Is War Between Generations Inevitable?
Friday, November 30, 2001
by Jagadeesh Gokhale and Laurence J. Kotlikoff
Table of Contents
- Executive Summary
- The Perfect Fiscal Storm
- What Color Is the Ink?
- The CBO's Fiscal Fantasy
- A Spending Reality Check
- Social Security's Long-Term Funding Shortfall
- How Valid Are the Social Security Trustees' Future Projections?
- Medicare's Long-Term Funding Imbalance
- Are Medicare's Trustees To Be Trusted?
- Social Security's and Medicare's Long-Term Finances: A Summary
- Generational Accounting
- Taking a Closer Look at Generational Accounts
- Policies to Achieve Generational Equity
- About the Authors
In less than a decade, members of the baby boom generation will begin reaching their retirement years. At that time, 77 million people will begin to leave the labor market. They will cease to be taxpayers and begin to receive Social Security and Medicare benefits. This will mark the beginning of an enormous conflict over resources. Indeed, it is probably no exaggeration to say that we are approaching generational warfare.
By the year 2030 - the midpoint of the baby boomer retirement years - the cost of elderly entitlement programs will be about double what it is today, relative to the national income. That means we will either have to double the payroll tax rate (currently 15.3 percent) or cut every benefit in half. If politicians refuse either to raise taxes or cut benefits, they will be forced to borrow - piling up a debt that will escalate each year. Beyond 2030, the financial crisis will continue to worsen indefinitely.
One way to appreciate the emerging conflict of economic interests is to compare the young and the old today. Seniors can forget about past taxes, since those are sunk costs. From here on out, they will receive far more benefits from government transfer programs (programs that redistribute resources among groups) than their share of the national tax burden. On average:
- A male reaching 65 years of age today can expect to receive $71,000 more in government "transfer" benefits (of all kinds at both the federal and state levels, but mainly from Social Security and Medicare) than he will pay in taxes (of all kinds at both the federal and state levels) before he dies.
- A 65-year-old female can expect a net gain of more than twice that amount; she can expect $163,000 more in benefits than she will pay in taxes.
Small wonder that seniors continue to push for an expansion of the Social Security and Medicare programs!
A far different picture confronts people entering the labor market today. In general, they will pay far more in taxes than they will receive from transfer programs, and any expansion of elderly entitlements will make things worse. For example:
- A 20-year-old female can expect to pay $92,000 more in taxes than she will receive in transfer benefits over her lifetime.
- The future looks more than three times as bleak for her male cohort, who can expect to pay $312,000 more in taxes than he will ever receive in benefits.
The technique of measuring the expected taxes each age group will pay net of transfer benefits they can expect to receive is called generational accounting. These generational accounts measure how much each group is contributing to the cost of government. For example:
- An American born today can expect to pay 17.7 percent of his or her lifetime income over and above any transfer benefits he will receive.
- Bad as that may seem, the burden will be much worse for those born in the future.
- Grouping together all Americans not yet born, future generations can expect to pay 35.8 percent of their income over and above any transfer benefits - more than twice the tax rate today's newborns will face.
These numbers reflect current policies that are designed to shift the cost of benefits from Americans now living to those not yet born. Despite the current focus on government surpluses, elderly entitlement programs are generating a huge implicit debt that future generations will have to pay off. Put another way, we are borrowing from our grandchildren and their children without their consent.
What will happen if we do nothing, if we do not change tax rates or benefits? The burden awaiting future taxpayers will grow rapidly. For example:
- If there is no change in elderly entitlement programs for the next 5 years, the net tax burden on all future generations combined will climb to 40 percent of their lifetime income.
- With no change in policy for 10 years, the lifetime net tax rate for future generations will reach 46 percent.
- After 20 years of no change in policy, future taxpayers will face lifetime tax rates of 63 percent.
Clearly, we are on an unsustainable path.
So what can we do? We can and must act immediately to correct the long-term funding crisis in Social Security and Medicare. Although the Social Security and Medicare trustees say the two programs are underfunded by about 3.3 percent of payroll, the situation is actually about three times worse. Indeed:
- We need an immediate and permanent increase in saving and investment equal to 10 percent of payroll.
- These funds need to be invested in interest-earning assets that can be sold in future years to pay benefits.
- The government can't use the presence of these funds (the fact that there would be a larger surplus) as an excuse to increase its purchases, raise Social Security or other benefit payments or cut other taxes.
Are there other ways to achieve generational equity that don't involve raising payroll taxes? Yes, but they are no less unpleasant. Specifically, generational equity could be achieved by:
- Increasing federal income taxes by 68 percent or all (federal and state) taxes by 25 percent and investing the additional proceeds!
- Cutting by 44 percent government transfer payments, including Medicaid, food stamps and welfare, in addition to Social Security and Medicare!
Such draconian measures are unlikely to be adopted. Yet the numbers illustrate the extent to which the benefits elders enjoy today will have to be paid for by people not yet born.