Paying for the baby boom generation's social security pensions: United States, United Kingdom, Germany, and Sweden

PAYING FOR THE BABY BOOM GENERATION’S SOCIAL SECURITY PENSIONS: United States, United Kingdom, Germany, and Sweden

JOHN B. WILLIAMSON* Boston College FRED C. PAMPEL University of Colorado

ABSTRACT: We compare four nations with respect to plans for dealing with the anticipatedpension burden due to the retirement of the baby boom generation. We assess the merits of the pay-as-you-go as opposed to the partially funded approach to financing. Policy alternatives drawn from the United Kingdom, Sweden, and Germany are reviewedfor their relevance to the United States. We conclude that the new German indexingformula or a recently proposed Swedish indexingformula, both of which emphasize intergenerational burden sharing, may make sense for the United States.

Between the year 2000 and 2040 the population age 65 and over is projected to increase from 12 to 20 percent in the United States with similar trends in other industrial nations such as Germany (17 to 28 percent), the United Kingdom (15 to 20 percent), and Sweden (17 to 23 percent). During this same 40 year period the old-age dependency ratio is projected to increase from .I8 to .32 for the United States again with similar trends for Germany (.25 to .48), the United Kingdom (.22 to .33), and Sweden (.25 to .37). The trend is much the same for projections with respect to increases in the share of *Direct all correspondence to: John B. Wililiamson. Department of Sociology, Hill, MA 02167. JOURNAL OF AGING STUDIES, Volume 7, Number 1, pages 41-54 Copyright @ 1993 by JAI Press Inc. All rights of reproduction in any form reserved. ISSN: OWO-4065.

Boston College, Chestnut

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the national income spent on public pensions. The projected increase between 2000 and 2040 is from 8.2 percent to 14.6 percent for the United States, from 7.5 to 11.2 percent for the United Kingdom, from 12.1 to 18.0 percent for Sweden, and from 16.4 to 31.1 for Germany (OECD 1988). The burden associated with the retirement of those born in the early postwar era will be severe in the United States and at least as great in all three of these other industrial nations. While some analysts seem to suggest that the burden associated with the retirement of the baby boom generation in the United States will be a temporary phenomenon, others argue that unless there is a dramatic increase in birth rates or a substantial liberalization of immigration policies, the proportion of GNP allocated to OASDI pensions is likely to remain relatively constant with little if any decline after 2040 (Aaron 1990; Myers 1989). These alternative scenarios have obvious implications for the debate as to whether or not it makes sense to build up large Social Security trust fund reserves during the next thirty years so as to cushion the impact of the retirement of the baby boom generation. Some analysts favor policies that emphasize the pay-as-you-go approach while others favor an approach that calls for the build up of substantial trust fund reserves. In this article we will take a close look at the arguments on both sides of this debate. As Germany, Sweden, and the United Kingdom are facing old-age dependency burdens at least as great as that in the United States, it will provide useful to take a look at how these nations are dealing with the same issue. We will be asking whether these countries are considering or have implemented policies that deserve serious consideration by American Social Security policy makers. In the United States current policy has been shaped in large measure by the 1977 and 1983 Social Security Amendments which have contributed to a shift away from the traditional pay-as-you-go approach toward a partially funded alternative that will produce a substantial buildup of Social Security trust fund reserves over the next few decades. Critics of the current policy have proposed a number of alternatives to investing these trust fund reserves in government bonds. One proposal would authorize the government to invest Social Security trust fund monies in state and local bonds to fund projects designed to enhance the country’s infrastructure. Another would allow these funds to be invested in basically the same public and private sector securities used by pension funds that are guaranteed by the Employee Retirement Income Security Act (ERISA). Yet another would allow workers to invest the surplus in private IRA type accounts (Kollmann 1991; Ferrara 1990). However, the alternative that has received the most attention is Senator Daniel Patrick Moynihan’s proposal calling for a reduction in payroll taxes and a shift back to pay-as-you-go financing. Moynihan has outlined this proposed changes in a series of bills. Of particular note are S.2016 and S.3167 introduced in the 1Olst Congress and S. 1 I introduced in the 102d Congress. There are potentially many different versions of the pay-as-you-go approach depending on what payroll tax rates are used and when they are scheduled to change (Koitz and Kollmann 1990; Myers 1989). In the discussion to follow we will focus on the approach outlined by Moynihan rather than one or another of the specific proposals he has made. The 1983 amendments introduced a number of policy changes designed to resolve the problem of financing old age pensions in the United States until well into the twenty-

