INTERPRETING GENERATIONAL ACCOUNTS: THE PROBLEMS OF ASSESSING THE LONG-TERM CONSEQUENCES OF CURRENT FISCAL POLICY

Since government tax and spending policies affect people differently at various times in their lives, it is important to understand the impact of policy on successive generations throughout their lifetimes. That is the issue highlighted by the creation of 'Generational Accounts' and their direct message of is that if things continue as they are, future generations will bear a significant fiscal burden arising from current policies. In an article published in the latest Economic Journal, James Banks, Richard Disney and Zoe Smith discuss the relevance of the UK's Generational Accounts in informing policy and consider some of the problems in interpreting the accounts in an economic context.

Generational Accounts are primarily an accounting concept, the researchers note. The ultimate incidence of government policy depends on the behavioural response of households and firms to tax and spending policies and to the current and prospective economic situation. Hence, the overall impact of current or future policy may be very different from that measured by the accounting exercise, and the fiscal deficits faced by future generations will therefore change.

What is more, constructed Generational Accounts are very sensitive to forecasts and assumptions about the future, both in terms of what government policies will be, and in terms of what other economic variables will be. In particular, the accounts depend crucially on how you think the lifetime profiles for tax payments and benefit receipts will look for future generations in comparison to their predecessors.

In the UK context, the researchers show that:

Between 1978-97, the earnings of women and the employment status of men evolved very differently to that which would have been predicted by looking at data from 1978 only. The evidence suggests that using similar data from 1996, as is done in the current generational accounts for the UK, could lead to equivalent prediction errors over the next twenty years and beyond.
There are substantial differences within generations (for example by education group, by socio-economic group or by region) and the activities of government are inherently complex. Taken together, these two facts mean that the experiences of an 'average' individual in each generation are not always the appropriate object for policy analysis.
Focusing in particular on pension provision, which is a key area where life cycle incidence differs from a simple 'snapshot' of people of different ages, the UK earnings related public pension system (SERPS) redistributes from rich to poor as well as from one generation to the next. As the coverage of SERPS declines and increasing numbers of individuals are 'contracted-out' of state provision, a dominant policy issue is whether differences in the experience of people within the same generation are larger than differences across generations. Generational Accounts are not a suitable tool with which to examine the former.
The current policy stance that needs to be built into the accounts is constantly changing in the UK. Even in areas where the government's future commitments are clearly spelt out, such as pensions, these commitments are frequently changed. In other areas, such as health and education, the precise nature of future policy commitments over the time horizon necessary to compute the accounts is even more unclear.
Nevertheless, the researchers conclude, in forcing governments to think about the issues relating to the long-term consequences of current actions, especially in the context of an ageing population, Generational Accounts perform a useful task.

Note for Editors: 'What Can We Learn from Generational Accounts for the UK?' by James Banks, Richard Disney and Zoë Smith is published in the November 2000 issue of the Economic Journal. Banks and Smith are at the Institute for Fiscal Studies (IFS); Disney is Professor of Economics at the University of Nottingham. The study was funded by the Economic and Social Research Council (ESRC) through the Centre for the Microeconometric Analysis of Fiscal Policy at IFS.

For Further Information: contact James Banks or Zoë Smith on 020-7291-4800 (email: james.banks@ifs.org.uk or zoe.smith@ifs.org.uk); Richard Disney on 0115-951-5619 or 07850-926937 (email: richard.disney@nottingham.ac.uk); RES Media Consultant Romesh Vaitilingam on 0117-983-9770 or 07768-661095 (email: romesh@compuserve.com); or RES Media Assistant Niall Flynn on 020-7878-2919 (email: nflynn@cepr.org).