Everyone Has to Lose Something: A Fiscal Grand Bargain for the Ageing West

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The fiscal problem facing much of the developed world is hardly mysterious. Ageing populations are increasing pension and healthcare costs while governments carry debts accumulated through financial crises, years of unusually cheap borrowing and the pandemic. Higher interest rates have made those debts harder to ignore.

Nor is there much mystery about the available remedies. Governments can raise taxes, reduce benefits, increase retirement ages, constrain healthcare spending, require people to finance more of their own retirement, or spend less elsewhere. The difficulty begins when someone has to choose who pays.

That makes the problem partly one of political design. The ageing West does not lack plausible ways of stabilising its public finances; it lacks reforms capable of surviving democratic politics for thirty years. A durable settlement would therefore look very different from a conventional austerity programme. It would make decisions early and implement them slowly, spread the adjustment widely without pretending that identical sacrifices are fair, protect productive investment, and turn some recurring political battles into predictable rules.

The aim is not a painless solution. There probably is no such thing. It is to make the costs small, predictable and widely shared enough that societies can actually live with them.

The arithmetic is less frightening than the politics

The demographic pressure is real. Across the OECD there were roughly 33 people aged 65 or older for every 100 people aged 20 to 64 in 2025. By 2050, the OECD projects that ratio to rise to around 52. The ratio is only a proxy: employment rates, immigration and labour-force participation all affect how many people are actually working. But the direction is clear. A substantially larger elderly population will draw pensions, healthcare and long-term care from economies in which the working-age population is growing more slowly or, in many countries, shrinking.

The IMF estimates that demographic pressures could add about three percentage points of GDP to pension and health expenditure in advanced economies over the next quarter century. Many governments are entering that transition with much larger debts than they carried a generation ago.

The United States is an unusually stark case. The Congressional Budget Office projects federal debt held by the public to rise from about 101 percent of GDP in 2026 to 120 percent in 2036. The deficit is projected to increase from 5.8 to 6.7 percent of GDP despite unemployment remaining below five percent, while rising Social Security, Medicare and interest costs are partly offset by declining discretionary spending relative to the economy.

Europe reaches similar pressures through different routes. Some countries already combine heavy taxation with expensive welfare states; others have healthier public balance sheets but worse demographics. Several are simultaneously trying to increase defence expenditure after decades in which those resources could be allocated elsewhere.

This still does not mean governments somehow have to repay the entire accumulated debt. The more realistic objective is to stabilise debt relative to the economy and eventually put it on a declining path. The required primary balance depends on the relationship between economic growth and borrowing costs: when nominal growth exceeds the effective interest rate, a country can sustain a somewhat weaker primary balance; when interest costs outrun growth, the required adjustment becomes larger. Either way, the problem for most rich countries is measured in several percentage points of GDP, not in repaying a century's debt in one enormous act of austerity.

That is difficult but manageable. The mistake is searching for one painless source of money large enough to do it.

From pension promises to pension assets

Calls to cut government spending are popular until the budget is opened. In the United States, long-run fiscal deterioration is not mainly the product of foreign aid, civil servants or obscure discretionary programmes. In European countries the composition differs, but the same political obstacle appears: modern welfare states are expensive because they provide pensions, healthcare, education, disability support, childcare, infrastructure, policing, defence and other services that voters generally want.

The obvious alternatives do not escape the trade-off. Taxing wealthy households more heavily may be justified, but there are too many retirees and too much healthcare expenditure for a small affluent minority to finance everything. Immigration can improve the ratio of workers to pensioners without eliminating ageing. Faster productivity growth would help greatly, but making today's promises on the assumption that artificial intelligence will deliver a permanent productivity boom would be an odd form of fiscal prudence. Every painless solution eventually runs into arithmetic.

For many ageing countries, pensions are therefore the obvious place to begin. Traditional pay-as-you-go systems are demographic arrangements: workers today largely finance retirees today. When workers are numerous and retirees relatively scarce, that is comfortable. As the ratio deteriorates, contributions must rise, benefits must grow more slowly, retirement must happen later, or the difference must be found elsewhere.

