Republic of Slovenia: Selected Issues

This paper provides a background on the key policy challenges for Slovenia in the euro zone. Then, it assesses the discretionary scope to adjust spending and proposes initial steps to enhance budget flexibility so that fiscal adjustment can be targeted on relatively inefficient spending. This study also discusses the long-term fiscal sustainability position of Slovenia using a generational accounting framework. A simulation of retirement incentives suggests that the pension system will encourage individuals to retire earlier than the statutory full pensionable age. These incentives are stronger for low-income earners.

Abstract

This paper provides a background on the key policy challenges for Slovenia in the euro zone. Then, it assesses the discretionary scope to adjust spending and proposes initial steps to enhance budget flexibility so that fiscal adjustment can be targeted on relatively inefficient spending. This study also discusses the long-term fiscal sustainability position of Slovenia using a generational accounting framework. A simulation of retirement incentives suggests that the pension system will encourage individuals to retire earlier than the statutory full pensionable age. These incentives are stronger for low-income earners.

III. Impact of Aging on Fiscal Sustainability in Slovenia 27

A. Introduction

49. Over the next decades, Slovenia is projected to age at one of the fastest rates in Europe. This demographic trend will put significant pressure on age–related spending. At the same time, a decline in potential growth will reduce income taxes and social contributions, pushing deficits and debt to unsustainable levels. This fiscal outlook is further dimmed by the generous eligibility conditions for pension benefits provided by the existing system, which encourage early withdrawal from the labor market, lower labor utilization, and dampen longer–term convergence prospects.

A03ufig09

Increase in Elderly Dependency Ratio 1/

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: United Nations.1/ Measures the increment in the population aged above 65 as a share of population between 15–64 years, relative to the 2005 level. EU–10 includes the new member states of the European Union and EU–15 includes the old member states.

50. To address these challenges, substantial reform measures have been introduced. Starting in 2000, a number of pension reform measures lowering the benefits level and tightening the eligibility criteria for pensions were phased in (see Appendix 1). Nevertheless, these reforms will not be sufficient in restoring fiscal viability of the pension system, especially as some of these measures are being gradually rolled back.

51. Against this background, this chapter seeks to assess the long–run sustainability of fiscal policy in Slovenia, given current policies and demographic projections. Using a generational accounting model, it estimates the size of the fiscal gap implied by the current policies, taking into account the approved pension reform measures. In addition, it aims to examine the impact of various additional pension reform scenarios and the generational burden of fiscal policies. Projections show that, in the absence of further reforms, the social benefits system will place severe demands on public finances. Under current policies, the relatively low debt position will worsen, and it is estimated that taxes would need to increase by over 10 percent of GDP, in net present value terms, to address the fiscal solvency constraint. In order to achieve a target debt–to–GDP ratio of 60 percent in 2050, taxes would need to increase permanently by almost 5 percent of GDP. An early, integrated reform agenda needs to be implemented in order to reduce the burden of adjustment and restore fiscal sustainability. Expenditure reform that seeks to target fiscal balance or a small surplus over the medium term is also needed to accommodate the rising age–related spending pressures. This chapter is organized as follows. Section B provides background on the current fiscal policies, and the demographic and labor market developments. Section C describes the model and the assumptions for the long–run projections. Section D presents the results, and Section E concludes.

B. Background

Demographic and labor market projections

52. Slovenia’s population is expected to age rapidly in the coming years. The population is projected to decline, starting around 2015, and the elderly dependency ratio—the ratio of population aged over 65 years to the working population aged 20 to 64 years—to increase from around 23 percent in 2004 to over 60 percent in 2050. Of this increase, a large share will be due to the rise in the population of the elderly who are above 80 years. Although, they accounted for nearly 19 percent of the population aged over 65 years in 2004, by 2050, they are expected to comprise about 34 percent. These trends are driven by the very low fertility rate in Slovenia—among the lowest in Europe—and relatively high life expectancy, especially of women (text tables).

