Canada's Looming Demographic "Fiscal Squeeze" - Christopher Ragan Clifford Clark Visiting Economist
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Canada’s Looming
Demographic “Fiscal Squeeze”
Christopher Ragan
Department of Economics
McGill University
and
Clifford Clark Visiting Economist
Finance Canada
Outline of Talk
1. The basic demographics of aging
2. A looming “fiscal squeeze”
3. Arithmetic thought experiments
4. A few thorny issues
5. Summary and final thoughts
2A declining fertility rate has reduced the population
growth rate ...
Population Growth, 1950-2040
Percent
3.5
Historical Projected
3.0
2.5
Current fertility
2.0 rate ~ 1.6 children
1.5
per woman
1.0
0.5
0.0
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040
Population Growth = Births + Net Immigration – Deaths
Source: Statistics Canada and Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.
3... which inevitably leads to population aging.
Distribution of the Population By Sex and Age Group
1970, Population: 21.7 M 2008, Population: 33.3 M 2040, Population: 41.2 M
90-94 90-94 90-94
75-79 75-79 75-79
60-64 60-64 60-64
45-49 45-49 45-49
30-34 30-34 30-34
15-19 15-19 15-19
0-4 0-4 0-4
8 6 4 2 0 2 4 6 8 8 6 4 2 0 2 4 6 8 8 6 4 2 0 2 4 6 8
percent of p opulation percent of p opulation per cent of population
Male Female Male Female Male Female
Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan and Statistics Canada.
4By 2040, Canada’s “providing ratio” will fall by half.
Ratio of people aged 15-64 to people aged 65+
(persons)
5
4
3
2
1
0
2008 2020 2030 2040
Source: Statistics Canada and Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.
5Aging will dramatically reduce the working-age share of
the population ...
Share of people aged 15-64 in Total Population
(percent)
75
Historical Projected
Entry of the baby boom generation Baby boomers gradually reaching
into the labour market. retirement age.
70
65
60
55
1966 1972 1978 1984 1990 1996 2002 2008 2014 2020 2026 2032 2038
Source: Office of the Chief Actuary’s 23rd Actuarial Report on the Canada Pension Plan.
6... and will also cause a shift toward groups with lower LF
participation rates …
LF Participation Rate by Age Group
(percent)
100
1998 2008
80
60
40
20
0
15 to 24 years 25 to 54 years 55 to 59 years 60 to 64 years 65 years and over
Source: Statistics Canada.
7… resulting in a reduction in the aggregate labour-force
participation rate.
Aggregate LF Participation Rate
(percent)
75
Historical Projected
70
Actual Trend
65
60
55
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020 2024 2028 2032 2036 2040
Source: Statistics Canada and Finance Canada calculations.
8Part 1 of the demographic “fiscal squeeze”
Declining LF participation rate:
Î reduced growth in real per capita GDP
(for given productivity growth)
Î reduced growth in per capita tax base
GDP/POP = (GDP/E) x (E/LF) x (LF/POP)
9The reduction in future labour-force growth.
Decomposition of Labour-Force Growth
(percent)
2.5
Historical Projected
2.0 Labour force of which:
Population 15+ contribution
1.5
Participation rate contribution
1.0
0.5
0.0
-0.5
-1.0
1971-1996 1997-2008 2009-2015 2016-2025 2026-2040
Source: Finance Canada calculations consistent with January 2009 average private sector forecast
10The reduction in real GDP growth.
Decomposition of Real GDP Growth
(percent)
4.0
Historical Projected
3.5
Real GDP of which:
3.0
Labour contribution
2.5 Labour productivity contribution*
2.0
1.5
1.0
0.5
0.0
1971-1996 1997-2008 2009-2015 2016-2025 2026-2040
* Assumes future labour productivity continues to grow at the average annual rate experienced between 1997 and 2008 (1.3%)
Source: Finance Canada calculations consistent with January 2009 average private sector forecast
11Part 2 of the demographic “fiscal squeeze”
1. Need for more public spending:
Health-Care Spending
Elderly Benefits
2. Offsetting effects expected to be small:
Education, children’s benefits and some
social services
12Not surprisingly, per capita health-care expenditures rise
rapidly in later years of life ...
