MIKLÓS SZABÓ: GENERATIONAL ACCOUNTING FOR HUNGARY

Transcription

1 PHD PROGRAM IN ECONOMICS BUDAPEST CORVINUS UNIVERSITY MIKLÓS SZABÓ: GENERATIONAL ACCOUNTING FOR HUNGARY FISCAL SUSTAINABILITY AND INTERGENERATIONAL REDISTRIBUTION (PHD THESIS) JUNE 2005 SUPERVISOR: PROF. MÁRIA AUGUSZTINOVICS

2 I. Inroducion In Hungary he demographic srucure will go hrough a dramaic change in he nex 50 years. Life expecancy is growing and he drop in feriliy rae leads o a higher dependency raio. These issues are becoming even more imporan as he presen welfare sysem exers a heavy pressure on Hungary s budge as indeed i does in many oher European counries. One of he mos imporan quesions in he debae on he fiscal implicaions of aging is wheher radiional indicaors can provide a comprehensive view on his phenomenon. We argue ha radiional indicaors such as he annual budge defici and official governmen deb do no give a full picure of he curren sae of public finances. Some economiss even say ha hese indicaors are illusory conceps. We need o look for new indicaors ha shed ligh on he ineremporal dimension of fiscal policies and assess heir effecs boh on he susainabiliy of fiscal policy and on inergeneraional redisribuion. Solvency requires ha he governmen mus saisfy he ineremporal budge consrain raher han any saic, backward-looking crierion. The definiion of solvency is ha he presen value of spending mus no exceed he presen value of axes plus curren asses. This is a crucial elemen of he generaional accouning mehod ha was developed by Alan Auerbach, Jagadeesh Gokhale and Laurence J. Kolikoff. The essence of generaional accouning is o record how he public secor, assuming he curren rules of spending and axes remain in place, gives and akes away from each generaion over heir remaining lifeime. The difference of he presen value of ax paymens over he presen value of benefis over he res of he life-ime gives a single informaive indicaor ha idenifies he ne fiscal burden of each generaion. 1 In Chaper II he generaional accouning mehod is discussed, saring wih he fiscal balance rule inroduced by Kolikoff [1993], hen i is explained how generaional accouns are consruced and how he residual approach (Bonin [2001]) produces he generaional imbalance measures. Chaper III shows our resuls, he ne ax profile as well as he generaional accouns ha are calculaed by using a slighly differen definiion of ne axes han Gál e al. [2005]. Our calculaions show ha he Hungarian fiscal policy was no on a susainable pah in In case of Hungary he main reason for he generaional imbalance is he change in he demographic srucure. If i would no change, he absolue generaional 1 The mehod has been applied in 25 counries so far. The counry sudies I am aware of are lised in Table A1 in he Appendix. 2

3 imbalance would be halved from 12.5 million F o 6.1 million F. Cancelling he (ne) deb would also help o ease he problems bu o a lesser exen. We have also analysed he effec of cyclical adjusmen. There are emporary and cyclical effecs ha, by definiion, do no las forever, so one can ge a clearer picure of he rue fiscal posiion if hese cyclical effecs are filered ou. Our resuls show ha he absolue generaional imbalance did no change significanly. Is series became smooher, i.e. hey fell less and rise less han he original relaive imbalance values. Following Bonin [2001] we applied he susainabiliy approach ha gives a criique of he residual approach. The noions of cohor defici and susainabiliy gap were inroduced and calculaed for he base year of The susainabiliy gap as a raio of base year GDP was 206,4% in If we ake ino accoun policy decisions of he 1997 pension reform ha will come ino effec afer 2001 (e.g. increase of he pension age o 62 for boh men and women, ec.) hen he susainabiliy gap falls o 115,1%. Finally, we have also analysed he effecs of sylised policy reforms. Four scenarios were assessed: (1) Change of he ax base: wha would happen if axes on labour income would be decreased and axes on consumpion increased? (2) Raise in pensions and cu of governmen purchases. In cases (3) and (4) he defici neuraliy assumpion was dropped and he effecs of a comprehensive ax cu (Case 3) and a simple raise in pensions (Case 4) were analysed. Our resuls show ha he long erm fiscal posiion did no change significanly in Cases 1 and 2, bu worsened in Cases 3 and 4. 3

