Austria: Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix presents estimates of potential output and the output gap for Austria to identify the scope for sustainable noninflation growth and allow an assessment of the current stance of macroeconomic policies. The estimates of the cyclical fluctuations in Austria are compared with those of the other countries of the European Union to provide the basis for an assessment of the relative economic benefits and constraints for Austria in the context of its participation in European Monetary Union, both in the short and longer term.

Abstract

This Selected Issues paper and Statistical Appendix presents estimates of potential output and the output gap for Austria to identify the scope for sustainable noninflation growth and allow an assessment of the current stance of macroeconomic policies. The estimates of the cyclical fluctuations in Austria are compared with those of the other countries of the European Union to provide the basis for an assessment of the relative economic benefits and constraints for Austria in the context of its participation in European Monetary Union, both in the short and longer term.

III Fiscal Policies in the Medium and Long term1

A. Introduction

106. The purpose of this chapter is to analyze the medium-to long-term challenges facing Austrian fiscal policy. The discussion tries to answer two main questions. First, what underlying fiscal position is required to respect the Stability and Growth Pact’s maximum deficit limit of 3 percent of GDP in “normal” times? In addition to purely cyclical developments, should a margin be added because of uncertainties attached to the implementation of fiscal policies or the need for counter-cyclical fiscal policies? Second, in the longer term, what does the prospective aging of the population imply about the fiscal policy target? In particular, should partial pre-funding of prospective pension expenditures be achieved through a once-and-for-all increase in contributions?

B. Medium-Term Requirements: The Stability and Growth Pact

107. The Stability and Growth Pact (SGP) aims at a medium-term budget position of close to balance or surplus and stipulates a maximum level for budget deficits of EMU participants. General government deficits are defined as excessive when larger than 3 percent of GDP, barring “exceptional circumstances” such as a severe downturn or events outside the government’s control. An output decline of 2 percent or more in the year of the breach would, as a rule, be considered as a severe downturn. To avoid sanctions, a country would normally be expected to bring down to 3 percent of GDP or less in the year following that in which an excessive deficit was identified, but the adjustment period may even be longer in the case of “special circumstances”. Sanctions would initially take the form of nonremunerated deposits, amounting to between 0.2 percent and 0.5 percent of GDP, depending on the size of the deficit. The deposit would be returned if the excessive deficit was corrected within two years; otherwise it would be converted into a fine.

108. To respect this agreement, it seems to be a reasonable strategy to aim for a structural budget deficit which allows to observe the 3 percent limit given “normal” cyclical developments and provides room for desired countercyclical fiscal policies. Figure III-1 depicts the variation in the output gap since 1970, together with its mean and standard deviation. The output gap was calculated using the production-function approach as presented in chapter I. Based on an estimated fiscal responsiveness of the budget deficit with respect to real output of 0.54, a medium-term deficit target of 1¼ percent of GDP would have prevented breaching the 3 percent limit in all of the 27 years of the observation period. None of these years would have qualified as a “severe downturn.”

Figure III-1.
Figure III-1.

Austria: Output Gap, Austria-Specific Demand Shocks, and Budget Balances, 1970-97

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: Staff estimates.1/ Calculated as the difference between Austria and EU-11 demand disturbances. The demand disturbances were derived from a structural VAR in output growth and unemployment for Austria and EU-11.

109. One way to assess the appropriate medium-term target is to consider the output gap as a normally distributed stochastic variable. In this case, the limits of a 95 percent confidence interval can be calculated as the sum of the mean of the output gap and the product of 1.96 times the standard deviation. Using the observation period 1970–96, the resulting confidence limit for the output gap is 3.43 percent of GDP. Thus, given a cyclical sensitivity coefficient of 0.54, a structural budget deficit of 1–1½ percent of GDP would be sufficient to prevent the actual budget deficit from exceeding the 3 percent of GDP limit in “normal” times. Based on Monte Carlo simulations to determine the distribution of the output gap, a recent WIFO study comes to a similar conclusion2.

110. Compared to other European countries, Austria stands out with a relatively low level of fiscal sensitivity to output variations and, more significantly, a low cyclical variability of output (Table III-1 and Swiderski, 1998). As explained in chapters I and II, the low level of output variation seems to be a reflection of a high degree of aggregate real-wage flexibility owing much to the social partnership arrangement. In particular, temporary shocks (“demand shocks”) are quickly attenuated, but the Austrian economy also adapts very quickly to supply shocks (see Figure I-10). The relatively low fiscal sensitivity may inter alia reflect a high level of indirect taxes, relatively long payment lags in corporate taxation, and favorable rules for loss write-offs.

