haveman, robert. should generational accounts replace public budgets and deficits

8/12/2019 Haveman, Robert. Should Generational Accounts Replace Public Budgets and Deficits

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Journal of Economic Perspectives Volume 8 Number 1 Winter 1994 Pages 95111

Should Generational Accounts ReplacePublic Budgets and Deficits?

Robert Haveman

Regardless of one's predilections, there appears to be no limit to theconceptual and definitional criticisms that can be made of the federalbudget. Many economists, national commissions, and congressionaland executive branch studies have proposed changes in public budgetingconcepts and procedures, changes ranging from technical to fundamental.Some recent proposals include treating capital expen diture s differently fromcurrent expenditures (for example, Eisner, 1986; U.S. General AccountingOffice, 1989a); finding a way to integrate the expenses of federal credit andloan (or loan guarantee) programs into the budget (U.S. Congressional BudgetOffice, 1989; U.S. General Accounting Office, 1989b); incorporating the futurecommitments of entitlement programs like Social Security into the deficit (forexample, see Feldstein, 1974); including changes in the value of such federalassets as land, structures, and financial claims (Eisner, 1986; Boskin, Robinson,and Hu ber, 1989; Bohn , 1991); and making certain price-level and interest-rateadjustments (Eisner, 1986). Some of these recomm endations have been a dop ted;most have not.Th e m ost radical of recent proposals is that the federal govern men t replacethe existing annu al bud get with the gene rational accounts developed by AlanAuerbach, Jagadeesh Gokhale, and LaurenceKotlikoff. These accounts and thebasis for their construction are presented in a prominent series of publications,including appendices to the last two federal budget documents.1 According to

1Th e assumptions and procedu res und erlying the construction of the accounts are presented mostcompletely in Auerbach, Gokhale, and Kotlikoff (1991), although both the FY 1993 and FY 1994 Robert Havem an is John Bascom Professor ofEconomicsand Pu blic Affairs Univer-sity of Wisconsin Mad ison and is affiliated with the La F ollette Institute of PublicAffairs and the Institute for Research on Poverty both at the U niversity of WisconsinWisconsin.


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Robert Haveman 97

Several aspects of these generational net tax values should be emphasized;while none of these considerations are disputed by Auerbach, Gokhale, andKotlikoff, neither are they highlighted in their presentations.First, as these accounts have usually been presented, it is the net amount offuture taxes paid and future transfers received by a generation that are rele-vant; past taxes paid or transfers received do not count.2 Second, while theaccounts record all of the taki ng by the public sector from a genera tion, onlya part of the giving is reco rde d; while taxes and cash and som e in-kindtransfers get counted, none of the benefits of the government's exhaustiveexpendituresresource-using activities generating real goods and services,such as schools, highways, environment, defense, and researchenter theaccounts. Third, all of these per person net tax values are constant dollar,present value amounts as of a current base year, and are calculated using amyriad of judg m ents that are open to question.

Finally, and most important for drawing the basic policy conclusion ofgenerational accounts, the net tax values assigned to various generations reflecta particular convention for allocating future tax and transfer flows betweencurrently living and future generations. For people of different ages alive todaycurrent generationsthe values reflect only the flows of aggregate futuretaxes and transfers due to current policy over their remaining lifetimes. Hence,no currently living person, irrespective of age, contributes to meeting thegovernment's long-term budget constraintto either servicing or paying offthe accum ulated public debt. Th e net tax values for future gen eratio ns,however, are calculated quite differently. In particular, they presume that eachmember of the set of future generations will pay the same(gender-spec ific) nettax, and that this tax burden must include enough revenue to meet thegovernment's long-term budget constraint; that is, to service and/or to pay offthe existing national debt plus any future increases in the debt due to thecurrent structure of tax and spending policy.

Given these and other assumptions, the resulting accounts support theassertion of generational imbalance and present-orientation. The generationalaccounts presented in the com panion pap er in this jour nal suggest that today's65-year-old male will secure a net gain of $74,000 from the future unfolding ofcurrent fiscal measures, while today's 30-year-old male incurs a net lossof over$205,000. Males yet unborn come into the world owing nearly $167,000.Advocates of the accounts cite the liabilities of future generations relative tothose of the youngest living generation as an indicator of the present-mindedness of current policy. In the base case estimate, the loss incurred by theaverage member of the future generation (those people born from 1992 on) is2The accounts presented in the FY 1994 federal budget (U.S. Office of Management and Budget,1993) include for the first time a tabulation of the lifetimetax rates of curren t and futuregenerations. These are defined as the present value of net taxes as of the birth date of a generationdivided by the present value at birth of the expected lifetime earnings of the generation. Calcula-tions of this sort are also presented in the companion paper in this volume.


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98 Journal of Economic Perspectives

more than double that of the average member of the cohort born in 1990 (theyoungest of today's current generations).The next two sections of this paper appraise generational accounting fromtwo distinct perspectives. First, I examine the theoretical conventions thatunderlie the Auerbach, Gokhale, and Kotlikoff accounts. Then I discuss thedependence of the generational impacts estimated in the accounts on theparameter choices which they have made. Clearly, the usefulness of genera-tional accounts depends on the plausibility and validity of these assumptions.

