THE MARKET WORKS
Governments around the world now face the daunting challenge of a rapidly aging population. Although the baby boom generation has accepted this change in demographics, the problem is not transitory. The combination of better medical care, higher standards of living, and improved lifestyles is permanently and irreversibly increasing the fraction of the population over the age of 65 and, even more rapidly, of those over 75 and 85.
This aging of the population means higher government costs for pensions and medical care. In the United States, the Congressional Budget Office estimates that under current law, the combined cost of Social Security retirement benefits and government spending on health care for the aged would increase from 10 percent of GDP now to 18 percent in 2030 and would go on rising after that. To pay for that 18 percent of GDP by raising taxes would require the equivalent of doubling the personal income tax or raising the payroll tax rate from 15 percent to more than 35 percent.
The situation in Europe is even worse. While the United States will see the ratio of persons 65 and over to those aged 20 to 64 rise from 21 percent in 1990 to 36 percent in 2030, the change in Germany will be from 24 percent to 54 percent. The Organization for Economic Cooperation and Development projects that government retirement benefits (excluding health costs) will exceed 16 percent of the GDP of Germany, France, and Italy by 2030, compared with about 7 percent of GDP in the United States. Although total health care costs are a smaller share of GDP in Europe than in the United States, the European governments' larger role in financing health care means that health spending requires more taxes. The high labor costs that result from high payroll taxes encourage businesses to substitute machinery for jobs and to shift production out of Western Europe. High payroll tax rates in combination with high effective minimum wages have thus been an important cause of the rise in European unemployment rates from less than half the U.S. level in the
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