¹The Research Institute of the Finnish Economy (ETLA), Lönnrotinkatu 4 B, 00120 Helsinki, Finland. Tel +358 9 609 900, fax + 358 9 601 753. Email jla@etla.fi, tv@etla.fi

^*The paper is part of the European Commission's research project "Demographic uncertainty and the sustainability of social welfare systems" (QLK6-CT-2002-02500). We also acknowledge financial support from the Foundation for Municipal Development in Finland. We thank Juha Alho, Namkee Ahn, Jukka Pekkarinen, Veli Pelkonen, Lasse Ristikartano, Barbora Slintakova, Hannu Tanninen, Pentti Vartia, Reijo Vuorento, Ed Westerhout and an anonymous referee for comments and Eija Kauppi for the model programming.

Abstract

Public health and long-term care services are predominantly used by old people and financed by taxes paid by working-age people. Fluctuating sizes of generations create variations in tax rates, similar to what occurs in pension contribution rates. Pre-funding is a commonly suggested cure for this variation in pension systems: could and should expenditure on health and long-term care also be pre-funded, and if so to what degree? To address this question, we examine several pre-funding rules using Finland as an example. If the focus is on tax smoothing during the next few decades, an effective rule is a buffer fund whose construction is based on the current population forecast. But if we lengthen the time horizon, the benefits of using rules conditional on new demographic information become evident, even though they may result in higher tax-rate variation during the first few decades.