Spain: Selected Background Issues
Author: International Monetary Fund
Publication Date:
16 May 1995
eISBN:
9781451811988
Language:
English
Keywords:
ISCR; CR; wage; severance pay; retirement age; tax rate; expenditure-control proposal; pension system; income tax; Aging
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This Selected Background Issues paper examines different aspects of the social security system in Spain. The paper describes the role of this system in the process of consolidating the government finances in the short- and medium-term, and to present possible measures to address the policy challenges of the longer term. An analysis of the finances of the social security system is presented. The paper provides a description of the main features of the pension system and projections of its financial situation in the long term.

Abstract

This Selected Background Issues paper examines different aspects of the social security system in Spain. The paper describes the role of this system in the process of consolidating the government finances in the short- and medium-term, and to present possible measures to address the policy challenges of the longer term. An analysis of the finances of the social security system is presented. The paper provides a description of the main features of the pension system and projections of its financial situation in the long term.

I. Aspects of the Social Security System in Spain 1/

1. Introduction

Expenditure on the two main branches of social security in Spain—pensions and health care—expanded significantly during the 1970s and has recently risen further (Chart 1 and Table 1). The initial growth of social security expenditure was motivated by the new aspirations of the population, following the transition to a democratic regime. The financial consequences of this growth, however, are large and have only partially been addressed by reforms introduced since the mid-1980s. The main issues currently facing the pension and health care systems entail both deepening the earlier reforms and putting the social security system in a position to face the coming demographic changes. The financial pressures on the health-care system are more immediate than those on the pension system and, the impact of health-care expenditure on the central government deficit is more direct, because the public health care system is largely financed by transfers from the central government. The ballooning of health-care expenditure in Spain—owing to the aging of population and more sophisticated and expensive medical techniques—has to some extent paralleled the experience in other developed countries. In Spain, however, it has been aggravated by regulations on services (such as on pharmacies) and labor (such as doctors), and by the universalization of services. The 1986 General Health Act established health care as a universal right. As such, it was to be financed out of general revenues. The 1989 Budget Law formalized this principle by establishing a mechanism of transfers from the central government. In 1995, these transfers will reach 3.7 percent of GDP, corresponding to about 80 percent of the deficit of the central government.

Table 1.

Spain: Social Security Finances

(As percentage of GDP)

article image
Source: Ministry of Finance.
Chart 1-1:
Chart 1-1:

SPAIN: Total Expenditure on Social Security

Citation: IMF Staff Country Reports 1995, 039; 10.5089/9781451811988.002.A001

Source: OECD

The main challenge to the pension system, on the other hand, will take place in the future, when the current slowdown of the birth rate and the increase in life expectancy will translate into a more aged population. As a result of that increase in the ratio of old-age persons to workers, contributions necessary to sustain the current level of benefits and coverage, on a pay-as-you-go basis, would have to be much higher than at present. Such a change could be made less abrupt through early changes in some key parameters ruling the public pension system and the beginning of pre-funding its liabilities. 2/ Because of the magnitude of these changes, and their impact on the welfare of the generation currently working, it is very important that they are discussed as soon as possible. An analysis of the long-term trends and the consequences of choices made today will certainly increase the confidence of participants-contributors in their pension systems.

This chapter attempts to provide an overview of the social security system in Spain, its role in the process of consolidating the government finances in the short-and medium-term, and to present possible measures to address the policy challenges of the longer term. The chapter is organized as follows. An analysis of the finances of the social security system is presented in section 2. Section 3 provides a description of the main features of the pension system and projections of its financial situation in the long run. These projections aim at illustrating the effects of the anticipated increase in the ratio of pensioners to working population and the scope of partially funding the liabilities of the public pension system. Section 4 discusses the features of the health-care system, pros and cons of financing public health care through taxes, and alternatives to reduce the burden on transfers out of general revenues, while avoiding increases in social security contributions. The main conclusions are summarized in section 5.

2. The financing of the social security system and the fiscal balance of general government

The expenditure on social security in 1995 will correspond to one third of general government expenditure and a little more than one sixth of GDP. 1/ Contributions will finance 60 percent of the expenditure; transfers from the central government will finance most of the rest. 2/ Resources transferred or lent by the central government to the social security system will amount to 5 percent of GDP. The importance of social security finances to the general government balance is also reflected by the fact that the amount of revenues raised by social security contributions exceeds that raised by income taxes. Amounts raised through another important tax, the VAT, are of about the size of health care expenditure alone.

Currently, the amount raised by social security contributions is equivalent to the expenditure on pensions, but a part of these contributions (amounting to about 1.0 percent of GDP) is used to help finance expenditure on health care (Table 2). General taxes finance the balance of health care expenditure, as well as supplements for low pensions and benefits to the handicapped and those of age over 65. Although the increasing transfers from the central government have been contemporaneous with successive increases in the VAT rate, this tax is not earmarked for that purpose.

Table 2.

Spain: 1995 Social Security Budget

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Fees and fines.

Administration cost of non-health benefits, maternity leave, payments due to occupational risk (mutuas) and the Navy.

Excludes costs of occupational risk insurance.

Services for the handicapped, the aged and other vulnerable groups.

The arithmetic of the social security accounts is such that contributions at the existing rate could fully finance all wage-related pension expenditure—including the administrative cost of the pension system and the supplements to low pensions. 3/ Such a redirection of resources would, of course, imply that an additional 1 percentage point of GDP in health-care expenditure would have to be tax financed. At almost 5 percent of GDP, health care expenditure represents by itself an important item of government expenditure. Trimming those outlays, or finding new source of revenues to fund them, can, therefore, play a fundamental role in the process of fiscal convergence pursued by the Government. An increase of 1 percent of GDP in government revenues—used to finance health care and to free resources to fund other government commitments—would be instrumental to reduce the government deficits to levels more compatible with the Maastricht criteria. Such strengthening in revenues might be achieved by raising social security contributions. Following this course might, however, be disadvantageous to economic growth; instead a broadly based direct tax would be more desirable.

