March 1, 2002

NOTE TO EDITORS

The latest edition of the New York Fed’s Current Issues in Economics and Finance, Live Long and Prosper: Challenges Ahead for an Aging Population, is available.

According to authors Erica Groshen and Tom Klitgaard, demographic changes over the next thirty years will make it increasingly difficult for the United States, Germany, and Japan to finance their social security programs. With life expectancy rising and fertility rates on the decline, retirees will account for a significantly larger share of the population, while the number of workers whose payroll taxes support each retiree will drop steadily.

The authors report that by 2030, there will be only three people in the U.S. working-age population for every retiree, down from more than five for every retiree today. In Germany and Japan, the ratio of working-age people to retirees will be even lower in 2030 – on the order of two to one. "Since workers fund retirees through the payment of a social security payroll tax," the authors observe, "a decline in their relative numbers will make it increasingly difficult to generate the income necessary to provide old-age benefits."

The authors contend that the structure of the social security programs in these countries has intensified the demographic problem. The programs are pay-as-you-go systems that channel payroll tax revenues directly to retirees. However, because the first group of social security recipients received much more in benefits than they were required to pay in taxes, the programs have carried a large liability over time. As the shift to an older population takes place, causing benefit payments to rise relative to taxes collected, this long-term liability will weigh more heavily on the programs.

Groshen and Klitgaard observe that the upcoming demographic changes will compel governments to make hard choices about the financing of their public retirement programs. Essentially, governments can increase social security taxes, decrease benefits, dedicate other tax revenues to social security, or combine these measures in some way. The United States, the authors note, implemented a major reform affecting both taxes and benefits in 1983. More recently, Germany and Japan moved to reduce future benefits by raising the retirement age and lowering the initial level of benefits.

The authors do acknowledge, however, that the pressures on the U.S., German, and Japanese social security systems would be eased if the economies of the three countries were to grow more strongly than expected. Such growth could be achieved through an expansion of the work force—if, for example, a greater percentage of those over 65 chose to continue working—or through an acceleration in labor productivity. Nevertheless, while both developments would boost the amount of payroll taxes collected and lighten the tax burden on individual workers, Groshen and Klitgaard caution that "the material well-being of both workers and retirees would still fall short of what it would have been without the demographic change."

Contact: Linda Ricci
(212) 720-6143