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How the geezers cashed in on the Gulf War; and why you'll pay for it.

And why you'll pay for it

Even if General H. Norman Schwarzkopf couldn't

count on $50,000 speaker's fees or his reported E$5 million book deal, the retired four-star would do just fine. As a general who maxed the pay grade, Schwarzkopf will take home 1,028,953 in federal retirement in the next decade alone. If he had quit the service before the Gulf war, however, he'd be taking home thousands of dollars less-not because of his service there, but thanks to a little-noticed statistical fillip created by George Bush's blind faith in the free market. Of course, Schwarzkopf isn't the only one cashing in. As a direct result of Bush's oil policy preceding Operation Desert Storm, the U.S. government will spend billions of extra dollars in the next decade upping the pensions of federal workers from the general on down to the lowliest GS-2.

Each year, all 3,700,000 military and federal civil service pensioners receive an annual cost-of-living adjustment (COLA). Even under ordinary circumstances, the bill for all these pension checks is staggering. Payouts this year alone are estimated at $56.5 billion, up three billion from two years ago. "I think it has something to do with inflation," a public information officer at the Pentagon offers helpfully. Problem is, inflation doesn't just happen. This time, George Bush helped hike it up.

Market forces are a complex product of popular mood and government action-or inaction, as in this case. Last August, oil prices shot up in the wake of Iraq's invasion of Kuwait, and fears of gas lines began to fuel a new national resolve to fight a war. At the same time, the Consumer Price Index, the government's main inflation barometer and the key indicator for the year's cost-of-living adjustment, shot up .8 percent, the biggest rise since the previous January. The oil price alone was responsible for about half of that increase.

But the oil shock did not last. A month later, President Bush opened the nation's strategic oil reserves, world oil prices plummeted to below pre-invasion levels, and inflation for the rest of the year retreated to a modest .3 percent. But by that time, irrevocable damage had been done. By failing to open the reserves sooner, Bush made himself responsible for $226 million in increased pension expenditures this year alone. Thanks to compounded COLAS, the outlay resulting from this brief increase in the inflation rate will probably reach $3 billion by 2001-money that might otherwise have been spent providing balanced meals for 3.7 million poor pregnant women or treating 790,000 little kids to Head Start.

The lesson here is both particular and general. First, extreme, short-term inflation that can be stopped through reasonable market intervention should be-and quickly-to protect the American economy from unnecessary long-term costs. But more importantly, the consequences of Bush's inaction highlight the larger folly of across-the-board government COLAS. Designed to protect the widow's mite against the scourge of inflation, COLAs have evolved into an annual windfall for millions and millions of people who don't need them. In general, they're a dreadful strain on the Treasury. And on occasion-as in the case of Bush's preparation for the Gulf war-they're just billions of dollars down the drain.

COLA wars

To the public, the oil shock might have seemed inevitable: Saddam invades Kuwait, 6 percent of the world's oil supply is taken off the market, and Exxon Super Premium starts to levitate. It wasn't. The Strategic Petroleum Reserve, created in 1975 in the wake of the Arab oil embargo, was designed for times just like these. The day of the invasion, 600 million barrels of crude oil-enough to replace Iraqi and Kuwaiti imports for nearly two and a half years -were tucked in caverns throughout Louisiana and Texas, ready to stave off oil panic and keep prices stable when called upon by the president. But George Bush just kept saying no.

Despite the fact that U.S. oil companies were holding more crude in their inventories than at any time in the eighties, oil executives gleefully seized the moment. Within days of the invasion, they began ratcheting up their prices in the face of grumbling from oil experts, congressional leaders, and the press. "Open the reserves!" screamed The New York Times and The Washington Post. "Act now!" advised oil analysts from Daniel Yergin to Philip Verleger. But while the president demurred that he would "explore whether and when we and our allies should draw down reserves," his policy was unequivocal: As he and his spokesmen patiently explained, mere price increases were no reason for a drawdown. Only "physical shortages"-bone-dry tanks at Exxon-would justify the move. The result? In July 1990, a barrel of crude oil was selling for less than $18. By September, the price had doubled.

