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1998 April Report of the Auditor General of Canada

Main Points

6.2 This demographic shift has the potential to affect government finances in a significant way. An aging population puts pressure on government spending through higher pension payments and increased demands for health care services. Also, unless there are significant changes in the patterns of work, this demographic change will reduce labour force growth dramatically, which in turn would slow down economic growth and, with that, the growth in government revenues. This combination could put enormous pressures on our public finances when the full impact of this demographic change is felt by the second decade of the next century, particularly if Canada's debt burden and tax levels remain high.

6.3 The government is well aware of these pressures; during consultations on reforming specific programs like the Canada Pension Plan, it provided detailed projections of the effects of demographic forces on CPP finances. This longer-term information not only helped inform public debate, but also motivated acceptance of the need for change. To a lesser extent, as government began discussing reforms to Old Age Security and the Guaranteed Income Supplement (the Seniors Benefit), it again provided longer-term projections of the financial impacts.

6.4 Yet what it has done to highlight the impact of demographics on the financial health of individual programs, it has failed to do for the financial health of the government as a whole. Consequently, parliamentarians are left to make annual financial decisions, many of which have lasting consequences, without a macro perspective - a summing up of the financial impacts that demographics can potentially have on the government's long-term financial health.

6.5 The importance of appropriate information to help parliamentarians understand the government's financial condition is clearly a responsibility and a theme on which we have reported over the last six years. This chapter, illustrating the feasibility of preparing such longer-term information and the significance of that information, is a continuum of the "Information for Parliament" chapters in our 1993 and 1995 Reports. The particular contribution of this chapter is its focus on the role of demographics in assessing the government's financial condition.

Introduction

6.7 Our 1992 Report stated that without a long-term focus, there is no anchor for short-term policies. In 1993, we suggested a series of five indicators that would help taxpayers understand how their tax dollars were being used. We also suggested that it was not enough to look simply at the past, but that this kind of information should be projected forward to show the long-term impact of current fiscal policies on these indicators.

6.8 Our 1995 Report continued the theme of the need for a longer view by indicating that most of the discussions about controlling government finances had been focussed on deficit reduction and balanced budgets. The government had not addressed the larger question of how much debt it could sustain over the long haul, and how that would fit within an overall view of taxation, the role of government and its impact on the Canadian economy.

6.9 Annual budget balances, desirable as they may be, have taken on an aura of importance as the pre-eminent scorecard of government accountability, rather than being recognized for what they truly are - only one of many components that provide an assessment of the government's overall financial condition. Simply relying on current deficits and debt ratios to come down does not provide a complete picture of financial condition, nor does it adequately identify the trade-offs Canadians need to make or the intergenerational choices that must be considered.

6.10 The government's response to our reports has been generally positive. Starting in 1994, it began producing an Annual Financial Report that included the five financial indicators we had proposed in 1993. More recently, the government has begun to pay more attention publicly to the debt-to-GDP ratio. To date, however, it has not provided Parliament with any specific debt targets or fiscal projections beyond two years ahead. The government's view seems to be that there is no need for a longer-term perspective as long as the debt ratio continues to fall. In our view this is insufficient, particularly if equity between generations is a concern. As we know, Canadians are facing choices today. To make those choices - particularly any changes to spending, taxation or debt reduction - Canadians need information about the impact their choices can have on government programs and how the financial burden of those programs will be shared between present and future generations.

6.11 The Minister of Finance alluded to these issues in his remarks to the House of Commons Standing Committee on Finance at the opening of the pre-Budget consultation process last fall, but put forward no specific discussion of their potential financial impacts. By contrast, when the federal government engaged the public in consultations about changing the Canada Pension Plan (CPP), it went much further and provided specific financial information about the difficulties the CPP would face in the coming decades because of predictable demographic developments. That information was provided to convince the public of the intergenerational inequity in the then-current contribution/benefit schedule. In our view, the funding and intergenerational issues that motivated action on the CPP are relevant to other areas of government spending as well.

6.12 To a lesser extent, the government is engaged in a similar exercise in the reform of the Old Age Security and Guaranteed Income Supplement programs. Missing, however, is a macro perspective - a summing up of the financial impacts that demographics can potentially have on the government's long-term financial health, and the importance that annual fiscal decisions have with respect to that health.

Focus of the study

6.14 This prospect has given rise to intense public debate about budgetary choices. However, this debate seems to be taking place in a vacuum of information about Canada's demographic profile and its potential impact on our public finances.