A03ufig10

Demographic Trends, 2005–50

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Slovene authorities.

Demographic Indicators in Slovenia, 2004

(In percent, unless indicated otherwise)

article image
Source: World Development Indicators.

Data are for 2000. Data represent percent of population.

53. Current labor market trends pose additional challenges. Labor force participation ratios have been declining, although this trend reversed slightly in 2005.28 The inactivity rate among the elderly—above 50 years of age—is very high,29 particularly among women. The employment rate for the elderly is also low, and flexible work arrangements more suitable for the elderly, such as part–time and fixed–term employment, are still relatively uncommon. These trends will exacerbate the fiscal burden as an increasingly large share of the population reaches retirement age.

Fiscal trends

54. Although fiscal deficits are currently smaller, the budgetary structure leaves little room for maneuver in accommodating fiscal pressures.30 Slovenia’s general government budget deficit has been low over the past decade, outperforming most Central European countries. Yet, the composition of expenditures shows that the share of pension and health care spending is larger than in the EU–25 countries. The Pension Fund has been in deficit since 1996, financed through general revenues of the state budget. In 2003, the state budget transferred the equivalent of 2.5 percent of GDP to finance deficits. The state also funds additional pension expenditure on noncontributory supplementary pension benefits, mandated under various laws such as those for farmers, police, and war veterans. In addition, nonpension benefits, such as recreation benefits and health insurance payments for pensioners, are substantial. Given the generous level of benefits and indexation mechanisms—the old–age pension net replacement rate in 2005 stood at 70 percent, and pensions and a number of noncontributory benefits are indexed to wages—the share of nondiscretionary spending remains large, posing further challenges for fiscal adjustment in the coming years.

55. These trends are expected to affect fiscal deficits through several channels:

  • As the number of elderly increase, the resulting demand on pension and long–term health care benefits will rise dramatically. Although expenditures on other age–related spending such as education will decline, this will be more than offset by the increased spending through pensions and health care.

  • With the number of young workers decreasing, the tax revenue base and the contribution base will also shrink, putting further pressure on pension finances. Since the contribution rates are already high, a further increase in the contribution rates would not be feasible, as it could drive down labor demand and reduce growth.

  • A decline in the size of the labor force will lower growth, unless labor productivity improves significantly. The decline in potential growth will further reduce in tax revenues.

  • As government borrowing increases to finance the fiscal gap, rising interest costs will put increasing pressure on deficits and debt sustainability, and undermine macroeconomic stability.

C. Model Simulations

56. A generational accounting model is used to simulate the fiscal impact of aging (see Appendix II for model details). This methodology is frequently used to assess long–run fiscal sustainability and the generational burden of fiscal policies (Cardarelli, Sefton, and Kotlikoff, 2000; Cardarelli and Sartor, 2000; and HM Treasury, 2004). The framework uses age and gender profiles (see Appendix III) that provide the distribution of taxes and transfers across age cohorts for a given year. These profiles, used in conjunction with the aggregate taxes and transfers in that year and the population distribution by age, provide estimates of the average taxes and transfers paid per person. These average per capita taxes and transfers, aside from pensions, are assumed to grow in line with wages, which, in turn, grow in line with labor productivity. Aggregate taxes and transfers are thus projected over the long run based on assumptions of productivity growth and population changes (text box). The projection of GDP is derived from the assumed productivity growth, labor participation rate, and employment rates.