Table III-1.

European Union: Automatic Responses of General Government Balances to Real GDP Growth Fluctuations

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Source: IMF Fiscal Affairs Department staff estimates.

Automatic percentage point change in the ratio of general government balance to GDP in response to a 1 percentage point increase in real GDP.

Weighted average excluding Luxembourg.

111. Prudent fiscal policies may, however, warrant a further reduction in the structural budget deficit. Although the Austrian schilling has been closely linked to the deutsche mark (in what could be called a de facto currency union) for more than 20 years, the switch to a broader currency union would warrant the increased use of countercyclical fiscal policies to offset any shocks specific to Austria. Adverse developments in Central and Eastern Europe could be one source for such an asymmetric shock. Owing to the hypothetical nature of these shocks, it is however difficult to quantify with any degree of precision the required additional “prudential margin”.

112. An indication of the magnitudes of such shocks can be obtained by analyzing past demand and supply shocks using a method introduced by Blanchard and Quah (1989). In a bi-variate structural vector autoregression of output growth and unemployment, permanent (“supply”) shocks were separated from temporary (“demand”) shocks. An approximate estimate of Austria-specific shocks was obtained by subtracting EU-11 demand shocks from the demand shocks identified in Austria.3 Assuming that the demand shocks are normally distributed and independent, the maximum “normal” Austria-specific demand shock amounts to about 1½ percent of GDP (about twice the standard deviation). Considering that only demand shocks should be offset by countercyclical fiscal policies and given a “fiscal multiplier” of around one half percent, countercyclical policies aimed at fully neutralizing such Austria-specific shocks could—in the case of a large negative demand shock—imply a structural deficit of 3 percent of GDP from a starting point of fiscal balance.

113. The active use of countercyclical policies would thus in some cases lead to a large structural deficit. If used effectively, the cyclical variation in output would also be reduced and no additional prudential margin should be necessary. In practice, fiscal policies are less well targeted or timed. Fiscal expansion is often only implemented when there is strong evidence of an economic recession and the output gap is large. In such a case, even moderate countercyclical fiscal policies would add to the total budget deficit and increase the risk of exceeding the 3 percent limit. Moreover, a bi-variate vector-autoregression based on past GDP growth and unemployment might underestimate the size of actual demand shocks since fiscal or monetary policies (excluded from the model) may already have partly neutralized these shocks.

114. Uncertainties attached to the implementation of the fiscal budget may also warrant some additional “prudential margin”. First, given the still high level of government indebtedness, an unexpected increase in interest rates could add a significant amount to the deficit. As a “rule of thumb”, a one percentage point increase in the long-term interest rate would increase the budget deficit by 0.15 percent of GDP. To the extent that this increase can be considered as temporary, the optimal fiscal response would be to leave the primary structural deficit unchanged, thus adding to the required margin. Second, the estimate of the fiscal sensitivity parameter (see above) is subject to a significant degree of uncertainty; e.g., for a given output growth the fiscal effect can vary substantially depending on the composition of demand. The implementation of the 1997 budget is a recent example of the type of implementation problems connected to this type of “parameter uncertainty”; due to the combination of weak private consumption and strong export growth, a substantial shortfall of tax income had to be compensated for by discretionary fiscal measures.

115. In sum, the combination of cyclical output variations; the need for increased countercyclical policies; and uncertainties attached to the implementation of fiscal policies, would call for a structural budget balance close to zero, or even a slight surplus.

C. Long-Term Fiscal Requirements: Fiscal Pressures from Population Aging

116. Medium-term considerations apart, the question of whether Austria should aim for a more ambitious fiscal target can be approached by assessing whether current fiscal policies are sustainable in the long term. Such an assessment involves the projection of fiscal revenue—i.e., taxes, social security contributions, and revenue from property—and fiscal expenditure—i.e., wages and salaries of civil servants, purchases of goods and services, social transfers, and capital expenditure. A number of fiscal parameters are assumed constant, such as tax rates, contribution rates, and rules for pension benefits, and the GDP ratios of some expenditure items are kept constant, unless there are clear plans for future changes of any of these parameters. Current fiscal policies are not sustainable if such a projection results in an ever increasing debt-to-GDP level, thus pushing forward to future generations the cost of fiscal adjustment.

