The graying budget
Several years ago at a speech in New York, I warned that “a future President Clinton or McCain would face a daunting budget challenge from population aging.” My political forecast was off, but my economic and demographic forecast is unchanged.
It is a well-known demographic fact that societies around the world are aging. It is not just a U.S. phenomenon (the impact is somewhat muted here by immigration) or a developed-world phenomenon. Even countries like Mexico and China are facing rapidly graying populations. Some demographers have suggested that the global population will reach an historic first in the current century: The proportion who are elderly is expected to exceed the proportion who are young.
Global aging has a fiscal impact, and there is no better demonstration of that than in the current U.S. budget outlook (see table below). Over the next 10 years, the federal government’s revenue is expected to grow by an additional $2 trillion. That growth in revenue will be entirely offset by additional Social Security and Medicare expenses (an increase of a half-trillion dollars each), growth in Medicaid (a material portion of which will pay for long-term nursing-home costs for older Americans), and interest on the debt.
Source: White House Office of Management and Budget.
As a percent of the aggregate economy, the deficit will fall from 10.6% to 4.2% over the period. Yet the economic policy goal should be to balance huge deficit spending today—necessary to counteract the financial crisis and “Depression 2.0″—with budget surpluses in the future. This is impossible given the inexorable rise of spending on old-age programs. As you can see from the numbers, if there were no material growth in aging programs over the coming decade, the collective budget would be in surplus by 2020 (lower benefits growth would also reduce interest costs).
In the current budget debate, the deficit issue has been conflated with the financial crisis. If the financial crisis had occurred 20 or 30 years ago, it would likely have meant a onetime surge in deficits and debt, and a relatively minor aberration in the long-term growth path of the U.S. But the banking crisis came at precisely the worst time—just on the threshold of a large wave in government spending on old-age programs. Hence the stream of red ink.
The good news, I suppose, is that the U.S. is better off than other countries. In Europe, public pensions are higher and immigration rates lower. Birth rates in both regions for non-immigrants are roughly the same: at replacement rates; the main difference is that in the U.S., (mostly Hispanic) immigrants are having more children, easing the aging burden. (That is a quite different perspective on the merits of immigration: Young immigrants pay Social Security and Medicare taxes!) Intertwined with this, of course, is the secular increase in health care costs, in the U.S. and around the world.
The Obama administration has created a new commission to tackle the long-term budget issue. The options have been known for several decades and are clear: higher taxes, which of course weigh heavily on working-age families and hinder economic growth, or reduced benefits, which means a transfer of resources away from older Americans and an increase in economic insecurity in old age.
In the end, the debate will be over how many public resources should be devoted to the old-age population—a debate over how gray the budget should be as the population ages.
Note: The link to the White House website will open a new browser window. Vanguard accepts no responsibility for content on third-party websites.
I much more prefer to gray than the alternative.
So my suggestion is that the youngsters gut it up and pay more taxes.
Personally, I would prefer that these taxes be steeply graduated.
An added benefit of higher top brackets is that historically, the higher the top tax rates the more stable our economy.
The party will soon be over. Social security always was a type of pyramid scheme. Means testing will someday become necessary. Those with the means to support themselves will not get social security. Those who can’t support themselves will get some kind of “minimum existence” payment.
Have more babies…and fast.
So what is the author’s recommendation? And for the individual investor, what should we do to safeguard our assets as we approach retirement?
It seems that the more we expect from government the less we will get. There is a founding father statement that says “a government that is big enough to give you everything is a goverment big enough to take everything you have. I worked for a company that provided a pension. That pension would have provided more income then the social security that I receive. The private sector has the potential to provide more finacial security than government at a far lower cost. When have we ever had the government do something that didn’t cost far more than was projected? Government is vital for the national security of a country and that should be about the only thing they are to do.
I would like to see taxes greatly increased now, while many of us boomers are still working. After all, we’re currently paying historically low tax rates. Many businesses eliminated pensions and 401Ks were promoted as a substitute. What will happen to the value of these investments when we boomers stop contributing to our 401Ks (stop purchasing stock)? Also,
I would like for the U.S. to adopt a single-payer health care system. Businesses in the U.S. will eventually not be able to afford insurance subsides for employees if they are to remain competitive globally.
1. More babies are not the solution. There are too many of us now.
2. The table suggests growth in the U.S. economy. No one can guarantee growth.
3. The “Greatest Generation” has left a Greatest Debt. We should plan to pay over
a stated period. What should that be? 100 years? 50 years? 25 years?
4. No one trusts Washington to be fiscally responsible. We should publish a plan
for discharging our debt and tax ourselves to do so. We should index all loans,
debts, transactions to inflation. Washington is not going to do this; states can.
5. We should simplify the tax code to one page only. Someone threw the
moneychangers out of the temple. We can do the same, state by state.
6. Every industry can have 10 competitors by law. Some economy of scale will
be lost, and we will never have companies that are too big to fail. Start with
reform state by state.
7. States and large cities can medically self-insure via optional non-profit
companies for those citizens seeking such care. Medical records can use
simple formats such as WordPerfect or Word, with optional encryption
controlled by patients for privacy of genetic information etc.
Thank you. What do you predict will be the growth of the US economy needed to reduce our debt to 4.2% by 2020?
You are right. The demographics tell us we have a very serious problem. But your link to the White House version of the Federal budget deficit is sadly lacking to illustrate your point. Your suggested link for the Federal budget deficit presents an overly-rosy scenario; the annual Federal budget deficit is subject to manipulation and omissions and tells only a tiny piece of the total gross debt problem. Many items are missing, for example the funds expended for Fannie Mae (today I think I read the number is up to $145 billion). Missing are the looming entitlements.
For anyone who is interested, the 2005 The Coming Generational Storm, 2005, by Laurence J. Kotlikoff gives a good picture of the demographics and how this looming debt burden will affect our economy. Since 2005, the picture only looks worse.
Neither party is addressing the gross national debt or the additional entitlements.
Thank you.