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An evaluation of policies to reduce fiscal pressure induced by population ageing in Australia

Bell, William Paul (2005): An evaluation of policies to reduce fiscal pressure induced by population ageing in Australia.

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Population ageing increases fiscal pressure by increasing the aged to working-age ratio, which simultaneously reduces the growth in government revenue and increases government social outlays. This study evaluates proposed tax and economic growth policies to meet the population ageing induced fiscal pressure in Australia.

The research in this thesis attempts to clarify inconsistencies between these policy proposals.

The literature indicates there are currently two contrasting tax policies recommended to cope with the fiscal pressure induced by an ageing population. The first recommendation known as a ‘pay as you go’ policy (PAYGP) involves progressively increasing taxes to meet increases in fiscal pressure. The second proposal is for a reduction in taxes or ‘tax-cut policy’. It is part of the government’s current policy mix to meet the fiscal pressure, along with an economic growth policy, and no cuts in government services. This study assesses the compatibility of a growth policy to reduce fiscal pressure and a tax-cut policy to increase economic growth. In addition, the proposition that growth in after-tax GDP per capita will continue to overwhelm any tax increases under a PAYGP is assessed under more stringent conditions.

Sensitivity analysis on a simulation model is used to investigate the effect of the tax and the economic growth policies on fiscal pressure and after-tax GDP per capita. This simulation model is based upon the Productivity Commission’s (2005a) model. Fiscal pressure sensitivity analysis investigates: increases in the labour force participation rate (LFPR) and the retirement age; changes in the labour productivity growth rate (LPGR); changes in the mortality, net overseas migration, and total fertility rates; and changes in the tax rate as a percentage of GDP. A ‘Tax elasticity of the labour supply’ (TELS) is used to simulate the disincentive/incentive effects of increases/decreases in the tax rate. The ‘After-tax GDP per capita’ sensitivity analysis investigates the PAYGP by measuring sensitivity to the LPGR and the TELS.

Analysis of the policy proposals resulted in the following conclusions. A tax-cut policy to increase the LFPR and LPGR is counterproductive in reducing fiscal pressure but sustainable during the demographic gift phase of population ageing. The PAYGP remains workable with continued growth in after-tax GDP per capita even at a low LPGR and high TELS values. A PAYGP has a greater growth in after-tax GDP per capita than a non-PAYGP with a slightly lower LPGR. Productivity policies to increase the LPGR are ineffective at reducing fiscal pressure but enhance a PAYGP. Participation policies to increase the LFPR and the retirement age are very effective at reducing fiscal pressure. Population policies are only slightly effective or ineffective in reducing fiscal pressure. A suitable policy mix to meet the fiscal pressure includes participation policies to increase the LFPR and a PAYGP enhanced with productivity policies to increase the LPGR to cover the remaining fiscal pressure

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