Commentary

Averting War Between the Generations

This article originally appeared in The Trenton Times on November 26, 2002.
Republican legislators will soon wake up from the thrill of victory to the reality of the huge challenges ahead. They face a yawning budget deficit after unrestrained spending growth the past four years. They want to mold 170,000 workers into an efficient homeland security force and not just another bloated bureaucracy. And they have plans to reform the complex and inefficient tax code to spur renewed economic growth.

That’s the easy stuff. Looming on the horizon is the fiscal crisis that will be caused by the tidal wave of baby boomers that begins retiring later this decade. The number of elderly will grow by 84 percent by 2030, but the number of workers supporting them will grow by just 16 percent. The gray-haired army is increasing in numbers and consumption appetite. A few decades ago, 70-year-olds consumed one-third less than 30-year-olds, on average. They now consume one-fifth more. In fiscal 2003, retirees will gobble up $470 billion in Social Security benefits and $260 billion in Medicare benefits, or about $4,700 for every worker in the country.

Congress has known for years that Social Security and Medicare face financial crises as future benefits outstrip the ability of taxpayers to support them. But Congress has yet to enact reforms. Policymakers were lulled into a false sense of security during the late 1990s because the budget was balanced and entitlement spending growth slowed. Indeed, Congress had it easy last decade as tax revenues poured in and defense spending fell.

The salad days are over. The budget is again in deficit, the economy is stalled, and the entitlement crisis is set to begin in a few years. Social Security’s crisis actually begins in 2006 - not the more distant dates that relate to the meaningless “trust fund.” In that year, the program’s trustees project that Social Security costs will begin an inexorable climb upward from 10.5 percent of taxable wages to 17.8 percent by 2040. Medicare and Medicaid costs will grow even faster.

All in all, those three entitlement programs will double in cost as a percentage of gross domestic product by 2040. In today’s dollars, that 7 percent-point increase would cost taxpayers more than $700 billion a year. Imagine a mob of entitlement recipients arriving at a young worker’s front door demanding a $4,500 increase in annual tribute. Tomorrow’s workers will not just roll over, and we will be in the midst of a financial war between the generations. It wasn’t supposed to turn out that way. When President Lyndon Johnson signed Medicare into law in July 1965, he said that “no longer will young families see their own incomes, and their own hopes, eaten away simply because they are carrying out their deep moral obligations” to provide for their parents. But it is now clear that the flawed structure of Medicare and Social Security will severely eat away at the incomes of young families in coming years.

The good news is that we can avoid eating our young by the creation of individual savings accounts for Social Security and Medicare. The first step is to create higher levels of voluntary savings by liberalizing IRAs and medical savings accounts. The next step is to redirect payroll taxes into mandatory savings accounts for workers who opt out of the old systems. Future retirees would use their savings to purchase annuities and health insurance coverage from competing providers. The precise details of such plans can be adjusted as Americans gain experience with them. The important thing is that reform is started right away to avoid the huge tax increases or benefit cuts that are cooked into the current pay-as-you-go systems as the country ages.

Unfortunately, Congress is still in denial about the need for Medicare reform, and is planning to add a $300 billion prescription drug benefit without offsetting cost cuts elsewhere. By contrast, Social Security is ripe for real reform, and the Republicans with their majority have been thrust the responsibility of making it happen. Reform is a political challenge, but the political rewards are even greater considering that private accounts would give 155 million potential voters an option to gain more financial freedom and control. Franklin Delano Roosevelt gained great fame in the 20th century as the champion of Social Security. President Bush would gain no less fame by delivering on the promise of a savings-based Social Security system for the 21st century.

Chris Edwards is director of fiscal policy at the Cato Institute.