The Next German Government Lacks Scope for New Pension Packages

Germany’s next federal government should refrain from providing additional pension benefits, as these would drive up the already growing expenses for old-age provision. This is what ifo researchers Joachim Ragnitz, Felix Rösel, and Marcel Thum call for in an article for ifo Schnelldienst. If pension financing is to remain stable, they write, an increase in the retirement age cannot be avoided in the long term. It should be linked to life expectancy or to years of life with good health.

“To finance the already foreseeable additional costs of pension insurance through value-added tax alone, the tax rate would have to rise from 19 percent to 23 percent between now and 2030,” says Marcel Thum, Director of the ifo Institute’s Dresden Branch. “By 2050, the full VAT rate would actually have to rise to 27 percent.” Demographic change is responsible for three-quarters of these additional costs for pension insurance, while one-quarter of the additional costs are attributable to the pension packages from 2014 to 2020.

Joachim Ragnitz, Managing Director of the ifo Institute’s Dresden Branch, points out what the consequences would be if the government extended pension insurance benefits: “The impact would be utterly dramatic if the new government promises both to keep the contribution rate below 20 percent beyond 2025 and not to let the standard pension level fall below 48 percent of average earned income.” Thum adds: “Keeping such a promise would entail spending 60 percent of the federal budget on pensions.” Even without this “double stop line,” pension fund financing will consume almost 40 percent of the federal budget by 2050.

“One particularly serious factor is that pensions are currently rising faster than employees’ wages,” Ragnitz explains. The pension adjustment mechanism would in fact have avoided such a development, but it has been suspended until 2025. “This suspension alone accounts for one-third of the reform-related increase in 2030 and 46 percent in 2050,” Ragnitz says. The reason this effect is so strong is that the pension level is increased permanently. “This could still be reversed now,” Ragnitz adds, “but that would require appropriate action immediately after the election.”