both contribute importantly to the difficult fiscal adjustments that will be necessary in years ahead.
Accordingly, it is difficult to isolate the effects of ongoing demographic change on the fiscal outlook. Furthermore, from a practical perspective, the ease with which our nation can adapt to the challenges of aging is greatly affected by the other factors shaping fiscal policy choices. For example, aging becomes a much more difficult problem in the face of rapidly rising health spending, and raising taxes to finance Social Security benefits becomes more difficult and has greater efficiency costs if taxes are already being raised to finance federal government debt or to pay for the pension and health benefits of state and local workers. Thus, in this chapter, the committee provides an overview of the financial imbalances projected for Social Security and Medicare, but it also focuses more broadly on the overall fiscal conditions of federal and state and local governments rather than solely on the challenges presented by aging.
Social Security and Medicare are the two largest federal programs that support the elderly. In addition, Medicaid, a joint federal-state program that provides health care to those of modest means, is an important source of financing for the long-term care needs of the elderly. These three programs currently account for over 40 percent of all federal spending and almost 10 percent of our nation’s gross domestic product. In addition, the federal government’s publicly held debt now stands at roughly $10 trillion, or about 62 percent of GDP, and current projections suggest that, under reasonable (though still quite uncertain) policy assumptions, it will rise to 80 percent of GDP over the coming decade (Auerbach and Gale, 2012). The projected slowdown in the rate of labor force growth, by lowering the growth rate of the tax base, also makes that debt more difficult to service.
The Social Security program assesses payroll taxes on workers and uses those revenues to provide cash benefits to retired workers and their dependents.2 Thus, Social Security revenues depend on the size and productivity of the labor force, whereas Social Security outlays depend on the size of the elderly population. Both increases in life expectancy (which increase the size of the elderly population) and reductions in fertility (which eventually
2While payroll taxes provide most of Social Security’s revenues, small amounts are also collected from the personal income taxes paid on Social Security benefits by upper-income taxpayers and from interest earned on trust fund reserves.