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Facing Demographic Challenges: Pension Cuts or Tax Hikes

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  • George Kudrna
  • Chung Tran
  • Alan Woodland

Abstract

In this paper, we investigate two fiscal policy options to mitigate fiscal pressure arising from an ageing of Australian population: pension cuts or tax hikes. Using a computable overlapping generations model, we find that while the two policy options achieve the same fiscal goal, the macroeconomic and welfare outcomes differ significantly. Future generations prefer pension cuts, whereas current generations prefer tax hikes to finance age-related government spending commitments. Interestingly, taxing consumption or income results in opposing effects on macroeconomic aggregates and welfare across different skill types of households. Increases in the consumption tax rate have positive effects on labour supply, domestic assets and output per capita (similarly to pension cuts), but reduce the welfare of low income households most. Conversely, increases in progressive income or payroll taxes have negative effects on most macroeconomic aggregates but reduce the welfare of low income households least. Our results highlight the intra- and inter-generational conflicts of interest and political constraints when implementing any structural fiscal reforms.

Suggested Citation

  • George Kudrna & Chung Tran & Alan Woodland, 2015. "Facing Demographic Challenges: Pension Cuts or Tax Hikes," ANU Working Papers in Economics and Econometrics 2015-626, Australian National University, College of Business and Economics, School of Economics.
  • Handle: RePEc:acb:cbeeco:2015-626
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    File URL: https://www.cbe.anu.edu.au/researchpapers/econ/wp626.pdf
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    References listed on IDEAS

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    Cited by:

    1. Christine Ma & Chung Tran, 2016. "Fiscal Space under Demographic Shift," ANU Working Papers in Economics and Econometrics 2016-642, Australian National University, College of Business and Economics, School of Economics.
    2. Mathias Dolls & Karina Doorley & Alari Paulus & Hilmar Schneider & Sebastian Siegloch & Eric Sommer, 2017. "Fiscal sustainability and demographic change: a micro-approach for 27 EU countries," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 24(4), pages 575-615, August.
    3. Chung Tran & Sebastian Wende, 2017. "On the Marginal Excess Burden of Taxation in an Overlapping Generations Model," ANU Working Papers in Economics and Econometrics 2017-652, Australian National University, College of Business and Economics, School of Economics.

    More about this item

    Keywords

    : Demographic Transition; Fiscal Cost; Fiscal Policy; Welfare; Overlapping Generations; Dynamic General Equilibrium;

    JEL classification:

    • H2 - Public Economics - - Taxation, Subsidies, and Revenue
    • J1 - Labor and Demographic Economics - - Demographic Economics
    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models

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