Contributions to social security are divided in two classes: basic contributions and contributions to occupational insurance. 1/ The contribution rate to social security has fluctuated over time, being lowered in the early 1980s and increased afterwards. The basic rate stands at 28.3 percent, computed as a share of wages up to three times the professional minimum wage. 2/ Because of the small dispersion of minimum wages across professions and of the ceiling on individual contributions, the top annual contribution (that of engineers and other employed professionals) is less than 5.5 times the lowest contribution—implying that contributions to the social security are in fact a regressive payroll tax. 3/ In addition, although social security contributions are not particularly high in Spain, they fall only on labor and are thus a factor depressing the demand for this factor. These considerations suggest that, if new revenue sources for the social security system are necessary, mechanisms other than an increase in contributions should be sought.

3. The pension system

a. Main features

(1) Development and coverage

The pension system in Spain evolved from a variety of regimes established at different times since the beginning of the century. As in many other countries, these regimes differed widely. Many were, pre-paid, but poorly funded, and all were hard hit by changes in the economic environment.

The system has been reformed four times in the last 30 years. The first reform followed legislation issued in 1963, taking effect in 1967. It converted almost all regimes to a pay-as-you-go system, improved some pensions, but made the financing of social security systematically dependent on government transfers by setting contributions at low levels. In 1972, the second reform made contributions proportional to wages, while loosening eligibility criteria significantly. A third reform, beginning in 1977, attempted to harmonize the many regimes existing and to provide them with an integrated administration. The differences in the value of the pensions paid by distinct systems were reduced (generally by increasing the lower pensions), and the administration of the pension system was put under the newly created National Social Security Institute (INSS). The ensuing expansion in coverage and increases in the real value of pensions raised the financing needs of the system so sharply that a fourth reform became necessary. In 1984–85, there was a tightening of eligibility criteria for disability pensions and a lengthening of contribution periods to obtain pensions and an increase in the number of years of salary considered when computing the wage-related pensions.

Currently, the system comprises six basic regimes and the occupational-risk insurance regime. 1/ The number of pensioners in all regimes increased from 3.8 million in 1977 to 6.8 million in 1994 (Chart 2, top). This increase reflected both the broadening of eligibility criteria and the aging of the population. The share of the population more than 65 years of age increased from 11.3 percent in 1980 to 14.8 percent in 1993; the corresponding increase in the pensioner per worker ratio exceeded two thirds from 1977 to 1993, to 0.53 (Chart 2, middle). 1/ Among the current basic regimes, the general regime is the which coverage has expanded most significantly since 1977, in part due to the incorporation of several small regimes (e.g., bullfighters, soccer players). 2/ The general regime currently covers about 70 percent of participants in the social security system and half of the total number of pensioners (Table 3). The regimes for the self-employed and agricultural workers cover another 35 percent of the pensioners. Only the general regime and the regime for the self-employed are expected to have a growing number of participants in the future.

Table 3.

Spain: Number of Pensions and Contributors

(In millions)

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Source: INE (Instituto Nacional de Estadistica).
Chart I-2
Chart I-2

SPAIN: Selected Characteristics of the Pension System, 1997–93

Citation: IMF Staff Country Reports 1995, 039; 10.5089/9781451811988.002.A001

The characteristics of benefits offered by the system are not unusual among European countries, except for the number of years of contributions and the retirement age. The standard retirement age is 65 years. 3/ Entitlement to a pension under the general regime requires 15 years of contributions, including the two years immediately before retirement. A full pension is granted after a contribution period of 35 years, being reduced by about 2 percent for each year short of that full career span. Surviving spouses get 45 percent of normal pensions, if the principal deceased before retirement, and 60 percent if after retirement. The value of the pension is proportional to the wage-based contributions in the last 8 years prior to retirement (adjusted by the CPI) and to the number of years of contributions. In 1994, the minimum annual retirement pension was Ptas 0.8 million (around US$6,500) for married pensioners above 65 years of wages, and Ptas 0.7 million for those married below 65 years of age. The latter is approximately the value of the minimum wage, adjusted for taxes.

Compared with other European pension systems, the minimum retirement age is relatively higher, but the contribution period is short. Although perhaps reasonable in the past, when coverage was still increasing, such a short contribution period is now more of a disincentive for continuous payment of contributions than an instrument for social justice. On the other hand, a high retirement age penalizes those who started to work earlier, a situation that would be worsened if the retirement age were raised. Instead, a lengthening of the contribution period could reduce the number of new pensioners, while not discriminating against those entering the labor force earlier.

b. Financing

The financial requirements of the pension system reflect basically the systematic increase in the real value of pensions in the last 10 years. The average value of pensions at constant prices increased by about 2 percent per year in real terms over the last 10 years (Chart 2, bottom). Compounded with the growth in the number of retirees, it meant that the share of GDP spent on pensions has steadily increased in the last 10 years, reaching 9 percent in 1994. As noted, contributions are currently enough to cover the so-called contributive benefits, i.e., wage-proportional retirement pensions and family allowances, temporary disability pensions, and occupational-risk insurance.

