GENERATIONAL ACCOUNTING
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1 GENERATIONAL ACCOUNTING G Many governmen programmes ransfer resources beween differen populaion groups. Programmes o provide reiremen and healh securiy levy axes on workers o finance ransfers o reirees. Iniiaing or expanding such programmes ofen redisribues wealh across generaions by alering heir lifeime ax burdens. Alhough sandard budge measures such as naional deb and deficis do no fully reflec hem, such public inergeneraional redisribuions could subsanially affec differen generaions economic choices. Generaional accouning measures he size of prospecive ne ax burdens facing differen generaions under curren governmen ax and expendiure policies. I also analyses how hose fiscal burdens would change under alernaive policies. Before he 1990s, sudies of he disribuional impac of fiscal policies disinguished beween groups according o heir income, wealh or consumpion a a poin in ime bu no according o heir life-cycle sage. Feldsein (1974) firs poined ou he possibiliy of implemening large resource ransfers across generaions even under balanced governmen budges. Neverheless, noions abou he impac of fiscal policies across generaions remained limied o a presumed posiive associaion beween larger budge deficis and larger ax burdens on fuure generaions. Auerbach, Gokhale, and Kolikoff (1991) developed generaional accouning, a mehod for esimaing he economic impac of fiscal policy on differen cohors including fuure ones disinguished by birh year and gender. Wih rapidly aging populaions in developed counries and growing coss of social insurance programmes ha redisribue resources from younger o older generaions, he demand for evaluaing he inergeneraional effecs of governmen fiscal policies increased considerably. As a resul, generaional accouning is now used as a fiscal-analysis ool in dozens of counries. Generaional accouning (GA) is a mehod of esimaing prospecive per capia lifeime ne ax burdens ha differen cohors would face under exising fiscal policies. Prospecive means ha fiscal burdens are evaluaed over cohors remaining lifeimes; ne ax means ha governmen ransfers are subraced from axes; and lifeime indicaes ha fuure dollar flows are acuarially discouned back o he presen and aggregaed ino a summary measure of he fiscal burden in presen value. Changes in he GAs of differen cohors arising from changes in governmen ax and spending policies measure fiscal policy-induced changes in hose cohors lifeime resources.
2 Generaional accouning mehod Under curren (year ) policies, he presen discouned value of he governmen s projeced purchases of goods and services (PVG ) mus be paid for ou of he governmen s curren ne financial wealh (NW ), he presen value of ne ax paymens by living generaions (PVL ), and he presen value ne ax paymens by fuure-born cohors (PVF ). In his governmen ineremporal budge consrain, PVG = NW + PVL + PVF, (1) NW is calculaed as he sum of pas budge surpluses which would be negaive if pas budges mosly accrued deficis. The governmen s real asses, such as land, roads, buildings and public parks, are no included because ha would require inclusion of a compensaing erm on he lef-hand-side of eq. (1) he renal cos of he services hose real asses provide. For calculaing PVL, official governmen projecions of annual aggregae axes and ransfers are firs disribued across officially projeced populaions using profiles of ax paymens and ransfer receips by age and gender obained from he laes available micro-daa surveys. Per capia axes and ransfers for years beyond he governmen projecion horizon are obained by growing he erminal year s per capia values a he labour produciviy growh rae underlying official aggregae projecions. Nex, each living cohor s GA is calculaed by acuarially discouning is projeced ne axes per capia using cohor-specific moraliy projecions and an assumed rae of discoun. Because fiscal dollar flows are more volaile han reurns on governmen bonds bu less volaile han privae capial reurns, an inermediae rae of ineres is used. Muliplying each cohor s GA by is year- populaion and aggregaing across all cohors yields PVL. PVG is calculaed by projecing governmen purchases of goods and services such as adminisraive and judicial services, defence, and infrasrucure a curren levels per capia using official populaion projecions, and discouning hose amouns back o year. The erm PVF in eq. (1) is calculaed as a residual. Boh PVL and PVG are calculaed by projecing fiscal flows under unchanged policies. PVL equals he presen value of ne axes ha cohors alive in year would pay collecively if heir fiscal reamen remained unchanged hroughou heir lifeimes. PVG indicaes he size of he bill in presen value for providing public goods and services a curren levels for ever. To mainain he curren fiscal reamen of living generaions and curren public goods and service levels for ever, he presen value cos ha fuure generaions mus pay equals PVG PVL NW. Thus, generaional accouning reveals he fiscal burden ha fuure generaions collecively face under curren governmen fiscal policies. Tha burden does no necessarily equal he governmen s ousanding deb: NW.
