A tax freight train is bearing down on your retirement. To protect yourself, you'll have to harness The Power of Zero.
Hi there. David McKnight. Welcome to The Power of Zero show. I am the best-selling author of The Power of Zero, Look Before You LIRP, and The Volatility Shield, all of which can be purchased in bulk at powerofzero.com/Books. If you are looking for a Power of Zero advisor, we would love to help you out. Head on over to davidmcknight.com and fill out the contact form, happy to help you navigate the pitfalls that stand between you and the 0% tax bracket. Of course, if you are a financial advisor and want help assimilating these concepts into your practice, we're here to help you with that as well, go over to powerofzero.com, opt-in to our video series.
I've got some exciting news for those of you who have watched The Power of Zero: The Tax Train Is Coming and are looking for a way to easily distribute viewings of that to your friends, clients, or family members, there's now a way to buy those viewings in bulk. We'll be announcing that here pretty soon. But the long and the short of it is you can go to reelhouse.org and you can buy these viewings in bulk. The minimum you can buy is 400 and it's $5 a viewing. The reason that is because Doug Orchard’s team has to do a lot of manual details behind-the-scenes to make this work so they can't do it for $10 or $20, there's just a lot of work that goes into keeping track of all these views. But you're going to be able to embed these into your websites. There are all sorts of interesting ways that this can be utilized. That's very exciting. That's coming out very, very soon. Stay tuned. If you have been to thetaxtrain.com, you can get more information probably in the next day or two about how that whole thing works.
Today, we're talking about “Is the federal government past the point of no return?” In other words, is there hope? Can they turn the ship around or is it a mathematical impossibility? I'm using, for my text today, I'm drawing from a very well-written article that I tweeted about a couple of days ago from medium.com. The person who wrote this has been studying financial markets for the last couple of decades. He submitted top-level analyses to Bill Gates, to Samsung, to Tencent, very, very smart as you'll see as we go through the information he provides.
But it's also, I've got to warn you, viewer discretion advised, this is very sobering, this is a very grim depiction of what our country is likely to go through over the next couple of decades. We'll talk about at the end what you can do to protect yourself but I'm not much into hyperbole and it doesn't seem like this guy is either. By the way, I'll provide a link to this article in the show notes but he starts off his article—which is entitled The Mathematical Certainty of U.S. Government Default, he wrote this back in 2018 but the numbers hold true today, they're probably a little bit worse than they were in 2018—he starts off by saying, “The thing about finance is that it’s not an opinion, ideology, or political debate—it’s math,” of course, this echoes everything we've said over the years. David Walker says tax rates have to double. Why? Because of math.
He says, “There's going to be a tipping point. The “way out” becomes default. The United States government reached that point at least 15 years ago. This is an update on the situation using the government’s very own financial statements.” He's using the numbers from the fiscal year 2017 to really make his point. Then he says, “Hey, look, people who calculate debt, especially those in the federal government never do it the right way.” They basically say, “Okay, what are the outstanding loans that people have made to us? How much money has China loaned us? How much money have we borrowed from Social Security? How much money have corporations and members of the public loaned to us?” He says, “That's only part of it. What you really have to do...” and this echoes everything that Larry Kotlikoff has said over the years, “...is you have to figure out the net present value of everything that we've promised over the years minus what we can actually afford to deliver.”
The federal government, for reasons that will become obvious in the next few minutes, only projects these things out over 75 years. Larry Kotlikoff and this gentleman who goes by the name of Ptolemy 3, that's a pseudonym, they are only really projecting these numbers out over 75 years. If they went out beyond 75 years, as you'll see shortly, the numbers get much, much worse. Essentially, what you're doing when you're figuring out what Larry Kotlikoff calls the fiscal gap is you're projecting out over the next 75 years what we've promised in the form of Social Security, Medicare, Medicaid, interest on the debt, all of the other expenses it takes to run the federal government versus what we're actually bringing into the US Treasury, which as you'll see shortly, is a fairly static amount. Expenses go up dramatically, whereas the cash flow remains relatively static based on current tax rates.
