The Effects of Population Ageing on the Personal Income Tax Revenue in Canada: A Simulation Approach

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The Effects of Population Ageing on the
Personal Income Tax Revenue in Canada:
A Simulation Approach
Wen-Fong Lu Wei Li Earl Bailey*
Abs tract
The Canadian population has been ageing since the 1980s with the
proportion of Canadians age 65 and over continuing to increase to the
middle of the century. It is envisioned that population ageing will have
implications on both the government’s expenditure and revenue sides.
This paper focuses on the revenue implications. The major objective of
the paper is to profile the ageing of the population and illustrate how it
will affect the patterns of personal income and taxes at the federal level.
The research is based on the Statistics Canada medium population growth
projection over the period 2000 to 2026 and applying these projections
to a micro-simulation model developed by the Canada Revenue Agency
to make projections of federal personal income tax.

Our major findings include: In the case of the demographic approach

* Although the authors are employees of the Canada Revenue Agency, the views presented in this
paper do not necessarily reflect those of the Agency. The authors appreciate the comments on
earlier drafts given by Allan McGrath and Thomas C. C. Chen of Nan Jeon Institute of Technology.
Correspondence concerning this paper should be addressed to Wen-Fong Lu; E-mail: Wen-Fong.
Lu@ccra-adrc.gc.ca

Receipt Date: 2004/02/20; Acceptance Date: 2005/01/20

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30
Wen-Fong Lu, Wei Li and Earl Bailey
that assumes only population structure change, the total personal taxable
income and the total net federal income tax over the period 2001 to 2026
will continue to increase, but the average taxable income and income tax
payable per return will show a decline from 2011 when the “baby boomers”
reach their retirement age. In the case of the combined demographic
and income approach under the assumptions that both population will
change structurally and that personal income will increase, the average
taxable income and income tax payable per return will continue to
increase over the whole projection period, but that the growth rate of
income tax revenue is expected to slow down after 2011.

Key Words: Population Ageing, Income Tax, Micro-Simulation Model

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The Effects of Population Ageing on the Personal Income Tax Revenue in Canada
31

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32
Wen-Fong Lu, Wei Li and Earl Bailey
I. INTRODUCTION
In recent decades, the proportion of senior1 people in many countries has increased
considerably compared to the total population growth. Canada is among this group of
countries. According to Statistics Canada, the proportion of seniors in year 2000 is
more than 12% and it will continue to rise to the middle of this century. Population
ageing is expected to have an effect on the labour force, federal taxation, federal
health care expenditures as well as other socio-economic characteristics and will
place financial pressure on Canada’s social system.

The major impact of population ageing on taxation is expected to on the revenues
from personal income tax, which accounts for about one-half of the total federal tax
revenues. Personal income tax is directly associated with people and could be
significantly affected by factors associated with the socio-economic characteristics of
people. Since the retired population usually earns less income than employed people,
the average taxable income might decrease with population ageing. The total income
tax revenue is affected not only by population ageing but also by other factors such
as the number of taxpayers, their income level, and the effective income tax rate.
Based on the population census and data from personal income tax returns and by
using the T1 Tax Analysis Model, this paper will examine the impact of Canadian
population ageing on federal income tax revenues.
II. LITERARURE REVIEW
In recent years, there has been significant research into the potential impact of
population ageing on industrialized countries’ socio-economic development (Corak,

1 Throughout this paper, the terms senior and elderly pertain to the population of 65 or more years of
age.

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The Effects of Population Ageing on the Personal Income Tax Revenue in Canada
33
1998; Denton and Spencer, 1999; Health Canada, 2002; Merette, 2002). However,
relatively little research has been done into the taxation implications of population
ageing. A U.S. study suggested that population ageing would cause a slow growth in
the number of people working and paying taxes but a rapid growth in the cost of health
and social security programs.2 Robson (2003) predicated that Canadian taxpayers
in the future would pay more for the entire package of public programs than their
predecessors providing the current age/sex distribution of the public expenditure in
these programs would remain the same. A study commissioned by the Group of Ten
countries concluded that government revenues would be adversely affected as the
baby boom generation moves from its high-income-generating years to retirement.
Countries whose revenues depend heavily on income or payroll taxes would face
deterioration in revenues.3

