National Institute of Economic and Social Research How to pay for the crisis Ray Barrell February 2010 NIESR

The Budget Problem Government borrowing is likely to be more than 10 percent of GDP for several years The Debt Stock may rise to 100% of GDP The structural deficit is 5-6% of GDP There is a permanent output scar of 3-5% incomes from the financial crisis –We have less to consume –Our children will be poorer Retiring later allows us to consume more now and burdens our children les

Raising the retirement age a year We assume that the retirement age is raised by one effective year over 5 years. –Those near retirement work 66% of normal hours so its 1.5 years on the age of retirement –This is anticipated and consumption reacts immediately to higher expected lifetime incomes Factor inputs depend on assumptions –Labour input rises over five years, and initially unemployment is marginally higher –Private sector capital adjusts fully Savings fall slowly, the current account stabilises at a lower level

Extending working lives in the UK National Institute NiGEM model results

How do we use the money Transfers reduced, direct and indirect tax up –With deficit targets direct tax rates fall –Direct tax rates fall more if government consumption and investment are unchanged Impacts of a one year increase in working lives on income tax as a proportion of total income with different spending and borrowing assumptions National Institute NiGEM model results

How to pay for the banking crisis We focus on impacts of a one effective year increase in working lives starting in five years, implemented slowly –saving fall permanently as they are less needed –government spending and income taxes are kept on current plans Gains in net revenue mean budget deficit is better by 1% of GDP after 12 years. After 30 years the debt stock is reduced by 20% of GDP

Employment and unemployment? Markets work slowly even when forward looking but policy can speed them up –About a million a quarter flow through unemployment –Real wages react to unemployment Unemployment will initially rise by up to third of the increase in the labour force –The increase will all be absorbed in five years –Policy and information can speed adjustment Real producer wages react to rises in unemployment in the UK

What are the net revenue gains? In 2008 terms a one percent of GDP budget improvement is almost £15 billion –Less borrowing means lower debt stocks and lower interest payments –Tax receipts higher because of higher incomes and consumption Policies have to be in place to shift MIG, TWIRLY, heating and other pension related payments Changes in allowances for wealthy pensioners may be wise Sources of budget improvement in 2019 with fixed direct tax rates

Conclusions on working lives What happens with extended working lives –Incomes will be higher –Consumption will be higher Governments face options –Taxes could be cut –Debt could be reduced One year on effective working lives could reduce government borrowing by 1% of GDP Pension systems need to be designed to permit this to happen The pension problem is in part caused by increases in life expectancy