The Great Demographic Shift

The young helping the old

In Canada in 2015, an interesting thing occurred that had never happened before. The number of people older than 65 began to exceed the number of people under fifteen. What’s more, the government projects that this divergence will increase for the foreseeable future. By the mid-2030s, the elderly could outnumber the kids by more than 50%.

This development is more than just trivia. I think it’s quite important, likely to affect our lives significantly in the future. For all of history, the elderly have been greatly outnumbered by the young. Our world has been built around this invariant. So what happens when things change?

Pensions collapse

Governments don’t save money in the same way that people save money. Or even the way businesses save money.

When a business runs a pension fund, it typically has to ensure that the pension is fully-funded. In other words, it has to contribute enough to ensure that all payouts of all the members can be met. If it looks like it doesn’t have enough assets in the pension fund, it has to contribute money to the pension, lowering the earnings of the business.

Government pensions, on the other hand, tend to be more like Ponzi schemes. Under their “pay-as-you-go” strategy, the government does not invest the money you contribute to your pension on your behalf. Instead, they give that money to the people who are collecting their pensions today. Thus, most government pensions are pyramid schemes where new “investors” are used to pay off the old “investors”. (Yes, this is the same thing that landed Bernie Madoff and many others in prison.)

It’s ridiculous, but historically, it’s worked. With dozens of workers for every pensioner, there has always been enough money to pay the bills. It’s a pyramid scheme, but it is one that has achieved the goal because the bottom of the pyramid has always been far broader than the top.

And this is where demographics can really mess things up. If you only have a few workers supporting each pensioner, the math falls apart. So, when the elderly outnumber the kids, you start to have a problem.

Canada’s solution

Luckily, Canada doesn’t actually use a pay-as-you go system. Rather, it uses a “steady state” system where contribution rates are set at levels that are sufficient to fund the system on a long term basis (75 years). Thus, in the decades with better ratios–more workers and fewer pensioners–the pension fund pulls in more contributions than it needs to pay out immediately, thereby accumulating reserves. Then, when the ratio worsens, it takes money out of the reserves.

This system isn’t as conservative as the system businesses use. If nobody new were to join the Canadian Pension Plan, then the reserves and future contributions of workers already in the system aren’t sufficient to pay the pensions. They’re over $800 billion short.

But new people will join the pension plan, which should make the combination of the contributions and reserve fund sufficient for the next 75 years.

That’s not to say that contribution rates won’t increase with these demographic shifts. If the number of elderly increases in proportion to the number of workers, the contribution rate will need to gradually increase. But it won’t be a huge, panicked, “we’re out of money” increase that could happen with some pay-as-you-go systems. Instead, it will be a slow increase as Canadian demographics change within the 75-year sliding window.

The medical bills

Thus, the big economic issue for Canada might not be pensions, but rather the cost of healthcare. The elderly tend to have more medical issues than the young. Only about 11% of Canadians die before they’re 65. And roughly a quarter of lifetime healthcare costs occur during the last year of life.

Canada, of course, has socialized medicine. Healthcare spending is about 38% of provincial budgets. Thus, this sort of demographic shift is quite problematic from an economic perspective. The increase in healthcare costs will likely function like a pay-as-you-go pension system since health insurance premiums aren’t going into a fund to pay your future costs, but rather are used to pay off the expenses of others today. So, with this demographic shift, we’re likely to end up with too few workers paying for the healthcare costs of too many elderly.

Luckily, a simple solution is presented in a 1976 movie called Logan’s Run….

Death and taxes

No, actually, exterminating anyone over the age of 30 isn’t a great solution. Because I am over the age of 30.

Debt isn’t a good option either. Canada’s provincial governments’ debts have already been increasing for decades. Rather, the solution is likely to involve higher taxes and fees.

British Columbia, for example, has about $46B in revenue and the government claims that the budget will be close to balanced. The government will spend about $17.5B of that revenue on healthcare, about the same as the 38% that is spent nationally.

Now, let’s suppose that that, over the long term, demographics cause that number increase by 50%. That would mean that we’d need about another $9B in revenue.

If you look at BC’s provincial budget, personal income taxes bring in about $7.8B. Corporate taxes are $2.4B. Sales taxes are $6.2B. Fuel and carbon taxes are about $2.1B. Health insurance premiums are about the same. Health transfers from the federal government are about $6.1B.

The total of all of these numbers is $26.7B. So, the $9B in revenue we’d need (admittedly a number that has no basis, just a guess) could be achieved by increasing these taxes and fees by about a third.

The bottom line

Is such an increase doable? I would guess so. I don’t think people would like it. But I also don’t think they’d like the idea of letting Grandma die because those green pills she devours are just too darn expensive.

I’m certainly willing to pay my share, particularly if the taxation is designed to add to the costs of those who create negative externalities. For instance, carbon taxes would be a nice way to start closing the gap.

Thus, I think there is a solution to the two key tax-related issues that will arise with this demographic shift. In a future blog, I will discuss other changes that may occur as the elderly start outnumber the young.

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