Supplementary transfers from the Government to guarantee minimum pensions have increased significantly over the years, reflecting the policy of raising and harmonizing minimum pensions. 1/ Currently, about 30 percent of retirement pensions and 40 percent of the widows’ pensions benefit from some supplementary benefit. However, because in many cases the difference to be covered is not very wide, the supplementary outlays (“complementos por minimos”) correspond to less than 4 percent of total pension payments (i.e., about 0.3 of GDP). Government also finances pensions to the old aged who do not belong to any of the pension regimes and to the handicapped. 1/ In 1995, the resources assigned to these pensions amount to 0.3 percent of GDP.

c. Problems, reforms, and outlook

In the past, the main problems of the pension system have been fraud and the rapid growth in the number of disability pensions. 2/ These problems have been tackled and have put the pension system in a relatively strong position to face the demands of the next few years. The measures taken in the 1980s to correct the trend on the permanent disability pensions and those recently taken to address the problem of temporary disability pensions (described below) illustrate the ability of the system to adjust to changing conditions and are encorageous signals that the greater challenges to be faced after the year 2000 can also be met with success.

The number of permanent disability pensions swelled in the late 1970s, especially in the general regime, because the number of years of contribution permitting a full disability pension was very small. 3/ This lead to curious situations. For instance, in the early 1980s, the proportion of disability pensions was higher in the general regime than in the regime of bullfighters (Chart 3, top). 4/ After the tightening in eligibility effected by the 1984 reform, the annual growth rate in the number of disability pensions fell from 6.6 percent to less than 3 percent in 1985 and about 1.2 percent by 1994. Despite this improvement, the INSS projects that in 1995, disability pensions will account for 25 percent of all pensions.

Chart I-3
Chart I-3

SPAIN: Pension Regimes and Demographics

Citation: IMF Staff Country Reports 1995, 039; 10.5089/9781451811988.002.A001

The transient and temporary disability pensions created another sort of problem. Expenditure on the first type of pension, which is actually a sick leave paid by the social security system, increased by 20 percent in 1990–91. This is not unique to Spain, because firms in many countries have strong incentives to promote sick leaves when the economy weakens. Legislation establishing that the ILT would be paid only after the 16th day of leave was issued in 1992, and in 1993 the (nominal) increase in expenditure for transient disability pension was limited to 5.3 percent. Temporary disability pensions, which are provided during a waiting period before an applicant becomes entitled to a permanent disability pension, were perceived as offering more lenient conditions than permanent disability pensions and hence often fully used. The waiting period before a final decision on eligibility for a permanent disability pensions could extend to up to 6 years, creating not only costs to the social security, but problems in the labor market (because while on temporary disability, the worker kept the right to return to his position in the firm). Legislation taking effect in 1995 merged the two types of pensions into a single temporary disability pension (incapacidad temporal) lasting no more than two years. In addition to an abatement in the future growth of expenditure, a modest reduction in its level is expected from this measure. Finally, the decision of granting a disability pension was shifted from employers and employees to newly created boards under the control of the social security system. 1/ This is expected to lead to a better medical screening.

More generally, the short-and medium-term outlook of the pension system is favorably impacted by the moderation in the number of new retirees in the coming years, due to the effects of the 1930s civil war on natality and infant mortality (Chart 3, bottom). In addition, the very abatement in the growth of disability pensions achieved since the 1984 reform has contributed to the more subdued increase in the number of retirees in recent years. This scenario will be modified, however, after the year 2000 by demographic changes. The consequences of the future demographic changes are analyzed in some detail in the following paragraphs.

4. Long-term financial prospects

The long-term financial situation of the social security will depend on the demographics of the next century and on the dynamism of the labor market. The so-called “baby-boom” took place in Spain some 10–15 years after the rest of Europe (lasting until the early 1970s). Therefore, the slump in the proportion of working-age people in total population will take place only after 2020 (Chart 4). Changes in the labor market itself can play an important role because the participation rate in the labor force in Spain is among the lowest in Europe. This is due to a still recent shift from agriculture, to the lower participation of women and, more generally, to rigidities in the market. In the medium term, if the labor market becomes more flexible, about 1 million new jobs could be created before the year 2000, permitting the contribution rate required to balance the pension system to be stable. 1/ And in the long run, by permitting higher sustained growth, a more flexible labor market would reduce the burden on the working force (for same level of benefits to pensioners).

Chart I-4
Chart I-4

SPAIN: Projected Demographic Situation of the Pension System, 1995–2055

Citation: IMF Staff Country Reports 1995, 039; 10.5089/9781451811988.002.A001

a. Demographic trends

The projections presented here, while only illustrative, are based on the detailed age distribution of the population published by INE, as well as on mortality rates in Dinh (1994) and Domenech and Escribano (1989). The natality rate reflects the current fecundity. It is expected to increase in coming years, when the bulk of the “baby boom” cohorts reach the peak of reproductive age. As shown in Chart 4 (top), the ratio of old-age (> 65 years) to working-age (> 15 years and < 65 years) populations would be projected to rise from 25 percent in 1995 to more than 60 percent in 2050.

In order to determine the implications for contribution rates, two scenarios regarding the employed to working age population ratio are considered. 2/ In the first scenario, the proportion for each age bracket stays at its 1990 level. In the second scenario the ratio for most age brackets gradually increases, reflecting mainly a larger participation of young (< 35 years) and middle age (> 45 years) women. In this scenario, the employed to working age ratio increases from 47.4 percent in 1995 to 53 percent in 2010, staying around this figure in the following years (Chart 4, middle). 3/

In the projections, the retirement age is kept constant at 65 years. Under this assumption, the ratio of pensioners to worker in the second scenario doubles between 1995 and 2050, with the big shift taking place after 2010, when it rises from 0.6 to 1 (Chart 4, bottom).

b. Output growth and pension contributions

For the purpose of these scenarios, real GDP growth has been projected using a Cobb-Douglas production function. The baseline increases in the capital stock (around 4 percent a year) and in the total factor productivity (1.4 percent a year) are exogenous (reflecting the recent history). The share of labor in total income is assumed to be of 61 percent (the average in the recent past) and yields an equivalent elasticity of output to changes in employment over the period. Ipso facto, output growth will slow in the future, as the available labor decreases (Table 4). The average growth rate during the first decades of the next century is thus projected to be around 2.2 percent, in the case of higher employment and about 0.2 percent less in the other case.

