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Thursday, February 26, 2009

The power of compounding

In your 401(k) account, the power of compound interest is amazing. The so-called "Rule of 72" is an easy way to think about compound interest. The rule says "take the interest rate, divide into 72, and the result is how many years it will take for your money to double." Thus, if interest rates are 6% (and constant) then money will double every 12 years. If you were to keep $1000 in a 6% return for 36 years, the result would be $8,000.

The "Rule of 72" can be used in any area where a growth rate is available. For instance, on Page 117 of the Proposed Budget is a table of projections for the increases in spending on the big three entitlement programs: Social Security, Medicare, Medicaid.

By 2019, it is projected that spending on Social Security will be $1.141T, spending on Medicare is $872B and on Medicaid $468B. Most assuredly the projections are too low - especially on the medical care. The average annual increase in spending in these three areas?

Social Security: 5.83%
Medicare: 7.74%
Medicaid: 8.25%

Over the next ten years, social security will just about double, spending on Medicare will just about double and spending on Medicaid will more than double.

Combined, the spending on those three programs alone will total what the government spends today in its entirety.

Therefore, to maintain all the other gimmicks that government undertakes either we have to become a heck of a lot more productive, import a heck of a lot more workers, or taxes are going to have to increase (unless benefits can be means tested, which I predict will be the case with Social Security).

Another interesting tidbit is on page 115 where the line item "Climate Revenues" is listed. The plan is for $235B in climate revenues generated from 2010-2014 and $675B from 2010-2019. What is the "climate revenue" used for? Some $10B is "dedicated to climate policy and clean energy technologies" which I recall from the campaign. The remainder is "dedicated to Make Work Pay" which is a tax credit for business to hire individuals.

Wait - we are going to tax emissions, ostensibly because of the negative externality such emissions pose to the rest of society, and then use the revenue to subsidize job creation? How does that resolve the externality problem?

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