On 4 December 2019 the OECD released a Working Paper entitled Population ageing and sub-central governments: long-term fiscal challenges and tax policy reform options. This looks at the taxation policy options for central and local governments in response to the long-term problem of ageing populations in OECD countries.

The average age of populations of the OECD countries is increasing and this will impact public expenditure and tax revenues. In 2020 around 17% of the population in the OECD countries will be above the age of 65 and by 2100 this will have increased to around 31%. In some countries including Germany, Italy, Spain and Japan the population ageing will be particularly strong.

The ageing of the populations will lead to additional government spending on public health and long-term care. This spending could increase by up 6.3 and 1.3 percentage points of GDP respectively by 2060. Pension expenditure is projected to increase in most G20 countries by 2060 and there could also be increases in spending on local transportation and community services for the elderly.

Population ageing will reduce direct tax revenues as not so many people will be active in the labour market. This will reduce revenue from personal income taxes and social security contributions (SSCs) which are important sources of revenue in developed countries. This could impact the capacity of central governments to provide transfers to local government and could affect local revenue where the personal income tax (PIT) is a significant source of local government revenue.

The effects of population ageing on savings and consumption, and therefore on consumption tax revenues, are uncertain. If middle-aged individuals increase saving and defer consumption this would impact the time when consumption taxes are paid. Tax revenue from immovable property and corporate income taxes are likely to be less affected by the ageing population.

The Working Paper looks at the consequences at sub-central government (SCG) levels using an ‘SCG fiscal vulnerability to ageing’ indicator to identify countries that are fiscally vulnerable to population ageing. The indicator uses an ‘SCG expenditure vulnerability’ indicator and an ‘SCG revenue vulnerability to ageing’ indicator.

Policy Recommendations

The consequences of an ageing population affect both central and local government and countries must therefore adopt a coherent fiscal strategy and a whole-of-government approach to identify the necessary tax and spending reforms.

The OECD Working Paper notes that tax systems must be adjusted to finance additional old-age spending and to cover the shortfall in labour income tax revenues. Increasing labour market participation can mitigate the costs of an ageing population. This could involve tax and benefit reforms to reduce disincentives to work combined with non-tax incentives to work such as training, provision of childcare and a higher pension age.

Reforms to PIT and SSCs could involve broadening the tax base rather than raising tax rates. SSCs could be levied on various forms of non-standard work and could be levied on the capital income of individuals. Countries could consider levying health SSCs on pension income. OECD countries could also consider introducing recurrent taxes on immovable property rather than property transaction taxes.

With regard to the tax powers of central and local government the OECD countries could consider adjusting grants and tax sharing agreements in order to take into account the ageing population. Rather than using earmarked grants the central governments could increase the use of block grants. Central and local governments could co-fund certain old-age expenditure categories.