These are the numbers, at the end of this particular portion of the podcast, I'll reveal to you what he says the net present value of the US debt is, but let's figure out what math he uses to draw these conclusions. He starts out by saying, “Look, you got to begin by analyzing US government positive cash flow. They're pretty stable, they come almost entirely from one source,” that's individual income taxes, and he says that any prediction that economic growth will rise dramatically over time is based on…” as Joseph Davis said in our movie based on religious belief, he says, “On short of some AI revolution, there's no data that suggests that economic growth is going to increase more than, say 2% over our lifetimes.”
Not only is it relatively static, there are some people that are suggesting that we have hit maturity in terms of economic growth and that we potentially could be closing in on decline. He says that the money coming into the Treasury absent to dramatic rise in taxes is going to remain relatively stable. He also says that the negative cash flows currently are $4.5 trillion. What are these going towards? This goes towards defense, social insurance programs like Social Security, Medicare, and Medicaid, interest payments on the national debt which would, of course, go up if interest rates went up, and he says “endless small programs.” He says, “These basic standard programs are not likely to change, they're not likely to go away because they're sticky.” Ronald Reagan once said, as I've said in the past podcasts that the greatest example of eternal life here on earth is a government program. We all know that once it comes into existence, it's very, very difficult to get rid of it. Four-point-five trillion against a three-point-four trillion-dollar positive cash flow.
Then he assembles all of this together, he starts off by saying, “Okay, what are the current assets and the current liabilities?” You have to take what we actually owe which is north of $23 trillion, you subtract from that our actual assets which are about $4 trillion, that leaves us with, currently, if you do the math for today's debt, it's about $23 trillion of debt. Then he says that you have to estimate what the future cash flows are. What are the estimated future cash flows over the next 75 years? He says that the actual cash flows can be negative if you break it down in different categories.
The first category talks about social insurance programs. He says that the net present value of the future obligation for these programs over the next 75 years is $49 trillion. What does that mean? That means that you would have to have $49 trillion sitting in a bank account today earning Treasury rates to be able to afford all of the things that we have promised. Take our existing debt, plus the $49 trillion, and you get a much bigger number which is closer to $70 trillion, $75 trillion. We're starting out there, $75 trillion.
Then he gets into core operations and he says, “Look, once you subtract out all of the expensive things, the core operations of the government, we’re actually running at a surplus and we're actually at a positive $28 trillion so we have plenty of money coming in to run the federal government in its core operations. Once you subtract out all of the things in the first category we talked about, the federal government can run positively.” Subtract from that $75 trillion, roughly $28 trillion to $30 trillion, not in horrible shape, they were in bad shape but not horrible shape.
This is where it really gets ugly when you get to the interest payments on the debt, when you project out the interest payments on the debt on what the debt is likely to accumulate over the years, that's when it gets really, really nasty. The current payment on the debt right now is only just north of $300 billion. That doesn't seem like a big deal. It was 9% of the federal government's revenue in 2018. However, the federal government actually predicts that interest rates will rise to 5.1% over that 75-year horizon. They'll actually average 5.1% over that horizon.
If we go from today's rates, which in 2020 are about 1.75% to 5.1%, over time, that's actually nearly a tripling of what it would require to service the national debt. This is the number that the federal government is using, they're using 5.1%. This is in their own financial statements. He says, when you plug all of that into the equation, we would have to have $110 trillion sitting in the bank account today earning Treasury rates to be able to deliver on all of this debt. This is just the cost of renting the money that we're using to pay for things that we can't afford.
The last category he talks about is what he calls a terminal value, he basically says that a terminal value represents what we would have to have in the 75th year to be able to bankroll the expenses of the federal government in perpetuity. Now, this becomes a really big number, it's $1.6 quadrillion, or in common parlance, it's $1.6 zillion. How much is that? If my math is right, that's 1,600 trillions that we would have to have sitting in a bank account today to not only pay off all the debt at a 75-year horizon but also to bankroll the costs of the federal government in perpetuity.