Economic Theory and the Conventionsof Generational AccountingThe generational accounts can be viewed as simply a tabulation of the neteffect of future taxes paid and transfers received by various generations,assuming that current policy remains unchanged into the indefinite future.However, to understand more clearly what these net tax numbers meananddo not m ean it may be helpful to com pare them to an alternative hypotheticalcalculation. Th is alternative account would answer the question: W hat is the

effect of the continuation of existing government taxation and spending policyon the economic well-being of rational, unconstrained, foresighted individualsof different ages, including those not yet bo rn ? Althou gh m any believe theAuerbach, Gokhale, and Kotlikoff accounts report the real effects of policy onintergenerational well-being,3 they do not. While the authors claim that theirestimates are consistent with economic theory me aning the idea of rational,foresighted peoplethey have made numerous assumptions that seem atvariance with such rationality and foresight.Behavioral Changes Associated with Tax-Transfer PoliciesIn generational accounting, the welfare burdens and benefits of publicfiscal m easure s are assum ed to equal the values on tax bills and transfer checks.But standard incidence analysis in public economics teaches that the burden oftaxes and the benefits of public expenditures can only be measured afteraccounting for the behavioral changes which these policies induce. The valuesin the generational accounts do not account for such changes. There are noconsumption or labor supply responses to taxes and transfers reflected in theaccounts, and no shifting of burdens or benefits. Hence, there can be no3Ind eed , Kotlikoff (1992) often describes the accounts in just such term s. Gene rational accountingis neoclassical economic theory's prescription for how to measure who will pay for government'sspend ing (p. 20). Th e accounts are variously described as mea suring the generational stance ofeconomic policy (p. 22) and the projected fiscal bur den on future...[and] cur ren t gener ations, asconsidering the entire gamut of governm ent economic policies (p. 23), and as summ arizing withone number the net amount we are currently paying the government... along with the net amountwe are likely to pay the governm ent down th e road (p. 26).


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ShouldGenerational AccountsReplace Public Bu dgets andDeficits 99

presumption that the dollar values shown in the accounts accurately capturethe welfare effects that we seek.A similar point can be made about bequest decisions. Although suchdecisions are dep end ent upon fiscal m easures, like their treatm ent of consum p-tion and labor supply decisions, the accounts ignore this dependence. Even ifcurrent policy were to be changed to favor younger people or future genera-tions, no offsetting shift in private bequests is permitted. Because the pattern ofprivate bequests directly affects the well-being of future relative to currentlyliving generationsthe central focus of the accountsthis assumption isnoteworthy.

Along with these microeconomic consequences, changes in the public debtwill tend to have macroeconomic effects, and will also alter the value of thefinancial wealth creation which is associated with public debt (Eisner, 1986).The generational accounts, however, also ignore these potential effects onwell-being.The Persistence of Current PolicyGovernments are reactive institutions; that is the essence of policy. Whenunemployment is unexpectedly high and persistent, extended jobless benefitsare legislated; when natural disasters strike, public expenditures to providerelief are appropriated; when expenditures on various programs increasebeyond projections, eligibility rules are tightened. Governments change taxa-tion, spending, and borrowing policy in response to changes in circumstances;that is what government is all about.However, this is not government in the world of generational accounting.In the Auerbach, Gokhale, and Kotlikoff accounts, current policyas reflectedin the forecasts used to establish th e base case counterfactuallasts forever.4 Infact, this assumption is necessary in the generational accounting framework toallow the analyst to conduct wh at i f thou ght experiments regard ing thegenerational effect of specified changes in tax or transfer policy. By altering onecomponent of tax or transfer policy while keeping all of the others constant,and reconstructing the accounts, the effect of the policy on the generationaldistribution of net taxes can be tabulated. But however useful the assumptionmay be for purposes of creating a base case for simulation purposes, it is clearly4After a l locating governmental receipts and expenditures to categories of households identif ied byage and sex in a base year , the sizes of these categories of people are a l lowed to change over t ime inaccordance with published Social Security Administra t ion projections to 2066 (which the authorsextend even fur ther in t ime) . Hence, in projecting future levels of public revenues and expendi-tures, only these future population developments can modify the balance between them; this is theonly fut ure that c i t izens are a l lowed to cons ider wh en formin g their expe cta tion s abo ut thefu ture m agni t ude of gove rnm ent taxes and t r ansfe r s to pa r t icu la r grou ps . Th ere i s one except ionto this descr iption: Recent versions of the generational accounts accept off ic ia l projections of taxand transfer tota ls to 2004 ref lecting existing policy, and Social Security and Health Care FinancingAdm inis t r a t ion pro jec t ions of Social Secu r i ty /M edic a re /M edica id expe ndi tu res to 2030 or 2066,again ref lecting exist ing legisla t ion. After the terminal year of these projections, average f lows byage and sex a re ex t rapola ted by apply ing an a ssumed ra te of pe r worke r produc t iv i ty growth( .0075, in the baseline case , a l though accounts using growth ra tes of .0025 and .0125 are a lsoshown) .


