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BU economist says future generations will pay for Bush tax cut -- and more

By David J. Craig

The nonpartisan Congressional Budget Office reported last month that during the next four years the United States will be forced to spend $30 billion designated for Social Security to cover the costs of other government programs. Defenders of President George W. Bush's massive 2001 federal tax cut, however, argue that the cuts pose no danger to the Social Security system, which currently has a $162 billion surplus.

	Laurence Kotlikoff, a CAS professor and chairman of the economics department, says that public officials have understated how severely the 2001 federal tax cuts jeopardize the future stability of the Social Security and Medicare systems. Photo by Kalman Zabarsky

But Laurence Kotlikoff, a CAS professor and chairman of the economics department, says that dramatic shifts in the nation's demographics will push Social Security to the verge of collapse within 30 years, and that this year's tax cut lessens the chances that the system will remain solvent.

"The Coming Generational Storm," a study he released in June, finds that when today's young workers retire, in order to receive the same benefits Social Security now provides, federal income tax rates would have to increase 68 percent immediately. That's because in 2030 there will be twice as many retirees in the U.S. as there are today, but only 15 percent more workers. With 77 million retired baby boomers sapping the nation's resources, Kotlikoff says, the Social Security and Medicare systems will be underfunded by 40 percent.

"The Bush tax cut helped, of course, make a terrible situation worse," he writes in the study. "Had the 2001 tax cut not been enacted, future generations would have faced net tax rates that were 80 percent rather than 96 percent larger than those facing current generations. And we'd need a 56 percent, rather than a 68 percent, immediate and permanent federal income tax hike" to ensure that future generations receive the level of Social Security and Medicare benefits currently provided. If taxes are not raised, he says, Social Security and Medicare benefits would have to be slashed by about one quarter "immediately and permanently" to maintain the stability of the systems.

Kotlikoff, who has studied the long-range effects of fiscal policy for 25 years, says also that arguments commonly made by both Republican and Democratic Congressional leaders -- that Social Security will be rescued by a reduction in government spending and by the nation's economic growth -- do not hold water. His study finds that the federal government's domestic spending is at its lowest in almost 40 years and is unlikely to be further reduced, and the higher tax burden caused by the wave of retiring baby boomers will siphon workers' savings and culminate in less worker capital. "The economy's performance will likely exacerbate, rather than mitigate, the fiscal problems we face in the years ahead," he writes.

See no evil

Why, if the nation's long-term financial outlook is so dismal, are politicians eager to return to taxpayers the federal government's budget surplus? Because, Kotlikoff says, when it comes to fiscal planning, it is in the interest of public officials to deliver rosy scenarios. Culprits include government forecasters at the Congressional Budget Office and the Office of Management and Budget, whose annual reports are the main source of public information about the nation's finances. These reports regularly paint an overly optimistic picture of the nation's future, he says, by underestimating the expected life span of American citizens, failing to forecast debt accumulation far enough into the future, and making unrealistic assumptions about how government spending relative to the economy might be reduced. "There is a lot of political pressure [put on the people who create such reports], and you see this in every place where the government makes forecasts," he says.

Kotlikoff's critics, such as Dean Baker, an economist at the Center for Economic and Policy Research, a Washington think tank, says there is too much uncertainty about future demographic trends and interest rates to accurately predict tax rates far in the future.

"There is very little uncertainty about the demographic trends because the baby boomers have been born and we know what their longevity is going to be like," Kotlikoff counters. "There is a huge tidal wave right there in the population statistics. We're alive and there are very few kids relative to middle-aged people. The only uncertainty is whether the economy is going to grow rapidly enough that we can somehow grow our way out of this, but even under very extreme and optimistic assumptions about productivity growth, we still have an enormous problem."

He believes that to salvage the nation's old-age welfare programs, the government should fully privatize Social Security by investing contributions in individual accounts in a global index fund that would accumulate the same return for all investors. A significant tax hike would be implemented to pay off the obligations of the old system. In the meantime, he says, the government should use its surplus to pay off the national debt, and if the debt gets paid off, the government should use such surpluses to buy assets.

Otherwise, the next generation could be in desperate trouble, he writes, "raising taxes to unprecedented levels, making drastic benefit cuts, cutting domestic government spending to the bone, borrowing far beyond its capacity to repay, and printing lots of money to meet its bills. You also [will] see major tax evasion, high and rising rates of inflation . . . and more people leaving than entering the country. In short, you [will] see an America in 2030 that looks a lot like Russia today."

Read the sidebar "401(k): too much of a good thing?

"The Coming Generational Storm" is available on Laurence Kotlikoff's Web site, http://econ.bu.edu/kotlikoff/.

7 September 2001
Boston University
Office of University Relations