Table 4.

Spain: Financial Situation of Social Security

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Source: IMF Statistics, staff projections.

Average wages are assumed to incorporate the increase in total factor productivity and thus to rise 1.4 percent a year further than the CPI. New pensions are assumed to be a constant fraction of average wages. Reflecting the current experience in Spain, old pensions are indexed to the CPI and not to wages (i.e., they are constant in real terms). The value of new pensions was estimated using figures provided by the social security administration. 1/

The method adopted avoids the pitfalls of simply extrapolating past growth of expenditure on pensions, which reflected a transient period of increasing coverage and harmonization of pension values. Instead, it permits an evaluation of the financial requirements of the pension system in a more stable institutional framework. A similar approach has been used for the G-7 countries (e.g., Van den Noord and Herd, 1993), but not for Spain. Of course the model, because it is a stylized one, is inadequate for detailed short-or even medium-term (5 years) estimation of the social security cash flow. For such a precise estimation, exact actuarial information on the particularities of the many regimes and classes inside them would be necessary. This information is not publicly available and is, in any event, of limited importance when making projections 30 years in the future.

c. Incorporating pre-funded public pensions

The projections also attempt to assess the scope of partially pre-funding public pensions. Such pre-funding can take many forms and could be introduced gradually to address the long-term problem. As an illustration, funds start to accumulate at a rate of 0.2 percent of GDP a year in the initial years, with the flow of saving increasing to up to 1.1 percent of GDP per year in the first decades of the next century is simulated. The additional domestic saving helps to finance a increase in the capital stock (over the baseline value), permitting higher growth and, when the withdrawals start, also limiting the increase in social security contribution rates required to finance a constant level of real benefits. In the projection, funds accumulated are assumed to be fully used by the year 2050.

d. Results

The main results of the projections are that, under the assumptions considered, (a) the average rate of contributions required to finance pensions on a exclusively pay-as-you-go basis will double by the middle of the next century; (b) the increase in contribution rates can be almost halved by a gradual pre-funding and full use of accumulated assets in a 20-year period.

These results (summarized in Table 4) indicate that the demographic pressure will be an important factor determining income distribution in the future. 1/ They highlight the different patterns of intergenerational transfers implied by some pay-as-you-go and partial pre-funding alternatives, and the importance of directing part of social security contributions to starting to fund the pension system. It is important to note that the pre-funding alternative implies higher contributions by the generation retiring before 2020, but a lesser increase in the contributions of those retiring in subsequent years, i.e., the transition generation will have to pay current pensions and save for their own pensions. It has been indicated elsewhere (Breyer and Staub, 1993 and Raffelhuschen, 1993) that under special conditions the transition to a partially pre-funded system could be achieved without significant cost to the transition generation. However, the conditions may be difficult to be achieved and therefore it is of importance to proceed with an early and ample debate of the issue before adopting key reforms. 2/

5. The health-care system

a. Hain features

(1) Development and coverage

The national health-care system in Spain dates back to 1942, when a compulsory sickness national insurance scheme for low-income workers and their families was introduced. The current organization began in late 1977, following the 1977 reform of the social security system, when the National Insurance Institute (INP) was divided into four different entities, one of which—the National Institute of Health (INSALUD)—became responsible for health care. At that time, the trend toward greater regional autonomy began to develop. Since, seven regions have become responsible for managing their health services. 1/ This transfer process, as well as the integration of the different providers of health-care-services-(i.e., INSALUD and municipal institutions) into a national health system (SNS) under the aegis of the social security system, was formalized in the 1986 General Health Act (Table 5).

Table 5.

Spain: Shares of Public Expenditure on Health Care

(In percent)

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Sources: Whitaker et al., and 1995 General Budget.

Share of expenditure under the control of social security.

Public health coverage has become almost universal since the late 1970s (increasing from about 80 percent in 1977 to 99 percent in 1992), and population health indicators now compare favorably to those in other industrial countries. Expenditure on health care increased from 3.6 percent of GDP in 1970 to 5.9 percent in 1980, and about 6.5 percent in 1990, most of the latter increase occurring after 1987 (Chart 5, top and Table 6). The later growth has been attributed to the aging of the population, the adoption of more sophisticated treatments, the reduction in working hours of health professionals (especially after the 1987 labor unrest), and lax monitoring of expenditure. 1/ Despite the increases in expenditure, there is still an excess demand, dealt with mainly through waiting lists for non-urgent interventions.

Table 6.

Spain: Total and Private Expenditure on Health

(As percentage of GDP)

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Source: OECD.
Chart I-5
Chart I-5

SPAIN: Expenditure on Health Care

Citation: IMF Staff Country Reports 1995, 039; 10.5089/9781451811988.002.A001

Annual Report, Ministry of Economy.

b. Financing

At present, between one third and one fourth of total expenditure on health is private, because users (except the elderly and chronically ill) pay for 40 percent of the cost of medicines consumed and because dental and some psychological services are not covered. In addition, patients covered by the public health system often prefer to go to private doctors and clinics to receive non-urgent or non-complex care, in order to avoid the waiting lists required for consultations in public health centers and because they value the amenities provided by private institutions. These services are usually paid by private insurers, who cover about 17 percent of the population. Complex interventions are usually done in public hospitals and are not covered by standard private insurance.

