Inequality, Aging and Capital Mobility: Implications for ... · 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