"Should We Increase the National Savings Rate – YES"

By Ben Russell

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The age structure in the United States is significantly changing. With fertility rates declining and life expectancy increasing, the average age of Americans has increased by 4.5 years since 1970. This change has not had a major economic impact on this country as of yet, but soon enough it will. Social insurance programs for the elderly are one of the most cherished government aides this country offers. However, with the current budget of programs such as social security and medicare, the immense elderly population of the future will not be able to reap the benefits these programs are intended to provide. The Baby Boomer generation, which is the main factor in our increasingly older population, will begin to retire around 2010 and the aged dependency ratio will drastically rise. When this happens, changes will have to be made in order to provide for them the government assistance they are expecting. Gary Burtless examines this dilemma in his article, "The Fiscal Challenge of an Aging Population." In this article, he lays out the problems foreseen in the future and solutions that can be administered now in order to uphold the social insurance programs this country so heavily depends on.

There are huge fiscal implications on the government with an aging population. In 1990, federal spending on the elderly exceeded $350 billion, accounting for more than 28 percent of the government budget. Only thirty years ago, less than 16 percent of government spending was put towards programs for the elderly. There are two main factors that help to determine the future of public spending on the elderly. The first is the growth rate of the elderly. This can be predicted with a high degree of confidence, since it is known how many citizens will reach the dependency age of 65 every year. The second determinant is the amount of spending that each beneficiary will receive. This is much harder to predict since the cost of medical help cannot be forecasted very far into the future. However, with the increasing costs of medical assistance and the growing dependency ratio is this country, it is highly unlikely that the government will be able to keep up with the current levels of support.

The actuaries of the social security and medicare programs prepare the most detailed predictions of future spending on the elderly. These projections are based on the size and age of the beneficiary population, average benefit rates and taxable payrolls. The amount of social security paid out generally corresponds with the trend of future dependency ratios while medicare spending increases with the increase in medical care costs. It can be seen that over the next two decades that the major increase in spending on social insurance programs for the elderly is a direct result of medical care cost inflation and not population aging. When Baby Boomers begin to retire in 2010 however, there will be an drastic acceleration in the amount of government spending due to the severe increase in the over 65 population. Their predictions state that by 2035, spending on the elderly will be above 40 percent of GNP, a jump of 25 percent since the mid-80’s.

Even though the costs of social insurance programs are increasing at an alarming rate, there is certainly no lack of public popularity. The payroll tax, specifically designated and earmarked as such for social security, has more than doubled between 1965 and 1986. Still, 82 percent of adults express their approval of the taxes they pay. The age group of 18-34 year olds supports the level of taxes just as much as the 50-64 year olds. One justification that could be made for the surprisingly high level of consent is that the U.S. total spending on the elderly is still considerably lower than that of most well to do European countries.

One option that the government has rather than continually increasing their costs with the growing demand of old age support and rising medical care costs, is to curtail benefits. This can be done either by having tighter restrictions on who is considered eligible for old age insurance or by lowering the entitlements given to the beneficiaries. In order to determine the effectiveness of either of these alternatives, it is useful to break down the future increases in spending into the two aforementioned categories. The first is the effect of the aging population and the second is the effect of changes in the level of benefit generosity. In order to measure the effect of population aging, you must hold benefit generosity constant. In reverse, to determine the effect of relative benefit generosity you must hold the number of beneficiaries with respect to active workers at a constant.

Singling out Medicare, it can be predicted that spending for this program will increase from 2 percent of GNP in 1990 to almost 7% of GNP by 2040. Until 2005, the increase will solely be a result of escalating generosity as medical care costs continue to rise. If this country could some how restrain the rate of increase in medicare generosity, it would avoid more than 70% of the increase in medicare spending from 1990 to 2015. After 2015 however, all increases in medicare spending will be due to the rising age structure, which can obviously not be prevented as easily.