The public financing of health care has experienced significant changes in the last 10 years. In the early 1980s, most public expenditure on health care was financed by social security contributions (only 5 percent was tax financed in 1979), but, in recent years, more than two thirds have been tax financed (77 percent in 1995). 1/ As noted above, this sharing reflects the principles in the 1986 General Health Act. However, while the burden on the central government has steadily increased with the swelling of health care expenditure, analysis of the funding of contributive and non-contributive expenditures is still complicated by the use of some contributions to finance health care, and of some general budgetary resources to finance some pensions.

The financing of services transferred to regions, handled by INSALUD, has been subjected to bargaining every year between central government and regional authorities. 2/ Actual expenditure has systematically been above budgeted transfers (Chart 5, bottom), leading to large debts. These debts have eventually been written off by the central government, despite contention about who should be responsible for accumulated interest charges. Currently, the central government is repaying the Ptas 0.7 trillion (1.1 percent of GDP) debt that had accumulated by 1992 (Table 7). The Government has indicated that the deviations of actual from budgeted expenditure resulted from conscious underestimation of costs aimed at putting pressure on INSALUD to curb expenditure. However, this strategy has increasingly been perceived as ineffective, prompting the recent effort to achieve a medium-term agreement between central and regional authorities.

Table 7.

Spain: Projected Health Expenditure 1/

(In trillions of pesetas)

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Source: Ministry of Finance.

According to the agreement with the Territorial Authorities.

Savings on the purchase of pharmaceutical products.

For expenditure of other institutions in the National Health System.

In 1994, the authorities achieved a multi-year (1994–97) agreement with the regions, establishing that accrued health expenditure should grow at the same rate of GDP, adjusted for the coverage rate in individual regions. Cash expenditure would diverge from this projected path by the additional amount budgeted for debt repayment. For the purpose of the plan, an estimate of the expenditure accrued in 1993 was computed and adopted as the base for future expenditure; this implied that the share of (accrued) public health expenditure should stabilize in the coming years at 4.7 percent of GDP. Following the agreement, the 1994 budgeted expenditure was increased by about Ptas 200 billion, the amount yielded by the new methodology as required to break with the old pattern of insufficient transfers.

c. Problems, reform proposals, and outlook

The agreement with regional authorities establishes goals, but does not provide a strategy to solve the imbalances in the health system (e.g., it does not have provisions to implement the expenditure-control proposals made in the report issued by the parliament in 1991) and may have little immediate impact on the amount of resources transferred from the central government and, hence, in the overall fiscal balance of the government. The imbalances of the health-care system stem largely from the difficulties associated with the devolution of services to regional authorities and inadequate monitoring and incentives in the system—the latter being reflected in the endemic absenteeism and chronic fraud by users and providers. The transfer of services to regional authorities has not always been followed by proportional reductions in the personnel in the central system, especially management, and there has been duplication of activities. Waste also takes place because the majority of doctors in primary care are not rewarded by performance, nor are they penalized for sending patients to specialists when care could be dispensed at the level of general practice; public hospitals do not face credible budget constraints, and are not managed by professionals; and contracts with private hospitals often establish per-day compensation (instead of per-case), hence encouraging long patient stays. In addition, although pharmaceutical producer prices are low in comparison to other developed countries, drugstore margins are large, patients often abuse the privilege of free medicines granted for the elderly, and, until recently, little control was exerted on doctors who over-prescribed medicines.

In 1991, a parliamentary commission issued a report (the “Abril Report”) analyzing most of the problems listed above and suggesting several measures to limit costs. Proposals included user fees, copayment on drugs to the elderly, limits on the incorporation of new drugs in the government-approved purchase lists (selective financing), and procedures to increase the awareness of patients about the actual cost of services provided. In addition, the commission suggested procurement reforms (including the creation of internal markets), more autonomy and budgetary responsibility to hospitals, increases in the number of beds for long-term care (including those offered by the private sector) in order to reduce the use of acute-care beds by chronic patients, and the contracting out of private services for interventions requiring long waiting periods. These measures were expected to greatly improve the overall efficiency of health care.

Most of the proposed measures, however, are difficult to implement and some would take time to produce significant effects. Savings on pharmaceuticals have been achieved (Table 7) and cases of fraud and inefficient procurement have been investigated, but most other propositions (e.g., user fees and administrative reforms) have either been discarded, or need further specific preparatory work. Given these problems and considering the trend in other OECD countries, the ratio of health-care expenditure to GDP is likely to increase in the near future, even if significant advances are made in the management of INSALUD. 1/ Therefore, the system will need more resources in the next few years and, barring steep increases in social contribution rates, reliance on taxes will continue. The need for fiscal consolidation at the level of the central government, however, suggests that simple transfers out of general revenues may not be the best alternative. Instead, dedicating some new source of tax revenues entirely to financing the health care system would both comply with the principle of government responsibility for public health and help reducing the government deficit.