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first century (Schultze 1990). One provision calls for a gradual increase in the age of retirement with full pension benefits from 65 to 67 over a twenty-seven year period starting in 2003. Another provision specifies that in years when the trust fund is low COLA adjustments are to be based on changes in wage levels rather than price levels if the former yields a lower figure. Both of these provisions amount to cuts in benefits. But even more important are the provisions speeding up the timetable for introducing payroll tax increases that had been scheduled for a later date under legislation enacted in 1977. The new rate schedule was designed to assure that the OASDI tax cont~butions would exceed actual pension benefits until 2016. As the OASDI trust funds will be building up reserves and these reserves will be earning interest, income is projected to exceed outgo through 2027. If no further payroll tax adjustments are made, these reserves will gradually be drawn down between 2027 and about 2043. Many analysts argue that this will ease the payroll tax burden on those in the labor force during the retirement of the baby boom generation. The financial strain of paying pensions to the baby boom generation will, however, start sooner than 2027; it is projected to start in about 2017 when OASDI tax receipts begin to fall below benefits paid (Kollmann 1991). In some respects current policy is working as planned. In recent years Social Security has been running in a surplus, much more money has been flowing into the OASI trust fund than is being paid out as current pension benefits (Weaver 1990). The difference is being invested in government bonds which will be cashed in over time as the trust fund begins to run a deficit. However, this effort to build up a trust fund reserve has come under sharp criticism in recent years. Some critics argue that these monies are not really being set aside as a trust fund reserve, rather they are being spent to finance current consumption (Moynihan 1990). They sometimes use such terms as “thievery” and “embezzlement” when referring to the use of the Social Security surplus to fund current consumption (Brockway 1990). One reason Moynihan is so critical of this practice is that it amounts to financing current government spending using monies generated by the regressive Social Security payroll tax rather than the progressive income tax. He also claims that these monies are being used to mask the true magnitude of the federal deficit. His proposal to cut the size of the OASDI tax contribution and return to pay-as-you-go financing is in large measure a response to this objection to the current policy. Is the Social Security surplus being used to mask the true magnitude of the federal deficit.? A case can be made that this claim was true during the 1980s and maybe during the 1970s as well. In 1969 a change was made in the way federal budget calculations were done. A shift was made to a “unified” budget in which Social Security monies were combined with general government monies for the purposes of determining the size of the federal deficit (or surplus). Some scholars have argued that this change was made because it was the combined or unified budget figure about which budget planners were generally most concerned (Schultze 1990). Others have argued that it was motived, as least in part, by the desire to mask the growing cost of the war in Vietnam. In 1985 legislation was passed specifying that as of 1986 Social Security monies would no longer be included in the federal budget totals, except for the purposes of determining whether the Gramm-Rudman-Hollings deficit targets were being met. This turned out to be such an important exception that for all practical purposes the unified budget remained in

