Reframing Generational Accounting

1. Reframing Generational Accounting John B. Williamson and Anna RhodesBoston College, Department of Sociology, Chestnut Hill, MA, 02467 USA OVERVIEW OF GENERATIONAL ACCOUNTING ABSTRACT REFRAMING GENERATIONAL EQUITY CONCLUSION • An important contribution of the generational accounting model is that it highlights the current and projected future gap between spending on transfer programs such as Social Security and available tax revenues, alerting policy makers to the need to enact legislation to bring the two into closer balance. • In theory, generational accounting models are ideologically neutral and of potential use by analysts on both the right and the left, but in practice they are primarily used to bolster calls for cuts in spending including spending on Social Security as part of an effort to reduce deficits and smooth the tax burden across age cohorts. • These models fail to adequately factor in the potentially adverse intra generational consequences of Social Security cuts being proposed in the name of reducing the future size of the government debt and the resulting tax burden on future generations. • Rather than rejecting generational accounting, our analysis proposes reframing it so as to include inter generational equity along with a much greater focus on intra generational equity. To address the evidence that the debt/GDP ratio is increasing in the United States, some policy changes must be made. But what combination of benefit cuts and tax increases should be used? • Who will be bear the greatest burden due to those changes? Will the resulting distribution of the tax burden be less fair than today? •The changes made will have potentially substantial implications for both inter generational equity and intra generational equity. • Conservatives tend to back calls for cuts in social spending programs such as Social Security (Longman 1987; Peterson 1996), while progressives generally argue that such cuts will harm vulnerable segments of the population (Quadagno 1989; Williamson & Watts-Roy 1999). • GA address these issues in a way that emphasizes age cohort specific differences in projected tax burdens associated with the increasing debt/GDP ratio in the absence of changes current tax and transfer policies. Projected lifetime imbalances in taxes are understood as demonstrating that these policies are unsustainable and therefore inter generationally inequitable. • The reframing of GA that we outline seeks to consider how proposed new policies would affect inter generational equity as well as other forms, particularly intra generational equity. • To examine intra generational equity we must recognize that changes to policies such as Social Security have different effects on people based on income level, race, ethnicity, immigration status, and gender, among other factors (Kingson & Williamson 1999). Our reframing of GA would put the emphasis on the need to assess the potential consequences of proposed policy changes on the most vulnerable segments of the population, not just those defined by their age cohort. • Some policy reforms may affect intergenerational altruistic assistance, both monetary and otherwise, as family transfers are ignored in current GA models (Haveman 1994). • Current GA models include government spending on scientific research, but fail to include even estimates of the benefits of that spending. The same is true with spending on infrastructure improvements, efforts to slow the rate of greenhouse gas emissions, and spending on national parks (Helliwell 1998). • The GA models generally focus on the average person in the specified cohort, a practice that potentially provides a less than accurate picture for those who differ substantially from that average as well as neglecting the distributional impacts of proposed new policies on intra generational differences as defined by race, ethnicity, income, age, and often gender (although gender specific models are sometimes estimated. • When Kotlikoff and Burns (2004) justify their call for the partial privatization of Social Security in the USA based on the GA model, they ignore the potentially substantial adverse distributional implications of such a policy change. Their version of GA does not fit with the reframed version of GA that we are proposing. • Unpredictable bad events can and do happen (wars, plagues, depressions, natural disasters) that make narrowly focused efforts to equalize age-cohort specific burdens, to the neglect of other intra generational burdens, impractical and politically unacceptable. Our proposed reframing of GA represents an effort to deal with the drawbacks of neglecting important intra generational aspects of GA as currently framed. The concept of “generational accounting” is typically used to support the argument that each generation (defined in terms