[Laurence Kotlikoff] Generational balance, not budget balance

Debt crises make great drama. The big shots attend meetings, look terribly worried, then stomp out, accusing each other of bad faith. Finally, at the witching hour, they reach agreement and tell us all is fine, for now.

The tough thing is sorting out what’s really going on. In the U.S. case, the answer is: not much. We need tax increases and spending reductions far beyond what’s being negotiated. Cutting the deficit by $1 trillion to $2 trillion over 10 years sounds like a big deal, but not when our unfunded Medicare and Social Security liabilities, by my calculations, are growing by more than $4 trillion a year.

Whatever you think of the House Republicans, they understand that our country is broke. But they have no idea how broke. They are pushing hard for a balanced-budget amendment. What we need is not budget balance, but generational balance.

If we are going to amend the Constitution, let’s prohibit today’s adults from leaving tomorrow’s generations with higher lifetime net tax rates. A Generational Balance Amendment would specify that, absent prolonged states of emergency, each generation would pay the same share of its lifetime labor earnings in taxes, net of benefits received.

Stabilizing lifetime net tax rates isn’t just a matter of fairness. It’s critical to our country’s long-term economic survival.

If we keep raising successive generations’ lifetime net tax rates, we will eventually be hitting up our progeny for every penny they earn, leaving them unable to consume or save. If they can’t save, they can’t invest, which means they won’t be able to maintain ― let alone increase ― the economy’s stock of capital needed to produce goods and services.

The U.S., incidentally, has a national savings rate of zero and a domestic net investment rate of only 4 percent of national income. Both are postwar lows.

Memo to House Republicans: Budget balance doesn’t imply generational balance.

Consider Taxdonia, a country with zero debt. Taxdonia has never borrowed a dime and never will. Its constitution forbids borrowing. But Taxdonia deserves its name, actually, its new name. Its old name was Lovelandia.

In Taxdonia, every young generation is hit with a higher and higher tax rate, historically called the Love Tax. The proceeds of the Love Tax are immediately handed to the contemporaneous old generation as transfer payments ― much as our Social Security taxes are transferred directly to current retirees. So taxes always equal spending, and the deficit is always zero.

Children in Taxdonia are taught to honor and pay the Love Tax. Their parents’ common refrain is this: “We paid our Love Tax when young. We honored our commitment to our parents. You honor yours.”

Historically, the elderly set the Love Tax. They were the only ones who bothered to vote. Each set of oldsters set the tax rate higher to ensure a very healthy return on the taxes they paid when young.

But times have changed. Today’s young aren’t feeling the love. They refuse to pay the sky-high Love Tax. They know if they pay, they will be left in the lurch. They won’t be able to raise the tax rate on their own kids because their children won’t be able or willing to pay.

Generational verbal warfare has broken out. Worse yet, the country’s single political party has split into two. One party, the Oldsters, wants to raise spending and taxes. The other, the Youngsters, wants to cut spending and taxes. Each side calls the other extremists and claims it is being cheated.

Economists in Taxdonia think both are nuts. “What’s wrong? We’ve got budget balance. No debt, no deficit, relax. And stop calling our country Taxdonia. This is Lovelandia! And if you must disagree, disagree agreeably.”

The Oldsters and Youngsters agree, disagreeably, on one thing: They both want to string up economists. They realize that their country, with the complicity of these fiscal experts, has incurred a huge, off-the-books liability to the oldsters ― a terrible debt, foisted on the young in a country where debt is verboten.

The Youngsters have hired some young economists to use generational accounting to examine the lifetime net tax treatment of different cohorts. Their report isn’t pretty. It shows that past cohorts received, on a lifetime basis, far more than they put in and that the current young are being asked to participate in a Ponzi scheme.

They also learn that measuring debt is a meaningless labeling game since the government can take from the young with the words “taxes,” rather than “borrowing,” and incur debts via promises of future repayment that are tied to the “taxes.”

The latest news: Taxdonia’s central bank, Love Bank, has assured the current young that if their kids can’t pay them their desired old-age benefits, the central bank will keep them whole. It will print money, which will be used to pay their claims.

The young are scratching their heads. “Won’t this lead to inflation and water down the real value of the money we already hold? Isn’t this just another way of taxing us?”

Love Bank’s reply: “You’re young and financially inexperienced. Go back to work, pay your taxes, and all will be fine.”

But the young aren’t buying it. They are shipping off to a new country, called Blessingden. When they retire, they plan to pass a balanced-budget amendment and levy the Bless You Tax. 

By Laurence Kotlikoff

Laurence J. Kotlikoff, a professor of economics at Boston University, is a Bloomberg View columnist. The opinions expressed are his own. ― Ed.

(Bloomberg)