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effect through 1990 when legislation passed ending this practice (Myers 1989). The Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508) specified that OASDI monies were to be excluded from all calculations of the federal budget deficit (Koitz 1991). There are those who argue that a separation of these monies for the purposes of calculating the size of the federal deficit does not have a significant impact on financial markets (The Economist 1990). As far as these markets are concerned, the important figure is and always was the combined (unified budget) figure; the separation of the monies into two separate accounts does not affect this crucial combined figure. Is the government spending the Social Security surplus on current consumption? It is safe to conclude that the government is spending a greater share of these monies on consumption that it would be were the rest of the budget in balance, but that does not mean it is all being spent on consumption. Much of it is being spent on items such as salaries and defense (current consumption), but some is also being spent on such items as roads and education (government investment). Longman (1990) and others argue that the surplus is not being used in ways that promote savings, investment, or long-term increases in productivity. A more accurate description would be that it is not being used for these purposes to the extent that it would were the rest of the budget in balance. Many analysts argue that the best way to “save” this surplus would be to use it to reduce the size of the federal debt. This would free up public sector monies for more productive purposes such as spending on education and the nation’s physical infrastructure. However, this can only be done if the rest of the federal budget is balanced or close to it (Schultze 1990). While there has been a surplus in the Social Security system during the past several years, during this same period there have been even larger deficits in the rest of the federal budget. As a result these monies are being used to meet current government obligations, not to reduce the debt (Aaron et al. 1989). A substantial portion of this money is being spent on defense, interest on the federal debt, the cost of bailing out failed savings and loan associations, and other current expenditures that make little if any contribution to future increases in productivity. How about the suggestion that the trust funds are being left with relatively worthless IOUs? As the OASDI monies come in, the Treasury makes a record and the trust funds are credited with interest bearing government bonds (Koitz and Kollmann 1990). Each year the trust funds are also credited with interest on these reserves which takes the form of additional bonds. These trust funds are in addition credited for the federal income tax revenues that are due to the tax on Social Security benefits for high income pensioners. The so called IOUs are government bonds, but for technical reasons they are not ordinary Treasury bonds. Rather they are special nonm~ketable bonds that do not fluctuate in value as do regular Treasury bonds. While these bonds are in a sense IOUs (that is true of any bond), they are secure. There is no doubt as to whether the government will make good on these bonds when they come due (Rivlin et al. 1990). The suggestion there may be nothing in the Social Security trust funds when it comes time for the baby boomers to retire is in large measure misleading. However, future Social Security benefits do ultimately depend upon potitical decision in the future. It is possibie that the government will decide to directly or indirectly reduce the size of these benefits, for example, by adjusting the formula used to compute initial benefits or cost of living adjustments.

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When it comes time to pay off the bonds being purchased with the current Social Security surplus, one result of having used these monies for current consumption rather than debt reduction (or investment) is going to be an increase in the burden of paying for the retirement of the baby boomers. The national debt is going to be greater than it would otherwise have been, the interest on that debt is going to be larger, and the overall national product will be lower. It will take a larger share of the average American’s income to pay for these pensions than it would have, had we used the surplus over the years for debt reduction (or investment). While workers will not be faced with a sharp increase in the Society Security payroll tax (because of all the bonds in the trust funds), they will not escape the burden of paying for the retirement of the baby boom generation (Rivlin et al. 1990). Higher general revenues, probably in the form of higher personal and corporate income taxes, will be needed to retire and pay interest on the bonds in the trust funds. Independent of whether an effort is made to build up a large reserve in the trust funds during the next few decades, the entire cost of the retirement of the baby boom generation will have to be paid for out of the national product produced during the years of that generation’s retirement (Aaron et al. 1989). Individuals can save for their own retirement and live off of the assets they have accumulated over the years, but it is not possible for an entire society or age cohort to do so (Thompson 1990). The goods and services the baby boom generation cons~es during retirement will have to be produced at that time. It is likely that it will be paid for in large measure by some combination of payroll taxes, income taxes, and corporate taxes with the exact combination influenced by how large the trust funds between now and 2020. While the goods and services consumed during the retirement of the baby boom generation will be produced by those in the labor force at that time, many baby boomers will be cont~buting to the support of their own generation as taxpayers. In addition, if economic growth rates tend to be low over the next several decades, retirement incomes will be low and that might increase the proportion of baby boomers remaining in the labor force (Kingson 1989). Suppose Congress were to go along with the proposal to reduce the payroll tax and shift back to a pay-as-you-go system. What difference would it make? In the absence of other tax and spending policy changes, the immediate effect would be to increase the disposable income of many workers. This would stimulate the economy, reduce unemployment, and contribute to short-term economic growth (Ferrara 1990). However it would also increase the size of the federal deficit and the national debt. This would eventually lead to higher interest rates which in turn would translate into less longterm economic growth and a lower national income when the baby boom generation retires (Rivlin et al. 1990). According to one recent CBO study, a shift to pay-as-yougo would have little effect on growth if offsetting changes were made in tax and spending policy. Without such offsetting changes GNP would be depressed relative to what it would be under current policy through 2016, but the study goes on to project that the pay-as-you-go alternative would result in stronger relative performance thereafter (U.S. Congressional Budget Office 1991). There are significant political implications associated with policies that do or do not promote increased long-term economic growth. If the nation were to experience a substantial increase in the national product between now and the time the bulk of the

