Aging and Entitlements

The U.S. Census Bureau came out with with a report this month on aging in the United States. Not to anyone's surprise, the report found that between now and 2050 we are projected to experience rapid growth among the older population. In fact, the number of Americans that will be aged 65 or older in 2050 is projected to double from what it is now (40.2 million in 2010). And as the Baby Boomers age, there will be a shift in the age structure, to the point where the older population will make up 19 percent of the population by 2030, as opposed to it's current 13 percent. The U.S. population as a whole will increase by 42% during this time period, growing from 310 million to 439 million.

This rapid aging of the population has a number of effects -- one of the main ones being entitlement spending. As data from CBO's long term outlook shows, projected entitlement spending is affected significantly by aging.

Note: The data in this chart is based on pre-health reform numbers.

As the chart shows, aging is a considerable contribution to long term entitlement growth. During the years when the Baby Boomers begin to put pressure on entitlement programs, the effect of aging rises, and does not go back down at any point in the long term picture. And it is not only that a huge group of people (the Baby Boomers) will be entering this group at one time; it is also that people are living longer than ever. While this is undoubtedly a positive statistic regarding the quality of life in this country, it does effect the safety net systems which are designed to support people during the last decades of their lives.

With a rapid increase in aging comes a number of costs. These include costs to Social Security and Medicare and Medicaid, as the graph above depicts. It also, however, affects revenue levels given fewer taxes paid on income as well as a smaller labor supply. This leads to lower savings and investment, and slower growth.

Growing entitlement spending also drives future debt levels. As we have pointed out before, Medicare, Medicaid, and Social Security will grow significantly over the next few decades, as the number of people covered by those programs grows. Social Security will grow by well over 1 percent of GDP over the next two decades, and Medicare and Medicaid will double as a portion of the economy (to 10 percent) by 2035. As these programs grow as a share of the budget, they will either serve to crowd out other spending or simply pile on to our already unsustainable debt.

And aging has even further effects on Social Security. According to the Office of the Chief Actuary, the number of covered workers per OASDI beneficiary has dropped over the last few decades, and is scheduled to drop even further.

The aging of our population affects the dependency ratio; that is, the number of workers per retirees. There are, broadly speaking, two ways to deal with these effects:

We could (and should) treat the symptoms. For entitlement programs like Social Security, Medicare and Medicaid, this means ultimately raising taxes or cutting benefits. For individuals and the economy, it means increasing personal and national savings rates.

Alternatively (or more likely, additionally), we could change the effective dependency ratio. Changes to immigration and fertility rates could accomplish this, of course, but there is another way -- encouraging longer working lives. By getting able-bodied retirees to spend a little more time in the labor force, we can essentially change the point at which someone transforms from a worker to a retiree. In turn, that would change the worker-to-retiree ratio.

If individuals work longer, it means a bigger labor supply and greater levels of savings/investment. Longer work also means that individuals would spend fewer years in retirement, reducing the burden of an aging population on the backend. All of this adds up to greater levels of revenue, lower spending, and stronger economic growth.  Longer work also offers individual benefits by allowing workers to save longer and spend during fewer years in retirement.

Thus, policy changes which can encourage people to work longer can significantly ease the economic burden of population aging. The normal and early retirement ages in Social Security offer some of the more direct levels. But there are a number of other options, ranging from tax reductions for workers beyond a certain age, to regulatory changes designed to promote flexible work and phased retirement, to changing the 401(k), IRA, and
private pension rules.

To be sure, not all workers will be able to work longer -- and we must be cognizant of that. But to the extent we can encourage productive aging, we must. This represents one of our best hopes to elevate the costs of an aging population.