Generational Accounting in the UK

Generational Accounting measures the burden that current fiscal policies are likely to impose on future generations. It also identifies the set of policy reforms needed to achieve generational balance a situation in which future generations face the same lifetime net tax rates as current generations. This paper presents the first set of generational accounts for the United Kingdom and compares the UK generational imbalance with that in the U.S., Japan, Germany, France, Italy, and twelve other countries in Europe, Asia, and South America. The preparation of this study was greatly aided by various departments of the government, particularly H.M. Treasury. In providing this assistance, the government has initiated an extremely important process of doing long-term fiscal planning for the nation on a systematic and comprehensive basis. That said, the particular findings and assessments presented in this paper are those of its authors and not those of Her Majesty's Government. Compared with other leading industrial countries like the U.S., Japan, and Germany, the imbalance in U.K. generational policy is, under our assumed baseline policy, quite modest; i.e., there is not a major intergenerational problem. Moreover the imbalance would entirely disappear if labour productivity growth should turn out to be 1/4 per cent higher than our baseline assumption and government expenditures were not raised in line with the increase in the tax base. Should this not arise, some fiscal adjustment would be needed to achieve generational balance. This could take a variety of forms, such as the equivalent of either a £5 bn increase in tax revenue or a £5 bn reduction in government spending with proportionate tax increases or spending reductions thereafter. Our baseline policy scenario, which represents our sense of current government policy, is marked by very considerable fiscal restraint and prudence. In particular, it assumes a) the price indexation of a variety of social benefits, including the Basic and SERPS pension benefits, and b) a slowdown in the growth of health care spending per beneficiary. In our baseline, pension and other social benefits payments decline by 2050 from 13 percent to 9 percent of GDP. Social security contributions also decline under the baseline, lowering total taxes relative to GDP after 2050. Due to population aging, health care spending rises in the baseline from 6 percent to 8 percent of GDP between now and 2050 notwithstanding the assumed slower growth of benefits per beneficiary. Despite our fiscally responsible baseline, these assumptions still leave a generational imbalance. Without great restraint in future government purchases of goods and services or increases (relative to our baseline projection) over time in the net tax payments of current British adults, future British children could well face higher lifetime net tax rates (the present value of lifetime net taxes divided by the present value of lifetime labour earnings) than their parents now face. Under an alternative policy scenario, that we label Looser Policy, pension and other social benefits are wage indexed and growth in health care spending per beneficiary remains at current levels through 2030. Since current generations pay less in net taxes under this alternative scenario, there is a larger fiscal bill left for future generations to pay. In this case, achieving generational balance would require much stronger medicine, either a substantial sustained cut in non education and non health government spending or an equally substantial increase in income tax revenues and a corresponding increase in social security contributions.