117. In Austria, long-term fiscal policy is complicated by a very generous “pay-as-you-go” pension system. In an international comparison, the Austrian pension system stands out in terms of the very high level of public expenditure—amounting to more than 15 percent of GDP—even when compared with countries with similar old-age demographic dependency ratios (i.e., the ratio of people above 60 years old to those between 15 and 60 years old). Indeed, among 46 countries—including both industrial and developing ones—Austria has the highest level of pension expenditure in relation to GDP (Figure III-2). Moreover, pension expenditures are likely to increase rapidly from 2015 to 2030, when the rise in the old-age dependency ratio is expected to accelerate. The projected increase in the old-age dependency ratio is in line with projections for Japan and slightly less than in Germany and Italy, but clearly higher than in countries like the United States, France, and Canada, all countries where the solvency of the public pension system has been an issue for public concern (Figure III-3).

Figure III-2
Figure III-2

Austria: Old Age Dependency Ratios, 1995-2050

(In percent)

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: World Bank, World Population Projections database.
Figure III-3
Figure III-3

Austria: Public Expenditure and Demographics in 46 Countries, 1985-92

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: World Bank, Averting the Old Age Crisis, Washington 1994.

118. The unfunded nature of the pension system has the effect of exposing the fiscal budget to developments in the ratio of retirees to contributors, which is generally closely linked to the old-age dependency ratio. Thus, the fiscal deficit has to be assessed in relation to the current level of the dependency ratio and the projection of this ratio in the future. Two issues are important in this respect: (i) developments of public debt over a reasonable projection period, say, until 2050; and, on a more fundamental level, (ii) whether the public debt-to-GDP ratio will ever stabilize even when the dependency ratio is projected to decline to a new level more in line with prospective birth and death rates. While the first of these two issues addresses the risk of exceeding a given debt-to-GDP ceiling, the second issue asks the question of whether current fiscal plans are consistent with the key parameters underlying the long-term demographic projections. These projections can then be used to assess the size of the adjustment needed to prevent public debt from increasing beyond a certain “tolerance level,” e.g., 60 percent of GDP.

Earlier studies of the public pension system

119. The prospective burden of aging on the public pension system in Austria has been analyzed in several studies. Koch and Thimann (1997) presented projections of expenditures and revenues of the two main public pension schemes in Austria, the employee and self-employed pension schemes, excluding pensions for civil servants (which account for about 30 percent of total pension expenditure) and several other, less important pension schemes. According to this study, the fiscal pressures from these pension schemes should increase significantly until 2020 and accelerate thereafter, reaching a peak in 2035.4 With unchanged contribution rates and benefit rules, pension expenditures were projected to increase from 10¼ percent of GDP to close to 16¼ percent of GDP in 20354; the two pension schemes would exhibit a primary deficit of more than 7 percent of GDP in 2030. The simulations were based on an annual labor productivity growth rate of 1½ percent and an annual inflation rate of 2¼ percent. The participation and unemployment rates were assumed to remain unchanged over the projection period5.

120. A study by Rürup (1997) commissioned by the Austrian Ministry of Labor, Health, and Social Affairs reached similar conclusions. Covering the same two pension schemes as Koch and Thimann (1997), Rürup estimated that—in a “status quo” scenario—pension expenditures could increase from around 10½ percent of GDP in 2000 to 14¼ percent of GDP in 2030. In this scenario, pension benefit rules were kept unchanged and the resulting “financing gap” was assumed to be closed by a combination of government transfers and increased contributions. The simulations were based on the interaction between the pension system and a large macroeconomic model in which the labor stock was determined as a function of labor demand and the age-gender distribution of the population.6

121. The recent pension reform, which passed parliament in November 1997 (Box III-1), goes some way toward correcting these imbalances. It has been estimated that the reform would eventually reduce pension expenditures of the employee and self-employed pension schemes by around 1½ percentage points of GDP. In addition, the budget transfers to the pension fund for federal civil servants would fall by around 0.1 percentage point of GDP. Two thirds of the estimated saving stems from the assumed gradual reduction of the replacement rate by one half of the increase in life expectancy. Although such a reduction is in principle agreed upon, it is not automatic and depends on future legislative action. Without the inclusion of the demographic factor, the total reduction in expenditures would not exceed ½ percentage point of GDP by 2030.

