A look at how four trends in the U.S. economy -- high taxes, low savings rates, an aging population, and astronomically high health care costs -- could constrain Americans' living standards over the next few decades.Budget deficits ; Saving and investment ; Insurance, Health

Jagadeesh Gokhale

English

Research Papers in Economics

July 1, 1992
eCONOMIG
GOMM6NTCIRY
Federal Reserve Bank of Cleveland
Has Someone Already Spent the Future?
by Jagadeesh Gokhale
XJLs massive budget deficits continue
to push the national debt to record levels,
Americans have grown increasingly con-
cerned about how lawmakers' seemingly
irresistible urge to spend now and pay
later may be compromising the nation's
economic future. Who among us has not
wondered how much heavier the burden
on our descendants will be because of
the government's refusal to live within
its means?
This Economic Commentary explores
how U.S. living standards are likely to
evolve over the next few decades given
present trends. While peering so far into
the future involves substantial uncer-
tainty, the current economic landscape
provides some fairly good clues about
where we are headed. Four factors in
particular can be expected to have a tre-
mendous effect on Americans' future
economic status: 1) current federal
spending and tax policies, 2) the aging
of the U.S. population, 3) trends in
health care expenditures, and 4) the pat-
tern of national saving.
• The National Debt and Deficits
The national debt reflects the explicit
commitment of the government to pay
back, with interest, funds it has borrowed
in the past. The amount borrowed each
year is dictated by the gap between fed-
eral spending and tax revenues collected.
Government spending falls into two
main categories: purchases of goods
and services and provision of entitle-
ments. The former, which are used for
such things as highway construction,
national defense, education, the judicial
and legislative functions of government,
and the conduct of international diplo-
macy, accounted for 57 percent of the gov-
ernment's total outlays last year. Entitle-
ments, which include Social Security,
Medicare, and welfare benefit payments to
old and needy individuals, represented 37
percent of the budget.
1 To finance some of
these transfer payments, the government
takes contributions from current working-
age Americans in exchange for implicit
promises of future benefit payments.
For most public goods and services, a
higher level of current provision does
not entail a reduction in future provi-
sion. Extremely durable items such as
highways, bridges, public parks, and
military equipment benefit both current
and future generations. This makes it
difficult to apportion the advantages
derived from such goods into amounts
accruing to different generations. But it
is possible to divide and distribute
among both current and future genera-
tions the burden of paying for these
items. Young and future generations
cannot participate in choosing the level
of provision because they are too
young or not yet born when the deci-
sions are made. They must, however,
make payments at a level chosen by
earlier generations.
Funds used for government expenditures
arise from one of three sources: 1) print-
ing more money, 2) taxation, and 3) bor-
rowing from the public. The first method
is dangerous because it operates through
the creation of inflation; that is, the gov-
ernment obtains resources by imposing a
loss in the value of the money that people
hold. Because this tax is not legislated, it
Of the myriad problems facing the
U.S. economy today, four hold the
potential to escalate and to repress
living standards early in the next cen-
tury. A confluence of low current
saving, astronomically high health
care costs, an aging population, and
generationally unbalanced fiscal
policies may burn a large hole in the
pockets of future Americans.
ISSN 0428-1276FIGURE 1 U.S. POPULATION BY AGE IN 1960,1980, AND 2000 (PROJECTED)
Millions of persons
5
30 40 50 60
1 -
10 20 80 90+
SOURCE: Social Security Administration.
has at times proven to be an irresistible
temptation for policymakers.
The undesirable economic consequences
of financing public expenditures through
an inflation tax have long been recognized.
The amount of money in the U.S. econ-
omy, however, is controlled not by the
government, but by an autonomous body
— the Federal Reserve System — which
is responsible for ensuring that the "cor-
rect" amount of money is circulating.
The second source of funding, taxation,
includes taxes on labor, interest and
dividend income; sales and excise
taxes; and property and payroll taxes.
Since the end of World War II, govern-
ment expenditures have exceeded tax
revenues in most years. As a result, the
government has had to resort to borrow-
ing money from the public — the third
funding source.
Federal government borrowing increased
dramatically during the 1980s, causing
the national debt to skyrocket from just
under $1 trillion in 1981 to more than
