THE FISCAL EFFECTS OF POPULATION AGING IN THE U.S.: ASSESSING THE UNCERTAINTIES

Abstract

Population aging, accelerating as the Baby Boom generations age, will have important fiscal consequences because expenditures on social security, Medicare, and institutional Medicaid make up more than a third of the federal budget. However, the projected fiscal pressures are far in the future, and long-term projections are very unreliable. Our analysis here has two goals: to examine the fiscal impact of population aging, and to do this in a probabilistic setting. We find that the old age dependency ratio is virtually certain to rise by more than 50% through the 2030s, and will probably continue to increase after 2050, possibly by a great deal. Under current program structures, population aging would be virtually certain to increase the costliness of Federal programs as a share of GDP by 35 percent (±2 percent) by the 2030s, and by 60 percent (±15 percent) in the second half of the century. We project Federal expenditures (excluding interest payments and pre-funded programs) to rise from 16 percent of GDP in 2000 to 30 percent in 2075, almost doubling, while state and local expenditures rise only modestly relative to GDP. Almost all of this increase is for programs going primarily to the elderly, which rise from 8 percent of GDP in 1999 to 21 percent of GDP in 2075, due mainly to costs of health care for the elderly, with pensions a distant second. We expect that governments will respond to these aging-induced cost changes by altering program structures, so that these conditional projections will not be realized. Looking at social security, we find that raising the payroll tax rate by 1.89 percent would have relatively little effect on the probabilities of early exhaustion, raising the 2.5 percent bound for the exhaustion date from 2024 to 2036, but raising the median date of exhaustion from 2036 to 2070, and with a 55 percent chance of insolvency within the 75 year horizon. Looking at Medicare, which now costs 2.2 percent of GDP, we project a median share in 2075 of 11 percent, five times as great, with a 95 percent probability interval at 5 percent to 26 percent of GDP. Thus there is a 97.5 percent chance that the ratio will at least double, and a 2.5 percent chance that it will increase at least twelve-fold. Although the future is highly uncertain in many respects, unforeseen demographic or economic change will almost certainly not avert the long-run fiscal crunch. Changing demographic realities will require some combination of substantial tax increases or substantial benefit cuts, or other forms of restructuring.