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baby boomers retire, it is likely that there would be strong support for the continuation of at least current levels of support for Social Security recipients. But if there were to be relatively little growth and if as a result the maintenance of the current benefit levels would leave the working population with a reduced standard of living, we would expect less support for maintenance of current benefit levels (Thompson 1990). When people take about the Social Security monies not being there when it comes time for the baby boomers to retire, this is what they are talking about. The bonds will be in the trust funds, but political pressure from taxpayers could lead to policies that call for benefit cuts most likely in the form of reductions in the annual cost of living adjustments. What would be the impact of a shift back to pay-as-you-go financing on the burden faced by taxpayers during the retirement years of the baby boom generation? As the baby boom generation began to retire, early in the next century, Social Security payroll taxes would have to be increased substantially (Schultze 1990). One estimate assumes that the OASDI component of the Social Security tax paid by employees would be cut from the current 6.2 percent to approximately 5 percent for the next fifteen years. Then over a period of several years this tax would increase to about 8 percent (Kollmann 1991). Under this alternative the entire cost of paying for these pension benefits would be born by the payroll tax. The political implications of the pay-as-you-go as opposed to the trust fund buildup alternatives are not the same. The current alternative will call for little if any increase in the payroll tax, but a substantial increase in the federal income tax as the baby boom generation retires. In contrast, the pay-as-you-go alternative would call for much less of an increase in the income tax, but a sharp increase in the payroll tax. It would be a mistake to neglect the implications of the distinct between these two alternatives. A dramatic increase in payroll taxes would put a great deal of pressure on Congress to take measures to reduce the size of Social Security pension benefits or at a minimum to reduce annual benefit adjustments to something well below actual increases in the cost of living. Some analysts have argued that a sharp increase in the payroll tax could lead to a breakdown in the perception (on the part of the general public) that Social Security is a form of social insurance, a benefit that has been earned as a result of prior “contributions”; it might come to be viewed as just another tax scheme without the special government obligations implicit in the idea that it is a form of social insurance. This in turn might undercut the currently strong middle-class support for the system. A rapid increases in the federal income tax would also be very unpopular, but would not be as directly linked to old-age pensions as Congress would be responding to the need to cover the cost of the overall national budget only part of which would be due to the bonds held by the Social Security trust funds (Rivlin et al. 1990). The impact of a shift to pay-as-you-go funding would have different consequences depending on what other changes were made at about the same time. Proponents of the payroll tax cut tend to argue that it would put pressure on Congress to reduce spending, increase taxes, and reduce the size of the deficit. They argue that it would bring the deficit in the general revenues portion of the budget into clearer focus. This might force a reluctant Congress to take action (Myers 1990). Moynihan (1991) argues that the money could be found now, but as time goes on it will get more and more difficult for Congress to find the money to make up for the payroll tax cut. However, many analysts do not believe that a reduction in payroll taxes would end up being

