2  Intergenerational distribution of the national consumption burden of ageing through fiscal policy

Much of the projected fiscal cost pressures in New Zealand are attributed to population ageing (see Section 4 for numbers). Popular discussion of the costs of population ageing tends to conflate the national economic burden of ageing with the fiscal costs of ageing. The former refers to the effect of ageing on national consumption per capita over time, which occurs through the effects on the support ratio, labour productivity and the consumption share of GDP.

2.1  Concepts

The fiscal costs of ageing refer to the extent to which government revenue falls and/or expenses (including transfer payments) rise under current policies, that is, under existing age-specific public consumption expenditures and tax rates. The way the government responds to these fiscal costs - its fiscal policy - determines the division of the national consumption cost between public sector consumption and private sector consumption, and intergenerationally (between present and future taxpayers). If the government adopts a balanced budget response by progressively raising tax rates or cutting spending, then the fiscal costs of ageing are borne by taxpayers on a Pay-As-You-Go (PAYG) basis. If the budget goes into deficit the consumption burden of ageing is back-loaded onto future taxpayers. If the government prepays the fiscal costs of ageing by running budget surpluses then the fiscal cost is front-loaded onto current generations. The fiscal adjustment in any given year can be met by: (i) cutting public consumption and/or increasing transfers; or (ii) raising taxes and/or reducing transfers. Figure 1 illustrates the three fiscal policy responses just described. Cutting consumption and increasing transfers falls on contemporaneous[2] generations of households.

Figure 1 - Intergenerational allocation of the national consumption burden of population ageing through fiscal policy

The intergenerational effect of raising taxes depends on the extent to which the tax increases reduce investment as well as consumption (an issue not pursued further here).

The relationships between current and future consumption, and private and public consumption, can be seen more clearly from national accounting relationships as follows. Let national income be the sum of labour income and capital income:

and define national consumption as national income minus national saving:

where, NI is national income, C is national consumption consisting of private consumption and public consumption, S is national saving, w is the average wage rate, L is labour supply, r is the interest rate, and W is national wealth which is defined as capital stock (K) minus net foreign liabilities (D). Substituting and rearranging, national consumption per capita is

The consumption burden of ageing refers to the impact on C/N through the right hand side variables in (3).[3] The most obvious and probably largest effect is the decline in the support ratio, L/N (discussed briefly below).

Fiscal policy can shift the consumption burden of ageing to future generations by running budget deficits, which arises from attempting to maintain public consumption and/or existing tax revenue as a share of GDP. This reduces national saving per worker (S/L) which, from (3), allows (C/N) to be higher. However lower saving reduces national wealth per worker, (K-D)/L, by either crowding out private investment (which reduces the capital stock, K/L) or increasing the current account deficit (which increases foreign liabilities, D/L). A lower capital stock lowers output and therefore future consumption possibilities. Higher foreign liabilities require higher debt servicing costs which also lowers the future consumption possibilities. In the opposite case, fiscal policy can shift the consumption burden of ageing to current generations by running initial budget surpluses which raises national saving and hence national wealth, allowing higher future consumption at the expense of current consumption. A middle path is to spread the consumption burden more evenly among generations through a balanced budget response to ageing.