Austria: Selected Issues

International Monetary Fund

doi:10.5089/9781451802382.002.A002

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Austria: Selected Issues

Author: International Monetary Fund

Publication Date:: 02 May 2007

eISBN:: 9781451802382

Language:: English

Keywords:: ISCR; CR; retirement age; expenditure; fiscal policy rule; early retirement; pension pressure; expenditure side; dependency ratio; long term care; projections of pension expenditure; Pensions

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This Selected Issues paper focuses on the medium-term budgetary framework (MTBF) for Austria. Austria is part of a trend among many countries to consider some form of MTBF. This paper describes the proposed framework in Austria and assesses it in light of the experience of other countries. The general conclusion is that the track records are mixed, but that, on balance, the experiences with MTBFs have been favorable. The paper also examines the long-term fiscal challenges arising from demographic change.

Abstract

II. Long-Run Fiscal Challenges in Austria²¹

A. Background

31. This chapter examines the long-run fiscal challenges arising from demographic change. Like many industrial countries, Austria faces an aging problem, caused by a reduction of total fertility rates below the replacement rate, and increased life expectancy. Thus, the old-age dependency ratio is expected to double by 2050, and aging pressures are likely to intensify after 2010.

32. Aging will put upward pressure on fiscal spending on pensions, health, and long-term old-age care costs, as the number of older people increases. This would, however, be partially offset by a reduction in fiscal expenditure on education and unemployment benefits as the population of younger school- and working-age persons declines. The chapter explores these costs, and their implications for fiscal sustainability.

B. Impact of Aging on Pension Expenditures

33. Austria has traditionally had relatively generous public pension schemes, with virtually universal coverage. These were generally based on occupation, and there were separate schemes for the self-employed, farmers, employees, federal civil servants, and civil servants at the provincial and municipality levels. These schemes were based on the pay-as-you-go (PAYG) system. Replacement rates were relatively high, and financing shortfalls for these schemes were covered by fiscal transfers. As a result, pension spending in Austria has been among the highest in the EU15 (Figure 1), and other (occupational and individual) pension pillars are relatively underdeveloped.

34. Earlier projections pointed to a significant increase in pension expenditures as a result of aging. For example, Eskesen (2002) projected that from 2000 to 2050 public pension expenditures could increase by 3 to 6 percentage points of GDP. The Austrian Stability Program for 2001-05 projected an increase of 2.5 percentage points of GDP in pension expenditures between 2000 and 2050.

35. Since then there have been two major waves of reform, in 2003 and 2005. The 2003 reforms primarily affected the public pensions for workers and employees—the Allgemeine Sozialversicherungsgesetz (ASVG)—and the federal civil service:

Regarding the ASVG, the average wage used as the base for calculation of pension benefits was changed from the average of the 15 best years to the average of the 40 best years of wages (with all wages expressed in constant prices). However, this is to be implemented with a long transition—the number of years used in the calculation is increased by one every 12 months, from 2004 onward, so that full implementation will be achieved only by 2028.
The accrual rate for pension benefits was reduced from 2 percent per annum to 1.78 percent per annum. The maximum pension was set at 80 percent of the average wage, so that a working (and contribution) history of 45 years would be needed to achieve this maximum rate.
The minimum age for early retirement was increased from 61.5 for men and 56.5 for women to the statutory retirement ages of 65 for men and 60 for women, to be phased in until 2017, thus essentially abolishing early retirement by 2017. During the transition period, when early retirement is still possible, the associated penalty was increased from 3 percent per year of early retirement to 4.2 percent, subject to a 15 percent cap.
At the same time, the premium for retiring later than the statutory age was also increased from 3 to 4.2 percent per year of late retirement, subject to a 10 percent limit, such that the maximum pension benefit from late retirement would be 90 percent of the average wage.
Access to early retirement on account of unemployment was eliminated.
But, reflecting political pressures, a 10 percent limit was placed on reductions of benefits to individual pensioners arising from the reforms.
For the federal civil service, the period for calculation of the average wage was also changed to 40 years (rather than the final wage), to be phased in by 2028. The annual accrual rate was reduced as well, the retirement age increased to 65 years, penalties for early retirement (from age 61.5 to 65 years) increased from 3 percent to 3.36 percent, and pension contributions increased by 1 percent.

