Economic Survey - Belgium 2005: The policy challenge: preparing for population ageing

 

The main policy challenge is to prepare for population ageing

Belgium’s population is ageing, albeit a little less quickly than the OECD average. Growing numbers of baby boomers will retire from around the end of the current decade. This will reduce economic growth mainly through lower growth in the labour supply and will put pressure on public finances for decades to come. While progress has been made in implementing policies to minimise the costs of this demographic shock, notably by a substantial reduction of public debt, the few years left before large numbers of baby boomers retire provide a window of opportunity to go further in implementing such policies and thereby preserving the essential elements of the system of social protection. First, budget consolidation is required to put public finances on a sustainable path – defined as one where government programmes can be financed indefinitely at constant tax rates and public debt eventually stabilises as a share of GDP (as a euro-area country, this must also be less than 60% of GDP). Second, reforms need to be made to increase employment rates, especially for the older working age-population, the younger working-age population and ethnic minorities, and to slow further the decline in working time. Finally, reforms are required to increase productivity growth. With the economy in the recovery phase of the business cycle, this is the ideal time to make substantial progress in implementing these policies.

Population ageing will reduce economic growth and put pressure on public finances

Assuming a persistent decrease of working time, albeit smaller than in the past 30 years, and no further significant decrease of the structural unemployment rate, economic growth could fall from an annual average rate of around 2% in the current decade to a little over 1% over the period 2010 50 according to OECD projections. However these projections do not take into account the future effects on labour supply of the 2001 tax reform, reductions in social security contributions, measures to increase job search and the 1996 pension reform. Taking these factors into account and assuming that further measures will be taken to increase the employment rate, notably for the older working-age population, and that the labour productivity growth rate will rise above the recent trend, the High Finance Council (HFC), which prepares annual projections of the economic- and budget impact of population ageing, projects a more modest decline in the economic growth rate, to around 1½ per cent by 2030. On the basis of this outlook and assuming that the government continues to take measures regularly to restrain healthcare outlays, the HFC projects that the budget cost of population ageing will rise to 3.4% of GDP in 2030, mainly reflecting higher outlays for pensions and healthcare. However, if economic growth were to be as projected by the OECD, which would entail a lower employment rate for the older working-age population, which receives high social benefits, the budget cost of population ageing would be about 1% of GDP higher.

There is also scope to attenuate the effects of population ageing by  slowing down the long-term decline in working time by further reducing taxes on labour income

In addition to increasing the employment rate, the impact of population ageing on labour supply could also be attenuated by slowing the long-term decline in working time per person employed. Working time has fallen in recent decades mainly because of rising productivity, increasing taxes on labour income and rising female participation, and is somewhat below the OECD average. One of the effects of further reductions in taxes and social security contributions on labour income, building on the programme of tax cuts and reductions in social security contributions already under way, would be to further slow down the decline in hours worked per person employed. Reducing the tax burden on labour income would also diminish incentives for economic activity to occur in the shadow economy, widening the tax base and further reducing the efficiency costs of taxation. Making a reduction in the tax burden on labour income would require a fall in government expenditure as a share of GDP. Phasing out social security payments for pre-pensioners and unemployed persons who are not job seekers, as recommended above, would reduce social security outlays by 1% of GDP. If job search requirements were strictly enforced and social partners agreed to spend more on training for older workers and to flatten the age/seniority premium in pay scales, most of the people who would otherwise have been drawing benefits in early retirement would be employed and paying taxes rather than becoming long-term unemployed. Hence, such measures could make a useful contribution to reducing government expenditure. In addition, the measures aimed at increasing employment rates and reducing unemployment rates for the younger age group and for ethnic minorities would also have a positive budget impact, making room for further cuts in tax on labour income.

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