Fiscal Effects of Population Ageing. The Case of Costa Rica

Costa Rica has experienced rapid demographic change, making it one of the oldest populations in Latin America. In this document, we compile historical data on government revenues and expenditures, as well as other macroeconomic aggregates, to estimate the fiscal effects of the demographic transition in the short, medium, and long term. The proposed model is based on National Institute of Statistics and Census (INEC’s, for the Spanish original) official population projections by single age groups. Two results stand out, on the one hand, the rapid erosion of VAT revenue in response to changes in the population distribution, and on the other, the rapid growth of pension expenditures. The deterioration in VAT revenue occurs because it responds inelastically to the extremes of the population distribution by age group (young and old, respectively), but elastically in the middle of the distribution (working-age population), which is the group that will contract the most in absolute terms once the demographic change is consolidated. In contrast, the increase in pension spending is explained by the depletion of the IVM scheme’s reserves. While pension spending can be partially financed by a decrease in education spending as a result of a smaller flow of young people attending the education system, tax revenues do not respond to any additional source that would guarantee higher revenue. The combined result will be a structural deficit in the general government balance starting in 2035, the year in which the demographic dividend ends according to INEC projections. Costa Rica has a 10-year window to consolidate its public finances and prepare them before crossing the point of no return, beyond which the debt-to-GDP ratio will begin to rise rapidly.