36. The 2005 reforms harmonized all the pension schemes for persons under 50 years of age on January 1, 2005 (excluding subnational civil servants) into a single system:

The new system is a notional defined-benefits system with individual accounts. For a person retiring at the statutory age of 65 years, with at least 40 years of work/contribution history, the pension benefit is calculated as 80 percent of the average income for the best 40 years of wages (at constant prices). Pension benefits are accumulated at an annual rate of 1.78 percent, so that 45 years of contributions are needed to obtain a full pension.
A retirement corridor of 62-68 years was introduced for persons with at least 37½ years of contribution history. Within this corridor, retirement at an age above the statutory age of 65 years attracts a premium, while retirement below 65 years generates a penalty. In both cases, the premium/penalty is 4.2 percent per year. Where a premium is earned, the maximum benefit is set at 90 percent of the (40 best years) average wage, while for retirement below 65 years the maximum penalty is set at 15 percent of the average wage. For women, further phased increases in the statutory retirement age to 65 would also take place between 2024 and 2033, and they would begin to participate in the “corridor pension” only after their statutory retirement age exceeded 62.
Given that many have already accumulated benefit rights under the previous pension system, calculation of benefits would involve dual calculations under the old and new systems. Thus, a long transition is envisaged—full implementation of the new system would take place around 2050.
To ease the pain of the reform, the 10 percent cap on benefit losses arising from the reforms was changed to a phased plan, where the cap was immediately reduced to 5 percent with effect from 2004, and set to increase by 0.25 percentage point per annum back to 10 percent by 2024.
Contribution rates would be 22.8 percent of wages. However, burden sharing differs according to occupation. For employees, contribution payments are split equally between employee and employer. For the self-employed, contributions would increase from 15 to 17.5 percent of income, while for farmers contribution rates would increase from 14.4 percent to 15 percent, with both increases phased in over 10 years, and the gap in contributions made up by transfers from the federal government budget.
Pension benefits would be adjusted annually according to consumer price inflation, in contrast to the earlier practice of adjusting benefits in line with wage growth.
However, in a step back from the objective of increasing the average retirement age, other avenues for early retirement were introduced. In particular, an early retirement scheme for those doing heavy physical work (with heavy work not well defined) was introduced. Also, access to disability retirement for unskilled persons aged 57 and older was relaxed.
There would be three-year reviews of the evolution of pension expenditure.

37. Following these reforms, the authorities’ projections (as reported in the 2006 ECFIN report on aging) estimate that pension pressures would be contained by 2050. These projections of pension expenditure can be decomposed into the underlying assumptions regarding the evolution of the old-age dependency ratio, benefits ratio, employment rate, and the eligibility rate for pensions (Figure 2).²² As demonstrated in the appendix to this chapter, the product of these four ratios equals the ratio of pension expenditure to GDP. As observed in Figure 2, the projections are based on a rising dependency ratio being offset by declines in eligibility and benefits ratios and an increase in the employment rate. By 2035, the downward pressures more than offset the upward pressures, and pension expenditure as a percentage of GDP falls slightly from then on.

38. The projections are subject to significant uncertainty margins, given the long projection horizon. With regard to the old-age dependency ratio, in addition to the baseline population projections (which underlie the authorities’ projections) Eurostat provides six other projections, with selected permutations of assumptions on net migration, the total fertility rate, and male and female life expectancy (Figure 3; next page). These are the “no migration” scenario, with zero net immigration; the “older age profile” with low net migration, low fertility, and high life expectancy; the “younger age profile” with high net migration, high fertility, and lower life expectancy; “high fertility” with high fertility and baseline net immigration and life expectancy; “high population” with high net migration, high fertility, and high life expectancy; and “low population” with low net migration, fertility, and life expectancy. These projections thus provide estimates of the likely range of variation in the dependency ratio up to 2050. For Austria, these suggest that the dependency ratio could vary between 44 percent and 66 percent by 2050 (Figure 4). With the other parameters—eligibility, employment and benefits ratios—assumed to be unchanged, this implies that pension expenditure in 2050 could vary between 10 percent of GDP and 15 percent of GDP, depending on the evolution of the population (Figure 5).

39. However, other variables could also evolve in a manner different from the authorities’ assumptions. The assumed substantial decline of the eligibility ratio appears optimistic. The OECD 2005 economic survey reports that inflows into disability pensions are large (over 30,000 persons in 2004, compared with an inflow of about 20,000 for retirement at the statutory age) and have jumped markedly since 2003, apparently because it is being exploited as a loophole to obtain early retirement.²³ Also, as mentioned above, the 2005 reforms introduced other avenues into early retirement, such as the hard-worker initiative.²⁴ As a result, without further measures to tighten eligibility for early retirement the average retirement age is unlikely to increase significantly, implying a higher eligibility ratio and lower employment of older workers than envisaged. In addition, it is unclear how realistic it is to assume only price indexation of pension benefits over a long horizon.

