Generational Accounts and Generational Balance

GENERATIONAL ACCOUNTS AND GENERATIONAL BALANCE GENERATIONAL ACCOUNTS AND GENERATIONAL BALANCE: AN ASSESSMENT PETER DIAMOND * Abstract - Generational accounting is accounting as part of normative presented by Auerbach, Gokhale, and consideration of government activity. A Kotlikoff for normative consideration of second strand is the use of generational government and positive analysis of accounting in a positive theory of individuals. Generational balance is individual behavior. A third strand is the presented as a normative criterion and a presentation of generational balance as useful target for political economy. This both a normative criterion and a useful assessment distinguishes cost and utility target for political economy. Relative to bases for such calculations and concludes all of these is also an attack on the that the cost basis is interesting and conventional deficit (in its standard more useful—easier to get straight variations) as a useful tool for economic conceptually and consistent with a analysis. In this assessment, I draw on residual calculation of the impact on the previous reviews by Baker (1995), future generations. Generational Cutler (1993) and Haveman (1994). balance as currently calculated does not seem good by itself for identifying either equitable policies or good ones. THREE PARALLELS It is useful to start with calculations that bear some partial resemblance to generational accounts and that have some familiarity. The three to be discussed are INTRODUCTION the projections for Old-Age, Survivors, The development of generational and Disability Insurance (OASDI) and accounting in the joint and separate Medicare, the calculations of the writings of Auerbach, Gokhale, and incidence of taxes, and the calculations Kotlikoff (for example, 1991, 1994, of federal government impact by state. 1995; AGK, hereafter) has three strands. One strand is the role of generational Each year projections are prepared for OASDI and Medicare. Since I am more *Department of Economics, Massachusetts Institute of familiar with the former, I will concen- Technology, Cambridge, MA 02139. trate on that one (Board of Trustees, 597 NATIONAL TAX JOURNAL VOL. XLIX NO. 4 1995). Three projections are prepared, a budget. This is done by identifying central “best” projection and two that groups (for example, by state) and straddle it to represent some measure of allocating both expenditures and taxes a range of alternative projections. The to the different groups (Forsythe and projection extends 75 years into the Friar, 1993). future. The focus of the projection is the state of the trust funds. The basis of the In allocating expenditures, there are two projection is existing legislation, ignoring ways that such a calculation could be a non-negativity constraint on the trust done, based on costs or utilities. One funds. Being a projection, the calcula- way would be to take the cost of tion describes what would happen to different expenditures and allocate the the trust funds if the assumptions cost to different people who are behind the projection came to be identified as benefiting from the realized. The central idea is to identify expenditures. This necessarily involves a with considerable lead time when the somewhat arbitrary allocation of current legislation is likely to be inconsis- common costs. It has the adding-up tent, to need changes in benefits and/or property that the total allocated is equal revenues in order to have a path on to the aggregate of government which Social Security can continue. In expenditures. This approach is based on addition to projecting current legisla- measuring from the government’s tion, the same methods are used to perspective who the money is spent on. calculate the implications of alternative A different approach would be to legislated changes that might restore calculate a utility-to-individuals for the actuarial balance. There are a variety of different expenditures. Thus, the short- and long-run concerns that the marginal rate of substitution between projections are meant to flag as reasons the government program and income for concern about the future of the forms the basis of the valuation, rather program. than a fraction of the cost of providing the program. In this case, one would be Since the late 1940s, there have been trying to value the net utility impact of repeated calculations of how the U.S. the combination of taxes paid, transfers tax system affects different groups in received, and benefits received as a the economy (Musgrave et al., 1951; result of the expenditures. Note that if Pechman, 1985). The focus of the there are insurance components to the analysis is to identify groups by income government-provided transfers, then an level and to allocate the tax revenue ex ante utility-based approach to taxes collected in a year to the different net of cash transfers needs to assess the groups, recognizing the incidence of the premium people are willing to pay for taxes, not just the legal liability to pay. In the insurance. When everyone is trading addition to the allocation of the entire the equivalent of all of the government tax revenue, the methodology is used taxes, transfers, and expenditures at the for differential incidence—the examina- same prices, then everyone will have the tion of the distributional impact of same marginal rates of substitution proposed tax changes. between their net receipts of dollars or benefits from different programs. In the While the tax analysis considers only tax more realistic case that there are not collection (possibly net of cash trans- complete and perfect markets, marginal fers), another approach is to consider rates of substitution will differ across the impact of the entire government people. 598 GENERATIONAL ACCOUNTS AND GENERATIONAL BALANCE Depending on how people valued the countries, educational expenditures), an expenditures, the sum of utilities from anomaly related to the definitions in the the expenditures might be larger or National Income and Product Accounts smaller than the aggregate level of (NIPA). The current calculation is a mix expenditures. This difference between of cost-based calculations and utility- the cost and utility approaches in the based calculations, which again is presence of an adding-up condition is anomalous. In terms of the grouping of relevant for the ability to allocate a the population, all the not-yet-born are residual aggregate cost to some group combined using a residual calculation, rather than estimating directly. That is, not separate generational calculations. with a cost-based approach, having The lack of a consistent cost-based allocated some of the cost to some calculation seems to make the use of a groups, the cost relevant for the remainder residual calculation for future genera- of the population is the difference be- tions inappropriate. tween the total and what has been allocated. The same residual approach cannot be used with a utility-based GENERATIONAL ACCOUNTING— approach. In addition, restriction to a RETROSPECTIVE 2 single year makes the treatment of invest- It seems to me that we are interested in ments somewhat awkward, since these comparing the impacts of alternative are meant, in part, to affect people government policies on people born at (somewhat the same people, somewhat different2 times. Thus, we want some different people) in future years. generational accounting, although we also continue to want calculations based In all three of these examples, the on other groupings. The issue in this response of equilibrium in the economy section is what generational accounting to the programs is not part of the can hope to measure and how it has calculation. That is, there is a partial been and could be done. equilibrium nature of the calculation, rather than general equilibrium determi- To delay some issues about projection, I nation of the full set of changes in the begin by discussing historical account- economy. ing. Assume that one had a full history of government actions. Year-by-year and From1 the perspective of these examples, person-by-person, assume that we had generational accounts are prospective a complete description of the impact of and cover many years, like the Social government actions. (For some people Security projections. Like the other two in some settings, even the year may be calculations,1 generational accounts are too long an accounting period—for concerned with an allocation among example, the utility of poverty alleviation groups (identified by date of birth and measures will depend on the frequency gender) not in the total budget or public and timing of payments.) For any debt. The current version of genera- individual, we would see the set of tax tional accounts is neither a calculation payments to the government. Given an based solely on taxes (or taxes net of incidence theory, one would also have cash transfers) nor a calculation allocat- year-by-year estimates of taxes “really” ing the full government budget. Rather, paid. Similarly, one would have a series it is the somewhat anomalous combina- of year-by-year estimates of cash tion of taxes, cash transfers, Medicare, transfers received. One also wants to and Medicaid (and, in some other value the benefits received other than in 599 NATIONAL TAX JOURNAL VOL. XLIX NO. 4 cash. (In a world with military drafts, precisely displaced identical private there are also costs-in-kind as well as insurance, having no real effects benefits-in-kind.) This would include whatsoever. Assume the government goods received free (highway use, for program is identical to the displaced example) and goods sold at less than private insurance, including the costs of what they would have cost without the running the program. Then, examina- government action (access to national tion3 of the cash flows would find that parks, for example). One might want to individuals are losing from the program recognize individual uncertainty and to the extent of the administrative costs, calculate as of some date the distribu- even though real allocations are tion of transfers that might have been unaffected.

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