MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting 6

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Government assets do not include the value of the government’s existing infrastructure, such as parks. Including such assets would have no impact on the estimated fiscal burden facing future generations because including these assets would require adding to the projected flow of government purchases an offsetting flow of imputed rent on the government’s existing infrastructure.

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting 5

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Assumptions Underlying Generational Account Calculations

To produce generational accounts, we require projections of population, taxes, transfers, and government expenditures, an initial value of government net debt, and a discount rate. We consider the impact of total, as opposed to just federal, government. Typically, we assume that government purchases grow at the same rate as GDP, although in some cases we break these purchases down into age-specific components and assume that each component remains constant per member of the relevant population, adjusted for the overall growth of GDP per capita. This causes different components of government purchases to grow more or less rapidly than GDP according to whether the relevant population grows or shrinks as a share of the overall population.

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting 4

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Generational Accounting versus Deficit Accounting

A final and critically important point to make about generational accounting is that the size of the fiscal burden confronting future generations (the second summation on the left-hand side of (1)), the generational accounts of newborn generations, and the imbalance in generational policy (measured as the difference in the accounts of newborns and the growth-adjusted accounts of future generations) are all invariant to the government’s fiscal labeling – how it describes its receipts and payments.

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting 3

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Assessing the Fiscal Burden Facing Future Generations

Given the right-hand-side of equation (1) and the first term on the left-hand-side of equation (1), we determine, as a residual, the value of the second term on the left-hand side of equation (1) — the collective payment, measured as a time-t present value, required of future generations. Based on this amount, we determine the average present value lifetime net tax payment of each member of each future generation under the assumption that the average lifetime tax payment of successive generations rises at the economy’s rate of productivity growth. This makes the lifetime payment a constant share of lifetime income. Controlling for this growth adjustment, the lifetime net tax payments of future generations are directly comparable with those of current newborns, since the generational accounts of both newborns and future generations take into account net tax payments over these generations’ entire lifetimes and are discounted back to their respective years of birth.

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting 2

The generational account Ntik is defined by:
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where K=max(t,k). In expression (2), T5tk stands for the projected average net tax payment to the government made in year s by a member of the generation bom in year k. The term Ps,k stands for the number of surviving members of the cohort in year s who were bom in year k. For generations bom prior to year t, the summation begins in year t and is discounted to year t. For generations bom in year k>t, the summation begins in year к and is discounted to that year.

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: The Method of Generational Accounting

The Method of Generational Accounting

This section draws heavily on Auerbach and Kotlikoff (1999) in summarizing the standard method of generational accounting. This methodology was first developed in Auerbach, Gokhale and Kotlikoff (1991).

Generational accounting is based on the government’s intertemporal budget constraint, which given in equation (1). This constraint requires that the remaining lifetime net tax payments of current generations and the lifetime net tax payments of future generations suffice, in present value, to cover the government’s bills – the present value of its future spending on goods and services as well as its official net indebtedness.
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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: Introduction 2

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Some of the revisions in the government’s fiscal forecasts are quite remarkable. Take Medicare expenditures between 2030 and 2040. Compared with their 1995 projections, the Health Care Financing Administration (HCFA) is now projecting these expenditures to be 2 to 3 percentage points smaller. To put this revised projection in perspective, Medicare expenditures are now roughly 2.5 percent of GDP. Hence, the new HCFA forecast eliminates future Medicare expenditures in the 2030s, which, when measured relative to the size of the economy, are as large as the entire current Medicare program!

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MEDICARE FROM THE PERSPECTIVE OF GENERATIONAL ACCOUNTING: Introduction

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Introduction

Notwithstanding all the attention being paid to our nation’s current budget surplus, the U.S. fiscal position is grave. Unless policies are changed and changed soon, future American generations can expect to pay 50 cents of every dollar they earn to local, state, and federal governments in net taxes (taxes paid net of transfer payments received). This 50 percent lifetime net tax rate is roughly 70 percent larger than the rate current workers are slated to pay over their lifetimes.

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