Canada's Demographic Time Bomb?

Paul Vieira of the National Post reports, Canada's demographic time bomb (HT: Gary):

Lost in the political drama over the 2011 federal budget was a spending line item that starkly illustrates the fiscal squeeze posed by the aging population — an issue yet to be addressed during the 41st election campaign.

As laid out in the budget, government spending on elderly benefits is set to surge 30% from 2010-11 levels to 2015-16, with annual increases of between 4.9% and 5.8%, well above projected rates of Canadian economic growth.

Dig a bit deeper and the fiscal noose around Ottawa gets tighter. During the next five years it is expected the federal government, of whichever political stripe, will need to find an extra $2-billion each year either through program cuts or tax increases to finance payments through the Old Age Security and Guaranteed Income Supplement schemes. From 2015 to 2020, that figure climbs to $3-billion each and every year.

“That money has to come from somewhere,” says Kevin Milligan, economics professor at University of British Columbia, who did the shortfall calculations based on actuarial reports compiled by the Office of the Superintendent of Financial Institutions.

But there has been little talk about this during the first week of the campaign. Instead, Canadians have been promised roughly $4-billion in annual goodies through income splitting, education and day care.

“By emptying the fridge with all of these current promises, it is going to make it harder for any future finance minister,” Prof. Milligan says.

The aging population is among the big issues that policymakers must confront, as the labour force shrinks, income tax receipts slow, and the pressure builds on governments to fund health care and benefits for the elderly who are living longer and longer. From here on, analysts warn, the government’s budget-making process will incorporate annual program and spending reviews, such as the one proposed in the 2011 federal budget, to find the needed money to pay for the rising price tag for elderly benefits, drugs and doctors. Program cuts, privatizations and outsourcing of back-office operations are all likely to be on the table.

That’s just the beginning. There’s also the issue of unfunded pension and benefits liabilities governments face from the wave of retiring Baby Boomers from the public service. The C.D. Howe Institute, a Toronto think-tank, has warned the unfunded liability in the pension plan for federal public-service workers is actually $65-billion larger than what Ottawa has accounted for on its books.

Glen Hodgson, chief economist at the Conference Board of Canada, said the demographic shift represents a “game changer” for the Canadian economy, much like the soaring loonie has altered the industrial landscape, forcing companies that survive to ramp up capital spending and adjust production.

The greying of Canada means the country will go from a position of surplus labour to labour shortage.

“There is a huge debate coming,” Mr. Hodgson says. “Provincial governments are a little bit ahead of the game as they can see the consequences for health care. But at the federal level it hasn’t become an issue yet — but it is going to have to.”

He cited aggressive moves by Quebec, from spending cuts to a two-percentage-point jump in its provincial sales tax, aimed at balancing the budget in just over two years — faster than what the federal government is proposing. Demographics are a factor driving Quebec’s policy decisions, as projections indicate the province will be among the oldest in the industrialized world, with people 65 and older making up more than 25% of the population by 2031.

“Quebec knows that a revenue crunch is coming,” Mr. Hodgson said. “So now is the time to get back to balance because, if you don’t do it now, the province is going to be hard pressed to do it down the road.”

Under population scenarios developed by Statistics Canada, the Canadian population could exceed 40 million by 2036, with aging projected to “accelerate rapidly” as the entire Baby Boom generation turns 65 in this time frame. The data agency also warned that the number of senior citizens could more than double by 2031, outnumbering children for the first time.

In economic terms, this means slower potential economic growth in the years ahead, which will ultimately translate into slower growth in tax revenue for Ottawa — just as the provinces demand more in transfers to finance an already stretched health-care regime that has to tend to an increased elderly population.

Kevin Page, the parliamentary budget watchdog, has projected the economy’s potential output — the level of goods and services the economy can produce without triggering inflation pressures — will drop to 1.3% by 2020 from 2.1% in 2010 and 3.7% in 2000.

He has cited demographics as a key factor in sticking to his forecast for a $10-billion deficit in 2015, whereas Jim Flaherty, the Minister of Finance, expects a surplus.