4 II. The Generaional Accouning Mehod Kolikoff [1993] consruced a model and defined he fiscal balance rule ha migh be considered he heoreical benchmark of generaional accouning. In order o define generaionally neural fiscal policy Kolikoff [1993] uses a wo-period overlapping generaions model in which people live for wo periods, only young people work, and old people consume wha hey have saved when hey were young. Wriing down he model and using simple manipulaions i can be shown ha he seady-sae budge consrain will be he following: m 1 2 m n = g + ( r n)b. (1) where n is populaion growh, g is governmen spending, r is he ineres rae, b is governmen deb, while m 1 and m 2 are lifeime ne ax paymens paid when young and old, respecively. All variables are expressed as per capia of he young generaion, excep m 2 ha is expressed as per capia of he old. The above equaion can be rearranged as r n m = g + 1+ n m ( 1+ n) b 1+ r 2. (2) 2 1 m where m is he presen value of lifeime ne axes in seady-sae, i.e. m= m r This is wha Kolikoff [1993] calls he fiscal balance rule. Whenever he governmen changes one of he parameers in (2) and does no adjus any oher variables in order o balance he change on he seady-sae budge hen i redisribues resources beween generaions. Now le us urn o how generaional accouns are consruced. Consider a given base year. The generaional accouns show he presen value of ne ax paymens of an average member of a generaion unil deah. For hose generaions already alive i looks like his: k + D i= ( r) i, i k Si, i k + i GA = τ 1, k (3) k where S i, j is he probabiliy in period i ha a person aged j will be alive in he nex period. For fuure generaions a similar expression can be applied: k + D i= k ( r) i, i k Si, i k + i f GA = τ 1, k > (4) k 4

5 The firs sep of producing generaional accouns is he calculaion of ne axes. Ne axes are broken down ino a se of ax and ransfer paymens for which τ = l i, j τ i, j l l, where τ is a l- ype ax paymen made by a j-year old in period i. As we calculae ne axes τ l > 0 means axes, while τ l < 0 refers o ransfers. The aggregae value of a paricular ax or ransfer caegory mus equal he sum of individual paymens by cohor weighed by he cohor size. D T = τ P, (5) j= 0 In he nex sep he ne axes are exrapolaed ha is done by using he so-called growh rule. I is usually assumed ha produciviy growh increases individual age-specific paymens and per capia ne governmen purchases a a consan rae, g. Fuure paymens can be expressed in erms of he base year s profile as, j, j i ( ) j τ + i, j = 1+ g τ,, (6) I follows ha he life cycle ne ax paymens of a member of a cohor born in he base year will be given by he following expression: D (, τ,..., τ ) ( τ,( 1+ g) τ,...,( g) τ ) τ (7), + 1, + D, =,, 1 1+, D In oher words, life cycle ne ax paymens are calculaed by using cross-secional informaion from he base year. One of he mos imporan caegories wihin he generaional accouning framework is he ineremporal budge consrain of he governmen. i, j i= N i = Gi + B, (8) I saes ha he (presen value of) ne ax revenues of he governmen ( N ) mus (a leas) equal he (presen value of) governmen purchases ( G ) and (ne) governmen deb ( B ). As he main purpose of generaional accouning is o combine he ineremporal perspecive of governmen finances wih he generaional perspecive i is useful o reformulae (8) in erms of generaional accouns: i= i i k = D N k = G i + i = B, (9) 5

6 where N k denoes he ne ax paymens made by he generaion born in k from he base period unil deah. Rearranging he lef hand side of (9) by spliing i ino wo groups (presen and fuure generaions) we ge he following: k = D f kgak + Pk,0GAk = Gi + k = + 1 i= P, B, (10) where P i, j denoes he number of j-year olds in period i. The ineremporal budge consrain can be considered as a no free lunch condiion. Someone eiher oday or laer will have o pay for wha we spend a he presen. Generaional accounans calculae he burden of presen generaions by exrapolaing ne axes of he base year as well as ne governmen purchases. The ne governmen deb is also known for he base year. If we ake a look a equaion (10) we can see ha only he aggregae burden of fuure generaions are unknown, bu hey can be calculaed residually by rearranging (10): f P k 0GAk = Gi + B P, k k = + 1 i= k = D, GA (11) Now he quesion arises how o calculae he burden of a paricular fuure generaion. The general assumpion is ha generaional accouns of fuure generaions are equal excep for economic growh. Algebraically he assumpion looks like his: k j 1 1+ g = GA + 1 GA + j, j = 1, (12) 1+ r Subsiuing i back o (11) he generaional accoun of fuure generaions is given by G + B k = + 1 i, k k f i= k = D GA + 1 = (13) k 1 P k,0 1+ g 1+ r In he numeraor we have he residual from he ineremporal budge consrain, while he denominaor can be inerpreed as he sum of discouned fuure populaion. The noion of residual approach comes from he fac ha he generaional accoun of fuure generaions is P GA calculaed residually from he ineremporal budge consrain. The nex and final sep is o idenify wheher he base year fiscal policy is susainable by comparing he generaional accouns of newborn and fuure generaions.. The measures 6

7 frequenly used are he absolue or relaive generaional imbalance ha show he difference and he raio of fuure and he newborn generaion s accouns, respecively. If he absolue (relaive) generaional imbalance is differen from zero (uniy) han generaional accouning suggess ha he base year fiscal policy is no susainable. The residual approach have cerain problems, paricularly he disincion beween ne axes and ne governmen purchase as well as no using all informaion from he demographic projecion. We will discuss hese issues in he following chaper. 7

