Generational Accounting

Tip of the Week #123 Tip Index

Go to the Prior Tip Advances in Decision Analysis from Foundations to Applications
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Go to Tip 121 The Clash of Generations also by Laurence Kotlikoff and Scott Burns
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The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy by Laurence J. Kotlikoff and Scott Burns, 2012, MIT Press, 275 p. (reviewed earlier as Tip 121)

The Coming Generational Storm: What You Need to Know about America’s Economic Future, Revised Edition by Laurence J. Kotlikoff and Scott Burns, 2005, MIT Press, 275 p.

Generational Accounting: Knowing Who Pays, and When, for What We Spend by Laurence J. Kotlikoff, 1993, The Free Press, 265 p.

Economics professor Laurence Kotlikoff, Boston University, has done a remarkable job of focusing on the problem. Investment strategist and columnist Scott Burns co-authored two of the three books above.

What is unique about Kotlikoff’s approach is looking at how different generations are impacted. His formula, best described in the two earlier books is:

A = C + D +V – T

Where	A	The present value (PV) burden on future generations
equals	C	The present value of government purchases
plus	D	Official debt
plus	V	Implicit debt (to pay for unfunded entitlements)
minus	T	The present value of taxes paid by current generations

Official debt is a fiction. Words like “debt” and “taxes” can be interchanged and revised in ways as to make them unrecognizable. The formula only requires that C + D be consistent with the other terms. And the other terms are based on cashflow projections. As my accounting friends say, “It’s hard to lie about cash.”

It’s difficult to comprehend the magnitudes and rapid growth rates of these numbers. The “fiscal gap” obligation left to future generations (A) is—depending upon whose numbers you use—is between $86 and $250 trillion. Kotlikoff’s higher number includes about $40 trillion for state and local government funding gaps (mostly pensions).

The lower $86 trillion number is provided by David Walker, former chief accountant of the U.S. Walker’s ongoing (Fall 2012) “$10 Million a Minute” bus tour (www.10MillionaMinute.com) is fostering awareness of the debt crisis ahead of the U.S. elections. $10 million per minute is about $5 trillion per year, the growth rate of the official debt (D) and implicit debt (V) in the formula. Most of this is the growth in unfunded promises for Social Security, Medicare and Medicaid.

I calculated a similar PV dollar growth number based largely upon the Congressional Budget Office’s projections of entitlements spending as fraction of the economy (GDP).

Kotlikoff has been building an influential following. While I’m not excited about some aspects of his proposals (www.thepurpleplans.org), at least he and Burns are attempting solutions. There are many good ideas here, and a notable following of Nobel Prize laureates have endorsed his proposals.

The two most-recent books (with Scott Burns) also prescribe lifestyle changes that can help readers cope with the rough waters ahead. At the end of the recent book they propose that Americans aged 18-35 form a Generational Equity Party whose mission is to represent the interests of today’s and tomorrow’s young generations. I think it's a great idea. Young people should not find themselves in financial servitude to pay for the benefits earlier generations promised themselves.

We're in a terrible mess. I blame the Roosevelt’s for starting us down this path: Teddy (26th President of the U.S.) softened us toward big government, and Franklin (32nd) launched this blight on our country. Every administration and congress since has added to the fiscal gap.

The U.S. is not alone in deferring obligations to future generations. It seems a character of politics. Getting elected or re-elected usually requires promising generous benefits to current generations and deferring payments to successor generations. Excessive debt is a terrible disease and one that can bring down governments.

Each of these books received abundant endorsements and were on bestseller lists. I recommend starting with The Clash of Generations mainly because it is more current.

—John Schuyler, Sep 2012