The Parliamentary Budget Office has released a Report (pdf) on the fiscal sustainability of benefits to the elderly.

This is not my area. I don't have a lot to say on the subject. I want to say a couple of things.

1. Do the numbers look right?

Stephen's old post linked to Statistics Canada demographic projections. This is from the Statistics Canada highlights:

"In 2009, for every 100 people in the working-age population, there were 24 children aged 14 years or under and 20 people aged 65 years or over. According to the medium-growth scenario, there would be 26 children and 39 seniors per 100 working-age people in 2036."

That increase from 20 to 39 old people, per 100 working-age people, is nearly doubling.

Let me do a very rough back of the envelope calculation. Assume that all of GDP is produced by working-age people. Assume that the number of old people per 100 working-age people exactly doubles. Assume that benefits per old person stay exactly the same percentage of GDP. Then benefits will double as a percentage of GDP.

Let's compare my BOE calculation with the PBO Report:

"PBO's 2011 FSR baseline projection of federal elderly benefits shows an increase in the cost of the program of 1 percentage point of gross domestic product (GDP) from 2.2 per cent of GDP ($36 billion) in 2010-­‐11 to a peak of 3.2 per cent of GDP ($142 billion) in 2036-­‐37 (see below), reflecting the entry of the baby-­‐boom cohorts into the 65-­‐and-­‐over segment of the population. This projection is somewhat higher than projected by the Office of the Chief Actuary as it includes some 'enrichment' to benefit payments over and above the statutory indexation to inflation."

An increase from 2.2% of GDP to 3.2% is GDP is an increase of 45%. That is much less than the 100% increase (doubling) given by my BOE calculation.

OK, my BOE calculation is probably an overestimate. Not all of GDP comes from labour, some comes from capital income, and the old have more capital than the young. Plus some old people will continue working. So let me revise my estimate. Assume that each old person contributes half as much to GDP as each working-age person.

So in 2009 we have 100 working-age people plus 20 old people, producing a GDP of 110. And in 2036 there are 100 working-age people plus 40 (should be 39, but lets keep the arithmetic simple) old people producing a GDP of 120. So we go from old people per GDP of (20/110)=0.182 in 2009, to (40/120)=0.333 in 2036. The increase from 0.182 to 0.333 is an increase of 83%. That's less than doubling, but still a lot bigger than the PBO's estimate of 45%.

Even if I make the extreme assumption that old people contribute exactly as much to GDP as working-age people, I still get an increase of 71% in old people per unit of GDP.

I don't get it. My guess is that the PBO is assuming that benefits per old person fall as a percentage of income per person, even though they are assuming full inflation-indexation plus some "enrichment". But the fall would have to be a big fall, to make our numbers compatible.

Maybe I got something wrong. I was never great at math.

2. Is "sustainability" enough?

Here's the basic message of the Report. Assume Canada recovers from the recession and the budget goes back to normal. Assume taxes and spending (excluding interest on debt) stay the same as a percentage of GDP. Then the Federal Debt/GDP ratio will decline over time and eventually fall to zero. Now add in the demographics. The increase in benefits to the elderly will slow down the rate at which the debt/GDP ratio falls to zero, but it will still fall to zero. Therefore it's sustainable.

And, from my quick reading of the papers, the reaction has been: "OK then, nothing to worry about here; we don't need to do anything, so let's do nothing".

I don't think that conclusion follows. If your plans for the future are not sustainable, you've got a problem, and need to change your plans. But just because your plans are sustainable doesn't mean you don't have a problem and don't need to change your plans. And what were our plans anyway? Were we planning to keep on doing exactly what we are doing now? Were we planning to keep taxes and spending exactly the same percentage of GDP as they are now? It is very obvious we weren't, or shouldn't have been. Because we presumably weren't planning to have the debt/GDP ratio fall to zero, then keep on falling into negative territory, and only stop falling when the government owns everything and runs out of things to buy. That's not sustainable either!

Presumably we weren't planning to make the Federal Debt/GDP negative. We were planning to reduce it to some lower level, and then cut taxes and/or increase spending to keep it at that level. So that when an emergency came up (like the recent recession) we would have plenty of room to allow a temporary deficit without worrying too much about it.

It would be nice to think that we had already factored demographics into those plans. After all, we could have seen this one coming since 1966, when the baby boom ended. But did we? David Dodge says that previous governments wanted to take action in the 1990's, but were scared to. Maybe the rest of us just didn't want to think about it, until we had to. OK, now let's think about it.

3. Federal benefits and provincial health.

Demographics raises two big fiscal problems. The first is Federal benefits, which is what the PBO Report is about. The second is health spending. And health is a provincial question. And from Bill Robson's estimates (pdf), health spending for the elderly is a much bigger deal.

If we had a unitary system of government, we would roll the two in together, and talk about demographics and the fiscal sustainability of the pair. But we don't. But we can't ignore the relationship between Federal and provincial finances. Either the Federal government will have to increase future transfers to the provinces to help them cope, or the Federal government will have to cut future tax rates to allow provinces to increase theirs. Or, we just ignore the question and let the younger generations carry the load with higher taxes to pay for boomers' benefits plus healthcare.