Dazzle Them with Demographics


The Coming Generational Storm: What You Need to Know About America’s Economic Future

274 pages, $27.95

Laurence Kotlikoff came to Texas in May, to speak to the graduating seniors in economics and to give a seminar at the department. After hearing him grimly forecast the impending bankruptcy of our government, I asked him how come the financial markets hadn’t noticed. Uncle Sam is still able to borrow for 20 years at a bit less than five percent. How come? Kotlikoff replied that the markets were crazy. Hubris is alive and well in economics.

The Coming Generational Storm, by Kotlikoff and financial journalist Scott Burns, comes endorsed by liberal and centrist academic economists, including Nobel Prize winners Dan McFadden and George Akerlof, the former chair of Clinton’s economic council Janet Yellen, and the financial economist Robert Shiller. The signature blurb, however, is by Peter G. Peterson, Secretary of Commerce in the Nixon administration and Wall Street’s leading Social Security Cassandra ever since. The world long ago ceased listening to Peterson, and he is obviously pleased to have a young ally with such impressive backing. It baffles me that the others could have read this book and still have said what they say.

You think I exaggerate? Read for yourself Kotlikoff’s prediction of life in these United States 26 years from now:

You see major tax evasion, high and rising rates of inflation, a growing underground economy, a rapidly depreciating currency, and more people exiting than entering the country. They’re leaving because they’re sure things will get still worse. You see political instability, unemployment, labor strikes, high and rising crime rates, record-high interest rates. You see financial markets in ruin. In short, you see America plunging headlong toward third world status.

It’s enough, in short, to make you pine for the days (not so very long ago) when forecasting fantasists were projecting the Dow at 36,000. At least that mania was optimistic. And what is the cause of this terrible future? It lies mainly in a terrible, terrible epidemic, no, a scourge, no a HOLOCAUST of unprotected sex. Sex? Yes, sex. Sex committed in all conjugal respectability by our parents and grandparents beginning 60 years ago, the seeds of doom sown in celebration of victory over Germany and Japan. Herein lie the literal seeds of our now-impending doom. The Baby Boom—the original sin, a ticking time bomb, an oncoming freight train, no, a tsunami, no, a KILLER ASTEROID on a demographic collusion course with planet America. Block that metaphor, as The New Yorker used to say. How is it, then, that Kotlikoff and Burns have uncovered what is unknown to the financial markets, unreported by the government, and previously undiscovered by professional economists—despite the fact that the very last Baby Boomer came into very well-documented, very well-counted existence almost a half-century back?

The answer is that Kotlikoff has created “inter-generational accounting.” The essence of this is that receipts must equal the commitments over time; the young must plan collectively to support themselves when old, by paying into a fund a sufficient amount to cover their eventual needs, allowing for the time-value of money. Whether this is done by taxes or by “investing”—by lending now to the government what would otherwise be taxed—is immaterial. The failure to do one or the other supposedly represents a burden on future generations. Kotlikoff’s concept of “fiscal relativity”—which he compares (I’m not kidding) to Einstein—holds that current measures of deficits, saving, and income are meaningless. The only thing that really matters is whether the present values of taxes and spending match. And when generational accounting is applied to the current commitments of the Federal Government, especially under Social Security and Medicare, some large gaps open up. Kotlikoff and Burns come up with a frightening inter-generational deficit number: $45 trillion in net present value terms.

But what is the meaning of $45 trillion in net present value? Our actual GDP is around $12 trillion a year. So we have a mortgage, of infinite maturity, of less than four times our current annual income. Does this sound so terribly out of line?

Moreover, the payment schedule is very back-loaded. Social Security is presently in cash surplus, and will be for years to come. The near-term cash “deficit” of Medicare—that part not covered by the payroll tax—is a mere one percent or so of GDP now, and it’s intentional. Medicare was always designed to be funded partly by general revenues, a point that doomsayers about the program determinedly ignore.

Projections show the Social-Security-and-Medicare cash deficit (most of it, Medicare) rising above 10 percent of GDP three quarters of a century from now. But these projections are highly pessimistic, partly because they assume that economic growth will be lower than what we’ve experienced in past decades. They also assume that medical expenses will continue to rise well above normal inflation rates, until medical costs per person reach four times what they are in every other developed country. This is possible; no doubt given the increased longevity of our seniors (itself a medical triumph), medical costs will rise. But is it likely? Let’s hope not.

Even conceding the forecasts, what do they come to? Kotlikoff and Burns claim they will require “doubling the payroll tax in the short run” (by which they mean by 2030) and tripling it by 2075. This ignores the possibility that other taxes—for instance on income or wealth—might be used to pay the bills. And if they were, would taxes have to be raised by the full amount, in this century, required to cover the gap?

The answer is no. The national debt is eternal, and the future goes on forever ahead. Those debts not paid in this century can actually be rolled over into the century after that. They will provide new financial assets for future generations to hold. And while this may seem a shocking suggestion, one should realize we have been doing just exactly that with the national debt for 200 years, and no one seems to be any worse off for it. Oh.

