Demographic change is one of the most important challenges for economic policy and public finance during the next decades. Among its consequences, particular attention should be given to the joint effects for the future sustainability of public finances that arise from a number of budget items where expenditure is likely to be most sensitive to changes in the age structure of the population. Based on simulations for the long-term development of public expenditure on old-age provision, health care, long-term care, education and unemployment insurance, the project aims at determining the potential dimension of these effects, thus providing a framework for continuously monitoring the impact of current political decisions on the sustainability of public finances.
The simulations are mainly based on a simple accounting framework, taking into account projected shifts in the age composition of the population. In any of the budget branches covered, aggregate expenditure and revenues are basically converted into per-capita amounts, differentiated by age and gender of beneficiaries/tax-payers, which are then used to estimate annual expenditure and revenues keeping track of with changes in population size and composition. A simple macroeconomic background scenario is used to include real growth of wages and GDP, hence benefits and future tax bases, in the calculations. Results are derived for a number of different scenarios, subjecting all assumptions made to extensive sensitivity testing and also simulating the consequences of relevant policy changes.
Based on a methodology developed by the OECD and the EU Economic Policy Committee, projections for all categories of public expenditure covered in the simulations are then combined to form indicators for the long-term sustainability of public finances („sustainability gaps“).
All variants of the simulations are based on the latest official population projections of the German Federal Office of Statistics. Projections for the economic development and the labour market situation start from actual data taken from the System of National Accounting. Current data relating to the financial situation of the different branches of social insurance and to public expenditure on education as well as on old-age provision for civil servants are taken from official statistics of the Association of German Public Pension Providers, the Federal Dept. of Health and Social Protection, the Federal Office of Labour, the Federal Ministry of the Interior and the Federal Ministry of Education and Research.
First, the simulations focus on two variants: a so-called “initial scenario” based on assumptions suggested by a government commission (“Rürup commission”) for long-term projections regarding the Statutory Pension Scheme and Statutory Health Insurance that were prepared in 2003; and a “risk scenario” that is based on less optimistic assumptions regarding long-term trends in labour force participation and employment. Projections for both these scenarios refer to the legal framework as of summer 2004, including future changes that have already been legislated.
In the initial scenario, the sum of all categories of public expenditure covered in the simulations goes up from a current (2003) 25.3 % of GDP – with some fluctuations during the projection period – to 27.8 % of GDP in 2050. In the risk scenario, the end-of-projection level of the relevant expenditure is 29.8 % of GDP. At the same time, the projections also imply a substantial increase in total social security contributions, from a current (2004) 42.0 % of taxable gross wages to 45.5 % in the initial scenario, 48.9 % in the risk scenario. Sustainability indicators calculated from these results point to “sustainability gaps” which – depending on the scenario considered and on the precise definition of the indicator– would only disappear if other public expenditure were cut by 1.2 % to 2.9 % of GDP immediately and on a permanent basis. Alternatively, if public revenues would be increased, higher excess burdens could increase the effective gap even beyond the margins just given. Sensitivity analyses show that the result that there is a substantial sustainability gap in German public finances is robust if assumptions regarding relevant demographic and economic parameters are altered within plausible ranges.
Policy simulations then deal with a number of options for closing the sustainability gap through reforms in the different branches of public expenditure considered. First of all, these simulations reveal that recent reforms regarding public old-age provision (2004) and the public health care system (2003) have definitely improved the sustainability of German public finances. Further simulations indicate that increasing the statutory retirement age (from 65 to 67 between 2011 and 2035) as well as further reforms reducing public health expenditure (through increased efficiency of services and/or a partial privatisation of the risks covered) would strongly contribute to limiting expenditure of these systems and enhancing the sustainability of German public finances in total.
M. Werding and A. Kaltschütz (2005), Modellrechnungen zur langfristigen Tragfähigkeit der öffentlichen Finanzen, ifo Beiträge zur Wirtschaftsforschung, Vol. 17 (Abstract, German).
RSS