The 1997 Pension Reform

After intense negotiations between the social partners, the Austrian parliament passed a pension reform in November 1997. The reform, which will be phased in over some 20 years, introduced:

  • (i) a gradual extension of the reference period used to calculate individual pension benefits from the best 15 years to the best 18 years for private-sector employees and from the last year to the “best” 18 years for civil servants;

  • (ii) increased contribution rates for the self-employed and civil servants to 20Vi percent from around 15 percent and 10% percent, respectively; and

  • (iii) increased the penalty for early retirement, from 1.6–1.8 percentage points to a 2 percentage point reduction (up to to a maximum of 10 percentage points) in the replacement rate per year of retirement prior to the statutory retirement age (60 for women and 65 for men);

Assuming, in addition, a still to be legislated reduction in average pensions equal to one-half of the actuarial value of the projected increase in longevity, the reform has been estimated by the Ministry for Labor, Health, and Social Affairs to reduce pension payments of the employee and self-employed pension schemes by 1½ percent of GDP by 2030. Beyond this, the Ministry of Finance has estimated that the need for federal contributions to the federal civil servants pensions would fall by 0.1 percentage point of GDP by 2030.

The increase in the reference period for pension calculations will be phased in gradually from 2003 to 2020, while the increased penalty for early retirement will be effective from 2000. In addition to these measures, the coverage of the public pension system was widened by allowing an “opting in” for lower paid workers and “casual jobs.” The compensation for child raising was also increased.

Long-term fiscal projections: 1998–2050 and beyond

122. Long-term fiscal projections of general government accounts is an effective way to assess whether current fiscal plans or trends are sustainable. Careful fiscal projections should reveal future fiscal pressures arising from implicit or contingent liabilities as well as the effects of debt-accumulations on net interest payments. The fiscal projections presented in Table III-2 and Figure III-4 extend the model developed in Koch and Thimann (1997) to include civil service pensions as well as health expenditures. Other public expenditure and revenue items were assumed to remain constant in relation to GDP. The projection also incorporates the 1997 pension reform and assumes in particular that the replacement rate is reduced in order to compensate for one half of the increased life expectancy.

Table III-2.

Austria: Baseline Projections: 1995-2050 1/

(Percent of GDP)

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Sources: Ministry of Finance; and staff estimates.

Including correction for increased life-expectancy.

“Labor augmenting” technical change, percent change.

Percent change in the implicit GDP deflator.

Percent. Average interest rate on government borrowing minus percent change in the implicit GDP deflator.

Figure III-4
Figure III-4

Austria: “No Policy Change” Projections, 1998-2120

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: Staff estimates.

123. The civil servant pensions were assumed to follow the same developments as other public pensions, and the ratio of civil servant pension expenditures to total public pensions was assumed to remain constant over the projection period7. In line with Roseveare and others (1996), health expenditure was assumed to be a function of the projected number of deaths, based on the observation that a large share of health expenditure is concentrated in the years just prior to the death of a person. The ratio of health expenditure to GDP was assumed to increase in line with one half of the increase in the population death ratio (the ratio of the number of deaths to the total population). The projection of public health care costs is, however, quite optimistic since it ignores any future cost pressures from new technologies or the commonly observed positive income elasticity of health care spending. On the relationship between health care costs and aging see World Bank (1994).

124. This “no policy change” scenario suggests that current fiscal policies—as defined above—are clearly unsustainable in the long term. As a result of the increase in public pension expenditure—increasing from around 15 percent of GDP in 2000 to 24¾ percent in 2030— and increasing health care costs (an increase of around 1½ percent of GDP over the same period), the debt-to-GDP ratio would nearly quadruple between 2000 and 2030. The primary fiscal deficit would reach 4 percent of GDP in 2030, while interest payments would amount to about 11 percent of GDP.

