America's Pension Black Hole: Dissecting Warren Buffett's Tapeworm

In Berkshire Hathaway's latest annual letter, Warren Buffett described public pension plans as a "gigantic financial tapeworm" and warned of a decade of pain. He was right on the first point, less so on the second.

On May 31, 2004, Alberta Martin (née Stewart) died of complications from a heart attack in Montgomery, Alabama. She was 97. With her death, the American Civil War Pension program finally laid to rest its last widow. Today, only two unnamed children -- each paid a modest $876 a year -- stand between the pension program and the end of a long convoluted journey that nobody foresaw, and which began over a century and a half ago in 1862.

The Civil War Pension scheme remains an enduring reminder of the unintended consequences of promises lightly made today, with little regard or planning for the future. Originally set up during the war to pay pensions to disabled Union veterans and their dependents (including widows and orphans), the scheme was gradually extended over successive decades to encompass all veterans and their families.

The consequences were punishing. During the 1880s, the pension scheme accounted for almost half the federal budget, leading to social tensions and public anger. For example, in 1887, President Grover Cleveland vetoed a new pensions bill, claiming that it "put a further premium on dishonesty and mendacity."

As veterans aged and died, they also became attractive annuities. Younger women married far older veterans, including the aforementioned Alberta Stewart, who married 81-year-old William Martin in 1927, aged just 21. When he died in 1931, she married his grandson two months later. By the time Alberta passed away in 2004, the Civil War pension schemes -- Union and Confederate -- had cost the federal government well over $100 billion in today's terms and far in excess of the Civil War's original cost.

Today, the American Civil War Pension scheme is an obscure historical footnote but its lessons are no less profound.

A Crisis in Slow Motion

One of the tragedies of the Great Recession is that we are so focused on the "urgent" today that we have completely forgotten about the far more important tomorrow. Human myopia dictates there will always be a bias, but the consequences of this ostrich mentality are far-reaching.

A century ago, retirement was an aspiration. The average life expectancy was 52 for men and 57 for women. Today, we will likely spend a third of our lives in retirement. It's a notable and staggering achievement. But as people live longer -- 15 minutes more for every passing hour, by some estimates -- there is a darker side: the cost of catering for this grey renaissance through pensions, health care and the like. As the baby boomers come up for retirement in coming years, this means enormous pressures on an already strained public balance sheet in key areas such as social security, Medicare and long-term care.

Today, these future liabilities are nebulous because they are not officially recorded. According to the CBO, the current debt-to-GDP ratio is 73 percent -- a "reassuring" number in today's world. But this official number only takes into account the acknowledged public debt. Add pension obligations, social security, Medicare etc., and you soon get a very different number.

The ratio now suddenly balloons to above 500 percent of GDP. But even that is only the beginning. Professor Laurence Kotlikoff at Boston University, an expert on long-term forecasting, calculates that the total gap between all projected spending and all projected taxes for the U.S. is a staggering $222 trillion, based on the CBO's latest projections.

This unfunded iceberg implies a very real solvency crisis for the U.S. in the long run. We can tinker with tax codes. We can make budgetary changes at the margin to control toady's far more miniscule deficit. But in terms of solving the far more important crisis beyond our horizon, this is the equivalent of using a thimble to bail out the Titanic.

Today, we no longer have that luxury. As generations continue to live longer, the strains on our social fabric continue to grow in the absence of solutions. If nothing changes, the U.S. will pay an additional 8 percent of GDP in age-related expenditure by 2050. That is another $1.1 trillion a year in additional costs, without even counting the accrued total burden by then.

Hope for Tomorrow

The long-term planning and management of society require a long-term perspective. In practice, the actions of policymakers always have a horizon far shorter than the complex system they manage.

But little decisions today play out in big ways tomorrow.

We choose to fight the urgent crisis today over the far more important crisis building up in the future. In our eyes, the overarching need is to preserve the financial system today. There is also the hope that if stimulus works, the economy will roar back into life and make those future larger payments eminently more affordable. There is always time enough to plan the deeper reforms tomorrow that will make social security, health care and other spending viable, and sustain society.

Unfortunately, hope is not a strategy. Tomorrow, there will be another urgent crisis and without action, our myopic horizon will push off deeper issues for another day.

It is time to remember the important, not just the urgent. Else, we risk repeating the familiar Roman motif of a vigorous beginning lapsing as usual into a careless end.

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