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an unrealistic basis for calculating numbers which are interpreted as reliableestimates of the net tax burdens of current and future generations. Forexam ple, if the re is a tax-transfer deficit (transfer paym ents exceed taxes) in thebase year for which the accounts are constructed, this deficit will persistindefinitely; no policy action in response to this situation is permitted becauseof the assumptions made in constructing the base case.The Present Value Budget Balance ConventionIn constructing the accounts, the government is required to meet a presentvalue, public budget constraint (including any unfunded liabilities implicit inprograms such as Social Security) by the end of the period of analysis. How-ever, the government balances this present value budget in a very particularway.In the Auerbach, Gokhale, and Kotlikoff tabulations, no person now alive(the current generation) is affected by the budget balance requirement; theirnet payments (benefits) are calculated as if government operates withoutconstraint. As a result, the burden of attaining present value budget balance isborne only by future generations (those individuals born in years after 1991).Hence, the shortfall in the present value of net taxes paid by generations livingtoday, plus the present value of the liabilities generated by all future genera-tions (those born from tomorrow on), must be covered by additional net taxpayments made only by these future citizens.5

It is largely for this reason that the accounts show a present value of netliabilities (payments) of a citizen born in 1992 that is more than twice that of anidentical citizen bo rn in 1991. Th e c ohort of one-year-olds is assume d tooperate under current laws, with no need for the government to satisfy abudget constraint; however, the members of future generationsfor example,those born tomorroware subject to a different set of rules. Indeed, theprim ary message of the gene rational accoun ts the excessive shifting of fiscalburdens to future generationsis largely an artifact of this rather specialconvention.The Treatment of Public Exhaustive ExpendituresIn standard public economics, governments undertake programs that yieldreal outputs designed to secure an increase in economic well-being. Citizensvote for spending on public education, public transportation, national parks,defenseto name only a fewbecause the willingness-to-pay benefits of theseactivities are expected to exceed their costs. Moreover, the bulk of the tax costsof these programs will be paid by citizens living when the programs areundertaken. However, implicit in the definition of the public budget constraint5In effect, there are two implicit fiscal regimes in place during future years when both members ofcurrent generations and members of future generations are living. The net taxes of currently livingpeople do not include a required contribution for debt retirement; the net value for future cohortsdoes.


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Robert Haveman 101

adopted in generational accounting are several conventions at variance withthis reality.The gains in well-being (benefits) which these publicly provided, utility-increasing activities generate are nowhere recorded in the accounts; thesebenefits evaporate. As the version of the accounts presented in the most recentbudg et puts it, generational accounts do not im pute to particular generationsthe value of the government purchases of goods and services made to providethem with educ ation, highways, national defense, and oth er services (U.S.Office of Management and Budget, 1993). In effect, the implicit benefit-costratio of public exhaustive expenditures is taken to be zero. Because many ofthese public activities yield their benefits in the futureconsider, for example,education expendituresgains that accrue to future generations are neglectedin the tabulation. The effect of this convention is to exaggerate the net taxburden assigned to future generations, and in their companion paper in thisissue, the authors acknowledge the importance of considering the distributionacross generations of the benefits of these public expenditures.

In addition to exaggerating the pre sen t orientation of curr ent publicpolicy, these conventions have another undesirable feature: they prevent theaccounts from reflecting any changes in the long- vs. short-run character of theportfolio of public investment activities. For example, a shift in the compositionof public exhaustive expenditures from short-lived activities (like traffic control)to long-lived capital investment (like education) would have no effect on thegenerational accounting tabulations. Although both younger cohorts of existinggenerations and future generations would be benefited by such a shift, theaccounts would fail to track these benefits.

A related anomaly arises in the treatment of public assets in the accounts.Consider, say, an increase in taxes paid by current generations and the use ofthe revenues for the purchase by the government of physical assets that arenon-revenue yieldingfor example, public lands or forests. The rationalutility-maximizer would record boththe loss from the increase in taxes an d th egain from the associated increase in public sector assets; the transaction wouldbe a wash. However, the generational accounts reflect only the increase intaxes, hence increasing the burden calculated for existing generations; thebenefit to citizens of the increase in the value of public assets is neglected.

Empirical Issues in Constructing Generational AccountsIn addition to those conceptual simplifications and conventions, Auerbach,Gokhale, and Kotlikoff make numerous assumptions about how demographicchanges unfold over the next centuries and how markets in the privateeconomy function. The bottom-line net tax numbers found in the accounts reston these assumptions.


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Clearly, all empirical assumptions are to some degree arbitrary, and equallydefensible assumptions would yield an equally reasonablethough probablyquite differentset of accounts. This is illustrated by the generational accountscalculated by these same a utho rs over the last few y ears, as und erlyin g forecastsand assumptions have been refined and changed. For example, the net taxesfor a future generation male were calculated at $90,000 in Auerbach, Gokhale,and Kotlikoff (1991) and Kotlikoff (1992), but at $137,000 in the FY 1993federal budget, and at $167,000 in the companion paper in this issue. Theratios of the net taxes of future generations to those of the newborn generationare 1.21, 1.79, and 2.11 (FY 1994 federal budget) across these evolving versionsof the accounts. Although the authors show consistent estimates within anypresentation of the accountsand often show results based on alternativeassumptionsit is clear that the extent of generational imbalance has increasedas the base year has changed, and as projections have been extended andassumptions modified. And this variation stems from changes in proceduresadopted by a common set of authors, over a period of only a few years.The Population the Economy and Policy in the FutureRecall for a moment some of the assumptions that must be made tocalculate generational accounts. How many males and females of what ages willbe living in 2050 or 2150? What will be the pattern of economic growth in thefuture, and how will the level of benefits and liabilities of a variety of publicprograms be affected by this growth? How will future relative prices, and thebehavioral (labor supply, savings) responses to these future values, affect vari-ous public expenditure and taxation programs, and the associated benefits andburdens of these policies accruing to individuals living in the future?