125. Looking further ahead, however, the fiscal pressures from aging should decline. It is expected that the dependency ratio will peak in 2040–50 as the demographic hump from the “baby-boom generation” disappears. Although it is extremely difficult to predict the dependency ratio that far ahead, the potential positive effects of its stabilizing at around 45 percent are presented in the last column of Figure III-4. It is assumed that a fall in the dependency ratio would result in a proportional decline in pension expenditure, and that health care expenditure would return to its 2000 level (in percent of GDP). As a result, the primary budget balance would swing to a surplus of around ¾ percent of GDP. Given the previous buildup of debt, however, interest rate costs would contribute to a continuous increase in the fiscal deficit and a spiraling debt-to-GDP ratio.

126. These fiscal projections are quite robust to any change in the assumed birth rates up until around 2020–30. An increase in birth rates would affect the projections, with a delay of about 15 years, i.e., when the newborn begin to reach working age. Thus, a sharp rise in the birth rate could only significantly increase contributions from around 2015, and would be partly offset by increased expenditures on child care in the earlier years. Moreover, rough calculations suggest that a 50 percent permanent increase in the birth rate—e.g., to the birth rate experienced in the early 1970s—would decrease the old-age dependency ratio by about 2 percentage points after 15 years, and by around 17 percentage points after 30 years. This compares to a projected increase of 32½ percentage points from 2000 to 2030.

127. Increased immigration would result in a more rapid increase in government revenue, but would also lead to higher pension expenditure when the immigrants retire. Assuming large-scale immigration from 2000 to 2005 (amounting to 2 percent of the work force per year in 2000–05 reaching an accumulative amount of around 10 percent of the labor force in 2005) the net positive effect on the budget could amount to about 1¼ percent of GDP in 2010, rising to about 1¾ percent of GDP in 2020–30, before it would turn negative when the immigrants begin to reach retirement age in 2040 (Table III-3). In this scenario, the positive effect of such immigration on the level of social security contributions would come in two waves: first, there would be the direct effect from the increased work force; this would be followed by a second wave 15–20 years later when the children of the immigrants enter the working-age population. On the basis of the rather optimistic assumption that the level of contributions per immigrant is equal to the average level of contributions, pension contributions would increase by 1¼ percent of GDP in 2010 and by 1¾ percent in 2030 relative to “no policy change”. By 2040, however, the expenditures on additional pensions for original immigrants would eventually exceed the increased pension contributions, and the net effect would turn negative by as much as 1–1¾ percent of GDP.

Table III-3.

Increased Immigration: Difference from “No Policy Change”

(Percent of GDP)

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Source: Fund staff estimates.

Establishing long-term fiscal sustainability

128. Fiscal sustainability could be achieved in several ways. The most obvious solution would be to delay the adjustment until expenditure is set to increase in 2020–30. In the case of such a delay, the required increase in contributions would, however, be very large: according to the “current services” projections presented above, average contributions would have to rise by 42 percent in 2020 and by 77 percent in 2040 relative to the “no policy change” projection. In adition, around 1½ percent of GDP in additional tax revenue would have to be raised in order to finance the increased health care costs. Alternatively, pension expenditure could be reduced by more than 40 percent in 2040.

129. By contrast, an up-front adjustment would considerably reduce the size of the adjustment needed. By acting early, assets could be accumulated that could be run down later and the interest earning on these assets would reduce future deficits (or increase future surpluses). An up-front increase in the contribution rate would entail a smaller percentage point increase than postponing the increase if the interest rate is higher than the rate of growth of wages and salaries: due to wage growth, a one percentage point increase in current contribution rates is less than a one percent increase in future contribution rates, but this effect is compensated by the return on the additional savings. Thus, the opportunity cost of postponing the adjustment is positive as long as the marginal return on investment (or cost of borrowing) is higher than the rate of growth of aggregate wages and salaries.

130. The effect of postponing the adjustment is compared with an up-front adjustment in Tables III-4 and III-5, and Figures III-5 and III-6. While in the case of the postponement scenario (see Table III-4) general government revenues would have to increase progressively to reach nearly 55 percent of GDP in 2030, Scenario II (see Table III-5 and Figures III-5) assumes a once-and-for-all increase in revenue from taxation or contributions by around 5¼ percent of GDP. On average, permanent costs equal to 1¼ percentage point of GDP would be “saved” by frontloading the adjustment. In both scenarios, the debt-to-GDP ratio reaches 60 percent in 2050.

Table III-4.

Austria: Scenario I: Debt Stabilization

(Percent of GDP)

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Sources; Ministry of Finance; and staff estimates.
Table III-5.