57. Pension projections are based on assumptions that consider labor market behavior, productivity growth, and the impact of pension benefit reform. Pension expenditure as a share of GDP is determined by developments in four areas: (i) the aging effect, which captures the demographic change as shown by the relative number of elderly; (ii) the eligibility effect, which represents the number of elderly that receive pensions; (iii) the benefits effect, which captures the generosity of benefits received by pensioners; and (iv) the employment effect, which indicates the share of the working–age population that are employed and its productivity level. Based on the assumption that active labor market policies and the higher retirement age of the elderly will increase labor participation, the contribution of the employment effect in reducing pension expenditure as a percent of GDP is expected to rise. Similarly, the eligibility effect will also contribute towards lowering the pension expenditure. The effect of the pension reform implemented since 2000 will also gradually reduce benefits through 2024. Despite these positive developments, these factors are not expected to offset the demographic effect (text figure), and pension expenditures will rise from 11 percent of GDP in 2005 to almost 16 percent of GDP in 2050 in this baseline scenario. Alternative scenarios also show that pension expenditure will rise by 1½ percent in the optimistic case, with higher elderly labor participation and productivity growth and lower net replacement rate, and over 6 percent in a more pessimistic case with lower labor participation by the elderly (see Appendix IV for details). This central scenario of pension growth, adjusted for a constant labor productivity growth assumption, is incorporated in the baseline generational accounting model.

A03ufig11

Contribution to Pension Growth, 2004–50

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Staff calculations

Long–Run Fiscal Projections: Underlying Data Assumptions

The demographic projections produced by the Statistical Office of Slovenia are used. Longer–run projections over the period 2051–2150 assume the same population structure as in 2050.

Labor productivity growth in Slovenia has been close to 3.5 percent in recent years. Over the long run, this rate of growth will be difficult to sustain as the economy converges closer to EU levels. Labor productivity growth is thus assumed to decline to 3 percent by 2008 and, in the baseline case, stay at 3 percent over the long run.

Labor force participation is assumed to rise marginally due to active employment policies and an increase in activity by the elderly, and to stabilize at 73.6 percent in the long run. The unemployment rate is also assumed to be lowered to 5.4 percent, following the assumptions in the Convergence Program (Ministry of Finance, 2005). With the working–age population gradually declining, this translates into negative employment growth of–0.7 percent over the long run.

GDP growth, which is derived from labor productivity and employment growth, gradually declines and stabilizes around 2.5 percent.

A discount rate of 4 percent is assumed, based on an average nominal interest rate on public debt of around 7 percent and a long–run inflation rate of 3 percent.

The relative age and gender profiles for tax revenues, social security taxes, expenditures, and other revenues were obtained from Ministry of Finance (see Appendix II). Although there is uncertainty over the age profiles because of the populations’ changing behavioral responses, it is assumed for simplicity that the age profiles remain stable. Since the age profiles are not adjusted over time to reflect certain policy changes, such as an increase in the retirement age, an upward bias is imported to the results through lower revenues.

For aggregate taxes and transfers, consolidated general government fiscal data up to 2005 and medium–term budget projections through 2007, based on a functional classification, were obtained from the Ministry of Finance. Longer–term projections for fiscal aggregates are based on labor productivity growth assumptions, as described in the baseline scenario.

D. Simulation Results

Baseline scenario

58. In the baseline scenario, age–related expenditures are expected to rise considerably while revenues as a share of GDP will remain more stable (text figures). Income taxes and social security contributions, assumed to grow on a per capita basis at the same rate as labor productivity growth, decline. As the GDP growth rate is also declining due to the shrinking labor force, the decline in revenues as a share of GDP is relatively small. Consumption taxes, such as the value–added and trade taxes, also assumed to grow in line with productivity growth, increase as a share of GDP since consumption by the elderly population is expected to remain high.

59. On the expenditure side, pensions and health care expenditures are expected to rise by over 7 percent of GDP. These costs will not be offset by the savings from education and social benefits. The simulations assume that health expenditures are also expected to grow at the same rate as wage growth. Historically, real per capita health spending has been higher than productivity growth in Slovenia. International experience has also shown that per capita health care costs usually rise faster than productivity growth, reflecting the high income elasticity of demand and rising costs of pharmaceuticals and advanced medical technologies. The increase in the population aged above 80 years will also drive up the costs of long–term care, as indicated by the age profile of health care costs (text figure). Another important factor affecting health care costs is the morbidity rate. If an increasing number of elderly are living healthier lives, the age profiles will show a gradual shift to the right, dampening the total increase in costs over the long run. Given these trends, total age–related expenditures in Slovenia is expected to rise to one of the highest levels in Europe by 2050 (text figure).

