Old Europe: Could America Follow?

Earlier this year, Defense Secretary Donald Rumsfeld raised eyebrows when he referred disparagingly to “Old Europe.” It was a jolting description, and one that angered our allies. Rumsfeld was making a geo-political point about Iraq, however, the concept of “Old Europe” also applies to a fundamental crisis now hitting European state retirement systems. Indeed, Europe’s pension disaster offers a chilling glimpse at the potential Social Security calamity we face here in the United States.

Because of rapidly declining birth rates, Western Europe is truly growing old, and is actually seeing its non-immigrant population shrink. One study by William Frey, a demographer at the Brookings Institution in Washington, predicts that by 2050, the median age in Europe will be 52.3 years old, skyrocketing up from 37.7 today.

Germany, in particular, is in meltdown. According to recent reporting by the New York Times, in 1950, 30 percent of the German population was under 20 and only about 2 percent was over 80. By 2050, the under-20 crowd is expected to be only 16 percent, while the over-80’s will reach about 12 percent.

These demographics matter because the European pension system, like America’s, is run on the “pay-as-you-go” principle. That means that current workers pay the pensions of current retirees; there is no retirement savings. The dramatic aging of Germany, for example, means the ratio of workers to retirees will shrink from 2 to1 to just about one worker supporting one retiree.

“Pay-as-you-go” is also the reason pension-system taxes in Germany are already a staggering 20.3 percent of workers’ earnings. Between that and oppressive union laws, no wonder the German unemployment rate is an astonishing 10.4 percent. How high can German pension taxes go without causing complete labor market collapse? There’s not much room left to raise taxes as more and more Germans simply stop working, or go into the underground economy. The only other option in this scenario, then, is cutting benefits. That’s why, in Germany, a pension reform commission is recommending reducing the pension amount from 70 percent of the average national salary to less than 60 percent. That will seriously squeeze retirees who depend on their fixed income pension to survive.

A similar demographic trap faces America’s “pay-as-you-go” retirement system as the baby boomers retire over the next fifteen years, and as retirees live longer. (In fact, several demographers predict one million Americans will be over the age of 100 in 2050.) Because of immigration, the median age in the U.S. will not rise nearly as much as Europe’s, but the underlying problem is the same: a Social Security system that will break down as relatively fewer workers must support increasingly more retirees.

The economic and budgetary implications are tremendous. Social Security, which is America’s largest government program, accounts for about 22 percent of all federal spending. The program currently runs surpluses, meaning more workers pay into the system than retirees receive benefits. Tragically, instead of saving this money, Congress simply spends it on other government programs. In Florida, retirees often have goofy bumper stickers that say, “I’m spending my child’s inheritance.” Members of Congress should have one that reads, “I’m spending your retirement savings.”

So, while your retirement is being given away as a National Endowment of the Arts grant or sugar subsidies to wealthy farmers, the crisis approaches. According to the 2003 report of the Social Security system’s Board of Trustees, in 2018, less than 15 years from now, the Social Security system will begin to run permanent deficits. That means the system will be sending more money out the door than it brings in with the payroll tax.

At that point, Congress will face a European dilemma—cut benefits or raise taxes, or do both. Do we really want an economy that looks like Germany’s?

There is another way, but we have to act now. They’re called Personal Retirement Accounts (PRAs), which are savings accounts that you own and manage, and which provide market returns instead of unrealistic political promises. Creating PRAs also shifts the entire system from an unstable “pay-as-you-go” footing to one where each worker has real resources waiting for them at retirement. But if we wait until the last minute to address this issue, America won’t have the time or payroll tax surpluses needed to create these key reforms.

Congress should learn from Old Europe’s pension disaster and move this year to create Personal Retirement Accounts as part of Social Security reform. The clock is ticking.