Two Problems, Not One
America in 2030 will be “a country whose collective population is older than that in Florida today.” It will be in “desperate trouble” because the expense of caring for all those old people will cause a fiscal crisis. The nation will be plagued by “political instability, unemployment, labor strikes, high and rising crime rates.” That’s the picture painted in The Coming Generational Storm by Laurence Kotlikoff and Scott Burns, a book that has helped to feed a rising tide of demographic alarm.
But is that picture right? Yes and no. America does have an aging population, and a responsible government would take preparatory action while the baby boomers are still in the labor force. America also has very serious long-run fiscal problems. But these issues aren’t nearly as closely linked as much of the discussion would lead you to believe. The view of demography as destiny is only a half-truth, and in some ways it’s as damaging as a lie.
In this essay I’ll try to set the record straight. Unfortunately, I can’t do that by following Kotlikoff and Burns closely. Kotlikoff is a fine economist, one of the world’s leading experts on long-run fiscal issues. His book with Burns is full of valuable information and sharp insights. Yet in their effort to grab the lay reader’s attention, Kotlikoff and Burns do little to alert readers to the distinction between two quite different issues—an aging population and rising spending on health care. And their failure to make that distinction grossly distorts their discussion.
The demographic problem is, of course, real. It is, however, of manageable size—exaggerating the problem by confounding it with the problem of medical costs just gets in the way of dealing with it. The problem posed by rising medical costs, on the other hand, would be there even if the population weren’t aging—and misrepresenting the problem as one of demography gets in the way of confronting it.
I’ll start here by looking at the demographic problem—the aging population—which mainly concerns Social Security, then at proposals for Social Security “reform”—the scare quotes are there because the scheme currently under discussion would undermine our social insurance system, not save it. At the end I’ll talk briefly about the much bigger, more intractable issue of paying for the expanding quality and quantity of health care, and the current state of political debate.
Social Security and the Demographic Challenge
Chapter 1 of Kotlikoff and Burns’s book is called “From Strollers to Walkers”—a catchy way to describe the aging of the US population. It’s followed with a chapter called “Truth Is Worse Than Fiction,” centered on a chart familiar to everyone who has looked at this issue: long-run projections from the Congressional Budget Office showing the combined expense of Social Security, Medicare, and Medicaid rising from less than 8 percent of GDP now to more than 20 percent by 2075. It seems natural to assume that the grim cost projections follow directly from the aging of the population, and the book doesn’t tell you that this assumption is wrong.
One way to describe the truth is to say that there is no program called Socialsecuritymedicareandmedicaid: these are separate programs with separate problems. Look at the accompanying chart which shows the same CBO projection that Kotlikoff and Burns present, but breaks it down by program. Yes, the total rises drastically—but Social Security, although it is the biggest of the programs now and the only one of the three programs whose costs are driven mainly by demography, accounts for only a small part of that rise. That tells us that demography is not the main driver of these long-run projections.
How big is the demographic challenge? Pundits who want to sound serious love to contrast Social Security as it was in 1950, when sixteen workers were paying in for every retiree drawing benefits, with Social Security as it will be once the baby boomers have retired, with only two workers per retiree. But most of the transition from sixteen to two happened a long time ago. Since the mid-1970s there have been about three workers per retiree—and Social Security has been running a surplus. The real issue is what happens when three goes to two. How big a problem is that?
The answer is, medium-sized. As you can see in the chart, the aging of the population will cause Social Security spending to rise from its current level of 4.2 percent of GDP to a little over 6 percent by 2030, at which point it will stabilize. If demography were the only factor driving rising Medicare spending, it would rise in roughly the same proportion, from 2.7 to around 4 percent of GDP. So if demography were the whole story, we’d be looking at an eventual demography-driven rise in spending of between 3 and 3.5 percent of GDP by 2030, and no further increase after that. That’s not a trivial increase, but it’s also not overwhelming; a tax increase big enough to cover that rise in spending would still leave overall taxation in the United States well below the average for other advanced countries.
Still, a responsible government would prepare for the aging of America. Textbook fiscal economics says that when a government knows that its expenses will rise in the future, it should start running a surplus now. At first, this surplus should be used to pay off debt, which reduces the government’s future interest costs. If the government runs out of debt to pay off, it can start to invest in assets such as stocks and bonds, which will yield future income. That’s exactly the path the Social Security system, though not the government as a whole, has been following.
