Demographic apocolypse 2020?

Pierre Fortin, who I usually find to be an interesting economic commentator on public policy issues, makes the case for demographic apocolypse. i used to share that fear, but I’ve done some number crunching on this issue in the BC context (i.e. more seniors than the national average) and am not convinced that the problem is as large as Fortin is making out.

Let’s take a closer look at Fortin’s commentary in the Toronto Star:

Baby boomers born between 1945 and 1960 are now between 45 and 60 years old. In 15 years, in 2020, they will be 60 to 75 years old. Most of them will have begun their retirement. Just as they entered the job market en masse between 1960 and 1980, they will leave it in large numbers between now and 2025. They will hardly be doing any work and they will not be paying many taxes. (The money they withdraw from their RRSPs will be taxable, but that really does not change the big picture.)

The consequence is obvious: Our governments will be cash-strapped.

a.. Fewer tax revenues.

This year, 51 per cent of Canada’s total population is working. In 2020, when the baby boomers’ departure will be well underway, only 49 per cent of the population will be working, if employment rates by age remain stable. The overall employment rate will thus have dropped two points from 51, the equivalent of a 4 per cent drop.

What will the impact be on government tax revenues? We can calculate how much governments would have lost in 2006 if the number of taxpayers had suddenly dropped by 4 per cent. Since Canadians will pay $500 billion in income and other taxes this year, our governments would have collected $20 billion less (4 per cent of $500 billion). But that’s not all.

OK, so the lost tax revenues will be about the size of the pre-Harper tax cuts federal surplus. I’m not worried yet. Plus, it seems likely that our healthier boomers, many of whom do work that they like, will not retire en masse to sit at home and collect their pensions. Many will want to work part-time. Moreover, a good child care program would enable many more women to enter the labour force. I think assuming a drop in the participation rate is problematic.

a.. More health-care spending

The passage of this large group of baby boomers into their golden years will push the percentage of senior citizens 65 years of age and older from 13 per cent of the total population in 2006 to 18 per cent in 2020. A senior citizen costs, on average, five times more in terms of health-care costs and social services compared with a younger adult. As a result, between now and 2020, there will be a 14 per cent increase in annual provincial spending in health care and social services – above and beyond the already extremely rapid increase in spending over the past several years (on average 7 per cent per year since 2000).

Once again, a simple way to comprehend the financial import of this demographic shock is to calculate the impact of a 14 per cent increase in provincial health care and social services spending in the year 2006. Given that total spending in these two areas will reach $112 billion this year, the 14 per cent increase would add $16 billion to the pressure on provincial finances (14 per cent of $112 billion).

Fortin’s numbers are consistent with what health care economists have estimated over the years: the cost of population aging is about one percent per year. This is much less than inflation in the health care system, and I would argue, easily manageable. The demographic changes coming will happen gradually not as a cliff we fall off one day. The real health care challenge, however, is the impact of new technology (drugs, diagnostics, surgical procudures, etc).

So 14% sounds large but this is by 2020. Assuming modest annual GDP growth of 4% per year (2% growth plus 2% inflation), our incomes will be 56% higher in 2020 (and lazy me, I did not compound the growth rates, so think closer to 60%). I’m still waiting for the punchline.

a.. More payments to seniors.

Another government program that is going to suffer the effects of the aging baby boomer population is federal payments to seniors, including the venerable “old age pension” and the guaranteed income supplement for lower-income seniors.

With 13 per cent of the population currently 65 years of age or older, the federal government expects to spend $31 billion in payments to seniors in 2006. If this percentage were to suddenly jump five points to 18 per cent, as is expected for the year 2020, Ottawa would have to come up with $12 billion more in 2006.

Will the aging of the Canadian population allow at least some savings? Yes, in the areas of children’s benefits, child-care allowances and education funding.

According to the average birth-rate and immigration scenario put out by Statistics Canada, the relative weight of young people (0-19 years old) in the total population will drop by 13 per cent between 2006 and 2020. School enrolment will decline accordingly.

This is where it gets more interesting. For BC, the “dependency ratio” which is the ratio of the 0-17 demographic plus the 65+ demographic divided by the 18-64 working age population will rise over the next three decades. From a ratio of 0.51 today, it will rise to 0.57 in 2020 and then to 0.66 in 2031.

The last time the ratio was as high as 0.66? Um, 1975, and prior to that it was even higher. In 1971 it was 0.74. So the numbers we are dealing with are well within the realm of historical experience, and we have lots of time to respond. True, now the “dependency” is dominated by seniors rather than children, but let’s not drive ourselves crazy.

This will permit proportional reductions in federal children’s benefits and provincial education and daycare spending. In 2006, the combined value of all these expenditures on children and students is $79 billion.

If these expenses dropped suddenly by 13 per cent, governments would save $10 billion.

Will the demographic transition threaten the viability of our public pension plans? No. To avoid any slips due to demographic shock waves, the various levels of government proactively revised the structure of the Canada Pension Plan and the Régime des renters du Québec some time ago. The general contribution rate was upped to 9.9 per cent of insurable earnings in 2003.

This rate will only need a slight increase to permit adequate financing for retirement income of baby boomers and their children for the foreseeable future.

The tab: $38 billion.

Of course, $38 billion is a lot of money to you and me. But Canada’s economy is $1.4 trillion, so this amounts to 2.7% of our total GDP. Over the past few years tax cuts have reduced government revenues from around 37% of GDP to 33% of GDP, a drop of 4 percentage points, or a larger amount that is required by Fortin.

And this is all happening 14 years from now. If total incomes rise by 2% per year in real terms (keeping things in 2006 dollars to be consistent with the $38 billion number) this is an increase in GDP of 28%, or $392 million. So we would have to dedicate 10% of that incremental income to be sure that we could pay for the boomers. I’m still not worried, as long as good public policies are put in place.

Fortin’s solution is debt reduction, one that I do not agree with, but then I disagree that there is a problem. The issue of debt reduction is all about the rate of return on alternative public investments. If we put our money instead into an early learning and child care program, I think we will realize greater returns in terms of outcomes for today’s children (do it for the children!) and for women (mothers) being better able to have a healthier relationship with the labour force. Any public education investment will garner higher rates of return than simple debt reduction.

Financially, governments have three options: go back into debt (the Japanese approach), cut or privatize public services (the U.S. approach) or raise taxes (the Swedish approach). Each government will choose the combination that best matches its political philosophy.

But in Ottawa, just as in the provinces, we cannot exclude the possibility of a new cycle of debt. A funding crisis could lead, more quickly than one might think, to a major transformation of our cherished health system. And we had better forget about major tax reductions for quite some time.

Growth and solidarity

Governments can implement two main kinds of policies to deal with the demographic shock: a policy of economic growth and a policy of intergenerational solidarity.

They can accelerate economic growth in the usual ways – fight unemployment and poverty, support employment of older workers, accelerate the integration of immigrant workers and foster education, entrepreneurship, savings, investment, innovation and productivity. Stronger economic growth will reduce the effects of overall economic decline and tax revenue losses due to the disappearance of the baby boomers.

Also, governments can try to protect new generations from debt, program spending cuts and tax hikes by convincing current generations to proactively share the tab.

This policy of solidarity between generations would be based on the repayment of public debt. A reduction of debt financed by today’s taxpayers will reduce interest charges paid by the taxpayers of tomorrow, who will therefore have more money to access the same level of public services as today, without being forced to overly add to their tax burden.