Paul Wallace 6 Sep 2018 05:13pm

Generational accounting: an age divide

Millennials versus baby boomers: there’s no denying that the generations are at loggerheads over what they want and how they plan to get it – and who’s to blame if they don’t. Paul Wallace asks, what light does generational accounting cast on the age divide?

Caption: Image: Fancy crave/Unsplash
Countries including the US, Spain and Britain have become increasingly defined by age rather than class. Polarisation tends to come to the fore politically during elections, but the economic and social roots go back longer. Particularly since the financial crisis a decade ago, the young have had a tough time. Their real earnings took a knock, whereas pensioners prospered. Surging asset values have helped older age groups while making it harder for the young to get onto the housing ladder. There is widespread concern that millennials will fare worse than their parents.

A sense of generational injustice is common across Europe, as a survey last year by ICAEW of 10,000 people in 10 European countries (including Britain) showed. Yet there was a twist in the tale: a majority among older as well as younger age groups believed their generation was not being treated fairly by their government when it decided on policies. The polling also revealed a similar lack of trust in governments taking into account the financial implications of policy decisions on future generations. ICAEW’s survey forms part of a broader effort to explore how the accountancy profession can contribute to a better understanding of generational equity as it becomes more salient to policymakers.

Accountants can enhance decisionmaking by ensuring the full disclosure of relevant data and helping to reveal the potential long-term financial impact of policy choices, says Susanna Di Feliciantonio, head of European Affairs at ICAEW, who is leading the initiative.

Economists have already been investigating these issues through generational accounting, which was invented in the 1990s as an alternative to conventional government bookkeeping.

Its proponents argued that the usual focus on short-term budget balances was flawed by ambiguity about what should be included, such as how to treat changes in unfunded retirement liabilities. By contrast, generational accounting looked at all spending commitments and taxation revenues stretching out to the distant future.

These were discounted back to present values to establish whether the budget was balanced over time. Typically these calculations showed gaping holes, imposing in effect a massive burden on unborn taxpayers. This early form of generational accounting is no longer in vogue, but it focused minds on the sustainability of public finances. As a result, governments now routinely carry out long-range projections to inform budgetary decisions. At the same time,
a wider research project has examined the economy from a generational and age-related perspective. The potential advantage of this approach is that it goes beyond piecemeal evidence such as the recent contrast between real incomes of the old and of the young. In principle it can provide a comprehensive appraisal of generational fairness.

National transfer accounts (NTA), developed by Ronald Lee, an eminent= demographer and economist at the University of California, Berkeley, now provide insights into the “generational economy” for many countries in the developed and developing world. NTA are consistent with the mainstream National Accounts that produce GDP, but go beyond them by presenting the information by age and for individuals rather than households. They also include private transfers, notably from parents to children, which do not appear in the National Accounts because they are subsumed within households and do not pass through the market.

These accounts reveal the pattern of consumption and labour income and the gap between them across the age spectrum. They highlight the transfers of resources between generations that support individuals through their life cycle as they start in deficit as children, move into surplus as workers and back into deficit in old age. NTA map the evolution from hunter-gatherer societies, where transfers from adults including the old were downward to the young, to mainly on old-age benefits. Precisely because the young receive education early in life, neglecting this transfer while highlighting benefits later in life distorts the overall picture.

Bequests should also feature in a comprehensive treatment of generational flows. According to the pure lifecycle theory of saving, in which people save to pay for their retirement, these should occur only to the extent that they die earlier than they expected. Yet the scale of legacies suggests that there is also a desire to leave money, contrary to the cavalier message of the American bumper sticker, “I’m spending my kids’ inheritance”.

Bequests have been a gap in NTA owing to the difficulty of tracking them. But now research led by economists David McCarthy and James Sefton at Imperial College is filling that hole. In a working paper they have developed Generational Wealth Accounts (GWA), which provide information about bequests. The GWA cover all residents in a country, including immigrants, with each generation defined by year of birth. Unlike NTA, which measure income and spending flows by age in any given year, GWA are balance sheets that record stocks, primarily
the capitalised values of current and future flows of resources and uses.

These estimates require both demographic and economic assumptions such as future mortality rates and productivity growth. The Imperial study uses a discount rate of 5% to work out present values.

