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Canadas Looming Fiscal Squeeze Essay

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a Macdonald-Laurier Institute Publication

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Canada’s Looming Fiscal Squeeze UPdated

the oldest babyboomers reach 65 this year.
in order to avoid a return to the high-debt situation of the mid 1990s, canadians and their governments must soon begin thinking in a systematic and critical way about their long-term fiscal priorities.

By Christopher Ragan
revised version, March 2012

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Christopher Ragan: Canada’s Looming Fiscal Squeeze

“True North in Canadian Public Policy”
Board of Directors
Chair: Rob Wildeboer, chairman, Martinrea international inc., Toronto Managing Director: Brian Lee Crowley, former clifford clark visiting economist at Finance canada Secretary: Lincoln Caylor, Partner, Bennett Jones, Toronto Treasurer: Martin MacKinnon, cFo, Black Bull resources inc., halifax; Directors: John Beck, chairman and ceo, aecon construction Ltd., Toronto; Erin Chutter, President and ceo, Puget ventures inc., vancouver; Navjeet (Bob) Dhillon, ceo, Mainstreet equity corp., calgary; Keith Gillam, former ceo of vanBot construction Ltd., Toronto; Wayne Gudbranson, ceo, Branham Group, ottawa; Stanley Hartt, chair, Macquarie capital Markets canada; Les Kom, BMo nesbitt Burns, ottawa; Peter John Nicholson, former President, canadian council of academies, ottawa; Rick Peterson, President, Peterson capital, vancouver; Jacquelyn Thayer Scott, past President & Professor, cape Breton University, sydney. Fasken Martineau, Toronto; Maurice B. Tobin, the Tobin Foundation, Washington dc.

Advisory Council
Purdy Crawford, former ceo, imasco, now counsel at osler hoskins; Jim Dinning, former Treasurer of alberta; Don Drummond, economics advisor to the Td Bank, Matthews Fellow in Global Policy and distinguished visiting scholar at the school of Policy studies at Queen’s University; Brian Flemming, international lawyer, writer and policy advisor; Robert Fulford, former editor of Saturday Night magazine, columnist with the National Post, Toronto; Calvin Helin, aboriginal author and entrepreneur, vancouver; Hon. Jim Peterson, former federal cabinet minister, now a partner at

Research Advisory Board
Janet Ajzenstat, Professor emeritus of Politics, McMaster University; Brian Ferguson, Professor, health care economics, University of Guelph; Jack Granatstein, historian and former head of the canadian War Museum; Patrick James, Professor, University of southern california; Rainer Knopff, Professor of Politics, University of calgary; Larry Martin, George Morris centre, University of Guelph; Christopher Sands, senior Fellow, hudson institute, Washington dc; William Watson, associate Professor of economics, McGill University.

The Macdonald-Laurier Institute exists to:
• Initiate and conduct research identifying current and emerging economic and public policy issues facing canadians, including, but not limited to, research into defence and security, foreign policy, immigration, economic and fiscal policy, canada-Us relations, regulatory, regional development, social policy and aboriginal affairs; Investigate and analyse the full range of options for public and private sector responses to the issues identified and to act as a catalyst for informed debate on those options; Communicate the conclusions of its research to a national audience in a clear, non-partisan way; Sponsor or organize conferences, meetings, seminars, lectures, training programs and publications using all media of communication (including, without restriction, the electronic media), for the purposes of achieving these objects; Provide research services on public policy issues, or other facilities, for institutions, corporations, agencies and individuals, including departments and agencies of canadian governments at the federal, provincial, regional and municipal levels, on such terms as may be mutually agreed, provided that the research is in furtherance of these objects.

