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Implicit Liabilities

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Implicit Liabilities

Have you ever heard of an implicit liability? What makes a liability implicit and why might they be different from regular liabilities? We hear about liabilities all the time and anyone can have them: businesses, banks, and even governments! And, there is not just one type of liability, but for this explanation, we will stick with learning all about implicit liabilities. So if you are curious about implicit liabilities, you are in the right place!

Implicit Liabilities Definition

Implicit liabilities are promises made by the government about future spending that are not legally binding but carry a moral obligation to be fulfilled. They are not accounted for in typical debt statistics, even though these liabilities have the same outcome as other debts. They carry the expectation that one day they will be paid.

Implicit liabilities are promises about future spending made by the government that function as a debt but are not included in debt statistics.

A liability is money that is owed to someone else. For private citizens or businesses, a mortgage is an example of a liability because it is money that needs to be paid back to an institution, such as a bank. The house that the mortgage was used to buy is an asset because by paying the mortgage you are building equity in the home, and in the future, the home can bring you economic benefit.

Implicit Liabilities colorful bank notes StudySmarterBank notes, pixabay

Liabilities that the government holds are treasury bills, bonds, securities, or certificates of deposits (CDs), which have varying amounts of time until they mature, meaning when they can be cashed out for their maximum value. These liabilities can be held by both foreign and domestic investors and are included in debt statistics calculations when calculating the federal budget deficit, and calculating the debt-GDP ratio. In the short-run, as long as GDP rises faster than the national debt, the debt burden that the government faces decreases since the nation is becoming wealthier.

The Debt-GDP Ratio

The Debt-GDP ratio calculates the government's debt as a percentage of the nation's GDP. When a country's GDP is growing faster than its deficit, the ratio will be decreasing even though the total deficit of the nation is rising. Since the country's GDP is growing, the government can expect to see increased tax revenue which improves its ability to pay back the debt in the future.

If GDP is growing more slowly than the government's debt, then the debt-GDP ratio rises, which means that the country's debt burden is increasing. This will make it harder for the country to pay off its debt in the future.

To learn more about the Debt-GDP ratio and national debt, check out our explanation - National Debt

The long-run is where implicit liabilities may become problematic for the government. Since implicit liabilities are not included in these debt statistics calculations, the future expenses incurred by these transfer payments are not fully taken into account since the degree to which they will have to be paid is not guaranteed. The amount is not guaranteed since implicit liabilities are moral obligations of the government because of promises made to the past and current workforce. How much they amount to will depend on how many people call on them to be and when.

Implicit Liabilities Examples

Examples of implicit liabilities are Social Security, Medicare, and Medicaid. These are the three largest implicit liabilities the U.S. government has to contend with as future expenditures. Medicare and Social Security expenditure is expected to rapidly increase in the next several decades due to the aging population and an increasing life expectancy, coupled with the rising cost of healthcare.

Want to learn more about the government's role in healthcare, housing, and other social welfare intervention? Read our explanation - Social Welfare Policy

Implicit Liabilities Examples: Social Security

Social Security is a program that is paid into by the current workforce and distributed among the retired workforce. You pay into social security while you are actively participating in the workforce and are collecting a federally taxed paycheck. Then once you reach retirement age, you collect your social security checks as a pension. The amount that you earn will impact the size of your checks. The more you earn, the larger the monthly checks.

This implicit liability can become such a burden to the government in the case of social security because of the coming changes to the demographics of the United States. The baby boomer generation consists of people born between 1946 and 1964. After World War II the birth rate increased massively producing the baby boomer generation. These are the workers that are now at the beginning of their retirement and starting to collect those social security payments that the government promised them when they first started paying into it. The workforce that is now beginning to pay into social security is smaller so the ratio of retirees to workers will rise. A way to combat this is by either raising taxes or decreasing social security benefits.

Implicit Liabilities Examples: Medicare and Medicaid

Medicare is an implicit liability because it is a federal health insurance program that relies on things like payroll and social security taxes, monthly premiums paid by beneficiaries, and interest for funding. There is no set amount that the government will be guaranteed to have to pay out as beneficiaries become eligible and call on the service as they need it. To qualify for Medicare in the United States, you must be 65 years or older or must be receiving social security disability benefits.

Implicit Liabilities Illustration of a doctor with stethoscope StudySmarterMedicare, pixabay


Medicaid, like Medicare, is a federal health insurance program, except it covers low-income adults, children, pregnant women, and people with disabilities. As healthcare costs are expected to keep rising and there are more people coming of age to demand these benefits, there will be a substantial increase in future spending.

implicit liabilities budget projections studysmarterFigure 1. Budget projections for current and future spending on Social Security, Medicare, and Medicaid as a % of GDP - StudySmarter. Source: Congressional Budget Office1


Figure 1 shows us the current spending on Social Security, Medicare, and Medicaid as a percentage of GDP. The cost of healthcare and an aging population is predicted to drive up the spending on these programs over the next decades. This can cause issues for the federal budget because healthcare spending has a tendency to rise faster than overall spending, so it will take up a higher percentage of GDP.