Auerbach, Gokhale, and Kotlikoff offer answers to each of these questions,based on their own or someone else's assumptions. The future demographicstructure of the population is based on projections to 2066 from the SocialSecurity Administration, extrapolated beyond that year to 2200. Future eco-nomic growth is taken to be .75 percent per year, per worker, and (after 2004)the taxes and transfers from existing policies are raised by this amount in eachfuture year. Without quarreling over the reasonableness of each of theseindividual assumptions, no one else has an especially good track record ofpredicting trends over future centuries. And changes in these parameters,projected over the next two centuries, could alter the generational pattern ofnet taxes considerably.6Although future relative prices (and the work, investment, and allocationchoices that respond to them) are affected by these demographic and economicdevelopments, none of these future price changes are reflected in the6A revealing discussion of the wide range of possible population projections ( in par t icular , of thee lde r ly popula t ion) r e su l t ing f rom a l te rna t ive r easonable a ssumpt ionsand the f i sca l impl ica t ionsof these a l ternativesis Singer and Manton (1993) .


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Should Generational Accounts Replace Public Budgets and Deficits 10 3

accountsthe numbers in the accounts assume a static, partial equilibriummodel with zero elasticities of response to either relative price and wagechanges or tax and transfer incentives. The time profile of the future benefitsand costs of fiscal measures is determined only by the interaction of the futureage-gender composition of the population and the set of policies and programsthat currently exist.The Discount RateThe net tax numbers in the generational accounts are present values;hence, the estimated net payment of $205,000 for today's 30-year-old male isthe present value of the transfer benefits which he is calculated to receive lessthe pre sen t value of his calculated taxes. Clearly, these estimates ar e sensitive tothe discount rate which is adopted.7From a macroeconomic growth perspective, what is desired is the discountrate that reflects the true opportunity cost to citizens of deferring presentconsumption. If the withdrawal of resources from the private sector by govern-ment displaces only private investment, the appropriate public discount ratewould be the interest rate used by private individuals making investmentdecisionsthe before-tax rate of return on uncertain private investments of,say, 1015 percent. However, if government resource use displaces privateconsumption and (as the generational accounts suggest) society is underinvest-ing, the correct discount rate is the social rate of time preference indicated bythe low after-tax rate on private savings of, say, 24 percent (Arrow and Kurz,1970; Bradford, 1975).The procedure used by Auerbach, Gokhale, and Kotlikoff reflects neitherof these perspectives. While they pay lip service to a low discount rateentertaining use of the real rate on short-term government securities 8theychoose a base case rate of 6 percent, reflecting the rate that risk averse citizensmight use in making savings and consumption choices. They write that because future governm ent receipts and expenditure s are risky, they should be discounted by a rate higher than the real rate of interest on governmentsecurities, but lower than th e real rate of re tur n on p rivate capital (U.S. Officeof Management and Budget, 1993, p. 9).Several issues regarding their procedure should be mentioned. First,having chosen a rate reflecting the risk-adjusted return on an uncertain

7This discussion draws from th e extensive l i tera ture on the ap pro pri a te d iscoun t ra te for socia lbenef i t-cost analysis . A recent summary of this l i tera ture is Lind (1982) .8 Th is ra te is just if ied by re lying on a par t icula r view of f iscal balance in the pre sence ofunce r ta inty . Th e notion is that future flows of exp end itu res and taxes are expec ted values, withsubjective re la t ive f requency distr ibutions surrounding these mean values. I f the expected value isnot realized, the public sector will have to increase or decrease i ts net borrowing accordingly, withthe result that the inter temporal budget constra int is lef t unaffected. This logic would lead to thechoice of the government borrowing ra te as the appropria te discount ra te . The fact that the realyie ld on U .S. Tre asu ry de bt has f luctuated from ne gative ra tes in the 1970s to over 7 percen t in the1980s is not addressed by Auerbach, Gokhale , and Kotlikoff.


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investment, the size of the uncertainty adjustment that they adopt is arbitrary. 9There is no more basis for raising the base rate from, say, 3 percent to 6perc ent tha n for alternative adjustments rang ing from 1 to, say, 10 percen tagepoints.Second, Auerbach, Gokhale, and Kotlikoff have nowhere given us theanalytic basis for the low discount rate reflected in the real return on short-termpublic debt. Arguments for rates both above and below this rate can be made.This is especially true for evaluating flows that will affect future generations,whose tastes are only vaguely reflected in today's capital markets.Third, Auerbach, Gokhale, and Kotlikoff apply their single risk-adjustedrate to both future expected tax liabilities and future expected receipts, and thisis clearly wrong. Consider the difference between uncertain future paymentsand uncertain future receipts. If risk-bearing entails a utility loss, the risk-adjusted discount rate for calculating the present value of an uncertain streamof benefits isgreaterthan the certain rate; the certainty-equivalent present valueof a future risky benefit stream is less than that of a certain benefit stream.However, by the same logic the appropriate risk-adjusted rate for calculatingthe present value of an uncertain stream of payments is less than the certainrate (Haveman, 1965; Hirshleifer and Shapiro, 1983; U.S. General AccountingOffice, 1991, pp . 10,40 ). By discoun ting future costs by the sam e risk-adjusteddiscount rate as is used for discounting future benefits, the present value of thecost stream is adjusted in the wrong direction; costs are lowered, rather thanincreased, because of uncertainty. As a result, the net tax values that theydisplay are in error by some potentially large amount.The choice of a discount rate is clearly of central importance to the pictureof generational imbalance that the accounts convey. For example, at the 6percent rate, the net payment required of future generations is estimated to be111 percent larger than that required of the newly born. However, genera-tional accounts calculated with alternative discount rates are also shown in theaccompanying paper; at 3 percent the future generation net tax payment is 89percent larger than the tax payment for the newborn generation, and at 9percent it is 193 percent larger. 10Fiscal Allocation vs. Fiscal IncidenceConstruction of generational accounts requires that government transferpayments and taxes be allocated to individuals of different ages and living in9This, of course, presumes that the time-related implications of using a risk-adjusted discount ratein accounting for u ncertainty in the evaluation of future flows of payments an d receipts is consistentwith the results from directly adjusting future expected and uncertain flows for risk anduncertaintya less restrictive procedure.10Strangely eno ugh, even the direction of the effect of altering the interest ra te seems to be unclear.In Auerbach, Gokhale, and Kotlikoff (1991), lower rates are associated with largerrelative burd enson future generations; in the version of the accounts in the accompanying paper, lower rates implysmallerrelative burd ens on future generations. T his may be because of changes in estimates ofaggregate taxes and transfers or the age-sex profiles used for allocating net tax burdens betweenthe two sets of accounts.


