Economic Survey - Spain 2005: Reforming the pension system

 

A downward revision of the parameters underlying pension calculations is needed

While lower public debt and rising employment contribute to ensure sustainability of public finances, the sustainability of the pension system is not guaranteed over the long term. The impact of ageing will be felt later on but more acutely than in other OECD countries, because it will be more pronounced than elsewhere and because the parameters underlying pension calculations are more generous – even if the average level of pensions is low at present. On the basis of favourable assumptions of increased immigration and employment, pension spending could rise by almost 8 percentage points as a proportion of GDP by 2050 if the generosity of the system remains unchanged, i.e. if the number of pensions received per person aged over 65 and the average benefit relative to productivity remain stable. Reforms are needed concerning both receipts and benefits. This was acknowledged in the Toledo Pact, but little progress has been made with reforms in recent years. However, in the context of the “Declaration in favour of social dialogue” signed in July 2004 a negotiation process has already started that will tackle pending challenges outlined in the Pact. Raising the level, or number of years of contributions to certain schemes, such as that for the self-employed, would be welcome. However, the average level of pensions compared to per capita GDP will have to be lowered by some means to contain the rise in pension outlays. The parameters underlying pension calculations will have to be revised to at least ensure that the discounted value of old-age pensions is not higher than the sum of the corresponding contributions, making the system actuarially fair considering that the revised parameters will only apply to future generations of pensioners affected by the demographic shock. This could mean basing pensions on earnings over an entire career instead of the last fifteen years, or reducing the average rate of accumulation of pension entitlements, but it may also be necessary to means-test revenues of those drawing on more than one pension.

Labour market and fiscal policies will be key to limiting the scale of pension reform

The need for such reforms in pensions will be more limited if the policies designed to boost productivity and employment are effective and fiscal management over the next few years is sound. The employment rate could be raised by reconsidering the rate of accumulation of pension entitlements, which is lower at the end of the career than at the beginning, reducing the incentive to stay in the labour market. Increasing the number of day-care facilities for young children and of health and home care provision for dependent elderly persons, in addition to labour market measures, would also help to raise female employment further. In view of the foreseeable rise in demand for long-term care, there is a need to organise efficient provision with the emphasis on enabling the elderly to remain in their own home. Consideration should also be given to the possibility of running a significant budget surplus over the coming years. Reducing general government indebtedness more quickly and increasing social security assets ahead of the demographic shock in 2015 20 would help to limit the fall in the relative level of pensions so that it remains socially acceptable. The temptation to lower social insurance contributions has to be resisted, despite the surpluses that the pension schemes have posted in recent years, and surpluses should be kept in the social security reserve fund in the years ahead. At the same time the generosity of the tax incentives favouring private pensions should be reconsidered. The net cost of these incentives is high as they appear to mainly affect portfolio allocation and generate little extra saving.

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