617: How Can We Fix Our BROKEN Economic System? - Laurence Kotlikoff

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It is my pleasure to welcome Lawrence Kotlikoff back to show. He's been on several times over the years and he has done a lot of research into the unfunded, entitlements, unfunded mandates discussion, which we talk about often here as I believe it's just a matter of inflating our way out of the problem. So we're going to chat about that today. But he's out with a new book and it is his 20th book and that is entitled Money Magic An Economist Secret to More Money, More, Less Risk and a Better Life. Welcome back. How are you?

Great. Great to be back with you, Jason. Doing great, thanks.

It's good to have you. So, first off, let's talk about this issue of the unfunded mandates. And I talk about this a lot, I mention your name a lot on the show in your absence in talking about this. And you're out with some new numbers on this and before we go into those new numbers that you've updated, which actually make the picture look a little better than we thought before. And I thought with all the pandemic money printing it would be the opposite. So actually there's some good news here, maybe. But first of all, what are unfunded mandates? What is the thing here that we're talking about? Just give us an overall context.

Well, the simple thing is that the government has the ability, by using words to put things, put liabilities off the books or on the books. Just a matter of choice of words. So, so if I'm, if I'm Uncle Sam and I take some money from 40 year old Jason and I say, look, Jason, I'm going to pay you back with interest in 20 years, I could say that the money I'm taking from you is a tax and the money I pay you back in the future is a transfer payment. In that case, there's no additional deficit, no extra debt. Although the obligation to pay you back in the future is there, but it's not on the books. But if I say I'm borrowing you, borrowing the money from you now, and the money I'm going to pay you back is principal plus interest. So if I use those words and I actually give you a piece of paper says IOU now it's called official borrowing. And now the obligation to pay you back is put on the books. So the difference between.

Official liabilities and unofficial liabilities has nothing to do with economics. It's just a word game. So we have to incorporate all the off the books liabilities as well as all the on the book liabilities to understand the true fiscal position of the country. Otherwise, we're kind of missing the forest for the trees. And as you said, when you do this, you get an enormously different picture. The official debt that's on the books is about one years of gdp. If you look at the true fiscal gap, if you put all the obligations on the books, no matter whether they're called official or not, look at just all the outlays for spending on Medicare, food stamps, highways, missile defense, Social Security benefits, net of all the receipts that are projected income taxes, excise taxes, corporate income taxes, all that. So you do a net.

Present value calculation of where the government is and ask whether and incorporate any official debt that's outstanding and any official assets of the government. Any, well, any assets the government has like reserves. The Federal Reserve, the Treasury has reserves like owns German treasury bonds, for example. We just confiscated Russian bank wealth. Maybe that's also part of our resources now. Anyway, main thing is that if you put it all together, we're about eight years of GDP short in terms of the thing balancing. Another way of putting this is that.

We need to get through time about 8% of GDP forever.

To cover 8% more GDP forever. It just turns out the number 8 is the same number.

Just by the calculation, just accidental. But we need about 8% more of GDP as a stream of extra taxes if we want to keep spending what we project to spend. Or we have to cut spending outlays through time by 8% of GDP. Now, to give you an idea about the magnitude of that problem, Social Security benefits are about 4% of GDP. So we're talking about two Social Security benefit programs that were short. So imagine cutting Social Security entirely all those benefits and then finding something else like Medicare, Medicaid, and cutting those benefits entirely. Now you've got a fiscal program that's sustainable. You don't have to raise taxes or you can raise taxes and keep those benefits the way they're projected. But that's 8% of GDP. That's going to increase.

Taxes by 60, 70%.

Federal taxes. So think about a 60, 70% federal tax hike starting immediately and continuing forever. That's what's needed. Now you said say that number again.

How much would the hike need to be be?

About 60%.

So that's. Folks, did you hear that? That's 60%. Six, zero. Okay. Would be the required tax hike to pay. Would that pay for the problem? Would we solve the problem with that?

