News | August 8, 2018

Transfers in an aging European Union

© nevio3 / photocase.com

The populations of all European countries are getting older, but not in same way or at the same pace. MPIDR researcher Fanny Kluge has offered a thought experiment: What would a transfer union look like in which the costs carried by the demographically disadvantaged countries is borne by other countries?

The countries of the European Union are alike in one way: they all have aging populations. Birth rates have fallen below replacement level in all European countries, including in France and the Scandinavian countries, which have the highest numbers of births per resident in the EU. And people are surviving to increasingly high ages in all European countries. In the western welfare states, every second girl born today could live to see her 100th birthday.

Projections based on these trends show that by 2050 just 14.8 percent of EU citizens will be under age 15, down from 15.6 percent in 2014. Over the same period, the share of EU citizens over age 65 is expected to increase from 18.9 percent to 28.5 percent.

However, while these general trends indicate that the populations of Europe will continue to age, the demographic development of individual European countries is differing greatly. An important factor in this variation in aging patterns is the point at which the decline in the birth rate began. In the EU founding countries of Germany and Italy, as well as in many southern and eastern European countries, birth rates were starting to fall as early as in the 1970s; and it is in these countries that demographic pressure will be felt most acutely in the coming decades. Thus, with the exception of Germany, demographic change is having the greatest impact in the EU countries that are currently struggling with economic problems.

It is a general rule that the revenues a country collects from and spends on each citizen vary by age group. At the beginning of life, people receive financial support from the state; mainly in the form of education. At the end of life, people receive pension and health care benefits from the state. In all European countries, tax revenues are collected primarily from people between the ages of 30 and 60. Older and economically weaker countries have lower tax revenues because they have more citizens in the age groups that pay little or no taxes. These countries run the risk that the younger population will leave if their economic burdens become too heavy. By moving to another EU country that has better living and working conditions, younger people can avoid having to make the higher contributions that will be required when a decreasing number of young people are supporting an increasing number of older people. This mobility within the EU is facilitated by current legal regulations.

The working population is, on average, paying most of the taxes. Migration within the EU is hitting the economically weaker countries especially hard because they are losing out on badly needed tax revenues. In addition, a large share of the national budget in these countries flows to education, even though these states no longer profit from these investments. Moreover, these countries have to plan for the possibility that some people who are working abroad will return to their home country when they reach retirement age. This can place additional burdens on the national budget, because even though a retiree’s pension benefit costs are covered by the country where s/he paid taxes while employed, the individual’s health and nursing care costs are borne by the country where s/he currently lives.

Just how quickly a country can be affected by migration within the EU can be seen by looking at the example of Spain. After the financial crisis of 2008/2009, many young people left Spain to look for work in another European country. In this article, published online in July 2018 in The Journal of the Economics of Ageing, we estimated the effects of this internal migration on budgetary planning in Spain. High emigration rates were observed among Spaniards between the ages of 25 and 40. In 2013, for example, two percent of 25- to 35-year-old Spaniards emigrated. The loss of two percent of its taxpayers has a large impact on a country’s budget. As a result of this emigration wave, the Spanish state had 2.7 billion euros less in expenditures, but collected 3.9 billion euros less in tax revenues in 2013. These model calculations can, however, provide no more than a rough estimate of the impact of emigration. For example, since it cannot be assumed that if the people who left these emigration countries had stayed they would have all been employed, there is no certainty that these projected surpluses would have actually materialized.

It is, however, possible to estimate the average tax revenues the state can expect to collect from each citizen: on average, a Spaniard will pay 60,000 euros in taxes between age 25 and the end of life, 51,000 euros between age 30 and the end of life, and 32,000 euros between age 35 and the end of life.

The data used in the analysis come from the National Transfer Account Project. These National Transfer Accounts are stored in an international open-access database (www.ntaccounts.org). Researchers from more than 60 countries have contributed to this database, and are analyzing the data to explore questions such as how many people in the different age groups are producing and consuming, what share of resources they are receiving, and what reserves they have built up. Using these data, the model yields the following results: Across Europe, the average gap between revenues and expenditures in public budgets is expected to increase from around 6.5 percent in 2030 to around 14 percent in 2050. The countries projected to have the biggest budget holes are southern and eastern European countries and Germany. Greece, Portugal, and Spain have the largest projected deficits: by 2050, the gap between revenues and expenditures in these countries will be around 20 percent. The countries expected to have the smallest deficits are Luxembourg (four percent), followed by Belgium, Sweden, and Denmark (about 10 percent). These estimates are based on the costs currently generated by people in different age groups, and on the assumption that current patterns of consumption and length of working life are unchanged. Even small changes in these trends – such as a delay in the actual retirement age of three years – would have significant effects, and could thus cause these deficits to shrink substantially.

Our findings indicate that the age composition of the population is the factor that has a substantial effect on the size of the deficit. We can therefore conclude that demography plays a major role in the development of public budgets.

In light of these diverging demographic trends and the growing costs associated with these developments, we may want to consider the following thought experiment: What if there were a pan-European transfer union through which all of the member states shared the risk of population aging? In this scenario, the EU countries would have to come up with around 150 billion euros in 2050 to cover the budget deficits of all member countries. In order to raise this sum, all EU countries would have to increase their taxes by 16 percent. If this tax hike were implemented, demographically advantaged countries, like Denmark, Belgium, and France, would collect more taxes than they required; while less advantaged countries, like Slovakia, Estonia, and Slovenia, would receive the tax revenues they needed to cover their budget shortfalls from this first group of countries.

From a political perspective it is hard to imagine that a majority of Europeans would agree to such a demographic transfer union. But if this demographic trend is ignored, it could turn into an issue that puts further pressure on the EU. It is probable that the economic imbalances within Europe caused by demography will become larger, and that the open borders of the EU will make the generational contract – under which younger people agree to take care of older people – harder to sustain in individual countries.

About the author:
Fanny Kluge is a postdoc in the MPIDR Laboratory of Digital and Computational Demography.

More Information

Original Article: Transfers in an aging European Union, Fanny A. Kluge, Joshua R. Goldstein, Tobias C. Vogt, The Journal of the Economics of Ageing, 23 July 2018 (online), https://doi.org/10.1016/j.jeoa.2018.07.004