hypothetical payment that must be imposed on future generations as a whole to deliver ex
post budget balance.19
Imposing existing fiscal policies on current newborns throughout their lifetimes yields
their generational account. Its ratio to the present value of their lifetime earnings, where
earnings are projected using an assumed rate of productivity growth, yields a lifetime net
tax rate for current newborns. Imposing the (hypothetical) residual unfunded obligation,
PV_Fh, exclusively on future generations (assuming an equal productivity-growth-
adjusted distribution per capita of the total hypothetical burden across all future
generations) implies a hypothetical lifetime net tax rate on those generations - again
under the assumed rate of labor productivity growth and labor earnings.
Current fiscal policy is considered to be balanced and sustainable if, given (i) government
spending commitment, PV_Pc, (ii) government net financial assets, NWc, and (iii) lifetime
net tax rates estimated under current fiscal policies for today’s newborns (based on their
net payments under current policies), the hypothetical total payment from future
generations, PV_Fh (that balances the government’s intertemporal budget constraint
specified in equation 3.1) implies the same lifetime net tax rate for future generations.20
Fiscal and Generational Imbalances
Fiscal and generational imbalance measures are an offshoot of generational accounting.
They are designed to parsimoniously capture the most important elements of generational
accounting with an eye toward simplicity and policy relevance. The fiscal imbalance
measure is the present value of government financial shortfalls projected to occur
throughout the future under the assumption that current policies remain unchanged.
However, unlike generational accounting’s distinction between the fiscal treatment of
living and future generations, the FI measure projects all (including future) generations’
net payments under current policies. In other words, it views the government’s
intertemporal budget constraint from a “current policy” (ex ante) perspective. Although
the government’s budget (equation (3.1)) would remain unbalanced under such a fiscal
treatment of future generations, that is precisely the point of the calculation - to measure
the size of the total imbalance built into current fiscal policies.
The FI measure equals the present value of prospective lifetime net payments (taxes
minus transfers) to living and future generations plus the present value of projected
government purchases and minus the government’s current net financial assets. Thus,
FI = PV_Pc - PV_Lc - PV_Fc - NWc (3.2)
Because it is the government’s budget choices that are being evaluated, present values are
calculated using the government’s opportunity cost of funds - the interest rate expected to
prevail on the longest-term government bonds.
FI measures can also be calculated for government subprograms that exclusively provide
transfers to private individuals (old-age retirement benefits, for example) and are financed
out of dedicated revenues (a payroll tax, for example). The revenues and expenditures of
such programs are attributable to particular generations.
19
20
Present values are calculated by using an interest rate reflecting private agents’ (average) opportunity
cost of investment.
Technical details about generational accounting methods are available in Gokhale et al. (1997).
64