Economic Report

Economic Report of the President predicted that the dependency ratio in the United States will increase from 0.30 in 2003 to 0.55 in 2080. [2] Roughly speaking, in other words, there are currently about three workers for every retiree, but by 2080 there will only be two workers per retiree. A Baby Boom in Our Model In our framework, we assumed that there was always one person alive at each age. This meant that the number of people working in any year was the same as the working life of an individual. Likewise, we were able to say that the number of people retired at a point in time was the same as the length of the retirement period. Here is a simple way to represent a baby boom: Let us suppose that, in one year only, two people are born instead of one. When the extra person enters the work force, the dependency ratio will decrease—there is still the same number of retirees, but there are more workers. If Social Security taxes are kept unchanged and the government continues to keep the system in balance every year, then the government can pay out higher benefits to retirees. For 45 years, retirees can enjoy the benefits of the larger workforce. Eventually, though, the baby boom generation reaches retirement age. At that point the extra individual stops contributing to the Social Security system and instead starts receiving benefits. What used to be a boon is now a problem. To keep the system in balance, the government must reduce Social Security benefits. Let us see how this works in terms of our framework. Begin with the situation before the baby boom. We saw earlier that the government budget constraint meant that Social Security revenues must be the same as Social Security payments: number of workers × Social Security tax = number of retirees × Social Security payment. If we divide both sides of this equation by the number of retirees, we find that

annual social security payment to each worker

= ( number of workers

number of retirees ) × social security tax.

The first expression on the right-hand side (number of workers/number of retirees) is the inverse of the dependency ratio.

 When the baby boom generation is working. Once the additional person starts

working, there is the same number of retirees, but there is now one extra worker. Social Security revenues therefore increase. If the government continues to keep the system in balance each year, it follows that the annual payment to each worker increases. The dependency ratio has gone down, so payments are larger. The government can make a larger payment to each retired person while still keeping the system in balance. Retirees during this period are lucky: they get a higher payout because there are relatively more workers.