3 Esimaing per capia fiscal burdens facing fuure-born generaions requires knowing how i would be disribued among hem. Generaional accouning assumes, hypoheically, an equal disribuion of he residual fiscal burden excep for an adjusmen for produciviy growh. If we ignore gender differences for simpliciy, he GA facing hose born in year + 1 is calculaed as s ( + 1) GA + 1 = ( PVG PVL NW )(1 + r + 1) / Ns[(1 + g) /(1 + r)]. (2) s= + 1 Here, r represens he discoun rae; g represens labour produciviy growh; s represens fuure cohors birh years; and N s represen heir populaion sizes. In eq. (2), he residual fiscal burden in presen value as of period + 1 is divided by he weighed sum of he populaion of fuure-born persons wih weighs based on r and g. The discoun rae, r, is included in he weighing scheme o accoun for he differences in he iming of ne ax paymens by differen fuure-born cohors. Such weighing s ( + 1) ensures ha people born in period s + 1 pay lifeime ne axes ha are (1 + g ) imes larger han hose paid by persons born in period +1. Generaional accouns for he Unied Saes By using projecions from he Budge of he US governmen for fiscal year 2005 (wih = fiscal year 2004), applying a five per cen discoun rae, and calculaing US dollar amouns in consan 2004 dollars, PVG is esimaed o be $26.8 rillion; NW equals $4.4 rillion; and PVL equals 4.9 rillion. Tha leaves fuure generaions o collecively pay $26.3 rillion. Table 1 Generaional accouns for he Unied Saes (housands of consan 2004 dollars) Year of birh Age in 2004 Male Female 2005 (fuure-born) (newborn) Source: Auhor s calculaions based on daa from Gokhale and Smeers (2006).
4 Table 1 shows GAs for seleced US male and female cohors wih = fiscal year They exhibi a sandard life-cycle paern: older cohors face negaive GAs hey receive benefis on ne and younger ones face posiive GAs. Younger women have smaller GAs han men because of heir lower labour-force paricipaion and earnings. Very young cohors wih many years o go before paying axes face considerably smaller GAs because of discouning. Older women receive larger ne benefis in presen value han older men despie heir lower prior labour-force aciviy because hey live longer and receive social insurance benefis based on heir male spouses earnings. The GA for hose born in 2005 (year + 1) equals $333,200 per capia considerably larger han ha for 2004-newborns. Lifeime ne ax raes and generaional balance Alernaively, fiscal burdens can be represened as lifeime ne ax raes (LNTR) ha differen generaions would face under he given assumpions. For fuure generaions, LNTRf = GA s /PVE s, for all s >, where PVE s represens he presen value as of period s of projeced (pre-ax) labour earnings per capia for he cohor born in period s. Fuure labour earnings per capia are projeced in a manner similar o ha used for projecing axes and ransfers. Equaion (2) s disribuion rule implies ha boh lifeime ne axes and lifeime earnings grow a he same rae for successive cohors, implying ha LNTRf applies o all fuure cohors. An imporan generaional accouning concep is ha of generaional balance. I is derived by comparing he lifeime ne ax rae facing year- newborns, LNTR = GA / PVE, wih LNTRf. Noe ha LNTR is based on curren ax and ransfer policies exended hroughou he lifeime of year- newborns whereas LNTRf is a hypoheical rae impued for fuure generaions based on an equal growh-adjused disribuion of he residual fiscal burden across fuure-born cohors. A finding of LNTR < LNTRf would show curren policy as being generaionally ou-of-balance one ha levies a smaller LNTR on curren newborns han would be required of fuure ones on average o balance he governmen s books. Thus, a policy ha is generaionally ou of balance is also unsusainable. Calculaions based on he GAs shown in Table 1 reveal ha US fiscal policy is considerably ou of generaional balance as of fiscal year The presen value of lifeime earnings for males born in 2004 is esimaed o be $562,000, making LNTR 2004 equal o 18.5 per cen. For fuure-born cohors, LNTRf equals 58.2 per cen. Coninuing exising ax and spending laws for living generaions would require fuure generaions o bear fiscal burdens ha are more han hree imes larger on average. If curren policy is ou of generaional balance (ha is, if LNTR < LNTRf), GA machinery can also be used o calculae alernaive policy changes ha would resore generaional balance. This exercise reveals he policy rade-offs involved in moving from a generaionally ou-of-balance policy o one ha is balanced. A large iniial generaional imbalance requires a large fiscal adjusmen. Resoring generaional balance o US fiscal policy via income ax hikes would require
