Ronald Lee January 15, 2009 Berkeley, CA NTA hands-on workshop Thoughts on Uses of NTA Ronald Lee January 15, 2009 Berkeley, CA NTA hands-on workshop

Plan I present some ideas Support ratios (fiscal and general) Fiscal projections (can be stochastic) Intergenerational accounts (history and projs) Economic growth and macro impact Demand for wealth Transfers vs assets Fertility and human capital investment Simulations/Optimal growth paths NTA for subgroups Are some policies too generous to elderly? General discussion of possibilities, and suggestions for a single compelling index. Full GA=general bequest? Also, hardcopy handout of some notes.

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How Population Aging Will Affect Government Budgets The fiscal support ratio for year t is: Population(x,t) weighted sum of taxes based on fixed age schedule of taxes, e.g. for 2000 ________________________________________ Population(x,t) weighted sum of benefits based on fixed age schedule of benefits e.g. for 2000 It shows the fiscal effects of changing population age distribution, e.g. as population ages, given the current program and price structure.

Fiscal Support Ratio Projections, 2000-2100

Fiscal Support Ratio Projections, 2000-2100 No pressure of population aging on state and local budgets – education dominates their budgets.

Fiscal Support Ratio Projections, 2000-2100 Major pressure on Federal budget, which covers public pensions (Social Security) and health care for the elderly (Medicare)

Given current program structure Balancing federal budget at end of century requires Cutting benefits by one third or Raising taxes by 50% As health care costs rise, larger adjustments will be necessary.

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Dependency and Support Concern about pop aging is mostly about old age dependency. Sharpest concerns for age-sensitive public sector programs pensions health care Long term care But should place these in broader context Full range of public programs Private consumption Use shape of estimated profile I just showed.

Support Ratios Effective labor is weighted sum of pop using labor income age profile. Effective consumers is similar. Ratio of effective labor to effective consumers is the “Support Ratio”. Other things equal, consumption per effective consumer is proportional to the support ratio.

Population aging First Dividend

2008

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Fiscal Projections for USA Support ratios do not take into account economic change: productivity growth, price changes for benefits, planned changes in programs Fiscal projections incorporate all of these, in addition to population change.

Mechanics of projections Projected productivity growth shifts both the tax profiles and the benefit profiles Productivity growth alters public pension cost profiles in ways that depend on the system’s rules Costs of health care benefits are projected separately to reflect faster growth Projected interest rates are used to update program debt or trust fund values Demography, productivity, and interest rates can all be modeled and projected stochastically, leading to probabilistic budget projections.

Total govt expenditures double relative to GDP 26% rises to 52%

Expenditures on the elderly triple relative to GDP, from 8% to 26%

References for this lecture Ronald Lee and Ryan Edwards (2002) "The Fiscal Effects of Population Aging in the US: Assessing the Uncertainties," James M. Poterba, ed., Tax Policy and Economy v.16 (NBER: MIT Press, 2002) pp. 141-181.

Stochastic fiscal projections Obviously great uncertainty about these projections. Useful to put probability intervals around them. Approaches: Time series analysis of inputs: Lee, Tuljapurkar, Edwards, Anderson, Miller Random scenario (Lutz and collaborators) Based on UN projections (Miller)

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Generational Accounts: Historical and Projected Future How estimate historical accounts? Use historical estimates of population age distributions. Use control totals which are generally much simpler, e.g. for public education, because govt programs were limited. Make assumptions about the shapes of age profiles, e.g. for education or pensions it is not hard. In US, have IPUMS back to 1850.

Ref for this section Bommier, Antoine, Ronald Lee, Timothy Miller, and Stephane Zuber (2004) “Who Wins and Who Loses? Public transfer accounts for US generations born 1850-2090,” National Bureau of Economic Research Working Paper No. 10969, December 2004 (http://www.nber.org/papers/w10969).

Public Education Benefits Received by Age and Time (2004 US $) per Native Born Individual Time (Calendar Year) 1850 1851 … 2004 2200 1 2 109 110

The changing age profiles of taxes and benefits in the US: 1900, 1930 and 2000 1850 80 % per capita gdp 1930 2000

Calculating NPV for generation born in year t (x,s) = tax paid at age x in year s β(x,s) = benefit received at age x in year s l(x,t+x) = proportion of births in year t surviving to age x in year t+x. NPV(t)= ∑e-rxl(x,t+x)[β(x,s+x) - (x,s+x)] r=.03 in baseline. Also try .02, .05. Also historical, varying year to year. NPV can be calculated from any age; here mostly at birth, i.e. age 0.

USA and France: A Comparison NPVs for the US NPVs for France

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Ronald Lee and Tim Miller, Chapter 7, New Americans Social Security benefits plus Medicare Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans

Ronald Lee and Tim Miller, Chapter 7, New Americans Total Fiscal Impact by Age at Arrival and Educational Status of Immigrants +$350,000 $0 -$250,000 Ronald Lee and Tim Miller, Chapter 7, New Americans

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Economic growth and macroeconomy Human capital and fertility change. Ramsey type dynamic optimization over the demographic transition, with NTA type transfers taken as given. Plan saving and consumption around this. Use approach like Auerbach-Kotlikoff Dynamic Fiscal Policy. Miguel Romero is working on. NTA style growth approach

Most important points Population aging drives increasing demand for wealth Demand for wealth can be satisfied through transfer wealth, either public or private, or through assets. Depending on which, population aging will generate more assets (domestic or abroad), or more transfer burden. But there are also advantages to transfers, so above is just one element to consider in forming old age support policies.

