42
Inequality, Aging and Capital Mobility: Implications for Fiscal and Monetary Policy Alan J. Auerbach June 1, 2018
Inequality, Aging and Capital
Mobility: Implications for Fiscal
and Monetary Policy
Alan J. Auerbach
June 1, 2018
The Setting: Three Phenomena
• Increasing economic inequality
• Population aging
• Increasing international capital mobility
First two put pressure on fiscal policy
Third limits scope for fiscal policy responses
Also, direct and indirect implications for
monetary policy
Population Aging
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Old-Age Dependency Ratios
2018 2050Source: US Census Bureau,
International Data Base
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Old-Age Dependency Ratios
2018 2050Source: US Census Bureau,
International Data Base
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Old-Age Dependency Ratios
2018 2050Source: US Census Bureau,
International Data Base
0
20
40
60
80
100
120
140
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Per
cen
t o
f G
DP
Net General Government Debt
2007 2016
Source: Auerbach and Gorodnichenko (2017), IMF WEO database
Fiscal Sustainability
• How to summarize necessary adjustments?
• Calculate a country’s fiscal gap to determine
how much need to reduce primary deficit
annually to achieve some target debt-GDP
ratio at the end of some period
– Express fiscal gap as a share of GDP
The Fiscal Gap
• Can view as determined by three components:
The Fiscal Gap
• Can view as determined by three components:
1. Past deficits, which sum to current level of debt,
and which require resources for debt service and,
possibly, to hit a more ambitious debt target
The Fiscal Gap
• Can view as determined by three components:
1. Past deficits, which sum to current level of debt,
and which require resources for debt service and,
possibly, to hit a more ambitious debt target
2. Current deficits, i.e., the current pattern of
spending and revenues, if continued into the
future as a share of GDP
The Fiscal Gap
• Can view as determined by three components:
1. Past deficits, which sum to current level of debt,
and which require resources for debt service and,
possibly, to hit a more ambitious debt target
2. Current deficits, i.e., the current pattern of
spending and revenues, if continued into the
future as a share of GDP
3. Future deficits, i.e., growth relative to GDP under
current policy due to demographics and rising
costs of government services, notably health care
Example: the US Now and in 1946
• In 1946, federal debt-GDP ratio = 110%
– But current primary deficits were small, as were
future commitments for old-age spending
• In 2017, federal debt-GDP ratio = 75%
– But current primary deficits and, especially, future
commitments for old-age spending massive
How Big are the Fiscal Gaps?
• Calculate through 2050
• Aim for a terminal debt-GDP ratio equal to
current one
• Use IMF projections for short-term primary
deficits and old-age spending growth
• Assume a real government interest rate of 3%
and a real growth rate of 2%
Source: Auerbach and Gorodnichenko (2017), IMF WEO database
-2
0
2
4
6
8
10
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Per
cen
t o
f G
DP
Fiscal Gaps (through 2050)
Baseline No Debt No Debt or P/H Terminal Debt/GDP = 60%
-2
0
2
4
6
8
10
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Per
cen
t o
f G
DP
Fiscal Gaps (through 2050)
Baseline No Debt No Debt or P/H Terminal Debt/GDP = 60%
Source: Auerbach and Gorodnichenko (2017), IMF WEO database
-2
0
2
4
6
8
10
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Per
cen
t o
f G
DP
Fiscal Gaps (through 2050)
Baseline No Debt No Debt or P/H Terminal Debt/GDP = 60%
Source: Auerbach and Gorodnichenko (2017), IMF WEO database
-2
0
2
4
6
8
10
Canada France Germany Italy Japan United
Kingdom
United
States
Ukraine
Per
cen
t o
f G
DP
Fiscal Gaps (through 2050)
Baseline No Debt No Debt or P/H Terminal Debt/GDP = 60%
Source: Auerbach and Gorodnichenko (2017), IMF WEO database
Fiscal and Monetary Policy
Implications
• Tax increases an obvious policy path, but…
• Are there other paths?
– Migration
– Inflation
– Pension reform
Increasing Inequality
Source: World Wealth & Income Database
0
5
10
15
20
25
Top 1% Income Share of Total Income (Percent)
Canada
France
Germany
Italy
Japan
United Kingdom
United States
Source: World Wealth & Income Database
0
5
10
15
20
25
Top 1% Income Share of Total Income (Percent)
Canada
France
Germany
Italy
Japan
United Kingdom
United States
Source: CBO (2016)
-50
0
50
100
150
200
250
300
350
Cumulative Growth in Real Market Income
Top 1 %
80-99%
Lowest 20%
Middle 60%
Source: CBO (2016)
-50
0
50
100
150
200
250
300
350
Cumulative Growth in After-Tax Income
Top 1 %
80-99%
Lowest 20%
Middle 60%
Source: CBO (2016)
0.35
0.45
0.55
0.65
1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012
Gin
i C
oef
fici
ent
Inequality and Effects of Taxes and Transfers
Market Income
+ Transfers
+ Transfers - Taxes
Are We Measuring Inequality
Correctly?