A03ufig13

Age-Related Public Expenditure, 2004-50

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Sources:Aging Working Group (2006); Statistical Yearbook of Slovenia (2005); EUROSTAT; Convergence Program of the Slovene Republic (2005); and staff calculations.
A03ufig14

Slovenia: Fiscal Impact of Aging, 2004–50

((In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Staff estimates.

60. Consequently, a widening primary deficit will lead to an unsustainable debt position. In this scenario, primary deficit and net debt are projected to reach around 10 and 300 percent of GDP, respectively, by 2050. Net debt is projected to pick up significantly beyond 2017, reaching a threshold of 60 percent by 2030. Rising interest costs will push debt up further to unsustainable levels. Calculations of the intertemporal fiscal sustainability gap—measured as the ratio of net present value of debt to the net present value of GDP over the next 150 years, indicating the permanent fiscal adjustment needed to fulfill the intertemporal budget constraint—corresponds to around 10 percent of GDP. An alternative measure of the fiscal gap, calculated as the size of permanent fiscal adjustment needed to reach a target debt–to–GDP ratio of 60 percent by 2050, is equivalent to nearly 5 percent of GDP (text figure). The same target debt–to–GDP ratio can also be achieved by a smoother adjustment path, which seeks to make incremental structural adjustments by offsetting the age–related spending pressures and targeting a position close to fiscal balance position.

61. While these results are very sensitive to the underlying assumptions on productivity and interest rates, sensitivity tests using alternative values of productivity and interest rates also suggest a wide fiscal gap (text table). In the model, productivity growth affects the fiscal gap measure through two different channels resulting in an asymmetric impact. First, a faster productivity growth leads to higher per–capita age–related expenditures since they are assumed to grow in line with wages, which, in turn, are set equal to productivity growth rates. On the other hand, it lowers the fiscal gap measure as it increases per–capita age–related revenue and also directly increases the level of GDP. The interest rate affects the fiscal gap measure through its impact on the discount rate. Under these alternative assumptions, the fiscal gap remains sizable.

Intertemporal Fiscal Gap 1/

(In percent of GDP)

article image

Immediate change in taxes needed to meet the intertemporal budget constraint.

62. Delaying fiscal adjustment will be costly. The demographic shift has already begun to exert fiscal pressure, though mitigated by the effect of the pension reform started in 2000. The costs are expected to pick up even more rapidly after 2023, when these reforms will be fully phased in. Given the lag with which pension and health care reform will have an impact, there is a need to use this window of 10 to 15 years to step up additional reform measures to ensure long–term debt sustainability. In fact, under the currently approved policies, the simulations show that if the tax or expenditure adjustment is delayed by a year, the additional adjustment needed to close the fiscal gap would rise by 1/8 percent of GDP.

Alternative scenarios

63. Given these projections, a comprehensive reform agenda will be needed to restore fiscal sustainability. To analyze the fiscal impact of reforms, several measures to reform the public pension system are considered (see Appendix IV). They include, over the long run, (i) increasing the retirement age to 65; (ii) lowering the net replacement rate from 70 percent to 52 percent; and (iii) indexing pensions to prices. Under each of these scenarios, the intertemporal fiscal gap will be reduced but would still remain significant (text table and text figures). This underscores the need for systemic reform of pensions rather than marginal parametric reforms. The projections show that increases in health care costs and non–age–related spending relative to GDP are also key drivers of the fiscal gap. Hence, the impact of slower growth of per capita health and non–age–related spending, set to lag productivity growth by half a percentage point, is also simulated. These measures also help to narrow the fiscal gap considerably, which suggests the importance of containing these nonpension costs. Indeed, as an example, a scenario that closes the fiscal gap would require an integrated pension reform through lower net replacement rate and extended retirement age, along with adjustments to lower the growth of non–age–related spending.

