Figure 19. Two alternative ways of achieving generational balance (percentage increases required)
Source: Kotlikoff and Raffelheuschen, ‘Generational Accounting’. The two different policies are considered under a definition of government expenditure that treats education as a transfer payment rather than a government purchase. It should also be noted that the figures are for all levels of government. For an earlier version which provides more methodological detail see Kotlikoff and Leibfritz, ‘International Comparison of Generational Accounts’.
The figure shows that seven countries would need to increase all taxes by more than 10 per cent to achieve generational balance. In the cases of Austria and Finland the necessary increase is not far short of 20 per cent. If Germany were to rely exclusively on across-the-board tax hikes, then tax rates at all levels of government (federal, regional and local) and of all types (value added, payroll, corporate income, personal income, excise, sales, property, estate, and gift) would have to rise overnight by over 9 per cent. The equivalent figure for the United States is nearly 11 per cent; for Japan it is 16 per cent. If countries relied solely on income tax increases, then Austria, Finland and France would each have to raise their income tax rates by over 50 per cent.73 A number of countries could achieve generational balance with relatively modest tax increases of under 5 per cent: Australia, Belgium, Canada, Denmark, Portugal and Britain. Only Ireland and New Zealand would not have to raise taxes to achieve generational balance. Indeed, Ireland could cut its income tax rates by about 5 per cent before needing to worry about burdening future generations.
It goes without saying that tax increases are seldom politically popular. What about the alternative, namely a reduction in government transfers (the source, after all, of much of the recent growth in spending and borrowing)? Figure 19 shows that five of the nineteen countries would need to cut all government transfers by more than a fifth to achieve generational balance: Austria, Finland, Japan, the Netherlands and the United States. Worst off is Japan, which would have to cut transfers by over 25 per cent. Best off once again is Ireland, which could legitimately increase transfers by 4 per cent. New Zealand too could afford a slight increase.
These figures are sobering. They show that only two or three of the world’s developed economies have generationally balanced fiscal policies. The two biggest economies in the world – the United States and Japan – are among the countries furthest from equilibrium. Among other things, this exposes as illusory the budget surpluses realized and blithely projected in the United States since 1998. While presidential candidates debated how to spend these supposed surpluses, the generational accounts of the United States were among the worst in the world: worse, according to the measures used here, than those of Italy.74 Only if official projections of growth prove to be too pessimistic will the American position improve. Otherwise there will almost certainly have to be reform of the state pension system – revealingly described by Vice-President Gore as ‘a solemn compact between the generations’.
It is also striking that generational accounting produces a very different ranking of European fiscal weakness from the conventional measures of debts and deficits as ratios of GDP specified in both the Maastricht Treaty and the 1997 Stability and Growth Pact. On the basis of the debt/GDP ratio (which the Maastricht Treaty vainly stipulated should not exceed 60 per cent in any country wishing to participate in Economic and Monetary Union), Belgium, Italy and the Netherlands have the most serious fiscal problems.75 But in terms of generational balance, it is Austria, Finland, Spain and Sweden that are in trouble. Among developed economies, Britain and her former colonies – Australia, Canada, Ireland and New Zealand – are the countries with least to worry about. Indeed, Britain’s generational imbalance would entirely disappear if labour productivity were to be 0.25 per cent higher than projected, and if government expenditures were not raised in line with the increase in the tax base. On the other hand, if there is no such improvement in productivity and no fiscal tightening, the British position is likely to deteriorate. If the government wished to achieve generational balance solely by increasing income tax – an unlikely scenario, admittedly – then there should have been an immediate and permanent 9.5 per cent income tax hike in 1999. But by 2004 the increase would need to be 11 per cent and 15 per cent ten years after that.76
Table 10. Dependency ratios, actual and projected, 1900–2050
Source: Economist, World in Figures, p. 17; McMorrow and Roeger, ‘Economic Consequences of Ageing Populations’.
What explains these differences between countries? The answer is partly differences in fiscal policy, but mainly differences in actual and future demographic structure. Table 10 gives figures for dependency ratios, meaning the ratio of the population under and above working age (under 15 or over 64) to the population aged from 15 to 65, or (in the last two columns) to the active employed population. These figures show that, contrary to some more alarmist predictions, dependency ratios today are lower in most major economies (except France) than they were a hundred years ago. The difference is that in 1900 most dependants were children: on average a third of the population of these countries was under 15. Today that figure is just 17 per cent, while the proportion of the population aged 65 or over has risen from an average of 5.6 per cent to 16 per cent. What makes the biggest difference to the various generational accounts is the extent to which this ageing of the population is projected to increase in the next fifty years. In all six cases in Table 10, the expected ‘greying’ of the population will increase the dependency ratios to unprecedented heights by the year 2050. If the ‘effective economic dependency’ ratio is used, the dependent population will actually outnumber the working population in Japan, Germany, France and Italy.77 In those countries, more than a fifth of the population will be aged 65 or over in just ten years’ time. The German position is worsened by the extent of early retirement, which in the 1970s and 1980s was naïvely believed to be a way of increasing job opportunities for the young. Only 39 per cent of Germans aged between 55 and 64 now work.78 By comparison, a country like Thailand is blissfully young: the proportion of the population aged over 64 will be just 10 per cent by 2010.79 This, along with distinctive features of the tax system, explains why the generational imbalance in Thailand is positive – in other words, to the advantage of future generations.80
What these figures tell us is that a new kind of distributional conflict is taking the place of the traditional class-based model that dominated the twentieth century. In a sense, the welfare state was designed to end the old struggles between rentiers, entrepreneurs and workers, and largely succeeded in doing so. But the price of success was the creation of a system of universal entitlements that has become unaffordable. If the generational accounts are out of kilter – as they are in most of Europe, Japan and the United States – substantial future cuts in expenditure or increases in taxation are inevitable. In one scenario, the next generation ends up paying in higher taxes for the present generation’s pensions and other transfers, including interest on bonds (a large part of their private pensions). Alternatively, entitlements to the elderly end up being reduced – for example by a cut in state pensions, a default on government bonds, or a big and unanticipated increase in inflation – and the bill is handed back to the generation that incurred it years before.
