Table Of ContentPopulation Economics
Editorial Board
John Ermisch
Bengt-Arne Wickstrom
Klaus F. Zimmermann
Springer-Verlag Berlin Heidelberg GmbH
Titel in the Series
Jacques J. Siegers . Jenny de Jong-Gierveld . Evert van Imhoff (Eds.)
Female Labour Market Behaviour and Fertility
Hendrik P. van Dalen
Economic Policy in a Demographically Divided World
Dieter Bos . Sijbren Cnossen (Eds.)
Fiscal Implications of an Aging Population
Klaus F. Zimmermann (Ed.)
Migration and Economic Development
Nico Heerink
Population Growth, Income Distribution, and Economic Development
(out of print)
Tommy Bengtsson (Ed.)
Population, Economy, and Welfare in Sweden
J. Haisken-De New
Migration and the Inter-Industry Wage Structure in Germany
D. A. Ahlburg . A. C. Kelley· K. Oppenheim Mason (Eds.)
The Impact of Population Growth on Well-being
in Developing Countries
Holger Bonin
Generational Accounting
Theory and Application
With 32 Figures
and 33 Tables
, Springer
Dr. Holger Bonin
Forschungsinstitut zur Zukunft der Arbeit (IZA)
Schaumburg-Lippe-StraBe 7-9
53113 Bonn
Germany
Printed with the support of the Deutsche Forschungsgemeinschaft D 25/10
ISBN 978-3-642-07601-5
Library of Congress Cataloging-in-Publication Data applied for
Die Deutsche Bibliothek - CIP-Einheitsaufnahme
Bonin, Holger: Generational Accounting: Theory and Application / Holger Bonin.
ISBN 978-3-642-07601-5 ISBN 978-3-662-04595-4 (eBook)
DOI 10.1007/978-3-662-04595-4
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Preface
We see which way the stream of time doth run
And are enforced from our most quiet sphere
By the rough torrent of occasion.
William Shakespeare
During the next decades, as a consequence of fertility decline combined with
ever-decreasing mortality, progressive population aging hits most developed
societies. The demographic transition ahead will put severe pressure on gov
ernment budgets, as the sizeable demands on public transfers made by the
elderly who collect public pensions and a major share of health and nursery
care spending, are largely unfunded by the current systems of social security.
Growing awareness that present fiscal policy assumes commitments impact
ing on public budgets only in the longer-term, has stimulated research on
fiscal indicators that incorporate the intertemporal effects of today's govern
ment policies.
Among the new methods to evaluate the long-term implications of current
fiscal policy measures, certainly the concept of generational accounting, put
forward in a series of papers by Alan Auerbach, Jagadeesh Gokhale and Lau
rence Kotlikoff, has become the most prominent. Generational accounting is
based on the fundamental notion of neoclassical dynamic analysis that fiscal
policy is restricted by the requirement to balance the intertemporal budget
of the public sector. This means that in the long term, the present value of
taxes paid by present and future generations must be sufficient to finance
the present value of projected government spending, including interest due
on the net liabilities of the public sector.
Defining the present value of taxes net of transfers paid by a representa
tive member of an age cohort over the remaining life cycle as a generational
account, the reference to the intertemporal financing constraint of the govern
ment can provide a number of closely related insights. Firstly, by linking the
cohort set of generational accounts to a long-term demographic projection,
one can analyze whether a set of tax and spending parameters selected by the
government is sustainable in the long term, i.e. consistent with an intertem
porally balanced public budget. Sustainable fiscal policy is generationally
VI Preface
balanced in the sense that it would allow to impose identical lifetime net tax
burdens on just-born and future generations. If continuation of current fiscal
policy violates against the intertemporal public budget constraint, consump
tion opportunities are redistributed between generations, because envisaged
tax and transfer levels cannot stay unchanged unless government non-transfer
spending is reduced. Generational accounting illustrates the value of the gov
ernment's unfunded spending commitments by the dimension of the required
policy revision.