8 III. Generaional accouning in Hungary To dae here have been four GA sudies for Hungary: Gál e al.[2000] and Gál e al.[2002] for he general public secor, Gál e al.[2001] for he pension sysem. The mos recen and mos comprehensive one is Gál e al.[2005], which covered he period of and produced generaional accouns for each of he 10 years. Our calculaions in his hesis draw heavily on heir work, using and exending heir basic GA model. Demography and parameer assumpions Demographic siuaion Figure 1 shows he developmen of he Hungarian populaion for hree paricular age groups: young (less han 14 year olds), middle-aged (15-64) and old people (65 and older). Figure 1: Demographic projecion for Hungary (Base case scenario), Toal One can idenify wo differen phenomena from Figure 1: he Hungarian populaion will decline over ime as well as is composiion by age will change significanly. According o he Base Case forecas of he Hungarian Saisical Office (KSH [2003]), he Hungarian populaion will fall from more han10 million in 1990 o 8.74 million in However, he age composiion of he populaion will also undergo a dramaic ransformaion. As Figure 2 shows, boh he old-age and he oal dependency raios will increase significanly. 8

9 Figure 2: Dependency raios, Old age Toal The old-age dependency raio (raio of old-aged people o middle-aged ones) will rise from 23% o 46.5%, while he oal dependency raio (raio of young and old-aged people o middle aged ones) will increase from 45.5% o 70%. Boh of hese movemens have major consequences for he susainabiliy of he Hungarian public finances. Discoun rae and growh parameer In order o be able o calculae he presen value of lifeime ne ax burdens we will have o choose a discoun rae. Generaional accouning considers all fuure paymens in presen value erms so we need o specify an ineres rae for discouning. We have chosen a single uniform discoun rae o ake all fuure ax paymens and governmen spending back o he base-year. In erms of (un)cerainy public receips and expendiures are somewhere beween non-risky long-erm governmen bonds and risky marke asses, so, accordingly, he discoun rae should range beween he average raes of reurn on hese asses. Consequenly we have oped for a sandard discoun rae of 5% per annum. Neverheless, sensiiviy ess are necessary, which we have done as well. Projecion of fuure ax paymens and receips demands an assumpion on he annual rae of produciviy growh. In his sudy, as in mos oher sudies, a consan rae of produciviy growh is applied se a 1.5 per annum. Like he discoun rae i is also subjeced o a sensiiviy es. Incidence assumpions In our own calculaions we follow he convenions used by European Commission [1999] and also adoped by Gál e a.[2005]. Again, following he sandards applied by mos former GA sudies we assume ha he incidence of all ax paymens and ransfer receips falls direcly on 9

10 he respecive axpayers or ransfer recipiens. Workers bear he labour income ax burden, suppliers of capial bear he burden of capial axaion, consumers bear he burden from indirec axes. Similarly, ransfers are regarded as beneficial only for he ransfer recipien. Age-specific ax and spending profiles Gál e al.[2005] disinguishes beween hree differen ypes of ax and ransfer caegories: ax and ransfer caegories for which he age disribuion is known; ax and ransfer caegories for which he age disribuion is no known bu should be consruced in principle; ne governmen purchases - he so-called G-caegories (mainly public goods). As Gál e al.[2005] inended o follow he convenions used by comparaive GA sudies as closely as possible, heir ne axes consised of only hose ax and spending caegories ha fell ino he firs caegory. Those iems in he second and hird group were considered as ne governmen purchases. We chose a differen approach in ha iems in he second group were included among ne axes assuming hey have a fla age disribuion. The ne ax profile Figure 3 shows he ne ax profile for he base year 2001 calculaed by using he new ne zax definiion. Figure 3: The ne ax profile (Base year: 2001, F) 1,000, , , , , , , , ,000 cohor I is imporan o sress he incidence assumpions used when calculaing he ne axes. Ne axes do no necessarily show acual ax paymens: e.g. i is common pracice of GA sudies o assume ha young people pay consumpion and value added axes, I realiy hey do no pay hese axes, bu GA sudies assume ha hey bear he burden of hese axes. 10

11 Ne axes paid by he newborns were -136,859 F in 2001, i.e. heir benefis were higher han heir ax burden by his amoun in The curve crosses he horizonal axis a he 22 year olds, hey are he ones whose ax paymens more or less equal o he benefis hy receive. The maximum poin is around he age of 40-45, who pay a lo of axes bu do no receive high benefis. The curve crosses he horizonal axis again a he 60 year olds. Those older han 60 receive a lo of benefis (mainly pensions and healh care services), while hey do no pay cerain axes and conribuions. Generaional accouns for 2001 Figure 4 shows he generaional accouns by age for he base year of Figure 4: Generaional accouns (Base year: 2001, F) 20,000,000 15,000,000 10,000,000 5,000, ,000,000 cohor -10,000,000 The major drop a he beginning of he curve is explained by he fac ha we include he fuure generaions accouns on his Figure (he -1 year olds), and heir accouns are considerably higher han hose of he newborns. In oher words, i shows ha here is a grea generaional imbalance. The newborns accouns equal o abou 1.4 million F. One could falsely argue ha hese generaions (and hose wih a posiive accoun) would be beer off wihou he sae. Bu his argumen does no ake ino accoun he public goods (more precisely all iems no included among he ne axes) provided for everyone. I is also misleading o compare he generaional accouns of differen cohors as hey are calculaed for differen lenghs of remaining lifeime. Generaional accouns are forwardlooking and hey show he presen value of he ne ax burden for he remaining lifeime of each cohor. The accouns of he elderly are ypically negaive bu only shows ha mos of heir conribuions have been made a an earlier sage in heir lifeime. As people become 11

