Can We Afford to Grow Old?

The new Democratic Congress will take up a number of important issues in the coming two years, including immigration, energy policy and the deepening crisis in the Middle East. But all these issues pale in comparison with one that Congress has refused to take seriously.

This challenge may seem distant and abstract, and the public isn't clamoring for a solution. But when Congress finally finds the guts to address it, the political strife will be enormous. This neglected issue? The cost of supporting an aging America.

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Stark numbers

Here are the sobering facts: By 2030, when most of the baby-boomers will have retired, 19% of the U.S. population will be older than age 65, compared with less than 12% today. Picture a nation with a higher median age than today's Florida, the state with the oldest population.

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And this graying -- a phenomenon throughout the developed world -- will occur in one of the few highly advanced nations that will at least experience some degree of population growth -- about 1% a year, from immigration and the higher birth rate of minorities.

These days, it takes payroll taxes from five working Americans to finance the Social Security and Medicare benefits of one retiree. But by 2030, each retiree will be supported by only three workers. Even if the U.S. economy continues to achieve strong productivity gains, this declining worker-to-retiree ratio -- accompanied by surging medical costs -- will almost certainly lead to a reduction in living standards. That's because generations yet to come will face a much higher tax burden if nothing is done to change senior benefits -- maybe 33% more, the Federal Reserve Board estimates.

The choices for funding future retiree benefits are clear, and painful: much higher taxes; flat or declining government spending on everything -- defense, education, public infrastructure, housing, scientific research -- except programs for seniors; slower growth of spending on senior entitlement programs; an ever-larger national debt; or some combination of these.

Among these choices, Fed chair Ben Bernanke leans toward fundamental reform of the senior entitlement programs. And the sooner the better, he says, so it will be easier "for people now in their working years to prepare by saving more today."

Soaring Medicare costs will be the biggest problem, but so far there's been more discussion of Social Security. Under President Bush's proposal, workers could divert, if they wished, a few percentage points of their FICA taxes into private retirement accounts. Assuming even modest investment returns over many years, today's younger workers would fare better under this plan than under Social Security.

Today's older workers, closer to retirement, could remain in the present system. The cost of transitioning to this partial, voluntary privatization of Social Security would be funded from general tax revenue -- and the number would be big. Democrats don't have a coherent plan yet, but most seem to favor raising the $97,500 wage base to which Social Security taxes apply.

The need for sacrifice

Of all the things we should be doing now to prepare for the graying of America, Bernanke says the most important is to boost our national savings rate. By saving more as individuals and by borrowing less as a government, "we can reduce the future burden of demographic change" on our progeny, he believes. "Saving more requires that we consume less or work more. Either case entails some sacrifice on the part of the current generation."

Is sacrifice an archaic value in an era in which we fool ourselves that we can have it all? I hope not. Fairness to generations unborn requires it.

Knight came to Kiplinger in 1983, after 13 years in daily newspaper journalism, the last six as Washington bureau chief of the Ottaway Newspapers division of Dow Jones. A frequent speaker before business audiences, he has appeared on NPR, CNN, Fox and CNBC, among other networks. Knight contributes to the weekly Kiplinger Letter.