Per Capita Provincial-Territorial Public Health Spending by Age Group, 2006
(thousands of dollars)
20
15
10
5
0
0-14 15-24 25-34 35-44 45-54 55-64 65-74 75-84 85+
Source: CIHI.
13... but “other factors” (than aging) will also contribute
to rising health-care costs.
Increase in Public Health Spending Spending pressures will likely come from
(percent of GDP) income growth and the development of
3.0 advanced (and costly) new treatments.
2.5
Contribution from other factors
2.0
Contribution from aging
1.5
1.0
0.5
0.0
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Source: OECD cost pressure scenario and author’s calculations.
FYI: Total spending on health care increased from 5.4 to 7.5 percent of GDP
between 1975 and 2008.
14Rising elderly benefits will also put upward pressure on
government spending as the population ages.
Increase in Elderly Benefits
(percent of GDP) Taken together, health and elderly benefits will add
roughly 3.5 percentage points of GDP to public
0.8 spending between 2020 and 2040!
0.6
0.4
0.2
0.0
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Source: Chief Actuary (scenario: benefits rates indexed at inflation plus 60% of the assumed real wage growth) and author’s calculations.
15We can view the fiscal squeeze in terms of the growing
divergence between per capita spending and tax revenues
per capita G and T G/POP
… but spending will grow faster
due to health-care costs. “Fiscal
Squeeze”
T/POP
Growth rate of tax revenues will
fall (but will still be positive) …
100
2020 2030 2040
G/POP = (G/GDP) x (GDP/POP)
Hold this constant
T/POP = (T/GDP) x (GDP/POP) 16What (non fiscal) polices are available to Canadian
governments to deal with this challenge?
1. Increase immigration rate?
2. Increase fertility rate?
3. Increase labour-force participation rate?
4. Restrain the growth of health-care spending?
5. Increase the productivity growth rate?
(more on this later)
17What broad fiscal choices are available?
1. Restrain non-age-related spending
2. Increase tax rates (or the “tax burden”)
3. Defer the problem
Î increase borrowing (debt)
18Can these costs be absorbed purely through debt?
Spending and Revenue Paths From 2020 to 2040
(percentage points of GDP)
4
3
Spending
Health
2 Spending
and
~ 35 p.p. Increase in FPT Elderly
Debt-to-GDP Ratio Benefits
1
(3.5 p.p.)
0
Revenue
-1
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Source: OECD, CIHI, and author’s calculations.
19For Canadian governments, this would mean a return to
the high-debt situation of the mid 1990s.
FPT Debt-to-GDP Ratio
(percent)
100
Historical Projected
80
Debt Ratio Constant High Debt!
at its 2009-10 level
60
40
20 Suppose we want to impose a
“debt ceiling” at 60%.
0
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Source: Author’s calculations.
20Many alternatives to stay under this “debt ceiling”:
#1. “Front-loaded” debt-reduction strategy:
Î Further reducing debt before the full impacts of aging
materialize
#2. “Back-loaded” fiscal-adjustment strategy:
Î Restrain non-age-related spending and/or increase taxes as
the impacts of aging materialize
#3. Many others …
21#1: Front-Loaded Debt-Reduction Strategy
FPT Debt-to-GDP Ratio
(percent)
90
Historical Projected No Action
80
Front-Loaded Debt Reduction
70 Strategy
60
50
40
30
20
25 %
10
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Source: Author’s calculations.
22But this requires considerable fiscal discipline over the
next decade by all levels of government.
FPT Budget Balance
(billions of dollars) The required budget surpluses
60 depend on future GDP growth!
40
20
0
-20
3 % GDP Growth: $41 B Surplus per Year
-40
3.5 % GDP Growth: $39 B Surplus per Year
-60 4 % GDP Growth $36 B Surplus per Year
-80
2009-10 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020
Source: September Update of Economic and Fiscal Projections, provincial-territorial Public Accounts and author’s calculations.
