Okay, I don’t really know. It is probably impossible using actual human beings (using mathematical models, you could probably figure it out). If you clicked a link to this post hoping for a great answer…I apologize, but I’ll try to grab your interest none the less.
Consider this:
In an interesting piece of work, economist Henning Bohn has forecast the future voting propensities of an aging electorate based on two things: how much in taxes a median voter would expect to pay until retirement, and the present value of his or her expected Social Security and Medicare benefits.
His conclusion: It will make financial sense for the median voter to vote for higher taxes on his remaining working years and on younger people in order to secure his benefits.
If you are familiar with entitlement programs in the U.S. like Social Security and Medicare then you already understand some of the problems our generation will face. If you don’t look at this graph:
We are going to have to pay a lot of money to finance these programs in the future. A lot of people wonder why we pay Social Security taxes for someone else’s retirement? Why not just pay for our own? Those taxes go to financing the current generation of retirees. In other words, a ‘pay as you go’ system.
This creates an incentive for older citizens to vote for tax increases that will last our lifetime and less than half of theirs. They will experience a greater return in government benefits upon retirement than they will pay in increased taxes.
The tool that economics has to deal with balancing the value of future dollar values is discounting.
Present Value = Future Value/(1 + i)^t, where i is the discount rate
It is fairly contentious what level i should be at. Some people contend that it should be the current interest rate, a conservative estimate of the opportunity cost of holding money (in other words the cost of holding money in the present). Others, believe i should be some average of market returns. For instance, the return on the S&P 500 over the last 40 years. On a more extreme level, some people believe the future should be valued at a 1:1 rate.
Let’s do an example with these three examples. Future Value = $100. Time = 5 periods.
1) i = Interest Rate, i = 1.5%
PV = 100/(1 + .015)^5 = 92.8259
2) i = S&P 500 over last 40 years, i = 7%
PV = 100/(1 + .07)^5 = 71.2986
3) 1:1 Valuation i = 0%
PV = 100/(1 + 0)^5 = 100
You can see that depending on how much money individuals expect to earn today on a dollar affects how they value the future. If you expect a low return (1) over the next five years, you would value a future benefit of $100 at $92. If you expect a higher return (2), you value the future benefit less at $71. Case 3 is a philosophical case that says I should value the future the same as I value the present. This case is grounded in an ideal of human rights and moral standing. This case is difficult to justify implementing in practice because opportunity cost of holding money is not 0.
Now the problems come in…If you change that 5 to a 10, 20, or 100, the present value gets smaller and smaller and smaller. With a higher i, that happens even faster.
Let’s take an example using the Fed Funds rate, since the market is so volatile right now 1.5% is a safe and conservative estimate. Also an estimate that values the future highly.
Social Security: $100 benefits
Retirement: 65
Generation 1: 40
Generation 2: 20
Generation 1 value:
100/(1 + .015)^25 = 68.9206
Generation 2 value:
100/(1 + .015)^45 = 51.1715
Generation 1 values 100 for retirement about 25% higher, even with an i that values the future highly. Let’s add another element, Generation 2 values the future less because it is farther away and thus expects to earn about 7% in the marketplace. Now, we can figure out how a younger generation values a $100 of benefits of the older generations retirement.
Generation 2’s revaluation of Generation 1’s benefits:
100/(1 + .07)^25 = 18.4249
Generation 2’s revaluation of their benefits:
100/(1 + .07)^45 = 4.7613
Let’s expand on this new data. First, let us take a step back. i = 7% means that individuals expect a high rate of return in the present and therefore value the future less because they could invest or save the money. This seems like a fair assumption for a younger generation who empirically often take riskier returns. At this rate, Generation 2 values Generation 1’s benefits that accrue in 25 years at less than $20, $50 less than what they value it at, almost 75% less. Furthermore, Generation 2 values their own benefits accruing in 45 years at less than $5.
Currently, from what I can find, employers and employees each pay 6.2% in income tax toward Social Security. I’m sitting in history lecture and can’t think about how to calculate this right now, but let’s consider:
Σ 100/(1 + .07)^t, from t = 45 to t = 25
Σ 100/(1 + .015)^t, from t = 25 to t = 0
Σ 120*(.062)*t, from t = 20 to t = 65
The first summation shows how Generation 2 values their Social Security benefits for 20 years when they are willing to take risks on higher returns and the second shows the last 25 years where they are less willing to take risk. The third summation shows income payed into Social Security until retirement. I put income at 120, assuming salaries are 20% higher than social security benefits.
I created this spreadsheet. Please critique it, I put it together quickly, but I try and show the difference in expected benefits and taxes.
I’m going to end this post now. But I think this gets at the heart of what Hayek says about diffuse decision-makers producing better results than a centralized decision-makers. In other words, with my money I can apportion it out correctly if I have sufficient information because I know how I value the future. Central decision-makers have to attempt to aggregate all of this data and ethically are expected to do it fairly. The result is everyone paying into an entitlement system that we can’t afford and giving out money that we may never see again.
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