6.15 The objectives of this study were twofold:

• to demonstrate the significance of a long-term perspective to a proper appreciation of the government's current financial condition, with specific reference to the fiscal implications of current demographic trends; and
• to draw attention to the inadequacy of the information provided by the government to Parliament and the public about the implications of current demographic trends and their potential impact on current fiscal decisions.

Study Findings

Demographic Trends

The aging of the population

6.18 Canada's population has been growing older through most of this century, brought on by falling fertility and mortality rates over time. As Exhibit 6.1 shows, there was a pause in this trend between 1950 and 1970. That pause reflects the sharp increase in the number of births in the two decades following World War II.

6.19 From fewer than 250,000 per year during the 1930s and early 1940s, births soared to a yearly average of 425,000 between 1946 and 1965. Those born over this 20-year period represent the so-called baby boom generation. A baby "bust" followed, with births falling well below 400,000 a year over the past three decades, despite a much larger population base. The fertility rate - the lifetime number of births per woman - plummeted from over 3.5 during the baby boom years to 1.7 over the past two decades, a rate significantly lower than the replacement rate of 2.1, the rate needed to maintain the population at a constant level in the absence of net immigration. (For a discussion of the source and nature of the demographic projections, see Exhibit 6.2. )

6.20 The baby boomers will begin reaching normal retirement age by about 2010. Over the subsequent two decades, as successive cohorts of this generation join the ranks of the population aged 65 and over, the size of this age group will expand greatly.

6.21 Another factor contributing to this expansion is that people are living longer, the result of improvements in medical services and better living standards. In 1952, when Old Age Security was first introduced (with eligibility for benefits to begin at age 70), a Canadian at birth was expected to live to 68.5 years. Today the average life expectancy is 78.5 years and is expected to grow to 80 years by 2016. In 1952, a 65-year-old Canadian was expected to live another 14 years on average. Today, life expectancy at 65 is over 18 years. In other words, over time, a growing proportion of Canadians are living long enough to qualify for social security benefits and on average they receive them for a longer time.

6.22 The onset of retirement of the baby boomers, together with gains in life expectancy, will result in rapid expansion of Canada's elderly population in the second and third decades of the next century. According to projections by Statistics Canada, the population 65 years and over will grow gradually from some 3.6 million today to five million by 2011 and then will soar to nine million by 2031 (see Exhibit 6.3 ). The rest of the population is also expected to grow over this period, but much more slowly. As a result, the proportion of the total population who are elderly will almost double, from 12 percent today to 22 percent by 2031. The elderly dependency ratio - the ratio of the population 65 and over to the population aged 20 to 64 - is also projected to nearly double, from 20 percent today to over 38 percent by 2031.

6.23 The oldest among the elderly will experience the fastest growth in numbers. The population aged 80 and over will almost quadruple over the next 45 years, growing from about 820,000 today to some 3.1 million in 2041. Its proportion of the total population will swell from less than 3 percent today to over 7 percent, or from 23 to 33 percent of the elderly. In short, over the next few decades, Canada's population of elderly will increase substantially and so will their average age.

6.24 The actual demographic future may differ from the one projected, but not significantly. The people who will be retiring over the next few decades are already in the current population. Changes in fertility rates are not easily susceptible to policy influence. At any rate, changes in fertility will not have a significant impact on the labour force for at least two decades. Finally, immigration levels are the only policy lever that can affect the population mix in the medium term. But its potential is limited, simply because even a doubling of current immigration levels would result in only a marginal decrease in the ratio of the elderly to the working-age population over the next few decades.

The role of a declining youth population

6.26 However, relying on these raw numbers as a basis for assessing the potential financial impact of the dependency ratio would be misleading because youth and the elderly do not represent equivalent demands on government spending. Estimates for Canada suggest that per capita spending on the elderly is two to three times greater than on the young.

6.27 Exhibit 6.5 shows elderly and youth dependency ratios, and ratios adjusted for the estimated differences in public spending on the young and the elderly. The table shows that on an expenditure-weighted basis, dependency ratios in the coming decades will be not only much higher than today but also higher than the high ratios of 30 to 40 years ago.

Demographic Changes and Economic Growth

Demographic developments will tend to depress domestic savings

6.30 Among individuals, a strong reason for saving is to smooth consumption over time. Typically, people consume a higher proportion of their income in their early years (when incomes are low), less during middle age, and then more again during retirement. The pattern of saving is the reverse of the consumption pattern.