Examining the social security program, it is expected that average benefits are expected to decrease relative to output per worker. Reasons for this curtailment are two fold. The first has been decisions by the President and Congress in both 1977 and 1983 to cut future benefits. By the third decade of the 21st Century, benefits for the elderly will be 15 percent less than what they are today. The second reason is the continuing erosion in the taxable wage base of social security. This is due to compensation being received as untaxed benefits such as employer contributions to health and retirement funds. Looking at the difference between the two factors determining future government spending on social security, it can be seen that basically all increases in public spending are a result of the "graying" of the U.S. population. In the long run, the increases in benefit generosity in medicare will be offset by the decreases in benefit generosity in social security. Therefore, the more important factor determining future government costs is the effect of population aging.

In order to finance the insurance programs for the elderly in the future, predicted tax levels for the working class must exceed 30 percent. Problems in the short run can be avoided by containing the benefit levels of medicare. In the long run however, the only way to keep the system alive would be to reduce social security and medicare benefits to levels much less generous than today. One way to get around the problems associated with future cost increases would be to implement fiscal policies aimed at raising future GNP. Taxes could be raised to levels of 30% or higher if each worker was making double the income that they are now. Burtless feels that it is feasible to raise future incomes over the next few decades if the right changes in fiscal policy are made.

Right now, social security and medicare insurance collect more from payroll taxes than they have to pay out to retirees. This excess is placed in government trust funds as reserves earning interest. Essentially the government is buying treasury bills with its own money and then paying itself interest every year. The government does not need to sell treasury bills to the public now since it is raising enough money on its own. The public now has more money to invest in private businesses instead of lending their money to the government. This raises the capital stock in this country and gradually raises the GNP. The future incomes of Americans are thus increased. The economic pie is getting larger are there is more income to be shared with the elderly. With this increase in incomes, future retirees are more economically independent and will need less money from the government when it is their turn to collect old age insurance.

The insurance surpluses that the government collects are by no means insignificant and could certainly help to raise the GNP in this country. At its peak, annual surpluses will reach levels of nearly 1.5 percent of GNP. These surpluses will not last forever because when the Baby Boomers begin to collect social security and medicare, benefit payments will exceed the government income from taxes. The surpluses will however remain until around 2020 and this large potential source of saving must be acted upon. The burden plaguing future retirees can be avoided if the social security surpluses are utilized to raise national saving and investment.

There is one major problem with this plan. Right now, old age insurance surpluses are being used to finance current operations of the U.S. government. The government has huge deficits in non-social security budget accounts and is utilizing the extra money from social security funds to finance those budgets. In order for Burtless’s plan to work, the government must achieve smaller or even negligible deficits in other areas of their budget outside of social security. They cannot plan on using the social security surplus to subsidize any deficits they are having in their budget. Only then could the insurance surpluses achieve the sought after result of raising the level of national saving.

The one argument that could be made against this plan to raise the national savings rate and subsequently GNP is that initially consumption will decline. The savings rate can only be increased at the expense of the current consumption rate. However, levels of consumption will increase in the future once the GNP begins to rise with the increased capital stock and private investments taking place. This short run sacrifice is difficult for politicians to recommend because it is the current workers and taxpayers who will suffer, and those who are going to benefit from this plan are not yet able to vote.

There are two main ways to deal with the future predicament in the social security system. The first would be to plan ahead and administer the program laid out by Burtless in which current surplus from old age insurance is used to increase the national savings rate and capital stock in this country and thus raise GNP. The other plan would be a pay-as-you-go program where no policy change would be made until the social security budget could no longer provide sufficient funds to the elderly. At that point, either taxes would be significantly raised or a process of curtailment including eligibility restrictions or cost containment would have to be implemented. These two programs have significantly different outcomes in both the short run and long run and have been the cause of series controversy and debate amongst both economists and politicians.

In the short run, there is an obvious argument for the pay-as-you-go program for old age insurance. There would be no tax increases in the near future and the consumption level of consumers would remain at a constant level. Many Americans fear making changes in fiscal policy when there is no immediate problem at hand. In the long run however, this country will be much better off and our social security system will be stronger than ever if we are able to increase the national savings rate now raising the GNP. Adopting a partial advance funding of social insurance programs for the elderly and utilizing the remaining surplus to increase the national savings rate will save this countries’ social security and medicare programs for future generations.