Demography and economic growth: the effect of tax composition

ABSTRACT

Several theories document the negative effect of population ageing on economic growth, either due to the smaller size of the labour force and consequent reduced productivity, or due to an excess of savings over desired investment. However, the evidence shows no such negative relationship. This paper argues that population ageing increases the demand for expenditure taxes rather than income taxes, leading to higher growth since the extent of distortionary relative to non-distortionary taxes falls and investment is facilitated. International panel evidence supports this hypothesis, and this relationship holds more firmly in stronger democracies.

KEYWORDS:

• Ageing
• growth
• income taxes
• expenditure taxes

JEL CLASSIFICATION:

• D78
• E62
• H20
• O40

Acknowledgments

I would like to thank the anonymous referee and the editor for helpful comments and suggestions.

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Admittedly, some countries include the pensions as income within the personal income tax. For simplicity, this paper follows Luo (2019) and assumes that income taxes are mainly contributed by workers.

² This paper also obtains essentially identical results if the author entered a dummy variable that takes the value of 1 when $POLITY2$ is positive and the value of 0 when the index is negative in the interaction term.