Redistribution between generations is not new, of course. Large public debts and unfunded public pensions have always meant a transfer from the young and unborn to the old, just as public spending on education transfers resources from the old to the young.81 However, the current scale of generational imbalances is probably unprecedented. The old are substantial net beneficiaries of most ‘first world’ fiscal systems, not only because of pensions but because they are the biggest consumers of subsidized health care; they are therefore the obvious targets for policies aimed at reducing spending. But, unlike the young and unborn, they also have votes. The question this raises is how far objective conflicts of interest b
etween generations could become subjective political conflicts.
In the past, generations tended to quarrel more about politics, art and hair-length than about the redistributive effects of fiscal policy. Bazarov has many grievances in Turgenev’s Father and Sons, but the cost of supporting the older generation is not among them. Even today, generational conflict over finance is limited by the fact that those who may be most disadvantaged by current policy are not enfranchised: in the words of the Italian economist Guido Tabellini, ‘If the young could vote on the decision to issue debt, they would all oppose it.’82 Nevertheless, it seems plausible that debates over pension reform could make generational conflicts more financially explicit in the future.
A good illustration of the changing importance of age in politics is provided by the case of Britain since 1979. The Thatcher government inherited a dual system of state pensions: the long-established basic pension, which was increased each year in line with the higher of two indices: the retail price index and the average earnings index. In addition, there was a new State Earnings Related Pension introduced in 1978.83 In its first budget, the new government amended the rule for increasing the basic pension so that it would rise in line with the retail price index only, breaking the link with average earnings. Six years later the additional pension was also made less generous. The short-run fiscal saving involved was substantial, since the growth of earnings was substantially higher than inflation after 1980 (around 180 per cent to 1995, compared with 120 per cent). The long-run saving was greater still (the UK’s unfunded public pension liability is a great deal smaller than those of most continental governments: as little as 5 per cent for the period to 2050, compared with 70 per cent for Italy, 105 per cent for France and 110 per cent for Germany).84 In the words of Nigel Lawson, Chancellor between 1983 and 1989, ‘this politically brave decision … was a critical part of regaining control of public expenditure’.85 No doubt; but it also represented a substantial inter-generational transfer, to the detriment of those in or approaching retirement. The surprising thing is the slowness and mildness with which the losers reacted.
Age has not been seen as a decisive political cleavage in British politics. It is, however, striking that the young tend disproportionately to vote Labour, and the old to vote Conservative. The reduction of the minimum voting age from 21 to 18, according to Britain’s leading psephologist, ‘probably cut [the Conservative] majority from 60 to 30 in 1970 and made the decisive difference in the two 1974 elections’ won by Labour.86 And it was those aged under 30 who defected from the Conservatives to Labour in the greatest numbers in 1997.87 The old, by comparison, have remained remarkably loyal to the Conservatives despite the Thatcherite cuts in state pensions. In 1992 nearly half of voters over 64 voted Tory, 4 per cent more than the figure for the electorate as a whole. The percentage fell by just 3 per cent in 1997, compared with a national decline in the Conservative vote from 43 per cent to 31 per cent. Pensioners were in fact the only age group that gave the Tories more support than Labour.88 It is nevertheless significant that one of the principal campaign issues of the 1997 election was the Labour claim that Social Security Secretary Peter Lilley was contemplating the complete abolition of the state pension. According to the Conservatives’ own polls and ‘focus groups’, the Labour attack on Lilley’s reform proposals was followed by a sharp dip in Tory support among the over-65s, though aggressive rebuttals may have reversed this effect before polling day.89 Gore tried the same tactic against Bush in 2000. It would be very remarkable if such ‘playing on the fears of the elderly’ did not become an increasingly important theme of elections in other countries in the coming decades. In the words of a European Commission paper published in November 1999:
With an increasing proportion of national resources being transferred to the retired population, it is difficult … to speculate as to the extent which these changes in the distribution of societies [sic] resources, between the employed and dependent populations, will be capable of being resolved without major crises and intergenerational conflicts…. The economic impact of the ‘greying’ of the population over the next 50 years will … become unbearable for the Community in the event that its labour markets, and by implication its tax and social security systems, remain in their present state …90
AN UNWELCOME ANSWER
