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The
Entitlement Debate
Brian
Trumbore
President/Editor, StocksandNews.com
Federal Reserve Chairman Ben Bernanke
has a reputation for plainspeak that his predecessor,
Alan Greenspan, was certainly not known for. So on
Wednesday, Oct. 4, Bernanke addressed the topic of
entitlements, the Baby Boomer generation, and the
coming crisis at a session of the Washington Economic
Club in Washington, D.C. Granted, this has not been
a market-moving subject over the years, and it's never
going to be one on any given day, week or even month.
But in the not-too-distant future it is likely to
begin eating away, bit by bit, and the Big Picture
outlook in terms of living standards, as Bernanke
addresses, is not a pretty one.
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"The
Coming Demographic Transition: Will We Treat Future
Generations Fairly?"
In
coming decades, many forces will shape our economy
and our society, but in all likelihood no single factor
will have as pervasive an effect as the aging of our
population. In 2008, as the first members of the baby-boom
generation reach the minimum age for receiving Social
Security benefits, there will be about five working-age
people (between the ages of twenty and sixty-four)
in the United States for each person aged sixty-five
and older, and those sixty-five and older will make
up about 12 percent of the U.S. population. Those
statistics are set to change rapidly, at least relative
to the speed with which one thinks of demographic
changes as usually taking place. For example, according
to the intermediate projections of the Social Security
Trustees, by 2030 - by which time most of the baby
boomers will have retired - the ratio of those of
working age to those sixty-five and older will have
fallen from five to about three. By that time, older
Americans will constitute about 19 percent of the
U.S. population, a greater share than of the population
of Florida today.
This
coming demographic transition is the result both of
the reduction in fertility that followed the post-World
War II baby boom and of ongoing increases in life
expectancy. Although demographers expect U.S. fertility
rates to remain close to current levels for the foreseeable
future, life expectancy is projected to continue rising.
As a consequence, the anticipated increase in the
share of the population aged sixty-five or older is
not simply the result of the retirement of the baby
bombers; the "pig in a python" image often used to
describe the effects of that generation on U.S. demographics
is misleading. Instead, over the next few decades
the U.S. population is expected to become progressively
older and remain so, even as the baby-boom generation
passes from the scene. As you may know, population
aging is also occurring in many other countries. Indeed,
many of these countries are further along than the
United States in this process and have already begun
to experience more fully some of its social and economic
implications.
Even
a practitioner of the dismal science like me would
find it difficult to describe increasing life expectancy
as bad news. Longer, healthier lives will provide
many benefits for individuals, families, and society
as a whole. However, an aging population also creates
some important economic challenges. For example, many
observers have noted the difficult choices that aging
will create for fiscal policy makers in the years
to come, and I will briefly note some of those budgetary
issues today. But the implications of demographic
change can also be viewed from a broader economic
perspective. As I will discuss, the broader perspective
shows clearly that adequate preparation for the coming
demographic transition may well involve significant
adjustments in our patterns of consumption, work effort,
and saving. Ultimately, the extent of these adjustments
depends on how we choose - either explicitly or implicitly
- to distribute the economic burdens of the aging
of our population across generations. Inherent in
that choice are questions of intergenerational equity
and economic efficiency, questions that are difficult
to answer definitely but are nonetheless among the
most critical that we face as a nation?..
Although
demographic change will affect many aspects of the
government's budget, the most dramatic effects will
be seen in the Social Security and Medicare programs,
which provide income support and medical care for
retirees and which have until now been funded largely
on a pay-as-you-go basis. Under current law, spending
on these two programs alone will increase from about
7 percent of the U.S. gross domestic product (GDP)
today to almost 13 percent of GDP by 2030 and to more
than 15 percent of the nation's output by 2050. The
outlook for Medicare is particularly sobering because
it reflects not only an increasing number of retirees
but also the expectation that Medicare expenditures
per beneficiary will continue to rise faster than
per capita GDP. For example, the Medicare trustees'
intermediate projections have Medicare spending growing
from about 3 percent of GDP today to about 9 percent
in 2050 - a larger share of national output than is
currently devoted to Social Security and Medicare
together.
The
fiscal consequences of these trends are large and
unavoidable. As the population ages, the nation will
have to choose among higher taxes, less non-entitlement
spending, a reduction in outlays for entitlement programs,
a sharply higher budget deficit, or some combination
thereof. To get a sense of the magnitudes involved,
suppose that we tried to finance projected entitlement
spending entirely by revenue increases. In that case,
the taxes collected by the federal government would
have to rise from about 18 percent of GDP today to
about 24 percent of GDP in 2030, an increase of one-third
in the tax burden over the next twenty-five years,
with more increases to follow. Alternatively, financing
the projected increase in entitlement spending entirely
by reducing outlays in other areas would require that
spending for programs other than Medicare and Social
Security be cut by about half, relative to GDP, from
its current value of 12 percent of GDP today to about
6 percent of GDP by 2030. In today's terms, this action
would be equivalent to a budget cut of approximately
$700 billion in non- entitlement spending.
Besides
tax increases, spending cuts, or reform of the major
entitlement programs, the fourth possible fiscal response
to population aging is to accommodate a portion of
rising entitlement obligations through increases in
the federal budget deficit?.Consequently, the choices
that fiscal policy makers make with respect to these
programs will be a crucial determinant of the way
the economic burden of an aging population is distributed
between the current generation and the generations
that will follow.