6. Aspects of tax financing for public health care

The financing of health care raises several issues, including the amount of services that are to be provided (and thus financed); the link between contributions and benefits (including the advantages and disadvantages of earmarked taxes, as well as the tax base chosen); and its consistency with the general income distribution objectives of the Government. Considering most of these public choices as given (and with limited scope for significant short-term impacts of structural reform), only a subset of issues related to the financing of health care is addressed in the following paragraphs. These are mainly related to the justification for tax financing, the usefulness of earmarking revenues to finance public health expenditure, and the choice of a tax base for this purpose.

a. Reasons for tax financing and the pros and cons of earmarking taxes

If health care is seen as a universal right—as it is in Spain—it may be more suitably financed by taxes, as are other rights offered to the population as a whole (e.g., security as provided by policy and the army), rather than through user fees or payroll taxes. 1/ Hence, a broad-based tax may be the most attractive solution for financing health care, with some mechanism—such as earmarking—to ensure that the resulting revenues are used to reduce transfers from the general budget, rather than to increase other expenditure.

Earmarking revenues is often viewed as welfare reducing, because it limits the ability of government to optimally allocate resources. This criticism, however, is based on the assumption of the existence of a benevolent fisc and has been largely nuanced by the recognition that governments are the result of the interaction of complex political interests. Modern constitutional economics suggests several instances where earmarking can be a welfare enhancing instrument (Buchanan, 1991). Following this approach, earmarking can be justified either as an implicit way of raising fees for specific services (i.e., a sort of exchange), or as a means to ensure that tax revenues are spent in providing benefits that are general in nature. 1/ The first justification suggests that taxpayers may be more willing to pay taxes if the return for them is clearly defined. In this more or less consensual framework, a tax used exclusively for financing health care may face less opposition than a simple increase in general taxes. Earmarking revenues to finance universal health care would also fit the second criterion.

Furthermore, earmarking revenues can help to stabilize the resources available to the public health care system on a yearly basis and make them more predictable in the medium term (including if a increasing trend is admitted). For instance, they may protect INSALUD from cuts in funding resulting from squeezes by other areas in government—which in any case usually result in arrears and a need for higher transfers in following years. They may also signal a sustainable expenditure path provided by the expected growth of the tax base. Management, especially of medium- and long-term issues, may be assisted by such predictability.

Given the trend in most developed countries (in spite of efforts to curb the growth of expenditure), a broadly based tax should also respond to the requirement to choose a tax that could be adjusted to the likelihood that the public health expenditure to GDP ratio will increase in coming years. Of course, payroll taxes (i.e., social security contributions), when used for funding health care, are a form of earmarked direct taxes and their rates can be adjusted to the financing needs of health expenditure. 2/ However, they have a relatively narrow base, that not only may be seen as nonequitable, but also creates impediments to employment growth because it puts all the fiscal burden on the labor factor. The VAT, being a consumption tax, compares favorably to payroll tax in this aspect, because it is broadly based. In Spain, the VAT has become increasingly important in helping to finance the transfers to the social security system. Further reliance on it may, however, be inconvenient.

b. Consequences of further reliance on the VAT

As noted, relying on the VAT for financing the public health care system is attractive because it has a broad base. However, increases in its rate are problematic. First, rates are subjected to the EU agreements, and although Spain still has relatively low rates, room for further increases is limited. Second, any increase in rates has a significant impact on the CPI, which conflicts with government priorities. Finally, even when tax evasion is taken into account, the VAT tends to be more regressive than direct taxation, thus conflicting with the income distribution goals of the Government. 1/ In that regard, some economic models suggest that progressive taxes may also dampen wage pressure in a unionized environment (Hersoug, 1984, Malcomson and Sator, 1987, Lockwood and Manning, 1993), hence favoring the Government’s goal of lowering inflation.

Burgos et al., (1993) estimated the effects of VAT increases in 1992. Their results suggest that a 1 percentage point increase in VAT rates translated into an increase of 0.35 percent in the CPI. 2/ Simulations published by the Ministry of Economy using their model MOISEES (Fernandez et al., 1994) suggest a smaller, but still significant, impact. 3/ Regarding the revenue raised by a 1 percentage point increase in the VAT rate, the Spanish authorities have indicated the expectation of a significant increase in VAT evasion following such increase in rates. The effect on the price level of increasing the VAT in order to raise 1 percent of GDP in new revenues would be an increase of prices of over 1.2 percent.

c. The scone of a generalized social security contribution

Considering the arguments above, an earmarked direct tax, akin to a contribution to the social security system but based on both capital and labor income, could be the most advantageous option. 4/ The discussion in section 2 indicated that health-care expenditure amounting to about 1 percent of GDP are funded by labor contributions. Hence, in response to redirecting contributions to finance only wage-related benefits (in the context discussed in section 2, this amount in new revenues could be sought out of such a broadly based health tax. How broad would the base of such “generalized contribution” be can be assessed by looking at the National Accounts. The National Accounts suggest that the (potential) base for a generalized contribution is about 50 percent larger than that of ordinary social contributions: income from capital and transfers (such as pensions and unemployment benefits), constitute about one third of total income (Table 8).

Table 8.

Spain: Sources of Household Income (1993)

(In percent)

article image
Sources: Cuantas Finacieras and staff estimates.1/ The share of self-employment income is computed using the number of self employed contributing to the social security, assuming that their average income is the same as the wage earners.

The rate of the “generalized contribution” required to raise 1 percent of GDP can be estimated using the information from the personal income tax. The effective average personal income tax rate in 1993 was about 10 percent of total household income, in spite of marginal income tax rates ranging from 20–53 percent. 1/ This is explained by the several exemptions (e.g., the minimum income subject to income tax), deductions (e.g., for costs related to employment) and credits (e.g., family allowances) granted. Hence, taking into account the exemptions for incomes below the income tax threshold, the rate required by the generalized social contribution on income to generate revenues amounting to 1 percent of GDP would be in the range of 1–2 percentage points (instead of the theoretical rate of 1 percentage point levied on total household income).