An Australian study indicated that even though population ageing would create
downward pressure on total personal income tax revenue (because of the declines in
the average tax paid per person in the higher age groups), several other factors such
as GDP growth, labour participation rate, wage rates, etc. make it uncertain which
direction total personal income tax revenue will take.4 Some studies that were done
by Finance Canada on the fiscal implications of population ageing show that a less
than severe impact is expected to occur over the next half century. King and Jackson
(2000) stated that, although ageing will have some impact on public finances, the
impact will play a minor role in the interaction of all the factors that are expected to
cause fiscal pressures. Jackson and Matier (2002) analyzed the long-term impact of
population ageing on important revenue and expenditure categories. Under their
definition of existing federal, provincial and territorial fiscal structures (all assumed

2 United States Government Printing Office (1997).
3 Group of ten (1998).
4 Department of the Treasury of Australia (2002).

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34
Wen-Fong Lu, Wei Li and Earl Bailey
to remain constant) and their criterion for long-term fiscal sustainability, their projec-
tion suggests that most governments will be in a fiscally sustainable position over the
long run.
III. PROFILE OF THE CANADIAN POPULATION AGEING
1. Population Projection
In 2001, Statistics Canada published its population projections for 2000-2026.
The projections use the 2000 preliminary population estimates that were based on the
1996 Census data. For the projections of the overall Canada population, there are
three growth scenarios – high, medium and low growth. Table 1 summarizes the
assumptions that were made in the scenarios. These assumptions reflect the following
components of population growth: the total fertility rate (T FR), life expectancy at
birth, immigration level, emigration rates and the number of non-permanent residents.

Table 1. Component Assumptions for Population Projections, 2000 to 2026
Component of Population Change
High Growth
Medium Growth
Low Growth
Total Fertility Rate
1.8
1.48
1.3
Age Expectancy at Birth (male/female)
81.5 / 85.0
80.0 / 84.0
78.5 / 83.0
Immigration
(persons)
270,000 225,000 180,000
Total Emigration
This is based on the 2-year average of the age-sex specific
emigration rate from 1997-1998 to 1998-1999.
Non-Permanent Residents (persons)
240,000, assumed constant over the projection period.
Source: Statistics Canada (2001).

Canada’s TFR in 2000 was 1.49 and according to Statistics Canada (2001) the
TFR in the medium assumption (obtained by averaging the low and high assumptions)
will reach 1.48 children per person by 2001 and remain constant thereafter. Since the

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The Effects of Population Ageing on the Personal Income Tax Revenue in Canada
35
fertility level has been quite stable in recent years, the current level is assumed to
continue. Secondly, the medium life expectancy at birth, which is based on the current
trend in the age-specific mortality rate, is assumed to continue to increase over the
projection period in a similar way shown in the recent past. Thirdly, the medium
immigration level is assumed to be the government’s current target of 225,000 per
year because the government has no plans to modify this quota in the short term.
Fourthly, regarding the emigration assumption, it is assumed that future migration
will equal the current migration level, this assumption being a confident practice in
the projection of international migration. Lastly, for the years 2000 to 2003, the
medium-growth consideration showed the least difference between Statistics Canada
population estimates that were based on the 1996 census models when compared to
Statistics Canada forecasts that were conditioned by the above components of population
change. For these reasons, Statistics Canada’s medium-growth quinquennial projections
are chosen for this study.

Figure 1 shows the population estimates for 2000 and the population projections
from 2006 to 2026. The Canadian population will increase over the next 20 to 30
years, with the total population expected to reach 33.4 million in 2011 (an 8% increase
over year 2000) and 36.2 million in 2026 (an 18% increase over year 2000). Also, the
distribution of population among the age groups will vary. During the 2000 to 2026
period, the population of the age groups under 15 will decrease slightly from 5.9 mil ion
to 5.4 million. The population aged 15-64 will increase moderately from 21.0 million
to 23.5 million by 2016, and then decline slightly to 23.1 million by 2026. The
number of persons aged 65 and over will be 4.8 million by 2011 and 7.8 million by
2026, or 1.3 and 2.0 times respectively compared to 3.9 million in year 2000.