Yeah, I mean, federal revenues are about 17% of. I think, actually. Yeah, I think they're about 17% of GDP. So we're talking about 8 relative to.

Yeah, so we've got, by the way, numbers there, just very rough numbers here.

GDP% increase, let's say 50% to be on the safe side. Yeah, about a 50% hike in all. Every single federal tax, the tax at the pump. When we pay excise taxes, the corporate income taxes, the payroll taxes, the federal income taxes, everything would have to grow up by about half.

Okay. Oh, wait, wait, wait. So that's even worse because when I said that number, people were probably thinking that's just income tax. But you're saying every federal tax would need to increase by about 50%. So it goes up by 50%. Every tax, every kind of federal tax, and then we pay for the problem. We've got a GDP of about 24 trillion. We've got revenue of somewhere around 4 trillion, I believe, currently. So that revenue needs to get up to what? Six trillion. Okay. And then this problem could start to solve itself. But of course, what we didn't talk about is the. Compared to what? The dogs that don't bark. The unintended consequence, which if you raise tax like that, the smart money will flee and people won't just sit around and pay it. You know, their economic activity could decline. Right. And that's sort of the Reaganomics idea, of course.

Well, just to correct one correction, GDP is about 22 trillion right now. We already have Americans in very high tax brackets. When you put everything together, think about poor people, they're not paying much in the way or anything really in federal income taxes at the margin if they're poor, but they are paying payroll taxes, they are paying state income taxes. In the 42 states that charge income tax, they're paying excise taxes and sales taxes. So when you earn money and you have to pay taxes to buy something that's in effect tax on your wages. Then they lose benefits of all kinds. There's about 18 different benefit programs. They lose Medicare, food stamps, welfare benefits, housing support. So you have about, about a quarter of the poor are in marginal tax brackets. When you put everything together of 70% or more. So every thousand dollars they lose $700 in either higher taxes or lower benefits. So we've trapped a good fraction of the poor into poverty. The so half are in marginal tax brackets above roughly 45%.

And then among the higher earners you also have, you have less dispersion because they're not in these benefit programs. So they don't lose these benefits, but they are in very high marginal tax brackets, around 45, 50% at the median. So we can't just willy nilly raise taxes without getting people to either stop working or leave the country, right?

Yeah.

And we're going to low occupation, low paying jobs because it's not worth it. So we have to fix the system. Now they the way I would fix the system would be to reform fundamentally the health care system, put everybody into Medicare, Part C for all. The Medicare Advantage plan, that's a Republican version of Medicare, seems to be extremely popular among the elderly. More and more people are into it. About half of people are joining, joining up to the Medicare Advantage part of Medicare rather than traditional Medicare at the margin. If we can get everybody there into that system, everybody in the country and have really competition between the different plans to attract people, we can get the cost of health care down from 18% of GDP down to about 15%, 14%. It's about 12% in Switzerland, so maybe we could even get down 12%. 18 to 12 is 6% of GDP. That could handle most of our long term fiscal gap problem just there. If you could really concentrate on fixing health care but get everybody covered.

Yeah, of course the problem is, as good as that sounds, you've got all these vested interests that don't want to fix it. Right. They're benefiting from the screwed up system we have. And so this is the problem. You have all these iron triangles that just keep everything the way it is, unfortunately. You know, I mean, what are the chances that we could fix.

I hate to say, but I do think I'm more optimistic.

Okay, good.

I'm older but more optimistic. I think if Biden came out and said, and this is the old Democratic theme, healthcare for all, health insurance for all, got this balkanized system, we have almost everybody covered directly or indirectly. Through the federal government in the most inefficient way possible.

It's absolutely terrible. The system is so broken, I can't even believe it.

I have one system and I want it to be the medic, the Medicare, Medicare for all. But I want it to be the Republican version, not Bernie Sanders version.

Right?

I love Bernie Sanders. I voted for him, okay? Just so everybody knows. I thought he was better than the alternatives when he thought he was better than Biden for running for president.

