Fiscal Effects of Population Ageing in Colombia

Among the most densely populated countries in Latin America and the Caribbean, Colombia is undergoing the fastest demographic transition. In this paper, we present a methodology to estimate the fiscal effects of this transition in the short, medium, and long term. To that end, we project public spending associated with demographic change through 2070. Our findings highlight the new pension spending and social security health spending that an increasingly aging population will require, while fiscal space is created by a relative decline in education spending as a result of a smaller flow of young people attending the education system. In contrast, on the revenue side, we estimate the response of VAT revenue to changes in the population distribution. Our findings suggest that VAT revenue exhibits a concave pattern across the life cycle, meaning that it responds inelastically in the tails of the population distribution (young and older adult populations) and elastically in the working-age population, and this latter group is the one that will contract the most as demographic change deepens over time. Regarding to revenue of income and complementary taxes, we expect this to be depleted as well due to a slower pace of economic growth caused by a gradual decline in the labor force. The combined effect on public finances will result in a structural fiscal imbalance, which will drive growth in the debt-to-GDP ratio. We estimate that Colombia has approximately 13 years before the fiscal effects begin to become more evident as a result of demographic change.