ECONOMY

Social security system reeling under heavy deficits, generous pension hikes

The sale of Emporiki Bank brought to the fore the difficulty of managing pension funds, most of which are losing money. Prompted by talks over the sale, Labor Minister Savvas Tsitouridis said on Thursday that the social security system is too complicated and unfair. Moreover, it is not viable. According to the latest published studies, the social security system will collapse around 2015 if it continues to operate in the same way it does now. A study by Alpha Bank shows that the financing of the system will put increasing pressure on the budget and will lead to a great rise in primary spending over the next decade. Greece’s social security system has many structural deficiencies. Its main features are: – First, its operation is almost completely under state control, with its viability dependent to a great extend on financing from the state budget. – Second, its exclusive operation as a system in which the currently employed pay for the current pensioners (pay-as-you-go system) with a very weak link between pensions, the years a pensioner has worked and his/her contributions to the pension fund. – Third, the actual retirement age is very low (until recently, below 60) and many of those employees who stay until the mandatory retirement age of 65 have few years as registered members of a pension fund. – Fourth, the substitution level of pensions, that is, their level as a percentage of the salary from which social security contributions were paid, is among the highest in the world. In other member states of the Organization for Economic Cooperation and Development (OECD), the substitution level for those with high incomes is very low. Specifically, the average net substitution level for incomes no higher than 50 percent of a country’s average is 84.1 percent in OECD members; that of average incomes is 68.7 percent and for incomes 2.5 times the average is 54.5 percent. In Greece, the pension granted from the main funds is 60-80 percent of the average salary over the past five years; to this, we must add the income from auxiliary pension funds, which adds another 20 percent. The European Commission has called Greece’s pension system «especially generous»: In its report, «The Impact of Aging on Public Expenditure,» published in January 2006, it estimates that the net substitution level (after taxes) for pensions is 115 percent in Greece, compared to 88 percent in Italy, 80 percent in France, 78 percent in Ireland and 63 percent in Germany. – Fifth, the salary on the basis of which the pension substitution level is calculated, is the average of the last five years of employment, rather than the whole period during which the employee has paid social security contributions. – Sixth, the imbalance produced by the combination of high substitution levels and relatively early retirement is exacerbated by the state’s raising of pensions at a higher pace than salaries, usually exceeding GDP growth. – Seventh, the existence of too many pension funds, which, in effect cancels the system’s redistributive nature. Payments shoot up During 2000-2005, gross domestic product (GDP) grew at almost double the pace forecast during the previous decade by studies on the social security system. Contributions to pension funds also rose fast, mostly due to more than 600,000 economic migrants joining the system. These developments should have improved the system’s finances. However, this did not happen because pension hikes exceeded GDP growth and the many voluntary retirement programs implemented by several companies contributed to a steep rise in the number of retirees. In 2000, pension payments equaled 12.6 percent of GDP. According to the International Monetary Fund (IMF), they rose to 13.1 percent in 2005. This is higher than in other OECD countries, and unacceptable if one considers that a) many pensioners have not contributed a proportionate amount to their pension funds, b) many pensions have been given to people retiring very early and/or with a limited number of years of employment, and c) pension payments are made from current income and not through accumulated reserves. It is estimated that spending on pensions will remain at around 13 percent of GDP until 2010, but will rise to 15.4 percent in 2020, 19.6 percent in 2030 and 24.8 percent in 2050. This is clearly not sustainable. The budget contribution to the social security system hovered between 4.8 and 5 percent of GDP in 2000-2005, despite the fact that nominal GDP rose more than 8 percent annually and that employer and employee contributions rose 9.2 percent annually. Without measures to make the system itself more viable, budget expenditures will rise to 6.9 percent of GDP in 2020, 11.1 percent in 2030 and 16.8 percent in 2050. Moreover, the system’s revenues from employer and employee contributions and fund investments, which now cover 62.7 percent of the total spending on pensions, will account for 69.6 percent in 2010, 58.3 percent in 2020, 46.1 percent in 2030 and just 38.7 percent in 2050. This will happen despite the fact that in 2025 those who entered the market after 1993 will start retiring; these employees will generally retire at a more advanced age and with lower pensions than their predecessors. What can be done It is necessary to reform and simplify the tax system in order to lower the tax burden on employers and employees who contribute to pension funds. The system’s viability will not be ensured by transferring the debts of the various pension funds to the government’s budget. Both the public debt, expected to reach 107 percent of GDP at the end of this year, and the debt of the social security system, unofficially estimated at over 300 percent of GDP, must be lowered. In order to achieve this simultaneous lowering of the debt, the budget must generate significant primary surpluses from now on and the pensions policy must be revised to achieve a better balance between revenues and payments. Cracking down on non-payment of social security contributions will contribute significantly toward raising pension funds’ revenue. This additional revenue, however, must be used to boost funds’ reserves and not current pensions, as happened during 2000-2005. Sustainable production of surplus budgets will require reforming and downsizing the public sector and capping the rise of budget contributions to social security. This will require a more rational organization of the system, by unifying pension funds, for example. It also needs an expanding private sector, with higher investment levels, which will be achieved only by the confidence of both domestic and foreign investors in Greece’s macroeconomic stability, currently threatened by the social security system’s imbalances and deficient organization. Greece has yet to lower its taxes on employee and employer contributions to levels that will make investment in the economy attractive. On the other hand, the budget deficits and the high debt level leave little room for deep tax cuts. Keeping spending on pensions at current levels, or even cutting it, seems the only way to make the social security system more viable and to enable employees to finance their retirement by investing in self-financing private pension funds. To ensure pensioners will continue to receive state pensions after 2015, it is necessary to boost the existing pension funds’ reserves and to manage them efficiently.