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Comparing Fiscal Sustainability in the US and Italy
By the standard Debt-to-GDP measure, the US is in somewhat better fiscal shape than Italy. Italy’s ratio is 135 percent. The US ratio is 123 percent. But the debt only measures the present value of servicing -- paying interest plus principal on -- official I.O.U.s. It excludes the present value of myriad off-the-books obligations, including paying pension and healthcare benefits to today’s and tomorrow’s retirees. Such “unofficial” commitments are no less economically costly or politically imperative.
But the problem with official debt runs far deeper than ignoring particular commitments. Scientifically speaking, it’s a measure in search of a concept. The decision to label certain commitments “official” and others “unofficial” is purely linguistic. The equations of economic models don’t tell us what language to use to discuss them, nor how to label their variables. Hence, we can just as well say that Social Security benefit commitments are ‘official’ and that promises to service the debt are ‘unofficial’.
In 1989, Berkeley economist Alan Auerbach, Penn-Wharton economist Jagadeesh Gokhale, and I developed two label-free measures of fiscal sustainability. The first is fiscal gap accounting (FGA), which measures the constant share of each future year’s GDP needed to balance the government’s intertemporal budget. This requisite annual fiscal adjustment can come via reduced outlays, higher receipts, or a combination.
The second is generational accounting (GA). GA calculates the lifetime net tax rate – lifetime taxes divided by lifetime labor earnings -- facing future generations if current generations pay nothing more in the form of higher net taxes to reduce the fiscal gap. FGA and GA incorporate all government outlays and receipts, whether put on or kept off the books. Critically, these measures produce the same answers for any internally consistent fiscal labeling convention.
Emanuele DiCarlo of the Bank of Italy, Mauro Marè of Luiss University, Marco Olivari of Boston University, and I have spent the past year conducting parallel FGA and GA studies for the US and Italy. Our just-released study tells a very different story about the two nations’ fiscal conditions than “official” debt figures convey. The U.S. fiscal gap is 7.4% of annual GDP. Italy’s is 4.0%. In conventional terms, the US needs to run a primary surplus of 5.1% of GDP, not its current -2.3% of GDP. Italy’s primary surplus needs to rise from 1.0% of GDP to 5.0 percent of GDP.
In practical terms, this requires an immediate and permanent increase in US federal, state, and local taxes by 26.5 percent. Alternatively, it requires immediately and permanently cutting all non-interest spending by 23.9 percent. And these figures are optimistic. Delay or unfavorable demographic shifts would require even larger adjustments. Italy’s required tax or spending adjustments are far smaller: 7.4% and 7.3%, respectively. Unlike the US Social Security system, Italy’s pension system is sustainable thanks to a series of major, painful reforms. And spending on Italy’s state-run healthcare system is neither excessively high nor growing excessively fast.
As for generational accounting, neither country can expect future generations to close their fiscal gaps on their own. Doing so requires levying lifetime net tax rates on both future Americans and Italians that exceed 100%. Yes, the US fiscal gap is a far larger share of future GDP than Italy’s. But, relatively speaking, future Americans will be more numerous and more productive than future Italians. This reflects Italy’s 1.22 fertility rate and 0.6% productivity growth rate, which are far below the respective 1.62% and 1.30% US values.
In short, both the US and Italy are running unsustainable fiscal policies. But the immediate adjustments needed to restore US fiscal solvency are far greater than those required of Italy. Fortunately, there is a saving grace for the US. Radical redesign of many US policies, if enacted immediately, can save the day. For example, adopting the healthcare system of Sweden could lower expected healthcare spending from 18 percent of GDP to 11 percent and achieve dramatically better -- 5th best, not 30th best -- healthcare outcomes.
Fiscally responsible countries take these label-free, long-term fiscal budgeting measures seriously. Take the European Union. It does FGA for all 27 member countries as part of its triennial Fiscal Sustainability Report. Or consider Norway’s $2 trillion state pension fund. Its origins lie in an early Norwegian FGA/GA study showing that, notwithstanding reporting a massive fiscal surplus (negative debt), the country was endangering future generations by overspending oil revenues from its finite North Sea reserves.
It’s time to face facts. The US is insolvent. Congress must mandate the Congressional Budget Office do FGA and GA on a routine basis and immediately adjust policy to eliminate our country’s massive fiscal gap.
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