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Robert Haveman 105

different perio ds. Th e m agn itude of the im plied task of specifying these profilesis daunting, and the resulting accounts are sensitive to the assignments made.Accepting the fact that the generational accounts reflect only fiscal allocationsrather than the theoretically preferred measure of fiscal incidence, what needsto be known in constructing them is from whose pockets tax dollars come, andinto whose pockets transfer dollars enter.In making their allocation estimates, Auerbach, Gokhale, and Kotlikoff usewhat economic research and survey data have to offer, which is often skimpy.The allocation of income transfers and directly paid taxes (for example, incomeand payroll taxes) is based on the distribution of these flows among householdsin the 1984 Survey of Income and Program Participation (SIPP). Excise taxesare assigned to households as the profile of expenditures and taxation patternsfound in the 1989 Consumer Expenditure Survey (CES); residential propertytaxes in proportion to the pattern of house values in SIPP, distributed by ageand sex, dividing the property of couples equally between them. To obtain theage and sex distributions of these amounts, the values assigned to families areattributedpresumably, equallyto both the children and the adults in thehouseholds, by age and sex. For any given tax or transfer program, thesehousehold and age-sex allocations are assumed constant over time.11

Clearly these procedures imply heroic assumptions regarding the stabilityof incidence patterns, intertemporal constancy in consumption and asset-holding patterns, and bequest arrangements. In fact, in several cases theassumptions are at odds with standard neoclassical theory. What must oneassume regarding the pattern of intrafamily income sharing to distribute, say,public disability transfers over all of the members of a living unit that may ormay not include children? On what basis can one presume that health carebenefitsor retirement pensionsassigned to the elderly represent net bene-fits to them , as opposed to their adult children on whom the burd en could havefallen were not the public program in place?12 In a world with bequests, wouldnot at least a portion of the burden of property taxes fall on the children ofproperty owners? Clearly, the numbers in the generational accounts are sensi-tive to the conventions adopted.

The most complex and controversial of these tax incidence procedures arethose applied to income taken to be the return to capitaldefined as the sumof all corporate taxes, plus capital's share of the base of the personal income tax(taken to be about 20 percent of net national product), plus estate taxes. Thisprocedure yields total capital income taxes that are equal to more than 50percent of aggregate taxes on labor income, a strikingly high figure. As indicated above, the policy observed in the base year (say, 1991), or reflected in base yearprojections of current policy, is assumed to be constant until the final year of the analysis, save forthe application of a growth factor to adjust for the higher expected incomes of people living inyears after 2004. The intergenera tional slide of the benefits of social insurance and oth er transfer progra ms isdiscussed in Lampman and Smeeding (1983).


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In effect, the approach of Auerbach, Gokhale, and Kotlikoff assumes a shiftto cash-flow capital income taxation with 100 percent expensing. In such acash-flow asset pricing approach to capital income taxation, the values of assetsare written down immediately upon purchase for the taxes that are expected tobe paid on the returns that they generate (Auerbach, 1986; Summers, 1985;Cutler, 1988). In this way, the incidence of capital taxes can be taken asinframarginal, falling on the holders of capital. Making such a shift in taxationregimes obviously results in changes in wealth for holders of existing capital,requiring a large adjustment in allocating capital taxes in each year among thevarious generations.

While this treatment of taxes on capital is consistent with a particular viewof the incidence of capital taxe s, that view has its critics. Th is framew ork restson a combination of perfect foresight and instantaneous capital market adjust-ment, a set of conditions that seem inconsistent with the ragged patterns ofactual market reactions to changes in capital taxes. Moreover, although a largeshare of these wealth holdings will no doubt be passed to children upon thedeath of the parents, the procedure assigns no property rights in existingcapital to them, and hence no capital tax liability. While there is no doubt someimplicit notion of bequests that lies behind this procedure, it is nowhereexplained or justified. O ne w ould h ope for tests of the sensitivity of thegenerational imbalance claim to alternative allocations of capital taxes acrossgenerations.