40. Finally, initiatives contained in the recent government program agreed during the coalition talks raise further concerns. In particular, it is proposed to significantly cut the penalties for early retirement for those governed by the 2005 pension reforms by cutting the penalty rate within the pension corridor from 4.2 percent to 2.1 percent. Also, persons with long working histories are to be allowed the right to retire early (55 for women and 60 for men) without penalty, until 2010. If offsetting measures are not also implemented, this is likely to substantially increase early retirement and pension expenditures.

41. To explore the quantitative implications of these possible developments, alternative projections were prepared. These assumed the following: (i) the number of pensioners grows at slightly below one-half of the growth rate of the old-age population above 65 years old, implying that the eligibility ratio declines from 1.8 in 2005 to 1.27 in 2050 rather than the authorities’ projected 1.17; (ii) the employment rate increases to 76 percent in 2050, rather than the authorities’ projection of 78 percent; and (iii) from 2025 onward, average pension benefits grow at a rate ¾ percentage point below average nominal wages. Figure 6 presents the results. As we can see, in this scenario where all three assumptions above are borne out, pension expenditures would rise to almost 15 percent of GDP in 2050.

42. Combining all these variants in the assumptions, we find that in a worst-case scenario, with no migration, higher eligibility and benefits rates, and a lower employment rate, pension expenditures could increase to 18 percent of GDP by 2050. However this scenario is an extreme case in which the authorities do not react at all even as the fiscal situation deteriorates, and is therefore one which has a low probability of occurring. On the other hand, if the eligibility, benefits, and employment rates evolve as envisaged under the baseline, and in addition the population evolves in line with the younger age profile variant, pension expenditure would decline to 10 percent of GDP (Figure 7).

C. Impact of Aging on Health and Long-Term Care Expenditures

43. Projecting health and long-term care expenditure is subject to significant uncertainties, related to the health status of the older population as life expectancy increases and the organization of health and care. Projections prepared by OECD staff point to health and long-term care expenditure increasing by 5.8 percentage points of GDP by 2050, in the absence of cost cutting measures (Figure 8). With (undefined) cost cutting measures, it is anticipated that this increase could be reduced to 3 percent of GDP. The ECFIN aging report considers six scenarios for health expenditure. These are: (i) pure aging, which assumes that all future increases in life expectancy are spent in bad health; (ii) constant health, which assumes that all future increases in life expectancy are spent in good health; (iii) death related costs, where health care spending on a person is driven by years of remaining life; (iv) higher income elasticity of demand, where the income elasticity of demand is assumed to be higher than unity; (v) unit costs in line with GDP, where costs are assumed to increase at the same rate as GDP per worker; and (vi) a baseline, referred to as the “AWG reference scenario,” which incorporates some increase in healthy life expectancy as overall life expectancy increases and an income elasticity of demand exceeding one.²⁵ On this basis, ECFIN’s projections point to increases in a range between 1 and 2¼ percentage points of GDP for health spending by 2050 (Figure 9). Similar projections also point to increases in long-term care expenditure of between ¾ and 1½ percentage points by 2050.

44. Cost-cutting measures could moderate the increase in health care expenditures. The health care infrastructure in Austria is complex, and there is reportedly room for significant improvements in efficiency in the provision of services, particularly regarding hospitals. A key structural issue is that decision making and financing of similar activities are spread across different levels of government by the constitution, thus leading to duplication and inefficiencies, and complicating reform efforts. Reforms in the health care sector have been limited thus far and have not yet addressed this fundamental structural issue.

45. Fundamental reforms would require changes to intergovernmental relations. This would be needed to unify the decision-making process in the health sector, strengthen transparency regarding the use of public funds in the health sector, and eliminate incentives for inefficient provision of health services. However, constitutional reforms intended to address these and other fiscal-federal issues have stalled so far for lack of the required parliamentary majority. Encouragingly, the new coalition agreement includes proposals for a restart of reform in these areas.

D. Education and Unemployment Benefits

46. In contrast with the upward pressures on public expenditure from pensions, health and long-term care, aging will lead to downward pressure on education and unemployment benefit spending. The ECFIN report estimates that by 2050 education spending in Austria would have declined by ¾ percentage point of GDP as the school age population declines, while unemployment benefits will also decline marginally by 0.1 percentage point of GDP.

E. Overall Impact of Aging on the Fiscal Position

47. Projections of the impact of aging on public expenditure are very sensitive to the underlying assumptions. Overall—combining the baseline projections of the impact of demographic changes on pensions, health, long term care, education, and unemployment benefits—by 2050 the aging process will raise fiscal expenditures by ¾ percentage point of GDP. However, reflecting the wide range of plausible paths for pensions, health, and long term care expenditure, in the best case fiscal expenditures would decline by 2 percentage points of GDP during this period, while in the worst case fiscal expenditures would increase by 9 percentage points of GDP.