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combined with a matching combination of general revenue tax increases and spending cuts. If a shift were made to pay-as-you-go funding, it is likely that there would be a substantial increase in the size of the deficit (Rivlin et al. 1990). This would, as mentioned earlier, increase the size of the federal debt; eventually it would lead to an increase interest rates and thus to the cost of servicing this debt. One consequences of this increased debt would be a decrease in the national savings rate and a decrease in the size of the national produce when it comes time for the baby boomers to retire. This would make it a harder burden to bear. A second consequence would be that as the baby boom generation began to retire, the federal tax burden would not be any lower than it would have been had the government accumulated a substantial debt to the Social Security trust fund. Instead of paying off bonds held in the Social Security trust fund, the government would be paying off about the same amount to domestic and foreign private sector creditors. When we add the anticipated increase in the payroll tax burden to what is likely to be an already high federal tax burden (due in part to increased interest payments on the national debt), we have a politically explosive mix that could lead to conflict between younger workers and retired baby boomers (Ball 1990). The case for a potential tax revolt could made on the basis of this pension burden alone. If in addition to we take into consideration the expected increase in the tax burden due to projected increases in the cost of health care, such a revolt becomes even more likely. If, on the other hand, the current policy of building up trust fund reserves were maintained while at the same time the rest of the federal budget were brough into balance or something very close to it, it is likely that the country would have a larger GNP per capita when it came time to pay for the retirement of the baby boomers than it would have with the same balanced budget, but no buildup of trust fund reserves (U.S. General Accounting Office 1989). The absolute cost of providing pensions for the baby boomers would be the same, but the larger national product and the higher per capita income would make it an easier burden to bear (Schultze 1990).

GERMANY, SWEDEN, AND THE UNITED KINGDOM As we mentioned earlier, Sweden, Germany, and the United Kingdom will all be facing old-age dependency burdens at least as severe as that in the United States. How will they be coping with this burden? Based on policy decisions to date, it looks like each of these countries will be dealing with this problem in its own way. Each will rely on a different combination of policies and in each case those policies will differ from what seems to be emerging in the United States. The German case is of particular interest as its public pension burden as a percentage of national income was in 1984 already larger than the burden the United States will be facing in 2020 (13.7 percent versus 11.3 percent), and according to current projections by the year 2000 the German burden (16.4 percent) will be greater than the figure (14.6 percent) projected for the United States in the year 2040 (OECD 1988). The evidence that Germany is able to manage its current pension burden as welI as it does leads some analysts to argue that the potential Social Security burden associated with the retirement of America’s baby boom generation is being blown out of proportion (Thompson 1990).

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The Germans are much aware of their impending old age dependency burden and have begun to take measures to deal with the problem. While they have instituted some major policy changes, the political support does not yet exist to introduce the even stronger measures that will be needed to deal with the level of old age dependency expected by about 2010 (Hinrichs 1991). The Germans are making no effort to build up trust fund reserves. German experts generally agree that there is no way around paying for the retirement of the baby boom generation except out of the national product produced during the years when this generation is retired. No attempt has made by the government to convince the German people of the need to set aside public monies in a rainy day account to be used to help ease the burden as the baby boomers retire. However, recent legislation calls for an important change in the formula used in the annual adjustment of pensions. For many years the procedure has been to make these annual adjustments on the basis of changes in gross wage levels so as to assure that pensioners share in the nation’s constantly improving standard of living along with the rest of the population. A change enacted in 1989 (and introduced in 1992) calls for a shift from gross wages to net wages for making these annual adjustments (Greza 1989). The net wage is the wage after removing social insurance contributions and income taxes. Starting in about 1996 social insurance contributions will begin to increase. Net income will as a result fall further below gross income. Over the years much of any increase in gross income will be offset by increases social insurance contributions and income taxes. As a result the annual pension adjustments will be smaller than they were under the prior formula. One consequence of policy change will be a sharing of the burden of paying for the retirement of the baby boom generation (Federal Minister of Labour and Social Affairs 1990). Workers will pay higher social insurance contributions than they do today, but pensioners will also get smaller annual pension adjustments. This reform is defended on the grounds that it is a reflection of and contributes to the intergenerational solidarity upon which the German pension system is based. There are other German reforms that can also be viewed as measures designed to help ease the impending dependency burden. One of the most important of these is a provision that calls for the phasing out of the prior policy of allowing many workers to retire early without penalty (Federal Minister of Labour and Social Affairs 1990). It will still be possible to retire early, but the pension benefits of those who do so will be actuarially reduced so as to discourage the trend toward early retirement. However, it is also of note that the 1989 legislation actually decreased, albeit slightly, the incentive to delay retirement from age 65 to 67 by reducing the increase in the size of the eventual pension from 7.2 to 6.0 percent per year of delay. The Swedish have what can be described as a partially funded (or as a modified payas-you-go) public pension system. During the first couple of decades contributions exceeded benefits paid by a substantial amount. The excess was accumulated in the National Pension Fund which today holds assets equal to about 5.5 times the amount paid out in pension benefits each year. Between 1983 and 1989 the contributions received by the system were less than was being paid out as pension benefits, but the total size of the fund continued to increase due to interest being earned on those assets. These monies are being invested in four separately administered funds. Three of these funds invest in government bonds, housing bonds, and in a variety of long-term capital