So you're a Northeastern professor. Nobody would be surprised that you would vote for Sanders.

I think that he's got the right heart. And the traditional Medicare for all would be better. And we could also lower the cost of total health care using traditional Medicare, but it would be less efficient than in terms of health care quality delivery. I've talked to Bernie directly about this. I think he is onto the right thing. We need to have universal health insurance. His system would lower the cost too, but it would not be, I don't think as efficient a system. But I think Biden could get and Mitch McConnell and say, look, we're going to fix this problem once and for all and it's going to be the Democratic desire, Republican method and get a solution. I don't think that's impossible to envision. Social Security, we need to basically freeze the old system and put everybody into a personal, have them contribute to a individual account, but not having Wall street involved at all.

I agree with that.

All the money would be invested by a single laptop, my laptop. Everybody would have their money invested in the same way in the global financial system on a market weighted basis. The government would make matching contributions for the poor.

The contributions would be divided 50, 50 between spouses and legal partners so that we wouldn't have the sexist kind of system that we now have under security.

And also the sex, the system that discriminates against singles. You know, there's so much nobody talks about discrimination against singles. Like married people get so many more benefits than single people get. You know, it's. Especially when it comes to like employer provided health care, etc. The single people are basically subsidizing the.

Married people in a lot, to a large extent, especially through Social Security. So we can have a modern version of Social Security pay off. When I say freeze the old system, I mean pay off everything as, as people retire, pay off everything they're owed as of the point of the reform as of the date. So you just fill zeros in their earnings records. So when they get to retirement age, they say okay, well here's your earnings up to the date of the reform and 0 thereafter. Here's your benefit. And that actually would give them, because the system is progressive, it would actually more than compensate people for what they are owed, dramatically more. And we would have a system that would be fully funded. And this is really the way corporate America has gotten out from under defined benefit pensions that they were scamming their workers over because they were promising something they couldn't deliver. And they froze the old systems and put people into D.C. so there are solutions. I have a book, the Money Magic book is the 20th book. But I wrote a book called you're hired. It's on my website. It's a free download@kotlikoff.net I ran for President, you may know, back in 2016, as a writing candidate. And I took my platform and I transformed it into this book. And each of the solutions is like 10 bullets. Basically no reform plan should be.

I should have introduced you as a presidential candidate. I apologize.

The reason I ran was to specify very simple plans that could fit on one page, 10 bullets can fit on one page to how to fix Social Security, health care, the tax system, the banking system, education. These are plans that any candidate, whether it's Republican or Democrat or any president, can pick up. And we get, I think, universal support. If. So if Biden wants to get reelected, he should grab that book and read it and adopt those policies.

Okay, so I don't want to go too deep down this rabbit hole because I know we could talk about it for a long time and there's so much going on in the world. I gotta get your thoughts on it. So the. If that doesn't happen, just to close up this part of the show, this topic, if.

Can we fight our way out of this? No. Yeah, but we're going to try. We're going to try. We have been printing money and the system automatically, if you're not, if you're spending so much and you're not taxing enough, that puts pressure on prices. So the system automatically, even without the government printing money raises prices. That lowers the real value of existing government debt, of nominal government debt. And so there's some kind of automatic feedback adjustment. But the problem is so big that you would have hyperinflation if you tried to print your way out of this problem. It's just not possible.

I agree with that. It's just too big a problem. What's your definition of hyperinflation? I mean, there's not really a. Nobody settled on the Academic definition of that. But what percent annually is that country specific?

We had 22 hyperinflations real above like 100% per year in the U.S. i think anything over 20% would be viewed as from our perspective, from our history of hyperinflation. But we already have seven and a half heading to 10. I don't see inflation coming down. I see it going up.

Yeah. How bad do you think inflation will get as we go through the next three, five, ten years?