• • •

Table of ConTenTs
Executive Summary................................................................................... 2 Sommaire .................................................................................................. 5 Introduction ............................................................................................. 8 Some Basic Demographic Projections....................................................... 9 declining Fertility, rising Life expectancy ......................................9 The inevitable aging of the Population..........................................10 declining Labour Force Participation ...........................................11 declining Growth of Material Living standards ...........................13 The Looming Fiscal Squeeze ................................................................... 15 slowing Tax revenues ..................................................................15 accelerating age-related spending................................................16 Two illustrations of the Fiscal squeeze ...........................................19 The dynamics of debt ..................................................................21 a return to the debt Wall? ...........................................................22 Federal-Provincial Tensions............................................................23 Non-Fiscal Solutions to the Fiscal Squeeze? ............................................ 24 increasing immigration .................................................................24 increasing Labour Force Participation............................................25 increasing Fertility rates ...............................................................26 restraining the Growth of healthcare spending ............................27 Faster Productivity Growth............................................................28 an inconvenient Truth ..................................................................28 Difficult Fiscal Choices ........................................................................... 29 The challenges of Fiscal adjustment .............................................30 intergenerational equity ................................................................31 Final Remarks ......................................................................................... 31 References ............................................................................................... 33

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executive Summary
This paper assembles a collection of increasingly familiar demographic projections and draws the not-sofamiliar implications for the fiscal challenges to be faced by future canadian governments. The emphasis is on the rising share of national income to be devoted to publicly provided healthcare and seniors’ benefits, and the increase in public debt that will occur if future governments do not adjust their spending programs or tax rates. The paper concludes that in order to avoid a return to the high-debt situation of the mid 1990s, canadians and their governments must soon begin thinking in a systematic and critical way about their longterm fiscal priorities. during the baby boom that followed the second World War, the average fertility rate in canada was 3.6 children per woman. Partly due to the increase in women participating in the canadian labour force, canada’s fertility rate dropped to 1.7 children per women by 2007. This change in the fertility rate is expected to continue to slow the population growth rate. Thanks to healthier lifestyles and improved technology, the average life expectancy of a canadian has risen from 68.5 years in 1951 to 80.5 years in 2006. The combination of fewer younger people entering the population and the current population living longer will act together to increase the average canadian’s age over the next few decades.

For the next twenty years there will be an inexorable decline in the working-age share of the population.

The aging of the baby boom resulted in a significant increase in the working-age share of the population, from 58 percent in 1962 to about 69 percent in the early 1980s. The youngest baby boomers came of age in the early 1980s, and in the subsequent three decades there were no significant changes in the working-age share of the population. But the oldest baby boomers reach 65 in 2011, and so for the next twenty years there will be an inexorable decline in the working-age share of the population, a decline that roughly mirrors the increase from thirty years earlier. With the ongoing aging of canada’s baby-boom generation, a growing fraction of the population will fall into these older age categories, thus reducing the economy’s overall labour force participation rate. The overall participation rate is projected to decline from over 67 percent today to below 61 percent by 2040, even with the assumption that age-specific participation rates increase by up to 4 percentage points between now and 2030, and remain constant thereafter. The falling labour force participation rate will cause a decline in the future growth rate of average living standards, as measured by real per capita GdP, leading to two policy conclusions. First, productivity growth is likely to account for more than 100 percent of growth in real per capita GdP over the next few decades, meaning that canadians and their governments must take seriously the issue of increasing productivity. second, the reduction in the labour force participation rate taken by itself will reduce the growth rate of real per capita GdP (for any assumed productivity growth rate) and thus reduce the growth rate of canadian governments’ per capita tax base.

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Christopher Ragan: Canada’s Looming Fiscal Squeeze