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projects. The fourth invests in corporate stocks. Since 1983 five employee investment subfunds have been added. Together these nine funds hold assets equal to approximately one-third of the Swedish GNP (Kollmann 1991). Despite this buildup of substantial pension reserves, many Swedes are concerned about the impact the retirement of the baby boom generation is going to have on future pension benefits and on the economy more generally. One reflection of this concern is the recent upswing in interest in private insurance and pension policies (Coughlin and Tomasson 1991). The Swedish pension reserves differ from the American buildup of OASDI reserves in several respects. One is that in Sweden the non-social security portion of the government budget has generally been, at least by American standards, close to being balanced. As a result these monies can appropriately be viewed as contributing to national savings, not current consumption. A second difference is that in Sweden employees make no contributions to either the ATP (earnings-related) or the AFP (universal) pensions. A third difference is that the Swedes do not limit their investments to government bonds; some of this money is invested in the private sector. As the monies in these reserve funds will be at least partially spent down during the retirement of the baby boom generation, there will be less pressure on income taxes than would have been the case had these monies been invested exclusively in government bonds. Because some of these monies have been invested in the private sector, we should expect that during the period of net redemptions there will be downward pressure on the value of stocks and on the economy more generally. However, as these monies have typically been invested in ways that contribute to long-term economic growth, the economy should be substantially larger than it would otherwise have been when it comes time to pay for the retirement of the baby boom generation. In Sweden organized labor has traditionally had a great deal more influence with respect to the formulation of social and economic policy than in the United States. While a few other interest groups such as the major employer organizations and organizations representing the interests of retirees are also influential, there are many fewer influential interest groups than in the United States. For this and related reasons it is likely that any effort at building up a Social Security trust fund with private sector investments would work very differently in the United States. There would be a great deal of interest group pressure to make investments in certain industries rather than others. It would be difficult to get these investments to somehow reflect long-term national planning. It is likely that short-term considerations would carry more weight as would parochial special interests. In the United States the option of private sector investment of Social Security trust funds has been considered several times in the past, most notably by the 1959 Advisory Council on Social Security Financing; but each time the idea has been rejected. There are many reasons. One has been the desire to avoid political pressure to preserve certain industries or to favor certain regions of the country. Another concern is that the government would come to control such a large share of equity markets that its buy and sell decisions would have a major impact on the market (Kollmann 1991; Aaron et al. 1989). In 1984 the Swedish Government appointed a commission to review the national pension system. This Pensions Commission (1991) recently issued a report that discusses

