NCPA - National Center for Policy Analysis

Generational Storm Brewing For Medicare (and Social Security)

April 16, 2002

Official predictions convey the idea that U.S. fiscal policy will have no difficulties coping with an aging population.

But a closer look at these predictions shows that they are too optimistic. According to economist Laurence Kotlikoff of Boston University, the government will have to raise taxes significantly and borrow beyond its means to deal with the retirement of 77 million Baby Boomers over the next decades. Both Social Security and Medicare will face financial problems that are three times larger than official estimates, says Kotlikoff.

  • Kotlikoff estimates the shortfall in Social Security will be 40 percent, assuming benefits are not cut.
  • In order to make the system solvent, the Social Security tax rate will have to be raised 6 percentage points.
  • Balancing Medicare would require a steep tax rate increase, more than doubling from the current 3 percent of wages to 7 percent.

The best solution would be to privatize Social Security. This would involve going from the current pay-as-you go system, which involves transferring income (contributions to the system) of current workers to current retirees, to a capitalization system, where each worker makes contributions to an account on which he draws once he retires. But Kotlikoff argues that politicians are not likely to undertake this reform, since it would involve paying out current retirees out of other fiscal resources.

The best way Americans can protect themselves from future problems with the Social Security system is, according to Kotlikoff, to save more today.

Source: "Deficit Delusions and Fiscal Fantasies," Economic Intuition, Summer 2001; based on Laurence J. Kotlikoff, "The Coming Generational Storm," Working Paper.

 

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