June 2004
The Coming Generational Storm: What You Need to Know About America’s Economic Future, Laurence J. Kotlikoff and Scott Burns, MIT Press (2004).
Per the authors (who base their findings on Government projections), the present value of unfunded future liabilities for Social Security and Medicare is $45 trillion (some nine times the size of our “National debt”). The reasons: longer human life spans due to advances in medical science, retirement of the baby boomers, and the disconnect between the consumption of medical services and the responsibility for paying for them.
Drastic action would be required to close the gap. Thus, the authors say, we could immediately increase federal income taxes by 69%, increase payroll taxes by 95%, or cut Social Security and Medicare benefits by 45%. We could make even more drastic adjustments in a few years. Or, we could do nothing and let the U.S. economy go into a meltdown with double-digit inflation fueled by the Government printing money.
Our political leaders are trying to ignore the problem, and, as Kotlikoff and Burns explain, the fault is ours. “The last thing we want is Uncle Sam telling us to save now for a tidal wave of obligations when the baby boomers retire. So we make sure that doesn’t happen. We hire [elect?] politicians who tell us what we want to hear.”
The authors go on to present a plan for reform, but they don’t expect their plan (or other reforms that could save the system) to be enacted. They end with advice as to how to look after yourself and your family if the politicians in Washington “miss this opportunity to save our ship of state.”
Laurence J. Kotlikoff is Professor of Economics at Boston University and a Research Associate at the National Bureau of Economic Research. Dallas Morning News personal finance columnist Scott Burns is nationally syndicated by Universal Press.
Even if Kotlikoff and Burns don’t have all the answers (we at SAFE think there are better approaches than their plan), they have diagnosed the problem very well. Moreover, The Coming Generational Storm is entertainingly written and refreshingly nonpartisan (lambasting both Republicans and Democrats with vigor). Don’t miss it.
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On November 12, 2004, Professor Laurence Kotlikoff spoke to a packed seminar room in Purnell Hall at the University of Delaware. He is a mild-mannered man, probably in his 50s, with very short hair. Instead of PowerPoint slides, he jotted a few notes on the blackboard. Mostly he just talked, alternating between sitting on top of a strategically placed table and walking around. The audience (mainly students) listened raptly for an hour – he comes across as smart, calm and believable – and then engaged him in a question and answer session.
The problem: Government spending has ratcheted up, taxes have been cut, and our senior entitlement programs (Social Security, Medicare & Medicaid) will explode because the baby boomers are about to start retiring and people will be living longer and longer. We face a fiscal gap of $51 trillion (including $6 trillion for the recently enacted prescription drug benefit for Medicare). Never mind that the Federal debt in outside hands is less than $5 trillion at this point, “our country is bankrupt right now.” Indeed, as Professor Kotlikoff sees it, we are in worse shape than Argentina. If the problem is allowed to continue, look for hyperinflation and a fiscal meltdown. It’s happened in many other countries, we are not immune.
The solution: Make me “President for a day,” says Kotlikoff, and here is how I would close the fiscal gap.
A. Replace Social Security payroll taxes with a Federal sales tax of 10-12%. Pay Social Security benefits accrued to date, no hardship for current retirees. Future Social Security accruals would go into individual accounts, with all account balances to be invested in a government-run global index fund. Cut fiscal gap by $5-10 trillion.
B. In lieu of Medicare and Medicaid, give everyone medical care vouchers (what our country can afford in the aggregate, not what is currently promised), and require them to use the vouchers to acquire health insurance from private companies. Tie voucher amounts to health of the individual, e.g., a healthy senior might get a $7K per year voucher while a senior with pancreatic cancer might get a $75K per year voucher. Cut fiscal gap by $20 trillion.
C. Repeal Bush income tax cuts, end “corporate welfare” spending, and trim other discretionary spending. Eliminate remainder of fiscal gap.
Maggie Thatcher forced the UK to bite the bullet in the 1970s, and now they don’t have a fiscal gap. We can do it too.
“How’s that,” Professor Kotlikoff asked as he invited Q&A, “for putting dismal back into the dismal science.”
Malthus was wrong, said one participant, so how do we know that you aren’t wrong too? Malthus assumed that the fertility rate would be maintained, representing a faulty assumption as to future human behavior. On the other hand, my analysis is based on the predictable aging of a population that is already living. OK, the fiscal gap could be resolved by euthanasia for senior citizens, but few of us would be willing to go along with that.
When will the fiscal meltdown start? That’s hard to predict, much as it is difficult to say when snow buildup on the upper slopes will create an avalanche. We can be sure, however, that a crisis is coming.
Since the problem has been in the making for 50 years or so, what’s the rush to do something now? The longer we wait, the more the fixes will hurt.
Why hasn’t Alan Greenspan spoken out like you have? If Greenspan told the full truth about this situation, there would probably be a crisis in the bond market tomorrow.
Can’t the advancing pace of technological change lead to faster economic growth, eliminating the problem? Not when Social Security benefits (pre-retirement accruals) are indexed to wage increases and health care benefits are growing even faster (in the last four years, Medicare expenditures grew 7 times faster than real wages!). We’ve run the numbers with higher economic growth assumptions, and they don’t look much better than the base case projection.
What are future workers going to do if their tax rates keep going up? Think about it. We’re going to have a predominantly Afro-American/Hispanic work force supporting seniors who are predominantly white, so the active workers won’t even be supporting their own parents. The social consequences could be nightmarish.
One thing is troublesome about Professor Kotlikoff’s analysis. Accepting that the fiscal gap is every bit as bad as he says, this problem was created by Government action. Why should we attempt to solve it by giving the Government even greater responsibilities, such as running the world’s largest index fund, assessing the health risks of every senior in the country, deciding how much our society needs to spend for health care, etc.? SAFE believes it would be better to move in the direction of less Government and let people make choices (such as how long should I work, what medical care do I and others in my family need, etc.) for themselves.