The aging of the canadian population will force canadian governments to face a significant two-part fiscal challenge. First, the aging of the population will lead to a slowing of national income, the primary tax base for governments, thus slowing tax revenues. second, key canadian public spending programs will become more costly as a share of GdP, especially those providing healthcare and income support for the elderly, even as the tax base slows considerably. confronting this fiscal challenge will likely create political tensions between provincial and federal governments and will force governments at all levels to make some difficult fiscal decisions. confronted with spending demands that rise faster than tax revenues, future canadian governments will be faced with three broad choices. First, they can attempt to reduce the growth rate of overall spending. second, they can attempt to increase the growth rate of revenues through increases in tax rates. Finally, they can choose to increase their public borrowing. of course, the third option is not a permanent solution since the debt eventually needs to be repaid and such repayment ultimately requires a command over resources, which in turn requires either spending reductions or increases in tax revenues. in the hypothetical situation in which future governments do not make any adjustments in spending or taxation but instead merely increase their borrowing, canada’s net public debt is projected to increase by between 25 and 50 percentage points of GdP by 2040. The net public debt-to-GdP ratio was approximately 92 percent in 1996, and canada was then seen by the international Monetary Fund (iMF) and others as having a serious fiscal problem. The failure to tackle the problem very soon would mean hitting the “debt wall”, with implications for declining access to global capital markets and rising domestic interest rates, just as we are now seeing in some european countries. The federal and provincial governments embarked on programs of significant fiscal consolidation. These actions, which quickly turned large annual budget deficits into modest budget surpluses, combined with a healthy economic recovery to produce a rapidly declining debt-to-GdP ratio. By the beginning of the 2008-09 financial crisis, the overall debt ratio was 37 percent of GdP, and as of the fall of 2011, it appears that most canadian governments are on paths back to budget balance. Policy decisions must be carefully examined with avoidance of the “debt wall” in mind.

Productivity growth is likely to account for more than 100 percent of growth in real per capita GdP over the next few decades.

We address five non-fiscal solutions to the fiscal squeeze: increasing the immigration rate, increasing the retirement age, increasing the fertility rate, restraining the growth of healthcare spending, and increasing the growth rate of productivity. immigrants also age over time, leading to eventual lower labour force participation and higher demands on public programs, and the immigration rate would have to at least double in order to merely continue the 2008 rate of growth of the canadian labour force. This is politically unfeasible. even an aggressive increase in the retirement age could not offset the impact of the large numbers of aging baby-boomers, who will inevitably drop out of the labour force and continue to require more healthcare. The fertility rate likely could not be raised from the current level of 1.7 children per woman to a level that would make a significant difference, and the programs required to marginally increase fertility would be prohibitively expensive. restraining the growth of healthcare spending may be possible, but given the magnitude of the underlying demographic forces canadian governments must recognize that even in an optimistic view of the future, there will be a significant increase in the share of national income devoted to public healthcare spending. Finally, faster productivity growth cannot be easily engineered by policy and would only help to lessen the fiscal squeeze if policy actions could somehow prevent the faster income growth from creating a similar expansion in the number or generosity of public spending programs. The inconvenient truth that canadians and their governments must face is that the demographic forces in play and the fiscal implications that follow are so large that governments will need to respond by making fundamental adjustments to their fiscal frameworks. as is always the case, the simple arithmetic of

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government budgets implies that there are only two broad fiscal choices available to address the coming fiscal squeeze: spending programs can be reduced or eliminated or taxes can be increased. There is nothing else. Government spending can be restrained in many ways, with some programs being reduced in scope while others are eliminated altogether. But such cuts are politically very difficult; one needs only to glance at the highly charged political debates going on in the United states and europe to be reminded about how unpopular it is to consider reductions in public spending, especially if the cuts fall on important social programs. Governments also have many choices when it comes to raising tax revenues, including personal and corporate income taxes, expenditure and sales taxes, and product-specific excise taxes. apart from the general unpopularity of higher taxes, an there are only two important choice would need to be made concerning which taxes would be raised and broad fiscal choices by how much. since government debt is often incurred to provide current goods and services, but is serviced and repaid in the distant future, public debt usually involves a redistribution of income away from future generations toward current generations. in general, the more the policy changes are delayed through time, the more debt will be incurred before those adjustments take place and thus the more the burden of the fiscal adjustment will ultimately fall on canadians who are currently young. conversely, the more immediate are the changes in spending and taxation, the less debt will be incurred and thus the more the overall burden of adjustment will fall on the same baby boomers whose aging is the fundamental cause of the looming fiscal squeeze. Which generation pays for the rising age-related expenditures of the baby boomers will be determined by the fiscal policy choices canadian governments make in the coming years. The government machine built over the past halfcentury was constructed during a time when the demographic forces were very advantageous: a young and fast-growing population. The implications were rapidly advancing living standards and the ability to easily fund many government programs. But as the oldest baby boomers reach 65 this year, and these demographic forces move into reverse for the next three decades, there will be a need to adjust this machine of government. The adjustment can occur primarily on the spending side or primarily on the revenue side – or indeed can occur on both. But some adjustment will be necessary. There will be a canadian tendency for this debate about overall fiscal priorities to become focused on the division of fiscal capacity between different levels of government. a focus on the “fiscal imbalance” rather than the more general “fiscal squeeze” should be avoided as it will both cloud the central issues and needlessly politicize a debate that will in any event be fraught with difficult decisions. canadians and their governments at all levels need to recognize that addressing canada’s looming fiscal squeeze will require a careful and transparent examination of our fiscal priorities.

