Paying for the Ageing Crisis: Who, How and When?

Abstract

In many countries population ageing creates an implicit public debt. That is, if policies remain unchanged, the public debt will ultimately become unsustainable. This paper explores the optimal way to achieve debt sustainability. In particular, it asks when policy reforms should be made, how policies should be changed and which generations should make which contributions. As regards timing, we find that policy reform should anticipate future demographic change. As regards policy instruments, we find that optimal policy reform features changes in all available instruments. This implies less consumption of all types of goods; only pure public goods consumption may escape a reduction. The labour supply functions of the young and the old determine the allocation over policy instruments. In particular, the more elastic is the labour supply of the young, the smaller should be the increase in the tax rate on labour income; the more elastic is the labour supply of the old, the larger should be the reduction in transfers to the elderly. As regards generations, we find that the old share relatively little in the fiscal burden; future generations share more or less than the young, depending on future population size. In addition, we find that the change of the public debt is not a given, but a feature of optimal policies. In general,