April 21, 2014

The Shape Of Things To Come

Volume IV, Number 13
December 8, 1998

With this week's White House Conference inaugurating a year of decision on Social Security, America is finally waking up to the challenge of the age wave. As the debate turns to the merits and mechanics of specific reform proposals, the Concord Coalition urges policy leaders not to lose sight of the critical issue--namely, the magnitude of what's at stake.

There are many who insist that Social Security needs just a few minor changes. As the status quoists tell it, Social Security will impose only a modest and easily affordable burden on tomorrow's workers. In any case, they say, the budget is now in balance and is likely to remain so for decades to come--which means that reform of senior entitlements is no longer urgent.

All of this is mistaken. Social Security's cost burden is on track to grow far larger than the status quoists pretend--large enough, together with other senior entitlements, to flatten worker living standards in the next century. As for the budget claim, it already counts as savings enormous cuts in health-benefit and discretionary programs that Congress has yet to enact.

The truth is that America, along with the rest of the developed world, is about to undergo an unprecedented demographic transformation for whose vast cost it has no idea how to pay. Whether it faces up to the challenge boldly enough and soon enough could determine whether it prospers or declines in the next century.

It's time we took an unflinching look at the shape of things to come. To this end, the Concord Coalition plans to devote a series of alerts to exploring the dimensions of the aging challenge--starting with this overview.

A Best-Case Scenario

The status quoists try to trivialize Social Security's future cost burden by focusing on a measure of the program's solvency called actuarial balance. In their 1998 annual report, the Trustees calculated this balance to be a relatively modest deficit of 2.2 percent of payroll. In theory, this is the amount that Congress would have to raise taxes or cut benefits, starting now, to keep the Social Security trust funds solvent for the next seventy-five years. But there's a hitch. The 2.2 percent solution assumes that trust-fund surpluses accumulated today constitute real economic savings that can offset widening trust-fund deficits incurred tomorrow. They don't.

What matters is not Social Security's actuarial balance, but its annual cost--and the growth in that cost will be anything but modest. According to the Trustees' official intermediate projection, the cost of Social Security will grow from 11.2 to 18.1 percent of workers' taxable wages by 2040, or by 6.9 percent of payroll. And this is probably a best-case scenario, since the official projection is based on demographic and economic assumptions that, on balance, seem quite optimistic:

  • Longevity. The Trustees assume that elder longevity, which determines the number of years Social Security benefits are collected, will grow at less than half the rate of the past twenty-five years. Most demographers, including those at the Census Bureau, believe that this assumption is too conservative. It implies, for instance, that U.S. life expectancy a half-century from now will be no greater than it already is in Japan today.
  • Productivity. The Trustees assume that productivity, which determines taxable wages per worker, will grow at a rate one-quarter faster than its recent historical average. Implausibly, this is assumed to happen despite the resurgent budget deficits, declining household savings, and global capital shortages that will accompany the aging of America and the developed world.
  • Fertility. The Trustees assume that the U.S. fertility rate, which determines the number of future workers available to support Social Security, will never drop beneath 1.9. A reasonable assumption? Perhaps. But it's worth noting that the average fertility rate in the developed world has already dropped to 1.6; in several countries, including Italy and Spain, it has dropped to 1.2.
  • Immigration. The Trustees assume that immigration, the other factor determining the size of tomorrow's workforce, will continue at today's level. Since at least one-third of today's immigration is illegal, the Trustees are banking on the continued arrival of 300,000 illegal immigrants annually--even as other federal agencies are urgently trying to shut the inflow down.

How much could Social Security's cost rise if the official optimism proves unfounded? It happens that the Trustees also publish a so-called high-cost scenario based on more prudent demographic and economic assumptions. Under this scenario, the cost of Social Security is projected to grow to 22.7 percent of workers' taxable wages by 2040--or by 11.5 percent of payroll.

Graying Means Paying

Social Security, of course, isn't the only program whose cost is due to rise as America's population ages. Graying means paying--not just for pensions, but for doctors, for hospitals, and for nursing homes. Under the Trustees' intermediate scenario, the cost of just the three major senior entitlements--Social Security, Medicare, and Medicaid for the elderly--is projected to reach 35 percent of payroll by 2040. Under the high-cost scenario, it is projected to reach 55 percent of payroll.

Clearly, both of these projections are unsustainable. Paying for the rising cost of senior entitlements would, under the intermediate scenario, wipe out most of the growth in real after-tax worker earnings over the next half-century. Under the high-cost scenario, real after-tax earnings would suffer a catastrophic decline. The status quoists refuse to confront the cost of the age wave in its totality. They argue instead that every senior entitlement should be regarded as a separate "deal"--regardless of whatever else is going on fiscally and economically. Thus is Social Security deemed to be "affordable."

The status quoists are right that the cost of Medicare and Medicaid is projected to rise faster than that of Social Security. But this faster growth merely makes achieving savings in Social Security more urgent.

Not Since Herbert Hoover

It is nonsense to claim that today's more favorable budget outlook makes preparing for the age wave less urgent. True, the CBO and GAO now project that the federal budget will run surpluses through about the year 2015--and OMB projects that the budget will remain in balance even longer. But these projections count on enormous future savings that Congress has yet to enact--and indeed, has no idea how to achieve.

Consider spending on health-benefit programs. Since the early 1970s, real per-beneficiary Medicare costs have grown at the blistering rate of 5 percent per year; in no five-year period have they grown at less than 3 percent per year. Yet the official budget projections assume that this growth will slow all the way to 1 percent per year by the 2020s. As the CBO nicely understates it, "That assumption is optimistic... since policies designed to achieve that result are not yet in place." Yet without that assumption, Medicare would by 2040 cost more than twice as much as the official projections.

Or consider spending on discretionary programs. Based on current spending caps, the official projections assume real-dollar cuts totaling 9 percent from now to 2002. Even the staunchest advocates of small government are hard-pressed to say how exactly these cuts are to be made. But no matter. Congress votes on appropriations only for the coming fiscal year. Beyond that, the projections can count mere wishes as savings.

The long-term projections are even more fanciful. The CBO assumes that discretionary spending will decline as a share of GDP throughout the next decade--and OMB assumes it will continue to decline throughout the next century. In the OMB projections, total discretionary spending--everything from defense to education to infrastructure--withers to just 2.8 percent of GDP by the year 2050, down from 11.3 percent in 1965 and 6.6 percent this year. That's less than one-sixth of the 18.4 percent of GDP the same projections say the budget will then be spending on benefits to individuals. In effect, we will have repealed general-purpose government to accommodate the rising cost of senior entitlements.

Not since Herbert Hoover has discretionary spending fallen to the levels projected by the White House for the next century. Even supposing that no new domestic challenges will demand new public resources, can we make the same assumption about foreign challenges?

The Specter of the Age Wave

The developed world of the next century will be comprised of societies much older than any we have ever known or imagined. By the 2030s, unless fertility rises, some European countries will exceed a median age of 55, twenty years older than the oldest median age of any country on earth as recently as 1970.

This demographic transformation will not pass us by. Today, with Boomers swelling the ranks of taxpaying workers, the specter of the age wave seems remote. But as Boomers start retiring a decade from now, the gray tsunami will hit full force. It's indeed time to take an unflinching look at the shape of things to come--and to begin designing a retirement system that is both more secure for the old and less burdensome for the young.