$3.5 trillion in 1991
 2 How will the gov-
ernment obtain the funds to repay this
massive debt (and interest) in the future?
Through taxation, of course, unless the
Federal Reserve prints more money, buys
up the debt, and allows a faster rate of in-
flation in the years ahead. Thus, in one
way or another, the obligation to repay
this debt will be foisted on generations
to come.
Unfortunately, the sizes of the national
debt and annual deficits do not fully
reveal how much of a burden will be
shifted onto young and future genera-
tions. Many of the laws enacted today
alter the rules about who (males or fe-
males, old or young, rich or poor) will
pay the government in the future, and
how much. Some policies redistribute
payment burdens among different gen-
erations, but leave total current revenue
unchanged. The effects of these policies
are not captured in the government's
annual deficits, which are based only
on current revenues and expenditures.
Generational accounting, a new method
of measuring the payment burdens fac-
ing different generations, shows that,
given current policies and plausible
assumptions about Medicare and Medi-
caid spending down the road, future
generations on average will be saddled
with net-payment burdens about 40 per-
cent larger than those facing current
generations. Higher future taxation
implies that Americans' budgets will be
smaller in the years to come.
Furthermore, calculations suggest that
unless corrective policy changes are
undertaken now, this imbalance will
worsen over time. If future Americans
perceive that much of their income will
be taxed away, their incentives to work
and save may be diminished, with ob-
vious detrimental effects on future U.S.
living standards.
• Population, Health Care,
and Saving
Viewed in isolation, neither the national
debt, deficits, or generational accounts
are adequate indicators of what may be
in store for the U.S. economy. One has
to look at these measures as part of a
broader picture that encompasses
trends in the overall economy and in
public policy. The current economic
situation suggests that strains on the
budgets of future Americans will be ex-
acerbated by three additional factors:
the age composition of the U.S. popula-
tion, trends in health care expenditures,
and the amount of national saving.
The postwar baby boom has created a
hump in the U.S. population that is get-
ting older (see figure 1). This trend has
far-reaching economic implications.
Americans on average participate in
the labor force between the ages of 20
and 65, though there is evidence of a
growing movement toward early retire-
ment. Moreover, advances in medicalFIGURE 2 U.S. HEALTH CARE EXPENDITURES AS A PERCENTAGE OF GROSS NATIONAL PRODUCT
1965 1970 1975
SOURCE: Health Care Financing Administration.
1980 1985 1990 1995 2000
FIGURE 3 U.S. NATIONAL SAVING AS A PERCENTAGE OF NET NATIONAL PRODUCT
Percent
12
0
1960 1965 1970 1975
SOURCE: Author's calculations based on Economic Report of the President, January 1992.
1980 1985 1990
technology have increased average life
expectancy, implying that people may
spend a greater number of years in re-
tirement. As the baby boomers, who are
now between 25 and 40, begin to bow
out of the work force, the growing non-
working segment of the population will
have to be supported by output produced
by a shrinking population of workers.
The earnings of future working-age
generations will thus have to sustain a
larger number of dependents.
Another factor that is likely to have an
adverse effect on future generations'
pocketbooks is the cost of health care.
Since the mid-1960s, medical expendi-
tures as a share of gross national
product have climbed steadily (see fig-
ure 2). Because people over 65 spend
twice as much per capita on these serv-
ices as younger individuals, the pro-
jected aging of the U.S. population will
cause the demand for medical care to
escalate. The provision of these serv-
ices, however, requires investment in
specialized and costly equipment and
highly trained personnel. Consequent-
ly, supply bottlenecks in the face of
rising demand are likely to further con-
strain Americans' budgets in the years
ahead.
The growing pressure to support the
elderly may not manifest itself solely
as a filial responsibility. Older Ameri-
cans will constitute a potent political
group that may be willing and power-
ful enough to bend Social Security,
Medicare, and tax policies to its own
advantage — and to the detriment of
younger generations. A large chunk of
future generations' income thus may be
taxed away and devoted to sustaining
the elderly.
These projected demographic burdens
may be mitigated in several ways, per-
haps most importantly through higher
saving and investment today. If the
baby boomers begin to put away a sub-
stantial part of their earnings, this sav-
ing could be used to finance a higher
level of investment. Higher investment
today will generate a larger capital
stock tomorrow. As a result, more and