Well, it's gone up over the last year. Every month it's gone up higher. So a year ago the projection was that inflation would be like 1.5%. It ended up 7.5% from this past January to the prior January. And the Producer Price Index, which is telling us about the cost of inputs into the outputs which are covered by the Consumer Price Index, that grew by closer to 10%, not seven and a half, but 10% over the January to the prior January. So we have the prospects for more like a 10% inflation certainly in the short run. Now the markets and the Fed are claiming it's going to drop precipitously starting in a few months. And the longer term we're going to be at 2% inflation. But when you have this long term fiscal imbalance and you have 7 million different companies setting prices, Jerome Powell is the Federal Reserve chairman. He's just kind of jawboning. You got the bully pulpit. He's saying it's going to be this. Everybody should get on board to raising prices at this rate. But once things get out of control, the 7 million companies who are individually setting prices are going to do what they think is optimal and they can't. I've got a little software company, we have this program called Maxify.com that's a.

Great software you have.

So we hadn't raised prices for five years and then we saw this. Inflation says we have to do it, otherwise we can't pay our workers, our engineers and other people. So we decided we just do it. We would leapfrog the process. We'd have a bigger price increase than was a riot because we hadn't raised prices for so long and we weren't going to do it again next year and may not do it again for another five years. So that's. We have to anticipate the price increase. We have to take. We have to err on the side of overshooting so that we don't get into a situation where we have to raise prices again and then upset our customers because they're Seeing a lot of price increases routinely. So we have to overshoot, and everybody else is in that boat of overshooting, and that makes inflation higher than would otherwise be. That's part of the risk here, right?

Yeah, no, it definitely is. Okay, so let's move on out of this topic because we just got so much to cover. Russia in Ukraine, what does that mean for the economy? What does it mean for investors? Absolutely terrible. What's going on. I think there's a big potential for escalation. I worry about Taiwan and this being like a license to, you know, for. For China to take Taiwan. Just give us your general thoughts.

I think you're right. You're on target there. I think Taiwan is probably gone within a year, if they have the wherewithal. I don't see us starting a war over Taiwan either. We don't have a treaty to defend Taiwan. So now we're in a situation where Russia and I think both leaders are making huge mistakes here because.

The end result here is we have a.

Two economy world, China and Russia and a few marginal countries.

Trading among themselves and the rest of the West, Europe and the US and South Pacific trading with us. And that actually, I think is good for the US and South America also, and Africa probably siding with us And India also. They're going to join up with us rather than China. And China is an old enemy of India. So we now have a situation where American producers are going to produce more in the US or in Mexico, South America. So I think this is just going to damage Russia and China long term. They will have to be in the sandbox by themselves. And we're actually, I think, better in creating new products and technology than they are. I've spent a lot of time in Russia in the last eight years. Six, eight years, working with the. On research with the Guidar Institute there. I know a lot of Russians are very, very unhappy about what's going on here. Yeah, they have no desire to.

They're protesting.

Yeah, yeah. And they're upset. And I have friends who've got relatives in Kiev, and my grandfather was born in Kiev. I feel a personal relationship at some level to this situation.

Yeah, no question. It's really terrible. Energy prices are going up. This is inflationary, I would assume. I mean, building material consumption there will be rebuilding. War is a terrible, terrible thing in terms of the human life and that it destroys things and they just need to be rebuilt. And it's expensive as hell. It's completely destructive. There's no benefit to war.

Absolutely. And we're going to have to put a lot of troops into Western Europe and the Baltics. So Putin is going to get exactly what he feared, which is the US Military. Right. Nose to nose. And eyeball to eyeball was the, the expression when in the early 60s during the Cuban Missile Crisis. So it is very dangerous because you have somebody who's talking in rather wild terms about nuclear weapons.