6.31 This pattern of consumption/saving suggests that baby boomers, who are now in their peak earning years, are also in their peak saving years. Other things being equal, then, personal savings may fall over the next few decades as this generation ages and leaves the work force for retirement. By how much savings may fall is difficult to say, because we lack good estimates of the responsiveness of saving to changes in life circumstances.

6.32 Government saving is also negatively affected by the population's aging. An aging population brings on pressures for governments to spend more, which is tantamount to saving less. The result is that Canada could experience a significant drop in total savings (private and government combined) during the second and third decades of the next century.

6.33 This prospect's relevance to government finances stems from the effect that savings have on economic growth and therefore on government revenue growth as well. Saving is the means to investment. Low rates of saving imply either low rates of domestic investment or higher foreign indebtedness, if we borrow abroad to keep investment levels high. Lower investment means lower capital per worker and hence lower productivity and income growth. Higher indebtedness to foreigners means that a higher proportion of incomes generated domestically accrues to non-residents in the form of interest or dividend payments. In either case, a reduction in the level of our domestic saving would leave future Canadians economically less well-off and the tax base available to Canadian governments correspondingly smaller.

Growth in labour force will slow sharply in coming decades

6.35 According to Statistics Canada projections, the annual increase in Canada's working-age population will fall from an average rate of 1.6 percent over the past 20 years to less than 1 percent during the second and third decades of the next century. Growth in the labour force will decline even more because the labour force participation rates are also expected to fall.

6.36 The anticipated reduction in labour force participation rates is also due to demographic factors. In the coming decades, an increasing proportion of the working-age population will fall within older age groups, which are characterized by lower participation rates. In particular, the baby boom generation is currently at its peak participation age (30 to 50 years old). As it grows older and its attachment to the labour force weakens, it will tend to pull down overall participation rates. Of course, factors other than demographics - factors such as wealth and income levels, social policies and attitudes - also affect labour force participation rates. Our projections do not reflect such factors, because their long-term impact is more difficult to assess than that of demographics.

6.37 Exhibit 6.6 shows historic and projected labour force growth rates over specific periods to the year 2031. The anticipated reduction in participation rates together with a slowdown in the growth of the source population result in a marked projected decrease in labour force growth over the next decade. By the second and third decades of the next century, as baby boomers leave the work force for retirement, labour force growth will slow to a near standstill.

6.38 This labour market outlook has a direct effect on the expected rate of economic growth. Growth consists essentially of the sum of growth in employment and in productivity, or output per person employed. As labour force growth weakens, therefore, so will economic growth unless productivity improvements offset the declines in employment growth.

6.39 Over the past 20 years, real GDP growth in Canada has averaged 2.6 percent a year. Productivity improvements accounted for approximately one third of this growth and employment growth for two thirds. Given the labour force projections we have outlined here, the contribution from employment growth will fall sharply in the years ahead. During the second and third decades of the next century, economic growth will be confined to essentially the rate of growth in productivity. If the productivity performance over these decades parallels that recorded over the past two decades, GDP growth will slow to little over one percent a year. To attain the average growth rate recorded since the mid-1970s, the rate of productivity growth will have to more than double.

Higher rates of productivity growth are possible but not assured

6.41 There are some who believe that this trend may change because of the revolution in information technology. There are also those who argue that the productivity effects of information technology are likely to remain small, either because the effects of computers are in fact relatively small or because they are not captured by official output data - for example, the benefits attached to Internet or banking machine access. If this view is correct, information technology may not show a large payoff in measured GDP growth.

6.42 Labour productivity could improve even without improvements in overall efficiency, if labour had more capital to work with. But with the potentially adverse impact of an aging population on saving rates, and consequently on capital, most long-range forecasts of the Canadian economy in fact show a declining growth rate for the capital stock in the coming decades.

6.43 In light of these considerations, significant increases in productivity growth are not assured. For the fiscal projections reported later in this chapter, we assume labour productivity will increase at an annual rate of one percent, only marginally higher than the average productivity growth experienced since the mid-1970s.

6.44 As already indicated, economic growth is basically the sum of growth in productivity and in the labour force. Then, if the rate of productivity growth remains roughly constant and there is a marked slowdown in labour force growth over the next few decades, this implies that economic growth will also decline markedly (see Exhibit 6.7 ).

