Who will pay for the pension reform?

The Council of Ministers approved last Tuesday, July 6, in the first round, the Draft Bill for the guarantee of the purchasing power of pensions and other measures to reinforce the financial and social sustainability of the system, after the agreement with the social partners CEOE, Cepyme, CCOO and UGT.

The draft bill, despite the fact that it transfers expenses from the Social Security Budget to that of the State and aims to advance the delay in the effective retirement age, represents a notable step backwards in the sustainability of our public social protection system by expressly repealing the Factor of Sustainability and link the annual rise in pensions to inflation, replacing the Pension Revaluation Index, which linked it to the financial health of the system.

In February 2020, and in review of the advances that had been made in the matter from Spain, the Staff Working Document of the European Commission dedicated to Spain indicated that “the linking of pensions to inflation announced by the new coalition government in its program could lead to an increase in pension spending by 2050 of around 4% of GDP.” It added, in turn, that “eliminating the sustainability mechanism included in the 2013 reform aimed at adjusting the initial level of pensions to changes in life expectancy (…) would add at least 0.7% of GDP to spending on long-term pensions ”. All of this led the Commission to conclude that “the elimination of both elements of the 2013 reform runs the risk of benefiting current pensioners at the expense of future generations, unless compensatory measures are adopted.”

In line with this, the European Commission report that accompanies its proposal for a decision to approve the Spanish Transformation, Recovery and Resilience Plan, highlights that “the reform of the pension system planned as part of component 30 includes measures that (.. .) would increase pension spending in the medium and long term, unless its impact is sufficiently balanced by compensatory measures.

Those compensatory measures in which the Commission insists, essentially, the definition of an Intergenerational Equity Factor that replaces the Sustainability Factor, the increase in the maximum contribution bases, or the modification of the pension calculation period, all of them that the aforementioned agreement does not detail, they have not been incorporated into the aforementioned draft law, although the Government has committed to the European Commission that they are in force before the end of 2022. As the European Commission indicates in the aforementioned report, “ if the compensatory and complementary measures were not sufficient (…) the overall budgetary impact of the increase in pension spending would have to be cushioned even more by means of proportional fiscal adjustments in the future ”.

Thus, if the aforementioned reforms are not approved – for which it is evident that unfortunately there is neither social nor parliamentary agreement today -, apart from putting at risk more than 11,400 million euros corresponding to the payment of the fourth tranche of transfers from the Mechanism of Recovery and Resilience to Spain due to breach of the commitment acquired, the burden of improving the adequacy of pensions that has just been agreed, which the Commission estimates at more than 4 points of GDP, will have to be assumed with fiscal adjustments.

Fedea has already estimated that to compensate for the repeal of the Sustainability Factor and the Pension Revaluation Index, it would be necessary to increase the total income tax quota by at least 50%. Alternatively, to compensate for this extra cost of the pension agreement, it would be necessary to multiply the collection per IBI by four, almost double the average effective rate of VAT, from 15% to 24%, or triple the collection of Corporation Tax. Increase in tax pressure that would be used simply to cover the increase in public spending derived from this agreement, without addressing the financing of other approved spending increase decisions, the cost of the energy transition, or, among others, the possible increase in cost of interest on public debt, which is already around 125% of GDP, and today it is being contained by the extraordinary liquidity measures implemented by the European Central Bank as a result of the pandemic.

Nothing is free. Given the risk that a Bill that will improve the adequacy of pensions will be sent to the Cortes in autumn without fully considering how it will be financed, for obvious reasons of transparency, responsibility and intergenerational solidarity, it would be recommended that before its approval If the increase in spending that it entails will be offset by other measures in the field of the pension system, with tax increases, with reforms that boost productivity and employment, with a combination of all of them, or simply, inaction, they will try to pass the bill by means of tax increases to the generations that come behind.

Juan Pablo Risk is a former secretary of state for employment and Alberto Garcia Valera former director general of taxes. They are both partners of EY.

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