Intertemporal Fiscal Gap 1/

(In percent of GDP)

article image

Immediate change in taxes needed to meet the intertemporal budget constraint.

Intergenerational burden

64. To a certain extent, making fiscal adjustments to restore sustainability would be more fair across generations. In the baseline case simulated above, we observe that fiscal policy is more generous to future generations, as implied by the intergenerational gap (text table and Appendix II). This measures the intertemporal fiscal gap under the hypothetical scenario that future generations pay the same net taxes as the current generation. In this case, the intergenerational fiscal gap is smaller than the intertemporal fiscal gap, which implies that the net taxes paid by the future generations were lower than the current generation, in the first instance. This corroborates the unsustainable outlook for current policies. In this situation, any fiscal adjustment policy that increases the net tax burden on future generations would serve to balance the burden across generations.

Generational Fairness

(In percent of GDP)

article image
Source: Staff calculations.

65. Nevertheless, reforms that restore a sustainable fiscal position would need to go beyond this rebalancing, thereby imposing a heavier burden on future generations. This can be seen in the scenario with an integrated pension and nonage spending reform, where the intergenerational gap becomes larger than the intertemporal fiscal gap. In other words, because the net tax burden on the current generation is lower under the reform scenario, if future generations paid the same net taxes as the current generation, the fiscal gap would widen. Any credible reform program would thus place a significant burden on future generations, and early implementation of fiscal reform is needed to minimize this burden.

A03ufig15

Primary Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Staff estimates.
A03ufig16

Net Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Staff estimates.

E. Conclusions

66. A large demographic shift, early retirement, and a rigid fiscal structure will pose significant challenges for fiscal policy in the coming decades. These trends will lead to a significant deterioration of public finances and adversely impact debt sustainability and macroeconomic stability. This chapter draws the following conclusions:

  • Early and comprehensive action is needed to deal with the age–related spending pressures. Such measures should seek to (i) reform the pension system on a more systemic basis through an increase in the effective retirement age and a reduction in the generosity of benefits, and, (ii) contain the costs of publicly provided health care and non–age–related spending.

  • To withstand aging pressures and contain debt within the Maastricht criterion, fiscal adjustment plans need to be more ambitious in trying to reach fiscal balance or a small surplus over the medium term.

  • Considering the long lags with which reforms have a fiscal impact, early action is warranted. Delays in reforms will be costly in terms of additional adjustment needed in the future to restore sustainability and will also pose a higher adjustment burden on future generations.

Appendix I: The Pension System in Slovenia

The pension system in Slovenia comprises a mandatory, defined–benefit, pay–as–you–go public pension insurance scheme and a voluntary supplemental pension system. The pay–as–you–go scheme covers old–age, disability, survivors’, and widow’s benefits, provided through earnings–related benefits. In addition, a state pension is provided on a means–tested basis. The Pension Fund is also responsible for noncontributory state benefits for select groups, such as farmers, policemen, customs officers, and war veterans, through various legal mandates. In 2005, expenditure on pensions stood at 10.7 percent of GDP. In addition to this first pillar, fully funded voluntary supplemental pension schemes offered through mutual fund and insurance companies also exist. A key player is the state–owned Pension Management Fund (Capital Fund), which manages the Capital Mutual Pension Fund. The latter is a mandatory supplementary scheme for certain occupational groups and a pension fund where privatization certificates can be saved. The total assets of collective voluntary occupational schemes were 1.4 percent of GDP in 2004.