Social Security has its own budget, with its own dedicated revenue base. In 1983, following the recommendations of a commission headed by Alan Greenspan, Congress tried to prepare the program to deal with the baby boomers: it raised the payroll tax, so that Social Security would run a surplus, with the express intention of building up a trust fund to help pay benefits once the baby boomers had retired. At first, it seemed that this action, together with some changes in benefits, had done the job: “For the next 75 years, the OASDI program is estimated to be in close actuarial balance,” declared the Social Security trustees in their 1985 report.1 Later, the trustees lowered their estimates; the public’s impression of a looming Social Security crisis largely dates from the mid-1990s, when they were predicting exhaustion of the trust fund by 2029. But the trustees have lately become more optimistic again: they now say the trust fund will last until 2042. The Congressional Budget Office says 2052, and many economists now think that the original optimism was right after all: if the economy grows as fast over the next fifty years as it did over the past fifty years, Social Security will be sound for the foreseeable future. And if the economy doesn’t grow that fast, by the way, the high rate of return on stocks needed to make privatization work can’t possibly materialize, either.
At this point a loud chorus on the right insists that such estimates are irrelevant, because the Social Security trust fund is just a meaningless piece of bookkeeping: it’s a claim by one part of the government on another part of the government. The real crisis will come much earlier than 2042, that chorus says, because payroll tax receipts will no longer cover the full cost of providing Social Security benefits as early as 2018.
Let’s take this argument a step at a time. There are two ways to look at Social Security: you can view it as a stand-alone program with its own funding, or you can view it as just part of the federal budget. These aren’t mutually exclusive views. On one side, Social Security has always been run as an independent program, and the independence of its budget has considerable legal and political force. On the other side, Social Security is, of course, part of the federal government, and its benefits must ultimately be paid out of the government’s revenue. Depending on the question, it’s sometimes useful to focus either on Social Security’s specific finances or on its role in overall budgeting. What one can’t do, however, is switch views in mid-argument. If you want to discuss the budget of the Social Security system, the trust fund and the interest paid on that fund must be part of the picture. If you want to discuss Social Security’s role in the overall federal budget, well, you have to talk about the federal budget as a whole; the fact that one particular tax brings in less revenue than one particular category of spending has no significance.
What the crisis-mongers do, however, is switch between views to suit their convenience. For example, in his magisterial survey of Social Security issues in The New York Times Magazine of January 16, Roger Lowenstein caught Michael Tanner of the Cato Institute red-handed. Mr. Tanner’s estimate of a $26 trillion deficit for Social Security turned out to be the result of a calculation based on the principle of heads I win, tails you lose: when Social Security runs a surplus, Mr. Tanner doesn’t count it, because the system is just part of the government, but when Social Security runs a deficit, he treats Social Security as an independent entity.
If all this seems metaphysical, let’s put it this way: What will actually happen when payroll tax receipts no longer cover 100 percent of benefits? The answer, quite clearly, is nothing.
There are only two ways Social Security could be unable to pay full benefits in 2018. One would be if Congress voted specifically to repudiate the Social Security trust fund, that is, not to pay interest or principal on the trust fund’s bonds, which would in effect be a decision not to honor debts to retirees. In 2018 the payments on the trust fund’s bonds would be sufficient to cover Social Security benefits. Repudiation of those payments is pretty much inconceivable as a political matter; writing in the periodical The Economists’ Voice, David Kaiser of the National War College suggests that such a repudiation might even violate the Constitution. In that sense, the trust fund is as real an obligation of the US government as bonds held by Japanese pension funds. The other way would be if the United States found itself in a general fiscal crisis, unable to honor any of its debt. Given the size of the current deficit and the prospect that the deficit will get much bigger over time, that could happen. But it won’t happen because of Social Security, which is a much smaller factor in projected deficits than either tax cuts or rising Medicare spending.
See www.ssa.gov/history/reports/trust/ trustyears.html, pp. 2–3.↩
See www.ssa.gov/history/reports/trust/ trustyears.html, pp. 2–3.↩