In a paper published for Policy Options magazine, Christopher Ragan, economics professor at McGill University, said the Baby Boomers’ exit from the labour force would pose a “significant drag” on growth. Given population trends and assuming productivity growth of 1% to 2% a year, real GDP per capita is set to grow only 1% annually over the next three decades — half the pace recorded in the previous 40 years.

Such a scenario may explain why Bank of Canada officials, led by governor Mark Carney, have urged policymakers and the private sector to confront the country’s “abysmal” productivity record.

“The implications for government tax revenue are clear: in the absence of changes to the governments’ various tax rates, the slowing of the growth in per-capita income will lead to a slowing of Canadian governments’ per-capita tax revenue,” Mr. Ragan said.

Slowing revenue, meanwhile, is on a collision course with increased expenditures on health care and elderly benefits. Mr. Ragan’s calculates the increase in those costs between 2020 and 2040 as people age will be equivalent to 3.5% of Canada’s GDP on an annual basis — or $56-billion in today’s economy, or more than 10% of federal and provincial spending, combined.

“As population aging drives the increase in age-related spending, provinces will demand greater financial transfers from the federal government,” Mr. Ragan said. “Based on the past experience, these heightened demands will create significant political tensions, the resolution of which will depend on the personalities and the political landscape in the place at the time.”

That political battle will take shape when the federal government and the provinces, which are responsible for delivering medical services, begin renegotiating the health-care transfer deal that expires in 2014. The Canada Health Transfer is the single largest expense item on the government books, accounting for $27-billion this fiscal year and more than $30-billion by the time the federal-provincial deal runs out in 2014.

Under the last deal, negotiated in 2004, the provinces were guaranteed 6% annual increases in health transfers. The federal government has said there are no plans to cut transfer payments as part of its deficit-reduction effort, but experts suggest the increases in transfers may be limited to between 3% and 4%.

“What we have is a classic zero sum, in which the provinces, which are at the front-line of the demographic time bomb, will be seeking more money from the federal government, and the federal government seeking to reduce its liabilities,” said Joshua Hjartarson, policy director at the Mowat Centre, a Toronto think-tank.

His concern is that the future of health-care funding will garner little discussion on the election campaign, because of the difficult policy dilemma it raises. In addition, Mr. Hjartarson said, the political leaders may simply resort to the old debate about how much transfers should increase as opposed to looking at new and radical ideas to address the funding crunch that the aging population presents. Issues that should be up for discussion include possibly handing over a chunk of GST revenue to the provinces, and some form of “tax swap” that would give provinces additional capacity to raise revenue.

“It would be a shame if the election doesn’t begin to highlight the problems in the transfer system. If not, our heads are in the sands,” Mr. Hjartarson said.

Will the "greying of Canada" mean the country will suffer huge deficits as soon as 2015? I'm not so sure. When I read articles on "demographic time bombs," I take them with a grain of salt. Why? First, more and more people are choosing to work past 65 years old. Why not? If they're healthy enough to work, why retire early?

More importantly, it's worth noting that Quebec's recent budget introduced significant pension changes: larger penalties for workers who retire under age 65, but more generous pensions and tax breaks for those who continue working past that age (smart move). The province will also be hoping to collect from tax evaders. It has hired 1,000 more employees to crack down on such chronically problematic fields as illegal tobacco sales and the construction industry (when it comes to tax evasion, there are bigger fish to fry).

All this to say that while demographics will impact the country long-term, in the near-term, I'm more worried about bigger problems like Canada's mortgage monster fueling the Canada bubble. When that pops -- and it ultimately will burst -- it will blow a massive hole in government revenues, forcing many Canadians to retire well past the age of 65.


Dan Braniff of CARP sent me these comments:
These scary numbers seem to ignore the reality that those over 50 hold 80% of the country's wealth that is growing and subject to ever-increasing tax at all levels. Then there is the final tax of the estate.

The pundits seem to assume that seniors stop paying taxes, just using up air, food and water while blocking medical facilities and basking in government handouts.

At 80 I pay more tax than I ever did even in my final salary years.

How do these factors play in the projections of doom and gloom?
I thank Dan for sending me his comments. These are all excellent points that were not discussed in the article above.