Pensions versus the euro

  • 2010-03-17
  • By Mila Chastukhina

TALLINN - In 2004, analysts predicted that joining the European Union for Estonia would favorably influence the growth in pensions, and forecast that the average level in 2010 would be 4,044 kroons (259 euros) per month. If Estonia wouldn’t have joined the EU, then, as the Ministry of Finance estimated, the average pension for 2010 would be only 3,310 kroons, they said. These calculations were based on a survey of 17 analysts, conducted in the summer of 2004, by the EU’s InfoSecretariat. “The budget for the state pension insurance in Estonia from 2005-2010 will grow by 10 percent if the country joins the EU, and by 6.9 percent if it doesn’t,” reports

Today, pensions in Estonia are the highest among the Baltic countries, at approximately 4,500 kroons.
The questions now is: what awaits pensioners this year?
Working for joining the eurozone is still the prevailing ideology in Estonian politics. Estonia has to make further cuts in the state budget to keep the government deficit below three percent of GDP (one of the conditions in joining the eurozone). This is forcing the country to use all available resources. Unhappily for the pensioners, this is one area where large savings - spending cuts - may be found.

The Estonian pension system is divided into three pillars. The government sets specific rules for the three-pillar system, administering the first pillar, guaranteeing the second pillar and providing an effective supervision and regulation system for both the second and third pillars. Employers make contributions (through the national social tax) to the first pillar. Employees make mandatory payments into the second pillar and are free to choose whether to contribute to the third pillar.

The support from the state pension (first pillar) for future pensioners will primarily depend on the number of future taxpayers, and the level of their income, which cannot be influenced by the pensioners themselves. The state pension is based on redistribution of income – the people working today pay social tax to cover the pensions of today’s pensioners.
As of now, the situation in Estonia is in decline: the number of workers is decreasing, while the number of pensioners is still high, and the spreading salary cuts will lead to a shortfall in social taxes.

Second pillar-funded pensions are based on pre-financing. Employees build up their own pension by paying 2 percent of their gross salary into the pension fund. The state then adds 4 percent of the 33 percent social tax calculated on the worker’s salary to this amount.

From the beginning of June, 2009, until the end of this year, the State will not contribute to the second pillar. In 2009, this stage took, from the State budget, about 2.6 billion kroons, a substantial amount, reports Eesti Reformierakond.
Retirees have another chance to maintain pensions at the appropriate level - existing legislation provides for the annual indexing of pensions. The State pension is indexed annually, from April 1, 2002, and a new order for indexation, from 2008, binds the level of average pensions to wage growth, which has resulted in pensions growing faster.
In these times of economic recession, there appear suggestions for the indexing to be revised, increasing the possibility for a decrease in pensions. They cannot fall below the level at which pensions have already touched. There are, however, objective conditions for reducing the growth of pensions in 2010.

A drop in GDP of 12 percent in 2009 suggests such a possibility: pensions, according to the current index, were to rise by 14 percent, but have actually increased by only five percent. If prices and wages fall, pensions will not increase, but maintain current levels. In making a purely mathematical indexation, the retirement level for 2010 will be somewhere in the range of 0.9. However, the law has established that the pension index cannot be less than 1.0. This will be taken into account in subsequent indexing, though it is planned to leave pensions at the same level, and the government does not intend to change the pension system itself.

But the main issue worrying many is the possibility of the government slowly increasing the retirement age. The crisis exposed a problem which is common to almost all European countries: a catastrophic aging in the population, which is putting a heavy burden on the pension system. Contributions to insurance funds have declined, and payments are growing. The social security system, due to structural deficiencies, may have difficulties in coping with the pension system.

On Feb. 17, the Amendments to the State Pension Insurance Act and Other Associated Acts, which will increase the retirement age, successfully passed the first reading in Riigikogu. The bill is based on the objective, set at the EU Council’s Barcelona Summit in 2002, to achieve a progressive increase of about 5 years in the effective average age at which people stop working, that is, to 65 years instead of the 59.9 years established in 2001.
Under current law, Estonian males retire at 63, women retire earlier, at 60 and a half years. If the bill will be adopted, in 2016 the retirement threshold for men and women will be equal, at 63 years, and from 2017 the retirement age for everyone will rise by three months a year (up to 65 years in 2026 for both men and women). Everyone who is older than 56 now will retire according to the law in effect now.

According to the initiators of the bill, its purpose is to guarantee the adequacy and stability of the pension system. Raising the retirement age would, by 2026, allow retirees to receive a pension averaging 5 – 10 percent higher than they receive now, and would leave 15,000 – 20,000 more people in the workforce, which would partially reduce the shortage of manpower due to the reduction in the number of the working-age population. Up-to-date research anticipates the loss of about 300,000 working age people in the next 50 years, which means that “if today in Estonia there are 4 working age people for each person that is over 65, then by 2030, this will drop to 3 people, and in 50 years, only 1.8 working age person will be paying the pension of one person,” said Hanno Pevkur, Minister of Social Affairs. He hopes for the quick proceeding of the draft in the Riigikogu, as indecisiveness could mean a situation for current working people where, in the future, it would no longer be possible to receive a fair pension. Prime Minister Andrus Ansip supported this opinion at a press conference on March 11, 2010.

Feelings are quite the opposite with the head of the Confederation of Trade Unions, Harri Taliga, who suggests for politicians to postpone raising the retirement age during the crisis. In his comments on the bill, he states that raising the retirement age in turn will increase employment for the population. Even in times of economic boom, when there were a lot of job vacancies, the employment of retirees did not dramatically increase, said Taliga. “If in 9 years the working capacity of the Estonian population grew by 84,000 people, the proportion of working pensioners grew by 6.3 percent only,” he added.
The Estonian Center Party Faction, the Estonian People’s Union Faction and the Social Democratic Party Faction moved to reject the bill at the first reading. Their motion was not supported. The result of voting to pass the bill was: 44 for, 41 against.

Taking stock, it can be said that Estonia has not been spared either the economic crisis or the influence from Western Europe. The crisis has affected the numbers of workers, and revenue to the budget. Estonia is ready to follow the general European trends in increasing the retirement age.

Nevertheless, due to accession to the EU, pensions in 2010 have increased by 25 percent in comparison to the scenario of not joining the EU, say the analysts. Considering that the government, for the sake of joining the eurozone, is ready to reduce the budget deficit by cutting pensions, leaves many wondering what else is Riigikogu ready to do in the area of support for social programs to achieve its euro objective.