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A welfare generation: lifetime welfare transfers between generations

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Concerns about the living standards of different generations are currently high on the agenda, and appear unlikely to dissipate any time soon. This is particularly the case when the coming decades bring with them a potent mix of increasing longevity and the sheer size of the baby boomer cohort swelling the older population, creating growing fiscal pressures and thus raising the question of ‘who pays?’.

Analysis of the effects of tax and benefit policy – whether by age, income or some other characteristic – tends to be related to a particular policy at a given point in time. However, taking full account of the impact of policy change across cohorts requires a much broader and longer view.

This latest research paper, the fourteenth for the Intergenerational Commission, attempts to do exactly that by updating John Hills’ seminal research on life-cycle welfare transfers between generations. We determine the extent to which past and future cohorts contribute to the welfare state via taxation and withdraw from its core pillars – education, health and social security – over the course of lifetimes. While this analysis is about averages for entire cohorts, and so does not consider distributional impacts, it does allow a better understanding of the relationship of different generations with the state over their lifetimes.

In practice the UK welfare system runs on a ‘pay as you go’ basis, with workers contributing to fund support for children, pensioners and those in need. If longevity, cohort size and levels of tax and spend remained the same across time, then, with an annual balanced budget, successive cohorts would put in precisely what they take out. Of course in reality that is not the case, and variation in each of those factors shapes the extent to which different cohorts as a whole are net withdrawers from the welfare state over their lifetimes.

Because the modern welfare state developed as they were in older working age, cohorts that have now mainly reached the end of their lives – members of the forgotten generation (born 1896-1910) and the oldest two-thirds of the greatest generation (1911-25) – emerge as clear net beneficiaries. Measured relative to GDP per capita, these cohorts’ average withdrawals were at least 25 per cent higher than their contributions. The silent generation (1926-45), however, were mostly in early working age during the establishment of the modern welfare state from the late-1940s onwards. This means that the increased spend on education for subsequent cohorts, along with health and pension provision they were taxed to fund for other cohorts, was almost greater than the support they received themselves, leaving them with ‘net withdrawals’ of 5 to 15 per cent.

To consider the lifetime position of younger cohorts that have not yet reached old age we are required to make big assumptions about the future path of tax and spending. In the first instance we follow John Hills’ approach and assume that taxes collected in any given year are sufficient to fund welfare spending in that year, and that this spending takes up a growing share of GDP, largely due to growing health spend, as long-term Office for Budget Responsibility (OBR) projections suggest it will. Under these assumptions, cohorts from the baby boomer generation (1946-66), generation X (1966-80) and the millennial generation (1981-2000) all have higher net withdrawals than the silent generation, of around 20 to 25 per cent.

However, these hypothetical outcomes rest on the ability of successive generations to pass ever growing costs – and in particular rising health spending – onto the generations that follow for ever more. The OBR have projected that over the next fifty years the welfare state is projected to increase in size by seven per cent of GDP. In our model, funding this means steadily raising taxation, not only in real terms but also as a share of GDP, largely of working age adults (we assume that the distribution of tax revenues by age retains its current pattern), a situation that seems unlikely to be sustainable indefinitely.

Alternatively, successive cohorts could pass on the growing costs in the form of higher debt. Indeed, OBR projections, which do not assume that tax policy will alter to cover changes in spending, suggest that the growing gap between tax revenues and spending commitments will see the national debt as a share of GDP rise to over 230 per cent by 2066. These are costs associated with retaining a welfare state of a similar level of generosity (i.e. service, which requires per-head funding for health provision to rise by an average 1.5 per cent a year above GDP in the long run) to that of today. If their taxes aren’t sufficient to fund this, the implication is that younger generations would be left with a growing debt burden to be financed, an outcome that is similarly unlikely to be sustainable indefinitely.

With neither ever-higher taxation of working age adults nor ever-rising debt appearing feasible long-term approaches, an alternative is for welfare spending to grow less quickly. To consider this position, we model a second set of assumptions under which welfare funding per-head does not rise in future. In this instance, we find that younger baby boomer cohorts are the big winners among generations alive today – the 1961-65 cohort has a net withdrawal from the welfare state around twice as large as that of the 1991-95 millennial cohort. It is notable that under these constant spending assumptions, levels of net withdrawal from the welfare state closely match fluctuations in cohort size, highlighting the all-else-equal advantages of being born into a big generation.

While large welfare reductions (mainly affecting families of working age) are currently underway, in practice a welfare retrenchment of the scale implied by this second set of assumptions would likely be equally as unpalatable as the alternatives of ever-rising working age taxation or debt. In this sense, our scenarios represent some of the extremes between which policy-makers must navigate and highlight the generational consequences of finding a way between the two.

While the precise path of future welfare spending remains hugely uncertain, it is clear that successive governments have so far failed to adjust either the UK’s tax-raising potential, or its welfare promise for current and future generations, to account for future fiscal pressures. Managing this trade-off is key to finding an equitable distribution of resources across generations and to maintaining the inter-generational contract.

In facing this challenge, it is important to question one assumption that is common to both of the scenarios we have described: that the additional tax burden associated with funding the services we currently value should fall on current or future working age populations. This is particularly the case given cohorts now entering retirement have wealth levels at each age exceeding those of both previous retirees and generations that follow.

What is certain is that of generations alive today, so far the baby boomers have been the winners and the silent generation the losers from generational burden-sharing as the welfare state has expanded and matured. The outcome is less clear for younger generations, their fate will ultimately be decided by future policy choices. As policy-makers wrestle with big questions about the future path of tax and spend we should remember the significant implications for generational living standards and equity.