48. As a result, also the projected debt paths vary widely. The underlying baseline fiscal scenario is a no-policy-change scenario, which assumes that the fiscal stance remains unchanged from 2006 onward, and that revenue and primary expenditure grow at the same rate as nominal GDP. This implies a constant underlying primary surplus of 1½ percent of GDP and an overall underlying deficit that varies between 1 and 1½ percent of GDP over the projection period. Consistent with ECFIN projections, it was assumed that contributions stay broadly stable as a percentage of GDP over the period 2005-50, so that the impact of aging on the fiscal balance is driven by changes in overall expenditures on pensions, health, long-term care, education, and unemployment benefits. The impact of aging was then included as an increase or decrease in primary expenditure, and the overall fiscal balance and public debt, including the impact of aging, was calculated. The average interest rate on public debt was assumed to be 5 percent over the projection period, slightly higher than the average observed for 2005 (4.7 percent), since recent interest rates have been historically low. On this basis, under the baseline aging scenario, public debt initially declines, from 63.3 percent of GDP in 2005 to 44.6 percent of GDP by 2025, but thereafter rises steadily as aging pressures build up, reaching 65.3 percent of GDP by 2050. However, there is a wide uncertainty margin. Under the best case scenario, where aging actually leads to an overall decline in spending, public debt falls below zero in 2044. On the other hand, under the worst-case scenario public debt jumps to more than 300 percent of GDP towards 2050.

49. With public debt on a rising path, and higher in 2050 than in 2005 under the no-policy-change baseline scenario, this uncertainty implies risks for the sustainability of the fiscal position, given aging (Figure 10). Moreover, public debt under the baseline could turn out significantly higher by 2050 if the plans to cut penalties for early retirement are implemented. Thus, further consolidation is needed to ensure sustainability. In this regard, it will be necessary to fully and forcefully implement all the pension reforms, and initiatives that would increase pension spending should be offset by cuts elsewhere. The three-year reviews mandated under the 2005 reforms could be a useful tool for containing pension pressures if vigorously implemented. Reforms in the health sector will also be key in containing fiscal pressures.

F. Concluding Remarks

50. Aging will create long-term challenges in Austria, although the exact size of the challenge is subject to uncertainty. Nevertheless, it is clear that fiscal consolidation is needed, particularly on the expenditure side, to ensure long-run fiscal sustainability, reduce public debt to a prudent level, and ease the tax burden in order to stimulate private sector activity. An early start to fiscal consolidation is advisable, since it would prevent the need for more wrenching changes later. In this light, recent initiatives to relax access to early retirement are likely to make this task more difficult, as further offsetting measures would be required to ensure sustainability.

Appendix. Decomposition of Pension Expenditures

Pension expenditures can be decomposed as follows:

\begin{matrix} \frac{P e n s i o n s p e n d i n g}{G D P} = \frac{P e n s i o n e r s \times A v e r a g e b e n e f i t s}{G D P} \\ = \frac{P e n s i o n e r s}{E m p l o y m e n t} \times \frac{A v e r a g e b e n e f i t s}{G D P / E m p l o y m e n t} \\ = \frac{P e n s i o n e r s}{E m p l o y m e n t} \times \frac{A v e r a g e b e n e f i t s}{L a b o r p r o d u c t i v i t y} \\ = \underset{1}{(\frac{P o p u l a t i o n \geq 65}{15 \leq P o p u l a t i o n < 65})} * \underset{2}{(\frac{15 \leq P o p u l a t i o n < 65}{E m p o l y m e n t})} * \underset{3}{(\frac{P e n s i o n e r s}{P o p u l a t i o n \geq 65})} * \underset{4}{(\frac{A v e r a g e b e n e f i t s}{L a b o r p r o d u c t i v i t y}) .} \end{matrix}

In the last line above, expression (1) is the old-age dependency ratio, expression (2) is the inverse employment rate, expression (3) is the eligibility ratio, and expression (4) is the benefits ratio. The pension-GDP ratio in any year is the product of these four expressions, and therefore its evolution over time is governed by the evolution of these underlying variables.

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Prepared by Daniel Kanda. This section provides background information and analysis in support of paragraphs 20-21, 32-34, and Appendix I of the Austria Staff Report.

The old-age dependency ratio is the ratio of the old-age population to the working-age population; the inverse employment rate is the ratio of working-age population to employment; the eligibility ratio is the ratio of pensioners to old-age population; and the benefits ratio is the ratio of average pension benefits to economy-wide labor productivity.

See Figure 2.2 of the report.

This allows for early retirement at a reduced penalty for persons who have done hard or onerous work.

AWG refers to the Aging Working Group of the Economic Policy Committee of the European Commission.

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