Is War Between Generations Inevitable?

Policy Reports | Social Security

No. 246
Friday, November 30, 2001
by Jagadeesh Gokhale and Laurence J. Kotlikoff

Policies to Achieve Generational Equity

As we've seen, the imbalance in U.S. generational policy is gigantic. To get a different sense of its size, consider alternative policies the government would have to undertake to equalize the net tax rates of newborns and future generations to achieve generational balance. The first column in Table III lists five such policies. The first policy involves raising federal income taxes. To be precise, suppose the government were to eliminate its generational imbalance by immediately and permanently raising the federal corporate and personal income tax by a given percentage. (Note that the revenue from this tax increase would have to be invested in interest-earning assets that could be sold in future years to pay benefits and that these assets could be held in individual private accounts.) How large would the tax hike have to be? The answer is 68 percent! Hence, based on the government's fiscal language, the current surplus is far too small compared to what is needed to achieve generational equity. An alternative to raising just federal income taxes is to raise all federal, state and local taxes. In this case, an across-the-board tax hike of 26 percent could deliver generational equity.

An alternative to raising taxes is to cut spending, including transfer payments or government purchases of good and services. Cutting all Social Security, Medicare, Medicaid, food stamps, unemployment insurance benefits, welfare benefits, housing support and other transfer payments by 44 percent is one way to eliminate the generational imbalance. Two final options considered in the table are immediately and permanently cutting all government purchases by 39 percent or (and this is easy) cutting just federal purchases by 117 percent.

"Our government is assuming away our fiscal problems rather than confronting and correcting them."

Cutting all government purchases to achieve generational balance would leave future generations paying in net taxes the same 18 percent share of lifetime earnings as current newborns are expected (under current policy) to pay. In contrast, either raising taxes or cutting transfer payments would mean higher lifetime net tax rates for those now alive. As Table III indicates, these alternative policies would leave newborns and all future generations paying roughly 26 cents out of every dollar earned in net taxes. This net tax rate is over 8 cents more per dollar earned than newborns are now forced to pay. The payoff from having newborns as well as everyone else who is currently alive pay more in net taxes is a reduction in the net tax rate facing future generations of close to 10 cents per dollar earned.

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