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Deficit dementia

Posted by: Michael Mandel on November 28

My regular readers know that I’m not terribly worried about the budget deficit, at least at current levels (see for example this piece here). Nor am I particularly worried about entitlement spending, which has been overhyped as a problem because of a weird forecasting methodology (see here)

So I was very happy to see a new post from Max Sawicky on “deficit dementia.” Max writes:

Let us recap ten fallacies of deficit dementia:

1. Lumping debt service, Social Security and other “entitlements” with the only genuine fiscal problem — Medicare and Medicaid.

2. Obsessing over retiree to worker ratios, instead of total population to worker ratios.

3. Exaggerating the tax adjustments required to finance Social Security.

4. Presuming that deficit reduction will spur capital formation and economic growth.

5. Assuming the Federal budget ought to be balanced, as a matter of course.

6. Treating tax increases to finance entitlement growth as “unprecedented” and politically impossible, but considering draconian benefits cuts as politically feasible and inevitable.

7. Assuming taxes could not be higher, for economic reasons.

8. Pretending we have a clue as to the nature of the economy forty (thirty? twenty?) years or more in the future.

9. Comparing the rate of return of equities over extended periods too long to be susceptible to prolonged slumps that would plague an actual investor to a program that a) paid the legacy costs of elderly who never contributed to Social Security, b) has lower risk than equities, c) provides an inflation-proof annuity with zero conversion cost at retirement, d) has minuscule administrative overhead, e) provides disability and survivors insurance, and f) provides insurance against low earnings over one’s lifetime.

10. Comparing accumulations of program deficits over 75, 100, or eternal time horizons to this year’s GDP.

To this I would add…counting government spending on as R&D, education—and yes, part of health care—as consumption rather than essential long-term investment that can be and should financed by borrowing.

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Reader Comments

Brandon W

November 28, 2006 12:26 PM

All true... as long as the Dollar remains the world's reserve currency and interest rates (returns) remain competitive against other potential reserve currencies. I don't see that as a given.

david foster

November 28, 2006 07:05 PM

"health-care costs per beneficiary will grow at a rate one percentage point faster than per-capita GDP" is this actually calculated--using like measures of GDP (real-to-real or nominal-to-nominal)?...or something stranger? For example, if real GDP is growing 3%/yr, are they assuming that real health care costs are going up 4% and then adding CPI to get a nominal number? Or what?


November 28, 2006 10:49 PM

Michael, you worry about the federal deficit but you overlook how our taxes are being spent.
You worry about the Housing Market but housing continues to be a safe investment in the long term. You worry about US Health Care but Americans are living longer.
You worry about our national savings rate but we are saving about 1 trillion dollars per year in IRAs and CDs.
Will you be upset if your building doesn't have Wi-Fi or HDTV? When does a luxury become a necessity?


November 29, 2006 05:10 AM

While I would somewhat agree with point 8, I'm not sure why you're reprinting this stupid list, especially with the ridiculous statements about Social Security. According to the CBO and the SS trustees, revenues will not cover benefits in 10-15 years. The "surplus" does not exist, it was frittered away by the government. If boomers think they will get away with raising taxes to pay for their social security benefits, they better think again. I am 27 and I will not vote to dump more money into SS and I'm willing to bet that other Gen-X and -Yers will not also (together we outnumber the boomers, btw). There is going to be a reduction in benefits no matter what, at the very least from wage indexing to price indexing, most likely an age hike and more. The people who will pay the price for this are those who believe the Democrats now: they are the ones who will get burned later. Rather than let that happen, we need to start privatizing SS now. Make it a mandatory 401(k) if you must, whatever it is, we will have to pay the price later if we don't do this now.

Mike Mandel

November 29, 2006 11:28 AM


Yes, you've got the gist of the health care spending forecast. Make whatever assumption you want about future real gdp growth, and add one percentage point to get the growth rate of health care (the actual methodology is actually a bit more complicated than that, but that's it).

The problem is that there is no way to grow your way out of the problem once you have made that assumption. Yucko...that's a technical term.

Mike Mandel

November 29, 2006 11:32 AM


Social Security can be fixed by some minor technical twiddles. According to the latest report from the SSA trustees, the 75 year deficit is about 2% of taxable payroll. That's very small.


November 29, 2006 01:38 PM

I thought that 2% number sounded fishy so I went to the trouble of looking it up. It comes from this table ( in the SSA report, where they have the temerity to count the supposed current trust fund of 1.86 trillion as an asset and actually subtract it from the predicted shortfall. As that 1.86 trillion is in actuality a debt that will have to be paid in 10 years, you really get a number of 3.4% of taxable payroll. That is, assuming you trust them not to also fudge the numbers elsewhere (the numbers in that table look too small to me, I don't trust whatever discount rate they're using).

