Maintaining Pension and Contribution Levels in the Long Term Leads to Increases in Both the Tax Burden and Retirement Age

The German coalition government has just agreed on a pension plan that would maintain both the pension level and contribution rates until 2025, as well as increase pay-outs for those on reduced earning capacity pensions and mothers of children born before 1992. Dr. Holger Stichnoth, deputy head of the Research Department “International Distribution and Redistribution” at the Centre for European Economic Research (ZEW), Mannheim, comments on the government’s new pension plan.

“This agreement over pensions shows that the government is swiftly putting the plans for social security outlined in the coalition agreement into action. The plans contain significant improvements, particularly with regard to the reduced earning capacity pension. Another positive development is the government’s decision not to extend the retention of the pension level and contribution rates beyond 2025. This retention serves only to create a superficial sense of security and dependability. In reality, it has deprived policymakers of two essential tools for tackling the effects of demographic change on the current pay-as-you-go pension system. The stable pension level and contribution rates come at the expense of uncertainty and an increase in both the tax burden and the retirement age.

The expansion of the flexible “midi-job” zone from 850 to 1,300 euros is another welcome move, lessening the sharp increase in contribution rates in this earning bracket. According to our calculations, which take into account the new nursing care insurance payments at a rate of 2.85 per cent and the recent decision to reduce unemployment insurance contributions to 2.5 per cent, this should save German workers and employers around 620 million euros a year in social security contributions.

The expansion of the midi-job zone produces mixed work incentives. People who previously did not work or only had a “mini-job” (earning less than 450 euros a month) now have the incentive to find work or work more hours. For people who currently earn between 850 and 1,300 euros, however, the marginal tax burden increases, leaving them with a smaller share of every additional euro of gross income earned in their pocket. Workers who currently earn just over 1,300 euros a month could thus also have an incentive to move back down into the more attractive “midi-job” zone. According to our calculations, these contrasting effects balance each other out. While we expect around 13,000 people to enter employment through this reform, we also expect some people currently in employment to reduce their working hours. The net effect on the total volume of work is almost zero.”