available: spending programs can be reduced or eliminated or taxes can be increased. there is nothing else.

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Christopher Ragan: Canada’s Looming Fiscal Squeeze

Sommaire
La présente étude rassemble une série de projections démographiques de plus en plus reconnues et acceptées et en tire des conclusions qui sont moins familières en ce qui a trait aux défis budgétaires auxquels seront confrontés les gouvernements canadiens dans l’avenir. L’analyse se concentre sur la portion grandissante du revenu national qui sera consacrée aux soins de santé fournis par le réseau public et aux prestations pour les personnes âgées, ainsi que sur l’augmentation de la dette publique qui sera encourue si les gouvernements n’ajustent pas leurs programmes de dépenses ou au cours des vingt leurs taux d’imposition. L’étude conclut que dans le but d’éviter un retour à la situation prochaines années, d’endettement élevée du milieu des années 1990, les canadiens et leurs gouvernements doivent commencer à réfléchir rapidement et de façon systématique et critique à leurs on assistera à un priorités financières à long terme. déclin inexorable durant les années de baby boom qui ont suivi la seconde Guerre mondiale, le taux âge de travailler de la moyen de fertilité au canada était de 3,6 enfants par femme. en partie à cause de population. l’arrivée d’un nombre plus élevé de femmes sur le marché du travail, le taux de fertilité avait chuté à 1,7 enfant par femme en 2007. on s’attend à ce que cette évolution du taux de fertilité continue d’entraîner un ralentissement du taux de croissance de la population. Grâce à un mode de vie plus sain et à des technologies plus avancées, l’espérance de vie moyenne des canadiens est passée de 68,5 années en 1951 à 80,5 années en 2006. L’effet combiné d’un plus petit nombre de jeunes et d’une population qui vit plus longtemps entraînera une augmentation de l’âge moyen des canadiens au cours des prochaines décennies. L’arrivée à l’âge adulte des boomers a eu pour conséquence une augmentation significative de la portion de la population en âge de travailler, de 58 % en 1962 à 69 % au début des années 1980. Les plus jeunes boomers sont devenus adultes au début des années 1980 et durant les trois décennies subséquentes, il n’y a pas eu de changement significatif dans la portion de la population en âge de travailler. Les plus vieux boomers ont toutefois eu 65 ans en 2011 et au cours des vingt prochaines années, on assistera à un déclin inexorable dans la portion en âge de travailler de la population, un déclin qui correspondra en gros à l’augmentation d’il y a trente ans. compte tenu du vieillissement en cours de la génération des boomers, une fraction de plus en plus large de la population va se retrouver dans cette catégorie des personnes âgées, ce qui réduira d’autant le taux global d’activité sur le marché du travail. il est prévu que le taux global d’activité passe de 67 % aujourd’hui à moins de 61 % en 2040, même en présumant que les taux de participation de certains groupes d’âge spécifiques augmentent de 4 % entre maintenant et 2030 et qu’ils restent stables par la suite. Le taux d’activité en baisse entraînera une diminution du taux de croissance du niveau de vie moyen, tel que mesuré par le PiB réel par habitant, ce qui mène à deux conclusions sur le plan des politiques publiques. Premièrement, la croissance de la productivité devrait compter pour plus de 100 % de la croissance du PiB réel par habitant au cours des prochaines décennies, ce qui signifie que les canadiens et leurs gouvernements doivent prendre au sérieux la problématique de la productivité. deuxièmement, la diminution du taux d’activité aura en soi pour conséquence de réduire le taux de croissance du PiB réel par habitant (quel que soit le taux présumé de croissance de la productivité) et donc de réduire le taux de croissance de l’assiette fiscale par habitant des gouvernements canadiens. Le vieillissement de la population canadienne forcera les gouvernements à s’attaquer à deux défis reliés significatifs sur le plan financier. Tout d’abord, le vieillissement de la population entraînera un ralentissement