Austria: Scenario II: Permanent Revenue Increase 1/

(Percent of GDP)

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Sources: Ministry of Finance; and staff estimates,

Current revenues increased by 5.2 percent of GDP.

Figure III-5.
Figure III-5.

Austria: Financial Balance and Primary Balance

(In percent of GDP)

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: Staff estimates.
Figure III-6.
Figure III-6.

Austria: Revenue, Current Primary Expenditure, and Public Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 1998, 107; 10.5089/9781451802313.002.A003

Source: Staff estimates.

131. An up-front adjustment could be achieved through a combination of several measures (Table III-6 and Figures III-5): (i) a full adjustment of benefits for increased longevity—compared with only one half in the “no policy change” projection; (ii) an increase in the average retirement age by 3 years; and (iii) an increase in the contribution rate of 5 percentage points. All these measures taken together would result in a small fiscal surplus in 2000–10 and a small deficit in 2020–50 while public debt would fluctuate between 20 percent and 55 percent of GDP. The lengthening of the retirement age would account for 75 percent of the total reduction in pension expenditure (5.6 percent of GDP less than in the “no policy change” projection). The increased adjustment for longevity contributes 18 percent to the reduction in pension expenditures. The increase in the effective retirement age—which at around 57 is very low in Austria—could be achieved by reducing further or even eliminating the current incentives for early retirement (see Appendix III-1). The fiscal effect of reducing the incentives for early retirement is likely to be very large and would, in addition, reduce labor market distortions.

Table III-6.

Austria: Scenario III: Reduced Early Retirement and Increased Contributions 1/

(Percent of GDP)

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Sources: Ministry of Finance; and staff estimates.

Includes the following reforms:

  • (i) 5 percent increase in average social security contributions,

  • (ii) Three-year increase in the effective retirement age from 2000.

  • (iii) Full adjustment for increased longevity.

132. The reform proposal presented in Scenario III (see Table III-5 and Figure III-6) would merely change the parameters of the current system, without fundamentally reforming the system itself. Thus, such a reform has been called a “parametric” reform (Jaeger, 1997). More fundamental reforms would consist of moving parts of the system to a private pension system. Such a reform could be mandatory, as in Chile, or voluntary, as in Colombia, Peru, and the United Kingdom.8 The introduction of private pensions could also be supported by tax incentives, as suggested by Rürup (1997), combined with a progressive reduction in pension benefits. “Privatization” of pension fund management would likely reduce governance problems associated with a large increase in public assets (as in Scenario II) as well as the political temptation to draw on the fund to increase public expenditure. Whether private or public, a move toward a system with a close link between pension liabilities and assets would reduce the system’s exposure to unexpected demographic developments.

133. Private pensions could be encouraged by the introduction of tax-sheltered savings accounts. This could become costly in the short run, but such a policy could have the effect of shifting forward tax revenues, which could partly offset the large aging-induced increase in public pension expenditures. If, in addition, public pension benefits were scaled back, the total effect of such a reform package could result in a sharp increase in private pensions without jeopardizing long-term fiscal sustainability. Table III-7 (Scenario IV) suggests that combining such tax-sheltered savings accounts with a removal of incentives for early retirement, full adjustment for increased longevity, and a reduction in future pension benefits would limit the increase in the debt-to-GDP ratio and result in a rapid asset accumulation in the private sector from 2010 onward.

Table III-7.

Austria: Scenario IV: Tax Incentives for Private Pension Savings 1/

(Percent of GDP)

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Sources: Ministry of Finance and staff estimates.

Includes the following reforms:

(i) Full tax deducibility of pension savings; pensions fully taxable. The tax rate is assumed to be 30 percent of wage-income and 20 percent for annuities.

(ii) Gradual reduction of public pension payments in line with the projected increase in private annuities.

(iii) Full adjustment for increased longevity.

(iv) Three-year increase in the effective retirement age.

