Economists have been developing a new technique called 'generational accounting'. Pioneered by American economist Larry Kotlikoff and now being applied to the UK economy by researchers at the National Institute of Economic and Social Research (NIESR), generational accounting measures the burden that current fiscal policies are likely to impose on future generations. It also identifies the set of policy reforms needed to achieve 'generational balance' - a situation in which future generations face the same lifetime net tax rates as current generations.
The central premise of generational accounting is that the current budget deficit is not a good indicator of the real fiscal position. For example, if pensions are generous and you expect a future surge in the number of retired people, then the position is unsustainable and future taxes will have to be higher. Generational accounting estimates the sustainability of a country's public finances by calculating the present value of all future expenditure and comparing it to the present value of all future tax returns. If expected spending exceeds expected revenues, then future generations will face higher taxes or lower spending.
With the assistance of HM Treasury and other government departments, the NIESR team has developed the first set of generational accounts for the UK. The main conclusion is that, assuming price indexation of social security transfers and moderate increases in health expenditure, the imbalance in UK generational policy is quite modest compared with other leading industrial countries. Given uncertainty about the future, the tax shortfall might not be a problem after all. Indeed, if the government's drive to improve productivity is successful, it is possible that we could end up with the balance favouring of current generations.
However, achieving generational balance could require much stronger medicine if the government decided to increase spending significantly relative to the baseline assumptions. In that case, either a substantial sustained cut in non-education and non-health government spending - or an equally substantial increase in income tax and a corresponding increase in social security contributions - would be required to restore balance.