Demographic Changes and Government Spending

Government spending in social security will accelerate

6.47 Exhibit 6.9 displays projections of social security spending to the year 2031, when all baby boomers will have reached retirement age. These projections are based on data provided by the Chief Actuary and assume a one percent annual growth in real wage rates. Projections for the QPP are based on the assumption that future outlays under that program will remain a constant percentage of CPP outlays. Under these assumptions, total CPP/QPP outlays are projected to grow from 2.7 percent of GDP in 1996 to 4.7 percent in 2031.

6.48 The projections for OAS/GIS do not incorporate changes under the proposed Seniors Benefit, since this reform has not yet been legislated and its final form was not known at the time this chapter was completed. Under the existing program, increases in OAS spending lag behind GDP growth in the earlier years of the projection period (since these benefits are linked to prices, not wages), but accelerate past it in the second decade of the next century when the leading edge of the baby boomers reaches OAS eligibility age. By 2031, OAS outlays are projected to rise to 2.9 percent of GDP compared with 2.0 percent today.

6.49 Expenditures under the GIS program also rise over the projection period, but less than OAS benefits and only marginally more than the economy as a whole. This is because GIS benefits are income-tested and thus tend to fall as other income sources grow.

Population aging will intensify pressures on medicare

6.51 Health care costs follow a pattern that varies with age. They tend to be relatively high in the earliest years, fall significantly during youth and young adulthood, rise gradually during middle age and then quite steeply during old age (see Exhibit 6.10 ). Generally, as people age they become more susceptible to illness and health problems that may limit their ability to function independently. The incidence of disabilities, for instance, increases significantly with age. The elderly are also more likely to require physician services, hospitalization or nursing home care. On average, per capita public spending on health for those aged 65 and over is almost five times greater than per capita spending on the rest of the population.

6.52 While health care costs are likely to rise as the population ages, projections of these costs are difficult to make with any degree of confidence because, in addition to demographics, they depend on many other factors that are highly uncertain. These include trends in the state of health of the elderly and relative inflation in the health care sector. They also include developments in technologies and treatments that, while adding to the quality of service, also tend to increase demand for health services and the need for highly trained - and highly paid - specialists. Finally, changes in the ways medicare services are organized and delivered can also significantly affect health care costs in the future.

6.53 Exhibit 6.11 shows the results of three separate health cost projections:

• a high-cost projection, which assumes that future age-specific per capita health costs rise at roughly the same rate as that experienced over the past two decades;
• a medium-cost projection based on the assumption that per capita health costs rise at the same rate as average wages (which are assumed to increase at an annual rate of 1 percent in real terms); and
• a cost-containment scenario in which health spending per capita rises only with the general price level, that is, age-specific health spending per capita remains constant in real terms.

6.55 Exhibit 6.12 summarizes the results of all the foregoing projections. It shows that government spending on social security and medicare rises from 11.6 percent of GDP in 1996 to somewhere between 14.7 and 20.7 percent by 2031, depending on the assumptions about health care cost increases. In the medium-cost projection (which has per capita health costs increasing at the same rate as the average wage), government spending on social security and health rises to 17.2 percent of GDP by 2031, 5.6 percentage points higher than today. In today's economy, such an increase is equivalent to roughly $50 billion.

Demographic Changes and Government Finances

Current budget decisions have long-term fiscal implications

6.58 The assumptions characterizing each scenario are set out in Exhibit 6.13 . In all three scenarios, government revenues are assumed to rise with the growth of the economy, so that the revenue share (as a percentage of GDP) stays constant throughout the projection period. The effective real interest on government debt is set at 5 percent, a rate that is high by historic standards but lower than the average rate over the past two decades. Government outlays on social security rise according to the projections discussed in the previous section. Spending on health care is made to rise with health care spending in general, which in turn is assumed to rise according to the "medium cost" projection set out in the previous section. (Modelling health spending this way may be questioned, since federal spending on health consists primarily of transfers to the provinces, which are not tied to actual spending on health. For a discussion of the rationale for this assumption, see Exhibit 6.14 .)

6.59 The three scenarios differ only in the assumptions we make about government "discretionary" spending (program spending in areas other than health and social security), and in the budget balances and debt levels that result from these assumptions.