Secondly, generational accounting indicates how fiscal burdens are spread
across generations. The method judges fiscal policy changes by the corre
sponding age-specific changes in lifetime net tax payments, which contributes
to the understanding of possible fiscal policy effects on cohort welfare, as well
as on capital formation and growth. Finally, generational accounting may help
in identifying policies that are intertemporally sustainable, or would move
public finances that are not toward a generationally more balanced outcome.
In the decade since its invention, generational accounting has had consid
erable success among analysts, as is illustrated by the large number of inter
national country studies currently before the public. While the basic ideas of
the generational accounting concept have not changed, practical experience
has lead to methodological and empirical sophistication. The principal aim
of this book is to survey the current theory and practice of generational ac
counting. It combines an in-depth and up-to-date introduction to the method
with a comprehensive empirical application.
The theoretical first part of the study, which runs from chapters 1 to 4,
addresses the various methodological issues involved in the construction of
generational accounts, so far scattered over the literature, from a unified per
spective. Special attention is paid to the shortcomings of the original residual
concept to construct the generational accounts of future generations, which
prompted the invention of the sustainability approach that has started to
replace the residual concept recently. It is shown how the sustainability ap
proach yields demographically unbiased estimates for the future generational
accounts. Furthermore the properties of the different indicators of intertem
poral fiscal imbalance provided by what seems to become the new method
ological standard of generational accounting are discussed.
The empirical part of the book uses the example of German public fi
nances for an application of the generational accounting method. The com
prehensive country study of chapters 5 to 7 allows to discuss in detail the
practical problems faced by analysts implementing generational accounting.
It is demonstrated how generational accounting can be used to assess the
long-term solvency of overall government and of isolated social insurance fi
nances, and to analyze both intertemporal and inter vivos redistribution of
resources between generations induced by reforms of fiscal policy.
In detail, the book is organized as follows. For an introduction, Chapter 1
gives a theoretical motivation of generational accounting. It is shown that
Preface VII
contemporaneous deficits provide ill-defined indicators in an intertemporal
context, provided agents are rational life cycle planners. The fiscal balance
rule is derived, which provides the fundamental reference of generationally
balanced policy used by generational accountants.
Generational accountants typically make a clear distinction between the
net tax burdens of current and future generations. While the accounts of
living generations are treated as given by current fiscal policy, the net tax
burdens faced by future generations are derived endogenously respecting the
requirement to balance the intertemporal public budget. The layout of chap
ters 2 to 4 follows this distinction. Chapter 2 presents the construction of
generational accounts under the conditions of current fiscal policy, and dis
cusses the implications of the underlying status quo perspective. Chapter 3
introduces the intertemporal budget constraint of the government and ex
plains how it is interpreted by generational accountants in order to draw a
link between the net tax burdens of present and future generations.
Chapter 4 explains how generational accountants illustrate fiscal imbal
ance by computing the changes in current fiscal policy required to balance
the intertemporal public budget. First the original residual approach to de
rive the tax burden of future generations and the corresponding conventional
indicator of generational redistribution - the relative change in lifetime tax
rates between just-born and future generations - are described. It is also
demonstrated that the concept of generational balance is independent from
aggregate redistribution between current and future generations. The ana
lytical shortcomings of the original approach to measure fiscal imbalance are
discussed in section 4.5. As an alternative, Section 4.6 presents the sustain
ability approach, which indicates the long-term solvency effects of current
fiscal policy by adding the correspondent present value of future primary
deficits to the initial net liabilities of the government. It is shown that the
resulting sustainability gap can provide a range of indicators translating the
crude intertemporal liabilities of the government into more illustrative mea
sures of generational redistribution.