134. Scenario IV is based on tax benefits similar to those provided in the United States Individual Retirement Accounts (IRA) and the Canadian Registered Retirement Saving Plans (RRSP): full deductibility of pension contributions, no taxation of accrued return, but full taxation of pension income (here assumed to be withdrawn as annuities from the age of 60) at a lower average tax rate.9 In line with Canadian experience, it was assumed that as much as 5 percent of GDP would be invested in such schemes from its introduction in 2000, resulting in a tax loss of 1½ percent of GDP per year (assuming a marginal income tax rate of 30 percent).10 Thereafter, the share of contributions to the tax-sheltered accounts would be kept constant in relation to public pension contributions. It was also assumed that the savings were made predominately by people aged 25–40, the age group most affected by the reduction in pension benefits from 2020 to 2050 (of an amount equal to the sum of all private annuities).

D. Conclusion

135. The immediate constraint on Austrian fiscal policy is represented by the Stability and Growth Pact’s requirement of a maximum deficit of 3 percent of GDP in “normal” times. Based on past output fluctuations, staff estimates suggest that a medium-term target of 1¼ percent would be sufficient to respect this requirement. Prudent fiscal policies would, however, warrant an additional margin with a view to provide some room for countercyclical fiscal policies. The need for a more active countercyclical fiscal policy is likely to increase with Austria’s participation in EMU as the ECB’s monetary policy may be less appropriate for the Austrian economy than the Bundesbank’s monetary policy under the peg to the deutsche mark. In addition, “parameter uncertainty” as well as a possible temporary increase in interest rates would merit some additional margin.

136. While further fiscal effort has to be made to achieve a fiscal position in accordance with these requirements, the main challenge for Austrian fiscal policy arises from population aging. Public expenditure on pensions and health care will increase rapidly in relation to GDP from about 2020 until it reaches a peak in 2040. While a postponement of the fiscal adjustment with incremental reforms as and when required to maintain balance is possible, an up-front once-and-for-all reform would have several advantages. First, reduced interest payments on debt would cut the need for future contribution increases. Second, by establishing a sustainable pension system, retirement planning of individuals would be facilitated, as the uncertainty about the net value of future pension rights would be reduced.

137. In addition to these advantages, a postponement of the necessary adjustment would likely increase the intergenerational imbalance. Although the present simulations do not provide complete intergenerational accounts—which would include the age-incidence of different taxes and public transfers, such as education—some basic conclusions about the intergenerational distribution can nevertheless be drawn. Postponing an increase in the contribution rate until around 2020 while maintaining pension benefits at their current level would leave most workers above the age of 40 relatively unaffected since they can expect to retire around 2020; younger workers, by contrast, would have to pay higher contributions for the same pensions. On the other hand, a decrease in future pensions would shift the burden of adjustment to workers expecting to retire in 2020–50, while an even more widespread distribution of the cost of adjustment could be achieved by an upfront adjustment of taxes or pension expenditure.

138. The simulations suggest that such an up-front adjustment could be achieved by removing the remaining incentives for early retirement with an actuarially fair discount for each additional year of (early) retirement. In addition, such a measure would reduce the distortions in the labor market and increase the labor supply of older people. Other reform proposals, such as the introduction of tax-sheltered pension accounts or privatization, have only been touched upon in this chapter. The example presented in Scenario IV does, however, suggest that a public pension reform could usefully be supplemented by the introduction of an improved regulatory environment for private pensions funds, including limited tax incentives. Incentives for a switch to private pensions could, alternatively, be introduced by allowing workers to reduce their public pension contributions (and future rights) if they invest in private pension accounts.

139. The scenarios presented ignore, however, any macroeconomic repercussions from the prospective aging of the population or arising from the reforms themselves. Although there is some debate about such effects, empirical evidence supports the view that a reduction in government debt and a cut in unfunded pension liabilities tends to increase private capital accumulation,11 while aging tends to reduce national capital accumulation. Thus, ignoring these effects results in an underestimation of the size of the fiscal problem and the positive effects of reform. General equilibrium simulations with an overlapping-generations model suggest that a permanent up-front reduction in the pension replacement rate of 20 percent, or an equivalent reduction in government debt, would increase GDP per capita by 1–1½ percent by 2020 in France, Japan, and Italy (Hviding and Mérette, 1998). The effects would be even larger if endogenous growth effects, resulting from increased investment, were included (Fougére and Mérette, 1998b).