Now, we all know that they're not going to be able to pull that off so how much would we have to have just to pay off the debt in year 75? We'd have to have an additional $38.8 trillion sitting in a bank account today earning Treasury rates to be able to pull all that off. When you add all these numbers up, he basically says that the net present value of our future obligations that we can't afford to pay for, in other words, what Larry Kotlikoff refers to as the fiscal gap in 2018, that was $190 trillion, we know that Larry Kotlikoff takes a very similar approach, he recently came out in 2019, he updated his numbers, he says, “The fiscal gap is $239 trillion.” I am waiting anxiously to see what it is in 2020 to see what his fiscal gap calculation is. I imagine it'll be $10 trillion or so higher than the $239 trillion.
To put that into perspective for you, that $190 trillion that he refers to back in 2017 as being our fiscal gap back then, he says that represents 68% of all of the money in the world. All of the global assets in the world are $280 trillion, our fiscal gap represents almost 70% of that number. It's just a mammoth number. Let's cut through all these numbers, the long and the short of it is this: We are deficit spending, what does that mean? That means we are borrowing money just to be able to pay our bills. As we borrow money to pay our bills, the debt starts to pile up. As the debt starts to pile up, we get to the point where it's a snowball that is reeling out of control. If the debt gets so big, we are not going to be able to afford the interest payments on this debt no matter how much we cut back on all these other programs.
You could say, “Hey, look, if we simply cut back on Social Security, Medicare, Medicaid, we somehow modified these programs, then we could right the ship.” Guess what, what we're about to talk about is how we're past the point of no return on that because the debt has gotten so big and the compounding interest has become so great that we simply can't turn back the hands of time to a point where we can now afford this. When interest rates go up, the cost of servicing this debt will triple. We could default on the debt, of course, but that would send shockwaves throughout the globe, precipitate a worldwide depression, and certainly, the US dollar would lose hegemony and that much is certain.
Fast forward in time and take a look at what would happen if we kept on the current path. He says that in 2038, the US government would run an annual deficit—that's not a debt, an annual deficit, remember, is the difference between what our budget calls for and what we can actually afford to pay—the annual deficit in 2038 would be $3.3 trillion. He says that number would persist for decades into the future. He says, “There's a good probability that we would default at this point.” He later says that we be better off defaulting in 2038 and starting over than waiting until what happens in 2058 because what happens in 2058 is that we will be running nearly $6 trillion deficits, that's a 210% debt to GDP ratio. He says that by the year 2092, which is when the federal government's projections stop, we would be running, get this, $14 trillion of annual deficits and we would have $1.6 quadrillion or $1.6 zillion, however you prefer it, in national debt.
This is sobering stuff. How did he come up with these numbers? He basically used tried-and-true models. There's a group called Gokhale and Smetters that use math very similar to Kotlikoff. In 2006, Larry Kotlikoff, we know he's from Boston University, he ran for president, foremost expert on what we call the fiscal gap accounting or generational counting. He published what this author says is the best paper ever on the topic “Is the United States Bankrupt?” He says that the answers are terrifying, “One solution is an immediate and permanent doubling of personal and corporate income taxes.” David Walker agrees with that assessment.
Another is an immediate and permanent two-thirds cut in Social Security, Medicare benefits. A third alternative, were it feasible, would be to get this immediately and permanently cut all federal discretionary spending by 143%. Put differently, he says that would require, and this is back in 2006, an immediate and permanent 58% hike in federal taxes or 38% cut in all spending. Very, very sobering stuff.
He ends up doing his own independent model, meaning Ptolemy 3, the author of this article and he comes to very, very similar conclusions. The problem, he says, is in using the federal government's numbers from their own financial reports, he says, “I ran into problems trying to reconcile their math, and so suspect they have cooked the books (I’ve been doing this a long time and recognize the signs when someone is trying to hide something). And finally, there are large numbers they seem to be excluding such as government employee benefits and…” get this, “Medicaid. And yet, optimistic as this model is—as social insurance payments come due, debt must be taken on, and the whole thing breaks. Every time. I’ve tried endless other combinations over the last decade I’ve been studying this problem, and talked to many financial professionals, and in every scenario default or hyperinflation is the outcome (which are not necessarily so different).”