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Sweden’s plans for dealing with the pension burden the nation will be facing in the early part of the next century. The members of this commission believe that if it is possible to maintain a rate of real economic growth of about 2 percent, it will be possible to pay for the pensions of the baby boom generation without any major changes in current policy. The focus seems to be much more on efforts to assure this relatively high rate of economic growth than on specific policies to deal with the pension burden in the event of much lower rates of economic growth. The Swedish are aware, however, that a low rate of economic growth would require changes in pension policy. The recent Pensions Commission (1991) has outlined a number of proposals that will be given serious consideration if the nation’s rate of economic growth begins to consistently fall below the level needed to assure that the funds will be there to provide for the retirement of the baby boom generation under current policy provisions. One proposal is that an effort be made over the next 15 years or so to increase the asset base of the National Pension Fund by making sure that more is taken in as contributions than is paid out as benefits during this period. Due to the nation’s already very heavy tax burden the proposal is to do this without any increase in the overall tax burden on the average Swedish worker. Thus this alternative might require cuts in other parts of the national budget. The plan is to gradually draw down these pension fund reserves between about 2015 and 2035 when the burden associated with the retirement of the baby boom generation will be the most severe. This proposal is very similar to current American policy. A second proposal is to change the rules with respect to how the National Pension Fund monies are invested so as to increase the long-term yield on these monies. The suggestion is to give those managing the trust funds greater latitude with respect to their investment options permitting them to invest a greater share of the pension fund assets in stocks and other securities that offer high yields. Higher returns on the National Pension Fund monies would reduce the size of the pension fund contributions needed to pay for the retirement of the baby boom generation. A third proposal calls for a shift from the 1% and 30-year rules to corresponding 20- and 40-year rules. At present for workers with more than 15 years of coverage, the size of the earnings-related pension is based on the 15 best (highest paid) years. Similarly, for workers with fewer than 30 qualifying years (years of coverage) the pension is reduced by l/30 for each year the total falls short of 30. The proposed shift from the best 15 to the best 20 years for the first of these rules and the shift to a reduction by l/40 for each year the total falls short of 40 years for the second of these rules would both have the effect of reducing pension spending. Pensions would tend to be lower, and it would be more difficult to qualify for a full pension. This would tend to increase the number of workers remaining in the labor force. All these factors would reduce the burden of paying the retirement pensions of the baby boom generation. A fourth proposal calls for a shift from the present indexing of pension benefits based on changes in consumer prices to an alternative index based on the level of economic growth the nation enjoys. When the rate of growth in the GNP falls below a specified level (e.g., 1.8 percent real growth) the annual pension adjustment would be less than it would be with the current indexing formula, and it would not necessarily keep up with price increases. On the other hand when the rate of growth in GNP rises above a specified level (e.g., 25 percent), the annual adjustment of pensions would