In Chapter 5, the sustainability approach is applied to an analysis of the
intertemporal state of government finances in Germany. Besides implement
ing the new methodological concept, the material presented in this book is
distinguished from previous German generational accounting studies by us
ing a new, extended set of profiles allocating tax payments and government
spending between age groups. Furthermore the calculations make an effort
to incorporate cohort effects, by designing maturation of statutory Social Se
curity benefits and the long-term development of civil servant pensions.
The results of the generational accounting analysis indicate that status
quo of fiscal policy in Germany is unsustainable. Moreover, the degree of
generational redistribution due to current debt, demographic aging and the
unfunded costs of German unification, is possibly large. Chapters 6 and 7
deal with possible policy measures to improve the sustain ability of public fi-
"III I'reface
nances. In Chapter 6, the extent to which demographic rejuvenation through
immigration can alleviate intertemporal generational redistribution is ana
lyzed. It is shown that immigrants' contribution to the intertemporal public
budget is on average positive so that immigration is financially beneficial for
the incumbent population. However, although the fiscal gains from immigra
tion can be increased by active migration policy aiming at higher immigrant
quality, immigration even well above historic levels is unlikely sufficient to
restore sustainable public finances in Germany.
Chapter 7 analyzes the generational consequences of different strategies to
reform statutory pension insurance whose unfunded spending commitments
are a major source of fiscal imbalance in Germany, as construction of sep
arated generational accounts for the pension system reveals. The approach
taken to evaluate the impact of policy reform distinguishes between aspects
of intertemporal generational redistribution (between current and future gen
erations), measured by changes in the sustainability gap, and aspects of inter
vivos redistribution (between current generations), indicated by the deviation
of cohort reform burdens relative to an age-neutral reform that would tax all
individuals with a uniform fraction of their pre-reform wealth.
The results indicate that plausible reforms keeping to the institution of
pay-as-you-go financing, like a cut in pension replacement rates and a turn
to a broader revenue base using indirect taxation, are hardly sufficient to
assure long-term viability of the German pension system. In contrast, imple
mentation of a partially funded pension system, though suitable to reduce
intertemporal fiscal pressure, requires careful design to avoid sizeable redistri
bution between current generations. The book concludes in Chapter 8 with a
brief outline of possible topics for future research on generational accounting.
The present volume came into life as a doctoral thesis at the University
of Freiburg. This is the occasion to thank all colleagues and friends whose
help and encouragement was essential to accomplish my thesis. In particular,
lowe a lot to my supervisor Bernd Raffelhiischen who introduced me to the
world of generational accounting, and to Laurence Kotlikoff and Jan Walliser
who made it possible for me to learn its practice at Boston University. My
special thanks go to Karen Feist and Erik Liith for many hours of discussions,
not only about generational accounting. The former is also the co-author of
the paper on which much of Chapter 7 is based. Finally, I would like to thank
Daniel Besendorfer and Christoph Borgmann who rendered me far more than
technical support.