For each yearly cohort already born, together with an entry for the unborn, the accounts tally not just the net assets they own but the present value of their labour income and of transfers, both public and private, received over their remaining lifetimes. When these exceed the present value of outflows in consumption and transfers paid (predominantly taxes), resources are available for bequests.

The calculation of bequests emerges from this forward-looking perspective rather than actual figures for legacies. The preliminary findings from this research for Britain confound the bumper sticker parody of the selfish old. Instead of spending to the hilt, older generations live well within their means, consuming much less than the resources available to them. Using data for 2012, the GWA showed that of £10.6trn held in assets, half (£5.4trn) was available in bequests. Put another way, that represented the surplus of the present value of resources over the present value of uses for generations then in their 40s or older. This amount was sufficient to meet the deficit being run by younger living generations while leaving £3.3trn spare for those then unborn.

Older generations, primarily parents but also grandparents, also support children through the time they spend with them as they are growing up. Though work is underway to draw up timetransfer accounts, the NTA and GWA are currently aligned with the National Accounts in excluding valuations of that time. If that were to be counted it would clearly have a very strong downward intergenerational effect, say McCarthy and Sefton.

The findings from the Imperial study do not contradict concerns about the poor health of the public finances. The GWA for 2012 showed an overall public shortfall of £5.6trn rather than the £1.3trn net debt recorded for that year in the public accounts. Most of this burden was being shunted forward to future generations (who were also in deficit).

Generational accounting cannot definitively explain whether the young are getting a raw deal because we will not know for decades to come whether their current difficulties are temporary or permanent. Baby boomers entering the labour market in the 1980s had a rough start as youth unemployment soared. Millennials may be experiencing a temporary today’s economies, where transfers are now also to the old. Strikingly, they reveal that these upward transfers occur in developing as well as advanced economies; what varies is the scale and the extent to which they are private or public.

In advanced economies upward transfers to the old through public spending on pensions and health are swelling relentlessly. That suggests a bad bargain for today’s young. However, such a view does not take into account the value of publicly financed education, which is a downward transfer to the young. Does this change the picture? A pioneering study published in 2010 worked out who wins and who loses from three public transfer programmes in the US. The authors, who included Lee, calculated the present value at birth (taking into account life expectancy) for cohorts stretching back to 1850 and forward to 2090 of public pensions through Social Security, health care for the old through Medicare, and public education.

They similarly worked out the present value of the taxes supporting these programmes. The projections required an assumption that all three run future balanced budgets with any deficits plugged half by benefit cuts and half by tax rises (since otherwise they would spiral out of financial control).

The study showed that including education did make a big difference. Contrary to received wisdom, millennials were among the most favoured generational beneficiaries of public transfer programmes. The crucial reason is the timing of benefits. Education occurs early in life. The average age when it is received is about 30 years before that of paying taxes, which is in turn about 30 years before the average age for old-age benefits. This gives the transfer of resources through education a greater weight in a calculation of net present value at birth.

At the 3% discount rate that the authors used, and taking into account survival probabilities, they reckoned that a dollar of education received as a child could “easily be worth $10 of old-age benefits”.

Of course these findings were specific to America and relied heavily on the assumption of balancing the budgets of old-age programmes in the future. Yet the study undoubtedly shows why it is vital to avoid partial analysis, such as the tendency to focus period of poor earnings related to the hiatus in productivity growth since the financial crisis.

What generational accounting can do is to put the current plight of the young in perspective. Despite the introduction of university tuition fees, millennials have benefited greatly from publicly financed education, not to mention all the unpaid time devoted to their upbringing. They can also expect to inherit a good portion of their parents’ wealth. The trouble is that such bequests will in practice be unevenly distributed. A quest for fairness between generations cannot duck the traditional concern about equity within generations.

Generational accounting does not tackle the vexed question of who bears the burden of climate change. Another snag is complexity. The virtue of generational accounting – its comprehensiveness – is also a vice through its challenge to comprehension. And for some an approach that looks forward so many years and includes those as yet unborn smacks too much of the black box.

Yet generational accounting does convey two important messages. First, generational equity should be considered in the round, including private as well as public transfers. Second, the most important way to help the young is by investing in their human capital. This has the virtue of being equitable both within and between generations. Above all, it will boost productivity growth, the surest way to dissipate generational tensions by raising the lifetime prosperity of today’s young.