Should We Increase Our National Savings Rate?

1. Should We Increase Our National Savings Rate? Victoria Vogel October 26, 2010

2. Does Population Aging Provide Rationale for an Increase in the Savings Rate? • Is the savings rate actually too low? • One of the lowest among developed nations • Households are myopic • Government policies with unintended anti-savings effects • Positive return to saving may be lower than the social return due to positive externalities from capital accumulation • Results from projected social welfare functions

3. The Changing Composition of the United States • In 2011, when the first of the baby boomers turn 65, there will be 4.5 adults of working age for every person 65 and over and the elderly will constitute 13% of the population • In 2029, there are expected to be less than 3 working-age adults per retiree and the elderly will take up 20 percent of the population • Demographic population aging a result of increased life expectancy and declining fertility

4. (Elmendorf, 2000)

5. Economic Effects of Population Aging • Increased life expectancy • The share of workers in the population is reduced, meaning that each worker will have to support an increased number of retirees in addition to the same number of children  lower level of consumption per capita. • Declining fertility • Dependency effect: increase in overall dependency rate  a lower level of consumption per capita • Solow effect: reduction in the workforce growth rate, meaning that less savings is necessary to keep capital per work growing at a steady state  higher level of consumption per capita • Capital intensity effect: capital/labor ratio increases, decreasing returns to capital and the return to saving is below social discount rate  boost optimal current consumption

6. Government Role (Elmendorf, 2000) • Social Security and Medicare Part A to become insolvent in 2037 and 2025, respectively • Making these programs self-financing for the next 75 years would require immediate increases in payroll taxes of 1.89 and 1.21 percentage points, or an equivalent cut in benefits

7. The Burden of Population Aging • The government will ultimately bear the brunt of the cost of aging through these public programs, while receiving few of the benefits. • Nation vs. Government • the national problem posed by population aging would require a 1½ percent decline in individuals’ consumption, relative to what it would be otherwise. • if the government were to finance the increased expenditure of the elderly, the necessary tax increases would amount to around 3% of consumption • These numbers suggest that the optimal response to population aging is to let individuals bear the costs, not the government. But which individuals?

8. Future Consumption in U.S. Unrealistic assumptions (Elmendorf, 2000)

9. Conclusions and Policy Implications • While an increase in the savings rate may benefit the U.S. in the long-term, it is not necessarily the solution to the aging problem • Instead, the financial burdens of population aging should be transferred to future cohorts, who will be more capable of affording it. • Neither a drastic reduction in benefits or increase in taxes is not currently a necessary action