6.60 Scenario one can be characterized as a case where the entire projected surplus is used for debt reduction. It represents essentially a continuation of the policy of fiscal restraint the government has been following in recent years. In this scenario, discretionary spending to the year 2010 is allowed to rise only with inflation. The fiscal surpluses resulting under this policy, while small at first, grow quickly over time, causing a correspondingly sharp reduction in the government debt. By 2010, the debt-to-GDP ratio shrinks to 23 percent, roughly the same ratio as in the mid-to-late 1970s (see Exhibit 6.15 ).

6.61 Scenario two can be viewed as a case where all projected surpluses are spent. That is, the budget is kept in balance till the year 2010. This scenario would allow discretionary spending to increase year over year, both in real terms and in relation to the GDP. The stock of debt remains unchanged in this scenario, but the debt-to-GDP ratio falls as the economy grows. Given the economic growth underlying the projections, the debt ratio falls to 42 percent by 2010, which is where it was approximately 14 years ago.

6.62 Scenario three is an intermediate option, where part of the projected surplus is spent and part is used to reduce the debt. More specifically, this scenario assumes that discretionary spending beyond the year 2000 rises at the same rate at which the economy grows. Given the large operating balance at the beginning of the projection period, this scenario also results in substantial and growing budget surpluses over time, though smaller than in the first scenario. The debt-to-GDP ratio in this case falls to about 33 percent by 2010, its level in 1982.

6.63 Clearly, the debt-to-GDP ratio falls significantly from current levels in all three scenarios, but never lower than it was 20 years ago. Moreover, the run-up in debt we have experienced since the mid-1970s occurred despite favourable demographic conditions, with the labour force growing strongly and dependency ratios declining. By contrast, in the years after 2010, labour force growth will be weak and dependency ratios will be rising. In this context, despite the 10 years of fiscal consolidation represented by each scenario, the government's financial health will still be poorer when baby boomers begin leaving the labour force than when they entered it.

6.64 The projections of discretionary spending in the years beyond 2010 help illustrate this point. Exhibit 6.16 shows average spending on government programs other than social security and health care ("discretionary spending") as a percent of GDP for specific periods to fiscal year 2032. It also shows discretionary spending during 1976-97, for comparison purposes.

6.65 Projections to the year 2010 show the results of the three scenarios described above. Projections beyond 2010 are calculated on the assumption that the debt-to-GDP ratio is held constant at the level where it happens to be in 2010 under each of the three scenarios. The assumptions concerning government revenue growth, interest costs and "entitlement spending" (spending on social security and health) stay the same as before. Discretionary spending is adjusted to maintain the fiscal balances required to keep the debt ratio constant.

6.66 A number of observations follow from the results displayed in Exhibit 6.16 .

6.67 First, under all three scenarios, discretionary spending over the next decade is much lower than in the years thereafter. In part, this represents the price of bringing the debt ratio down, which means that until 2010 the budget is kept in surplus or in balance. It also represents the payoff from this period of fiscal restraint: with a much lower debt burden in the years beyond 2010, a smaller portion of the budget is absorbed by debt service costs and more is left over for program spending.

6.68 A measure of the payoff from fiscal restraint is also provided by the differences in the level of discretionary spending associated with each scenario. A policy of "banking" prospective surpluses over the next decade, such as that of scenario one, results in a level of "discretionary" spending in the long term that is approximately 6 percent higher than under the balanced budget scenario. In today's economy, this amounts to approximately $5 billion. But even in the most stringent of the three scenarios, discretionary spending in the second and third decade of the next century remains well below levels experienced in the 1970s and 1980s.

6.69 Each of the three scenarios in effect represents a particular fiscal path to the year 2010. The greater the fiscal restraint associated with a path - that is, the more of the potential surpluses we "bank" rather than spend along the way - the smaller will be the stock of debt at the end of it. A lower debt implies lower debt service payments, and therefore more spending available for programs at any given revenue level. In short, the more we spend today, the less we or our children can spend tomorrow.

6.70 Finally, Exhibit 6.16 also shows that discretionary spending (relative to the size of the economy) is lower in the second half of the period 2011-32 than in the first. This decline reflects primarily the pressures of entitlement spending (OAS/GIS and health) on other programs. As discussed earlier in this chapter, the growth of Canada's elderly population will accelerate during the second and third decades of the next century, as the huge baby boom generation joins the ranks of those over 65. Under current policies, this aging trend will result in significant increases in government spending on social security and health care. If these spending increases are to be met without increasing the overall tax burden or the level of indebtedness, government spending in other areas will have to fall.

