Christoph S.: Do mounting COVID-19 debts pose a threat to our pensions?

Rising public debt can become a looming burden for an economy in general. If the cost of debt takes up increasingly larger parts of the budget, the government will at some point have to take countermeasures in order to maintain sufficient fiscal room to maneuver and, in extreme cases, to prevent the budget from sliding into bankruptcy.

Austria is very far from such a scenario

The country has a high credit rating and can obtain financing on the capital markets at low interest rates. Nevertheless, drastic budget consolidation measures may be necessary to reduce the country’s mounting debt, especially if the symptoms of the crisis subside and interest rates (i.e. the cost of debt) rise again. Potentially, all components of the budget would be affected by such a development, which would make far-reaching spending cuts and/or tax increases necessary.

The Austrian pension system is organized on a pay-as-you-go basis. Pension payments to retired people are financed by contributions from the generations that are still actively working. However, these contributions are not enough to finance all pensions. The system suffers from a funding gap that must be covered by federal tax revenues. Pension payments amount to about €56 billion per year (14% of the GDP). The share of this sum that is covered from the federal budget is about €20 billion. This figure corresponds to about a quarter of total federal spending (based on 2019 figures). Any budget consolidation measures carried out would therefore very likely also include the pension system. Possible steps for strengthening the sustainability of the system may include raising the retirement age, but also increasing contributions or reducing pension entitlements. 

Links between government debt and pensions

There are also other links between government debt and pensions, however. From a short-term perspective, losses of income from paid work cause the amounts of the contributions to fall. If the pension entitlements remain unchanged, this places an additional burden on the budget because it causes the federal contributions to pension payments to increase. In an economic recovery, however, when employment and incomes rise again, the situation would be reversed, reducing the strain on the pension system.

Phenomenon called “fiscal equivalence”

Taking a more long-term perspective, mounting debts may dampen people’s expectations for the future. This phenomenon, called “fiscal equivalence,” describes a scenario where people anticipate a budget consolidation and the corresponding negative effects on their consumption possibilities. In such a scenario, people would have to increase their private savings to hedge against possible income loss in the future. A pay-as-you-go pension system compensates such negative effects and thus has a stabilizing effect on people’s expectations.

A full-blown system collapse are unlikely

In summary, the mounting COVID-19 debts could make it necessary to take measures for saving costs in the pension system. Radical cuts or a full-blown system collapse are unlikely, however.

Rupert Sausgruber, head of the Institute for Public Sector Economics