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
How Valid Are the Social Security Trustees' Future Projections?
A 38 percent increase in worker contributions - even if saved and invested - most likely will not suffice to address Social Security's problems. The 38 percent figure is computed using the actuaries' intermediate economic and demographic assumptions. But the "intermediate" nature of these assumptions is questioned by top economists and demographers. Indeed, the Social Security Advisory Board's 1999 Technical Panel recommended changes in the assumed intermediate rates of increase in life expectancy, real wage growth and interest on government securities.
The most important of these changes involves projections of lifespan extension. The Technical Panel recommended a four-year increase in the life expectancy used in the actuaries' intermediate assumptions. In demographic terms, four years is a huge increase. In advocating this increase, the Technical Panel pointed out that the actuaries were assuming it would take Americans 50 years to start living as long as the Japanese currently live. The Social Security trustees paid mostly lip service to the Technical Panel's recommendation. They too are under political pressure to make the system look good. Consequently, they raised life expectancy assumption by only one year.
Overly optimistic Social Security forecasting is not new. As just indicated, from the perspective of 1983, only about a third of the current 75-year OASDI funding shortfall is due to the truncation of the projection horizon. The remaining two-thirds is divided roughly evenly between overoptimistic economic and demographic assumptions and methodological mistakes in forecasting.
"Social Security is short 40 percent of the funds needed to avoid substantial benefit cuts."
Taken together, the Technical Panel's recommended assumptions raise the increase needed to achieve true long-run solvency from 4.7 to almost 6 percent of payroll. Given the current 12.4 percent OASDI tax rate, this means workers should be saving and investing 50 percent more! If one assumes that the Social Security Trust Fund is available to pay benefits, the system has only about 60 percent of the current and future resources it needs to continue paying benefits through time. Stated differently, Social Security is short 40 percent of the funds it needs if we are to avoid substantial benefit cuts.
However, the Trust Fund's assets are liabilities of the U.S. Treasury. So Trust Fund "assets" can be used to pay benefits only if the government raises other tax rates. If one believes that every dollar of assets accumulated in the Social Security Trust Fund has led, on balance, to an extra dollar of debt owed by the Treasury, one could argue that Social Security has no real assets and is actually 50 percent broke rather than 40 percent broke. We will return to this issue later.