12 older hey become eniled o pension benefis and use he healh care sysem more ofen, and heir generaional accouns simply represen ha. The maximum poin is around he 25 year olds, whose generaional accoun is 10.8 million F. These cohors have finished heir sudies and heir acive years are ahead of hem while hey will ge mos of heir benefis in he disan fuure and hose paymens are discouned heavily. Those older han years can expec posiive accouns, i.e hey are ne beneficiaries of he redisribuion sysem. I can also be seen ha while he ne ax curve was decreasing coninually afer a cerain age, i canno be said for he generaional accouns. The reason is ha very old people will enjoy he benefis for a shorer period, while hose around he pension age (60-65 year olds) can expec o ge hese benefis for years. The effec of demographic change and he official deb Wha explains he significan differences in he ne ax burdens of generaions? I is common pracice in he generaional accouning lieraure o analyse o wha exen can he differences be explained by he demographic change or by he official deb. Table 1 shows our findings. In case of Hungary he main reason for he generaional imbalance is he change in he demographic srucure. If i would no change, he absolue generaional imbalance would be halved from 12.5 million F o 6.1 million F. Cancelling he (ne) deb would help o ease he problems bu o a lesser exen. Table 1: Reasons for generaional imbalance (Base year: 2001, F) Base case No demographic Zero ne deb change Newborns accouns 1,408,386 6,105,166 1,408,454 Fuure generaions 13,999,395 9,675,143 11,990,814 accouns Absolue generaional 12,590,809 6,105,166 10,582,360 imbalance Susainabiliy gap 206.4% 118.1% 173.4% In heir comparaive sudy Kolikoff and Leibfriz [1999] presen similar resuls for oher counries. If he demographic srucure remained consan, he generaional differences would vanish in he USA, he Neherlands and Ialy, and he imbalance would even urn ino posiive in Canada, Denmark and Norway. 12

13 The effec of cyclical adjusmen The essence of generaional accouning is o ake he fiscal policy of he base year as given and projec ha ino he fuure. I also means however, ha all facors affecing he curren fiscal policy will be projeced ino he fuure and i may or may no creae a bias in he calculaions. There are emporary and cyclical effecs ha, by definiion, do no las forever and we will ge a clearer picure of he rue (or srucural) fiscal posiion if hese cyclical and one-off effecs are filered ou. Cyclical adjusmen of he budge defici is a commonly used ool by several inernaional organisaions. The European Commission (European Commission [2002]), he European Cenral Bank (Bouhevillain e al.[2001]), he Inernaional Moneary Fund (Hagemann [1999]) and he Organisaion for Economic Cooperaion and Developmen (van den Noord [2000] and OECD [2004]) all produce esimaions for cyclically adjused budge balances. The cyclical adjusmen procedure usually akes hree seps. Firs, he business cycle posiion of he economy is idenified, hen in he second sep he sensiiviy of he budge iems affeced by he business cycle is calculaed, and finally he cyclical componens are subraced from he acual values ha gives he cyclically adjused or srucural defici. When idenifying he economy s cyclical posiion all insiuions excep he European Cenral Bank employ an aggregaed approach. The filering iself is usually done by eiher using a simple economeric echnique called he Hodrick-Presco filer or wih a producion funcion. The mehod is called aggregaed as he fiscal elasiciies produced eiher by economic esimaion or some oher way are muliplied by an aggregae oupu gap. In oher words, his approach disregards he composiion of he oupu gap. I is problemaic because axes and spending will differ considerably if GDP growh is lead by an increase in consumpion or in expor. Disaggregaed approaches such as he one applied here employ disaggregaed gaps for he macroeconomic bases of all budge iems affeced by he economic cycle. These bases are privae consumpion for consumpion and value added axes, privae secor wages and employmen for personal income axes and social securiy conribuions and he number of unemployed for he unemploymen benefis, ec. In he GA lieraure he imporance of cyclical adjusmen has been realised only recenly (see e.g. Gjersem [2001], Manzke [2002], Paxo and Bonin [2004]). The mos comprehensive sudy is Manzke [2002] ha covers he period of for Germany. We 13