Implicit Liabilities Examples: Public Investment Projects

Public investment projects are implicit liabilities because there are not exactly federal laws mandating that the government has to build new roads and maintain them or fund housing projects, or build libraries. However, it is an expectation that the government will fund such endeavors because it is in the economy's best interest and the public expects it.

Impacts of Implicit Liabilities on the Economy

The impact of implicit liabilities on the economy is an increase in government debt and an increase in government spending. We are seeing an increase in the number of people collecting social security, a decrease in those paying into it, and rising healthcare costs. This will impact government spending because the government will have to supplement the social security payments by increased spending. Federal program expenditures on Social Security and Medicare made up about 45% of the government's expenditures in 20182. In 2019, federal spending on social insurance programs was at about 13% of the nation's GDP3.

Currently, Social Security collects more in revenue than it pays out, so this extra revenue is placed into trust funds to earn interest to be able to supplement future payments. The trust fund holds these funds as government bonds, which are included as government debt. Essentially, one sector of the government owes money to another sector, since the social security funds are held as bonds and that money is owed by the government to the Social Security trust fund. If we included this intragovernmental debt in the public debt, we have a more accurate representation of the financial health of the country.

Implicit Contingent Liabilities

Implicit contingent liabilities are implicit liabilities that will only come due in the case of a specific event. When something is contingent, it is dependent on something else happening first. The difference between an implicit liability and an implicit contingent liability is that the first is an expense that will most likely be incurred but the amount which it will cost cannot be accurately estimated, and the latter will only be paid if an unpredictable event happens first.

Implicit contingent liabilities are implicit liabilities that will only come due in the case of a specific event.

An example of implicit contingent liability is bank bailouts. When the financial system of a nation is in turmoil as it was in the 2008 financial crisis, the government injects massive amounts of funds into the economy in the form of bailout payments to keep certain banks and businesses afloat to prevent a total collapse. These payments will only happen though if there is a need for bailouts.

Implicit Liabilities cartoon buildings in an earthquake StudySmarterImplicit contingent liability, pixabay

Another example is disaster relief. When a hurricane causes damage to a populated area, the government comes in and provides physical and financial relief to the victims in those areas.

Managing Implicit Liabilities

In the case of Social Security, the government manages the implicit liability by placing excess funds collected from those currently paying into the program into a trust fund. This is essentially a bank account that holds excess Social Security taxes in the form of U.S. government bonds and any interest revenue that these bonds earn. This money will be used to supplement Social Security payments in the case that the current Social Security taxes will not cover the payments that are due, as would be the case with an aging population demographic.

Currently, there are more people paying into Social Security than there are those collecting it, but as the baby boomer generation enters retirement, this is expected to shift. Essentially, the government manages implicit liabilities by trying to predict future expenditures via unbiased means and save up in case the current payments meant to cover these future expenses are inadequate.

U.S. government bonds are a form of government debt that is accounted for in debt statistics so a portion of the implicit liabilities is in fact reflected in the national debt as intragovernmental debt rather than pubic debt. It is debt owed by one part of the government (the government outside of Social Security) to another (the Social Security trust fund).

Implicit Liabilities - Key takeaways

  • Implicit liabilities are promises made by the government about future spending that are not legally binding but carry a moral obligation to be fulfilled. They are not accounted for in typical debt statistics, but they carry the expectation that one day they will be paid.

  • In the long run, is where implicit liabilities may become problematic since they are not included in these debt statistics calculations, and the future expenses incurred by these transfer payments are not fully taken into account since the degree to which they will have to be paid is not guaranteed.

  • Medicare and Social Security expenditure is expected to rapidly increase in the next several decades due to the aging population and an increasing life expectancy, coupled with the rising cost of healthcare.

  • The effects of implicit liabilities in the economy are an increase in government debt and an increase in government spending because we are seeing an increase in the number of people collecting social security, a decrease in those paying into it, and rising healthcare costs, the government will have to supplement the payments.

  • Implicit contingent liabilities differ from implicit liabilities in that they will only come due in the case of a specific event happening.


References

  1. Congressional Budget Office, Long-Term Budget Projections June 2012, https://www.cbo.gov/data/budget-economic-data#1
  2. The Social Security and Medicare Trustees Reports, Status of the Social Security and Medicare Programs, 2019, https://www.ssa.gov/oact/TRSUM/tr19summary.pdf
  3. Mitchell Barns et al., The social insurance system in the US: Policies to protect workers and families, 2021, https://www.brookings.edu/research/the-social-insurance-system-in-the-u-s-policies-to-protect-workers-and-families/#:~:text=In%20fiscal%20year%202019%20the,GDP)%20on%20social%20insurance%20programs.