So the potential for things to get out of hand. So I think the risk part of the story here is the West, I think will, without China and Russia, ultimately there'll be more demand for US Production and it'd probably be better for our economy, less competition, if you like, from those regions, but the potential for a major war, World War iii, that really goes beyond into nuclear exchange. That's there. So the risk environment's greater. So investors need to be more cautious and more diversified. They want to be when things are riskier. And I think the stock market is riskier because of all this, because consumer sentiment is flipping around so quickly. You want to pull out of things that are riskier. When the risk goes up, you want to time them. One of the lessons of the book Money Magic is you want to time the market for risk, not for return. There's no saying that if the market, the stock is here, that and you think it's, it's going up, that it will necessarily go back down, or if it's down, that will necessarily go back up. That's one of the lessons of economics and finance, that the market is evolving as a random walk based on or formerly as a martingale based on the arrival of new news, which is not predictable. Exactly. If it's new, it's by definition new. Right. It could be good news or bad news. That's why the market is not predictable. But Wall street is claiming that stocks are safe for the long, in the long run, if you could just hold them long enough. They're safe, they're not safe. And on a risk adjusted basis, the stock market today is earning a, a zero return. So we have to find safe ways to raise our living standard. That's what the Money Magic book is largely about.

So give us some tips from the book, if you would.

Yeah, well, I mean, being smart about Social Security can dramatically raise your living standard. Being smart about when you retire, a lot of people are retiring longer than they actually worked. So understanding how to think about that calculation, how to calculate what it's going to cost you to retire early.

Think about, you know, Roth conversions, doing, doing smart things with the retirement accounts to Lower your taxes of how to untrap, trap equity in your home, how to downsize, maybe move to Texas.

Move to Texas. I mean I, I guess you're saying from California or New York. Right?

Yeah, I was thinking about implicitly from a high tax state to a no tax state.

Right, right. Or Florida, obviously.

But you have to think about everything going on in Texas. They have high property tax taxes. And if you're, you know, thinking about just starting out, should I go to college or should I become a plumber or should I try and become a doctor versus a plumber? The first chapter is called My daughter the Plumber.

Right.

The plumbers on a lifetime basis can now make more than a gp.

Yeah.

When you take into account all the costs, the gp, there's a chapter, don't borrow for college, which is talking about how crazy it is for people to be borrowing for college when 40% are dropping out, not making it through and how expensive it is and how it's like modern day debtors prison.

It's a total scam. You won't get any argument from me on that.

So I, I'm very forceful. Even though I went to college, went to graduate school, went to top places, Penn and Harvard. I'm telling kids, go to community college.

Yep.

Go to Harvard and Stanford and Penn and these places. BU.

Remotely taking online courses for a grade, for certificate and a grade. And then present your, I give the example of taking quantum computing online courses. Take 20 from 20 top places with grades, present them to IBM, graduated from a community college.

Fortunately, the college thing, even corporate America has come around to it. Fortunately, you know, they get it now. Right. Just show them that you're smart and you're ambitious and like you're saying, that's good advice. I would add to that internships, it's not just the cost of college, but the cost of someone's time. Right. If you're spending five years in college, because I don't know how many people do it in four anymore, but if you're spending four or five years in college, I mean you could do a whole bunch of internships and you know, just work in a bunch of businesses and get someone's coffee for them in the morning and you know, do it. I mean, you're going to learn, you're going to make connections, it's going to be great. That's, that's what I would tell young people to do. Just go work for free, be a grunt and you'll learn a ton of stuff.

Yeah, the key, the key thing statistic that people need to keep in mind here is that especially on the borrowing for college, that 40% of kids don't complete college. And the other key thing is that 70% of our young people never finish college, don't have a college degree when they're 30. When they're 40, they don't have a college when they're 70 they don't have a college degree. The expression for shame or disgrace and Yiddish is called shunda. We would say it's no shunda not to have a college degree because most people don't. So we have embedded in our kids brains the idea that they're somehow second rate if they become a plumber or if they become a carpenter.

Well the, the college debt, enslavement, industrial complex is all behind that and they're behind making community colleges less capable. And it's just a dirty game. It's just you know, follow the money. It's, it's disgusting.

Yeah, so, so this book is really about, you know, practical advice to help people to all ages pick careers, pick occupations, how to do it, how to do the basic arithmetic. But it's not a book about arithmetic. It's basically a fun, people have said it's fun read. So.