To minimize problems of tax evasion, collection of the generalized contribution could replicate the mechanism adopted for collecting ordinary social security contributions and income taxes, as happens with the Contribution Sociale Généralisée.

7. Conclusions

The social security system in Spain has steadily expanded since the late 1970s. The public health care system currently provides an almost universal coverage for the population, while the pension system has permitted a significant improvement in the standard of living of persons of age. Contemporary to these major achievements, however, social security expenditure has also increased, reaching more than 15 percent of GDP in 1994 and is now an important factor in the fiscal imbalance of the general government.

The growth of health care expenditure is broadly due to the aging of the population, more sophisticated medical treatments, increasing labor costs, and inadequate monitoring and incentives in the system. Considering these facts and the trend in other OECD countries, the major measure taken by the Government to curb the growth of expenditure—the multi-year financial program agreed between central and regional authorities—is unlike to significantly reduce the need of transfers from the central government in the near future.

Currently, the central government funds more than two thirds of the budget of the health care system, the rest being supported by social security contributions. Given the need of fiscal consolidation of the general government to allow Spain to attain the targets set in the Maastricht Treaty, and the difficulties for trimming health care expenditure, a new source of fiscal revenues appears to be needed. This source should be broadly based, have a minimum impact on price levels, not be regressive, and permit to free social security contributions to fund only wage-related benefits. A flat-rate tax levied on the income from labor and capital, earmarked for funding health care and yielding about 1 percent of GDP would respond to these requirements.

The main challenge of the pension system lies in the future. The demographic changes that will take place in Spain after the first decades of the next century will significantly increase the proportion of the population aged above 65 years. For a pay-as-you-go scheme, such as the public pension system in Spain, such an increase will be reflected in a large increase in contributions from workers. Because of the large impact of these developments in the intergenerational income distribution, an early discussion of this challenge is very important. Current contributors should be informed about the possible alternatives and their consequences.

Future increases in pension contributions can be moderated by changes in some parameters of the system (e.g., the contribution period), partial pre-funding of future liabilities and greater flexibility in the labor market (which would lead to an increase the ratio of employed to working age persons). The illustrative projections presented in this study suggest that if these actions are taken soon, the increase in contributions by the time the current “baby-boom” generation will be retired would be halved in relation to a scenario where no action is taken. They also point to the importance of building a surplus in the pension system at an early stage.

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1/

Prepared by J. Levy.

2/

Spain already has a legislation permitting the organization of private pensions funds and, hence, this issue is not discussed here. The 1993 National Financial Accounts indicate that pension plans’ reserves amounted to close to Ptas 4 trillion (7 percent of annual CDP). As an example of the continuous attention to the matter, the Government has recently presented a bill requiring firms to take pension assets out of their balance sheets.

1/

More precisely, 36 percent of the consolidated budget of the Central Administration (the budgets of Territorial Authorities have not been approved yet, but should correspond to about 10 percent of the general government budget) and 15.6 percent of GDP.

2/

Other resources (e.g., capital income) correspond to less than 2 percent of total social security revenues. The 1995 budget also projects a deficit of 0.6 percent of GDP, to be financed by a loan from the central government.

3/

As the economy recovers, it is probable that contributions will in fact grow faster than these expenditures; in this case, they would generate a small surplus to the pension system.

1/

The occupational-risk insurance is run by the social security and mutual groups (mutuas) formed at the level of firms and industries. Other contributions from labor (payroll taxes) are for the unemployment insurance (7.8 percent), technical training (0.7 percent) and FOGASA, the compensation fund for workers of bankrupted firms (0.4 percent). These programs, however, are not managed by the social security system.

2/

Employers pay 23.6 percent of wages as contribution (84 percent of total contribution) and the remainder is paid by employees. The rate was reduced by 1 percentage point in January 1995. Rates on overtime work are between 50 percent and 100 percent higher than on normal hours depending on the cause of the overtime. The State contributes to social security on behalf of the unemployed.

3/

In 1994, the maximum and minimum bases for contributions by engineers were Ptas 0.35 million a month and 0.11 million a month, respectively. Reflecting the small dispersion of minimum wages across professions, the lowest bases ranged between Ptas 0.07 million a month and Ptas 0.11 million a month. The rate applied in every case was the same.

1/

The basic regimes are the general regime, the regime for workers in the agriculture, the miners’ regime, the seaworkers’ regime, the household workers’ regime and the self-employed’s regime.

1/

Sluggish employment growth in period and the low participation rate of the population of age 16 to 65 also Contributed to the increase in this ratio. The participation rate in Spain stands below 50 percent of the population in Spain, contrasting with the rate of, for instance, France, which stands above 55 percent. As a result of the higher participation rate, the dependency ratio there is around 10 percentage points below that in Spain, although in France the social security is well developed and the population over age 65 is nearly as high as in Spain, corresponding to 14.5 percent of the total population.

2/

The last integration was in 1993, and few new integrations are expected in the future.

3/

Early retirement is permitted in special cases, in particular for those who started to contribute before 1967, but in principle implies a reduction of 8 percent of the value of the pension for each year before 65. Early retirement resulting from collective layoffs are regulated by special legislation.

1/

In the 1986–90 period, minimum pensions increased 15 percent more than standard pensions.

1/

Following the 1990 Social Insertion of the Handicapped Act (LISMI), pensions are gradually falling under the responsibility of INSS, instead of the social service arm of the social security (INSERSO).

2/

During the previous economic slowdown, fraudulent bankruptcies, involving the default of past social security payments, became a fairly widespread practice for firms facing financial difficulties. The practice, however, has been combatted and was significantly reduced in recent years, and the problem of fraud is not discussed here, except in the context of lax enforcement of eligibility criteria for disability pensions.