All that said, I don't think SS is a disaster. However, it will put a lot of elderly people in pain when everyone else refuses to bail them out and SS as a whole is prone to even more political mismanagement. That is why I think we should take this opportunity to restructure this antiquated safety net rather than continuing blithely along, pretending it will be able to take the weight of all the boomers who will fall into it in the coming decades.


November 29, 2006 01:51 PM

Social Security can be fixed very easily by simply indexing the retirement age to the continually rising life expectancy.

For people born after 1960, make the early age 65 and the full age 69.
From there, add on 3 months for every year of birth. Thus, for people born in 1964, the ages are 66/70. For people born in 1968, the ages are 67/71. For people born in 1972, the ages are 68/72, and so on.

That alone would slash the expenditures.

Beyond that, I agree that privitazation is the answer. People who oppose it are fools, because it is *optional*. People could choose to keep it in money market funds rather than equities if they wanted. Currently, people are *forced* to keep it in T-bills and do not have the choice of equities.

Thirdly, the SS payroll tax is far too regressive. Low income people still pay 6.2% of their pay, yet people who make above $94,500 pay nothing on income above that level.

Instead, we should not collect it on the first $30,000 of income, but instead start from $30,001 and go until unlimited income. The revenue the govt collects would be about the same, but lower income people would pay much less, and this would effectively have the same economic stimulus benefit as a tax cut.

For example :

A person making $30,000 pays nothing, and neither does his employers.
A person making $70,000 pays 6.2% of $40,000 and his employer matches that.
A person making $200,000 pays 6.2% of $170,000, his employer matches that.
A person making $3 million pays 6.2% of $2,970,000, and so on.

This would be a far better way to collect the benefits, and would make privitization easier, since now contributions have shifted to people who are more likely to max out their 401K anyway, and are thus more favorable to private accounts.

Mike Mandel

November 29, 2006 02:09 PM

Hi Ajay,

If you don't like the 2%, how about this from the trustee report:

"benefits could be reduced to the level that is payable with scheduled tax rates in each year beginning in 2040. Under this scenario,
benefits would be reduced 26 percent at the point of trust fund exhaustion in 2040, with reductions reaching 30 percent in 2080."

That is, if nothing else changes, the inflows and outflows would be balanced if benefits in 2080 are cut by 30% below the current projections.

However, for a medium earner, real benefits in 2080 are currently projected to be approximately $35316 per year, compared to $16127 now. That is to say, benefits in 75 years are projected to be roughly 120% higher, in real terms, than today's benefits.
(see here

So if we cut future benefits by 30%, they are still more than 50% higher than today's benefits. True, the new benefits only replace 29% of income, rather than 41%. So that means middle-income Americans who retire in 2080 will have to accept a decline in living standards equivalent to about 13% of their pre-retirement income, or find another income source. Is that horrible? I don't think so.


November 29, 2006 03:15 PM

I like this list a lot. SS has been made a crisis by those with political axes to grind and those gullible enough to fall for it.


November 29, 2006 04:16 PM

2080? There won't be middle-income Americans in 2080. There won't be humans in 2080. There will have been a technological singularity before then, where humans merge with their technology.

All credible futurists agree upon the singularity, and differ only on the timing and details of it.

Anyone who simply takes the trends of the last 75 years and projects them linearly over the next 75 going to be grossly off the mark in predicting the world of 2080.

Janus Daniels

December 3, 2006 02:03 PM

"credible futurists"
boneless ribs, military intelligence, religious freedom, government efficiency, Microsoft Works, reality television, working vacations...

Mike Mandel

December 4, 2006 08:53 AM


From an economic point of view, what would such a singularity look like? Health care spending merges with info-tech spending?


December 4, 2006 04:30 PM


Highly speculative, of course, but I would think :

1) Biotech becomes a heavily information-oriented discipline, where we routinely see the costs of certain products like Genentech's drugs drop by half every 2 years or so. So those items would seem to merge with info-tech spending in the broadest conceptual sense (knowledge-based products with almost no raw-material costs).

2) Continual improvements in medical devices throught IT would introduce deflationary forces into healthcare spending, like this :

3) Biotech patents in 2005 were 4-5 times more than in 1999, and, as you noted in your May '04 article, economic impact of this is seen 10-25 years hence.