Source: Auerbach et al (2017)
0
5
10
15
20
25
30
35
40
45
Quintile 1 Quintile 2 Quintile 3 Quintile 4 Quintile 5
US Life Expectancy at Age 50 by Lifetime
Earnings, Males
1930 cohort 1960 cohort
Source: Auerbach, Kotlikoff and Koehler (2016)
3.8%
7.9%
12.9%
19.8%
55.6%
28.6%
13.0%
4.1%8.6%
13.6%
20.3%
53.3%
27.8%
12.9%
Lowest Second Third Fourth Highest Top 5% Top 1%
Lifetime Resources and Current Income by
Resource Percentile Range, Ages 40 - 49
Share of Lifetime Resources Share of Current Income
-40.6%
4.2%
11.9%
19.2%
32.2%38.2%
43.3%
-26.1%
17.0%
24.2%27.9%
37.4%41.4%
44.7%
Lowest Second Third Fourth Highest Top 5% Top 1%
Average Lifetime and Current Year Net Tax
Rates by Percentile Range, Ages 40 - 49
Average Lifetime Net Tax Rate Average Current Year Net Tax Rate
Source: Auerbach, Kotlikoff and Koehler (2016)
Increased Fiscal Pressure
• To deal with inequality
• To deal with fiscal imbalances
Increased Fiscal Pressure
• To deal with inequality
• To deal with fiscal imbalances
• A logical solution: progressive tax increases
and expenditure reductions
Increased Fiscal Pressure
• To deal with inequality
• To deal with fiscal imbalances
• A logical solution: progressive tax increases
and expenditure reductions
• But another major challenge stands in the way
Source: OECD Tax Database
0
10
20
30
40
50
60
70
1990 1994 1998 2002 2006 2010 2014 2018
Per
cen
tG-7 Corporate Tax Rates
Germany
Italy
JapanCanada
France
United Kingdom
United States
Source: OECD Tax Database
0
10
20
30
40
50
60
70
1990 1994 1998 2002 2006 2010 2014 2018
Per
cen
tG-7 Corporate Tax Rates
Germany
Italy
JapanCanada
France
United Kingdom
United States
Options
1. Initiatives to resist corporate tax avoidance
– OECD Base Erosion and Profit Shifting (BEPS)
project
• Problems:
– Can lessen profit shifting, but not capital mobility
– Weak incentives for many countries to participate,
including those seeking to attract foreign direct
investment
Options
2. New taxes, targeted toward the wealthy
– Financial transactions taxes
– General wealth taxes
• Problems:
– Ultimate burden of such taxes may fall elsewhere
– Mobility/observability of wealth and transactions
make administration and enforcement difficult
Options
3. Rely on taxes on less mobile activities, such
as consumption-based taxation
• Attractive from an enforcement perspective,
since easier to track and measure than capital
income or wealth
• In the form of a VAT, has been growing in use
0
5
10
15
20
25
1975 1980 1985 1990 1995 2000 2005 2010 2015
Per
cen
t
G-7 VAT Rates
United KingdomFrance
Germany
Canada
Japan
Italy
Source: OECD Tax Database
Options
3. Rely on taxes on less mobile activities, such
as consumption-based taxation
• Attractive from an enforcement perspective,
since easier to track and measure than capital
income or wealth
• In the form of a VAT, has been growing in use
• But a VAT doesn’t get at the problem of
inequality
Consumption-Based Taxation
• Can also use as a model for corporate tax
reform: A destination-based corporate cash-
flow tax (DBCFT), as considered by US
– Border adjustment eliminates business
opportunities to shift profits
– Does not require international cooperation
– Progressive (no tax on labor or shifting to labor)
– Encourages domestic investment and production
US Experience
• Ultimately, US did not adopt DBCFT
– Fiscal devaluation (border adjustment taxes
imports and subsidizes exports) led to concerns
about dollar appreciation and trade disruptions
• But US reform did include smaller provisions
affecting exports, imports in same direction
• Implication – as other countries move in this
direction, exchange rate movements
Monetary Policy
• With challenges facing fiscal policy, more
pressure on monetary policy; however,
monetary policy ill-suited to deal with these
challenges
– Fiscal gap
– Inequality
• Strengthens argument for CB independence