Frequently Asked Questions about Implicit Liabilities

Implicit liabilities are promises about future spending made by the government that function as a debt but are not included in debt statistics.

Implicit liabilities are usually social insurance-type programs or programs that benefit society. There are no laws requiring these types of programs or payments but they are a massive help to society.

An example of an implicit liability is the Social Security Insurance, which is a government pension plan, and Medicare which is a government health insurance for the low-income and disabled population.

Implicit liabilities affect the economy by increasing government debt and government spending. 

Implicit liabilities are currently dealt with by placing excess tax revenue collected by Social Security and Medicare into special trust funds. These trust funds earn interest and will be used to supplement future Social Security and Medicare payments when the tax revenues are not enough to cover benefit payments.

Final Implicit Liabilities Quiz

Question

What is an implicit liability?

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Implicit liabilities are promises about future spending made by the government that function as a debt but are not included in debt statistics.

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What is an implicit contingent liability?

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Implicit contingent liabilities are implicit liabilities that will only come due in the case of a specific event.

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What is an example of an implicit liability?

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Social Security Insurance, Medicare, and Medicaid.

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What is an example of an implicit contingent liability? 

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Bailout payments, or disaster relief payments.

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If GDP rises faster than the national debt, does the debt burden that the government faces increase or decrease?


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It decreases.

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Why are transfer payments in the form of Social Security and Medicare expected to increase over the next decades?

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They are expected to increase because the demographic of the nation is shifting to where there will be more people receiving benefits than people paying into the system.

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How do implicit liabilities help society? 

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Implicit liabilities are usually social insurance-type programs or programs that benefit society like Medicare and Social Security.

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What is Social Security Insurance? 

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Social Security Insurance is a government pension plan that is paid into by the current workforce and distributed among the retired workforce.

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What is Medicare? What is Medicaid?

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Both are federal health insurance programs, except Medicare is for people over 65 years of age or those receiving Social Security disability benefits. Medicaid covers low-income adults, children, pregnant women, and people with disabilities.

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What are the impacts of Implicit liabilities? 

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An increase in government debt and government spending.

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Why will government spending increase because of implicit liabilities? 

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Government spending will increase because it will have to supplement Social Security payment funds once more people are receiving social security and fewer are paying into it to be able to maintain the same level of payment.

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Why is spending on Medicare expected to increase?

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Medicare spending is expected to increase because the cost of healthcare is increasing.

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Where does excess Social Security tax revenue go for future use?  

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Excess tax revenue collected by Social Security goes into special trust funds that earn interest and will be used to supplement future payments when the tax revenue is not as large

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What is the difference between an implicit liability and an implicit contingent liability?

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The difference is that an implicit liability is an expense that will most likely be incurred but the amount which it will cost cannot be accurately estimated. Implicit contingent liability will only be paid if an unpredictable event occurs.

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How much of federal spending is made up of Social Security and Medicare?

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45% of the federal spending is made up of Social Security and Medicare.

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How much percent of GDP was spent on social insurance programs?

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Federal spending on social insurance programs was at about 13% of GDP.

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Promises made by the government about future spending that are not legally binding but carry a moral obligation to be fulfilled.

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Implicit liabilities

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True or False: implicit liabilities are accounted for in debt statistics.

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False

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A popular example of liability for individuals is:

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mortgage

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Which of the following is NOT a liability that the government holds.

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none of the above

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Which of the following is NOT an example of an implicit liability

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bonds

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A program that is paid into by the current workforce and distributed among the retired workforce.


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social security

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You must be 65 years or older or must be receiving social security disability benefits to receive this.


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medicare

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A federal health insurance program that covers low-income adults, children, pregnant women, and people with disabilities


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medicaid

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What are the impacts of implicit liabilities?

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rising debt

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Implicit liabilities that will only come due in the case of a specific event.


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implicit contingent liabilities

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What is an example of an implicit contingent liability?

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bank bailouts

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True or False: Implicit contingent liabilities differ from implicit liabilities in that they will only come due in the case of a specific event happening.

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True

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True or False: The effects of implicit liabilities in the economy are a decrease in government debt and an increase in government spending

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False

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True or False: Medicare and Social Security expenditure is expected to rapidly decrease in the next several decades

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False

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True or False: Implicit liabilities are promises made by the government about future spending that are not legally binding but carry a moral obligation to be fulfilled. 

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True

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True or False: To help manage implicit liabilities, governments are placing excess funds collected from those currently paying into the program into a trust fund

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True

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True or False: bank bailouts are an implicit liability.

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False

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True or False: Disaster relief is an implicit liaability.

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False

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Calculates the government's debt as a percentage of the nation's GDP.


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Debt-to-GDP ratio

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If GDP is growing more slowly than the government's debt, then


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 the debt-GDP ratio rises.

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