of the labor force lowers payroll tax revenues and lowers gross domestic product (GDP) growth, making it more difficult to service existing debt. States finance part of Medicaid as well, so they, too, face financial pressure from demographic change. In addition, many states have promised pension and health benefits to their retirees, and these commitments will also put pressure on budgets as the population ages.
From an academic perspective, it would be interesting to distinguish the effects of demographic change from other factors affecting the fiscal outlook. However, in order to do so, it would be necessary to construct a counterfactual baseline (alternative scenario) of what the history and future of spending and tax revenues would have been in a world with no demographic change. Such a counterfactual is very difficult to create, because it is difficult to know how policies might have been different under alternative demographic patterns. To cite just a couple of examples: One would have to know how Medicare policies concerning payments to hospitals and physicians might have evolved differently in the absence of the looming fiscal challenges associated with an aging population or whether Medicaid benefits might have been more limited had states had to finance the education of the much larger cohort of children who would have been born had fertility not declined.
To the extent that the policies currently in place already reflect the actual or anticipated effects of demographic change, an examination of the current fiscal outlook may understate the impact of such change. For example, the 1983 Social Security Commission raised payroll taxes and increased the Social Security full retirement age. These measures reduced the imbalances in Social Security by, in essence, lowering consumption by workers through higher payroll taxes and a reduction in expected benefits. Thus, the current imbalances in the Social Security system provide a measure of how much further policy needs to adjust, but not of the entire effect of demographic change on consumption and/or labor force participation.1
On the other hand, for many parts of the budget, the projected imbalances between revenues and expenditures are only partially explained by demographic change. In particular, excess cost growth in health care and past tax and spending policies that contributed to today’s outsized deficits
1Some observers believe that the buildup of surpluses in the Social Security trust fund was used to offset deficits in the on-budget accounts—that is, that taxes would have been higher or spending lower had those surpluses not been amassed. In that case, it is still true that the combined effects of the earlier tax increases and benefit cuts provide a good metric, when combined with the adjustments that still need to made, of the effects of aging on Social Security. However, if on-budget deficits are higher than they would have been in the absence of the tax increase, it means that, as a society, we have yet to make any of the adjustments required in the face of aging—some of the adjustments need to be made to shore up the Social Security trust fund, and other adjustments need to be made to pay off the extra debt that was amassed.