The age profile of income and the burden of unfunded transfers in four countries: Evidence from the Luxembourg Income Study

This paper uses micro-census income data from the Luxembourg Income Study (LIS) to measure the current and future burden of financing public transfers, especially benefits supporting the aged and near-aged. The analysis distinguishes between income obtained from households' own saving and labor earnings, on the one hand, and the part financed with unfunded transfers, on the other. The burden of unfunded transfers is defined as the tax on factor income that is needed to pay for such transfers under a balanced budget rule. The paper develops a framework for estimating and forecasting this burden using micro-census reports on the current age distribution of factor incomes, the age distribution of transfer incomes, and U.S. Census Bureau projections of the future age structure of the population. Because survey data are inaccurate and incomplete, the micro-census income reports are adjusted to reflect under-reporting based on estimates of aggregate income from the national income and product accounts. Empirical estimates of current and future tax burdens are derived for four OECD countries. These show that the burden of German and U.S. transfers is unusually sensitive to the effects of an aging population. In contrast, the burden of public transfers in Finland and Britain is less sensitive to the effects of an older population because transfers in those countries are less heavily tilted toward aged beneficiaries. Factor incomes received by aged Americans are high by international standards, providing a partial offset to the sharp tilt of U.S. transfers in favor of the elderly. As the U.S. population grows older, factor incomes will decline more gradually than is the case in other rich countries, helping to maintain the size of its tax base.