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Pay as You Go Sustainability

February 8, 2013

In my previous post, I wrote “Past generations took more out than they paid in, often by quite a lot.” However, that alone is not sufficient for a “Pay as you go” to be unsustainable. The default condition of the economy and the population in the past 100 years has been steady growth. If the population is constantly growing, the number of young workers will always outnumber the number of old retirees. If the economy is constantly growing, each generation is richer than the last and can afford to pay a little more to the generation who came before.

If you assume the standard lifecycle of an American:
0-22: Schooling and part time work, 23-65: Productive work, 65-83: Retirement. 42 Years of Productive work, 22 years of dependancy, and 18 years of retirement. With a steady population size, each dollar of taxes paid into a PAYG pension scheme results in $2.33 of benefits. With a growing population, the young will be an even larger fraction of the population than the old. Instead of 2.33 workers per retiree, there could be 5. Each dollar of taxes could result in $5 of benefits, and each generation could take out more than they put in because they created more children to shoulder the burden.

If you assume 2% real economic growth, which has been about the average post 1900, the picture becomes even better. Every 20 years, the size of the economy increases about 50%. One’s grandchildren would be more than twice as wealthy. Because of their additional wealth and income, it would be easier for them to shoulder more of a burden paying for their parent’s retirement. Furthermore, if one considers equality from an intertemporal perspective, it may be fair to take from those who grew up with Xboxes and give to those who grew up with iceboxes. If you assume a constant tax of 15.3% (which is where it is now), the tax revenue would increase 230% over one’s 42 year working life.

Just as the baby boomers are hitting retirement, the economy has hit a brick wall. Median income growth has been low for the last two decades and fertility rates have plummeted. Remember that incomes over about $100,000 is untaxed for social security, so the 1% getting richer isn’t increasing SSA revenue. Hostility towards immigrants is quite high these days, barring population increases via that method. The past justifications for paying retirees more than they put in are growing smaller, but are still far from 0. Our society can still afford to give retirees a decent amount of money, but it cannot support the levels of transfers it once did.

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