Aging and the Macroeconomy Long-Term Implications of an Older Population (2012) / Chapter Skim
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9 The Outlook for Fiscal Policy
9 The Outlook for Fiscal Policy
Pages 174-193
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From page 174... ...
Thus, as in the economy in general, population aging requires changes to government programs that ultimately involve some combination of lower consumption (which can be achieved through lower benefits or higher taxes) and higher labor force participation in order to remain financially viable.
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From page 175... ...
Thus, the current imbalances in the Social Security system provide a measure of how much further policy needs to adjust, but not of the entire effect of demographic change on consumption and/or labor force participation.1 On the other hand, for many parts of the budget, the projected imbalances between revenues and expenditures are only partially explained by demographic change. In particular, excess cost growth in health care and past tax and spending policies that contributed to today's outsized deficits 1Some observers believe that the buildup of surpluses in the Social Security trust fund was used to offset deficits in the on-budget accounts -- that is, that taxes would have been higher or spending lower had those surpluses not been amassed.
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From page 176... ...
Social Security The Social Security program assesses payroll taxes on workers and uses those revenues to provide cash benefits to retired workers and their dependents.2 Thus, Social Security revenues depend on the size and productivity of the labor force, whereas Social Security outlays depend on the size of the elderly population. Both increases in life expectancy (which increase the size of the elderly population)
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From page 177... ...
, in 2010 about 35 percent of Medicare spending was financed by the payroll tax, about 12 percent by beneficiaries' premiums, almost 40 percent through general revenues, and the remainder through various other sources, including income taxes on high-earning Social Security beneficiaries.
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From page 178... ...
A far more important source of uncertainty concerns the expected rate 5Increased life expectancy raises the share of the population that is 85 years and older, but the large flow of baby boomers entering into retirement raises the share of the young elderly. The average age of Medicare beneficiaries is projected to decline into the 2030s; after that, the average age of the elderly population increases gradually over time with increased life expectancy.
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From page 179... ...
included provisions to lower the annual updates to provider payment rates and to cap annual Medicare growth. According to the 2011 Trustees' projections, with these payment changes, average excess cost growth for Medicare spending under the ACA will be close to zero over 6The share increased to 18 percent in 2009, but this sharp increase reflects the effects of the severe economic downturn, which lowered GDP more than it lowered health spending.
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From page 180... ...
. the long-run projection period; that is, most of the increase in Medicare spending in the Trustees baseline projection is the result of demographic change rather than health care cost growth.9 There is a great deal of uncertainty about whether these lower payment updates will allow Medicare beneficiaries to continue to be provided health care at a level roughly comparable to that received by the nonelderly and, if not, whether such a system would continue to be viewed as desirable (see Boards of Trustees, Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds, 2011, also referred to as the Medicare Trustees Report)
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From page 181... ...
The anticipated slowdown in health spending is important to these projections; under the assumption of no slowdown in excess cost growth, Medicare spending reaches over 10 percent of GDP by 2050. Medicaid and Other Health Programs Medicaid, a program that is financed in part by the federal government and in part by the states, is not an old-age program, yet it plays an important part in financing the long-term care needs of the elderly.
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From page 182... ...
Medicaid expenditure growth is also affected by excess cost growth in health spending (Table 9-1) as well by the recently enacted health reform, which expanded eligibility for the program.
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From page 183... ...
Much of this rise is attributable to rapidly increasing excess cost growth (the GAO assumes slightly faster growth of excess health cost growth for Medicaid and retiree health insurance than does the CBO)
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From page 184... ...
The more pessimistic scenario uses the CBO "alternative" projection for Medicare spending, which is considerably higher than that of the Medicare Trustees, assumes that Congress will maintain tax revenues at roughly its recent historical average of 18 percent of GDP, and assumes that parts of the Budget Control Act will be repealed.12 This scenario can be interpreted as one in which taxes and entitlement programs operate largely as they have in the past, whereas the optimistic scenario already incorporates some adjustments to demographic change, including a reining in of health care cost growth and an increase in average tax rates. Under the optimistic scenario, noninterest expenditures fall from 22 percent to roughly 20 percent of GDP by 2018 as the economy recovers and then rise slowly thereafter, to about 22 percent by 2030 and 23 percent by 2050.
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From page 185... ...
. 25 20 Percent of GDP 15 10 5 0 2012 2016 2020 2024 2028 2032 2036 2040 2044 2048 Total Deficit, Optimistic Scenario Total Deficit, Pessimistic Scenario FIGURE 9-5 Alternative federal deficit projections, 2012-2050.
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From page 186... ...
In the pessimistic scenario, the deficit hovers around 5 percent of GDP for much for the next decade but climbs sharply thereafter, reaching over 10 percent of GDP by 2030 and over 20 percent of GDP by 2050. The sharp acceleration in the future deficits under the pessimistic scenario reflects the combination of continued rapid growth in health expenditures as well as rapidly rising interest payments from continued large deficits.
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From page 187... ...
Under the pessimistic scenario, which assumes significantly lower tax revenues and higher health expenditures, the required adjustments are significantly larger. MACROECONOMIC IMPLICATIONS OF RESPONSES TO DEMOGRAPHIC CHANGE The aforementioned budget projections indicate that a large change in the combined trajectory of federal tax revenues and expenditures will be
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From page 188... ...
, there is a predictable reaction function of government spending to the deficit: As the deficit falls as a share of GDP, government spending increases and tax revenues fall as a share of GDP. Thus, policies that would significantly lower deficits ahead of the baby boom retirement, while possibly economically attractive, might prove politically unsustainable.
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From page 189... ...
To the extent individuals are forward looking, this change in policy would have boosted private saving in the years prior to its implementation, as people increased their saving in anticipation of lower future Social Security benefits. Changes That Explicitly or Implicitly Increase Marginal Tax Rates Some policy changes quite explicitly increase marginal tax rates.14 Most tax increases would do so, unless accompanied by changes in tax structure.
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From page 190... ...
from income reductions imposed on 70-year-olds than from equal-size reductions imposed on 40-year-olds, because the latter group is in a better position to offset income losses by increasing labor force participation. Likewise, we would expect larger changes in labor supply from increased marginal income tax rates on 40-year-olds than from increased marginal income tax rates on 70-year-olds, who are mostly retired and out of the labor force.
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From page 191... ...
For example, budget deficits rise when the economy is weak because of a loss in revenues, so if policy aims to achieve a fixed budget reduction, budget cuts must be larger when the economy is weak and individual resources are low. In summary, to analyze the macroeconomic effects of a given policy trajectory, one would like to estimate the inter- and intragenerational distribution of changes in resources and marginal tax rates under the policy, the dates at which future policy changes are anticipated, and the distribution of possible policy paths and how these paths relate to the economy's possible trajectories.
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From page 192... ...
Steps to Rein in Excess Health Care Cost Growth One of the key differences between the most optimistic and most pessimistic scenarios in Figure 9-4 is the assumption about the trajectory of federal spending on health programs after 2020. Under the optimistic scenario, per-beneficiary health spending grows roughly in line with GDP, whereas under the pessimistic scenario, rapid health spending is responsible for a large and growing portion of the fiscal imbalances over time.
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From page 193... ...
The challenges of population aging are made more difficult by rapidly growing health costs and by the underlying structural budget deficits that federal and state and local governments face even in the absence of demographic change. Although government debt can grow faster than the economy for a time, policy changes that increase revenues and/or lower expenditures are inevitable in the next few decades.
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