4) A very broad way to look at it is this :

5) As human lifespans rise and self-enhancing technologies become more common (due to the huge market forces behind this), people will begin to choose to merge with technology. Thus, our descendants and their technology become one and the same. But this is 40-50 years away.

Nicolaas J Smith

January 7, 2007 12:50 PM

Non-monetary inflation can be stopped.

"People today use the term `inflation' to refer to the phenomenon that is an inevitable consequence of inflation, that is the tendency of all prices and wage rates to rise." Ludwig von Mises - "Inflation: An Unworkable Fiscal Policy".

All prices do not rise. Only the prices of variable real value non-monetary items while many constant real value non-monetary items are not fully updated and many are not updated at all.

The second inevitable consequence of inflation is the tendency of many constant real value non-monetary items NOT to rise at all - during the Historical Cost era while some constant real value non-monetary items are not fully updated.

Inflation today has and always had a second consequence during the 700 year old Historical Cost era.

Inflation has a monetary consequence, called cash inflation refered to above by Ludwig von Mises and defined as the economic process that results in the destruction of real economic value in depreciating money and depreciating monetary values over time as indicated by the change in the Consumer Price Index.

Inflation´s second consequence is a non-monetary consequence defined as Historical Cost Accounting inflation which is always and everywhere the destruction of real economic value in constant real value non-monetary items not fully or never updated (increased) over time due to the use of the Historical Cost Accounting model or any other accounting model which does not allow the continuous updating (increasing) in constant real value non-monetary items in an economy subject to cash inflation.

Inflation´s second consequence is solely caused by the global stable measuring unit assumption.

The stable measuring unit assumption means that we regard the annual destruction of a portion of the real value of our monetary unit by cash inflation in low inflation economies as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

This results in the destruction of at least $31bn in the real value of Dow companies´ Retained Income balances each and every year. Globally this value probably reaches in excess of $200bn per annum for the real value thus destroyed in all companies´ Retained Income balances.

The International Accounting Standards Board recognizes two economic items:

1) Monetary items: money held and "items to be received or paid in money" – in terms of the IASB definition.

2) Non-monetary items: All items that are not monetary items.

Non-monetary items include variable real value non-monetary items valued, for example, at fair value, market value, present value, net realizable value or recoverable value.

Historical Cost items valued at cost in terms of the stable measuring unit assumption are also included in non-monetary items. This makes these HC items, unfortunately, equal to monetary items in the case of companies´ Retained Income balances and the issued share capital values of companies without well located and well maintained land and/or buildings or without other variable real value non-monetary items able to be revalued at least equal to the original real value of each contribution of issued share capital.

The stable measuring unit assumption thus allows the IASB and the Financial Accounting Standards Board to conveniently side-step the split between variable and constant real value non-monetary items. This is a very costly mistake in low cash inflation economies - or 99.9% of the world economy.

Retained Income is a constant real value non-monetary item, but, it has been in the past and is, for now, valued at Historical Cost which makes it, very logically, subject to the destruction of its real value by cash inflation in low inflation economies - just like in cash.

It is an undeniable fact that the functional currency's internal real value is constantly being destroyed by cash inflation in the case of low inflation economies, but this is considered as of not sufficient importance to adjust the real values of constant real value non-monetary items in the financial statements – the universal stable measuring unit assumption which is the cornerstone of the Historical Cost Accounting model.

The combination of the implementation of the stable measuring unit assumption and low inflation is thus indirectly responsible for the destruction of the real value of Retained Income equal to the annual average value of Retained Income times the average annual rate of inflation. This value is easy to calculate in the case of each and very company in the world with Retained Income for any given period.

Everybody agrees that the destruction of the internal real value of the monetary unit of account is a very important matter and that cash inflation thus destroys the real value of all variable real value non-monetary items when they are not valued at fair value, market value, present value, net realizable value or recoverable value.

But, everybody suddenly agrees, in the same breath, that for the purpose of valuing Retained Income – a constant real value non-monetary item – the change in the real value of money is regarded as of not sufficient importance to update the real value of Retained Income in the financial statements. Everybody suddenly then agrees to destroy hundreds of billions of Dollars in real value in all companies´ Retained Income balances all around the world.

Yes, inflation is very important! All central banks and thousands of economists and commentators spend huge amounts of time on the matter. Thousands of books are available on the matter. Financial newspapers and economics journals devote thousands of columns to the discussion of the fight against inflation.

But, when it comes to constant real value non-monetary items:

No sir, inflation is not important! We happily destroy hundreds of billions of Dollars in Retained Income real value year after year after year.