Indeed,
framing the issue in generational terms highlights
the fact that the economic implications of the coming
demographic transition go well beyond standard considerations
of fiscal policy and government finance, important
as those are. For reasons that I will explain in a
moment, the aging of the population is likely to lead
to lower average living standards than those that
would have been experienced without this demographic
change. How that burden of lower living standards
is divided between the present and the future has
important implications for both intergenerational
fairness and economic efficiency.
Why
will the coming demographic transition carry a cost
in terms of long-run living standards? Assuming it
unfolds as expected, the projected aging of the population
implies a decline over time in the share of the overall
population that is of working age and thus, presumably,
in the share of the population that is employed. For
any given level of output 'per worker' that might
be attained at some future date, this decline in the
share of people working implies that the level of
output 'per person' must be lower than it otherwise
would have been. In a sense, each worker's output
will have to be shared among more people. Thus, all
else being the same, the expected decline in labor
force participation will reduce per capita real GDP
and thus per capita consumption relative to what they
would have been without population aging. These reductions
in output and consumption per person represent an
economic burden created by the demographic transition?.
[Ed.
Bernanke then talks about solutions, including finding
ways to increase the national saving rate.]
However,
as any economist will tell you, there is no such thing
as a free lunch. Saving more requires that we consume
less (to free up the needed resources) or work more
(to increase the amount of output available to dedicate
to such activities). Either case entails some sacrifice
on the part of the current generation. Consequently,
a tradeoff exists: We can mitigate the adverse effect
of the aging population on future generations but
only by foregoing consumption or leisure today. This
analysis is simple, but it shows why the coming demographic
transition has economic implications that go well
beyond the effect of aging on the federal budget?.
If
we don't begin soon to provide for the coming demographic
transition, the relative burden on future generations
may be significantly greater than it otherwise could
have been?.
The
choice of which generations should bear the burden
of population aging has consequences for economic
efficiency as well as for intergenerational equity.
If we decide to pass the burden on to future generations
- that is, if we neither increase saving now nor reduce
the benefits to be paid in the future by Social Security
and Medicare - then the children and grandchildren
of the baby boomers are likely to face much higher
tax rates. A large increase in tax rates would surely
have adverse effects on a wide range of economic incentives,
including the incentives to work and save, which would
hamper economic performance. Alternatively, to avoid
large tax increases, the government could decide to
sharply reduce non-entitlement spending in the future.
However, such actions might also have important social
costs that need to be taken into consideration.
[Ed.
Back to the topic of saving?]
Unfortunately,
many years of concentrated attention on this issue
by policymakers and economists have failed to uncover
a silver bullet for increasing household saving. One
promising area that deserves more attention is financial
education. The Federal Reserve has actively supported
such efforts, which may be useful in helping people
understand the importance of saving and to learn about
alternative saving vehicles. Psychologists have also
studied how the framing of alternatives affects people's
saving decisions. For example, studies suggest that
employees are much more likely to participate in 401(k)
retirement plans at work if they are enrolled automatically
- with a choice to opt out - rather than being required
to actively choose to join. The pension bill recently
passed by Congress and signed by the President included
provisions to increase employers' incentives to adopt
such opt-out rules; it will be interesting to see
whether such rules are adopted and, if so, how effective
they are in promoting employee saving?.
Another
response to population aging is to adopt measures
that encourage participation in the labor force, particularly
among older workers. In the near term, increases in
labor force participation would raise income; some
of this income would be saved and would thus be available
to augment the capital stock. In the long run, higher
rates of labor force participation, particularly by
those who would otherwise be in retirement, could
help to offset the negative effect of population aging
on the share of the population that is working?.
Reform
of our unsustainable entitlement programs should also
be a priority. The nature and timing of those reforms
will be determined, of course, by our elected representatives.
However, the intergenerational perspective does provide
a few insights that might be helpful to policymakers
as they undertake the needed reforms. First, restructuring
the finances of our entitlement programs to minimize
their reliance on deficit spending will enhance national
saving and reduce the burden on future generations.
Second, changes in the structure of entitlement programs
should preserve or enhance the incentives to work
and to save; for example, we should take care that
benefits rules do not penalize those who may wish
to work part-time after retirement. Finally, the imperative
to undertake reform earlier rather than later is great.
As illustrated by the simulation I discussed earlier,
the longer the delay in putting our entitlement programs
on a sound fiscal footing, the heavier the burden
that will be passed on to future generations. Moreover,
the sooner any restructuring of entitlement programs
takes place, the easier it will be for people now
in their working years to prepare, for example, by
saving more today. However, if reform is delayed and
fiscal exigencies ultimately force changes in these
programs with little notice to potential retirees,
their ability to adjust their behavior appropriately
could be much reduced?.
(The)
coming demographic transition will create severe fiscal
challenges, as the cost of entitlement programs rises
sharply. I hope to have persuaded you today, however,
that the economic implications of this transition
go well beyond fiscal policy. From a broader economic
perspective, the question is how the burden of an
aging population is to be shared between our generation
and the generations that will follow us. A failure
on our part to prepare for demographic change will
have substantial adverse effects on the economic welfare
of our children and grandchildren and on the long-run
productive potential of the U.S. economy.
---
Source:
federalreserve.gov
Wall
Street History returns next week?the European Union.
Brian
Trumbore
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