Ifo Viewpoint No. 15: 20% is the Limit

Hans-Werner Sinn
Munich 26 September 2000

By the year 2035 Germany will have the oldest population on earth. For every ten Germans currently no more than seven children are born, and life expectancy is increasing by one year every eight years. In 2035 there will be twice as many elderly as today. A major crisis is brewing for the pension system (see Viewpoint No. 4).

A broad consensus among politicians has been formed that entitlement from the state pension systems must be reduced and supplemented by funded pension plans from an individual's own savings. But there is still no consensus as to how great the entitlement cuts should be and who should be required to save how much.

The responsibility for the pension crisis is attributable to the decline in births among those born after about 1955. They have reared, on average, too few children to guarantee the stability of the pay-as-you-go pension system. For this reason it is only fair that they bear the consequences of their decisions in the form of decreasing pension entitlements. The money that these generations did not spend on child rearing should be invested in capital markets as a form of retirement savings. With regard to the total burden on every generation from the pension system and child rearing, this is both reasonable and fair.

As the generational balances calculated by the Ifo Institute show (ifo Schnelldienst, 18/2000), the total burden of all generations from the net pension burden and child-rearing costs is smoothed to the greatest extent if the social insurance contribution is frozen at its current level and the future demographic distortions are completely offset by corresponding reductions in pension entitlements. The generations that are both responsible for and affected by the pension cuts still have time to finance their retirement consumption by private savings. For this reason, the social security contribution rate should never exceed 20%. The alternative of imposing a lower limit for net pensions must be rejected since it would unduly favour the generations that bore fewer children.

Of course, all those born in a particular year cannot be treated in the same way, disregarding the number of children they reared. It is the number of children that distinguishes the contribution an individual has actually made to safeguarding future pensions and also the financial leeway that remains for supplementary retirement savings. For this reason, the amount of pension cuts that will be necessary in future from the freezing of the contribution rate, as well as the reasonable amount of obligatory savings in funded pensions system, should be graded according to the number of children.

Hans-Werner Sinn
President of the Ifo Institute

Sinn, Hans-Werner and Martin Werding, "Rentenniveausenkung und Teilkapitaldeckung - ifo Empfehlungen zur Konsolidierung des Umlageverfahrens", ifo Schnelldienst 53 (18), 2000, 12–25.