As the crisis deepened and the economic costs escalated, Bush faithfully toed the free-market line. It was not until October, when the price of oil had sky-rocketed to a decade high of $40, that Bush began to comprehend the economic damage being wreaked by rampant oil speculation. Finally, he responded to common sense. He opened the reserves-a day late, $3 billion short.

Today, with a barrel of crude going for about $22.50, the Gulf war and its oil shock seem like ancient history. But some things aren't so easily left behind. Last year the government had estimated its COLA would be 3.9 percent. Thanks to the oil hike, it ended up paying 5.4 percent-the biggest increase in nine years. "The oil and gas increase had a cost that nobody has recognized," says Ed Herman, professor emeritus of the Wharton School of Business. "And this fed into the budget in ways that nobody has paid any attention to."


Why should attention be paid? The numbers speak for themselves-and those numbers were bad enough before the oil shock. In the civil service and military, the "unfunded pension liability" (the amount by which scheduled pension benefits exceed workers' contributions) now exceeds one trillion dollars. That's a debt all of us will eventually have to pay, through increased taxes or decreased spending.

The original rationale for decent pensions for government workers was noble: In exchange for what were then relatively meager salaries, workers could count on a comfortable, federally funded dotage. But as government salaries crept up in the seventies and eighties, pensions also kept on creeping. Today, the average civil servant can expect to earn two and a half times as much in retirement as a private pensioner, who, according to the Employee Benefits Research Institute, generally receives no adjustment for inflation at all. Yet after so many years on the gravy train, civil servants began looking at generous pensions not as compensation for low wages, but as a fundamental right. Inevitably, the annual cost-of-living increase became an intrinsic part of that expectation.

While few people bother to question it anymore, the illogic of COLAs is three-fold. First, they aren't applied year after year to a base pension figure, but are compounded annually, COLA on top of COLA. Say you start with a $20,000 base pension, to which a $3,000 COLA is added. The next year, the base figure is $23,000, not $20,000; your adjustment is a percentage of the higher figure-a difference that adds up. Second, and worse, COLAs are applied across the board to all pensioners, no matter how lavishly provided for. COLAs make great sense for the career GS-5 whose pension barely covers his apartment and cat food; in that case, an annual adjustment protects him from real economic misfortune. Problem is, Ted Kennedy will get exactly the same adjustment, even though he'll get a pension of $1 1 1,000 a year if he quits the Senate at the end of this term. With a trillion dollar liability, a $279 billion deficit, and tremendous social needs going unmet, that sort of "fairness" simply isn't fair.

Finally, COLAs are a self-fulfilling prophecy. When inflation prompts a rise in COLAs-as it inevitably does-it starts a chain reaction that leads to higher inflation, economists argue. "COLAs mean higher wages, and higher wages lead to inflation," says Laurence Ball, a Princeton University economist. "Simply put, COLAs magnify inflationary shocks."

What is fair? Means-test the COLA, as pension reform groups like the National Committee on Public Employee Pension Systems have long demanded. Under a reasonable system, the first $18,000 of a retiree's pension-and only that $18,000-would be indexed to inflation. While that baseline inflation-proofing would ensure that those who need COLAs don't have to skimp on Purina Cat Chow or the rent, it also ensures that COLAs aren't handed out promiscuously to Schwarzkopfs and senators with summer homes.

That single, modest step would reduce the pension liability by a formidable $500 billion and protect Americans from huge, unnecessary losses like the one we suffered before we ever made war in the Gulf. If we can't stop Bush's love affair with the free market, at least we can mitigate the far-reaching economic and social damage it will cause.
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Author:Ericson, Edward
Publication:Washington Monthly
Date:Nov 1, 1991
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