An obvious solution to the problem of ‘greying’ populations – though one not mentioned in the EC report cited above – is, of course, increased immigration, since immigrants are generally of working age, with above-average economic motivation. This is happening. In the early 1990s around 80 million people were estimated to be living outside the country of their birth; by the year 2000 that figure had risen to 120 million, around 2 per cent of the world’s total population.91 The huge influx of new migrants to the United States since the 1980s – around 850,000 a year on average – may well represent the best hope for the American social security system, provided the newcomers are quickly integrated into the tax system.92 Germany too is likely to benefit (as it did in the 1950s) from large-scale immigration: there are now 7.3 million foreigners resident in the country, around 9 per cent of the population.93
Unfortunately, a number of those countries most in need of immigrants are among those least inclined to admit them. The Austrian fiscal system suffers from one of the most serious generational imbalances in Europe. Yet nowhere have anti-immigration policies attracted more popular support, to the extent that the openly xenophobic Freedom Party entered government in 2000. Moreover, anti-immigration laws have a perverse effect: because most borders are in practice impossible to seal, they create a large category of illegal immigrants who are outside the tax system, and therefore make no direct contribution to the fiscal system. In the European Union, for example, there are an estimated 3 million illegal immigrants; in the United States roughly 2 million out of 7 million Mexican-born residents are there illegally. The total number of illegal immigrants in the US is estimated to be around 6 million.94 If the past is any guide, however, there is little reason to expect these semi-enforceable laws to be relaxed in the near future. It was precisely at the zenith of the last age of globalization that the United States and other labour-importing states began to restrict immigration, beginning with the exclusion of migrants from China and Japan before the First World War.95
The enactment of anti-immigration legislation is a good example of the way a democratic preference can run counter to a society’s long-run economic interests. (As a rule, immigration tends to erode the real wages of unskilled workers, but it benefits the host economy as a whole.) In the same way, most proponents of generational accounting are pessimistic about the chances that their recommendations – whether for tax increases or spending cuts – will be heeded. Politicians, it tends to be assumed, are incapable of looking further than the next election. They are certainly not likely to favour policies that are in the interests of voters as yet unborn if they involve sacrifices by voters today.
To pursue this issue further, the next chapter moves from the realm of distributional conflicts into the arena of politics. Cobbett’s belief was, as we have seen, that democratization would lead to an improvement in fiscal policy: the widening of the franchise would put a stop to the reign of the ‘tax eaters’ by forcing politicians to reduce (by some unspecified means) the ‘blessed Debt’. In practice, however, new debts have piled up – and the ranks of the tax eaters have swollen not shrunk. Why?
8
The Myth of the Feelgood Factor
Are you better off now than you were four years ago?
RONALD REAGAN, 1980
It has become an axiom of modern politics that there is a causal relationship between economic activity and government popularity: to be precise, that the performance of the economy has a direct bearing on the electoral success of an incumbent government. A good illustration of this new economic determinism was the widespread explanation of the failure to impeach President Clinton for perjury and the obstruction of justice in
connection with his numerous sexual misdemeanours. By February 1999 a majority of Americans believed Clinton was guilty of the charges against him, but only a small minority wanted him to resign as president. According to Senator Robert Byrd – and many other commentators – the explanation was simple: ‘No president will ever be removed … when the economy is at record highs. People are voting with their wallets in answering the polls.’1
This, the Financial Times’s correspondent suggested, was the difference between Clinton and Richard Nixon, who was forced out of the White House in August 1974. In the year and a half leading up to Nixon’s fall, his ‘approval rating fell from about 60 per cent … to less than 30 per cent…. Over that period, output suffered its most severe slowdown since the Second World War, unemployment rose by almost 1 million and the inflation rate doubled … On Wall Street the stock market fell by a third.’ But Clinton’s approval rating rose from a low of 40 per cent (when Kenneth Starr was appointed Special Prosecutor in 1994) to above 70 per cent at the end of 1999, after a year dominated by the Monica Lewinsky scandal. This was because, the FT’s man suggested, ‘since the Lewinsky affair broke … the US has created more than 3 million jobs, the unemployment rate has dropped to a 40-year low and growth has been at its strongest sustained level in more than a decade. On Wall Street, the Dow Jones Industrial Average has risen more than 15 per cent.’
This chapter was co-authored with Glen O’Hara.
Figure 20. President Clinton’s approval rating and the Dow-Jones Index, 1993–2000
Sources: Gallup Organization; Economagic.
Notes: Dow Jones Industrial Average index, daily closing; ‘Approve’: percentage of those surveyed who answered ‘Approve’ to the question: ‘Do you approve or disapprove of the way Bill Clinton is handling his job as president?’
The Cash Nexus: Money and Politics in Modern History, 1700-2000 Page 27