of age cohorts) should bear the same net lifetime tax burden. Generational accounting is often used both in the United States and internationally to bolster calls for cuts in spending on public pensions and other government social programs. It is argued that these cuts will serve to equalize the burden on each generation. Our analysis begins with an assessment of the pros and cons of the generational accounting model. A benefit is that it has contributed to an increased awareness of the generational implications of government spending policies. However, questions can be raised concerning some of the underlying assumptions (e.g., rational foresight) used in the model. In addition, there are a number of serious omissions such as social class and other forms of intra-generational inequity. The costs are included, but the benefits are excluded when it comes to government spending on programs such as national parks and scientific research because it is not possible to specify the value of their outputs in precise monetary terms. Our proposed reframing of generational accounting takes into consideration a broader range of the burdens and benefits of government spending programs including some with outputs that cannot be monetarily measured. Although it gives up the precision of the current generational accounting model, it fosters needed attention to the broad range of social equity issues that are important for policy makers to consider when making decisions about spending on pubic pensions and other social programs. • The GA model compares tax burdens by calculating account balances, in present value, for each age cohort assuming the continuation of current tax and transfer policies combined with projections of the population, government wealth, government expenditures, and a discount rate (Auerbach and Kotlikoff 1999). The account balances generated reflect each age cohort’s projected lifetime net tax payment, that is, projected lifetime tax payments less lifetime transfers looking forward from the specified base year. • Two different techniques for doing GA have been outlined, the first is used much more extensively than the second. The first involves calculating account balances for each generation forward from a chosen base year (Auerbach, Gokhale, & Kotlikoff 1991). Since these accounts do not include past taxes and transfers, it is not, for example, appropriate to compare the accounts of a cohort at age 20 and a cohort at age 65. The cohorts that can most appropriately be compared are newborns in the base year and as yet unborn future age cohorts as their account balances will all represent projections from birth to death. The second method is used to calculate the accounts forward from the birth year of each cohort so that the accounts of different cohorts can be compared (Auerbach, Gokhale, & Kotlikoff 1994). This method can be used to estimate the size of the change in cohort lifetime net tax payments under different tax policies. REFERENCES • Auerbach, Alan J., Jagadeesh Gokhale, & Laurence J. Kotlikoff. 1991. “Generational Accounts – A Meaningful Alternative to Deficit Accounting.” Working Paper No. 3589, National Bureau of Economic Research, Cambridge, MA. • Auerbach, Alan J., Jagadeesh Gokhale, & Laurence J. Kotlikoff. 1994. “Generational Accounting: A Meaningful Way to Evaluate Fiscal Policy.” Journal of Economic Perspectives 8(1):73-94. • Auerbach, Alan J. & Laurence J. Kotlikoff. 1999. “The Methodology of Generational Accounting.” Pp. 31-41 in Generational Accounting Around the World, edited by Alan J. Auerbach, Laurence J. • Cutler, David M. 1993. “Review of Generational Accounting: Knowing Who Pays, and When, for What We Spend.” National Tax Journal 46(1):61-67. Kotlikoff, & Willi Leibfritz. Chicago: The University of Chicago Press. • Buchanan, Neil H. 2005. “Social Security, Generational Justice, and Long-Term Deficits.” Working Paper No. 20, Rutgers Law School (Newark) Faculty Papers, Newark, NJ. • Feist, Karen. 2003. “Generational Accounting as a Tool for Modelling Social Expenditure in Europe.” Futures, 35:49-59. • Gokhale, Jagadeesh & Laurence J. Kotlikoff. 2001. “Is War Between the Generations Inevitable?” Policy Report No. 246, National Center for Policy Analysis, Dallas, TX. • Haveman, Robert. 1994. “Should Generational Accounts Replace Public Budgets and Deficits?” Journal of Economic Perspectives 8(1):95-111. • Helliwell, John F. 1998. “What Will We Be Leaving You?” Pp. 141-147 in Miles Corak (Ed.) Government Finances and Generational Equity, Ottawa, Canada: Statistics Canada, Minister of Industry. • Kingson, Eric R. & John B. Williamson. 