Entitlements and Retirement Policy: the Importance of Demographics

By John Iekel • October 06, 2016 • 0 Comments
In the second of a series of articles that features the insights of American Enterprise Institute (AEI) Resident Scholar Andrew Biggs in light of AEI’s recent paper, “Increasing the Effectiveness and Sustainability of the Nation’s Entitlement Programs,” Biggs shares his views on how demographics relate to and affect entitlements and retirement policy and benefits.

Is there any prospect for the growth of entitlements slowing or even being reversed? And if that takes place, would it have any effect on retirement-related entitlements? “Not in the short term,” says Biggs, noting political opposition to Social Security benefit reductions, and support for expanding its benefits. “Medicare cost growth may slow if current trends continue,” he says, but also adds that “much of the growth of Medicare funding is simply demographics — 10,000 Baby Boomers per day shifting from being workers supporting the program to retirees collecting from it.” And, says Biggs, “No easy program changes can counter that basic fact.”

To what extent will these demographic changes exacerbate the difficulties that already exist in reining in an entitlement? "Social Security’s cost growth is nearly 100% demographics; Medicare’s is partly demographic and partly due to rising spending per person,” says Biggs. “Overall, roughly three-quarters of entitlement cost growth over the next several decades is due purely to demographics,” he adds.

Does that change portend other consequences for retirement policy? Biggs thinks so. “If people retire later — and the average Social Security claiming has risen by about a year — then some of the demographically based changes in the worker-to-retiree ratio can be changed. Americans are already delaying retirement on their own and labor supply among retirees and near-retirees has risen even as younger Americans are working less.”

“But we also need policies to encourage longer work lives,” Biggs adds. “One of my favorites,” he says, “is to reduce the payroll tax for Americans 62 and over, to give a direct and visible incentive to stay on the job for a few extra years.”

Is it possible to balance the good of having a solvent elderly population that does not face deprivations in old age, on the one hand, with the good of budget economy and a society that is not dependent on government and that bolsters the private sector on the other? Biggs argues that it is.

“It’s totally possible,” says Biggs, “but only if we design our retirement policies correctly. There are reams of research from both the US and other countries regarding how households’ personal saving reacts to government-provided retirement benefits.”

Biggs offers a look at these reactions. “Across these studies, there’s a clear finding that educated, higher-income households react to higher government benefits by saving less on their own and to lower government benefits by saving more. Lower-income households, by contrast, don’t seem to react very strongly to pension changes: they save very little to begin with and, because of lower levels of financial literacy, don’t seem to plan for retirement in a way that draws government benefits and personal saving together.”

“This means,” says Biggs, that “we can have a strong safety net for the poor without reducing their saving very much, while if we reduce Social Security benefits for middle and upper-income households they’re likely to save more as a result. So you can have a strong safety net along with strong private saving, but the current Social Security benefit structure doesn’t do a great job of either.”

This is the second of a three-part series.