In 1999, the Slovene authorities approved a far–reaching pension reform program. Substantial parametric reforms were approved, to be phased in by 2024. Key measures included (i) lowering the accrual rate from 85 percent to 72.5 percent for full pension service years (40 years of service for men and 38 years for women); (ii) lengthening the period of assessment of wages from 10 to 18 best consecutive years of earnings; and (iii) increasing the full pensionable retirement age to 63 for men and 61 for women with a minimum 20 years of service (Majcen, Nieuwkoop and Verbic, 2005, Government of Republic of Slovenia, 2005). The reform plan also eschewed introduction of a mandatory second–pillar pension system. These reform measures were also applied to existing pensioners in order to ensure generational equity. With these reforms and given the indexation and valorization mechanisms, pension growth was set to lag wage growth at an increasing rate over time. In 2005, this indexation policy was changed, and pension indexation was set to grow at the same rate as wage growth, adjusted for the reduced benefits under the reform plans. It is envisaged that, after these measures are fully phased in, the net replacement rate will stand at 56 percent of wages.

Despite these reforms, which are being phased in very gradually, the pension benefits remain relatively generous. The average net replacement rate—the level of old–age pension benefits relative to wage levels—was close to 70 percent in 2005, one of the highest among new EU member states. Key parameters, such as the period for assessing wages that is used to calculate the pension base and the indexation of average pensions to wage growth, remain generous. The full pensionable age, even after the reforms, is still low by EU–15 standards, and workers can retire even earlier with full pensions depending on the number of children. Significant number of retirees also exit the system through disability pensions.

Appendix II: Generational Accounting Model

Projection methodology

Let Xt denote the aggregate transfer of health care benefits in the base year. This can be expressed as the sum of transfers to different age groups, i, as

Xt=Σ1100Xi,t,

where Xi,t, is the transfer to the age cohort i at time t. Xi,t, can be calculated using the relative age profile,Ri,t, which attributes the share of the total transfers to the different age groups:

Xi,t=Ri,tXt.

To project forward the age–specific transfers, the per capita transfers are calculated as

Ai,t=Xi,tPi,t

where, Ai,t, denotes the per capita transfer to an individual of age i at time t ; and Pi,t, is the number of individuals in this age cohort. In other words, the aggregate transfers can also be calculated as

Xt=Σ1100Ai,tPi,t

The projection for each of the transfers would thus depend upon the growth of the per capita transfers, g, and the population growth within each cohort:

Xt+1=Σ1100Ai,t+1Pi,t+1Xt+1=Σ1100Ai,t(1+g)Pi,t+1.

The growth of the per capita transfers is typically linked to per capita productivity growth to reflect the indexation to wages. If the transfers are indexed only to inflation, however, per capita growth would equal zero.

It is also assumed that the relative profile remains constant:

Ri,t=Ri.

Thus, transfers are projected as

Xt+1=Σ1100RiXtPi,t+1Pi,t(1+g).

Under some scenarios, such as an extension of the retirement age, the relative age profile is allowed to vary for specific variables, such as income taxes, social security contributions, and pensions. Similarly, depending on the healthiness of the aging population, the age profile for health care can also be shifted to the right if more of the elderly are expected to live healthier lives..

Generational accounts

The generational account of an individual measures the present value at time t of the average remaining lifetime net tax payment. This is defined as

Nt,k=Σs=max(t,k)k+100Ts,kps,kpt,k(1+r)-(s-t).

Here, Ts, k, is the projected average net tax payment to the government in the year s by a member of the generation born in the year k, which essentially represents the sum of the per capita transfer (or tax) Ak,s, of an individual born in the year k across all the government taxes and transfers at time s. The term Ps,kPt,k is the proportion of members of cohort k alive at time t who will also be alive at time s. The net tax payments are discounted using the real discount factor, r. Thus, the generational account captures the average present value over all net tax and transfer payments, as well as probability of survival.