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more than compensate for inflation; it would add an additional amount reflecting the increase in overall standard of living. This alternative indexing mechanism (the economic-adjustment index) would thus assure that pensioners would share with the working generation the increase in the standard of living during the good times, but they would also share the economic burdens associated with slow economic growth (Pensions Commission 1991). This policy change would promote intergenerational solidarity and reduce generational conflict during the retirement years of the baby boom generation. The British are moving in yet another direction with their trend toward the privatization of pensions. Currently about half of the employed work force has opted for the private alternative to SERPS (the public pension system) for earnings-related pension coverage (International Benefit Guidelines 1989). The private sector alternative now includes a choice between company (occupational) and personal (IRAlike) pension schemes. In the years ahead an increasing share of British workers will be depending on private sector alternatives to the public sector earnings-related pension. This will reduce the pressure on the government treasury as the baby boom generation retires. Another factor that will reduce the pressure on the public treasury is a provision in the Social Security Act of 1986 calling for a reduction in the earningsrelated pension during the first decade of the next century (Williamson and Pampel 1993). Between 2000 and 2010 the proportion of average annual revalued earnings replaced will be reduced from 25 to 20 percent (OECD 1988). In the United Kingdom the impending dependency burden will be shared among workers and employers who will be required to pay higher payroll taxes and taxpayers who will end up paying higher income taxes. But this is only part of the story. The retirement of the baby boom generation is also likely to put heavy selling pressure on the private sector pension funds. This is likely to lower the value of the securities held by these funds. It could also depress stock and bond markets more generally, spreading the burden even more broadly. The British trend toward private sector alternatives to public pensions is unlikely to be picked up in the United States. Such an option would constitute an even more radical change in the United States given the one-tier structure of the American public pension system, that is, due to the lack of a universal pension scheme. There would be concern that such a shift would undermine confidence in and support for OASDI and eventually transform it from a social insurance to a public welfare program. Britain, Germany, Sweden, and the United States all have provisions that call for an increase in pension benefits for those who delay the start of those pension benefits, but Britain provides the strongest incentive. Between age 65 and 69 (60 and 64 for women) pension benefits are increased by 7.5 percent for each year of delay. The Swedish increment pensions by 7.2 percent for each year between 65 and 69. The Germans increment by 6.0 percent between ages 65 and 67. The lowest incentive of all is provided by the United States, an increment of 3 or 4 percent per year (depending on year of birth) between age 65 and 69 (U.S. Social Security Administration 1990). The incentive in the United States is, however, being gradually increased and will be up to 8 percent by 2010 (Tomasson 1984). In addition, a case can be made that due to the 20 percent reduction in benefits for those who retire at age 62, there is in effect a 6.7 percent increase for each year a person delays retirement between age 61 and

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65. These incentives

do not seem to have done much to delay the age of retirement in any of these countries, and thus the approach may not hold much promise as an alternative for dealing with the burden of paying for the retirement of the baby boom generation.

CONCLUSION One of the most important Social Security policy questions facing the United States today is whether or not to return to pay-as-you-go financing for OASDI pensions. The policy most analysts favor and the one that makes the most sense to us is to bring the non-OASDI portion of the federal budget into balance, or something very close to it, during the next few years while continuing to use the Social Security surplus to build up the trust funds reserves over the next thirty years. However, if as we suspect, it proves politically impossible to get Congress to bring the non-OASDI portion of the budget into balance, a choice may have to be made between two other alternatives neither of which are attractive. One alternative would be to cut the payroll tax and return to pay-as-you-go financing. The other would be to continue the current “buildup” of the OASDI trust funds despite huge deficits in the rest of the federal budget. The first alternative risks substantially increasing in the size of the federal debt. The second may lead to increased dependence on a regressive form of taxation to pay for current government expenditures. We see no easy way to choose between these two unattractive alternatives. While a return to pay-as-you-go financing would unquestionably be more fair to low-income workers today, there is a very real possibility that the adverse long-term impact on the economy would end up extracting an even higher cost on these same people during the retirement of the baby boom generation. If the economy does not grow very much over the next thirty years or so, it is possible that there will be pressure for benefit reductions (maybe in the form of reduced cost of living increases) when the burden on the federal budget mounts in connection with the retirement of the baby boom generation. It will, in all probability, be those retirees who had been low-wage workers who will end up being most adversely affected by any such cuts. While some analysts will, no doubt, draw on the British and the Swedish cases to support proposals that call for investing at least a portion of our Social Security reserves in the private sector or increasing our emphasis on private sector pensions, it does not seem to us that such proposals will be making much headway any time soon. However, it might be feasible to obtain the necessary support for something along the lines of the new German indexing formula or the proposed Swedish indexing formula; both would automatically distribute the increase in the burden associated with paying for the retirement of the baby boom generation between pensioners and workers. These types of indexing formulas would tend to dampen generational conflict and reduce the chance of a tax revolt linked to the burden of paying for the retirement of the baby boom generation. At the same time they would contribute to intergenerational solidarity. The authors take full responsibility for any errors in this article, but would like to express their appreciation for comments on earlier drafts of this article from: Karl Hinrichs, Eric R. Kingson, Martin Kohli, Sven Olsson, and Joseph F. Quinn.

ACKNOWLEDGMENTS

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