Is War Between Generations Inevitable?

Studies | Social Security

No. 246
Friday, November 30, 2001
by Jagadeesh Gokhale and Laurence J. Kotlikoff


Social Security's and Medicare's Long-Term Finances: A Summary

"By 2030 we will have to double the payroll tax rate, cut every benefit in half - or borrow and pile up debt."

The combined employer-employee OASDHI payroll tax rate is now 15.3 percent. Adding to this the 6.0 and 4.1 percent additional saving and investment that is needed to secure Social Security's and Medicare's finances brings the total required contribution to 25.4 percent.6 This calculation illustrates the magnitude of the fiscal burden facing current and future workers. Further, saving and investing an additional 10 percent of labor income will suffice to correct the Social Security system's long-term imbalances only if implemented immediately. Any delay will necessitate even higher rates in the future if benefits are to be paid in full.

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 current 15.3 percent payroll tax rate or cut every benefit in half. If politicians refuse either to raise taxes or cut benefits, they will be forced to borrow - piling up debt that will escalate each year. Beyond 2030, the financial crisis will worsen indefinitely.

American workers already face high marginal tax rates. Indeed, when one factors in payroll taxes, federal income taxes, the implicit marginal taxation of the earned income tax credit, state income taxes, local wage taxes, state sales taxes, federal excise taxes and other features of our tax-transfer system, it is hard to find any workers who don't surrender 50 cents or more of each dollar earned to government, either when they receive the dollar or when they spend it. Putting American workers into marginal tax brackets that are 10 to 15 percentage points higher will substantially reduce their incentives to work. It will also dramatically increase the economic distortions arising from the tax system, since these distortions grow with the square of total effective tax rates on labor supply and saving.

To sum up, the Social Security system has only about three-fifths of the long-term revenues it needs to pay its bills. Getting the remaining two-fifths through higher taxation would seriously impair the operation of our economy, not to mention the well being of today's and tomorrow's workers. But are such draconian tax hikes or huge future benefit cuts really needed? Or can Social Security and Medicare be rescued by the rest of the government's operations? Answering this question requires putting all of the government's fiscal activities on an equal footing. This is one of the objectives of generational accounting.


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