The dynamic fiscal effects of demographic shift: The case of Australia

Abstract

We develop a small open economy, overlapping-generations model that incorporates non-stationary demographic transition paths to study the dynamic fiscal effects of demographic shift in Australia. Since the recent ageing of Australia's population is projected to exacerbate over the coming decades, there are potentially significant macroeconomic implications and impacts on fiscal commitments for old-age related expenditures. To investigate these implications and fiscal impacts, our model pays special attention to Australia's taxation and retirement schemes, to the age structure of government expenditures, and to population dynamics via fertility, longevity and immigration. Our simulation results demonstrate that population ageing shifts the tax base from labour income towards asset income and consumption, and substantially increases old-age related government expenditures. Significant future adjustments in other government expenditures and taxes will be required to finance these expenditures. Interestingly, the main driving factor behind increased fiscal costs is the increase in survival, not the decline in fertility, rates. Increases in fertility and immigration are not effective solutions to such fiscal challenges.