6.71 In all of the three scenarios discussed here, discretionary spending is the variable that adjusts to meet the different policy-determined fiscal targets. This way of casting policy was done for ease of exposition only. The same targets could also be met through tax changes or through a combination of tax and spending measures.

6.72 Any long-term projections are highly speculative. They are based on assumptions that may turn out to be wrong. But while precise outcomes are uncertain, the overall trend is not: the ratio of working to non-working population will shrink dramatically in the next few decades and this will increase pressures on government spending while reducing the government's capacity to respond. How serious these effects turn out to be will depend crucially on policies followed in the meantime to minimize their impact. Clearly presented long-term projections, made available to Parliament and the public, can help identify the fiscal challenges that lie ahead and the trade-offs associated with different options for dealing with them.

Government Initiatives

Many countries are budgeting within a long-term framework

6.74 The United States and Denmark have probably moved further in this direction than most. Both countries prepare and make public projections of fiscal balances under various assumptions 40 to 50 years ahead. Demographic impacts on public finances are explicitly considered in these projections.

6.75 Other countries, while not engaged in detailed long-term projections, nevertheless supplement their fiscal statements in other ways that introduce a long-term perspective in budget decision making. In New Zealand, for example, the government is required by law to establish long-term fiscal objectives and to discuss in the budget how the government's fiscal plans support those objectives. As part of this process, the New Zealand government has begun reporting on the demographic pressures looming over the following several decades and how these could affect the government's fiscal position. Legislation similar to that of New Zealand is currently before Parliament in Australia.

6.76 Another way of bringing a long-term perspective to budget making is through the production of so-called generational accounts (see Exhibit 6.17 .). Generational accounts have been provided in recent years by governments in the U.S., Argentina, New Zealand and Norway. In November 1997, the UK government announced a project to develop such accounts for the UK as well.

Canada is not among them

6.78 Regular long-term actuarial analyses of the CPP, the OAS, and several public service pension plans are carried out because legislation requires them. Except for these analyses, however, there is no legal requirement for long-term financial projections of other government commitments, and none is made on a regular basis. A study on the cost of government and expenditure management was completed in 1992 by a joint federal-provincial working group at the request of ministers of finance and treasurers. Part of that study examined future pressures on government spending and provided long-term projections (to the year 2025) of expenditures on health, education and social services, under various economic and demographic assumptions. Also, a number of internal studies have been prepared that look at the long-term economic implications of aging. In the fall of 1997, the government sponsored a conference of experts to discuss such implications.

6.79 More recently, the Department of Finance has developed an economic model that is capable of making long-term projections of potential growth of the Canadian economy. It would not require significantly more resources to supplement that model with a fiscal component that would enable the Department to also prepare long-term projections of budget balances and debt levels.

Conclusion

6.81 Also indisputable is the fact that these demographic trends will have a significant impact on the economy down the road. Aging affects the amount and the way we save and therefore the amount we invest in the economy; aging also affects the size and composition of the labour force, which in turn affects the growth in the economy. Of course, events can change, but no event can change the reality that we have a baby boom bulge and that our fertility rates have been below rates that would sustain the existing population level. Unless our productivity somehow increases significantly or patterns of work and retirement change substantially, the current demographic trends suggest that the growth in the economy and the associated growth in government revenues will tail off in the coming decades.

6.82 Demographics can also have an impact on government spending. Under current legislation, the combined costs of Old Age Security and the Guaranteed Income Supplement will rise both in absolute terms and relative to GDP. Health costs in the economy as a whole will also rise relative to GDP. How much this will affect actual federal expenditures depends on a number of factors, including the continuance of the existing fiscal transfers, the likelihood that new federal programs like pharmacare and home care will be introduced, and other elements that could affect the federal share of health care expenditures. But if the federal share falls, someone somewhere will have to pick it up, whether it is the provinces or private health care arrangements. Since there is only one taxpayer, if private or provincial financial responsibilities increase there will be pressure to reduce federal taxation.

6.83 The exact magnitude of the impending demographic impact is not certain. However, the direction is clear. We do know that the lower the debt ratio becomes, the easier it will be for future governments to meet commitments to seniors and to fund other program areas like the environment, science and technology, and education. The scenarios we projected point out the nature and extent of the trade-offs involved.

6.84 Of course, events could change that might affect labour force growth or even productivity. Events could also affect the federal government's cost and share of health care. In any case, it is possible to demonstrate that demographics do matter, and that they can affect the long-term financial condition of government.

