Demography and the composition of taxes: a political economy theory

ABSTRACT

This article analyzes the impact of population aging on the composition of taxes in an overlapping generations model. Taxes are levied on both income and expenditure, with the median voter being pivotal in the political-economy theoretical framework in question. As in Razin, Sadka, and Swagel (2002. “The Aging Population and the Size of the Welfare State.” Journal of Political Economy 110 (4): 900–918. doi:10.1086/340780), an increased fraction of retirees in the population leads to lower income taxes. Conversely, the results for expenditure taxes are ambiguous. The main proposition is that the composition of taxes–defined as the extent to which taxes are levied on income relative to expenditure–falls unambiguously with the share of retirees increasing as the tax burden is rebalanced toward the retired population.

KEYWORDS:

• Aging
• tax structure
• political economy theory
• income taxes
• expenditure taxes

JEL CLASSIFICATION:

• D78
• E62
• H20

Acknowledgments

I am grateful for the helpful comments and suggestions from the two anonymous referees and Toby S. James (the Editor). I would also like to thank Andrew Pickering, Paulo Santos Monteiro, Gulcin Ozkan, Frank Cowell, and seminar participants at the University of York for useful comments and discussions. Part of this work and idea took place whilst Luo was studying at the University of Cambridge and Luo is grateful for their generous support and hospitality, and insightful advices from Toke Aidt (mentor).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been corrected with minor changes. These changes do not impact the academic content of the article.

Notes

1 Luo (2019) only developed a verbal theory.

2 One alternative interpretation is that, arguably, countries with a higher dependency ratio tend to be fairly richer, whereas richer countries tend to collect a greater share of income taxes.

3 The author of this article is aware of the high debt-to-GDP ratio, especially in member states of the Organisation for Economic Co-operation and Development (OECD). Note that this article primarily focuses on the composition of taxes rather than debt decisions.

4 According to Persson and Tabellini (2002), if all voters have single-peaked policy preferences over a given ordering of policy alternatives, a Condorcet winner always exists and coincides with the median-ranked bliss point.

5 In practice, Japan, as a country with an aging population, provides interesting anecdotes. In April 2014, Japan's government increased its expenditure tax rate from 5% to 8%, and again raised this rate to 10% in October 2019.

6 The author of this article is also aware that income taxes are primarily levied on pensions and labor/self-employment income. Owing to the lower social security contributions and lower pension incomes, the effective tax rate on the retired population is lower overall.

7 Besley and Persson (2014) found that low-income nations typically collect taxes of between 10 and 20% of gross domestic product (GDP), whereas the average for high-income states is approximately 40%.

8 In the model, expenditure taxes seem to be broadly associated with consumption taxes. As indicated above, we can also rename expenditure taxes as consumption taxes. Moreover, the income tax defined in the model appears to be consistent with the definition of personal income taxes, which are levied on physical persons as opposed to corporate entities. For brevity and following Pickering and Rajput (2018), this article will describe these as “income taxes” in the text.

9 In voting on tax rates in period t individuals take ${\tau }_{c,t+1}$ as exogenous.

10 In practice, taxes on income are more progressive in nature than taxes on expenditure.

11 The median voter is not among the retirees, as is probably still the case in all developed countries as well as developing nations.

Additional information

Funding

This research was supported by the National Natural Science Foundation of China (grant 72304022), and the research launch plan project of Beijing International Studies University (grant KYQH23A008).

Notes on contributors

Weijie Luo

Dr. Weijie Luo is an associate professor in economics at Beijing International Studies University (BISU). Prior to joining BISU, Dr. Luo was an associate professor in economics at the Central University of Finance and Economics, and an associate lecturer in economics at the University of York, where he completed his PhD in economics. He also served as a visiting researcher at the University of Cambridge in 2018. His research interests are in macroeconomics, political economy and economic policy. His research work has been published (or accepted for publication) in journals such as Applied Economics, Economics Letters, International Review of Financial Analysis, Pacific-Basin Finance Journal, etc. He is currently serving as an anonymous referee in journals such as Scottish Journal of Political Economy, World Development, etc. One of his papers won the first prize award for the best PhD paper at the 49th Money Macro and Finance Annual Conference.