Financing of Social Protection

Executive summary

OECD and EU countries face rising expenditure on pensions, health and long-term care as their populations age. Structural change and technology-driven job reallocation may also add to spending needs. At the same time, labour income, the main financing base for social protection in most countries, is under pressure from population ageing as well as non-standard forms of work. With few sizeable and politically feasible spending cuts available, many countries are reviewing their financing mixes and considering broader funding bases.

Social protection expenditure accounts for 23% of GDP in the OECD and EU

Old-age, health and disability benefits are the largest areas of public social spending, ahead of e.g. family, unemployment benefits or social assistance. Between 2023 and 2045, spending on pensions is projected to further increase by 1.1 percentage points (p.p.) of GDP in the OECD, and by 1 p.p. of GDP in the EU. Spending on health- and long-term care is projected to rise by 1.5 p.p. of GDP in the OECD, and by 0.7 p.p. in the EU. Private social spending (such as payments by occupational pension funds) remains limited in the EU, averaging 2.3% of GDP in 2021.

On average, roughly half of public social spending is financed through social security contributions (SSCs)

Financing strategies differ significantly across countries. Across the OECD, SSCs financed 43% of social spending in 2023, down from 47% in 1995. As a share of GDP, they have remained stable, while general-revenue‑funded spending expanded. In the EU, employers pay more than half (60%) of social contributions, although their share in total financing decreased by 4 p.p. over the past decade, while employee contributions rose by 2.7 ppts. SSC financing is much higher for earnings-related old-age and unemployment benefits (63%) than for family benefits (23%), reflecting the stronger link with employment-related risks of the first two.

The self-employed account for 14% of employment but only 4% of contributions in the EU

This reflects both formal coverage gaps and the concentration of the self-employed among both low- and high earners. Coverage gaps are largest for unemployment benefits while pension coverage is more robust. While many countries offer voluntary schemes for otherwise uninsured risks, take‑up is low, connected to low willingness to pay. Voluntary schemes also struggle with adverse selection effects, and thus incomplete risk pooling. Several countries are expanding coverage for the self-employed, including platform workers, especially since the COVID‑19 crisis.

Population ageing will reduce total hours worked

If employment rates follow projected age‑ and gender-specific trends and hours worked by worker remain unchanged, total hours worked will decline in almost all countries – by around 9% across the OECD and almost 20% across the EU between 2024 and 2060, directly affecting total labour income. Higher employment among under-represented groups and longer working hours could offset this decline on average, though not everywhere. However, this would require costly government action, and yet the full potential is unlikely to be realised.

The labour income share declined between the 1970s and the 1990s, but has remained broadly stable since then

As SSCs are mainly levied on labour income, the share of GDP accruing to labour is key for social protection financing. While there is no consensus on the drivers of its decline, the rise of high-productivity, low labour-intensity firms appears to play a role. Technological change may reduce the labour share by raising capital productivity, even without aggregate job losses. The implications of AI remain uncertain: while it may automate some tasks, it may also create new tasks and jobs.

Tax revenue is likely to decline because of population ageing

Without changes in labour supply, wages, or tax policy, total labour income is projected to decline because of a shrinking working-age population. This will in turn lead to lower tax revenue, about half of which is raised from labour income. In contrast, capital income may be more resilient as older people hold more wealth. Income from capital – including dividends, capital gains and interest – also tends to be more favourably taxed than labour income in most OECD countries. Countries may therefore consider increasing the share of capital income taxation in their tax mix.

Inheritances are set to increase

Average inheritances are expected to increase because of asset appreciation and fewer heirs per bequest due to lower fertility. Inheritance taxes may therefore play a bigger role in countries’ tax mix. If well-designed, they can raise revenue while enhancing equity, at lower efficiency and administrative cost than other alternatives. However, they are unpopular: only one‑third of respondents to the OECD Risks that Matter Survey considered them “fair or very fair”.

Taxes on immovable property are underutilised in many countries

Property taxes are relatively non-distortionary given the immobile tax base but require frequent property revaluations. Higher property tax revenues could help local governments meet spending pressures, including, in some countries, for long-term care, which are expected to increase as populations age.

Benefits unrelated to employment could be financed from general revenue

General revenue could play a greater role in financing benefits and services not designed to insure against employment-related risks, such as poverty prevention and child benefits, or services such as health and long-term care. Such a shift would reduce reliance on funding bases vulnerable to population ageing and automation. However, changing the financing structure may be politically difficult as governance is often linked to financing (e.g. through autonomous social insurance institutions). Higher general revenue subsidies to insurance‑based schemes offer an alternative, though categories such as the self-employed or those with unstable careers benefit less from insurance‑based schemes in some countries. General-revenue subsidies may therefore be well-suited for benefits not directly tied to contributions, such as pension credits for care leave and unemployment.

Undeclared work narrows the financing base, weakens risk pooling and leaves workers uninsured

Effective responses may combine enforcement with measures that make formal work more attractive. For workers and firms with the capacity to operate formally, the priority should be compliance, supported by digital technologies. For low-paid vulnerable workers, subsidising social contributions can help encourage formal employment.