Pay-as-you-go financing is not the only possible architecture. The OECD identifies compulsory funded defined-contribution schemes for future retirees in eleven member countries, while countries including Denmark, the Netherlands, Sweden and the United Kingdom also have broad occupational funded systems. A long-run settlement could move towards three layers:

Component	Function
Basic public pension	Protect against old-age poverty and extreme longevity risk
Smaller contributory public pension	Provide earnings-related social insurance
Mandatory funded pension	Build real retirement assets throughout working life

The purpose would not be to abolish state pensions. Governments are unusually well placed to insure risks that individual savings accounts handle poorly: disability, survivor benefits, very long lives, and careers interrupted by unemployment, care work or low earnings. But a greater share of ordinary retirement income could come from assets accumulated during working life rather than claims almost entirely on future taxpayers.

That changes the politics as well as the financing. Asking a 25-year-old to pay another two percentage points of salary into an unreformed pension system feels like another tax. Putting part of that contribution into a low-cost fund visibly accumulating in the worker's name gives the sacrifice a counterpart: present consumption has been given up, but an asset has been acquired.

Funded pensions also alter the way demographic risk is borne. Internationally diversified assets give retirees claims on productive activity beyond their own domestic workforce. They cannot abolish ageing — pensioners still consume goods and services that somebody must produce — but they reduce the direct dependence of retirement income on future domestic payroll contributions.

Prefunding is not free of risk. It exchanges some demographic and political risk for market risk. Badly designed personal accounts expose retirees to investment mistakes, excessive fees and badly timed market falls, which is why any compulsory funded pillar would need inexpensive default funds, lifecycle investing and a public floor underneath it rather than expecting every citizen to become a portfolio manager.

There is also a harder transition problem. Today's workers already finance today's pensioners. Diverting part of their contributions into investments immediately removes money from the old system while its obligations barely change. The transition generation is effectively asked to finance its parents' retirement while beginning to finance its own.

That cost cannot be engineered away; it can only be distributed. Contributions could shift towards funded accounts by fractions of a percentage point over decades, with people close to retirement largely protected and younger cohorts progressively moved towards the new structure. A reform announced to a 25-year-old can be incorporated into forty years of financial planning. The same reform imposed unexpectedly on someone aged 63 is much closer to a broken promise.

If lives get longer, working lives probably must too

Retirement ages face the same arithmetic. A society cannot continuously extend life expectancy, keep retirement ages unchanged and expect pension expenditure to remain unaffected. That does not mean every additional year of life must become another year at work. Richer societies can reasonably spend part of their prosperity on longer retirement.

A defensible rule might divide gains in healthy life expectancy between additional working life and additional retirement. An extra twelve months of healthy life might eventually produce six or eight months of work and four or six months of retirement. That ratio is a policy judgement rather than a scientific constant. The important part is that the direction of adjustment is known in advance.

Several OECD countries already link pension ages to longevity in some form, and statutory retirement ages are scheduled to rise across much of the developed world. The OECD calculates that a man entering the labour market at 22 in 2024 will, under existing legislation, face an average normal retirement age of 66.4 across OECD countries, compared with 64.7 for someone retiring in 2024.

A universal formula would still need exceptions. Healthy life expectancy differs by occupation, income and social conditions. Someone who began physically demanding construction work at 18 should not necessarily face the same adjustment as someone who began an office career at 28. Disability, arduous work and exceptionally long contribution histories are legitimate reasons for different rules. Fairness does not require pretending everyone reaches 65 in the same condition.

Take arithmetic out of election campaigns

Some fiscal choices reflect genuine disagreement about values and should remain political. Others eventually become arithmetic pretending to be politics.

Sweden's pension reform is useful because it addresses both sides of the problem. Its public pension system contains an automatic balancing mechanism: when liabilities exceed the system's assets, indexation is adjusted so that the imbalance does not compound indefinitely. The reform was not merely a clever piece of pension engineering. Its architecture grew out of a five-party agreement reached in 1994 and survived implementation across changes of government. Fiscal durability was reinforced by political durability.

The broader lesson is to decide some rules while there is still time rather than repeatedly voting on the same demographic arithmetic. Retirement ages can respond gradually to longevity. Pension indexation can respond to system finances. Temporary emergency programmes can contain expiry dates. Fiscal rules can become tighter as an economy returns to normal, while unexpected revenues can be directed partly towards debt reduction when debt is already high.

This does not remove democratic control. Parliament establishes the rules and can change them. What changes is the default. Today, sustainability frequently requires politicians to vote repeatedly for something unpopular while inaction requires no decision at all. A better structure makes gradual adjustment normal and forces politicians to vote explicitly when they want to abandon it.

