Staff Paper Prepared for the President's Commission to Study Capital Budgeting

April 21, 1998

Generational accounting is a method of long-term fiscal analysis that has been developed over the past decade by Laurence Kotlikoff, Alan Auerbach, Jagadeesh Gokhale, and associates in this country and around the world. It is used to assess the sustainability of fiscal policy and the fiscal burdens facing past, current, and future generations. For a given set of policy assumptions, it estimates the present value of taxes that the average person of any age today will ever pay and the present value of benefits that he or she will ever receive as transfer payments; the implications of this policy for the net taxes (taxes paid less transfers received) of people born in the future; and the lifetime net tax rates of generations born in specific years in the past and born in the future.

Generational accounts are thus forward looking, based on estimates made far into the future. They are calculated in four steps:

Generational accounts can thus be presented as either: What do generational accounts show? First, they have always shown that the prevailing fiscal policy is not sustainable in the United States or in most other countries. An increase in net taxes or a reduction in purchases of goods and services, even if not large, is needed for the government to pay its bills if current tax and spending policy are otherwise to continue.

Second, they show how much of a change is needed. This amount is sensitive to whether the increase in net tax is paid only by future generations (as the authors almost always assume) or, more realistically, also by everybody who is alive when Congress enacts the policy change. If paid only by future generations, the latest estimate is that the lifetime net tax rate would have to increase by 72 percent (from 29 percent to 49 percent). If paid both by future generations and by everybody who is alive when taxes are raised, the income tax at all levels of government would have to increase by 20 percent or all taxes by 9 percent. Both the newly born generation and future generations would have a lifetime net tax rate of 32 percent.

These increases are much smaller than calculated a few years ago, such as in early 1994, when the lifetime net tax rate of future generations was estimated as 82 percent instead of 49 percent (assuming the increase was paid only by future generations). These increases would be still smaller if the estimates were updated for the legislation enacted last summer and the recently improved budget outlook.

Third, generational accounts can be used to assess what alternative fiscal policies can achieve generational balance, which is defined as the government paying all its bills.

Fourth, generational accounts can be used to assess how tax and transfer policy can redistribute income among generations.

Fifth, generational accounts can show distributional trends over time. The lifetime net tax rate rose in the early part of this century. For generations born from 1920 to 1995, it falls within the range of 29-33 percent. Unless changes are enacted soon that affect living generations as well as future generations, the lifetime net tax rate will be higher still for future generations.

The creators of generational accounting have contended that the budget deficit cannot answer these questions and therefore is irrelevant and ought to be replaced by generational accounts. This has not happened.

Generational accounting's appeal as an analytical tool to supplement the budget has also been limited. OMB published an experimental chapter on generational accounts for three years under the Bush and Clinton Administrations, but it was eventually dropped. For long-range analysis, OMB finds year-by-year budget projections more illuminating, such as those extending to 2070 in the FY 1999 Analytical Perspectives.

CBO published a careful, extensive report on generational accounts, Who Pays and When?, over two years ago. After evaluating its methods, contributions, and limitations, CBO concluded that "despite the valuable insights generational accounts afford, they should not become part of the regular budget outlook. They lie in the realm of analysis, not accounting. Therefore, CBO believes that the accounts should remain as a tool to analyze policy from a conceptual perspective, rather than serve as an official statement."

Selected References

Alan J. Auerbach, Jagadeesh Gokhale, and Laurence J. Kotlikoff, "Generational Accounting -- A Meaningful Way to Evaluate Fiscal Policy," Journal of Economic Perspectives, vol. 8 (Winter 1994), pp. 73-94. A reply to Haveman and other critics.

Alan J. Auerbach, Jagadeesh Gokhale, and Laurence J. Kotlikoff, "Generational Accounts: A Meaningful Alternative to Deficit Accounting," in David Bradford, ed., Tax Policy and the Economy, vol. 5 (MIT Press for the NBER, 1991), pp. 55-110. The theory and early estimates.

Jagadeesh Gokhale and others, "Generational Accounts for the United States: An Update," forthcoming in the Federal Reserve Bank of Cleveland, Economic Review, vol. 33 (Quarter 4, 1997). The latest estimates for the U.S.

Robert Haveman, "Should Generational Accounts Replace Public Budgets and Deficits?", Journal of Economic Perspectives, vol. 8 (Winter 1994), pp. 95-111. A critical evaluation.

Laurence J. Kotlikoff, "Generational Accounting," in NBER Reporter, Winter 1995/6, pp. 8-14. A clear exposition with an outline of the research program.

U.S. Congressional Budget Office, Who Pays and When? An Assessment of Generational Accounting (November 1995). A careful and extensive analysis.

U.S. Office of Management and Budget, "Generational Accounting," chapter 3 in Budget of the United States Government, Analytical Perspectives, Fiscal Year 1999. Earlier presentations were in Budget Baselines, Historical Data, and Alternatives for the Future (January 1993), Appendix F, and Budget of the United States Government, Fiscal Year 1993, chap. 23. An experimental supplement to the regular budget presentation.

President's Commission to Study Capital Budgeting