The aging of the Western world

President Bush is encouraging Congress to reform social security. Part of that reform, Bush suggests, should be an option for workers to contribute their money into a personal retirement account, instead of having the money be sent to the United States Treasury. Tech Central Station columnist Arnold Kling supports the personal retirement accounts concept, as do I. But Kling points to a flaw in the manner that many "experts," of the left and right, describe the current social security system, it's financial problems and how these problems are likely to be solved. Here's an excerpt from one of Kling's numerous columns on social security:

If the Baby Boomers were to postpone their retirement, the problem would go away. There would be more workers producing output, and there would be fewer retirees to absorb Social Security taxes.

Kling references an analysis of the demographics of the Western world. It seems that Japan is facing the worst demographic nightmare of the developed nations, with Italy not very far behind. Back to Kling's column......

It is fair to conclude that the Social Security problem is largely an artifact of the retirement age. Raising the retirement age to something like 73 would make Social Security quite manageable. This increase in the retirement age does not need to affect anyone currently over the age of 50. In other words, the higher retirement age would not take effect for more than 15 years. By that time, continued improvements in health should make work a viable option for most Baby Boomers.

Of course, no one would be forced to work. People who are too unhealthy to work would still be eligible for disability. People who are healthy but want to retire before age 73 would have to finance their early retirement out of their own savings.

It is important to recognize that we are not necessarily doomed by demographics to suffer a reduced standard of living in 25 years. (It is even more important to recognize this in Japan and Europe, where, as Culhane's paper shows, populations are aging faster than in the United States.) A lower standard of living comes from demographics combined with the strict retirement age, which provides a strong disincentive for the elderly to work. There are mainstream economists on the left and on the right who agree that reducing the distortion caused by the retirement age is the single most powerful policy tool that we have available for addressing the Baby Boom Social Security issue.

Kling believes that implementing personal retirement accounts will improve the United States economy, independent of whether the retirement age is raised or projected benefits are reduced. Kling sees an incentive effect in having people contribute to their own account rather than having their money absorbed by the government combined with an unenforceable promise to pay retirement benefits in the distant future. Workers will see that their accounts grow faster when they earn more money and contribute more to their personal retirement account.

As for the transition cost of allowing for personal retirement accounts, Kling argues such a transition cost is really not a cost at all. The government is simply meeting its commitment to today's workers today, instead of meeting that commitment decades later when they retire.

Personally, I believe that a simple and effective way of reducing projected taxpayer paid social security benefits for future retirees would be to, from here on out, replace the wage indexing with the price indexing of contributions or even get rid of indexing altogether. (See the Social Security Administration's web site for details on indexing and how retirement benefits are calculated.)Confused? Read the entire column by Kling and you are less likely to get snowed by the upcoming debate.