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The Coming Generational Storm
By Laurence J. Kotlikoff and Scott Burns
The Coming Generational Storm: What You Need to Know about America's Economic Future by Laurence J. Kotlikoff and Scott Burns discusses the financial crisis Americans face due to the combined aging of America and generously-promised, but economically-unrealistic, Social Security and Medicare benefits.
We learn that two-thirds of older Americans get over half of their income from Social Security. Nearly 40% of poorer, older Americans get essentially all of their income from Social Security. The authors calculate the value received by an older American from Social Security is approximately equivalent to a portfolio worth about $600,000.
Further, the benefits provided by Medicare significantly exceed the value of Social Security to elderly America. Reduced Social Security and Medicare benefits would financially hurt most older Americans, especially poorer Americans.
However, Kotlikoff and Burns point out the level of promised future benefits is unfundable. According to the economists who created the Federal 2004 budget, America faces a fiscal gap of $51 trillion (the gap was $45 trillion before the Medicare prescription drug benefit--more about that later.), or about $159,000 per American. The bulk of this liability is promised Medicare benefits. We can compare this to the current federal debt of $4 trillion, or about $14,300 per American.
According to the authors, to cover these promised liabilities, we'd need to raise taxes by 69%, if we hope to keep tax rates constant for further generations. Otherwise, future tax rates will need to increase by more than double for future generations. These conclusions were in the Federal Budget for 2004 (until they were removed).
Kotlikoff and Burns tell us President Bush felt these facts might dampen support for his third round of tax cuts, so this information was deleted before the 2004 budget was widely distributed and posted on whitehouse.gov (Page 67). Of course, tax cuts only add to the problem.
This brings us to the crux of the problem. If Americans made significant sacrifices now (lower benefits, increased taxes) the problem could be made manageable. However, the authors say politicians don't want to tell Americans the truth and deal with the problem. Instead, they want to make Americans believe there isn't a problem, because it helps get them elected and serves their personal interests.
Politicians are putting their own well-being above that of America and future generations will suffer because of it. (A special mention should go to Billy Tauzin, one of the Congressmen who crafted the prescription drug bill behind closed doors. The legislation denies the government the right to bargain for lower prices on prescription drugs, which amounts to billions of dollars in windfall profits to the pharmaceutical companies. After crafting the legislation, Tauzin announced he was retiring from Congress to take a $2 million per year position with the primary lobbying firm of the pharmaceutical industry. (http://www.registerguard.com/news/2004/12/19/ed.edit.tauzin.1219.html). The drug companies will get billions of dollars in extra profits, paid by your tax dollars, of course. Tauzin gets $2 million per year salary paid by the pharmaceutical industry. And, we know what Americans get. Six trillion dollars more in unfundable future liabilities.)
Because our political leaders won't deal with the problem we are facing "The Coming Generational Storm." While much of the book is insightful, the chapter that most interested me was "Securing Your Future" which offered some practical advice for how individuals can deal with the situation.
Kotlikoff and Burns make several basic predictions. First, eventually, tax rates will need to go up. A lot. Second, Social Security and Medicare benefits will need to be cut. A lot. Third, before this happens, America will face tremendous economic stress when the government starts printing more money to pretend the liabilities are manageable.
America is fortunate because the U.S. dollar is the world's currency. The authors argue foreign investors will be less willing to hold dollars when the U.S. currency faces devaluation. (We've already seen a significant shift in the value of the U.S. dollar relative to the euro. This is attributed to foreign investors lacking faith in America's fiscal policy.)
The authors suggest individuals hold a small percentage of their investment portfolios in non-U.S.-dollar-denominated investments. For example, they mention EverBank.com as a source of foreign certificates of deposit. So, you can hold euros or Chinese yuan, if the U.S. dollar goes kaput. They suggest considering international bond funds which don't hedge currency risk, and, of course, international equity funds (Vanguard International Total Stock Market), precious metal funds, commodity funds (T. Row Price New Era) and health care funds (Vanguard Healthcare fund).
Kotlikoff and Burns point out that it's important to keep your investment costs low, by favoring index funds or low management expense funds. Portfolio survival is discussed. This is an area made better known to the public by Scott Burns, who is a financial columnist (ScottBurns.com). In particular, if you sell shares from a portfolio that drops in value, you might wind up selling so many shares during a down market that you destroy your portfolio.
The authors also suggest you consider your "health capital." In other words stay healthy, because you won't be able to afford aging otherwise! (They also mention the contrarian position: "Live hard. Die young.") Sites like livingto100.com can help us estimate our life expectancy.
Kotlikoff and Burns say we should reevaluating 401(k) contributions. They argue with future tax rates likely higher and with extra taxation of Social Security benefits with rising income during old age, 401(k)s can lead to paying higher taxes in the future.
However, I'd argue many upper income earners would rather have $1 million to $2 million in a 401(k) rather than worry that they might have their Social Security taxed, because they have too much income during retirement! In other words, when you do your financial planning, you might consider the effects of your decisions on your Social Security or you might just proceed as many semi-affluent and affluent do--assume no Social Security at all. If you get it, great. But, don't readjust your plans because of Social Security. (You probably could maximize your estimated Social Security in the future by having no other future income. Not the best plan!)
Of course, the argument of using low-cost index funds outside of tax-deferred retirement accounts also makes a certain sense, especially with current tax rates.
The authors also suggest considering the Roth IRA, if you're eligible, because the contributions have already been taxed, and, therefore, the government probably won't tax Roth IRA money in the future. That suggestion seems sort of naïve.
As pointed out by financial columnist Eric Tyson, the Roth IRA is only a promise that future withdrawals won't be taxed. It would be trivial for the government to examine a Roth IRA and say, "Hmm…you contributed $30,000, but it's worth $200,000. That means you haven't paid taxes on $170,000. Ante up!" And, we know that the government might promise things it can't or won't deliver in the future. However, I'm still a fan of the Roth.
Overall, I thought The Coming Generational Storm: What You Need to Know about America's Economic Future was a great read.