Intertemporal fiscal gap

The intertemporal fiscal gap, based on a dynamic analysis of fiscal policy, is defined as the imbalance in the intertemporal budget constraint. This constraint simply states that in present value terms, the future net tax payments of current and future generations should cover the government’s future purchases of goods and services and the initial net debt. Formally, the intertemporal budget constraint, is expressed as

Σs=0Gt+s(1+r)ts+Dt=Σs=0100Nt,tsPt,ts+Σs=1Nt,t+sPt,t+s(1+r)ts,

where G is the government’s purchase of goods and services, D is the initial net debt, and Nt,k, is the generational account in year t of an individual born in year k . The first term on the right–hand side thus represents the net tax payments over the remaining lifetime of the currently living generation, while the second term is the present value of the net tax payments of future, yet unborn, generations. The intertemporal fiscal gap is calculated as the immediate and permanent adjustment in taxes or expenditures needed to ensure that the above constraint holds:

IBG=[ΣS=0Gt+s(1+r)ts+DtΣs=0100Nt,tsPt,tsΣs=1Nt,t+sPt,t+s(1+r)ts]/GDP.

Intergenerational balance gap

The intergenerational balance gap is a hypothetical calculation of the intertemporal budget gap based on the assumption that net tax payments of the future generation are the same as that of the newborn in the currently living generation, adjusted for growth:

Σs=1Nt,t+sPt,t+s(1+r)ts=Σs=1Nt,t(1+g)Pt,t+s(1+r)ts.GBG=[ΣS=0Gt+s(1+r)ts+DtΣs=0100Nt,tsPt,tsΣs=1Nt,t(1+g)Pt,t+s(1+r)ts]/GDP.

Thus, IBG will be greater than GBG if Nt,t+s, is lower than Nt,t(1+g). In other words, if the current policy is favorable to future generations such that the net taxes owed by a member of the future generation are lower than those of a currently newborn, the intertemporal budget gap will be wider than the intergenerational balance gap. For further details on these concepts, see Cardarelli, Sefton, and Kotlikoff (2000).

Appendix III

uapp03fig20

Slovenia: Age and Gender Profiles, 2003

(Ratio)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Ministry of Finance of Slovenia.

Appendix IV: Pension Projections

The evolution of public pensions as a share of GDP depends on the pension system’s level of generosity, the number of people receiving pension benefits, and the productivity and effort of the labor force. More specifically, the ratio of pension expenditure to GDP can be expressed as the following:

PensionExpenditureGDP=AveragepensionbenefitsAverageproductivity*NumberofpensionersNumberofemployed=AveragepensionbenefitsAverageproductivity*Numberofpensioners(Population>55)*(Population>55)(15<Population<64)*(15<Population<64)(Numberofemployed)=AveragepensionbenefitsAverageproductivity*Numberofpensioners(Population>55)*(Population>55)(15<Population<64)*1emplrate*participationrate=BenefitEffect(BE)*EligibilityEfect(ELIGE)*AgingEffect(AE)*1/Employment(EMPE),

where

Aging Effect = (Population > 55)/(15< population <64)

Eligibility Effect = (Number of pension recipients) / (Population > 55)

Benefit Effect = Average benefits / Average productivity

Employment Effect = Number of employed/(15< population <64)

  • = Employment rate * Labor participation rate.

The contribution of each of these factors can be derived by differencing the log–linearized version of the equation above:

d(PensionExpenditure/GDP)d(t)=[dln(BE)*d(t)dln(ELIGE)d(t)*dln(AE)d(t)*dln(EMPE)]d(t)*PensionExpGDP(t=0)+err

where Pension Exp/ GDP (t=0), measures the pension expenditure in the initial period. To minimize the residual, the difference is taken over the short period of a year and summed over the entire period (Eskesen, 2002).