Healthcare, taxes and the rest of government

Pensions cannot carry the whole adjustment. Healthcare is especially difficult because rising expenditure is not necessarily evidence of failure. Richer societies should be willing to spend more on medicine, and some treatments are expensive precisely because they can now achieve things that were once impossible. Turning an untreatable cancer into a treatable one may raise healthcare expenditure while representing extraordinary progress.

The useful question is therefore not whether healthcare spending rises, but whether the additional spending produces enough additional health. Drug procurement, administrative simplification, generics and biosimilars, chronic-care coordination, prevention, payment incentives, digitalisation and fraud control can improve value. Affluent elderly households can also reasonably be asked to contribute more towards some non-catastrophic costs while protection against serious medical risk remains broad.

But “healthcare efficiency” cannot become the fiscal equivalent of “eliminate government waste”: an undefined reservoir of painless savings large enough to avoid difficult choices. Some genuine cost control eventually means deciding that a particular additional treatment, subsidy or administrative layer does not produce enough value to justify its price.

Other current expenditure can adjust more gently. Governments do not necessarily need large nominal cuts. If nominal GDP grows by four percent while non-age-related current spending grows by three, those programmes still receive more money each year while gradually consuming a smaller share of the economy. Repeated over a decade, that can create substantial fiscal space without resembling emergency austerity and, more importantly, forces governments to choose between programmes rather than layering every new priority permanently on top of the old ones.

Productive investment should be treated differently. Cutting infrastructure, research, energy systems or useful education programmes is often politically easier than reducing current benefits because tomorrow's beneficiaries do not protest. It can also be terrible economics. An indebted country should be especially reluctant to preserve every unit of present consumption by sacrificing investments that determine its future productive capacity and tax base.

Taxes cannot be exempt from the bargain, although the appropriate mix differs sharply between countries. According to OECD Revenue Statistics, the United States collected taxes equal to about 25.6 percent of GDP in 2024, compared with an OECD average of 34.1 percent and 42.6 percent in Belgium. A US settlement can therefore plausibly contain more revenue in a way that an already heavily taxed European country may find much harder to replicate.

The more general principle is to broaden tax bases, remove poorly justified exemptions and special regimes, improve enforcement, and avoid pretending that legally imposing a tax on one group means nobody else bears any of its economic cost. As discussed previously in the Journal, understanding who ultimately bears a tax matters when designing broad financing for broad public benefits. Wealthier pensioners may lose some special treatment, businesses may lose sector-specific subsidies, and high earners may lose deductions without treating any one of those groups as an inexhaustible source of revenue.

Everyone contributes, but not equally

This is the politically uncomfortable centre of the bargain. A reform that concentrates enormous losses on one identifiable group creates an obvious coalition dedicated to destroying it. A package in which every major constituency gives up something smaller is harder to portray as an attack on one class or generation.

Group	Part of the bargain
Low-income existing retirees	Almost completely protected
Wealthier retirees	Slower benefit growth and somewhat higher healthcare contributions
People close to retirement	Only minor changes
Middle-aged workers	Gradually later retirement and greater funded saving
Young workers	A pension increasingly based on accumulated assets rather than future taxpayers
High earners	Fewer exemptions and unusually generous tax privileges
Businesses	Fewer subsidies and special regimes
Public-sector workers	Convergence with general pension arrangements where privileges are unusually large
Government departments	Non-age-related current expenditure grows more slowly than the economy
General taxpayers	Some broader revenue contribution where necessary
Future governments	Less freedom to run persistent structural deficits in good times

This is not equality of sacrifice, and it should not be. Taking €100 from somebody living on €1,200 a month is not equivalent to taking €100 from somebody receiving €6,000. The defensible principle is broad participation combined with different capacity to absorb the adjustment. Low-income retirees can be largely protected while affluent retirees contribute more; younger generations can accept more responsibility for funding their pensions if older generations are not completely exempt; taxpayers can contribute additional revenue where necessary if governments simultaneously constrain expenditure.

