Three card Monte with Social Security, Medicare and Medicaid

At this point everyone has heard the story of how Social Security and Medicare are going to bankrupt our children. There is a whole industry dedicated to promoting the idea that our kids risk having much lower standards of living than their parents or grandparents because of these programs.

This story is routinely repeated in various forms by politicians and columnists who decry the fact that we don't care enough for our children and that the elderly have too much political power. The remarkable part of this story is that there is no conceivable way that it is true and every economist knows it. Unfortunately, economists generally feel little need to inform the public about important policy matters -- or at least that seems to be the case when the information might undermine the agenda of powerful interests.

The conventional story of how Social Security, Medicare and Medicaid will bankrupt our children is a game of three card Monte. It's about getting people to focus on the non-issue and to ignore the real issue.

The story is that we will have to pay higher taxes in the future than we do today to support these programs because of a falling ratio of workers to retirees. This is true.

Of course even at this most basic level the demographics are horribly misrepresented. Most of the projected rise in the cost of these programs comes from the projection that rising per person health-care costs will drive up the cost of Medicare and Medicaid, not the ageing of the population.

The answer to this problem is to fix our health-care system. If our per-person cost were in line with those of any other wealthy country, our projections would be showing long-term surpluses, not deficits.

But this is really the sidebar; the trick is that the deficit gang has got everyone to focus on the deficit and prospective tax burdens as a measure of their well-being. The implication is that if our children face a higher tax burden than we do then they will have lower living standards.

This is absurd on its face. Suppose Bill Gates paid a 90 percent tax rate on all of his income. He still would have a far higher after-tax income than just about all of us. And this is exactly the story with our children. On average they will have a much higher before-tax income than do workers today. As a result, even if they have large increases in their tax rates, on average they will have much higher after-tax incomes.

This is hardly a secret. The Social Security Trustees Report gives a typical set of projections. It shows that before-tax wages will be on average almost 50 percent higher in 2040 than they are today. This means that even if we had very large increases in tax rates, our children and grandchildren will have a much higher after-tax income in 2040 than workers do today. 

All economists know this. The basic point is not in dispute. Yet how often is this point made in policy debates? Do our representatives in Congress who whine about the plight facing our children and grandchildren, who sometimes talk about child abuse because of the risk that tax rates could rise, realize that our children are virtually certain to enjoy higher after-tax income than workers today?

In fact, the situation is even more distorted than these numbers imply. A large percentage -- quite likely a majority -- of economists holds the view that the consumer price index overstates the true rate of inflation. This is important because it means that wages will actually rise much more rapidly than projections like those in the Social Security Trustees Report indicate.

A recent paper published by the Brookings Institution assumed that the overstatement of inflation is 0.8 percentage points annually. The implication of this claim is that the wage of an average worker will be more than 80 percent higher in 2040 than it is today. It would take some really huge tax increases to push these workers' after-tax wages below the after-tax wages of workers today.

In other words, the idea that workers in 20, 30 or 40 years will on average have lower after-tax wages than do workers today is absurd on its face. Yet tens of millions of people believe it. This absurd concern has been at the center of national debate for much of the last quarter century.

This is the great Three Card Monte trick. What will matter to the living standards of our children and grandchildren is the upward redistribution that we have seen over the last three decades. If this upward redistribution continues, then most workers will see little benefit from economic growth in the future. In that situation, their living standards may not be much better than those that workers are seeing today and possibly even worse, because a small group at the top will get most of the benefits of growth.

However this is not an issue of inter-generational distribution, it is a question of intra-generational distribution. Yet many economists are running around saying the opposite, arguing that we have to cut Social Security, Medicare and other programs that primarily benefit the elderly in order to help our children.

This speaks to the incredible corruption of the economics profession. The vast majority of economists are supporting, or at least acquiescing, in plans to cut Social Security and Medicare even though they know that the upward redistribution of income is the real threat to future living standards.