Aging population makes this deficit scarier

June 15th 2003 - Huge tax cuts, soaring spending and rising deficits. It's beginning to look a lot like the 1980s again — with one big difference.

When deficits started taking off 20 years ago, the retirement of the baby boom generation was just a distant worry. Now, as the nation faces years of red ink, including at least a $400 billion shortfall in 2003 alone, the graying population is a fast-approaching reality that will put unprecedented strains on Medicare, Social Security and the economy starting around 2010.

While recent advances in productivity are expected to help the nation cope with the bulge in retirees, the reduced workforce, possible slowing of immigration and huge new fiscal burdens mean that, unlike the 1990s, the nation could have a tougher time growing out of new budget problems, economists say.

At the same time, by locking in years of deficits, lawmakers and the White House are reducing national savings and putting upward pressure on interest rates. That could limit their flexibility to increase taxes, issue bonds or take other steps to reform the massive health and retirement programs — while forcing deeper benefit cuts.

Warning from Greenspan

Federal Reserve Chairman Alan Greenspan has warned of an "unstable system" of rising debt relative to the size of the economy without changes in budget and program policies.

"On the one hand, from an economic point of view we should be stimulating the economy," says Robert Pozen, former vice chairman of Fidelity Investments and a member of President Bush's 2001 Social Security Commission, referring to the need for deficit spending in light of current, sluggish growth.

But, he adds, building in deficits now increases pressures down the line. "It's a serious problem, and it's not just Social Security, it's Medicare," Pozen says.

Legislation to add a 10-year, $400 billion prescription drug benefit to Medicare, which the Senate could vote on this week, could make the problems far worse. The White House, which originally wanted any drug bill to include major changes to reduce costs and move Medicare closer to the private insurance market, has largely dropped those demands.

Thomas Saving, director of the Private Enterprise Research Center at Texas A&M and one of the public trustees overseeing Medicare and Social Security, estimates the drug plan could add nearly $3 trillion in costs over a 75-year forecasting window — based on the assumption Congress will extend the benefit.

Today, Social Security and Medicare payroll taxes are generating a trust fund of surpluses. But by 2008, the government will have to start pumping more money into Medicare. Even without a drug benefit, the health program alone is expected to consume 20% of all revenue by 2026.

"The pressure on the Treasury really begins when the surplus in these programs peaks, and that's going to happen in just a couple of years," Saving says. "At that point, the actual revenue coming into Treasury, net of what they have to use for Social Security and Medicare, will start to fall."

Deficits expected through 2011

Overall, the non-partisan Congressional Budget Office (CBO) forecasts a 2003 deficit of $400 billion, with private economists expecting a bigger shortfall next year. Excluding the Social Security surplus, the CBO, which projected a $5.6 trillion, 10-year surplus in 2001, expects deficits through 2011. That does not include the Medicare drug plan.

Demographic changes are already having an impact in other industrialized nations. Austrian and French workers have been striking in protest of planned cuts in government pension plans. Germany and other nations face similar pressures and forecasts of lower growth as their populations age.

The USA is in comparatively good shape. While there are graying pressures in some developing nations, like South Korea, the USA will have the slowest rising median age of any country for the next 50 years, says Paul Hewitt, director of the global aging initiative at the Center for Strategic and International Studies.

Still, he predicts, "The boomers leaving will create a giant sucking sound in the workforce," making it harder to maintain elevated productivity. Mexico, a major source of immigrants, is aging faster than the United States and may not supply as many workers. Expected slower growth in Europe could affect the USA.

"If it was just the pension crisis, we wouldn't have a crisis. ... The problem is all on the health care side, driven by our crazy system," Hewitt says.

The Fed predicts that in the next 30 years, the U.S. working-age population will increase about 0.5% a year, compared with 1% now. The percentage of the population over 65 will rise from less than 13% to about 20% by 2030.

Spending on Medicare, Social Security, Medicaid health care for the poor and interest on the federal debt, could zoom from 8% of the economy to 21% by 2075, according to the CBO.

The impact of deficits is political, as well. Two years ago, with a $5.6 trillion surplus, it seemed reasonable for politicians to claim they could finance major changes — a Medicare drug benefit or the hefty upfront costs of transforming Social Security into a system of private investment accounts.

While the surpluses were never sufficient for the job, lawmakers may be losing political cover and public trust in their ability to act as responsible stewards as the deficits steadily pile up.

A May poll by the Pew Research Center for the People and the Press asked a variety of questions about the economy and the latest, $350 billion tax cut. More than half thought it would mainly help the wealthy and increase the deficit, 44% said it would help the economy, while 42% said it would force spending cuts. About a fifth thought it was fair to all.

Greenspan, who in the early 1980s chaired a commission that recommended raising taxes and increasing the retirement age to solve a previous Social Security financing gap, has told Congress the earlier it acts, the better chance it has of minimizing economic and social dislocations.

"I must say, the silence is deafening," he recently told a congressional hearing.

Many economists, while heeding Greenspan's warnings, argue the deficits — including the $350 billion tax cut law signed by Bush last month — have been necessary, given the slack economy. With interest rates already at historic lows, they argue the Fed has limited room to act.

"When you have an economy that's underperforming and far away from potential, the opportunity that you miss every year by not being back to full employment, the cost is enormous," says Jim Glassman, chief economist at J.P. Morgan Chase. He predicted the recent tax cut could increase economic growth by 1/2 percentage point in the next two years,

Dimitri Papadimitriou, president of the Levy Economics Institute at Bard College, says the deficit should be as much as $600 billion to jolt the economy, though he would have preferred a payroll tax cut. "For the time being, I don't think one should worry about the deficits," Papadimitriou says.

Others say Congress and the White House have used short-term economic problems as an excuse for policies with long-term ramifications. The House last week passed $82 billion in 10-year tax cuts — on top of the $350 billion measure, Bush's 2001 $1.6 trillion tax cut plan and a 2002 stimulus bill.

"It builds up the pressure to cut benefits over the long run," says Art Benavie, economics professor at the University of North Carolina at Chapel Hill, who has written a book on deficits.

"You're going to have structural deficits down the road as far as we can see, long-term deficits in an economy that's eventually going to be around full employment, which crowds out private investment ... personally, it makes me nauseous," Benavie says.