Why Intergenerational Equity Matters to Taxpayers

November 23, 2009

Taxpayers should get what they pay for, and pay for what they get—that is the core notion behind intergenerational equity in government. When governments live within their means, balancing revenues and expenditures without hoarding excess cash or borrowing from the future, they achieve intergenerational equity among taxpayers and others who pay for and receive government services.

If today’s taxpayers pay less than the full cost of the services they use today, a future taxpayer will pay instead. That could be your future taxpaying self, or other taxpayers coming after you.

Government provides infrastructure (e.g., streets, sewers), goods (e.g., municipal water, food assistance), and services (e.g. emergency response, building inspection). A significant portion of the cost of government is capital expenditures and wages and benefits of public employees.

In order to pay for infrastructure, governments often issue bonds whose maturities should be no longer than the lifespan of the new asset. If you build a road expected to last 30 years before it needs to be rebuilt, it is appropriate to spread the cost over the next 30 years so that future taxpayers benefiting from that road contribute to it financially. That is an intergenerationally equitable way to pay for infrastructure.

When it comes to paying for personnel costs (roughly 75% of many governments’ budgets), ensuring the intergenerational equity of retirement benefits can be tricky. This is because government retirement benefits are earned today by today’s employees but paid to them years from now when they become retirees. It is important to calculate the projected future cost of those benefits and set aside today’s taxes to pay for those future retirement checks in order to pay the true full cost of today’s government employee services. Financial reporting standards introduced by the Governmental Accounting Standards Board now make it possible to see whether a government is setting aside enough money today to pay the estimated costs of the pension and retiree health care benefits they’ve promised to pay today’s workers in the future.

Why does intergenerational equity matter to citizens? When full costs are being deferred, you are paying less than the true cost for your government services. That sounds like a good deal until, like racking up credit card debt, it becomes unsustainable and the government has to rebalance by raising taxes, cutting services, or both. When that happens, suddenly you (or your children or grandchildren) are paying more for less government service. So while deferring the true cost of today’s services is convenient in the short-term, it is ultimately unfair to either your future self or to other future taxpayers.

Why doesn’t intergenerational equity matter to elected officials? Unfortunately, voters often reward elected officials for decisions that are expedient in the short-term but push costs out into the future. When faced with the decision to raise taxes (or cut services) this year or next year, most elected officials choose next year because most voters also prefer next year. Until voters hold elected officials accountable for decisions that push true costs into the future, they will have little incentive to make the right choices for the long-term.

The Chicago Transit Authority recently provided an excellent example of why citizens should be concerned about intergenerational equity. For decades, the CTA management and unions underfunded the pension system to a point where it was on the verge of running out of money at a time when the CTA was already struggling to balance its budget. In 2008, the Illinois General Assembly approved legislation to reform the pension system and increase sales taxes and real estate transfer taxes for the CTA. The CTA has also raised fares significantly in the last few years, having failed to raise base fares at all between 1991 and 2003. We are paying higher taxes and fares today because for many years the CTA was not asking taxpayers and riders to pay the full cost of transit.

The enormous debts and pension liabilities of the State of Illinois and the City of Chicago portend similar adjustments by those governments in the near future. The State and City have racked up over $73 billion and $10 billion, respectively, in unfunded pension liabilities. Both governments face huge budget deficits that were exacerbated by the recession but existed well before it.

Taxpayers and voters can unfortunately expect to soon be paying more for less from their governments.

In order to restore intergenerational equity, elected officials and voters need to avoid short-term expediency and instead support policy choices such as fully funding employee pension plans, not using one-time revenues or borrowing to pay for operating expenses, and matching expenses to revenues.

For more on intergenerational equity and government financial reporting, see the recent Governmental Accounting Standards Board newsletter on this topic.