The Commonwealth Government's Intergenerational Report 2002-03 claims that Australia's ageing population poses a serious challenge for responsible fiscal policy in the longer term, a claim repeated in subsequent official pronouncements. We reject this claim, pointing to its rhetorical nature and to the lack of systematic sensitivity analysis of many of the critical variables. We conclude that the ageing 'crisis' is largely mythical.
The definitive document setting out the official position on the 'ageing crisis' is the Intergenerational Report 2002-03, (1) circulated by the Commonwealth Treasury as 2002-03 Budget Paper No. 5. We shall draw heavily on it in this article, supplemented by a May 2004 address by the Secretary to the Treasury, Ken Henry, to a meeting of Australian Business Economists. (2) In March 2005 the Productivity Commission weighed in with a 403-page report plus appendices. (3) Soon after, the 2005-06 Commonwealth Budget (4) reiterated the ageing crisis theme, picked up on the Productivity Commission's report, and inaugurated the 'Future Fund'.
The Intergenerational Report claims that: 'a steadily ageing population is likely to continue to place significant pressure on Commonwealth Government finances ... The projections in this report suggest that, if policies are not adjusted, the current generation of taxpayers is likely to impose a higher tax burden on the next generation', amounting to five per cent of GDP by 2041-2. The Report emphasises that 'Governments will need to exercise sound policy management to minimise the tax burden transferred to the next generation, particularly if Australia is to keep its position as a lower taxing and spending country'. (5)
Evidence to support these claims is presented in the form of population projections, (6) which reveal a rapid increase in the 65-84 and 85 plus age-groups between 2002 and 2042, while the 15-64 age-group will grow only slowly and the 0-14 age-group will decline slightly in numbers. This will increase the 'children and aged to working-age ratio', as shown in Chart 14 of the Report. (7) 'With projected lower growth in the labour force and falling participation rates, annual employment growth could be significantly lower over coming decades', (8) reducing the growth in real GDP per person from an assumed 2.2 per cent per annum in the 2000s to 1.4 per cent or 1.5 per cent in the 2010s, 2020s and 2030s. (9) At the same time as output per person is decelerating, spending per person will rise more rapidly: 'Over half of Commonwealth Government expenditure is directed to health and aged care, the social safety net (payments to individuals and education). All of this spending is sensitive to demographic changes'. (10) Hence the looming fiscal crisis.
Not surprisingly, the Intergenerational Report has been cited in support of a number of contentious policy changes. These include: active discouragement of early retirement, which will almost inevitably culminate (as it already has in several European countries) in an increase in the age at which people become eligible for a state Age Pension; continued, and probably even tighter, means- and asset-testing of the pension itself; an increase in the 'preservation' age at which superannuants may gain access to their superannuation funds; large and extremely inefficient subsidies to private health insurance as a means of reducing public expenditure on health; dismantling labour market protections for employees through the 2006 WorkChoices legislation, which (it is claimed) will lead to accelerated productivity growth and higher employment rates; and the extension of the 'mutual obligation' principle to many of those in receipt of single parent and disability support payments, again justified in terms of the over-riding need to increase the labour-force participation rate.
In another paper we dissect the rhetoric that has been used in defence of these proposals, with particular reference to the concepts of 'fiscal sustainability, 'inter-generational equity' and the 'non-accelerating inflation rate of unemployment', or NAIRU. (11) In section 2 of the present paper we locate the kernel of truth inside the myth, and in section 3 we conduct some detailed sensitivity analysis to establish how large the problem really is. In the conclusion (section 4) we raise some important issues related to ageing that do not feature prominently in the official discourse.
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A KERNEL OF TRUTH
Although the rhetoric of the ageing 'crisis' is profoundly misleading, it would be a mistake to go to the other extreme and deny the existence of the real problems that are connected to demographic change. The population is ageing (see Figure 1); this will (ceteris paribus) reduce the working population as a proportion of the total population; and this in turn can be expected (again, ceteris paribus) to constrain the growth of output per person and to increase both government expenditure and taxation per person. Some very simple algebra can be used to summarise these propositions:
(1) Y/P = (Y/L)(L/WP)(WP/P)
where Y is output, L is employment, P is total population and WP is the population of working age. Thus Y/P is output per head of the population, a (very rough) proxy for living standards; (Y/L) is labour productivity; (L/WP) is the average participation rate for those of working age; and (WP/P) is the proportion of the total population that is of working age.
Equation (1) can be made more complicated by allowing for changes in average hours of work and for unemployment but, in its simple form, it does reveal the most important variables. If (WP/P) falls, (Y/P) will be lower than it would otherwise have been unless the effects of ageing are offset by increases in (Y/L) or (L/WP).
The fiscal implications can also be summarised:
(2) G/P =...