The Demographic Crisis is a Fiscal Crisis

Fewer Babies Today Could Bankrupt the Safety Net Tomorrow

This is Part II in a mini-series on why falling birth rates are a crisis. In Part I, I focused on how cultural shifts in how we view children are a crisis for parents and especially for mothers. Part III – releasing next week – will focus on arguments against birth rate declines being a crisis and why the cultural and economic costs outweigh the benefits.

Last week, the Medicare and Social Security Trustees Report released – reaffirming the grim picture for American entitlement programs. The Old-Age and Survivors Insurance Trust Fund can only fully fund benefits through 2033. After that, the fund’s reserves will be depleted and program income will only be sufficient to pay 77% of total scheduled benefits. As my colleague and former Social Security Trustee Chuck Blahous pointed out, this funding shortfall is massive and is only becoming harder to correct. The longer we wait to either reform social security or make family life more affordable, the less likely it is that the younger generations receive any entitlement dollars at all.

Looming Shortfalls and Shrinking Workforces

The insolvency of entitlement programs goes hand-in-hand with declining birth rates. America’s population is aging rapidly and families are having fewer children. It’s easy math to see that more retirees and fewer prime-aged workers is a recipe for fiscal disaster. In just a few years, only two active workers will support each retiree on Social Security. In 1950, this worker-to-beneficiary ratio was 16:1.

The decreasing size of the worker-to-beneficiary ratio comes at a massive fiscal cost to both entitlement programs and individuals. Care programs for Seniors already consume a growing portion of our federal budget and the Congressional Budget Office projects that by 2034, half of all federal non-interest outlays will go to Seniors. If the trust fund runs out, Congress will be forced to raise payroll taxes, increase the cap on taxable earnings, or use general revenue. If policymakers do not act, the payroll tax will need to rise to 16.7% in order to cover the shortfall - or $13,500 per year in Social Security taxes for the median household.

Insolvent entitlement programs will take money away from younger generations in other ways besides higher payroll taxes. Federal spending on children is falling further and further behind federal expenditures on the elderly. The Urban Institute projects that, without entitlement reform, the share of federal spending on children will continue to decline - from 9% in 2023 to just 6% by 2034. All while spending on the oldest generations continues to grow. This focus on investing in older generations at the expense of younger ones threatens social mobility and economic growth.

All of this is concerning as it is, but looking closer at the models used by the Social Security Administration gives more reason for alarm. The models used by the Administration assume that the birth rate will bounce back to the replacement rate. If the birth rate stays stable or declines further, the entitlement crisis may be sooner than expected.

Other Countries Warn of What’s To Come

Other countries with lower birth rates show the reality of continued demographic pressures: higher taxes, lower productivity, and lower growth.

In the long run, the aging population of Japan (birth rate: 1.26) will push pension spending and medical expenditures on health and long term up by 3% and 2% of GDP respectively. The public portion will increase from 5.9% to 8.2%. But the biggest fiscal squeeze Japan will experience is rising consumption and labor taxes. To cover the rising age ratio, consumption taxes will need to rise from 5% to 19.3% while labor income taxes will need to rise from 35.3% to 48.8% – of course such a dramatic increase in taxes will in turn depress labor participation and savings, causing more economic damage.

The economic effects of birth rate declines in South Korea (0.78) are even more concerning. The critically low birth rate of South Korea has negative economic consequences in every dimension. Without significant labor market interventions (like increased migration), real GDP growth in South Korea will reach zero and remain negative after – as soon as 2050. Projections also indicate that the South Korean labor force could shrink by over 25% by 2050, leading to a potential annual decline of 0.67 percentage points in potential GDP growth. As birth rates continue to fall, this declining growth will only make the fiscal imbalance worse. Even the most conservative scenarios predict a deficit of 7.8% of GDP and net government debt exceeding 131% of GDP by 2050. Comparatively, South Korea ran a surplus in 2019.

Can the U.S. Avoid the Same Fate?

Fewer births means a drastically different economic future. Shrinking workforces have already led to labor shortages and slower growth in East Asian Countries. If the U.S. birth rate continues to decline, we can expect a similar path - especially if Congress refuses to make any meaningful reform to entitlement programs.

But it isn’t all doom and gloom. Automation and productivity-enhancing technologies could offset some of the economic drag caused by a shrinking labor force by boosting output per worker. Increasing immigration at all levels can also help offset some of the effects of lower birth rates. Breakthrough technologies, however, could take decades to diffuse across sectors. Immigrants have long helped ease the pain of demographic shifts, but now political conditions and demographic shifts in home countries make relying on immigration a risky strategy. Policy shouldn’t be just “hoping for the best.”

This isn’t to say that higher birth rates are a silver bullet to reverse the shortfall. In order to turn around the shortfall, birth rates would need to immediately increase to 3.42 children, meaning returning to the birth rates of the 1960s. But higher birth rates do indeed play an important role in keeping our entitlement programs solvent. Policymakers should do both entitlement reform and reforms that make family life more affordable. Inaction all but guarantees higher taxes, lower growth, and a more regressive social safety net.

Time Users

• What I’m Reading: I reread Melissa Kearney’s The Two Parent Privilege this week to prepare for the class I taught last night. A great book to intro young people to gender and family economics.

• Something I Found Interesting: Nearly one-in-five childcare workers are immigrants, but in seven of the 10 largest cities immigrants make up a larger share of the child care workforce than any other industry. Data from this paper in the Journal of Public Economics

• What I’m Listening To: HAIM’s new album I Quit

• What I’m Making: Not necessarily “making” but I went to a craft thrift store on Sunday with some crafty friends to scope out a moving sale. If you have one near you and you do anything creative, you have to go. DC area readers go to Creative ReUse in Alexandria when it reopens in August!