Should Generational Accounts Replace the Current Budget?With these criticisms in mind, then, what should we make of generationalaccounting, and in particular the Auerbach, Gokhale, and Kotlikoff accounts?The idea of tracking the monetary effect of fiscal policy measures on represen-tative members of all present and future age groups is enormously attractive.

Indeed, what legislator or economistindeed, what citizenwould not desiresuch information? In principle, a version of generational accounts could be avaluable public finance tool.It does seem likely to me that while the specific numbers in generationalaccounts can be questioned, for all the reasons described here, the generaldirection of effects which the accounts show is unlikely to be overturned byplausible alternative sets of conventions. Generational accounts do alert us tothe likely tilt of fiscal policy toward the present and away from the future.When presented with warnings, caveats, and sensitivity analyses, such accountsdo provide a more organized way of conveying the present vs. future orienta-tion of policy than other forms of evidence that economists have heretoforemustered, and that is a service. Auerbach, Gokhale, and Kotlikoff should becommended for both thinking through the complex issues underlying any such


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Should Gene rational Accounts Replace Public Budgets and Deficits? 107

effort, and for actually carrying through the calculations necessary to offergenerational accounts with numbers in them.But moving beyond the concept and the very broad lesson of intergenera-tional equity, what should economists make of the specific accounts with whichwe have been presented? Such accounts inevitably rest on a set of particularviews and assumptions regarding both private and government behavior, manyof them without any especially clear basis. In making a jud gm en t on wh etherthese specific accounts give a reliable picture of the generational effects ofgovernment, one must test the assumptions on which they rest against empiri-cal evidence and the prevailing theoretical consensus of economists. Only if theassumptions underlying the current set of accounts meet this test can one becomfortable in their world. If they do not meet the test, the generationalaccounts will feel like an ill-fitting suit, and should be reg ard ed as no m ore thanillustrative.

But Auerbach, Gokhale, and Kotlikoff claim their accounts to be far morethan illustration, and emphasize that their calculations are consistent withtheory in a way that curr ent budg et figures can never b e. Should economistsasthey suggeststrike terms such as the deficit, annual tax revenue and annualpublic expenditures from our analytical lexicon? Should generational accountsreplace public budgets? Consider three reasons given for abandoning conven-tional budgets: nonconformance with economic theory; the susceptibility of thedefinition of the deficit to political manipulation; and the absence of a relation-ship between the deficit and macroeconomic variables.Generational accounts pose as more consistent with life-cycle, neoclassicaltheory than figures based on annual budget data. It is claimed that the deficitcan never be consistent with economic theory, whether it is the annual govern-ment deficit as officially defined, or the deficit as adjusted for inflation, relatedchanges in net private wealth, deviations from full employment, payments ofnet interest on the debt, or government real net investment (Eisner, 1986;Blejer and Cheasty, 1991). In his book on generational accounting, Kotlikoff(1992) states that those economists who make use of measured deficits in theiranalysis (and taxes and transfers, as well) are adh ere nts to the Keynesianmo del, which has no fundamental theory underlying it (p. 30). Moreover, Keyn esian em pirical rese arch has been successfully discredited by the rational expectations revolution (p. 32).While in principle a lifetime, cross-generational economic well-being analy-sis could reveal more than an annual deficit measure, the generational net taxvalues which have been calculated require assumptions and conventions thatare dictated as much by hunch and the necessity to make some calculation asthey are by straightforward economic theory. While many of the proceduresadopted by Auerbach, Gokhale, and Kotlikoff are reasonable, others are not.Moreover, there has been no careful review of, nor professional consensus on,many of them. Equally bright, informed, and well-intentioned analysts could


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108 Journal of Econom ic Perspectives

ado pt equally justifiable ass um ptions and con ventions and p rod uce equallydefensible accounts with quite different numbers and implications.At the most fundamental level, the critique that generational accountingmakes of the bud get deficit is that only the pr esen t values of taxes and transfersmatter, and not their timing. But if citizens are to base their decisions on abudget constraint defined over lifetime wealth and prices, and the timing ofpayments and benefits is not to matter, it must also be true that individualshave full rationality and foresight, that capital markets readily facilitate con-sumption smoothing, that individuals are not generally liquidity constrained, 13and/or that nondistortionary taxes and transfers are feasible.14 While it issurely true that under these conditions, annual tax and benefit flows arelacking as indicators of the effects of fiscal policy on either choices or aggregatewell-being, it is also tru e th at few of these assum ptions conform to the econom yin which we live. Moreover, while considerations of imperfect rationality andforesight, liquidity constraints, and imperfect credit markets are often notincorporated into models of economic theory, they should be. When they are,the superiority of lifetime to annual measures will become an empirical ques-tion, and I suspect that annual measures will not appear as irrelevant as theyhave been depicted.Indeed, standard family financial planning procedures suggest the value ofan annual budget approach. Most families draw up budgets on an annual basis,and on even sho rter time frames, not on a lifetime basis. A doc um ent thatincorporated the effect of particular household decisions on its lifetime wealthaccount would no doubt be valuable, but effective household planning alsoappears to require understanding the relationship of current-year income toexpenditures. Apparently, such budgets offer discipline and fiscal control, andthey tell whether net assets or net debt are growingproperties that peopleseem to value. This in spite of the fact that the definitions of income, spending,and borrowing implicit in such annual budgets lack the clear tie to a rational,foresighted family which considers carefully its position in the life cycle. Indeed,the fact that most individuals do not substitute lifetime household accounts forannual budgets indicates that at least some of the presumptions of the life-cycleframeworklike foresightedness and lack of liquidity constraintsare violated.And to the extent that they are violated, annual deficits will matter.As to the second issuethe belief that no generally accepted economic oraccounting principles exist to guide the calculation of the deficit, allowingindividuals and special interests to manipulate its definition for politicalpurposesI see little difference between the current account budget andgenerational accounts. Assume for a moment that some set of generationalaccounts were to replace conventional public budgets. Is there any doubt that13Kotlikoff (1993) argues that liquidity constraints are not im mutab le, and th at their prevalence isoverstated. He also suggests that the arbitrary nature of governmental deficit definitions makes thisconcept irrelevant in any case. In fact, none of these issues have been resolved in any general sense.4On the point regarding lump-sum taxation, see Bohn (1991).