Political survivability also requires giving some of those sacrifices a visible counterpart. Fiscal consolidation suffers from the fact that its benefits are usually diffuse and delayed. A tax exemption disappears today; retirement moves six months further away; the benefit is that debt in 2047 is lower than it otherwise would have been. This is a version of the democratic signal problem: immediate losses create organised opposition, while many beneficiaries of lower future debt are scattered, politically quiet or not yet old enough to vote.

Funded pensions partly solve that problem because workers can see assets accumulating in their own names. Later retirement can produce visibly higher annual pension entitlements for the extra years worked. If debt falls below predetermined thresholds or pension finances outperform expectations, some of the resulting fiscal room could return to citizens through lower taxes, stronger pension accrual or productive investment. A rule that only ever operates as a brake eventually looks like an enemy; one that shares upside as well as downside looks more like insurance.

Timing matters just as much. If demographic arithmetic requires retirement to occur two years later by 2050, governments can ignore the problem until 2047 and impose a sudden increase, or legislate the destination decades in advance and move towards it a month at a time. The eventual fiscal arithmetic may be similar, but the human consequences are not. People can alter careers, savings, housing choices and retirement plans when they know the rules early enough. The fairest fiscal reform is often the one enacted soonest.

Borrow when the world actually catches fire

None of this requires governments to balance their budgets every year. If a pandemic shuts down economic activity, borrow. If a banking collapse threatens the financial system, intervene. If unemployment rises sharply in a recession, allow automatic stabilisers to work. If a genuine security crisis requires rapid military expenditure, finance it. Sovereign borrowing exists partly because governments can spread severe shocks across time in a way households and businesses cannot.

The lesson from COVID is therefore not that governments should have refused to borrow during an emergency. Much of that borrowing was justified. The harder question is why temporary deterioration so often becomes part of the permanent fiscal baseline.

A credible fiscal framework needs escape clauses in both directions. During a defined emergency, ordinary deficit constraints can be suspended. Once the relevant conditions disappear, temporary measures should expire and a predetermined route back towards structural balance should begin. The IMF's current fiscal guidance similarly stresses that high-debt advanced economies need concrete, well-sequenced adjustment rather than distant aspirations while retaining room to respond to shocks.

Emergency fiscal policy should resemble emergency medicine: use as much as necessary while the patient is in danger, but do not continue administering it simply because everyone became accustomed to the dose.

A welfare state designed to survive ageing

Put the pieces together and the settlement is less radical than the arguments surrounding each individual reform suggest. People work somewhat longer as they live longer. A growing share of retirement income comes from assets accumulated throughout working life. The state continues to insure poverty, disability, extreme longevity and catastrophic medical costs. Existing pension expectations adjust gradually rather than being abruptly repudiated. Healthcare remains generous but faces a real value constraint. Ordinary government consumption grows somewhat more slowly than the economy while productive investment is protected. Tax privileges narrow, and additional revenue is raised where the commitments voters want genuinely require it.

Fiscal rules allow governments to borrow aggressively during real emergencies while obliging them to rebuild room for the next crisis once normal conditions return. Much of the demographic adjustment happens through mechanisms announced decades beforehand rather than recurring political confrontation. No individual measure solves the problem, which is precisely why a broad bargain has a better chance than the recurring search for one painless answer.

The usual political debate offers false choices: dismantle the welfare state or tolerate permanently rising debt; tax the rich or impose austerity; preserve every pension promise or betray a generation. There is a large territory between those extremes. A worker might receive a somewhat smaller public pension at 68 while owning far more retirement assets personally. An affluent retiree might contribute more towards healthcare while a poorer pensioner remains protected. Taxpayers might accept a broader tax base while government departments are simultaneously required to restrain ordinary spending. Society might accept that not every existing programme can grow as quickly as national income while continuing to invest heavily in infrastructure, research and future productivity.

Nobody receives everything they want. That is probably a feature rather than a flaw. The political attraction of borrowing has always been its ability to postpone precisely these trade-offs: benefits can rise without taxes rising immediately, taxes can fall without benefits being cut immediately, and emergencies can be financed without presenting anyone with the full bill.

For a surprisingly long time, exceptionally low interest rates made postponement cheap. They did not make the underlying choices disappear.

The ageing West does not need a heroic generation prepared to endure years of brutal austerity. It needs governments willing to make difficult decisions early enough that the individual adjustments can remain modest. The real choice is not between austerity and doing nothing. It is between making many modest adjustments while there is still time, or eventually making a few very large ones when there isn't.