Human capital and fertility change

Amount spent on HK is around 5 or 6 years of labor income, regardless of fertility. A strong negative relationship, with a slope close to -1 (log-log).

Production and Human capital Baseline Specifications Human capital (HK) Portion of wage, W(t), workers invest in their children is inversely related to their fertility, F(t) Human capital of workers one period later is HK(t+1) = h(F(t)) W(t) Wage (W) Wage is increasing in human capital W(t) = g(HK(t))

Other sources of variation in fertility/HK choice Pref for HK: Rate of return to HK; survival rates; consumption value of HK. Price of HK due to medical technology, transportation improvements, etc. Price of number: family allowances, fines for second child, changing access to effective contraceptives Cultural influences on varying share of income allocated to total HK expenditures and on number.

Model—basic structure Take fertility variations as given, trace out consequences for HK, w, consumption. 3 generations: children, workers, retirees; usual accounting identities. No saving or physical capital. HK drives wage growth; wage growth drives HK growth. (Lee and Mason 2008)

(demoraphic dividend) Boom (demoraphic dividend) Fertility bust, but consumption remains high Fertility recovers: modest effect on C/EA Bottom line: Low fertility leads to higher consumption. Human capital investment has moderated the impact of fertility swings on standards of living.

During first dividend phase, consumption does not rise as much as support ratio. The difference is invested in HK. That is why ih later periods, consumption is proportionately higher than the support ratio.

Human Capital and fertility Lee-Mason paper developing NTA relation between HK investment per child and Total Fertility Rate in survey year. Cannot establish causality; here just assume that changing fertility drives changing HK. Simple little model makes HK of kid depend on HK of parent generation. Labor income depends on own HK Elder generation supported by transfers. Simulate out the effect of low fertility on consumption: does increased HK compensate for fewer workers per elderly? Alexia has developed more sophisticated model building on this.

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NTA style growth approach

Here take a different approach – no optimization--emphasizes institutional setting Assume share of old age consumption supported by asset income stays constant over time. altruistic sharing maintains the shape of the cross sectional consumption age profile. Demography is known in advance. Can solve recursively for unique growth path and asset holdings.

Two scenarios: high level of transfers to elderly (65%); or low level (35%) Other assumptions Productivity growth raises income age profile by 2% per year. Open economy; rate of return on assets is 3%. Aggregate saving is calculated to maintain asset share of old age consumption support. Results will be shown relative to a 2% growth trajectory from prod gr.

Simulated Saving Rate, ASEAN (S.E. Asian countries), 1950-2050

Simulated Assets/Labor Income, ASEAN Ratio of assets to labor income rises greatly in any case, but 3 or 4 times as much with low IG transfers.

Simulated Consumption, ASEAN With low IG transfers, saving is higher from 1990 to 2020, reducing consumption. Thereafter, it is higher.

These sorts of results are qualitatively like those from optimization approaches Timing of swings differs Level of savings rates differs Capital/labor income ratios differ Big picture is the same: The demographic transition leads to a major increase in capital per worker. The greater the role of transfers to the elderly, the smaller is the increase in capital intensity. Eventually consumption rises with lower transfers, but initially it is lower. Population aging leads to a decline in savings rates but an increase in capital intensity.

Other ideas NTA for subgroups by race/ethnicity, educational attainment, or other. Discuss. If elderly receive public transfers and then make large net private transfers to others, is this a problem? Or is this good?

A single compelling index One possibility is B, the total bequest to a birth. B is the sum of net public and gross private downward transfers per child, B = OC + HK + AIV + EOL This is a longitudinal net present value at birth measure, which might be constructed from the cross-sectional accounts under appropriate assumptions. Compare to NPV of life time earnings, e.g. Eventually perhaps it can be calculated longitudinally as we did for the main public transfers in the US and in France

B in the US for generation born in 2000 (rough, many assumps) Use cross-section for 2000. Assume transfers rise at 1.5% per year (prod gr) Discount at 3% Adjust public transfers for future budget balance (50-50 cut taxes, cut benefits) Assume public debt = public capital

Value of B for US newborns in 2000 (NPV at birth) NPV of Public Transfers (Pub Ed, Soc Sec and Medicare only) assuming budget is balanced 50-50 by cutting taxes and benefits: +47K (assumes govt debt = value of pub capital) Note key importance of public education! NPV of Intervivos familial transfers received including consumption: 220K Private end of life bequests: 27K Total:   294K

B in context: US 2000 Relative to NPV of child’s life time earnings = 34% Health and Education as a share of total bequest = 33% Private as a share of B = 84%

Some questions for future work How has B changed over 20th Cent? Has it fallen with rise of transfers to elderly in second half of century? Private transfers have surely fluctuated along with fertility, lower for baby boom gens, higher after. Compare similar calculations across countries.

P is sum of gross upward transfers to adults, mainly to elderly (double counting with B, so caution needed) Components of P Familial transfers to elderly Public transfers including

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