The baseline scenario follows the assumptions in the Convergence Program of Slovenia. It is assumed that labor activation policies adopted by the Slovene government will help to lower the unemployment rate by 1 percentage point from the current 6.4 percent to 5.4 percent by 2020 and stabilize at this level thereafter. Similarly, the labor participation rate is assumed to increase from 68 to 73.6 percent by 2050 on account of these and other legislative measures to increase the full pensionable age. The demographic shift also affects the participation rate as the number of elderly with a lower participation rate increases. The number of pension recipients is also assumed to rise reflecting an increase in the average effective retirement age to 62 by 2023, in line with the approved pension reforms. It is also expected that average benefits will decline due to the reform measures introduced in 2000. The replacement rate is expected to decline from 70 percent to 62 percent by 2030 as per the estimates on the impact of the pension reform outlined in World Bank (2004). Average productivity growth is also assumed to decline gradually from 3.5 percent to 1.7 percent by 2050 as the economy converges to higher income levels and growth slows down. Under these assumptions, pension expenditure is expected to rise rapidly after 2024 to almost 16 percent of GDP by 2050.

Pension projections are very sensitive to underlying assumptions (Appendix figures). An optimistic scenario is projected assuming stronger productivity growth, higher labor participation by the elderly, and further pension reform to lower the benefits level. Specifically, the labor participation rate is assumed to be higher by 1 percentage point, and the net replacement rate is assumed to decline further to 49 percent of wages over the long run. Labor productivity growth is expected to stay constant at 3.5 percent at current levels. Although the labor productivity growth rate is assumed to be higher, it does not reduce pension expenditure as a share of GDP because wages, to which pension benefits are indexed, also grow in line with productivity. In this scenario, pension benefits as a share of GDP rise to 12.3 percent. Under a more pessimistic scenario, when the average retirement age is assumed to increase only to 59 years, the eligibility effect will lead to higher pension expenditure than in the baseline case. Similarly, the labor participation rate is expected to rise to 71 percent by 2050. In this scenario, pension expenditure is expected to rise to 17.3 percent.

In each of the three cases, the demographic effect contributes the most to the rise in pension expenditure (Appendix figures). Despite the negative contribution of the eligibility effect, the benefits effect, and the employment effect, these do not offset the impact of population aging. Even under the optimistic scenario, when benefits are assumed to decline further and the number of retirees declines relative to the base case—as the elderly work longer—the demographic effect dominates.

To analyze the impact of pension reform on debt sustainability, alternative scenarios showing the impact of pension reform on pension expenditure are also projected (Appendix figures). Four different scenarios are considered. First, we consider the impact of a gradual increase in the average effective retirement age from 61 years to 63 years—2 years beyond the baseline scenario assumption. The demographic pressure on pension expenditure is delayed, with a reduction of over 2 percent of GDP by 2050 relative to the baseline. Second, benefit reform—such as through an increase in the number of years used for calculating the pension base—that results in a further lowering of the entry net replacement rate to 52 percent is assumed. This estimate corresponds to the replacement rate under the reforms implemented in 2000 but before the indexation to wages introduced in 2005. In this case, the rate of increase of pension expenditure is lowered, although it still remains high at over 13.5 percent. Third, a more dramatic reform that indexes existing pensions to prices is estimated. This would substantially lower pension expenditure, to 8.0 percent of GDP through 2025, as the impact of pension reforms is also evident. Subsequently, demographic pressure increases spending to 11 percent of GDP. Last, a combined scenario that incorporates an increase in the retirement age and a decline in the entry net replacement rate is considered. In this case, pension expenditure is contained at around 11 percent of GDP over the next 50 years.

A03uapp02fig01

Slovenia: Pension Projections, 2004-50

(In percent of GDP)

Citation: IMF Staff Country Reports 2006, 250; 10.5089/9781451835786.002.A003

Source: Staff calculations.

References

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27

Prepared by Anita Tuladhar. The author thanks Mr. Slaven Mickovic of the Ministry of Finance of Slovenia for providing valuable data for the model.

28

See Chapter III on “Slovenia: Tax and Benefits System and Incentives to Work”.

29

See Chapter IV on “Retirement Incentives in the Pension System in Slovenia”.

30

See Appendix I for details of the pension system. Chapter I on “Budget Rigidity and Expenditure Efficiency in Slovenia” discusses fiscal rigidities in further detail.

Republic of Slovenia: Selected Issues
Author: International Monetary Fund