Arnold Kling blogs on Aging vs Health Care

The always-interesting Arnold Kling at EconLog has a short post drawing attention to my recent AEI paper comparing how population aging and health care cost inflation will contribute to the long-term fiscal gap. (Hint: aging plays a much bigger role than many say.)

Here's Arnold's thoughts:

From my perspective, the health care cost issue is a bit of a red herring. If you had government out of the health care financing business, you would not worry about what health care costs are doing. If my fellow citizens choose to spend more of their money on their health care, that's not my concern. It's the prospect of my fellow citizens spending more of my money on their health care that has me worried.

A good point. There are good reasons to spend more on health care – rising incomes make health care more attractive than other good, and new technologies make new treatments available – but there are also a lot of reasons we shouldn't be spending so much. While I'm not a health care expert, I do believe that if customers saw more of the bill they were paying there would be greater pressure for efficiency in the health care sector.

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How much is a child worth to Social Security?

Recently, analysts on the political right have debated the merits of "family friendly" tax cuts versus tax policy designed for economic growth, in particular, reductions in marginal income tax rates. (See also here.) This is a complex question on which I'm not fully qualified to comment, but here are a few basic points, plus a calculation specific to Social Security (on which, presumably, I am qualified to comment).

First, family friendly tax cuts can increase economic growth down the road if reductions in the cost of having children increase the number of children families have. Since today's child is tomorrow's work, total GDP can be expected to increase along with fertility. Whether GDP per capita increases is another story (that is, it's unclear whether a family having an additional child will improve the economic prospects of other children).

Second, if family friendly tax cuts improve the human capital development of children – say, by enabling a mother to stay home with her children rather than sending the child to day care – then this might also improve economic growth down the road, since human capital is an import contributor to output. Of course, policies such as the child tax credit don't alter incentives to work or stay home at the margin, so the effect is unclear. (In other words, families might use the child tax credit to pay for their daycare…) A more effective incentive actually comes through the Social Security spousal benefit, which is available to non-working spouses but is reduced on a dollar-for-dollar basis by their earned retirement benefits. This effectively increases the net marginal tax on working spouses and so encourages them to leave the labor force. Whether this is fair or good policy overall is a question for another day (I suspect it isn't).

Third – and here's where might be able to add some substance – is the question of how having a child affects the federal budget, in this case Social Security. The Social Security Trustees Report tells us that higher fertility improves Social Security's finances. The sensitivity analysis for the total fertility rate tells that Social Security's 75-year balance improves on a basically a one-for-one basis with increases in the average number of children born per woman. If the total fertility rate rose from the projected value of 2.0 children per woman to 2.1, the 75-year deficit of 1.7 percent of payroll would improve to around 1.6 percent of payroll.

However, this method of accounting is flawed for this question because it measures system financing on a truncated 75-year basis. Cutting off measurement at 75-years increases the measured effect of fertility because it counts all the taxes paid by these new children but not all the benefits that would be owed to them, since much would occur after the 75^th year. A solution is to calculate the effect of rising fertility in the infinite horizon. The Trustees don't make such calculations. (I could run the numbers, though I suspect the effects would actually be negative, much as the effects of economic growth are negative in the infinite horizon. This result is counterintuitive and probably not appropriate in this context.)

Instead, I'm here calculating the value of a child on an individual basis. According to SSA's actuaries, the "money's worth ratio" – that is, the ratio of the present value of lifetime benefits received to lifetime taxes paid – is around 0.81 for a single medium wage male entering the workforce today and 0.90 for a single female. Put another way, under scheduled benefits, a single male earner can expect to receive back 81% of his taxes in the form of benefits, while a single female could expect to receive around 90% of her taxes back. Social Security effectively keeps the rest, which implies that more people paying into the program are good for the system's finances.

How good? Using projections of the average wage from the Trustees Report and simulated earnings patterns from the SSA actuaries, I constructed a lifetime earnings path for a medium wage earner. Over the course of his lifetime, a medium wage earner entering the workforce can expect to have earnings worth about $1,159,000 in present value. (The present value of lifetime earnings is the amount today that, earning interest, could produce annual payments equal to the individual's annual earnings.) Assuming the worker bears the full 12.4% payroll tax, his lifetime taxes would equal $149,869. Since the actuaries project that a male would receive around 81% of his taxes back as benefits, his lifetime expected benefits have a present value of $121,394; for a women, where the money's worth ratio equals 0.90, lifetime benefits would total $134,883.

What this shows is that, even if Social Security paid these new workers full promised benefits, they would pay more in taxes they receive back in benefits. For a male, Social Security would pocket $28,475 in present value; for a female, $14,987.

So, purely from Social Security's point of view (emphasis added to avoid confusion), if the program could identify families that are not planning on having additional children, it would make financial sense for Social Security to offer them a cash payment of up to $28,475 to have a boy and $14,987 to have a girl. Anything more than that would be an expected money-loser for Social Security, but anything less than that a money gainer.

Now, this isn't a particularly practical policy, since we can't identify families who would have additional children only for the cash payment, nor can we tell the future earnings of children, which is a big determinant of how much of a financial gain they would be to the program. Nevertheless, this gives a rough idea of the effects of larger families on Social Security's financing.

I've uploaded an Excel file with the calculations for anyone who is interested.

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Life expectancy and Social Security

A number of commentators on Andrew Sullivan's blog bring up this table published by the SSA as evidence that rising life expectancies don't play a big role in Social Security's funding problems. Referencing the right hand columns, they point out that since 1940 life expectancies for men have increased by less than three years.

Leaving aside that an increase in life expectancy from 12.7 to 15.3 years implies a 20% increase in costs, these commentators also ignore the left-hand columns: these show the probability of a 21-year old surviving to collect benefits at 65. These probabilities have risen sharply: from 53.9% to 72.3% for men; from 60.6% to 83.5% for women. Now, this isn't simply a cost increase for the program, since people who survive longer also pay taxes longer.


Nevertheless, if you multiply the percentages in the left-hand columns by the life expectancies in the right-hand columns, you get the expected years of retirement the program would have to finance for a 21-year entering the program. For men, this rises from 6.8 it 11.1 years, for women it rises from 8.9 to 16.4. That’s a pretty big increase in costs.

Obviously, declining fertility also plays a major role. Nevertheless, even after the fertility rate stabilizes, life expectancies are projected to continue increasing. This is the factor that tends to drive costs up in the long term (e.g., from the 2030s onward).


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