5 average income ax raes o be 39 per cen larger. Tha is, federal income ax revenues ha according o he US Congressional Budge Office (2006) amouned o 8.6 per cen of GDP in 2004 would have o be immediaely and permanenly increased o 11.9 per cen of GDP. Alernaively, federal discreionary oulays would have o be reduced immediaely and permanenly by 67 per cen. Criicisms of generaional accouning Generaional accouning has been subjec o several criicisms. Firs, i measures he direc ne coss of axes and ransfers bu excludes he benefis derived from governmen public goods and service purchases. If he benefis from some purchases accrue much laer, he average GA facing fuure generaions may no accuraely reflec heir fiscal reamen under curren policies. Second, generaional accouning does no facor in he coss and benefis from governmen insurance provision. These wo criicisms indicae ha generaional accouning is no a uiliy measure of he impac of fiscal policies on differen generaions. However, dynamic simulaion sudies sugges ha changes in GAs correspond reasonably well o welfare gains and losses arising from policy changes. Third, generaional accouning ignores dynamic economic responses when esimaing policy adjusmens for resoring generaional balance. However, is saic esimaes consiue lower bounds of he required adjusmens. For example, increasing income axes would normally reduce labour supply and require a larger ax hike o achieve generaional balance. Fourh, o qualify as budge conceps fiscal measures mus show he implicaions of keeping policies unchanged. However, he generaional balance measure employs a hypoheical policy for fuure generaions. Gokhale and Smeers (2003) provide alernaive fiscal and generaional imbalance measures ha do no involve hypoheical policies. Fifh, generaional accouning discouns fuure fiscal flows using a common discoun rae whereas axes and ransfers may be subjec o differen degrees of policy and economic uncerainies. And sixh, i may be appropriae o use differen discoun raes for differen cohors because hey face differen risks. However, generaional accouning sudies include sensiiviy analyses under alernaive assumpions, including alernaive discoun raes. Final remarks I is imporan o noe ha generaional accouning racks only he redisribuive impac of governmen fiscal policies. I does no include he impac of privae bequess and iner vivos gifs. In heory, privae inergeneraional ransfers may subsanially or fully offse governmen ransfers. However, he weigh of evidence, a leas for he Unied Saes, suggess ha such offses are quie small. A chief lesson from he generaional accouning lieraure is ha he frequenly cied aggregae cash-flow measures of fiscal policy such as he size of naional deb
6 and annual budge deficis are uninformaive and, indeed, may mislead policymakers abou he rue disribuional and economic implicaions of curren fiscal policies and policy changes. To he exen ha radiional defici and deb measures miss significan policyinduced inergeneraional redisribuions wih poenially large effecs on agens economic choices such as consumpion and labour supply generaional accouning calculaions can provide useful informaion o policymakers and he public. Generaional accouning is also likely o prove useful in furher economics and public-policy research. For example, generaional accouns could be combined wih oher elemens of wealh human, non-human and privae pension wealh on a cohor basis o esimae wheher changes over ime in he cohor-disribuion of resources are relaed o changes in cohor saving and labour force paricipaion. Generaional accouns could also be used o calculae changes in he degree of cohor wealh annuiizaion for examining he exen of insurance agains uncerain longeviy. In many counries, governmen programmes for providing insurance o he public agains various ypes of economic risks are financially unsusainable. Uncerainy abou prospecive changes in axes and ransfers for correcing hose fiscal imbalances consiue a major source of risk for households. Analyses using generaional accouning may help in beer undersanding he exen o which governmen fiscal policies miigae or exacerbae he economic risks facing differen generaions. See also aging populaions; public deb; public finance Jagadeesh Gokhale Bibliography Auerbach, A., Gokhale, J. and Kolikoff, L Generaional accouns: a meaningful alernaive o defici accouning. Tax Policy and he Economy 5. Cambridge, MA: MIT Press and he NBER. Auerbach, A., Gokhale, J. and Kolikoff, L Generaional accouning: a meaningful way o evaluae fiscal policy. Journal of Economic Perspecives 8(1), Congressional Budge Office Hisorical Budge Daa, 26 January, Table 4. Online. Available a hp:// accessed 28 June Diamond, P Generaional accouning and generaional balance: an assessmen. Naional Tax Journal 49, Feldsein, M Social Securiy, induced reiremen, and aggregae capial accumulaion. Journal of Poliical Economy 82,
7 Gokhale, J., Kolikoff, L. and Sabelhaus, J Undersanding he poswar decline in U.S. saving: a cohor analysis. Brookings Papers on Economic Aciviy 1996(1), Gokhale, J. and Smeers, K Fiscal and Generaional Imbalances: New Budge Measures for New Budge Prioriies. Washingon, DC: American Enerprise Insiue Press. Gokhale, J. and Smeers, K Fiscal and generaional imbalances: an updae. Tax Policy and he Economy, vol. 20, ed. J. Poerba. Cambridge, MA: MIT Press and he NBER (forhcoming). Kolikoff, L. and Fehr, H. 1996/97.Generaional accouning in general equilibrium. Finanzarchiv 53, Kolikoff, L Reply o Culer s and Diamond s views on generaional accouning. Naional Tax Journal 50, Index erms aging populaions budge deficis consumpion fiscal burden fiscal policy generaional accouning generaional balance gifs governmen ineremporal budge consrain inheriance and bequess inergeneraional ransfers income axes labour produciviy labour supply labour-force paricipaion lifeime ne ax raes naional deb redisribuion of income and wealh
8 risk saving sensiiviy analysis social insurance wealh
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