However, when you are operating in an economy with hyperinflation, then we all agree that, yes sir, you have to update everything in terms of International Accounting Standard IAS 29 Financial Reporting in Hyperinflationary Economies: Variable and constant real value non-monetary items.

But ONLY as long as your annual inflation rate has been 26% for three years in a row adding up to 100% - the rate required for the implementation of IAS 29. Once you are not in hyperinflation anymore (for example, Turkey from 2005 onwards), then, with an annual inflation rate anywhere from 2% to 20% for as many years as you want, you are prohibited from updating constant real value non-monetary items. Then you are forced by the FASB´s US GAAP and the IASB´s International Accounting Standards and International Financial Reporting Standards to destroy their value again – at 2% to 20% per annum - as applicable!

For example:

Shareholder value permanently destroyed by the implementation of the Historical Cost Accounting model in Exxon Mobil’s accounting of their Retained Income during 2005 exceeded $4.7bn for the first time. This compares to the $4.5bn shareholder real value permanently destroyed in 2004 in this manner. (Dec 2005 values).

The application by BP, the global energy and petrochemical company, of the stable measuring unit assumption in the accounting of their Retained Income resulted in the destruction of at least $1.3bn of shareholder value during 2005. (Dec 2005 values).

Royal Dutch Shell Plc, a global group of energy and petrochemical companies, permanently destroyed $2.974 billion of shareholder value during 2005 as a result of their implementation of the stable measuring unit assumption in the valuation of their Retained Income. (Dec 2005 values).

Revoking the stable measuring unit assumption is actually allowed this very moment by IAS 29 but ONLY for companies in hyperinflationary economies. At 26% per annum for three years in a row, yes! At any lower rate, no!

It is prohibited by US GAAP and IASB International Standards for companies that are operating in a low inflation economy.

That means the following at this very moment in time: Today all companies in, most probably, only Zimbabwe (1000% inflation) are allowed to update all their variable real value non-monetary items as well as all their constant real value non-monetary items.

But not the rest of the world.

The rest of the world is forced by current US GAAP and IASB International Standards to destroy their/our Retained Income balances each and every year at the rate of inflation because of the implementation of the stable measuring unit assumption whereby we are all forced to regard the change in the value of the unit of account - our low inflation currencies - as of not sufficient importance to update the real values of constant real value non-monetary items in our financial statements.

We are forced to destroy them year after year at the rate of inflation till they will reach zero real value as in the case of Retained Income and the issued share capital values of all companies with no well located and well maintained land and/or buildings at least equal to the original real value of each contribution of issued share capital.

The 30 Dow companies destroy at least $31bn annually in the real value of their Retained Income balances as a result of the implementation of the stable measuring unit assumption. Every single year.

Retained Income can be paid out to shareholders as dividens. Poor Dow company shareholders. They will never see that $31bn of dividens destroyed each and every year.

We have all been doing this for the last 700 years: from around the year 1300 when the double entry accounting model was perfected in Venice.

When we do this at the rate of 2% inflation ("price stability" as per the European Central Bank and as per Mr Trichet, the president of the ECB) we are forced to destroy 51% of the real value of the Retained Income balances in all companies operating in the European Monetary Union over the next 35 years - when that Retained Income remains in the companies for the 35 years - all else except cash inflation being equal.

Each and every one of those 35 years will be classified as a year of "price stability" by the ECB and Mr Trichet. Mr Trichet will not be the president of the ECB in 35 years time.

I think we will do ourselves a great favour by revoking the stable measuring unit assumption as soon as possible.

FREE DOWNLOAD : You can download the book "RealValueAccounting.Com - The next step in our fundamental model of accounting." on the Social Science Research Network (SSRN) at


Nicolaas J Smith


January 9, 2007 01:10 AM

I've been meaning to reply to Mike's last comment for some time now. I don't know why you keep ignoring the accounting fraud that I and many others have pointed out. Your numbers in your last comment are still based on taking the trust fund surplus at face value, when in actuality the money has already been spent by the federal government. That means we will have to deal with this problem in 10 years, not in 30 as you state, and the required benefit cuts will have to be larger. The earlier we face reality and account for this, the easier it will be to do something. Given the complete mishandling of the situation by the government, I think privatizing social security is the only viable solution. On the other hand, the way you keep ignoring the point that there is double-counting going on here makes me wonder if you are complicit in this deception. As I said before, if the boomers who will increasingly depend on social security starting in 10 years think that younger generations will bail them out and accept higher taxes to pay for their spendthrift ways, they better think again.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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