America's Achilles Heel: A Looming Financial Disaster Awaits

January 14, 2015 Topic: EconomicsPolitics Region: United States

America's Achilles Heel: A Looming Financial Disaster Awaits

Get ready: America is on a tenuous fiscal path and a return to trillion-dollar deficits is less than a decade away. However, lessons learned from one reeling U.S. city might offer some important lessons. 

Obviously, this is not a simple question and involves complex issues like urban decline, suburban flight and manufacturing changes. However, one key element was big government spending—increasingly financed by debt—which was unsustainable even in the best of times. Though the city downsized one fourth of its workers, it had lost three quarters of its tax base over fifty years. It threw corporate welfare subsidies at Chrysler to help finance its Jefferson North Assembly Plant. But particularly unaffordable were generous pensions and retiree health-care plans for city employees like police and firefighters. For example, retiree health care grew at an unaffordable 46 percent from 2000 to 2012. For over twenty years, city leaders even handed out cash from the pension funds known as “13th checks” to pensioners and workers.

Like many state and local governments across America, Detroit underfunded its pensions through a variety of accounting and actuarial maneuvers, including using unreasonable earnings assumptions and outdated mortality tables. The underlying theme was making promises in the present that would be paid at some future date. One former Detroit staffer noted, “That was the whole culture—how do we get what we want and not pay for it until tomorrow and tomorrow and tomorrow?” When retirement benefits and debt service swallowed 43 percent of the city’s tax revenues, the Detroit’s leaders put the city into bankruptcy.

Detroit’s fiscal picture presents some strong parallels to the federal government’s—borrowing to pay current bills; large and mounting debt; escalating debt service costs; swelling retirement pension and health programs with huge benefit costs due in the future years; along with corrosive corporate welfare, cronyism and pork barrel spending. And unlike Detroit, the federal government cannot simply declare bankruptcy to force reforms. Instead, policy makers must take intentional steps to address the growth in the federal government and the looming crisis.

Though some may think Detroit an extreme case unsuitable for comparison, consider this: when Detroit entered bankruptcy in July, 2013, its total debt was estimated at $18 billion. Half of that—$9.2 billion—was from future unfunded pension and retiree health-care costs. While U.S. debt held by the public was nearly $12 trillion at the time of Detroit's bankruptcy, similar retirement obligations were far, far larger. Federal employee and military retirement benefits, along with unfunded benefit costs from Social Security and Medicare (remember, these programs are not truly budgeted) were nearly $54 trillion. Because these obligations are paid in the future, they are not counted in debt measures. And, while the federal debt alone is worrisome enough, the federal government's fiscal exposure from retirement and health costs is 4.5 times larger. Put differently, when Detroit filed for bankruptcy, the city's obligations were nearly $27,000 per capita. The federal government’s were $218,000.

The New Year has brought an opportunity for policy makers to turn the tide of rising red ink. This will not be easy politically, but it is vital. Moreover, for policy makers to succeed, the public must embrace such change. This will mean ending cronyism and corporate welfare. It will also mean lower discretionary spending from welfare to education to defense. And, it must mean reining in entitlements. This is not impossible. Even Detroit's public-sector retirees ultimately accepted some reductions to their pension benefits to avoid massive cuts down the road.

The lesson from Detroit seems obvious: Making impossible promises in the form of unaffordable government benefit programs may help some for a while, even a long while. But ultimately, when the bills can’t be paid, it makes those who rely on them worse off.

Detroit at least has a plan, no matter how uncertain. Washington does not.

Alison Acosta Fraser is Managing Director of Policy and Research at the Charles Koch Institute.

Image: Flickr/carnagenyc/CC by-nc 2.0