Long-Term Budget Projections: Can They Help Governments Address The Ageing Problem?

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Long-Term Budget ProjectionsCan They Help
GovernmentsAddress The Ageing Problem?

• Presentation by
• Barry Anderson
• At the
• 2006 Meeting of the
• OECD Asia Senior Budget Officials Network
• Bangkok, Thailand
• December 14-15, 2006

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Outline

• Goals of Presentation
• Why do long-term projections?
• How are long-term projections prepared?
• How can long-term projections be used?
• An example of the use of long-term projections

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Goals of Presentation

• Increase your awareness of long-term budget
  projections as a mechanism to assess fiscal risks
• Describe how long-term projections are made
• Describe how long-term projections can be used
• Provide and discuss an example of their use
• This presentation is based on OECDs recent
  paper Assessing Fiscal Risks Through Long-Term
  Budget Projections by Paal Ulla, which was
  presented at the 27th Annual Meeting of Senior
  Budget Officials held in June 2006 in Sydney.

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Why Do Long-Term Projections?

• Addresses fiscal sustainability by identifying
  the long-term fiscal consequences of near-term
  political decisions
• Promotes transparency by forcing the estimation
  of the costs and consequences of policy actions
• Better quantifies significant fiscal risksand
  thus helps plan for funding core
  functionsthrough use of sensitivity analysis
• Allows for analyses of contingent liabilities and
  the potential costs of natural disasters
• Most of all, unlike generational accounting
  balance sheet analysis, it is relatively easy to
  understand use

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How are long-term projections prepared?

• Demographics
• Economics
• Current policy baseline
• Spending
• Age related
• Other mandatory
• Discretionary
• Contingent liabilities
• Revenues
• Debt service

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Demographic Projections

• The most important are
• Life expectancy
• Fertility rates
• Net immigration
• But demographic factors usually dont change
  quickly, and immigration changes have to be huge
  to have much of an influence

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Economic Projections

• The most important are
• Productivity
• Labour market participation
• Interest rates
• As the future is unknowable, sensitivity analysis
  is particularly valuable
• Use of past trends as possible indicators of the
  future can also be instructive

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Current Policy Baseline

• A good starting point in that it permits
  displaying the potential costs of proposed
  legislation
• Assumes current policies/laws are in place
  until/unless they expire under law
• The major exception to this unchanged policy
  baseline is revenuessee below

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Age Related Spending

• Public pensions
• Health
• Long-term care
• Education
• Unemployment

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Other Spending Categories

• Other mandatory
• Usually done as a percentage of GDP
• Discretionary
• Usually done as a percentage of GDP
• Contingent liabilities
• Credit, especially insurance loan guarantees
• Government-owned enterprises
• Public-Private Partnerships
• Fiscal consequences of natural disasters

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Revenues

• The unchanged policy scenario can be unrealistic
  here.
• Even if kept constant in real terms, real growth
  over the long run would eventually push the
  entire population to paying income taxes at the
  highest marginal rate.
• So, an option is to keep the overall tax rate
  constant on household income.

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Debt Service

• Base is determined by above calculations
• Strongly influenced by interest rates

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How can long-term projections be used?

• Sensitivity analyses on, for example
• Life expectancy
• Immigration rates
• Productivity growth
• Size if the labour force
• Pension reforms
• Health care expenditures
• Interest rates
• Medium-term objectives

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Examples of the Time Frames Covered in Long-Term
Projections
Projection Time Frame Covered
Australia 40 years
Canada 10 years
Denmark 10 years
Germany 45 years
New Zealand 45 years
Norway 55 years
United Kingdom 50 years
United States 75 years
European Commission 45 years
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An Example of the Use of Long-Term Projections

• Based on a Special Policy Briefing before the
  Lisbon Council on the Sustainability of Public
  Finances by Joaquin Almunia, EC Commissioner for
  Economic and Monetary Affairs, Brussels, October
  9, 2006. (http//www.lisboncouncil.net/index.php?o
  ptioncom_contenttaskviewid32Itemidlangen)
  
• See also The Long-Term Sustainability of Public
  Finance in the European Union, a report by the
  European Commission Services, October, 2006.
  (http//ec.europa.eu/economy_finance/publications/
  european_economy/2006/ee0406sustainability_en.htm)

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Population Pyramids for EU25 2004
2050
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Population Pyramid Summary for the UNITED STATES,
2004 2050
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Population Pyramid Summary for AUSTRALIA, 2004
2050


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Population Pyramid Summary for JAPAN, 2004 2050
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Population Pyramid Summary for THAILAND, 2004
2050
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Population Pyramid Summary for KOREA, 2004 2050
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Population Pyramid Summary for SINGAPORE, 2004
2050
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Population Pyramid Summary for INDIA, 2004 2050
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Population Pyramid Summary for CHINA, 2004 2050
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The EU Sustainability Gap 2¼ of GDP (the
gap between the structural budgetary position in
2005 and the 60 reference value used by the EC)
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Impact of Changes in Assumptions on the
Sustainability Gap for the EU
Demographic Economic Assumptions of GDP
Higher life expectancy, of which .5
-pensions .2
-health care .2
-long-term care .1
Higher labour productivity -.3
Higher employment of older workers -.2
Higher employment if due to
-an increase in the labour supply -.1
-a decrease in the NAIRU -.3
Higher interest rates .2
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Employment Rates Projected to Increase in the EU
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The Cost of Delay in Implementing Structural
Government Balance by 2010
Selected Countries of GDP
Portugal 1.4
Hungary 1.3
Germany .7
Italy .7
Luxembourg .7
France .6
Greece .6
United Kingdom .6
Czech Republic .4
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Average Exit Age from the Labour Market in 2004
Luxembourg 57.7
Poland 57.7
Slovak Republic 58.5
Austria 59.2
France 58.9
Belgium 59.4
Greece 59.5
Czech Republic 60.0
Finland 60.5
Hungary 60.5
Italy 61.0
Netherlands 61.1
Germany 61.3
Denmark 62.1
United Kingdom 62.1
Portugal 62.2
Spain 62.2
Ireland 62.8
Sweden 62.8

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The Benefits of Implementing Balance Budgets (MTO
Scenario) by 2010
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Commissioner Almunias 3-prongedStrategy to
Ensure Sustainability
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Commissioner Almunias Conclusions

• The status quo is not sustainable and therefore
  not an option.
• More movement towards structural balance in
  needed.
• Growth potential needs to be improved by raising
  productivity and employment and this means that
  Europes social models have to be adapted.
• Structural reforms, notably in pensions, should
  improve government finances over the long-term
  and make Europes social models more
  sustainable.
• Implementing the Lisbon strategy by fostering
  productivity, employment creation and
  adaptability of the economies is paramount, as it
  is the best way to increase economic growth and
  prosperity and contributes to fiscal
  sustainability.
• The challenge is considerable, but manageable.
  This is supported by the progress towards
  sustainability made by countries who have cut
  deficits and reformed pension systems.
• Our future is in our hands.

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My Observations

• There are no easy answers.
• Higher growth alone is not sufficient.
• Higher productivity alone is not sufficient.
• Higher population or labour force growth alone is
  not sufficientand mechanisms to induce greater
  labour force participation are not cheap or easy.
• Higher taxes and/or higher debt can have serious
  detrimental effects.
• Thus, benefit cuts must be part of a solution.
• The sooner a country begins, the easier it will
  be. For example, the best way to prevent firing
  public employees in the future is not to hire
  them today.
• Incorporating long-term projections into the
  annual budget process is worthwhile.