23#2: Back-Loaded Fiscal-Adjustment Strategy
Fiscal Adjustments between 2020 and 2040 As shown, the policy mix is 29% on
G, 29% on T, and 43% on debt.
(percentage points of GDP)
3.5
Spending Cuts
2.5
1.5 3.5
p.p. p.p.
1.5 ~ 15 p.p. Increase in FPT Debt-
to-GDP Ratio
0.5
-0.5 Revenue Increases
2020 2022 2024 2026 2028 2030 2032 2034 2036 2038 2040
Source: Author’s calculations.
24This alternative also honours the “debt ceiling”, but does
not avoid the need to make difficult decisions.
Federal-Provincial-Territorial Debt-to-GDP Ratio
(percent)
No Action
90
Back-Loaded Spending Reduction Strategy
80 Front-Loaded Debt Reduction Strategy
70 Historical Projected
60
50
40
30
20
25 %
10
1995 2000 2005 2010 2015 2020 2025 2030 2035 2040
Which decisions? Tax burden increases by 1 pp of GDP and total
Source: Author’s calculations.
spending falls by 1 pp of GDP between 2020 and 2040.
25A Key Difference?
1. Both approaches honour the “debt ceiling”
and both involve making difficult decisions.
2. But they have very different implications for
intergenerational equity.
3. Who “should” pay for the baby-boom
generation’s old-age health care?
26A Few Thorny Issues
1. Aren’t we getting steadily richer?
2. Would higher productivity growth help?
3. A Federal-Provincial Dimension?
27#1: Won’t our growing income provide the resources
necessary to finance these health-care costs?
1. I have already assumed a baseline rate of
productivity growth (1.3% p.a.).
2. So, it is true that real living standards are rising
throughout the projection period.
3. But I have also assumed a constant tax burden
(in option #1) or a rising tax burden (option #2),
so these rising incomes are already built into tax
revenues.
4. So the size of the challenge is not overstated.
28#2: Can a higher productivity growth rate help ease
the fiscal squeeze?
1. Yes -- subject to some important caveats:
2. How will increases in GDP translate into greater
demand for health-care (and other) spending?
Is the income elasticity for health care > 1?
3. Will governments be able to restrain the spending
pressures created by income growth?
29Impact of higher productivity growth on revenues and
spending as shares of GDP
Change in ppts of GDP
If G/GDP falls as productivity growth
rises, the fiscal squeeze will be eased.
G/GDP
3.5
“Fiscal
Squeeze”
T/GDP
0
2020 2030 2040
Crucial question: As GDP rises more quickly, which elements of public
spending will be unaffected, so that G/GDP falls?Some possible effects of higher productivity growth on
the fiscal squeeze:
Additional productivity growth rate required to keep the debt ratio
below the 60% ceiling (with no change in the tax burden)
If age-related spending is unaffected
~ 0.4 percentage points
by higher productivity growth:
If all public spending is unaffected
~ 0.2 percentage points
by higher productivity growth:
Recall that baseline productivity growth is assumed to be 1.3 % per year.
31#3: The Federal-Provincial Dimension
1. Provision of direct health-care services is a provincial
jurisdiction.
2. The federal government plays an important role,
especially through federal transfers and its responsibility
for providing health-care services to special groups.
3. How will the coming fiscal squeeze be shared between
the two levels of government?
32Summary and Final Thoughts
1. The coming demographic forces will lead to much
higher spending on “age-related” items.
2. We must adjust to this increase in spending – but how?
3. Regard to intergenerational equity suggests reducing
the debt ratio well ahead of 2020.
4. But this means a fairly rapid return to a balanced
budget, followed by substantial budget surpluses.
5. How do we maintain public support for such surpluses?
33Summary and Final Thoughts
6. Apart from debt reduction, there are several actions that
governments can take:
7. Restraining spending and/or increasing taxes in the
future is another approach.
8. Policies aimed at increasing the LF participation rate
can play a role (eg., immigration, retirement, etc..).
9. Faster productivity growth will:
1. certainly be good for living standards
2. probably help to ease the fiscal squeeze
34Questions?
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