A few years ago, Kotlikoff evidently got the government to prepare a special analysis of the inter-generational accounting “problem.” Much to his distress, the government cut the paper from the published budget in 2004. It is possible that they did this to save Bush’s third tax cut, as Kotlikoff and Burns now allege. Far be it from me to defend Team Bush from any charge of improper conduct. But it is also possible that cooler heads in the federal government just thought it better not to concede a flawed case.

And it is flawed. For, in fact, the entire characterization of the Social-Security-and-Medicare problem as “inter-generational” is misleading. It conflates and confuses two very different things: the problem of caring for today’s elderly by today’s young, and the problem of paying today for the future care of the elderly tomorrow. The first is a problem that must be faced today, and that will have to be faced at every future date. The second, which is what Kotlikoff and Burns want you to worry about, is an illusion.

Today’s population, whether young or old, cannot set aside resources to pay real benefits or provide medical services five, ten, or twenty years from now. All we can do is make promises, as we have done, that certain benefits will be paid and services provided. When the time comes, each year’s needs are met, well or poorly, by production in that year. Only a few things can be stored over long times, and medical care and food are not among them.

Moreover, the growing older generation will be with us, whether they are cared for by Social Security and Medicare or not. If they are not, some will be cared for (up to some point) by their children. Those without children will suffer. And children without living parents will be unburdened, both financially and as a matter of conscience, relative to young people who do have aging parents to support.

Thus the real transfer effected, every year, by Social Security and Medicare is not from today’s young to tomorrow’s old. And it is not even from today’s young to today’s old, since that transfer would have to occur in any event. It is, rather, from children without parents to children with parents. And it is from seniors with children to seniors without them. In this way, past work is honored, irrespective of reproductive choices and luck. And current virtue (the child who would care for her parents anyway) is not punished. Rather, the basic needs and medical care of all the elderly are taken care of out of a common fund.

You cannot imagine the cruelty of family life in America if Social Security and Medicare did not exist. And this is why it is difficult to fathom the folly of Kotlikoff and Burns, in their argument that these two programs should be gradually abolished.

Kotlikoff and Burns would replace Social Security by a personally funded pension system with greatly reduced benefits, undoubtedly increasing poverty and insecurity among the old. They would replace Medicare with a weird voucher scheme for private medical insurance, which would require the government to keep complete and timely records of everyone’s health. They would abolish the payroll tax and impose a national sales tax, spreading the special burden of paying for their own retirement benefits to the elderly themselves, and also to the non-working poor. As in a Bushite’s wet dream, no tax they propose would touch the cash holdings of the idle rich.

What actually should be done? Social Security should be left alone. Yes, the Trust Funds will run down as the baby boomers retire. That was the intention of the Greenspan Commission back in 1983. Social Security can perfectly well be funded partly from general revenue, which means that the burden of paying for retirees would be spread beyond workers to those with higher incomes, including the elderly who have financial wealth. What’s wrong with that? Nothing. If it is politically prudent to “keep the Trust Fund solvent,” then Congress could credit the estate tax, plus income tax paid on Social Security benefits, to the Trust Fund. Assuming the estate tax is not repealed, those two measures would go a long way to filling what is, in any event, a purely cosmetic gap.

Medicare does have a problem. But it is the larger problem of American health care. The problem is that we lack a rational system to decide who gets what and how much is to be paid. The fact that America spends 14 percent of our enormous GDP on health care is, actually, a marvel, guaranteeing the possibility of first-class service to everyone. It would be better, of course, if everyone had decent insurance, if there were adequate coverage for prescription drugs, if we did not waste three percent out of the 14 on financial paperwork. But Medicare itself is not the source of those issues; indeed Medicare is by far the most efficient part of the health care system we do have. Cutting actual medical spending in half—merely to eliminate the so-called “Medicare deficit”—just as the population ages and requires more care would not be a good idea.

Can the economy of the United States really, truly support its future elderly in reasonable comfort, over the years and decades to come?

Kotlikoff and Burns say no. They argue—or appear to argue on page 98— that average real wages (the incomes of the young) will fall by 10 percent by 2075, thanks to the huge tax burdens that meeting Social Security and Medicare obligations will impose. Unless, that is, Social Security and Medicare are themselves retired. That sounds terrible.

But, as those of us who attended Kotlikoff’s seminar in Texas eventually learned, that projected real wage cut is not from current levels. It is, rather, from projected levels, which include an allowance for productivity change and real wage growth. In their book, Kotlikoff and Burns mention a 1.7 percent annual productivity gain, and they concede that this will be built into growing real wages. If that holds, then in 2075 workers would be 3.3 times richer on average than today. This is on the assumption that Social Security and Medicare are killed off as recommended, and that today’s boomers die miserable and poor. And, if nothing is done? If we continue to pay the terrible price of supporting tomorrow’s elderly exactly as we are currently promising to do? Well, then, according to these same assumptions, tomorrow’s workers would still be three times richer than today’s.

Put that way, the future doesn’t look so bad. But Kotlikoff and Burns never spell this out in The Coming Generational Storm.

James K. Galbraith holds the Lloyd M. Bentsen, Jr. Chair in Government/Business Relations at the LBJ School of Public Affairs, The University of Texas at Austin, and is a Senior Scholar with the Levy Economics Institute.