Designing prudent fiscal policy that treats successive generations equitably requires estimates of how population ageing will affect government social expenditures. One way to derive estimates is to start with age-specific expenditure levels and calculate how overall expenditure levels vary in response to changing age structures. Substantial progress has been made in this area (Creedy 2002, Dang, Antolin and Oxley 2001, Foote and Spoor 2001, Woods 2000). A complementary approach is to examine the effect on the policy process of increases in the population share of older people. The conventional view is that an increase in the number of older voters will create strong pressures for increased social spending.
Razin, Sakda, and Swagel (2002) cast doubt on this view. Razin et al present a model of how changes in dependency rates affect social expenditures via their effect on the interests of the median voter. They show that, under some parameter settings, an increase in dependency rates can lead to a decline in per capita social expenditures. They also present results from a regression analysis, based on panel data for the United States and 12 European countries, suggesting that per capita social expenditures are indeed negatively correlated with dependency levels.
This paper argues, however, that Razin et al’s approach needs to be extended to allow slightly more demographic detail. Neither Razin et al’s model nor their empirics distinguish between old-age dependency and youth dependency. As with many overlapping generations models, the model contains only two age groups: young workers and old dependants. Razin et al’s empirical analysis carries over the use of one working and one dependent group, with the dependent group including both young and old.
Using data supplied by Razin et al, I have repeated their empirical analysis, but with dependency disaggregated into youth and old-age components. The revised analysis suggests that taxes and transfers are negatively correlated with youth dependency but positively correlated with old-age dependency. This finding can be reconciled with an extended version of Razin et al’s theoretical model.
The first two sections of this paper describe Razin et al’s theoretical model and empirical results. The third section describes a new analysis. The final section discusses the implications.