The only bone that I have to pick with him in this article is he doesn't bring up the fact that is brought up by Alan Auerbach over at Berkeley which he said in our movie is that you cannot inflate your way out of Social Security and Medicare because those two programs are tied to inflation. As you increase the supply of money, you increase the inherent cost of these programs. As the supply of money grows, the cost of the programs grow and you can never really catch up with the cost of these programs.
He says that even if you used the federal government's own numbers, their fiscal policy is not sustainable and there's a 100% probability this ends in some sort of default. He says that the longer the delay, the bigger the default. He says, “Since current revenue is $3.4T, that means per their own analysis they would need to cut spending from $4.5T to $3.0T starting right now...” which is in 2018, “into perpetuity, not even to close the NPV gap to zero...” that's a net present value gap, “...but just to hold the GDP ratio down to a sustainable and ‘reasonable’ level.”
He says, “How does this end? Badly. Again, it’s just basic finance math. People always say “oh, there is hope, they will think of something, we have survived worse,” but there’s no such thing as magic. NPV (net present value) math is simple is simple and authoritative—either revenues need to be increased, or costs need to be decreased. But the amount revenue would need to be increased is impossible.”
Yes, tax rate is to go up but to be able to cover this bogey, tax rates would have to go up to, essentially, 100% of what we're earning. That would not ultimately bode well for the economy. We have really painted ourselves into a corner. We've made promises that we can't afford to keep. We deficit spend in order to honor these promises. As we deficit spend in order to honor these promises, the debt grows to unsustainable levels such that by the time interest rates go up, we will literally have to dedicate the majority of US tax revenue under current tax rates just to pay the interest on the debt, that's not to pay it down.
His conclusion, “The takeaway—this is the largest Ponzi scheme in human history, and as the bubble pops during our lifetimes, it’s going to get very ugly. Like all Ponzi schemes, the longer they are able to hold their disastrous financial situation together due to people’s trust in them and their special access (world’s largest economy + reserve currency), the greater the eventual damage will be when the bubble pops.”
I warned you ahead of time listener discretion advised, this is sobering stuff but I think that we need to face these challenges in a very clear-eyed and realistic way, especially when it comes to our retirement. As Don Blanton said, “Are we willing to enter into 401(k)s and IRAs where we are essentially allowing the government to choose how much of our money we really get to keep?” It's like given the federal government alone and saying “are we willing to trust them to pay back that loan” when they're currently $23 trillion in debt—and according to Larry Kotlikoff, they're really $239 trillion in debt—and this is really what drives the whole Power of Zero paradigm. We believe that tax rates in the future have to go up to keep our country solvent.
We also believe that spending has to go down. It's going to be some combination of these two things but we also believe that as debt grows to unsustainable levels, we will be put in a situation where we can't borrow our way out of it, we can't print our way out of it, we're going to have to tax our way out of it, therefore, what can you do today to protect yourself from the reality that tax rates down the road are going to be higher than they are today? One thing that you can do is you can start systematically repositioning your tax-deferred dollars to tax-free, take advantage of historically low tax rates, take advantage of the tax sale in order to get dollars repositioned to tax-free. Why do we love the 0% percent tax bracket? Because if tax rates double, two times zero is still zero.
Hang in there, folks, I think that there's plenty of good news in all of this and that's the tax rates are historically low. You can take advantage of taxes. They will never be this low in our lifetime. We will look back in the year 2030 and we'll say, “Why did we not take advantage of tax rates while they’re historically low?” Because remember, all the tax rates have to do in the future is go by 1% for the math here to make sense.
That's the show for today. One last call to action for those of you who have yet to do a review of The Power of Zero or any of my other books on Amazon, I really, really would appreciate it. When people get handed the book The Power of Zero, 90% of the time, the first thing they do is they go to Amazon and they say, “Okay, how many reviews does this book have?” That informs how seriously they take the book. The quality of the reviews is important but how many total reviews also inform whether they take the book seriously. If you are in the habit of passing out the book to friends, family, or clients and you haven't yet put a review on Amazon, please do so. It means the general public will take these strategies and this paradigm much more seriously.
Again, subscribe so that you can get this podcast delivered to your email inbox through whatever channel you listen to podcasts. Thanks for being on the show. We'll talk to you next week.