1999. “Why Privatizing Social Security is a Bad Idea.” Pp. 204-219 in The Generational Equity Debate, edited by John B. Williamson, Diane M. Watts-Roy, & Eric R. Kingson. New York: Columbia University Press. • Kotlikoff, Laurence J. 1992. Generational Accounting. New York: The Free Press. • Kotlikoff, Laurence J. 2006. “Is the United States Bankrupt?” Federal Reserve Bank of St. Louis Review 88(4):235-249. • Kotlikoff, Laurence J. & Scott Burns. 2004. The Coming Generational Storm. Cambridge, MA: The MIT Press. • Longman, Phillip. 1987. Born to Pay: The New Politics of Aging in America. Boston: Houghton Mifflin. • Peterson, Peter G. 1996. Will America Grow Up Before It Grows Old? New York: Random House. • Quadango, Jill. 1989. “Generational Equity and the Politics of the Welfare State.” Politics and Society 17:353-376. • Raffelhüschen, Bernd. 1999. “Generational Accounting in Europe.” American Economic Review, Papers and Proceedings of the One Hundred Eleventh Annual Meetings of the American Economic Association 89(2): 167-170. • Wilcox, David W. 1989. “Social Security Benefits, Consumption Expenditure, and the Life Cycle Hypothesis.” Journal of Political Economy 97(2): 288-304. • Williamson, John B. & Diane M. Watts-Roy. 1999. “Framing the Generational Equity Debate.” Pp. 33-37 in The Generational Equity Debate, edited by John B. Williamson, Diane M Watts-Roy, & Eric R. Kingson. New York: Columbia University Press. • Williamson, John B. & Diane M. Watts-Roy. 2009. “Aging Boomers, Generational Equity, and Framing the Debate over Social Security.” Pp. 153-169 in Boomer Bust? Economic and Political Issues of the Graying Society, Vol. 1, edited by Robert B. Hudson. Westport, CT: Praeger. ECONOMIC CRITICISMS • Generational accounting has it supporters in the economic community, but it also has its critics, many of whom argue that the GA model, like other economic forecasting models, is based on assumptions which may, in hindsight, prove highly inaccurate (Buchanan 2005; Haveman 1994; Cutler 1993). Some criticisms focus on the assumptions underpinning the model while others focus on the ways in which the model has been applied. We focus on three major criticisms. • One is of the set of assumptions linked the life-cycle model used. The GA model assumes that people will “smooth” their consumption over their lifetime based on expectations about their lifetime earnings, but many do not do so (Feist 2003). • Another criticism concerns the discount rate and how it is used. In short, the GA model assumes that at any given time, future fiscal policy, future income, and future interest rates are as important to people’s consumption as current fiscal policy, income, and interest rates (Wilcox 1989). Cutler (1993) disagrees, arguing that due to lack of rational foresight many people are unable to accurately assess the consequences of current fiscal policies for future taxes and related benefits. • A third criticism is that the GA model does not factor in who would be paying for certain government transfers to old people if not the government. Feist (2003) points out that for certain expenses such as health care it would most likely would be their children. When these family transfers that would take place are factored in, a case can be made that the generational accounts are less out of balance and thus more sustainable than the GA estimates suggest. INTRODUCTION • Generational Accounting (hereafter GA) is a concept and model developed by Laurence Kotlikoff and his colleagues to project how resources (transfers) and tax burdens are distributed across generations, actually age-cohorts (Kotlikoff 1992; 2006; Kotlikoff & Burns 2004; Auerbach, Gokhale, & Kotlikoff 1991). • Research on GA can be viewed as a contribution to the broader literature on “generational equity” (Longman 1987; Quadagno 1989; Peterson 1996). • The generational equity debate began in the United States in the 1980s as a contest between two interpretative packages: the generation equity frame and the generational interdependence frame (Williamson & Watts-Roy 2009). • Proponents of the generational interdependence frame tend to oppose proposals to make large cuts in Social Security due to concern about adverse consequences for economically vulnerable segments of the population. • Our study examines the current framing of generational accounting and how the model is used in debates about government fiscal policy. • Proponents say it shows that current fiscal policy is unsustainable and therefore inequitable across generations, while critics argue that the model is too narrowly focused on government taxes and transfers while excluding the potential benefits of spending on some social programs with outcomes that cannot be measured in precise monetary terms. • The GA model has also been used to analyze projected generational tax burdens in several European countries such as Austria, Finland, Germany, Italy, and Sweden (Raffelhüschen 1999). Additional Contact Information John B. Williamson, Ph.D. Phone: 00 1 617 552 8530 Email: jbw@bc.edu Web: www2.bc.edu/~jbw