Right. Yeah. Good stuff, good stuff. Well Larry, what else do you want people to know? Just about the future. I mean everybody's I think very on edge about the future, about what's coming next. Any more thoughts as we wrap it up today as to what's coming in the economy and the markets with so much uncertainty right now?

Well, I think inflation's coming so you have to protect yourself. One way to do that would be to. I'll just give you one example of something I talked about in the book which is build your own inflation hedge. Borrow money on your house, let's say. Or take out a mortgage and buy inflation index bonds with it. Or I bonds is another form of that. So if inflation takes off, you get to pay back the mortgage and water down dollars. But you're protected on the investment because this inflation protected bonds. Right.

And we would say buy rental properties with that. So you get another 30 year mortgage and you get that inflation induced debt destruction. Do something with that lazy sleepy money, that equity sitting in the house. Right.

It's losing. Well just cash in the bank and a lot of people are into cash because things are. The market seem is so highly, you know, highly valued, overvalued possibly. Arguably it's not at an all time price earnings ratio high but it's at a pretty High level compared to the past. And so people, a lot of people are in cash, but they lost 7.5% in real terms on that cash holding. I'm an example. I mean, I was also nervous about the market and didn't quite see anywhere else to invest. Had a good chunk in the market, but kept a lot in cash and realized, hey, I just lost 7.5% of that cash because of inflation that I hadn't expected. I got to do something.

Right.

So now we are looking at real estate, thinking about this kind of hedge, mortgage hedge and other. Other ideas.

Yeah, good stuff. Give out your website. The book is available in all the usual places and it's called Money Magic. Do you want to give out a website as well?

Well, if you go to kotlikoff.net you can see all the, the places to buy the book. You can buy it at a discount at Porchlight. That's one of the places that's listed. So kotlakov.net, it has everything. I've written, all the columns I've been writing about Ukraine and what kind of an answer. My solution was we should have invited three weeks ago, both Russia and the Ukraine into NATO that day because Russia then would be committed to defending the west, would have then been obligated to defend the Ukraine against Russia. And Russia would have, you know, and anybody, they're saying they're going to be invaded by NATO. Any NATO country that would invade Russia, like the U.S. germany and other countries would have to defend it because they're part of NATO. So this would have called Putin's bluff and they didn't do it. We should have tried that because what we're now seeing is that he's not really so focused on insecurity, he's focused on conquest.

Yeah. Yeah, absolutely. One more question about that, by the way. We started off with that. Over what time frame do we need to pay for those as a country? Is that over the next 10 years or. I know they all sort of have different due dates.

You know, it's over, really. The infinite future. And you might say, well, it's a long time, so we can get. We can just keep this game up and let's just leave the future to pay for it. And interest rates are low, government borrowing rates are low. So somehow continuing this is cheap. There's a couple papers on my website showing that's complete malarkey.

The real discount rate we need to use here is return on US wealth. And that's been about 9.5% real in the last decade. So we can't. That's the real cost of the economy, of letting people consume more. Because we're foregoing earning 9.5% real for every unit that we consume. And that means future generations. We could be saving, investing, earning that, the taxes facing our kids. So that's the right discount rate. Even though former Treasury Secretary Larry Summers and other people were mistakenly telling you the government borrowing rate is relevant, it's just not appropriate. We do have a long time, but we are getting in a deeper and deeper hole. We're in the worst shape of any developed country, any of the European countries, their number is not 8% of GDP more than they need. They're more like around 3, 4% at most. Italy's actually around 1, 2%. Italy looks really bad on an official debt basis, but on the end of off the book liabilities, they've actually got very, very little. So they're actually in the best fiscal shape of any European country. Much better than we are.

No one would think that, by the way. But yeah, that's interesting. Yeah, yeah.

The calculations being done so. So in a. Correct incorrectly. So I would say the US has got long term fiscal problems. They are solvable.

Well, Lauren Scotlikoff, thank you for joining us. We could talk all day, of course, but we gotta wrap it up. Thanks for joining us.

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