Privatizing Social Security

Studies | Social Security

No. 217
Wednesday, July 01, 1998
by Laurence J. Kotlikoff

Our Economy Is Being Jeopardized

The decades-long policy of "pass-the-generational-buck" that threatens our children's livelihoods also has adversely affected our economy.

Subsidizing elderly consumption. In taking from the young and giving to the old, the government has been taking from savers and giving to spenders. In the process, it has engineered an enormous increase in the absolute and relative consumption of the elderly. Today's typical 70 year-old consumes roughly 40 percent more than today's typical 30 year-old. Back in 1960 these figures were reversed.

"The average 20-year-old female can expect to pay $115,000 over and above benefits received."

The elderly are big spenders compared to the young for a simple reason: they have fewer years left over which to spread their assets. This encourages them to spend a bigger fraction of any dollar they have on immediate consumption. Indeed, research I coauthored indicated that the fraction of each additional dollar spent on consumption by older Americans is roughly twice that of younger ones.5

The consumption propensities of older Americans are also larger than those of Americans not yet born, since their propensity to consume in the present is obviously zero. When the government makes a transfer to the current elderly and forces those not yet born to pay for it by paying interest on explicit debt or paying payroll taxes to pay-as-you-go-financed social insurance schemes, it engineers an unambiguous immediate increase in aggregate consumption, since the consumption of the current elderly goes up and that of future generations remains at zero.

"The increase in consumption by the elderly has raised national consumption and lowered national saving."

Reducing national saving and investment. The increase over the last few decades in the absolute and relative consumption by the elderly has raised national consumption and lowered national saving. Since national saving finances domestic investment, domestic investment has fallen as well. To be precise, national saving and domestic investment rates today are roughly half of their levels in the 1950s and 1960s. The domestic investment rate indicates the speed at which we add to the stock of computers, machines, factories, and other tools that make workers more productive. Domestic investment is also a critically important mechanism for introducing new technology. Together the capital stock and the state of our technology determine workers' productivity. Workers' productivity, in turn, is the main determinant of their real wages.

Hence, in financing a consumption binge by the elderly, the government has reduced not only saving and investment, but also labor productivity and the growth of real wages. Although labor productivity and real wage growth have improved in the last couple of years, since the early 1970s they have been growing at roughly one-third the rate observed in the 1950s and 1960s.

Prospects for the future. Unfortunately, the long-run prospects for our economy are bleak. If we don't get Social Security, Medicare and the rest of our fiscal house in order very soon, we'll end up with payroll tax rates of 35 percent or more and even higher federal income tax rates than those we now face. When tax rates get too high, people will stop working and saving, and output will stop growing. The government will find it cannot collect the taxes it needs to pay its bills and will resort to printing money. This will cause inflation and all of its attendant problems, including high interest rates and a weak currency. The resulting stagflation could linger for decades until some devastating economic event, like hyperinflation, wipes out the government's explicit or implicit liabilities.

This augury will seem overly pessimistic only to those unfamiliar with the degree to which retrograde government policies have undermined economies in Latin America, the former Soviet Union, Africa and other regions of the world.

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