Question

As Canadians consider how best to use current and future budget surpluses, they should remember that the retirement of the huge cohorts of baby boomers will greatly change the pressures on government. Starting about 20 years from now, the public purse will have to accommodate a sharp rise in the proportion of the population collecting public pensions, a concomitant falloff in tax receipts, and a large increase in the need for health care. Policymakers do not always look so far ahead, but the fiscal decisions they make now will greatly affect the country’s economic health in 2020 and beyond. A tool for examining the long-range implications of alternative fiscal policies is generational accounting, by which analysts examine long-run fiscal feasibility, given demographic projections and the requirement that government be able to eventually pay its obligations from accrued debt. The same technique permits examination of the tax burden by age cohorts. Such analysis suggests that Canada is now on a fiscal track that can be sustained if budget surpluses are used to reduce the debt. Using them to increase spending or cut taxes will require government to tighten fiscal policy down the road, which would have the additional unfortunate result of throwing increased tax burdens on Canadians who are now very young or yet unborn.

Read Oreopoulos and Vaillancourt (1998) to answer the following:

a) (6 points) What question is generational accounting used to answer?

b) (6 points) What age range pays positive net taxes (taxes minus transfers) in 1995?

c) (6 points) What is the ability-to-pay principle? How can it inform policy in the context of demographic transition?

Answer 1

A. What question is generational accounting used to answe

1The fiscal impact of the aging of the baby boomers will be large but will not occur until after 2018. Not anticipating this impact will lead to ill-informed policy recommendations that may have unintended effects on various age groups.

2. Any policy change that benefits one group will hinder others. There is no objective way to decide on an appropriate steady state of taxes and transfers among different age groups

3.the consolidated government budget is on a sustainable track, but only if decisionmakers use projected budget surpluses to pay down the debt.

4.The ratio of debt to gross domestic product (GDP) will decline substantially for some years, but after 2018 pressures from rising expenditures for the elderly will slow this trend and possibly even reverse it

5.lifetime net taxes as a percentage of lifetime income have been rising for successive generations.

6. country’s long-run fiscal policy is feasible

b What age range pays positive net taxes?

1 the Age range 20-39 will give the postive net tax in 1995

2. A policy that assumes government will increase spending to keep its budget roughly in balance cannot be sustained without imposing substantially higher net tax rates in the future.

3 For individuals born in 1995, net lifetime tax rates drop to less than 30 percent.

4. Real per capita amounts for elder care do not grow over the 1996–2010 period; thereafter, they rise at 0.5 percent.

5. Net tax rates for newborns in 1995 average almost 35 percent of lifetime income, while future age groups have to face rates of 33 percent for a sustainable policy.

6. Someone born in 1995 can expect to pay 38 percent. In other words, younger generations are paying a higher portion of their lifetime earnings in net taxes than generations born earlier.

C. Ability to pay primcipal means redistribution is desirable if it goes from those who have more to those who have less.

1.ability-to-pay principle, one might consider budget deficits appropriate because they transfer a portion of a future cohort’s higher after-tax income to an earlier-born cohort with lower after-tax income.

2.The larger the future tax bill, the more incentive people will have to find ways to avoid it.

3.Another reason for restraining net lifetime tax rates from further growth is that these rates were never meant to be so high.

4.There are essentially three choices: to use a sizable portion of the surplus to pay down accumulated debt, to increase spending, or to reduce taxes.

5.The use of surpluses for tax reduction is not, however, implausible. Indeed, the original PEAP projection used cuts in the federal personal income tax, instead of expenditure increases

6.The main difference between the spending-hike and debt-reduction scenarios in these years is on the spending side. The former assumes expenditure increases in social security health care, and government purchases to keep federal budget surpluses in balance.