Academic journal article NBER Reporter

Generational Accounting

Academic journal article NBER Reporter

Generational Accounting

Article excerpt

Generational accounting is a method of long-term fiscal analysis and planning that I developed with Alan J. Auerbach and Jagadeesh Gokhale.[1] It is used to assess the sustainability of fiscal policy and to measure the fiscal burdens facing current and future generations. Although the concept is only five years old, it already has been applied to the United States, Germany, Italy, Norway, Sweden, Canada, New Zealand, Australia, and Thailand.[2] In addition, generational accounting projects are underway for Japan, Portugal, and Argentina. The U.S. government has included generational accounts in past editions of its Federal Budget,[3] and it is being implemented by New Zealand's Treasury and the Bank of Japan, as well. This article first briefly describes generational accounting, then compares it to deficit accounting, applies it to U.S. fiscal policy, considers its shortcomings, and finally suggests areas for future research.

How It Works and What It Does

Generational accounting is based on the government's intertemporal budget constraint that requires that either current or future generations pay the government's bills (which are the present value of the government's projected future purchases of goods and services, plus its official net financial liabilities). Subtracting from these bills the present value of projected future net tax payments of current generations yields the present value net tax burden facing future generations that is implicit in current policy. (Net tax payments are taxes paid minus Social Security, Medicare, and other transfer payments received.)[4]

The net tax burden facing future generations divided by the present value of their projected labor earnings will produce a lifetime net tax rate. By comparing the lifetime net tax rates facing future generations with those facing current newborns (who are assumed to pay, over their lifetimes, only the net taxes implied by current policy), one can assess the sustainability of current fiscal policies. For example, if the lifetime net tax rate facing future generations is higher than the rate facing newborns, then maintaining current policy through time - which means taxing successive new generations at the same rate as current generations - is not sustainable, because it won't pay all of the government's bills.

Generational accounting also calculates the (present value) changes in net taxes of generations, both living and future, that result from changes in fiscal policies. For example, an expansion of pay-as-you-go-financed Social Security retirement benefits will help current older and harm current younger and future generations, according to generational accounting. Specifically, this method records the reduction in the present value net tax payments of older generations arising under the policy as well as the increase in the present value net tax payments of young and future generations (whose increased payroll taxes have a larger present value than do their increased Social Security retirement benefits).[5]

Finally, generational accounting can identify the set of sustainable policies available to the government. For example, it can be used to calculate the immediate and permanent annual percentage increase in income tax revenues (relative to the baseline projected time path of these revenues) needed to achieve intertemporal budget balance. This calculation takes the government's projected expenditures and non-income tax receipts as given and asks: "By what percentage would one need to immediately and permanently raise income taxes so as to be able (in conjunction with other tax receipts) to pay for the government's projected future expenditures and its current net financial liabilities, and never have to raise taxes again?"

This sustainability calculation is, by the way, essentially identical to that undertaken annually by the Social Security trustees when they calculate the immediate and permanent percentage increase in payroll taxes needed to equate the present value of projected future Social Security expenditures to the present value of projected future taxes plus the current Social Security trust fund. …

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