Can an Ageing Scotland Afford Independence?
Lisenkova, Katerina, Merette, Marcel, National Institute Economic Review
The aim and scope of this paper is to isolate the effects of population ageing in the context of potential Scottish independence. A dynamic multiregional Overlapping Generations Computable General Equilibrium (OLG-CGE) model is used to evaluate the two scenarios. The status quo scenario assumes that Scotland stays part of the UK and all government expenditures associated with its ageing population are funded on a UK-wide basis. In the independence scenario, Scotland and the rest of the UK pay for the growing demands of their ageing populations independently. The comparison suggests that Scotland is worse off in the case of independence. The effective labour income tax rate in the independence scenario has to increase further compared with the status quo scenario. The additional increase reaches its maximum in 2035 at 1.4 percentage points. The additional rise in the tax rate is non-negligible, but is much smaller than the population ageing effect (status quo scenario) which generates an increase of about 8.5 percentage points by 2060. The difference for government finances between the status quo and independence scenarios is thus relatively small.
Keywords: Scotland; independence; OLG; government spending; population ageing
JEL Classifications: C68; E17; H53; J11
In the light of the current Scottish independence debate, much attention is being paid to whether Scotland and the rest of the UK will be better off after the separation. One of the arguments that has been raised during the debate is that Scotland is in a worse demographic situation than the rest of the UK, and independence will make the fiscal challenge harder in the context of its ageing population. In 2012, the old-age dependency ratio (OADR) (1) in Scotland and the rest of the UK was the same at 29 per cent. However, in the future the Scottish population is projected to age more rapidly, and by 2037 OADR in Scotland will reach 48 per cent, while in RUK it will reach 45 per cent. (2) However, by 2050 OADR in both regions will converge again.
This paper uses a dynamic multiregional Overlapping Generations Computable General Equilibrium (OLG-- CGE) model for Scotland, the rest of the UK (RUK) and the rest of the World (ROW) to evaluate demographic scenarios for Scotland and RUK with and without independence. The model is in the Auerbach and Kotlikoff (1987) tradition and introduces age-specific mortality following Boersch-Supan et al. (2006).
We use the 2012-based principal population projections produced by the Office for National Statistics (ONS) as an exogenous demographic shock for Scotland and RUK. The status quo scenario assumes that Scotland stays part of the UK and all government expenditures associated with ageing population (mainly pensions and health) are funded on a UK-wide basis. In the status quo scenario, population ageing has a strong impact on economic development in both regions. By 2060 output per person falls in Scotland and RUK by 10 per cent and total government spending increases by 4 percentage points of GDP. To achieve government budget balance the effective labour income tax rate has to increase from about 13.0 per cent to 21.5 per cent, i.e. by 8.5 percentage points.
In the independence scenario, RUK and Scotland have separate government budget constraints and each of them has to pay for the growing demands of their ageing populations independently. As expected, Scotland is worse off in the case of independence, although the difference with the status quo scenario is not large, especially when compared with the overall effect of the demographic shock. The greatest difference is in 2035 and at this point the effective labour income tax rate in Scotland is 1.4 percentage points higher in the independence scenario compared with the status quo scenario. The difference is non-negligible but it is much smaller than the effect of population ageing itself.
It is interesting to compare the results presented in this paper with the Institute for Fiscal Studies (IFS) report on the fiscal sustainability of an independent Scotland (Amior et al. …