While Congress figures out a scheme to escape from enduring its self-imposed fiscal cliff, the United States' debt grows higher and GDP growth estimates fall. The hole we dug ourselves in the last recession is deeper than any since World War II, and the current pace of job growth is lower than what's needed to simply keep up with population growth.
Even so, living today is much better than what the prospects look like for tomorrow. Take a look:
Living it up today
That chart shows how much each age bracket benefits from current policies, and how much future generations, yet to be born, will have to pay to cover the benefits consumed today. The age group that benefits the most is made up of those aged 65 in 2010, who will receive $332 billion in benefits over what they pay in taxes. And of course, the age group that pays the most is made up of those who have no vote, the unborn, who will have to pay in $388 billion to cover previous costs. It's important to note that these numbers don't mean all of the government's debt must be repaid but simply must keep up with interest payments on the debt.
With a bleak tomorrow
According to the IMF, "a typical American in the future might face net tax rates at least 21.5 percentage points higher than today." It also states, "the main drivers of the U.S. generational imbalance are the 2001 and 2003 tax cuts ... and the projected rapid increase in health care spending." Even with repealing those tax cuts, future taxes would be 18% higher than today.
The IMF report also uses an interest rate of 3% for its calculations, which means future dollars are worth that much less each year. Today, however, inflation over the past 12 months has been 1.7%, and a majority of the Federal Reserve members now believe the Fed won't increase interest rates until 2015. That would total six years of near-zero interest rates and could put us in Japan's situation of low rates and increasing debt, although recent strength in housing gives the U.S. a point of difference from Japan. But it also means that the 3% rate the IMF used to calculate the future burden could undervalue future dollars and actually increase the amount future generations will have to pay.
No matter the math
That interest-rate issue highlights one of the issues of the practice of calculating future tax burdens, called generational accounting. As the Federal Reserve Bank of St. Louis writes, "This is potentially problematic because the true discount rate is not known -- and even if it was, it would probably not stay constant over time." The St. Louis Fed also points out, "assuming that future taxes, transfer payments, population, and government spending all increase at a fixed rate seems implausible."
Even with these issues inherent in generational accounting, the fact that we can't keep up with current spending and low taxes without having future generations incur a heavier tax burden is clear. The Economist puts forward some solutions, such as faster growth, strict austerity, or higher inflation. However, each has its own problems. Growth is limited by high debt and a lack of infrastructure spending, which was "3% in the early 1960s" and "roughly 1% in 2007." The level of generational imbalance would require a nearly politically impossible 35% cut in transfer payments and a 35% increase in taxes. And inflation would help younger debtors but hurt older savers.
Help out your future children
Short of a major reorganization of taxes, policy, and changing from short-term to long-term thinking, this represents why you must plan for your family and yourself. The fiscal cliff offers an opportunity to practice the planning required, no matter what Congress decides. For example, there's a chance that dividends could be taxed at your income-tax rate instead of 15%, so you might want to look over possible REITs. They already incur income tax rates on the dividends they pay out, so current investors wouldn't see any change in how they are taxed. Retail Opportunity Investment (Nasdaq: ROIC) , to name one, offers a 4.3% dividend yield with the chance to easily grow from its small-cap stature.
To help out your kids and grandchildren further, look for companies to invest in that have a history of returning value to shareholders with competitive advantages and high profit margins, or quality companies for short. Some holdings of one of my favorite funds, the GMO Quality fund, include Johnson & Johnson (NYSE: JNJ) and Coca-Cola (NYSE: KO) . Both companies typically have double-digit profit margins that held up well in the last recession, along with strong brands, worldwide operations, and dividend yields above 2.5%.
How the generational accounting works out is anyone's guess, but right now we can set up a plan to help out future generations for the best. For two other relatively easy buy decisions, including more information on investing in Coke, grab your copy of our free report: "3 Dow Stocks Dividend Investors Need."