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Robert Haveman 109

politicians would propose changing some assumption or convention underlyingthe net tax numbers in these accounts if a policy that they wish enacted onother grounds is shown to burden future generations? Is there any reason tobelieve that generational accounting conventions would be less immune tomanipulation than are current budget accounting definitions?While the issue of how to interpret deficit numbers remains, it should alsobe noted that the standards of accuracy for the numbers in public budgets (andother official government statistics) are uniquely high, even relative to those ofthe best scientific journals and scholarly monographs. Moreover, the trans-parency of their basis and calculation relative to those in the generationalaccounts is striking.

Finally, advocates of the generational accounts assert that neither officialnor adjusted deficits are related to a variety of important macroeconomicvariablesin particular, interest rates, savings and investment rates, or eco-nomic growth. Kotlikoff (1992) most strongly argues this view, relying primarilyon a number of time-series charts and the writings of Evans (1985, 1987, 1989).In fact, the empirical findings on the effects of the federal budget deficit onmacroeconomic variables are mixed (Poterba and Summers, 1987; Eisner,1986, 1989, and the references therein). In general, most studies that rely onthe unadjusted deficit as an explanatory variable find a weak, if not perverse,relationship between it and variables such as the interest rate, savings, oreconomic growth. However, studies that adjust the reported deficit for theeffects of inflation, the real value of assets, and cyclical factors, and which arecareful in modeling the effects of lags, find right-signed and statistically signifi-cant effects of the deficit (for example, Barth, Iden, and Russek, 1984/85;Hoelscher, 1986). And there are good analytical reasons to believe that studiesbased on simple historical time-series data are unlikely to detect theserelationships.My answer, then, is that I see no merit in replacing existing public budgets,limited though they are, with generational accounts. While a comprehensive setof generational accounts would provide a more full-bodied picture of the effectson various generations of the current structure of policy than does the currentaccount deficit, this latter figure is not devoid of information on the relativeburdens being imposed by government on existing vs. future generations.Indeed, consistent with the present value, public budget constraint used inconstructing the Auerbach, Gokhale, and Kotlikoff accounts, a wide range offiscal measures designed to reduce the cu rren t bu dget deficitfor examp le, acurrent increase in taxes, a current reduction in transfers, a cut in exhaustivespendingwould simultaneously reduce the net tax burden of future genera-tions relative to people living today. While the contents of the two approacheswould differ, the basic message would not.Information about what the government spends and collects in taxes in anygiven year (and about how expenditure and taxation levels change over time)will surely not answer all the important questions. However, the annual


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spending, tax, and deficit numbers do accurately measure the scarce real andfinancial resources that are being allocated by government in any given year, ina way that highlights their immediate opportunity costs.Indeed, focusing only on the numbers in the generational accounts couldwell divert us from larger policy issues with important influences on both oureconomic well-being and that of our children. Generational accounts recordguesstimated future fiscal flows in a world abstracted from any macroeconomicconsiderations. While a large short-term deficit leaves a debt that the accountswould record as an encum brance on future generations, it may result in the useof otherwise idle resources in the production of outputs of value to all genera-tions, which outputs would, in its absence, be forgone. Surely this latter realoutput effect is more important to economic well-being than the incurring andhanding on of debt, together with the financial assets to which it gives rise.There is substantial room for improvement in public budgeting practice,including movement toward accrual accounting, improved accounting for pub-lic assets and liabilities (a public balance sheet), accurate accounting for avariety of off-budget guarantee and subsidy arrangements, and inclusion offuture entitlement commitments. Of course, each of these changes is fraughtwith conceptual and informational problems of its own. Along with theseextensions of annual budget and deficit accounting, generational accounts canserve as a useful supplement to the annual budget, but not as a replacementof it.

I have benefited greatly from the helpful comm ents on earlier versions of this paperoffered by Henry Aaron Chris Barker Robert Eisner Jagade esh Gokhale Eric HanushekAlan Krueger LaurenceKotlikoff John K arl Scholz Carl Shapiro Robert Strauss JohnSturrock Timothy Taylor Kenn eth W est Barbara Wolfe and MichaelWolkoff A longerand more complete discussion of these issues is available from the author upon reque st.

ReferencesArrow Kenneth J. and Mordechai Kurz

Public Investment The Rate of Return and Opti-mal Fiscal Policy. Baltimore: Johns HopkinsPress, 1970.Auerbach Alan J. Tax Reform and Ad-justment Costs: The Impact on Investmentand M arket Value, National Bureau of Eco-nomic Research Working Paper No. 2103,Cambridge, 1986.