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36
Wen-Fong Lu, Wei Li and Earl Bailey
40,000
35,000
30,000
25,000
Aged 65+
20,000
Aged 15-64
15,000
Aged 0-14
10,000
Population (000's) 5,000
0
2000
2006
2011
2016
2021
2026
Year

Source: Based on Statistics Canada (2001).
Figure 1. Canadian Population Size by Age Group 2000 - 2026
2. Population Ageing
Canadian population will age faster after 2011 when the “baby boomers” (1946-
1960) reach their retired age. The senior population, which was 12.6% of the total
population in 2000, is expected to be 14.5% in 2011 and 21.4% in 2026 (see Figure 2).
There will be one senior in every five people in year 2026. The aged dependency
ratio, which is defined as the ratio of the number of persons 65 years and over to the
15-64 population, will increase from 0.18 in 2000, to 0.21 in 2011, and to 0.34 in
2026 (see Figure 3).5 The child dependency ratio (the number of persons under 15
years to the 15-64 population) will decrease from 0.28 to 0.23 during the same period.
The total dependency ratio (the number of persons under 15 and 65 years and over to
the 15-64 age group population) will initial y decrease from 0.46 to 0.44 by year 2011

5 Although the aged dependency rate could continue increasing beyond 2026, the discussion of ageing
implications in this paper stops at the year 2026 because of the constraint on availability of popula-
tion age specific forecast data after 2026 from Statistics Canada.

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The Effects of Population Ageing on the Personal Income Tax Revenue in Canada
37

80
70
60
50
0-14
% 40
15-64
30
65 and Over
20
10
0
2000
2006
2011
2016
2021
2026
Year

Source: Based on Statistics Canada (2001).
Figure 2. Canadian Population Age Structure 2000 - 2026

0.6
0.5
Child
0.4
Dependancy
Ratio
0.3
Aged
Ratio
Dependancy
0.2
Ratio
Total
0.1
Dependancy
Ratio
0
2000
2006
2011
2016
2021
2026
Year

Source: Based on Statistics Canada (2001).
Figure 3. Canadian Population Dependency Ratios 2000 – 2026

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38
Wen-Fong Lu, Wei Li and Earl Bailey
because of the decreasing proportion under 15, and then increase to 0.57 by year
2026, which is an increase of 0.11 over 2000. By 2026, it is implied that, on average,
for every working age person there will be 0.23 children and 0.34 seniors.

According to the United Nations’ estimates shown in Table 2, 14.4% of the
Canadian population will be aged 65 or over in 2010 rising to 21.3% in 2025. The

Table 2. Major Population Indicators of North American Countries, 2000 to 2025
Indicator

2000 2005 2010 2015 2020 2025
Canada






Population
(thousands)
30,769 31,972 33,069 34,133 35,166 36,128
Percentage
aged
0-14
(%)
19.0 17.3 15.6 14.8 14.7 14.8
Percentage
aged
15-64
(%) 68.4 69.5 70.0 68.8 66.6 63.9
Percentage
aged
65+
(%)
12.6 13.2 14.4 16.4 18.7 21.3
Aged
dependency
ratio

0.18 0.19 0.21 0.24 0.28 0.33
Median
age
(years)
36.9 38.9 40.6 41.9 43.0 43.9
U.S.A.






Population
(thousands)
285,003 300,038 314,921 329,669 344,270 358,030
Percentage
aged
0-14
(%)
21.9 21.3 20.5 20.3 20.1 19.8
Percentage
aged
15-64
(%) 65.8 66.4 66.7 65.5 64.0 62.4
Percentage
aged
65+
(%)
12.3 12.3 12.8 14.2 15.9 17.8
Aged
dependency
ratio
0.19 0.19 0.19 0.22 0.25 0.29
Median
age
(years)
35.2 35.9 36.3 36.6 37.0 37.6
Mexico






Population
(thousands)
98,933 106,385 113,320 119,618 125,176 129,866
Percentage
aged
0-14
(%)
33.8 31.3 28.7 26.4 24.3 22.5
Percentage
aged
15-64
(%) 61.4 63.4 65.3 66.8 67.7 68.0
Percentage aged 65+ (%)
4.8
5.3
6.0
6.8
8.0
9.5
Aged
dependency
ratio
0.08 0.08 0.09 0.10 0.12 0.14
Median
age
(years)
22.9 24.7 26.6 28.5 30.6 32.7
Source: Population Division of the Department of Economic and Social Affairs of the United Nations
Secretariat (2003).

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