Dependency Ratio Essay

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The dependency ratio is the number of elderly people and children as a fraction of the number of working-age adults. For example, a dependency ratio of 30 percent would indicate that there are 30 children and elderly people for every 100 working-age adults. The definitions of the age groups may vary. For example, some calculations treat people between the ages of 20 and 64 as working-age adults, whereas others define this group as people ages 15 to 64. The ratio is intended to capture the size of the population that is too old or young to work, relative to the population that is capable of producing economic output; that is, it reflects the number of children and elderly who must be “supported” by each working-age adult. The aged (or old-age) dependency ratio is similar but includes only the number of elderly people as a fraction of the number of working-age adults.

An increase in the dependency ratio typically places additional stress on the public sector, as the working-age population must bear an increased tax burden to support programs for children and the elderly. The aged dependency ratio has particular significance for policy debates in the United States and other industrialized countries, where aging populations are putting a strain on public retirement programs and other programs targeted toward the elderly.

Trends and Forecasts

The aged dependency ratio in the United States (using the 20-64 working age definition) rose from 13.8 percent in 1950 to 20.3 percent in 2005. According to the latest projections of the Social Security Board of Trustees, this dependency ratio will rise rapidly between 2010 and 2030, reaching 34.9 percent in 2030. After that, it should increase more slowly, to 38.0 percent in 2050 and to 42.1 percent in 2080. However, significant uncertainty surrounding such forecasts exists. The Social Security trustees estimate that the dependency ratio in 2080 could be as high as 58.1 percent (the “high-cost” scenario) or as low as 31.6 percent (the “low-cost” scenario). A similar trend is occurring around the world, particularly in industrialized countries. According to official UN estimates, the aged dependency ratio (using working age as 15-64) for developed countries could rise from 22.6 percent in 2005 to 44.4 percent in 2050.

Changes in a country’s dependency ratio can result from a number of demographic factors, including fertility, mortality, and immigration. Affecting the projected rapid increase in the U.S. dependency ratio prior to 2030 is the aging of the baby boom generation. Driving the more gradual, long-term upward trend is increasing life expectancy due to medical advances, combined with a low fertility rate. The period life expectancy for a 20-year-old in the mid-20th century was 71.2 years; by 2003 this increased to 78.4 years. Whereas the total fertility rate varied greatly over the past century, it has remained at around 2.0 children per woman recently (below the rate of 2.1 required to maintain zero population growth in the absence of immigration and changes in life expectancy).

Relevance for Fiscal Policy

The upward trend in the dependency ratio has significant implications for public sector programs, particularly Social Security and Medicare. In a pay-as-you-go (PAYGO) retirement program, the following mathematical relationship holds at every point in time:

twNy = bNo

Here, t is the payroll tax rate, Ny is the number of workers covered by the program, w is average covered earnings per worker, b is the average benefit per retiree, and No is the number of retirees. The equation implies that all payroll taxes collected in the current period are paid out as benefits to current retirees; this is the defining characteristic of a PAYGO system. This equation can be rearranged as follows:

t = (b/w)(No /Ny)

Here, the side to the left of the equal sign is the payroll tax rate, and the side to the right of the equal sign is the product of the replacement rate (fraction of the average worker’s earnings that the retirement benefit replaces, or b/w) and the aged dependency ratio (retirees per worker, or No /Ny). This equation shows that the payroll tax required to support the system is directly proportional to the dependency ratio.

Currently, the payroll tax rate for Social Security’s Old-Age and Survivors Insurance (OASI) program is 10.6 percent, while the replacement rate is approximately 42 percent for a worker with average earnings.

Taken together with the dependency ratio of 20.3 percent, one can see that the left-hand side of the equation is larger than the right-hand side, indicating that OASI is running a surplus. As the dependency ratio rises to 42.1 percent (its expected value in 2080), the right-hand side grows larger than the left. This indicates that OASI will run deficits (drawing down the trust fund) unless either the payroll tax is raised or benefits are cut. The Social Security trustees estimate that the OASI program will begin to run deficits in 2018 and that the trust fund will be exhausted in 2042. The Medicare Hospital Insurance program, which operates in a similar manner, also is greatly affected by increases in the dependency ratio. Medicare trustees predict that the hospital insurance program will begin to run deficits in 2010 and that the trust fund will be exhausted in 2018. The sizes of the long-run imbalances are significant, with Social Security’s unfunded obligations amounting to $13.4 trillion and the Medicare Hospital Insurance program’s amounting to $28.1 trillion.

Bibliography:

  1. UN Department of Economic and Social Affairs. Population Division. 2005. “World Population Prospects: The 2004 Revision.” Vol. 3, Analytical Report. New York: United Nations.
  2. S. Department of Health and Human Services. Centers for Medicare and Medicaid Services. 2006. “The 2006 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds.” Washington, DC: U.S. Government Printing Office.
  3. U.S. Social Security Administration. Office of the Chief Actuary. 2006. “The 2006 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds.” Washington, DC: U.S. Government Printing Office.

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