Opinion on the Social Insurance Act Amendment

Opinion on the Social Insurance Act Amendment
In line with the Fiscal Responsibility Act, the CBR draws up and publishes its opinions on various legislative proposals submitted to the parliament, either on its own initiative or if invited to do so by a parliamentary caucus. In August 2012, the CBR received a letter in which the SDKÚ-DS caucus asked for an opinion on an amendment to Act No. 461/2003 on Social Insurance. Although having been in existence for several months only and still in the process of creating its databases and models, the CBR agreed to draw up its opinion by the end of November 2012. This opinion reflects the final wording of the amendment as adopted by the parliament on 10 August 2012, and its main text does not take into account other laws enacted in the meantime.

According to its authors, the amendment was proposed mainly for three reasons. Firstly, the amendment sought to improve long-term sustainability of the pension system. Secondly, some provisions were designed to facilitate immediate consolidation of public finances. Thirdly, one of the purposes of the amendment was to abolish certain exemptions and special regimes applicable to social security contributions (particularly with regard to the self-employed and casual workers).

The CBR assessed the legislative changes from three perspectives: short-term impact on households and businesses, short- and medium-term consequences for macroeconomic development, and implications for public finances.

The adopted measures influence the net income of the insured persons, both in the short and medium run. The changes in the contribution rates have a major impact in the short run. In the case of employees, the amendment negatively affects those whose gross wage is above 1.5 times the average wage (12% of employees). Net wage reduction is more substantial in the case of those earning 3 times the average wage (2% of employees) and even more so in the case of those earning 4 times the average wage (1% of employees). The tax wedge in these earning categories will increase by 2 to 7 p.p., which represents an increase in tax burden by 5 to 16%. The marginal tax rates for these categories of persons increased from 19% to approximately 50%. Similarly steep increases in the marginal effective tax rates have also occurred in certain categories of casual workers and the self-employed.

In the long run, the amendment will mainly affect pensioners. The first key change links the age of retirement to the average life expectancy for senior citizens. Secondly, the amendment links the indexation of pensions solely to inflation; for the purpose of indexation, inflation represents the average price growth in the pensioners’ households reported by the Statistical Office. Thirdly, the amendment reinforces solidarity in the pension system by adjusting the existing correction coefficients. The CBR simulations show that if the mean life expectancy continues to grow in line with Eurostat expectations, the retirement age should progressively increase to almost 68 by 2060. At the same time, the replacement rate from the pay-as-you-go pillar is likely to decline, mainly for those earning higher wages. The net replacement rate will increase by 3.3 p.p. for minimum-wage earners and fall by 3.9 p.p. for those who earn five times the average wage. However, the changed indexation mechanism has a negative impact on all pensions, with gradual effect of 11% to 12%. The overall effects of the amendment on pensions through changes in the fully-funded pillar are difficult to quantify. A lot depends on the setup of the [pension funds’] investment policies and management fees, consumers’ risk aversion and the global capital market performance. The amendment adversely affects particularly those with savings in index funds. At the same time, the reduced rate of contributions to the fully-funded pillar limits the diversification of the sources of pensioners’ income.

The changes in the system of taxes and social contributions affect the economic growth primarily by incentivising individual groups of taxpayers towards working, saving or investing. In the short term, these impacts will be primarily felt through changes in demand and, in the long term, through the supply of labour and of capital. The CBR’s indicative simulations show that the amendment will reduce economic growth by 0.1 to 0.2%, in the short term, while potential output will contract by 0.4 to 1.1% in the long term (through reduction in the number of hours worked, which represents 18,000 to 47,000 persons working on a full-time basis).

From a medium-term perspective, the amendment will improve the government’s fiscal performance by more than 1% of GDP. Many legislative changes incorporated into the forecast will affect the behaviour of taxpayers (dynamic effects), but since their ultimate impact on the tax and social contribution revenues is difficult to assess, they represent a risk of the quantification. The second element of uncertainty lies in the number of savers who will switch back to the purely pay-as-you-go system.

From the perspective of the long-term sustainability of public finances, the amendment improves the position of Slovakia. The reduction of contributions to the fully-funded pillar does not have a positive effect per se, but the increased retirement age, reduced average replacement rates, and changes in the assessment bases clearly improve the long-term balance of public finances. The overall impact of the amendment on long-term sustainability has been calculated using the S2 sustainability indicator defined by the European Commission. According to CBR’s calculations, the amendment should reduce the need for a permanent improvement of budget balance in order to make the debt sustainable in the infinite horizon from 8.5% of GDP to 6.3% of GDP.