The choice of financing method has economic implications. First, capital accumulation will be further crowded out by the 9.5 percentage points of higher taxes. This means that capital per worker will decline as in Figure 6b. There is a counteracting mechanism, however, since there will be fewer workers in the future and therefore increase the capital per worker ratio. Furthermore, higher life expectancy will have a tendency to increase the saving rate (Figure 6a) and the capital per worker ratio, but these dynamics are all interdependent over the projected period, and as the saving rate starts falling, the steepness of the decline in the capital worker ratio would also increase.

**Figure 7a. Benefit-financing will Increase Figure 7b. Lifetime Welfare will Increase if Debt** **<u>Lifetime Income for each Generation Burden is Postponed for Future Generations</u>**

<!-- Start of picture text -->
1.05  1.07<br>1.03<br>1.05<br>1.01<br>0.99  1.03<br>0.97<br>0.95  1.01<br>0.93<br>0.99<br>0.91<br>0.89  0.97<br>0.87<br>0.95<br>0.85<br>2010 2030 2050<br>2010 2030 2050<br>Lifetime welfare (Benefit Financing)<br>Lifetime income (Benefit Financing)<br>Lifetime welfare (Tax Financing)<br>Lifetime income (Tax Financing)<br>Lifetime welfare (Debt Financing)<br>Lifetime income (Debt Financing)<br><!-- End of picture text -->

Source: Author’s estimations.

Source: Author’s estimations.

A key issue when interpreting the projected trajectory for the saving rate and other macroeconomic variables is the combination of the demographic factors that contribute to population aging. The fall in the population growth rate will generally reduce the saving rate, while the increase in life expectancy will tend to increase the saving rate. The rate of decline in the population growth rate is seen from Figure 1a to decrease over time, so the life-cycle response of the model — in which workers save and retirees do not — will become smaller over time. However, the increase in the saving rate from longer life expectancy will also flatten out over time. The percentage changes are much larger for the reduction in population growth than it is for life expectancy. As a result, over the longer term, the saving rate is projected to fall.

In terms of wealth and welfare, the Tax-Financing scenario will yield a lower lifetime income mainly because increased taxes lead to lower income in people’s working life. Also, as net income falls the slightly increased saving rate will not increase aggregate saving sufficiently but reduce it slightly. This is evident from the evolution of capital per worker which fall only a little over the next 20 years but falls faster after that. Consequently, income in old age also falls — rendering lifetime income smaller at an increasing rate. This reduced wealth accumulation corresponds to the simulated path for lifetime welfare in Figure 7b.

The bottom line from the analysis of this Tax-Financing scenario is that capital accumulation and, thus, wealth will fall, which means that this policy choice will negatively affect the second demographic dividend. Saving and the saving rate will eventually fall, and leave less capital per worker. This will in turn reduce lifetime income. Altogether, raising taxes negatively affects welfare.

23