6.85 The government recognizes this and has done a considerable amount of work on this theme. The Department of Finance has supported academic workshops to encourage debate on the issue and it has built a long-run model to assess the factors involved. To date, however, the government has not made projections of this kind publicly available.

6.86 As an audit office, our role is not to compete with or supplement the work of think tanks and forecasting services that provide a range of predictions for the Canadian economy and government financial health. Our responsibility, among other things, is to comment on the credibility, reliability, and understandability of government financial reporting. As we have said many times before, that means looking forward, to understand the impact that the future holds in assessing current financial health. In this regard, it is our view that the government has not been sufficiently forthcoming in providing Canadians with information to allow them to make choices that affect not only them today but also generations down the road.

6.87 In this regard, to help legislators and Canadians gain a better appreciation of the fiscal challenges looming ahead, the government ought to produce long-term financial projections on the basis of status quo policies and alternatives. These projections would then be reported to Parliament, either as part of the annual budget presentation or during pre-budget consultations. There are two main reasons for doing this: first, the more transparent information is, the better its quality becomes. There is an expression that "sunlight is the best antiseptic". In this case, even if government projections are not perfect (as is inherent in any projection), public exposure will allow greater scrutiny and ultimately improve the information. The second reason is that if the information is made available publicly, Parliament and the public can better appreciate the long-term fiscal implications of current budgetary choices.

6.88 Finally, in making these suggestions, our purpose is not to put the government in a position of being accountable for financial results five, ten or twenty years down the road. Clearly that would not be fair or feasible. No government could ever publish estimates of its revenues or expenditures for the medium to longer term that it could guarantee it would meet. In this regard, being accountable for two-year rolling targets seems very defensible.

6.89 Yet dealing with the potential fallout that an aging society can have on government's long-term financial condition requires making intelligent choices today. And providing information to help parliamentarians with those choices is not about being accountable for the longer term, but simply taking the longer term into account. At this juncture, with the aging of the population a virtual certainty, we believe that for government financial reporting to be useful, telling people about the potential impacts that demographics can have is fundamental.

Department's response: The government continues to conduct its fiscal planning based on a simple strategy - that of achieving long-run goals by setting and meeting realistic short-run targets. This is a measured and responsible approach. It is also an effective approach.

Moreover, government financial management is not taking place in isolation; rather, government policy is being carried out with full awareness of the fiscal implications of population aging. The government and the Department of Finance have taken concrete steps in both analyzing and addressing the problem of population aging.

Indeed, the very extrapolations contained in the chapter largely replicate the results of a study produced six years ago by a joint working group of Department of Finance and provincial treasury officials. The government is also currently participating in the G-10 Working Party on the Aging of Populations, which is further investigating the economic and fiscal implications of population aging (population aging is not a phenomenon unique to Canada).

Beyond simply studying the issue, the government has proposed two important policy changes to ensure that our public pension system can be sustained in the face of changing demographics. The first was the 1996 Budget proposal to replace the current Old Age Security and Guaranteed Income Supplement programs with the Seniors Benefit. The fundamental objective of the proposed reform is to slow the growth in costs while protecting and enhancing pensions for low- and modest-income seniors. The second was the recent agreement between the federal and eight provincial governments to reform the Canada Pension Plan. This reform will ensure that the CPP program remains financially sound in the long run and continues to be in place for future generations.

The government believes that presenting long-run fiscal projections to Parliament every year would serve only to detract attention from the important goal of debt reduction. The best approach to fiscal management is the considered and deliberate one of achieving long-run goals through realistic short-run targets, and taking tangible measures to ensure that programs remain sustainable in the face of upcoming demographic changes.

About the Study

Objectives

• to demonstrate the significance of a long-term perspective to a proper appreciation of the government's current financial condition, with specific reference to the fiscal implications of current demographic trends; and
• to draw attention to the inadequacy of the information provided by the government to Parliament and the public about the implications of current demographic trends and their potential impact on current fiscal decisions.

Scope and Approach

The findings of the study were based on:

• a review of published information on demographic trends and their long-term fiscal implications;
• Statistics Canada census and economic data and population projections;
• actuarial projections by the Chief Actuary of the OAS/GIS and CPP programs;
• examination of internal studies and working papers on demographics and economic growth by the Department of Finance, and interviews with departmental officials;
• a review of budgetary reporting practices in Canada and several other developed countries.

Study Team

Paul Zind

For information, please contact Jeff Greenberg.