Bonn, April 2001 Holger Bonin
Contents
1. The Rationale for Generational Accounting. . . . . . . . . . . . . . . 1
1.1 Deficit Accounting and Generational Redistribution. . . . . . . . . 2
1.2 Generational Redistribution and the Economy.. . . .. . . .. . . . 5
1.2.1 An Overlapping Generations Model. . . . . . .. . . . . . . . .. 5
1.2.2 The Fiscal Balance Rule .......................... 8
2. Net Taxes of Living Generations........... ............... 13
2.1 Generational Accounts Defined ..................... , . . . .. 14
2.2 The Meaning of Net Taxes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 16
2.3 The Projection of Taxes and Transfers. .. . . .. . ... . . . . . . . .. 20
2.4 Accounting for Economic Growth.. . . . . .. . . . . . . .. . . . . .. . .. 25
2.5 General Equilibrium Considerations. . . . . . . . . . . . . . . . . . . . . .. 29
2.6 Breaking Down Generational Accounts. . . . . . . . . . . . . . . . . . .. 32
2.7 Ambiguities of Generational Accounts. . . . . . . . . . . . . . . . . . . .. 33
3. The Intertemporal Public Budget. . . . . . . . . . . . . . . . . . . . . . . .. 37
3.1 The Intertemporal Budget Constraint. . . . . . . . . . . . . . . . . . . .. 37
3.2 Determinants of Government Wealth. . . . . . . . . . . . . . . . . . . . .. 40
3.3 The No-Ponzi Game Condition .......................... , 44
3.4 The Mechanics of the Intertemporal Budget ............... 46
4. Assessing Fiscal Imbalance ............................... 49
4.1 The Residual Approach. . . . . . . . . . . . .. .. . . . . .. . . .. . . .. . .. 49
4.2 The Conventional Sustainability Index . . . . . . . . . . . . . . . . . . .. 54
4.3 Subgroup Accounts and Fiscal Sustainability . . . . . . . . . . . . . .. 58
4.4 Sustainability and Generational Redistribution. . . . . . . . . . . .. 61
4.5 Analytical Shortcomings of the Residual Approach. . . . . . . . .. 67
4.5.1 Ambiguous Policy Implications.. . . . . . . . . . . . . .. . . . .. 68
4.5.2 Sensitivity to the Concept of Net Taxes . . . . . . . . . . . .. 70
4.5.3 Fiscal Policy Indicators ........................... 72
4.6 The Sustainability Approach. . . . . . . . .. .. . . . . . . . . .. . . . . . .. 77
4.6.1 The Sustainability Gap ........................... 78
4.6.2 A Set of Sustainability Indicators. . . . . . . . . . . . . . . . . .. 81
X Contents
5. The Intertemporal State of German Public Finances. . . . .. 93
5.1 Introduction........................................... 93
5.2 The Demographic and Fiscal Scenarios. . . . . . . . . . . . . . . . . . .. 98
5.2.1 Demographic Scenarios.. . . . . . . . . . . . . . .. . . . . . . . . . .. 98
5.2.2 Relative Tax and Government Spending Profiles ...... 106
5.2.3 Aggregate Budget and Absolute Net Tax Payments ... 117
5.2.4 The Future Economic Environment ................. 125
5.3 Generational Redistribution in Germany .................. 132
5.3.1 Net Tax Burdens of Present Generations ............ 132
5.3.2 Intertemporal Fiscal Imbalance ..................... 142
5.3.3 Sensitivity Analysis ............................... 151
6. Immigration Policy and Fiscal Sustainability .............. 163
6.1 Immigration and Generational Accounting ................. 163
6.2 Migration Scenarios and Parameter Estimates .............. 166
6.3 The Fiscal Contribution of Immigrants . . . . . . . . . . . . . . . . . . .. 174
6.3.1 Generational Accounts by Resident Group ........... 174
6.3.2 Immigrant Cohort Deficits ......................... 179
6.3.3 The Sustainability Impacts of Immigration Policies ... 181
6.4 Conclusion ............................................ 187
7. Options for Social Security Reform . . . . . . . . . . . . . . . . . . . . . . . 189
7.1 Social Security and Fiscal Sustainability in Germany ........ 189
7.2 The Measurement of Generational Reform Burdens ......... 204
7.3 The Generational Impacts of Pension Reform .............. 208
7.3.1 Reforming the Pay-as-you-go Pension System ........ 209
7.3.2 Proposals for Partially Funded Pension Systems ...... 220
7.4 Conclusion ............................................ 233
8. Whither Generational Accounting? ....................... 235
A. Appendix: Proofs ......................................... 241
A.1 Separability of Generational Accounts ..................... 241
A.2 Invariance of the Relative Fiscal Imbalance ................ 242
A.3 Normal Reaction of Future Generational Accounts .......... 243
B. Appendix: The Demographic Model ...................... 245
C. Appendix: German Public Sector Budgets ................ 251
References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254
