No, economic growth won't save us from the increasing fiscal costs of population ageing

Last week I wrote a post about ageing and creating tax incentives for older people to work longer. The impetus for the tax incentives is the projected increase in the older population, and reductions in support ratios (the number of working people for each older person). However, the issue may not be as bad as assumed by most people (including me).

This new article by Ian McDonald (University of Melbourne), published in the journal Australian Economic Review (sorry I don't see an ungated version online) tells a different story. McDonald first outlines the problem:

The likely prospect of an ageing population, that is, an increase in the share of old people in the population, will put upward pressure on the level of government expenditure in the future. High government expenditures per old person multiplied by the increase in the proportion of old people in the population will drive an increase in government expenditure. This is a major fiscal challenge which we are starting to experience.

He then goes on to summarise projections of government spending, based on assumptions about population growth, and an assumption of unchanged government policy (which is a standard assumption - we can't easily forecast what future government policy may be). He finds that various projections (by McDonald himself, and others):

...suggest that an increase in government spending due to the ageing population somewhere in the range of 4.9–7.8 percentage points of GDP over the 40‐year period seems to be a reasonable projection assuming unchanged government policy.

So, essentially the government would need to either increase spending by 4.9-7.8 percentage points of GDP. McDonald seems to suggest this is not a big deal, but given that government spending in Australia is around 40 percent of GDP, that would entail a 12-20% increase in government spending. That means taxes would need to be 12-20% higher than currently, or government services (or service quality) would need to be cut to compensate for the extra spending.

McDonald's argument that the costs are not prohibitive rests on this:

The prospect of an increasing proportion of old people raises the spectre that our continuing support will be impossible. However, this fear ignores the fact that because of the continuing growth of labour productivity, we who will finance this support will be better off than we are today and will indeed be well able to support older people.

Specifically, he finds that the increase in government spending required for the ageing population is dwarfed by the increase in GDP itself. I don't find this argument entirely persuasive, because if taxpayers were happy to give up some proportion of their income growth in higher taxes, the government could do that right now. In fact, governments tend to be moving in the opposite direction, decreasing taxes even though income per capita is increasing. That suggests that there is already an unwillingness, either by taxpayers or by government, to increase taxes to offset increased costs due to ageing.

I don't think you can just wave your hands, cite 'economic growth', and 'poof!' - all problems relating to the increasing costs of an ageing population disappear. And that appears to be what McDonald is doing. Which is disappointing - I usually like the 'For the Student' section of the Australian Economic Review, but this is one article that falls short of the mark.