Standard Life Investments

Weekly Economic Briefing


Ageing: bad for your fiscal health


With both President Trump and congressional Republicans pushing for large individual and corporate tax cuts before the end of the year, market participants are understandably getting excited about the prospect of a near-term boost to the economy and corporate earnings. There is, however, an important catch. Analysis by the Tax Policy Centre suggests that Trump’s tax plan would add around USD 7 billion to the federal debt by 2028 and close to USD 21 billion by 2036. House Republicans’ plans are more modest, but would still add more than USD 6 billion to the federal debt over the next 20 years.

Getting older... ... is expensive

From a public finance perspective, permanent, unfinanced tax cuts are never ideal. But they are potentially disastrous when public debt levels are already high and future federal spending is projected to grow more quickly than revenues due to ageing populations and the cost of financing higher debt. The numbers make grim reading. Although the Congressional Budget Office (CBO) expects the population to grow by 0.7% per annum over the next 30 years, taking the population towards the 400 million mark from today’s 328 million, that growth would be slower than the historical average. Moreover, it does not take into account any slowing of net immigration flows in the wake of rising populism. Slower population growth will also be accompanied by less favourable demographics; by 2046 those aged 65 and older are expected to make up 21% of the US population, compared with 15% at present (see Chart 2). Spending on social security and the major federal healthcare programmes such as Medicare and Medicaid, currently represents 11% of GDP (see Chart 3). That is projected by the CBO to rise to just over 16% of GDP by 2046, with more than half of that increase accounted for by the effect of ageing. The rest of the increase comes from the design inefficiencies of the current healthcare system, which allow the costs of care to rise more quickly than the overall price level.

Without remedial action, the implications of these trends are dire. Not only could the federal budget deficit rise to nearly 9% of GDP by 2046, from around 3% today, but public debt could rise from 75% of GDP to 141% of GDP. Interest costs on servicing that debt could reach more than 5% of GDP, though that depends heavily on how long-term interest rates evolve. There would also be considerable negative long-term economic costs from such a large deterioration in the country’s fiscal position. Government savings would decline substantially, forcing upward pressure on private savings rates. Investment would be crowded out by higher interest costs, lowering potential growth. A weak fiscal position would also limit lawmakers’ room to react to economic shocks, increase the likelihood of a fiscal crisis and put pressure on the Federal Reserve to engage in even more financial repression and accommodate much higher inflation. With this in mind it should not be surprising that we are not fans of the Trump or House Republican tax plans. Revenue-neutral corporate tax reform is worthwhile, but Congress should be working with the president to address the unsustainable path of entitlement spending, identify new sources of revenue (such as a European style VAT), substantially lift public investment in projects with high long-term payoffs and embark on structural reforms to boost productivity growth and potential labour supply. Doing anything less would be akin to ‘fiddling while Rome burns’.

Jeremy Lawson, Chief Economist