14 employ a similar, disaggregaed approach ha is quie close o he European Cenral Bank s model and explained in deail in Deuche Bank publicaions (Deuche Bundesbank [1997], [2000]). Mos sudies of cyclical adjusmen ake ino accoun four ax caegories: (1) personal income axes, (2) profi axes, (3) social securiy conribuions and (4) indirec axes. On he expendiure side only unemploymen benefis are considered bu in case of Hungary pension benefis are also included because of he paricular pension formula. Table 2 shows he magniude and proporion of he budge iems covered in his sudy for he year Table 2: Budge iems covered in his sudy, 2001 (million F) Revenues Expendiures Million F Raio Million F Raio Personal income ax 1,116, Unemploymen 49, benefis Social securiz 1,465, Pensions 1,213, conribuions VAT 1,243, Oher consumpion 539, and excise axes Profi ax 351, Toal 6,332, Toal 6,765, Source: Minisry of Finance, ÁHIR daabase. The firs sep is o calculae he cyclical componen of he macroeconomic bases of he corresponding budge iems. We have used he already menioned Hodrick-Presco filer, which is a very simple, ransparen economeric echnique, bu no wihou is own problems. I is argued ha he choice of he smoohing parameer is arbirary and he mehod is quie mechanical as here is no economic heory behind i. Moreover, as he filer is basically a moving average process here is an end-poin bias problem, and he filer can give biased resuls if here are srucural breaks in he ime series. As an illusraion we show he oupu gap for he period of

15 Figure 5: Oupu gap, (%) Fiscal elasiciies In he nex sep he elasiciies of budge iems o heir bases are calculaed by an error correcion model. Wriing down an error correcion model is helpful as i makes i possible o disinguish beween shor and long erm effecs. The long erm parameers were esimaed by he following equaion: The esimaed long erm equaions are presened in Table 3. y = α + βx + u (14) Table 3: Long erm parameers pi = -3, ,352 avewage (-3,527) (16,258) profax = -3, ,030 profi (-2,809) (12,263) va = -2, ,028 cons (-1,269) (7,743) unempben = 0, ,995 unemp (0,897) (192,95) Noe: -values in brackes. All long erm parameers are significan and heir magniude seem o be accepable. In case of VAT, profi ax and unemploymen benefis he parameer is equal o 1 ha is reasonable, while he parameer is greaer han 1 for he personal income ax ha poins o he progressive naure of ha ax ype. I was no possible o ge economically meaningful resuls for he social securiy conribuions and for pensions so we have adoped resuls of oher sudies, which were 0.9 for social securiy conribuions and 1 for pensions (see P.Kiss and Vadas [2005] and OECD [2004]). 15

16 The shor erm parameers were esimaed he following way: Table 4 shows he esimaed long erm equaions: ( y α βx) u y = γ x + δ + (15) Table 4: Shor erm parameers pi = ,494 avewage - 0,292 ( pi + 3,341 1,352avewage) 1 (-0,194) (2,367) (-2,273) profax = 0,020-0,140 profi - 0,276 ( profax + 3,274 1,030 profi) 1 (1,037) (-0,233) (-2,868) va = ,993 cons - 0,913 ( va + 2,416 1,028cons) 1 (0,496) (1,483) (-5,530) unempben = -0,001-0,934 unemp - 0,549 ( unempben 0,059 0,995unemp) 1 (-0,297) (30,064) (-4,205) Noe: -values in brackes. The shor erm parameers are boh negaive and significan as expeced, and heir magniudes also seem o be accepable. I means ha in all four cases all condiions of he error correcion model are fulfilled and he corresponding variables are coinegraed. I is now possible o calculae he cyclically adjused defici, and hey are presened for he period of in Table 5. The second column of he able shows resuls for a case in which we have assumed uni elasiciy for all budge iems. I makes sense as all cases in which he budge elasiciies are differen from uniy can be considered as resuls of some discreionary decision by policy-makers. P.Kiss and Vadas [2005] argue ha he noion of consan fiscal policy may be inerpreed as unchanged oal ax burden which corresponds o uni fiscal elasiciies. Table 5: Cyclical componen of budge defici as a raio of GDP, Year Esimaed fiscal elasiciies Uni fiscal elasiciies ECB mehod HNB mehod ,3-0,2-0,4 0, ,6-0,6-1,0-0, ,5-0,5-0,9-0, ,2-0,3-0,4 0, ,4 0,4 0,1-0, ,2 0,2 0,2 0, ,2 0,2 0,0-0, ,2 0,3 0,5 0, ,1 0,1 0,8 0,4 Source: Own calculaions and P.Kiss and Vadas [2005] The sign of he cyclical componens are similar o hose of P.Kiss and Vadas [2005] and heir magniudes are of similar order oo. The differences in he resuls mus come from he slighly differen esimaion mehods, he daa used and he coverage of budge iems. 1 16

