America’s Pensions & the “Gigantic Financial Tapeworm”

In the latest annual letter for Berkshire Hathaway, Warren Buffett chose to describe public pension plans as a “gigantic financial tapeworm” and warned of a decade worth of pain. He was certainly right about the first point, but not necessarily about the second point.

Alberta Martin (Stewart) died in Montgomery, Alabama from complications of a heart attack on May 31, 2004. She was 97 years old. When she died, the American Civil War Pension program finally laid its last widow to rest. As of today, only two children that have gone unnamed – and each only being paid a small amount of $876 a year – stand between the pension program and the overall end of a long, convoluted journey that nobody could have foresaw, which began in 1862 nearly a century and a half ago.

The Civil War Pension plan remains a large reminder of promises made lately and their unintended consequences, without having much regard for planning for the future. The plan was originally set up during the war to pay disabled union veterans pensions along with their dependents (including orphans and widows), and the scheme was extended gradually over successive decades to encompass all veterans as well as their families.

There were punishing consequences. During the 1880s, this pension scheme took up nearly half of the federal budget, leading to public anger and social tensions. As an example, in 1887, President Grover Cleveland vetoed a bill of a new pension, claiming that it “put a further premium on dishonesty and mendacity.”

As veterans grew older and passed on from this world, they also became attractive commodities. Many younger women began to marry veterans that were far older than them, including Alberta Stewart, who in 1927 at just 21 years old married the 81-year-old William Martin. After he passed away in 1931, she remarried just a few months later and was hitched to his grandson. By the time Alberta passed on from this world in 2004, the Civil War Pension plan – both Confederate and Union – cost the federal government more than $100 billion in excess of the original cost of the Civil War, in today’s terms.

As of today, the American Civil War Pension plan is an obscure footnote in history, but its lessons are quite profound.

A Slow-Motion Crisis

One of the biggest tragedies of the Great Recession is that we are focusing so much on the “urgent” today that we are completely forgetting about tomorrow. The shortsightedness of humans tells us that there’s always going to be a bias, but there are far reaching consequences to this particular mentality.

Retirement was a major aspiration just a century ago. Women’s average life expectancy was 57 years old, and for men it was only 52. In today’s world, it’s likely that we will spend one third of our lives while retired. It’s a staggering achievement, and quite notable. But as people begin to live longer – an extra 15 minutes for every hour, according to some estimates – there is also a darker side: the cost of paying for this through health care, pensions and other similar things. As the baby boomers begin to retire in the coming years, this will put enormous pressures on the ever strained public balance sheet in particular areas such as Medicare, long-term care and Social Security.

These future liabilities today are vague since they are not recorded officially. According to the CBO, the current debt to GDP ratio is 73% – a “reassuring” figure for today’s world. But this only takes into account the acknowledged public debt and the official number. If you add in Social Security, Medicare and pension obligations, you’ll soon begin to see a much different number.

This ratio suddenly takes GDP to well above 500%. And this is only just scratching the surface. Boston University’s Professor Laurence Kotlikoff, a long-term forecasting expert, calculates that the gap between projected taxes for the US and projected spending is an incredible $222 trillion, based on the latest projections of the CBO.

This unfunded area is going to present a real solvency crisis for the United States over the long run. We can mess around with tax codes. We can make changes to the budget at the margin in order to control the far smaller deficit of today. But as far as solving the major crisis coming up on the horizon, it’s equivalent to using a teacup to attempt to bail out the Titanic.

We no longer have this luxury today. As people begin to live longer, the social fabric strains will continue to grow due to lack of solutions. If things do not change, by 2050 the US is going to pay an additional 8% of GDP due to age-related expenditures. That is another $1.1 trillion a year in additional costs, and this is not even taking into account the whole burden that will be accrued by then.

Hope for the Future

The long-term management and planning for society require a much longer term perspective. In practice, policymaker actions always have a much shorter horizon than the large systems that they manage.

Little decisions made today will play out in big ways in the future.

We choose to fight the small crisis that is presented today instead of fixing the important crises that are building up in the future. Because many people believe it’s more important to preserve today’s financial system. There is also hope that if using stimulus works, the economy is going to come back to life and make those much larger future payments a lot more affordable. There is always going to be enough time to plan the bigger reforms tomorrow that will make health care, Social Security and other spending more viable in order to sustain society.

Hope is not a strategy unfortunately. There is going to be another urgent crisis tomorrow, and if we do not take action, our shady horizon will push off the bigger issues for another day.

It’s time to take into account the important issues, and not just the urgent ones. Or else we run the risk of repeating the familiar Roman pattern of a strong beginning that ended up careless at the end.

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