Youthful dependents and economic growth: the effect of tax composition

ABSTRACT

Several theories document the positive effect of younger population on economic growth due to the larger size of the labour force. However, the evidence shows no such positive relationship. This paper argues that an increase in the youthful fraction of the population increases the demand for income taxes rather than expenditure taxes, as expenditure taxes are shared by three generations whilst income taxes are mainly afforded by the working-age population who increasingly dislikes being double-taxed at consumption when they raise their dependent children. This then reduces growth since the extent of distortionary relative to non-distortionary taxes rises and investment is constrained. International panel evidence supports this hypothesis.

KEYWORDS:

• Youthful dependents
• growth
• income taxes
• expenditure taxes

JEL CLASSIFICATION:

• D78
• E63
• H20
• J13
• O40

Acknowledgments

We would like to thank the anonymous referee and the editor for helpful comments and suggestions. Part of this work and idea took place whilst Luo was studying at the University of York and Luo is grateful for their generous support and hospitality.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Admittedly, if the younger generation are given proper education, then the human capital they possess can to some extent mitigate the negative consequences of distortions of taxes on investment.

² Data on GDP per capita are taken from the Penn World Tables.

³ Data on population by age are extracted from the World Development Indicators database.

⁴ As a robustness check, we also examine how youthful dependents affect the composition of taxes (ln($\frac{t_y}{t_c}$)), utilizing the dataset used in Luo (2019). The replication of Table 2 in Luo (2019) instead using the youthful fraction of the population as the key explanatory variable yields a significant positive relationship between the measure of youth and the tax ratio, as conjectured by the argument invoked in this paper.

⁵ As a robustness check, we also obtain similar patterns with a greater size of interval – regressions of the change in GDP per capita on different measures of demography using ten-year period data.

⁶ Both data are derived from the 2019 Revision of World Population Prospects, United Nations.

⁷ The estimated effect is sizeable: A one-standard-deviation-increase in the ratio of children to workers is statistically associated with the change in GDP per capita, which is lower by 0.21, holding all else equal.

⁸ This paper also obtains essentially identical results if we, in the interaction term, entered a dummy variable that takes the value of 1 when POLITY2 is positive and the value of 0 when the index is negative.

⁹ In Table 4, the results relating to the control variables are of some interest. As documented by models considering conditional convergence, the coefficients on initial income is negative and statistically significant. In addition, countries with stronger democratic credentials are found to have a higher rate of growth, in line with Acemoglu et al. (2019).