The economic consequences of the UK’s ageing population

The UK is in the process of a major demographic shift as its population ages. Thirty years ago, only 1.6% of the population was aged 85 years and over, but by 2020 this had risen to 2.5%, equivalent to 1.7 million people. This trend is predicted to continue with the Office for National Statistics forecasting that by 2045, 4.3% of the population will be aged 85 years and over. This is equivalent to an almost doubling of the number of elderly people over the next two decades, driven both by increases in life expectancy and the ageing of baby boomers born in the 1960s. Moreover, this rapid growth isn’t just for the very old. The number of people aged 70 years and over, for example, is predicted to rise from 9.2 million in 2020 to 13.5 million in 2045. This ageing of the population will undoubtedly have large economic, cultural and social consequences for the UK. 

Boomers and bust?

An ageing population will significantly affect the UK’s labour market as the elderly are much less likely to work than other adults. At the end of 2021, the labour market participation rate, defined as the percentage of people in the population who are either employed or seeking employment, was 79% for those aged 16 to 64 compared to just 11% for those aged 65 and over. An ageing population will therefore reduce the proportion of the population who are in work. Since it is typically those in the labour force who contribute to economic output (at least as measured by GDP), this means that output per capita, and therefore the overall size of the economy, will be lower when less of the population is in work. 

However, the age that people retire is not fixed and is influenced by many factors, including social norms, financial incentives and preferences for work. There is already evidence that people are working at older ages than in the past and this is likely to continue as life expectancy rises. One important factor for people’s decision to retire is the value of their pension. Most people will have access to two types of pensions: state pension (paid by the government to (most) people above state pension age; currently 66) and private pensions.  Despite these pensions, most people see their income fall when they retire, and this is an important reason why some decide to continue working after retirement age. As life expectancy increases, people will spend more years in retirement, and so will need larger pensions to sustain the same level of spending in retirement or be forced to spend less each year. This means some will work later in life to increase the value of their pension and to reduce the number of years spent in retirement.  As well as people choosing to retire later, the government has, in recent years, started increasing the state pension age, forcing some people to retire later. If average retirement ages increase this will likely reduce the impact of an ageing population on the labour market and the size of the economy, as a greater proportion of the population will remain in work.

Another macroeconomic consequence of an ageing population will be changes to the structure of the economy. Different age groups consume different types of goods and services, and in different quantities. As the population ages, industries that cater more to the elderly, such as health and social care, will likely grow and employ a larger percentage of the (smaller) workforce relative to sectors that cater towards younger people, such as education. 

An ageing population and a growing state 

The ageing population will also have a major impact on both government tax revenue and public spending. Put simply, government spending is highest for the elderly, while tax revenues are highest for those of working age. This means that, all else being equal, a larger elderly population will increase government spending per person and decrease tax revenue per person, so that in the long-term the government will need to either raise taxes, cut spending or borrow more.

On the government spending side, the elderly are the heaviest users of many public services (most obviously healthcare), and public service spending per person is therefore far higher for the elderly than any other age group. The Office for Budget Responsibility (OBR) predicts that in 2023-24, average government spending will be £23,700 a year for 75-year olds and £32,400 for 85-year olds. This compares to £19,100 for 15-year olds and £7,900 for 45-year olds. Indeed, the OBR forecast that government health spending will rise from its pre-pandemic level of 7.2% of GDP in 2018-19 to 13.8% of GDP in 2067-78 as the population ages and healthcare costs rise. 

A major driver of higher government spending on the elderly is the state pension. The state pension payments of those who are currently retired are paid for by the taxes of those who are currently working. An increasing percentage of the population who are retired therefore means a shrinking number of working taxpayers funding the pensions of an expanding group of retirees. For this reason, the government has raised the state pension age and plans to continue to raise it over the coming years. This will reduce government spending on pensions and, by encouraging people to work for longer, indirectly increasing tax revenues. Nonetheless the OBR forecasts that government spending on state pensions will rise from 5.0% of GDP in 2022-23 to 6.9% in 2067-68.

As well as government spending being higher for the elderly, revenue raised by taxation on the elderly is lower than that for working-aged adults. The three largest sources of revenue for the UK government are income tax, national insurance contributions (NICs) and value-added tax (VAT). For those over 65, pensions (both state and private) make up the vast majority of taxable income. While the elderly still pay income tax on pension income, it is typically lower than what they earned during their career, meaning a lower tax bill. For example, in 2018-19, the median tax payer aged 45 to 49 paid £3,140 in income tax, compared to the median 70 to 74-year-old taxpayer who paid £1,580. The elderly’s lower incomes also mean lower spending, and so revenues from VAT (which is added to the price of good and services) are also lower for the elderly. Finally, National insurance contributions are not paid on pensions, further reducing tax revenue from the elderly.  Taken together, the ageing population will therefore likely reduce tax revenue per person that the government receives, though this will be somewhat offset by higher average retirement ages. It is worth noting that although the elderly will have contributed more to tax revenues during their working life, for the public finances it is ultimately only the current tax revenue and spending that matters.

Overall, an ageing population will therefore reduce tax revenue per capita and increase public spending per capita. With no changes to tax and spending levels, this could well lead to increasing deficits and government debt. In practice, it is likely that the government will have to change what it spends its money on. Already health spending is growing as a percentage of government spending on day-to-day public services, from 14.6% in 1980-81 to 28% in 2019-20. This trend will likely continue as health and other areas that serve the elderly are prioritised over other areas of public spending.

Conclusions

The ageing of the UK’s population is likely to have significant impacts on many aspects of the economy, including labour markets, economic output, pensions, government tax revenue and public service spending. However, it is important to remember that although many of these changes may be challenging, an ageing population is ultimately a good problem to have, since it is driven by increases in life expectancy. 

Moreover, these impacts are not set in stone. Demographic processes, such as retirement ages and the number of children people choose to have are not fixed, but are influenced by many factors including economic conditions and social norms. This means that changes in the economy and changes to government policy can influence the process and impacts of an ageing population. We saw an example of this earlier where a combination of government policy, changing social norms and financial incentives have increased the average age that people retire. 

Finally, this ageing of the population isn’t unique to the UK but is occurring in nearly all developed countries. Some countries such as Japan are ahead of the UK, which means we can and should learn from their experiences of an ageing population.