17 Le s now urn our aenion o he cyclically adjused generaional imbalance measures. The values of budge iems did no change significanly afer he cyclical adjusmen so one would expec ha he generaional accouns would no change eiher. I is no necessarily rue as small differences in he presen migh become huge in he long run. However, Table 6 jusifies our earlier conjecure and he absolue generaional imbalance did no change much. Is series became smooher, i.e. hey fell less and rise less han he original relaive imbalance series. Table 6: Absolue generaional imbalance, (consan 2001 prices, F) Following cyclical adjusmen Year Base case Esimaed fiscal Uni fiscal elasiciies elasiciies ,859,107 10,395,821 10,469, ,327,679 6,015,494 6,073, ,923,556 8,221,906 8,228, ,815,752 16,465,560 16,479, ,127,985 12,694,100 12,701, ,618,070 12,920,927 12,936, ,590,809 12,828,259 12,818,871 The susainabiliy approach The generaional imbalance measure is produced using wha Bonin [2001] calls he residual approach. There are some problems wih his approach, and we lis hese problems in his secion. Firsly, i is no obvious where he dividing line is beween ne axes and ne governmen purchases. There are wo opposing views in he GA lieraure. One, which follows he seminal papers by Auerbach e al. [1991], [1992] and forms he basis of all inernaional comparaive sudies in his subjec, pus more emphasis on who pays for governmen services an who benefis from hem (see Buier [1995). I has been argued, however, ha alhough cerain goods and benefis are no included among ne axes (e.g. public goods) hey definiely increase people s welfare. Therefore, generaional accouns of presen generaions are no affeced by ne governmen purchases and hey are biased esimaes of individual s welfare. Ter rele [1997] and Raffelhüschen [1999] sugges a compleely differen soluion, in which all axes and spending caegories (including all public goods) are included among ne axes. In oher words, ne governmen purchases are diminished. The inerpreaion of 17

18 generaional accouns is compleely ransformed and hey become a welfare indicaor (Bonin and Paxo [2004]). As we menioned earlier Gál e al.[2005] disinguished beween hree differen budge caegories: (1) ax and ransfer caegories for which he age disribuion is known, (2) ax and ransfer caegories for which he age disribuion is no known bu should be consruced in principle and (3) ne governmen purchases. Conrary o Gál e al.[2005] who include only (1) among he ne axes, we chose a differen approach in ha iems in he second group were included among ne axes assuming hey have a fla age disribuion. Table 7 shows generaional accouns for he hree differen ne ax definiions (base case, our approach, and he one in which ne governmen purchases are zero). Table 7: Generaional accouns wih differen ne ax definiions (Base year: 2001, F) Generaion s age in 2001 Base case G includes only public goods G = 0 Fuure 15,727,098 13,999,195 6,749, ,865,599 1,408,386-4,705, ,356,485 1,918,196-4,116, ,116,753 3,738,032-2,046, ,435,546 6,095, , ,752,625 8,459,162 3,032, ,642,204 10,419,788 5,290, ,542,761 10,371,646 5,457, ,113,184 8,997,978 4,318, ,917,028 6,860,792 2,429, ,397,083 4,418, , ,567,255 1,673,956-2,074, ,134,407-1,951,022-5,377, ,510,749-5,243,942-8,320, ,679,194-6,326,394-9,041, ,424,876-5,974,027-8,278, ,711,234-5,154,505-7,014, ,181,581-2,366,325-3,141,475 Absolue generaional 12,861,498 12,590,809 11,455,046 imbalance Realive generaional imbalance Source: Gál e al.[2005] and own calculaions The able shows ha he resuls are considerably differen in he hree cases, and i raises he problem of manipulaion of generaional accouns. In he hird case he relaive generaional imbalance is negaive bu i does no signal redisribuion from presen generaions o fuure ones, simply is he resul of he newborns accouns being negaive and ha of fuure generaions being posiive. 18

19 Bonin [2001] menions wo oher problems of he residual approach. This approach only uses he number of fuure newborns from he demographic projecion so does no use all informaion on demography. I is no clear he burden of fuure generaions is he resul of wha fiscal policy exacly. I is only parially rue ha i is he resul of consan fiscal policy. Fuure generaions pay according o he residual derived from he ineremporal budge consrain. The cohor defici Bonin [2001] suggess a soluion where he employs a narrow definiion of ne axes and produces separae accouns for ne governmen purchases exacly he same way as generaional accouns are consruced. For each generaion (cohor) he difference beween he presen value of ne governmen purchases and generaional accouns calculaed on he basis of he narrow ne axes definiion is he cohor defici. I shows wheher he ne axes paid by each generaion is enough o finance ne governmen purchases for hem in heir remaining lifeime. If he defici is posiive hen ne axes paid by his generaion for he remaining of heir lifeime is no enough o finance heir share of ne governmen purchases for he same period. I also follows ha in order for fiscal policy o be susainable in he long run here mus be generaions wih negaive cohor defici. Table 8 shows generaional accouns, he ne governmen purchases accouns and he cohor defici for differen cohors. The cohor defici is simply he negaive of he generaional accoun calculaed by he broad definiion of ne axes suggesed by er Rele [1997] and Raffelhüschen [1999]. 19

