Pensions and public finances in Finland – A generational accounting perspective

onsdag, 14 mai 2014

A distinguishing feature of Finnish society is that the baby-boom generations are exceptionally large. Finland has already entered the stage of demographic transition where the share of the working-age population is declining because of the population ageing. This is expected to continue at an accelerating rate during the next two decades.

In this paper, we evaluate generational incidence and sustainability of fiscal policy using the method of generational accounting (GA). Our attention is in the relative importance of earnings related pension on sustainability of public finances. We perform two sustainability calculations. Assuming the current structure of public income and expenditure, the sustainability gap in public finances, measured as a need to increase the overall tax rate, is estimated to be 7.2 per cent of GDP, when future taxes and benefits are discounted by a 3.5 per cent interest rate. Due to the 2005 pension reform and recent labor market agreements, both contribution and benefit structures are changing. Using actuarial estimates of the impacts of the pension reform, the sustainability gap diminishes to 5.8 per cent of GDP. Using an alternative discount rate of 5 per cent, the respective figures would be 4.6 and 3.6 per cent.

The contribution of earnings-related pensions to the sustainability of public finances, assuming the current structure of benefits, is 1.1 per cent relative to GDP. Using actuarial estimates of pension expenditures, we find out that the pension system as a whole has a positive contribution to the sustainability of public finances, which is 0.3 per cent relative to GDP. A significant proportion of the difference compared to a status quo calculation is due to the automatic adjustment as a result of the life expectancy coefficient that is reflected only in actuarial calculations. The diminishing size of public sector pensions liabilities is another major reason.