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Dodging reality of future's costs

In business, the penalties for poor bookkeeping can be severe. The first principle of accounts is that they should present, as far as possible, a fair and accurate picture of an organization's financial position. That means not only reporting a year's income and expenditure, and listing current assets and liabilities, but also setting out future obligations and sources of revenue.

Executives who ignore these precepts risk being hauled before the courts for deceiving investors.

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Yet for all the vigor with which America's politicians have denounced recent corporate scandals, it is not clear that the government's books are any fairer or more accurate than Enron's.

The government's accounts are drawn up on a cash basis. In the private sector, such a practice is followed only by firms such as consultancies, which have few assets to produce revenue over the long term, and few long-term liabilities. In such cases, cash flow is a good measure of prosperity.

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The government, however, reasonably expects to draw revenue from many of its assets, and from its citizens, for many years. It also has many obligations - for example, for Social Security and health care - stretching decades into the future. A fair portrayal of the government's financial condition should at least try to sketch what may lie ahead.

Among economists, there is a lively debate over how gloomy the true picture is. In a recent working paper, Michael Boskin of the Hoover Institution argues that the government has lots of hidden assets. Some are tangible, such as land and mineral rights. Others are intangible, the chief being, he says, tax-deferred savings programs. As the baby-boom generation retires and draws down its 401(k) pension plans, claims his paper, the government can expect an extra $12 trillion in taxes (in present-value terms), which are largely absent from current projections.

Boskin's paper has attracted a lot of fire, notably from Alan Auerbach of the University of California, Berkeley and William Gale and Peter Orszag of the Brookings Institution. Most of the savings he has found, they say, are included in the government's projections. They say his model is too optimistic in several ways: It assumes, for example, much too high a tax rate on income from tax-deferred savings.

Boskin has conceded that he made one mistake: He should have noted that the baby boomers' cashing out would reduce national saving, and thus corporate investment, profits and tax revenues. He says he is reworking his model to account for this. However, this deals with only part of the criticism. Pending Boskin's revisions, his critics have the advantage.

Others are trying to measure the budget gap. Last month the American Enterprise Institute published a paper by Jagadeesh Gokhale and Kent Smetters that proposes two new measures to gauge the sustainability of the current budget. The first, fiscal imbalance (FI), calculates the difference between the present value of all the government's future obligations and its future revenues, assuming that policies remain unchanged. A sustainable budget will have an FI of zero. Otherwise American taxpayers risk a similar fate to that which befell Enron's shareholders when the company's hidden liabilities came to light.

However, an FI of zero does not guarantee that a budget is sustainable. A law that lavished new spending on today's citizens, but fully paid for it by levying a 90 percent income tax on everybody born after this year, would have an FI of zero. It would not, however, be sustainable - future taxpayers would surely rebel - and it would be monstrously unfair.

So Gokhale and Smetters propose a second measure, which they call generational imbalance (GI). This is the difference between the present value of the spending to be done for the benefit of current generations and the present value of the tax revenues they may be expected to produce. The resulting number represents the bill that those alive today are handing on to generations yet unborn.

The results are staggering. The authors estimate that the money the government is promising to spend outstrips the taxes it can expect to collect by $44 trillion - 20 times today's federal budget, and more than four times America's gross domestic product. Their estimate of the GI is also enormous.

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Medicare alone represents a net transfer of more than $20 trillion from future generations to those now alive. Boskin's deferred tax assets are not likely to be much help. In their paper, Auerbach, Gale and Orszag reckon that any benefit from them is largely already included in the FI and GI calculations.

Like any private company teetering on the verge of insolvency, the American government must either find more revenue or cut spending. And the sooner the better, not just because it is unfair to hand the bill for today's spending to future generations, but also because the later changes are made, the bigger they need to be. Gokhale and Smetters calculate that waiting until 2008 to repair the imbalance will turn the $44 trillion into $54 trillion.

As the late Herbert Stein, a noted economist, said, "If something cannot go on forever, it will stop." One way or another, America's budget gap will have to be closed. The question is, will it be done responsibly, by coming clean about the hidden liabilities now and taking the necessary, if painful, steps to deal with them? Or will the top management, like Enron's, stave off acknowledging the true state of America's finances until it is forced to do so by some spectacular collapse?


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