Why does the Corona crisis financially hit contributors more than pensioners? | Max-Planck-Institut für Sozialrecht und Sozialpolitik - MPISOC
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06.05.2020 / Sozialpolitik (MEA) EN

Why does the Corona crisis financially hit contributors more than pensioners?

Why does the Corona crisis financially hit contributors more than pensioners - and could pensioners even financially benefit from the crisis?

Due to a variety of factors, pensioners are financially less affected by the Corona crisis than the working population. Paradoxically, pensioners will even be better off in the long term caused by the effects of the crisis. There are several reasons for this effects, which are explained in the following:

Pension adjustments in Germany always occur with a delay of one or two years. Due to the positive economic development in recent years pensioners will receive a pension increase in the Corona year 2020. Specifically, pensions will increase by 3.45% (West Germany) and 4.2% (East Germany) (1) as of July 01, 2020. Moreover, crisis-related income losses for contributors affect them immediate: the number of unemployed and short-time workers increased in March/April 2020. According to the Federal Employment Agency (Bundesagentur für Arbeit), 10.1 million people in Germany announced short-time work during these months – a new record. The number of the unemployed increased by 308,000 in April 2020 compared to the previous month; which is 415,000 more than in April 2019 (2). The Federal Employment Agency estimates that "(...) the Corona pandemic is likely to cause the worst recession in German post-war history." (3)

As a result of the drop in wage income due to the direct impacts of the crisis on the labour market, the pension security level will rise significantly the greater the recession. This means that the percentage ratio of wage (average pay) to (standard) pension will move towards 50 percent or even above (cf.: MEA Discussion Paper 11-2020, Fig. 6, p.12). Overall, this effect is well-known in the German pension insurance system and is only problematic insofar as rising pensions can be accompanied by a lack of understanding in society when wages and salaries stagnate or even fall. Nevertheless, these pension increases are fair in the sense that pensioners are entitled to participate in the positive development of previous years, even though belatedly and at an unfortunate moment.

In addition, the pension security level would normally be adjusted again to wage levels in the years following the crisis. Future adjustments of pensions to the now crisis-related stagnating or even negative wage developments would normally cause pensions to stagnate or even decrease with the same delay. However, 2005 an amendment was introduced into the German pension law that prevents the value of pensions from falling: the pension guarantee. It says that while pensions can stagnate and no longer rise, pensioners do not have to suffer losses, such as those incurred by contributors as a result of lower wage income in previous years. Thus, pensions cannot fall, yet one or two years without a pension raise are quite conceivable.

This pension guarantee already came into effect after the 2008 financial crisis and protected pensioners at that time. However, in order to ensure that all generations make the same contribution to mitigating the crisis, this protection for pensioners was offset by the so-called "catch-up" factor in subsequent years. In other words, the catch-up factor meant that pension increases, linked to wage trends, were lower in order to restore the balance between the old and the young. Pensioners thus made a contribution to overcoming the crisis over a course of several years and the initially positive effect on the level of pension security caused by the crisis was eventually reduced in the long run.

Interim conclusion: Pensioners will receive a pension increase in the Corona year and will not have to fear any cuts in subsequent years due to the crisis. However, high pension increases are unlikely in the foreseeable future.

This leads to the question of whether pensioners could benefit financially from the crisis:

After the crisis, wages are expected to rise again. Pensioners will benefit from this – again, with a time lag of one to two years. What is different now is that the federal government has suspended the catch-up factor until 2025 with the 2018 Pension Pact and the introduction of the "double stop line." This means that pensioners will profit from the "recovery", although they did not suffer any negative losses in the "recession". The catch-up factor will be reintroduced after 2025 according to current legislation. Yet, this is too late for taking into account the mitigation of pension increases before 2025. In this sense, the "too high" security level will thus remain permanently in place once the crisis is overcome.

It is therefore expected that pensioners will lose less purchasing power than contributors. Although pensioners will not benefit from the crisis in absolute numbers, relative to employees they will.

The double stop line is valid until 2025 and will also cap the contribution rate increase (currently 18.6%) at 20%. As a result, increased federal funding for the statutory German pension scheme can be expected from 2021 onwards. Except in the event of a relatively mild or short recession, the 20% stop line will be reached as early as 2021 – an event that would not have occurred until 2025 without the Corona crisis. Consequentially, federal subsidies will have to increase up to 5 billion Euro as early as next year (2021) and up to 19 billion Euro by 2025.

This tax money will have to be contributed by all taxpayers, that is, both pensioners and the younger generation. How the burden will be prorated exactly depends on the funding of the federal budget. The increased financial demand could be covered by rising the income tax, excise taxes or a mixture of different types of taxes. Caused by the introduction of downstream taxation of pensions, the income tax will cover both pensioners and the working population; however, pensioners will contribute to a much lesser extent in the long term. The second major revenue share of the federal budget is the value-added tax, which is also likely to burden the older generation less than the younger generation, as the younger generation generally has higher consumption spending. All in all, an asymmetrical effect of the crisis becomes also evident in this dimension, specifically a tendency to favouring pensioners and burdening the younger generation.

Details on the calculations and the different scenarios can be found in the MEA Discussion Paper 11-2020, available >> here (German only).

 

(1) Information from the German Pension Insurance as of 20.03.2020

(2) Effects of the Corona crisis on the Labour Market, Arbeitsmarkt kompakt, Federal Employment Agency, April 2020, p. 6ff.

(3) Monthly Report on the Labour Market, Labour Market Focus, Federal Employment Agency, April 2020.