Tax Notes To An Unborn Grandchild

Dear Grandchild,

You’re probably wondering why I've saddled you with huge taxes to pay for debts run up before you were born.  As I write today, the total US debt is about 5 times the average personal income,  about $250,000 per person, and growing, rapidly.

The reason is, fortunately for me, that I won’t be paying the debt off.  Unfortunately for you, you will.  You probably think this is unfair but by the time you figure this out I’ll be dead.  Good luck with that.

Social Contracts

Although this game of pass the debt parcel to the next generation no doubt seems wrong to you it’s part of what is known as the intergenerational social contract.  Under this contract I, and my generation, have paid for our parents and grandparents’ social benefits and pensions.  You, in turn, are expected to pay for ours.  The problem, of course, comes because we’ve run up a ton of debt, eaten all the fish and melted the polar ice caps by using up all the oil along the way.  In fact, arguably, we’ve broken the contract by borrowing money to pay for our side of the bargain which you’ll have to repay, rather than paying for it ourselves.

Of course it isn’t quite as simple as you might think.  After all, we have had a couple of hundred years experience of economic growth so we might reasonably expect you to be richer than us.  If that’s the case it doesn’t make that much sense for us to invest for you now: it would be like poor people giving money to rich ones (we do that as well, it’s called “investing” to make people think they’re doing something for themselves rather than making rich people even richer).  There’s a technical economic term, the social discount rate, which determines how much we should invest in your welfare.

Calculating the social discount rate is quite difficult, because we have no idea how much wealthier than us you’re going to be.  One report estimates that in 2200 global per capita consumption will be $94,000 a year compared to $7,000 a year now: given how much richer you’ll be than me does it really make much sense for me to invest for your future?

Ethical Welfare

We can also look at history.  That $250,000 per person you’ll be paying back is equivalent to $40,000 back in 1962, 50 years ago, when average household income was $6,000.  You can see the effect of inflation and wealth creation: $40,000 per person is a lot of money, but not mindbogglingly impossible to pay off over a career.  Of course, that’s a false comparison, firstly because my parents weren’t stupid enough to get in this much debt, and secondly because the current levels of debt are continuing to increase, rather rapidly.

Nonetheless it shows that you may be able to afford the debts we’re running up.  But, of course, we don't know that for sure and there’s a big argument about what the proper value of the social discount rate, because economists can’t agree on how we should value your welfare.  Come to think of it, they can’t agree on anything. 

One philosophical argument is that it’s ethically wrong for us to value your welfare at less than ours, so the social discount rate should be set to zero.  Another, more practical view, says that we’re actually not that nice and our behavior reveals that we care more for ourselves than we do for you: we don’t save very much, for instance, and we’re merrily depleting the world’s natural resources without worrying too much about the consequences for you (See: Peak Oil: The Revenge Of Planet Earth?).

Stern Economics

We’ve also been having a bit of a debate about those environmental concerns.  In Nicolas Stern’s report on the economics of climate change for the UK government he effectively set the discount rate to zero.  Well, actually he set it slightly above zero, to take into account the possibility that we might actually exterminate ourselves before you ever get to read this: so he thought that people next year are only 99.99% as important as people this year. 

In effect this means that we should be prepared to spend $1000 now to mitigate $1000 worth of damage in 100 years time.  A higher discount rate would mean that we would only be prepared to spend today’s net equivalent of $1000 – so, for instance, a 5% discount would mean we would only be prepared to spend $7.60 now.

The result of Stern’s near zero social discount rate was a recommendation that we spend 1% of our global GDP on your welfare; stabilizing the world’s temperatures at levels below those calculated to damage your economic welfare. In general this proposal hasn’t gone down too well; we’re far more interested in protecting our own standard of living than worrying about whether you’ll have any at all. 

Black Swan Environments

Also Stern doesn’t address the possibility of an environmental collapse due to global warming – the low probability, catastrophic events we call Black Swans, and which are very common in financial markets. There are plenty of commentators around who think that this is more important than carrying out unquantifiable cost benefit analyses around your future welfare; rather we should worry about whether you have a future at all.

At the heart of these debates, about the amount of debt we’re saddling you with and the environmental depletion we’re handing on and how much richer than us you will be is the question of intergenerational justice, the so-called “social contract”.  To be frank we’re not very good at planning for our own futures – it’s been shown that we fail to save for our own retirements at least partly because we don’t think about the person retiring as being ourselves.  How much harder is it, then, to consider your futures when we don’t even know you? (See: Be Kind To An Old Person - Start With Yourself)

In any case, if we gave you loads of money you’d probably just waste it on recreational drugs, terrible music and visits to shady clubs staffed by people of dubious sexual proclivities.  After all, that’s what we did.

Theories of Justice

Our general lack of savings reveals that we really don’t value your futures at anything like the level we value our present, but this isn’t necessarily ethically correct.  John Rawls has attempted to create an intergenerational theory of justice, which argues that we should act towards you as we would have wished previous generations to have acted towards us. 

Unfortunately, as we’re all experiencing just about the best living conditions in the history of the world, while busily laying down debt and environmental damage for your generation, this appears to be more about hope and expectation than reality.  Most democratic governments aren’t very keen on making us pay for our lifestyles, and prefer to push the problems out to future generations.  We’re all already quite upset we have to work a few years longer to get our state pensions, and aren’t interested in the fact that pension ages were set in an age when most people didn’t live long enough to draw on them (See: The End Of The Age Of Retirement).

Who's The Prisoner?

Hence it appears that we’re playing an intergenerational game of the Prisoner’s Dilemma: if we care for the previous generation then the next generation will look after us.  Unfortunately this doesn’t appear to meet the basic criteria laid out by Robert Axelrod and William Hamilton in their seminal paper The Evolution of Co-operation: the problem is that if we defect, you can’t punish us.  It’s a sequence of so-called one-shot games, not a properly iterated version where you can retaliate: we’re dead, it’ll be hard to punish us (See: Altruism: Signalling Corporate Fitness).

So I hope you can see that this isn’t quite as simple as you might have thought.  We may be laying down debt for you to repay, using up irreplaceable fossil fuels and over-exploiting renewable resources but we can console ourselves with the thought that you’ll be far richer than us.

Only, of course, we don’t know that.  Global economic growth only took off about 200 years ago and we can’t guarantee that it will continue, especially if we destroy capital stocks with debt and wreak environmental damage with our high carbon lifestyles.  Still, if it all goes wrong it won’t be our problem.  But you’ll know who to blame.  

Love, Grandad.

Related articles:

• Peak Oil: The Revenge Of Planet Earth?
• Be Kind To An Old Person - Start With Yourself
• The End Of The Age Of Retirement
• Altruism: Signalling Corporate Fitness