The Danish Pension System Properties, outcomes and challenges Torben M. Andersen Aarhus University, Denmark Eight International FIAP- ASOFONDOS Congress, Carteagena April 2015
Pension system: Multiple objectives Distribution: Ensuring that all elderly have a decent living standard (minimum standards) Consumption smoothing: Ensuring that living standards after retirement stand in a resonable relation to living standards while working Insurance: Coverage of various events (spouse, long life……)
World Bank 1994 Danish pension system I: Public pensions (PAYG – defined benefits) Base pension for all (flat rate) Supplements – means tested All benefits are wage indexed II: Labour market pensions (defined contribution) Bargained, but mandatory for the individual Covers the majority of the work-force Provide annuitities + insurance (spouse/children; health) III: Private pension saving Tax subsidized and tied until retirement Free savings (property, financial assets…..) World Bank 1994
International comparisons
Background -Danish welfare model Extended welfare state Pensions Health Old-age care Universalism Equal entitlements for all Tax financed Strong distributional objectives
Current pension system - developments Savings deficit – systematic current account deficits Political discussion on employee-owned firms (wage-earner funds) Social partners: Agreement on development of labour market pensions (centralized labour market; high unionization) Collective - voluntary /bargaining Individual - mandatory
Labour market pensions – stepping up Kilder: Bidragssatser; Basispensioner, Penge- og Pensionspanelet, 2012. Pensionsformue; Skatteministeriet (www.skm.dk)
Changing importance of public and private pensions Pensions, % GDP
Current system
Replacement rates (2012) Projections: - Replacement rates will increase Private pensions will increase in importance Public pensions will remain important
Low income among pensioners Share with income below 50% of median income for entire population 0.3 % of persons above 64 falls below the official poverty line
Financially robust? Labour market pensions: Public pensions: Funded Non-firm specific Public pensions: Criteria for fiscal sustainability are met! Reforms to increase the statutory pension age Reducing possibilities for early retirement Discrete increases in pension age from 65 to 67 Indexation of pension ages based on life expectancy at the age of 60; expected pension period 14.5 years
Challenges Interplay between public and private pensions (means testing) Taxation of various types of savings Not all are covered by a labour market pension Balance expansion – macroeconomic (in)stability
Distribution dilemma Binding distributional constraint – ensure some minimum income (working age and pensioners) Impossible to reach this target through mandatory pension savings for groups with income close to the limit Division of labour between public and private pension via means-testing – targeting public pensions towards low-income groups
Means-testing and incentives How to transit from public to private pensions? (means-testing)’ If higher private pension = lower public pension ; implicit form of taxation in addition to regular taxes Effective tax rates can be high - Slow phasing out: low tax rates, but costly - Quick phasing out: high tax, less costly
Incentives – savings and retirement High effectiv tax rates on pension savings and later retirement Applies for low income groups! Effective tax rates on pension savings
Means-testing and insurance Low contribution due to involuntary unemployment, illness etc. Low return on investments etc. = lower private labour market pension = higher public pension Stabilizes/insures total net pension
Taxation of savings ETT-regime for pension savings Large variations in taxation of various types of savings Asset allocation Balance expansion
Balance expansion High level of pension savings (illiquid) High level of borrowing (large share with variable interest rate) High risk exposure? Effects on macroeconomic stability % of GDP Financial assets Financial liabilities Financial net assets Pension wealth, after tax Deferred taxes
Pensions for all! Bargained solution= support from social partners But not all covered! (recipients of social transfers, some employed, self-employed) ”Myopia” – insufficient savings (The argument for mandatory pensions saving) Free-rider aspects + effect on public budgets Solution: Mandatory pension savings for all??
Conclusions Long transition phase – still on-going Robust system Meets distributional objectives Ensures high replacement rates Financially viable Unsolvable dilemma – how to reconcile (re)distribution with incentives? Current system has clear incentive problems (savings, retirement) Uneven taxation of various types of pensions saving Ensuring coverage for all – mandatory scheme or?