Auerbach Alan J. and Laurence J. Kot-liko Dynamic FiscalPolicy. Cambridge: Cam-bridge University Press, 1987.

Auerbach Alan J. Jagadeesh Gokhale andLaurence J. Kotlikoff Generational Ac-counts: A Meaningful Alternative to DeficitAccounting. In Bradford, David, ed.,Tax Pol-icy and theEconomy, Vol. 5. Cambridge: MITPress, 1991, 55110.


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ShouldGenerational AccountsReplace Public Budgets andDeficits 11 1

Barth James George Iden and Frank S.Russek Do Federal Deficits Really Matter?Contemporary Policy Issues, Fall 1984 85, 3:1 ,7995.Blejer Mario I. and Adrienn e CheastyThe Measurement of Fiscal Deficits: Analyti-cal and Methodological Issues, Journal ofEco-nomic Literature, December 1991,29, 166478.Bohn Henning Budget Deficits and Gov-ernm ent Accounting, mim eo, University ofPennsylvania, October 1991.Boskin Michael Marc Robinson and AlanHuber Government Savings, Capital Forma-tion, and Wealth in the United States,194785. In Lipsey, R., and H. Tice, eds.,The Measurement of Savings Investmen t andWealth. Chicago: University of Chicago Press,1989, 287353.Bradford David F. Constraints on Gov-ernment Investment Opportunities and theChoice of Discount Rate, American EconomicReview , December 1975,65 :5, 88799.Cutler David Tax Reform and the StockMarket: An Asset Price Approach, AmericanEconomic Review , Decem ber 1988, 75 :5 ,110717.Eisner Robert How Real Is the FederalDeficit? New York: Macmillan, 1986.Eisner Robert Budget Deficits: Rhetoricand Reality, Journal ofEconomic Perspectives,Spring 1989, 3:2 , 7393.Evans Paul Do Larger Deficits ProduceHigh Interest Rates? American Economic Re -view , March 1985, 75 :1, 6887.Evans Paul Interest Rates and ExpectedFuture Budget Deficits in the United States,Journal of PoliticalEconomy,February 1987,95:1, 3458.Evans Paul A Test of Steady-State Gov-ernment Debt Neutrality, Economic Inquiry,January 1989, 27 :1, 3955.Feldstein Martin Social Security, InducedRetirement, and Aggregate Capital Forma-tion, Journal ofPolitical Economy, September1974, 82 :5, 90526.Haveman Robert Water Resources Investmentand the Public Interest.Nashville: Van derbiltUniversity Press, 1965.Hirshleifer Jack and David Shapiro TheTre atm ent of Risk and Uncertainty, In Have-man, Robert, and Julius Margolis, eds., PublicExpenditures and Policy Analysis . New York:Houghton, Mifflin, 1983.Hoelscher Gregory New Evidence onDeficits and Interest Rates, Journal ofMoneyCredita nd Banking,February 1986,18 :1, 117.

Kotlikoff Laurence J. GenerationalAccount-ing:Knowing WhoPays and When for What WeSpend. New York: The Free Press, 1992.Kotlikoff Laurence J. From Deficit Delu-sion to Fiscal Balance RuleLooking for aSensible Rule to Measure Fiscal Policy, Jour-nal of Economics, Supplement 7, 1993, 1741.Lampman Robert and Timothy SmeedingInterfamily Transfers as Alternatives to Gov-ernment Transfers to Persons, Review of In-comeand Wealth, March 1983, series 29, no. 1,4566.Lind Robert A Primer on the Major Is-sues Relating to the Discount Rate for Evaluat-ing National Energy Optio ns. In Lind,Robert, ed., Discounting for Time and Risk inEnergyPolicy. B altimore: Joh ns H opkins Press,1982, 2194.Poterba James and Lawrence SummersFinite Lifetimes and the Effects of BudgetDeficits on National Saving, Journal ofMone-tary Economics, September 1987, 20 :2 ,36991.Singer Burton H. and Kenneth G. Man-ton How Many Elderly in the Next Genera-tion? Focus, (Newsletter of the Institute forResearch on Poverty), Summer/Fall 1993,75 :2, 110.

Summers Lawrence H. The Asset PriceApproach to the Analysis of Capital IncomeTaxatio n. In Felwil, George R., ed., Issues inContemporary Macroeconomics and Distribution.Londo n: Macmillan, 1985, 429 43 .U.S. Congress Congressional Budget Of-fice Credit Reform:Comparable BudgetCostsforCash and Credit. Washington D.C.: C ongres-sional Budget Office, 1989.U.S. General Accounting Office Managingthe Cost ofGovernment: Proposals fo r ReformingFederal Budgeting Practices, GAO/AFMD-90-1.Washington, D.C.: General Accounting Office,October 1989a.U.S. General Accounting Office BudgetaryTreatment ofFederal Credit Programs, AFMD-89-42 . Washington, D.C.: General AccountingOffice, 1989b.U.S. General Accounting Office DiscountRate Policy, GA O/OC E-17-1-1. Washington,D.C.: General Accounting Office, May 1991.U.S. Office of Management and BudgetBudget of the United StatesGovernment; FiscalYear 1993. Washington, D.C.: GovernmentPrinting Office, 1992.U.S. Office of Management and BudgetBudget of the United StatesGovernment; FiscalYear 1994. Washington, D.C.: GovernmentPrinting Office, 1993.


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