Wednesday, April 13, 2005

Your children are not the same as other people's grandparents

Marginal Revolution and Gary Burtless seem to believe that the aging population will have little net effect on working people's ability to support non working people because both old people and young people are dependent on working people, and an aging population means the burden from young dependents goes down while the burden from old dependents goes up -- net net it could all end up being a wash.

I think this is bogus, for simple reasons that should be clear to any economist.

1) Most of the transfer from working people to young dependents is via parents taking care of and educating their children. This is clearly consumption and investment by the parents because 1) they want to have and take care of children (even if kids are a pain sometimes) and 2) educating a child is pure investment in human capital, good for the parent if they anticipate being looked after in their old age and good for society because it now has a skilled worker.

2) Most of the transfer from working people to old dependents is via social security and medicare taxes, ie. money is going from your pocket to give other people consumption. This is a tax, and therefore has all the wealth destroying, growth curdling effects of all taxes through dead weight loss. I will work harder to earn more money to send my child to a better school, but I will not work harder to pay more in social security to give to old people I do not know. Moreover, this is a very high tax so the dead weight loss effect is likely to be very large.

If worker's dependent burden shifts from their children to other people's parents the effect will not be benign or cancel out even if the numbers do. The harm that comes from transfers is the growth destroying dead weight loss that comes with them, destruction which is evident in the highly retarded economies of high-tax Europe. In addition, such a shift signals a large reduction in investment and a large increase in consumption, which does not bode well for the economy going forward.

A buddy of mine still at Chicago was chatting with a recent Bates medal winner (not Levitt) about what the most important economic principal was, and my friend said "dead weight loss". The Bates winner had never heard of this, which shocked both me and him. I guess that dead weight loss is only taught at Chicago these days, and the whole notion that people respond to incentives has become passe to other economists.


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