20 Table 8: Generaional accouns and cohor deficis (Base year: 2001, F) Generaion s age in 2001 Generaional accoun Governmen purchases accoun Cohor defici 0 1,408,386 6,114,194 4,705, ,918,196 6,034,791 4,116, ,738,032 5,784,853 2,046, ,095,118 5,624, , ,459,162 5,427,128-3,032, ,419,788 5,129,030-5,290, ,371,646 4,913,780-5,457, ,997,978 4,679,196-4,318, ,860,792 4,431,767-2,429, ,418,943 4,104, , ,673,956 3,748,117 2,074, ,951,022 3,426,364 5,377, ,243,942 3,076,342 8,320, ,326,394 2,715,531 9,041, ,974,027 2,304,133 8,278, ,154,505 1,859,882 7,014, ,366, ,151 3,141,475 As ne governmen purchases are disribued evenly among individuals, i is no surprising ha he ne governmen purchases accouns are decreasing by age. As people ge older hey will receive hese benefis for a shorer period. We can also see ha he cohor defici urns negaive a around he age of 50, which is quie early compared o he resuls of oher sudies (for Germany i was closer o 60, see Bonin [2001]). A likely explanaion for his is he high rae of inaciviy in he Hungarian populaion, especially among hose aged 50 or older. The susainabiliy gap The susainabiliy approach aemps o resolve he deficiencies of he residual approach (Auerbach [1997], Raffelhüschen [1999], Bonin [2001]). The saring poin of his approach is ha he consan fiscal policy assumpion says in place bu he ineremporal budge consrain does no hold. Generaional accouns of fuure generaions are based on he base year s fiscal policy and also hey are affeced no only by he number of fuure newborns bu he whole demographic projecion. Nex we inroduce he concep of he susainabiliy gap, which measures he difference beween he revenue and expendiure side of he ineremporal budge consrain. In oher words i shows he revenue demand ha needs o be covered by adjusing he fuure level of axes, benefis or governmen purchases. I can also be inerpreed as wha he presen value of fuure primary surpluses or deficis would be if he governmen would no be resriced by he ineremporal budge consrain. In algebraic erms i looks like his: 20

21 SG = Gi Nk N k + i= k= D k= + 1 where he bar in he hird erm refers o he fac ha he burdens of fuure generaions are calculaed assuming of consan fiscal policy and no residually from he ineremporal budge consrain. The susainabiliy gap can be produced for each base year and i is shown on Figure 6 for he period of Boh he base case and he one which akes ino accoun he pension reform are shown. Figure 6: Susainabiliy gap, for base years (as a raio of base year GDP) 350 B (16) Base case Wih pension reform Le s sar wih he base case. The susainabiliy gap as a raio of base year GDP was 206,4% in This is he financial need of he governmen ha would pu he fiscal policy of 2001 ono a susainable pah. If we ake ino accoun hose policy decisions of he pension reform ha will come ino effec afer 2001 (e.g. increase of he pension age o 62 for boh me and women, ec.) hen he susainabiliy gap falls o 115,1%. These numbers show ha fiscal policy was no susainable in 2001, and fuure governmens will need o eiher raise ne axes or cu ne governmen purchases. These numbers are very high bu ha kind of imbalance is no unique if we compare i wih calculaions made for oher counries. Table 9 shows he susainabiliy gap for seleced European counries. The base year for hese calculaions was 1995 so one needs o be careful when making comparisons. 21

22 Table 9: Susainabiliy gap for some European Union counries (Base year: 1995, as a raio of base year GDP) Counry Susainabiliy gap Ausria 192,5 Belgium 18,8 Denmark 71,2 Finland 253,2 France 81,3 Germany 136,0 Ireland -4,3 Ialy 107,3 Neherlands 75,9 Spain 151,9 Sweden 236,5 UK 184,8 Forrás: Raffelhüschen [1999]. The susainabiliy gap in 1995 was higher in Sweden and Finland han in Hungary (in 2001) and was a a similar level in Ausria and in he UK. I is common pracice in he new GA lieraure o repor he susainabiliy gap in erms of he base year GDP. However, one could argue ha he susainabiliy gap is he presen value of deb accumulaed in an infinie horizon so i ough o be divided by he presen value of GDP for ha same period. Algebraically, κ = SG (17) GDP i= + 1 The susainabiliy gap calculaed his way was 7,1% for he base case and 3,96% wih pension reform in Effecs of changes in ax and benefi rules on generaions welfare and fiscal susainabiliy The generaional accouning mehod is capable of idenifying he possible effecs of changes in he ax-benefi rules. We will analyse for four sylised policy scenarios. (1) Change of he ax base: wha would happen if axes on labour income (i.e. personal income axes and social securiy conribuions) would be decreased and axes on consumpion increased. (2) Raise in pensions and cu of governmen purchases. Boh opions are defici neural, i.e. decrease in some axes (raise in expendiure) is exacly offse by increase in some oher axes (cu in expendiure). In cases (3) and (4) he defici neuraliy assumpion is dropped and he effecs of a comprehensive ax cu (Case 3) and a simple raise in pensions (Case 4) are analysed. Herer are he four scenarios in deail:, i 22

