Fiscal Illusion and Entitlements

As the State of the Union address and subsequent pronouncements have made clear, American politics is in the firm grip of fiscal illusion.

One example is President Biden’s bragging that “In the last two years, my administration has cut the deficit by more than $1.7 trillion—the largest deficit reduction in American history,” which implied that we should only look at a short run effect which had little, if anything, to do with the policies he adopted, in evaluating his fiscal policy.

However, he did not mention that the CBO estimates that the average yearly federal deficit over the next decade will be $1.6 trillion (under current policies, not including any expansions that have not yet been enacted), which implies his current policies continue to massively rip off future generations.

Understanding such issues in terms of fiscal illusion was a major contribution of Nobel Prize-winning economist James Buchanan, who died just over a decade ago. As Romina Boccia described the issue:

Fiscal illusion arises when the true costs of public policies are obscured or hidden from view, leading individuals to underestimate the policies’ impact. Government programs appear less costly to taxpayers than they are because the current generation bears only part of the burden. Deficit-financing transfers some of the burden to future generation in the form of government debt obligations. This fiscal illusion leads current taxpayers to demand more government than they otherwise would and harms future taxpayers in the process.

As that description reveals, the most common example of fiscal illusion, for the few that ever talk about it (particularly rare among those inside the Washington beltway), is federal deficit financing. It increases the national debt, forcing some of the price tag onto future Americans, a price tag that grows each year with the size of deficits. And it works to the extent that people don’t take into account the future costs imposed by the debt created.

Another way of viewing it that is even more directly related to the federal debt is to consider someone who has a Treasury bond in their financial portfolio. They would consider that bond as an asset, adding to their wealth. That is correct from their perspective alone, which doesn’t recognize the future consequences of that debt for others. But that personal asset is really a promised transfer of wealth to the bondholder from the future taxpayers who must pay for it, not greater wealth for society. Counting such bond holdings as net wealth rather than as a transfer from others in the future is a fiscal illusion. And if Americans believe they are wealthier than is really the case, one of the effects is an increased demand for more government spending.

However, as important as the fiscal illusion associated with government debt is, a very strong argument can be made that it is an even bigger problem for the unfunded liabilities created by the Social Security and Medicare programs.

First of all, the unfunded liabilities of Social Security and Medicare are far larger than the national debt, and growing faster, making the stakes even larger. Second, it is far harder to “see” their future burdens than those of federal debt. Rather than a single cumulative number called debt and even a “debt clock” that is keeping track of its level over time, the precise dollar extent of unfunded liabilities depends on many assumptions about the future.

What is expected to happen to birth rates, lifespans, retirement ages, economic growth, interest rates, labor force participation, etc., will change the magnitude of unfunded liabilities and so will how far a study looks into the future. And even if those unfunded liabilities overmatch the federal debt under a very wide range of assumptions, the absence of any single definitive number often severely handicaps those who want people to pay attention to the problems.

Yet we know we should begin addressing those shortfalls now, because they are very, very large under almost any plausible set of assumptions about the world of inherent uncertainty we face, and doing something to begin to address their harm to future Americans does not require that we know an exact number now.

The fiscal illusion of unfunded liabilities is illustrated by Biden’s attacks on Republicans for supposedly wanting to cut Social Security and Medicare, in search of more senior citizen votes in 2024, by claiming a sharp contrast with him, because “I will not cut a single Social Security or Medicare benefit.” However, given those programs’ massive (estimated) unfunded liabilities, the status quo is not in fact a sustainable option, so doing nothing now about the programs means imposing an even larger hit on seniors beginning in the very near future.

That is even clearly noted by the Social Security Administration, and referred to in individual’s benefit statements. Consequently, Biden’s promise that no one’s benefits will be cut while he is in office just means imposing a far bigger fiscal hit to those in the program, whether as contributors or recipients, soon thereafter.

An even clearer indicator of the fiscal illusion being manipulated in the unfunded liabilities discussion is the Democrat support for the Social Security 2100 Act, which, in the guise of protecting a “Sacred Trust,” increases current benefits in the program. Doing so in a system which we know will not be able to pay its accumulated bills is to raise its future liabilities, increasing its generational unfairness, but by portraying themselves as “saving” Social Security, rather than as increasing more burdens on future Americans, they are doubling down on their manipulation of the fiscal illusion involved.

As a result of his studies of fiscal illusion, James Buchanan and his co-author of Democracy in Deficit, fellow public finance scholar Richard Wagner, wrote, “Budgets cannot be left adrift in the sea of democratic politics.” Further constraints on the degrees of freedom that democratic election of representatives gives those in power are necessary.

That is still true, especially when we are further off-course from fiscal responsibility than ever. But we should recognize that manipulating fiscal illusion, with even larger stakes, is also at work in the political treatment of entitlements programs. And as we see demonstrated before our eyes today, those programs cannot be trusted to the sea of democratic politics either.