ifo Viewpoint 256: Saving on Social Security Contributions? That Would Need a Comprehensive Strategy
The German Federal Constitutional Court’s ruling on compliance with the debt brake has sparked a controversial debate on how to limit new borrowing in the federal budget. The question of whether social spending, which accounts for half of government spending, should be cut is particularly controversial. Since categories of expenditure such as interest, defense, and public investment are either unchangeable or have high priority, it must be clear to everyone involved that curbing government spending without touching social spending is a difficult undertaking.
In 2000, social spending accounted for 52 % of government spending. In 2019, before the current crises, it had risen to 54 %, and is expected to be 51.5 % in 2023.
Increasing Pressure on Social Spending
In other words, the ratio is comparatively stable. The recent decline is mainly due to the increase in other government spending. And the stability also takes on a different hue when one considers that the number of unemployed in 2000 was significantly higher than today at around four million. Politicians have compensated for the resulting reduction in support to the unemployed by increasing expenditure on pensions and healthcare.
This structural shift is not surprising given the aging of the population. However, it shows that in the years ahead, when the baby boomers retire, the pressure to increase spending on healthcare and pensions will rise. This suggests that the aim now with social spending is not to reduce it but rather to limit any further increase. And the question of which measures and reforms are suitable for this is all the more important. Although the demographically induced burdens, particularly for public pensions, have been known for a long time, politicians have opted for an ostrich policy in recent years and declared the “double stop line”: contribution rates are not to rise until 2025, nor is the increase in pensions to slow down. This can only mean that the gaps in the pension fund will be plugged by a growing subsidy from the federal budget. This subsidy is already eating up one-quarter of this budget.
Reform Proposals for the Pension Fund
In view of the budget crisis, this pension policy is now reaching its limits. What are the options for reform? It would be possible to slow down the increase in pensions by changing the pension formula. However, organizing political majorities for this with a growing number of current or soon-to-be pensioners is challenging.
An alternative would be to ease the burden on the pension fund by further raising the retirement age. From a political economy perspective, it is to be expected that those who are about to retire will raise objections. The large number of people who are already retired, on the other hand, are likely to support a higher retirement age. This is because while this doesn’t affect them directly, it does leave their pensions more secure, since it would reduce the political pressure to tinker with the level of old-age pensions.
The extension of compulsory pension insurance to the self-employed or civil servants, which is often called for, would have less of a supportive effect on pension finances. Although these people would initially pay contributions, they would then also have pension entitlements. Keeping these entitlements lower than the contributions is likely to be politically and legally difficult. The option of further increasing pension insurance contributions also has its limits: such a policy encourages people to leave jobs that are subject to social security contributions and reduces the incentives to work at all.
What’s Required Is a Strategy, Not a Patchwork
If we include the rising expenditure on health and care, it becomes clear that there is no way to avoid limiting social benefits in Germany. But that alone is not enough. We need a comprehensive strategy to strengthen the financial basis of the welfare state. Above all, this calls both for better incentives to take up employment that is subject to social insurance contributions and for higher labor productivity. We need better coordination of social benefits in the lower income brackets so that it pays to work full-time rather than part-time. In the healthcare sector, the key to success lies in digitalization and the consolidation of hospitals.
In this respect, the current debate on public finances also offers an opportunity – for us to finally develop a broad political strategy to overcome the demographic challenges facing our welfare state.
Clemens Fuest
Professor of National Economics and Finance
President of the ifo Institute