APPENDIX I Incentives For Early Retirement

140. The retirement decision depends inter alia on the preference for leisure, health, the net wage rate, and the cost in terms of a decreased pension. When a worker desires to retire early, a pension fund would have to reduce the pension in order to compensate for two factors:

  • (i) The increase in the expected duration of pension payments. With an average life-expectancy of around 15 years at age 65 and life-expectancy at 64 of 15.95 (the probability of death is assumed equal to 5 percent), a retirement at 64 years of age would increase the expected pension payments by about (15.95/15)-1 = 6.3 percent.

  • (ii) In addition, in the case of early retirement the wage earner and his employer would pay one year less of pension contributions. In Austria, the value of forgone pension contributions is equal to 22.8 percent of the last year’s gross wage.

141. A pension system that allows for an early retirement without compensating for the loss from (i) and (ii) does in effect “subsidize” early retirement. In addition, the worker’s choice between retirement and work is distorted resulting in a sub-optimal supply of labor. From the viewpoint of the Austrian pension system, the average incremental loss from one year of early retirement (from 65 to 64) can be calculated using the following formula:

(1A)ΔL=w0*0.228+wa*0.80*(15.9515)

where ΔL stands for the incremental loss in schilling terms, w0 is the last salary, and wa is the base reference salary (the “best” 15 years). As a percentage of standard pensions P = (wa*0.80*15), the required pension reduction becomes:

(2A)ΔL/P=(w0/wa)*0.228/(0.80*15)+(15.95/151)

which—assuming w0/wa equal to 1.2—amounts to close to 8½ percent or, in terms of a compensatory reduction in the replacement rate; e.g., a reduction from 80 percent to 73 percent or around 7 percentage points. This compares to a discount of 2 percentage points a year after the 1997 reform.

142. The calculations above are based on an average individual and could underestimate the incentives for early retirement. In addition to the effects discussed above, there might be adverse selection effects arising from the self-selection of workers with relatively short life expectancy: the percentage increase in expected pension payments would thus be larger for these workers than for the average worker and would warrant a larger reduction in the replacement rate in order to remove any incentives for early retirement.

References

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  • Hviding, Ketil and Marcel Merette, 1998, “Macroeconomic Effects of Pension Reform in the Context of Ageing Populations: OLG Simulations for Seven OECD Countries”, Economics Department Working Paper, (Paris: OECD).

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1

Prepared by Ketil Hviding.

2

Url (1997) estimated the 95 percent confidence limit of the structural budget deficit at 1.25 percent of GDP.

3

The EU11 comprises all EU countries, except Denmark, Greece, Sweden, and the United Kingdom.

4

Population projections were taken from World Bank (1994).

5

Estimates made at the OECD by Roseveare and others (1996) are in line with the findings in Koch and Thimann (1997). Including only the employee pension system, they estimated that pension expenditures would rise from around 8¾ percent of GDP in 1995 to 14 percent of GDP in 2030. Based on a productivity growth rate of 1½ percent per year and a discount rate of 5 percent of GDP, it was estimated that the net present value (expenditure less contributions) amounted to 93 percent of 1994 GDP.

6

Although it is difficult to compare the projections in Rürup (1997) with those of Koch and Thimann (1997), the smaller increase in pension expenditure in Rürup (1997) is likely to arise from different labor market assumptions: while Koch and Thimann (1997) assumed constant unemployment and participation rates, Rürup (1997) projected the unemployment rate would fall from 6½ percent in 2000 to 4½ percent in 2030.

7

This simple assumption was chosen in the absence of any available actuarial study of the civil servant pensions.

8

See Palacios and Whitehouse (1998) for a discussion of the issue of a voluntary switch to a private pension system.

9

Tax sheltered saving accounts are currently available in. Austria, but the ceilings are low and depend on the level of income.

11

See Masson and others (1995) for empirical evidence of the negative effect of public deficits on national savings. OECD (1997) reviews the evidence on saving effects of unfunded pension liabilities.

Austria: Selected Issues and Statistical Appendix
Author: International Monetary Fund
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    Austria: Output Gap, Austria-Specific Demand Shocks, and Budget Balances, 1970-97

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    Austria: Old Age Dependency Ratios, 1995-2050

    (In percent)

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    Austria: Public Expenditure and Demographics in 46 Countries, 1985-92

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    Austria: “No Policy Change” Projections, 1998-2120

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    Austria: Financial Balance and Primary Balance

    (In percent of GDP)

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    Austria: Revenue, Current Primary Expenditure, and Public Debt

    (In percent of GDP)