Generational accounting – definition and meaning

Generational accounting or GA is a way of estimating prospective lifetime net tax burdens per capita. Specifically, it estimates what burdens different groups of people would face now and in future under current fiscal policies. It is a type of accounting that monitors a country’s current economic status based on current and previous years. It aims to determine how the economy will function in future, i.e., in the next generation gap.

Put simply; generational accounting is an accounting method that determines how current fiscal policies will affect future taxpayers. Fiscal policy refers to government spending and tax collection.

Generational accounting looks at current government tax programs and spending that benefit people today. It then tries to determine whether they will create an unfair tax burden on future generations.

According to the OECD Glossary of Statistical Terms:

“Generational accounts are used to assess the distributional implications of fiscal policy for different cohorts.”

“This is accomplished by estimating the present value of net tax payments (taxes paid less benefits received) over the lifetime of different generations under current tax and spending policies.”

Generational Accounting - definition and illustration
Generational accounting shows that most governments overspend and build up debts that will burden future taxpayers.

Generational accounting – why it matters

Governments’ adjust their fiscal policies and tax programs according to the needs of certain members of society.

However, when they spend more on a specific group of people, other generations often have to pay the costs. In fact, the other generations might have to pay without receiving the benefit and without representation.

For example, who pays for state pensions? In most countries, younger generations pay so that older adults can receive their state pension.

In the case of pensions, the ‘other’ (younger) generation exists and currently pays tax. However, we can extend this concept to future generations.

Let’s suppose the government significantly increased spending on programs that would provide short-term benefits today for some people.

The government might have to borrow so much that current taxpayers would not be able to repay the debt. In other words, during their tax-paying lifetimes, current payers would not be able to pay back the whole debt.

The government would, therefore, have to pass on the burden to the next generation of taxpayers.

This next generation of taxpayers, however, would be paying for something but receiving no benefits. Even though current government spending would affect them in future, they would have no say on that fiscal decision.

Generational accounting attempts to estimate how much this future burden would be for future generations. It also aims to eliminate policies that affect future generations negatively.

Generational accounting is forward-looking

Generational accounting is, therefore, forward-looking. People involved in generational accounting make estimates far into the future.

According to ClintonWhiteHouse4.archives.gov, we make these calculations in four steps:

1. We estimate the future net taxes people in all living generations pay over their remaining lifetimes.

2. Then, we estimate how much the government will spend in future on goods and services. We use present values for that calculation.

3. We calculate, using current values, how much tax future generations will pay. Specifically, how much they will pay so that the government can pay its bills as determined by steps 1 and 2.

There must also be enough income for the government to service its debt.

4. Finally, we estimate lifetime net tax rates for all generations. We base this on the lifetime labor incomes and net taxes of each generation.

Thus, we present generational accounts as either:

– The current value of net taxes of each living generation, plus future generations, as a whole.

or

– The lifetime net tax rate of each generation of living taxpayers, and of ‘future generations’ as a whole.

In most cases, generational accounting shows that current fiscal policy in most countries is unsustainable. In other words, governments are either spending too much or not taxing people enough.

Politicians care more about people’s voting intentions in the next elections than future generations’ tax burdens.

Video – What is generational accounting?

This Investor Trading Academy video explains what generational accounting is. It is a relatively new method for analyzing fiscal policy.

Specifically, it identifies the financial costs and benefits of government policies to current and future generations.