colloquy podcast continues and adds to the conversations found in Colloquy magazine. New episodes drop each month during the fall and spring terms.

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