3/

Until 1995, there were three types of disability pensions: a transient (incapacidad laboral transitoria, ILT), a temporary (invalidez provisional) and a permanent. These pensions cover both occupational and nor-occupational disabilities. As explained below, the first two benefits were merged in January 1995. The value of permanent disability pensions is reduced if the worker is handicapped for the former profession, but not for other jobs, but it is increased if the worker is older than 55 years—making a disability pension sometimes more attractive than a retirement pension. Because, before 1985, the minimum period of contributions was 5 years, there were strong incentives to seek a disability pension. In 1985, the minimum period was increased to 8.75 years for those 55 years old and 11.25 years for those 65 years old.

4/

The statistics suggests that a larger fraction of matadores were entitled to old-age pensions (instead of physical disability pensions) than that of average workers, despite the physically dangerous occupation the former had; the proportion of widow’s pensions was similar in both regimes.

1/

The administration of the mutuas (intermediary bodies managing the occupational risk insurance) was also reformed.

1/

If the structural changes fail to be implemented, employment growth may be limited to some 0.6 million new jobs in the next five years.

2/

The two scenarios are useful to compare the sensitivity of results to projected changes in employment, given the difficulty of estimating the participation of women in the labor force and the ability of the labor market to absorb the supply of labor. How much of the increase in the labor force will be translated into a higher worker to working age population ratio will depend inter alia on the future flexibility of the labor market. Employment figures after the year 2000 do not consider economic cycles.

3/

This growth reflects the assumption that, not only the number of women working will increase, but the trend of delayed pregnancies and of re-entrance into the labor force a few years after childbearing will be strengthened in the future.

1/

The average value of new retirement pension in the first quarter of 1994 was 25 higher than the average retirement pension.

1/

The projections show only the average contribution to labor income ratio. As contribution rates increase, it may be necessary to increase the ceiling of contributions (the “bases”) above the current 3 minimum wages. This increase in progressivity may be important if wage dispersion continues to augment.

2/

In addition to pre-funding the pension system, a change in parameters such as the number of years of contribution and the maximum contribution would have to be considered soon.

1/

The regions are Andalucia, Cacaloniz, Valencia, Basque country, Galicia, Navarra and Canaries. The Basque country and Navarra have special financial arrangements, because, for historical reasons, they raise their own taxes. The Social Security, through INSALUD, finances the health-care services managed by both central and regional authorities.

1/

Personnel costs correspond to about 75 percent of current expenditure of hospitals and about half of that of the INSALUD.

1/

Fees correspond to only Ptas 40 billion.

2/

The conditions for the transfer were also the result of bargaining processes, and because in most cases they reflected the level of expenditure in the regions at the time the transfer took place, they have tended to perpetuate the differences in services between regions. It should also be noted that although regions are responsible for managing their services, most policy and financing decisions are taken at the national level.

1/

Rowlett and Lloyd (1994) estimate the GDP elasticities of health care expenditure for developed countries to be between 1.4 and 2.3. Gerdtham et al. (1994) find that (in OECD countries GDP) per capita, with a coefficient of elasticity significantly larger than one, appears to be the most important factor in (cross country) health care expenditure variations, being stable in the last 20 years.

1/

This principle does not apply to pensions. Instead, it is widely considered preferable to have pensions funded by labor contributions, because this establishes a link between retirement income and the effort of workers in their productive years.

1/

Earmarking complementary goods and services (e.g., earmarking a fuel tax to finance roads) can also be understood as a way to protect a minority from a majority. If revenues, once collected, can have only specific uses, the incentives for excessive taxation are decreased. In the exchange model, efficiency is not guaranteed if the level of taxation is not jointly set with the destination of the tax.

2/

Contributions in this case are a tax because the benefits in terms of health care are not actually related to the contribution paid.

1/

Evasion from both direct and indirect taxation is widespread. Studies quoted in Fernandez at al., 1994 (Secretaria de Estado de Economia (1994) and Melia (1992)) suggest that VAT evasion is estimated at about 30 percent.

2/

The increase of 2 percentage points in July 1992 explained about 0.7 percentage points in the CPI increase recorded in the following 3 months. The 1 percentage point increase in the VAT in January 1992 explained about 0.6 percentage points of the subsequent increase in the CPI. However, the increase in VAT in January was accompanied by an increase in the taxes on gas and tobacco and the effects of this contemporary increases were not disentangled. The transmission of an increase in the VAT should be less than 100 percent, since food is not taxed.

3/

MOISEES is a Keynesian model that assumes that prices reflect a markup over wages and capital costs; in the simulations, interest and exchange rates are fixed.

4/

Such an approach has been used by the French since 1990, when the Contribution Sociale Généralisée was introduced. This contribution is in fact a flat-rate income tax based on capital (including rents and financial assets’ returns) and labor revenues (including pensions).

1/

The income of households (an non-profit institutions) amounted to 103 percent of GDP in 1993.

Same Series

Other IMF Content

Other Publishers

Cover IMF Staff Country Reports
Spain: Selected Background Issues
Author: International Monetary Fund
Volume/Issue:
Volume 1995: Issue 039
Publisher:
International Monetary Fund
ISBN:
9781451811988
ISSN:
1934-7685
Pages:
119
DOI:
https://doi.org/10.5089/9781451811988.002

SPAIN: Total Expenditure on Social Security

SPAIN: Selected Characteristics of the Pension System, 1997–93

SPAIN: Pension Regimes and Demographics

SPAIN: Projected Demographic Situation of the Pension System, 1995–2055

SPAIN: Expenditure on Health Care