dans la portion en

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de l’augmentation du revenu national, qui constitue le fondement de l’assiette fiscale des gouvernements, réduisant donc d’autant les recettes fiscales. ensuite, certains programmes de dépenses très importants deviendront plus coûteux en termes de proportion du PiB, en particulier ceux qui fournissent des soins de santé et un soutien au revenu des personnes âgées, et cela en même temps que l’assiette fiscale croît beaucoup moins vite. relever ce défi financier créera probablement des tensions politiques entre les gouvernements fédéral et provinciaux et forcera les gouvernements à tous les niveaux à faire des choix budgétaire difficiles. devant une telle situation où les besoins sur le plan des dépenses augmenteront plus vite que les recettes fiscales, les gouvernements auront en gros trois choix. Premièrement, ils pourront tenter de réduire le rythme de croissance des dépenses globales. deuxièmement, ils pourront essayer d’accroître le taux de croissance des recettes fiscales en augmentant les taux d’imposition. enfin, ils pourront choisir d’augmenter les emprunts publics. La troisième solution n’est bien sûr pas une solution permanente puisque la dette doit à un certain moment êt...

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rises.10 risk road rob robert robson role room rose rotat rough rout run rythm réduction réduir réduira réduisant réduit réel réfléchir régler répondr réseau réussissait sain sale san sand santé saturday save saw scale scarth scenario scheme scholar school scope scott scénario se second secretari section sector secur see seek seem seen select self self-impos sembl seminar senior sens sensibl sensit separ septemb sera seri serious seront servent servic set sever shade share sharp sheet short short-run short-term show shown si side side.17 signif signifi signific significatif similar simpl simplement simpli simplic simplifi sinc sir situat sixti size siècl slight slope slow slowdown slower slowli small smaller smallest smooth so.16 sober social sociaux socio socio-econom société sofamiliar soi soient soin soit solid solut somehow someon sommair son sont soon sooner soupes sourc sous sous-jacent southern soutien souvent specif spend spent split sponsor spécifiqu squar squeez stabil stabl stagnant stand standard stanley start state statist status stay steadili stephen still stimulus stop stori straightforward strategi strive strong structur studi style subsequ subsid subsidi subséquent success suffer suffici suffit suggest suit suivi summari superintend supplement support sur sure surplus surpris surround surtout survey survienn suscit sustain sydney system systemat systématiqu série sérieux sûr t/gdp t/pop tabl tackl tailor take taken tank tapp tard target task taux tax tax-and-transf taxat td technolog tel tell tellement temp temporari ten tend tendenc tension tenter tenu term territori thank thayer thenceforth thereaft therebi therefor think third thirti though thought three throughout thus time tire tobin today togeth toronto total touchent tough toujour tour tous tout toutefoi toward train trait transfer transform transformé translat transpar transparent travail treasur treatment tremblay trend trent triangl troi troisièm trouver true truth très turn turn-around twenti twice two two-part two-third type typic ultim un unaffect unavoid unawar unborn uncertainti unchang uncomfort under une unemploy unfeas unfold unfortun uni unif unison unit univers unknown unless unpleas unpopular unsur unsustain unthink updat upon upward urgenc us use usual va valu vanbot vancouv vari variabl variat various vengeanc venir vent ventur ver version vie vieilliss viennent vient vieux view vilifi vingt visit vit vite voie voir véritabl w wage wall war washington watson way wayn weak websit well whatev wherea wherev whether whole wholli whose wildebo william wilner winner wise wish within without woman women word work worker workforc working-ag world worthwhil would writer wrong x y year yellow yet yield young younger youngest youth zero à âge âgées économiqu élevé élimin épisod époqu équilibr étaient était état étatiqu états-uni étude été éviter évolut être œil δd