better machinery and improved skills
will be available to produce the goods
and services that current and future
Americans will want.
The greater saving would also provide
the baby boomers with additional assets
for financing their own retirement,
while increased investment and im-
proved technology would mean higher
labor productivity and hence higher
wages for all workers. In short, more
resources would be available all aroundfor supporting a larger dependent
population in the future.
Unfortunately, the record on saving in
the United States provides little reason
for optimism. Coincident with the baby
boomers entering the labor force during
the 1970s and 1980s, U.S. saving rates
have plummeted to record lows. Figure
3 depicts the clear downward trend in
the national saving rate, which as a per-
centage of net national product dropped
by almost half from the 1960s (9.1 per-
cent) to the 1980s (4.7 percent). In
1991, this rate was a measly 1.7 per-
cent. Economists have been unable to
pinpoint the reasons behind this dramat-
ic downturn, but a reversal in the trend
is clearly imperative for preventing fu-
ture declines in U.S. living standards.
• Conclusion
If current trends in the U.S. economy
persist, high taxes, a growing depend-
ent population, low national saving
rates, and burgeoning health care costs
are all likely to present serious obsta-
cles to improving the nation's standard
of living.
Although nothing can be done about the
aging of the population, determined
efforts to reduce the growth of health
care expenditures could prove success-
ful. Similarly, lower tax burdens on
future generations may be secured
through either higher current taxation
or, preferably, permanently lower gov-
ernment spending. And baby boomers,
up against a growing need to safeguard
their own future, may be moved to
boost current saving and investment.
That such changes are essential for a
better economic future is obvious. The
challenge for policymakers today lies
in fostering an economic and political
environment that will increase the
likelihood of their realization.
• Footnotes
1. The remaining 6 percent of expenditures
consisted of interest payments. These num-
bers were obtained from Economic Report of
the President, January 1992, p. 390.
2. Ibid., p. 385.
3. See Alan J. Auerbach, Jagadeesh Gokhale,
and Laurence J. Kotlikoff, "Generational
Accounts: A Meaningful Alternative to Deficit
Accounting," in David Bradford, ed.. Tax
Policy and the Economy, vol. 5. Cambridge,
Mass.: National Bureau of Economic Research
and MIT Press, 1991, pp. 55-111. See also
Laurence J. Kotlikoff, Generational Account-
ing: Knowing Who Pays, and When, for What
We Spend. New York: The Free Press, 1992.
4. In the November 15, 1991 Economic
Commentary, a 20 percent differential was
reported, based on the National Income and
Product Accounts for 1989. The base case
reported in the 1993 Budget of the United
States Government (table 26-1, column 1,
and table 26-4, column 5) notes a differential
of almost 80 percent. This assumes, however,
that Medicare and Medicaid expenditures
will continue to grow at their current rate of
4.5 percent per year until the year 2030.
Under the more plausible assumption that fu-
ture policy intervention will reduce this rate
of growth to equal that of the rest of the
economy by the year 2000, a differential of
about 40 percent results.
5. See Laurence J. Kotlikoff and David A.
Wise, "Incentive Effects of Private Pension
Plans," in Zvi Bodie, John B. Shoven, and
David A. Wise, eds., Issues in Pension
Economics. Chicago: University of Chicago
Press, 1987, pp. 283-339.
6. See U.S. Health Care Spending: Trends,
Contributing Factors, and Proposals for Re-
form. Report to the Chairman, Committee on
Ways and Means, House of Representatives.
Washington, D.C.: U.S. General Accounting
Office, June 1991.
7. Author's calculations are based on Eco-
nomic Report of the President, January 1992.
Jagadeesh Gokhale is an economist at the
Federal Reserve Bank of Cleveland. The
material in this Economic Commentary is
based on a speech presented to the Univer-
sity for Young Americans, Cleveland, Ohio,
on May 7,1992. The author would like to
thank David Altig and Mark S. Sniderman
for helpful comments.
The views stated herein are those of the
author and not necessarily those of the
Federal Reserve Bank of Cleveland or of the
Board of Governors of the Federal Reserve
System.
Federal Reserve Bank of Cleveland
Research Department
P.O. Box 6387
Cleveland, OH 44101
BULK RATE
U.S. Postage Paid
Cleveland, OH
Permit No. 385
Address Correction Requested:
Please send corrected mailing label to
the above address.
Material may be reprinted provided that
the source is credited. Please send copies
of reprinted materials to the editor.

Has someone already spent the future?

http://www.clevelandfed.org/Research/commentary/1992/0701.pdf

Has someone already spent the future?

Abstract

Similar works

Full text

Available Versions

Research Papers in Economics