Monday, March 18, 2013

The Real Economic Implications of Our Senior Entitlements Challenge

March 18, 2013
The Real Economic Implications of Our Senior Entitlements Challenge

Economics is art masquerading as science. Demographics is not only science, but destiny. Chart 1 shows the changing demographics of America. It shows the rising trend in the proportion of senior “takers” in America. Back in 1960, those U.S. residents aged 65 or over made up 9.2% of the total population. That percentage had risen to 13.1% by 2010 and is projected to move up rapidly in the coming decades, reaching 21.9% by 2060. I refer to this (my) age cohort as “takers” because most Americans in this age group retire from the workforce – stop “making” – and primarily just “take” or consume. The preparation, or lack thereof, for this significant increase in senior “takers” has important implications for the future long-term potential per capita growth of the U.S. economy.

Chart 1

My perception is that this changing demographic phenomenon is being discussed in the mainstream media primarily in terms of its impact on federal government spending. Indeed, the projected increase in the number of U.S. seniors will have important implications for federal government spending, more so on the composition of total spending than the growth in total spending. Chart 2 shows actual and CBO- baseline projected fiscal year-over-year percent changes in total federal government outlays from 1974 through 2023. Also shown in Chart 2 are the actual and CBO-baseline projected federal expenditures on senior entitlements – Social Security and Medicare – as a percentage of total federal outlays for the fiscal years 1973 through 2023. The senior entitlement spending is understated because it does not include Medicaid expenditures for senior nursing home care.

Chart 2

The projected median annual growth in total federal outlays in the fiscal years 2013 through 2023 is 5.5%. This is lower than the 6.1% annual median growth in total federal outlays in the fiscal years 1974 through 2012. So, projected growth in total federal outlays in an environment of a rising proportion of U.S. seniors is not extraordinary. As an aside, average annual growth in total federal outlays in the three fiscal years ended 2012 was 0.2%. So, the perception that federal government spending currently is excessive may hold for the absolute level, but not for its rate of growth in the past three fiscal years. But let us never allow facts to get in the way of opinions.

What is more noteworthy in Chart 2 than the projected annual rates of growth in total federal government spending is the rising percentage of that spending dedicated to senior entitlements. In fiscal year 1973, senior entitlements accounted for 24.4% of total federal outlays. By fiscal year 2012, this percentage had risen to 37.3% and is now projected by the CBO to rise further to 42.1% by fiscal year 2023. Assuming that there is a desire by the body politic to limit growth in total federal outlays, federal senior entitlement spending inexorably is “crowding out” other categories of federal government expenditures, for example, infrastructure, education and scientific research.  Now we are getting to the implication for future per capita economic growth as a result of the aging of America. To the degree that federal government spending on infrastructure, education and scientific research enhances productivity growth – and, to be sure, there is much disagreement as to this degree – then the crowding out of this federal spending by increased senior entitlement spending implies slower future per-capita growth in the U.S. economy.

Assuming it were politically feasible, could we mitigate the negative effect on future per capita economic growth emanating from increased federal spending on senior entitlements by simply cutting back on these entitlements? This would not change the demographic trend. There still will be millions of baby boomers moving into their mid to late 60s in the next 20 years. If their federal entitlements were curtailed, some baby boomers might try to delay their transition from “makers” to “takers”. [With apologies to Ms. Hortense Mintz, who drilled me and attempted to skill me in the writing of the English language at Manhattan Elementary School in Tampa, Florida, I am adopting the British convention regarding the placement of punctuation in relation to quotation marks because it seems more logical to me.] Others, who already have become “takers”, might transition back to “makers”.  But this is unlikely  to materially affect the large number of U.S. residents exiting the labor force because of age. So, there still is going to be a significant increase in the number of Americans, due to aging, consuming without producing in the next 20 years. If the federal government does not transfer funds from the cohort of “makers” to these senior “takers”, then the children of the senior “takers” or charities will provide funds to help feed, house, clothe and medicate them (me). This certainly would reduce the amount that senior “takers” consume, especially on discretionary goods and services, compared to what would have occurred if the government had not cut back on senior entitlements. For example, if Carnival Cruise Lines has problems now with its equipment breakdowns, just wait until senior “takers” ask their children for some extra cash so that they can take that winter Caribbean voyage! Regardless of who writes the check, in the next 20 years, there is going to be a substantial increase in the number of Americans who are consuming without producing. This is going to divert resources away from productivity enhancing uses, such as investment in physical and human capital. This, in turn, implies slower future real per-capita economic growth.

This slower future real per-capita economic growth that I expect was not inevitable had we saved for this demographic event. Had the private sector saved more, then the capital stock, both physical as well as human, would have grown faster. In turn, this would have enhanced future productivity growth and, thus, future real per capita economic growth. The advent of Social Security in 1935 and Medicare in 1965 created disincentives for American households to save for their consumption in retirement. Why should households save as much for their retirement when the government has promised to supplement their effective retirement income? If the government is going to supplement retiree income, then it is incumbent on the government to save more in anticipation of this. Had the government saved more, i.e., run surpluses or smaller deficits, this would have left more resources for use in building up the stock of physical and human capital. Had the nation as a whole saved more, then the U.S. economy might have been running trade surpluses with the rest of the world rather than persistent trade deficits. Cumulative trade surpluses would have allowed us to import more goods and services as “makers” transitioned into “takers”, permitting us to continue building up our capital stock so that future “makers” would be more productive. But, alas, as shown in Chart 3, the saving of combined government entities in the U.S. has been trending lower relative to GDP throughout the post-WWII era. Private saving relative to GDP has been trending lower since the mid 1980s. It is ironic that total net national saving as a percent of GDP peaked in 1965, the year in which the Medicare entitlement was signed into law.

Chart 3

 In sum, because we did not increase our aggregate saving in anticipation of the significant rise in the proportion of senior “takers” , real per capita economic growth in this country is likely to be adversely affected in the next 20 years. This does not mean that growth in our aggregate standard of living will be stagnant. But it does suggest that our per capita standard of living will grow slower than it has in most of the post-WWII era. Even if it were politically feasible to pare back entitlements to current senior recipients, this would have only marginal salutatory effects on the economy’s per capita real growth in the next two decades. Similar to the estimated 11 million undocumented “makers”, we baby-boom “takers” are here and we are not going away, voluntarily, at least. One way or another, we are going to eat and get medical care, which is going to use resources that otherwise could have been used to enhance the productivity of current and future “makers”.  There is no use crying over spilled milk. But we can take steps individually and, dare I say, collectively, to lower the probabilities of “spilling milk” for future generations. Those of us senior “takers” who are fortunate enough not to be destitute without our entitlements could voluntarily set up educational trust funds at Legacy Private Trust Company of Neenah, Wisconsin for our grandchildren, funding these trusts with our Social Security checks and/or with the funds we otherwise would have spent dining out or taking that annual Carnival Cruise. I have not looked at the data, but I doubt that there are enough senior “takers” in this financial position to make a significant impact in the aggregate. But for those that can set up these trusts, when you rest in peace you can also rest assured that your grandchildren will reflect fondly on you. Collectively, we can encourage our elected officials to enact policies that promote increased saving – both private and public – so that future generations of senior “takers” do not adversely affect growth in real per capita income when they transition from “makers”. Good luck with that!

Paul L. Kasriel
Senior Economic and Invest Adviser to Legacy Private Trust Company
Econtrarian, LLC

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