Generational Accounting

Generational Accounting

Kranacher, Mary-Jo

An Alternative Method of Fiscal Accountability

Laurence J. Kotiikoff, a professor of economics at Boston University and a research associate at the National Bureau of Economic Research, discussed the concept of “generational accounting” at the International Federation of Accountants’ (IFAC) World Accountancy Forum in New York City last month. What follows is taken from his keynote address.

“The goals of generational accounting are to understand whether fiscal policy is sustainable, and if it’s not, how much more today’s and tomorrow’s children will have to pay to achieve sustainability,” Kotlikoff said in his presentation. “Generational accounting also seeks to understand generational incidence-how changes in policy affect different generations.”

This method of accounting-which can be presented on a cohort-specific basis (i.e., focused on a certain age or other demographic group) or in a condensed form as the present value of a fiscal gap-has been used in dozens of countries by treasury departments, central banks, the International Monetary Fund (IMF), and the World Bank.

According to Kotiikoff, a recent fiscalgap accounting analysis of the United States “suggests that upwards of $70 trillion separates projected future federal spending from projected future federal receipts when measured in present value. This fiscal gap is enormous and indicates that our nation is, quite literally, facing bankruptcy.”

Kotlikoff recognizes that bankruptcy is a strong term: “In a business context it means that future earnings don’t cover costs. It also means defaulting on creditors. In a government context, bankruptcy means future receipts don’t cover future expenditures. It also means defaulting on creditors-all those expecting to receive government healthcare, pension, welfare, and other benefits, as well as all those expecting to be employed by the government. Government bankruptcy also means jacking up tax rates and printing money to ‘pay’ for what the government spends.”

David Walker, U.S. Comptroller General and head of the Government Accountability Office (GAO), shares Kotlikoff’s concern that the federal government may be heading down a fiscally imprudent course. Walker has undertaken a “Fiscal Wake-Up Tour” to educate the American public that saving our future requires tough economic choices today. The national savings rate, close to 13% in 1960, is now less than 3%. In Kotlikoff’s analysis, this low savings rate is what has led to our current trade imbalance as well as the dollar’s recent swoon against other major currencies.

A nation that saves too little will, by direct consequence, consume too much. “As a share of national income,” Kotlikoff said, “the federal government is consuming at roughly twice the rate it did a decade ago. But the main explanation for the decline in U.S. saving is not Uncle Sam’s spending, it’s the spending-the consumption-of households. And among households, the group whose consumption has been rising most rapidly is the elderly.” Since 1960, average annual consumption per elderly U.S. citizen has roughly doubled relative to the average annual consumption for younger Americans.

In large part, the U.S. government is footing the bill for this increased consumption by elderly Americans. Every year that the federal government allows Medicare and Medicaid benefits, the vast majority of which go to the elderly, to grow faster than the economy, the result is increased consumption by the elderly. Kotlikoff points out that this has been happening for virtually each of the past 60 years. In addition, he says, Uncle Sam has been effectively cutting taxes on the elderly, which has also permitted them to consume significantly more.

Generational accounting has its limitations, but it focuses our attention on future fiscal problems and provides a framework for understanding the issues involved. Seen through the lens of generational accounting, we have a picture of Uncle Sam redistributing resources from young savers to old spenders. When framed this way, we can have a national discussion about how federal taxation and spending policies affect different cohorts and what our national priorities should be.

Critics of generational accounting properly note that the future is unknowable. And it’s true that the greatest limitation of generational accounting lies in the difficulty of predicting the present value of government revenues and obligations, which are dependent upon the business cycle and spending priorities of future legislators. Kotlikoff does not, however, believe that traditional short-term fiscal budgeting-deficit accounting-is the answer, because of the inherent problem of how we arbitrarily label government receipts and payments.

Kotlikoff said that his hope rests with accountants in this matter. I agree with his statement and with much of Kotlikoff’s incisive analysis. It’s up to CPAs to “take the lead in endorsing meaningful fiscal measurement and discarding senseless tabulation.” Time is of the essence. According to Kotlikoffs estimates, our country’s fiscal gap is growing by more than $2 trillion per year. We owe it to future generations to address the problem now, so changes will have the maximum positive impact.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA, CFE

Editor-in-Chief

mkranacher@nysscpa.org

Copyright New York State Society of Certified Public Accountants Jan 2008

Provided by ProQuest Information and Learning Company. All rights Reserved