23 1. Reform 1: Cu of personal income ax and social securiy conribuions by 10% and raise of consumpion axes by 16%, 2. Reform 2: Raise of pensions by 20% and cu of ne governmen purchases by 12%, 3. Reform 3: Cu of personal income ax, social securiy conribuions and consumpion axes by 10%, 4. Reform 4: Raise of pensions by 20% (wihou cuing governmen purchases). Figure 7 shows he difference beween he new and he old ne ax profiles for he year of Figure 7: Difference beween old and new ax profiles (Base year: 2001, F) 40,000 20, , ,000-60,000-80, ,000 Reform 1 Reform 2 és 4 Reform 3 There are only hree curves on he figure because in cases (2) and (4) he new ne ax profiles are he same. As we menioned before neiher ne axes nor generaional accouns do no cach he effecs of changes in ne governmen purchases. Posiive values on Figure 4.10 suggess ha he corresponding generaion s ne ax burden is increased. Case 2, 3 and 4 are rivial as boh raising pensions wih or wihou cuing governmen purchases (Cases 2 and 4) and cuing axes (Case 3) will decrease ne axes (i.e. will be welfare improving). In Case 1 ne axes of younger and older cohors increase while ha of middle aged people decrease. I is no surprising as pensioners pay consumpion axes bu do no (or rarely) pay income axes while he young will have o face an increased burden of consumpion axes in he presen while paying less income axes in he fuure. Middle aged pay mos of axes on labour income so heir overall ne ax burden will be lower. 23

24 The quesion sill remains how generaional accouns and more imporanly cohor deficis are affeced. Table 10 repors hese for he base case as well as for he four policy scenarios. 24

25 Table 10: Generaional accouns and cohor deficis (Base year: 2001, F) Base case Reform 1 Reform 2 Reform 3 Reform 4 Generaion s age in 2001 Generaional accoun Cohor defici Generaional accoun Cohor defici Generaional accoun Cohor defici Generaional accoun Cohor defici Generaional accoun Cohor defici

26 In Cases 2 and 4 generaional accouns are lower han in he base case. I is reasonable, as we have argued before, generaional accouns of presen generaions only show changes in ne axes and no changes in governmen purchases. The bigges winners are hose around he pension age as hey can enjoy he benefis of increased pensions immediaely and for a long ime. In Case 3 lowered axes lead o lower generaional accouns (and higher cohor deficis) for all presen generaions. The case of broadening he ax base (Case 1) is more complex. The accouns of old people will be higher as consumpion axes (ha represens majoriy of he axes wihin heir ne axes) are increased. Typically hey do no pay income and payroll axes so canno enjoy he benefis of lower raes. The very young are also losers of he reform as hey will need o pay higher consumpion axes immediaely and for long periods while hey will enjoy he lower raes of personal income axes and social securiy conribuions years laer in heir acive years. All oher generaions (hose beween 15 and 50 years) are ne gainers of his reform opion. Labour income axes will be lower immediaely and for a long ime and alhough hey need o pay higher axes on consumpion, hese exra burdens will be much lower han he lower labour income axes. Finally, le us emphasise ha alhough he generaional accouns are equal in Cases 2 and 4, cohor deficis are no. The laer pick up he effecs of changes in ne governmen purchases and, we argue, are beer measures of generaional welfare han generaional accouns. Cohor deficis will be higher in Case 4 han in Case 2, i.e. all presen generaions pay less for he governmen purchases in Case 4 han in Case 2. Having discussed he inergeneraional redisribuion dimension, le us now urn o he issue of how fiscal susainabiliy is affeced in he four cases. Figure 8 shows he susainabiliy gap for four scenarios as well as for he base case. 26

27 Figure 8: Susainabiliy gaps (Base case: 2001, as a raio of base year GDP) Base case Reform1 Reform2 Reform3 Reform4 The susainabiliy gap does no change significanly in Cases 1 and 2, bu increases in Cases 3 and 4. The laer wo cases are sraighforward. GA models repor worsening of he long-erm fiscal posiion in cases where he governmen only increases expendiures or lower axes. Fewer middle aged people in he fuure would have paid less personal income axes and social securiy conribuions anyway, now wih lower raes hey conribue even less o he budge. I is no obvious how consumpion ax revenues from old people will be affeced (more older people and lower consumpion ax raes), bu he fewer young will definiely conribue less o he budge coffers, and as a resul of Reform 3 he susainabiliy gap increases o 291,3% of GDP. In Case 4 higher pensions are no balanced wih higher conribuions or axes and he susainabiliy gap becomes higher a 261.2%. In he oher wo cases i is no obvious how he fiscal posiion is affeced. If higher pensions are financed by lower governmen purchases hen basically he srucure of he expendiure side is alered. The susainabiliy gap is slighly increased o 212.6% of GDP. Reform 1 is he mos inriguing case. There are wo unambiguous effecs: Fewer acive people paying personal income axes and social securiy conribuions a lower raes resuling in lower revenues, More older people paying consumpion axes a higher raes will resul in higher revenues. According o he demographic projecion of KSH [2003] he number of young and middle aged (acive) people will fall by 30% by 2050 and hey will pay consumpion axes a higher raes. These effec evenually resul in a more or less unchanged long-erm fiscal posiion, he susainabiliy gap being 205.1% of GDP. 27

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